2006
Annual Report and Accounts
HSBC Holdings plc
H S B C H O L D I N G S P L C
Annual Report and Accounts 2006
Headquartered in London, HSBC is one of the largest banking and financial
services organisations in the world. Its international network comprises over
10,000 properties in 82 countries and territories in Europe; Hong Kong; Rest of
Asia-Pacific, including the Middle East and Africa; North America and Latin
America.
With listings on the London, Hong Kong, New York, Paris and Bermuda stock
exchanges, shares in HSBC Holdings plc are held by about 200,000 shareholders
in over 100 countries and territories. The shares are traded on the New York Stock
Exchange in the form of American Depositary Shares.
HSBC provides a comprehensive range of financial services to more than
125 million customers through four customer groups and global businesses:
Personal Financial Services (including consumer finance); Commercial Banking;
Corporate, Investment Banking and Markets; and Private Banking.
Contents
Page
Page
Financial Highlights ........................................... 1
Statement of Directors’ Responsibilities
in Relation to Financial Statements ............. 290
Cautionary Statement Regarding
Forward-Looking Statements ....................... 4
Report of the Directors ..................................... 6
Business Review ............................................... 6
Financial Review ............................................. 110
The Management of Risk ................................. 165
Governance ...................................................... 248
Independent Auditor’s Report ......................... 291
Financial Statements ......................................... 293
Notes on the Financial Statements ................... 301
Shareholder Information .................................. 435
Directors’ Remuneration Report ..................... 280
Glossary and Index ........................................... 446
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 subsidiaries. Within this document the Hong Kong Special Administrative
Region of the People’s Republic of China is referred to as ‘Hong Kong’. When used in the terms ‘shareholders’
equity’ and ‘total shareholders’ equity’, ‘shareholders’ means holders of HSBC Holdings ordinary and preference
shares classified as equity.
This document comprises the Annual Report and Accounts 2006 for HSBC Holdings plc and its subsidiaries. It contains the Report of the
Directors and Financial Statements, together with the Independent Auditor’s Report thereon, as required by the UK Companies Act 1985.
The Annual Review 2006 of HSBC Holdings plc is published as a separate document. The Report of the Directors on pages 6 to 279 and
the Directors’ Remuneration Report on pages 280 to 289 have each been drawn up in accordance with the requirements of English law,
and liability in respect thereof is also governed by English law. In particular, the liability of the Directors for these reports is solely to
HSBC Holdings.
H S B C H O L D I N G S P L C
Financial Highlights
For the year
•
•
•
•
•
•
Total operating income up 13.6 per cent to US$70,070 million (2005: US$61,704 million).
Net operating income up 9.9 per cent to US$54,793 million (2005: US$49,836 million).
Group pre-tax profit up 5.3 per cent to US$22,086 million (2005: US$20,966 million).
Profit attributable to shareholders of the parent company up 4.7 per cent to US$15,789 million
(2005: US$15,081 million).
Return on average invested capital of 14.9 per cent (2005: 15.9 per cent).
Earnings per share up 2.9 per cent to US$1.40 (2005: US$1.36).
At the year-end
• Total equity up 17.0 per cent to US$114,928 million (2005: US$98,226 million).
• Customer accounts and deposits by banks up 23.2 per cent to US$996,528 million (2005:
US$809,146 million).
• Risk-weighted assets up 13.5 per cent to US$938,678 million (2005: US$827,164 million).
Dividends and capital position
•
•
2006
2005
2004
2003
2002
2006
2005
2004
2003
2002
Tier 1 capital ratio of 9.4 per cent and total capital ratio of 13.5 per cent.
Fourth interim dividend for 2006 of US$0.36 per share, an increase of 16.1 per cent; total
dividends declared in 2006 of US$0.76 per share, an increase of 10.1 per cent over 2005.
Dividends per share
(US dollars)
Return on average invested capital
(per cent)
0.76
0.69
0.63
0.60
0.53
Earnings per share
(US dollars)
0.84
0.67
1.40
1.36
1.18
2006
2005
2004
2003
2002
2006
2005
2004
Cost efficiency ratio
(per cent)
14.9
15.9
15.0
51.6
13.7
12.9
5 1.3
51.2
Data for 2004 to 2006 are presented based on financial statements prepared in accordance with IFRSs; data for 2002 and 2003 in
accordance with UK GAAP. Further information about the results is given in the consolidated income statement on page 294.
1
H S B C H O L D I N G S P L C
Financial Highlights (continued)
Ratios / 5-year comparison
Capital and performance ratios
Capital ratios
Tier 1 capital ......................................................................................................................................
Total capital .......................................................................................................................................
Performance ratios
Return on average invested capital1 ...................................................................................................
Return on average total shareholders’ equity2 ...................................................................................
Post-tax return on average total assets ..............................................................................................
Post-tax return on average risk-weighted assets ...............................................................................
Credit coverage ratios
Loan impairment charges as a percentage of total operating income ...............................................
Loan impairment charges as a percentage of average gross customer advances ..............................
Total impairment allowances outstanding as a percentage of impaired loans at the year-end .........
Efficiency and revenue mix ratios
Cost efficiency ratio3 .........................................................................................................................
– constant currency basis ..............................................................................................................
As a percentage of total operating income:
– net interest income .....................................................................................................................
– net fee income ............................................................................................................................
– trading income ............................................................................................................................
2006
%
9.4
13.5
14.9
15.7
1.00
1.93
15.05
1.39
98.5
51.3
51.3
49.2
24.5
11.7
Financial ratio
Average total shareholders’ equity to average total assets ...........................................................
5.97
2005
%
9.0
12.8
15.9
16.8
1.06
2.01
12.74
1.16
99.1
51.2
51.3
50.8
23.4
9.5
5.96
Share information at the year-end
US$0.50 ordinary shares in issue (million) .......................................................................................
Market capitalisation (billion) ...........................................................................................................
Closing market price per ordinary share:
2006
11,572
US$212
2005
11,334
US$182
– London ........................................................................................................................................
– Hong Kong .................................................................................................................................
Closing market price per American Depositary Share4 .....................................................................
£9.31
HK$142.40
US$91.65
£9.33
HK$124.50
US$80.47
HSBC total shareholder return to 31 December 20065 ...................................
Benchmarks:
– FTSE 1006 ................................................................................................
– MSCI World7 ............................................................................................
104.6
114.4
105.8
122.0
153.8
139.9
148.4
141.1
122.4
Over 1 year
Over 3 years
Over 5 years
For footnotes, see page 4.
The consolidated financial statements of HSBC and the separate financial statements of HSBC Holdings have been
prepared in accordance with International Financial Reporting Standards (‘IFRSs’) as endorsed by the EU.
EU-endorsed IFRSs may differ from IFRSs as published by the International Accounting Standards Board (‘IASB’)
if, at any point in time, new or amended IFRSs have not been endorsed by the EU. At 31 December 2006, there were
no unendorsed standards effective for the year ended 31 December 2006 affecting these consolidated and separate
financial statements, and there was no difference in application to HSBC between IFRSs endorsed by the EU and
IFRSs issued by the IASB.
Information for the years prior to 2004 has been prepared under previous HSBC policies in accordance with UK
Generally Accepted Accounting Principles (‘UK GAAP’), which are not comparable with IFRSs.
HSBC uses the US dollar as its presentation currency because the US dollar and currencies linked to it form the
major currency bloc in which HSBC transacts its business. Unless otherwise stated, the information presented in this
document has been prepared in accordance with IFRSs.
When reference to ‘underlying basis’ is made in commentaries, comparative information has been expressed at
constant currency (see page 110) and adjusted for the effects of acquisitions, disposals and the change in presentation
of non-equity minority interests.
2
Five-year comparison
Amounts in accordance with
IFRSs8
For the year
Net interest income ...................................
Other operating income ............................
Loan impairment charges and other
credit risk provisions ............................
Provisions for bad and doubtful debts ......
Total operating expenses ..........................
Profit before tax ........................................
Profit attributable to shareholders of the
parent company ....................................
Dividends ..................................................
At the year-end
Called up share capital ..............................
Total shareholders’ equity ........................
Shareholders’ funds ..................................
Capital resources10 ....................................
Customer accounts ....................................
Undated subordinated loan capital ...........
Preferred securities and dated
subordinated loan capital11 ...................
Loans and advances to customers12,13 .......
Total assets ................................................
Per ordinary share
Basic earnings ...........................................
Diluted earnings ........................................
Dividends14 ...............................................
Net asset value at year-end .......................
Share information
US$0.50 ordinary shares in
2006
US$m
34,486
35,584
(10,573)
–
(33,553)
22,086
15,789
8,769
5,786
108,352
–
127,074
896,834
3,219
42,642
868,133
1,860,758
US$
1.40
1.39
0.76
9.24
Amounts in accordance with
UK GAAP9
2003
US$m
2002
US$m
2005
US$m
2004
US$m
31,334
30,370
(7,801)
–
(29,514)
20,966
15,081
7,750
5,667
92,432
–
105,449
739,419
3,474
35,856
740,002
1,501,970
31,099
24,889
(6,191)
–
(26,487)
18,943
12,918
6,932
5,587
85,522
–
90,780
693,072
3,686
32,914
672,891
1,279,974
25,598
15,474
–
(6,093)
(22,532)
12,816
8,774
6,532
5,481
–
74,473
74,042
573,130
3,617
17,580
528,977
1,034,216
US$
US$
US$
1.36
1.35
0.69
8.03
1.18
1.17
0.63
7.66
0.84
0.83
0.60
6.79
15,460
11,135
–
(1,321)
(15,808)
9,650
6,239
5,001
4,741
–
51,765
57,430
495,438
3,540
14,831
352,344
758,605
US$
0.67
0.66
0.53
5.46
issue (millions) ......................................
11,572
11,334
11,172
10,960
9,481
Financial ratios
Dividend payout ratio15 ............................
Post-tax return on average total assets .....
Return on average total shareholders’
equity ....................................................
Return on average shareholders’ funds ....
Average total shareholders’ equity to
average total assets ...............................
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$1 .....................................
For footnotes, see page 4.
%
54.3
1.00
15.7
–
5.97
–
9.4
13.5
0.509
0.759
0.543
0.797
%
%
%
50.7
1.06
16.8
–
5.96
53.4
1.14
16.3
–
6.35
60.6
1.01
–
13.0
–
–
–
7.06
9.0
12.8
8.9
12.0
8.9
12.0
%
69.7
0.97
–
12.4
–
6.91
9.0
13.3
0.581
0.847
0.550
0.805
0.517
0.733
0.546
0.805
0.560
0.793
0.612
0.885
0.620
0.953
0.666
1.061
3
H S B C H O L D I N G S P L C
Financial Highlights (continued)
5-year comparison / Cautionary statement
Amounts in accordance with US GAAP
Income statement for the year
Net income available for ordinary
shareholders ..........................................
Other comprehensive income ...................
Dividends ..................................................
Balance sheet at 31 December
Total assets ................................................
Total shareholders’ equity ........................
Per ordinary share
Basic earnings ...........................................
Diluted earnings ........................................
Dividends ..................................................
Net asset value at year end .......................
Footnotes to ‘Financial Highlights’
2006
US$m
2005
US$m
2004
US$m
2003
US$m
2002
US$m
16,358
3,133
8,769
14,703
(7,271)
7,750
12,506
983
6,932
7,231
7,401
6,974
4,900
5,502
4,632
1,712,627
108,540
1,406,944
93,524
1,266,365
90,082
1,012,023
80,251
763,565
55,831
US$
US$
US$
US$
1.45
1.44
0.76
9.38
1.33
1.32
0.69
8.25
1.15
1.13
0.63
8.06
0.69
0.69
0.685
7.32
US$
0.52
0.52
0.495
5.89
1 The definition of return on average invested capital and a reconciliation to the equivalent GAAP measures are set out on page 146.
2 The return on average total shareholders’ equity is defined as profit attributable to shareholders of the parent company divided by
average total shareholders’ equity.
3 The cost efficiency ratio is defined as total operating expenses divided by net operating income before loan impairment charges and
other credit risk provisions.
4 Each American Depositary Share (‘ADS’) represents five ordinary shares.
5 Total shareholder return (‘TSR’) is defined on page 281.
6 The Financial Times-Stock Exchange 100 Index.
7 The Morgan Stanley Capital International World Index.
8 Comparative data for 2004 excludes the provisions of IAS 32, IAS 39 and IFRS 4, which were adopted for the first time with effect from
1 January 2005.
9 The periods 2002 and 2003 were prepared in accordance with previous HSBC accounting policies under UK GAAP. HSBC’s
accounting policies under UK GAAP are stated in Note 2 on the Financial Statements in the Annual Report and Accounts 2004.
10 Capital resources are total regulatory capital, the calculation of which is set out on page 243.
11 Includes perpetual preferred securities, details of which can found in Note 32 on the Financial Statements.
12 Net of suspended interest and provisions for bad and doubtful debts (UK GAAP).
13 Net of impairment allowances (IFRSs).
14 First, second and third interim dividends for 2006, each of US$0.15 per ordinary share, were paid on 6 July 2006, 4 October 2006 and
18 January 2007 respectively. Note 11 on the Financial Statements on page 339 gives more information on the dividends declared in
2006. On 5 March 2007, the Directors declared a fourth interim dividend for 2006 of US$0.36 per ordinary share in lieu of a final
dividend, which will be payable to ordinary shareholders on 10 May 2007 in cash in US dollars, or in sterling or Hong Kong dollars at
exchange rates to be determined on 30 April 2007, with a scrip dividend alternative. The reserves available for distribution at
31 December 2006 were US$12,045 million.
Quarterly dividends of US$15.50 per 6.20 per cent non-cumulative US dollar preference share, Series A (‘Series A dollar preference
share’), equivalent to a dividend of US$0.3875 per Series A American Depositary Shares, each of which represents one-fortieth of a
Series A dollar preference share, were paid on 15 March 2006, 15 June 2006, 15 September 2006 and 15 December 2006.
15 Dividends per share expressed as a percentage of earnings per share (2002 and 2003: excluding goodwill amortisation).
Cautionary Statement Regarding Forward-Looking Statements
The Annual Report and Accounts 2006 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’ and ‘reasonably
possible’, 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
4
Authority, the US Federal Reserve, the US
Securities and Exchange Commission, the
US Office of the Comptroller of the
Currency, 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; and
the effects of competition in the markets
where HSBC operates including increased
competition from non-bank financial
services companies, including securities
firms.
–
–
–
–
–
–
–
•
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.
United States 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 pound sterling)
and government-established exchange rates
(for example, between the Hong Kong
dollar and 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 funding of 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 other
regulatory authorities, including the UK
Financial Services Authority, the Bank of
England, the Hong Kong Monetary
5
H S B C H O L D I N G S P L C
Report of the Directors: Business Review
Group Chairman’s statement
Group Chairman’s statement
It is a testament to HSBC’s strength and
diversity that we grew pre-tax profits in 2006 to
US$22 billion, despite a major setback in part
of our mortgage business in the United States.
For the third year running, return on average
shareholders equity exceeded 15 per cent, revenue
growth was in double digits and we maintained an
essentially flat cost-efficiency ratio. In 2006, pre-tax
profits from Asia, the Middle East, Latin America
and other emerging markets approached 50 per cent
of the Group’s total.
There were a number of outstanding
achievements, for example, exceeding US$1 billion
pre-tax profits for the first time in both Mexico and
the Middle East, and in each of our Private Banking
and Commercial Banking businesses in Asia outside
Hong Kong. We added around an extra US$1 billion
of pre-tax profits in Asia outside Hong Kong and
another US$1 billion in our Commercial Banking
businesses worldwide. In Hong Kong, net fee
income from personal customers grew over 30 per
cent to approach US$1 billion for the first time.
However, our pre-tax profits fell by
US$725 million in our personal businesses in the
United States. This was caused by one portfolio of
purchased sub-prime mortgages in our US Consumer
Finance subsidiary, Mortgage Services, which
evidenced much higher delinquency than had
been built into the pricing of these products. We are
restructuring this business to avoid any repetition of
the risk concentration that built up over the past two
years. As part of this exercise we have effected broad
changes in management and strengthened risk
controls and processes.
Despite the issues in our US mortgage business,
Group profit attributable to shareholders grew by
5 per cent to US$15,789 million. We met our
6
objective of funding organic expansion through
productivity improvements. To achieve this in a year
of continuing investment in developing our
distribution platforms and product capabilities is a
tribute to the focus which HSBC’s 312,000 staff
around the world have placed on serving our
customers.
Earnings continued to be well diversified both
geographically and by customer group. Regionally,
Asia, including Hong Kong, had record results as did
our newly designated Latin American Region, which
combines Mexico and Central America with our
South American businesses. Within our customer
groups, Commercial Banking again delivered a
record performance, as did Private Banking and
Corporate, Investment Banking and Markets, which
made strong progress in the areas in which we have
been investing in recent years. Personal Financial
Services profits declined as growth in Asia and Latin
America was masked by the problems in the US
Mortgage Services business.
The Board has declared a fourth interim
dividend of US$0.36 per share, taking the total
dividend in respect of 2006 to US$0.81 per share, an
increase of 11 per cent over the comparable payout
last year. In sterling terms, dividend growth is 5 per
cent. The fourth interim dividend is payable on
10 May 2007 to shareholders on the register on
23 March 2007 with a scrip dividend alternative
available for shareholders who prefer this option.
Global economic trends and their impact
on HSBC
Globalisation is determining how we think about
positioning HSBC to take advantage of the changing
pattern of economic flows. Historical patterns based
on national boundaries are becoming less relevant.
In aggregate, our operations within countries
designated as emerging markets grew by 19 per cent
in 2006, the third year running of high double-digit
growth. However, this understates the importance of
emerging markets to HSBC, as their influence is also
significant to the results of our operations in
developed economies. This reflects the growth in
export flows to meet the infrastructure development
needs of emerging markets and the reorganisation of
global supply chains to optimise international
resourcing. HSBC is strongly positioned to benefit
from these trends. HSBC seeks to differentiate itself
by taking developed market opportunities to
emerging market customers and bringing emerging
market products to developed investment markets.
For example:
•
In Commercial Banking, we launched a new
customer referral system, which led to
international referrals with an aggregate facility
value of US$3 billion, involving over 50 sites
and 4,000 relationship managers.
• Within Group Investment Businesses, the
Group’s India, China and BRIC (Brazil, Russia,
India, China) funds were major contributors to a
record performance in the year as we leveraged
our reputation for emerging market expertise to
become a major distributor as well as manager
of such funds. Performance fees reached record
levels.
•
In the UK, the Passport bank account provides
individuals newly arrived in the UK with
discounted remittance services back home
together with guidance on establishing
themselves in the UK.
• Corporate, Investment Banking and Markets’
strategy to be a leading wholesale bank by
focusing on financing and emerging markets
was recognised by industry awards including
European Loan House of the Year, China Loan
House of the Year and Asian Domestic Currency
Bond House of the Year by International
Financing Review. Our Global Markets business
was named Best at Treasury and Risk
Management in Asia by Euromoney for the
ninth consecutive year.
Leveraging our global services
HSBC continued to deepen its relevance to its
customer base by offering coordinated services on a
worldwide scale. As the globalisation of business
increasingly becomes the norm, international
capabilities become more and more critical to an
ever wider range of customers. We responded to this
trend by developing our business in a number of
ways.
Benefiting from growing international trade, the
Group’s payments and cash management business
had a record year, particularly in Asia, as increasing
numbers of commercial customers expanded
internationally.
As emerging market stock exchanges
outperformed, the Group’s custody businesses
benefited from the higher volumes and value flowing
into emerging market equities. HSBC retained its
position as the leading sub-custodian in Asia and the
Middle East, being ranked first in 19 of the
28 markets it serves. Growth in both assets under
custody and assets under administration exceeded
25 per cent, as interest in emerging market equities
7
increased and the alternative fund management
sector expanded.
The customer base of International Premier, the
Group’s personal banking service targeted at affluent
customers with financial needs in more than one
country, grew by 35 per cent to reach 1.8 million. We
see great opportunities to develop this service
further.
Cross-border distribution was a noteworthy
feature of many HSBC-led debt capital market and
equity capital market transactions. Highlights
included: America Movil’s 8 billion Mexican peso
bond, Khazanah Nasional of Malaysia’s
US$750 million Islamic exchangeable ‘Sukuk’;
Emaar Economic City’s US$680 million IPO in
Saudi Arabia; and Shui On Land’s US$876 million
IPO in Hong Kong.
Transferring best practice
HSBC seeks to transfer best practice and product
innovation internationally. Through such linkages,
HSBC is able to achieve both cost efficiency and
speed to market, giving us competitive advantages
over purely domestic or regional peers. In 2006, we
launched a number of successful initiatives.
Using Group technology and marketing
expertise, we expanded the Group’s card base in
Asia by some 1.9 million to 11.9 million. In addition,
Bank of Communications’ cards business in
mainland China, with which we cooperate, reached
over 2 million cards in issue at the end of the year
from its launch in May 2005.
Also in mainland China, we cooperated with
Bank of Communications in launching point of sale
finance in partnership with Wal-Mart and SuNing,
one of China’s largest consumer electronics chain. In
Argentina, our relationship with C&A added
100,000 cards, while in Australia we entered the
retail storecard market and now offer point of sale
finance in over 1,000 locations through over
100 merchants.
We took the successful direct retail deposit
service introduced in the US at the end of 2005 and
used the experience to launch in Taiwan in
September 2006. In the first 15 weeks, over
24,000 customers had signed up for the service and
US$182 million had been raised in deposits. In the
US, by the end of 2006, the direct deposit product
had raised some US$7 billion of funding for our
businesses there.
Building on our experience of Takaful (Islamic
insurance) in Singapore and United Arab Emirates,
we were among the first to be awarded licences to
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Group Chairman’s statement
conduct Takaful business in both Malaysia and Saudi
Arabia during 2006.
Creating advantage from scale, technology
and process engineering
We continue to make progress in streamlining our
operations by focusing on straight through
processing and simplifying our products.
During 2006, among other things, we introduced
2,300 advanced self-service terminals, added
13 countries to HSBCnet, which is our strategic
internet platform for corporate and institutional
clients and made over 900,000 online insurance
sales.
HSBC in Mexico was the first bank to offer pre-
approved online mortgages in 2006, allowing
customers to apply and obtain details about amounts,
duration and monthly payments within minutes.
In Hong Kong in the past four years, processing
has been moved from the branches in favour of
sales-related activities, with the result that less than
5 per cent of transactions are now being handled
physically in the branches.
In the UK retail network, product simplification
has reduced the range of products by two-thirds over
the last two years which, together with branch
relocation and refurbishment and adopting retail
store hours, is having a positive impact on sales
volumes.
Credit environment
The global credit environment, particularly in the
corporate and commercial segments, remained
generally favourable throughout 2006. In part, this
continued to reflect a general abundance of liquidity
and the prevalence of historically low nominal
interest rates. A significant proportion of the trade
surpluses of the major Asian exporting countries and
the oil producers continued to be recycled into
government debt in developed markets.
Consequently, risk premia remained at record
low levels. This encouraged increasing interest in
structured products and the acceptance of greater
leverage as fixed income investors sought higher
yielding assets. The risks arising from this activity
were widely distributed using a range of market
techniques.
The major credit issue affecting the Group in
2006 arose in the US in the sub-prime mortgage
market. A slowdown in the rate of growth in US
house prices accelerated delinquency trends in the
US sub-prime mortgage market. Deterioration was
8
marked in the more recent loans, as the absence of
equity appreciation reduced customers’ options for
refinancing. Reduced refinancing options also
highlighted the fact that, as adjustable rate mortgages
reset over the next few years at higher interest rates
than their original rates, the effect of the greater
contractual payment obligations will lead to further
delinquency.
We took these factors into account in
determining the appropriate level of impairment
allowances at 31 December 2006 against the
Mortgage Services loan book. We factored into our
allowances the most recent trends in delinquency
and loss severity and estimated the effect of the
higher payments due on adjustable rate mortgages as
they reset, in particular where we hold a second lien
mortgage behind an adjusting first mortgage. Going
forward, the level of future impairment allowances
will be sensitive to economic conditions and, in
particular, to the state of the housing market, the
level of interest rates and the availability of
financing options for sub-prime borrowers.
Elsewhere in consumer finance in the US, the
delinquency rate rose during the year, in large part
due to the unusually low levels of delinquency at the
end of 2005. This resulted from the effect of changes
in bankruptcy law in the fourth quarter of 2005,
portfolio ageing and the mix of the Metris portfolio
acquired at the end of that year.
In UK Personal Financial Services, loan
impairment charges as a percentage of lending
remained broadly in line with last year, as actions
taken on underwriting and collections mitigated the
increasing trend of indebted customers to seek
recourse in debt management services. Similarly, in
Taiwan, measures taken to deal with the effect of
mandatory regulatory relief from credit card debt,
which increased impairment charges in the first half
of 2006, reduced the charge in the second half of the
year.
In the context of HSBC’s financial strength and
operating profitability, the areas of current weakness
are well covered and they will not restrict our ability
to develop our business opportunities as planned, or
maintain our progressive dividend policy. They have,
however, brought additional focus on the uncertain
longevity of today’s generally benign conditions and
on the credit risks inherent in economies where asset
prices are accelerating ahead of real wage rises and
cash flows are being leveraged using financial
products designed to support higher levels of debt.
We will ensure that our credit appetite reflects these
risks.
Group Strategy
As noted above, in 2006, pre-tax profits from Asia,
the Middle East, Latin America and other emerging
markets approached 50 per cent of the Group’s total.
We intend the contribution from these markets to
trend upwards over the next five years. These
economies are growing faster than developed
markets and, therefore, we will concentrate
investment primarily in these markets in the form of
both organic development and acquisition.
During 2006, we brought together our
businesses in Latin America into a single
management framework to provide clarity and
consistency of direction for this important region.
Hong Kong and mainland China are already
managed on a combined basis, reflecting the fact that
this is increasingly a seamless business.
In mature markets, we will focus particularly on
serving customers with international financial needs
and connectivity, including the diaspora from
emerging markets. In an increasingly competitive
world, we will enforce tight cost control and will re-
engineer or dispose of businesses that dilute our
return on capital or do not fit with our core strategy.
Insurance and retirement services will be a growing
part of our business.
To deliver our strategy, we have articulated
seven ‘global pillars’ – the actions we will take to
build a financial services company based on the
concept of recommendation, both as a place to work
and a place to do business. Michael Geoghegan,
Group CEO and the senior management team are
leading this.
We will remain a broad-based universal bank,
with four strategic businesses:
• Personal Financial Services, within which
consumer finance will remain a core
competence;
• Corporate, Investment Banking and
Markets, which will be a leading wholesale
bank by focusing on financing and emerging
markets;
• Commercial Banking, for which our
international service capabilities and
connectivity provide a unique competitive
platform; and
• Private Banking, with its broad international
network and connectivity with the rest of the
Group’s businesses.
These businesses will be increasingly
interconnected. In particular, as derivatives markets
9
expand in product breadth and liquidity and as more
risk is securitised globally, our Global Markets
business will take a central role in the efficient
management of HSBC’s capital, risk and related
profitability.
Investments in franchise development
In November 2006, we completed the acquisition of
Grupo Banistmo S.A., the leading Central American
banking group, adding operations in Panama,
Colombia, Costa Rica, El Salvador, Honduras and
Nicaragua to our existing operations in Mexico,
Brazil, Argentina, Uruguay, Chile and Paraguay.
HSBC is now one of the leading foreign banks in
Latin America. Apart from Banistmo, 2006 was a
year of only modest acquisition activity. Very few of
the opportunities we examined met our hurdle rates.
Subsequent to the end of the year, we announced
our intention to acquire, when regulations permit, a
further 10 per cent stake in Techcombank, the third
largest joint stock bank in Vietnam, taking our
ownership interest to 20 per cent as rules are relaxed
to make higher levels of foreign ownership possible.
Organic investment
In 2006 in China, where we are the largest
international bank, we opened 13 new offices, taking
the total to 45. We made significant progress in
developing our personal and commercial distribution
platforms throughout Asia, the Middle East and
Latin America. We added 25 consumer finance
offices in India and 28 in Indonesia. We established a
further 38 branches in Turkey and 3 in Malaysia. In
Mexico our continuing development of our business
added 2,000 new jobs, bringing the total of new jobs
created since we acquired Bital to 8,000. We have
also continued to invest in and improve our physical
infrastructure in Mexico, with 372 ATMs added in
2006, bringing the total number to over 5,400.
The beginning of 2007 has been marked by our
application to incorporate our operations in mainland
China after 141 years of unbroken presence in the
country. Today, HSBC offers renminbi deposit
services in nine cities: Beijing, Dalian, Guangzhou,
Qingdao, Shanghai, Shenzhen, Tianjin, Wuhan and
Xiamen. The provision of diversified and
international banking services to mainland Chinese
citizens constitutes one of the most significant
growth opportunities for HSBC in the near and long-
term and we will support this opportunity with
capital and technology resources as required.
Increasingly important to our ongoing success is
our brand. Starting in 2007 we will progressively
invest more to support and enhance the customer
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Group Chairman’s statement / Principal activities / Strategic direction
experience that drives the brand’s strength.
The Board
It is important to HSBC to continue to ensure that
the Board is representative of the Group's broad
international franchise and the diversity of our
businesses. As usual, there will be changes to the
make-up of the Board in 2007. As previously
announced, as part of planned succession, Simon
Robertson will become Senior Independent non-
executive Director, Rona Fairhead will become
Chairman of the Group Audit Committee and Sir
Brian Williamson will become Chairman of the
Nomination Committee at the conclusion of this
year's AGM. Raymond Ch’ien, Sharon Hintze and
Helmut Sohmen will all retire at the 2007 AGM after
many years distinguished service. I thank them all
for their counsel and guidance.
Outlook
Although growth expectations in the US are
moderating, the economic outlook elsewhere
remains encouraging as globalisation expands
market access and emerging markets grow stronger,
forcing competitive restructuring. The financial
markets are playing a major part in this realignment
by financing the infrastructure needed to deliver the
necessary energy and material resources from
producer to consumer nations, and by facilitating
trade flows. Additionally, financial markets are
providing more sophisticated tools to help personal
customers plan their long-term financial affairs,
corporates to hedge their business risks and investors
to manage their portfolio risks. The demand for
financial services, therefore, remains strong,
particularly for internationally linked services. This
plays to HSBC’s huge competitive strengths.
The most significant risks to continuing growth
currently relate to political and macro events which
are outside our control. Recognising that the effect
of such risks materialising could be immediate and
potentially severe, we remain strongly capitalised
and liquid.
The Board of HSBC Holdings plc will continue
to oversee the pursuit of the company’s goals by
executive management and to exercise rigorous
stewardship of your company.
Our focus as we enter 2007 is resolutely on
continuing to play to our strengths of linking
emerging and developed markets and building
comparative advantage by utilising our scale and our
local and international reach. We continue to see
opportunities to deploy capital profitably to the long-
term advantage of shareholders and are committed to
so doing.
S K Green, Group Chairman
5 March 2007
10
Principal activities .......................................
Strategic direction .......................................
Customer groups and global businesses ......
Personal Financial Services ....................
Commercial Banking ...............................
Corporate, Investment Banking and
Page
11
11
12
13
16
Markets ................................................
Private Banking .......................................
Other ........................................................
Analysis by customer group and global
18
20
22
business ................................................
Geographical regions ...................................
Summary of geographical regions ...........
Competitive environment .........................
Europe .....................................................
Hong Kong ...............................................
Rest of Asia-Pacific ..................................
North America .........................................
Latin America ..........................................
23
26
26
27
31
48
60
75
91
Other information ........................................ 106
Products and services .............................. 106
Property ................................................... 109
Legal proceedings .................................... 109
Principal activities
HSBC is one of the largest banking and financial
services organisations in the world, with a market
capitalisation of US$212 billion at 31 December
2006.
Through its subsidiaries and associates, HSBC
provides a comprehensive range of banking and
related financial services. Headquartered in London,
HSBC operates through long-established businesses
and has an international network of over 10,000
properties in 82 countries and territories in five
geographical regions: Europe; Hong Kong; Rest of
Asia-Pacific, including the Middle East and Africa;
North America and Latin America1. Within these
regions, a comprehensive range of financial services
is offered to personal, commercial, corporate,
institutional, investment and private banking clients.
Services are delivered primarily by domestic banks,
typically with large retail deposit bases, and
consumer finance operations. Taken together, the
five largest customers of HSBC do not account for
more than one per cent of HSBC’s income.
1 In 2006, the geographical segment presentation was
changed with the reclassification of Mexico and Panama
from North America to South America, and the renaming of
the latter as Latin America and the Caribbean (‘Latin
America’). Comparative data have been restated to bring
them into line with the presentation adopted in 2006.
11
The principal acquisitions made during the year
are described on page 369. There were no significant
disposals.
Strategic direction
HSBC’s strategic direction, as set out in its
‘Managing for Growth’ strategy, is to be the world’s
leading financial services company, with ‘leading’
meaning the HSBC brand is preferred to others and
HSBC’s corporate character is admired, its earnings
per share growth is dynamic and it holds leadership
positions in selected markets. Financial success is
measured by comparing the Group’s Total
Shareholder Return (‘TSR’) target against a
weighted TSR benchmark composed of a peer group
of banks.
To achieve its strategy, the Group has identified
seven priorities or ‘global pillars’ that will guide the
Group’s strategic initiatives in 2007 and 2008.
Success in achieving the priorities will be assessed
by reviewing a suite of key performance indicators,
which are discussed on page 115. The global pillars
are:
•
•
•
•
•
•
•
to exploit HSBC’s global reach by more
effectively joining up the company by country,
distribution channel, customer group and global
business;
to improve its customer experience so that
customers feel that HSBC is the best place to
bank;
to invest in developing HSBC’s brand and to
encourage all staff to live HSBC’s brand values
in their day-to-day activities;
to improve staff engagement by ensuring
employment policies are progressive,
perceptive, responsive, respectful and fair;
to grow the business by focusing on deposit-
taking and achieving the right balance between
risk and reward;
to enhance working practices and use
technology more effectively to make it easier for
customers to do business with the Group; and
to clearly allocate responsibility for delivery of
the above initiatives to country managers and
heads of customer groups and global businesses,
with Group Head Office and regional head
offices providing guidance and, where
appropriate, delegating authority.
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Customer groups > Summary / Business highlights
Customer groups and global
businesses
Summary
HSBC manages its business through two customer
groups, Personal Financial Services and Commercial
Banking, and two global businesses, Corporate,
Profit before tax
Investment Banking and Markets, and Private
Banking. Personal Financial Services incorporates
the Group’s consumer finance businesses, reflecting
their increasing integration within mainstream
financial services around the world. The largest of
these is HSBC Finance Corporation (‘HSBC
Finance’), one of the leading consumer finance
companies in the US.
2006
US$m
9,457
5,997
5,806
1,214
(388)
%
42.8
27.2
26.3
5.5
(1.8)
Year ended 31 December
2005
US$m
%
9,904
4,961
47.2
23.7
5,163
912
26
24.6
4.4
0.1
2004
US$m
8,497
4,057
5,288
697
404
%
44.9
21.4
27.9
3.7
2.1
22,086 100.0
20,966 100.0
18,943 100.0
Personal Financial Services .....................
Commercial Banking ...............................
Corporate, Investment Banking and
Markets ................................................
Private Banking .......................................
Other ........................................................
Total assets
Personal Financial Services ..........................................................................
Commercial Banking ....................................................................................
Corporate, Investment Banking and Markets ...............................................
Private Banking ............................................................................................
Other .............................................................................................................
At 31 December
2006
US$m
546,568
213,450
994,436
73,026
33,278
%
29.4
11.5
53.4
3.9
1.8
2005
US$m
484,314
175,120
755,056
59,827
27,653
%
32.2
11.7
50.3
4.0
1.8
1,860,758 100.0
1,501,970 100.0
12
Personal Financial Services
Strategic direction
Profit before tax
Year ended 31 December
2006
US$m
2005
US$m
2004
US$m
Net interest income .........
26,076
23,351
21,422
Net fee income ................
8,762
7,313
6,406
Trading income excluding
net interest income .......
Net interest income on
trading activities ...........
Net trading income1 ........
Net income from financial
instruments designated
at fair value ..................
Net investment income on
assets backing policy-
holders’ liabilities .........
Gains less losses from
financial investments ...
Dividend income .............
Net earned insurance
premiums .....................
Other operating income ..
391
220
611
360
214
574
320
–
320
739
574
–
–
78
31
–
19
16
635
79
16
5,130
782
4,864
729
3,652
360
Total operating income
42,209
37,440
32,890
Net insurance claims2 .....
(4,365)
(3,716)
(2,953)
Net operating income3 ...
37,844
33,724
29,937
Loan impairment charges
and other credit risk
provisions .....................
(9,949)
(7,537)
(6,500)
Net operating income ...
27,895
26,187
23,437
Total operating expenses
(18,818)
(16,427)
(15,009)
Operating profit ............
9,077
9,760
8,428
Share of profit in
associates and joint
ventures ........................
380
144
69
Profit before tax ............
9,457
9,904
8,497
By geographical region
Europe .............................
Hong Kong .....................
Rest of Asia-Pacific ........
North America4 ...............
Latin America4 ................
Profit before tax ..............
Share of HSBC’s profit
before tax .....................
Cost efficiency ratio ........
Selected balance sheet
data5
Loans and advances to
customers (net) .............
Total assets ......................
Customer accounts ..........
For footnotes, see page 26.
1,909
2,880
477
3,391
800
9,457
1,932
2,628
377
4,181
786
9,904
%
%
42.8
49.7
47.2
48.7
1,621
2,063
336
3,826
651
8,497
%
44.9
50.1
US$m
US$m
US$m
448,545
546,568
388,468
398,884
484,314
321,240
370,576
452,992
319,485
13
HSBC’s strategic direction in Personal Financial
Services is to be the world’s preferred provider, with
a top class ethical sales and service culture. Growth
will be driven in key markets by offering attractive
products through a range of appropriate delivery
channels. The strategy focuses on:
-
-
-
-
simplifying core products, delivered directly via
the latest web-based technology and supported
by newly designed modern customer-friendly
branches in selected markets;
facilitating direct multi-channel access to the
Group’s services, and building a high quality
system to help manage banking relationships;
enhancing HSBC Premier as a signature
product for the Group, offering a premium
banking service utilising HSBC’s international
capabilities; and
concentrating growth in the consumer finance
business in markets affording appropriate long-
term risk-adjusted returns, and in new markets
offering attractive potential for growth.
Business highlights in 2006
• Pre-tax profits from Personal Financial Services
were US$9,457 million in 2006, a decrease of
5 per cent on the previous year. This was caused
by higher impairment charges, particularly in
the US, which masked the increasing
contributions from a number of key emerging
markets, from HSBC’s strategic investments in
associates and from strong growth in Hong
Kong. On an underlying basis, profit before tax
was 8 per cent lower.
• Underlying growth in net operating income
before loan impairment charges was 9 per cent.
This was lower than cost growth, however, as
HSBC invested approximately US$400 million
to extend distribution in emerging markets, add
deposits through direct channels in the US and
Taiwan, refurbish the branch network in the UK
and generally improve direct channel
capabilities. HSBC also added collection
resources in the US in response to the rise in
loan delinquency evident towards the end of the
year.
• Loan impairment charges were 32 per cent
higher, or 27 per cent on an underlying basis.
This primarily reflected the effect of a slowing
housing market and rising interest rates on sub-
prime mortgage lending in the US, in particular
where HSBC had a second lien position. The
increase was concentrated in the correspondent
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Business highlights
channel, ‘mortgage services’, which acquires
loans from correspondent banks and mortgage
brokers. Credit quality in the majority of other
portfolios in the US was relatively stable. In
Taiwan, a short-term increase in the first half of
2006 arose from government-sponsored
measures to relieve over-indebtedness in the
consumer sector, which had the effect of
significantly increasing the number of customers
successfully obtaining some element of debt
restructuring. In Hong Kong, there was a return
to a more normal level of charges following a
net release in 2005; credit quality remained
stable. In the UK, while overall charges as a
percentage of lending were broadly stable, there
was an increase in the consumer finance lending
book, reflecting rising personal bankruptcies
and Individual Voluntary Arrangements
(‘IVA’s), and the effect of increased consumer
indebtedness on delinquency.
• Responding to a clear shift in customer
preferences, HSBC continued to emphasise the
development of direct channels within its
distribution capabilities. Websites were updated
to offer additional features, personalised content
and improved customer accessibility. The new
technology behind these developments gives
HSBC enhanced targeting and analytical
insights to better meet customer needs and drive
sales growth. Overall, online personal customer
numbers rose by nearly 40 per cent to 16 million
and online sales volumes increased by more
than 55 per cent compared with 2005.
• Following its successful launch in the US in
2005, HSBC’s direct banking and savings
proposition, HSBC Direct, was introduced in
Taiwan – a first for HSBC in Asia. In the US,
HSBC Direct customer numbers passed
343,000, with deposits exceeding
US$7.2 billion.
• To further its direct banking strategy, HSBC
introduced 2,300 advanced self-service
terminals offering a wider range of services than
traditional ATMs (automated teller machines),
including payments, enquiry and sales features.
The functionality of over 11,000 traditional
ATMs was also enhanced.
• The number of customers using HSBC Premier
grew for the seventh consecutive year, to
1.8 million, an increase of 35 per cent compared
with 2005. This service is now available in
36 countries.
branches. Investment in the retail network
continued in Europe, North America and parts
of Asia-Pacific.
•
In the latter, HSBC began to introduce its
Group-wide credit card system, expanded
consumer finance in India and Indonesia, and
agreed retail finance arrangements in mainland
China and Australia.
• The efforts described above were recognised by
Retail Banker International in naming HSBC
the ‘Best Retail Bank’ globally. HSBC was also
named the ‘Best Global Bank - Best Consumer
Bank’ by Global Finance magazine. HSBC’s
online enhancements helped earn the ‘Best
Global Consumer Internet Bank’ award in the
Global Finance Awards.
Europe
•
•
In the UK, HSBC refined its approach to
segmenting its customer base and aligned its
products and distribution capabilities to better
serve these segments. It refurbished
104 branches, increased the number of non-
branch ATMs by over 35 per cent, including
135 in Marks & Spencer stores, and rolled out
some 1,450 advanced self-service machines.
This latter initiative was recognised by The
Banker in awarding HSBC the international
‘Technology Award for New Channels’.
In France, a focus on reinforcing HSBC’s
profile following the 2005 rebranding exercise
drove a marked increase in brand awareness.
HSBC was named ‘Best in Class’ among French
retail banks in a number of categories in the
Cosmosbay Vectis Survey.
• HSBC opened new branches in the UK, Turkey,
France and Malta. In Eastern Europe, HSBC
developed its consumer finance operations with
the establishment of a regional head office and
management team.
Hong Kong
• Efforts to expand the scope of internet banking
and increase the proportion of transactions
conducted online proved successful. Fewer than
4.3 per cent of all transactions were conducted
through the branch network in 2006, while the
proportion of sales conducted online reached
nearly one quarter. HSBC was named the ‘Best
Consumer Internet Bank’ in Hong Kong in the
annual Global Finance Awards.
• An innovation was the launch of seven-day
opening in selected UK, US and Hong Kong
• Wealth management, including insurance, was a
focal point in 2006, and enhancements to
14
HSBC’s product and channel offerings delivered
a 50 per cent rise in sales of investment related
funds.
• HSBC maintained its position as the largest
credit card issuer in Hong Kong with over
4.6 million cards in force. HSBC was named
‘MasterCard Hong Kong Bank of the Year’ for a
record sixth consecutive time.
Rest of Asia-Pacific
• HSBC invested in selected markets within the
region, notably in cards, consumer finance,
insurance, direct banking and Islamic banking.
New branches were opened in India, mainland
China, Malaysia and Bangladesh.
• The Hongkong and Shanghai Banking
Corporation Limited and Hang Seng Bank had
30 and 15 service outlets in mainland China
respectively at 31 December 2006 and
continued to maintain the largest network
amongst foreign banks.
• Credit cards remained a key area of growth in
the region. The number of cards in force rose by
1.2 million to 7.3 million.
North America
• HSBC’s growth strategy is built around deposit
gathering through selective branch expansion,
competitive pricing, in part enabled by
increasing internet delivery, and improved
marketing and customer analytics. All these
strands to the strategy were developed
during 2006.
• Driven by the success of the online savings
product and branch expansion, deposit balances
in the US grew by 25 per cent in 2006.
US$9 billion of deposits have been attracted
since the launch of the deposit gathering
strategy there in 2005, of which US$718 million
have been generated from new branches since
the expansion programme began in the same
year.
• The integration of the credit card business of
Metris Companies Inc. (‘Metris’), acquired in
2005 for approximately US$1.6 billion, was
completed. The business performed above
expectations, generating US$233 million of
profit before tax.
• HSBC Finance Corporation (‘HSBC Finance’)
completed the acquisition of the Champion
Mortgage portfolio during 2006, adding
15
•
US$2.5 billion in mostly first lien sub-prime
mortgages.
In the US, HSBC entered into an agreement
which extended the brands under which it is
able to offer cards, uniquely, to American
Express, Discover Network, MasterCard and
Visa. The retail services business launched co-
branded initiatives with Saks, Neiman Marcus
and Best Buy. HSBC is now the seventh largest
card issuer in the US.
• Asset growth continued in Canada with strong
consumer spending resulting in higher personal
lending and mortgage balances. Led by the
success of new products such as the High Rate
Savings Account, deposit balances rose.
Latin America
• The Personal Financial Services business in
Mexico continued to grow strongly in credit
cards, mortgages, personal loans and the
industry-leading ‘Tu Cuenta’ packaged account,
which passed 1 million account holders in 2006.
HSBC was the first bank to offer pre-approved
online mortgages and received an award for the
‘Best Integrated Consumer Bank Site’ in Latin
America from Global Finance magazine.
• The credit card business across the region
continued to expand strongly. In Mexico, the
number of cards in circulation rose by 76 per
cent to 1.7 million, average balances more
than doubled, and market share improved by
230 basis points. In Brazil, record credit card
sales were reported and, in Argentina, the
number of cards in issue increased by 39 per
cent.
• The acquisition of Banistmo, with 1.3 million
existing customers, complements HSBC’s
existing operations in the region and establishes
a presence in five new markets; Colombia,
Costa Rica, El Salvador, Honduras and
Nicaragua, providing access to a total
population of 83 million people.
•
•
In Argentina, HSBC acquired the operations
of Banca Nazionale del Lavoro (‘Banca
Nazionale’), whose 92 branches will establish
a more substantial and geographically diverse
presence in retail banking.
In Brazil, the consumer finance division,
Losango, saw strong growth in store loans.
Vehicle finance, payroll and credit card lending
all grew strongly too, augmented by new retail
partnerships which increased market access.
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Business highlights
Commercial Banking
Profit before tax
Year ended 31 December
2006
US$m
2005
US$m
2004
US$m
Net interest income .........
7,514
Net fee income ................
3,207
6,310
2,876
4,875
2,645
Trading income excluding
net interest income .......
Net interest income/
(expense) on trading
activities .......................
Net trading income1 ........
Net expense from
financial instruments
designated at fair value
Net investment income on
assets backing policy-
holders’ liabilities .........
Gains less losses from
financial investments ...
Dividend income .............
Net earned insurance
premiums ......................
Other operating income ..
204
150
234
20
224
(3)
147
–
234
(22)
(12)
–
–
44
6
258
250
–
9
9
236
327
324
6
37
1,072
513
9,706
Total operating income
11,481
9,902
Net insurance claims2 .....
(96)
(118)
(1,264)
Net operating income3 ...
11,385
9,784
8,442
Loan impairment charges
and other credit risk
provisions .....................
(697)
(547)
Net operating income ....
10,688
9,237
(200)
8,242
Total operating expenses
(4,979)
(4,453)
(4,220)
Operating profit ............
5,709
4,784
4,022
Share of profit in
associates and joint
ventures ........................
288
177
35
Profit before tax ............
5,997
4,961
4,057
By geographical region
Europe .............................
Hong Kong ......................
Rest of Asia-Pacific ........
North America4 ...............
Latin America4 ................
Profit before tax ..............
Share of HSBC’s profit
before tax .....................
Cost efficiency ratio ........
Selected balance sheet
data5
Loans and advances to
customers (net) .............
Total assets ......................
Customer accounts ..........
For footnotes, see page 26.
2,234
1,321
1,034
957
451
5,997
1,939
955
818
892
357
4,961
%
%
27.2
43.7
23.7
45.5
1,663
904
483
691
316
4,057
%
21.4
50.0
US$m
US$m
US$m
172,976
213,450
190,853
142,041
175,120
148,106
130,160
159,251
137,801
16
Strategic direction
HSBC’s strategy is to be the leading international
business bank for Commercial Banking customers,
with a particular focus on being the best bank for
small businesses in target markets, by:
- making full use of HSBC’s extensive
geographical network to support Commercial
Banking customers in trading, investing and
commencing business across borders;
- building upon HSBC’s Global Transaction
Banking and receivables finance expertise to
facilitate domestic and international trade flows;
- deepening HSBC’s understanding of its
customers through research and segmentation
and tailoring services to meet their needs;
- developing multi-channel relationships and
further enhancing and rolling out direct
Commercial Banking services; and
-
enhancing service levels and driving efficiencies
by making full use of HSBC’s operational
processing and IT capabilities.
Business highlights in 2006
• Pre-tax profit increased by 21 per cent to
US$5,997 million, driven by strongly rising
operating income. This comfortably exceeded
the increased loan impairment charges and
higher costs associated with business expansion.
The cost efficiency ratio improved from 45.5 per
cent to 43.7 per cent. On an underlying basis,
profits increased by 19 per cent. Since 2004,
Commercial Banking’s pre-tax profits have
grown by approximately 48 per cent.
• Customer loans and accounts grew by 22 per
cent and 29 per cent respectively and customer
numbers increased by 116,000 to 2.6 million.
Global Transaction Banking revenue from
Commercial Banking customers increased by
14 per cent to US$3.9 billion.
• As part of its strategy to be recognised as the
leading international business bank, HSBC
continued to invest in initiatives designed to
facilitate customers’ cross-border activities.
International Business Centres were established
in 16 locations and a new cross-border credit
arrangement was launched, in order to recognise
HSBC’s global relationship with international
customers in making local lending decisions.
These milestones, together with the
implementation of a new referral system, led to
international referrals with an aggregate facility
value of US$3 billion, involving over 50 sites
and 4,000 relationship managers.
• HSBC achieved considerable success in pursuit
of its objective to be the best bank for small
business. Customer numbers increased in
response to the launch of specialised
Commercial Banking centres and new products
tailored to meet their needs.
• Development of HSBC’s IT platform for
business banking contributed to a 29 per cent
increase in customers registered for internet
banking. Online transaction volumes increased
by 22 per cent and web traffic grew by 41 per
cent to over 132 million user sessions.
• HSBC continued to develop its commercial
insurance and wealth management capabilities,
hiring new staff, establishing specialist teams
and offering new products.
Europe
• As part of its emerging market focus, HSBC
expanded its Eastern European operations by
adding new premises, developing Global
Transaction Banking capabilities and
strengthening local relationship management
teams.
• BusinessDirect, which provides small and micro
businesses with a no-fee internet and phone
banking service, was successfully launched in
the UK.
• HSBC opened 11 innovative Commercial
Centres in the UK, providing state-of-the-art
business facilities in more convenient locations
for business customers.
•
•
In Turkey, HSBC reinforced product launches
and other initiatives undertaken in 2005 by
establishing a small and micro business
presence in 55 Commercial Centres. This
contributed to a 40 per cent rise in active
Commercial Banking customer numbers.
In France, HSBC raised its brand profile in the
business community, which led to new customer
numbers increasing by approximately a third.
Hong Kong
• HSBC was named ‘World’s Best Trade Finance
Bank in Hong Kong’ by Global Finance
magazine, recognising the bank’s efforts
developing a centre of excellence for
international trade.
• A new micro-business lending programme was
launched, with a streamlined loan application
17
process for new and existing customers which,
in conjunction with campaigns to increase
usage, led to a doubling of lending to micro
businesses.
• Three Commercial Transaction Centres were
opened to provide tailored Commercial Banking
services in lower cost sites near to customers.
Rest of Asia-Pacific
• As Asian trade flows expanded strongly, HSBC
opened International Banking Centres in seven
sites in the Rest of Asia-Pacific during 2006.
HSBC’s strength in international trade was
recognised with a number of Trade Finance
awards including Global Finance magazine’s
‘World’s Best Trade Finance Bank in Asia’.
• Branches focused on Commercial Banking were
opened in mainland China, India and
Bangladesh. A commercial customer call centre
was opened in South Korea, while Shariah-
compliant Amanah services for commercial
customers were rolled out in the Middle East.
• Small businesses benefited from a number of
new products and services including an online
business insurance package in the Middle East
and a new receivables finance product in India.
North America
• HSBC continued to expand its operations
outside New York State. New branches were
opened in Chicago, Los Angeles, New Jersey,
Connecticut and Washington D.C., supported by
a 13 per cent increase in the number of
relationship managers.
• The launch of International Banking Centres in
the US and Canada resulted in an increased
focus on international business opportunities.
Latin America
• HSBC opened International Banking Centres in
Mexico and Brazil and commenced Commercial
Banking operations in Peru. In Argentina, HSBC
opened a dedicated trade services call centre.
• HSBC’s share of the international trade market
in Mexico grew following service enhancements
and the launch of new products, including
‘Estimulo Empresarial’, a packaged product
targeted at small businesses.
•
In Brazil, enhancements to the giro fácil
revolving loan and overdraft facility for small
businesses led to record sales.
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Business highlights
Corporate, Investment Banking and Markets
Strategic direction
Profit before tax
Year ended 31 December
2006
US$m
2005
US$m
2004
US$m
Net interest income .........
3,168
Net fee income ................
3,718
3,001
2,967
3,994
2,764
Trading income excluding
net interest income .......
Net interest income/
(expense) on trading
activities .......................
4,890
2,919
1,935
(379)
306
–
Net trading income1 ........
4,511
3,225
1,935
Net income from financial
instruments designated
at fair value ..................
Net investment income on
assets backing policy-
holders’ liabilities ........
Gains less losses from
financial investments ...
Dividend income .............
Net earned insurance
premiums ......................
Other operating income ..
20
67
–
534
235
–
475
79
73
1,378
76
1,621
–
9
197
548
86
1,029
Total operating income
13,637
11,511
10,562
Net insurance claims2 .....
(62)
(54)
(59)
Net operating income3 ...
13,575
11,457
10,503
Net recovery of loan
impairment charges
and other credit risk
provisions .....................
119
272
499
Net operating income ....
13,694
11,729
11,002
Total operating expenses
(7,991)
(6,838)
(5,809)
Operating profit ............
5,703
4,891
5,193
Share of profit in
associates and joint
ventures ........................
103
272
95
Profit before tax ............
5,806
5,163
5,288
By geographical region
Europe .............................
Hong Kong ......................
Rest of Asia-Pacific ........
North America4 ...............
Latin America4 ................
Profit before tax ..............
Share of HSBC’s profit
before tax .....................
Cost efficiency ratio ........
For footnotes, see page 26.
2,304
955
1,649
423
475
5,806
2,114
922
1,207
573
347
5,163
%
%
26.3
58.9
24.6
59.7
1,668
1,603
942
879
196
5,288
%
27.9
55.3
18
HSBC’s strategy is to be a leading wholesale bank
by focusing on financing and emerging markets, and:
–
–
–
leveraging the Group’s unique footprint and
heritage;
using HSBC’s network and client franchises as
the foundation on which Corporate, Investment
Banking and Markets develops its hub-and-
spoke business model; and
continuing to build skills and capabilities in its
major centres to support the delivery of an
advanced suite of services to corporate,
institutional and government clients across the
HSBC network.
Ensuring that this combination of product depth
and distribution strength meets the needs of existing
and new clients will allow Corporate, Investment
Banking and Markets to achieve its strategic goals.
Business highlights in 2006
• Pre-tax profit rose by 12 per cent to
US$5,806 million, driven by an 18 per cent
increase in total operating income. This was
achieved despite a declining contribution from
balance sheet management activities, which fell
by US$534 million as existing positions
unwound and opportunities for reinvestment
were limited by the flat interest rate yield curve
environment. On an underlying basis and
excluding balance sheet management activities,
total operating income improved by 24 per cent,
reflecting positive revenue trends in product
areas in which HSBC has invested. The increase
in operating expenses reflected the first full-year
effect of recruitment in 2005. Performance-
related compensation increased in line with
robust revenue growth, while higher operational
costs reflected volume increases in payments
and cash management and securities services.
The cost efficiency ratio improved moderately.
In 2006, over 1,700 people were recruited and
1,150 departed.
• Corporate, Investment Banking and Markets’
strength in emerging markets was recognised by
industry awards. HSBC was named European
Loan House of the Year, China Loan House of
the Year and Asian Domestic Currency Bond
House of the Year by International Financing
Review. Mittal Steel’s acquisition of Arcelor, in
which HSBC held senior financing and advisory
roles, was voted European mergers and
acquisitions Deal of the Year by Financial News
and Cross-Border Deal of the Year by
•
Credit and Rates revenue was boosted by an
enhanced product range, market volatility and
increased investor appetite for emerging market
bonds. A substantial rise in structured
derivatives income reflected enhanced sales
coverage. The securities services business
benefited from increased customer volumes in
higher-value products and strong income growth
in emerging markets. Assets under custody rose
by 28 per cent.
In Global Banking, total operating income rose
by 15 per cent, due to a strong performance in
payments and cash management and improved
results in investment banking. In the latter,
satisfactory progress in capital markets resulted
in HSBC being ranked fourth in the
international bond league table, according to
Bloomberg, up from fifth in 2005 and seventh in
2004, and first in the Asian local currency bond
league table for the fifth consecutive year.
Cross-border distribution was a noteworthy
feature of many HSBC-led debt capital market
and equity capital market transactions.
Highlights included America Movil’s 8 billion
Mexican peso bond; Khazanah Nasional of
Malaysia’s US$750 million exchangeable
‘Sukuk’; and Shui On Land’s US$876 million
Initial Public Offering (‘IPO’) in Hong Kong.
Income from the lending business was broadly
in line with 2005. Globally, the corporate credit
environment was stable, though corporate
spreads remained under pressure. HSBC made
significant progress in leveraged and acquisition
finance in 2006. Key transactions included debt
facilities backing Yell Group’s acquisition of
Telefonica Publicidad e Informacion and a
Macquarie Bank-led consortium’s acquisition of
Thames Water.
Payments and cash management delivered a
strong performance across all regions, driven by
growth in client deposits and improved spreads.
• Group Investment Businesses’ operating income
rose by 45 per cent partly due to higher
performance fees on emerging market funds
and strong results from quantitative and
multi-manager products. Funds under
management grew by 11 per cent, driven by
supportive market conditions and US$14 billion
of net client inflows, including significant
inflows into emerging market funds.
Management view of total operating income
Year ended 31 December
2006
US$m
2005
US$m
2004
US$m
Global Markets .............
Foreign exchange ............
Credit and Rates ..............
Structured derivatives .....
Equities ...........................
HSBC Securities
Services ........................
Global Banking .............
Investment banking ........
Lending ...........................
Payments and cash
management .................
Other transaction services
Balance sheet
5,279
1,516
1,321
725
381
1,336
4,059
1,156
1,257
1,249
397
3,767
1,200
931
387
324
925
3,530
1,022
1,260
901
347
3,171
1,125
655
386
256
749
3,065
877
1,188
694
306
management ...............
704
1,238
2,376
Group Investment
Businesses ...................
Private equity ................
Other1 ..............................
Total operating
1,104
564
1,927
762
648
1,566
732
207
1,011
income ..........................
13,637
11,511
10,562
Selected balance sheet
data5
Loans and advances to:
– customers (net) ............
– banks (net) ...................
Total assets ......................
Customer accounts ..........
Trading assets, financial
instruments designated
at fair value, and
financial investments ...
Deposits by banks ...........
210,220
156,548
994,436
235,965
169,435
106,123
755,056
202,361
145,353
128,032
584,779
177,449
487,943
92,954
373,787
65,853
252,459
80,443
1 ‘Other’ includes the Corporate, Investment Banking and
Markets business of HSBC Trinkaus & Burkhardt AG, the
effect of consolidating investments held by HSBC’s property
investment funds, and net interest earned on free capital
held in Corporate, Investment Banking and Markets not
assigned to products.
For other footnotes, see page 26.
•
Acquisitions Monthly. HSBC was named Best
Investment Bank in the Middle East and, for the
ninth consecutive year, Best at Treasury and
Risk Management in Asia by Euromoney, and
Best Foreign Bank in China, Indonesia,
Malaysia and Vietnam by FinanceAsia.
In Global Markets, operating income increased
by 40 per cent, with robust growth in foreign
exchange, Credit and Rates and structured
derivatives complemented by a significant
increase in securities services revenues. Foreign
exchange gains were driven by increased
customer activity, encouraged by US dollar
weakness and volatility in emerging markets.
19
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Business highlights
Private Banking
Profit before tax
Year ended 31 December
2006
US$m
2005
US$m
2004
US$m
Net interest income .........
1,011
848
Net fee income ................
1,323
1,080
Net trading income1 ........
364
317
Net income/(expense)
from financial
instruments designated
at fair value ..................
Gains less losses from
financial investments ...
Dividend income .............
Other operating income ..
1
166
5
61
(1)
45
9
68
718
962
257
–
39
5
24
Total operating income
2,931
2,366
2,005
Net insurance claims2 .....
–
–
–
Net operating income3 ...
2,931
2,366
2,005
Loan impairment
(charges)/recoveries
and other credit risk
provisions .....................
(33)
12
11
Strategic direction
The strategy for Private Banking is to be one of the
world’s leading international private banks, by
providing excellent client service.
HSBC’s global network and brand provides a
base from which the private bank, working in
conjunction with HSBC’s other customer groups and
global businesses, serves the complex international
needs of its clients, utilising traditional and
innovative ways of managing and preserving the
wealth of high net worth individuals while
optimising returns.
The private bank’s strategy is to reinforce its
product capabilities in areas such as credit, hedge
funds, investment advice and estate planning. This
will be achieved by attracting, retaining and
motivating talented individuals, by surveying clients
and employees on a regular basis and by increasing
expenditure targeted on marketing and brand
awareness initiatives. Private Banking’s onshore
business will also be expanded.
Net operating income ....
2,898
2,378
2,016
Business highlights in 2006
• Pre-tax profits of US$1,214 million grew by
33 per cent on both reported and underlying
bases compared with 2005, supported by strong
growth in client assets and lending. Revenue
growth comfortably exceeded cost growth
leading to an improvement in the cost efficiency
ratio of 4.5 percentage points to 57.5 per cent.
Reported pre-tax profits have increased by
74 per cent since 2004.
• A significant gain of US$117 million arose from
the partial sale of an investment in the
Hermitage fund, a public equity fund dedicated
to investment in Russia.
• HSBC continued to expand its alternative
investment platform as client preferences
favoured such investments. Total client
investment in hedge funds reached
US$39 billion. Two funds managed by HSBC
Private Bank France received first and equal
second place in the L’Agefi awards
‘International Equity Category’.
• Client assets increased by 22 per cent to
US$333 billion, with net new money inflows of
US$34 billion in 2006. On an underlying basis,
growth was 17 per cent.
Total operating expenses
(1,685)
(1,466)
(1,319)
Operating profit ............
1,213
912
697
Share of profit in
associates and joint
ventures ........................
1
Profit before tax ............
1,214
By geographical region
Europe .............................
Hong Kong ......................
Rest of Asia-Pacific ........
North America4 ...............
Latin America4 ................
805
201
80
114
14
Profit before tax ..............
1,214
Share of HSBC’s profit
before tax .....................
Cost efficiency ratio ........
Selected balance sheet
data5
Loans and advances to
customers (net) .............
Total assets ......................
Customer accounts ..........
For footnotes, see page 26.
–
912
539
190
78
104
1
912
%
4.4
62.0
–
697
438
131
60
68
–
697
%
3.7
65.8
%
5.5
57.5
US$m
US$m
US$m
34,297
73,026
80,303
27,749
59,827
67,205
24,463
56,751
57,780
20
In Europe, HSBC’s Private Banking operations
had a very strong year on the back of
recruitment of client-facing staff and marketing
in key growth regions.
• Synergies were achieved in Switzerland,
through the merger of the two existing Swiss
trust businesses and the two Lugano branches.
• Private Banking expanded its onshore business
through the launch of further regional offices in
Bristol and Manchester in the UK and in
Bordeaux, Marseille and Nice in France.
• Client assets increased by 25 per cent, or 18 per
cent on an underlying basis, with net new
money reaching US$19 billion, primarily driven
by the Swiss business.
Asia
• Front office recruitment continued in Hong
Kong and Singapore and Private Banking
capabilities were expanded through the opening
of representative offices in mainland China and
the Philippines.
•
Investment in Taiwan, Japan and the Middle
East continued and, in India, the private bank
network expanded to six offices with the
addition of Chennai and Hyderabad.
• Client assets increased by 26 per cent, or 23 per
cent on an underlying basis with net new money
reaching US$9 billion.
Americas
• HSBC expanded its presence in the US with the
opening of domestic Private Banking offices in
Chicago and Greenwich.
• Wealth and Tax Advisory Services (‘WTAS’)
generated strong growth in revenue and
expanded through the opening of offices in Palo
Alto, Seattle, Fort Washington, Greenwich and
Chicago.
• Client assets increased by 6 per cent with net
new money reaching US$6 billion.
Client assets
Europe
2006
US$bn
2005
US$bn
•
At 1 January ........................................
Net new money ...................................
Value change .......................................
Exchange and other ............................
Total ....................................................
273
34
21
5
333
239
36
13
(15)
273
Client assets by investment class
2006
US$bn
2005
US$bn
Equities ...............................................
Bonds ..................................................
Structured products .............................
Funds ...................................................
Cash, fiduciary deposits and other .....
Total ....................................................
62
55
16
83
117
333
51
53
9
67
93
273
• Strong performance of the Strategic Investment
Solutions (‘SIS’) and related Core Investment
Solutions (‘CIS’) products was reflected in
greater investment by clients in this suite of
discretionary managed products, which reached
a value of US$4.8 billion.
• Recognising the value to be derived from closer
links with other customer groups, dedicated
teams working with Commercial Banking,
Personal Financial Services and Corporate,
Investment Banking and Markets produced a
significant increase in intra-Group referrals in
2006.
• The lending book grew strongly to satisfy
demand from clients for finance to invest in
residential properties and other asset classes.
• HSBC won a number of awards in the
Euromoney annual private banking survey. In
the global private banking awards, notable wins
included ‘1st Private Bank for Services for the
Super Affluent’ and ‘1st Private Bank for
Islamic Services’. HSBC maintained its position
in the top three within the ‘Best private banking
services overall’ category.
21
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Business highlights / Profit/(loss) before tax
Notes
• For a description of the main items reported
under ‘Other’, see footnote 6 on page 26.
• HSBC sold a number of properties in Hong
Kong and the Rest of Asia-Pacific region,
realising gains of US$187 million, significantly
higher than in 2005. These sales led to a
reduction in the size of HSBC’s property
portfolio which, together with slower growth
in Hong Kong property prices, resulted in a
59 per cent decrease in property revaluation
gains to US$61 million.
• The sale of part of HSBC’s stake in UTI Bank
Limited realised a gain of US$101 million in the
first half of 2006.
• HSBC reported a US$95 million fall in the fair
value of own debt designated at fair value in
2006, compared with a gain of US$386 million
in 2005. The movement was principally in North
America and Europe.
• Higher US interest rates led to increased costs to
HSBC of servicing its floating rate subordinated
debt, partly offset by higher earnings on US
dollar-denominated centrally held funds.
• The development of HSBC’s ten Group Service
Centres, primarily in India and mainland China,
continued apace and staff numbers increased by
32 per cent to 25,000. Increased activity in the
centres resulted in a 54 per cent increase in
costs to US$343 million. The recovery of
substantially all of these costs from the relevant
customer groups is reported under ‘Other
operating income’.
•
Increased business volumes, branch expansion,
the development of new IT capabilities and the
integration of Metris led to an 8 per cent
increase in costs at the Group’s North American
technology centre to US$1,191 million, also
recharged through ‘Other operating income’.
• During 2005, HSBC in Argentina benefited
from certain gains associated with the receipt of
coverage bonds and other items related to the
2002 sovereign debt crisis. These benefits were
not repeated in 2006.
For footnotes, see page 26.
(expense)1 .....................
(146)
(103)
Other
Profit before tax
Net interest income/
(expense) ......................
Net fee income ................
Trading income/(expense)
excluding net interest
income ..........................
Net interest income/
(expense) on trading
activities .......................
Net trading income/
Net income/(expense)
from financial
instruments designated
at fair value ..................
Net investment income on
assets backing policy-
holders’ liabilities
Gains less losses from
financial investments ...
Dividend income .............
Net earned insurance
premiums ......................
Other operating income ..
Year ended 31 December
2006
US$m
2005
US$m
2004
US$m
(625)
172
(472)
220
(228)
(90)
82
(13)
(81)
406
–
–
147
63
207
3,254
–
144
42
260
2,634
3,131
90
171
40
–
40
44
219
16
558
2,050
3,188
(359)
2,829
Total operating income
2,991
Net insurance claims2 .....
(181)
(179)
Net operating income3 ...
2,810
2,952
Loan impairment charges
and other credit risk
provisions .....................
(13)
(1)
(1)
Net operating income ....
2,797
2,951
2,828
Total operating expenses
(3,259)
(2,976)
(2,493)
Operating profit/(loss) ..
(462)
(25)
335
Share of profit in joint
ventures and associates
74
Profit/(loss) before tax ..
(388)
By geographical region
Europe .............................
Hong Kong ......................
Rest of Asia-Pacific ........
North America4 ...............
Latin America4 ................
Profit/(loss) before tax ....
(278)
(175)
287
(217)
(5)
(388)
%
51
26
(168)
(178)
94
165
113
26
%
Share of HSBC’s profit
before tax .....................
Cost efficiency ratio ........
(1.8)
116.0
0.1
100.8
69
404
366
129
26
(196)
79
404
%
2.1
88.1
Selected balance sheet
data5
Loans and advances to
customers (net) .............
Total assets ......................
Customer accounts ..........
US$m
US$m
US$m
2,095
33,278
1,245
1,893
27,653
507
2,339
26,201
557
22
Inter-
segment
elimination
US$m
(2,658)
–
–
2,658
2,658
–
–
–
–
(3,179)
(3,179)
–
(3,179)
Other6
US$m
(625)
172
(228)
82
(146)
(81)
147
63
207
3,254
2,991
(181)
2,810
Total
US$m
34,486
17,182
5,619
2,603
8,222
657
969
340
5,668
2,546
70,070
(4,704)
65,366
(13)
–
(10,573)
2,797
(3,179)
54,793
3,179
(33,553)
–
–
–
21,240
846
22,086
%
100.0
51.3
US$m
868,133
1,860,758
896,834
Analysis by customer group and global business
Profit/(loss) before tax
Year ended 31 December 2006
Total
Net interest income/(expense) ....
Net fee income ............................
Trading income/(expense)
excluding net interest income
Net interest income/ (expense)
on trading activities ................
Net trading income/(expense)1 ...
Net income/(expense) from
financial instruments
designated at fair value ...........
Gains less losses from
financial investments ..............
Dividend income .........................
Net earned insurance premiums .
Other operating income ..............
Personal
Financial
Services
US$m
26,076
8,762
Commercial
Banking
US$m
7,514
3,207
391
220
611
739
78
31
5,130
782
204
20
224
(22)
44
6
258
250
Corporate,
Investment
Banking &
Markets
US$m
3,168
3,718
4,890
(379)
4,511
20
534
235
73
1,378
Private
Banking
US$m
1,011
1,323
362
2
364
1
166
5
–
61
Total operating income ............
42,209
11,481
13,637
2,931
Net insurance claims2 .................
Net operating income3 ..............
(4,365)
37,844
(96)
(62)
–
11,385
13,575
2,931
Loan impairment (charges)/
recoveries and other credit
risk provisions ........................
(9,949)
(697)
119
Net operating income ...............
27,895
10,688
13,694
Total operating expenses ............
Operating profit/(loss) ..............
(18,818)
9,077
(4,979)
5,709
(7,991)
5,703
Share of profit in associates
and joint ventures ...................
Profit/(loss) before tax ..............
Share of HSBC’s profit before
tax ...........................................
Cost efficiency ratio ...................
Selected balance sheet data5
Loans and advances to
customers (net) .......................
Total assets ..................................
Customer accounts ......................
The following assets and
liabilities were significant
to Corporate, Investment
Banking and Markets:
– loans and advances to
banks (net) ..........................
– trading assets, financial
assets designated at fair
value, and financial
investments .........................
– deposits by banks ...............
For footnotes, see page 26.
(33)
2,898
(1,685)
1,213
1
1,214
%
5.5
57.5
(3,259)
(462)
74
(388)
%
(1.8)
116.0
380
9,457
%
42.8
49.7
288
5,997
%
27.2
43.7
103
5,806
%
26.3
58.9
US$m
US$m
US$m
US$m
US$m
448,545
546,568
388,468
172,976
213,450
190,853
210,220
994,436
235,965
34,297
73,026
80,303
2,095
33,278
1,245
156,548
487,943
92,954
23
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Customer groups > Profit/(loss) before tax
Profit/(loss) before tax (continued)
Year ended 31 December 2005
Total
Personal
Financial
Services
US$m
Commercial
Banking
US$m
Corporate,
Investment
Banking &
Markets
US$m
Net interest income/(expense) ....
Net fee income ............................
23,351
7,313
6,310
2,876
Trading income/(expense)
excluding net interest income
Net interest income/ (expense)
on trading activities ................
Net trading income/(expense)1 ...
Net income/(expense) from
financial instruments
designated at fair value ...........
Gains less losses from
financial investments ..............
Dividend income .........................
Net earned insurance premiums .
Other operating income ..............
Total operating income ...............
Net insurance claims2 .................
Net operating income3 ................
Loan impairment (charges)/
recoveries and other credit
risk provisions ........................
Net operating income .................
Total operating expenses ............
Operating profit/(loss) ................
Share of profit in associates
and joint ventures ...................
Profit before tax ..........................
Share of HSBC’s profit before
tax ...........................................
Cost efficiency ratio ...................
Selected balance sheet data5
Loans and advances to
customers (net) .......................
Total assets .................................
Customer accounts ......................
The following assets and
liabilities were significant
to Corporate, Investment
Banking and Markets:
– loans and advances to
banks (net) ..........................
– trading assets, financial
assets designated at fair
value, and financial
investments .........................
– deposits by banks ...............
For footnotes, see page 26.
Private
Banking
US$m
848
1,080
317
–
317
(1)
45
9
–
68
3,001
2,967
2,919
306
3,225
67
475
79
76
1,621
11,511
2,366
(54)
–
11,457
2,366
272
11,729
(6,838)
4,891
272
5,163
%
24.6
59.7
12
2,378
(1,466)
912
–
912
%
4.4
62.0
Inter-
segment
elimination
US$m
(1,704)
–
–
1,704
1,704
–
–
–
–
(2,646)
(2,646)
–
(2,646)
Other6
US$m
(472)
220
(90)
(13)
(103)
406
144
42
260
2,634
3,131
(179)
2,952
Total
US$m
31,334
14,456
3,656
2,208
5,864
1,034
692
155
5,436
2,733
61,704
(4,067)
57,637
(1)
–
(7,801)
2,951
(2,646)
49,836
(2,976)
2,646
(29,514)
(25)
51
26
%
0.1
100.8
–
–
–
20,322
644
20,966
%
100.0
51.2
US$m
360
214
574
574
19
16
4,864
729
37,440
(3,716)
33,724
(7,537)
26,187
(16,427)
9,760
144
9,904
%
47.2
48.7
150
(3)
147
(12)
9
9
236
327
9,902
(118)
9,784
(547)
9,237
(4,453)
4,784
177
4,961
%
23.7
45.5
US$m
US$m
US$m
US$m
US$m
398,884
484,314
321,240
142,041
175,120
148,106
169,435
755,056
202,361
27,749
59,827
67,205
1,893
27,653
507
740,002
1,501,970
739,419
106,123
373,787
65,853
24
Year ended 31 December 2004
Personal
Financial
Services
US$m
Commercial
Banking
US$m
Corporate,
Investment
Banking &
Markets
US$m
Private
Banking
US$m
Inter-
segment
elimination
US$m
Other6
US$m
Total
Net interest income .....................
21,422
Net fee income ............................
Trading income ...........................
Net investment income on
assets backing policy-
holders’ liabilities....................
Gains less losses from
financial investments ..............
Dividend income .........................
Net earned insurance premiums .
Other operating income ..............
6,406
320
635
79
16
3,652
360
Total operating income ...............
32,890
Net insurance claims2 .................
Net operating income3 ................
(2,953)
29,937
Loan impairment (charges)/
recoveries and other credit
risk provisions ........................
(6,500)
Net operating income .................
23,437
Total operating expenses ............
(15,009)
Operating profit ..........................
8,428
Share of profit in associates
and joint ventures ...................
Profit before tax ..........................
Share of HSBC’s profit
before tax ................................
Cost efficiency ratio ...................
69
8,497
%
44.9
50.1
4,875
2,645
234
324
6
37
1,072
513
9,706
(1,264)
8,442
(200)
8,242
(4,220)
4,022
35
4,057
%
21.4
50.0
3,994
2,764
1,935
9
197
548
86
1,029
718
962
257
–
39
5
–
24
10,562
2,005
(59)
–
10,503
2,005
499
11,002
(5,809)
5,193
95
5,288
%
27.9
55.3
11
2,016
(1,319)
697
–
697
%
3.7
65.8
90
171
40
44
219
16
558
2,050
3,188
(359)
2,829
(1)
2,828
(2,493)
335
69
404
%
2.1
88.1
US$m
US$m
US$m
US$m
US$m
Total
US$m
31,099
12,948
2,786
1,012
540
622
5,368
1,613
55,988
(4,635)
51,353
–
–
–
–
–
–
–
(2,363)
(2,363)
–
(2,363)
–
(2,363)
(6,191)
45,162
2,363
(26,487)
–
–
–
18,675
268
18,943
%
100.0
51.6
US$m
Selected balance sheet data5
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) ..........................
– trading assets, financial
assets designated at fair
value, and financial
investments .........................
– deposits by banks ...............
For footnotes, see page 26.
370,576
452,992
319,485
130,160
159,251
137,801
145,353
584,779
177,449
24,463
56,751
57,780
2,339
26,201
557
672,891
1,279,974
693,072
128,032
252,459
80,443
25
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Geographical regions > Summary / Competitive environment
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 inter-segment funding as well as
inter-company and inter-business line transactions. All such transactions are undertaken on arm’s length terms.
Footnotes to the analyses of customer groups and global businesses on pages 12 to 25.
1 In the analyses of customer groups and global businesses, net trading income comprises all gains and losses from changes in the fair
value of financial assets and financial liabilities classified as held for trading, together with related external and internal interest
income and interest expense, and dividends received; in the statutory presentation internal interest income and expense are eliminated.
2 Net insurance claims incurred and movement in policyholders’ liabilities.
3 Net operating income before loan impairment charges and other credit risk provisions.
4 In 2006, Mexico and Panama were reclassified from the North America segment to Latin America. Comparative information has been
restated accordingly.
5 Third party only.
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, movements in the fair value of own debt
designated at fair value, 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 operating income of the Group’s wholesale insurance operations amounted to US$371 million in 2006 (2005:
US$460 million; 2004: US$511 million). ‘Other’ also includes the costs incurred by the Group Service Centres and Shared Service
Organisations and associated recoveries.
Geographical regions
Summary
In the analysis of profit by geographical regions that follows, operating income and operating expenses include
intra-HSBC items of US$1,494 million (2005: US$938 million; 2004: US$631 million).
Profit before tax
Europe ......................................................
Hong Kong ..............................................
Rest of Asia-Pacific .................................
North America1 ........................................
Latin America1 .........................................
Total assets2
2006
US$m
6,974
5,182
3,527
4,668
1,735
%
31.5
23.5
16.0
21.1
7.9
Year ended 31 December
2005
US$m
6,356
4,517
2,574
5,915
1,604
%
30.3
21.5
12.3
28.2
7.7
2004
US$m
5,756
4,830
1,847
5,268
1,242
%
30.4
25.5
9.8
27.8
6.5
22,086
100.0
20,966 100.0
18,943 100.0
Europe ...........................................................................................................
Hong Kong ...................................................................................................
Rest of Asia-Pacific ......................................................................................
North America1 .............................................................................................
Latin America1 ..............................................................................................
At 31 December
2006
US$m
828,701
272,428
167,668
511,190
80,771
%
44.6
14.6
9.0
27.5
4.3
2005
US$m
636,703
235,376
142,014
432,490
55,387
%
42.4
15.7
9.4
28.8
3.7
1,860,758 100.0
1,501,970 100.0
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly.
2 Third party only.
26
Additional information on results in 2006 may be
found in the ‘Report of the Directors: Financial
Review’ on pages 110 to 164.
Europe
HSBC’s principal banking operations in Europe are
HSBC Bank plc (‘HSBC Bank’) in the UK, HSBC
France, HSBC Bank A.S. in Turkey, HSBC Bank
Malta p.l.c., HSBC Private Bank (Suisse) S.A.
(‘HSBC Private Bank (Suisse)’), HSBC Trinkaus &
Burkhardt AG and HSBC Guyerzeller Bank AG.
Through these operations HSBC provides a wide
range of banking, treasury and financial services to
personal, commercial and corporate customers
across Europe.
Hong Kong
HSBC’s principal banking subsidiaries in Hong
Kong are The Hongkong and Shanghai Banking
Corporation Limited (‘The Hongkong and Shanghai
Banking Corporation’) and Hang Seng Bank Limited
(‘Hang Seng Bank’). The former 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 65 per cent by value of banknotes in
circulation in 2006.
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 14 branches and 16 sub-branches.
Hang Seng Bank offers personal and commercial
banking services and operates seven branches, seven
sub-branches and one representative office in eight
cities in mainland China. HSBC also participates
indirectly in mainland China through its three
associates, Bank of Communications Limited (‘Bank
of Communications’) (19.9 per cent owned), Ping
An Insurance (Group) Company of China, Limited
(‘Ping An Insurance’) (16.8 per cent) and Industrial
Bank Co. Ltd (‘Industrial Bank’) (12.78 per cent),
and has a further interest of 8 per cent in Bank of
Shanghai.
Outside Hong Kong and mainland China, the
HSBC Group conducts business in 21 countries in
the Asia-Pacific region, primarily through branches
and subsidiaries of The Hongkong and Shanghai
Banking Corporation, with particularly strong
coverage in India, Indonesia, South Korea,
Singapore and Taiwan. HSBC’s presence in the
27
Middle East is led by HSBC Bank Middle East
Limited (‘HSBC Bank Middle East’) whose network
of branches, subsidiaries and associates has the
widest coverage in the region; in Australia by HSBC
Bank Australia Limited; and in Malaysia by HSBC
Bank Malaysia Berhad (‘HSBC Bank Malaysia’),
which is the largest foreign-owned bank in the
country by income, profits and assets. HSBC’s
associate in Saudi Arabia, The Saudi British Bank
(40 per cent owned), is the Kingdom’s seventh
largest bank by total assets.
North America
HSBC’s North American businesses are located in
the US, Canada and Bermuda. Operations in the US
are primarily conducted through HSBC Bank USA,
N.A. (‘HSBC Bank USA’) which is concentrated in
New York State, and HSBC Finance, a national
consumer finance company based in Chicago. HSBC
Bank Canada and The Bank of Bermuda Limited
(‘Bank of Bermuda’) are responsible for operations
in their respective countries.
Latin America
HSBC’s operations in Latin America and the
Caribbean principally comprise HSBC México, S.A.
(‘HSBC Mexico’), HSBC Bank Brasil S.A.-Banco
Múltiplo (‘HSBC Bank Brazil’), HSBC Bank
Argentina S.A. (‘HSBC Bank Argentina’) and Grupo
Banistmo S.A. (‘Banistmo’). HSBC is also
represented by subsidiaries in Chile, the Bahamas,
Peru and Uruguay and, with the acquisition of
Banistmo, in Costa Rica, Honduras, Colombia,
Nicaragua and El Salvador, and by a representative
office in Venezuela. In addition to banking services,
HSBC operates large insurance businesses in
Argentina, Brazil and Panama. In Argentina,
HSBC’s main insurance business is HSBC La
Buenos Aires and, through Máxima and HSBC New
York Life, HSBC offers pension and life insurance
products. In Brazil, HSBC offers consumer finance
products through its subsidiary, Losango.
Competitive environment
HSBC believes that open and competitive markets
are good for both local economies and their
participants. The Group faces very strong
competition in the markets it serves. In personal and
commercial banking, it competes with a wide range
of institutions including commercial banks,
consumer finance companies, retail financial service
companies, savings and loan associations, credit
unions, general retailers, brokerage firms and
investment companies. In investment banking,
HSBC faces competition from specialist providers
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Competitive environment
and the investment banking operations of other
commercial banks.
in these areas, and to offer its services through the
channels preferred by its customers.
Regulators routinely monitor and investigate the
competitiveness of the financial services industry
(of which HSBC is a part) in a number of areas,
particularly in the UK and continental Europe.
HSBC’s policy is to co-operate and work positively
with all its regulators, inputting data and providing
perspective on those issues which affect all financial
service providers both directly and through industry
bodies.
Global factors
Consolidation in the banking industry
Over the past few decades there has been a trend
towards consolidation in banking and financial
services, both nationally and internationally. This
development has created a large and growing
number of institutions which are capable of
competing with HSBC across a wide range of
services.
Limited market growth
The majority of HSBC’s business is conducted in the
domestic markets of the US, the UK and Hong
Kong. In the UK and the US, penetration of standard
banking services is nearing saturation, and potential
for growth is largely in the provision of a wider
range of financial services, including consumer
finance, to new and existing customers. HSBC has
increased its focus on its interconnected Hong Kong
and mainland China businesses, the other emerging
economies in Asia-Pacific, Latin America, the
Middle East, Turkey and, to a lesser extent, Eastern
Europe as the engines of future growth. This is being
developed by expanding domestic operations within
emerging markets and by concentrating capabilities
in developed markets on servicing growing financial
needs in the emerging markets.
Advances in technology
Over the past decade, the development of the
internet and related innovative technologies has
provided the financial services industry with the
ability to deliver products and services through a
growing number of channels, often more efficiently
than by means of traditional face-to-face
transactions. This has lowered barriers to entry and,
as a consequence, competition has been fierce.
Complementing its traditional branch network,
HSBC offers a growing range of services utilising
the new technologies, currently including the
internet, interactive TV, mobile phone and WAP, and
telephone banking. HSBC will continue to innovate
28
Regional factors
Europe
The European Commission commenced an inquiry
into retail banking across all member states in 2006,
with which HSBC’s individual local entities
cooperated fully. Published in January 2007, a final
report highlighted concerns over the ways in which
competition in banking was operating in Europe. No
single country received particular attention.
The Single European Payments Area
programme, which will integrate retail payments
through harmonising euro currency transfers,
bankers’ orders and cards transactions in the
eurozone, reached implementation phase. Full
implementation is scheduled for 2008, according to
an agreement signed by the 65 member banks of the
European Payments Council. This should offer
strong growth opportunities for some banks but is
also expected to lead to more competition. HSBC is
positioning itself to capitalise fully on the
opportunities presented.
The Markets in Financial Instruments Directive
comes into effect on 1 November 2007, when it will
replace the existing Investment Services Directive,
covering a broader range of investment instruments
and market structures and, because conduct of
business rules are set at EU level, should mean less
additional requirements when passporting into
another member state.
UK
In April 2006, the Office of Fair Trading (‘OFT’)
concluded its inquiry into credit card terms under the
Unfair Terms in Consumer Contracts Regulations,
and announced that it did not intend to intervene
further where issuers reduced their default fees to
£12 or less. Subsequently, the OFT launched an
informal high-level fact-finding exercise on
overdraft fees, through the industry’s representative
body, the British Bankers’ Association. This is due to
conclude in March 2007, following which the
industry and the OFT are to review their respective
positions. Media interest has been considerable.
The OFT conducted a market study into
Payment Protection Insurance (‘PPI’) and referred
the PPI market in the UK to the Competition
Commission. The Competition Commission recently
announced that they will be working with the
Financial Services Authority (‘FSA’) to investigate
whether there is a case for changing the existing
rules for the sale of PPI.
The OFT conducted the follow-up review of the
SME market, prescribed by its report published in
2002. HSBC cooperated with this review and awaits
the findings.
Following MasterCard’s appeal to the
Competition Commission Appeals Tribunal, the OFT
withdrew its original interchange fee case to
concentrate on a new case against both MasterCard
and Visa. The European Commission is also
investigating interchange fees, and HSBC has
responded to its requests for information.
In November the winding down of the Payment
Systems Taskforce was announced, and a new
governance body for payment systems, the Payments
Industry Association, was established. HSBC is
positioned to deliver the faster electronic payments
introduced by the Payment Systems Taskforce and
meets its minimum standards for cheque clearing.
France
Stable interest rates in the eurozone contributed to a
strong growth in real estate investment in France.
Competition between French banks concentrated on
the promotion of real estate mortgage loans, which
are the principal means by which new customers in
France are acquired. Market activity increased and
consumers continued to enjoy improved pricing to
the detriment of bank margins.
The payment of interest on sight deposits,
authorised from the beginning of 2005, was
introduced by one major mutual French bank, albeit
linked to a quarterly fee for banking services. Market
reaction was muted and, to date, no other leading
French bank has followed suit.
From January 2006 the Banque Postale was able
to offer real estate lending and financial services,
including the sale of investment products
manufactured by third party providers. Given the
scale of Banque Postale’s geographical coverage,
this will increase competition in an already
competitive market.
At the end of December 2005, French banks
were granted approval, as in the UK, to provide
equity release mortgages. This will assist customers
to invest in real estate and finance consumption.
Hong Kong
There was some improvement in the lending market
in 2006, as the stable interest rate environment,
liquid market, and moderate cost of borrowing
supported growth in consumer spending, and
demand for personal loans and credit cards rose in
consequence.
Competition remained fierce in traditional
mortgage products due to the still subdued property
market. Robust equity markets buoyed sales of
investment products and also benefited investment-
related loans.
The sustained appreciation of the Chinese
currency during 2006 had no marked effect on Hong
Kong’s renminbi deposit business. Instead, funds
were attracted to Chinese stocks listed in Hong
Kong, notably in relation to some of the substantial
Chinese IPOs. Nevertheless, local currency deposits
continued to grow rapidly due to rising household
incomes.
Rest of Asia-Pacific
(including the Middle East)
The competitive environment in the Rest of
Asia-Pacific continued to intensify as international
banks focused on targeted sectors in emerging
markets in pursuit of higher returns. Local banks
also actively expanded their reach and business, both
within countries and across borders. Competition
remained intense throughout the region in all of the
customer groups served by HSBC. Regulations in
certain countries act to limit the ability of foreign-
owned banks to grow both by acquisition and
organically by adding distribution or participating in
shared networks with domestic banks. However, in
many countries the growing sophistication of the
relatively young population and increasing affluence
of the middle class continued to provide HSBC with
further opportunities for growth.
The French government reformed the household
Banks and non-banks, both local and
tax law for 2006/2007, notably introducing a tax
exemption on capital gains on equities sold after an
eight-year holding period and a cap on total
household taxes (including income, wealth and local
taxes) at 60 per cent of income. The higher marginal
tax rate has been limited to 40 per cent. These
reforms will increase disposable income for the
wealthier individuals who form one of HSBC
France’s key customer segments.
international, are rapidly building consumer finance
and direct banking businesses in a number of
countries in the region.
North America
In an already highly competitive US financial
services industry, institutions involved in a broad
range of financial products and services continued to
29
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Competitive environment / Europe > 2006
consolidate. Within the banking sector, consolidation
continued in 2006, with a greater focus on national
networks and retail branch banking.
The Group’s principal US subsidiaries, HSBC
Bank USA and HSBC Finance, faced vigorous
competition from a wide array of financial
institutions. These include banks, thrifts, insurance
companies, credit unions, mortgage lenders and
brokers, and non-bank suppliers of consumer credit
and other financial services. Many of these
institutions are not subject to US banking industry
regulation, unlike HSBC. This gives some of them
cost and product advantages and thus increases
competitive pressure. HSBC competes by expanding
its customer base through portfolio acquisitions or
alliances, co-branding opportunities and direct sales
channels, by offering a very wide variety of
consumer loan products and by maintaining a strong
service orientation.
The slowing US housing market has had an
adverse effect on sub-prime mortgage originators
and lenders, including HSBC. Numerous sub-prime
lenders have exited the industry or have announced
that they are exploring alternatives. Investment
banks have been active purchasers of distressed
competitors in an attempt to vertically integrate
origination platforms to feed secondary market
demands.
The six largest banks in Canada dominate the
country’s financial services industry. Despite this,
the market remains very competitive with
comparable financial products and services offered
by other banks, insurance companies and other
institutions. Merger activity among the largest banks
in Canada remains possible but, without such
consolidation, growth opportunities for the larger
banks will continue to exist mainly outside of
Canada.
Latin America
Mexico’s financial system remains highly
concentrated. Five banks dominate the industry,
controlling some 80 per cent of banking assets. Of
these five, four (including HSBC) are foreign-
owned. In 2006, new banking licences were granted
to 13 bank and non-bank institutions. This will
increase competition, mainly in customer segments
in which banking is currently under-represented.
These segments also represent potential growth areas
for the existing five major banks in the medium to
long term.
There is increasing regulatory pressure on
banking and pension management fees and
commissions, which has constrained growth in
non-funds income. As a result, competition is fierce
in consumer lending, as financial institutions seek to
build alternative income streams despite difficulties
in establishing reliable consumer credit histories.
HSBC seeks to differentiate through customer
service, and is well positioned to capitalise on
economic growth with its extensive branch and ATM
network, and growing young customer base.
In Brazil, concentration in the industry
increased, with the top ten banking groups
accounting for some 70 per cent of assets and
87 per cent of branches at 31 December 2006 (2005:
68 per cent and 86 per cent respectively). These top
ten banking groups consist mainly of state-owned,
privately owned and large foreign banks (including
HSBC), and the most significant change in the
Brazilian financial system was the growing market
share of the larger privately owned banks through
consolidation in the industry and partnerships
established with national retailers.
Improvements in the macro-economic
environment, particularly in increased solvency and
liquidity in the market and in monetary policy, have
benefited the consumer through constraining
inflationary growth. Notwithstanding persistently
high interest rates, consumer borrowing has
increased. However, total lending as a percentage of
Gross Domestic Product (‘GDP’) remained low in
international terms at 34 per cent. This, together with
the fact that within the economically active
population an estimated 40 million people have
limited access to financial services, indicates that the
outlook for further growth is positive.
In Argentina, HSBC’s direct competition comes
primarily from international financial groups that
provide an equivalent range of banking, insurance,
pension and annuity products and services. Given the
growth experienced over recent years in the
Argentine economy, there has been resurgent
demand for credit products, coupled with increases
in deposits. The strong recovery in consumer
confidence is reflected in the level of private sector
loans and private deposits that grew by 40 per cent
and 22 per cent respectively compared with 2005.
The life and annuities market increased by 17 per
cent in terms of assets, while pension funds
collections increased by 30 per cent.
30
Europe
Profit/(loss) before tax by country within customer groups and global businesses
Year ended 31 December
Personal Financial Services ..........................................................................
United Kingdom ..............................................................................................
France1 .............................................................................................................
Turkey...............................................................................................................
Other ................................................................................................................
Commercial Banking .....................................................................................
United Kingdom ..............................................................................................
France1 .............................................................................................................
Turkey...............................................................................................................
Other ................................................................................................................
Corporate, Investment Banking and Markets2 ..........................................
United Kingdom ..............................................................................................
France1 .............................................................................................................
Turkey...............................................................................................................
Other ................................................................................................................
Private Banking .............................................................................................
United Kingdom ..............................................................................................
France1 .............................................................................................................
Switzerland ......................................................................................................
Other ................................................................................................................
Other ...............................................................................................................
United Kingdom ..............................................................................................
France1 .............................................................................................................
Turkey ..............................................................................................................
Other ................................................................................................................
Total ................................................................................................................
United Kingdom ..............................................................................................
France1 .............................................................................................................
Turkey...............................................................................................................
Switzerland ......................................................................................................
Other ................................................................................................................
2006
US$m
1,909
1,496
174
121
118
2,234
1,801
236
50
147
2,304
1,299
545
64
396
805
380
22
305
98
(278)
(185)
(107)
(18)
32
6,974
4,791
870
217
305
791
2005
US$m
1,932
1,475
223
134
100
1,939
1,495
278
39
127
2,114
1,186
472
92
364
539
171
7
254
107
(168)
(47)
(147)
–
26
6,356
4,280
833
265
254
724
2004
US$m
1,621
1,340
205
29
47
1,663
1,258
272
25
108
1,668
1,021
337
88
222
438
135
(22)
203
122
366
477
(123)
–
12
5,756
4,231
669
142
203
511
1 France primarily comprises the domestic operations of HSBC France and the Paris branch of HSBC Bank.
2 Including venture capital gains of US$457 million (2005: US$610 million; 2004: US$170 million).
Year ended 31 December 2006 compared
with year ended 31 December 2005
Economic briefing
UK GDP growth increased in 2006 to about 2.7 per
cent from 1.9 per cent in 2005. This followed a
recovery in both household and company spending.
Consumer Price Index (‘CPI’) inflation increased
through the year from 1.9 per cent in January to
3.0 per cent in December, following large increases
in the price of petrol and gas. The Bank of England
raised interest rates from 4.5 per cent to 5 per cent,
citing concerns about spare capacity, rapid money
growth and the possibility of inflation staying above
target for some time. House price inflation remained
strong but consumer spending appeared unaffected.
Secured lending continued to increase although
unsecured lending plateaued. There was evidence
that a number of households were struggling with the
burden of debt as personal insolvencies and
repossessions increased. Employment rose, although
by less than the increase in available workers as
migrant inflows remained strong and the
participation rate of UK residents in the labour force
increased. As a result, the unemployment rate
increased, contributing to constrained wage growth
throughout the year despite relatively high rates of
headline inflation.
The recovery in the eurozone economy
gathered momentum through the course of 2006.
GDP rose by approximately 2.7 per cent, the fastest
rate since 2000. Much of the improvement reflected
increases in exports and investment, as global
demand remained strong and corporate activity and
profits rose. Consumer spending remained subdued,
despite a gradual rise in employment. German
31
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Europe > 2006
Profit before tax
Europe
Net interest income ..........................................................................................
Net fee income .................................................................................................
Net trading income ..........................................................................................
Net income from financial instruments designated at fair value ....................
Net investment income on assets backing policyholders’ liabilities ..............
Gains less losses from financial investments ..................................................
Dividend income ..............................................................................................
Net earned insurance premiums ......................................................................
Other operating income ...................................................................................
Total operating income .................................................................................
Net insurance claims incurred and movement in policyholders’ liabilities ....
Net operating income before loan impairment charges and other
credit risk provisions ................................................................................
Loan impairment charges and other credit risk provisions .............................
Net operating income ....................................................................................
Total operating expenses .................................................................................
Operating profit .............................................................................................
Share of profit/(loss) in associates and joint ventures ....................................
Profit before tax .............................................................................................
Share of HSBC’s profit before tax ........................................................................
Cost efficiency ratio ..............................................................................................
2006
US$m
8,289
7,108
4,529
144
–
624
183
1,298
1,428
23,603
(531)
23,072
(2,155)
20,917
(13,871)
7,046
(72)
6,974
%
31.5
60.1
Year-end staff numbers (full-time equivalent) ......................................................
78,311
Selected balance sheet data1
Loans and advances to customers (net) .................................................................
Loans and advances to banks (net) ........................................................................
Trading assets, financial instruments designated at fair value and
financial investments2 .......................................................................................
Total assets ............................................................................................................
Deposits by banks ..................................................................................................
Customer accounts .................................................................................................
1 Third party only.
2 Including financial assets which may be repledged or resold by counterparties.
US$m
392,499
76,830
242,010
828,701
67,821
419,365
Year ended 31 December
2005
US$m
8,221
6,299
3,036
362
–
439
63
1,599
1,603
21,622
(818)
20,804
(1,929)
18,875
(12,639)
6,236
120
6,356
%
30.3
60.8
77,755
US$m
312,537
44,360
146,777
636,703
47,202
334,200
2004
US$m
9,098
5,980
997
–
571
154
558
1,875
1,175
20,408
(1,628)
18,780
(1,033)
17,747
(12,028)
5,719
37
5,756
%
30.4
64.0
74,861
US$m
277,560
56,049
139,183
545,557
55,720
292,568
growth improved sharply, while growth in France
and Italy was less impressive. Eurozone inflation
was heavily affected by rises in energy and food
prices. Inflation, excluding energy and food,
remained contained at just 1.7 per cent. The
European Central Bank (‘ECB’) increased the key
policy interest rate from 2.25 per cent at the
beginning of 2006 to 3.5 per cent in December. The
ECB continued to describe monetary policy as
‘accommodative’, thereby effectively ending the
year with a bias towards tightening.
quarter. The current account deficit continued to
widen, reaching 8 per cent of GDP in December,
partly from high-energy prices but also from the
increasing substitution of imported materials for
local ones due to the overvalued currency. More than
half of the deficit was financed by healthy foreign
direct investment inflows. The International
Monetary Fund’s programme for Turkey remained
on track.
Review of business performance
Turkey’s economy slowed markedly in the
third quarter, with year-on-year GDP growth of
3.4 per cent, down from 7.8 per cent in the second
European operations reported a pre-tax profit
of US$6,974 million compared with
US$6,356 million in 2005, an increase of 10 per
32
cent. On an underlying basis, pre-tax profits grew by
8 per cent. Underlying net operating income
increased by 9 per cent, in line with operating
expenses. Commercial Banking delivered a third
successive year of growth, driven by strong balance
sheet growth in the UK and organic expansion in
Turkey. Record profits in Private Banking were
driven by strong client asset inflows, a more
sophisticated product mix and lending growth.
Corporate, Investment Banking and Markets made
encouraging gains in trading activities, and operating
expenses rose in line with net operating income. In
Personal Financial Services, net operating income
growth slowed as HSBC tightened its underwriting
criteria on unsecured credit. An emphasis on deposit,
wealth and insurance products contributed to an
increase in costs, which were driven by
infrastructure investment both in the physical
environment and direct channels.
The following commentary is on an underlying
basis.
Personal Financial Services reported a pre-tax
profit of US$1,909 million, 2 per cent lower than in
2005. Net operating income rose by 4 per cent and
loan impairment charges increased by slightly more
than revenues as increasing numbers of debtors
sought formal protection from their obligations.
Costs grew by 7 per cent, reflecting investment in
infrastructure throughout the region, and the cost
efficiency ratio rose by 1.2 percentage points to
59.2 per cent.
In the UK, HSBC responded to concerns over
high levels of consumer indebtedness and the growth
in personal bankruptcies and IVAs by adopting more
selective underwriting criteria and reducing credit
origination. Revenues from credit-related insurance
declined as a consequence. In response, HSBC
increased its focus on non credit-related income
streams, particularly savings and high-value current
accounts. Strong balance growth in these products
was achieved through marketing initiatives,
competitive pricing and the success of innovative
propositions such as the packaged ‘Plus’ and
‘Passport’ current accounts, the latter supported by
the implementation during the year of a more refined
approach to customer segmentation.
Considerable strategic attention was given to
enhancing product distribution and channel
management. The branch refurbishment programme
continued and improvements were made to direct
banking, notably the introduction of self-service
machines and the upgrading of cash machine service
offerings. HSBC’s internet offering was also
33
enhanced to offer personalised content and sales
capabilities, with improved customer accessibility.
In France, a marked improvement in brand
awareness after the 2005 rebranding to ‘HSBC
France’, supported by competitive pricing, aided the
recruitment of target customers and consequential
balance sheet growth, most notably in residential
property lending. Despite this growth, there was a
decline in profit before tax, due to competitive
pressures on margin and the time lag between
incurring costs on customer acquisition and earning
incremental revenue from future opportunities to
cross-sell.
In Turkey profit before tax declined by 2 per
cent, as revenue growth was offset by investment
costs. Organic development was furthered by the
opening of 37 new branches during the year,
bringing the total to 193, and a number of marketing
initiatives to build brand awareness. Balance sheet
and revenue growth accelerated as a result, as did
customer recruitment. Overall customer numbers
stood at 2.3 million at the end of 2006.
Net interest income increased by 5 per cent to
US$5,653 million, substantially from balance sheet
growth throughout the region.
In the UK, net interest income was driven by
growth in savings, deposit and current accounts, with
higher balances achieved through targeted sales and
marketing efforts. Interest income from credit cards
and mortgages also increased.
A focus on liabilities helped boost new UK
savings account volumes markedly in a buoyant yet
highly competitive savings market. HSBC’s
competitive internet-based products were the key
driver of growth. Cash invested in First Direct’s
‘e-savings’ product trebled; balances in HSBC’s
‘Online Saver’ increased sixfold. Overall, average
savings balances, excluding money market
investments, increased by 28 per cent and net
interest income rose by 25 per cent.
Current account balances in the UK increased
by 6 per cent to US$26.0 billion. Within this, the
proportion of value-added packaged current accounts
attracting fees rose significantly. The number of
HSBC’s fee-based accounts more than doubled
during 2006. In aggregate, packaged current account
balances increased by 25 per cent and represented
nearly half of the overall increase in current
accounts. Spreads remained broadly in line with
2005.
Average UK credit card balances rose by 5 per
cent, to US$13.7 billion, driven by promotional
campaigns and marketing. Growth was strongest in
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Europe > 2006
M&S branded cards, which represented 4 percentage
points of the increase, driven by an increased sales
focus which included extensive media advertising.
This was partly offset by declining balances within
the store cards business and the cards business of
HFC Bank Ltd (‘HFC’), reflecting HSBC’s more
restricted credit appetite. Spreads increased modestly
compared with 2005.
investment products drove fee growth. Fees from
unsecured lending also rose. These benefits were
partly offset by lower creditor protection income,
reflecting the steps taken by HSBC to constrain
lending growth. Reduced loan sales and smaller
average loans (the result of this initiative) led to both
lower insurance sales and a reduction in average
premiums.
Average UK mortgage balances rose by 11 per
In France, banking fees rose through higher
cent to US$68.9 billion, primarily in fixed rate
mortgages. Growth was achieved through
competitive pricing and targeted marketing
strategies, including the launch of new fixed,
discount and tracker-rate mortgages during the year.
A slight narrowing of spreads reflected a change in
mix away from variable rate mortgages to fixed rate
mortgages, and the competitive positioning referred
to above.
Average unsecured lending balances in the UK
declined by 4 per cent, reflecting HSBC’s decision
to contain growth through stricter underwriting
criteria. Spreads narrowed, following the
introduction in 2005 of preferential pricing for
lower-risk customers, and a change in mix towards
higher-value but lower-yielding loans.
In France, net interest income fell by 8 per cent.
Spreads narrowed as older higher-yielding
investments matured, while competitive pricing
reduced lending yields, particularly in the residential
mortgage market. These pressures on margin were
only partially offset by strong balance sheet growth.
Marketing campaigns building on the ‘HSBC
France’ brand aided strong sales and customer
recruitment, most notably in residential property
lending and current accounts and also increased
future cross-selling opportunities.
In Turkey, net interest income rose by 14 per
cent. Lending grew strongly, substantially funded by
deposit growth. Overall, deposit balances rose by
over 50 per cent, largely driven by customer
recruitment aided by the branch network expansion
referred to above. Spreads widened following
increases in overnight interest rates and the value of
funds rose as a consequence. Marketing initiatives
and cross-sales with credit card customers helped
more than double average unsecured lending
balances. Mortgage lending was also strong, with a
60 per cent increase in balances. Credit card
balances rose by 22 per cent, with growth dampened
by credit calming measures imposed by government
regulation.
Net fee income increased by 8 per cent to
US$2,533 million. In the UK, rising sales of fee-
earning packaged current accounts, travel money and
34
sales of packaged current accounts. Transactional
and overdraft fees and insurance distribution fees
also increased, reflecting growth in the customer
base. In Turkey, strong growth in lending volumes
and, to a lesser extent, credit cards, helped drive fee
income growth. Additional sales staff were recruited
to reinforce the emphasis on wealth management,
and the launch of new pension products also helped
boost fees.
In 2006, MasterCard became publicly listed
through an IPO, and the US$37 million gain from
financial investments mainly reflected Personal
Financial Services’ share of the proceeds of the IPO.
Responding to changes in work and shopping
patterns among its customers and the increasing
acceptance of direct channels. HSBC appraised its
UK property portfolio during the year, and higher
other operating income reflected Personal Financial
Services’ share of revenue from branch sale and
lease-back transactions. Personal Financial Services’
US$37 million share of income on the sale of
HSBC’s stake in The Cyprus Popular Bank was also
included within other operating income.
Lower sales of life and creditor repayment
protection, which were driven by the constraints on
personal lending growth referred to above, and a
change in reinsurance arrangements at the end of
2005, contributed to the decrease in net earned
insurance premiums. Lower sales of investment-
linked insurance products, together with the effect of
market movements on related insurance and
investment assets, contributed to the decline in net
income from financial instruments designated at fair
value. This was largely offset by a corresponding
decrease in net insurance claims and movements in
policyholders’ liabilities.
Loan impairment charges and other credit risk
provisions of US$1,838 million were 6 per cent
higher than in 2005, largely reflecting lending
growth in the region.
In the UK, the 8 per cent rise in loan impairment
charges was broadly in line with lending growth.
Actions taken on underwriting and collection
activities mitigated a continuation of the rising trend
in personal bankruptcies and IVAs seen since the
legislative change in 2004. In 2006, IVAs became
the main driver of loan impairment growth across the
industry as the availability and marketing of third-
party debt reduction services increased.
Within the UK, loan impairment was most
pronounced in consumer finance unsecured
portfolios, in which delinquency also rose as the
effect of interest rate increases on relatively high
levels of indebtedness put pressure on household
cash flows. In HSBC’s other portfolios, action
undertaken by HSBC during 2005 and early 2006,
predominantly tightening underwriting criteria and
collections procedures, proved successful in
improving credit quality indicators on more recently
written debt. In the second half of 2006, HSBC
strengthened the measures available to manage
insolvencies and impaired debt including, inter alia,
the further development of predictive modelling to
enhance underwriting decisions.
In France, credit quality was sound
notwithstanding strong growth in customer
advances, and the loan impairment charge remained
low. In Turkey, overall credit quality was also
sound, and delinquency on credit cards improved
following enhanced collections efforts and changes
in government regulation. This was reflected in a
36 per cent reduction in loan impairment charges.
Operating expenses increased by 7 per cent.
A US$57 million write-down of intangibles was
attributed to card portfolios acquired in the UK
which were written off in the light of the higher
impairment charges being experienced. Excluding
this item, the increase was 6 per cent, primarily
reflecting investment in upgrading and expanding
capacity and infrastructure across the region.
In the UK, 104 branches were refurbished
during 2006. Responding to changing customer
preferences and upgrading its customer service,
HSBC extended its opening hours in certain
branches, necessitating the recruitment of additional
counter staff, and increased its IT investment in self-
service machines and other direct banking channels,
in the process improving cost efficiency.
In France, there was a 4 per cent rise in
operating expenses, driven by the recruitment of
additional sales staff, higher marketing expenditure
to attract new customers, and the migration to a
common IT infrastructure. In Turkey, the opening of
37 new branches and associated growth in numbers
of sales staff and infrastructure costs drove a 26 per
cent rise in costs. Marketing expenditure also
increased in support of the growing consumer
lending, insurance and pensions businesses.
35
Commercial Banking reported a pre-tax profit
of US$2,234 million, an increase of 14 per cent
compared with 2005. Adjusting for the sale of the
UK fleet management and vehicle finance leasing
business, which was sold in the autumn of 2005,
profit before tax grew by 17 per cent, driven by
growth of 10 per cent in net operating income
compared with just 4 per cent in costs. Revenues
increased by 9 per cent through balance sheet
growth, customer recruitment and improved
cross-sales in the UK, and expansion of the middle
market, small and micro businesses in Turkey. The
4 per cent growth in operating expenses primarily
reflected investment to support business expansion
throughout the region. Credit quality was stable.
In the UK, HSBC invested to expand sales
capacity and improve service through recruitment
and the opening of commercial centres. To support
HSBC’s strategic intention to lead the market in
international commercial banking, a dedicated
International Banking Centre was created which, as
part of a global network, simplified cross-border
account opening. HSBC also simplified and
launched new foreign currency accounts. Significant
progress was made in enhancing the functionality of
HSBC’s award-winning internet banking, including
the implementation of the UK’s first same-day high-
value payments offering and the launch of HSBC’s
first commercial direct banking proposition,
Business Direct, which attracted over 19,000 small
and micro business accounts during the year.
In France, HSBC increased customer
recruitment by approximately one third by
concentrating on improving brand awareness among
commercial businesses. HSBC became the principal
banker for the majority of new customers recruited.
In Turkey, the establishment of eight centres, the
recruitment of additional relationship management
staff and a focus on maintaining high service levels
contributed to a 40 per cent increase in the number
of active customers as HSBC successfully sustained
its efforts to grow its share of middle market, small
and micro-business banking.
Net interest income increased by 8 per cent,
largely driven by increases in the UK and Turkey. In
France, the benefit of strong balance sheet growth
was more than offset by competitive pressure on
margins.
HSBC slowed the rate of growth in lending in
the UK during 2006 by refining underwriting criteria
and emphasising non-lending related revenue
streams and, consequently, average lending balances
rose by 8 per cent during the year and spreads
remained broadly flat. Increased priority was given
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Europe > 2006
to raising deposits through transactional and savings
accounts and, as a result, deposit balances rose by
37 per cent and current account balances by 8 per
cent. The benefit of this volume growth was partly
offset by spread compression on sterling-
denominated accounts as customers were offered
more attractive pricing.
HSBC boosted the recruitment of small and
micro business customers in the UK by holding
commercial theme weeks and increasing client
contact by embedding business specialists in selected
branches. These initiatives delivered increases in the
number of start-up accounts and the number of
customers who switched their business from other
banks to HSBC. Higher-value international and
foreign currency accounts rose as a consequence.
Net interest income in France was broadly in
line with 2005 as the benefit of strong balance sheet
growth, driven by the acquisition of new customers
and improved levels of customer retention, was
offset by narrowing spreads from competitive market
pressures and lower earnings from free funds.
Net interest income in Turkey increased by
41 per cent, driven by a doubling in lending
balances. HSBC extended its geographic coverage
through expansion of the branch network, including
the launch of eight new centres dedicated to smaller
commercial customers, and these boosted customer
recruitment. The introduction of pre-approved credit
limits for existing customers also contributed to
lending growth, and the focus on attracting liability
products helped more than double deposit balances.
Net fee income increased by 4 per cent to
US$1,707 million. Current account and money
transmission fees rose as a result of customer
recruitment and higher transaction volumes in most
countries. In the UK, client workshops and other
promotional activities were deployed to support
increased sales of treasury products, boosting
treasury revenue as foreign exchange volumes grew.
In France a 2 per cent increase in income was largely
in transactional current account fees, reflecting
growth in the customer base.
Other operating income was 41 per cent lower
than in 2005 and reflected lower asset finance
revenues following the sale of the UK fleet
management business referred to above. This was
partly offset by the inclusion of Commercial
Banking’s share of the gain on the sale of
HSBC’s stake in The Cyprus Popular Bank
(US$38 million), and the income from UK branch
sale and lease-back transactions.
36
Credit quality in Commercial Banking was
stable in most countries. In the UK, loan impairment
charges and other credit risk provisions fell by
16 per cent, largely due to the non-recurrence of an
individual loan impairment allowance against a
single customer in 2005. Excluding this, there was a
modest decline in UK impairment charges, as the
effect of lending growth was more than offset by
improved credit quality, particularly in relation to
HSBC’s larger exposures. In France, loan
impairment charges, while remaining low, returned
to a more normal level after relatively high
recoveries in 2005. In Turkey, higher loan
impairment charges reflected growth in lending.
Operating expenses decreased by 1 per cent.
Excluding the sale of the UK fleet management
activities referred to above, costs were 4 per cent
higher than in 2005, reflecting investment to drive
business growth throughout the region. As a result of
revenues growing significantly faster than costs,
there was a 3.1 percentage point improvement in the
cost efficiency ratio. In the UK, increased costs
reflected the recruitment of additional sales staff and
higher IT expenditure. Costs in France fell by 2 per
cent compared with 2005 as savings from cost
control offset increases from the recruitment of
additional sales staff and expenses associated with
the migration to common IT platforms. In Turkey,
recruitment and marketing costs incurred in support
of the growing small and micro businesses drove a
38 per cent rise in expenses.
Corporate, Investment Banking and Markets
reported a pre-tax profit of US$2,304 million, an
increase of 5 per cent, compared with 2005. A
reduction in recoveries of loan impairment charges
and lower private equity gains masked strong growth
in core operating activities. Global Markets’
revenues were 36 per cent higher than in 2005 as
robust performances in the global capital markets
and securities services businesses were
complemented by strong trading gains. The cost
efficiency ratio improved modestly compared with
2005.
Total operating income was US$6,560 million,
17 per cent higher than in 2005. This was despite the
fact that in the UK, France and Turkey, balance
sheet management revenues continued to fall,
resulting in an overall decline of 56 per cent. This
shortfall was partly offset by higher net interest
income in HSBC Securities Services as customer
volumes grew in higher-value products such as
securities lending and foreign exchange. The lending
business delivered a 13 per cent increase in corporate
balances and corporate spreads remained broadly in
line with 2005.
Net interest income in the payments and cash
management business rose as deposit balances
increased by 18 per cent. Surplus liquidity in the
market fed higher business volumes. Increased
transaction volumes resulting from new client
acquisitions and recent expansion initiatives also
contributed to higher revenues.
Net fee income rose by 23 per cent, reflecting a
63 per cent fee increase in the global capital markets
business and fees more than doubling in the
securities services business. The financing and
advisory businesses benefited from a higher number
of deals mandated and a broader product range.
Assets under custody grew by 22 per cent with
notable increases in alternative fund assets,
particularly from Ireland and Luxembourg.
In Group Investment Businesses, revenues
increased significantly, boosted by a 4 per cent
increase in funds under management and higher
performance fees allied to revenues from disposals
of property and structured finance fund investments.
Trading income increased with positive revenue
trends in the key product areas where HSBC has
invested, notably Credit and Rates, foreign exchange
and structured derivatives. Revenues increased
substantially, particularly in the area of interest rate
derivatives, which benefited from opportunities
created by a relatively volatile market. Additional
gains were reported in emerging market bonds due to
higher volumes, as investors adjusted their risk
appetite and responded to a general improvement in
market sentiment towards developing economies.
Higher foreign exchange revenue was driven by
greater customer volumes and increased trading
opportunities offered by a combination of US dollar
volatility and more uncertain economic conditions in
emerging markets. Structured derivatives income
increased by 88 per cent as HSBC leveraged its
investment in this business to meet the needs of its
institutional clients.
Gains from sales of financial investments, at
US$413 million, were in line with 2005. Notable
among the investments realised in the year were the
sales of specialist property and structured finance
fund investments by Group Investment Businesses.
Other income declined by 26 per cent as one-off
gains from restructuring and syndication of assets in
Global Investment Banking were not repeated.
The overall credit environment remained
favourable with market liquidity supporting debt
reconstruction as credit spreads tightened. As a
result, HSBC achieved net recoveries for the third
year in succession, albeit at a lower level than in
37
2005, when HSBC benefited from a release of
collective impairment allowances in the second half.
Operating expenses were 14 per cent higher at
US$4,224 million, largely supporting volume growth
in various businesses and performance-related
compensation in Global Markets, where revenues
increased by 36 per cent. Costs in 2006 also reflected
the full-year effect of the investment made
throughout 2005 as well as ongoing investment in
product development, particularly in structured
derivatives and Credit and Rates. In Group
Investment Businesses, a robust performance
resulted in higher staff and support costs.
A rise in operational expenditure was driven by
increased volumes as well as new business won in
respect of payments and cash management funds
administration, securities services and Group
Investment Businesses.
The decline in HSBC’s share of profits in
associates and joint ventures reflected a loss arising
from an impairment charge on a private equity
investment within an associate. This was
compounded by the non-recurrence of one-off gains
realised in 2005, a significant proportion of which
were recognised in the second half of the year.
Private Banking delivered a record pre-tax
profit of US$805 million in Europe, an increase of
48 per cent compared with 2005. The cost efficiency
ratio improved by 6.7 percentage points to 55.7 per
cent. There was a US$108 million gain on the partial
sale of an investment in the Hermitage Fund and,
excluding this, pre-tax profit increased by 28 per
cent. This result was achieved through growth in
client assets, increased lending and transaction
volumes and distribution of a broader and more
sophisticated product range. Growth in intra-Group
referrals with other customer groups was
encouraging and also contributed to increased
revenues.
Net interest income was 23 per cent higher at
US$675 million, driven by balance sheet growth,
primarily in the UK and Switzerland. Lending
balances were 24 per cent higher and were funded by
increased deposits. In the UK, the 31 per cent
expansion of the lending book resulted primarily
from growth in mortgage balances driven by a
market which remained buoyant at the upper end. In
Switzerland, an 18 per cent rise in lending largely
reflected client appetite for leverage to facilitate
equity and alternative investment opportunities.
Fee income increased by 19 per cent to
US$869 million. This growth resulted from
increased funds under management and a favourable
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Europe > 2006 / 2005
mix change towards higher fee-generating
discretionary and advisory managed funds, including
the continued success of the SIS and CIS products
and the launch of the ‘Actively Managed Portfolio’
product. A significant performance fee came from
the Hermitage Fund, a public equity fund dedicated
to Russia, which was US$23 million greater than in
2005. The expansion of HSBC’s residential property
advisory business, which opened new offices in the
UK and France, also contributed to fee income
growth.
Gains from financial investments in both 2005
and 2006 arose mainly from the sale of debt and
investment holdings. Gains in 2006 included
US$108 million from the partial disposal of HSBC’s
investment in the Hermitage Fund.
Excluding gains from financial investments,
trading and other operating income was marginally
lower than in 2005.
Client assets, including deposits, rose by 18 per
cent to US$218 billion. Net new money was
US$19 billion, with the largest inflows arising in
Switzerland and the UK. In Switzerland, improved
brand awareness, successful product placement and
cross-referrals with other customer groups, all
contributed to significant net new money of
US$11 billion. In the UK, net new money of
US$3 billion was garnered from referrals from
Commercial Banking and the retail network, new
regional offices and continued growth in the
underlying business. Net new money in Monaco and
Germany exceeded US$1 billion and US$2 billion,
respectively, also contributing to the growth in client
assets. The value of clients’ investments in HSBC’s
discretionary managed suite of SIS and CIS products
grew very strongly, reaching US$1.7 billion.
Operating expenses were 13 per cent higher than
in 2005 due to higher performance-related
remuneration, recruitment of client-facing
professionals across the region to support the
growth of the business, and continued investment
in the recently opened UK regional offices. The
combination of HSBC’s principal trust businesses in
Switzerland also added to costs in 2006 but is
expected to bring efficiency gains in subsequent
years. Overall increased expenses were more than
offset by greater revenue generation which
contributed to the 6.7 per cent improvement in the
cost efficiency ratio.
In Other, increases in US interest rates led to
higher earnings on capital, which were partly offset
by increased subordinated debt-servicing costs.
38
Movements in the fair value of own debt and
associated hedges were US$33 million, compared
with an adverse movement of US$15 million in
2005, principally from movements in HSBC’s own
credit spread. The fair value of own debt
incorporates an element attributable to the credit
spread on HSBC’s debt instruments. As HSBC’s
credit spreads narrow, accounting losses are
reported, and the reverse is true in the event of
spreads widening. These valuation adjustments do
not alter the cash flows envisaged as part of the
documented interest rate management strategy.
Operating expenses decreased by 5 per cent,
driven by the non-recurrence of litigation expenses
in France.
Year ended 31 December 2005 compared
with year ended 31 December 2004
Economic briefing
Growth in the UK economy remained subdued
during 2005 at 1.9 per cent, the lowest rate since
1992. Consumer spending and housing activity
slowed sharply during the first nine months of the
year, staging a minor recovery in the final quarter.
Doubts remained over the strength of consumer
spending, given the rise in unemployment in ten
consecutive months and reduced confidence in the
housing market. The boost to the economy from
government spending in recent years was also not
expected to be as significant. The recovery in
exports was maintained, helped in large part by the
strength of the global economy, though the industrial
sector continued to struggle. Industrial output
contracted in 2005 for the fourth time in the past five
years. Companies remained reluctant to invest
despite a general profit recovery, stronger balance
sheets and an impressive equity market performance.
Although commodity prices rose sharply, inflation
remained well contained at around 2 per cent and
wage growth eased. In response to weaker economic
activity, the Bank of England cut interest rates in
August to 4.5 per cent.
The eurozone experienced lacklustre economic
growth in 2005 of 1.4 per cent, although momentum
accelerated during the course of the year. With
consumer spending growth remaining subdued, the
strongest areas were exports and fixed investment.
There was, as usual, considerable divergence
between countries: Italy and Portugal saw hardly any
economic growth while Spain, Greece and Ireland
grew by over 3 per cent. Growth in France slowed
from 2.1 per cent in 2004 to 1.4 per cent in 2005 but
both investment and consumer spending revived a
little in the second half of the year. Weak domestic
demand continued to constrain German GDP
growth, which slowed from 1.1 per cent in 2004 to
0.9 per cent in 2005, despite a strong increase in
exports, particularly capital goods. Eurozone
inflation averaged a little over 2 per cent in 2005,
with higher energy prices boosting inflation by
around 0.5 per cent. The European Central Bank
raised interest rates from 2.0 per cent to 2.25 per cent
in early December, the first increase for almost five
years.
The performance of the Turkish economy in
2005 remained very positive. GDP grew by
approximately 5.5 per cent, while inflation continued
to fall, to 7.7 per cent in December from 9.7 per cent
a year earlier. Economic policy remained anchored
by the government’s agreement with the IMF.
Turkey’s current account deficit, which reached
US$23.1 billion, or approximately 6.3 per cent of
GDP in 2005, is increasingly being financed by
longer-term foreign direct investment into the
country, which should help reduce Turkey’s
vulnerability to a sudden reversal in short-term
capital flows.
Review of business performance
European operations reported a pre-tax profit of
US$6,356 million compared with US$5,756 million
in 2004, an increase of 10 per cent. IFRSs changes to
the treatment of preference share dividends led to a
US$275 million reduction in pre-tax profits. On an
underlying basis, pre-tax profits grew by 25 per cent
and represented around 30 per cent of HSBC’s
equivalent total profits. In the UK, strong revenue
growth in Personal Financial Services and good cost
discipline were partially tempered by a weaker credit
experience. A quadrupling of pre-tax profits in
Turkey reflected the strong growth in customer
acquisition and retention achieved in the country. In
Commercial Banking, HSBC’s strong service
proposition attracted a 5 per cent growth in
customers with consequent growth in deposits,
receivables and service revenues. Corporate,
Investment Banking and Markets delivered strong
revenue growth in Europe, notably in client-related
trading activities, Global Transaction Banking and
securities services. In aggregate, European
Corporate, Investment Banking and Markets’
revenues grew by 15 per cent against a 9 per cent
increase in operating expenses.
The commentary that follows is on an
underlying basis.
Personal Financial Services reported a pre-tax
profit of US$1,932 million, an increase of 16 per
cent compared with 2004, driven by revenue growth
39
and productivity improvements in the UK and
expansion in Turkey, where pre-tax profit more than
quadrupled to US$134 million. In France, revenue
growth benefited from the rebranding of CCF and
four subsidiary banks to ‘HSBC France’, with a
notable increase in international products,
particularly mortgage lending to overseas customers.
Continued emphasis was placed on streamlining
the business to improve productivity, and on sales
and channel management, particularly in the UK,
where one third of sales were made through direct
channels in 2005. Attention was also paid to further
simplifying HSBC’s product range in the UK, and on
integrating the Marks and Spencer (‘M&S’) Money
business in its first full year since acquisition. A
number of innovative marketing campaigns and
promotions during 2005 heightened brand
awareness, leading to greater customer consideration
of HSBC products. This was evidenced in strong
balance growth and market share gains across most
major product lines. In Turkey, an emphasis on
business expansion and customer acquisition
delivered increased card sales and utilisation
combined with higher mortgage sales. In France,
marketing campaigns in conjunction with the
rebranding exercise boosted mortgage lending and
sales of insurance and investment products.
Net interest income increased by 10 per cent to
US$5,309 million. This arose substantially in the UK
through increases in mortgage and credit card
lending, and in Turkey, mainly in credit cards.
Increased net interest income from balance sheet
growth in France was offset by spread compression.
Despite a more subdued housing market, net
interest income from UK mortgages increased by
37 per cent, driven by balance growth of 22 per cent
and improvements in customer retention. Spreads
also increased, reflecting the inclusion from
1 January 2005 of fee income within the effective
interest rate calculation under IFRSs. New lending
was strongest in the first time buyer market, where
successful pricing and marketing strategies helped
gain market share of new sales in a market which
contracted overall.
Net interest income from UK credit cards
increased by 24 per cent, driven by balance growth
and the IFRSs impact noted above. Increased card
utilisation by existing customers, as well as new
customers attracted by competitive pricing,
marketing and cross-sales, contributed to an increase
of 16 per cent in average balances. HSBC-branded
cards increased market share of new cards issued;
sales of the John Lewis branded credit card also
increased. Income benefited from the roll-off of
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Europe> 2005
balance transfers introduced in the ‘0 per cent’
campaign at the end of 2004, while more
sophisticated risk-based pricing enabled customer
rates to be differentiated more acutely.
Net interest income from other unsecured
lending in the UK increased by 4 per cent. The
launch of differentiated pricing initiatives in April,
notably through preferential personal lending rate
offers to lower-risk customers, helped boost average
loan balances by 9 per cent, and increase HSBC’s
market share of gross advances from 10.7 to 11.7 per
cent. Focused sales and marketing, notably the
‘January sale’, also contributed to higher balances.
As indebtedness levels grew, growth was curtailed
through a tightening of underwriting criteria in the
more difficult credit environment. The introduction
of preferential pricing, and a mix change towards
higher value but lower-yielding loans, led to a
48 basis point narrowing of spreads.
Recruitment of new current account customers
was strong, and HSBC’s market share of new current
accounts increased to 14.7 per cent, largely through
brand-led awareness and marketing. The launch of
two new current account propositions, including
HSBC’s first value-driven packaged account in the
UK market, and improved cross-sales aided growth
of 6 per cent in overall customer accounts. This led
to an increase in net interest income from UK
current accounts of 5 per cent to US$1.0 billion,
broadly in line with the 6 per cent increase in
average balances.
Sales of new UK savings accounts increased
markedly, and average balances rose by 15 per cent,
driven by a greater front-line focus, competitive
pricing and the launch of new products, including
‘Regular Saver’ and ‘Online Saver’. Included in this
was growth of over US$1.2 billion in First Direct’s
‘e-savings’ product, launched in September 2004.
Net interest income, however, fell by 5 per cent,
largely due to the non-recurrence of the benefit to
spreads from base rate rises in 2004, and a slight
reduction in margin. The latter arose from
competitive pricing initiatives partly designed to
improve brand awareness and widen product
consideration.
In Turkey, innovative marketing initiatives and
advertising campaigns, with an emphasis on
attracting new customers, contributed to strong
growth in net interest income, which more than
doubled compared with 2004. Average card balances
increased by 66 per cent to US$0.9 billion, and
average mortgage balances more than doubled to
US$0.6 billion. Higher card usage by existing
customers, higher average mortgage advances and a
40
7 per cent increase in overall customer numbers
contributed to the growth.
In France, net interest income was broadly in
line with 2004. Marketing campaigns in the run-up
to the rebranding exercise contributed to a 54 per
cent increase in mortgage sales in a buoyant market,
and a resultant 18 per cent increase in average
balances. Cross-sales of current and special
regulated savings accounts were strong, and
average deposit balances grew by 4 per cent to
US$14.9 billion. The benefit of this balance sheet
expansion was largely offset by lower spreads, as
competitive pricing reduced yields on lending
products, and the maturing of older, higher-yielding
investments reduced the funding benefit from
deposits.
Excluding net interest income, net operating
income before loan impairment charges grew by
16 per cent to US$3,386 million, of which
12 percentage points was in the UK and largely
attributable to increased fees associated with the
increase in personal lending, mortgage and credit
card volumes described above. Increased card
utilisation also led to higher cash advance fees and
currency conversion income. An improved
investment fund offering, following the
depolarisation of the previously tied sales force, was
reflected in a 5 per cent increase in related
commissions. In Turkey, fee income benefited from
increased lending activity. In France, privatisations
boosted brokerage income, and new product
launches and marketing aided growth in insurance
and investment sales.
Under IFRSs, changes in presentation from
1 January 2005, notably for certain contracts
previously accounted for as insurance, and with the
designation of insurance-related assets at fair value,
caused large movements within certain individual
income lines. These had a negligible effect on
income overall. There was also a US$32 million gain
from the fair value measurement of options linked to
French home-savings products.
Loan impairment charges of US$1,711 million
were 73 per cent higher than 2004, the majority of
which occurred in the UK. In large part, this
reflected the strong growth in higher margin credit
card and other unsecured lending in recent years.
Weakening economic conditions and sharply rising
personal bankruptcies, following the change in
legislation in 2004, were also significant
contributors.
Loan impairment charges as a percentage of
period end net customer advances rose from 0.8 per
cent to 1.4 per cent.
HSBC responded to the weaker UK credit
environment by further refining its credit eligibility
criteria, and by enhancing its credit scorecards with
full positive credit reference data. HSBC became the
first UK high street clearing bank to share full
customer credit performance data in 2005.
Underwriting activity was also further centralised.
Collections capabilities were enhanced, resulting in
an increase in amounts collected, and resources were
added to the Retail Credit Risk Management
function. As a result, lending activity in the second
half of the year indicated that the credit quality of
more recent unsecured lending had improved.
Higher charges in Turkey were broadly in line
with balance sheet growth, while credit quality in
France remained sound.
Operating expenses were largely unchanged
from 2004. The 7.5 percentage point fall in the cost
efficiency ratio, to 58 per cent, was largely driven by
productivity improvements in the UK. This reflected
the benefits of the cost reduction strategy introduced
in 2004. Increased focus on direct channels, and the
greater centralisation of support functions enabled by
this, reduced the UK cost base in 2005, which also
benefited from the non-recurrence of the
restructuring costs incurred in implementing this
strategy. Costs in 2004 also included amounts for
compensation expected to be payable to UK
customers for shortfalls on certain mortgage
endowment policies and investment products.
Operating expenses in 2005 included the initial
phase of a UK branch refurbishment programme
designed to improve customer experience, which
added US$73 million to costs.
In France, a 2 per cent increase in operating
expenses was driven by the recruitment of additional
sales staff, as well as the rebranding exercise and
associated marketing expenditure. In Turkey,
marketing costs increased by 30 per cent and staff
costs by 33 per cent, largely in support of the
growing credit card business.
Commercial Banking reported a pre-tax profit
of US$1,939 million, an increase of 18 per cent. In
highly competitive markets, revenues grew by
6 per cent and profit improvement largely reflected
reduced costs, more than offsetting higher loan
impairment charges.
In the UK, improved market segmentation led to
a more acute focus on the needs of individual
customers and underpinned a 20 per cent increase in
pre-tax profits. The establishment in 2004 of
Corporate Banking Centres to improve the service
offered to MMEs, and Commercial Centres focusing
on larger SMEs, together with the recruitment of
41
additional sales staff, contributed to a 6 per cent
increase in customers and strong growth in lending.
Revenues responded strongly, and costs were lower
following a reorganisation in the UK in 2004 to
improve efficiency. UK credit quality experienced
some weakening in the fourth quarter of 2005,
reflecting higher interest rates and the resulting
slowdown in consumer spending. However, the
quality of HSBC’s commercial lending book
remained strong overall with impairment charges
continuing to run below historical levels: as in prior
periods, loan impairment charges principally
reflected allowances against a small number of
accounts.
Net interest income increased by 16 per cent. In
the UK, lending and overdraft balances increased by
23 per cent, or US$6.6 billion, as a result of strong
customer demand. HSBC increased its lending
market share, with particularly strong growth in the
property, distribution and services sectors. In invoice
financing, a 12 per cent increase in customer
numbers supported by a sales force realignment led
to higher balances and a 10 per cent increase in net
interest income. Risk-based pricing improved
overdraft spreads by 15 basis points, while term
lending margins were in line with 2004.
A campaign designed to secure a greater share
of the commercial savings market, in part through
more competitive pricing, contributed to an 11 per
cent increase in UK deposit balances, with spreads
falling by 16 basis points. Overall, UK commercial
customer liability balances benefited from both
deposit growth and a 12 per cent increase in current
account balances. Current account customer numbers
rose to over 700,000 with over 20,000 customers
switching their business to HSBC following
marketing and advertising campaigns in 2005. In the
UK, HSBC attracted over 90,000 start-up accounts,
representing a 20 per cent market share. Spreads on
sterling current accounts fell as customers continued
to migrate to interest-paying current accounts.
Increases in US interest rates led to a widening of
spreads on international and foreign currency current
accounts.
Net interest income in Turkey increased by
29 per cent, principally as a result of higher lending
and deposit balances, which increased by 25 per cent
and 19 per cent respectively. HSBC deepened its
relationships with its larger commercial banking
customers and recruited additional sales staff to
support the launch of SME banking in the second
half of 2005.
In France, increased marketing activity
highlighting HSBC’s international capabilities as
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Europe > 2005
CCF rebranded to HSBC France, together with a
programme to align the bank’s 350 largest
Commercial Banking customers with the most
experienced relationship managers, led to a 10 per
cent increase in medium term loan balances. Sight
deposit balances grew by 7 per cent, though deposit
spreads decreased as maturing funds were placed at
lower prevailing interest rates.
Net fee income increased by 2 per cent to
US$1,621 million, net of IFRSs changes to switch
some fees into the effective interest rate calculation,
which led to a 15 per cent reduction in fee income.
In the UK, higher new business volumes and lending
activity contributed to a US$77 million, or 27 per
cent, increase in loan and overdraft fee income.
Increased customer numbers, coupled with the
introduction of a new small business tariff in January
2005, led to a 13 per cent increase in current account
fee income. Card acquiring income increased by
8 per cent, despite a slowdown in consumer
spending driven by a 6 per cent increase in
transaction volumes, reflecting merchant acquisition.
A 21 per cent increase in card customer numbers
contributed to higher card issuing income.
HSBC benefited from the recruitment of
additional sales staff, development of profitable
relationships with brokers and the success of
dedicated corporate and commercial centres. Invoice
financing fee income increased by 9 per cent,
benefiting from an expanded client base, while a
tariff review contributed to a 16 per cent increase in
treasury income. The recruitment, in both 2004 and
2005, of commercial independent financial advisers,
together with the development of existing sales staff,
led to a 13 per cent increase in insurance and
investment income, with fee income from savings
and investment products increasing by a third.
Income in the vehicle and equipment leasing
businesses decreased by 13 per cent, following an
agreement to outsource the operational functions of
the UK vehicle finance contract hire business to Lex
Vehicle Leasing, which took effect from November
2005. Excluding the transfer, net fee income from
leasing increased by 5 per cent.
Loan impairment charges and other credit
risk provisions increased by 26 per cent to
US$378 million. In the UK, lending growth and
sizeable allowances against a small number of
accounts led to a US$162 million increase in
charges. Overall credit quality remained relatively
strong, although some deterioration was evident in
the market in the last three months of 2005 as
consumer spending declined. In France, new
individually assessed allowances were largely offset
by higher recoveries, while in Malta net releases
42
decreased as a large release against a single customer
in 2004 was not repeated.
Operating expenses decreased by 5 per cent and,
together with increased income, resulted in a
6 percentage point improvement in the cost
efficiency ratio. In the UK, the non-recurrence of
cost reduction expenditure in 2004, together with the
resulting fall in staff numbers and strong cost
control, contributed to a 10 per cent decrease in
operating expenses. Although overall staff numbers
declined, additional sales staff were hired to take
advantage of business opportunities in support of
revenue growth. These sales staff were supported by
press and other advertising campaigns aimed at
attracting customers switching banks and start-up
businesses to HSBC, together with a campaign
targeting SMEs which contributed to an increase in
marketing costs.
In France, staff recruitment, increased marketing
activity and re-branding led to an 8 per cent increase
in costs. Staff costs rose as HSBC France recruited
additional sales staff to support business expansion,
and success led to higher performance-related
remuneration. Campaigns targeting top tier
commercial customers and supporting product
launches led to an increase in marketing expenditure,
while rebranding and supporting activity to
emphasise the ‘HSBC’ name change also
contributed.
In an economy which grew by 5.5 per cent in
2005, increased business activity, the launch of SME
banking and the recruitment of additional sales and
support staff in Turkey contributed to a rise in
income and a 17 per cent increase in operating
expenses.
Corporate, Investment Banking and Markets
reported a pre-tax profit of US$2,114 million, an
increase of 27 per cent, compared with 2004.
Revenues from all major client-related trading
activities increased, particularly from the credit and
rates, equities and structured derivatives businesses
where HSBC has invested in upgrading its
capabilities. Operating expenses rose, reflecting the
first full-year cost of the expanded sales and
execution capabilities. However, cost growth slowed
in the second half of 2005 and in aggregate in
Europe, revenue growth comfortably surpassed
growth in costs. In Europe, 2005 marked the
transition from the investment phase of Corporate,
Investment Banking and Markets’ development
strategy to a focus on implementation.
Total operating income increased by 15 per cent
to US$5,510 million. Balance sheet management and
money market revenues declined by approximately
46 per cent reflecting a challenging interest rate
environment of higher short-term rates and a
flattening yield curve.
Corporate lending spreads remained under
pressure as customers refinanced and negotiated
better terms in response to falling credit spreads on
virtually all publicly traded debt instruments and
strong liquidity in the banking system. In the UK,
the adverse impact of a 23 basis point decrease in
spreads on customer lending was partly mitigated by
a 7 per cent increase in lending balances. Corporate
and Institutional Banking also implemented a
balance sheet securitisation programme to enhance
returns. In Global Transaction Banking, net interest
income increased, primarily due to an increase in
balances held on behalf of customers, coupled with
the favourable impact of rising short-term rates.
Customer deposit balances increased by 23 per cent
and spreads improved by 9 basis points.
Net fees rose by 7 per cent, partly due to an
increase in earnings from the equity capital markets
business. Additionally, as equity markets became
more buoyant, HSBC Securities Services fees
increased and assets under custody grew by
15 per cent to US$3,242 billion, primarily due to
new business and market value appreciation. The
asset-backed securities product also generated higher
fees with several notable transactions closing in
2005. In Germany, a 31 per cent rise in net fees was
driven by origination activity and higher sales of
structured solutions.
The increase in income from trading activities
arose from positive revenue trends on core products
within Global Markets in response to the investment
made in client-facing trading capabilities. Fixed
income revenues were boosted by higher volumes
processed through electronic trading platforms and
by the expansion of primary dealing activity in
European government bond markets. In the UK, a
strong performance in structured derivatives
reflected investment in new hybrid derivatives and
structured fund derivatives businesses, while income
in the credit and rates business rose by 25 per cent as
a result of higher revenues from securities trading,
asset-backed securities and credit default swaps.
There was growth in income from currency
derivatives on the back of increasing client business.
Other income was boosted by gains from the
restructuring and syndication of existing assets in
Global Investment Banking.
Gains from sales of financial investments
increased significantly to US$396 million, due to
higher realisations from Private Equity.
43
The overall credit environment remained
favourable, with a net recovery in 2005 as in 2004.
There were, however, lower recoveries of loan
impairment charges in the UK and France, as HSBC
had benefited from a number of successful
refinancings in 2004. In Italy, a net recovery
reflected relatively lower allowances against loan
impairment, coupled with releases of provisions
made in 2004.
Operating expenses increased by 9 per cent to
US$3,647 million, partly from the first full year
effect of recruitment in 2004 and partly from a
further 980 people recruited in 2005 to deliver the
expanded capabilities reflected in the revenue gains
described above. Extensive investment was also
made to develop the infrastructure and technology
platform required to integrate and support the
business expansion. In Global Markets, costs rose as
new capabilities were added to the cash equities
platform, the structured derivatives business in the
UK and the credit and rates business. An increase in
operational costs, particularly in Global Transaction
Banking, was due to higher transaction volumes.
Private Banking reported a pre-tax profit of
US$539 million, an increase of 23 per cent
compared with 2004, driven by strong growth in
client assets, transaction volumes and the lending
book. Operating expenses rose with a recruitment-
driven increase in staff costs partly offset by
efficiency savings and the non-recurrence of
restructuring costs in France in 2004.
Net interest income increased by 31 per cent,
driven by strong balance sheet growth in the UK,
Switzerland and, to a lesser extent, Germany.
Overall, lending balances increased by 21 per cent to
US$16.7 billion, as clients borrowed in the low
interest rate environment to make alternative
investments. This included strong growth in UK
mortgage balances, which increased by 39 per cent,
in part reflecting synergies with HSBC’s residential
property advisory business. Deposits increased by
20 per cent to US$38.6 billion, as new clients placed
cash prior to investment.
Client assets, including deposits, increased by
22 per cent to US$174.7 billion. Net new money of
US$23.4 billion reflected notably strong inflows in
Switzerland, Germany, Monaco and the UK. In
Switzerland, an increased marketing effort and
successful product placement aided net new money
of US$9.6 billion. In Germany, US$7.6 billion of
new money was predominantly due to the success of
a new wealth management team. In Monaco, a focus
on building the onshore business generated inflows
of US$4.1 billion, while in the UK, cross-referrals
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Europe > 2005 / Profit/(loss) before tax
with the wider Group contributed to nearly one
quarter of the US$1.6 billion of new money.
A US$20 million lower performance fee from a
public equity fund dedicated to Russia was more
than offset by increased core fees and commissions
in line with growth in client assets, and transactional
income as new clients invested. Higher fee income
also reflected growth in discretionary and advisory
managed assets, and volume growth, which was
boosted by the success of new products launched in
2005, notably in alternative investments. Gains from
financial investments in both 2004 and 2005 were
mainly on the sale of debt instruments. The overall
gain in 2005 of US$27 million was 17 per cent lower
than in the previous year.
The net release of loan impairment charges in
2005 related largely to specific clients; improved
credit quality overall also led to a release of
collective impairment provisions.
Operating expenses rose by 11 per cent, of
which front office recruitment and increased
performance-related remuneration comprised 4 and
5 percentage points respectively. Investment costs,
largely in IT and marketing, and supporting business
growth contributed further to the increase. These
were in part offset by back office efficiency savings
and lower restructuring costs following 2004’s
merger of HSBC’s four French private banks.
Within Other, net operating income benefited
from the change to the presentation of inter-company
preference share dividends received from
Hong Kong under IFRSs from 1 January 2005.
Head office operating expenses increased, reflecting
higher brand advertising and marketing costs,
increased professional fees incurred to comply with
additional regulatory requirements including
Sarbanes-Oxley and Basel II, and restructuring costs.
In 2004, operating expenses benefited from the
release of litigation provisions.
44
Profit/(loss) before tax by customer groups and global businesses
Personal
Financial
Services
US$m
5,653
2,533
Commercial
Banking
US$m
2,923
1,707
119
(6)
113
80
37
2
979
128
9,525
(331)
27
15
42
27
22
3
110
103
4,937
(19)
Year ended 31 December 2006
Corporate,
Investment
Banking &
Markets
US$m
Private
Banking
US$m
Other
US$m
1,222
1,673
2,636
(523)
2,113
11
413
171
–
957
675
869
99
2
101
–
149
5
–
13
6,560
1,812
14
326
(39)
1
(38)
26
3
2
209
256
798
–
–
(181)
Inter-
segment
elimination
US$m
(2,198)
–
–
2,198
2,198
–
–
–
–
(29)
(29)
–
Total
US$m
8,289
7,108
2,842
1,687
4,529
144
624
183
1,298
1,428
23,603
(531)
9,194
4,918
6,560
1,812
617
(29)
23,072
Europe
Net interest income .....................
Net fee income ............................
Trading income/(expense)
excluding net interest income
Net interest income/(expense)
on trading activities ................
Net trading income/(expense) ....
Net income from financial
instruments designated at
fair value .................................
Gains less losses from financial
investments .............................
Dividend income .........................
Net earned insurance premiums .
Other operating income ..............
Total operating income ............
Net insurance claims1 .................
Net operating income before
loan impairment charges
and other credit risk
provisions ..............................
Loan impairment (charges)/
recoveries and other credit
risk provisions ........................
Net operating income ...............
(2,155)
20,917
(13,871)
7,046
(72)
6,974
%
31.5
60.1
US$m
392,499
828,701
419,365
(1,838)
7,356
(386)
4,532
Total operating expenses ............
(5,447)
(2,298)
Operating profit/(loss) ..............
1,909
2,234
Share of profit/(loss) in
associates and joint ventures ..
–
–
Profit/(loss) before tax ..............
1,909
2,234
Share of HSBC’s profit
before tax ................................
Cost efficiency ratio ....................
%
8.6
59.2
%
10.1
46.7
64
6,624
(4,224)
2,400
(96)
2,304
%
10.4
64.4
2
1,814
(1,010)
804
1
805
%
3.6
55.7
3
620
(921)
(301)
23
(278)
%
(1.2)
149.3
–
(29)
29
–
–
–
Selected balance sheet data2
Loans and advances to
customers (net) .......................
Total assets ..................................
Customer accounts ......................
The following assets and
liabilities were significant
to Corporate, Investment
Banking and Markets:
– loans and advances to
banks (net) ..........................
– trading assets, financial
instruments designated at
fair value, and financial
investments .........................
– deposits by banks ................
US$m
US$m
US$m
US$m
US$m
147,507
174,865
152,411
81,430
98,073
80,312
140,277
502,340
139,416
23,283
49,440
47,223
2
3,983
3
63,788
219,304
65,963
45
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Europe > Profit/(loss) before tax
Profit/(loss) before tax by customer groups and global businesses (continued)
Year ended 31 December 2005
Europe
Personal
Financial
Services
US$m
Commercial
Banking
US$m
Corporate,
Investment
Banking &
Markets
US$m
Net interest income .....................
Net fee income ............................
5,309
2,314
2,659
1,621
Private
Banking
US$m
548
730
Other
US$m
95
295
827
1,339
1,493
159
1,652
17
396
27
–
1,252
5,510
–
93
–
93
–
27
9
–
18
1,425
81
3
84
305
(4)
2
1,220
42
9,272
(577)
16
2
18
71
4
7
115
178
4,673
(62)
Inter-
segment
elimination
US$m
(1,217)
–
–
(23)
(5)
1,217
(28)
1,217
(31)
16
18
264
329
958
–
–
–
–
(216)
(216)
–
Total
US$m
8,221
6,299
1,660
1,376
3,036
362
439
63
1,599
1,603
21,622
(818)
–
(179)
8,695
4,611
5,510
1,425
779
(216)
20,804
Trading income/(expense)
excluding net interest income
Net interest income/(expense)
on trading activities ................
Net trading income/(expense) ....
Net income/(expense) from
financial instruments
designated at fair value ...........
Gains less losses from financial
investments .............................
Dividend income .........................
Net earned insurance premiums .
Other operating income ..............
Total operating income ...............
Net insurance claims1 .................
Net operating income before
loan impairment charges and
other credit risk provisions .....
Loan impairment (charges)/
recoveries and other credit
risk provisions ........................
Net operating income .................
–
(1,929)
(216)
18,875
216
(12,639)
–
–
–
6,236
120
6,356
%
30.3
60.8
US$m
312,537
636,703
334,200
(1,711)
6,984
(378)
4,233
Total operating expenses ............
(5,058)
(2,301)
Operating profit/(loss) ................
1,926
1,932
Share of profit in associates
and joint ventures ...................
6
7
Profit/(loss) before tax ................
1,932
1,939
Share of HSBC’s profit
before tax ................................
Cost efficiency ratio ...................
%
9.2
58.2
%
9.2
49.9
155
5,665
(3,647)
2,018
96
2,114
%
10.1
66.2
5
1,430
(891)
539
–
539
%
2.6
62.5
–
779
(958)
(179)
11
(168)
%
(0.8)
122.9
Selected balance sheet data2
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) ..........................
– trading assets, financial
instruments designated at
fair value, and financial
investments .........................
– deposits by banks ...............
US$m
US$m
US$m
US$m
US$m
120,302
143,095
122,118
66,965
80,864
61,789
107,899
367,893
109,086
17,368
40,971
41,206
3
3,880
1
34,218
168,062
45,075
46
Year ended 31 December 2004
Personal
Financial
Services
US$m
Commercial
Banking
US$m
Corporate,
Investment
Banking &
Markets
US$m
Private
Banking
US$m
Inter-
segment
elimination
US$m
Other
US$m
4,644
2,110
–
445
–
–
1,254
26
8,479
2,305
1,593
116
127
1
36
409
285
4,872
(487)
1,403
1,261
735
–
122
526
12
770
421
658
104
–
33
5
–
19
325
358
42
(1)
(2)
(9)
200
255
4,829
1,240
–
–
1,168
(115)
–
–
–
–
–
–
–
(180)
(180)
–
7,453
4,385
4,829
1,240
1,053
(180)
18,780
Europe
Net interest income .....................
Net fee income ............................
Trading income ...........................
Net investment income/
(expense) on assets backing
policyholders’ liabilities .........
Gains less losses from financial
investments .............................
Dividend income/(expense) ........
Net earned insurance premiums .
Other operating income ..............
Total operating income ...............
Net operating income before
loan impairment charges and
other credit risk provisions .....
Loan impairment (charges)/
recoveries and other credit
risk provisions ........................
Net operating income .................
Net insurance claims1 ..................
(1,026)
(939)
6,514
(306)
4,079
(2,422)
1,657
Total operating expenses ............
(4,898)
Operating profit ..........................
1,616
Share of profit in associates
and joint ventures ...................
5
6
Profit before tax ..........................
1,621
1,663
Share of HSBC’s profit
before tax ................................
Cost efficiency ratio ...................
%
8.6
65.7
%
8.8
55.2
207
5,036
(3,380)
1,656
12
1,668
%
8.8
70.0
4
1,244
(806)
438
–
438
%
2.3
65.0
1
1,054
(702)
352
14
366
%
1.9
66.7
–
(180)
180
–
–
–
Total
US$m
9,098
5,980
997
571
154
558
1,875
1,175
20,408
(1,628)
(1,033)
17,747
(12,028)
5,719
37
5,756
%
30.4
64.0
US$m
277,560
545,557
292,568
Selected balance sheet data2
Loans and advances to
customers (net) .......................
Total assets .................................
Customer accounts ......................
The following assets and
liabilities were significant
to Corporate, Investment
Banking and Markets:
– loans and advances to
banks (net) ..........................
– trading assets, financial
instruments designated at
fair value, and financial
investments .........................
– deposits by banks ...............
US$m
US$m
US$m
US$m
US$m
118,796
143,515
121,599
67,458
83,289
57,798
75,628
273,906
78,031
15,676
40,140
35,140
2
4,707
–
47,802
116,492
53,646
1 Net insurance claims incurred and movement in policyholders’ liabilities.
2 Third party only.
47
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Hong Kong > 2006
Hong Kong
Profit/(loss) before tax by customer groups and global businesses
Year ended 31 December
2006
US$m
2,880
1,321
955
201
(175)
5,182
2005
US$m
2,628
955
922
190
(178)
4,517
Year ended 31 December
2004
US$m
2,063
904
1,603
131
129
4,830
2004
US$m
3,638
1,703
659
–
314
175
27
2,247
536
9,299
2005
US$m
4,064
1,674
546
(6)
–
108
41
2,334
805
9,566
(2,059)
(2,154)
7,507
(146)
7,361
(2,867)
4,494
23
4,517
%
21.5
38.2
25,931
US$m
83,208
42,751
81,631
235,376
4,708
173,726
7,145
220
7,365
(2,558)
4,807
23
4,830
%
25.5
35.8
25,552
US$m
78,824
45,710
75,721
225,336
4,325
178,033
2006
US$m
4,685
2,056
617
260
–
162
61
2,628
834
11,303
(2,699)
8,604
(172)
8,432
(3,269)
5,163
19
5,182
%
23.5
38.0
27,586
US$m
84,282
50,359
103,734
272,428
4,799
196,691
Personal Financial Services .............................................................................
Commercial Banking .......................................................................................
Corporate, Investment Banking and Markets ..................................................
Private Banking ...............................................................................................
Other .................................................................................................................
Profit before tax
Net interest income ..........................................................................................
Net fee income .................................................................................................
Trading income ................................................................................................
Net income/(expense) from financial instruments designated at fair value ...
Net investment income on assets backing policyholders’ liabilities ..............
Gains less losses from financial investments ..................................................
Dividend income ..............................................................................................
Net earned insurance premiums ......................................................................
Other operating income ...................................................................................
Total operating income .................................................................................
Net insurance claims incurred and movement in policyholders’ liabilities ....
Net operating income before loan impairment charges and other
credit risk provisions .................................................................................
Loan impairment (charges)/recoveries and other credit risk provisions ........
Net operating income ....................................................................................
Total operating expenses .................................................................................
Operating profit .............................................................................................
Share of profit in associates and joint ventures ...............................................
Profit before tax .............................................................................................
Share of HSBC’s profit before tax ..................................................................
Cost efficiency ratio ........................................................................................
Year-end staff numbers (full-time equivalent) ................................................
Selected balance sheet data1
Loans and advances to customers (net) ...........................................................
Loans and advances to banks (net) ..................................................................
Trading assets, financial instruments designated at fair value, and
financial investments ...................................................................................
Total assets ......................................................................................................
Deposits by banks ............................................................................................
Customer accounts ...........................................................................................
1 Third party only.
48
Year ended 31 December 2006 compared
with year ended 31 December 2005
Economic briefing
Hong Kong experienced sustained economic
expansion in the second half of 2006 with growth,
particularly in exports, regaining momentum
following a mild slowdown in the second quarter.
Domestic demand underpinned the economy
throughout 2006 despite volatility in the stock
market, which suffered a correction in the second
quarter but recovered strongly in the second half of
the year. Falling unemployment, improved
household incomes and positive longer-term
economic prospects were the key elements
supporting domestic consumption. Hong Kong’s
unemployment rate fell to a six-year low of 4.4 per
cent towards the end of 2006, and the labour market
began to tighten in certain sectors, with wage
pressure increasingly evident. Despite this, inflation
remained low, averaging 2 per cent in 2006.
Investment growth surged in the second half of the
year as the local interest rate cycle peaked. The
residential property market divided, with prices of
luxury property exceeding levels last seen in the
boom in 1997 while, elsewhere in the sector, activity
and prices remained flat. At the same time,
investment in the construction sector was weak in
the absence of large-scale infrastructure projects and
general uncertainty. Externally, trade performance
improved in the second half of 2006 following
difficulties in the first half of the year due to volatile
external demand from western markets.
Review of business performance
HSBC’s operations in Hong Kong reported a pre-tax
profit of US$5,182 million compared with
US$4,517 million in 2005, an increase of 15 per
cent. On an underlying basis, pre-tax profit also grew
by 15 per cent. Underlying net operating income
increased by 14 per cent, driven by widening deposit
spreads in Personal Financial Services and
Commercial Banking and strong net fee income
growth in all customer groups. In Corporate,
Investment Banking and Markets, an increase in
trading income offset the negative impact of lower
balance sheet management income. Underlying
operating expenses rose by 14 per cent.
The following commentary is on an underlying
basis.
Personal Financial Services pre-tax profits
increased by 9 per cent to US$2,880 million. Net
operating income before impairment charges grew
by 13 per cent, driven by higher income from
savings and current accounts and increased fee
49
income. Marketing activities were successful,
helping HSBC enlarge its share of the credit card
and mortgage markets and attract higher deposit
balances. As a result, customer numbers increased
by over 100,000. The cost efficiency ratio improved
by 1.1 percentage points as cost growth of 9 per cent
was restricted to less than the increase in net
revenue. Credit quality remained favourable and
loan impairment charges were low, although higher
than in 2005 when a modest recovery was recorded.
Net interest income of US$2,882 million was
10 per cent higher than in 2005, principally as a
result of deposit growth and wider liability spreads.
Average savings balances increased by 7 per cent to
US$119 billion, reflecting the success of
promotional campaigns and HSBC’s competitive
pricing strategy, and supported by increased demand
for deposit products in the rising interest rate
environment. Effective deposit pricing amid rising
interest rates led to wider deposit spreads.
HSBC increased its share of new mortgage
business to 33 per cent, the highest of any lender,
benefiting from the launch of a simplified,
transparent pricing structure in the first half of
2006 which was supported by extensive media
coverage. The relaunch of a number of key products
and the introduction of a two-month interest free
offer in the fourth quarter of 2006 also contributed to
the increase in market share. Excluding the reduction
in balances under the Government Home Ownership
Scheme (‘GHOS’), HSBC’s mortgage portfolio grew
by 7 per cent to US$23 billion.
Average cardholder balances increased by
16 per cent to US$3.5 billion and HSBC issued over
1 million new cards during 2006, which led to a
17 per cent rise in cards in issue to a record
4.6 million. The launch of a mass card acquisition
programme comprising increased promotional
activity, direct marketing and the use of incentives to
increase cardholder spending contributed directly to
this rise. As a result, HSBC’s share of the Hong
Kong credit card market increased to 46 per cent of
card receivable balances.
Net fee income increased by 32 per cent to
US$977 million. Buoyant regional and global stock
markets led to increased demand for equity-based
products among local investors and HSBC
responded by launching 69 new investment funds,
including a number of innovative fund products,
designed to meet investors’ changing demands in a
rising interest rate environment. These launches
were supported by greater marketing activity,
improved pricing transparency and the development
of new customer retention activities. As a result,
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Hong Kong > 2006
sales of unit trusts rose by 61 per cent and fee
income from the sale of investment products, and
custody and broking activities increased by 39 per
cent.
The increase in cards in issue led to a 24 per
cent rise in credit card fees. Expansion of the current
account base, partly due to higher sales of packaged
products, led to increased remittance and account
servicing fees. HSBC focused on attracting
additional funds from existing Premier customers
during 2006 and deposits managed on their behalf
increased by 29 per cent, reflecting the success of
marketing campaigns and enhanced customer
benefits.
Insurance fee income increased by 21 per cent
and insurance premiums rose by 13 per cent. The
development of HSBC’s retirement planning
proposition was reflected in the launch of new
savings, protection and medical insurance products,
supported by increased promotional and marketing
activity and the successful development of internet
and telephone distribution channels. As a result,
sales of life and non-life insurance products rose.
Gains less losses from financial investments
increased to US$14 million, reflecting proceeds from
the MasterCard Incorporated IPO. In July 2006,
HSBC transferred most of its Asian card acquiring
business into a joint venture with Global Payments
Inc. HSBC retained a 44 per cent stake in the new
venture and recognised an overall gain on transfer of
US$55 million, of which US$12 million was
allocated to the Hong Kong Personal Financial
Services business and reported in ‘Other operating
income’.
Following a net release in 2005, loan
impairment charges of US$119 million reflected
asset growth and lower releases and recoveries. In
2005, rising property prices led to the release of
impairment allowances against HSBC’s mortgage
lending portfolio and against restructured lending
facilities, neither of which were repeated in 2006.
Increased staff numbers, additional marketing
activity and higher IT expenditure led to a 9 per cent
rise in operating expenses. Staff recruited to support
extended opening hours, together with higher
performance-related remuneration and annual pay
rises, led to increased employment costs. These were
mitigated by a reduction in branch back-office staff
numbers as customers utilised lower-cost
distribution channels for an increasing proportion of
their banking business. Rising Hong Kong
commercial property rental yields in 2006 coincided
with the expansion of certain branches with high
growth potential and resulted in higher premises
50
costs. Marketing costs rose in support of promotional
activity related to credit cards, insurance and wealth
management products. Similarly, IT expenditure
rose as improved portfolio management systems and
enhanced channel capabilities were delivered in
order to drive revenue growth.
In Commercial Banking, pre-tax profits
increased significantly by 38 per cent to
US$1,321 million. Net operating income grew by
32 per cent, driven by higher deposit balances and
fee income, increased liability spreads and lower
loan impairment charges. Cost growth was
comfortably within the growth in revenues, and the
cost efficiency ratio improved by 1.1 percentage
points to 26.1 per cent.
During 2006, HSBC launched a number of
initiatives designed to further its position in the small
business banking market, including customer service
enhancements, improvements to account opening
procedures and targeted promotional activity. As a
result, Commercial Banking customer numbers
increased (by 13,000 to 377,000), as did the number
of products sold per customer. Investments to
enhance the attractiveness of HSBC’s distribution
channels improved customer service, facilitated
customer acquisition and encouraged the migration
of routine transactions to automated channels.
Net interest income rose by 23 per cent to
US$1,344 million. Deposit and current account
balances increased by 10 per cent, partly due to the
deployment of a team dedicated to attracting
deposits from small businesses, and other service
enhancements. BusinessVantage, HSBC’s market
leading integrated account for business, reinforced
its leadership position through increased promotional
activity, including a new referral programme. HSBC
opened over 25,000 new BusinessVantage accounts
in 2006, 21 per cent more than in 2005. Interest rate
rises led to a 30 basis point widening of deposit and
current account spreads and contributed to increased
demand for savings products.
Non-trade lending balances increased by 16 per
cent to US$16.8 billion. The continued strength of
the Hong Kong economy and, most importantly, its
proximity to the strongly growing mainland Chinese
market, led to increased business activity among
mid-market clients, resulting in higher demand for
credit. Lending to the property and retail sectors was
particularly strong, while manufacturers with
operations in mainland China raised borrowings to
fund further expansion and take advantage of both
the growing Chinese domestic market and the strong
export climate. HSBC’s regional alignment
programme, which is designed to identify and
capitalise on cross-border financing opportunities
between Hong Kong, mainland China, Taiwan and
Vietnam was instrumental in contributing to the
growth in mid-market lending balances.
Growth in small business lending was facilitated
through a streamlined lending process and the
adoption of a new credit scorecard. As a result, the
number of small business customers borrowing from
HSBC increased by 12 per cent and small business
lending balances rose by 9 per cent. Increased
competition led to a 12 basis point narrowing of
asset spreads.
Net fee income of US$454 million was 13 per
cent higher than in 2005. Cash management and
remittance fees increased by 18 per cent, driven by
growth in the number of current account customers,
enhancements to the product range and increased
cross-border remittances. Robust local equity
markets prompted the launch of 88 new investment
products amid resurgent demand. Sales of unit trusts
were consequently 15 per cent higher, while
derivative and structured product sales rose by
83 per cent.
The establishment of a new Commercial
Banking insurance business in October 2005
contributed to life insurance policy sales more than
doubling and an 18 per cent rise in non-life policies
in force. As a result, insurance fee income more than
doubled and premium income increased by 23 per
cent.
Effective promotion contributed to a 31 per cent
rise in receivables finance fee income, while
increased hedging activity and a rise in the value of
multi-currency transactions by Commercial Banking
customers contributed to a 57 per cent increase in
treasury income.
The transfer of the majority of HSBC’s card
acquiring business into a joint venture with Global
Payments Inc. realised a gain of US$13 million for
Commercial Banking, reported in ‘Other operating
income’. Fee income in HSBC’s remaining card
acquiring business not included in the transfer rose
by 43 per cent, reflecting an increase in the number
of merchant customers and higher transaction values.
Loan impairment charges decreased by 59 per
cent, principally due to the non-recurrence of
significant charges against a single client in 2005.
Credit quality remained strong and non-performing
loans as a proportion of lending balances fell by
22 basis points to 62 basis points, reflecting prudent
lending policies and risk mitigation procedures.
Operating expenses increased by 17 per cent to
US$491 million to support the strong revenue
51
opportunities evident in the market. The recruitment
of additional sales and support staff and the
development of the Commercial Banking insurance
business contributed to higher staff numbers which,
together with the effect of pay rises, resulted in
higher staff costs. Marketing costs rose as HSBC
stepped up its advertising and promotional activity,
including the launch of the global Commercial
Banking campaign to build market share. Cost
efficiency was improved by the continuing migration
of sales and transaction activity to lower-cost direct
channels.
Corporate, Investment Banking and Markets
reported a pre-tax profit of US$955 million, an
increase of 3 per cent compared with 2005. Global
Markets performance remained robust, with
encouraging revenue growth in areas in which
HSBC has invested, complemented by strong
income growth in the securities services business.
The cost efficiency ratio increased slightly, primarily
due to the first full year effect of various growth
initiatives taken in 2005.
Total operating income of US$1,849 million
was 7 per cent higher. Although balance sheet
management reported an overall decline, revenues
recovered modestly in the second half of 2006 as
lower yielding positions matured. In Global
Banking, net interest income from payments and
cash management activity rose sharply as a 6 per
cent increase in deposits was complemented by
wider spreads. Revenues benefited from improved
customer flows following the launch of services
offered through HSBCnet in the latter part of 2005.
Income from lending activities decreased as the
benefit of higher lending balances was more than
offset by the effect of spread compression resulting
from an abundance of credit in a highly competitive
market.
Net fee income rose by 24 per cent. HSBC
Securities Services reported a 28 per cent increase in
fees as buoyant stock markets drove higher customer
activity. Debt underwriting volumes increased as
tightening credit spreads encouraged issuers to lock
in to the favourable credit environment by extending
the term of finance or by raising new debt in local
markets. By contrast, equity underwriting fees
declined.
Group Investment Businesses used HSBC’s
extensive distribution network to take advantage of
the global trend of strong investment flows to
emerging markets. Higher fees reflected strong
performance fees from HSBC’s emerging market
funds. Client funds under management grew by
23 per cent to US$35 billion, as HSBC launched new
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Hong Kong > 2006 / 2005
funds to capture increased demand for equity-based
investments. Fees from the asset and structured
finance business also rose.
Net trading income increased by 18 per cent.
HSBC retained its leadership position in foreign
exchange, with revenues strengthening as trading
activity increased in response to volatility in the
value of the US dollar and economic conditions in
certain local markets. Investments in equity sales and
trading operations in previous years led to higher
revenues. HSBC also benefited from internal
synergies linking product structuring and hedging
capabilities with distribution scale, as foreign
exchange option-linked deposits and other
instruments were offered to retail and corporate
customers.
Private Equity investments also performed
strongly. However, Credit and Rates were adversely
affected by lower volumes due to unfavourable
market conditions in a rising interest rate
environment.
The overall credit environment remained stable
with a net recovery of US$27 million.
Operating expenses increased by 12 per cent to
US$911 million, primarily due to the first full year
effect of initiatives implemented in the second half
of 2005 which extended the product range in Global
Markets and strengthened the regional investment
banking platform in Hong Kong.
Additional cost increase reflected a rise in
performance-related remuneration coupled with
higher operational costs in line with increased
volumes, particularly in payments and cash
management and securities services businesses.
Private Banking contributed a pre-tax profit of
US$201 million, an increase of 5 per cent compared
with 2005. Growth in client assets and rising sales of
higher fee-generating discretionary managed
products were partially offset by the adverse effect
of a flattening yield curve on income from the
investment of surplus liquidity. Demand for
experienced private banking staff in Hong Kong was
fierce as competitors built up their locally-based
operations and, despite strong revenue growth,
the resultant increase in staff costs led to a
5.2 percentage points deterioration in the cost
efficiency ratio to 49.5 per cent.
Net interest income was US$76 million, in line
with 2005. Steady growth in deposit balances was
offset by competitive pressure on deposit rates and
by a challenging interest rate environment for
treasury management activities. Loans and advances
to customers at 31 December 2006 were marginally
52
lower than at the same point in 2005 as higher
interest rates reduced clients’ appetite for credit.
There was excellent growth in fee income,
which increased to US$123 million, a rise of 31 per
cent. Growth in funds under management and
success in increasing the proportion of clients’ assets
invested in higher fee-earning discretionary managed
assets contributed towards increased fee revenue.
Fee income growth also benefited from increased
client holdings of funds and alternative investments.
Trading and other revenues were 18 per cent higher
at US$199 million, driven largely by sales of bonds
and structured products.
Client assets increased by 27 per cent to
US$51 billion, with net new money inflows of
US$8 billion. This growth was assisted by better
marketing and successful product placement,
including a broadening of the discretionary managed
product range. Sales of HSBC’s discretionary
managed SIS and CIS products, in which the value
of investments by clients reached US$1.4 billion,
continued to be a key driver of this asset class.
Continued investment in relationship management,
improved stock market performance and growing
cross-referrals from within the Group, primarily the
retail and commercial networks, also added to the
growth.
Operating expenses were 31 per cent higher than
in 2005, primarily due to increased staff costs driven
by recruitment and the retention of front office staff
in a competitive market, where demand for
experienced private bankers was high. Performance-
related remuneration rose, reflecting strong revenue
growth and a 19 per cent increase in customer
relationship staff. Increased marketing expenditure
and technology costs were incurred in support of
growing the business.
The sale of part of HSBC’s interest in UTI Bank
Limited resulted in gains of US$101 million,
recognised in Other. The disposal of Hang Seng’s
head office building realised a gain of
US$100 million and the resulting reduction in
HSBC’s investment property portfolio, together with
slower growth in the Hong Kong property market,
led to lower property revaluation gains.
Increased US interest rates led to higher costs of
servicing US dollar denominated floating rate
subordinated debt, partly offset by higher earnings
on centrally held funds. In 2006, HSBC benefited
from higher dividend income from strategic
investments. Hong Kong head office and central IT
costs rose, reflecting increased activity in support of
HSBC’s growing Asian businesses, offset by higher
recoveries from other customer groups.
Year ended 31 December 2005 compared
with year ended 31 December 2004
in deposit spreads as short-term interest rates
increased in a benign credit environment.
Economic briefing
Hong Kong’s economy grew by 7.3 per cent in
2005, down from the growth of 8.6 per cent achieved
in 2004. Robust domestic demand provided strong
support, particularly in the second half of the year,
and external trade maintained its rapid rate of
growth. Despite a substantial rise of more than 3 per
cent in local interest rates in 2005, domestic demand
continued to expand, reflecting a sustained
improvement in business and consumer confidence.
Increased consumer spending, spurred by greater job
security as unemployment fell and improving
household incomes, became a key driver of growth
in the latter part of the year. The rise in domestic
spending more than offset the slower growth in
tourists’ spending which occurred in 2005,
particularly among mainland visitors, and consumer
optimism remained unaffected by a cooling in the
property market induced by the higher interest rate
environment. Hong Kong’s strong export
performance also propelled growth, benefiting from
sustained external demand and foreign importers
building up inventories as trade talks continued on
textile quotas between mainland China and its major
trading partners. Domestic exports also picked up,
reflecting increased local production. In 2005,
inflation rose to 1.1 per cent, mainly driven by
increased demand for property rentals.
Review of business performance
HSBC’s operations in Hong Kong reported a pre-tax
profit of US$4,517 million, compared with
US$4,830 million in 2004. IFRSs changes to the
treatment of preference share dividends led to a
US$387 million decrease in pre-tax profits.
Excluding this, profits increased by 2 per cent.
Subdued profit growth was largely attributable to a
turnaround in loan impairment charges, as 2004
benefited from non-recurring releases from general
provisions, and a fall in balance sheet management
revenues. Pre-tax profits in Hong Kong represented
around 22 per cent of HSBC’s total profit at this
level. In Corporate, Investment Banking and
Markets, balance sheet management revenues were
negatively affected by the influence of short-term
interest rate rises and a flattening yield curve.
Expense growth in Corporate, Investment Banking
and Markets reflected the first full-year effect of the
investment made to support business expansion. Pre-
tax profits of Personal Financial Services and
Commercial Banking grew by 27 per cent and
6 per cent respectively, benefiting from a sharp rise
53
The commentary that follows is on an
underlying basis.
Personal Financial Services reported a pre-tax
profit of US$2,628 million, 27 per cent higher than
in 2004. This was largely due to widening deposit
spreads, deposit growth and improved credit quality.
During the year, HSBC placed considerable
emphasis on maintaining its leadership position and
meeting customer needs in both the credit cards and
insurance businesses. Market share of both spend
and balances grew in respect of credit cards along
with strong insurance revenue growth.
Net interest income grew by 30 per cent to
US$2,618 million. During 2005, interest rates in
Hong Kong rose significantly, reflecting rising US
dollar interest rates. In addition, adjustments to the
Hong Kong: US dollar linked exchange rate system
reduced the likelihood of an upward realignment of
the Hong Kong dollar, prompting a reversal of much
of the inward flows from investors that had
depressed local market rates in 2004. Consequently,
deposit spreads widened to more normal levels after
the exceptionally low spreads experienced in 2004.
Interest rate rises also helped stimulate growth in
average deposit balances as investor sentiment
moved away from long-term equity-related
investments into shorter-term liquid deposits.
Despite the competitive deposit market, average
balances grew by US$2.9 billion, or 3 per cent.
The mortgage market remained highly
competitive during 2005. During the first half of the
year, HSBC did not aggressively compete on price
but maintained a selective approach to mortgage
approvals, mainly by offering competitive rates to
the existing customer base. Yields gradually
improved during the year, as HSBC repriced
upwards following a series of interest rate increases.
Spreads declined compared with 2004 as
improvements in yields were more than offset by
higher funding costs following rising interest rates.
Average mortgage balances, excluding the reduction
in balances under the suspended Hong Kong GHOS
grew by 1 per cent, despite the highly competitive
environment.
Average credit card balances grew by 10 per
cent, and HSBC’s market share of card balances also
increased by 550 basis points led by targeted
promotional campaigns and rewards programmes.
These volume benefits were more than offset by
lower spreads, mainly due to higher funding costs as
interest rates rose.
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Hong Kong > 2005
Net fees fell by 6 per cent to US$740 million,
driven mainly by lower sales of unit trusts and
capital guaranteed funds, partly offset by higher
sales of structured deposit products and open-ended
funds. A 34 per cent fall in unit trust fee income was
driven by a change in market sentiment during 2005.
The combined effect of higher interest rates and a
flattening yield curve reduced customer demand for
capital guaranteed funds and longer-term equity-
related investment products. Investors preferred
shorter-term investment products which in turn
generated lower fees. Revenues from open-ended
fund sales reflected this, increasing by 32 per cent to
US$95 million with the introduction of 173 new
funds increasing the choice available to investors.
This was an important strategic initiative to position
HSBC as the leading investment service provider in
Hong Kong, where customers can now choose from
over 300 funds.
Revenues from structured deposit products
grew, with strong sales volumes aided by new
products launched. The success of the Exclusive
Placement Service, launched in 2004 for HSBC
Premier customers, continued with year-on-year
revenue growth of 178 per cent. The service offers
an extensive product range of yield enhancement
options, re-priced daily and linked to foreign
exchange or interest rates. IPO certificate of deposit
offerings doubled. These were partly offset by lower
revenues from ‘Deposit plus’ and ‘Equity linked
note’ products.
Fee income from credit cards grew by 9 per
cent, reflecting a 21 per cent increase in spending
along with a 15 per cent rise in the number of cards
in circulation to four million. In stockbroking and
custody services, new services were launched aimed
at facilitating securities management by customers.
Competitive pricing and a high quality of service on
the internet led to a 15 per cent growth in customers
holding securities with HSBC.
HSBC continued to place significant emphasis
on the growth and development of its insurance
business, and increased the range of products
offered. Insurance revenues grew by 20 per cent,
aided by new products launched which included the
‘Five year excel’ and the ‘Three year express wealth’
joint life insurance and wealth products. HSBC was
Hong Kong’s leading online insurance provider,
offering 12 insurance products. This, coupled with
competitive pricing, led to a 91 per cent growth in
online insurance revenues. Medical insurance
products were enhanced and heavily marketed in
response to the growing public demand for private
medical protection to complement new medical
reforms being introduced.
54
Improvements in credit conditions, which
benefited from economic growth, higher property
prices and lower bankruptcies, underpinned a net
release of loan impairment charges and other credit
risk provisions of US$11 million in 2005, compared
with a net charge of US$56 million in 2004. This
was mainly driven by continued improvement in
credit quality within the credit card portfolio, and a
collective provision release of US$23 million in
respect of prior year impairment allowances on the
restructured lending portfolio. The strong housing
market enabled individually assessed allowance
releases of US$24 million in the mortgage portfolio.
There was also a release of US$11 million in respect
of collective loan impairment allowances, benefiting
from the improved economic conditions highlighted
above.
Operating expenses fell by 4 per cent to
US$1,305 million. This was largely due to a change
in the method by which centrally incurred costs are
allocated to the customer groups. IT development
costs rose in support of future growth initiatives, and
higher marketing and advertising expenditure was
incurred to underpin organic growth. Staff costs
were marginally lower in 2005. Branch teams were
restructured to dedicate more staff to sales and
customer service, and significant improvements were
made to the reward structure to ensure retention of
high calibre individuals. Overall, headcount in the
branch network fell by 4 per cent, reflecting
operating efficiency improvements and higher
utilisation of the Group Service Centres.
Pre-tax profits in Commercial Banking
increased by 6 per cent to US$955 million. Increased
deposit spreads and a rise in lending and deposit
balances led to higher net interest income, though
this was partly offset by larger loan impairment
charges and the non-recurrence of loan allowance
releases.
Net interest income increased by 60 per cent as
a result of increased deposit spreads and asset and
liability growth. The appointment of a number of
experienced relationship managers to service key
accounts, together with the establishment of core
business banking centres, contributed to growth in
deposits and lending. Interest rate rises led to a
67 basis point increase in deposit spreads and,
together with active management of the deposit base,
contributed to increased customer demand for
savings products which resulted in a 6 per cent
increase in deposit balances to US$28.7 billion. The
introduction of a pre-approved lending programme
for SMEs, together with strong demand for credit in
the property, manufacturing, trading and retail
sectors, contributed to a 29 per cent increase in
lending balances. However, increased competition
reduced lending spreads by 43 basis points. Current
account customers rose by 2 per cent to 329,000 and,
together with higher spreads, contributed to an
81 per cent increase in current account net interest
income. The ‘BusinessVantage’ all-in-one account
continued to perform strongly, with customers
increasing by 23 per cent, which led to income more
than doubling in 2005.
Net fee income increased by 10 per cent to
US$402 million as a result of efforts to encourage
cross-sales, which led to an increase in average
products per customer. Investment in HSBC’s
insurance business, including the establishment of a
new Commercial Banking insurance division in
October 2005, delivered a 10 per cent increase in
insurance income. Enhanced product offerings and
focused sales efforts in the areas of currency and
interest rate management products more than
doubled income. Growth in the number of merchant
customers following targeted marketing campaigns,
together with higher consumer spending, led to a
22 per cent increase in card income. However,
these increases were partly offset by a reduced
contribution from investment products, even though
sales increased by 20 per cent, reflecting changes in
the product mix, as demand for capital protected
funds decreased in the rising interest rate
environment.
Loan impairment charges and other credit risk
provisions of US$168 million contrasted with net
recoveries in 2004, and included a significant charge
against a client in the manufacturing sector. Releases
and recoveries in 2005 were lower, although
impaired loans as a proportion of lending balances
decreased.
Operating expenses were 3 per cent higher,
principally as a result of staff recruitment to support
business development and expansion. This was
particularly true with respect to business with
mainland China, where additional resources were
focused on increasing cross-sales and insurance
income. Expenditure on new marketing campaigns
promoted HSBC’s lower-cost delivery channels.
These campaigns, together with additional
investment to increase customer access to ATMs and
cheque deposit machines, grew the proportion of
transactions using low cost channels to 35 per cent
from 25 per cent in 2004. This released staff to
concentrate on increasing sales and offering
enhanced customer service.
Corporate, Investment Banking and Markets
reported a pre-tax profit of US$922 million,
43 per cent lower than in 2004, primarily driven by a
55
decline in net interest income in Global Markets and
lower recoveries and releases of loan impairment
allowances. In addition, operating expenses
increased in line with initiatives taken to extend the
product range in Global Markets and to strengthen
the Global Investment Banking advisory platform for
Asia in Hong Kong.
A 19 per cent decline in total operating income
was driven by a 74 per cent fall in balance sheet
management and money market revenues due to
rising short-term US and Hong Kong interest rates
and flattening yield curves.
In Corporate and Institutional Banking, deposit
spreads increased in line with higher local interest
rates, although this was offset by lending spreads
which fell amidst fierce local competition. In Global
Transaction Banking revenues increased, benefiting
from the improvement in deposit spreads, together
with higher deposit balances as business volumes
grew from the upgraded cash management service
delivered through HSBCnet.
Net fees fell by 19 per cent, driven primarily by
a reduction in structured finance revenues. However,
a number of significant equity related transactions
were concluded. Fee income from Group Investment
Businesses was boosted by sales of investment
products and a US$3.7 billion growth in funds under
management.
Income from trading activities rose as new
structured product capabilities were added in respect
of credit, equities, interest rate and foreign exchange
trading. Higher foreign exchange derivatives
revenues reflected an increased focus on sales and
execution. These gains were partly offset by a
decline in sales of structured product solutions to the
personal and commercial businesses, as retail
investors switched to shorter deposit products in the
higher interest rate environment. Losses were also
incurred on the trading of Asian high-yield bonds,
where revenues fell following the downgrading of
the automobile sector in the first half of 2005.
The overall credit environment remained
favourable and there was a small net release of loan
impairment charges, although this was below levels
seen in 2004 when HSBC benefited from corporate
restructuring and refinancing in the property,
industrial and telecommunications sectors.
A 20 per cent rise in operating expenses was due
to the first full-year impact of the investment made
in Hong Kong’s Corporate, Investment Banking and
Markets businesses. Employee compensation and
benefits rose by 24 per cent, in part driven by an
increase in senior relationship managers recruited to
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Hong Kong > 2005 / Profit/(loss) before tax
extend coverage along industry sector lines. In total,
over 90 people were recruited to support the
expansion. Technology and infrastructure costs rose
as support and control functions added new
resources and improved services to facilitate
business expansion.
Private Banking contributed a pre-tax profit of
US$190 million, an increase of 45 per cent
compared with 2004. The benefits of strong growth
in client assets, and consequently higher brokerage
and trading income, were partly offset by the adverse
effect of a flattening yield curve on income from the
investment of surplus liquidity.
Net operating income was 29 per cent higher
than in 2004. A 25 per cent increase in fee income
reflected higher client assets, as well as the benefits
of a strategy to increase the level of higher fee
generating discretionary managed assets, which
increased by 50 per cent during the year. Trading
income increased by 39 per cent, boosted by higher
volumes which reflected growth in the customer
base, and a generally buoyant market. Revenue from
bond trading increased by 13 per cent, and from
foreign exchange and sales of structured products by
6 and 21 per cent respectively. Gains from financial
investments of US$16 million were mainly from the
sale of debt instruments.
Overall, client assets increased by 17 per cent
to US$47.3 billion. Net new money inflows of
US$5.8 billion were notably strong, with recruitment
of front office staff, the success of last year’s launch
of the ‘HSBC Private Bank’ brand, and cross-
referrals with the wider Group all contributing to the
growth. Marketing, successful product placement
and the enhancement of the related front office teams
also aided in the increase of discretionary managed
assets, with a near doubling of assets invested in the
Strategic Investment Solutions product.
Operating expenses increased by 14 per cent.
Costs from front office recruitment, and higher
expenditure on marketing in support of the growing
customer base, were partly offset by the non-
recurrence of rebranding costs in 2004.
In Other, gains on the sale of investments and
properties decreased by US$136 million in 2005,
following significant sales in 2004. These were
partly offset by increased gains on the revaluation of
properties of US$70 million. Net interest income
decreased as, from 1 January 2005 under IFRSs,
dividends paid on certain intra-group preference
shares were reclassified from non-equity minority
interests to net interest income; this was partly offset
by higher earnings on US dollar denominated assets
following interest rate rises in the US.
56
4,418
1,881
1,838
398
345
(276)
8,604
Profit/(loss) before tax by customer groups and global businesses
Year ended 31 December 2006
Corporate,
Investment
Banking &
Markets
US$m
Private
Banking
US$m
Personal
Financial
Services
US$m
2,882
977
Commercial
Banking
US$m
1,344
454
Net insurance claims1 .................
(2,638)
1,931
(50)
1,849
(11)
Hong Kong
Net interest income/(expense) .. ..
Net fee income/(expense) ............
Trading income excluding net
interest income .......................
Net interest income on trading
activities ..................................
Net trading income ......................
Net income/(expense) from
financial instruments
designated at fair value ...........
Gains less losses from
financial investments ..............
Dividend income .........................
Net earned insurance premiums .
Other operating income ..............
Total operating income ............
Net operating income before
loan impairment charges
and other credit risk
provisions ..............................
Loan impairment (charges)/
recoveries and other credit
risk provisions ........................
Net operating income ...............
Total operating expenses ............
Operating profit/(loss) ..............
Share of profit in associates
and joint ventures ...................
84
4
88
373
14
1
2,519
202
7,056
57
–
57
(53)
–
1
95
33
(119)
4,299
(1,422)
2,877
(69)
1,812
(491)
1,321
3
–
Profit/(loss) before tax ..............
2,880
1,321
Share of HSBC’s profit
before tax ................................
Cost efficiency ratio ...................
%
13.0
32.2
%
6.0
26.1
553
534
573
88
661
5
(1)
2
14
81
Inter-
segment
elimination
US$m
476
–
–
(476)
(476)
–
–
–
–
(276)
(276)
–
Other
US$m
(646)
(32)
34
77
111
(66)
140
57
–
781
345
–
Total
US$m
4,685
2,056
924
(307)
617
260
162
61
2,628
834
11,303
(2,699)
76
123
176
–
176
1
9
–
–
13
398
–
–
(276)
276
–
–
–
27
1,865
(911)
954
1
955
%
4.3
49.6
–
398
(197)
201
–
201
%
0.9
49.5
(11)
334
(524)
(190)
15
(175)
%
(0.7)
151.9
(172)
8,432
(3,269)
5,163
19
5,182
%
23.5
38.0
US$m
84,282
272,428
196,691
Selected balance sheet data2
Loans and advances to
customers (net) .......................
Total assets .................................
Customer accounts ......................
The following assets and
liabilities were significant
to Corporate, Investment
Banking and Markets:
– loans and advances to
banks (net) ..........................
– trading assets, financial
instruments designated at
fair value, and financial
investments .........................
– deposits by banks ...............
US$m
US$m
US$m
US$m
US$m
35,445
57,348
118,201
23,520
29,786
41,493
20,270
153,200
24,530
3,081
10,462
11,991
1,966
21,632
476
45,023
80,036
4,363
57
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Hong Kong > Profit/(loss) before tax
Profit/(loss) before tax by customer groups and global businesses (continued)
Year ended 31 December 2005
Hong Kong
Personal
Financial
Services
US$m
Commercial
Banking
US$m
Corporate,
Investment
Banking &
Markets
US$m
Private
Banking
US$m
Net interest income/(expense) ....
Net fee income ............................
2,618
740
1,096
402
Trading income/(expense)
excluding net interest income
Net interest income/(expense)
on trading activities ................
Net trading income/(expense) .....
Net income/(expense) from
financial instruments
designated at fair value ...........
Gains less losses from
financial investments ..............
Dividend income .........................
Net earned insurance premiums ..
Other operating income ..............
Total operating income ...............
Net insurance claims1 .................
Net operating income before
loan impairment charges and
other credit risk provisions .....
Loan impairment (charges)/
recoveries and other credit
risk provisions ........................
Net operating income .................
Total operating expenses ............
Operating profit/(loss) .................
Share of profit in associates
and joint ventures ...................
Profit/(loss) before tax ................
Share of HSBC’s profit
before tax ................................
Cost efficiency ratio ...................
Selected balance sheet data2
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) ..........................
– trading assets, financial
instruments designated at
fair value, and financial
investments .........................
– deposits by banks ...............
607
431
601
(40)
561
14
–
18
19
83
48
–
48
(84)
–
2
77
35
67
–
67
41
–
1
2,238
230
5,935
(2,016)
1,576
(34)
1,733
(9)
75
93
140
–
140
–
16
–
–
13
337
–
Inter-
segment
elimination
US$m
197
–
–
(197)
(197)
–
–
–
–
(238)
(238)
Total
US$m
4,064
1,674
773
(227)
546
(6)
108
41
2,334
805
9,566
–
(2,059)
Other
US$m
(529)
8
(83)
10
(73)
23
92
20
–
682
223
–
3,919
1,542
1,724
337
223
(238)
7,507
11
3,930
(1,305)
2,625
3
2,628
%
12.5
33.3
(168)
1,374
(419)
955
–
955
%
4.6
27.2
7
1,731
(809)
922
–
922
%
4.4
46.9
3
340
(150)
190
–
190
%
0.9
44.5
1
224
(422)
(198)
20
(178)
%
(0.9)
189.0
US$m
US$m
US$m
US$m
US$m
–
(238)
238
–
–
–
34,318
52,798
105,801
20,292
25,625
37,417
23,712
133,005
21,070
3,107
7,621
9,216
1,779
16,327
222
(146)
7,361
(2,867)
4,494
23
4,517
%
21.5
38.2
US$m
83,208
235,376
173,726
39,164
63,813
4,373
58
Year ended 31 December 2004
Hong Kong
Personal
Financial
Services
US$m
Commercial
Banking
US$m
Corporate,
Investment
Banking &
Markets
US$m
Private
Banking
US$m
Net interest income/(expense) ....
2,015
Net fee income/(expense) ...........
Trading income/(expense)...........
Net investment income on
assets backing policyholders’
liabilities .................................
Gains less losses from
financial investments ..............
Dividend income .........................
Net earned insurance premiums ..
Other operating income ..............
Total operating income ...............
786
47
118
(2)
2
1,620
294
4,880
Net insurance claims1 .................
(1,400)
684
365
39
196
–
1
609
52
998
529
476
–
2
2
19
101
1,946
(742)
2,127
(12)
85
75
101
–
–
–
–
(2)
259
–
Inter-
segment
elimination
US$m
–
–
–
–
–
–
–
(470)
(470)
Total
US$m
3,638
1,703
659
314
175
27
2,247
536
9,299
–
(2,154)
Other
US$m
(144)
(52)
(4)
–
175
22
(1)
561
557
–
3,480
1,204
2,115
259
557
(470)
7,145
–
(470)
470
–
–
220
7,365
(2,558)
4,807
23
–
4,830
%
25.5
35.8
US$m
78,824
225,336
178,033
Net operating income before
loan impairment charges and
other credit risk provisions .....
Loan impairment (charges)/
recoveries and other
credit risk provisions ..............
(56)
Net operating income .................
3,424
Total operating expenses ............
(1,364)
Operating profit ...........................
2,060
Share of profit/(loss) in
associates and joint ventures ..
3
Profit before tax ..........................
2,063
Share of HSBC’s profit
before tax ................................
Cost efficiency ratio ...................
%
10.9
39.2
110
1,314
(406)
908
(4)
904
%
4.7
33.7
164
2,279
(674)
1,605
(2)
1,603
%
8.5
31.9
4
263
(132)
131
–
131
%
0.7
51.0
(2)
555
(452)
103
26
129
%
0.7
81.1
Selected balance sheet data2
Loans and advances to
customers (net) .......................
Total assets .................................
Customer accounts ......................
The following assets and
liabilities were significant
to Corporate, Investment
Banking and Markets:
– loans and advances to
banks (net) ..........................
– trading assets, financial
instruments designated at
fair value, and financial
investments .........................
– deposits by banks ...............
US$m
US$m
US$m
US$m
US$m
33,646
49,620
114,302
17,883
23,272
35,226
22,440
129,986
18,903
2,954
7,490
9,264
1,901
14,968
338
42,515
59,703
4,205
1 Net insurance claims incurred and movement in policyholders’ liabilities.
2 Third party only.
59
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Rest of Asia-Pacific > 2006
Rest of Asia-Pacific (including the Middle East)
Profit/(loss) before tax by customer groups and global businesses and by country
Personal Financial Services .............................................................................
Commercial Banking .......................................................................................
Corporate, Investment Banking and Markets ..................................................
Private Banking ...............................................................................................
Other ................................................................................................................
Australia and New Zealand .............................................................................
Brunei ..............................................................................................................
India .................................................................................................................
Indonesia ..........................................................................................................
Japan ................................................................................................................
Mainland China ...............................................................................................
Malaysia ...........................................................................................................
Middle East (excluding Saudi Arabia) ............................................................
Saudi Arabia ....................................................................................................
Middle East ......................................................................................................
Philippines .......................................................................................................
Singapore .........................................................................................................
South Korea .....................................................................................................
Taiwan .............................................................................................................
Thailand ...........................................................................................................
Other ................................................................................................................
Year ended 31 December
2006
US$m
477
1,034
1,649
80
287
3,527
2005
US$m
377
818
1,207
78
94
2,574
Year ended 31 December
2006
US$m
182
36
393
71
123
708
274
730
305
1,035
58
365
59
(23)
49
197
3,527
2005
US$m
111
35
212
113
(1)
334
236
585
236
821
41
289
94
68
61
160
2004
US$m
336
483
942
60
26
1,847
2004
US$m
84
33
178
76
50
32
214
364
122
486
38
272
89
107
60
128
2,574
1,847
Year ended 31 December 2006 compared
with year ended 31 December 2005
Economic briefing
Mainland China’s economy continued to grow
strongly, with GDP rising by 10.7 per cent in 2006,
the fourth consecutive year of double-digit growth.
Despite the government’s stated intention of
promoting consumption in favour of investment
growth, economic performance remained primarily
dependent on investment and exports. However,
some success was achieved in this respect, as urban
fixed-asset investment slowed significantly to about
22 per cent in the second half of 2006 from 31 per
cent in the first half of the year. This resulted from a
combination of measures, including several interest
rate rises, increases in banks’ required reserve ratios,
and the draining of liquidity via bill sales and
‘window guidance’, the exercise of influence by the
authorities over the banks on policy matters, such as
slowing lending growth.
Export growth remained strong, accelerating
slightly during the second half of 2006 despite
evidence of slower global growth. Although a
slowdown in the US growth rate in 2007 could
negatively affect mainland China’s exports, the
slowdown in investment spending referred to above
provides the authorities with the scope to ease policy
and stimulate domestic spending if exports falter.
Consumer spending rose steadily in 2006 with retail
sales rising by about 13 per cent, and bank loans
continued to grow rapidly. The inflationary
environment remained benign, with consumer prices
rising by less than 2 per cent. Mainland China’s
foreign exchange reserves rose to above
US$1 trillion, the world’s highest level. The
currency appreciated gradually against the US dollar,
with an increase of over 3 per cent in 2006.
Japan’s economy, the largest in the region,
grew in 2006. Export growth was steady despite a
slight slowing in the second half of the year, and
private capital investment remained firm, driven by
record levels of corporate profits and the need to
upgrade the capital stock to maintain global
competitiveness. Consumer spending was
disappointing, however, and was the major reason
why GDP growth was less than expected. Core
consumer prices generally rose.
60
Profit before tax
Year ended 31 December
Rest of Asia-Pacific (including the Middle East)
Net interest income ..........................................................................................
Net fee income .................................................................................................
Trading income ................................................................................................
Net income from financial instruments designated at fair value ....................
Net investment income on assets backing policyholders’ liabilities ..............
Gains less losses from financial investments ..................................................
Dividend income ..............................................................................................
Net earned insurance premiums ......................................................................
Other operating income ...................................................................................
Total operating income .................................................................................
Net insurance claims incurred and movement in policyholders’ liabilities ....
Net operating income before loan impairment charges and other
credit risk provisions ................................................................................
Loan impairment charges and other credit risk provisions .............................
Net operating income ....................................................................................
Total operating expenses .................................................................................
Operating profit .............................................................................................
Share of profit in associates and joint ventures ...............................................
Profit before tax .............................................................................................
Share of HSBC’s profit before tax ..................................................................
Cost efficiency ratio ........................................................................................
Year-end staff numbers (full-time equivalent) ................................................
Selected balance sheet data1
Loans and advances to customers (net) ...........................................................
Loans and advances to banks (net) ..................................................................
Trading assets, financial instruments designated at fair value, and
financial investments ...................................................................................
Total assets ......................................................................................................
Deposits by banks ............................................................................................
Customer accounts ...........................................................................................
1 Third party only.
2006
US$m
3,047
1,622
1,181
79
–
41
5
174
765
6,914
(192)
6,722
(512)
6,210
(3,548)
2,662
865
3,527
%
16.0
52.8
72,265
US$m
77,574
27,517
41,585
167,668
10,323
108,995
2005
US$m
2,412
1,340
860
58
–
18
5
155
335
5,183
(166)
5,017
(134)
4,883
(2,762)
2,121
453
2,574
%
12.3
55.1
55,577
US$m
70,016
19,559
30,348
142,014
7,439
89,118
2004
US$m
2,060
1,041
494
–
32
17
3
97
146
3,890
(82)
3,808
(89)
3,719
(2,087)
1,632
215
1,847
%
9.8
54.8
41,031
US$m
60,663
14,887
31,065
120,530
8,046
78,613
Economic growth in the Middle East remained
robust over the second half of the year, continuing a
strong expansionary phase that HSBC estimates will
result in GDP in the Gulf region doubling in the
space of just four years. Buoyed by high oil prices
and strong production, earnings from energy reached
record highs in 2006. Strong revenue growth
encouraged government spending across the region,
particularly on capital projects. Private investment,
from both domestic and foreign sources, was also
high while abundant liquidity, rising employment and
rapid population growth supported further increases
in private consumption. Although interest rates rose,
tracking those in the US over the course of the year,
credit growth continued to be strong. Robust
domestic demand and the weakness of the US dollar
boosted inflationary pressures. Following corrections
in the first half of 2006, the major regional stock
exchange indices continued to trade at significant
discounts to the record levels registered in late 2005,
with markets remaining generally sluggish.
Elsewhere in the region, most economies
continued to perform impressively, particularly India,
Singapore and Vietnam. The main drivers of growth
were exports, demand for technology, and domestic
consumption, with investment demand lagging
behind. India was among the strongest performing
economies in the world, with GDP growth of about
9 per cent in 2006. This led to some signs of
overheating, with inflation rising during the year. The
61
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Rest of Asia-Pacific > 2006
Reserve Bank of India responded by raising interest
rates, and there may be more increases to come. GDP
in Singapore grew by 8 per cent in 2006, in Vietnam
by over 7 per cent and in Malaysia by approximately
6 per cent, their economies benefiting from generally
low inflation and strong domestic and external
demand. Most Asian currencies ended 2006 stronger
than the US dollar. A US slowdown is a risk for the
region.
Review of business performance
HSBC’s operations in the Rest of Asia-Pacific
delivered a pre-tax profit of US$3,527 million
compared with US$2,574 million in 2005, an
increase of 37 per cent. On an underlying basis, pre-
tax profits grew by 29 per cent, with the major
change in composition of the Group being the
additional 10 per cent stake purchased in Ping An
Insurance in August 2005 which made that company
a 19.9 per cent owned associate of HSBC.
Pre-tax profits in the region have nearly doubled
in the past two years, justifying HSBC’s strategy of
investing in emerging markets. Momentum in 2006
was strong, with underlying net operating income
increasing by 26 per cent, notwithstanding a
significant rise in loan impairment charges arising
primarily from industry-wide credit deterioration in
the credit card portfolio in Taiwan, mainly in the first
half of 2006. Significant increases in total operating
income and pre-tax profits were reported in the
Middle East, India, Singapore and Malaysia. In
Taiwan, HSBC launched the direct savings
proposition which had been received very positively
in the US. HSBC’s strategic investments in mainland
China, Bank of Communications and Industrial
Bank, contributed to a 54 per cent underlying
increase in income from associates.
The commentary that follows is on an underlying
basis.
Personal Financial Services reported a pre-tax
profit of US$477 million, 16 per cent lower than in
2005. Strong operating trends were masked by a
US$160 million rise in loan impairment charges in
Taiwan, which suffered from regulatory changes
introduced to address high levels of consumer
indebtedness. Pre-provision operating income
increased by 29 per cent, driven by balance sheet
growth, wider deposit spreads and increased fee
income. Income growth was supported by business
development activity which contributed to a 26 per
cent increase in operating costs. The cost efficiency
ratio improved by 1.3 percentage points.
The development of HSBC’s regional business
continued apace, and double digit profit growth was
62
achieved in 5 sites, namely the Middle East,
mainland China, Malaysia, Singapore and the
Philippines. Customer numbers increased by
1.5 million, or 21 per cent, to 8.9 million, through
strong growth in the credit card business, increased
marketing activity and expansion of the sales force.
36 new branches and 28 consumer loan centres were
opened in 13 countries, most notably Indonesia,
mainland China and the Middle East, and at the end
of 2006, HSBC had 396 branches in the Rest of Asia-
Pacific region and 7.3 million cards in issue.
Net interest income increased by 24 per cent to
US$1,520 million. Average asset and liability
balances grew strongly, while interest rate rises
contributed to a 31 basis point widening of deposit
spreads. Asset spreads were in line with 2005.
Average deposit balances rose by 16 per cent to
US$34.4 billion, principally due to growth in the
HSBC Premier customer base. Development of the
Premier business was supported by a concerted
customer acquisition campaign which included
regional and local advertising and the establishment
of new, dedicated Premier centres. Overall deposit
balance growth was especially strong in Singapore,
the Middle East and mainland China. In Singapore,
promotional campaigns, which included a deposit
product sale, contributed to a 23 per cent increase in
liability balances while, in the Middle East, HSBC
ran a deposit raising campaign with new product
launches, marketing and internal sales incentives,
leading to a 20 per cent rise in average deposit
balances. In mainland China, growth in HSBC
Premier, which accompanied the opening of 12 new
Premier sub-branches, contributed to higher deposit
balances.
Average loans and advances to customers rose
by 16 per cent, driven by higher credit card advances
and increased mortgage balances. Average card
balances increased by 22 per cent to US$3.1 billion,
reflecting higher cardholder spending and a 21 per
cent increase in cards in circulation. Over 2.5 million
cards were issued during 2006, with new products
launched in the Middle East, Sri Lanka and
Singapore. HSBC ran marketing and incentive
campaigns in a number of countries and card
balances rose substantially in Malaysia, the Middle
East, Indonesia, India and the Philippines.
Average mortgage balances increased by 13 per
cent to US$18.9 billion, reflecting robust growth in
Singapore, Taiwan, India and Malaysia. In
Singapore, HSBC used targeted promotional rates to
build market share and this, together with increased
marketing activity, contributed to a 25 per cent
increase in mortgage balances. In Taiwan,
competitive pricing and customer retention initiatives
contributed to a rise in customer numbers and
resulted in a 22 per cent increase in average mortgage
balances. In India, mortgage balances rose by 27 per
cent, benefiting from increased marketing and direct
sales efforts, while in Malaysia, the successful
promotion of Homesmart, a flexible offset mortgage
product, enabled HSBC to increase average mortgage
balances by 10 per cent and widen spreads in a
highly competitive market.
Malaysia, offering Shariah-compliant insurance
products. In the Middle East, cardholder credit
insurance was launched in the fourth quarter of
2006. These product launches were supported by
increased marketing activity and targeted investment
to increase HSBC’s presence and market share.
Consequently, the number of policies in force at the
end of 2006 rose by 89 per cent to 800,000 and
insurance fee income and insurance premiums rose
by 12 per cent and 4 per cent respectively.
Personal lending balances increased by 22 per
Other operating income increased by
cent, partly as a result of significant growth in
HSBC’s consumer finance business in India,
Australia and Indonesia. In Indonesia, HSBC opened
28 dedicated consumer finance outlets while, in
India, 25 new outlets were opened in branches. In
Australia, consumer finance was developed in
partnership with well known international retailers
such as IKEA and Bang & Olufsen, together with
established local retailers including Clive Peeters and
Bing Lee. HSBC signed a number of exclusive
supplier agreements with retailers and, as a result, the
number of retail distribution outlets grew to more
than 1,100, which enabled HSBC to increase its
market share. In Malaysia, the success of HSBC’s
instalment loan product, ‘Anytime Money’, which
was re-launched in 2005, contributed to a 93 per cent
rise in average personal lending balances. In the
Middle East, HSBC focused on promoting a select
portfolio of products following a product
simplification exercise instigated in the fourth quarter
of 2005 which led to a 22 per cent rise in personal
lending balances. Investments in HSBC’s South
Korean operations had immediate results and
personal lending balances more than doubled.
Net fee income rose by 24 per cent to
US$524 million. Regional card fees were 30 per cent
higher, reflecting solid growth in cardholder
spending while, in Indonesia, higher card fee income
was a consequence of a rise in delinquencies.
The robust performance of regional stock
markets during 2006 contributed to strong demand
for investment products and led to the launch of new
investment funds, which together generated a 27 per
cent increase in investment fee income, including
custody and broking fees. Growth was particularly
strong in South Korea, Taiwan, India and Singapore.
Sales of investment products, including unit trusts,
bonds and structured products, increased by 19 per
cent to US$8.0 billion and funds under management
grew by 19 per cent to US$8.6 billion.
HSBC continued to develop its regional
insurance business by launching medical insurance in
Singapore and establishing a Takaful joint venture in
US$71 million due to gains on the sale of HSBC’s
Australian stockbroking, margin lending and
mortgage broker businesses. Additionally, HSBC
established a joint venture with Global Payments Inc.
to manage the majority of the bank’s Asian card
acquiring business. This was transferred to the joint
venture in July 2006, realising a gain of
US$10 million in the region’s Personal Financial
Services business.
Loan impairment charges and other credit risk
provisions more than doubled to US$545 million,
mainly due to higher charges for personal lending in
Taiwan and Indonesia. In Taiwan, regulatory changes
restricted collection activities and eased repayment
terms for delinquent borrowers. These changes,
coupled with a deteriorating credit environment, led
to a US$160 million increase in loan impairment
charges related mainly to the credit card portfolio,
most of which were recognised in the first half of
2006. In Indonesia, changes in minimum repayment
amounts, along with hardship following a significant
reduction in the government subsidy of fuel prices,
led to increased delinquency rates on credit cards,
also mainly in the first half of 2006. Elsewhere in the
region, credit quality was broadly stable and growth
in impairment charges followed increases in credit
card and personal lending balances.
Operating expenses increased by 26 per cent to
US$1,593 million, largely tracking revenue growth.
Expansion of the branch network and development of
sales and support functions led to higher staff
numbers and, together with higher performance-
related incentive payments, contributed to a rise in
staff costs. The new branch openings increased
premises and equipment costs. The establishment of
a number of consumer finance businesses and HSBC
Direct’s introduction in Taiwan were also factors in
the rise in operating expenses.
Marketing costs rose as HSBC increased
advertising and promotional activity directed to
attracting new customers, enlarging HSBC’s share of
the credit card, mortgage and unsecured personal
lending markets and increasing deposit balances. In
63
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Rest of Asia-Pacific > 2006
the Middle East, IT expenditure rose as HSBC
introduced a new internet banking infrastructure,
implemented HSBC’s WHIRL credit card system
and made major updates to customer relationship
management software.
Largely driven by a strong performance in
HSBC’s strategic investment in Ping An Insurance,
which reported record results in 2006, income from
associates rose by 59 per cent. In Saudi Arabia there
were buoyant revenues from stock trading and
investment business, particularly in the first half of
2006 although, subsequently, turbulent local stock
markets affected investor sentiment and contributed
to lower income in the second half of the year.
Commercial Banking reported a pre-tax
profit of US$1,034 million, 25 per cent higher than in
2005. Pre-provision operating income increased by
25 per cent, driven by higher deposit and lending
balances and widening liability spreads. The
migration of routine activities to lower-cost channels
helped to mitigate business expansion costs, and
operating expenses consequently increased by 21 per
cent. The cost efficiency ratio improved by
1.4 percentage points.
During 2006, HSBC focused on developing its
cross-border business banking activities and
increasing its presence in the small business market,
supported by investment in delivery channels and
increased promotional activity. International business
banking benefited from the strong performance of
HSBC’s two regional alignment programmes,
centred on mainland China and the Middle East,
together with the establishment of International
Business Centres in seven sites including Australia,
mainland China, India and Taiwan. In addition, new
branches in mainland China, India, Malaysia,
Bangladesh and Sri Lanka were complemented by
enhancements to internet banking services in
Malaysia and India and improved self-service
terminals in a number of countries. The launch of
HSBC’s inaugural global Commercial Banking
advertising campaign, increased local marketing
activity and the reorganisation of business
development teams throughout the Asia-Pacific
region contributed to an 8 per cent increase in
Commercial Banking customer numbers to
177,000, with particularly strong growth in
Malaysia, mainland China and India.
Net interest income rose by 33 per cent to
US$848 million. Higher customer numbers
contributed to increased average asset and liability
balances, while interest rate rises led to wider
liability spreads, partly offset by narrower asset
spreads.
64
Interest rate rises also contributed to higher
demand for deposit products and liability balances
increased in a number of countries, most notably the
Middle East, Singapore, Taiwan, Malaysia and India.
In the Middle East, HSBC successfully initiated a
targeted marketing campaign offering preferential
savings rates to selected customers while, in
Singapore and Taiwan, enhanced sales incentives
contributed to growth in liability balances. In
Malaysia, expansion of the branch network together
with fresh marketing campaigns, competitive pricing
and product enhancements increased customer
numbers and led to a 31 per cent rise in average
liability balances. In India, current account and
deposit balances increased by 40 per cent, partly
from liquidity chasing new IPOs, which surged in
line with strong local equity markets.
In 2006, HSBC successfully launched a number
of initiatives designed to increase asset balances
throughout the Rest of Asia-Pacific region to deploy
the additional deposit base being attracted. For
example, in Malaysia, television and press
advertising helped trigger a 31 per cent increase in
average non-trade lending balances. ‘Trade and Save’
marketing campaigns launched in Malaysia and India
in the wake of higher regional trade flows, offered
customer incentives designed to expand HSBC’s
market share in trade lending. Targeted incentive
programmes were also launched in Singapore, Sri
Lanka, mainland China, South Korea and Indonesia.
In the Middle East, strong demand for credit
underpinned by robust economic expansion resulted
in a 26 per cent rise in average lending balances.
Net fee income rose by 7 per cent to
US$330 million as volume-related increases in trade
fees were recorded in the Middle East and India.
HSBC in India also benefited from higher fees from
lending activities, reflecting growth in the number of
borrowing customers, while payments and cash
management fee income rose in the Middle East.
Trading income increased by 25 per cent. In the
Middle East, HSBC continued to invest in its
Commercial Banking treasury business to support
an increasingly international customer base. As
customer demands became more sophisticated,
15 new products were launched in 2006, while higher
marketing activity and the establishment of an online
e-trading platform also contributed to a rise in
customer trading volumes. Increased hedging activity
among Commercial Banking customers also led to
increased foreign exchange earnings in India and
Malaysia.
The transfer of the majority of HSBC’s Asian
card acquiring business into a joint venture with
Global Payments Inc. led to the recognition of a gain
of US$10 million in Commercial Banking, reported
in ‘Other operating income’.
Strong economic conditions supported a further
net release of loan impairment charges, which
decreased by 57 per cent compared with 2005.
Underlying credit quality remained strong.
Operating expenses increased by 21 per cent to
US$554 million in support of business expansion.
HSBC recruited additional sales and support staff,
increased its Commercial Banking presence in the
branch network and committed to higher marketing
activity in a number of countries, most notably the
Middle East, India and mainland China. Strong
revenue growth resulted in higher performance
payments and this, together with salary inflation,
added to rising staff costs. In South Korea, the
Commercial Banking business expansion proceeded
as planned, staff numbers more than doubled, and
HSBC incurred higher premises, equipment and
infrastructure costs as a consequence. In the Middle
East, increased business volumes necessitated
systems improvements which resulted in higher IT
costs.
Income from HSBC’s strategic investments in
associates increased by 47 per cent. Income from
Bank of Communications rose by 45 per cent as a
result of higher asset and liability balances, effective
credit control and improvements in the cost
efficiency ratio, while income from Industrial Bank
was 55 per cent higher. In the Middle East, net
releases of loan impairments, following net charges
in 2005, led to strong growth in Commercial Banking
income in The Saudi British Bank.
Corporate, Investment Banking and Markets
delivered a record pre-tax profit of US$1,649 million,
an increase of 35 per cent compared with 2005.
Positive revenue trends were reported across most
countries, reflecting continued growth in HSBC’s
wholesale banking businesses in emerging markets.
The Middle East, India, Taiwan and Singapore
accounted for 66 per cent of the increase in pre-tax
profits. The cost efficiency ratio improved by
3.5 percentage points to 37.6 per cent.
Total operating income increased by 29 per cent
compared with 2005 to US$2,311 million. In Global
Markets, the securities services business benefited
from investment flows into and within emerging
markets, leading to higher customer volumes in
buoyant local markets.
In Global Banking, payments and cash
management services increased in all countries, with
significant contributions from businesses in India, the
65
Middle East, Singapore and mainland China reflected
in higher net interest income. The strength of
domestic economies within emerging markets,
coupled with the global trend of rising interest rates,
drove deposit balances and improvements in spreads.
Corporate lending income in the Middle East
increased by 33 per cent as economic growth
continued and infrastructure investment rose. These
gains were partly offset by lower balance sheet
management revenues.
Net fee income increased by 38 per cent to
US$688 million. A significant increase in fee income
in Global Markets was driven by higher securities
services business volumes, reflecting improved
investment sentiment and buoyant local markets,
particularly in early 2006. Debt underwriting
volumes increased, particularly in the Middle East, as
lower credit spreads encouraged issuers to lock into
the favourable credit environment by extending the
term of finance or raising new debt in local markets.
In Global Banking, income from the advisory
business was boosted by a steady flow of new deals,
driven by the strong momentum provided by
economic development in the Middle East. Trade
finance and payments and cash management fee
income also benefited from higher customer
volumes.
Group Investment Businesses revenues more
than doubled, reflecting higher funds under
management and performance fees on emerging
market funds.
Net trading income of US$717 million rose by
26 per cent, benefiting from an increasing interest
rate environment and volatile foreign exchange
markets. Although, generally, volatility levels were
lower than those experienced in 2005, the emerging
market correction in May 2006 combined with a
rapid recovery in the second half of the year to
stimulate a rise in foreign exchange and Credit and
Rates volumes in most countries. HSBC also
benefited from higher foreign investment flows as
investor confidence in the improved stability of
emerging economies grew. In the second half of
2006, growth in revenues from retail structured
investment products moderated as investors sought
outright exposure to equities and deposit yields
improved. However, in the Middle East, there was
strong demand for structured interest rate products
among corporate and institutional customers and for
risk management advisory products as clients
continued to hedge exposures.
Gains on the disposal of financial investments
were higher than in 2005, largely due to income from
the sale of debt securities in the Philippines in 2006,
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Rest of Asia-Pacific > 2006 / 2005
together with the non-recurrence of losses on the
disposal of US dollar securities in Japan in January
2005.
The net recovery in loan impairment charges
declined significantly due to the non-recurrence of a
large recovery in Malaysia in 2005.
Operating expenses increased by 18 per cent to
US$869 million, in part due to an increase in
performance-related incentives which reflected the
robust growth in operating income. In the Middle
East and India, higher staff costs also arose from
additional recruitment to support the expansion of
capabilities across various businesses.
In Global Markets, support costs increased in
line with higher transaction volumes and greater
product complexity, while a rise in payments and
cash management activity, primarily in HSBC’s
operations in India, mainland China, Singapore,
South Korea and Indonesia, resulted in higher
operational expense.
The share of profits in associates increased by
47 per cent, primarily reflecting higher contributions
from HSBC’s investments in Bank of
Communications in mainland China and The
Saudi British Bank.
Private Banking reported a pre-tax profit of
US$80 million, a modest increase compared with
2005. Revenue growth was strong across the region
despite challenging market conditions, particularly in
Singapore, with notable contributions from the
onshore Private Banking operations launched in the
Middle East and India during 2005. Employee
benefits rose at a faster rate than revenue, driven by a
fiercely competitive market for experienced private
banking staff, and this led to a deterioration of the
cost efficiency ratio from 50.7 per cent in 2005 to
54.5 per cent in 2006.
Net interest income grew by 21 per cent to
US$35 million. Growth was predominantly in
Singapore, where treasury performance improved and
unfavourable positions unwound, and India, where
the recently launched business was successful in
attracting deposits.
Fee income increased by 62 per cent to
US$68 million, with significant growth in Singapore,
India and the Middle East. Initiatives to attract clients
to HSBC’s suite of discretionary managed products,
particularly the SIS and CIS products, proved
successful.
Trading and other operating income was slightly
lower than in 2005, due to sluggish stock market
66
performance and correspondingly subdued client
activity.
Client assets increased by 12 per cent to
US$16 billion, benefiting from the recruitment of
front office staff, client appetite for investment in
newly launched funds and the successful growth of
recently launched onshore businesses in the region.
Investment in funds benefited from higher demand
for HSBC and third party manager funds, including
the SIS and CIS products in which the value of client
investments grew to US$291 million. Higher deposits
and investments in equities also contributed to the
growth in client assets.
Operating expenses increased by 25 per cent,
reflecting continued investment in the onshore
Japanese operations and growth of the business in
India. Staff costs rose as competition for front-office
professionals intensified, putting upward pressure on
staff rewards, and the full-year impact of the
expansion in staff recruitment in 2005 fed through.
HSBC sold properties in Japan and India,
realising gains of US$87 million in Other,
US$77 million higher than in 2005. Costs and
recoveries in the Group Service Centres both rose,
reflecting increased activity supported by higher staff
numbers. Interest rate rises and higher retained
earnings led to a doubling of earnings on centrally
held funds.
Year ended 31 December 2005 compared
with year ended 31 December 2004
Economic briefing
Mainland China’s economy grew by 9.9 per cent in
2005. Despite ongoing monetary tightening, total
urban fixed asset investment growth showed no sign
of slowing, though investment in steel and real estate
sectors moderated. Consumer spending also
remained strong, with retail sales growing by 13 per
cent in 2005. Producer price inflation slowed, but
still remained above 3 per cent thanks to strong
investment demand. In July 2005, the People’s Bank
of China announced that, with immediate effect, the
arrangement by which the renminbi (‘RMB’) was
pegged to the US dollar would be replaced with a
managed float. Initially, the exchange rate was set at
US$1 to RMB8.11, equivalent to an appreciation of
approximately 2 per cent. This had little impact on
export growth, which remained very strong, boosting
mainland China’s annual trade surplus from
US$32 billion in 2004 to US$102 billion in 2005.
Growth in food prices slowed as mainland China’s
grain production increased 3 per cent in 2005. This
lowered consumer price inflation to 1.8 per cent from
3.9 per cent at the end of 2004.
Japan’s economy in 2005 achieved its strongest
Review of business performance
growth in five years, and the long process of
structural readjustment following the collapse in
asset prices was largely completed. In particular, the
excess corporate capacity, employment and debt of
the past decade was eliminated, and impaired bank
loans returned to historically normal levels. After a
downturn which began in mid-2004, exports began to
recover vigorously in March 2005, led by strong
demand from mainland China. The decline in
corporate borrowing ceased, and the end of net
corporate debt reduction freed up cash which drove
stronger growth in private capital investment. The
tightening of the labour market boosted employment
and led to a sustained rise in real wages for the first
time in five years, providing strong support for
consumer spending. The rise in the core consumer
price index in November 2005 set the stage for the
end of the Bank of Japan’s quantitative easing policy.
Elsewhere in the region, most economies
performed impressively in 2005, in particular India’s.
The main drivers of growth were exports, demand for
technology, and domestic consumption. Investment
demand, by contrast, remained weak. Strong
domestic growth and continued firmness in energy
prices resulted in an increase in inflationary
pressures, especially in Indonesia and Thailand,
where fuel subsidies were lowered or removed.
Central banks in both these countries increased rates
substantially. Elsewhere, particularly in South Korea
and Taiwan, energy prices did not significantly affect
headline inflation, and the benign inflationary
environment was maintained with less need for
monetary tightening. Most Asian currencies ended
the year strongly against the US dollar.
2005 was a good year economically for the
Middle East, where growth was boosted by high oil
prices and additional capacity in downstream oil and
gas, real estate, transportation and tourism. Long-
term growth was reinforced through economic
liberalisation. The result was to encourage private
sector investment in both established and new sectors
of the region’s economy. Regional interest rates
mirrored US dollar rate increases during the year
without any noticeable effect on credit growth,
though inflationary pressures arose from the US
dollar’s weakness and general economic expansion.
GDP growth is estimated by the International
Monetary Fund to have been over 6 per cent in Saudi
Arabia in 2005. Economies in the region which are
not as dependent on oil also performed well, with the
United Arab Emirates, for example, registering
strong growth in non-oil sectors such as financial
services and tourism.
67
HSBC’s operations in the Rest of Asia-Pacific
reported a pre-tax profit of US$2,574 million,
compared with US$1,847 million in 2004,
representing an increase of 39 per cent. On an
underlying basis, pre-tax profits grew by 29 per cent
and represented around 12 per cent of HSBC’s
equivalent total profit. Strong growth across the
majority of countries in the region resulted in higher
revenues across all customer groups.
The commentary that follows is on an underlying
basis.
Personal Financial Services reported a pre-tax
profit of US$377 million, an increase of 6 per cent
compared with 2004, reflecting higher net interest
income led by strong asset and deposit growth,
increased fee income and higher income from
investments in the Middle East and mainland China.
Costs in support of business expansion rose and were
broadly in line with revenue growth. Higher loan
impairment charges reflected growth in credit card
lending and the non-recurrence in 2005 of loan
impairment provision releases in 2004.
Net interest income grew by 25 per cent to
US$1,208 million, reflecting strong growth across
the majority of countries in the region. Deposit
balances generally grew strongly during 2005. This
was due in part to the range of new products
launched during the year, including dual currency,
floating rate and higher-yielding time deposits. The
number of Premier account holders rose
significantly, with a 40 per cent growth across the
region generating US$3.5 billion of additional
balances. In mainland China, organic expansion
continued, with the opening of ten new branches and
sub-branches. The deposit base grew by 80 per cent,
as considerable emphasis was placed on the provision
of wealth management services through the HSBC
Premier account service. Deposit spreads also
widened as interest rates rose, contributing to higher
net interest income in mainland China, Singapore and
India.
In the Middle East, a rise of 37 per cent in net
interest income was driven by a combination of
widening deposit spreads and strong loan growth,
partly offset by lower asset spreads as funding costs
increased following interest rate rises. Average
mortgage balances increased by 27 per cent to
US$16.7 billion. This growth reflected marketing
campaigns in India, Malaysia and Singapore
alongside new products introduced in Australia and
South Korea. Higher sales volumes were also
generated by direct sales forces across the region,
notably in India, where mortgage balances grew by
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Rest of Asia-Pacific > 2005
43 per cent. The benefits of higher mortgage balances
were partly offset by lower spreads as pricing stayed
highly competitive.
The credit card business continued to expand in
a number of countries. Credit card spending
increased by 33 per cent, contributing to a 42 per cent
growth in average card balances. Other notable
developments included promotional campaigns, new
product launches and a series of customer acquisition
strategies including the exclusive rewards
programme, ‘Home and Away’. At the end of the
year, the number of cards in circulation stood at
6.3 million, representing an increase of 34 per cent
over 2004. In India, the number of cards in
circulation exceeded one million for the first time.
Higher card balances led to higher net interest
income in Indonesia, India, Taiwan, Malaysia and the
Philippines.
Net fee income grew by 46 per cent to
US$419 million, largely attributable to strong sales
of investment and insurance products, and increased
account service fees. Credit card fee incomes rose,
driven by the strong growth in cardholder spending.
Commissions from sales of unit trusts and funds
under management were particularly strong in
Singapore, India and Taiwan. Sales of investment
products, comprising unit trusts, bonds and structured
notes, grew by 43 per cent to US$6.5 billion,
generating a 56 per cent increase in fee income. The
launch of over 217 tranches of structured notes and
deposit products in 11 countries across the region
achieved total sales of US$952 million. Total funds
under management rose by 33 per cent or
US$7.2 billion, led by increased marketing activity
and the considerable focus placed on wealth
management services during the year. HSBC Bank
Malaysia maintained its position as the leading
international institutional unit trust agent in the
country. Brokerage and custody fees grew,
particularly in Australia, where a 13 per cent rise
reflected increased stock market activity.
HSBC continued to emphasise the expansion of
its insurance business across the region. The number
of policies in force increased by 27 per cent and
revenues grew by 16 per cent.
Loan impairment charges and other credit risk
provisions doubled compared with 2004. This was
due to the non-recurrence of a release of a general
provision in Malaysia in 2004, and a sharp rise in
credit card provisions in Taiwan, reflecting
deteriorating credit conditions. Growth in personal
unsecured lending and credit cards across the region
contributed further to the increased charge.
68
Operating expenses increased by 29 per cent to
US$1,245 million in support of business growth.
HSBC spent considerable amounts in the region
enhancing its existing infrastructure in order to
benefit fully from the opportunities presented by the
Asian growth economies. Staff costs of
US$469 million rose by 23 per cent, as employee
numbers increased to support business growth and to
increase sales and wealth management activities.
Performance-related remuneration costs were also
higher as a result of the strong growth in profitability.
Marketing costs rose as major campaigns were
run to support product promotions in mortgages,
credit cards, insurance and investment products.
Continued emphasis was placed on brand awareness
in order to generate additional business and reinforce
HSBC’s position as the world’s local bank across the
region, and this further increased costs. Various
growth initiatives required investment in technology,
and the development of new distribution channels
resulted in higher IT costs. Other expenses, including
professional fees and communications costs, rose in
support of business expansion.
Increased contributions from HSBC’s
investments in Bank of Communications and
Industrial Bank in mainland China, together with
record earnings from The Saudi British Bank,
contributed to strong growth in profit from
associates.
Commercial Banking reported a pre-tax profit
of US$818 million, 45 per cent higher than that
delivered in 2004. The increase was mainly due to
higher net interest income as growth in customer
numbers and strong credit demand to fund
infrastructure investment drove balance sheet growth.
Higher contributions from Bank of Communications
and Industrial Bank in mainland China, as well as a
strong performance in The Saudi British Bank,
produced higher income from associates. Lending
balances increased by 16 per cent, exceeded by a
24 per cent rise in deposits.
Net interest income increased by 33 per cent to
US$631 million, reflecting growth in the Middle
East, Singapore, mainland China, Indonesia and
Taiwan. In the Middle East, strong regional
economies and significant government-backed
infrastructure and property projects, principally in the
United Arab Emirates, contributed to a 37 per cent
growth in lending balances and a 42 per cent increase
in customer account balances. Higher trade flows
generated a 25 per cent increase in net interest
income from trade services, while higher interest
rates raised liability spreads by 118 basis points. A
new Amanah term investment product was launched
in May 2005, attracting US$120 million of deposits,
principally from new customers seeking Shariah-
compliant investment opportunities.
In mainland China, strong economic growth,
expansion of the branch network and the recruitment
of additional sales staff resulted in a 39 per cent
increase in lending balances. Deposit balances also
benefited from economic growth, increasing by
38 per cent, while deposit spreads widened by
76 basis points following increases in US interest
rates.
In Singapore, interest rate rises prompted
increased demand for savings products and
consequently deposit balances grew by 13 per cent,
while deposit spreads increased by 13 basis points.
Lending balances rose by 27 per cent, following the
selective recruitment of more experienced
relationship managers and a reorganisation of
customers into key industrial sectors to provide
greater focus on identifying service opportunities.
Asset spreads decreased by 42 basis points as a result
of competitive pressures and market liquidity.
In Taiwan, a loyalty campaign designed to
increase deposits, together with higher current
account income and an increase in deposit spreads,
contributed to an 80 per cent increase in net interest
income. In Mauritius, net interest income doubled as
a result of liability balance growth. In India,
increased trade contributed to higher trade services
net interest income and strong economic growth
stimulated demand for credit. This resulted in lending
balances increasing by 72 per cent, while customer
acquisition increased average current account
balances by 37 per cent. Liability spreads widened by
73 basis points following interest rate rises. In
Indonesia, increased sales efforts and a more focused
approach to customer relationship management
contributed to an 84 per cent growth in asset balances
and a 66 per cent increase in net interest income.
Net fee income of US$307 million was 15 per
cent higher than in 2004. In the Middle East,
increased trade flows led to a 17 per cent increase in
trade services income, while current account income
increased by 80 per cent, benefiting from the
introduction of new cash management capabilities.
Short-term IPO loan funding reflecting, in part, the
robustness of the regional capital market, also
contributed to a 40 per cent increase in net fee
income. In mainland China, a 31 per cent increase in
trade customers and a significant rise in imports led
to higher trade services income, while a 49 per cent
increase in current account customers and higher
lending fees also contributed to an 8 per cent increase
in fee income. Increased lending, current account and
69
trade activities raised net fee income by 30 per cent
in Indonesia. A number of sites, including Vietnam
and Thailand, also reported strong growth, driven by
the success of HSBC’s strategy of focusing on
business opportunities involving international trade.
There was a net release of loan impairment
charges of US$67 million, following net charges in
2004. Credit quality in the Middle East improved. In
mainland China there was a significant reduction in
loan impairment charges as higher collective
impairment charges were more than offset by the
release of allowances against a small number of
accounts and the non-recurrence of a significant
charge against a single customer in 2004. In India,
strong economic growth led to improved credit
quality, while in Malaysia, Singapore and Indonesia,
credit quality improved significantly although
releases of impairment charges were lower than in
2004.
Operating expenses were 27 per cent higher than
last year, broadly in line with revenue growth. In the
Middle East, the recruitment of sales and support
staff substantially increased income, leading to
higher incentive payments. In mainland China,
revenue growth was driven by branch expansion,
increased sales and support staff and higher
marketing expenditure. In Malaysia, the direct sales
teams were expanded and business banking units
were extended to all branches in support of the
bank’s growth strategy, resulting in a 16 per cent
increase in costs.
In India, the recruitment of additional sales staff
boosted customer facing staff by 85 per cent in 2005.
In South Korea, staff recruitment and heightened
marketing activity supported HSBC’s four recently
established commercial banking centres, contributing
to an increase in costs. Higher costs throughout the
rest of the region largely reflected increases in sales
and support staff and initiatives to support business
expansion.
Increased income from associates reflected
strong performance in The Saudi British Bank and
gains on the sale of HSBC’s indirect stake in MISR
International, an Egyptian Bank. Income from the
bank’s strategic investments in mainland China,
Bank of Communications and Industrial Bank, which
were acquired in 2004, also increased.
Corporate, Investment Banking and Markets
reported a pre-tax profit of US$1,207 million, an
increase of 22 per cent compared with 2004. HSBC’s
progress in this region was marked by positive
revenue trends across most countries, with strong
growth being reported in the Middle East, Malaysia,
South Korea, India and mainland China.
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Rest of Asia-Pacific > 2005
Operating income rose by 25 per cent to
US$1,769 million. Higher Corporate and Institutional
Banking revenues reflected a 53 per cent increase in
lending balances in mainland China, a result of
strong demand for corporate credit, primarily from
the industrial and technology sector. Deposit
balances increased by 36 per cent and this, together
with a 40 basis point rise in deposit spreads, also
contributed to the growth in revenues.
HSBC’s operations in the Middle East reported a
63 per cent rise in customer advances, primarily due
to strong demand for corporate credit, driven by
government spending on regional infrastructure
projects.
Global Transaction Banking revenues increased,
as payments and cash management benefited from an
increase in regional mandates which added to
average balances, together with a widening of deposit
spreads, notably in Singapore, India and Thailand.
In Global Markets, balance sheet management
and money market revenues fell, particularly in
Singapore and Japan, due to the effect of rising short-
term interest rates and a flattening of the yield
curves.
Net fee income increased by 17 per cent. In
Global Transaction Banking, the expansion in
business capabilities which took place in the latter
part of 2004 drove an increase in volumes, with
marked improvements in Singapore, South Korea and
India. Revenues from the custody business increased
against the backdrop of rising local stock market
indices as investor sentiment in the region improved.
Additionally, securities services in India generated
higher business volumes, with assets under custody
growing by US$9 billion to US$34 billion. In
Singapore, fee income increased by 55 per cent,
reflecting an increase in revenues from securities
services activities as HSBC leveraged its relationship
strength and product capabilities to attract new
business.
In the Middle East, corporate lending and trade
finance activity generated higher customer volumes
as regional economies strengthened from an increase
in foreign investment, tourism and higher real estate
and oil prices. Global Investment Banking benefited
from the resulting demand for cross-border business,
with an increase in fees from advisory and project
and export finance services.
Income from trading activities increased, in part
due to higher revenues from foreign exchange and
structured derivatives, which were driven by
enhanced distribution and expanded product
capabilities. In South Korea, volatility in the Korean
70
won against the US dollar encouraged strong
customer flows in foreign exchange. In Malaysia, a
rise in customer demand, following the move to a
managed float for the Malaysian ringgit, improved
trading volumes in foreign exchange. Global Markets
in Taiwan generated higher revenues, due to
improved sales of structured derivative products.
Falling interest rates in the Philippines resulted in
favourable price movements on government bond
portfolios. In the Middle East, HSBC’s enhanced
capability in structured transactions and greater focus
on trading in the regional currencies drove volumes
higher in a volatile market.
Gains from the disposal of the Group’s asset
management business in Australia added
US$8 million to other operating income.
Net recoveries on loan impairment charges were
marginally lower than in 2004.
Reflecting higher performance-related
incentives, operating expenses increased by
21 per cent to US$733 million, broadly in line with
the growth in operating income. 2005 bore the first
full-year effect of the recruitment in 2004 of over
600 additional staff, of which more than half were in
Global Transaction Banking. The upgrade of
corporate and support teams across the region within
Corporate and Institutional Banking resulted in some
280 additional people. The cost base was further
affected by investment in HSBCnet and other
technology costs incurred to support business
expansion.
Income from associates included increased
contributions from HSBC’s investments in Bank of
Communications and Industrial Bank, which were
acquired in 2004.
Private Banking reported a pre-tax profit of
US$78 million, an increase of 32 per cent compared
with 2004. Investment in the business over the past
two years was reflected in strong growth in client
assets and net new money inflows of US$2.3 billion,
against a backdrop of intense competition in the
region. Net operating income increased by 17 per
cent, predominantly due to higher trading income.
Net interest income fell by 29 per cent to
US$30 million compared with 2004. Balance sheet
growth was mainly in Singapore and Japan, where
client deposits increased by 44 and 64 per cent
respectively. Lending to customers also grew
strongly, with the loan book increasing by some
26 per cent. The net interest income benefits of these
were more than offset by lower treasury margins
earned in the rising interest rate environment, and the
reclassification under IFRSs from 1 January 2005 of
net interest income on certain derivatives to ‘net
trading income’.
Trading income increased by 62 per cent. Strong
growth in bond trading and sales of structured
products, which increased by 28 and 20 per cent
respectively, was compounded by the reclassification
from net interest income mentioned above. Fee
income was broadly in line with 2004, with the
benefit of growth in client assets largely offset by the
non-recurrence of exceptionally high brokerage
volumes driven by the market recovery last year.
Client assets increased by 23 per cent to
US$13.7 billion. Front office recruitment and
marketing campaigns, and inflows from the
operations launched in Dubai in 2005 and Malaysia
in 2004, boosted asset growth in the region. Net new
money of US$2.3 billion was 22 per cent higher than
last year, with inflows strongest in Singapore and
Japan.
Operating expenses increased by only 6 per cent,
leading to a 5 percentage point improvement in the
cost efficiency ratio. Front office recruitment in most
countries contributed to a small increase in staff
costs, and expenditure on marketing and
administrative expenses rose to support business
growth.
In Other, the Group’s Service Centres continued
to expand to support HSBC’s productivity
improvements, incurring US$129 million of
incremental costs, offset by higher recharges to other
customer groups. Higher interest rates led to
increased earnings on centrally held investments. In
Thailand, the sale of a residential property led to a
gain of US$11 million and in India, litigation
provisions raised in 2004 were not repeated.
71
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Rest of Asia-Pacific > Profit before tax
Profit before tax by customer groups and global businesses
2,242
1,305
2,311
176
779
(91)
6,722
Total
US$m
3,047
1,622
935
246
1,181
79
41
5
174
765
6,914
(192)
(512)
6,210
(3,548)
2,662
865
3,527
%
16.0
52.8
US$m
77,574
167,668
108,995
Rest of Asia-Pacific (including
the Middle East)
Net interest income .....................
Net fee income ............................
Trading income/(expense)
excluding net interest income
Net interest income on trading
activities ..................................
Net trading income .....................
Net income from financial
instruments designated at
fair value .................................
Gains less losses from
financial investments ..............
Dividend income .........................
Net earned insurance premiums .
Other operating income ..............
Total operating income ............
Net insurance claims1 ..................
Net operating income before
loan impairment charges
and other credit risk
provisions ..............................
Loan impairment (charges)/
recoveries and other
credit risk provisions ..............
Net operating income ...............
Personal
Financial
Services
US$m
1,520
524
61
–
61
59
2
–
148
108
2,422
(180)
(545)
1,697
Total operating expenses ............
(1,593)
Operating profit ........................
Share of profit in associates
and joint ventures ...................
Profit before tax ........................
Share of HSBC’s profit
before tax ................................
Cost efficiency ratio ...................
104
373
477
%
2.2
71.1
Year ended 31 December 2006
Corporate,
Investment
Banking &
Markets
US$m
Commercial
Banking
US$m
Private
Banking
US$m
Inter-
segment
elimination
US$m
Other
US$m
848
330
86
–
86
4
2
–
26
20
802
688
717
–
717
4
38
1
–
61
1,316
(11)
2,311
–
35
68
74
–
74
–
(1)
–
–
–
176
–
61
12
(3)
27
24
12
–
4
–
667
780
(1)
(219)
–
–
219
219
–
–
–
–
(91)
(91)
–
29
1,334
(554)
780
254
1,034
%
4.7
42.5
5
2,316
(869)
1,447
202
1,649
%
7.5
37.6
–
176
(96)
80
–
80
%
0.4
54.5
(1)
778
(527)
251
36
287
%
1.2
67.7
–
(91)
91
–
–
–
Selected balance sheet data2
Loans and advances to
customers (net) .......................
Total assets .................................
Customer accounts ......................
The following assets and
liabilities were significant
to Corporate, Investment
Banking and Markets:
– loans and advances to
banks (net) ..........................
– trading assets, financial
instruments designated at
fair value, and financial
investments .........................
– deposits by banks ...............
US$m
US$m
US$m
US$m
US$m
28,911
35,317
38,557
21,912
26,335
24,228
24,311
93,605
36,623
2,313
6,476
8,929
127
5,935
658
22,171
36,580
9,849
72
Rest of Asia-Pacific (including
the Middle East)
Year ended 31 December 2005
Personal
Financial
Services
US$m
Commercial
Banking
US$m
Corporate,
Investment
Banking &
Markets
US$m
Private
Banking
US$m
Other
US$m
Net interest income .....................
Net fee income ............................
1,208
419
Trading income/(expense)
excluding net interest income
Net interest income/(expense)
on trading activities ................
Net trading income/(expense) ....
Net income from financial
instruments designated at
fair value .................................
Gains less losses from
financial investments ..............
Dividend income .........................
Net earned insurance premiums .
Other operating income ..............
Total operating income ...............
Net insurance claims1 ..................
Net operating income before
loan impairment charges and
other credit risk provisions .....
Loan impairment (charges)/
recoveries and other
credit risk provisions ..............
Net operating income .................
37
1
38
44
–
–
134
37
1,880
(157)
(236)
1,487
Total operating expenses ............
(1,245)
Operating profit ..........................
Share of profit in associates
and joint ventures ...................
Profit before tax ..........................
Share of HSBC’s profit
before tax ................................
Cost efficiency ratio ...................
242
135
377
%
1.8
72.3
631
307
70
(1)
69
1
4
–
21
9
614
498
579
(21)
558
4
12
1
–
82
1,042
(9)
1,769
–
30
43
74
–
74
–
2
–
–
4
153
–
54
73
(7)
3
(4)
9
–
4
–
287
423
–
Inter-
segment
elimination
US$m
(125)
–
–
125
125
–
–
–
–
(84)
(84)
–
Total
US$m
2,412
1,340
753
107
860
58
18
5
155
335
5,183
(166)
67
1,100
(452)
648
170
818
%
3.9
43.8
35
1,804
(733)
1,071
136
1,207
%
5.8
41.4
2
155
(77)
78
–
78
%
0.4
50.3
(2)
421
(339)
82
12
94
%
0.4
80.1
–
(84)
84
–
–
–
(134)
4,883
(2,762)
2,121
453
2,574
%
12.3
55.1
US$m
70,016
142,014
89,118
1,723
1,033
1,769
153
423
(84)
5,017
Selected balance sheet data2
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) ..........................
– trading assets, financial
instruments designated at
fair value, and financial
investments .........................
– deposits by banks ...............
US$m
US$m
US$m
US$m
US$m
27,433
32,224
31,250
18,694
22,570
18,612
21,431
76,026
32,102
2,347
5,359
7,092
111
5,835
62
15,352
26,113
7,041
73
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Rest of Asia-Pacific > Profit before tax / North America > 2006
Profit before tax by customer groups and global businesses (continued)
Year ended 31 December 2004
Personal
Financial
Services
US$m
Commercial
Banking
US$m
Corporate,
Investment
Banking &
Markets
US$m
Private
Banking
US$m
Inter-
segment
elimination
US$m
Other
US$m
Rest of Asia-Pacific (including
the Middle East)
Net interest income .....................
Net fee income ............................
Trading income ...........................
Net investment income on
assets backing policyholders’
liabilities .................................
Gains less losses from
financial investments ..............
Dividend income .........................
Net earned insurance premiums .
Other operating income ..............
948
284
43
32
1
–
77
28
Total operating income ...............
1,413
Net insurance claims1 ..................
(72)
472
266
59
–
–
–
20
13
830
(10)
596
421
344
–
6
–
–
26
1,393
–
42
41
46
–
–
–
–
2
131
–
2
29
2
–
10
3
–
157
203
–
–
–
–
–
–
–
–
(80)
(80)
–
Total
US$m
2,060
1,041
494
32
17
3
97
146
3,890
(82)
Net operating income before
loan impairment charges and
other credit risk provisions .....
Loan impairment (charges)/
recoveries and other
credit risk provisions ..............
Net operating income .................
Total operating expenses ............
Operating profit ...........................
Share of profit in associates
and joint ventures ...................
Profit before tax ..........................
Share of HSBC’s profit
before tax ................................
Cost efficiency ratio ...................
Selected balance sheet data2
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) ..........................
– trading assets, financial
instruments designated at
fair value, and financial
investments .........................
– deposits by banks ...............
1,341
820
1,393
131
203
(80)
3,808
(117)
1,224
(949)
275
61
336
%
1.8
70.8
(20)
800
(350)
450
33
483
%
2.6
42.7
47
1,440
(598)
842
100
942
%
5.0
43.0
1
132
(72)
60
–
60
%
0.3
55.0
–
203
(198)
5
21
26
%
0.1
97.5
US$m
US$m
US$m
US$m
US$m
22,886
25,577
28,961
16,444
18,845
15,381
19,276
66,438
28,620
1,960
4,549
5,543
97
5,121
108
–
(80)
80
–
–
–
(89)
3,719
(2,087)
1,632
215
1,847
%
9.8
54.8
US$m
60,663
120,530
78,613
12,119
26,555
7,156
1 Net insurance claims incurred and movement in policyholders’ liabilities.
2 Third party only.
74
North America
Profit/(loss) before tax by country within customer groups and global businesses
Year ended 31 December
Personal Financial Services ..........................................................................
United States ....................................................................................................
Canada .............................................................................................................
Bermuda ...........................................................................................................
Commercial Banking .....................................................................................
United States ....................................................................................................
Canada .............................................................................................................
Bermuda ...........................................................................................................
Corporate, Investment Banking and Markets ...........................................
United States ....................................................................................................
Canada .............................................................................................................
Bermuda ...........................................................................................................
Other ................................................................................................................
Private Banking .............................................................................................
United States ....................................................................................................
Bermuda ...........................................................................................................
Other ...............................................................................................................
United States ....................................................................................................
Canada .............................................................................................................
Bermuda ...........................................................................................................
Other ................................................................................................................
Total .................................................................................................................
United States ....................................................................................................
Canada .............................................................................................................
Bermuda ...........................................................................................................
Other ................................................................................................................
2006
US$m
3,391
3,128
253
10
957
442
437
78
423
199
189
31
4
114
107
7
(217)
(264)
17
29
1
4,668
3,612
896
155
5
20051
US$m
4,181
3,853
310
18
892
447
403
42
573
373
154
43
3
104
104
–
165
158
(12)
19
–
5,915
4,935
855
122
3
20041
US$m
3,826
3,642
157
27
691
417
239
35
879
741
134
4
–
68
65
3
(196)
(201)
–
5
–
5,268
4,664
530
74
–
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly.
Year ended 31 December 2006 compared
with year ended 31 December 2005
Economic briefing
In the US, GDP growth in 2006 was 3.4 per cent.
Growth in the second half of the year moderated to
below 3 per cent, after average annualised growth of
4.1 per cent in the first half of the year. Consumer
spending in 2006 grew by 3.4 per cent, with average
annualised growth of 3.6 per cent in the second half
of the year. Housing activity weakened substantially
in 2006, with annualised declines in residential
investment of 11 per cent in the second quarter
followed by annualised declines of 19 per cent in the
third and fourth quarters of the year. There was some
optimism that housing starts may have begun to
stabilise by the year-end, with housing permits rising
in December after ten successive monthly falls.
Continued strong profits growth meant that business
investment remained robust but industrial production
weakened markedly towards the end of the year. The
unemployment rate remained relatively low,
averaging 4.6 per cent in 2006. The trade deficit
stabilised through most of the year and narrowed in
the final months of 2006 in response to strong global
growth and a weaker US dollar. Inflation rose by
4.3 per cent in the first half of the year due to energy
price rises but subsequently fell to an annual rate of
about 2 per cent as energy prices declined. The
Federal Reserve raised short-term interest rates by
1 per cent in the first half of 2006 to 5.25 per cent,
but kept rates unchanged thereafter. After rising
from 4.4 per cent to 5.2 per cent in the first half of
2006, 10-year note yields fell to a low of 4.4 per cent
in early December before increasing to 4.7 per cent
by the year-end. The S&P500 stock market index
rose by 13.6 per cent in the year.
The Canadian economy slowed during 2006,
with GDP growth falling from an annualised rate of
3.6 per cent at the beginning of the year to 1.7 per
cent by the third quarter, largely reflecting slower
export growth. Domestic demand remained robust
and HSBC expects the momentum seen in 2006 to
continue through 2007, supported by historically low
levels of unemployment and a housing market
75
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
North America > 2006
Profit before tax
North America
Net interest income ..........................................................................................
Net fee income .................................................................................................
Trading income ................................................................................................
Net income/(expense) from financial instruments designated at fair value ...
Net investment income from assets backing policyholders’ liabilities ..........
Gains less losses from financial investments ..................................................
Dividend income ..............................................................................................
Net earned insurance premiums ......................................................................
Other operating income ...................................................................................
Total operating income .................................................................................
Net insurance claims incurred and movement in policyholders’ liabilities ....
Net operating income before loan impairment charges and other
credit risk provisions .................................................................................
Loan impairment charges and other credit risk provisions .............................
Net operating income ....................................................................................
Total operating expenses .................................................................................
Operating profit .............................................................................................
Share of profit/(loss) in associates and joint ventures ....................................
Profit before tax .............................................................................................
Share of HSBC’s profit before tax ..................................................................
Cost efficiency ratio ........................................................................................
Year-end staff numbers (full-time equivalent) ................................................
Selected balance sheet data2
Loans and advances to customers (net) ...........................................................
Loans and advances to banks (net) ..................................................................
Trading assets, financial instruments designated at fair value, and
financial investments3 .................................................................................
Total assets ......................................................................................................
Deposits by banks ............................................................................................
Customer accounts ...........................................................................................
Year ended 31 December
2006
US$m
14,268
4,766
1,358
(63)
–
58
85
492
922
21,886
(259)
21,627
(6,796)
14,831
(10,193)
4,638
30
4,668
%
21.1
47.1
55,642
US$m
277,987
17,865
145,700
511,190
11,484
120,922
20051
US$m
13,295
3,952
885
434
–
47
41
477
642
19,773
(232)
19,541
(4,916)
14,625
(8,758)
5,867
48
5,915
%
28.2
44.8
53,608
US$m
252,560
10,331
112,225
432,490
7,780
111,386
20041
US$m
13,787
3,197
509
–
–
147
32
450
341
18,463
(236)
18,227
(5,036)
13,191
(7,915)
5,276
(8)
5,268
%
27.8
43.4
49,416
US$m
240,151
20,911
49,196
348,132
13,720
117,551
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly.
2 Third party only.
3 Including financial assets which may be repledged or resold by counterparties.
which, although showing signs of moderation,
remained strong throughout 2006. Although energy
prices eased, 2006’s commodity boom was expected
to continue benefiting the Canadian economy
through 2007. Inflation remained problematic with
core prices moving above the Bank of Canada’s
(‘BoC’) preferred target rate of 2 per cent, and
productivity remained relatively weak. Having raised
its overnight interest rate from 3.25 per cent at the
start of 2006 to 4.25 per cent in May, the BoC kept
rates on hold for the rest of the year.
Review of business performance
HSBC’s operations in North America reported a
pre-tax profit of US$4,668 million compared with
US$5,915 million in 2005, a decrease of 21 per cent.
On an underlying basis, pre-tax profits declined by
25 per cent. Underlying net operating income before
loan impairment charges was higher by 6 per cent,
reflecting the income benefit of asset growth in
Personal Financial Services. This revenue growth
was more than offset by a significant rise in loan
impairment charges in the correspondent mortgage
services business within HSBC Finance, as slowing
house price appreciation and the projected effect of
76
interest rate resets impacted loss estimates from
rising credit delinquency. This is described more
fully below and on page 189. In Commercial
Banking, investment in distribution channels
delivered growth from increased lending and deposit
taking. In Corporate, Investment Banking and
Markets, strong trading results more than offset
lower balance sheet management revenues, which
were constrained by compressed spreads in a flat
interest rate yield curve environment. Underlying
operating expenses increased by 13 per cent to
support investment in business expansion and branch
openings in the Personal Financial Services business.
The commentary that follows is on an
underlying basis.
Personal Financial Services generated a pre-
tax profit of US$3,391 million, a decrease of 23 per
cent compared with 2005. Net operating income rose
at a slower rate than cost growth, due to constrained
balance sheet growth in the second half of the year,
higher collection expense and significantly higher
loan impairment charges. The increased loan
impairment charges recognised in respect of HSBC
Finance’s correspondent mortgage services business
more than offset the non-recurrence of charges
arising in respect of hurricane Katrina and the
change in bankruptcy legislation in 2005. The cost
efficiency ratio worsened as costs rose faster than
revenues.
In the US, pre-tax profit of US$3,128 million
was 24 per cent lower than in 2005, reflecting the
significantly higher loan impairment charges noted
above and additional costs incurred in support of
business expansion in both the consumer finance
company and the retail bank. Beginning in 2004,
HSBC implemented a growth strategy for its core
banking network in the US which included building
deposits over a three to five year period across
multiple markets and segments utilising diverse
delivery systems. During 2006 the strategy included
various initiatives, the most important of these being
growing the deposit base by emphasising more
competitive pricing and introducing high yielding
products, including internet savings accounts. These
have grown significantly since late 2005 to
US$7 billion, of which US$6 billion arose in 2006
and US$5 billion of the 2006 growth was from new
customers. Retail branch expansion in existing and
new geographic markets was also a key initiative,
with 25 new branches opened in 2006.
In Canada, profit before tax was 21 per cent
lower, partly due to the absence of provision releases
made in 2005 in the core banking operations.
Revenues rose but this was offset by costs incurred
77
in support of expansion in consumer finance and
investments made in the bank distribution channels.
Net interest income of US$12,964 million was
7 per cent higher than in 2005. In the US, there was
strong growth in mortgages, cards and other personal
non-credit card lending, particularly in the first half
of the year, and this, coupled with higher deposit
balances, led to a 6 per cent increase in net interest
income as competition reduced both asset and
deposit spreads.
Average deposit balances in the US rose by
21 per cent to US$32.2 billion, mainly led by the
continued success of online savings. The HSBC
Premier investor product also continued to grow
strongly. During the year over 22,000 new accounts
were opened and balances rose by 139 per cent as
US$2.1 billion in incremental deposits were taken.
Customers migrated to higher yielding products
which led to a change in product mix, and the
consequent reduction in spreads partly offset the
benefits of balance growth.
There was a marked slowdown in the US
housing market during 2006, although towards the
end of the year demand for housing showed signs of
stabilising. However, the supply of houses for sale
remained high, with the overall outlook still
uncertain. Average mortgage balances rose by 9 per
cent to US$123.8 billion, with growth concentrated
in non-prime balances in the mortgage services
correspondent and branch-based consumer lending
businesses. Prime mortgage balances originated and
retained through the core banking network continued
to decline. This reflected an ongoing strategic
initiative to manage the balance sheet by selling the
majority of new prime loan originations to
government-sponsored enterprises and private
investors, along with planned securitisations and the
normal run-off of balances. Overall, yields improved
from the combined effects of a change in product
mix to higher-yielding non-prime mortgages and re-
pricing initiatives. Despite this improvement in
yields, spreads narrowed due to higher funding costs
as interest rates rose, and this reduced the positive
income benefit of the higher lending balances.
The following comments on mortgage lending
relate to HSBC Finance as mortgage lending growth
in 2006 was concentrated in this business.
In the branch-based consumer lending business,
average mortgage balances grew by 15 per cent to
US$41.2 billion as lending secured on real estate,
which included a near-prime product introduced in
2003, was pursued. This growth was augmented
by portfolio acquisitions, most notably the
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
North America > 2006
US$2.5 billion Champion mortgage portfolio
purchased from KeyBank, NA in November 2006.
In the mortgage services correspondent
business, average balances of US$49.9 billion were
28 per cent higher than in 2005. During 2005 and the
first half of 2006, emphasis was placed on increasing
both first and second lien mortgages by expanding
sources for the purchase of loans from
correspondents. In the second quarter of 2006,
HSBC began to witness deterioration in the
performance of mortgages acquired in 2005,
particularly in the second lien and portions of the
first lien portfolios. This deterioration continued in
the third quarter and began to affect the equivalent
loans acquired in 2006. In the final quarter of 2006,
the deterioration worsened considerably, mainly in
first lien adjustable rate mortgage (‘ARM’) balances
and second lien loans.
A series of actions were initiated in the third
quarter to mitigate risk in the affected components of
the portfolio. These included revising pricing in
selected origination segments, tightening
underwriting criteria to eliminate or substantially
reduce higher risk products (especially in respect of
second lien, stated income (low documentation) and
lower credit scoring segments), and enhancing
segmentation and analytics to identify higher risk
portions of the portfolio and increase collections.
These initiatives led to a decline in overall portfolio
balances during the second half of 2006, mostly
attributable to lower purchases of second lien and
certain higher-risk products, along with the normal
run-off of balances.
Average credit card balances in the US rose by
6 per cent to US$26.8 billion. The market continued
to be highly competitive with many lenders placing
reliance on promotional rate offers to generate
growth. HSBC took a strategic decision to reduce the
amount of its equivalent offers and instead grew its
HSBC branded prime, Union Privilege and non-
prime portfolios largely from targeted marketing
campaigns. Margins widened, reflecting improved
yields as the product mix changed towards higher
levels of non-prime and lower levels of promotional
balances, coupled with other re-pricing initiatives
undertaken on variable rate products. This more than
offset the adverse effect of higher funding costs and
augmented the income benefits of the increased loan
book.
In the retail services business, average balances
rose by 6 per cent to US$15.8 billion. This was
mainly driven by newer merchants, changes in
product mix and the launch of three co-branded
programmes; the MasterCard and Visa partnerships
78
with Best Buy and Saks Fifth Avenue, and the
Neiman Marcus co-branded card with American
Express. The positive income benefits from higher
balances were more than offset by lower spreads, as
a large proportion of the loan book priced at fixed
rates was affected by higher funding costs. This was
further affected by changes in the product mix as
lower yielding department store card balances grew
more strongly, and by competitive downward pricing
pressures. Changes in merchant contractual
obligations also led to lower net interest income,
though this was offset by reduced partnership
payments to those merchants.
Growth opportunities in the motor vehicle
financing industry were particularly challenging in
2006, driven by a reduction in incentive programmes
offered by manufacturers and a rising interest rate
environment. Notwithstanding these factors, average
balances rose by 12 per cent. This was led by strong
organic growth in the near-prime portfolio from an
increased emphasis on strengthening relationships
with active dealers, and greater volumes generated
from the consumer direct programme. Refinancing
volumes rose, directly attributable to the successful
consumer refinance programme, which recorded a
48 per cent increase in originations.
In Canada, net interest income rose by 16 per
cent due to lending and deposit growth. Average
mortgage balances grew as a result of the continued
strength of the housing market and ongoing branch
expansion in the consumer finance business. The
strong economy drove higher levels of unsecured
lending as consumer spending rose. Expansion of the
consumer finance motor vehicle proposition and the
launch of a MasterCard programme in 2005
contributed further to asset growth, while increased
marketing activity led to a rise in personal non-credit
card lending balances. Asset spreads narrowed,
largely from lower yields which reflected changes in
product mix and competitive market conditions.
Average deposit balances grew by 6 per cent
compared with 2005, with the notable success of a
new high rate savings account and a sale campaign
celebrating HSBC’s 25th anniversary in Canada.
Deposit spreads widened as interest rates rose,
contributing further to the increase in net interest
income.
Net fee income grew by 13 per cent to
US$3,675 million, with increases in both the US and
Canada. The 13 per cent rise in the US was largely
led by higher fees from the credit card and retail
services businesses. Credit card fee income from the
consumer finance business increased by 8 per cent,
primarily from balance growth in the non-prime
portfolio, improved interchange rates and lower fee
charge-offs. Revenues from credit card partnership
enhancement services rose due to greater sales
volumes, expansion into new customer segments and
balance growth.
Within the US retail services business, net fee
income rose, reflecting lower merchant payments, in
part due to changes in contract obligations with
certain merchants. A rise in late fees from growth in
customer account balances and higher fees on
overdue payments contributed further to the
increase.
In the US mortgage-banking business, net fee
income declined. Although mortgage loan service
volumes grew in 2006, contributing additional fee
income from the greater proportion of mortgages
originated and then sold with mortgage servicing
rights retained, these benefits were more than offset
by higher amortisation charges and lower releases of
temporary impairment provisions on mortgage
servicing rights. The taxpayer financial services
business generated higher fee income from increased
loan volumes during the 2006 tax season.
In Canada, net fee income rose by 5 per cent to
US$217 million. Continued growth in the wealth
management business resulted in higher investment
administration fees, and credit card fee income rose,
driven by increased lending.
Trading income fell by 17 per cent, due to lower
income on HSBC Finance’s Decision One mortgage
balances held for resale to secondary market
purchasers. This primarily reflected additional losses
incurred following the repurchase of certain
mortgages previously sold to external third parties
which had subsequently gone into default. Higher
losses on derivatives that did not meet the criteria for
hedge accounting contributed further to the decrease.
A US$20 million gain from the MasterCard
Incorporated IPO was the key reason for the increase
in gains from financial instruments.
Other operating income also rose, primarily
driven by gains on various asset disposals. Most
notably, a US$123 million profit was achieved on
disposal of HSBC’s investment in Kanbay
International Inc, a worldwide information
technology services firm. Income from overnight
and short-term money market investments also rose.
These benefits were partly offset by greater losses
incurred on sales of repossessed properties,
following a 42 per cent rise in such properties as
customers defaulted on their mortgage payments.
higher than in 2005. In the US, loan impairment
charges rose by 28 per cent despite the non-
recurrence of significant charges which arose in
2005 following hurricane Katrina and increased
levels of bankruptcy filings in the final quarter of the
year. Loan impairment charges were also higher in
the second half of 2006 compared with both the
preceding half and the second half of 2005. The
increase was primarily driven by significantly higher
delinquencies and losses in the mortgage services
correspondent business, concentrated in second lien
and portions of first lien mortgages originated and
purchased in 2005 and 2006. As noted previously,
HSBC witnessed a deterioration in the performance
of these 2005 originations during the first half of
2006. This deterioration continued into the third
quarter and started to affect equivalent loans
originated in 2006. In the final quarter of 2006,
deterioration of these loans, largely the first lien
adjustable rate and second lien loans, worsened
considerably. The heightened risk of loss was
attributable to lower equity in homes as price growth
moderated or reversed, together with a higher
prospective interest burden from ARM resets. As
many of these mortgages were being re-priced in an
environment of higher interest rates, slower asset
price appreciation and tightening credit, HSBC
considers it highly likely that these factors will lead
to increased instances of default in the future on both
first and any associated second lien loans.
Accordingly, a significant increase in loan
impairment charges was recorded in the final
quarter of the year.
Higher lending, the seasoning1 of the loan
portfolio, and a return to more normal historical
levels of delinquency from the exceptionally
favourable credit conditions experienced in recent
periods, all contributed to the overall increase in
impairment charges in the US. This was partly offset
by lower numbers and levels of bankruptcy filings
and the positive effect of low unemployment. The
credit card business, in addition, benefited from
improved recovery rates from loans previously
written off. Notwithstanding the accelerated credit
weakness witnessed in the mortgage services
correspondent business, credit performance as
measured by delinquency and loss in the majority of
the other lending portfolios, including mortgage
balances originated through the branch-based
consumer lending business gradually deteriorated
from the seasoning of a growing portfolio and the
rising proportion of credit card balances. Loan
impairment charges in these portfolios were
Loan impairment charges and other credit risk
provisions of US$6,683 million were 28 per cent
1 ‘Seasoning’ describes the emergence of credit
loss patterns in portfolios over time.
79
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
North America > 2006
consequently higher in the second half of 2006 as
these portfolios seasoned, coinciding with the
weakening housing market.
In Canada, loan impairment charges were 38 per
cent higher. This primarily reflected the non-
recurrence of loan impairment releases from core
banking operations, which occurred in 2005, as well
as growth in both secured and unsecured lending
balances and higher delinquency rates in the motor
vehicle finance business.
Operating expenses grew by 12 per cent
to US$7,379 million. In the US, costs of
US$6,706 million were 11 per cent higher than in
2005. In the consumer finance business, the rise
was driven by increased headcount to support
incremental collections activity, and greater
volumes. Higher costs were incurred in marketing
cards to support the launch of new co-branded
credit cards, greater levels of mailing and other
promotional campaigns in the cards and retail
services businesses. IT and administrative expenses
grew in support of higher asset balances. A lower
level of deferred origination costs in the mortgage
services business, due to a decline in volumes,
contributed further to the cost growth.
In HSBC Bank USA, expense growth was
primarily driven by branch staff costs from
additional headcount recruited to support investment
in business expansion and new branch openings.
Greater emphasis placed on increasing the quality
and number of branch staff dedicated to sales and
customer relationship activities, which changed the
staff mix, also contributed to cost growth. The
continued promotion of the on-line savings product,
new branch openings and branding initiatives at the
John F. Kennedy International and LaGuardia
airports in New York led to a rise in marketing costs.
IT costs also grew following significant investment
expenditure incurred on several key network
efficiency projects.
In Canada, costs rose by 19 per cent, mainly due
to higher staff and marketing costs. Staff costs grew
by 13 per cent, with increased headcount supporting
expansion of the consumer finance business and
bank distribution network. Continuing investment in
growing the wealth management business and higher
incentive costs reflecting improved revenues also
contributed to the increase. Marketing costs grew
following external campaigns to improve brand
awareness.
Commercial Banking’s pre-tax profits rose by
4 per cent to US$957 million, largely driven by
lending and deposit growth and higher fee income,
partly offset by increased loan impairment charges.
80
Costs rose mainly from geographical expansion in
the US and branch and business expansion in
Canada. The cost efficiency ratio worsened by
2.1 percentage points, as costs grew faster than
revenues.
Net interest income grew by 15 per cent to
US$1,362 million. In the US, net interest income
was 13 per cent higher, as HSBC continued to
expand its geographical presence, notably in Boston,
Connecticut, New Jersey, Philadelphia, Washington
D.C., Chicago and Los Angeles. Average deposit
balances rose by 30 per cent, aided by geographical
expansion and greater focus placed on generating
balances from commercial real estate companies and
middle market customers. In particular, there was an
increased emphasis on attracting high margin
balances from cash management sales activities.
Rising interest rates encouraged customers to
transfer funds to higher yielding products and the
resulting change in product mix led to a narrowing
of liability spreads.
The 7 per cent growth in average lending
balances was principally led by greater volumes
generated from small business and middle market
customers. This was achieved by a combination of
geographical expansion, increased marketing activity
and the recruitment of additional small-business
relationship managers. Asset spreads narrowed due
to competitive pricing pressures, particularly in the
middle market customer segment, which partly
offset the income benefits from higher lending
volumes.
In Canada, net interest income increased by
14 per cent. The strong economy encouraged
continued business investment by customers and
this, in conjunction with HSBC’s reputation for
customer service and relationship management,
helped generate a 15 per cent growth in average
lending balances. Loan spreads were broadly in line
with 2005. There was a 35 per cent improvement in
average deposit balances, driven by various factors
including the acquisition of new customers,
strengthening relationships with existing ones, and
enhancing payment and cash management products.
Deposit spreads widened as interest rates rose,
augmenting the income benefits from higher
balances.
Net interest income in Bermuda grew by
42 per cent, partly due to interest rate rises which
widened deposit spreads. Deposit balances increased
by 26 per cent, while increased cross-sales activity
contributed to a 26 per cent rise in average lending
balances.
Net fee income improved by 13 per cent to
US$329 million. In the US, the 11 per cent rise was
primarily due to an increase in syndication
capabilities, which led to higher commercial
mortgage fees, and from business expansion into
new geographical markets. In Canada, growth in
new lending business led to higher levels of service
charges, and credit fees increased following the rise
in customer numbers. Product enhancements and
additions to the sales force helped grow fee income
from payment and cash management services.
There was a small reduction in other operating
income, largely due to the net effects of lower gains
on asset disposals in the US.
Also in the US, the redemption of bonds
issued by the Venezuelan government led to a
US$19 million gain from financial instruments.
Loan impairment charges were US$74 million
compared with a net release of US$21 million in
2005. In the US, the increase reflected strong growth
in lending balances to small and middle market
customers, higher write-offs in the small business
segment and the exceptionally low charges recorded
in 2005 compared with historical levels. Loan
impairment charges rose in Canada following the
non-recurrence of releases which occurred in 2005
and, in Bermuda, net releases compared with charges
in 2005.
Operating expenses grew by 21 per cent to
US$814 million. The 27 per cent rise in the US was
driven by a combination of increased costs incurred
in support of geographical expansion and the
recruitment of additional sales staff to drive revenue
growth. In Canada, operating expenses were 14 per
cent higher from additional headcount recruited to
support branch and network expansion and increased
salary and bonus costs, which reflected improved
revenues. Expenditure incurred in order to develop
the business, largely due to HSBC brand campaigns,
contributed further to cost growth.
Income from associates rose by US$34 million,
including HSBC’s share from an equity investment
in Wells Fargo HSBC Trade Bank N.A. of
US$11 million in the US. Income from associates of
US$22 million in Canada was attributable to higher
gains and distributions from private equity fund
investments. These funds, in which HSBC has
maintained a minority interest, were established to
provide institutional investors with access to private
equity investment opportunities.
Corporate, Investment Banking and Markets
reported a pre-tax profit of US$423 million, 28 per
cent lower than in 2005. The result in 2005 benefited
81
from a US$106 million favourable movement on
ineffective hedges on HSBC’s own debt and,
excluding this, profit before tax decreased by 12 per
cent. The fall in profits was primarily due to a
decline in balance sheet management revenues.
Balance sheet management activity continued to be
constrained by compressed spreads in a flat interest
rate yield curve environment, with a resultant
decrease of US$347 million. Operating expenses
were higher by 19 per cent with a significant portion
of the increase driven by the first full year effect of
recruitment and business expansion in 2005, and by
specific initiatives taken in early 2006. This
investment in extending the trading platform,
notably in mortgage-backed securities, structured
derivatives, metals and foreign exchange, produced
record trading revenues.
Net fee income and trading income also grew,
reflecting the measures taken to strengthen HSBC’s
presence in the region.
In Global Banking, net interest income in
payments and cash management rose by 66 per cent,
largely due to an over 50 per cent growth in
balances.
Net fee income rose by 13 per cent to
US$656 million. Increases in fee income within the
newly expanded mortgage-backed securities and
equity underwriting businesses were driven by
higher volumes. The securities services business
benefited from a combination of new client volumes
and market-driven asset growth. However, income
from debt underwriting activity declined due to
fewer deals, particularly in the second half of the
year. In Global Banking, higher transaction volumes
in the recently enhanced payments and cash
management business, and an increase in customer
volumes driven by a wider product offering, led to
higher net fee income.
HSBC’s operation in Canada reported a 31 per
cent increase in fees, reflecting a growth in funds
under management within Group Investment
Businesses, coupled with higher fees from the
lending business and HSBC Securities Services.
Net trading income more than doubled to
US$818 million. In Global Markets, a wider product
offering and improved sales capabilities drove
significant gains across all major client-related
activities. Revenues were further boosted by the first
full year contribution from the mortgage-backed
securities trading business. Credit and Rates
benefited from tightening credit spreads and
increased customer flows. Structured derivatives
income more than doubled, reflecting successful
product launches as well as increased sales of
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
North America > 2006 / 2005
tailored solutions. Revenues in the foreign exchange
business remained robust against the backdrop of a
weakening US dollar.
In Canada, trading income more than doubled,
with higher gains from foreign exchange; a result of
increased volatility of the Canadian dollar against
the US dollar.
Gains from financial investments were
79 per cent lower as income from the disposal of
securities declined.
A 50 per cent increase in other income was
driven in part by higher revenues in HSBC’s
Sharia-compliant property fund business, which
were offset by higher related costs.
The overall credit environment remained stable,
although a small loan impairment charge of
US$3 million compared unfavourably to a net
release of US$64 million in 2005.
Operating expenses increased by 19 per cent to
US$1,641 million, mainly due to the first full year
effect of the business expansion which took place in
2005 and additional expenditure in early 2006. In
Global Markets, cost growth was primarily driven by
the mortgage-backed securities, structured
derivatives and equity businesses. Staff costs
increased by 11 per cent, reflecting the first full year
effect of people recruited in 2005, performance
incentives that rose in line with revenue and
selective hires in early 2006.
Operational expenses in the payments and cash
management and the securities services businesses
increased as business volumes grew and the related
support businesses were expanded.
HSBC’s share of profits from associates
declined significantly reflecting the non-recurrence
of distributions from a private equity associate.
Private Banking contributed a pre-tax profit of
US$114 million, an increase of 12 per cent
compared with 2005. HSBC’s onshore presence was
enhanced by the opening of offices in Chicago and
Greenwich, Connecticut. Revenue growth, driven by
significantly higher core fees and commissions and
improved trading results, was offset in part by loan
impairment charges of US$35 million,
US$29 million of which related to a single customer.
The cost efficiency ratio improved by 6.2 percentage
points to 70.4 per cent.
Net interest income increased by 15 per cent to
US$212 million. A deposit-raising campaign proved
successful at garnering funds, the total raised by the
year-end reaching US$2.5 billion. Overall, deposit
balances rose by 25 per cent and lending balances
82
increased by 14 per cent. Deposit spreads were
marginally lower than in 2005.
Net fee income grew strongly, increasing by
20 per cent to US$240 million. Wealth and Tax
Advisory Services (‘WTAS’) continued to expand its
client base – it rose by 31 per cent in 2006 – and
reported significant revenue growth, benefiting from
restrictions placed on the major auditing firms with
regard to providing personal tax advice to employees
of audit clients. Higher funds under management and
an increase in referrals with other HSBC businesses
also contributed to the increased level of fee income.
A one-off gain of US$9 million arose from a
partial disposal of a holding in the Hermitage Fund,
offsetting the non-recurrence of US$9 million of
income following the sale of a number of small trust
businesses in 2005.
Client assets increased by 5 per cent to
US$43 billion, with net new money of US$5 billion.
This included a significant contribution from the
higher fee-earning discretionary SIS and CIS
products in which the value of client assets rose to
US$1.4 billion.
Operating expenses of US$355 million were
10 per cent higher than in 2005. This rise was
primarily attributable to hiring front office private
banking staff and fee-earning staff within WTAS.
In Other, movements in the fair value of own
debt and associated swaps resulted in losses of
US$128 million in 2006, compared with profits of
US$401 million in 2005.
Business expansion led to higher transaction
volumes, which resulted in increased utilisation of IT
systems and solutions. Branch expansion, the
integration of Metris, and the launch of new products
also contributed to an 8 per cent increase in costs and
income at the group’s North American technology
centre. In hsbc.com, accrued costs associated with
the development of HSBC’s second generation
internet banking platforms were recharged to other
customer groups, which resulted in higher operating
income.
Year ended 31 December 2005 compared
with year ended 31 December 2004
Economic briefing
Despite cooling in the fourth quarter, GDP growth in
the US was 3.5 per cent in 2005. Consumer spending
grew by a healthy 3.6 per cent in 2005 despite
slowing in the fourth quarter because of the
hurricanes, higher energy costs and lower auto sales.
Growth in equipment and software investment was
robust, rising 11 per cent. Unemployment fell by
0.5 per cent to 4.9 per cent in 2005, with 2 million
new jobs created. The Federal Reserve’s favoured
inflation measure, the core personal consumption
expenditure deflator, was contained, rising 2 per cent
in 2005. Headline inflation in 2005 was higher due
to increased energy prices, as the full year consumer
price index rose 3.4 per cent. The Federal Reserve
raised interest rates eight times during the year, from
2.25 per cent to 4.25 per cent. 10-year bond yields
and equity markets rose moderately during 2005 as
the US dollar strengthened, ending the year at
US$1.18 to the euro compared with US$1.35 at the
end of 2004.
Canada’s growth was 2.9 per cent in 2005, as
strong employment growth and, late in the year,
rising earnings, boosted consumer spending. The
unemployment rate fell to 6.4 per cent, the lowest
level since 1976. In the second half of the year,
exports rose, boosted by strong global demand. In
the energy sector, investment and profits rose
strongly as oil prices soared, with the positive
economic impact being most pronounced in Western
Canada. Gasoline prices lifted headline inflation to a
peak of 3.4 per cent in September, but it fell back
sharply and core inflation was 1.6 per cent by the
year-end. Having been kept on hold for much of the
year, interest rates were raised by 75 basis points
between September and December. The BoC has
indicated that further increases may be required.
Review of business performance
HSBC’s operations in North America reported a pre-
tax profit of US$5,915 million, compared with
US$5,268 million in 2004, representing an increase
of 12 per cent. On an underlying basis, pre-tax
profits grew by 11 per cent and represented around
28 per cent of HSBC’s equivalent total profit. In the
US, the benefits from strong deposit growth in
Personal Financial Services were partly negated by
narrowing spreads on lending in the rising interest
rate environment. In Commercial Banking, growth in
pre-tax profits was largely driven by lending and
deposit balance growth and improved liability
interest margins. In Corporate, Investment Banking
and Markets, growth in revenues was offset by
investment expenditure to build the platform and
infrastructure required for future growth.
The commentary that follows is on an
underlying basis.
Personal Financial Services, including the
consumer finance business, generated a pre-tax
profit of US$4,181 million, 9 per cent higher than in
2004. Under IFRSs, from 1 January 2005, HSBC
83
changed the accounting treatment for certain debt
issued and related interest rate swaps. This did not
change the underlying economics of the transactions.
The resulting revenues of US$618 million in 2004
are excluded from the following commentary. In
addition, interest income earned on mortgage
balances held on HSBC’s balance sheet pending sale
into the US secondary mortgage market was reported
under trading income. In 2004 this was reported in
net interest income. This difference in treatment is
also excluded from the following commentary.
In the US, profit before tax rose 28 per cent to
US$3,853 million. The rise in profit was largely
driven by widening deposit spreads, strong deposit
and customer loan growth and higher fee income,
partly offset by lower asset spreads due to higher
funding costs. Loan impairment charges fell,
notwithstanding the higher charges due to the
combined effects of hurricane Katrina and changes
in bankruptcy legislation. Profit before tax in Canada
rose 93 per cent as net interest income increased due
to strong asset and liability growth and widening
deposit spreads.
Net interest income grew by 3 per cent to
US$11,636 million, mainly from increases in both
the US and Canada. In the US, net interest income
rose by 3 per cent, largely driven by higher deposit
balances and widening deposit spreads. Average
loan balances grew strongly, in particular from prime
and non-prime residential mortgages. With ongoing
strong demand for unsecured lending, the credit
card, private label card and personal non-credit card
portfolios continued to grow. The benefits of strong
asset growth were largely offset by lower spreads as
interest rates rose.
Additional resources were focused on the core
retail banking business in the US as high priority
was given to growing the deposit base. Investment in
the retail branch network continued, to ensure a
presence in locations with high growth potential.
During the year, 27 new branches were opened, each
tailored to meet the needs of the local market. The
launch of two new deposit products, HSBC’s first
national savings product, ‘Online Savings’, and
‘HSBC Premier Savings’, augmented by a 45 per
cent rise in new personal account openings, led to a
4 per cent growth in average deposit balances to
US$26.7 billion.
Overall, average mortgage balances, including
US$3.3 billion held for resale, rose by 27 per cent to
US$112.1 billion. This was due to the significant
expansion of ARMs originated during 2004 in the
US bank and strong growth within the mortgage
services and branch-based consumer lending
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
North America > 2005
businesses. These volume benefits were largely
offset by narrowing spreads as yields fell due to
changes in product mix and higher funding costs.
Prime mortgages originated in 2005 were
largely sold into the large government-sponsored
mortgage associations, reflecting a strategic decision
to focus on loans originated through the retail
channel and reduce HSBC’s reliance on lower
spread business generated by the network of
mortgage correspondents. The improvements in
retail channel sales were achieved by capitalising on
the HSBC brand, and the newly expanded branch
network and customer base. As interest rates rose,
demand for ARM products in 2005 declined as
customers migrated towards longer-term fixed rate
mortgages. ARM-originated loans fell from 67 per
cent of all loans originated in 2004 to 30 per cent in
2005. Spreads narrowed on prime mortgages, largely
because of higher funding costs and marginally
lower yields, the latter due to the full year effect of
the strong growth of lower-yielding ARMs
originated in 2004.
HSBC continued to grow its sub-prime and
near-prime mortgage portfolios, primarily within the
mortgage services and branch-based consumer
lending businesses. The mortgage services business,
which purchases mortgage loans from a network of
correspondents, recorded strong average loan growth
of 42 per cent to US$39.1 billion, of which
US$1.7 billion related to mortgages held for resale.
Continued focus on growing the second lien
portfolio, widening the first lien product offering and
expanding sources for the purchase of loans from
‘flow’ correspondents contributed further to the
increase. Within the branch-based consumer lending
business, average mortgage balances grew by 19 per
cent to US$35.7 billion, reflecting a combination of
increased marketing activity and higher sales
volumes of near-prime mortgages and ARMs, first
introduced in the second half of 2004. In addition,
the consumer lending business purchased
US$1.7 billion of largely sub-prime mortgage loans
through a portfolio acquisition programme. The
benefits of higher sub-prime and near-prime
balances were largely offset by lower spreads. Yields
fell due to the combined effects of strong refinancing
activity, significant amounts of older higher-yielding
loans seasoning, continued product expansion into
the near-prime customer segments and competitive
pricing pressures. The higher cost of funds due to
rising interest rates also contributed to the decline in
spreads.
Average loan balances within the consumer
finance credit cards business rose by 7 per cent to
US$19.8 billion, despite the highly competitive
84
environment, where overall market growth remained
weak. By increasing the level of marketing
promotions, HSBC was able to grow organically the
HSBC branded prime, Union Privilege and non-
prime portfolios. The benefit of higher balances was
more than offset by higher funding costs. Yields,
however, improved due to a combination of higher-
yielding sub-prime receivable balances, increased
pricing on variable rate products and other re-pricing
initiatives.
In the retail services cards business, average
loan balances grew by 7 per cent to US$15.9 billion.
This growth was driven by new loan originations and
the agreement of new merchant relationships with
The Neiman Marcus Group Inc, Bon Ton Stores Inc
and OfficeMax, which contributed US$506 million
of the overall increase. The benefit of higher loan
balances was more than offset by lower spreads.
Spreads declined as a large proportion of the loan
book, priced at fixed rates, was affected by higher
funding costs as interest rates rose. Spreads also
narrowed as changes in the product mix reflected
strong growth of lower-yielding recreational vehicle
balances and external pricing pressures. Changes in
contractual obligations associated with a merchant
also had an adverse effect, but this resulted in lower
merchant fees payable.
The vehicle finance business reported strong
organic growth, with a 14 per cent increase in
average loan balances, largely due to increases in the
near-prime portfolio. This growth in balances was
mainly driven by a combination of higher new loan
originations acquired from the dealer network, in
part due to the success of the ‘employee pricing’
incentive programmes introduced by a number of the
large car manufacturers, and strong growth in the
consumer direct loan programme. A new strategic
alliance helped grow loans further, generating
US$234 million of new balances. These volume
benefits were largely offset by lower spreads, due to
higher funding costs and lower yields. Yields fell
due to product expansion into the near-prime
portfolio, coupled with competitive pricing pressures
due to excess market capacity.
Personal non-credit card average loan balances
in the consumer finance business grew by 8 per cent
to US$16.0 billion, reflecting the success of several
large direct mail campaigns and increased
availability of this product in the US market.
Improvements in underwriting processes, aided by
continued improvements in the US economy, also
contributed to the increase. These benefits were
partly offset by lower spreads, due to higher funding
costs.
In Canada, net interest income grew by 21 per
cent, due to growth in average loan and deposit
balances, augmented by widening deposit spreads.
Branch expansion in the consumer finance business
generated higher average loan balances in real estate
secured and unsecured lending. Credit card balances
also grew, following the successful launch of a
MasterCard programme.
Net fee income grew by 23 per cent to
US$3,050 million, driven by the strong performance
in the US, where the 23 per cent increase was mainly
from retail and credit card services, the mortgage
banking business and the taxpayer financial services
business. Fee income within the consumer finance
credit cards business increased by 19 per cent, or
US$300 million, largely because of increased
transaction volumes, loan balance growth and
improved interchange rates. Greater use of the
‘intellicheck’ product, which enables customers to
pay their credit card balances over the telephone,
contributed an additional US$33 million of revenues.
Revenues from ancillary services rose by
US$77 million, reflecting higher sales volumes, new
product launches and expansion into new customer
segments.
Within the US retail services business, fee
income rose, mainly because merchant partnership
payments fell due to changes in contractual
obligations with certain clients. In part, this reflected
reduced loan spreads associated with the lower
merchant payments.
Fee income from the US mortgage-banking
business increased. As interest rates gradually rose,
refinancing prepayments of mortgages declined, with
levels of loan refinancing activity falling from 50 per
cent of total loans originated in 2004 to 44 per cent
in 2005. This led to lower amortisation charges and
the subsequent release of temporary impairment
provisions on mortgage servicing rights. In addition,
the value of servicing rights was better protected by
an improved economic hedging programme using a
combination of derivative financial instruments and
investment securities. A revised fee structure,
introduced in the second half of 2004, produced a
6 per cent increase in fee income from deposit-
related services in HSBC’s US bank.
Within the US taxpayer financial services
business, fee income grew by 12 per cent, driven by
higher average loan balances and the sale of
previously written-off loan balances. HSBC is the
sole provider of bank products to H&R Block, the
largest retail tax preparation firm in the US, and in
September 2005 extended this arrangement by
signing a new five-year contract. Since June 2004,
85
HSBC has retained in-house the clearing business
for refund anticipation payments which was
previously carried out by a third party. This
generated additional revenues of US$19 million
for HSBC in the US.
In Canada fee income rose from higher
investment management fees driven by growth in
funds under management and higher credit card fee
income from the consumer finance business.
Trading income in 2005 was 10 per cent lower.
In the US mortgage banking business revenues
increased, largely as a result of more originations
and sales related income, which reflected improved
gains on each individual sale and a 41 per cent
increase in the volume of originated loans sold. In
addition, a higher percentage of ARM loans that
previously would have been held on balance sheet
were sold in 2005. This was offset by lower gains on
Decision One sales in the mortgage services
business.
The increase in other income largely arose in the
US. Losses from the sale of properties repossessed
after customers had defaulted on their mortgage
payments, which were recorded as a reduction in
other income, were US$96 million lower than in
2004. This was attributable to improvements in the
process by which fair market value was determined
at the time of repossession, and to a reduction in the
number of properties falling into repossession as
credit quality improved.
Loan impairment charges and other credit risk
provisions of US$5,001 million were 3 per cent
lower than in 2004. In the US, charges were lower
notwithstanding the adverse effect of hurricane
Katrina and higher bankruptcy filings following
changes in bankruptcy legislation. Partly offsetting
the effect of these events was the non-recurrence of
US$47 million of charges which arose from the
adoption in 2004 of Federal Financial Institutions
Examination Council (‘FFIEC’) charge-off policies
relating to retail and credit card balances. Excluding
these factors, the lower charge reflected favourable
credit conditions in the US. Higher levels of secured
lending, continued targeting of higher credit quality
customers and improvements in underwriting
contributed to the reduction. In Canada, charges
were in line with prior year, as higher charges in the
consumer lending business due to loan growth were
offset by provision releases in the core bank
business.
Operating expenses grew by 4 per cent to
US$6,317 million. In the US, costs increased by
3 per cent as staff and marketing expenses rose in
the consumer finance business to support revenue
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
North America > 2005
growth, and acquisition costs were incurred
following the Metris purchase. In the credit cards
business, marketing expenditure increased on the
non-prime portfolios and from investment in new
initiatives. Marketing expenses also rose following
changes in July 2004 in contractual obligations
associated with the General Motors’ co-branded
credit card portfolio, but these were partly offset by
improved income from lower account origination
fees.
In HSBC’s US bank, costs grew to support
business expansion and new branch openings. Brand
awareness programmes in the second and fourth
quarters increased marketing costs, and expenditure
was incurred on promoting the online savings
product. The benefit of these initiatives was reflected
in a significant increase in customer awareness of the
HSBC brand. Within the retail brokerage business,
cost increases reflected more stringent regulatory
requirements.
In Canada, operating expenses grew, mainly due
to the opening of new branches within the consumer
finance business, and expansion of the mortgage and
credit cards businesses.
Commercial Banking’s pre-tax profits
increased by 26 per cent to US$892 million,
primarily due to lending growth and improved
liability interest spreads.
Net interest income increased by 19 per cent to
US$1,157 million. In the US, deposit growth,
particularly among small businesses, contributed to a
20 per cent increase in net interest income. The
recruitment of additional sales and support staff and
expansion on both the East and West coasts led to a
15 per cent increase in deposits and a 16 per cent
increase in lending balances, with income from
commercial real estate lending rising by 27 per cent.
HSBC achieved particularly strong growth in the
SME market and maintained its market-leading
position in small business administration lending in
New York State. Following its launch in the first half
of 2005, the ‘Select Investor’ product, which offers
competitive tiered interest rates, attracted
US$420 million of deposits. ‘Business Smart’, a
product offering free checking and other value
offerings to commercial customers, performed
strongly following its launch at the end of 2004,
attracting 41,000 new customers and balances of
over US$1.0 billion.
In Canada, net interest income increased by
16 per cent as higher oil and other natural resource
prices led to strong economic growth, and low
interest rates increased demand for lending products.
Average lending balances increased by 20 per cent,
86
as leasing balances grew by 33 per cent and
commercial real estate lending rose by 19 per cent.
Average deposit and current account balances
increased by 21 per cent and 24 per cent
respectively, reflecting the buoyant economy, the
launch of HSBCnet in Canada and more brand
advertising. Both asset and liability spreads were
broadly in line with 2004.
Other income, including net fee income,
increased by 7 per cent to US$374 million as a result
of higher gains on the sale of properties and
investments in the US.
There was a US$21 million net release of loan
impairment charges compared with a net charge of
US$7 million in 2004. Significant releases in Canada
were partly offset by higher charges, driven by
lending growth, in the US. In Canada, improved
credit quality led to a US$34 million net release of
loan impairment provisions. In the US, credit quality
remained high in the favourable economic
conditions, with the proportion of impaired loans to
assets decreasing by 49 basis points.
Operating expenses increased by 8 per cent to
US$660 million, driven by the US where expansion
in the SME and MME markets and in the
commercial mortgage sector led to a 17 per cent
increase in staff numbers. New MME offices were
opened in Philadelphia and New Jersey, following
the establishment of offices in Los Angeles and San
Francisco in 2004. The launch of ‘Select Investor’
and promotion of ‘Business Smart’ led to higher
marketing costs.
Corporate, Investment Banking and Markets
reported a pre-tax profit of US$573 million, 37 per
cent lower than in 2004. The overall increase in
revenue was exceeded by higher expenses, which
reflected the full year cost of the expanded
operations in the US and the continuing investment
in a number of specific initiatives designed to build
stronger execution and delivery capabilities.
Total operating income rose by 4 per cent. In
the US and Canada, balance sheet management and
money market revenues declined by US$353 million
as rising US dollar short-term interest rates led to
further flattening of the yield curve.
Net interest income from the payments and cash
management business in the US grew by 65 per cent,
principally due to an 82 per cent growth in balances.
Net fees increased by 24 per cent, primarily due
to higher volumes in Global Investment Banking,
reflecting positive momentum from an extension of
the product range, particularly in debt capital
markets, where earnings grew by 67 per cent. Equity
capital markets revenue improved from a low base
and higher income streams were generated from a
regular flow of new deals from asset-backed
securities. Global Transaction Banking fees rose,
reflecting higher customer volumes in payments and
cash management.
Income from trading activities increased, due in
part to higher revenues in the US from credit trading
following losses in 2004, and a tightening of credit
spreads. Business lines in which HSBC has invested,
such as equities and structured derivatives, also
showed strong year-on-year gains.
There was a reduction of US$24 million in the
net release of loan impairment allowances, primarily
due to the non-recurrence of a number of large
releases. New impairment allowances against
corporate clients remained broadly in line with last
year.
Operating expenses increased by 44 per cent to
US$1,376 million. In 2005, the proportionately
greater investment in North America compared with
other regions reflected HSBC’s commitment to
strengthen global reach by developing its presence in
this region. HSBC continued to invest throughout the
year in expanding product capabilities, particularly
in structured derivatives, equities, research,
mortgage-backed securities and advisory, and the
build-out of specialist sector teams in the US. Nearly
half of the incremental cost was attributable to this
investment.
Staff costs rose by 40 per cent, reflecting the full
year of recruitment in the latter part of 2004 and
selective hiring in 2005 which resulted in an increase
of 856 staff in Corporate, Investment Banking and
Markets in North America.
Non-staff costs grew correspondingly and
included the expense incurred in building critical
infrastructure and investment in new technology.
Private Banking contributed a pre-tax profit of
US$104 million, an increase of 55 per cent on 2004,
driven by growth in client assets and the balance
sheet, and the expansion of Wealth and Tax
Advisory Services (‘WTAS’).
Net interest income increased by 11 per cent.
Lending balances rose by over 30 per cent as clients
borrowed on a secured basis to make alternative
investments. Mortgage lending also grew, supported
by the launch of a ‘Tailored Mortgage’ product
during the year. Spreads on current accounts
increased by 40 basis points, reflecting the benefit of
interest rate increases during the year.
A number of smaller trust accounts were sold in
2005, generating one-off income of US$9 million.
This was partly offset by the non-recurrence of gains
from financial investments arising from the sale of
seed capital investments in 2004. Having expanded
its presence in New York, Philadelphia, Los
Angeles, San Francisco and Virginia through the
recruitment of fee-generating staff, and having
grown organically from referrals, WTAS contributed
to an increase of 13 per cent in fee income.
Client assets grew by 4 per cent to
US$40.8 billion, contributing to the rise in fee and
other operating income. US$1.8 billion of net new
money reflected client acquisition in the US, partly
offset by the divestment of trust accounts referred to
above. The ‘Strategic Investment Solutions’ product,
launched in March 2004, was markedly successful in
attracting new funds. Discretionary managed assets
invested in this product reached US$0.9 billion.
Operating expenses of US$324 million were
9 per cent higher than in 2004. The recruitment of
front office staff in Private Banking and new fee-
generating staff in WTAS added to the cost base.
This was partly offset by a reduction in staff
numbers through restructuring and the sale of the
trust account business referred to above.
Increased activity at HSBC’s North American
technology centre led to an increase in both costs
and net operating income in Other, as higher
network and systems maintenance costs and
development expenditure to meet increased
technological requirements were recharged to other
customer groups. Movements in the fair value of
own debt and the associated swaps designated at fair
value led to a US$401 million increase in total
operating income.
87
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
North America > Profit/(loss) before tax
Profit/(loss) before tax by customer groups and global businesses
Year ended 31 December 2006
Personal
Financial
Services
US$m
Commercial
Banking
US$m
Corporate,
Investment
Banking &
Markets
US$m
Private
Banking
US$m
Other
US$m
North America
Net interest income/(expense) ....
12,964
Net fee income/(expense) ...........
3,675
1,362
329
Trading income/(expense)
excluding net interest income
Net interest income/(expense)
on trading activities ................
Net trading income/(expense) ....
Net expense from financial
instruments designated at
fair value .................................
Gains less losses from financial
investments .............................
Dividend income .........................
Net earned insurance premiums .
Other operating income ..............
66
208
274
–
14
23
492
270
13
–
13
–
19
1
–
87
266
656
746
72
818
(11)
12
61
–
269
Total operating income ............
17,712
1,811
2,071
Net insurance claims1 .................
(259)
–
–
212
240
12
–
12
–
9
–
–
31
504
–
(52)
(134)
(220)
(23)
(243)
(52)
4
–
–
1,536
1,059
–
Inter-
segment
elimination
US$m
(484)
–
–
484
484
–
–
–
–
(1,271)
(1,271)
–
Total
US$m
14,268
4,766
617
741
1,358
(63)
58
85
492
922
21,886
(259)
Net operating income before
loan impairment charges
and other credit risk
provisions ..............................
Loan impairment charges and
other credit risk provisions .....
Net operating income ...............
Total operating expenses ............
Operating profit/(loss) ..............
Share of profit/(loss) in
associates and joint ventures ..
Profit/(loss) before tax ..............
Share of HSBC’s profit
before tax ................................
Cost efficiency ratio ...................
Selected balance sheet data2
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) ..........................
– trading assets, financial
instruments designated at
fair value, and financial
investments3 .......................
– deposits by banks ...............
17,453
1,811
2,071
504
1,059
(1,271)
21,627
(6,683)
10,770
(7,379)
3,391
–
3,391
%
15.4
42.3
(74)
1,737
(814)
923
34
957
%
4.3
44.9
(3)
2,068
(1,641)
427
(4)
423
%
1.9
79.2
(35)
469
(355)
114
–
114
%
0.5
70.4
(1)
1,058
(1,275)
(217)
–
(217)
%
(1.0)
120.4
US$m
US$m
US$m
US$m
US$m
220,517
250,985
54,099
34,651
43,012
31,066
17,215
208,958
23,711
5,604
6,558
11,938
–
1,677
108
–
(1,271)
(6,796)
14,831
1,271
(10,193)
–
–
–
4,638
30
4,668
%
21.1
47.1
US$m
277,987
511,190
120,922
15,862
136,141
9,664
88
Year ended 31 December 20054
North America
Net interest income/(expense) ....
Net fee income/(expense) ...........
Trading income excluding net
interest income .......................
Net interest income/(expense)
on trading activities ................
Net trading income .....................
Net income/(expense) from
financial instruments
designated at fair value ...........
Gains less losses from financial
investments .............................
Dividend income .........................
Net earned insurance premiums .
Other operating income ..............
Personal
Financial
Services
US$m
Commercial
Banking
US$m
11,636
3,050
1,157
283
119
210
329
10
(12)
8
478
232
7
(4)
3
–
1
–
–
87
Corporate,
Investment
Banking &
Markets
US$m
661
577
95
221
316
23
57
33
–
179
Total operating income ...............
15,731
1,531
1,846
Net insurance claims1 .................
(232)
–
–
Private
Banking
US$m
185
200
7
(1)
6
(1)
–
–
–
34
424
–
Inter-
segment
elimination
US$m
Total
US$m
(230)
13,295
–
–
230
230
–
–
–
–
(1,170)
(1,170)
–
3,952
250
635
885
434
47
41
477
642
19,773
(232)
Other
US$m
(114)
(158)
22
(21)
1
402
1
–
(1)
1,280
1,411
–
15,499
1,531
1,846
424
1,411
(1,170)
19,541
Net operating income before
loan impairment charges and
other credit risk provisions .....
Loan impairment (charges)/
recoveries and other credit
risk provisions ........................
(5,001)
Net operating income .................
10,498
Total operating expenses ............
(6,317)
Operating profit ..........................
4,181
Share of profit in associates
and joint ventures ...................
Profit before tax ..........................
Share of HSBC’s profit
before tax ................................
Cost efficiency ratio ...................
–
4,181
%
19.9
40.8
21
1,552
(660)
892
–
892
%
4.3
43.1
64
1,910
(1,376)
534
39
573
%
2.7
74.5
–
(1,170)
1,170
–
–
–
4
428
(324)
104
–
104
%
0.5
76.4
(4)
1,407
(1,251)
156
9
165
%
0.8
88.7
(4,916)
14,625
(8,758)
5,867
48
5,915
%
28.2
44.8
US$m
252,560
432,490
111,386
Selected balance sheet data2
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) ..........................
– trading assets, financial
instruments designated at
fair value, and financial
investments3 .......................
– deposits by banks ...............
US$m
US$m
US$m
US$m
US$m
207,598
240,474
44,769
29,666
36,570
25,585
10,381
149,623
31,442
4,915
5,823
9,589
–
–
1
9,979
102,732
7,506
89
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
North America > Profit/(loss) before tax / Latin America > 2006
Profit/(loss) before tax by customer groups and global businesses (continued)
Year ended 31 December 20044
North America
Net interest income/(expense) ....
Net fee income/(expense) ...........
Trading income ...........................
Gains less losses from financial
investments .............................
Dividend income/(expense) ........
Net earned insurance premiums .
Other operating income/
(expense) ................................
Net operating income before
loan impairment charges and
other credit risk provisions .....
Loan impairment (charges)/
recoveries and other credit
risk provisions ........................
Net operating income .................
11,998
2,461
195
72
14
450
(13)
(5,118)
9,823
Total operating income ...............
15,177
Net insurance claims1 .................
(236)
Total operating expenses ............
(5,997)
Operating profit/(loss) ................
3,826
Share of profit/(loss) in
associates and joint ventures ..
–
Profit/(loss) before tax ................
3,826
Share of HSBC’s profit
before tax ................................
Cost efficiency ratio ....................
%
20.2
40.1
Personal
Financial
Services
US$m
Commercial
Banking
US$m
Corporate,
Investment
Banking &
Markets
US$m
Private
Banking
US$m
166
176
6
6
–
–
4
358
–
Inter-
segment
elimination
US$m
–
–
–
–
–
–
(986)
(986)
–
Other
US$m
(105)
(89)
1
1
(2)
–
1,065
871
–
Total
US$m
13,787
3,197
509
147
32
450
341
18,463
(236)
948
191
8
–
–
–
145
1,292
–
780
458
299
68
20
–
126
1,751
–
14,941
1,292
1,751
358
871
(986)
18,227
(7)
1,285
(594)
691
–
691
%
3.6
46.0
88
1,839
(945)
894
(15)
879
%
4.6
54.0
2
360
(292)
68
–
68
%
0.4
81.6
(1)
870
(1,073)
(203)
7
(196)
%
(1.0)
123.2
–
(986)
986
–
–
–
(5,036)
13,191
(7,915)
5,276
(8)
5,268
%
27.8
43.4
US$m
240,151
348,132
117,551
Selected balance sheet data2
Loans and advances to
customers (net) .......................
Total assets .................................
Customer accounts ......................
The following assets and
liabilities were significant
to Corporate, Investment
Banking and Markets:
– loans and advances to
banks (net) ..........................
– trading assets, financial
instruments designated at
fair value, and financial
investments3 .......................
– deposits by banks ...............
US$m
US$m
US$m
US$m
US$m
185,539
217,307
40,981
25,354
28,818
23,112
25,387
97,435
45,636
3,871
4,538
7,822
–
34
–
20,550
41,849
13,611
1 Net insurance claims incurred and movement in policyholders’ liabilities.
2 Third party only.
3 Including financial assets which may be repledged or resold by counterparties.
4 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly.
90
Latin America
Profit/(loss) before tax by country within customer groups and global businesses
Year ended 31 December
2006
US$m
20051
US$m
20041
US$m
Personal Financial Services ..........................................................................
Mexico .............................................................................................................
Brazil ................................................................................................................
Argentina .........................................................................................................
Other ................................................................................................................
Commercial Banking .....................................................................................
Mexico .............................................................................................................
Brazil ................................................................................................................
Argentina .........................................................................................................
Other ................................................................................................................
Corporate, Investment Banking and Markets ...........................................
Mexico .............................................................................................................
Brazil ................................................................................................................
Argentina .........................................................................................................
Other ................................................................................................................
Private Banking .............................................................................................
Mexico .............................................................................................................
Brazil ................................................................................................................
Other ................................................................................................................
Other ...............................................................................................................
Mexico .............................................................................................................
Brazil ................................................................................................................
Argentina .........................................................................................................
Other ................................................................................................................
Total ................................................................................................................
Mexico .............................................................................................................
Brazil ................................................................................................................
Argentina .........................................................................................................
Other ................................................................................................................
800
628
121
35
16
451
197
185
51
18
475
177
218
68
12
14
7
6
1
(5)
–
(4)
3
(4)
1,735
1,009
526
157
43
786
570
167
37
12
357
161
147
35
14
347
192
95
56
4
1
–
1
–
113
–
(4)
116
1
1,604
923
406
244
31
651
549
98
(5)
9
316
140
108
50
18
196
85
92
8
11
–
–
1
(1)
79
–
(18)
101
(4)
1,242
774
281
154
33
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly.
Year ended 31 December 2006 compared
with year ended 31 December 2005
than US$12 billion and the Bank of Mexico to
increase foreign exchange reserves.
Economic briefing
Mexico’s GDP growth improved significantly in
2006 to 4.8 per cent from 3.0 per cent in 2005,
mostly in response to increased external demand
from the US. Commercial bank credit continued to
recover strongly, with over 80 per cent growth in
real mortgage loans. By the end of 2006, headline
inflation had increased to 3.8 per cent from 3.0 per
cent earlier in the year, largely as a result of
increases in agricultural supply prices. Record oil
revenues, combined with high non-oil export growth
and increasing inward remittances from Mexicans
working outside the country produced an almost
balanced current account for the year. Significant
capital inflows, including an estimated
US$18 billion in foreign direct investment, enabled
the Government to reduce its external debt by more
In Brazil, GDP is expected to have grown by
2.6 per cent in 2006 compared with 2.3 per cent in
2005. Growth was driven by domestic demand, with
private consumption increasing by 3.8 per cent and
capital spending by 5.9 per cent. Net exports, by
contrast, fell by 18 per cent in the first three quarters
of the year compared with the same period in
2005, as the increase in domestic demand translated
into higher imports rather than an expansion of
output. The unemployment rate averaged 10.0 per
cent in 2006, slightly up from 9.8 per cent averaged
in 2005. Inflation continued to decline, to 3.1 per
cent in 2006, compared with 5.7 per cent in
2005 and, as a result, the Central Bank continued to
ease monetary policy. Overnight rates fell to 13.25
per cent in December 2006 from 17.25 per cent a
year before. The trade balance continued to be
91
20041
US$m
2,516
1,027
127
–
95
47
2
699
46
4,559
(535)
4,024
(253)
3,771
(2,530)
1,241
1
1,242
%
6.5
62.9
52,473
US$m
15,693
5,892
12,327
40,419
2,244
26,307
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Latin America > 2006
Profit before tax
Latin America
Net interest income ..........................................................................................
Net fee income .................................................................................................
Trading income ................................................................................................
Net income from financial instruments designated at fair value ....................
Net investment income on assets backing policyholders’ liabilities ..............
Gains less losses from financial investments ..................................................
Dividend income ..............................................................................................
Net earned insurance premiums ......................................................................
Other operating income ...................................................................................
Total operating income .................................................................................
2006
US$m
4,197
1,630
537
237
–
84
6
1,076
91
7,858
Net insurance claims incurred and movement in policyholders’ liabilities ....
(1,023)
Net operating income before loan impairment charges and other
credit risk provisions ................................................................................
Loan impairment charges and other credit risk provisions .............................
Net operating income ....................................................................................
Total operating expenses .................................................................................
Operating profit .............................................................................................
Share of profit in associates and joint ventures ...............................................
Profit before tax .............................................................................................
Share of HSBC’s profit before tax ..................................................................
Cost efficiency ratio ........................................................................................
6,835
(938)
5,897
(4,166)
1,731
4
1,735
%
7.9
61.0
Year ended 31 December
20051
US$m
3,342
1,191
537
186
–
80
5
871
286
6,498
(792)
5,706
(676)
5,030
(3,426)
1,604
–
1,604
%
7.7
60.0
Year-end staff numbers (full-time equivalent) ................................................
67,116
55,600
Selected balance sheet data2
Loans and advances to customers (net) ...........................................................
Loans and advances to banks (net) ..................................................................
Trading assets, financial instruments designated at fair value, and
financial investments ...................................................................................
Total assets ......................................................................................................
Deposits by banks ............................................................................................
Customer accounts ...........................................................................................
US$m
US$m
35,791
12,634
20,497
80,771
5,267
50,861
21,681
8,964
16,945
55,387
2,598
30,989
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly.
2 Third party only.
robust, with a surplus of US$46.1 billion in 2006, just
above the amount achieved in 2005.
In Argentina, real GDP growth in 2006
exceeded 8.3 per cent and, after growing for four
consecutive years at an average rate of approximately
9 per cent, the country’s GDP was nearly 15 per cent
above 1998, when its recession began. The strong
growth was due to a competitive exchange rate, a
strong fiscal stance and a favourable business
environment, which HSBC expects to continue in
2007. The main potential constraint on growth
remains the risk of disruption in energy supply,
where there has been a lack of investment and limited
price adjustments for residential consumers since
2001/2. Inflation was approximately 10 per cent at
the end of 2006, having tripled in the past three years,
though it was below its peak of more than 12 per cent
in 2005. Interest rates rose steadily in 2006 and the
peso weakened slightly against the US dollar. Given
Argentina’s higher inflation rate, however, the
exchange rate appreciated in real terms.
Review of business performance
HSBC’s operations in Latin America reported a
pre-tax profit of US$1,735 million compared
with US$1,604 million in 2005, an increase of
92
8 per cent. On an underlying basis, pre-tax profits
rose by 5 per cent. Growth in profitability was
constrained by the non-recurrence of one-off
coverage bond receipts and other items related to the
2001 sovereign debt default and subsequent
pesification in Argentina, which added
US$122 million to 2005 profits. In addition, a gain
of US$89 million from the sale of the property and
casualty insurance business, HSBC Seguros de
Automoveis e Bens Limitada, to HDI Seguros S.A.,
was recorded in 2005. Excluding these prior year
profits, and on an underlying basis, profit before tax
increased by 21 per cent, with net operating income
increasing by 15 per cent and operating expenses by
12 per cent. Corporate, Investment Banking and
Markets delivered a strong performance, driven by
growth in fee and trading income, with notable
success in bringing Latin American borrowers to
global capital markets. Commercial Banking also
grew well as domestic economies expanded. During
2006, HSBC made two significant acquisitions in the
region. In May, HSBC acquired the Argentine
banking operations of Banca Nazionale del Lavoro
SpA (‘Banca Nazionale’) to build its distribution
capabilities and, in November, Grupo Banistmo in
Central America, adding markets in five countries
new to the Group.
The following commentary is on an underlying
basis.
Personal Financial Services reported a pre-tax
profit of US$800 million, a rise of 1 per cent over
2005, which had benefited from a US$89 million
gain on the sale of the Group’s property and casualty
insurance business in Brazil. Adjusting for this, pre-
tax profits grew by 16 per cent, driven by 12 per cent
growth in revenues and 10 per cent growth in costs.
The underlying improvement in revenues was led by
strong asset and deposit growth together with higher
fee income, offset in part by consequential expense
growth and a rise in impairment charges as the loan
book both grew and seasoned.
In Mexico, profit before tax rose by 10 per cent.
During 2006, 56,000 Personal Financial Services
customers were transferred to the Commercial
Banking customer group, where HSBC is better
placed to meet their banking requirements. Adjusting
for this, profits were 20 per cent higher, driven by
strong balance sheet growth and improved fee
income.
Adjusting for the gain in 2005 from the sale of
the property and casualty business, pre-tax profits
were 46 per cent higher in Brazil. The strong
domestic economy stimulated robust growth in
lending and a rise in the number of current account
93
holders. During the year, a new and innovative
internet banking service ‘Meu HSBC’ was introduced
to Personal Financial Services customers, allowing
them to conduct different types of transactions
online using the same password as their ATM card.
In Argentina, profit before tax was marginally
higher, with strong balance sheet growth, higher fees
and improved revenues from the insurance business.
This was largely offset by increased loan impairment
charges and cost growth incurred in support of
business expansion as HSBC prepared for an
improving domestic economic environment.
Net interest income rose by 11 per cent to
US$3,057 million, largely from balance sheet growth
partly offset by lower deposit spreads.
In Mexico, net interest income increased by
12 per cent to US$1,218 million. Adjusting for the
effect of customer account transfers to Commercial
Banking, net interest income rose by 20 per cent,
driven by strong growth in credit card and mortgage
balances and increases in deposits which were
generated by the ongoing success of the ‘Tu Cuenta’
product. Overall, asset spreads improved as the
relative increase in higher margin card balances led to
a favourable change in the product mix. By contrast,
deposit spreads narrowed as interest rates declined.
Excluding customer account transfers, average
deposit balances in Mexico rose by 10 per cent.
HSBC continued to be one of the market leaders with
respect to balance growth, despite fierce competition
from other banks, improving its market share by
35 basis points. A strong increase in low-cost
deposits was reflective of the continuing success of
‘Tu Cuenta’, the first integrated financial services
product of its kind offered locally, with nearly
400,000 new accounts opened in 2006. HSBC
Premier performed well as 84,000 new customers
were added during the year. Premier deposits
represented over one third of the total personal
deposit base at 31 December 2006. The income
benefit from higher deposit balances was partly
mitigated by reduced spreads in the falling interest
rate environment, notwithstanding the positive shift
in mix from growth in non-interest bearing deposit
balances.
The credit card market in Mexico was buoyant in
2006 and HSBC’s business performed very
successfully with average balances doubling to
US$886 million. Various initiatives were
implemented to develop the business, most notably
cross-sales to ‘Tu Cuenta’ customers, targeted
customer relationship campaigns to existing clients,
successful portfolio management strategies and
promotions, development of new sales channels and
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Latin America > 2006
improvements in card activation times. These
initiatives helped HSBC become the market leader in
credit card balance growth, improving market share
by 2.3 per cent. The number of cards in circulation
reached 1.7 million at the year end, representing an
increase of 76 per cent.
Demand for housing from first time buyers
remained strong in Mexico, and market conditions
continued to be highly competitive. Average
mortgage balances rose by 81 per cent to
US$969 million, reflecting HSBC’s competitive
pricing and innovation in product design. HSBC was
the first bank in Mexico to market pre-approved
online mortgages, and enhanced this offering with the
subsequent introduction of ‘Mortgage Express
Approval’, which provides customers with much
faster access to details concerning the loan amount,
duration and monthly payments at the point of
application. Improvements in the processing of
mortgage applications, upgraded customer service
and increased marketing activity also contributed to
the rise in lending balances. The income benefits of
balance growth were partly offset by narrower
spreads, driven by the highly competitive market
conditions.
As the Mexican economy grew strongly, there
was robust growth in personal and payroll lending
balances. The introduction of a dedicated and mobile
sales force during the second half of 2006 to expand
distribution capabilities led to a fourfold increase in
average personal lending balances during the year.
This initiative also helped to reduce time to market,
increase cross-sales and, through closer interaction
with the branch network, improve client coverage.
The popularity of the personal loan product, where
customers apply directly via HSBC’s extensive and
well-positioned ATM network grew, and this was the
key driver behind a 37 per cent rise in average payroll
loan balances.
In Brazil, net interest income increased by 9 per
cent as lower inflation and the improving domestic
economy triggered a rise in demand for credit which,
in turn, contributed to strong lending growth.
Average loan balances were 18 per cent higher,
driven by rising customer numbers and increases in
vehicle financing, pension and payroll loans. On the
liability side, there was a 7 per cent rise in current
account holders, largely driven by growth in the
number of customers with payroll loans and greater
levels of sales activity.
Average vehicle finance balances in Brazil rose
by 36 per cent, led by continued portfolio growth as
HSBC strengthened its relationships with car
dealerships. The combined pension and payroll loan
94
portfolios registered an 84 per cent increase in
average balances, a consequence of increased
borrowings per customer, portfolio acquisitions, and
growing customer demand for these products.
Spreads also improved, largely as a result of lower
funding costs, which augmented the positive income
benefits of balance growth. Average card balances
rose by 19 per cent, with an increase of 27 per cent in
the number of cards in issue, reflecting the launch of
various initiatives aimed at improving retention,
activation and utilisation. Spreads improved from
lower funding costs and price increases initiated in
the second half of 2005, complementing the benefits
derived from higher lending volumes.
In Argentina, net interest income grew by 12 per
cent, primarily driven by increased demand for credit
card, other personal and motor vehicle lending. This
was largely attributable to more effective promotional
activity and productivity improvements in the
telemarketing and branch channels. Higher funding
costs, however, resulted in a narrowing of lending
spreads, offsetting volume benefits. Deposit balances
rose, reflecting the increased emphasis placed on
growing liability products, the benefit from which
was augmented by a widening of spreads.
Net fee income was 25 per cent higher, reflecting
strong growth across the region generally.
Fee income grew by 21 per cent in Mexico,
largely due to higher credit card and ‘Tu Cuenta’
income. Fee income from cards rose by 51 per cent,
reflecting a significant growth in the number of cards
in circulation and improvements made in reducing
activation times. The improvement in ‘Tu Cuenta’
income was driven by sales of over 1 million new
accounts and re-pricing initiatives. In order to capture
a higher volume of ATM revenues, HSBC added
372 new machines to its already well-positioned
network, which increased ATM fees from greater
levels of transactional activity and a 22 per cent rise
in transactions from non-HSBC customers. Growth in
mutual fund fees was mainly driven by higher sales
volumes and expanded product offerings in the
stronger economic environment.
Fee income in Brazil rose by 25 per cent, largely
from increased current account fees, reflecting
growth in customer numbers, greater transaction
volumes and re-pricing initiatives. Higher payroll and
vehicle balances also led to increased fees from
lending activities. In Argentina, higher credit card
fees from balance growth, re-pricing initiatives on
savings accounts, and the discontinuance of a free
current account promotion led to an improvement in
fee income.
Across the region, HSBC’s insurance businesses
continued to perform well. Sales of insurance
products in Mexico remained strong, with increased
cross-selling through the branch network of simple
insurance products together with other Personal
Financial Services products containing insurance
components. This led to a 19 per cent rise in net
premiums, mainly in respect of individual life
insurance products. In Brazil, excluding the effect of
the property and casualty insurance business sold in
2005, insurance revenues rose, largely from life and
pension products. In Argentina, increased advertising,
partnerships with established local consumer brands
and internal cross-selling initiatives led to a rise in
motor, home and extended-warranty insurance
premium income. Life and annuity premiums also
increased in line with higher customer salaries. The
‘Maxima’ pension funds business delivered higher
revenues helped by improvements in the economic
climate and greater levels of employment.
Lower other operating income reflected the non-
recurrence of profit on the sale of HSBC’s Brazilian
property and casualty insurance business.
Loan impairment charges and other credit risk
provisions rose by 15 per cent to US$764 million as
lending grew and the loan book seasoned. In Mexico,
the higher charge was primarily driven by the growth
in credit card lending. In Brazil, loan impairment
charges increased modestly, driven by growth in
vehicle finance, instalment loans (‘credito parcelado’)
and credit card lending. As the credit environment
weakened during the first half of the year, various
measures were taken to mitigate the effects. These
included tightening lending criteria, enhancing credit
analytics, revising the collection policy, prioritising
secured lending ahead of unsecured advances and
strengthening credit operations. Following
implementation of these measures, several key credit
indicators showed improvement.
Operating expenses rose by 10 per cent. In
Mexico, expense growth of 10 per cent was mainly
driven by increased staff costs. This largely reflected
the recruitment of 2,200 employees to improve
customer service levels in branches and grow sales.
Incentive costs increased as profits rose, and
marketing costs grew as a result of various
promotional campaigns. The continued expansion
of the branch network and ATM infrastructure,
together with the new HSBC headquarters building
in Mexico City, led to increases in IT, premises and
equipment costs.
In Brazil, expenses were 10 per cent higher. As
in Mexico, this reflected the cost of new employees
95
recruited to support business expansion, including the
strengthening of credit operations, and new branch
openings. This, together with annual pay rises and
increased incentive payments, triggered a 13 per cent
growth in staff costs. Advertising costs rose to
promote brand awareness, while an HSBC Premier
promotion led to higher marketing costs.
Costs grew by 26 per cent in Argentina, with
higher staff costs driven by union-agreed pay rises in
2005, and increased incentives and commissions paid
in light of revenue growth. Marketing costs also
increased to support the launch of various promotions
and campaigns.
Commercial Banking reported pre-tax profits of
US$451 million, 17 per cent higher than in 2005.
Growth in net operating income before loan
impairment charges was strong at 26 per cent as
domestic economies in the region grew and HSBC
built market share. Cost growth in support of this
expansion was held within revenue growth and the
cost efficiency ratio improved by 2.5 per cent.
Net interest income rose by 24 per cent, largely
driven by business expansion in Mexico and Brazil.
In Mexico, net interest income rose by 49 per
cent, reflecting asset and deposit growth, in part due
to the transfer of the 56,000 customers from Personal
Financial Services noted above. As HSBC extended
its presence in the small and middle market business
segments, average deposit balances increased by
65 per cent (31 per cent excluding the transferred
customer accounts), although the benefit of this
volume growth was partly mitigated by lower deposit
spreads in a falling rate environment.
Lending balances in Mexico were 41 per cent
higher, primarily driven by strong demand in the
rapidly growing real estate and residential
construction sectors. During the final quarter of the
year, HSBC opened an International Banking Centre
to develop cross-border business for global
Commercial Banking customers, with 75 business
accounts acquired since its inception. Attention
placed on higher yielding small and middle market
businesses, following refinements made to the
customer segmentation strategy, contributed to asset
growth as greater emphasis was put on increasing
revenues from this segment. These volume benefits
were augmented by improved lending spreads from
lower funding costs in the falling interest rate
environment, which offset reduced yields.
In Brazil, net interest income was 12 per cent
higher. Overall, lending balances rose by 16 per cent,
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Latin America > 2006 / 2005
primarily driven by small and middle market
customers. The recruitment of additional relationship
managers and sales staff, investments made in
receivables financing and greater levels of
promotional activity all combined to build HSBC’s
position in this market segment. There was ongoing
success from the ‘giro fácil’ product, offering both
revolving loan and overdraft facilities, with average
balances recording a 13 per cent increase. Spreads
widened as interest rates fell, further augmenting the
income benefits of higher lending volumes.
A 42 per cent rise in net interest income in
Argentina was primarily attributable to strong asset
and liability growth. Average lending and deposit
balances increased by 39 per cent and 19 per cent
respectively, as customer numbers rose, particularly
to the small and micro businesses, helped by
favourable economic conditions and investment in
new sales channels. Asset spreads declined, however,
due to competitive market pressures on pricing, partly
offsetting the income benefits of higher lending
volumes. By contrast, deposit spreads improved.
Net fee income was 36 per cent higher, driven by
robust increases across Mexico, Brazil and Argentina.
In Mexico, fee income rose by 28 per cent with
notable success in increasing cross-sales activity.
Growth in customer numbers contributed to higher
transactional volumes which, combined with an
expanded and improved product offering plus
increased marketing activity and re-pricing
initiatives, led to a 41 per cent rise in income from
payments and cash management services. The
‘Estimulo’ product offering, comprising a packaged
suite of seven different products including a loan
facility, continued to perform well with fee income
nearly trebling compared with 2005. During the third
quarter, a similar product, ‘Estimulo Empresarial’,
was launched, targeting upper-end small business
customers. This product encompasses a suite of
eleven different services and since its introduction
more than 165 clients have been signed, generating
US$50 million of new loans. HSBC’s share of the
trade services market continued to grow, building on
the Group’s international network and product
capabilities. Fees from international factoring and
domestic invoicing payment products also rose, as
new products were successfully piloted and marketed
to existing clients. The signing of new merchant
customers led to higher transaction volumes and a
subsequent 60 per cent rise in card acquiring fees.
In Brazil, fee income rose by 47 per cent as
effective cross-selling led to an increase in the
average number of products held per customer.
Current account fee income grew from higher levels
96
of transactional activity and tariff increases
implemented in 2005. Pricing changes introduced
part-way through 2006 led to higher revenues from
payment and cash management services. There was
improved fee income from assets under management,
and additional marketing to promote trade products
led to a rise in trade services fees.
Fee income in Argentina was 27 per cent higher,
primarily from increases in account and trade
services along with payments and cash management
fees.
Loan impairment charges and other credit risk
provisions doubled, reflecting strong lending growth,
a higher proportion of small and micro business
lending, and the seasoning of the portfolio.
In Mexico, strong growth in the lower-end small
and micro business lending balances led to increased
loan impairment charges during the year.
A 41 per cent rise in Brazil again reflected large
increases in small and micro business lending
balances and higher delinquency rates as the portfolio
seasoned. This led to a 12 basis point increase in the
proportion of impaired loans to assets. Various
actions were undertaken to manage the effects of the
weakening credit environment, with debt collection
operations enhanced and closer cooperation forged
between sales and collections staff. Changes were
also made to underwriting criteria, coupled with
revisions to sales staff incentive schemes. Following
these measures, an improvement in credit quality was
seen and charges reduced in the second half of the
year compared with the first half. In Argentina,
releases were lower than in 2005.
Operating expenses of US$822 million were
21 per cent higher than in 2005, as businesses
expanded strongly across Latin America.
In Mexico, operating expenses rose by 26 per
cent, largely driven by higher transactional volumes,
new clients acquired and increased lending activity.
Non-staff costs were higher, reflecting the marketing
and IT-related support to business growth.
In Brazil, expenses grew by 19 per cent,
also largely from higher staff, marketing and
administrative costs. Business expansion activities in
the small and middle market customer segments
followed the recruitment of 270 additional employees
and this, together with union-agreed pay increases,
were the principal drivers behind the 21 per cent rise
in staff costs. Continued enlargement of the branch
network, the opening of an International Banking
Centre and new sales offices combined with increases
in marketing and administration costs in support of
business expansion, contributed further to cost
growth. Costs in Argentina rose by 30 per cent,
primarily staff costs which reflected annual pay
increases and additional headcount driven by
accelerated business activity. In supporting the
growth of the business, there was increased
expenditure on branding, technology and distribution,
with ongoing improvements made to the internet
banking service.
Corporate, Investment Banking and Markets
reported a pre-tax profit of US$475 million, an
increase of 30 per cent compared with 2005. HSBC’s
strong global presence, together with selective
investment in extending service and delivery
capabilities in the region, resulted in higher volumes
with new and existing clients. The cost efficiency
ratio improved moderately.
Total operating income increased by 23 per cent
to US$846 million compared with 2005. In Brazil,
balance sheet management revenues grew
significantly as relatively low short-term interest rates
reduced funding costs. In Argentina, higher net
interest income reflected an increase in index linked
securities portfolios and a growing demand for credit
as regional economies and market confidence
continued their recent improvement. By contrast, in
Mexico, balance sheet management revenues were
constrained by a flattening of the interest rate curve
and relatively stable market conditions.
Net interest income from payments and cash
management rose by 64 per cent as customer volumes
grew, reflecting new client mandates.
Net fee income increased by 29 per cent to
US$167 million, predominantly through increased
performance-related fees on emerging markets funds
managed by Group Investment Businesses. Income in
HSBC Securities Services benefited from strong
equity market indices and growth in new business as
assets under custody increased significantly to
US$89 billion.
In Mexico, a 32 per cent rise in payments and
cash management fees was driven by a wider product
offering and the leveraging of established credit
related products and services.
Higher revenues from trading activities in Brazil
flowed from marketing the wider product range and
enhanced delivery capabilities of Global Markets.
Greater volatility in local markets resulted in higher
business volumes in foreign exchange and currency
derivatives. In Argentina, economic and political
stability increased liquidity in the market with foreign
exchange trading benefiting from greater customer
activity. In Mexico, a 23 per cent increase in trading
income was driven by a combination of successful
97
positioning for a flattening yield curve and higher
client volumes delivered through the extended suite
of products.
A net release of US$26 million in loan
impairment charges reflected a stable corporate credit
environment and the implementation of improved
risk management strategies in Mexico.
Operating expenses rose by 20 per cent to
US$346 million, primarily driven by higher staff
costs reflecting increased performance-related
incentives in line with revenue growth, and pay rises
agreed with local unions. Higher operational costs
reflected increased volumes, particularly in payments
and cash management and securities services
businesses, and the continued investment in building
the Corporate, Investment Banking and Markets’
business in the region.
Private Banking reported a pre-tax profit of
US$14 million, a significant increase on 2005. Profit
growth was strong in both Mexico and Brazil. In
Brazil, revenue and cost benefits arose from
initiatives to join up the business, including cross-
referrals with other customer groups. Strong revenue
growth in the newly launched business in Mexico
resulted primarily from greater client participation in
capital markets, notably commercial paper
placements, which contributed towards a 53 per cent
rise in fee income. This strong performance was
reflected in the cost efficiency ratio which improved
by 23.4 percentage points to 65.9 per cent.
Within Other, the non-recurrence of coverage
bond receipts and other items related to the 2001
Argentinean sovereign debt crisis led to lower
earnings.
Year ended 31 December 2005 compared
with year ended 31 December 2004
Economic briefing
Mexico’s GDP growth was 3.0 per cent compared
with 4.2 per cent in 2004, in line with lower external
demand from the US. The fiscal accounts for the year
showed a reduced deficit of 0.9 per cent, mostly from
windfall earnings from high oil prices. As in 2004,
high oil receipts and increasing levels of workers’
remittances helped minimise the current account
deficit at an estimated less than 1 per cent of GDP.
The biggest achievement was the reduction in
headline inflation from 5.2 per cent at the end of
2004 to 3.3 per cent in December 2005, with core
inflation finishing the year at 3.1 per cent. HSBC
viewed macroeconomic stability as encouragingly
robust ahead of what looks likely to be a keenly
contested presidential election in mid-2006.
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Latin America > 2005
In Brazil, the cyclical slowdown which began in
The commentary that follows is on an underlying
late 2004 continued throughout 2005, with full-year
GDP growth of 2.3 per cent compared with 4.9 per
cent in 2004. This modest performance was the result
of tight monetary policy, political uncertainty and the
appreciation of the Brazilian real. External demand
provided support, with exports growing by 23 per
cent in 2005 to record levels, helping to create trade
and current account surpluses of US$45 billion and
US$14 billion respectively, and increasing net
international reserves by 96 per cent to
US$54 billion. The tight monetary policy, with real
interest rates among the highest in the world at
10.5 per cent, slowed inflation from 7.6 per cent in
2004 to 5.7 per cent in 2005, in line to achieve the
Central Bank’s 4.5 per cent inflation target for 2006.
Having established its anti-inflationary credentials,
the Central Bank cut interest rates by 175 basis points
between September and the end of 2005 in order to
stimulate growth and ease the pressure on the real.
In Argentina, the recovery from the crisis of
2001 continued in 2005, helped by a favourable
external environment and the success of the offer to
exchange replacement discount bonds issued in June
for defaulted debt. Average GDP growth was 9.1 per
cent in 2005. Fiscal performance remained strong,
with the public sector posting an overall surplus of
approximately 3.3 per cent of GDP. This surplus
helped to offset the expansionary effect on money
supply growth of the large foreign exchange
interventions of the Central Bank, which continued to
pursue a nominal rate policy of near stability against
the US dollar despite strong upward pressure on the
Argentine peso. This policy was supported by newly
introduced controls on capital inflows. Inflation
remained a concern, however, having accelerated to
12.3 per cent in December 2005. Following the
example of Brazil, at the end of the year the
authorities decided to make an early repayment of
Argentina’s US$9.8 billion debt owed to the IMF.
Review of business performance
HSBC’s operations in Latin America reported a pre-
tax profit of US$1,604 million, compared with
US$1,242 million in 2004, representing an increase
of 29 per cent. On an underlying basis, pre-tax profits
grew by 19 per cent and represented around
8 per cent of HSBC’s equivalent total profit. Growth
was achieved, in part, as a result of a US$89 million
gain on the sale of Brazil’s property and casualty
insurance business. In Mexico, robust balance sheet
growth drove higher profit before tax and HSBC in
Argentina benefited from a strong economic recovery
and certain one-off items including the receipt of
compensation bonds.
98
basis.
Personal Financial Services reported a pre-tax
profit of US$786 million, an increase of 13 per cent.
In Mexico, excluding the transfer of some customers
to the Commercial Banking segment, pre-tax profits
rose. This was driven by strong revenue growth from
higher deposit balances and widening spreads, strong
loan growth and higher fee income, partly offset by
the non-recurrence in 2005 of loan impairment
provision releases in 2004.
The rise in pre-tax profits in Brazil was partly as
a result of gains on the sale of the property and
casualty insurance business, with the remaining
increase driven by strong loan growth in vehicle
finance and personal lending, together with record
credit card sales. The cost efficiency ratio improved
by 2 percentage points as higher income was partly
offset by increased costs incurred in supporting
business expansion and developing alternative sales
channels. Loan impairment charges increased
reflecting, in Brazil, lending growth and an increase
in delinquency rates in the consumer finance business
and, in Mexico, higher charges from increased
lending and the non-recurrence in 2005 of loan
impairment provision releases in 2004. In 2005, the
Brazilian insurance business was transferred from
‘Other’ to Personal Financial Services. Profit before
tax increased by US$16 million as a result, though
individual account lines showed much larger
variances: where appropriate, the reasons are noted
below.
Net interest income rose by 27 per cent
compared with 2004. Consumer demand for credit
remained strong, fuelled by lower unemployment
across the region and declining inflation in Brazil and
Mexico. This contributed to significant growth in
personal lending, mortgages, vehicle finance loans
and credit cards.
In Mexico, net interest income rose, primarily
from strong deposit and loan growth and the
widening of deposit spreads. In 2005, HSBC in
Mexico widened its competitive funding advantage,
maintaining the lowest funding cost in the market.
There was strong growth in consumer lending,
although asset spreads declined, reflecting a
reduction in yields in an increasingly competitive
market. Funding costs rose, due to higher average
interest rates.
HSBC in Mexico continued to lead the market in
customer deposit growth, with a 1.5 per cent increase
in market share to 15.9 per cent despite a highly
competitive market place. This was largely due to the
success of ‘Tu Cuenta’, the only integrated financial
services product of its kind offered locally. From its
launch in February 2005, over 600,000 accounts were
opened in the year, averaging some 2,300 new
customers per day.
The continued success of HSBC’s competitive
fixed rate mortgage product in Mexico, helped by
strong demand from first time buyers, led to average
mortgage balances increasing by 93 per cent to
US$522 million and market share reaching 10.7 per
cent. In Mexico, HSBC continued to be the leader in
vehicle finance with a market share of 26.5 per cent.
A unique new internet-based product ‘Venta Directa’
was launched during the year, enabling the direct sale
of used cars between customers using HSBC’s
financing and website as the intermediary. The
targeting of new customer segments and more
competitive pricing drove average vehicle finance
loans higher by US$228 million to US$796 million, a
40 per cent increase over 2004. Average payroll loan
balances more than doubled to US$253 million,
reflecting HSBC’s unique ability in the market to
grant pre-approved personal loans through its ATM
network. Average credit card balances were 55 per
cent higher, with cards in circulation increasing by
80 per cent to over 1.1 million cards. This was largely
driven by cross-selling to the existing customer base
using CRM systems and the successful launch of the
‘Tarjeta inmediata’ or Instant credit card, which
generated 109,000 new cards.
In Brazil, HSBC continued to position itself for
future growth, investing in infrastructure to ensure
the delivery of integrated solutions to customers.
Enhancements to distribution, together with
marketing campaigns and promotions, including
partnerships with motor finance dealers, drove a
49 per cent rise in vehicle finance loans.
A combination of increased customers and
targeted marketing initiatives contributed to a 40 per
cent growth in personal lending. Personal lending
balances also benefited from the successful launch in
the first half of 2005 of pension-linked loans offering
attractive rates of interest, with repayments drawn
directly from the borrower’s pension income.
Balances of pension-linked loans increased to
US$110 million, partly as the result of an agreement
to acquire the pension-linked loan production of
Banco Schahin, a local bank.
The cards business continued to expand, due to
both the continued strength of consumer expenditure
and the launch of a private label card with Petrobras
gas stations in 2004. During 2005, HSBC improved
its competitive position, issuing over a million credit
cards and having over two million in circulation, an
increase of 21 per cent. Card utilisation grew and
99
cardholder spending increased, while average card
balances rose by 30 per cent to US$373 million.
Credit card spreads increased as HSBC repositioned
its card proposition by increasing interest rates to fall
broadly in line with the bank’s major competitors.
In Argentina, HSBC focused on pre-approved
sales mailings and on developing direct sales
channels. Net interest income more than doubled,
driven by a 59 per cent increase in asset balances.
The strong demand for credit resulted in personal
unsecured lending more than doubling. Credit cards
in circulation increased by 25 per cent, following a
discount campaign launched in June 2005 and the
launch of a private label card with C&A which
contributed to a 53 per cent increase in card balances.
Savings and deposit balances increased by 34 per
cent, reflecting the improved economic environment.
Net fee income decreased by 7 per cent, as
increases in Mexico and Argentina were more than
offset by a significant reduction in Brazil.
HSBC in Mexico reported strong growth in fee
income, driven by higher revenues from credit cards,
remittances, mortgages and ATM transactions. The
increase in the number of credit cards in circulation
contributed to the 85 per cent increase in credit card
fee income. Fees from the ‘Afore’ pension funds
business continued to perform strongly, with 50 per
cent growth and 394,000 new customers. Fee income
from international remittances rose by 55 per cent,
partly led by the continued success of ‘La Efectiva’,
HSBC’s electronic remittance card. Monthly
transactions exceeded one million, representing a
20 per cent market share and a near seven-fold
increase since December 2002. Strong sales of
insurance products resulted from increased cross-
selling through the branch network and from
combining sales with other Personal Financial
Services products containing insurance components.
Mutual fund balances grew by 58 per cent, partly
attributable to the successful launch of new funds
targeting different market segments, along with
strong cross-sales among HSBC’s extensive customer
base.
In Brazil, the 52 per cent fall in net fee income
was driven by both the inclusion of HSBC’s Brazilian
insurance business, previously reported in the ‘Other’
business segment, and IFRSs related changes to the
reporting of effective interest rates. These decreases
were mitigated by higher current account, credit card
and lending fees. The recruitment of new customers,
particularly through the payroll portfolio, led to a
21 per cent rise in HSBC’s current account base
which, together with revised tariffs, increased
account service fees by 21 per cent. Growth in
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Latin America > 2005
lending volumes and the introduction of a new
pricing structure contributed to a 36 per cent rise in
credit-related fee income. Higher credit card
spending and additional performance-driven fees
from credit card companies generated a 72 per cent
increase in credit card fee income. In Argentina, net
fee income increased by US$27 million, reflecting a
29 per cent increase in credit card fees and a 29 per
cent increase in current account fee income, driven
by increased transaction volumes in a recovering
economy.
The sale of HSBC’s Brazilian property and
casualty insurance business, HSBC Seguros de
Automoveis e Bens Limitada, to HDI Seguros S.A.
resulted in the recognition of an US$89 million gain,
which was reported in other operating income.
Loan impairment charges and other credit risk
provisions increased to US$600 million, reflecting
strong growth in unsecured lending. In Mexico, loan
impairment charges rose in line with higher lending
volumes and the non-recurrence in 2005 of loan
impairment provision releases in 2004, while
underlying credit quality remained stable. Credit
quality in Brazil remained stable in the majority of
product lines, but there was a 5 per cent increase in
impaired loans as a proportion of assets in the
consumer finance business. The consumer finance
sector experienced increased credit availability,
which led to indebtedness exceeding customers’
repayment capacity and a rise in delinquencies.
However, tightening of credit approval policies and
enhancements in the credit scoring model resulted in
an improvement in the charge as a proportion of
assets in the fourth quarter. Credit quality in
Argentina improved, reflecting generally better
economic conditions.
Operating expenses increased by 25 per cent. In
Mexico, they grew by 21 per cent, driven by a
combination of higher staff, marketing and IT costs.
Staff costs grew by 12 per cent, reflecting increases
incurred in improving customer service levels within
the branch network, and a rise in bonus costs in line
with increased sales. Marketing costs grew to support
the credit cards business, evidenced by the 80 per
cent increase in the number of cards in circulation.
IT costs rose as new systems were rolled out to meet
Group standards, such as the WHIRL credit card
platform.
In Brazil, the acquisition of Valeu Promotora de
Vendas and CrediMatone S.A. led to a significant
increase in average staff numbers, though by the end
of 2005 staff numbers were 2 per cent lower than at
December 2004 following a restructuring of the
consumer finance business. The higher average
100
number of full-time employees, the impact of a
mandatory national salary increase and the transfer of
the Brazilian insurance business from the ‘Other’
business segment contributed to a 25 per cent
increase in Brazilian staff costs. Other expenses grew
to support business expansion and the development
of direct sales channels, while transactional taxes
increased by 21 per cent, driven by higher operating
income. In Argentina, costs were 3 per cent up on
2004 as increased performance-related remuneration
and union-agreed salary increases led to higher staff
costs.
Commercial Banking reported pre-tax profits of
US$357 million, 4 per cent higher than in 2004. In
Mexico, excluding the transfer of customers from
Personal Financial Services, profit before tax rose
due to higher net interest and fee income, partly
offset by increased loan impairment charges and cost
growth. In Brazil, pre-tax profits increased by 12 per
cent as asset growth drove higher revenues, which
were mitigated by increased loan impairment charges
and higher costs. In Argentina, pre-tax profits
declined by 31 per cent, as significant loan recoveries
were not repeated.
Net interest income increased by 47 per cent,
driven by asset and deposit growth coupled with
widening deposit spreads. In Mexico, the transfer of a
number of customers from Personal Financial
Services increased both revenues and costs. Net
interest income rose by 42 per cent, due in part to a
22 per cent increase in Commercial Banking
customers. Deposit balances grew by 38 per cent as a
result of expansion into the SME market, while
deposit spreads increased by 76 basis points
following interest rate rises. Loan balances rose by
21 per cent, principally in the services and commerce
sectors, though competitive pricing led to a tightening
of lending spreads. The ‘Estimulo’ combined loan
and overdraft product, which was launched at the end
of 2004, performed strongly, attracting balances of
US$155 million.
In Brazil, a growing economy and a 30 per cent
rise in customer numbers led to increases in both
assets and liabilities. Overdraft balances grew by
41 per cent as both the number and the average size
of facilities grew, contributing US$40 million of
additional income. Overdraft spreads increased by
3 percentage points as a result of increases in the rate
charged to new borrowers. The continuing success of
Giro fácil, a revolving loan and overdraft facility,
resulted in a 13 per cent increase in customer
numbers which, together with an increase in facility
utilisation, resulted in a 77 per cent increase in
balances. Invoice financing balances rose by 30 per
cent, benefiting from both increased marketing and
higher sales to Losango clients, approximately a third
of whom now have a commercial banking
relationship with HSBC.
Deposit balances in Brazil increased by 21 per
cent, reflecting initiatives to incentivise staff to
prioritise sales of liability products. However,
competitive pressures contributed to a 5 percentage
points decrease in spreads on loans and advances to
customers, while deposit spreads were 13 basis points
lower. In Argentina, deposits from commercial
customers increased by 42 per cent, reflecting the
continuing economic recovery, while loans and
overdrafts more than doubled and current account
balances increased by 38 per cent. HSBC increased
its market share in both loans and deposits.
Net fee income was 3 per cent higher, led by
increases in Mexico and Brazil which were partly
offset by IFRSs changes to accounting for effective
interest rates which reduced fee income by 22 per
cent.
In Mexico, marketing campaigns, tariff
reductions and the promotion of business internet
banking, together with increased customer numbers,
contributed to a 31 per cent increase in payment and
cash management fees, while card fees increased
following the launch of a credit card as part of the
‘Estimulo’ suite of products. Trade services fee
income increased by 63 per cent as a result of
customer acquisition and increased cross-sales to
existing customers, nearly doubling the bank’s
market share in a growing market.
In Brazil, the increase was due to higher fees
from payments and cash management, current
accounts, and lending. Current account fees increased
by 26 per cent, reflecting tariff increases, improved
collection procedures and higher transaction volumes,
while lending fees benefited from higher business
volumes. In Argentina, the launch of a commercial
banking call centre in the first half of 2005 enhanced
the customer service proposition. This, together with
the recruitment of additional relationship managers,
supported a 14 per cent increase in customer numbers
and, as a result, current account fee income increased
by 21 per cent. Improvements in the Argentinian
economic climate contributed to increased trade
flows which, together with the establishment of a
dedicated trade service sales team, led to a 22 per
cent increase in trade services income.
Loan impairment charges and other credit risk
provisions of US$89 million compared with a net
release of US$23 million in 2004. In Mexico, growth
in the lending portfolio led to a US$49 million
increase in loan impairment charges, although
underlying credit quality improved.
101
In Brazil, asset growth contributed to a
US$47 million increase in charges. Impaired loans as
a proportion of assets increased by 3 percentage
points in the SME portfolio, in line with overall
market performance, and MME credit quality also
declined slightly. In Argentina, net recoveries
decreased as significant releases from amounts
recognised at the time of the sovereign debt default
and pesification were not repeated. However,
underlying credit quality improved substantially and
impaired loans as a percentage of assets more than
halved.
Operating expenses of US$621 million were
23 per cent higher than in 2004, though the cost
efficiency ratio improved by 3 percentage points as
income grew faster than costs. In Mexico, operating
expenses increased by 29 per cent, due to an 11 per
cent increase in staff numbers to support business
growth, higher incentive payments reflecting strong
income growth, and increased ‘Estimulo’ marketing
expenditure.
Staff numbers in Brazil increased by 34 per cent
following a recruitment drive initiated in the second
half of 2004 to support expansion of the SME
business. Higher incentive payments, reflecting
increased income, and union-agreed pay increases
also contributed to an increase in staff costs. New
marketing campaigns, including the award winning
‘30, 60, 90 Dias de Apuros’ campaign focusing on
invoice financing, increased advertising and
marketing costs. Expenses in Argentina increased by
24 per cent, driven by higher staff costs, reflecting
pay rises agreed with local unions, together with a
9 per cent increase in headcount in support of
business expansion.
Corporate, Investment Banking and Markets
reported a pre-tax profit of US$347 million, an
increase of 56 per cent, primarily driven by strong
growth in net interest income and trading revenues in
Mexico.
Total operating income at US$653 million
increased by 28 per cent compared with 2004. In
Mexico, net interest income more than doubled, due
to the strong performance in balance sheet
management, which benefited from higher volumes
and successful strategic positioning against a rising
short-term interest rate environment, with an overall
flattening of the yield curve in the first part of 2005.
In the latter half of the year, positions were
effectively managed to take advantage of the decline
in local rates.
In Argentina, a reduction in funding costs in
Global Markets was augmented by the positive
impact of an appreciating CER (an inflation-linked
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Latin America > 2005 / Profit/(loss) before tax
index) on holdings of government bonds. Continuing
economic growth and improved market confidence
stimulated demand for credit, resulting in a 67 per
cent growth in balances. Brazil reported a decrease in
balance sheet management and money market
revenues as a result of high short-term interest rates
and an inverted yield curve.
Net fee income rose by 12 per cent reflecting
higher fees in Global Transaction Banking. The
payments and cash management business generated
higher customer volumes following an extension of
the product range and reflected the benefit of
improved delivery and distribution channels in
Mexico.
Trading activities generated higher income as
foreign exchange and derivatives trading were
facilitated by the introduction of the Group’s standard
derivatives system in Mexico. Global Markets in
Brazil benefited from a wider product range and the
addition of new delivery capabilities. This investment
and the relatively buoyant local market resulted in
higher business volumes, particularly in foreign
exchange. In Argentina, Global Markets income rose
in line with increased trading activity in response to
the sovereign debt swap.
A US$11 million net release of loan impairment
charges compared favourably with a net charge in
2004. In Brazil, a recovery in the energy sector was
accompanied by the non-recurrence of allowances
raised against two specific corporate accounts in
2004.
Operating expenses of US$273 million were
17 per cent higher than in 2004. In Mexico,
operational costs rose in line with higher
transactional volumes, while an increase in staff costs
partly reflected recruitment to support expansion
initiatives. In Brazil, the benefit of a reduction in
profit share and bonus payments was partly offset by
higher centralised support function staff costs, driven
by pay rises agreed with local unions. In Argentina,
operating expenses were broadly in line with 2004.
Private Banking reported flat profits. Strong
growth in client assets, including US$2.4 billion of
net new money, was driven by growth in Mexico
following the launch of Private Banking there in
2004. In Brazil, the business was reorganised in
2005, with the transfer of smaller accounts to
Personal Financial Services following a
resegmentation of the customer base.
In Brazil, HSBC’s insurance business was
reclassified from Other to Personal Financial
Services in 2005. As a result, operating income
decreased by US$106 million and operating expenses
fell by US$90 million. In Argentina, the receipt of
compensation bonds and other items related to the
pesification in 2002 led to a US$17 million increase
in profit before tax.
102
Profit/(loss) before tax by customer groups and global businesses
Year ended 31 December 2006
Personal
Financial
Services
US$m
3,057
1,053
Commercial
Banking
US$m
1,037
387
61
14
75
227
11
5
992
74
5,494
(957)
21
5
26
–
1
1
27
7
1,486
(16)
Corporate,
Investment
Banking &
Markets
US$m
Private
Banking
US$m
325
167
218
(16)
202
11
72
-
59
10
846
(51)
13
23
1
–
1
–
–
–
–
4
41
–
Inter-
segment
elimination
US$m
(233)
Other
US$m
(2)
–
–
–
–
(1)
–
–
(2)
14
9
1
–
–
233
233
–
–
–
–
(18)
(18)
–
Total
US$m
4,197
1,630
301
236
537
237
84
6
1,076
91
7,858
(1,023)
4,537
1,470
795
41
10
(18)
6,835
Latin America
Net interest income/(expense) ....
Net fee income ............................
Trading income excluding net
interest income .......................
Net interest income/(expense)
on trading activities ................
Net trading income .....................
Net income/(expense) from
financial instruments
designated at fair value ...........
Gains less losses from financial
investments .............................
Dividend income .........................
Net earned insurance premiums .
Other operating income ..............
Total operating income ............
Net insurance claims1 .................
Net operating income before
loan impairment charges
and other credit risk
provisions ..............................
Loan impairment (charges)/
recoveries and other credit
risk provisions ........................
Net operating income ...............
(938)
5,897
(4,166)
1,731
4
1,735
%
7.9
61.0
US$m
35,791
80,771
50,861
(764)
3,773
Total operating expenses ............
(2,977)
Operating profit/(loss) ..............
Share of profit in associates
and joint ventures ...................
Profit/(loss) before tax ..............
Share of HSBC’s profit
before tax ................................
Cost efficiency ratio ...................
796
4
800
%
3.6
65.6
(197)
1,273
(822)
451
–
451
%
2.0
55.9
26
821
(346)
475
–
475
%
2.2
43.5
–
41
(27)
14
–
14
%
0.1
65.9
(3)
7
(12)
(5)
–
(5)
%
–
120.0
–
(18)
18
–
–
–
Selected balance sheet data2
Loans and advances to
customers (net) .......................
Total assets .................................
Customer accounts ......................
The following assets and
liabilities were significant
to Corporate, Investment
Banking and Markets:
– loans and advances to
banks (net) ..........................
– trading assets, financial
instruments designated at
fair value, and financial
investments .........................
– deposits by banks ...............
US$m
US$m
US$m
US$m
US$m
16,165
28,053
25,200
11,463
16,244
13,754
8,147
36,333
11,685
16
90
222
–
51
–
9,704
15,882
3,115
103
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Latin America > Profit/(loss) before tax
Profit/(loss) before tax by customer groups and global businesses (continued)
Year ended 31 December 20053
Personal
Financial
Services
US$m
Commercial
Banking
US$m
Corporate,
Investment
Banking &
Markets
US$m
Private
Banking
US$m
Other
US$m
Latin America
Inter-
segment
elimination
US$m
(329)
–
–
329
329
–
–
–
–
–
–
–
–
–
–
–
–
–
–
10
14
3
1
4
–
–
–
–
(1)
27
–
27
(2)
25
(24)
1
–
1
22
2
1
–
1
3
35
–
(3)
56
116
–
116
4
120
(6)
114
(1)
113
%
–
88.9
%
0.5
5.2
Total
US$m
3,342
1,191
220
317
537
186
80
5
871
286
6,498
(792)
5,706
(676)
5,030
(3,426)
1,604
–
1,604
%
7.7
60.0
US$m
21,681
55,387
30,989
Net interest income .....................
Net fee income ............................
2,580
790
Trading income excluding net
interest income .......................
Net interest expense on trading
activities ..................................
Net trading income .....................
Net income from financial
instruments designated at
fair value .................................
Gains less losses from financial
investments .............................
Dividend income .........................
Net earned insurance premiums .
Other operating income/
(expense) ................................
56
–
56
174
35
5
794
188
767
263
9
–
9
–
–
–
23
18
Total operating income ...............
Net insurance claims1 .................
4,622
(734)
1,080
(13)
292
122
151
(13)
138
9
10
–
57
25
653
(45)
3,888
1,067
608
Net operating income before
loan impairment charges and
other credit risk provisions .....
Loan impairment (charges)/
recoveries and other credit
risk provisions ........................
Net operating income .................
(600)
3,288
Total operating expenses ............
(2,502)
Operating profit ..........................
Share of profit/(loss) in
associates and joint ventures ..
Profit before tax ..........................
Share of HSBC’s profit
before tax ................................
Cost efficiency ratio ...................
786
–
786
%
3.8
64.4
(89)
978
(621)
357
–
357
%
1.7
58.2
11
619
(273)
346
1
347
%
1.7
44.9
Selected balance sheet data2
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) ..........................
– trading assets, financial
instruments designated at
fair value, and financial
investments .........................
– deposits by banks ...............
US$m
US$m
US$m
US$m
US$m
9,233
15,723
17,302
6,424
9,491
4,703
6,012
28,509
8,661
12
53
102
–
1,611
221
7,410
13,067
1,858
104
2,722
741
415
145
(16)
4,024
Year ended 31 December 20043
Personal
Financial
Services
US$m
Commercial
Banking
US$m
Corporate,
Investment
Banking &
Markets
US$m
Private
Banking
US$m
Inter-
segment
elimination
US$m
Other
US$m
Latin America
Net interest income .....................
1,817
Net fee income/(expense) ...........
Trading income/(expense) ..........
Net investment income on
assets backing policyholders’
liabilities .................................
Gains less losses from financial
investments .............................
Dividend income .........................
Net earned insurance premiums .
Other operating income ..............
765
35
40
8
–
251
25
Total operating income ...............
Net insurance claims1 .................
2,941
(219)
466
230
12
1
5
–
34
18
766
(25)
217
95
81
9
(1)
–
55
6
462
(47)
Net operating income before
loan impairment charges and
other credit risk provisions .....
Loan impairment (charges)/
recoveries and other credit
risk provisions ........................
Net operating income .................
(270)
2,452
Total operating expenses ............
(1,801)
Operating profit ..........................
Share of profit in associates
and joint ventures ...................
Profit before tax ..........................
Share of HSBC’s profit
before tax ................................
Cost efficiency ratio ...................
651
–
651
%
3.4
66.2
23
764
(448)
316
–
316
%
1.7
60.5
(7)
408
(212)
196
–
196
%
1.0
51.1
4
12
–
–
–
–
–
1
17
–
17
–
17
(17)
–
–
–
%
–
100.0
12
(75)
(1)
45
35
2
359
12
389
(244)
–
–
–
–
–
–
–
(16)
(16)
–
–
(16)
16
–
–
–
1
146
(68)
78
1
79
%
0.4
46.9
Selected balance sheet data2
Loans and advances to
customers (net) .......................
Total assets .................................
Customer accounts ......................
The following assets and
liabilities were significant
to Corporate, Investment
Banking and Markets:
– loans and advances to
banks (net) ..........................
– trading assets, financial
instruments designated at
fair value, and financial
investments .........................
– deposits by banks ...............
US$m
US$m
US$m
US$m
US$m
9,709
16,973
13,642
3,021
5,027
6,284
2,622
17,014
6,259
2
34
11
339
1,371
111
5,046
7,860
1,825
Total
US$m
2,516
1,027
127
95
47
2
699
46
4,559
(535)
(253)
3,771
(2,530)
1,241
1
1,242
%
6.5
62.9
US$m
15,693
40,419
26,307
1 Net insurance claims incurred and movement in policyholders’ liabilities.
2 Third party only.
3 In 2006, Mexico and Panama were reclassified from the North America segment to Latin America. Comparative information has been
restated accordingly.
105
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Products and services
Other information
Products and services
Personal Financial Services
Personal Financial Services provides over
120 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 positioning of
HSBC’s local businesses. Typically, products
provided include current and savings accounts,
mortgages and personal loans, credit cards, and local
and international payment services.
HSBC uses its global reach to offer tailored
financial services to customers banking in more than
one country.
Personal customers prefer to conduct their
financial business at times convenient to them, using a
range of delivery channels. This demand for flexibility
is met through the increased provision of direct
channels such as the internet and self-service terminals,
in addition to traditional and automated branches and
service centres accessed by telephone.
Delivering the right products and services 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
systems are effectively used to identify and fulfil sales
opportunities, and to manage the sales process.
HSBC Premier is a premium banking service
providing personalised relationship management,
24-hour priority telephone access, global travel
assistance and cheque encashment facilities. There are
now over 1.8 million HSBC Premier customers, who
can use more than 250 specially designated Premier
branches and centres in 36 countries and territories,
either temporarily when visiting or on a more
permanent basis if they require a banking relationship
in more than one country.
HSBC Finance’s operations in the US, the UK
and Canada make credit available to customers 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 2006, HSBC Finance
had over 66 million customers with total gross
advances of US$217.3 billion.
106
HSBC Finance serves personal customers
through the following business units:
• The consumer lending business unit is one of
the largest sub-prime home equity originators in
the US, marketed under the HFC and Beneficial
brand names. Consumer lending also acquires
sub-prime loans on the secondary market.
• The mortgage services business unit purchases
first and second lien mortgage loans, including
open-end home equity loans, from a network of
over 220 unaffiliated third-party lenders in the
US. Decision One Mortgage Company, a
subsidiary of HSBC Finance, originates
mortgage loans sourced by mortgage brokers
and sells all loans to secondary market
purchasers, including HSBC’s mortgage
services business.
• The retail services business unit 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 66 merchant
relationships and 16.6 million active customer
accounts.
•
In addition to originating and refinancing motor
vehicle loans, HSBC Finance’s motor vehicle
finance business unit 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 9,500 motor dealers.
• The credit card services business unit is the
fifth largest issuer of MasterCard and Visa credit
cards in the US, and includes affiliation
programmes such as the GM Card, the AFL-
CIO Union Plus credit card, the Household
Bank, Orchard Bank and, HSBC branded cards,
and the Direct Merchants Bank MasterCard.
Credit card services also cross-sell to customers
in the consumer lending, motor vehicle finance,
retail services and taxpayer financial services
businesses.
• The taxpayer financial services business unit
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’s business in the UK, HFC
Bank, provides mid-market consumers with
mortgages, secured and unsecured loans, retail
finance and insurance products. In Canada, similar
products are offered through trust operations of
HSBC Finance’s subsidiary there.
Insurance and investment products play an
important part in meeting the needs of customers.
Insurance products distributed by HSBC through its
direct channels and branch networks include loan
protection, life, property and health insurance and
pensions. Acting as both broker and underwriter,
HSBC sees continuing opportunities to deliver
insurance products to its customer base.
HSBC also makes available a wide range of
investment products. A choice of third party and
proprietary funds is offered, including traditional
‘long only’ equity and bond funds; structured funds
that provide capital security and opportunities for an
enhanced return; and ‘fund of funds’ products which
offer customers the ability to diversify their
investments across a range of best-in-class fund
managers chosen after 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.
Commercial Banking
HSBC is one of the world’s leading, and most
international, banks, with 2.6 million Commercial
Banking customers in 62 locations, including sole
proprietors, partnerships, clubs and associations,
incorporated businesses and publicly quoted
companies. At 31 December 2006, HSBC had total
commercial customer account balances of
US$191 billion and total commercial customer loans
and advances, net of loan impairment allowances, of
US$173 billion.
HSBC segments its Commercial Banking
business into corporate, medium, small and micro
business, allowing the development of tailored
customer propositions whilst adopting a broader
view of the entire Commercial Banking sector, from
sole traders to top end mid-market corporations. This
allows HSBC to provide continuous support to
companies as they grow in size both domestically
and internationally, and ensures a clear focus on the
small and micro business sectors, which are typically
the key to innovation and growth in market
economies.
HSBC places particular emphasis on
geographical collaboration to meet its business
customers’ needs and aims to be recognised as the
leading international business bank and the best bank
107
for small business in target markets. The range of
products and services includes:
Financing: HSBC provides a range of short and
longer-term financing options for Commercial
Banking customers, both domestically and cross-
border, including overdrafts, receivables finance,
term loans and property finance. HSBC offers forms
of asset finance in five sites and has established
specialised divisions providing leasing and
instalment finance for vehicles, plant and equipment.
Payments and cash management: HSBC is a
leading provider of domestic and cross-border
payments, collections, liquidity management and
account services worldwide. HSBC’s extensive
network of offices and direct access to numerous
local clearing systems, enhances its customers’
ability to manage their cash efficiently on a global
basis.
International trade: HSBC finances and
facilitates significant volumes of international trade,
under both open account terms and traditional trade
finance instruments. HSBC also provides
international factoring, commodity and insured
export finance, and forfaiting services. HSBC
utilises its extensive international network to build
customer relationships at both ends of trade flows,
and maximises efficiency through expertise in
documentary checking and processing, and highly
automated systems.
Treasury and capital markets: Commercial
Banking customers are volume users of the Group’s
foreign exchange capabilities, including
sophisticated currency and interest rate options.
Commercial cards: HSBC offers commercial
card services in 16 countries. Commercial card
issuing provides its customers with services which
enhance cash management, improve cost control and
streamline purchasing processes. HSBC offers card
acquiring services, either directly or as part of a joint
venture, enabling merchants to accept credit card
payments either in store or on the internet.
Insurance: HSBC offers insurance services in
25 sites, which cover a full range of commercial
insurance products designed to meet the needs of
businesses and their employees, including employee
benefit, pension and healthcare programmes. 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. HSBC
also provides insurance due diligence reviews, and
actuarial and employee benefit consultancy services.
Wealth management services: These include
advice and products related to savings and
H S B C H O L D I N G S P L C
Report of the Directors: Business Review (continued)
Products and services / Property / Legal proceedings
investments provided to Commercial Banking
customers and their employees through HSBC’s
worldwide network, with clients being referred to
Private Banking where appropriate.
Investment banking: A small number of
Commercial Banking customers need corporate
finance and advisory support. These requirements
are serviced by the Group on a client-specific basis.
Delivery channels: HSBC deploys a full range
of delivery channels, including specific online and
direct banking offerings such as HSBCnet and
Business Internet Banking.
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 60 countries and access to
HSBC’s worldwide presence and capabilities, this
business serves subsidiaries and offices of its clients
on a global basis.
Corporate, Investment Banking and Markets is
managed as three principal business lines: Global
Markets, Global Banking and Group Investment
Businesses. This structure allows HSBC to focus on
relationships and sectors that best fit the Group’s
footprint and facilitates seamless delivery of HSBC’s
products and services to clients.
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
108
•
•
trading for institutional, corporate and private
clients and asset management services;
distribution of capital markets instruments,
including debt, equity and structured products,
utilising links with HSBC’s global networks;
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.
Global Banking
HSBC’s operations in Global Banking consist of
financing, advisory and transaction services for
corporations, institutional and private investors,
financial institutions, and governments and their
agencies. Products include:
•
•
•
•
investment banking, which comprises capital
raising, including debt and equity capital, and
corporate finance and advisory services;
lending, comprising bilateral and syndicated
lending, leveraged and acquisition finance,
structured and project finance; lease finance;
and non-retail deposit-taking;
international, regional and domestic payments
and cash management services; and
other transaction services, including trade
services, factoring and banknotes.
Group Investment Businesses
These comprise asset management products and
services for institutional investors, intermediaries
and individual investors and their advisers.
Other
Other products include private equity, which
comprises HSBC’s captive private equity funds,
strategic relationships with third party private equity
managers and other investments.
Private Banking
HSBC’s presence in all the major wealth-creating
regions has enabled it to build one of the world’s
leading private banking groups, providing financial
services to high net worth individuals and their
families from 90 locations in 35 countries and
territories, with client assets of US$333 billion at
31 December 2006.
HSBC Private Bank is the principal marketing
name of the HSBC Group’s international private
banking business which, together with HSBC
Guyerzeller and HSBC Trinkaus & Burkhardt,
provides the services noted below.
area of approximately 65.4 million square feet
(2005: 63.8 million square feet).
Freehold, long leasehold and short leasehold
land and buildings carried on the balance sheet
represented 40 per cent of HSBC’s operational
space. In addition, properties with a net book value
of US$1,949 million were held for investment
purposes. Of the total net book value of HSBC
properties, more than 78 per cent were owned or
held under long-term leases.
HSBC’s properties are stated at cost, being
historical cost or fair value at the date of transition to
IFRSs (their deemed cost) less any impairment
losses, and are depreciated on a basis calculated to
write off the assets over their estimated useful lives.
Properties owned as a consequence of an acquisition
are recognised initially at fair value.
Valuation of freehold and leasehold land and
buildings
HSBC’s freehold and long leasehold properties,
together with all leasehold properties in Hong Kong,
were valued in 2006. The value of these properties
was US$1.7 billion in excess of their carrying
amount in the consolidated balance sheet.
Further details are included in Note 23 on the
Financial Statements on page 366.
Legal proceedings
HSBC is party to legal actions in a number of
jurisdictions including the UK, Hong Kong and the
US, arising out of its normal business operations.
HSBC considers that none of the actions is regarded
as material, and none is expected to result in a
significant adverse effect on the financial position of
HSBC, either individually or in the aggregate.
Management believes that adequate provisions have
been made in respect of such litigation. HSBC has
not disclosed any contingent liability associated with
these legal actions because it is not practicable to do
so.
Utilising the most suitable products from the
marketplace, Private Banking works with its clients
to offer both traditional and innovative ways to
manage and preserve wealth while 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, options,
futures, structured products, mutual funds and
alternative products, such as hedge funds and fund of
funds. By accessing regional expertise located within
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,
foundation and company administration, charitable
trusts and foundations, insurance and offshore
structures.
Specialist advisory services: Private Banking
offers expertise in several specialist areas of wealth
management including tax advisory and financial
planning, family office advisory, corporate finance,
consolidated reporting, industry services such as
charities and foundations, media, shipping, diamond
and jewellery, and real estate planning. 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 comprise
treasury and foreign exchange, offshore and onshore
deposits, credit and specialised lending, tailor-made
loans and internet banking. Private Banking works to
ensure its clients have full access to relevant skills
and products available throughout HSBC, such as
corporate banking, investment banking and
insurance.
Property
At 31 December 2006, HSBC operated from some
10,200 operational properties worldwide, of which
approximately 3,200 were located in Europe, 700 in
Hong Kong and the Rest of Asia-Pacific, 2,300 in
North America and 4,000 in Latin America
(including 1,550 in Mexico). These properties had an
109
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Report of the Directors: Financial Review
Introduction / Critical accounting policies
Introduction ...................................................
Critical accounting policies ...........................
Key performance indicators ..........................
Financial summary ........................................
Income statement .......................................
Net interest income ....................................
Net fee income ...........................................
Net trading income ....................................
Net income from financial instruments
Page
110
111
115
119
119
122
125
128
designated at fair value ..........................
129
Gains less losses from financial
investments .............................................
Net earned insurance premiums ................
Other operating income .............................
Net insurance claims incurred and
131
132
133
movement in policyholders’ liabilities ...
135
Loan impairment charges and other
credit risk provisions ..............................
Operating expenses ....................................
Share of profit in associates and joint
ventures ..................................................
Asset deployment .......................................
Trading assets and financial
investments ............................................
Funds under management ..........................
Assets in custody and under
administration ........................................
Economic profit .........................................
Other financial information ...........................
Average balance sheet and net interest
136
139
142
144
144
145
145
146
147
income ....................................................
147
Analysis of changes in net interest
income ....................................................
Share capital and reserves .........................
Short-term borrowings ...............................
Contractual obligations .............................
Loan maturity and interest sensitivity
analysis ..................................................
Deposits .....................................................
Certificates of deposit and other time
deposits ..................................................
Off-balance sheet arrangements ................
154
157
158
158
159
160
162
163
110
Introduction
The consolidated financial statements of HSBC and
the separate financial statements of HSBC Holdings
have been prepared in accordance with International
Financial Reporting Standards (‘IFRSs’) as endorsed
by the European Union (‘EU’). EU-endorsed IFRSs
may differ temporarily from IFRSs as published by
the International Accounting Standards Board
(‘IASB’) if, at any point in time, new or amended
IFRSs have not been endorsed by the EU. At
31 December 2006, there were no unendorsed
standards, effective for the year ended 31 December
2006, affecting these consolidated and separate
financial statements, and there was no difference in
application to HSBC between IFRSs endorsed by the
EU and IFRSs issued by the IASB.
Certain information for years prior to 2004 has
been prepared under UK Generally Accepted
Accounting Principles (‘UK GAAP’), which are not
comparable with IFRSs.
HSBC uses the US dollar as its presentation
currency because the US dollar and currencies linked
to it form the major currency bloc in which HSBC
transacts its business. Unless otherwise stated, the
accounting information presented in this document
has been prepared in accordance with IFRSs.
IFRSs compared with US GAAP
Net income
US GAAP .................
IFRSs ........................
Shareholders’ equity
US GAAP .................
IFRSs ........................
2006
US$m
16,358
15,789
2005
US$m
14,703
15,081
2004
US$m
12,506
12,918
108,540
108,352
93,524
92,432
90,082
85,522
HSBC provides details of its net income and
shareholders’ equity calculated in accordance with
US GAAP, which differs in certain respects from
IFRSs. Differences in net income and shareholders’
equity are explained in Note 47 on the Financial
Statements on pages 403 to 434.
Constant currency
Constant currency comparatives in respect of 2005
and 2004 used in the 2006 and 2005 commentaries
respectively are computed by retranslating into US
dollars:
•
the income statements for 2005 and 2004 of
non-US dollar branches, subsidiaries, joint
ventures and associates at the average rates of
exchange for 2006 and 2005 respectively; and
•
the balance sheets at 31 December 2005 and
2004 for non-US dollar branches, subsidiaries,
joint ventures and associates at the prevailing
rates of exchange on 31 December 2006 and
2005 respectively.
No adjustments are made to the exchange rates
used to translate assets and liabilities denominated in
foreign currencies into the functional currencies of
any HSBC branch, subsidiary, joint venture or
associate.
Operating income and cost growth
Total operating income .................................................
Net operating income before loan impairment
charges and other credit risk provisions ...................
Total operating expenses ..............................................
Comparison of financial information
When reference is made to ‘constant currency’ or
‘constant exchange rates’ in commentaries,
comparative data reported in the functional
currencies of HSBC’s operations have been
translated at the appropriate exchange rates applied
in the current period in respect of the income
statement or the balance sheet. When reference to
‘underlying basis’ is made, comparative information
has been expressed at constant currency and adjusted
for the effect of acquisitions, disposals, and the
change in presentation of non-equity minority issues
affecting the 2005 comparison with 2004.
As the transition to IFRSs affected the
comparability of the financial information presented
in this document (see Note 1 on the Financial
Statements), the commentaries that follow specify
the impact when this is material to a reader’s
understanding of the underlying business trends.
Critical accounting policies
(Audited)
Introduction
The results of HSBC 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 on the Financial Statements.
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.
The accounting policies that are deemed critical
to HSBC’s IFRSs results and financial position, in
terms of the materiality of the items to which the
2006 compared with 2005
2005 compared with 2004
As
reported
Constant
currency on
an underlying
basis
%
14
13
14
%
11
11
11
As
reported
%
10
12
11
Constant
currency on
an underlying
basis
%
10
12
9
policy is applied, and which involve a high degree of
judgement and estimation, are discussed below.
Impairment of loans
HSBC’s accounting policy for losses arising from
the impairment of customer loans and advances is
described in Note 2(f) on the Financial Statements.
Losses in respect of impaired loans are reported
in HSBC’s income statement under the caption
‘Loan impairment charges and other credit risk
provisions’. An increase in these losses has the effect
of reducing HSBC’s profit for the period by a
corresponding amount (while a decrease in
impairment charges or reversal of impairment
charges has the opposite effect).
Losses for impaired loans are recognised
promptly when there is objective evidence that
impairment of a loan or portfolio of loans has
occurred. Impairment losses are calculated on
individual loans and on loans assessed collectively.
Losses expected from future events, no matter how
likely, are not recognised.
Individually assessed loans
At each balance sheet date, HSBC assesses on a
case-by-case basis whether there is any objective
evidence that a loan is impaired. This procedure is
applied to all accounts that are considered
individually significant. In determining impairment
losses on these loans, the following factors are
considered:
• HSBC’s aggregate exposure to the customer;
•
the viability of the customer’s business model
and their capacity to trade successfully out of
financial difficulties and generate sufficient cash
flow to service debt obligations;
111
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Report of the Directors: Financial Review (continued)
Critical accounting policies
•
•
•
•
•
•
•
the amount and timing of expected receipts and
recoveries;
the likely dividend available on liquidation or
bankruptcy;
the extent of other creditors’ commitments
ranking ahead of, or pari passu with, HSBC 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 realisable value of security (or other credit
mitigants) and likelihood of successful
repossession;
the likely deduction of any costs involved in
recovery of amounts outstanding;
the ability of the borrower to obtain, and make
payments in, the currency of the loan if not
denominated in local currency; and
• when available, the secondary market price of
the debt.
Impairment losses are calculated by discounting
the expected future cash flows of a loan at its
original effective interest rate, and comparing the
resultant present value with the loan’s current
carrying amount.
The carrying amount of impaired loans on the
balance sheet is reduced through the use of an
allowance account. HSBC’s policy requires a review
of the level of impairment allowances on individual
facilities above materiality thresholds at least half-
yearly, or more regularly when individual
circumstances require. This normally includes a
review of collateral held (including re-confirmation
of its enforceability) and an assessment of actual and
anticipated receipts.
Collectively assessed loans
Impairment is assessed on a collective basis in two
circumstances:
•
•
to cover losses which have been incurred but
have not yet been identified on loans subject to
individual assessment; and
for homogeneous groups of loans that are not
considered individually significant.
Incurred but not yet identified impairment
Individually assessed loans for which no evidence of
loss has been specifically identified on an individual
112
basis are grouped together according to their credit
risk characteristics for the purpose of calculating an
estimated collective loss. This reflects impairment
losses incurred at the balance sheet date which will
only be individually identified in the future.
The collective impairment allowance is
determined after taking into account:
•
•
historical loss experience in portfolios of similar
credit risk characteristics (for example, by
industry sector, loan grade or product);
the estimated period between impairment
occurring and the loss being identified and
evidenced by the establishment of an
appropriate allowance against the individual
loan; and
• management’s experienced judgement as to
whether 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 period between a loss occurring and its
identification is estimated by local management for
each identified portfolio.
Homogeneous groups of loans
For homogeneous groups of loans that are not
considered individually significant, two alternative
methods are used to calculate allowances on a
portfolio basis:
When appropriate empirical information is
available, HSBC utilises roll-rate methodology. This
methodology employs statistical analysis of
historical trends of delinquency and default to
estimate the likelihood that loans will progress
through the various stages of delinquency and
ultimately prove irrecoverable. The estimated loss is
the difference between the present value of expected
future cash flows, discounted at the original effective
interest rate of the portfolio, and the carrying amount
of the portfolio. Current economic conditions are
also evaluated when calculating the appropriate level
of allowance required to cover inherent loss. In
certain highly developed markets, sophisticated
models also take into account behavioural and
account management trends as revealed in, for
example, bankruptcy and rescheduling statistics.
In other cases, when the portfolio size is small
or when information is insufficient or not reliable
enough to adopt a roll-rate methodology, HSBC
adopts a formulaic approach which allocates
progressively higher percentage loss rates the longer
a customer’s loan is overdue. Loss rates are
objectively to an event occurring after the
impairment was recognised, the excess is written
back by reducing the loan impairment allowance
account accordingly. The reversal is recognised in
the income statement.
Assets acquired in exchange for loans
Non-financial assets acquired in exchange for loans
as part of an orderly realisation are recorded as
assets held for sale and reported in ‘Other assets’.
The asset acquired is recorded at the lower of its fair
value (less costs to sell) and the carrying amount of
the loan (net of impairment allowance) at the date of
exchange. No depreciation is charged in respect of
assets held for sale. Any subsequent write-down of
the acquired asset to fair value less costs to sell is
recognised in the income statement in ‘Other
operating income’. Any subsequent increase in the
fair value less costs to sell, to the extent this does not
exceed the cumulative write down, is also recognised
in ‘Other operating income’, together with any
realised gains or losses on disposal.
Renegotiated loans
The impairment of personal loans is generally
subject to collective assessment. Personal loans
whose terms have been renegotiated are no longer
considered past due, but are treated as new loans
only after a minimum required number of payments
required under the new arrangements have been
received.
Loans subject to individual impairment
assessment whose terms have been renegotiated are
subject to ongoing review to determine whether they
remain impaired or should be considered past due.
Further information on impairment assessment
and impairment allowances is set out on pages
174 to 176.
Goodwill impairment
HSBC’s accounting policy for goodwill is described
in Note 2(o) on the Financial Statements.
Goodwill arises on business combinations,
including the acquisition of subsidiaries, and
interests in joint ventures and associates, when the
cost of acquisition exceeds the fair value of HSBC’s
share of the identifiable assets, liabilities and
contingent liabilities acquired. By contrast, if
HSBC’s interest in the fair value of the identifiable
assets, liabilities and contingent liabilities of an
calculated from the discounted expected future cash
flows from a portfolio.
In normal circumstances, historical experience
provides the most objective and relevant information
from which to assess inherent loss within each
portfolio. In certain circumstances, historical loss
experience provides less relevant information about
the inherent loss in a given portfolio at the balance
sheet date, for example, where there have been
changes in economic, regulatory or behavioural
conditions such that the most recent trends in the
portfolio risk factors are not fully reflected in the
statistical models. In these circumstances, such risk
factors are taken into account when calculating the
appropriate level of impairment allowances, by
adjusting the impairment allowances derived solely
from historical loss experience. Key risk factors
include recent trends in charge-off and delinquency,
economic conditions such as national and local
trends in housing markets, changes in product mix
and concentration, bankruptcy trends, other market
conditions such as changes in interest rates and
energy prices, changes in laws and regulations and
natural disasters.
Roll rates, loss rates and the expected timing of
future recoveries are regularly benchmarked against
actual outcomes to ensure they remain appropriate.
The portfolio approach is generally applied to
the following types of portfolios:
•
•
•
low value, homogeneous small business
accounts in certain jurisdictions;
residential mortgages;
credit cards and other unsecured consumer
lending products; and
• motor vehicle financing.
These portfolio allowances are generally
reassessed monthly and charges for new allowances,
or reversals of existing allowances, are calculated for
each separately identified portfolio.
Loan write-offs
Loans (and the related impairment allowance
accounts) 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 realising security have been received.
Reversals of impairment
If the amount of an impairment loss decreases in a
subsequent period, and the decrease can be related
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Report of the Directors: Financial Review (continued)
Critical accounting policies / Key performance indicators
acquired business is greater than the cost of
acquisition, the excess is recognised immediately in
the income statement.
At the date of disposal of a business, attributable
goodwill is included in HSBC’s share of net assets in
the calculation of the gain or loss on disposal.
Goodwill is allocated to cash-generating units
(‘CGU’) for the purpose of impairment testing,
which is undertaken at the lowest level at which
goodwill is monitored for internal management
purposes. Impairment testing is performed at least
annually by comparing the present value of the
expected future cash flows from a business with the
carrying amount of its net assets, including
attributable goodwill.
Significant management judgement is involved
in two aspects of the process of identifying and
evaluating goodwill impairment.
First, the cost of capital assigned to an
individual CGU and used to discount its future cash
flows can have a significant effect on the CGU’s
valuation. The cost of capital percentage is generally
derived from a Capital Asset Pricing Model, which
itself depends on inputs reflecting a number of
financial and economic variables including the risk-
free interest rate in the country concerned and a
premium to reflect the inherent risk of the business
being evaluated. These variables are established on
the basis of management judgement.
Second, management judgement is required in
estimating the future cash flows of the CGU. These
values are sensitive to the cash flows projected for
the periods for which detailed forecasts are available,
and to assumptions regarding the long-term pattern
of sustainable cash flows thereafter. While the
acceptable range within which underlying
assumptions can be applied is governed by the
requirement to compare resulting forecasts with
actual performance and verifiable economic data in
future years, the cash flow forecasts necessarily and
appropriately reflect management’s view of future
business prospects.
When this exercise demonstrates that the
expected cash flows of a CGU have declined and/or
that its cost of capital has increased, the effect is to
reduce the CGU’s estimated fair value. If this results
in an estimated recoverable amount that is lower
than the carrying value of the CGU, a charge for
impairment of goodwill will be recorded, thereby
reducing by a corresponding amount HSBC’s profit
for the year. Goodwill is stated at cost less
accumulated impairment losses.
Goodwill on acquisitions of interests in joint
ventures or associates is included in ‘Interests in
associates and joint ventures’.
114
Valuation of financial instruments
HSBC’s accounting policy for valuation of financial
instruments is described in Note 2(d) on the
Financial Statements.
All financial instruments are recognised initially
at fair value. The fair value of a financial instrument
on initial recognition is normally the transaction
price, i.e. the fair value of the consideration given or
received. In certain circumstances, however, the
initial fair value may be based on other observable
current market transactions in the same instrument,
without modification or repackaging, or on a
valuation technique whose variables include only
data from observable markets.
Subsequent to initial recognition, the fair values
of financial instruments measured at fair value that
are quoted in active markets are based on bid prices
for assets held and offer prices for liabilities. When
independent prices are not available, fair values are
determined by using valuation techniques which
refer to observable market data. These include
comparisons with similar financial instruments for
which market observable prices exist, discounted
cash flow analyses, option pricing models and other
valuation techniques commonly used by market
participants.
The main factors which management considers
when applying a 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 when the ability of the
counterparty to service the instrument in
accordance with the contractual terms is in
doubt; and
an appropriate discount rate for the instrument.
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 with which the position held is being
compared. When valuing instruments on a model
basis using the fair value of underlying components,
management considers, in addition, the need for
adjustments to take account of factors such as bid-
offer spread, credit profile and model uncertainty.
These adjustments are based on defined policies
which are applied consistently across HSBC.
When unobservable market data have a
significant impact on the valuation of derivatives, the
entire initial difference in fair value indicated by the
valuation model from the transaction price is not
recognised immediately in the income statement but
is recognised over the life of the transaction on an
appropriate basis or is recognised in the income
statement when the inputs become observable, or
when the transaction matures or is closed out.
Financial instruments measured at fair value
through profit or loss comprise financial instruments
held for trading and financial instruments designated
at fair value. Changes in their fair value directly
impact HSBC’s income statement in the period in
which they occur.
A change in the fair value of a financial asset
which is classified as ‘available-for-sale’ is recorded
directly in equity until the financial asset is sold, at
which point the cumulative change in fair value is
charged or credited to the income statement. When a
decline in the fair value of an available-for-sale
financial asset has been recognised directly in equity
and there is objective evidence that the asset is
impaired, the cumulative loss that had been
recognised directly in equity is removed from equity
and recognised in profit or loss, reducing HSBC’s
operating profit.
In Notes on the Financial Statements, Note 15
includes a table which summarises HSBC’s trading
portfolio by valuation methodology, and Note 33
provides an analysis of the fair value of financial
instruments not measured at fair value in the balance
sheet.
Key performance indicators
The Board of Directors and the Group Management
Board each monitors HSBC’s progress against its
strategic objectives on a regular basis. Progress is
assessed by comparison with the Group’s strategy,
its operating plan targets and its historical
performance using both financial and non-financial
measures.
As a prerequisite for the vesting of performance
shares, the Remuneration Committee must satisfy
itself that HSBC’s financial performance has shown
a sustained improvement in the period since the
award date. In determining this, the Remuneration
Committee takes into account HSBC’s financial
performance with regard to the financial key
performance indicators (‘KPIs’) described below.
For awards made since 2005, the KPIs are compared
with the same group of 28 comparator banks as for
the TSR performance condition.
Financial KPIs
HSBC’s strategic plan, ‘Managing for Growth’,
provides HSBC with a blueprint for organic growth
and development. This began in 2003 and will
continue up to 2008. The plan is aimed at guiding
the Group to achieve management’s vision for
HSBC to be the world’s leading financial services
company.
To support the Group’s strategy and ensure that
HSBC’s performance can be monitored,
management utilises a number of financial KPIs. The
table below presents these KPIs for the period from
2004 to 2006. At a business level, the KPIs are
complemented by a range of benchmarks which are
relevant to the planning process and to reviewing
business performance.
115
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Key performance indicators
Financial KPIs used by HSBC’s management
Revenue growth1 ........................
Revenue mix2
Net interest income ...............
Net fee income ......................
Other income3 ........................
Cost efficiency4 ..........................
Credit performance as measured
by risk adjusted margin5 ........
Return on average
2006
%
2005
%
200410
%
13.4
12.2
–
52.8
26.3
20.9
51.3
54.4
25.1
20.5
51.2
60.6
25.2
14.2
51.6
6.3
6.3
6.8
invested capital6 .....................
Dividend performance7 ..............
Earnings per share8 (US$) ..........
14.9
10.1
1.40
15.9
9.5
1.36
15.0
5.0
1.18
Over Over
1 year 3 years
Over
5 years
Total shareholder return9
HSBC TSR ................................ 104.6
Benchmarks:
122.0
148.4
– FTSE 100 ........................... 114.4 153.8
139.9
– MSCI World ...................... 105.8
141.1
122.4
1 The percentage increase in net operating income before
loan impairment and other credit risk charges since the
previous reporting period.
2 As a percentage of net operating income before loan
impairment charges and other credit risk provisions.
3 Other income comprises net operating income before loan
impairment charges and other credit risk provisions less
net interest income and net fee income.
4 Total operating expenses divided by net operating income
before loan impairment and other credit risk charges.
5 Net operating income divided by average risk-weighted
assets.
6 Profit attributable to ordinary shareholders divided by
average invested capital.
7 The percentage increase in dividend per share since the
previous reporting period.
8 Basic earnings per share is defined in note 12.
9 Total shareholder return is defined on page 281.
10 Presentational changes introduced under IFRSs on
1 January 2005 distort comparison of 2004 data with
succeeding years.
Revenue growth provides an important guide to the
Group’s success in generating business. In 2006,
total revenue grew by 13.4 per cent to
US$65.4 billion, 10.5 per cent on an underlying
basis, reflecting HSBC’s expansion into new
products and markets, improved brand recognition
and refinements in segmentation to better meet
customer needs. The trend maintained the strong
performance in 2005 when the underlying increase
was 11.7 per cent. Higher revenue was largely driven
by balance sheet growth and strong contributions
from emerging markets, where HSBC continued to
introduce products and services developed in mature
economies to these faster growing regions.
Revenue mix represents the relative distribution
of revenue streams between net interest income, net
fee income and other revenue. It is used to
understand how changing economic factors affect
116
the Group, to highlight dependence on balance sheet
utilisation for income generation and to indicate
success in cross-selling fee-based services to
customers with loan facilities. This understanding
assists management in making business investment
decisions. Comparison of the revenue mix since
2004 indicates that it has been broadly stable over
recent years. The percentage of revenue attributable
to net interest income fell, however, from 54.4 per
cent in 2005 to 52.8 per cent in 2006 as balance
sheet management revenues were constrained by an
adverse interest rate environment while fee and
trading-based revenue streams have grown more
strongly.
Cost efficiency is a relative measure that
indicates the consumption of resources in generating
revenue. Management uses this metric to assess the
success of technology utilisation and, more
generally, the productivity of the Group’s
distribution platforms and sales forces. The cost
efficiency ratio for 2006 was broadly in line with
the previous two years notwithstanding ongoing
investment in HSBC’s businesses, particularly in
emerging markets, and in improving the Group’s
distribution and technology platforms.
Credit performance as measured by risk-
adjusted margin is an essential gauge for assessing
whether credit is correctly priced so that the returns
available after recognising impairment charges meet
the Group’s required return parameters. The ratio for
2006 was 6.3 per cent, unchanged from 2005,
showing a trend to higher-margin earnings relative to
risk, notwithstanding the significant credit losses in
the mortgage services business in the US described
on page 189. Management aims to improve
risk-adjusted performance over time.
Return on average invested capital measures
the return on the capital investment made in the
business, enabling management to benchmark HSBC
against competitors. In 2006, the ratio of 14.9 per
cent was 100 basis points lower than that reported in
2005. This decline reflected the fact that profitability
grew more slowly than the capital utilised in
generating the profit because of the higher
impairment charges recognised in 2006, largely in
respect of the mortgage services business in the US.
HSBC aims to deliver sustained dividend
performance for its shareholders. The dividend per
share for the year was US$0.76, an increase of
10.1 per cent on 2005, a larger increase than the
9.5 per cent increase in dividend per share reported
in 2005. HSBC has delivered a compound rate of
increase in dividends of 9.6 per cent per annum over
the past 5 years.
Basic earnings per share (‘EPS’) is a ratio that
Employee engagement
shows the level of earnings generated per ordinary
share. EPS is one of two key performance measures
used in rewarding employees and is discussed in
more detail in the Director’s Remuneration Report.
EPS for 2006 was US$1.40, an increase of 2.9 per
cent on 2005. This demonstrated the benefit of
diversified earnings as the losses in the US mortgage
services business were more than compensated for
by strong growth in other markets and products. In
2005, EPS grew by 15 percentage points over that
reported in 2004.
Total shareholder return (‘TSR’) is used as a
method of assessing the overall return to
shareholders on their investment in HSBC,
comprising both the growth in share value and
declared dividends. TSR is a key performance
measure in rewarding employees and is discussed in
more detail in the Director’s Remuneration Report.
The TSR benchmark is an index set at 100 and
measured over one, three and five years for the
purpose of comparison with the performance of a
group of competitor banks which reflect HSBC’s
range and breadth of activities. The TSR levels at the
end of 2006 were 104.6, 122.0, and 148.4 over one,
three and five years respectively. HSBC’s TSR over
one and three years has underperformed the
benchmark. This is attributed largely to the impact
on the share price of the current weakness in the US
sub-prime mortgage business and investor
preference over this time for companies with smaller
market values, particularly those for which there is
the possibility of participating in domestic or
regional consolidation. Over five years HSBC’s TSR
outperformed the benchmark, reflecting its strong
and consistent growth in profits and dividends.
Management believes that KPIs must remain
relevant to the business so may be changed over time
to reflect changes in the Group’s composition and
the strategies employed.
Non-financial KPIs
HSBC has chosen four non-financial KPIs which are
important to the future success of the Group in
delivering its strategic objectives. These non-
financial KPIs are currently reported internally
within HSBC on a local basis. Going forward, a
common framework is being established with
considered definitions and metrics so that these KPIs
can be published from next year.
Employee engagement is a measure of employees’
emotional and rational attachment to HSBC that
motivates them to remain with the Group and align
themselves wholeheartedly with its success.
HSBC regularly surveys its employees on a
regional or business basis, achieving on average a
response rate of over 80 per cent. In 2006 over
168,000 employees were surveyed.
From 2007 onwards, HSBC will launch a
Group-wide employee engagement survey in
conjunction with a leading external partner, which
will include core questions designed to measure
employee engagement levels consistently. This will
be used to improve business performance through
employee engagement, reward senior management
for meeting and exceeding target engagement scores,
and benchmark HSBC both internally and externally.
The analysis of the survey results will be undertaken
by the external partner, taking into account cultural
norms and industry benchmarks. Survey results and
action plans developed in response thereto will be
communicated to all employees.
Brand perception
HSBC has conducted brand tracking surveys in its
major Personal Financial Services markets for five
years, assessing the strength of the brand by
measuring awareness, consideration, momentum,
image and differentiation. From 2007, HSBC will
extend the exercise to include customers in HSBC’s
major Commercial Banking markets. The surveys
will be conducted by accredited independent third
party organisations, and will produce a blended
measure which will compare HSBC’s performance
with its competitors in its major markets.
Customer satisfaction
HSBC has also regularly conducted customer
satisfaction surveys in its main markets over many
years. Going forward, HSBC will use a consistent
measure of recommendation to gauge customer
satisfaction with the services provided by the
Group’s Personal Financial Services and
Commercial Banking businesses, and benchmark the
measures of reported customer satisfaction against
those reported in respect of the customers of its main
competitors in each of these markets.
117
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Key performance indicators / Financial summary
IT performance and systems reliability
HSBC tracks two key measures of IT performance,
namely, the number of customer transactions
processed and the reliability and resilience of Group
systems measured in terms of service availability
targets.
The number of customer transactions processed
is a measure of the ease with which customers can
access IT-developed and supported systems, the
extent to which these systems meet customer
expectations and the success of the Group’s IT
function in meeting straight-through delivery
processing targets.
Customer transactions processed
HSBC’s IT function establishes with its end
users service level agreements for systems
performance (e.g. systems up-time 99.9 per cent of
the time and credit card authorisations within two
seconds) and monitors the achievement of each of
these commitments. The following chart shows the
percentage of time throughout the year IT has
consistently achieved all of its service level
commitments. It is intended that comparisons of
these numbers will be provided in the future.
Percentage of IT services meeting or exceeding
targets in 2006
1 Interactive voice response system
118
Financial summary
Income statement
Year ended 31 December
Interest income ................................................................................................
Interest expense ...............................................................................................
Net interest income ..........................................................................................
Fee income .......................................................................................................
Fee expense ......................................................................................................
Net fee income .................................................................................................
Trading income excluding net interest income ...............................................
Net interest income on trading activities .........................................................
Net trading income1 .........................................................................................
Net income from financial instruments designated at fair value ....................
Net investment income on assets backing policyholders’ liabilities ..............
Gains less losses from financial investments ..................................................
Dividend income ..............................................................................................
Net earned insurance premiums ......................................................................
Other operating income ...................................................................................
Total operating income .................................................................................
Net insurance claims incurred and movement in policyholders’ liabilities ....
Net operating income before loan impairment charges and other
credit risk provisions ................................................................................
Loan impairment charges and other credit risk provisions .............................
Net operating income ....................................................................................
Employee compensation and benefits .............................................................
General and administrative expenses ..............................................................
Depreciation of property, plant and equipment ...............................................
Amortisation and impairment of intangible assets ..........................................
Total operating expenses ...............................................................................
Operating profit .............................................................................................
Share of profit in associates and joint ventures ...............................................
Profit before tax .............................................................................................
Tax expense .....................................................................................................
Profit for the year ..........................................................................................
Profit attributable to shareholders of the parent company ..............................
Profit attributable to minority interests ...........................................................
2006
US$m
75,879
(41,393)
34,486
21,080
(3,898)
17,182
5,619
2,603
8,222
657
–
969
340
5,668
2,546
70,070
(4,704)
65,366
(10,573)
54,793
(18,500)
(12,823)
(1,514)
(716)
(33,553)
21,240
846
22,086
(5,215)
16,871
15,789
1,082
2005
US$m
60,094
(28,760)
31,334
17,486
(3,030)
14,456
3,656
2,208
5,864
1,034
–
692
155
5,436
2,733
61,704
(4,067)
57,637
(7,801)
49,836
(16,145)
(11,183)
(1,632)
(554)
(29,514)
20,322
644
20,966
(5,093)
15,873
15,081
792
2004
US$m
50,471
(19,372)
31,099
15,902
(2,954)
12,948
2,786
–
2,786
–
1,012
540
622
5,368
1,613
55,988
(4,635)
51,353
(6,191)
45,162
(14,523)
(9,739)
(1,731)
(494)
(26,487)
18,675
268
18,943
(4,685)
14,258
12,918
1,340
1 ‘Net trading income’ comprises all gains and losses from changes in the fair value of financial assets and financial liabilities held for
trading, together with related external interest income, interest expense and dividend income. The 2004 comparative figure does not
include interest income and interest expense on trading assets and liabilities except for trading derivatives, nor does it include dividend
income on trading assets and so is not strictly comparable with the figures for 2005 and 2006.
Year ended 31 December 2006 compared
with year ended 31 December 2005
HSBC made a profit before tax of
US$22,086 million, a rise of US$1,120 million, or
5 per cent, compared with 2005. Incremental
contributions to pre-tax profit from Metris in the US,
the Argentine retail operations acquired from Banca
Nazionale and Ping An Insurance in mainland China,
less the profits of The Cyprus Popular Bank, which
was sold during the year, accounted for
US$347 million of the increase in pre-tax profit in
the period. These represented the bulk of changes in
the constitution of the Group. On an underlying
basis, which is described on page 111, profit before
tax increased by 3 per cent.
Average invested capital increased by
US$10.6 billion compared with 2005 and return on
that capital fell slightly by 1.0 per cent to
119
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Summary income statement
14.9 per cent. Revenue growth was 13 per cent and
the cost efficiency ratio was broadly unchanged at
51.3 per cent; the Group’s Tier 1 ratio strengthened
to 9.4 per cent.
HSBC’s results in 2006 reflected the benefits of
diversification of earnings. There were a number of
outstanding achievements, for example, exceeding
US$1 billion pre-tax profits for the first time in
Mexico and the Middle East, and in each of the
Group Private Banking and Commercial Banking
businesses in the Rest of Asia-Pacific. HSBC added
approximately US$1 billion in extra pre-tax profits
in the Rest of Asia-Pacific and globally in the
Commercial Banking businesses.
However, results in 2006 also reflected a decline
in pre-tax profits of around US$725 million in the
Group’s personal businesses in the US as a portfolio
of sub-prime mortgages purchased by a subsidiary of
HSBC Finance (‘mortgage services’) suffered much
higher delinquency than had been built into pricing
these products.
Earnings continued to be well diversified, both
geographically and by customer group. Regionally,
Asia including Hong Kong, had record results as did
the Group’s newly designated Latin America region,
which combines Mexico and Central America with
HSBC’s South American businesses. Within the
Customer Groups, Commercial Banking again
delivered a record performance, as did Private
Banking and Corporate, Investment Banking and
Markets, which made strong progress in the areas in
which the Group has been investing in recent years.
Personal Financial Services declined as growth in
Asia and Latin America was masked by the
problems in the US mortgage services business.
The economic backdrop in 2006 was favourable.
Global equity markets enjoyed strong gains for much
of the year, encouraging expanded investment flows
and creating a receptive marketplace for the high
level of mergers and acquisitions and IPO activity
which followed. However, in these favourable
conditions, the cumulative effect of rising short-term
rates, benign credit conditions and strong liquidity
put pressure on interest margins.
The credit environment for corporate and
commercial lending continued to be exceptionally
good. However, on the back of slowing housing
markets and rising interest rates, a marked
deterioration was experienced in the sub-prime
mortgage market in the US. This more than
outweighed the non-recurrence in 2006 of loan
impairment costs associated with a surge in
bankruptcy filings in the US in the fourth quarter
of 2005, and the effect of hurricane Katrina.
120
Net operating income before loan impairment
charges and other credit risk provisions of
US$65,366 million was US$7,729 million or 13 per
cent higher than in 2005, 11 per cent higher on an
underlying basis. Commercial Banking, Corporate,
Investment Banking and Markets and Private
Banking operations all achieved strong double-digit
growth. Operating income performance was well
spread geographically, with the strongest growth in
HSBC’s operations in Asia and in Latin America.
Loan impairment and other credit risk
provisions, expressed as a percentage of gross
average advances to customers, at 1.4 per cent, were
20 basis points higher in 2006 than the 1.2 per cent
recorded in 2005. There was also a 20 basis point
rise in the ratio of new loan impairment charges to
gross average advances to customers, from 1.4 per
cent in 2005 to 1.6 per cent in 2006. The charge of
US$10,573 million was US$2,772 million, or 36 per
cent, higher than in 2005, 30 per cent higher on an
underlying basis. Of this increase, approximately
60 per cent arose in the Group’s Personal Financial
Services businesses in North America, with the
major increase being in the US sub-prime mortgage
portfolio acquired through mortgage services.
Impairment charges in the UK were broadly stable as
a percentage of lending to customers despite a rising
trend of consumer recourse to debt mitigation
arrangements. There was also some credit
deterioration in a few emerging market countries,
notably in the first half of 2006, as a consequence of
regulatory changes.
Total operating expenses of US$33,553 million
were US$4,039 million or 14 per cent higher than in
2005, 11 per cent higher on an underlying basis.
Much of the growth reflected investment to expand
the Group’s geographic presence and add product
expertise and sales support. This expansion was most
marked in Personal Financial Services in North
America, and in Corporate, Investment Banking and
Markets, where the cost efficiency ratio improved
slightly as strong revenue growth offset the first full
year effect of investment expenditure in previous
years.
HSBC’s share of profit in associates and joint
ventures increased by US$202 million, with
improved contributions from The Saudi British
Bank, Bank of Communications and Industrial Bank,
supplemented by a first full year contribution from
Ping An Insurance. HSBC’s share of profits from
investments in associates in the Rest of Asia-Pacific
accounted for nearly a quarter of the profits from
that region. For further detailed discussion and
analysis of the Group’s results by geographical
conditions in the UK were adversely affected by
slower economic growth and changes in bankruptcy
legislation. This was offset by improved credit
experience in the US, notwithstanding the impact of
hurricane Katrina and an acceleration of bankruptcy
filings ahead of legislative changes in the fourth
quarter of 2005. In Brazil, HSBC also experienced
higher charges as increased credit availability,
particularly in the consumer segment, led to over-
indebtedness.
Total operating expenses of US$29,514 million
were US$3,027 million or 11 per cent higher than in
2004, 9 per cent higher on an underlying basis.
Much of the growth reflected investment to expand
the Group’s geographic presence and adding product
expertise and sales support. This expansion was most
marked in Personal Financial Services in the Rest of
Asia-Pacific and in Corporate, Investment Banking
and Markets, where investment spend peaked during
2005. In addition, business expansion in the Middle
East and Latin America contributed to cost growth.
Productivity improvements achieved in the UK
and Hong Kong allowed the Group to continue
building its Personal Financial Services and
Commercial Banking businesses in the Rest of Asia-
Pacific, and expanding its capabilities in Corporate,
Investment Banking and Markets, without
deterioration in the Group’s cost efficiency ratio. In
the UK, the focus on improving utilisation of the
existing infrastructure led to broadly flat costs in
Personal Financial Services and Commercial
Banking compared with underlying combined
revenue growth of 10 per cent.
HSBC’s cost efficiency ratio, which is
calculated as total operating expenses divided by net
operating income before loan impairment charges
and other credit risk provisions, improved slightly to
51.2 per cent in 2005 from 51.6 per cent in 2004.
HSBC’s share of profit in associates and joint
ventures increased by US$376 million, boosted by
full year contributions from Bank of
Communications and Industrial Bank in mainland
China, and increased income from The Saudi British
Bank, which reported a record performance on the
back of a vibrant economy and a strong oil price.
segment see Report of the Directors: Business
Review on page 31.
Year ended 31 December 2005 compared
with year ended 31 December 2004
HSBC made a profit before tax of
US$20,966 million, a rise of US$2,023 million or
11 per cent compared with 2004. Of this increase,
US$267 million was attributable to additional
contributions of ten and two months from M&S
Money and Bank of Bermuda respectively, one
month’s contribution from Metris, and the first full
year effect of HSBC’s investments in Bank of
Communications and Industrial Bank.
As a result of the transition to full IFRSs, the
format of the income statement changed. In
particular, US$685 million of what would,
previously, have been included in non-equity
minority interest, moved within the income
statement and was classified as ‘Interest expense’ in
2005, rather than ‘Profit attributable to minority
interests’. As the applicable IFRSs requiring these
changes only came into effect from 1 January 2005,
the comparative 2004 figures are presented on the
previous basis.
On an underlying basis, which is described on
page 111, profit before tax increased by 13 per cent.
Total operating income of US$61,704 million
was US$5,716 million or 10 per cent higher than in
2004. On an underlying basis, total operating income
also rose by 10 per cent. This reflected organic
lending growth in all regions and expansion in
transactional banking revenues from increased trade,
funds under management, administration and
custody activities. Strong growth was also seen in
fixed income and credit trading. Operating income
performance was well spread geographically with
particularly strong growth in HSBC’s operations in
Latin America, the Middle East and the Rest of Asia-
Pacific.
Loan impairment and other credit risk
provisions as a percentage of gross average advances
to customers was moderately higher in 2005 at
1.16 per cent than in 2004, 0.99 per cent. There was
also a small rise in the percentage ratio of new loan
impairment charges to gross average advances to
customers from 1.41 in 2004 to 1.50 in 2005. The
charge of US$7,801 million was US$1,610 million
or 26 per cent higher than in 2004 and on an
underlying basis 23 per cent higher. Of this increase,
approximately half was driven by growth in lending,
with the remainder attributable to the higher rate of
new provisions and the non-recurrence of general
provision releases benefiting 2004. Underlying credit
121
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Net interest income
Net interest income
By geographical region
Europe ......................................................
Hong Kong ..............................................
Rest of Asia-Pacific .................................
North America1 ........................................
Latin America1 .........................................
2006
US$m
8,289
4,685
3,047
14,268
4,197
%
24.0
13.6
8.8
41.4
12.2
Year ended 31 December
2005
US$m
8,221
4,064
2,412
13,295
3,342
%
26.2
13.0
7.7
42.4
10.7
2004
US$m
9,098
3,638
2,060
13,787
2,516
%
29.3
11.7
6.6
44.3
8.1
Net interest income2 .................................
34,486
100.0
31,334 100.0
31,099 100.0
Net interest income2..........................................................................................
Average interest-earning assets .......................................................................
Gross interest yield (per cent)3 ........................................................................
Net interest spread (per cent)4 .........................................................................
Net interest margin (per cent)5 ........................................................................
Year ended 31 December
2006
US$m
34,486
1,113,404
6.82
2.94
3.10
2005
US$m
31,334
999,421
6.01
2.84
3.14
2004
US$m
31,099
976,387
5.17
2.97
3.19
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly.
2 ‘Net interest income’ comprises interest income less interest expense on financial assets and liabilities which is not recognised as part of
‘Net trading income’ or ‘Net income earned from financial instruments designated at fair value’. In 2004, all interest income and
expense was included within ‘Net interest income’ so these figures are not strictly comparable with those for 2005 and 2006.
3 Gross interest yield is the average annualised interest rate earned on average interest-earning assets (‘AIEA’).
4 Net interest spread is the difference between the average annualised interest rate earned on AIEA, net of amortised premiums and loan
fees, and the average annualised interest rate paid on average interest-bearing funds.
5 Net interest margin is net interest income expressed as an annualised percentage of AIEA.
Year ended 31 December 2006 compared
with year ended 31 December 2005
Net interest income of US$34,486 million was
10 per cent higher than in 2005 and 7 per cent higher
on an underlying basis. The commentary that follows
is on an underlying basis.
Movements in net interest income were
particularly influenced by the following factors:
•
•
rising short-term interest rates in US dollars and
linked currencies, and in sterling, increased the
value of low-cost deposits and transactional
balances and increased the interest income
earned from investing those balances. This was
particularly relevant to the Personal Financial
Services and Commercial Banking businesses in
Asia and the UK, and also improved the value
of cash balances within the Group’s custody and
payments and cash management businesses and
increased the resultant investment income;
the cumulative effect of higher short-term
interest rates in most major currencies in recent
years has been to flatten interest rate yield
curves and to reduce the opportunities available
to HSBC’s balance sheet management
operations to generate additional income. This
reduced growth in net interest income compared
with 2005 by some 2 percentage points;
•
strong liquidity and benign credit conditions put
pressure on lending margins in corporate and
commercial banking and credit spreads
tightened as a consequence. Increased
competition for core deposits also reduced
deposit spreads in certain markets;
• HSBC deployed an increased proportion of
liabilities into trading assets. Reported net
interest income includes the cost of internally
funding these assets, while related revenue is
included in trading income. This was
particularly relevant to the UK, France and the
US. The cost of funding net long positions is
included within trading as an interest expense in
HSBC’s customer group reporting; and
• HSBC concentrated balance sheet expansion on
attracting liabilities and, as a result, customer
deposits, at constant currency but including
acquisitions, grew by 3 percentage points more
than customer loans.
In Europe, net interest income increased by
1 per cent. The benefit of balance growth in Personal
Financial Services and Commercial Banking was
substantially offset by the increased deployment of
liabilities to the fund trading activity referred to
above; there was a corresponding rise in trading
income. This was most pronounced in the UK and
France.
122
In the UK, growth in Personal Financial
Services was strong in savings and packaged current
accounts, but mortgage and credit card lending also
increased. In Commercial Banking, customer
recruitment boosted growth in deposit balances and
spreads widened, particularly on US dollar
denominated accounts. Commercial lending balances
were higher, in part reflecting the strong growth
throughout 2005. In France, revenues declined
despite growth in lending, due to competitive pricing
pressures and the impact of older, higher-yielding
hedges of the network’s funding surplus maturing.
Corporate, Investment Banking and Markets’
balance sheet management revenues declined as the
rising trend in short-term interest rates continued to
flatten yield curves.
In Hong Kong, net interest income rose by
15 per cent. Deposit spreads widened with
progressive interest rate rises, and balances increased
as customers took advantage of higher rates. HSBC
supported this growth with a number of promotions
and marketing campaigns during the year. In
Personal Financial Services, average savings and
deposit balances rose by 7 per cent. The launch of a
simplified mortgage pricing structure helped boost
mortgage balances and grow market share. A clear
focus on sales and targeted marketing helped achieve
strong growth in credit card balances, and the
number of cards in issue rose by 17 per cent to
4.6 million. Average corporate lending balances rose
as the economy gained momentum and investment
was channelled into mainland China. The benefit of
these developments, however, was substantially
offset by spread compression through the rising cost
of funds, and lower balance sheet management
revenues as short term interest rates continued to
rise, and yield curves remained flat.
In the Rest of Asia-Pacific, a 25 per cent rise in
net interest income was fuelled by balance sheet
growth in Personal Financial Services and
Commercial Banking. This reflected HSBC’s
continuing investment in growing the business
through network expansion, customer recruitment
and targeted marketing and promotions. In Personal
Financial Services, the emphasis on the recruitment
of HSBC Premier customers generated strong
deposit growth throughout the region, which funded
increased mortgage and credit card borrowing. Other
unsecured lending balances also grew significantly,
as HSBC expanded its consumer finance operations
in India, Australia and Indonesia. In corporate and
commercial banking, increased deposits raised
through customer recruitment and through higher
transactional balances in the payments and cash
management and the custody businesses were
123
significant to the growth in net interest income. On
the asset side, growth reflected strong demand for
credit as regional economies continued to expand
and trade flows increased.
In North America, net interest income increased
by 3 per cent. In the US Personal Financial Services
business, strong growth in mortgages, cards, and
other personal unsecured non-credit card lending
was funded by a 21 per cent rise in average deposits
to US$32.2 billion. This was led by the continued
success of the online savings product which grew by
US$6 billion to US$7 billion at 31 December 2006.
Higher spreads in credit cards, reflecting a lower
proportion of promotional balances and a degree of
re-pricing, were in contrast with most other
portfolios. Overall, asset spreads contracted, driven
by the effect on funding costs of a succession of
interest rate rises, while competitive pricing and
customer migration to higher yielding products
reduced spreads on deposits. Net interest income was
boosted in Canada by strong lending to personal and
commercial customers, supported by deposit raising
initiatives. However, these benefits were partly
offset by lower Corporate, Investment Banking and
Markets’ balance sheet management income as
spreads narrowed as a result of higher short-term
rates coupled with a flat yield curve in the US. The
increased deployment of liabilities to fund trading
activity also reduced growth in net interest income,
with a corresponding increase in trading income.
In Latin America, net interest income increased
by 17 per cent. In Mexico, deposit growth was
boosted by the continuing success of the ‘Tu Cuenta’
packaged account in Personal Financial Services.
Credit card, unsecured lending and mortgage
balances also grew strongly, though the benefit of
the latter was offset by competitive pressure on
spreads. In Brazil, where the domestic economy
improved and inflation remained low, rising
consumer demand for credit, together with increased
sales activity and customer recruitment, drove strong
lending growth. Deposits rose through current
accounts linked to the growing payroll loan business.
Growth in Commercial Banking was mainly in the
small and middle market customer segments. HSBC
increased focus on these businesses through network
expansion and the recruitment of additional sales
staff throughout the region. In Corporate, Investment
Banking and Markets, improved balance sheet
management revenues and growth in the payments
and cash management business were the major
contributors to interest income growth.
Average interest earning assets of
US$1,113 billion were US$114 billion, or 11 per
cent, higher than in 2005. On an underlying basis,
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Net interest income / Net fee income
growth was 10 per cent. HSBC’s net interest margin
was 3.10 per cent in 2006, compared with 3.14 per
cent in 2005.
Year ended 31 December 2005 compared
with year ended 31 December 2004
Net interest income of US$31,334 million was
US$235 million, or 1 per cent, higher than in 2004.
Under IFRSs, HSBC’s presentation of net
interest income in 2005 was particularly affected by:
•
•
•
the reclassification of certain preference
dividends within non-equity minority interests
as interest expense;
the inclusion of certain loan origination fees and
expenses as part of an effective interest rate
calculation instead of being recognised in full on
inception of the loan; and
external interest income and expense on trading
assets and liabilities now included within ‘Net
trading income’.
Adjusting for these changes and on an
underlying basis, net interest income increased by
12 per cent. The commentary that follows is on this
basis.
The benefit of strong growth in interest-earning
assets globally more than offset the effect of spread
compression from flattening yield curves in the
major currencies. This latter phenomenon reduced
opportunities for HSBC’s balance sheet management
operations to enhance margin by placing the Group’s
surplus liquidity longer term than the
behaviouralised deposit funding base. In addition,
short-term interest rate rises in the US reduced
spreads on consumer finance loans.
In Europe, higher personal and commercial
lending and increased deposit balances led to a
12 per cent increase in net interest income. UK
Personal Financial Services balances grew strongly
in mortgages, unsecured lending and cards, mainly
funded by a 12 per cent increase in deposit and
savings balances. In Turkey, card balances grew
from increased marketing and working with HSBC’s
retail partners. Spreads tightened on UK personal
lending, reflecting the introduction of preferential
pricing for lower-risk and higher-value customers,
and on savings, due to better pricing for customers.
In Commercial Banking in the UK, lending and
overdraft balances increased by 23 per cent, with
growth particularly strong in the property,
distribution and services sectors. Deposit balances
grew by 11 per cent, partly from keen pricing,
though this reduced deposit spreads. Yields on UK
124
corporate lending, which were lower largely as a
result of competitive pressure, were only partly
offset by higher loan balances, while lower balance
sheet management income reflected the effect of
rising short-term rates and flattening yield curves on
balance sheet management revenues.
In North America, net interest income increased
by 4 per cent. Growth in mortgage, card and
unsecured personal lending balances was strong,
offsetting spread contraction as the cost of funds rose
with progressive interest rate rises. Core deposit
growth benefited from expansion of the branch
network and the launch of new savings products,
including an online savings product which attracted
a significant number of new customers. Treasury
income from balance sheet management within
Corporate, Investment Banking and Markets
diminished as the rise in short-term interest rates
limited opportunities to profit from placing the
liquidity generated from core banking operations
over extended periods.
In Hong Kong, net interest income rose by
17 per cent. Rising interest rates reinvigorated
demand for traditional savings products, driving
increases in personal and commercial savings
balances. Coupled with the rise in deposit spreads,
which increased in line with interest rates, this led to
a sharp rise in net interest income. Mortgage spreads
contracted, however, as the gradual increase in
yields during the year, in line with higher rates, was
more than offset by rising funding costs. There was
little net new lending for residential mortgages as
interest rate rises cooled the residential property
market in the second half of 2005. Economic growth
in mainland China boosted commercial lending to
the trade and manufacturing sectors, and property
lending also increased. Treasury income remained
under pressure, with rising short-term interest rates
and a flat yield curve providing limited opportunities
to profitably deploy surplus liquidity and increasing
funding costs.
In the Rest of Asia-Pacific, net interest income
increased by 24 per cent, reflecting business
expansion and favourable economic conditions
throughout the region. In the Middle East, buoyant
oil-based economies stimulated demand for credit
for property and infrastructure projects. Increasing
personal and corporate wealth contributed to growth
in deposit balances, while interest rate rises led to
higher deposit spreads. General economic expansion
created demand for consumption credit which
boosted credit card lending. For the reasons noted
above, treasury income from balance sheet
management was weaker.
In Latin America, the positive economic
environment encouraged growth in personal and
commercial lending, particularly in credit cards and
vehicle finance, which led to a 32 per cent increase
in net interest income. In Mexico, HSBC continued
to lead the market in personal customer deposit
growth. Recruitment of commercial customers was
also strong. A significant rise in customer acquisition
and the development of the Losango customer base
in Brazil also contributed.
Average interest-earning assets increased by
US$23 billion, or 2 per cent, compared with 2004.
Net fee income
At constant exchange rates, and excluding the
US$84.7 billion of trading assets in 2004, average
interest-earning assets increased by 11 per cent,
reflecting strong growth in mortgages, personal
lending and cards globally, and increased lending in
Commercial Banking.
HSBC’s net interest margin was 3.14 per cent in
2005 compared with 3.19 in 2004. For the reasons
set out in the opening paragraphs, these figures were
not strictly comparable as a result of presentation
changes under IFRSs from 1 January 2005.
By geographical region
Europe ......................................................
Hong Kong ..............................................
Rest of Asia-Pacific .................................
North America1 ........................................
Latin America1 .........................................
2006
US$m
7,108
2,056
1,622
4,766
1,630
%
41.4
12.0
9.4
27.7
9.5
Year ended 31 December
2005
US$m
6,299
1,674
1,340
3,952
1,191
%
43.6
11.6
9.3
27.3
8.2
2004
US$m
5,980
1,703
1,041
3,197
1,027
%
46.2
13.2
8.0
24.7
7.9
Net fee income .........................................
17,182 100.0
14,456 100.0
12,948 100.0
Year ended 31 December
Cards ................................................................................................................
Account services ..............................................................................................
Funds under management ................................................................................
Broking income ...............................................................................................
Insurance ..........................................................................................................
Credit facilities2 ...............................................................................................
Global custody .................................................................................................
Imports/exports ................................................................................................
Unit trusts ........................................................................................................
Remittances .....................................................................................................
Underwriting ....................................................................................................
Corporate finance ............................................................................................
Trust income ....................................................................................................
Maintenance income on operating leases ........................................................
Mortgage servicing ..........................................................................................
Other ................................................................................................................
Total fee income ..............................................................................................
Less: fee expense .............................................................................................
Net fee income .................................................................................................
2006
US$m
5,708
3,633
2,718
1,354
1,017
922
797
780
520
472
286
255
248
122
97
2,151
21,080
(3,898)
17,182
2005
US$m
4,699
3,132
1,831
1,104
1,082
880
656
722
388
396
274
211
199
180
76
1,656
17,486
(3,030)
14,456
2004
US$m
3,987
2,779
1,479
943
1,001
1,179
564
692
498
353
234
193
203
190
80
1,527
15,902
(2,954)
12,948
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly.
2 Under IFRSs from 2005, a higher proportion of fees on credit facilities is dealt with as part of an effective interest rate calculation than
previously. This change in accounting affects both the timing of fee income recognition and its presentation in the accounts. In
accordance with the transition arrangements to IFRSs, the 2004 comparative figure is presented on the previous accounting basis.
Year ended 31 December 2006 compared
with year ended 31 December 2005
underlying basis. The commentary that follows is on
an underlying basis.
Net fee income of US$17,182 million was 19 per
cent higher than in 2005, or 16 per cent higher on an
• Robust global stock market performance,
particularly in emerging markets, led to
increased customer appetite for equity-based
125
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Net fee income
products. HSBC responded by launching new
investment products and increasing promotional
activity, which contributed to higher unit trust,
broking and custody fees.
• There was an increase in cards in issue, which
drove higher transaction volumes and balances
and led to a 16 per cent rise in card fee income,
principally in the US;
•
Strong equity market performance also
benefited HSBC’s asset management activities.
Funds under management grew by 16 per cent
and performance fees rose strongly, most
notably in HSBC’s BRIC (Brazil, Russia, India
and China) funds and in the Hermitage Fund, a
leading fund investing in Russia.
• The successful promotion of packaged account
products which, together with increased
customer numbers and higher transaction
volumes, led to a 13 per cent rise in account
services fees. Higher cross-border currency
flows led to increased remittance income.
• Reduced sales of creditor insurance products in
the UK were largely offset by higher fees in
HSBC’s Latin American insurance businesses,
particularly in Argentina and Brazil.
•
Increased taxpayer services fees, higher income
from investment and other services provided by
HSBC’s insurance businesses, and increased
corporate and WTAS advisory fees in the US
contributed to the increase in other fee income.
In Europe, account service fees increased as a
result of customer acquisition, higher sales of
packaged products and increased transaction
volumes. Rising stock markets led to higher sales of
investment products and growth in funds under
management, while product mix improvements and
service enhancements also contributed to a rise in
investment fees. Higher performance fees in respect
of the Hermitage Fund contributed an additional
US$23 million in fee income, net of performance
fees paid to the fund’s investment advisor. Offsetting
these increases, HSBC’s decision to constrain
unsecured lending growth in the UK resulted in
lower creditor protection insurance fees.
In Hong Kong, a buoyant IPO market together
with product launches and enhancements contributed
to higher sales of investment products; this was
augmented by increased transaction volumes
following strong growth in local and regional equity
markets. As global customers continued to seek
investment opportunities in emerging markets, funds
under management increased. Growth in cards in
issue led to higher card fees.
126
In the Rest of Asia-Pacific, higher trade and
remittance flows led to increased payments and cash
management income. Investment flows into
emerging market funds triggered growth in custody
and funds administration fees, while rising equity
markets and product launches contributed to
increased investor demand and higher income from
custody, brokerage and the sale of investments.
In North America, card fees increased as a result
of higher balances and improved interchange rates,
while private label card fees benefited from
renegotiations with a number of merchants.
Increases in 2006 were partly offset by the effect of
FFIEC guidance, which limits certain fee billings for
non-prime credit card accounts. Following its launch
in 2005, activity within HSBC’s mortgage-backed
securities business increased rapidly during 2006. As
a result, a greater proportion of loans originated by
HSBC were sold to the secondary market and
mortgage servicing fees grew accordingly, while
income in the mortgage-backed securities business
also rose. Tariff increases contributed to higher
account service fees. Higher business volumes led to
a rise in taxpayer services fees, while the WTAS
business progressed strongly, expanding its customer
base and reporting significantly higher fee income.
In Latin America, increased cards in circulation
and improvements in activation times led to higher
card issuing fees, while growth in the merchant
customer base led to a rise in card acquiring income.
Account servicing fees benefited from higher
packaged account sales, enhancements to other
current account products, price increases and greater
transaction volumes. The expansion of HSBC’s
ATM network in Mexico drove higher ATM fees.
Year ended 31 December 2005 compared
with year ended 31 December 2004
Net fee income of US$14,456 million was
US$1,508 million or 12 per cent higher than in 2004.
Under IFRSs, a greater proportion of fees relating to
the provision of credit facilities is now amortised and
accounted for in net interest income as part of an
effective interest rate calculation than was the case
before 1 January 2005. This resulted in a reduction
in reported net fee income of approximately 4 per
cent. Excluding this effect and on an underlying
basis, growth in net fee income was 14 per cent and
the comments that follow are presented on this basis.
The principal drivers of this growth were:
•
the increase in card fee income, reflecting strong
growth in personal credit card sales across the
Group and increased transaction volumes;
•
•
•
•
increased customer numbers, higher transaction
volumes, an increase in packaged accounts and
the selective management of tariffs led to an
11 per cent increase in account services fees;
in Private Banking, the introduction of a wider
range of alternative investment products and
services generated higher fee income;
increased demand for credit among personal and
commercial customers drove mortgage and
lending fees up by 11 per cent; and
rising equity markets and renewed interest in
emerging markets led to higher global custody,
broking and asset management fees.
Offsetting these positive trends, after a strong
run of growth, fee income from unit trust sales in
Hong Kong fell as rising interest rates made
traditional deposit products more attractive.
In Europe, fee income increased by 9 per cent.
Higher personal and commercial lending volumes
led to a 19 per cent increase in credit fees. Card fee
income rose by 22 per cent, principally in the UK
which benefited from higher customer numbers and
greater card utilisation. Account service fees
increased by 9 per cent, reflecting increased
customer numbers, the launch of a new packaged
product in the UK and the introduction of a Small
Business Tariff in Commercial Banking. Buoyant
equity markets benefited custody fees, which grew
as a result of both increased asset values and strong
new business volumes. Private Banking fee income
was 12 per cent higher than in 2004 following
increases in client assets under management and
transaction volumes.
In Hong Kong, net fee income was in line with
2004. Unit trust fees decreased by 42 per cent as
Personal Financial Services customers switched to
traditional deposit savings and shorter-term
investment products. The launch of 173 new open-
ended funds established HSBC as the leading
investment service provider in Hong Kong. This,
together with the successful attraction of client assets
in Private Banking, contributed to a rise in income
from funds under management. Credit card fee
income increased by 18 per cent, reflecting growth
in cardholder spending as HSBC strengthened its
position as the largest credit card issuer in Hong
Kong. In Commercial Banking, net fees increased as
trade services, insurance and lending income rose.
However, lower Structured Finance revenues led to
reduced Corporate, Investment Banking and Markets
fees.
Net fee income in the Rest of Asia-Pacific rose
by 28 per cent from higher card transaction volumes
and increased account service fees in response to the
expansion of the Personal Financial Services
business in the region. Rising equity markets,
buoyant regional economies and an increase in
personal wealth combined with the launch of new
products to increase sales of investment products to
personal customers. Client assets in Private Banking
also grew. Global Transaction Banking revenues
increased in line with transaction volumes following
investment in 2004 to expand capabilities. Custody
fees grew by 29 per cent as a result of improved
investor sentiment and rising local equity markets.
Trade services income rose by 13 per cent, reflecting
strong trade flows.
In North America, net fee income grew by
23 per cent. Card fee income grew as a result of
higher transactions, increased receivables and
improvements in the interchange rate, while US
mortgage lending fees benefited from lower
refinancing prepayments and the consequent release
of impairment provisions on mortgage servicing
rights. Investment banking fees increased in
response to HSBC’s success in attracting customers
with an expanded range of products.
Net fee income in Latin America increased by
17 per cent, principally due to higher card, lending
and current account servicing fees. Increased card
fees reflected higher spending in Brazil and
Argentina, as well as strong growth in the cards base
in Mexico. Lending growth was predominantly
volume driven, while current account fees benefited
from increased customer numbers, tariff increases in
Brazil and Argentina and higher transaction-driven
ATM and remittance income in Mexico.
127
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Net trading income / Net income from financial instruments designated at fair value
Net trading income
By geographical region
Europe .........................................................
Hong Kong .................................................
Rest of Asia-Pacific ....................................
North America1 ...........................................
Latin America1 ............................................
2006
US$m
%
4,529
617
1,181
1,358
537
55.1
7.5
14.4
16.5
6.5
Year ended 31 December
2005
US$m
3,036
546
860
885
537
%
51.7
9.3
14.7
15.1
9.2
2004
US$m
997
659
494
509
127
%
35.8
23.7
17.7
18.3
4.5
Net trading income .....................................
8,222
100.0
5,864 100.0
2,786 100.0
1 In 2006, Mexico and Panama were reclassified from the North America segment to Latin America. Comparative information has been
restated accordingly.
Trading activities .............................................................................................
Net interest income on trading activities .........................................................
Other trading income
Hedge ineffectiveness:
– on cash flow hedges ...............................................................................
– on fair value hedges ...............................................................................
Non-qualifying hedges ....................................................................................
Net trading income ..........................................................................................
Year ended 31 December
2006
US$m
5,465
2,603
(122)
16
260
8,222
2005
US$m
3,884
2,208
(96)
14
(146)
5,864
2004
US$m
2,786
–
–
–
–
2,786
trading business, revenues doubled, primarily due to
the underlying strength in precious metals and
increased price volatility.
Within the Credit and Rates business, higher
gains from interest rate derivatives and emerging
market bonds reflected increased volumes of new
deals, a tightening of credit spreads and greater
interest rate volatility.
In Europe, a significant increase in trading
income was driven by higher foreign exchange flows
and a greater focus on emerging market products.
Overall, customer volumes rose, as increased
hedging activity and a change in risk appetite among
investors drove a general improvement in market
sentiment towards developing economies.
On an underlying basis trading income in the
Rest of Asia-Pacific grew by 35 per cent, driven by
HSBC’s strong distribution network and experience
in developing markets activity, which contributed to
particularly strong increases reported in India the
Middle East and mainland China.
Performance in HSBC’s operations in the US
remained robust benefiting, in part, from the first full
year contribution from the US residential mortgage-
backed securities business and successful product
launches in structured derivatives.
Year ended 31 December 2006 compared
with year ended 31 December 2005
Net trading income increased significantly in
comparison with 2005, reflecting the investment
made in widening Global Markets' product range and
developing its sales and execution capabilities.
Positive revenue trends were recorded in key product
areas, although the rate of income growth slowed in
the second half of the year, principally due to lower
market volatility and a decrease in deal volumes in
the third quarter. The cost of internal funding on
long positions is excluded from the reported ‘Net
trading income’ and included within the ‘Net interest
income’ line. However, this cost has been reinstated
in ‘Net trading income’ in HSBC’s customer group
reporting.
Income from structured derivatives grew by
74 per cent, as investments in technical expertise and
systems enabled HSBC to address a broader
spectrum of client needs. Increased market volatility,
together with expansion in the provision of
structured fund products, resulted in higher customer
volumes. As the business matured and markets
deepened and became more transparent, revenues
were boosted by a rise of US$193 million in the
recognition of income deferred in previous periods.
Foreign exchange income remained strong
throughout 2006, principally driven by an increase in
customer activity encouraged by US dollar weakness
and volatility in emerging markets. In the metals
128
Year ended 31 December 2005 compared
with year ended 31 December 2004
Net trading income of US$5,864 million rose by
110 per cent against 2004. Under IFRSs, HSBC’s
presentation of trading income for 2005 reclassified
under net trading income external interest income
and dividend income on trading assets and interest
expense on trading liabilities.
The external funding of long trading positions is
reported separately within ‘Net interest income on
trading activities’; in the 2004 comparatives this was
included within ‘Interest expense’. The net effect of
these adjustments added approximately
US$2.9 billion to net trading income.
In the segmental analysis, both net internal
funding and net external interest income on trading
activities are reported as ‘Net interest income on
trading activities’. The offset to the net internal
funding is reported as ‘Net interest income’ within
the lending customer group. The resulting ‘Net
trading income’ line comprises all gains and losses
from changes in the fair value of financial assets and
financial liabilities classified as held for trading,
together with related external interest income and
interest expense and dividends received.
Income from trading activities rose, reflecting
positive revenue trends on core products within
Global Markets following the investment made in
client-facing trading capabilities. In Europe,
revenues were boosted from higher volumes through
electronic trading platforms and from the expansion
of primary dealing activity in European government
bond markets. In the US, the benefit of favourable
movements on credit spreads was compounded by
the non-recurrence of losses experienced in the
industrial sector in 2004.
In Asia, volatility in the value of the Korean
won against the US dollar, the introduction of a
managed float for Malaysian ringgit and the
enhancement of capabilities coupled with greater
focus on trading regional currencies in the Middle
East all contributed to higher foreign exchange
revenues. In Europe, the weakening euro and market
volatility following the general election in the UK
and the French referendum on the EU constitutional
treaty afforded opportunities to increase foreign
exchange revenues.
Derivatives activity grew strongly as structured
product capabilities were added in the credit, equity,
and interest rate and foreign exchange areas. Further
benefit was derived from the greater focus put on
client-driven risk management and the investment
made in sales and execution expertise in previous
years. In accordance with IFRSs, the inception
profits on certain derivative transactions are deferred
as described in Note 17 on the Financial Statements.
Net income from financial instruments designated at fair value
By geographical region
Europe ........................................................................................
Hong Kong ................................................................................
Rest of Asia-Pacific ...................................................................
North America ...........................................................................
Latin America ............................................................................
Net income from financial instruments designated
Year ended
31 December 2006
Net income
US$m
144
260
79
(63)
237
%
21.9
39.6
12.0
(9.6)
36.1
At
31 December 2006
Assets
US$m
Liabilities
US$m
12,164
4,745
1,729
–
1,935
32,630
4,291
410
32,880
–
at fair value ............................................................................
657
100.0
20,573
70,211
By geographical region
Europe ........................................................................................
Hong Kong ................................................................................
Rest of Asia-Pacific ...................................................................
North America ...........................................................................
Latin America ............................................................................
Net income from financial instruments designated
Year ended
31 December 2005
Net income
US$m
362
(6)
58
434
186
%
35.0
(0.6)
5.6
42.0
18.0
At
31 December 2005
Assets
US$m
Liabilities
US$m
9,077
3,909
872
–
1,188
27,442
3,999
300
29,934
154
at fair value ............................................................................
1,034
100.0
15,046
61,829
129
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Net income from financial instruments designated at fair value / Gains less losses from financial investments
Income from assets held to meet liabilities under insurance and investment contracts ...................
Change in fair value of liabilities to customers under investment contracts ....................................
Movement in fair value of HSBC’s long-term debt issued and related derivatives .........................
– change in own credit spread on long-term debt .........................................................................
– other changes in fair value .........................................................................................................
Income from other instruments designated at fair value ...................................................................
Net income from financial instruments designated at fair value ......................................................
2006
US$m
1,552
(1,008)
(35)
(388)
353
148
657
2005
US$m
1,760
(1,126)
403
(70)
473
(3)
1,034
HSBC utilised ‘Amendment to IAS 39 Financial
Instruments: Recognition and Measurement: the Fair
Value Option’ with effect from 1 January 2005.
HSBC may designate financial instruments at fair
value under the option in order to remove or reduce
accounting mismatches in measurement or
recognition, or where financial instruments are
managed, and their performance is evaluated,
together on a fair value basis. All income and
expense on financial instruments for which the fair
value option was taken were included in this line
except for issued debt securities and related
derivatives, where the interest components were
shown in interest expense.
HSBC used the fair value designation principally
in the following instances:
•
•
for certain fixed-rate long-term debt issues
whose interest rate characteristic has been
changed to floating through interest rate swaps,
as part of a documented interest rate
management strategy. Approximately
US$56 billion (2005: US$51 billion) of the
Group’s debt issues have been accounted for
using the fair value option. The movement in fair
value of these debt issues includes the effect of
own credit spread changes and any
ineffectiveness in the economic relationship
between the related swaps and own debt;
as credit spreads narrow accounting losses are
booked, and the reverse is true in the event of
spreads widening. Ineffectiveness arises from the
different credit characteristics of the swap and
own debt coupled with the sensitivity of the
floating leg of the swap to changes in short-term
interest rates. In addition, the economic
relationship between the swap and own debt can
be affected by relative movements in market
factors, such as bond and swap rates, and the
relative bond and swap rates at inception. The
size and direction of the accounting
consequences of changes in own credit spread
and ineffectiveness can be volatile from period
to period, but do not alter the cash flows
envisaged as part of the documented interest rate
management strategy;
•
•
for certain financial assets held by insurance
operations and managed at fair value to meet
liabilities under insurance contracts
(approximately US$6 billion of assets); and
for financial liabilities under investment
contracts and the related financial assets, when
the change in value of the assets is correlated
with the change in value of the liabilities to
policyholders (approximately US$12 billion of
assets and related liabilities).
Net income from assets designated at fair value
and held to meet liabilities under insurance and
investment contracts is correlated with changes in
liabilities under the related investment and insurance
contracts. Under IFRSs, liabilities under investment
contracts are classified as financial instruments.
There is, however, a mismatch in presentation of the
insurance business results for which asset returns are
included within ‘Net income from financial
instruments designated at fair value’ with the related
change in the value of the insurance contract
liabilities included within ‘Net insurance claims
incurred and movement in policyholders’ liabilities’.
Year ended 31 December 2006 compared
with year ended 31 December 2005
Net income from financial instruments designated at
fair value decreased compared with 2005. This was
primarily driven by a narrowing (i.e. improvement)
in credit spreads on certain fixed-rate long-term debt
issued by HSBC Finance and lower net mark-to-
market movements on this debt and the related
interest rate swaps. During 2006, HSBC Finance’s
debt received improved ratings from both Moody’s
and Standard and Poor’s (‘S&P’). Perversely, this
improvement generated accounting losses of some
US$388 million which will reverse over the residual
maturity of the debt instruments.
Income from assets held to meet liabilities under
insurance and investment contracts was some 12 per
cent lower, reflecting movements in the market
130
values of assets. The increase in the fair value of
liabilities under investment contracts was 10 per cent
lower than in 2005.
Year ended 31 December 2005 compared
with year ended 31 December 2004
The introduction of the new categories of financial
instruments under IAS 39 on 1 January 2005 has led
to a change in income statement presentation for the
results of HSBC’s life insurance business. In 2005,
income from assets designated at fair value and held
to meet liabilities under insurance and investment
contracts of US$1,760 million is reported under ‘Net
income from financial instruments designated at fair
value’. In 2004, the corresponding amounts were
reported within ‘Net investment income on assets
backing policyholders’ liabilities’.
Gains less losses from financial investments
Income from assets designated at fair value and
held to meet liabilities under insurance and
investment contracts during 2005 was correlated with
increases in liabilities under the related investment
and insurance contracts. Under IFRSs, only
investment contracts can be designated as financial
instruments. Changes in the liability under these
contracts, therefore, like the related assets, were
included within the heading ‘Net income from
financial instruments designated at fair value’. The
element of the increase in liabilities under insurance
contracts that reflected investment performance was
reported separately within ‘Net insurance claims
incurred and movements in policyholders’ liabilities’.
In 2004, investment income on assets backing
policyholder liabilities was offset against the
movement in policyholders’ liabilities without
distinction between insurance and investment
contracts.
By geographical region
Europe ......................................................
Hong Kong ..............................................
Rest of Asia-Pacific .................................
North America1 ........................................
Latin America1 .........................................
Gains less losses from financial
2006
US$m
624
162
41
58
84
%
64.4
16.7
4.2
6.0
8.7
Year ended 31 December
2005
US$m
439
108
18
47
80
%
63.4
15.6
2.6
6.8
11.6
2004
US$m
154
175
17
147
47
%
28.5
32.4
3.1
27.3
8.7
investments ..........................................
969
100.0
692
100.0
540 100.0
Net gain from disposal of:
– debt securities ...............................................................................................
– equity securities ............................................................................................
– other financial investments ...........................................................................
Recovery of impairment losses .......................................................................
Gains less losses from financial investments ..................................................
Year ended 31 December
2006
US$m
2005
US$m
2004
US$m
252
702
15
969
–
969
138
505
7
650
42
692
202
296
42
540
–
540
1 In 2006, Mexico and Panama were reclassified from the North America segment to Latin America. Comparative information has been
restated accordingly.
Year ended 31 December 2006 compared
with year ended 31 December 2005
HSBC reported net gains of US$969 million from
the disposal of available-for-sale financial
investments during 2006, 40 per cent higher than in
2005. On an underlying basis, gains were 35 per cent
greater than in 2005. Gains from financial
investments were mainly attributable to the
following transactions:
•
•
a gain of US$93 million arising from the partial
redemption of HSBC’s investment in
MasterCard Incorporated following its IPO in
May. The gain was distributed across all
geographic regions as most HSBC Group banks
were members of MasterCard;
a gain of US$101 million on the sale of part of
HSBC’s stake in UTI Bank Limited, an Indian
retail bank;
131
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Net earned insurance premiums / Other operating income
•
•
the partial sale by Private Banking of a holding
in the Hermitage Fund contributed a gain of
US$117 million for the year; and
the sale of a portfolio of structured finance
investments, classified as debt securities,
contributed a gain of US$112 million.
Year ended 31 December 2005 compared
with year ended 31 December 2004
The net gain of US$692 million from the disposal of
available-for-sale financial investments was
28 per cent higher than in 2004. Lower income from
the disposal of debt securities was more than
compensated for by an increase in gains from the
disposal of private equity investments, particularly in
HSBC’s European operations.
Net earned insurance premiums
By geographical region
Europe ......................................................
Hong Kong ..............................................
Rest of Asia-Pacific .................................
North America1 ........................................
Latin America1 .........................................
2006
US$m
1,298
2,628
174
492
1,076
%
22.9
46.3
3.1
8.7
19.0
Year ended 31 December
2005
US$m
1,599
2,334
155
477
871
%
29.4
42.9
2.9
8.8
16.0
2004
US$m
1,875
2,247
97
450
699
%
34.9
41.9
1.8
8.4
13.0
Net earned insurance premiums ..............
5,668 100.0
5,436 100.0
5,368 100.0
Gross insurance premium income ...................................................................
Reinsurance premiums ....................................................................................
Net earned insurance premiums ......................................................................
Year ended 31 December
2006
US$m
6,455
(787)
5,668
2005
US$m
6,152
(716)
5,436
2004
US$m
6,022
(654)
5,368
1 In 2006, Mexico and Panama were reclassified from the North America segment to Latin America. Comparative information has been
restated accordingly.
Year ended 31 December 2006 compared
with year ended 31 December 2005
Net earned insurance premiums of US$5,668 million
were 4 per cent higher than in 2005, 3 per cent on an
underlying basis. The commentary that follows is on
an underlying basis.
In Europe, net earned premium income
decreased by 19 per cent to US$1,298 million. This
was largely in the UK, where lower sales of single
premium insurance contracts, a lower market
appreciation of investment assets and the effect of
changes in reinsurance arrangements were the
principal drivers of the decrease.
In Hong Kong, net earned premium income
increased by 13 per cent, driven by the life insurance
business. New products, many designed to meet
financial needs identified in HSBC’s global study on
the future of retirement, were supported by increased
promotional and marketing activity, and the
development of internet and telephone distribution
channels. Sales rose in consequence.
In the Rest of Asia-Pacific net earned
premium income rose by 5 per cent growth to
US$174 million. This was concentrated in Singapore
and reflected the success of new product launches,
supported by increased marketing. Increased sales of
individual life policies were the main driver of the
growth. HSBC continued to expand its insurance
business across the Rest of Asia-Pacific with a
number of initiatives including the establishment of
HSBC’s first Islamic insurance company in
Malaysia.
In North America, the modest rise in net
premium income to US$492 million reflected growth
from new life business underwritten in 2006, which
was substantially offset by a decline in the non-life
business.
Improved cross-selling drove growth across
Latin America, and income rose by 18 per cent to
US$1,076 million. In Mexico, growth in individual
life, casualty and motor insurance was partly offset
by increased reinsurance costs. In Brazil, growth was
led by strong sales of both life and pension products.
In Argentina, increased advertising partnerships with
established local consumer brands and internal cross-
selling initiatives led to a rise in motor, home and
extended-warranty insurance premium income. This
132
was, in part, offset by the effects of the disposal of
the Brazilian general insurer HSBC Seguros during
the latter half of 2005, which resulted in a significant
reduction in non-life premium income.
Year ended 31 December 2005 compared
with year ended 31 December 2004
Net earned insurance premiums of US$5,436 million
increased by US$68 million compared with 2004.
On an underlying basis, net earned insurance
premiums were in line with 2004.
Under IFRSs, in 2005 there were changes in the
presentation of certain aspects of HSBC’s insurance
business, which are now treated as liabilities under
investment contracts. Investment income from these
products was reported as ‘Net income from financial
investments designated at fair value’. Income that
was previously reported as ‘Net earned insurance
premiums’ was taken directly to the balance sheet as
customer liabilities, with a corresponding movement
in net insurance claims. Net insurance claims fell to
a greater extent than premium income, due to the
additional impact of the reclassification of the fair
value movement in respect of liabilities under
investment contracts.
The commentary that follows excludes the
presentational changes discussed above, and is on an
underlying basis.
Other operating income
2006
US$m
By geographical region
Europe ......................................................
Hong Kong ..............................................
Rest of Asia-Pacific .................................
North America1 ........................................
Latin America1 .........................................
Intra-HSBC elimination ...........................
Other operating income ...........................
1,428
834
765
922
91
4,040
(1,494)
2,546
Higher premium income in Europe was due to
an increased uptake of creditor protection products
in the UK. The increase in premiums in Hong Kong
reflected HSBC’s continued emphasis on the growth
and development of its insurance proposition. Higher
volumes of life assurance new business were directly
driven by the launch of new endowment products,
augmented by HSBC’s leading position in online
personal insurance provision. In addition, greater
demand for private medical insurance products was
driven by the public response to government
deliberation over reforms to healthcare financing.
Investment in HSBC’s insurance business included
the establishment of a new Commercial Banking
insurance division in October, which positively
contributed to higher volumes of new business.
In the Rest of Asia-Pacific, the increase in
premiums was mainly attributable to growth in the
number of personal insurance policies, resulting
from an expansion of HSBC’s insurance operations
in the region.
In North America, increased cross-sales of
insurance products through the branch network,
combined with strong sales of other personal
insurance-related products, resulted in an increase in
net earned insurance premiums.
On an underlying basis, net earned insurance
premiums in Latin America were broadly in line
with 2004.
Year ended 31 December
2005
US$m
1,603
805
335
642
286
%
43.7
21.9
9.1
17.5
7.8
%
35.4
20.6
18.9
22.8
2.3
2004
US$m
1,175
536
146
341
46
%
52.4
23.9
6.5
15.2
2.0
100.0
3,671 100.0
(938)
2,244 100.0
(631)
2,733
1,613
133
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Other operating income / Net insurance claims incurred
Year ended 31 December
2006
US$m
2005
US$m
2004
US$m
Rent received ...................................................................................................
Gain/(loss) on disposal of assets held for resale .............................................
Valuation gains on investment properties .......................................................
Gain on disposal of property, plant and equipment, and non-financial
investments ..................................................................................................
Gain on disposal of operating leases ...............................................................
Change in present value of in-force long-term insurance business ................
Other ................................................................................................................
687
28
164
781
–
40
846
859
11
201
703
26
40
893
793
(93)
99
267
–
71
476
Other operating income ...................................................................................
2,546
2,733
1,613
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly.
Year ended 31 December 2006 compared
with year ended 31 December 2005
Other operating income of US$2,546 million was
7 per cent lower than in 2005, 9 per cent lower on an
underlying basis. The commentary that follows is on
an underlying basis.
In Europe, other operating income declined by
14 per cent. This largely resulted from the non-
recurrence of one-off gains from the restructuring
and syndication of assets in Global Investment
Banking in 2005. Gains on private equity were also
lower. There was a 29 per cent fall in rental income,
with a compensating effect on operating expenses,
following the sale of the operational functions of
HSBC’s vehicle financing and fleet management
business in 2005, combined with the non-recurrence
of gains made in that year on disposal of structured
finance leases in the UK. This decline was partly
offset by profit recognised on the sale of HSBC’s
stake in The Cyprus Popular Bank Limited of
US$93 million, and income from UK branch sale
and lease-back transactions.
In Hong Kong, the modest increase in other
operating income reflected profits earned from the
sale of the former head office building of Hang Seng
Bank and income received from the transfer of the
credit card acquiring business into a joint venture
between HSBC and Global Payments Inc. These
factors were partly offset by lower revaluation gains
on Hang Seng Bank’s investment properties
following a slowdown in the rate of property price
appreciation and the non-recurrence of the disposal
of a leasehold residential property.
Other operating income in the Rest of Asia-
Pacific more than doubled, reflecting profits earned
from various business disposals in Australia and the
sale of an office building in Japan. Higher levels of
activity at the Group Service Centres resulted in
rising income in the region and contributed further to
the increase.
134
In North America, the 42 per cent increase
largely resulted from gains on the disposal of various
investments and real estate, and higher lease income
from property investments by Amanah Finance.
The 73 per cent decline in Latin America was
mainly driven by the non-recurrence of the receipt of
coverage bonds issued as compensation for
asymmetric pesification in Argentina last year. The
non-recurrence of the gain on sale of the insurance
underwriter, HSBC Seguros, in Brazil in 2005
(US$89 million) contributed further to the reduction.
Year ended 31 December 2005 compared
with year ended 31 December 2004
Other operating income of US$2,733 million was
US$1,120 million higher than in 2004. On an
underlying basis, other operating income grew by
69 per cent.
The commentary that follows is on an
underlying basis.
In Europe, the increase in other operating
income was largely driven by increased rental
income on the leasing of train rolling stock, higher
disposals of assets and a number of private equity
realisations.
In Hong Kong, higher other operating income
was driven mainly by an increase in market value of
the investment property portfolio and the disposal of
a leasehold residential property. HSBC’s investment
properties are located principally in Hong Kong.
Under IFRSs, valuation movements on investment
properties are reflected in the income statement
rather than through revaluation reserves. Within
Hong Kong, the commercial property sector enjoyed
good growth as the economy grew and vacant space
fell markedly with a corresponding rise in rents.
The increase in other operating income in the
Rest of Asia-Pacific was, in part, due to gains
realised on the sale of the Group’s asset management
operations in Australia.
Other operating income in North America rose
by 83 per cent, in part due to improved revenues
from the sale of consumer real estate owned assets,
higher rental income and disposals of property, plant
and equipment.
In Latin America, other operating income
increased by US$240 million, primarily as a result of
the sale of the insurance underwriter HSBC Seguros
de Automoveis e Bens Limitada in Brazil, and the
receipt of compensation and coverage bonds in
Argentina. The receipt of non-core income in
Mexico from the distribution of third-party products
through the HSBC network contributed further to the
increase.
HSBC’s rental income mainly arose from
leasing in the UK. Europe accounted for 80 per cent
of total rental income; the remainder was attributable
to North America and Hong Kong.
The increase in the ‘Other’ caption was largely
driven by the increase in Latin America, reflecting
the receipt of compensation and coverage bonds in
Argentina, increased revenues from ‘capitalisation’
products in Brazil and the receipt of non-core
income in Mexico as noted above.
Net insurance claims incurred and movement in policyholders’ liabilities
By geographical region
Europe ......................................................
Hong Kong ..............................................
Rest of Asia-Pacific .................................
North America1 ........................................
Latin America1 .........................................
Net insurance claims incurred and
movement in policyholders’
liabilities ..............................................
2006
US$m
531
2,699
192
259
1,023
%
11.3
57.4
4.1
5.5
21.7
Year ended 31 December
2005
US$m
818
2,059
166
232
792
%
20.1
50.6
4.1
5.7
19.5
2004
US$m
1,628
2,154
82
236
535
%
35.1
46.5
1.8
5.1
11.5
4,704
100.0
4,067
100.0
4,635
100.0
Gross insurance claims and movement in policyholders’ liabilities ...............
Reinsurers’ share of claims incurred and movement in
policyholders’ liabilities ..............................................................................
Net insurance claims incurred and movement in policyholders’ liabilities ....
Year ended 31 December
2006
US$m
5,072
(368)
4,704
2005
US$m
4,153
(86)
4,067
2004
US$m
5,220
(585)
4,635
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly.
Year ended 31 December 2006 compared
with year ended 31 December 2005
Net insurance claims incurred and movement in
policyholders’ liabilities of US$4,704 million were
16 per cent higher than in 2005, 15 per cent on an
underlying basis. The commentary that follows is on
an underlying basis.
Net insurance claims incurred and the
movement in policyholders’ liabilities arise from
both life and non-life insurance business. For non-
life business, amounts reported here represent the
cost of claims paid during the year and the estimated
cost of notified claims. For life business, the main
elements of claims are the liability to policyholders
that is created on the initial underwriting of the
policy and any subsequent movement in the liability
that arises, primarily from the attribution of
investment performance to savings-related policies.
Consequently, claims rise in line with increases in
sales of savings-related business and with investment
market growth.
In Europe, net insurance claims incurred and
movement in policyholders’ liabilities decreased by
35 per cent to US$531 million, primarily driven by
lower sales of critical illness and creditor protection
products, along with the effect of adverse
movements in fixed interest rate markets on the
value of policyholders’ liabilities.
Net insurance claims and movement in
policyholders’ liabilities in Hong Kong increased by
31 per cent, predominantly in the life insurance
business, in which reserves for policyholders’
liabilities rose with business growth, together with
the rising value of investments. Growth in the
135
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Net insurance claims incurred / Loan impairment charges
underwriting of accident and health business resulted
in higher non-life insurance claims reserves.
Net insurance claims and movement in
policyholders’ liabilities in North America rose by
12 per cent to US$259 million, mainly reflecting an
increase in reserves for new life insurance business
underwritten in 2006.
In Latin America, higher sales of life and
pension fund products led to an increase in net
insurance claims incurred and movement in
policyholders’ liabilities of 24 per cent to
US$1,023 million. Lower movements in the non-life
insurance liabilities were due to the sale of the non-
life insurance business, HSBC Seguros, in Brazil
during the latter half of 2005.
Year ended 31 December 2005 compared
with year ended 31 December 2004
Net insurance claims incurred and movement in
policyholders’ liabilities of US$4,067 million
decreased by 12 per cent compared with 2004. On
an underlying basis, net insurance claims incurred
decreased by 13 per cent.
As with net earned insurance premiums, the
primary reason for the reduction was the required
reclassification under IFRSs in 2005 of
policyholders’ liabilities in respect of long-term
insurance contracts which were reclassified as
‘Liabilities to customers under investment contracts’.
As a consequence, reported net insurance claims
incurred and movement in policyholders’ liabilities
reduced.
The majority of HSBC’s non-life insurance
business largely relates to the provision of personal
insurance products. Minimal impact from hurricane
damage in the US and a lack of significant claims
events during 2005 resulted in a relatively stable
claims experience, augmented by negligible prior-
year reserve development in respect of 2004.
Excluding the effect of the above
reclassification, the most significant reduction in net
claims occurred in Europe, due to the effect of
revised actuarial valuations of existing life insurance
policies in the UK life operation.
The reinsurers’ share of claims incurred and
movement in policyholder liabilities in 2004
included the renegotiation of a reinsurance treaty in
the UK life operation, in which a greater proportion
of risk was transferred to the reinsurer. The
subsequent implementation of a revised liability
valuation system in 2005 reduced the amount of
reserves held for liabilities in respect of income
protection products, bringing additional benefits in
terms of capital efficiency of the UK life operation.
Loan impairment charges and other credit risk provisions
By geographical region
Europe ......................................................
Hong Kong ..............................................
Rest of Asia-Pacific .................................
North America1 ........................................
Latin America1 .........................................
Total loan impairment charges and other
credit risk provisions ...........................
As a percentage of net operating income
before loan impairment charges and
other credit risk provisions ..................
Impairment charges on loans and
advances to customers as a percentage
of gross average loans and advances to
customers .............................................
2006
US$m
2,155
172
512
6,796
938
%
20.4
1.6
4.8
64.3
8.9
Year ended 31 December
2005
US$m
1,929
146
134
4,916
676
%
24.7
1.9
1.7
63.0
8.7
2004
US$m
1,033
(220)
89
5,036
253
%
16.8
(3.6)
1.4
81.3
4.1
10,573
100.0
7,801
100.0
6,191
100.0
16.2
1.4
13.5
1.2
12.1
1.4
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly.
136
Loan impairment charges1
New allowances net of allowance releases .................................................
Recoveries of amounts previously written off ............................................
Individually assessed allowances ....................................................................
Collectively assessed allowances ....................................................................
General provisions ...........................................................................................
Other credit risk provisions .............................................................................
Total loan impairment charges and other credit risk provisions .....................
Customer impaired loans .................................................................................
Customer loan impairment allowances ...........................................................
1 Loan impairment charges in 2004 refer to specific provisions.
Year ended 31 December
2006
US$m
11,326
(779)
10,547
458
10,089
–
26
10,573
13,785
13,578
2005
US$m
8,354
(494)
7,860
518
7,342
–
(59)
7,801
11,446
11,357
2004
US$m
7,606
(913)
6,693
–
–
(498)
(4)
6,191
12,427
12,542
Year ended 31 December 2006 compared
with year ended 31 December 2005
The charge for loan impairments and other credit
risk provisions was US$10,573 million, a 36 per cent
increase over that reported in 2005. The analysis that
follows is on an underlying basis.
On an underlying basis, charges increased by
30 per cent. This reflected:
•
•
•
•
•
•
increased loss experience in the US mortgage
services business, particularly in second lien,
portions of first lien and adjustable rate
mortgages acquired from correspondent brokers
and banks in 2005 and in the first half of 2006;
10 per cent underlying lending growth
(excluding lending to the financial sector and
settlement accounts), notably in the UK, the US,
Mexico, Brazil and Asia;
the continuing effect in the UK of consumer
recourse to formal debt mitigation
arrangements;
credit deterioration, principally in the first half
of 2006, in unsecured personal and credit card
lending in Taiwan and Indonesia; offset by
the non-recurrence of a surge in bankruptcy
filings in the US in the fourth quarter of 2005
and the effect of hurricane Katrina; and
a continued benign commercial and corporate
credit environment.
In Europe, net loan impairment charges rose by
10 per cent to US$2,155 million. In the UK, net
charges rose by a modest 4 per cent as growth in the
personal customer impairment charge, which was
broadly in line with lending growth, was partially
offset by favourable movements on the impairment
charge for commercial loans in a robust corporate
credit environment. The personal sector continued to
137
experience higher levels of IVA and bankruptcy
filings, following an easing of bankruptcy
regulations in 2004, growth in consumer
indebtedness and a rise in unemployment. This was
mitigated by action taken on underwriting and
collections. In France, the non-recurrence of several
significant recoveries in 2005 resulted in an increase
in net loan impairment charges in 2006.
Loan impairment charges in Hong Kong
remained low at US$172 million, underpinned by
robust personal and commercial credit quality in a
strong economy with low unemployment.
In the Rest of Asia-Pacific, loan impairment
charges rose sharply to US$512 million. Taiwan and
Indonesia experienced credit deterioration during
2006, although the problem peaked in the first half
of the year. Taiwan was affected by the imposition
of a mandatory government debt renegotiation
scheme which allowed customers to extend and
heavily discount repayment terms, leading to
market-wide credit losses. Indonesia was also
affected by regulations, specifically with respect to
minimum re-payment terms which compounded
higher impairments brought about by a reduction in
fuel subsidies. Elsewhere in the Rest of Asia-Pacific
credit quality was stable.
In North America, the net loan impairment
charge increased significantly, by 32 per cent to
US$6,796 million, largely in the second half of
2006, driven by the credit deterioration in US sub-
prime mortgages described in the first bullet point
above. The effects of the decline in US house price
inflation and rising interest rates during 2006 were
accentuated by the increased percentage of second
lien loan originations to total loans originated in
2005 and the first half of 2006, and the underwriting
of stated income (low documentation) products. The
US net loan impairment charges increased by 37 per
cent after taking into account the most recent trends
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Loan impairment charges / Operating expenses
in delinquency and loss severity, projecting the
probable impact of re-pricing ARMs, and
incorporating the effect of re-pricing on parallel
second lien loans. Further details are provided on
page 189. Credit delinquency in other parts of the
mortgage portfolio and in other US businesses rose
modestly, driven by unusually low levels at the end
of 2005, and growing loan maturity in 2006.
Partially offsetting the effects of credit deterioration
were a decline in bankruptcy filings following the
surge at the end of 2005, relatively low
unemployment and a fall in exposure estimated to
result from hurricane Katrina.
In Latin America, the rise in impairment charges
by 24 per cent to US$938 million was largely
recorded in Mexico and, to a lesser extent, Brazil
and Argentina. In Mexico, strong loan growth,
particularly in 2006, led to increased loan
impairment charges. In Brazil, the credit weaknesses
seen in 2005 and the first half of 2006, particularly
in the consumer market, were mitigated by changes
to underwriting procedures. Net charges in Brazil
increased by 7 per cent compared with 54 per cent in
2005 and declined in the second half of 2006
compared with the first half. In Argentina, net
charges rose as a result of the non-recurrence of
releases and recoveries in 2005.
The aggregate outstanding customer loan
impairment allowances at 31 December 2006 of
US$13,578 million represented 1.6 per cent of gross
customer advances (net of reverse repos and
settlement accounts), compared with 1.5 per cent at
the same time in 2005.
Impaired loans to customers were
US$13,785 million at 31 December 2006 compared
with US$11,446 million at 31 December 2005. On a
constant currency basis, impaired loans were 14 per
cent higher than in 2005 compared with lending
growth (excluding loans to the financial sector and
settlement accounts) of 10 per cent.
Year ended 31 December 2005 compared
with year ended 31 December 2004
During 2005, the underlying growth in customer
lending excluding loans to the financial sector and
the impact of grossing adjustments required from
1 January 2005 under IFRSs, was 12 per cent.
Personal lending accounted for 63 per cent of this
increase, principally in mortgages, credit cards and
other personal lending products. At 31 December
2005, personal lending accounted for 56 per cent of
the customer loan portfolio, in line with 2004. The
proportion of the portfolio attributable to corporate
and commercial lending was augmented by the
138
IFRSs adjustment noted above. Residential
mortgages comprised 56 per cent of the personal
lending portfolio.
The charge for loan impairment adjusts the
balance sheet allowance for loan impairment to the
level that management deems adequate to absorb
actual and inherent losses in the Group’s loan
portfolios. The majority of the Group’s loan
impairment charges were determined on a portfolio
basis, employing statistical calculations using roll
rate methodologies. The total charge for loan
impairment and other credit risk provisions in 2005
was US$7,801 million compared with a total charge
of US$6,191 million in 2004, a rise of 26 per cent.
This reflected:
• underlying growth in lending of 12 per cent;
• a weakening credit environment in the UK and
Brazil but an improved credit experience in the
US; and
•
the non-recurrence of the 2004 net release of
general provision of US$498 million.
In the US, the underlying trend in loan
impairment charges was favourable compared with
2004, notwithstanding the negative effect on loan
impairment charges of hurricane Katrina and a surge
in personal bankruptcies in October ahead of new
legislation making such declarations more onerous.
This was due to a change in portfolio mix towards
higher quality lending and a positive economic
environment.
In the UK, credit costs rose following an
expansion in personal lending, which was
accompanied by an increase in delinquencies as the
economy slowed during 2005. This was evidenced
by rising personal bankruptcy, caused in part by
legislative changes which facilitated debt
reconstruction procedures, an increase in
unemployment and higher levels of personal debt. In
Hong Kong, the credit environment remained
benign, with falling bankruptcies contributing to a
modest reduction in loan impairment allowances in
the personal sector. A fall in releases in the corporate
sector, however, contributed to a modest charge for
loan impairment as compared with a net release in
2004. In the Rest of Asia-Pacific, continuing releases
and recoveries partly offset the impact of lending
growth in the region. Higher charges in the personal
sector in Brazil followed intense competitive
pressure in the consumer segment, where significant
increases in the availability of credit led to customers
becoming over-indebted.
The aggregate customer loan impairment
allowances at 31 December 2005 of
US$11,357 million represented 1.5 per cent of
gross customer advances (net of reverse repos,
settlement accounts and netting) compared with
2.0 per cent at 31 December 2004. As in 2004,
HSBC’s cross-border exposures did not necessitate
significant allowances.
Impaired loans to customers were
US$11,446 million at 31 December 2005 compared
Operating expenses
with US$12,427 million at 31 December 2004,
largely reflecting the write-off of impaired loans
against the provisions held in respect of these loans.
At constant exchange rates, impaired loans were
3 per cent lower than 2004 compared with
underlying lending growth (excluding lending to the
financial sector and settlement accounts) of
12 per cent.
By geographical region
Europe ......................................................
Hong Kong ..............................................
Rest of Asia-Pacific .................................
North America1 ........................................
Latin America1 .........................................
2006
US$m
13,871
3,269
3,548
10,193
4,166
%
39.6
9.3
10.1
29.1
11.9
Year ended 31 December
2005
US$m
12,639
2,867
2,762
8,758
3,426
%
41.4
9.4
9.1
28.8
11.3
2004
US$m
12,028
2,558
2,087
7,915
2,530
%
44.4
9.4
7.7
29.2
9.3
35,047 100.0
30,452 100.0
27,118 100.0
Intra-HSBC elimination ...........................
Total operating expenses .........................
(1,494)
33,553
(938)
29,514
(631)
26,487
By expense category
Employee compensation and benefits2 ............................................................
Premises and equipment (excluding depreciation and impairment) ...............
General and administrative expenses ..............................................................
Administrative expenses ..................................................................................
Depreciation and impairment of property, plant and equipment ....................
Amortisation and impairment of intangible assets3 .........................................
Total operating expenses .................................................................................
Staff numbers (full-time equivalent)
Europe ..............................................................................................................
Hong Kong ......................................................................................................
Rest of Asia-Pacific .........................................................................................
North America1 ................................................................................................
Latin America1 .................................................................................................
Year ended 31 December
2006
US$m
18,500
3,389
9,434
31,323
1,514
716
33,553
2006
78,311
27,586
72,265
55,642
67,116
2005
US$m
16,145
2,977
8,206
27,328
1,632
554
29,514
At 31 December
2005
77,755
25,931
55,577
53,608
55,600
2004
US$m
14,523
2,615
7,124
24,262
1,731
494
26,487
2004
74,861
25,552
41,031
49,416
52,473
Total staff numbers ..........................................................................................
300,920
268,471
243,333
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly.
2 A charge of US$135 million was realised in 2006 arising from the waiver of the TSR-related performance condition in respect of the
2003 awards under the HSBC Holdings Group Share Option Plan (‘the Plan’). As explained in the Annual Report and Accounts 2005,
in light of the impressive and sustained performance and shareholder returns over the three years covered by the 2003 awards, the
Group Remuneration Committee exercised its discretion, as permitted within the Plan, to waive the TSR performance condition. Under
both IFRSs and US GAAP this is treated as a modification which requires an additional accounting charge: this is a non-cash item.
3 Intangible asset amortisation comprises the expensing through the income statement of purchased intangibles such as mortgage
servicing rights and customer/merchant relationships and amounts allocated to intangible assets on the fair valuation of assets within
acquired business combinations. This latter category principally includes customer relationships.
139
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Operating expenses
Year ended 31 December 2006 compared
with year ended 31 December 2005
Operating expenses of US$33,553 million were
US$4,039 million, or 14 per cent, higher than in
2005, and 11 per cent higher on an underlying basis.
The commentary that follows is on an
underlying basis.
The main drivers of cost growth were as
follows:
•
•
various business expansion initiatives were
undertaken during the year. The retail banking
operation in the US was enhanced in the form of
new branches and improved geographical
coverage of Commercial Banking. In the UK,
major work was undertaken to refurbish the
branch network, improve and increase the
number of self-service machines and extend
opening hours in certain branches. Across the
Rest of the Asia-Pacific region, the branch
network expanded, the rollout of the consumer
finance business continued, and Commercial
Banking’s operations were further developed. In
Latin America, improvements were made to
HSBC’s operations in Mexico through the
continued expansion of the branch and ATM
network;
the higher costs incurred in Corporate,
Investment Banking and Markets reflected the
first full year effect of investments made in
2005, together with volume-driven growth in
transactional banking and securities services
activities and performance-related pay, which
rose as revenues grew. The cost efficiency ratio
of Corporate, Investment Banking and Markets
improved by 40 basis points as net operating
income before loan impairment charges grew
faster than costs; and
• HSBC’s expenditure on marketing continued in
order to increase brand awareness, grow market
share in key products and support the launch of
new products. Notable successes included the
online savings product in the US, strong growth
in credit card acquisition across the Group, and
an innovative new online mortgage product
offered in Mexico.
The following points are also of note.
In Europe, the cost growth of 9 per cent was
concentrated in Personal Financial Services and
Corporate, Investment Banking and Markets. In
Personal Financial Services, business expansion
across the region drove the expenditure. In the UK,
costs rose as the branch network refurbishment
140
programme proceeded, additional staff were
recruited to support longer opening hours in certain
branches and IT costs increased. In France and
Turkey, costs rose from the recruitment of additional
sales staff and higher marketing expenditure. Costs
in Corporate, Investment Banking and Markets
increased, reflecting higher performance-related staff
costs and the full year effect of the investment in
2005 in the business, especially in structured
derivatives and Global Transaction Banking, where
significant revenue growth was seen. These cost
increases were partly offset by a reduction in
Commercial Banking expenses following the sale of
vehicle finance fleet management activities in the
UK.
In Hong Kong, the increase in operating
expenses of 14 per cent was mainly due to higher
staff and marketing costs. Additional staff recruited
to support longer opening hours in the branch
network and the expansion of Commercial
Banking, and an increase in revenue-driven
performance-related awards drove staff costs higher.
Marketing expenditure incurred on advertising and
promotional activities rose in support of credit card
and investment fund products in Personal Financial
Services and the launch of Commercial Banking’s
global campaign. The full year effect of the
enhancement in the second half of 2005 of
Corporate, Investment Banking and Markets’
business contributed further to the cost growth.
The 27 per cent rise in operating expenses in the
Rest of Asia-Pacific region was primarily incurred in
supporting retail business expansion. Staff costs rose
from increased recruitment to support new business
initiatives and incentive payments grew in response
to improved revenues. Marketing expenses rose as
advertising and promotional activity aimed at
enlarging HSBC’s market share in cards, mortgages
and other unsecured lending grew, and Commercial
Banking marketing activity across several countries
increased. In Corporate, Investment Banking and
Markets, cost growth reflected higher revenue-driven
performance-related costs and increased expenditure
in Global Transaction Banking necessitated by
business volumes.
In North America, costs rose by 13 per cent in
2006. In the US, the increase accompanied the
expansion of both the core banking network (by
25 branches) and the geographical presence of
Commercial Banking, and arose from incremental
costs incurred in support of revenue growth in the
consumer finance business. Marketing expenditure
also rose, in line with increased levels of activity in
the cards businesses in the US, continued promotion
of the online savings product and airport branding
initiatives. Cost growth in Canada followed higher
revenues. The first full year effect of the expansion
of various Corporate, Investment Banking and
Markets businesses that commenced last year,
together with higher performance-linked pay
contributed further to the expense growth.
In Latin America, operating expenses rose by
12 per cent. Staff costs grew as additional staff were
recruited to support business expansion and pay rises
were agreed with the unions. Marketing expenditure
was higher as a consequence of advertising
campaigns run by Personal Financial Services and
Commercial Banking. The continued expansion of
the branch network and ATM infrastructure in
Mexico, in conjunction with construction of the new
headquarters, also contributed to the overall cost
growth in the region. Costs rose in Corporate,
Investment Banking and Markets in line with higher
transactional volumes, increased headcount and
union-agreed pay rises.
Year ended 31 December 2005 compared
with year ended 31 December 2004
Operating expenses of US$29,514 million were
US$3,027 million, or 11 per cent, higher than in
2004. On an underlying basis, cost growth was 9 per
cent, trailing net operating income growth before
impairment charges by 3 percentage points. This
resulted in a slight improvement in the cost
efficiency ratio to 51 per cent. The three main
drivers of cost growth were as follows:
•
volume expansion in many markets drove both
revenue and costs. In Personal Financial
Services and Commercial Banking, business
expansion drove cost growth of 6 per cent and
4 per cent respectively, though this was
exceeded by growth in net operating income
before loan impairment charges of 11 per cent
and 15 per cent respectively. In Mexico, Turkey
and Brazil, cost increases contributed over half
of the overall increase, but were significantly
exceeded by income growth;
• HSBC continued to improve productivity in
mature markets. In the UK, reorganisations in
Personal Financial Services and Commercial
Banking in 2004 resulted, in aggregate, in
broadly flat costs compared with growth of
10 per cent in net operating income before loan
impairment charges. This was delivered through
greater utilisation of direct channels, improved
training and increased incentives. In Hong
Kong, the promotion of cost-efficient delivery
channels and greater utilisation of the Group
Service Centres contributed to a 6 percentage
141
•
point improvement in the cost efficiency ratios
in Personal Financial Services and Commercial
Banking; and
following a number of senior hires in 2004 in
Corporate, Investment Banking and Markets,
subsequent investment was focused on
operations and technology, to support revenue
growth. Non-staff costs increased by 23 per cent
in 2005, with staff costs growing by 14 per cent.
The rate of cost growth peaked during the year
and the cost efficiency ratio was 2 percentage
points better in the second half of the year than
the first half, as net operating income before
loan impairment charges grew faster than costs.
The following points are also of note. In Europe,
costs included the rebranding of the Group’s
operations in France, the refurbishment of 60 UK
branches and increased marketing costs. These
increases were offset by lower costs in Commercial
Banking in the UK following restructuring activity
in 2004. Costs in Corporate, Investment Banking and
Markets increased by 9 per cent, reflecting increased
staff numbers and investments in technology and
infrastructure.
In Hong Kong, higher operating expenses
reflected business expansion in Corporate,
Investment Banking and Markets, supported by
increased staff in the investment banking division
and the recruitment of senior relationship managers.
This was partly offset by the effect of branch
restructuring and increased utilisation of the Group
Service Centres in Personal Financial Services,
which led to a 4 per cent fall in branch headcount.
Underlying operating expenses in the Rest of
Asia-Pacific increased by 31 per cent, reflecting
investment in broadening the customer base and the
distribution platform. HSBC’s branch network was
extended in mainland China, South Korea, and India,
and additional sales and support staff were recruited
in Personal Financial Services and Commercial
Banking. Staff numbers also increased in response to
the migration of call centre activities to the Group
Service Centres in the region. Growth initiatives
required investment in infrastructure and technology,
and accordingly non-staff costs increased by 39 per
cent.
In North America, costs bore a particularly large
share of the investment in Corporate, Investment
Banking and Markets, reflecting HSBC’s
commitment to growing its presence in the region.
Costs also reflected the expansion of the network,
with the opening of 27 new branches in 2005 and the
launch of HSBC’s online savings account in the US.
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Operating expenses / Share of profit in associates and joint ventures
HSBC’s Latin American operations reported a
21 per cent increase in operating expenses on an
underlying basis, partly as a result of higher average
staff numbers following the acquisition of consumer
finance businesses in 2004. Marketing costs rose
following a number of high profile campaigns in
2005, while transactional taxes and incentive
payments grew as a direct consequence of higher
income.
Productivity improvements and strong disposal
gains allowed HSBC to substantially complete its
investment in Corporate, Investment Banking and
Markets without any deterioration in the Group’s
cost efficiency ratio.
Cost efficiency ratios
HSBC ..............................................................................................................
Personal Financial Services ..........................................................................
Europe .............................................................................................................
Hong Kong ......................................................................................................
Rest of Asia-Pacific .........................................................................................
North America1 ................................................................................................
Latin America1 .................................................................................................
Commercial Banking ....................................................................................
Europe .............................................................................................................
Hong Kong ......................................................................................................
Rest of Asia-Pacific .........................................................................................
North America1 ................................................................................................
Latin America1 .................................................................................................
Year ended 31 December
2006
%
51.3
49.7
59.2
32.2
71.1
42.3
65.6
43.7
46.7
26.1
42.5
44.9
55.9
2005
%
51.2
48.7
58.2
33.3
72.3
40.8
64.4
45.5
49.9
27.2
43.8
43.1
58.2
2004
%
51.6
50.1
65.7
39.2
70.8
40.1
66.2
50.0
55.2
33.7
42.7
46.0
60.5
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly.
HSBC’s cost efficiency ratio worsened by 10 basis
points. On an underlying basis there was a 20 basis
point deterioration.
In Personal Financial Services, there was a
100 basis point deterioration in the cost efficiency
ratio as the growth of costs incurred in Europe,
North America and Latin America in support of
business expansion exceeded revenue growth. The
cost efficiency ratio in Corporate, Investment
Banking and Markets improved by 80 basis points to
58.9 per cent as revenues grew 1 per cent faster than
costs, and in Commercial Banking by 180 basis
points to 43.7 per cent. In Private Banking, the cost
efficiency ratio improved from 62 per cent to
57.5 per cent.
Share of profit in associates and joint ventures
By geographical region
Europe ......................................................
Hong Kong ..............................................
Rest of Asia-Pacific .................................
North America1 ........................................
Latin America1..........................................
Share of profit in associates and joint
2006
US$m
%
(72)
19
865
30
4
(8.4)
2.2
102.2
3.5
0.5
Year ended 31 December
2005
US$m
120
23
453
48
–
%
18.6
3.6
70.3
7.5
–
2004
US$m
37
23
215
(8)
1
%
13.8
8.6
80.2
(3.0)
0.4
ventures ...............................................
846
100.0
644
100.0
268
100.0
142
Share of profit in:
– associates ..................................................................................................
– joint ventures ............................................................................................
Share of profit in associates and joint ventures ...............................................
Year ended 31 December
2006
US$m
823
23
846
2005
US$m
546
98
644
2004
US$m
266
2
268
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly.
Year ended 31 December 2006 compared
with year ended 31 December 2005
Income from associates and joint ventures was
US$846 million, an increase of 31 per cent
compared with 2005, and 7 per cent on an
underlying basis.
The commentary that follows is on an
underlying basis.
Improved contributions from The Saudi British
Bank, Bank of Communications and Industrial Bank
were supplemented by a first full year contribution
from Ping An Insurance. These strategic investments
are of increasing significance to HSBC’s operations
in the Rest of Asia-Pacific region. The profits were
partly offset by a loss arising from an impairment
charge on a private equity investment of an associate
in Europe.
•
In August 2005, HSBC made an additional
investment to increase its stake in Ping An
Insurance to 19.9 per cent. The associate
reported record results for 2006, with steady
growth in the core insurance business
complemented by strong investment
performance following buoyant stock markets.
During 2006, Ping An Insurance group’s
nationwide back-office operation in Shanghai
became fully functional and the centralisation of
the life insurance underwriting and claims
business was completed.
• HSBC’s share of income from Bank of
Communications rose by 44 per cent, driven by
wider spreads and an improved product mix,
with increased corporate and consumer lending.
Fee income also rose as significant progress was
made in expanding its investment banking
operations.
In 2006, effective risk management and cost
control drove operating efficiency with an
improvement in the cost efficiency ratio, despite
a period of business expansion.
• During the second half of 2006, HSBC and The
Saudi British Bank jointly established HSBC
Saudi Arabia Limited, the first full-service
143
independent investment bank in Saudi Arabia
licensed under the local new Capital Market
law. HSBC, through a wholly owned subsidiary,
holds 60 per cent of the equity in the new
company and The Saudi British Bank, in which
HSBC has a 40 per cent shareholding, holds the
remaining 40 per cent.
The share of profits from The Saudi British
Bank grew by 21 per cent reflecting a strong
performance in all core businesses.
Year ended 31 December 2005 compared
with year ended 31 December 2004
Income from associates and joint ventures grew
significantly to US$644 million. On an underlying
basis, an increase of 72 per cent was driven by
strong performance in The Saudi British Bank and
gains on the sale of HSBC’s indirect stake in MISR
International, an Egyptian Bank. These revenue
streams were complemented by increased
contributions from the bank’s strategic investments
in mainland China; Bank of Communications and
Industrial Bank, interests in which were acquired in
2004, and Ping An Insurance, which became an
associate in August 2005.
Bank of Communications is the fifth largest
bank in mainland China as measured by assets.
HSBC’s share of Bank of Communications’ profits
in 2005 was US$175 million, significantly higher
than those reported in 2004. This largely reflected
the first full year of profits in 2005, though Bank of
Communications recorded an overall increase on a
like-for-like basis, principally as a result of asset and
liability growth combined with moderate expansion
in operating expenses.
Ping An Insurance is one of mainland China’s
leading insurance groups focusing on providing life
and property and casualty insurance products. In
August 2005, HSBC increased its stake in Ping An
Insurance to 19.9 per cent, began to account for it as
an associate.
The Saudi British Bank is 40 per cent owned by
HSBC. HSBC’s share of its profits increased by
53 per cent to US$268 million in 2005, largely
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Asset deployment / Funds under management / Assets held in custody
driven by strong investment banking performance, a
buoyant stock market and rapid growth in Shariah-
compliant products and services.
Asset deployment
Loans and advances to customers ..........................................................
Loans and advances to banks .................................................................
Trading assets .........................................................................................
Financial investments .............................................................................
Derivatives ..............................................................................................
Goodwill and intangible assets ...............................................................
Other .......................................................................................................
At 31 December
2006
US$m
868,133
185,205
328,147
204,806
103,702
37,335
133,430
%
46.6
10.0
17.6
11.0
5.6
2.0
7.2
2005
US$m
740,002
125,965
232,909
182,342
73,928
33,200
113,624
%
49.3
8.4
15.5
12.1
4.9
2.2
7.6
1,860,758
100.0
1,501,970
100.0
Loans and advances to customers include:
– reverse repos ...................................................................................
– settlement accounts ........................................................................
Loans and advances to banks include:
– reverse repos ...................................................................................
– settlement accounts ........................................................................
18,755
3,254
45,019
2,028
14,610
2,142
24,754
2,669
Year ended 31 December 2006 compared
with year ended 31 December 2005
HSBC’s total assets at 31 December 2006 were
US$1,861 billion, an increase of US$359 billion or
24 per cent since 31 December 2005. Two thirds of
the increase was driven by balance sheet growth
within Corporate, Investment Banking and Markets,
the largest component of which was trading assets.
Acquisitions added US$13 billion to total assets. On
an underlying basis, total assets grew by 17 per cent.
The commentary that follows is on an underlying
basis.
At 31 December 2006, HSBC’s balance sheet
remained highly liquid. The proportion of assets
deployed in customer advances fell to 47 per cent,
predominantly due to a significant increase in trading
assets which, at 31 December 2006, were
2 percentage points higher than in 2005 at
US$328 billion, representing 18 per cent of total
assets. The increase of US$95 billion in trading
assets resulted primarily from higher holdings of debt
securities.
Customer advances increased 17 per cent as a
result of expansion in mortgages and other personal
banking loans. Residential mortgage growth in the
first half of 2006 was mainly in the US, though this
slowed in the second half as HSBC reduced its
exposure to mortgages generated by correspondents
and tightened lending criteria. In the second half of
the year mortgage increases were strongest in the UK
although HSBC saw its market share fall modestly in
a buoyant UK housing market. Growth in other
personal banking advances in the first half of 2006
was driven by second lien mortgages and unsecured
lending in the US and, in the second half of the year,
in the UK, notwithstanding tighter underwriting
criteria. In France, mortgage lending falling outside
of the strict classification of residential mortgages
contributed significantly to growth. Growth in
corporate lending was mainly in Commercial
Banking, with significant increases in lending to the
services and energy sectors.
Trading assets and financial investments
Trading assets principally consist of debt and equity
instruments acquired for the purpose of market
making or to benefit from short-term price
movements. Securities classified as held for trading
are carried in the balance sheet at fair value with
movements in fair value reflected within the income
statement.
Trading assets of US$328 billion at
31 December 2006 were 41 per cent higher than at
31 December 2005. On an underlying basis, the
increase was 32 per cent. A 27 per cent rise in debt
securities resulted from increased holdings of
shorter-maturity assets in the UK and deployment of
the increased commercial surplus in Hong Kong. In
the US, trading assets rose, reflecting the first full
year effect of the residential mortgage-backed
securities business following its launch in 2005.
Financial investments include debt and equity
instruments that are classified as available for sale or,
to a very small extent, held to maturity. Available-
for-sale investments essentially represent a core
element of the Group’s liquidity and may be disposed
144
Funds under management
At 1 January ...............................
Net new money ..........................
Value change .............................
Exchange and other ....................
At 31 December .........................
Funds under management by
business
Group Investment Businesses ....
Private Banking1 ........................
Affiliates ....................................
Other1 .........................................
2006
US$bn
2005
US$bn
561
44
57
33
695
476
63
45
(23)
561
Year ended 31 December
2005
US$bn
2006
US$bn
328
232
2
133
695
267
194
5
95
561
1 2005 has been restated to transfer US$8 billion from Private
Banking to Other.
Client assets, which provide an indicator of
overall Private Banking volumes and include funds
under management, cash deposits and certain on-
balance sheet trust assets, rose by 22 per cent
compared with 31 December 2005 to reach
US$333 billion.
Assets held in custody and under
administration
At 31 December 2006, assets held by HSBC as
custodian amounted to US$4,572 billion, 41 per cent
higher than the US$3,242 billion held at
31 December 2005. At constant exchange rates
growth was 28 per cent. Custody is the safekeeping
and administration of securities and financial
instruments on behalf of others.
Complementing this is HSBC’s assets under
administration business. At 31 December 2006, the
value of assets held under administration by the
Group amounted to US$1,150 billion, 48 per cent
higher than the US$779 billion held at 31 December
2005. At constant exchange rates, growth was
37 per cent.
of either to manage that liquidity or in response to
investment opportunities arising from favourable
movements in economic indicators, such as interest
rates, foreign exchange rates and equity prices. They
are carried at fair value with unrealised gains and
losses from movements thereon reported in equity
until disposal. On disposal the accumulated
unrealised gain or loss is recognised through the
income statement and reported as ‘Gains less losses
from financial investments’.
Financial investments of US$205 billion at
31 December 2006 were 12 per cent higher than at
31 December 2005 and 8 per cent higher on an
underlying basis. This was primarily driven by an
increase in holdings of debt securities. HSBC’s
operations in Europe, reported a rise in the credit risk
arbitrage portfolio reflecting strong investor demand
for commercial paper while, in Hong Kong, the
increase was driven by the deployment of increased
commercial surplus. Net unrealised gains in the
valuation of equities amounted to US$2,299 million.
Funds under management
Funds under management at 31 December 2006 were
US$695 billion, an increase of US$134 billion, or
24 per cent, compared with 31 December 2005. The
increase was 16 per cent on an underlying basis. Both
Group Investment Businesses and Private Banking
delivered good investment performance and strong
net new money. HSBC is among the world’s largest
emerging market asset managers with US$62 billion
of funds under management invested in emerging
market assets.
Group Investment Businesses managed
US$328 billion of assets at 31 December 2006, a rise
of 23 per cent compared with 31 December 2005,
recording US$14 billion of net new money and good
investment performance.
Private Banking attracted net new money of
US$24 billion, due in part to greater brand awareness
and an enhanced product range, which together
with good investment performance contributed
towards increased funds under management of
US$232 billion at 31 December 2006, 20 per cent
higher than at 31 December 2005.
Other funds under management, of which the
main constituent was a corporate trust business
in Asia, reported funds under management of
US$133 billion at 31 December 2006, an increase
of 40 per cent compared with 31 December 2005.
145
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Economic profit / Other financial information
Economic profit
HSBC’s internal performance measures include
economic profit, a calculation which compares the
return on 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 a means of deciding 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 its
geographical and customer group diversification,
HSBC believes that its true cost of capital on a
consolidated basis remains 10 per cent. HSBC plans
to continue using this rate until the end of the current
five-year strategic plan in 2008 in order to ensure
consistency and comparability.
Economic profit decreased by US$418 million,
or 7 per cent compared with 2005. The rate of growth
in profit attributable was slower than the growth in
average shareholders’ equity, mainly due to increased
loan impairment charges in the US mortgage service
business. This was also reflected in a lower return on
average invested capital and in consequence
economic spread, which fell by 1 percentage point
compared with 2005.
Year ended 31 December
Average total shareholders’ equity .........................................................
Add: Goodwill previously amortised or written off ...............................
Less: Property revaluation reserves ........................................................
Reserves representing unrealised gains on
%1
2006
US$m
100,860
8,172
(1,062)
effective cash flow hedges .........................................................
(126)
Reserves representing unrealised gains on
available-for-sale securities .......................................................
Preference shares ...........................................................................
Average invested capital2 ........................................................................
Return on invested capital3 .....................................................................
Benchmark cost of capital ......................................................................
Economic profit/spread ..........................................................................
(1,156)
(1,405)
105,283
15,699
(10,528)
5,171
14.9
(10.0)
4.9
2005
US$m
89,589
8,172
(1,092)
(315)
(1,294)
(351)
94,709
15,060
(9,471)
5,589
%1
15.9
(10.0)
5.9
1 Expressed as a percentage of average invested capital.
2 Average invested capital is measured as average total shareholders’ equity after:
– adding back the average balance of goodwill impaired or amortised pre transition to IFRS or subsequent written-off, directly to
reserves;
– deducting the average balance of HSBC’s revaluation surplus relating to property held for own use. This reserve was generated when
determining the deemed carrying cost of such properties on transition to IFRS and will run down over time as the properties are sold;
– deducting average preference shares issued by HSBC Holdings, and;
– deducting average reserves for unrealised gains/(losses) on effective cash flow hedges and available-for-sale securities.
3 Return on invested capital is based on the profit attributable to ordinary shareholders of the parent company.
146
Other financial information
Average balance sheet and net interest
income
Average balances and the related interest are shown
for the domestic operations of HSBC’s principal
commercial banks by geographic region with all
other commercial banking and investment banking
balances and transactions included in ‘Other
operations’.
Net interest margin numbers are calculated by
dividing net interest income as reported in the
income statement by the average interest earning
assets from which interest income is reported within
the ‘Net interest income’ line of the income
statement. Interest income and interest expense
arising from trading assets and liabilities and the
funding thereof is included within ‘Net trading
income’ in the income statement.
Assets
Year ended 31 December
2006
2005
2004
Average
balance
Interest
income
US$m US$m
Yield
Average
balance
% US$m
Interest
income
US$m
Yield
Average
balance
% US$m
Interest
income Yield
%
US$m
Short-term funds and loans and advances
to banks
Europe
Hong Kong
HSBC Bank ...................... 33,856
HSBC Private Banking
Holdings (Suisse) .........
4,956
HSBC France ................... 20,197
Hang Seng Bank ............... 10,360
The Hongkong and
Shanghai Banking
Corporation .................. 38,802
1,536
4.54
21,875
774
3.54 24,173
669
2.77
190
690
3.83
3.42
3,606
16,829
113
387
3.13
2,644
2.30 26,007
89
960
3.37
3.69
483
4.66
8,061
288
3.57
8,328
221
2.65
1,645
4.24
36,904
1,058
2.87
28,172
538
1.91
Rest of
The Hongkong and
Asia-Pacific
North America
Latin America
Shanghai Banking
Corporation .................. 13,388
2,492
4,279
HSBC Bank Malaysia ......
HSBC Bank Middle East .
HSBC Bank USA ............ .
HSBC Bank Canada .........
HSBC Mexico ..................
Brazilian operations1 ........
HSBC Bank Argentina .....
8,422
3,167
3,395
4,129
196
520
87
208
465
138
3.88
3.49
4.86
5.52
4.36
6.69
227
572 13.85
4.08
8
11,667
1,767
3,262
3,579
2,115
2,994
3,305
264
351
49
111
151
62
3.01
2.77
3.40
4.22
2.93
7.62
228
565 17.10
2.65
7
9,180
1,348
1,619
2,323
2,163
3,771
1,954
250
198
36
29
56
45
2.16
2.67
1.79
2.41
2.08
6.02
227
237 12.13
1.20
3
Other operations .............................................. 16,816
627
3.73
15,023
456
3.04 19,515
329
1.69
164,455
7,396
4.50
131,251
4,600
3.50 131,447
3,637
2.77
Trading assets2
Europe
Hong Kong
HSBC Bank ......................
HSBC France ...................
Hang Seng Bank ...............
The Hongkong and
Shanghai Banking
Corporation ..................
Rest of
The Hongkong and
Asia-Pacific
North America
Latin America
Shanghai Banking
Corporation ..................
HSBC Bank Malaysia ......
HSBC Bank USA ............ .
HSBC Bank Canada .........
HSBC Markets Inc ...........
HSBC Mexico ..................
Brazilian operations1 ........
HSBC Bank Argentina .....
Other operations ..............................................
For footnotes, see page 156.
147
29,183
13,663
1,147
365
3.93
2.67
369
13
3.52
11,209
298
2.66
2,487
145
5,447
1,177
11,543
2,957
843
19
5,661
101
4
115
25
421
4.06
2.76
2.11
2.12
3.65
173
5.86
128 15.18
5.26
1
232
4.10
84,703
3,023
3.57
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Other financial information > Average balance sheet
Assets (continued)
Year ended 31 December
2006
2005
2004
Average
balance
Interest
income
US$m US$m
Yield
Average
balance
% US$m
Interest
income
US$m
Yield
Average
balance
% US$m
Interest
income Yield
%
US$m
Loans and advances to customers
Europe
Hong Kong
HSBC Bank ...................... 226,528
HSBC Private Banking
Holdings (Suisse) .........
7,134
HSBC France ................... 52,990
5,932
HSBC Finance ..................
Hang Seng Bank ............... 34,416
The Hongkong and
Shanghai Banking
Corporation .................. 47,292
Rest of
The Hongkong and
Asia-Pacific
North America
Shanghai Banking
Corporation .................. 52,159
HSBC Bank Malaysia ......
6,292
HSBC Bank Middle East . 12,757
HSBC Bank USA ............ . 88,563
HSBC Finance .................. 147,336
HSBC Bank Canada ......... 35,055
14,166
6.25
203,568
12,223
6.00 170,939
9,521
5.57
338
2,463
4.74
4.65
671 11.31
5,795
41,977
9,951
211
1,710
1,086 10.91
3.64
4,700
4.07 42,149
9,276
2.45
115
1,892
4.49
1,055 11.37
1,952
5.67
32,893
1,323
4.02 31,234
882
2.82
2,843
6.01
43,971
2,061
4.69
41,901
1,406
3.36
3,449
430
957
6.61
6.83
7.50
46,652
5,380
10,038
2,659
325
635
5.70
6.04
6.33
36,775
4,937
7,425
1,781
278
418
4.84
5.63
5.63
6,141
6.93
17,061 11.58
5.81
2,037
86,800
118,215
28,491
6.44 61,659
5,594
13,307 11.26 114,393
5.05 22,603
1,439
2,936
4.76
13,146 11.49
4.86
1,099
Latin America
HSBC Mexico .................. 13,193
Brazilian operations1 ........
9,461
838
HSBC Bank Argentina .....
1,532 11.61
3,244 34.29
107 12.77
9,983
7,447
914
1,210 12.12
2,647 35.54
122 13.35
8,095
4,726
903
878 10.85
1,527 32.31
101 11.18
Other operations .............................................. 20,984
1,620
7.72
27,203
1,352
4.97 35,713
1,113
3.12
760,930
59,011
7.76
679,278
47,904
7.05 597,428 38,148
6.39
Financial investments
Europe
Hong Kong
HSBC Bank ...................... 42,726
HSBC Private Banking
Holdings (Suisse) .........
HSBC France ...................
8,729
2,545
Hang Seng Bank ............... 27,288
The Hongkong and
Shanghai Banking
Corporation .................. 20,362
Rest of
The Hongkong and
Asia-Pacific
North America
Latin America
Shanghai Banking
Corporation .................. 17,179
954
1,387
HSBC Bank Malaysia ......
HSBC Bank Middle East .
HSBC Bank USA ............ . 22,214
3,724
HSBC Finance ..................
4,351
HSBC Bank Canada .........
HSBC Mexico ..................
Brazilian operations1 ........
HSBC Bank Argentina .....
4,049
3,862
311
1,977
4.63
35,787
1,297
3.62 22,488
824
3.66
391
95
4.48
3.73
8,725
4,482
342
143
3.92
3.19
10,828
6,957
303
240
2.80
3.45
1,224
4.49
23,445
815
3.48 20,924
507
2.42
911
4.47
29,508
924
3.13
33,798
779
2.30
737
36
72
1,109
200
174
4.29
3.77
5.19
4.99
5.37
4.00
427 10.55
501 12.97
38 12.22
15,100
1,182
1,311
19,262
3,945
3,951
4,995
2,328
218
592
41
44
864
221
116
3.92
3.47
3.36
15,902
1,156
1,104
4.49 18,213
5.60
4,153
2.94
2,814
537
40
27
884
166
65
3.38
3.46
2.45
4.85
4.00
2.31
583 11.67
324 13.92
23 10.55
3,822
843
169
395 10.33
128 15.18
7.10
12
Other operations .............................................. 25,171
1,212
4.82
17,769
881
4.96 17,485
564
3.23
184,852
9,104
4.93
172,008
7,210
4.19 160,656
5,471
3.41
For footnotes, see page 156.
148
Year ended 31 December
Average
balance
2006
Interest
income
US$m US$m
2005
2004
Yield
Average
balance
% US$m
Interest
income
US$m
Yield
Average
balance
% US$m
Interest
income Yield
%
US$m
9,938
652
6.56
14,748
543
3.68
8,629
361
4.18
14,558
6,434
732
173
5.03
2.69
11,831
9,811
416
442
3.52
4.51
7,611
7,533
146
62
1.92
0.82
538
28
5.20
81
3
3.70
813
17
2.09
19,246
909
4.72
18,310
443
2.42
16,926
316
1.87
6,938
178
380
1,867
767
1,006
–
1,004
23
449
10
32
82
43
32
6.47
5.62
8.42
4.39
5.61
3.18
–
–
190 18.92
3 13.04
4,836
283
371
1,444
2,063
641
1,186
558
43
200
8
18
43
67
18
4.14
2.83
4.85
2.98
3.25
2.81
16
1.35
162 29.03
4.65
2
4,757
153
164
784
651
233
336
284
30
179
3
10
26
64
8
3.76
1.96
6.10
3.32
9.83
3.43
5
1.49
36 12.68
–
–
Other interest-earning assets
Europe
Hong Kong
Rest of
Asia-Pacific
North America
Latin America
HSBC Bank .....................
HSBC Private Banking
Holdings (Suisse) ........
HSBC France ..................
Hang Seng Bank ..............
The Hongkong and
Shanghai Banking
Corporation .................
The Hongkong and
Shanghai Banking
Corporation .................
HSBC Bank Malaysia .....
HSBC Bank Middle East
HSBC Bank USA ........... .
HSBC Finance .................
HSBC Bank Canada ........
HSBC Mexico .................
Brazilian operations1 .......
HSBC Bank Argentina ....
Other operations .............................................
(59,710)
(2,967)
(49,322)
(2,001)
(46,751)
(1,040)
3,167
368 11.62
16,884
380
2.25
2,153
193
8.96
Total interest-earning assets
Europe
HSBC Bank ..................... 313,048
HSBC Private Banking
Holdings (Suisse) ........
HSBC France ..................
HSBC Finance .................
35,377
82,166
5,932
18,331
5.86
275,977
14,837
5.38 255,412
12,522
4.90
1,651
3,421
4.67
4.16
671 11.31
29,957
73,099
10,553
1,082
2,682
1,081 10.24
3.61
25,783
3.67 96,310
9,342
2.53
653
3,520
3.65
1,074 11.50
Hong Kong
Hang Seng Bank ..............
The Hongkong and
72,602
3,687
5.08
64,958
2,447
3.77 61,669
1,614
2.62
Shanghai Banking
Corporation ................. 125,702
6,308
5.02
128,693
4,485
3.49
132,007
3,337
2.53
Rest of
Asia-Pacific
The Hongkong and
Shanghai Banking
Corporation .................
HSBC Bank Malaysia .....
HSBC Bank Middle East
89,664
9,916
18,803
5,156
563
1,269
5.75
5.68
6.75
78,255
8,612
14,982
3,802
423
808
69,102
4.86
4.91
7,739
5.39 10,348
2,796
361
485
4.05
4.66
4.69
North America
HSBC Bank USA ........... . 121,066
HSBC Finance ................. 151,827
43,579
HSBC Bank Canada ........
7,797
6.44
17,304 11.40
5.46
2,381
111,085
124,223
35,198
5.99 88,426
6,652
13,595 10.94 119,197
4.65 28,990
1,635
4,017
4.54
13,376 11.22
4.28
1,242
Latin America
HSBC Mexico .................
Brazilian operations1 .......
HSBC Bank Argentina ....
20,637
18,456
1,368
2,186 10.59
4,507 24.42
156 11.40
19,159
13,637
1,440
2,038 10.64 18,982
3,697 27.11
9,186
154 10.69
1,371
1,678
8.84
2,231 24.29
8.53
117
Other operations .............................................
3,261
492 15.06
9,593
676
7.05 42,523
1,449
3.41
1,113,404
75,879
6.82
999,421
60,094
6.01 976,387
50,472
5.17
Summary
Total interest-margin assets ............................ 1,113,404
Trading assets2 ................................................ 288,605
Financial assets designated at fair value3 ........
7,681
Impairment provisions ....................................
(11,864)
Non-interest-earning assets ............................ 291,741
75,879
12,445
290
6.82
4.31
3.78
999,421
292,404
15,247
(12,469)
207,337
60,094
7,232
405
6.01 976,387
2.47
2.66
(12,958)
285,912
50,472
5.17
Total assets and interest income ..................... 1,689,567
88,614
5.24 1,501,940
67,731
4.51 1,249,341
50,472
4.04
149
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Other financial information > Average balance sheet
Assets (continued)
Year ended 31 December
2006
%
2005
%
Distribution of average total assets
Europe
HSBC Bank ...................................................................
HSBC Private Banking Holdings (Suisse) ....................
HSBC France .................................................................
HSBC Finance ...............................................................
Hong Kong
Hang Seng Bank ............................................................
The Hongkong and Shanghai Banking Corporation .....
Rest of Asia-Pacific The Hongkong and Shanghai Banking Corporation .....
HSBC Bank Malaysia ...................................................
HSBC Bank Middle East ..............................................
North America
Latin America
HSBC Bank USA ..........................................................
HSBC Finance ...............................................................
HSBC Bank Canada ......................................................
HSBC Mexico ...............................................................
Brazilian operations1 .....................................................
HSBC Bank Argentina ..................................................
Other operations (including consolidation adjustments) ...................................
30.6
2.3
10.0
0.5
4.3
10.7
6.0
0.6
1.3
11.3
10.0
2.4
1.7
1.5
0.1
6.7
30.1
2.2
9.9
0.7
4.8
12.7
6.5
0.6
1.1
10.7
9.3
2.6
1.6
1.4
0.1
5.7
2004
%
28.3
2.2
9.8
0.9
5.2
14.2
6.6
0.7
0.9
8.8
10.8
2.4
1.8
0.9
0.1
6.4
For footnotes, see page 156.
100.0
100.0
100.0
150
Total equity and liabilities
Year ended 31 December
2006
2005
2004
Average
balance
Interest
expense
US$m US$m
Cost
Average
balance
% US$m
Interest
expense
US$m
Cost
Average
balance
% US$m
Interest
expense Cost
%
US$m
Deposits by banks4
Europe
Hong Kong
HSBC Bank ...................... 32,825
HSBC Private Banking
Holdings (Suisse) .........
1,030
HSBC France ................... 23,171
1,311
3.99
32,673
1,037
3.17 26,950
412
1.53
33
886
3.20
3.82
886
17,935
20
582
2.26
1,446
3.25 22,162
27
526
1.87
2.37
Hang Seng Bank ...............
The Hongkong and
Shanghai Banking
Corporation ..................
2,031
84
4.14
1,876
61
3.25
685
14
2.04
2,745
125
4.55
3,430
116
3.38
3,139
39
1.24
Rest of
The Hongkong and
Asia-Pacific
North America
Latin America
Shanghai Banking
Corporation ..................
HSBC Bank Malaysia ......
HSBC Bank Middle East .
HSBC Bank USA ............ .
HSBC Bank Canada .........
HSBC Mexico ..................
Brazilian operations1 ........
HSBC Bank Argentina .....
6,276
280
453
3,695
1,520
781
1,033
72
246
9
23
208
68
50
101
5
3.92
3.21
5.08
5.63
4.47
6.40
9.78
6.94
4,973
238
888
4,251
926
1,051
1,355
111
168
5
27
202
34
70
125
8
3.38
2.10
3.04
4.75
3.67
6.66
9.23
7.21
3,505
98
1,104
3,833
392
914
914
140
95
2
23
74
8
48
57
8
2.71
2.04
2.08
1.93
2.04
5.25
6.24
5.71
Other operations ..............................................
5,653
351
6.24
3,962
211
5.33 11,182
206
1.84
81,565
3,500
4.29
74,555
2,666
3.58 76,464
1,539
2.01
Customer accounts5
Europe
Hong Kong
HSBC Bank ...................... 221,369
HSBC Private Banking
Holdings (Suisse) ......... 25,346
HSBC France ................... 23,579
Hang Seng Bank ............... 54,267
The Hongkong and
Shanghai Banking
Corporation .................. 104,441
Rest of
The Hongkong and
Asia-Pacific
Shanghai Banking
Corporation .................. 56,760
HSBC Bank Malaysia ......
7,260
HSBC Bank Middle East . 11,713
North America
HSBC Bank USA ............ . 71,031
HSBC Bank Canada ......... 25,277
Latin America
HSBC Mexico .................. 13,625
Brazilian operations1 ........ 14,887
983
HSBC Bank Argentina .....
7,031
3.18
186,996
5,359
2.87 169,501
3,986
2.35
1,069
752
4.22
3.19
19,908
24,538
622
611
3.12
17,339
2.49 22,072
377
575
2.17
2.61
1,712
3.15
51,460
874
1.70 50,944
290
0.57
2,934
2.81
95,496
1,322
1.38
92,579
392
0.42
1,903
212
411
2,490
804
3.35
2.92
3.51
3.51
3.18
471
3.46
2,056 13.81
4.17
41
48,997
6,123
8,696
60,795
21,635
8,272
10,790
903
1,293
157
207
2.64
2.56
2.38
42,625
5,744
5,978
1,385
475
2.28 52,813
2.20 18,191
188
1,859 17.23
3.10
28
2.27 11,157
5,787
898
891
151
60
680
351
2.09
2.63
1.00
1.29
1.93
377
3.38
842 14.55
3.01
27
Other operations .............................................. 50,844
1,845
3.63
44,816
1,273
2.84 56,494
918
1.62
681,382
23,731
3.48
589,425
15,653
2.66 552,122
9,917
1.80
For footnotes, see page 156.
151
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Other financial information > Average balance sheet
Total equity and liabilities (continued)
Year ended 31 December
2006
2005
2004
Average
balance
Interest
expense
US$m US$m
Cost
Average
balance
% US$m
Interest
expense
US$m
Cost
Average
balance
% US$m
Interest
expense Cost
%
US$m
Financial liabilities designated at fair
value – own debt issued6
Europe
HSBC Holdings ................ 15,132
7,888
HSBC Bank ......................
North America
HSBC Bank USA ............ .
1,892
HSBC Finance .................. 29,917
745
373
116
1,877
4.92
4.73
6.13
6.27
13,928
5,919
1,469
28,146
496
327
96
1,098
3.56
5.52
6.54
3.90
Other operations ..............................................
461
49 10.63
288
20
6.94
55,290
3,160
5.72
49,750
2,037
4.09
Debt securities in issue
Europe
Hong Kong
HSBC Bank ...................... 45,870
HSBC France ................... 19,818
548
HSBC Finance ..................
2,047
633
32
4.46
3.19
5.84
28,620
14,271
3,330
1,817
314
77
6.35
2.20
2.31
26,320
16,250
3,524
1,103
434
163
4.19
2.67
4.63
Hang Seng Bank ...............
The Hongkong and
Shanghai Banking
Corporation ..................
1,622
64
3.95
1,523
53
3.48
1,266
30
2.37
–
–
–
–
–
–
11,192
437
3.90
Rest of
The Hongkong and
Asia-Pacific
North America
Latin America
Shanghai Banking
Corporation ..................
HSBC Bank Malaysia ......
7,990
371
HSBC Bank USA ............ . 28,832
HSBC Finance .................. 112,353
HSBC Bank Canada ......... 10,616
HSBC Mexico ..................
Brazilian operations1 ........
HSBC Bank Argentina .....
249
700
–
438
13
1,407
5,047
460
5.48
3.50
4.88
4.49
4.33
23
9.24
70 10.00
–
–
6,523
572
25,537
75,913
7,963
4,585
401
7
315
16
4.83
2.80
5,313
261
1,073
3,399
268
4.20
11,125
4.48 101,269
5,994
3.37
229
8
376
2,751
165
4.31
3.07
3.38
2.72
2.75
285
6.22
67 16.71
1 14.29
3,566
360
95
134
3.76
65 18.06
7.37
7
Other operations ..............................................
3,105
110
3.54
6,834
90
1.32 18,136
234
1.29
232,074
10,344
4.46
176,079
7,775
4.42 204,671
6,136
3.00
Other interest-bearing liabilities
Europe
HSBC Bank ...................... 23,196
HSBC Private Banking
Holdings (Suisse) .........
3,545
HSBC France ................... 13,476
4,211
HSBC Finance ..................
1,026
4.42
23,924
547
2.29 30,504
870
2.85
155
488
219
4.37
3.62
5.20
4,247
14,154
5,299
130
220
361
3.06
2,505
1.55 20,117
6.81
4,298
38
601
258
1.52
2.99
6.00
Hong Kong
Hang Seng Bank ...............
The Hongkong and
Shanghai Banking
Corporation ..................
Rest of
The Hongkong and
1,378
64
4.64
1,228
36
2.93
1,161
22
1.89
8,140
365
4.48
6,981
221
3.17
10,495
171
1.63
Asia-Pacific
North America
Shanghai Banking
Corporation .................. 13,425
235
1,046
HSBC Bank Malaysia ......
HSBC Bank Middle East .
629
9
63
4.69
3.83
6.02
HSBC Bank USA ............ . 11,966
1,134
HSBC Bank Canada .........
2,883
HSBC Markets Inc ...........
1,211 10.12
1.94
3.05
22
88
Latin America
HSBC Mexico ..................
Brazilian operations1 ........
HSBC Bank Argentina .....
135
817
79
8
5.93
105 12.85
10 12.66
13,725
137
767
13,287
856
4,718
1,258
2,264
35
460
4
23
3.35
2.92
3.00
12,972
195
407
1,332 10.02 12,618
1.40
938
2.56 12,652
12
121
2.38
30
3.80
86
4 11.43
195
565
319
228
3
20
324
20
460
15
47
3
1.76
1.54
4.91
2.57
2.13
3.64
7.69
8.32
0.94
Other operations .............................................. (68,331)
(3,804)
(62,593)
(2,958)
(64,040)
(1,301)
17,335
658
3.80
30,287
629
2.08 45,901
1,779
3.88
For footnotes, see page 156.
152
Year ended 31 December
Average
balance
US$m
2006
Interest
expense
US$m
2005
2004
Cost
Average
balance
% US$m
Interest
expense
US$m
Cost
Average
balance
% US$m
Interest
expense Cost
%
US$m
331,148
11,788
3.56
278,131
9,087
3.27 253,275
6,371
2.52
29,921
80,044
4,759
1,257
2,759
251
4.20
3.45
5.27
25,041
71,115
8,667
772
1,732
470
3.08
21,290
2.44 80,601
8,152
5.42
442
2,136
421
2.08
2.65
5.16
59,298
1,924
3.24
56,087
1,024
1.83
54,056
357
0.66
115,326
3,424
2.97
105,907
1,659
1.57 117,404
1,038
0.88
84,451
8,146
3,216
243
3.81
2.98
74,218
7,070
2,236
182
3.01
2.57
64,415
6,298
1,443
163
2.24
2.59
Total interest-bearing liabilities
Europe
Hong Kong
Rest of
Asia-Pacific
HSBC Bank ....................
HSBC Private Banking
Holdings (Suisse) .......
HSBC France .................
HSBC Finance ................
Hang Seng Bank .............
The Hongkong and
Shanghai Banking
Corporation ................
The Hongkong and
Shanghai Banking
Corporation ................
HSBC Bank Malaysia ....
HSBC Bank Middle
East .............................
13,212
497
3.76
10,351
289
2.79
7,489
103
1.38
North America
Latin America
HSBC Bank USA ...........
HSBC Finance ................
HSBC Bank Canada .......
HSBC Markets Inc .........
HSBC Mexico ................
Brazilian operations1 ......
HSBC Bank Argentina ...
117,416
142,270
38,547
2,883
14,790
17,437
1,134
5,432
6,924
1,354
88
4.63
4.87
3.51
3.05
552
3.73
2,332 13.37
4.94
56
105,339
116,164
31,380
4,718
15,165
14,810
1,056
4,088
4,933
789
121
80,389
3.88
4.25 112,973
25,516
2.51
28,563
2.56
1,454
2,964
544
701
1.81
2.62
2.13
2.45
573
3.78
2,137 14.43
3.88
41
15,832
7,626
1,453
574
3.63
1,010 13.24
3.17
46
Other operations ............................................
6,864
(703)
(17,224)
(1,373)
(6,174)
(396)
1,067,646
41,393
3.88
907,995
28,760
3.17 879,158
19,371
2.20
Summary
Total interest-margin liabilities ..................... 1,067,646
Trading liabilities............................................
224,050
Financial liabilities designated at fair value
(excluding own debt issued) .....................
Non-interest-bearing current accounts ..........
Total equity and other non-interest-bearing
liabilities ........................................................
12,537
71,744
313,590
41,393
9,842
3.88
4.39
907,995
211,059
28,760
5,024
3.17 879,158
2.38
19,371
2.20
9,787
65,509
307,590
56,043
314,140
Total equity and liabilities ............................. 1,689,567
51,235
3.03 1,501,940
33,784
2.25 1,249,341
19,371
1.55
Net interest margin
Year ended 31 December
Europe
HSBC Bank ...................................................................
HSBC Private Banking Holdings (Suisse) ....................
HSBC France .................................................................
HSBC Finance ...............................................................
Hong Kong
Hang Seng Bank ............................................................
The Hongkong and Shanghai Banking Corporation .....
Rest of Asia-Pacific The Hongkong and Shanghai Banking Corporation .....
HSBC Bank Malaysia ...................................................
HSBC Bank Middle East ..............................................
North America
Latin America
HSBC Bank USA ..........................................................
HSBC Finance ...............................................................
HSBC Bank Canada ......................................................
HSBC Mexico ...............................................................
Brazilian operations1 .....................................................
HSBC Bank Argentina ..................................................
Other operations (including consolidation adjustments) ...................................
For footnotes, see page 156.
153
2006
%
2.09
1.15
0.80
5.92
2.43
2.29
2.16
3.22
3.76
1.95
6.84
2.36
7.92
11.78
7.24
0.04
3.10
2005
%
2.08
1.03
1.30
5.79
2.19
2.20
2.00
2.80
3.46
2.31
6.97
2.40
7.65
11.44
7.87
0.20
3.14
2004
%
2.41
0.82
1.44
6.99
2.08
1.74
1.96
2.56
3.69
2.90
8.74
2.41
5.82
13.29
5.18
0.03
3.19
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Other financial information > Changes in net interest income
Analysis of changes in net interest income
The following table allocates changes in net interest
income between volume and rate for 2006 compared
with 2005, and for 2005 compared with 2004.
Changes due to a combination of volume and rate,
and the effect of reclassifying items on the adoption
of IAS 32 and IAS 39 at 1 January 2005, are
allocated to rate.
Interest income
Short-term funds and loans and advances to banks
2006 compared with 2005
Increase/(decrease)
2006 Volume
US$m
US$m
Rate
US$m
2005 compared with 2004
Increase/(decrease)
Volume
US$m
2005
US$m
Rate
US$m
1,536
425
Banking Corporation ..............
1,645
Europe
Hong Kong
Rest of
Asia-Pacific
HSBC Bank .................................
HSBC Private Banking
Holdings (Suisse) ....................
HSBC France ..............................
Hang Seng Bank ..........................
The Hongkong and Shanghai
The Hongkong and Shanghai
Banking Corporation ..............
HSBC Bank Malaysia .................
HSBC Bank Middle East ............
North America
HSBC Bank USA ........................
HSBC Bank Canada ....................
Latin America
HSBC Mexico .............................
Brazilian operations1 ...................
HSBC Bank Argentina ................
Other operations ........................................................
Trading assets ..........................................................
Loans and advances to customers
Europe
Hong Kong
Rest of
Asia-Pacific
North America
Latin America
HSBC Bank .................................
HSBC Private Banking
Holdings (Suisse) ....................
HSBC France ..............................
HSBC Finance .............................
Hang Seng Bank ..........................
The Hongkong and Shanghai
The Hongkong and Shanghai
Banking Corporation ..............
HSBC Bank Malaysia ..................
HSBC Bank Middle East ............
HSBC Bank USA ........................
HSBC Finance .............................
HSBC Bank Canada ....................
HSBC Mexico .............................
Brazilian operations1 ...................
HSBC Bank Argentina ................
Other operations ........................................................
For footnotes, see page 156.
190
690
483
520
87
208
465
138
227
572
8
627
338
2,463
671
1,952
3,449
430
957
6,141
17,061
2,037
1,532
3,244
107
1,620
Banking Corporation ..............
2,843
42
77
82
54
52
20
35
204
31
31
141
(2)
55
337
35
226
113
774
113
387
288
(64)
169
32
(339)
(7)
(8)
(234)
74
533
1,058
167
353
117
18
62
110
45
(32)
(134)
3
116
351
49
111
151
62
228
565
7
456
54
11
29
30
(1)
(47)
164
–
(76)
(5)
99
2
53
65
18
48
164
4
203
968
7,396
1,162
1,634
4,600
2004
US$m
669
89
960
221
538
198
36
29
56
45
227
237
3
329
3,637
3,023
14,166
1,378
565
12,223
1,817
885
9,521
49
449
(438)
61
156
314
55
172
114
3,278
331
389
716
(10)
(309)
78
304
23
568
626
476
50
150
433
476
267
(67)
(119)
(5)
577
211
1,710
1,086
1,323
2,061
2,659
325
635
5,594
13,307
1,439
1,210
2,647
122
1,352
27
(8)
77
47
70
478
25
147
1,197
439
286
205
879
1
(266)
69
(174)
(46)
394
115
1,892
1,055
882
585
1,406
400
22
70
1,461
(278)
54
127
241
20
505
1,781
278
418
2,936
13,146
1,099
878
1,527
101
1,113
59,011
5,756
5,351
47,904
5,230
4,526
38,148
154
2004
US$m
824
303
240
507
779
537
40
27
884
166
65
395
128
12
564
412
27
526
14
39
95
2
23
74
8
48
57
8
2006 compared with 2005
Increase/(decrease)
2006 Volume
US$m
US$m
Rate
US$m
2005 compared with 2004
Increase/(decrease)
Volume
US$m
2005
US$m
Rate
US$m
Financial investments
Europe
Hong Kong
HSBC Bank .................................
HSBC Private Banking
Holdings (Suisse) ....................
HSBC France ..............................
Hang Seng Bank ..........................
The Hongkong and Shanghai
1,977
391
95
1,224
251
0
(62)
134
Banking Corporation ..............
911
(286)
Rest of
The Hongkong and Shanghai
Asia-Pacific
North America
Latin America
Banking Corporation ..............
HSBC Bank Malaysia .................
HSBC Bank Middle East ............
HSBC Bank USA ........................
HSBC Finance .............................
HSBC Bank Canada ....................
HSBC Mexico .............................
Brazilian operations1 ...................
HSBC Bank Argentina ................
737
36
72
1,109
200
174
427
501
38
Other operations ........................................................
1,212
9,104
81
(8)
3
133
(12)
12
(110)
214
10
367
538
429
1,297
487
(14)
49
14
275
273
64
3
25
112
(9)
46
(46)
(37)
5
(36)
342
143
815
924
592
41
44
864
221
116
583
324
23
881
(59)
(85)
61
98
(12)
247
(99)
244
(27)
1
5
51
(8)
26
121
225
3
9
82
–
12
(71)
63
25
67
(29)
8
308
Deposits by banks
Europe
Hong Kong
HSBC Bank .................................
HSBC Private Banking
Holdings (Suisse) ....................
HSBC France ..............................
Hang Seng Bank ..........................
The Hongkong and Shanghai
Banking Corporation ..............
Rest of
The Hongkong and Shanghai
Asia-Pacific
Banking Corporation ..............
HSBC Bank Malaysia ..................
HSBC Bank Middle East ............
North America
HSBC Bank USA ........................
HSBC Bank Canada ....................
Latin America
HSBC Mexico .............................
Brazilian operations1 ...................
HSBC Bank Argentina ................
Other operations ........................................................
For footnotes, see page 156.
1,356
7,210
387
1,352
5,471
1,311
5
269
1,037
87
538
33
886
84
125
246
9
23
208
68
50
101
5
351
3
170
5
(23)
44
1
(13)
(26)
22
(18)
(30)
(3)
90
10
134
18
32
34
3
9
32
12
(2)
6
–
50
20
582
61
116
168
5
27
202
34
70
125
8
211
(10)
(100)
24
4
40
3
(5)
8
11
7
28
(2)
3
156
23
73
33
–
9
120
15
15
40
2
(133)
138
206
3,500
251
583
2,666
(38)
1,165
1,539
155
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Other financial information > Changes in net interest income / Share capital and reserves
Interest expense
Customer accounts
2006 compared with 2005
Increase/(decrease)
2006 Volume
US$m
US$m
Rate
US$m
Europe
Hong Kong
HSBC Bank .................................
HSBC Private Banking
Holdings (Suisse) ....................
HSBC France ..............................
Hang Seng Bank ..........................
The Hongkong and Shanghai
7,031
1,069
752
1,712
987
170
(24)
48
685
277
165
790
Banking Corporation ..............
2,934
123
1,489
1,322
Rest of
The Hongkong and Shanghai
Asia-Pacific
Banking Corporation ..............
HSBC Bank Malaysia .................
HSBC Bank Middle East ............
North America
HSBC Bank USA ........................
HSBC Bank Canada ....................
Latin America
HSBC Mexico .............................
Brazilian operations1 ...................
HSBC Bank Argentina ................
1,903
212
411
2,490
804
471
2,056
41
Other operations ........................................................
1,845
205
29
72
233
80
122
706
2
171
405
26
132
872
249
161
(509)
11
401
1,293
157
207
1,385
475
188
1,859
28
1,273
2005 compared with 2004
Increase/(decrease)
Volume
US$m
2005
US$m
Rate
US$m
2004
US$m
5,359
411
962
3,986
622
611
874
56
64
3
12
133
10
27
103
66
(97)
728
–
(190)
189
(28)
581
918
269
(4)
120
602
58
(92)
289
1
545
377
575
290
392
891
151
60
680
351
377
842
27
918
Financial liabilities designated at fair value –
own debt issued
Debt securities in issue
Europe
Hong Kong
HSBC Bank .................................
HSBC France ..............................
HSBC Finance .............................
Hang Seng Bank ..........................
The Hongkong and Shanghai
Banking Corporation ..............
Rest of
The Hongkong and Shanghai
Asia-Pacific
Banking Corporation ..............
HSBC Bank Malaysia ..................
North America
Latin America
HSBC Bank USA ........................
HSBC Finance .............................
HSBC Bank Canada ....................
HSBC Mexico .............................
Brazilian operations1 ...................
HSBC Bank Argentina ................
23,731
2,442
5,636
15,653
670
5,066
9,917
3,160
227
896
2,037
2,047
633
32
64
–
438
13
1,407
5,047
460
23
70
–
1,095
122
(64)
3
–
71
(6)
138
1,633
89
(270)
50
(1)
(49)
(865)
197
19
8
–
52
3
196
15
103
8
(47)
–
69
61
1,817
314
77
53
–
315
16
1,073
3,399
268
285
67
1
90
96
(53)
(9)
6
618
(67)
(77)
17
(437)
–
52
10
487
(689)
54
38
7
(6)
(146)
34
(2)
210
1,337
49
113
(5)
–
2
1,103
434
163
30
437
229
8
376
2,751
165
134
65
7
234
7,775
(857)
2,496
6,136
Other operations ........................................................
110
10,344
2,508
Footnotes to ‘Average balance sheet and net interest income’ and ‘Analysis of changes in net
interest income’.
1 Brazilian operations comprise HSBC Bank Brasil S.A.-Banco Múltiplo and subsidiaries, plus HSBC Serviços e Participações Limitada.
2 Interest income on trading assets is reported as ‘Net trading income’ in the consolidated income statement in 2005 and 2006.
3 Interest income on financial assets designated at fair value is reported as ‘Net income from financial instruments designated at fair
value’ in the consolidated income statement.
4 This table analyses interest-bearing bank deposits only. See page 160 for an analysis of all bank deposits.
5 This table analyses interest-bearing customer accounts only. See page 161 for an analysis of all customer accounts.
6 Interest expense on financial liabilities designated at fair value is reported as ‘Net income on financial liabilities designated at fair
value’ in the consolidated income statement other than interest on own debt.
156
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) In 2004 ‘Loans accounted for on a non-accrual basis’ and ‘Loans on which interest has been accrued but suspended’ were included in
‘Loans and advances to banks’ and ‘Loans and advances to customers’. Interest income on such loans was included in the
consolidated income statement to the extent to which it had 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) In 2004 non-equity minority interests were included within shareholders’ equity and other non interest-bearing liabilities and the
related coupon payments were included within ‘Profit attributable to minority interests’.
Share capital and reserves
The following events in relation to the share capital
of HSBC Holdings occurred during the year:
Ordinary shares of US$0.50 each
Scrip dividends
1. 24,184,953 ordinary shares were issued at par
on 19 January 2006 to shareholders who elected
to receive new shares in lieu of the third interim
dividend for 2005. The market value per share
used to calculate shareholders’ entitlements to
new shares was US$16.2150, being the
US dollar equivalent of £9.40.
2. 91,685,145 ordinary shares were issued at par
on 11 May 2006 to shareholders who elected to
receive new shares in lieu of the fourth interim
dividend for 2005. The market value per share
used to calculate shareholders’ entitlements to
new shares was US$16.8175, being the US
dollar equivalent of £9.621.
3. 14,090,830 ordinary shares were issued at par
on 6 July 2006 to shareholders who elected to
receive new shares in lieu of the first interim
dividend for 2006. The market value per share
used to calculate shareholders’ entitlements to
new shares was US$17.5938, being the
US dollar equivalent of £9.346.
4. 28,617,819 ordinary shares were issued at par
on 4 October 2006 to shareholders who elected
to receive new shares in lieu of the second
interim dividend for 2006. The market value per
share used to calculate shareholders’
entitlements to new shares was US$17.9844,
being the US dollar equivalent of £9.51.
All-Employee share plans
5. 25,334,998 ordinary shares were issued at prices
ranging from £5.3496 to £7.6736 and
926 ordinary shares were issued at
HK$103.4401 per share in connection with the
157
exercise of options under the HSBC Holdings
savings-related share option plans. Options over
7,870,495 ordinary shares lapsed.
6. 2,533,496 ordinary shares were issued at
€11.3921 per share and 502,454 ordinary shares
were issued at €12.8161 per share in connection
with a Plan d’Epargne Entreprise for the benefit
of non-UK resident employees of HSBC France
and its subsidiaries.
7. Options over 22,626,714 ordinary shares were
granted at nil consideration on 26 April 2006 to
over 52,900 HSBC employees resident in nearly
60 countries and territories under the HSBC
Holdings savings-related share option plans.
Discretionary share incentive plans
8. 9,767,102 ordinary shares were issued at prices
ranging from £3.3334 to £7.7984 per share in
connection with the exercise of options under
the HSBC Holdings Executive Share Option
Scheme. Options over 450,801 ordinary shares
lapsed.
9. 37,817,808 ordinary shares were issued at prices
ranging from £6.91 to £9.642 per share in
connection with the exercise of options under
the HSBC Holdings Group Share Option Plan.
Options over 5,536,526 ordinary shares lapsed.
HSBC Finance
10. 3,424,742 ordinary shares were issued at
US$9.60 per share in connection with the early
settlement and maturity of HSBC Finance
8.875 per cent Adjustable Conversion-Rate
Equity Security Units.
11. 643,520 ordinary shares were issued at prices
ranging from US$16.06 to US$18.79 per share
in connection with the vesting of Restricted
Stock Rights under HSBC Finance share plans
that have been converted into rights over HSBC
Holdings ordinary shares.
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Other financial information > Share capital and reserves / Short term borrowings / Contractual obligations / Loan maturity
Authority to repurchase ordinary shares
12. At the Annual General Meeting in 2006,
shareholders renewed the authority for the
Company to make market repurchases of up to
1,137,200,000 ordinary shares. The Directors
have not exercised this authority. In accordance
with the terms of a waiver granted by the Hong
Kong Stock Exchange on 19 December 2005,
HSBC Holdings will comply with the applicable
law and regulation in the UK in relation to the
holding of any shares in treasury and with the
conditions of the waiver, in connection with any
shares it may hold in treasury.
Authority to allot shares
13. At the Annual General Meeting in 2006
shareholders renewed the authority for the
Directors to allot new shares. The authority was
to allot up to 2,274,400,000 ordinary shares,
10,000,000 non-cumulative preference shares of
£0.01 each, 8,550,000 non-cumulative
preference shares of US$0.01 each and
10,000,000 non-cumulative preference shares of
€0.01 each.
Other than as described in paragraphs 1 to 6 and
8 to 11 above, the Directors did not allot any
shares during 2006.
Short-term borrowings
HSBC includes short-term borrowings within
customer accounts, deposits by banks and debt
securities in issue and does not show short-term
borrowings separately on the balance sheet. Short-
term borrowings are defined by the US Securities
and Exchange Commission (‘SEC’) as Federal funds
purchased and securities sold under agreements to
repurchase, commercial paper and other short-term
borrowings. HSBC’s only significant short-term
borrowings are securities sold under agreements to
repurchase and certain debt securities in issue.
Additional information on these is provided in the
tables below.
Year ended 31 December
Securities sold under agreements to repurchase
Outstanding at 31 December ...........................................................................
Average amount outstanding during the year .................................................
Maximum quarter-end balance outstanding during the year ..........................
Weighted average interest rate during the year ...............................................
Weighted average interest rate at the year-end ...............................................
Short term bonds
Outstanding at 31 December ...........................................................................
Average amount outstanding during the year .................................................
Maximum quarter-end balance outstanding during the year ..........................
Weighted average interest rate during the year ...............................................
Weighted average interest rate at the year-end ...............................................
Contractual obligations
2006
US$m
97,139
102,715
109,689
4.3%
4.6%
37,906
37,729
38,907
5.1%
4.8%
2005
US$m
75,745
74,143
78,590
3.6%
4.0%
40,642
31,908
40,642
4.6%
3.7%
2004
US$m
43,726
46,229
53,188
2.7%
2.9%
36,085
29,238
36,085
2.8%
2.5%
The table below provides details of HSBC’s material contractual obligations as at 31 December 2006.
Long-term debt obligations ..........................................
Term deposits and certificates of deposit .....................
Capital (finance) lease obligations ...............................
Operating lease obligations ..........................................
Purchase obligations .....................................................
Short positions in debt securities and equity shares......
Pension obligations .......................................................
Payments due by period
Less than
1 year
US$m
1–5 years
US$m
More than
5 years
US$m
94,334
188,520
41
799
611
55,289
1,153
340,747
120,642
20,819
21
2,311
648
5,948
2,272
152,661
80,358
–
645
1,198
–
10,050
6,188
98,439
Total
US$m
295,334
209,339
707
4,308
1,259
71,287
9,613
591,847
158
Loan maturity and interest sensitivity analysis
At 31 December 2006, the geographical analysis of loan maturity and interest sensitivity by loan type on a
contractual repayment basis was as follows:
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
Loans and advances to customers ......................
Maturity after 1 year but within 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
Loans and advances to customers ......................
Interest rate sensitivity of loans and advances to
banks and commercial loans to customers:
Fixed interest rate ...........................................
Variable interest rate ......................................
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 .
Loans and advances to customers ......................
Interest rate sensitivity of loans and advances to
banks and commercial loans to customers
Fixed interest rate ...........................................
Variable interest rate ......................................
Hong
Kong
US$m
Rest
of Asia-
Pacific
US$m
Europe
US$m
North
Latin
America
America
US$m
US$m
Total
US$m
74,381
50,306
26,913
17,673
9,974
179,247
67,619
17,021
35,616
1,256
37,976
159,488
–
37,027
196,515
270,896
12,560
6,442
1,221
265
2,059
22,547
451
10,791
33,789
84,095
20,839
4,210
2,071
1,114
5,220
33,454
–
11,107
44,561
71,474
4,098
7,309
11,105
115
8,025
30,652
–
49,495
80,147
97,820
6,378
1,128
1,095
486
2,371
11,458
–
7,298
18,756
28,730
111,494
36,110
51,108
3,236
55,651
257,599
451
115,718
373,768
553,015
2,066
53
250
166
135
2,670
3,992
9,034
348
286
2,629
3,867
3,875
797
491
2,542
5,662
7,867
932
81
2,070
16,289
11,572
16,612
2,916
798
486
2,548
1,238
7,986
–
4,088
12,074
12,209
4,036
4,085
8,121
35,909
32,976
5,947
3,814
18,088
96,734
1,410
116,672
214,816
217,486
19,751
79,653
99,404
–
54,970
71,582
71,748
3,299
13,479
16,778
26
2,525
3,295
1,244
3,537
221
24
733
5,759
–
127,746
133,505
133,531
1,301
4,484
5,785
743
224
52
909
513
2,441
–
3,909
6,350
8,875
857
4,109
4,966
14,706
18,445
2,149
1,940
13,992
51,232
2,217
239,678
293,127
296,422
12,191
42,335
54,526
–
8,255
19,827
20,077
2,195
9,627
11,822
354
490
908
58
311
929
2,696
–
11,391
14,087
14,441
1,078
1,972
3,050
19,472
11,402
3,384
408
9,609
44,275
–
42,271
86,546
88,612
10,142
36,199
46,341
1,410
7,088
24,787
24,840
79
16,263
16,342
390
–
11,936
9,848
1,055
696
10,129
33,664
–
79,450
113,114
113,504
8,925
25,129
34,054
293
3,928
763
–
1,688
6,672
2,217
17,182
26,071
26,071
30
6,641
6,671
159
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Other financial information > Deposits
Deposits
The following tables analyse the average amount of bank deposits, 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.
2006
Average
balance
Average
Deposits by banks
Europe
Demand and other – non-interest
bearing ................................................
Demand – interest bearing .....................
Time ........................................................
Other .......................................................
Hong Kong
Demand and other – non-interest
bearing ................................................
Demand – interest bearing .....................
Time ........................................................
Other .......................................................
Rest of Asia-Pacific
Demand and other – non-interest
bearing ................................................
Demand – interest bearing .....................
Time ........................................................
Other .......................................................
North America
Demand and other – non-interest
bearing ................................................
Demand – interest bearing .....................
Time ........................................................
Other .......................................................
Latin America
Demand and other – non-interest
bearing ................................................
Demand – interest bearing .....................
Time ........................................................
Other .......................................................
Total
Demand and other – non-interest
bearing ................................................
Demand – interest bearing .....................
Time ........................................................
Other .......................................................
US$m
9,814
8,368
27,447
23,396
69,025
1,031
2,428
2,016
362
5,837
1,618
1,960
3,645
2,157
9,380
767
3,033
3,543
699
8,042
702
96
1,732
683
3,213
13,932
15,885
38,383
27,297
95,497
rate
%
–
3.7
4.0
3.5
–
4.6
4.3
3.3
–
2.4
4.8
4.5
–
5.3
5.4
5.6
–
6.3
5.5
9.4
–
4.5
4.5
3.9
Year ended 31 December
2005
Average
balance
Average
rate
US$m
%
14,252
9,418
28,021
16,111
67,802
2,054
3,104
2,012
218
7,388
2,164
1,442
4,375
761
8,742
1,334
3,647
2,406
38
7,425
49
117
1,810
1,075
3,051
19,853
17,728
38,624
18,203
94,408
–
2.9
3.0
3.6
–
3.5
3.2
2.3
–
1.9
4.3
5.4
–
3.6
6.0
5.3
–
7.7
6.4
8.9
–
3.1
3.5
4.1
2004
Average
balance
US$m
Average
rate
%
14,746
9,237
22,029
22,870
68,882
1,752
2,484
1,016
416
5,668
1,641
1,013
4,410
1,146
8,210
1,670
3,025
1,861
4,436
10,992
291
221
1,553
747
2,812
20,100
15,980
30,869
29,615
96,564
–
1.5
2.8
2.5
–
1.2
1.6
1.7
–
2.3
3.1
2.7
–
1.4
3.0
1.8
–
5.4
4.1
5.6
–
1.5
2.9
2.4
160
Customer accounts
Europe
Demand and other – non-interest
bearing ................................................
Demand – interest bearing .....................
Savings ...................................................
Time ........................................................
Other .......................................................
Hong Kong
Demand and other – non-interest
bearing ................................................
Demand – interest bearing .....................
Savings ...................................................
Time ........................................................
Other .......................................................
Rest of Asia-Pacific
Demand and other – non-interest
bearing ................................................
Demand – interest bearing .....................
Savings ...................................................
Time ........................................................
Other .......................................................
North America
Demand and other – non-interest
bearing ................................................
Demand – interest bearing .....................
Savings ...................................................
Time ........................................................
Other .......................................................
Latin America
Demand and other – non-interest
bearing ................................................
Demand – interest bearing .....................
Savings ...................................................
Time ........................................................
Other .......................................................
Total
Demand and other – non-interest
bearing ................................................
Demand – interest bearing .....................
Savings ...................................................
Time ........................................................
Other .......................................................
CDs and other money market instruments
Europe ............................................................
Hong Kong ....................................................
Rest of Asia-Pacific .......................................
North America ...............................................
Latin America ................................................
Year ended 31 December
2005
Average
balance
Average
rate
US$m
%
28,501
146,484
46,248
48,201
10,967
280,401
13,365
91,723
50,281
14,054
15
169,438
11,825
27,721
31,584
10,484
1,895
83,509
13,627
11,723
52,458
21,759
2,549
102,116
–
2.4
3.3
3.9
2.7
–
0.9
2.4
2.7
6.7
–
1.7
3.3
3.5
3.9
–
1.9
1.6
3.6
4.5
5,583
6,341
10,980
2,529
1,429
26,862
–
1.2
15.2
5.6
17.5
72,901
283,992
191,551
97,027
16,855
662,326
27,778
1,599
7,467
19,566
4,657
61,067
–
1.8
3.3
3.7
4.4
5.8
3.1
6.2
3.1
6.4
5.0
2004
Average
balance
US$m
Average
rate
%
37,184
128,249
37,846
47,941
15,167
266,387
13,508
94,629
46,817
12,015
106
167,075
8,592
24,480
27,171
7,597
2,866
70,706
18,735
10,730
51,780
12,267
13,119
106,631
–
2.0
2.5
3.1
2.2
–
0.1
1.0
1.6
4.7
–
1.2
2.9
2.1
1.2
–
1.1
1.3
2.1
1.6
4,201
5,973
7,115
1,973
4,281
23,543
–
1.1
11.5
3.6
7.4
82,220
264,061
170,729
81,793
35,539
634,342
24,684
10,031
6,804
17,224
3,668
62,411
–
1.2
2.2
2.6
2.5
2.6
3.3
4.4
1.8
4.1
2.9
2006
Average
balance
Average
rate
%
–
2.7
3.9
4.2
4.1
–
2.4
3.8
3.6
3.9
–
2.1
4.3
4.5
3.5
–
2.9
2.8
5.4
2.0
–
1.6
11.3
5.9
13.4
–
2.6
4.1
4.5
4.6
US$m
33,000
173,150
50,525
59,374
9,249
325,298
12,362
88,754
58,883
20,454
51
181,153
13,107
29,816
42,153
10,246
2,233
97,555
13,662
14,406
65,216
21,124
3,339
117,747
7,995
5,438
16,512
7,665
2,145
39,757
80,126
311,564
233,289
118,863
17,666
761,510
48,238
1,191
6,621
23,472
318
4.2
3.5
5.6
4.6
10.7
79,840
4.5
161
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Other financial information > Certificates of deposit and other time deposits / Off-balance sheet arrangements
Certificates of deposit and other time deposits
At 31 December 2006, the maturity analysis of certificates of deposit and other wholesale time deposits, by
remaining maturity, was as follows:
Europe
Certificates of deposit ..........................
Time deposits:
– banks ..................................................
– customers ...........................................
Hong Kong
Certificates of deposit ..........................
Time deposits:
– banks ..................................................
– customers ...........................................
Rest of Asia-Pacific
Certificates of deposit ..........................
Time deposits:
– banks ..................................................
– customers ...........................................
North America
Certificates of deposit ..........................
Time deposits:
– banks ..................................................
– customers ...........................................
Latin America
Certificates of deposit ..........................
Time deposits:
– banks ..................................................
– customers ...........................................
Total
Certificates of deposit ..........................
Time deposits:
– banks ..................................................
– customers ...........................................
3 months
or less
US$m
16,471
26,492
58,703
101,666
608
1,312
15,337
17,257
3,916
3,610
9,677
17,203
–
3,792
12,152
15,944
–
1,884
9,282
11,166
20,995
37,090
105,151
163,236
After
3 months
but within
6 months
After
6 months
but within
12 months
US$m
US$m
1,721
3,089
3,684
8,494
738
88
300
1,126
986
1,165
490
2,641
–
255
1,317
1,572
–
492
546
1,038
3,445
5,089
6,337
170
1,611
1,625
3,406
1,999
64
293
2,356
855
109
223
1,187
–
345
1,709
2,054
–
321
1,089
1,410
3,024
2,450
4,939
After
12 months
US$m
Total
US$m
–
18,362
3,227
3,776
7,003
6,701
34
1,227
7,962
299
191
1,800
2,290
–
–
1,669
1,669
389
817
689
1,895
7,389
4,269
9,161
34,419
67,788
120,569
10,046
1,498
17,157
28,701
6,056
5,075
12,190
23,321
–
4,392
16,847
21,239
389
3,514
11,606
15,509
34,853
48,898
125,588
209,339
14,871
10,413
20,819
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.
162
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 41 on the Financial Statements on page 396 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 ‘Other provisions’.
(ii) Commitments to lend
Undrawn credit lines are disclosed in Note 41 on the Financial Statements on page 396. The majority by value of
undrawn credit lines arise from ‘open to buy’ lines on personal credit cards, cheques 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 its principal dealing operations, 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 offsetting credit derivative
contracts with other counterparties.
HSBC manages the credit risk arising on buying and selling credit derivative protection by including the
exposure to any credit risk that arises from such transactions within its overall credit limits structure to the
relevant counterparty. 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.
Credit derivatives are also used for the management of credit risk in the Group’s loan portfolio. HSBC’s use of
credit derivatives in this manner is not significant, however.The following table presents the notional amounts of
credit derivatives protection bought and sold by HSBC:
Notional amount of protection bought .....................................................................................
Notional amount of protection sold .........................................................................................
540,229
569,599
At 31 December
2006
US$m
2005
US$m
249,347
262,393
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.
(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 the balance sheet under IFRSs.
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
163
H S B C H O L D I N G S P L C
Report of the Directors: Financial Review (continued)
Other financial information > Off balance sheet arrangements / Regulation and supervision
party. The cash flows received by SPEs on pools 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 upon initial establishment to ensure appropriate purpose and
governance. 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 or profitability. For a further discussion of HSBC’s involvement with SPEs and
the accounting treatments under IFRSs and US GAAP, see Note 47(j) on the Financial Statements on page 429.
164
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk
Regulation and supervision
Regulation and supervision1 .......................
Risk management1 ......................................
Credit risk ...................................................
Credit risk management2 ........................
Credit exposure3 .....................................
Credit quality3 .........................................
Impairment allowances and charges3 ......
HSBC Holdings2 .....................................
Risk elements in the loan portfolio1 ........
Liquidity and funding management ............
Policies and procedures2 .........................
Primary sources of funding3 ...................
HSBC Holdings2 .....................................
Market risk management ............................
Value at risk3 ..........................................
Trading portfolios2 ..................................
Non-trading portfolios2 ...........................
Sensitivity of net interest income1 ...........
Structural foreign exchange exposures1 .
HSBC Holdings3 .....................................
Residual value risk management1 ...............
Operational risk management1 ...................
Legal litigation risk1 ...............................
Pension risk1 ...............................................
Reputational risk management1 ..................
Sustainability risk management1 ................
Risk management of insurance
Page
165
170
171
171
176
192
197
211
211
213
213
213
215
216
216
218
219
221
223
223
224
225
225
226
227
227
operations2 ..............................................
Life insurance business2 ...........................
Non-life insurance business2 ....................
Insurance risk2 ........................................
Financial risks2 .......................................
Market risk2 .............................................
Credit risk2 ...............................................
Liquidity risk2 .........................................
Present value of in-force long-term
insurance business2 .............................
Capital management and allocation ............
Capital management2 ..............................
Capital measurement and allocation3 .....
Risk-weighted assets by principal
228
228
228
229
233
235
237
240
241
243
243
243
subsidiary1 ............................................
247
1 Unaudited.
2 Audited.
3 Audited where indicated.
Regulation and supervision
(Unaudited)
With 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 (‘FSA’); 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 ADSs,
HSBC Holdings’ shares are registered with the US
Securities and Exchange Commission. As a
consequence of its US listing, HSBC Holdings is
also subject to the reporting and other requirements
of the US Securities Act of 1933, as amended, 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 issued by the Financial Reporting
Council and with the Code on Corporate Governance
Practices in 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: Governance’ on page 248.
HSBC’s operations throughout the world are
regulated and supervised by approximately
510 different central banks and regulatory authorities
in those jurisdictions in which HSBC has offices,
branches or subsidiaries. These authorities impose a
variety of requirements and controls designed to
improve financial stability and the transparency of
financial markets and their contribution to economic
growth. These regulations and controls cover, 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
165
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Regulation and supervision
regulations requiring a specified percentage of local
ownership; and restrictions on investment and other
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 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 introduced a new capital adequacy
framework to replace the 1988 Basel Capital Accord
in the form of a final Accord (commonly known as
‘Basel II’). Details of the EU’s implementation of
Basel II and how this will affect HSBC are set out
on page 244.
UK 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 EU directives
relating to banking, securities, insurance 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 the FSMA. These
include retail banking, life and general insurance,
pensions, mortgages, custody and branch share-
dealing businesses, and treasury and capital markets
activity. 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 243 to 247. The
FSA’s approach to capital requirements for UK
insurers is to require minimum capital to be
166
calculated on two bases. First, firms must calculate
their liabilities on a prudent basis and add a statutory
solvency margin (Pillar 1). Secondly, firms must
calculate their liabilities on a realistic basis then add
to this their own calculation of risk-based capital.
The sum of realistic reserves and risk-based capital
(Pillar 2) is agreed with the FSA. Insurers are
required to maintain capital equal to the higher of
Pillars 1 and 2. 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$3,927) of a claim plus 90 per cent
of any further amount up to £33,000 (US$64,794)
(the maximum amount payable being £31,700
(US$62,241)). Payments under the scheme in respect
of investment business compensation are limited to
100 per cent of the first £30,000 (US$58,903) of a
claim plus 90 per cent of any further amount up to
£20,000 (US$39,269) (the maximum amount
payable being £48,000 (US$94,246)). In addition,
the Financial Services Compensation Scheme has
been extended to cover mortgage advice and
arranging, certain long term and general insurance
products, and the provision of general advice and
arranging services. Differing levels of compensation
limits apply to each of these additional areas.
The EU Savings Directive took effect on 1 July
2005. Under the directive, each member state other
than Austria, Belgium, and Luxembourg is required
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. For a transitional period beginning on
the same date, Austria, Belgium, and Luxembourg
have imposed a withholding tax on such income.
The withholding tax rate is 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. These future conditions
will depend on other key financial centres –
Switzerland, Liechtenstein, San Marino, Andorra and
the US – not exchanging information. These
financial centres and several other European
countries and related offshore territories have also
entered into similar agreements to the Savings
Directive with the EU states.
Hong Kong regulation and supervision
Banking in Hong Kong is subject to the provisions
of the Banking Ordinance (the ‘Banking
Ordinance’), and to the powers, functions and duties
ascribed by the Banking Ordinance to the Hong
Kong Monetary Authority (the ‘HKMA’). The
principal function of the HKMA is to promote the
general stability and effective working of the
banking system in Hong Kong. The HKMA 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 HKMA and the
Financial Secretary with respect to the exercise of
their respective functions under the Banking
Ordinance.
The HKMA has responsibility for authorising
banks, and has discretion to attach conditions to its
authorisation. The HKMA 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 HKMA 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 HKMA requires all authorised
institutions to have adequate systems of internal
control and requires the institutions’ external
167
auditors, upon request, to report on those systems
and other matters such as the accuracy of
information provided to the HKMA. In addition, the
HKMA may from time to time conduct tripartite
discussions with banks and their external auditors.
The HKMA, 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 HKMA has the power to
divest controlling interests in a bank from persons 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 HKMA.
The HKMA 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 HKMA 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 1988 Basel
Capital Accord. 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 the bank’s capital
base to its risk-weighted exposure) of at least 8 per
cent. For banks with subsidiaries, the HKMA is
empowered to require that the ratio be calculated on
a consolidated basis, or on both consolidated and
unconsolidated bases. If circumstances require, the
HKMA is empowered to increase the minimum
capital adequacy ratio (to up to 16 per cent), after
consultation with the bank.
A deposit protection scheme came into force
during 2006 pursuant to the Deposit Protection
Scheme Ordinance. The Scheme only covers
standard deposits held with licensed banks in Hong
Kong subject to a maximum of HK$100,000
(US$12,860).
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
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Regulation and supervision
Kong (the ‘Securities and Futures Ordinance’).
Entities engaging in activities regulated by the
Securities and Futures Ordinance are required to be
licensed. The HKMA is the primary regulator for
banks involved in the securities business, while the
Securities and Futures Commission is the regulator
for non-banking entities.
In Hong Kong, insurance business is regulated
under the Insurance Companies Ordinance and by
the Insurance Authority of Hong Kong (‘IA’). The IA
is responsible for the licensing of insurers and
insurance brokers, although insurance business can
also be licensed by the Confederation of Insurance
Brokers (the ‘CIB’). Separately, insurance agents are
licensed by the Hong Kong Federation of Insurers
(the ‘HKFI’). Both the HKFI and the CIB have
enacted Codes of Conduct for insurance agents and
brokers respectively and can impose sanctions for
misbehaviour or breach.
HSBC Insurance (Asia-Pacific) Holdings
Limited (‘INAH’) is licensed by the IA as an insurer.
The Hongkong and Shanghai Banking Corporation,
which is authorised by the HKFI, acts as an agent for
INAH, and HSBC Insurance Brokers (Asia-Pacific)
Limited act as insurance brokers licensed by the
CIB.
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
Office of the Comptroller of the Currency (‘OCC’)
and the Federal Deposit Insurance Corporation
(‘FDIC’) 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
Company Act of 1956 (the ‘BHCA’). HSBC and
HSBC North America Holdings Inc. (‘HNAH’),
formed to hold all of its North American operations,
are ‘bank holding companies’ by virtue of their
ownership and control of HSBC Bank USA, N.A.
(‘HSBC Bank USA’), HSBC National Bank USA
(‘HSBC Bank Maryland’), and HSBC Trust
Company (Delaware), N.A. (‘HSBC Bank
Delaware’). These three banks are nationally
chartered commercial banks and members of the
Federal Reserve System. HSBC Bank Maryland is a
new bank that opened for business on 30 October
2006. HSBC Bank Delaware opened on 1 July 2005,
as an institution limited to trust activities. On
24 November 2006, having received federal deposit
168
insurance, it expanded to become a full-service
commercial bank. HSBC also owns HSBC Bank
Nevada, N.A. (‘HSBC Bank Nevada’), a nationally
chartered bank limited to credit card activities which
is also a member of the Federal Reserve System.
These four banks are subject to regulation,
supervision and examination by the OCC and, as
their deposits are insured by the FDIC, they are
subject to relevant FDIC regulation. Both HSBC and
HNAH are registered as financial holding companies
(‘FHCs’) under the BHCA, enabling them to offer a
broad range of financial products and services
through their subsidiaries. HSBC’s 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 their US depository
institution subsidiaries, HSBC Bank USA, HSBC
Bank Maryland, HSBC Bank Nevada and HSBC
Bank Delaware, 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. At
31 December 2006, HSBC Bank USA, HSBC Bank
Maryland, HSBC Bank Nevada, HSBC Bank
Delaware and Wells Fargo HSBC Trade Bank, N.A.
were each well capitalised and well managed under
Federal Reserve Board regulations.
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, bank holding company or many other types of
depository institutions and/or their holding
companies without the prior approval of the Federal
Reserve Board and potentially other US banking
regulatory agencies.
The Gramm-Leach-Bliley Act of 1999
(‘GLBA’) and the regulations issued thereunder
contain a number of other provisions that could
affect HSBC’s operations and the operations of all
financial institutions. One such provision relates to
the financial privacy of consumers. In addition, the
so-called ‘push-out’ provisions of GLBA narrow the
exclusion of banks (including HSBC Bank USA,
N.A. from the definitions of ‘broker’ and ‘dealer’
under the Exchange Act of 1934, as amended
(‘Exchange Act’). The SEC has granted a series of
temporary exemptions to delay the required
implementation of these push-out provisions. The
narrowed ‘dealer’ definition took effect in September
2003, and the narrowed ‘broker’ definition is
currently expected to take effect no earlier than July
2007. As a result, it is likely that certain securities
activities currently conducted by HSBC Bank USA
will need to be restructured or transferred to one or
more US-registered broker-dealer affiliates.
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 insured depository institutions (such as
HSBC Bank USA, HSBC Bank Maryland, HSBC
Bank Delaware, HSBC Bank Nevada 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, HSBC Bank Maryland,
HSBC Bank Delaware, HSBC Bank Nevada 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.
The USA Patriot Act (‘Patriot Act’) imposes
significant record keeping and customer identity
requirements, expands the US federal government’s
169
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. Pursuant to the Patriot Act, final
regulations are in effect which impose anti-money
laundering compliance obligations on 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). Many of the anti-money
laundering compliance requirements imposed by the
Patriot Act and these implementing regulations are
generally consistent with the anti-money laundering
compliance obligations existing for banks prior to
the Patriot Act. 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 of the Patriot Act were
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.
If HSBC were to fail to maintain and implement
adequate programmes to combat money laundering
and terrorist financing and to comply with economic
sanctions, or was found to be in breach of relevant
laws and regulations, including by failing to observe
economic sanctions, serious legal and reputational
consequences for the Group could arise.
HSBC takes its obligations to prevent money
laundering and terrorist financing very seriously.
HSBC has policies, procedures and training intended
to ensure that its employees know and understand
HSBC’s criteria for when a client relationship or
business should be evaluated as higher risk. As part
of its continuing evaluation of risk, HSBC monitors
activities relating to Cuba, Iran, Myanmar, North
Korea, Sudan and Syria. HSBC’s business activities
include correspondent banking services to banks
located in some of these countries and private
banking services for nationals of, and clients
domiciled in, some of the above countries. The
Group has a small representative office in Tehran,
Iran.
The US State Department has designated such
countries as state sponsors of terrorism, and US law
generally prohibits US persons from doing business
with such countries. HSBC is aware of initiatives by
governmental entities and institutions in the US to
adopt rules, regulations or policies prohibiting
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Regulation and supervision / Risk management / Credit risk
transactions with or investments in entities doing
business with such countries. HSBC does not believe
its business activities with counterparties in, or
directly relating to, such countries are material to its
business, and such activities represented a very small
part of total assets as of 31 December 2006 and total
revenues for the year ended 31 December 2006.
HSBC’s US insurance agency and underwriting
operations are subject to regulatory supervision
under the laws of the states in which they operate.
Insurance laws and regulations vary from state to
state but generally require forms and rates to be filed
with, and approved by, the state insurance
departments, and cover licensing of insurance
companies; corporate governance; premiums and
loss rates; dividend restrictions; types of insurance
that may be sold; underwriting processes;
permissible investments; reserve requirements; and
insurance advertising and marketing practices. Each
HSBC US insurance subsidiary undergoes periodic
market conduct and financial examinations by the
relevant state insurance departments, and HSBC’s
insurance agencies and agents are subject to state
licensing and registration requirements.
Additionally, with respect to credit insurance,
because it is sold in connection with a loan, state
loan laws often contain requirements related to
offering, cancelling and refunding credit insurance.
Although insurance is not generally regulated by the
federal government, certain federal regulations
related to lending disclosures apply to the sale and
cancellation of credit insurance.
HSBC’s US consumer finance operations are
subject to extensive state-by-state regulation in the
US, and to laws relating to consumer protection
(both in general, and in respect of ‘sub-prime’
lending operations, which have been subject to
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
170
consumer finance lending subsidiary and/or its
control person 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 US Internal Revenue
Code of 1986 and has completed the Qualified
Intermediary Withholding Agreement with the
Internal Revenue Service. Various HSBC operations
outside the US are qualified intermediaries.
Risk management
(Unaudited)
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,
residual value risk, reputational risk, operational
risk, pension risk, insurance risk and sustainability
(environmental or social) risks. Market risk includes
foreign exchange, interest rate and equity price risk.
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
adherence to limits by means of reliable and up-to-
date administrative and information systems. HSBC
regularly reviews its risk management policies and
systems to reflect changes in markets, products and
emerging best practice. Individual responsibility and
accountability, instilled through training, are designed
to deliver a disciplined, conservative and constructive
culture of risk management and control.
The Group Management Board formulates high
level Group risk management policy under authority
delegated by the Board of Directors. A separately
convened Risk Management Meeting of the Group
Management Board monitors risk and receives
reports which allow it to review the effectiveness of
HSBC’s risk management policies.
The management of all risks that are significant
to HSBC is discussed below. Given the distinct
characteristics of the Group’s insurance businesses
the management of their credit, liquidity and market
risk along with insurance risk, is discussed
separately in ‘Risk management of insurance
operations’ section.
Credit risk
Credit risk management
(Audited)
Credit risk is the risk of financial loss if a customer
or counterparty fails to meet an obligation under a
contract. It arises principally from lending, trade
finance, treasury and leasing business. Credit risk
also arises when issuers of debt securities are
downgraded and, as a result, the value of HSBC’s
holdings of assets falls. HSBC has standards,
policies and procedures dedicated to controlling and
monitoring risk from all such activities.
Within Group Head Office, a specialised
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. Its responsibilities
include the following:
• Formulating Group credit policies and
•
monitoring compliance with them. These
policies are embodied in the HSBC standards
with which all HSBC’s operating companies are
required to comply, and consistent with which
they must formulate and record in instruction
manuals their detailed credit policies and
procedures.
Issuing policy guidelines to HSBC’s operating
companies on the Group’s attitude toward, and
appetite for, credit risk exposure to specified
market sectors, activities and banking products.
Each HSBC operating company and major
business unit is required to base its own lending
guidelines on HSBC’s standards, to regularly
update them and disseminate them to its credit
and lending executives. Group Credit and Risk
controls HSBC’s exposures to the automotive
and hedge fund sectors, and closely monitors
exposures to others such as real estate and
securities houses. When necessary, restrictions
are imposed on new business or exposures in
HSBC’s operating companies are capped.
• Undertaking an independent review and
objective assessment of risk. Group Credit and
Risk assesses all commercial non-bank credit
facilities and exposures – including those
embedded in derivatives – that are originated,
renewed or reviewed by HSBC’s operating
171
companies in excess of designated limits, prior
to the facilities being committed to customers or
transactions being undertaken. Operating
companies may not confirm credit approval
without this concurrence.
• Monitoring the performance and management of
retail portfolios across the Group and reviewing
whether any adverse trends are being managed
appropriately by Group businesses.
• Controlling centrally exposures to sovereign
entities, banks and other financial institutions.
HSBC’s credit and settlement risk limits to
counterparties in these sectors are approved
centrally and globally managed by a dedicated
unit within Group Credit and Risk, to optimise
the use of credit availability and avoid excessive
risk concentration.
• Managing exposures to debt securities by
establishing controls in respect of the liquidity
of securities held for trading purposes and
setting issuer limits for securities not held for
trading. Separate portfolio limits are established
for asset-backed securities and similar
instruments.
• Maintaining HSBC’s policy on large credit
exposures, controlling these to ensure that
exposure to any individual counterparty or
group of closely related counterparties, or to
individual geographic areas or industry sectors,
does not become excessive in relation to the
Group’s capital base and is kept within internal
and regulatory limits. The approach is designed
to be more conservative than internationally
accepted regulatory standards. A dedicated unit
within Group Credit and Risk manages this
process, and also monitors HSBC’s intra-Group
exposures to ensure that they are maintained
within regulatory limits. The FSA has
announced changes to the regime for managing
intra-Group exposures, which will operate by
reference to a ‘UK Integrated Group’ and a
‘Wider Integrated Group’. HSBC is developing
plans to adopt the new regime in accordance
with the FSA’s transition timetable.
• Controlling cross-border exposures, 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.
• Maintaining and developing HSBC’s risk
ratings in order to categorise exposures
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Credit risk management
meaningfully and facilitate focused management
of the attendant risks. Historically, HSBC’s risk
rating framework has consisted of a minimum of
seven grades, taking into account the risk of
default and the availability of security or other
credit risk mitigation. A more sophisticated risk-
rating framework for banks and other customers,
based on default probability and loss estimates
and comprising up to 22 categories, is now used
in all major business units for the credit
assessment of individually significant
customers. It is increasingly being used for
credit portfolio reporting at subsidiary level;
work continues on integrating the framework
into reporting structures to enable Board and
external reporting on the new basis in 2008.
This approach allows a more granular analysis
of risk and trends. Rating 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 risk-rating processes are
increasingly in use, for the larger facilities
ultimate responsibility for setting risk grades
rests in each case with the final approving
executive.
• 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 senior executives on aspects of the
HSBC credit risk portfolio. These executives, as
well as the Risk Management Meeting, the
Group Audit Committee and the Board of
Directors of HSBC Holdings, receive a variety
of regular reports covering:
–
–
–
–
–
–
–
risk concentrations and exposure to market
sectors;
large customer group exposures;
retail portfolio performance on a regional
basis;
specific segments of the portfolio, e.g. real
estate, banks, and the automotive and hedge
fund sectors, as well as ad hoc reviews;
emerging market debt and impairment
allowances;
large impaired accounts and impairment
allowances;
country limits, cross-border exposures and
impairment allowances; and
172
–
causes of unexpected loss and lessons to be
learned.
• Managing and directing credit risk management
systems initiatives. HSBC has a centralised
database of large corporate, sovereign and bank
facilities and is constructing a database covering
all the Group’s credit assets. A systems-based
credit application process for bank lending is
operational throughout the Group and an
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;
risk modelling;
collective impairment allowances;
new products;
training courses; and
credit risk reporting.
• Acting on behalf of HSBC Holdings as the
primary interface, for credit-related issues, with
external parties including the Bank of England,
the 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 Credit
Officer or Chief Risk Officer who reports to the local
Chief Executive Officer on credit-related issues and
has 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 retail product segments.
Special attention is paid to problem loans. When
appropriate, specialist units are established by
HSBC’s operating companies to provide customers
with support in order to help them avoid default
wherever possible.
Periodic risk-based audits of operating
companies’ credit processes and portfolios are
undertaken by HSBC’s Internal Audit function.
Audits include a 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; a consideration
of any oversight or review work performed by Credit
and Risk functions; review of model validation
procedures; review of management objectives and a
check that Group and local standards and policies are
adhered to in the granting and management of credit
facilities. Individual accounts are reviewed on a
sample basis to ensure that risk grades are
appropriate, that credit and collection procedures
have been properly followed and that, when an
account or portfolio evidences deterioration,
impairment allowances are raised in accordance with
the Group’s established processes. Internal Audit
discusses with management risk ratings it considers
to be inappropriate; its subsequent recommendations
for revised grades must then normally be adopted.
Collateral and other credit enhancements
(Audited)
Loans and advances
It is HSBC’s policy to establish that loans are within
the customer’s capacity to repay, rather than to rely
excessively on security. Depending on the
customer’s standing and the type of product,
facilities may be unsecured. Nevertheless, collateral
can be an important mitigant of credit risk.
When appropriate, operating companies are
required to implement guidelines on the acceptability
of specific classes of collateral or credit risk
mitigation, and determine suitable valuation
parameters. Such parameters are expected to be
conservative, reviewed regularly and supported by
empirical evidence. Security structures and legal
covenants are required to be subject to regular
review to ensure that they continue to fulfil their
intended purpose and remain in line with local
market practice. The principal collateral types are as
follows:
•
•
in the personal sector, mortgages over
residential properties;
in the commercial and industrial sector, charges
173
•
•
•
over business assets such as premises, stock and
debtors;
in the commercial real estate sector, charges
over the properties being financed;
in the financial sector, charges over financial
instruments such as debt securities and equities
in support of trading facilities; and
credit derivatives are also used to manage credit
risk in the Group’s loan portfolio, but are not
significant.
Other financial assets
Collateral held as security for financial assets other
than loans and advances is determined by the nature
of the instrument. Debt securities, treasury and other
eligible bills are generally unsecured with the
exception of asset backed securities and similar
instruments, which are secured by pools of financial
assets.
The ISDA Master Agreement is HSBC’s
preferred agreement for documenting derivatives
activity. It provides the contractual framework
within which dealing activity across a full range of
over-the-counter products is conducted, and
contractually binds both parties to apply close-out
netting across all outstanding transactions covered
by an agreement if either party defaults or other pre-
agreed termination events occur. It is common, and
HSBC’s preferred practice, for the parties to execute
a Credit Support Annex (‘CSA’) in conjunction with
the ISDA Master Agreement. Under a CSA,
collateral is passed between the parties to mitigate
the market-contingent counterparty risk inherent in
the outstanding positions.
Settlement risk arises in any situation where a
payment in cash, securities or equities is made in the
expectation of a corresponding receipt in cash,
securities or equities. Daily settlement limits are
established for each counterparty to cover the
aggregate of all settlement risk arising from HSBC’s
investment banking and markets transactions on any
single day. Settlement risk on many transactions,
particularly those involving securities and equities, is
substantially mitigated when effected via assured
payment systems, or on a delivery versus payment
basis.
Credit quality of loans and advances
(Audited)
HSBC’s credit risk rating processes are designed to
highlight exposures which require closer
management attention because of their greater
probability of default and potential loss. Risk ratings
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Credit risk management
are reviewed regularly and amendments, where
necessary, are implemented promptly.
The credit quality of unimpaired loans is
assessed by reference to the Group’s standard credit
rating system.
Grades 1 and 2 include corporate facilities
demonstrating financial condition, risk factors and
capacity to repay that are good to excellent,
residential mortgages with low to moderate loan to
value ratios and other retail accounts which are
maintained within product guidelines.
Grade 3 represents satisfactory risk, and
includes corporate facilities that require closer
monitoring, mortgages with higher loan to value
ratios, credit card exposures and other retail
exposures which operate outside product guidelines
without being impaired.
Grades 4 and 5 include facilities that require
varying degrees of special attention and all retail
exposures that are progressively between 30 and 90
days past due.
Grades 6 and 7 relate to impaired loans and
advances.
Impaired loans and advances
For individually assessed accounts, loans are treated
as impaired as soon as there is objective evidence
that an impairment loss has been incurred. The
criteria used by HSBC to determine that there is such
objective evidence include, inter alia:
•
•
•
•
•
known cash flow difficulties experienced by the
borrower;
overdue contractual payments of either principal
or interest;
breach of loan covenants or conditions;
the probability that the borrower will enter
bankruptcy or other financial realisation; and
a significant downgrading in credit rating by an
external credit rating agency.
For accounts in portfolios of homogeneous
loans, impairment allowances are calculated on a
collective basis, as set out below.
Impairment assessment
(Audited)
It is HSBC’s policy that each operating company
make allowance for impaired loans promptly and on
a consistent basis.
Management regularly evaluates the adequacy
of the established allowances for impaired loans by
174
conducting a detailed review of the loan portfolio,
comparing performance and delinquency statistics
with historical trends and assessing the impact of
current economic conditions.
Two types of impairment allowance are in place:
individually assessed and collectively assessed.
These are discussed below.
Individually assessed impairment allowances
These are determined by evaluating the exposure to
loss, case by case, on all individually significant
accounts and all other accounts that do not qualify
for the collective assessment approach outlined
below. In determining allowances on individually
assessed accounts, the following factors are
considered:
• HSBC’s aggregate exposure to the customer;
•
•
•
•
•
•
•
•
the viability of the customer’s business model
and their capacity to trade successfully out of
financial difficulties, generating sufficient cash
flow to service debt obligations;
the ability of the borrower to obtain, and make
payments in, the currency of the loan if not
denominated in local currency;
the amount and timing of expected receipts and
recoveries;
the extent of other creditors’ commitments
ranking ahead of, or pari passu with, HSBC 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 realisable value of security (or other credit
mitigants) and likelihood of successful
repossession;
the likely dividend available on liquidation or
bankruptcy;
the likely deduction of any costs involved in
recovering amounts outstanding, and
• when available, the secondary market price of
the debt.
Group policy requires the level of impairment
allowances on individual facilities that are above
materiality thresholds to be reviewed at least semi-
annually, and more regularly when individual
circumstances require. The review normally
encompasses 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 insolvency and
specific market sectors are used to assess likely
losses on significant individual exposures.
Individually assessed impairment allowances are
only reversed when the Group has reasonable and
objective evidence of a reduction in the established
loss estimate.
Collectively assessed impairment allowances
Impairment is assessed on a collective basis in two
circumstances:
•
•
to cover losses which have been incurred but
have not yet been identified on loans subject to
individual assessment; and
for homogeneous groups of loans that are not
considered individually significant.
Incurred but not yet identified impairment
Individually assessed loans for which no evidence of
impairment has been specifically identified on an
individual basis are grouped together according to
their credit risk characteristics. A collective loan loss
allowance is calculated to reflect impairment losses
incurred at the balance sheet date which will only be
individually identified in the future.
The collective impairment allowance is
determined having taken into account:
•
•
historical loss experience in portfolios of similar
credit risk characteristics (for example, by
industry sector, risk rating or product segment);
the estimated period between impairment
occurring and the loss being identified and
evidenced by the establishment of an
appropriate allowance against the individual
loan; and
• management’s experienced judgement as to
whether 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 period between a loss occurring and its
identification is estimated by local management for
each identified portfolio. In general, the periods used
vary between four and twelve months although, in
exceptional cases, longer periods are warranted.
The basis on which impairment allowances for
incurred but not yet identified losses is established in
175
each reporting entity is documented and reviewed by
senior Group Credit and Risk management to ensure
conformity with Group policy.
Homogeneous groups of loans
Two methodologies are used to calculate impairment
allowances where large numbers of relatively low-
value assets are managed using a portfolio approach,
typically:
•
•
•
low-value, homogeneous small business
accounts in certain countries or territories;
residential mortgages that have not been
individually assessed;
credit cards and other unsecured consumer
lending products; and
• motor vehicle financing.
When appropriate empirical information is
available, the Group uses roll rate methodology. This
employs a statistical analysis of historical trends of
default and the amount of consequential loss, based
on the delinquency of accounts within a portfolio of
homogeneous accounts. Other historical data and
current economic conditions are also evaluated when
calculating the appropriate level of impairment
allowance required to cover inherent loss. In certain
highly developed markets, models also take into
account behavioural and account management trends
revealed in, for example, bankruptcy and
rescheduling statistics.
When the portfolio size is small, or when
information is insufficient or not reliable enough to
adopt a roll rate methodology, a formulaic approach
is used which allocates progressively higher
percentage loss rates the longer a customer’s loan is
overdue. Loss rates reflect the discounted expected
future cash flows for a portfolio.
In normal circumstances, historical experience
is the most objective and relevant information from
which to assess inherent loss within each portfolio.
In circumstances where historical loss experience
provides less relevant information about the inherent
loss in a given portfolio at the balance sheet date –
for example, where there have been changes in
economic conditions or regulations – management
considers the more recent trends in the portfolio risk
factors which may not be adequately reflected in its
statistical models and, subject to guidance from
Group Credit and Risk, adjusts impairment
allowances accordingly.
Roll rates, loss rates and the expected timing of
future recoveries are regularly benchmarked against
actual outcomes to ensure they remain appropriate.
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Credit risk management / Exposure
Collectively assessed allowances are generally
calculated monthly and charges for new allowances,
or reversals of existing allowances, are determined
for each separately identified portfolio.
Impairment allowances
When impairment losses occur, HSBC reduces the
carrying amount of loans and advances and held-to-
maturity financial investments through the use of an
allowance account. When impairment of available-
for-sale financial assets occurs, the carrying amount
of the asset is reduced directly.
Loan write-offs
Loans, and the related impairment allowances, are
normally written off, either partially or in full, in the
case of that portion of the loan amount not covered
by the value of security, when there is no realistic
prospect of further recovery; and in the case of
secured balances, after proceeds from the realisation
of security have been received. Unsecured consumer
facilities are normally written off between 150 and
210 days overdue. In HSBC Finance, this period is
generally extended to 300 days overdue (240 days
for real estate secured products).
Instances of write-off periods exceeding
360 days overdue are few, but can arise where
certain consumer finance accounts are deemed
collectible beyond this point or where, in a few
countries, regulation or legislation constrain earlier
write-off.
In the event of bankruptcy, or analogous
proceedings, write-off can occur earlier.
Cross-border exposures
Management assesses the vulnerability of countries
to foreign currency payment restrictions when
considering impairment allowances on cross-border
exposures. This assessment includes an analysis of
the economic and political factors existing at the
time. 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, threats to security, and the
quality and independence of the legal system.
Impairment allowances are applied to all
qualifying exposures within these countries unless
these exposures and the inherent risks are:
•
performing, trade-related and of less than one
year’s maturity;
• mitigated by acceptable security cover which is,
other than in exceptional cases, held outside the
country concerned;
•
•
•
in the form of securities held for trading
purposes for which a liquid and active market
exists, and which are measured at fair value
daily;
performing facilities with principal (excluding
security) of US$1 million or below; or
performing facilities with maturity dates shorter
than three months.
Credit exposure
Maximum exposure to credit risk
(Audited)
Factors which had a direct impact on changes in
HSBC’s maximum exposure to credit risk during
2006 related to the curtailment of growth in
mortgage lending in the US in response to
deteriorating conditions, and slowed growth in UK
personal unsecured lending following an increase in
personal bankruptcies and IVAs. Elsewhere, growth
reflected underlying economic trends on a
geographic basis.
The following table presents the maximum
exposure to credit risk of balance sheet and off
balance sheet financial instruments, before taking
account of any collateral held or other credit
enhancements unless such credit enhancements meet
offsetting requirements as set out in Note 2(m) on
the Financial Statements. For financial assets
recognised on the balance sheet, the exposure to
credit risk equals their carrying amount. For
financial guarantees granted, the maximum exposure
to credit risk is the maximum amount that HSBC
would have to pay if the guarantees are called upon.
For loan commitments and other credit related
commitments that are irrevocable over the life of the
respective facilities, the maximum exposure to credit
risk is the full amount of the committed facilities.
176
Maximum exposure to credit risk
(Audited)
Items in course of collection from other banks .................................................................................
Trading assets ....................................................................................................................................
Treasury and other eligible bills ....................................................................................................
Debt securities ................................................................................................................................
Loans and advances .......................................................................................................................
Financial assets designated at fair value ...........................................................................................
Treasury and other eligible bills ....................................................................................................
Debt securities ................................................................................................................................
Loans and advances .......................................................................................................................
Derivatives .........................................................................................................................................
Loans and advances to banks ............................................................................................................
Loans and advances to customers .....................................................................................................
Financial investments ........................................................................................................................
Treasury and other eligible bills ....................................................................................................
Debt securities ................................................................................................................................
Other assets
Endorsements and acceptances .....................................................................................................
Other ..............................................................................................................................................
Financial guarantees ..........................................................................................................................
Loan commitments and other credit related commitments1 .............................................................
Maximum exposure
2006
US$m
14,144
300,998
21,759
155,447
123,792
9,971
133
9,449
389
103,702
185,205
868,133
196,509
25,313
171,196
22,846
9,577
13,269
62,014
714,630
2005
US$m
11,300
212,706
12,746
117,659
82,301
6,513
53
5,705
755
73,928
125,965
740,002
174,823
25,042
149,781
18,954
7,973
10,981
66,805
654,343
At 31 December .................................................................................................................................
2,478,152
2,085,339
1 The amount of the loan commitments shown above reflects, where relevant, the expected level of take-up of pre-approved loan offers
made by mailshots to personal customers. In addition to those amounts, there is a further maximum possible exposure to credit risk of
US$464,984 million (2005: US$313,629 million), reflecting the full take-up of such irrevocable loan commitments. The take-up of such
offers is generally at modest levels. 2005 data have also been adjusted to ensure consistency with 2006 data for this disclosure.
Concentration of exposure
(Audited)
Concentrations of credit risk exist when a number of
counterparties are engaged in similar activities, or
operate in the same geographical areas or industry
sectors and have similar economic characteristics so
that their ability to meet contractual obligations is
similarly affected by changes in economic, political
or other conditions.
Loans and advances
(Unaudited)
Loans and advances were well spread across both
industry sectors and jurisdictions.
At constant exchange rates, gross loans and
advances to customers (excluding the finance sector
and settlement accounts) grew by US$82 billion or
11 per cent during 2006. On the same basis, personal
lending comprised 58 per cent of HSBC’s loan
portfolio and 47 per cent of the growth in loans in
2006.
Including the financial sector and settlement
accounts, personal lending represented
US$476 billion, or 54 per cent, of total loans and
advances to customers at 31 December 2006. Within
177
this total, residential mortgages were US$265 billion
and, at 30 per cent of total advances to customers,
were the Group’s largest single sectoral
concentration.
Corporate, commercial and financial lending,
including settlement accounts, comprised 46 per cent
of gross lending to customers at 31 December 2006.
The largest single industry concentrations were in
non-bank financial institutions and commercial real
estate lending, each of which amounted to 7 per cent
of total gross lending to customers, broadly in line
with 2005.
Commercial, industrial and international trade
lending grew strongly in 2006, notably to the service
industry. This increased this class of lending by
a percentage point to 18 per cent of total gross loans
and advances to customers. Within this category the
largest concentration of lending was to the service
industry, which amounted to just over 5 per cent of
total gross lending to customers.
Advances to banks were widely distributed,
principally to major institutions, and with no single
exposure more than 5 per cent of total advances to
banks.
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk
Credit risk > Exposure > 2006
Financial investments
(Unaudited)
At US$205 billion, total financial investments were
12 per cent higher than at the end of 2005.
Investments of US$93 billion in corporate debt and
other securities were the largest single concentration
of these assets, representing 46 per cent of overall
investments, compared with 53 per cent at
31 December 2005. HSBC’s holdings of corporate
debt, asset-backed securities and other securities
were spread across a wide range of issuers and
geographical regions, with 72 per cent invested in
securities issued by banks and other financial
institutions.
Investments in governments and government
agencies of US$76 billion were 37 per cent of
overall financial investments, 4 percentage points
lower than in 2005. One third of these investments
were held in treasury and other eligible bills.
Gross loans and advances by industry sector
(Unaudited)
The insurance businesses had a diversified
portfolio of debt and equity securities designated
at fair value (US$18 billion) and debt securities
classified as financial investments (US$10 billion).
Securities held for trading
(Unaudited)
Total securities held for trading within trading assets
were US$204 billion. The largest concentration of
these assets was government and government agency
securities, which amounted to US$94 billion, or
46 per cent of overall trading securities. This
included US$22 billion of treasury and other eligible
bills. Corporate debt and other securities were
US$67 billion or 33 per cent of overall trading
securities, 4 percentage points lower than in 2005.
Included within this were US$36 billion of debt
securities issued by banks and other financial
institutions.
At
31 December
2005
US$m
Constant
currency
effect
US$m
Movement on a
constant
currency basis
US$m
At
31 December
2006
US$m
Loans and advances to customers
Personal:
Residential mortgages1 .............................................
Other personal2 .........................................................
Total personal ...........................................................
Corporate and commercial:
Commercial, industrial and international trade.........
Commercial real estate .............................................
Other property-related ..............................................
Government ..............................................................
Other commercial3 ....................................................
Total corporate and commercial ..............................
Financial:
Non-bank financial institutions ................................
Settlement accounts ..................................................
Total financial ..........................................................
Total loans and advances to customers ........................
Loans and advances to banks ....................................
Total gross loans and advances ....................................
238,546
181,930
420,476
130,802
51,815
22,196
8,218
65,678
278,709
50,032
2,142
52,174
751,359
125,974
877,333
11,036
6,294
17,330
10,887
3,158
1,150
191
5,828
21,214
4,698
82
4,780
43,324
5,953
49,277
15,755
22,585
38,340
20,420
5,393
3,819
581
12,971
43,184
4,474
1,030
5,504
87,028
53,285
265,337
210,809
476,146
162,109
60,366
27,165
8,990
84,477
343,107
59,204
3,254
62,458
881,711
185,212
140,313
1,066,923
Includes Hong Kong Government Home Ownership Scheme loans (US$4,078 million at 31 December 2006).
1
2 Other personal loans and advances include second lien mortgages and other property-related lending.
3 Other commercial loans and advances include advances in respect of agriculture, transport, energy and utilities.
Year ended 31 December 2006 compared
with year ended 31 December 2005
(Unaudited)
The commentary below analyses the movement in
lending on a constant currency basis noted in the
table above compared with the position at
31 December 2005. On this basis, total loans and
advances to customers grew by 11 per cent and gross
loans and advances increased by 15 per cent.
Geographically, total lending to personal
customers was dominated by the diverse portfolios
in North America (US$232 billion), the UK
178
(US$129 billion) and Hong Kong (US$39 billion).
Collectively, these lending books accounted for
84 per cent of total lending to the personal sector,
3 percentage points lower than the 87 per cent level
reported at 31 December 2005.
Residential mortgages rose by US$16 billion, or
6 per cent, to US$265 billion, representing 30 per
cent of total gross loans to customers at
31 December 2006. Residential mortgages include
only first lien secured loans. In value terms, growth
was greatest in the UK, where residential mortgages
increased by 7 per cent to US$83 billion, and in
North America, where mortgage balances rose by
6 per cent to US$124 billion. In the US, mortgage
balances within HSBC Finance increased by 13 per
cent to US$76 billion. In Hong Kong, mortgage
balances rose by 1 per cent.
In North America, growth in residential
mortgage balances was attributable both to increases
in non-prime lending originated through the branch-
based consumer lending business and balances
acquired from correspondent brokers and banks
through the mortgage services business.
In light of emerging evidence of unforeseen
deterioration within the US mortgage services
business in respect of originations made in 2005 and
the first half of 2006, a wide range of initiatives was
implemented to mitigate the impact on the affected
portions of the business. Consequently, in the second
half of the year, growth in real estate lending slowed,
as the mortgage services business tightened its
underwriting criteria, as detailed on page 189. Prime
mortgage balances held in the US banking network
also declined, as HSBC sold the majority of its new
prime mortgage originations into the secondary
market and increased its securitisation programme,
which together augmented the normal run-off of
balances. In Canada, mortgage balances rose,
primarily due to a strong housing market and
continued expansion of HSBC’s consumer finance
business and core banking distribution channels.
In the UK, mortgage balances rose by 7 per
cent, primarily in the form of fixed rate mortgages as
customers sought to insulate themselves from rising
interest rates. Mortgage lending in France
experienced strong growth, benefiting from
competitive pricing and a marked improvement in
brand awareness following the rebranding of the
business in 2005.
Residential mortgage balances in Hong Kong
rose as increased marketing and product
development contributed to HSBC raising its market
share. This occurred despite a subdued housing
179
market, fierce competition and continuing reduction
in assets from the suspended GHOS.
In the Rest of Asia-Pacific, mortgage balances
fell by 6 per cent, as the sale of the broker-originated
mortgage business in Australia offset modest growth
in most other countries.
Other personal lending grew by 12 per cent to
US$211 billion at 31 December 2006, representing
24 per cent of gross loans and advances to
customers.
In North America, growth in other personal
lending was largely driven by credit card activity and
increased second lien mortgage balances. In the US,
increased uptake of both prime and non-prime credit
cards was driven by targeted marketing campaigns
and the launch of several new co-branded cards. The
credit card market continued to be highly
competitive with many competitors relying on zero
per cent offers to generate growth. HSBC, by
contrast, reduced the amount of its equivalent offers
and focused instead on increased marketing. In the
first half of 2006, the US mortgage services business
significantly increased the levels of second lien
mortgages, continuing the growth of this loan type
that was instigated in 2005. The rate of growth of the
second lien mortgage book slowed in the latter half
of the year as the deterioration of credit quality of
the portfolio became apparent. This is discussed in
further detail under mortgage lending in the US on
page 189. The US motor vehicle finance portfolio
also grew, due to increased volumes in both the
dealer network and the consumer direct loan
programme, dampened by the expiration of fixed-
term loans and reduction in the level of incentives
offered by car manufacturers.
Other personal lending grew by 10 per cent in
Europe. In the UK, unsecured personal loan balances
declined, reflecting a policy decision to constrain
growth to selected segments by tightening
underwriting criteria. Credit card balances increased,
driven by promotional and marketing campaigns,
with strong growth in M&S branded credit cards. In
Turkey, unsecured personal lending grew strongly
reflecting the success of marketing initiatives and
cross-sales with existing credit card clients.
Promotional and marketing activity contributed
towards a strengthening of HSBC’s position as the
largest credit card issuer in Hong Kong, with over
4.6 million cards in force.
In the Rest of Asia-Pacific, other personal
lending rose by 15 per cent. Credit card balances
grew rapidly with an increase of over 1.2 million
cards in circulation in 2006 following new product
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Exposure > 2006 / By industry sector
launches in the Middle East, Sri Lanka and
Singapore and marketing and incentive campaigns
across the region. Other unsecured lending balances
rose during 2006, partly as a result of expansion of
HSBC’s consumer finance business in India,
Australia and Indonesia.
In Latin America, other personal lending
showed significant growth, rising by 49 per cent,
with cross-sales of the ‘Tu Cuenta’ product
generating strong demand for credit cards in Mexico.
Personal lending balances, excluding mortgages,
rose by 25 per cent in Brazil, with increased vehicle
finance lending benefiting from strengthened
relationships with car dealers, and higher numbers of
credit cards in issue following a number of
campaigns designed to improve retention and
utilisation.
Loans and advances to corporate and
commercial customers grew by 14 per cent to
US$343 billion. Lending was primarily in Europe,
which accounted for 57 per cent of advances, over
three quarters of which was concentrated in the UK.
In Europe, corporate and commercial advances
rose by 9 per cent, driven by lending growth in the
UK, France and Turkey. In the UK, there was firm
growth in lending to the service industry and real
estate and related construction businesses. In France,
improved retention of existing clients and
recruitment of new customers resulted in higher
lending balances, while in Turkey expansion of the
branch network, including dedicated SME centres,
contributed to growth in commercial advances.
In Hong Kong there was strong demand for
credit from larger Commercial Banking customers in
the property sector and from manufacturers with
operations in mainland China seeking to fund
expansion. New initiatives designed to increase
commercial lending included a pre-approved lending
scheme and a telesales campaign, which led to
growth in SME lending and a doubling in the
number of lending relationships in this segment. This
strong growth in Commercial Banking lending was
offset by the repayment of two large facilities by
Corporate, Investment Banking and Markets clients.
In the Rest of Asia-Pacific, strong economic
expansion in the Middle East led to greater demand
for credit and regional lending balances rose in
response to increases in regional trade flows and
increased marketing activity.
In North America, expansion into new regional
markets, higher levels of marketing and the
recruitment of additional SME relationship managers
to meet customer demand contributed to growth in
corporate and commercial lending balances.
HSBC experienced strong growth in lending
balances to SME businesses across Latin America
due to favourable economic conditions.
Additionally, in Mexico, strong demand for credit
from the rapidly growing real estate and residential
construction sectors contributed to greater levels of
lending.
The following tables analyse loans and advances
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.
180
Loans and advances to customers by industry sector and by geographical region
(Audited)
At 31 December 2006
Europe
US$m
Personal
Residential mortgages1 ............
Other personal .........................
91,534
67,214
Hong
Kong
US$m
28,743
10,396
Rest of
Asia-
Pacific
US$m
17,478
13,275
Gross
loans and
advances to
customers
Latin
America
US$m
US$m
Gross loans
by industry
sector as a
% of total
gross loans
%
North
America
US$m
123,955
108,256
3,627
11,668
265,337
210,809
158,748
39,139
30,753
232,211
15,295
476,146
99,027
28,655
9,616
2,360
56,650
16,845
12,481
6,923
551
5,553
25,196
5,502
3,491
1,916
8,468
11,004
12,782
5,931
220
9,736
10,037
946
1,204
3,943
4,070
162,109
60,366
27,165
8,990
84,477
196,308
42,353
44,573
39,673
20,200
343,107
40,055
1,064
41,119
2,332
823
3,155
2,926
223
3,149
12,258
1,092
13,350
1,633
52
59,204
3,254
1,685
62,458
396,175
84,647
78,475
285,234
37,180
881,711
100.0
30.1
23.9
54.0
18.4
6.8
3.1
1.0
9.6
38.9
6.7
0.4
7.1
Corporate and commercial
Commercial, industrial and
international trade ...............
Commercial real estate ............
Other property-related .............
Government .............................
Other commercial2 ...................
Financial
Non-bank financial
institutions ...........................
Settlement accounts .................
Total gross loans and advances
to customers3 ............................
Percentage of Group loans and
advances by geographical
region .......................................
Impaired loans .............................
5,847
454
44.9%
9.6%
8.9%
1,184
32.4%
4,822
4.2%
100.0%
1,478
13,785
Impaired loans as a percentage of
gross loans and advances to
customers .................................
Impairment allowances
outstanding against loans
and advances4 ..........................
Impairment allowances
outstanding as a percentage
of impaired loans4 ....................
1.5%
0.5%
1.5%
1.7%
4.0%
1.6%
3,676
365
901
7,247
1,389
13,578
62.9%
80.4%
76.1%
150.3%
94.0%
98.5%
1 Includes Hong Kong Government Home Ownership Scheme loans (US$4,078 million at 31 December 2006).
2 Other commercial loans and advances include advances in respect of agriculture, transport, energy and utilities.
3 Included within this total is credit card lending of US$74,518 million.
4 Impairment allowances include collective impairment allowances on collectively assessed loans and advances.
Included in personal lending in North America are the following balances relating to the US:
(Unaudited)
At 31 December
2006
US$m
Residential mortgages – HSBC Bank USA ........................................................................................
Residential mortgages – HSBC Finance .............................................................................................
Motor vehicle finance ..........................................................................................................................
MasterCard/Visa credit cards ..............................................................................................................
Private label cards ................................................................................................................................
Other unsecured personal lending .......................................................................................................
31,589
75,903
13,146
29,269
16,645
41,214
2005
US$m
36,170
67,359
12,792
26,795
15,488
35,545
207,766
194,149
181
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Exposure > By industry sector
Loans and advances to customers by industry sector and by geographical region
(Audited)
At 31 December 2005 (restated5)
Europe
US$m
Personal
Residential mortgages1 ............
Other personal .........................
73,923
55,672
Hong
Kong
US$m
28,492
9,978
Rest of
Asia-
Pacific
US$m
17,641
11,178
North
America
US$m
116,448
97,663
Gross
loans and
advances to
customers
Latin
America
US$m
US$m
Gross loans
by industry
sector as a
% of total
gross loans
%
2,042
7,439
238,546
181,930
129,595
38,470
28,819
214,111
9,481
420,476
76,687
22,071
7,603
1,821
41,944
16,736
12,557
6,147
303
6,922
21,286
5,081
3,426
2,147
7,716
10,375
11,714
4,447
192
7,189
5,718
392
573
3,755
1,907
130,802
51,815
22,196
8,218
65,678
150,126
42,665
39,656
33,917
12,345
278,709
35,305
1,002
36,307
1,966
505
2,471
2,202
175
2,377
9,464
416
9,880
1,095
44
1,139
50,032
2,142
52,174
316,028
83,606
70,852
257,908
22,965
751,359
100.0
31.7
24.2
55.9
17.4
6.9
3.0
1.1
8.7
37.1
6.7
0.3
7.0
Corporate and commercial
Commercial, industrial and
international trade ...............
Commercial real estate ............
Other property-related .............
Government .............................
Other commercial2 ...................
Financial
Non-bank financial
institutions ...........................
Settlement accounts .................
Total gross loans and advances
to customers3 ............................
Percentage of Group loans and
advances by geographical
region .......................................
Impaired loans ..............................
5,068
506
42.1%
11.1%
9.4%
936
34.3%
3,710
3.1%
100.0%
1,226
11,446
Impaired loans as a percentage of
gross loans and advances to
customers .................................
Impairment allowances
outstanding against loans
and advances4 ..........................
Impairment allowances
outstanding as a percentage
of impaired loans4 ....................
1.6%
0.6%
1.3%
1.4%
5.3%
1.5%
3,491
398
836
5,349
1,283
11,357
68.9%
78.7%
89.3%
144.2%
104.6%
99.2%
1 Includes Hong Kong Government Home Ownership Scheme loans (US$4,680 million at 31 December 2005).
2 Other commercial loans and advances include advances in respect of agriculture, transport, energy and utilities.
3 Included within this total is credit card lending of US$66,020 million.
4 Impairment allowances include collective impairment allowances on collectively assessed loans and advances.
5 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13 on the Financial Statements.
182
(Unaudited)
At 31 December 2004 (restated6)
Europe
US$m
70,546
57,920
Hong
Kong
US$m
29,373
9,105
Rest of
Asia-
Pacific
US$m
14,860
9,079
Gross
loans and
advances to
customers
US$m
Gross loans
by industry
sector as a
% of total
gross loans
%
North
America
US$m
Latin
America
US$m
111,455
78,984
1,613
4,917
227,847
160,005
128,466
38,478
23,939
190,439
6,530
387,852
55,018
18,917
6,850
3,663
34,185
14,132
10,388
5,959
615
7,294
19,177
4,232
3,350
1,432
7,015
9,544
9,712
4,266
1,174
5,173
4,005
220
324
3,643
1,484
101,876
43,469
20,749
10,527
55,151
118,633
38,388
35,206
29,869
9,676
231,772
30,901
4,476
35,377
1,932
596
2,528
2,297
305
2,602
16,624
8,431
25,055
575
11
586
52,329
13,819
66,148
33.3
23.3
56.6
14.9
6.3
3.0
1.5
8.1
33.8
7.6
2.0
9.6
282,476
79,394
61,747
245,363
16,792
685,772
100.0
41.2%
6,039
11.6%
696
9.0%
1,160
35.8%
3,555
2.4%
977
100.0%
12,427
2.1%
0.9%
1.9%
1.4%
5.8%
1.8%
4,036
320
785
4,106
770
10,017
66.8%
46.0%
67.7%
115.5%
78.8%
80.6%
Personal
Residential mortgages1 ...........
Other personal ........................
Corporate and commercial
Commercial, industrial and
international trade ..............
Commercial real estate ...........
Other property-related ............
Government ............................
Other commercial2...................
Financial
Non-bank financial
institutions ..........................
Settlement accounts ................
Total gross loans and
advances to customers3 ...........
Percentage of Group loans and
advances by geographical
region ......................................
Impaired loans4,5 ..........................
Impaired loans as a percentage of
gross loans and advances4 .......
Specific provisions outstanding
against loans and advances5 ...
Specific provisions outstanding
as a percentage of impaired
loans4,5 .....................................
1 Includes Hong Kong Government Home Ownership Scheme loans (US$5,383 million at 31 December 2004).
2 Other commercial loans and advances include advances in respect of agriculture, transport, energy and utilities.
3 Included within this total is credit card lending of US$56,222 million.
4 Net of suspended interest.
5 Included in North America are impaired loans of US$3,020 million and specific provisions of US$3,443 million in HSBC Finance;
excluding HSBC Finance, specific provisions outstanding as a percentage of impaired loans was 54.6 per cent.
6 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13 on the Financial Statements.
183
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Exposure > By industry sector
Loans and advances to customers by industry sector and by geographical region (continued)
(Unaudited)
At 31 December 20032 (restated7)
Europe
US$m
51,721
42,041
Hong
Kong
US$m
29,954
7,420
Rest of
Asia-
Pacific
US$m
12,101
7,135
North
America
US$m
76,485
73,717
Gross
loans and
advances to
customers
Latin
America
US$m
US$m
Gross loans
by industry
sector as a
% of total
gross loans
%
1,493
3,832
171,754
134,145
93,762
37,374
19,236
150,202
5,325
305,899
49,468
15,517
5,416
2,462
24,239
10,966
8,548
5,075
927
6,754
14,892
3,149
2,597
1,450
5,735
7,265
7,699
3,850
375
5,682
3,077
175
202
4,376
1,620
85,668
35,088
17,140
9,590
44,030
97,102
32,270
27,823
24,871
9,450
191,516
21,226
3,068
24,294
4,921
556
5,477
2,027
188
2,215
8,588
4,767
13,355
329
15
344
37,091
8,594
45,685
31.6
24.7
56.3
15.7
6.5
3.2
1.8
8.1
35.3
6.8
1.6
8.4
215,158
75,121
49,274
188,428
15,119
543,100
100.0
Personal
Residential mortgages1 ............
Other personal .........................
Corporate and commercial
Commercial, industrial and
international trade ...............
Commercial real estate ............
Other property-related .............
Government .............................
Other commercial3 ...................
Financial
Non-bank financial
institutions ...........................
Settlement accounts .................
Total gross loans and advances
to customers4 ............................
Percentage of Group loans and
advances by geographical
region .......................................
Non-performing loans6 .................
5,701
1,671
39.6%
13.8%
9.1%
1,538
34.7%
4,889
2.8%
100.0%
1,251
15,050
Non-performing loans as a
percentage of gross loans and
advances to customers5 ............
Specific provisions outstanding
against loans and advances6 ....
Specific provisions outstanding
as a percentage of non-
performing loans6 .....................
2.6%
2.2%
3.1%
2.6%
8.3%
2.8%
3,554
629
981
4,660
1,054
10,878
62.3%
37.6%
63.8%
95.3%
84.3%
72.3%
1 Includes Hong Kong Government Home Ownership Scheme loans (US$6,290 million at 31 December 2003).
2 Figures presented in this table were prepared in accordance with UK GAAP.
3 Other commercial loans and advances include advances in respect of agriculture, transport, energy and utilities.
4 Included within this total is credit card lending of US$48,634 million.
5 Net of suspended interest.
6 Included in North America are non-performing loans of US$4,335 million and specific provisions of US$4,448 million in HSBC
Finance; excluding HSBC Finance, specific provisions outstanding as a percentage of non-performing loans was 69.2 per cent.
7 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13 on the Financial Statements.
184
(Unaudited)
At 31 December 20022 (restated6)
Europe
US$m
Personal
Residential mortgages1 ............
Other personal .........................
38,719
26,748
Hong
Kong
US$m
31,094
7,066
Rest of
Asia-
Pacific
US$m
7,507
5,900
North
America
US$m
25,127
6,514
Gross
loans and
advances to
customers
Latin
America
US$m
US$m
Gross loans
by industry
sector as a
% of total
gross loans
%
1,792
2,334
104,239
48,562
65,467
38,160
13,407
31,641
4,126
152,801
44,424
11,887
3,970
2,164
22,712
10,173
8,336
4,805
719
6,612
12,582
2,701
2,031
933
5,950
8,706
6,158
4,250
446
3,925
3,130
185
291
4,691
1,475
79,015
29,267
15,347
8,953
40,674
85,157
30,645
24,197
23,485
9,772
173,256
15,221
2,622
17,843
2,055
347
2,402
931
192
8,953
5,224
1,123
14,177
327
–
327
27,487
8,385
35,872
28.9
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
69,303
14,225
361,929
100.0
Corporate and commercial
Commercial, industrial and
international trade ...............
Commercial real estate ............
Other property-related .............
Government .............................
Other commercial3 ...................
Financial
Non-bank financial institutions
Settlement accounts .................
Total gross loans and advances
to customers4 ............................
Percentage of Group loans and
advances by geographical
region........................................
Non-performing loans5 ................
4,495
1,724
46.5%
19.7%
10.7%
2,055
19.2%
3.9%
100.0%
508
1,741
10,523
Non-performing loans as a
percentage of gross loans and
advances to customers5 ............
Specific provisions outstanding
2.7%
2.4%
5.3%
0.7%
12.2%
2.9%
against loans and advances .....
2,774
688
1,321
222
1,601
6,606
Specific provisions outstanding
as a percentage of non-
performing loans5 .....................
61.7%
39.9%
64.3%
43.7%
92.0%
62.8%
1 Includes Hong Kong Government Home Ownership Scheme loans (US$7,255 million at 31 December 2002).
2 Figures presented in this table were prepared in accordance with UK GAAP.
3 Other commercial loans include advances in respect of agriculture, transport, energy and utilities.
4 Included within this total is credit card lending of US$9,950 million.
5 Net of suspended interest.
6 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13 on the Financial Statements.
185
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Exposure > Rest of Asia-Pacific and Latin America / Banks / Financial assets
Loans and advances to customers by principal area within Rest of Asia-Pacific and Latin America
(Audited)
Loans and advances (gross)
Residential
mortgages
US$m
Other
personal
US$m
Property-
related
US$m
Commercial,
international
trade and
other
US$m
At 31 December 2006
Australia and New Zealand ...................
India .......................................................
Indonesia ................................................
Japan ......................................................
Mainland China .....................................
Malaysia .................................................
Middle East ............................................
Singapore ...............................................
South Korea ...........................................
Taiwan ...................................................
Thailand .................................................
Other ......................................................
4,493
1,338
17
18
377
2,456
434
3,090
2,708
2,273
26
248
622
1,067
371
131
9
1,277
3,134
3,225
862
881
385
1,311
Total of Rest of Asia-Pacific .................
17,478
13,275
Argentina ...............................................
Brazil ......................................................
Mexico ...................................................
Other ......................................................
Total of Latin America ..........................
At 31 December 2005 (restated1)
Australia and New Zealand ...................
India .......................................................
Indonesia ................................................
Japan ......................................................
Mainland China .....................................
Malaysia .................................................
Middle East ............................................
Singapore ...............................................
South Korea ...........................................
Taiwan ...................................................
Thailand .................................................
Other ......................................................
22
211
1,801
1,593
3,627
5,912
1,139
13
14
358
2,223
258
2,811
2,585
2,094
23
211
314
6,579
3,353
1,422
11,668
694
545
338
139
11
871
2,320
3,395
460
1,057
220
1,128
Total of Rest of Asia-Pacific .................
17,641
11,178
Argentina ...............................................
Brazil ......................................................
Mexico ...................................................
Other ......................................................
Total of Latin America ..........................
4
187
1,394
457
2,042
147
4,838
2,289
165
7,439
2,472
203
2
648
1,504
589
1,733
1,286
45
15
132
364
8,993
52
251
959
888
4,127
2,363
1,014
2,601
4,226
3,537
10,595
2,052
2,655
970
1,043
3,546
38,729
1,625
5,212
8,648
4,250
2,150
19,735
2,588
104
8
696
1,210
496
1,448
1,441
31
14
75
396
8,507
31
206
525
203
965
3,698
1,819
921
2,352
3,426
2,925
9,403
2,249
2,219
727
958
2,829
33,526
1,000
3,432
7,503
584
12,519
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13 on the Financial Statements.
Total
US$m
11,714
4,971
1,404
3,398
6,116
7,859
15,896
9,653
6,270
4,139
1,586
5,469
78,475
2,013
12,253
14,761
8,153
37,180
12,892
3,607
1,280
3,201
5,005
6,515
13,429
9,896
5,295
3,892
1,276
4,564
70,852
1,182
8,663
11,711
1,409
22,965
186
Loans and advances to banks by geographical region
Europe
US$m
76,837
44,369
56,063
51,806
39,398
Hong
Kong
US$m
50,359
42,751
45,710
38,639
33,359
Rest of
Asia-
Pacific
US$m
27,517
19,559
14,890
12,948
10,708
At 31 December 2006 (audited) .
At 31 December 2005 (audited)1..
At 31 December 2004 (unaudited)1
At 31 December 2003 (unaudited)1
At 31 December 2002 (unaudited)1
Gross
loans and
advances
North
America
US$m
Latin
America
US$m
to banks
US$m
Impairment
allowances2
US$m
17,865
10,331
20,911
6,852
5,188
12,634
8,964
5,892
6,955
6,868
185,212
125,974
143,466
117,200
95,521
(7)
(9)
(17)
(24)
(23)
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative information
has been restated accordingly. See Note 13 on the Financial Statements.
2 2002 to 2004: provisions for bad and doubtful debts.
Financial assets – net exposure to credit risk
(Audited)
In respect of certain financial assets, HSBC has legally enforceable rights to offset them with financial liabilities.
However, in normal circumstances, there would be no intention of settling net, or of realising the financial assets and
settling the financial liabilities simultaneously. Consequently, the financial assets are not offset against the respective
financial liabilities for financial reporting purposes. However, the exposure to credit risk relating to the respective
financial assets is mitigated as follows.
At 31 December 2006
At 31 December 2005
Carrying
amount
US$m
Net
exposure to
credit risk1
US$m
Offset
US$m
Carrying
amount
US$m
Net
exposure to
credit risk1
US$m
Offset
US$m
Loans and advances held at amortised cost
Loans and advances to customers ..................
Loans and advances to banks .........................
868,133
185,205
(68,076)
(455)
800,057
184,750
751,359
125,974
(48,495)
(51)
702,864
125,923
1,053,338
(68,531)
984,807
877,333
(48,546)
828,787
Trading assets
Treasury and other eligible bills .....................
Debt securities ................................................
Loans and advances to banks .........................
Loans and advances to customers ..................
Financial assets designated at fair value
Treasury and other eligible bills .....................
Debt securities ................................................
Loans and advances to banks .........................
Loans and advances to customers ..................
21,759
155,447
52,006
71,786
300,998
133
9,449
236
153
9,971
(16)
(1,036)
–
(7,186)
(8,238)
21,743
154,411
52,006
64,600
12,746
117,659
29,806
52,495
–
–
(19)
(7,411)
12,746
117,659
29,787
45,084
292,760
212,706
(7,430)
205,276
–
–
–
–
–
133
9,449
236
153
9,971
53
5,705
124
631
6,513
–
(464)
–
–
(464)
53
5,241
124
631
6,049
Derivatives ..........................................................
103,702
(62,741)
40,961
73,928
(46,060)
27,868
Financial investments
Treasury and other similar bills ......................
Debt securities ................................................
25,313
171,196
196,509
(30)
(1)
(31)
25,283
171,195
25,042
149,781
196,478
174,823
–
–
–
25,042
149,781
174,823
Other assets
Endorsements and acceptances ......................
9,577
(187)
9,390
7,973
(9)
7,964
1,674,095
(139,728)
1,534,367
1,353,276
(102,509)
1,250,767
1 Excluding the value of any collateral held or other credit enhancements.
187
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Exposure > Debt securities / Areas of special interest
Debt securities and other bills by rating agency designation
(Audited)
The following table presents an analysis by rating agency designation of debt and similar securities, other than loans,
based on Standard and Poor’s ratings or their equivalent. Debt securities with short-term ratings are reported against
the long-term rating of the issuer of the short-term debt securities. If major rating agencies have different ratings for
the same debt securities, the securities are reported against the lower rating.
Treasury
bills
US$m
Other
eligible bills
US$m
Debt
securities
US$m
At 31 December 2006
AAA ..............................................................................
AA – to AA + ...............................................................
A – to A + .....................................................................
Lower than A – .............................................................
Unrated .........................................................................
Supporting liabilities under linked insurance
and investment contracts and investment contracts
with DPF1 ..................................................................
Of which issued by:
– governments .........................................................
– local authorities ....................................................
– corporates .............................................................
– other ......................................................................
Of which classified as:
– trading assets ........................................................
– financial instruments designated at fair value .....
– available-for-sale securities .................................
– held-to-maturity investments ...............................
At 31 December 20052
AAA ..............................................................................
AA – to AA + ...............................................................
A – to A + .....................................................................
Lower than A – .............................................................
Unrated .........................................................................
Of which issued by:
– governments .........................................................
– local authorities ....................................................
– corporates .............................................................
– other ......................................................................
Of which classified as:
– trading assets ........................................................
– financial instruments designated at fair value .....
– available-for-sale securities .................................
– held-to-maturity investments ...............................
20,360
15,478
8,146
1,208
1,134
54
46,380
44,941
370
–
1,069
46,380
21,751
133
24,451
45
46,380
16,798
3,089
11,147
3,287
2,563
36,884
19,634
16,646
7
597
36,884
12,649
53
23,974
208
36,884
282
247
91
205
–
–
825
–
–
68
757
825
8
–
817
–
825
381
264
110
202
–
957
–
–
84
873
957
97
–
860
–
957
146,087
77,578
66,408
21,240
20,475
4,304
336,092
120,369
8,704
122,980
84,039
336,092
155,447
9,449
161,870
9,326
336,092
113,429
62,684
46,538
23,359
27,135
273,145
91,279
10,516
63,384
107,966
273,145
117,659
5,705
141,699
8,082
273,145
Total
US$m
166,729
93,303
74,645
22,653
21,609
4,358
383,297
165,310
9,074
123,048
85,865
383,297
177,206
9,582
187,138
9,371
383,297
130,608
66,037
57,795
26,848
29,698
310,986
110,913
27,162
63,475
109,436
310,986
130,405
5,758
166,533
8,290
310,986
1 For securities supporting liabilities under linked insurance and investment contracts and investment contracts with discretionary
participation features (DPF), financial risks are substantially borne by the policyholders.
2 Securities supporting liabilities under linked insurance and investment contracts and investment contracts with DPF are analysed across
the rating agency designations.
188
Areas of special interest
Mortgage lending products
(Unaudited)
HSBC underwrites first lien residential mortgages,
as well as loans secured by second lien mortgages
which are reported within ‘Other personal lending’
in the market sector analysis. In addition to capital or
principal repayment mortgages that may be subject
to either fixed or variable interest rates, HSBC
responds to customer needs by periodically testing
and underwriting an increasing range of mortgage
products designed to meet the growing demand for
flexible house purchase loans.
Interest-only mortgages, including endowment
mortgages which are most prevalent in the UK,
allow customers to pay only the interest that accrues
on the loan, with the principal sum repaid at a later
stage. In many cases, customers contribute to an
endowment or other investment policy that should,
on maturity, provide sufficient capital to repay the
principal amount. Alternatively, customers may
repay the principal of their loan from the proceeds of
the sale of the property on which the loan is secured
or from other repayment sources
‘Affordability’ mortgages include all products
where the customer’s monthly payments are
maintained at a low or fixed level in early periods
using discounted or fixed interest rates, or an
interest-only introductory period, before resetting to
a higher variable rate or a capital repayment profile
in later years.
The US has, in recent years seen a significant
change in the structure of borrowing products in
the sub-prime mortgage market. In particular,
affordability mortgages have grown faster than more
traditional fixed rate mortgages. These have included
interest-only, stated income (low documentation),
adjustable rate with alternative payment options
(known as option ARMs), negatively amortising and
layered risk loans, the latter of which includes
secondary loans. The growth of affordability
mortgages has occurred simultaneously with
gradually rising loan-to-value ratios.
Stated income loans have a lesser income
documentation requirement during the underwriting
process and, accordingly, carry a higher risk.
Interest-only loans allow customers to pay only
accruing interest for a period of time, and provide
customers with repayment flexibility. Adjustable-rate
mortgages are loans where the interest rate is
periodically adjusted based on an index. Secondary
loans which are, for example, drawn down to finance
the costs of relocation and property acquisition, are
also increasingly common.
As a consequence of US consumer demand for
affordability mortgages, this segment of the US loan
portfolio experienced rapid growth in 2005,
continuing into 2006. HSBC does not offer, and does
not anticipate offering, option ARMs or other
negative amortisation products.
As with all lending, HSBC underwrites in
accordance with criteria that consider the particular
terms of the loan and prices affordability products in
a manner designed to compensate for the higher risk
that exists in these products, notably the increase in
payments required at the end of the introductory
interest-only period or following the rate reset date.
The following table shows the level of mortgage
products in the various portfolios of HSBC Finance
and the rest of the HSBC Group.
At 31 December 2006
At 31 December 2005
HSBC
Finance1
US$m
Other
US$m
Total
US$m
HSBC
Finance1
US$m
Other
US$m
Total
US$m
Total mortgage lending2 ......................................
95,915
192,583
288,498
81,131
176,022
257,153
Interest-only (including endowment) mortgages
Affordability mortgages, including ARMs .........
Other ...................................................................
Total interest only and affordability lending ......
–
29,536
–
29,536
33,190
60,739
295
33,190
90,275
295
94,224
123,760
–
23,971
–
23,971
27,418
57,669
388
27,418
81,640
388
85,475
109,446
As a percentage of total mortgage lending .........
30.8%
48.9%
Second lien mortgages ........................................
19,265
As a percentage of total mortgage lending .........
20.1%
Negative equity2 .................................................
Other loan to value ratios greater than 90 per cent3
.........................................................................
12,343
44,450
56,793
As a percentage of total mortgage lending .........
59.2%
5,093
2.6%
2,454
20,870
23,324
12.1%
42.9%
24,358
29.5%
48.6%
42.6%
14,975
4,889
19,864
8.4%
18.5%
2.8%
7.7%
14,797
65,320
80,117
27.8%
14,160
33,302
2,336
22,680
16,496
55,982
47,462
25,016
72,478
58.5%
14.2%
28.2%
189
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Exposure > Areas of special interest / Cross-border distribution
1 HSBC Finance includes lending in Canada and the UK and excludes loans transferred to HSBC USA Inc.
2 Total mortgage lending includes residential mortgages and second lien mortgage lending included within ‘Other personal lending’.
3 Loan to value ratios are generally based on values at origination date.
Mortgage lending in the US
(Unaudited)
Mortgage lending in the US includes loans and
advances to customers with a first lien interest over
a property. These balances are secured and are
reported within residential mortgages. Loans with
only a second lien are reported in other personal
lending. The commentary that follows discusses both
residential mortgages and second lien loans included
within other personal lending.
HSBC continues to monitor a range of trends
affecting the US mortgage lending industry. Housing
markets in a large part of the US have been affected
by a general slowing in the rate of appreciation in
property values, or an actual decline in some
markets, while the period of time properties remain
unsold has increased. In addition, the ability of some
borrowers to service their adjustable-rate mortgages
(‘ARM’s) has been compromised as interest rates
have risen, increasing the amounts payable on their
loans as prices reset higher under their contracts. The
effect of interest rate adjustments on first mortgages
are also estimated to have had a direct impact on
borrowers’ ability to repay any additional second
lien mortgages taken out on the same properties.
Similarly, as interest-only mortgages leave the
interest-only payment period, rising payment
obligations are expected to strain the ability of
borrowers to make the increased payments. Studies
published in the US, and HSBC’s own experience,
indicate that mortgages originated throughout the
industry in 2005 and 2006 are performing worse than
loans originated in prior periods.
The effects of these recent trends have been
concentrated in the mortgage services business
(‘mortgage services’), which purchases first and
second lien mortgages from a network of over
220 third party lenders. As detailed in the
table below, this business has approximately
US$49.5 billion of loans and advances to personal
customers, 10.4 per cent of the Group’s gross loans
and advances to personal customers.
In 2005 and continuing into the first six months
of 2006, second lien mortgage loans in mortgage
services increased significantly as a percentage of
total loans acquired compared with prior periods.
During the second quarter of 2006 HSBC began to
experience deterioration in the credit performance of
mortgages acquired in 2005 by mortgage services in
the second lien and portions of the first lien
portfolios. The deterioration continued in the third
190
quarter of 2006 and began to affect second and first
lien loans acquired in that year. Further deterioration
in the fourth quarter of 2006 was largely in the first
lien adjustable-rate and second lien portfolios.
HSBC also determined that a significant number of
its second lien customers have underlying
adjustable-rate first mortgages that face repricing in
the near-term which, based on experience, are
estimated to adversely affect the probability of
repayment on the related second lien mortgage. As
numerous interest rate rises have occurred as credit
has tightened and there has been either a slowdown
in the rate of appreciation of properties or a decline
in their value, it is estimated that the probability of
default on adjustable-rate first mortgages subject to
repricing, and on any second lien mortgage loans
that are subordinate to adjustable-rate first liens, is
greater than has been experienced in the past. As a
result, loan impairment charges relating to the
mortgage services portfolio have increased
significantly.
Accordingly, while overall credit performance,
as measured by delinquency and write-off rates, has
performed broadly in line with industry trends across
other parts of the US mortgage portfolio, higher
delinquency and losses have been reported in
mortgage services, largely in the aforementioned
loans originated in 2005 and 2006. A number of
steps have been taken to mitigate risk in the affected
parts of the portfolio. These include enhanced
segmentation and analytics to identify the higher risk
portions of the portfolio, and increased collections
capacity. HSBC is restructuring or modifying loans
in accordance with defined policies if it believes that
customers will continue to pay the restructured or
modified loan. Also, customers who have adjustable-
rate mortgage loans nearing the first reset, and who
are expected to be the most affected by a rate
adjustment, are being contacted in order to assess
their ability to make the higher payment and, as
appropriate, refinance or modify their loans.
Furthermore, HSBC has slowed growth in this
portion of the portfolio by implementing repricing
initiatives in selected segments of the originated
loans and tightening underwriting criteria, especially
for second lien, stated income (low documentation)
and other higher risk segments. These actions,
combined with normal attrition, resulted in a net
reduction in loans and advances in mortgage services
during the second half of 2006. It is expected that
this portfolio will remain under pressure as the loans
originated in 2005 and 2006 season. It is also
expected that this portfolio will run off faster than in
the past as originations in it will be limited in 2007
and beyond. Accordingly, the increasing trend in
overall delinquency and write-offs in mortgage
services is expected to continue.
US mortgage loan balances
(Unaudited)
The following table summarises mortgage balance
information for the mortgage services and consumer
lending businesses within Personal Financial
Services in the US. Mortgages include first lien
residential mortgages, and second lien mortgage
lending which is reported within ‘Other personal
lending’ in the market sector analysis.
At 31 December 2006, the outstanding balance
of interest-only loans in the US mortgage services
business was US$6.3 billion, or 1.3 per cent of the
Group’s gross loans and advances to personal
customers, a rise of 22 per cent compared with
US$5.2 billion, or 1.2 per cent of loans in 2005.
The outstanding balance of adjustable rate
mortgages in the US mortgage services business at
31 December 2006 was US$20.8 billion, 4.4 per cent
of the Group’s gross loans and advances to personal
customers, a rise of 9 per cent compared with the
end of 2005.
In 2007, approximately US$13.2 billion of
adjustable rate mortgage loans will reach their first
interest rate reset, of which US$2.5 billion relate to
HSBC USA Inc and US$10.7 billion to HSBC
Finance, within which US$9.9 billion is mortgage
services, the remainder consumer lending. In 2008, a
further US$8.7 billion of adjustable-rate mortgage
loans will reset for the first time, of which
US$3.6 billion relate to HSBC USA Inc and
US$5.1 billion to HSBC Finance, within which
US$3.8 billion is mortgage services, the remainder
consumer lending. Adjustable rate mortgages in
HSBC USA Inc. are largely prime balances.
The balance of stated income mortgages was
approximately US$14.4 billion at the end of 2006, or
3 per cent of Group’s gross loans and advances to
personal customers. At the end of 2005, the
outstanding balance was US$9.6 billion, or 2.3 per
cent of loans. Of these amounts, US$11.8 billion and
US$7.3 billion at the end of 2006 and 2005,
respectively, relate to HSBC Finance mortgage
services. There were no stated income mortgages in
consumer lending in either period. The remainder of
the stated income balances are held by HSBC USA
Inc.
(Unaudited)
Year ended 31 December 2006
Year ended 31 December 2005
Mortgage
services
US$m
Consumer
lending
US$m
Other
mortgage
lending
US$m
Mortgage
Consumer
services
US$m
lending
US$m
Other
mortgage
lending
US$m
Fixed rate ............................................................
Adjustable-rate ....................................................
Total ....................................................................
First lien ..............................................................
Second lien .........................................................
Total ....................................................................
Adjustable-rate ....................................................
Interest-only ........................................................
Total adjustable-rate ...........................................
22,358
27,114
49,472
39,404
10,068
49,472
20,795
6,319
27,114
42,371
3,528
45,899
39,399
6,500
45,899
3,528
–
3,528
7,655
24,817
32,472
28,780
3,692
32,472
16,251
8,566
24,817
20,088
24,211
44,299
36,278
8,021
44,299
19,037
5,174
24,211
36,187
1,796
37,983
33,242
4,741
37,983
1,796
–
1,796
6,507
29,110
35,617
32,286
3,331
35,617
19,473
9,637
29,110
Country distribution of outstandings and
cross-border exposures
(Unaudited)
HSBC controls the risk associated with cross-border
lending, essentially that foreign currency will not be
made available to local residents to make payments,
through a centralised structure of internal country
limits which are determined by taking into account
relevant economic and political factors. Exposures to
individual countries and cross-border exposure in
aggregate are kept under continual review.
The following table summarises 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
HSBC’s total assets. The classification is based on
the country of residence of the borrower but also
recognises the transfer of country risk in respect of
third party guarantees, eligible collateral held and
residence of the head office when the borrower is a
branch. In accordance with the Bank of England
Country Exposure Report (Form CE) guidelines,
191
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Exposure / Credit quality > Loans and advances
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.
In-country foreign currency and cross-border outstandings
(Unaudited)
At 31 December 2006
UK ...................................................................................
Germany .........................................................................
US ...................................................................................
France .............................................................................
The Netherlands ..............................................................
Italy .................................................................................
At 31 December 2005
UK ...................................................................................
US ...................................................................................
Germany .........................................................................
France .............................................................................
The Netherlands ..............................................................
Italy .................................................................................
At 31 December 2004
UK ...................................................................................
US ...................................................................................
Germany .........................................................................
France .............................................................................
Italy .................................................................................
The Netherlands ..............................................................
Hong Kong .....................................................................
At 31 December 2006, HSBC had in-country foreign
currency and cross-border outstandings to
counterparties in Australia and Hong Kong 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$17.5 billion;
Hong Kong: US$15.5 billion.
At 31 December 2005, HSBC had in-country
foreign currency and cross-border outstandings to
counterparties in Hong Kong, 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 Hong Kong:
US$14.6 billion; Australia: US$12.5 billion; Canada:
US$11.7 billion.
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$11.8 billion.
Government
and official
institutions
US$bn
Banks
US$bn
Other
US$bn
Total
US$bn
24.8
23.7
9.5
22.1
14.4
4.7
19.6
10.2
21.6
11.5
11.9
4.4
19.7
9.2
17.8
11.1
5.7
9.1
1.6
–
18.9
12.7
2.4
2.1
12.5
3.7
11.1
12.7
4.7
2.6
10.6
3.8
13.3
10.4
3.7
9.7
2.2
1.1
33.5
2.0
16.2
6.1
3.9
1.4
16.2
17.1
3.3
5.4
4.4
3.5
24.5
14.0
4.0
4.6
2.1
4.2
10.3
58.3
44.6
38.4
30.6
20.4
18.6
39.5
38.4
37.6
21.6
18.9
18.5
48.0
36.5
32.2
19.4
17.5
15.5
13.0
Credit quality
The following tables reflect broadly stable credit
quality across the majority of the Group’s
businesses. However, loans and advances in grades
1-3 (satisfactory risk) declined to 91.7 per cent
(2005: 96.4 per cent) of loans and advances to
customers neither past due nor impaired. This was
mainly due to the transfer of the US mortgage
services book of US$44.5 billion to grades 4 and 5 to
reflect increased scrutiny of this portfolio for the
reasons explained on page 189. Excluding this
realignment, satisfactory risk across the remainder of
the Group showed a marginally improving trend.
The deterioration in quality in US first lien and
second lien mortgages (and, to a lesser extent, UK
personal unsecured portfolios) also reflected in an
increase in the proportion of customer loans and
advances which were past due but not impaired to
1.28 per cent (2005: 1.17 per cent).
Credit quality of loans and advances to banks
was stable.
192
Loans and advances
Distribution of loans and advances by credit quality
(Audited)
Loans and advances:
– neither past due nor impaired ................................
– past due but not impaired ......................................
– impaired .................................................................
At 31 December 2006
At 31 December 2005
Loans and
advances to
customers
US$m
Loans and
advances to
banks
US$m
856,681
11,245
13,785
881,711
185,125
72
15
185,212
Loans and
advances to
customers
US$m
731,116
8,797
11,446
751,359
Loans and
advances to
banks
US$m
125,930
22
22
125,974
Distribution of loans and advances neither past due nor impaired
(Audited)
The credit quality of the portfolio of loans and
advances that were neither past due nor impaired can
be assessed by reference to the Group’s standard
credit grading system, as described on page 173. The
following information is based on that system:
Grades:
1 to 3 – satisfactory risk ...........................................
4 – watch list and special mention ...........................
5 – sub-standard but not impaired ............................
At 31 December 2006
At 31 December 2005
Loans and
advances to
customers
US$m
Loans and
advances to
banks
US$m
785,946
62,557
8,178
856,681
184,059
1,040
26
185,125
Loans and
advances to
customers
US$m
705,036
19,950
6,130
731,116
Loans and
advances to
banks
US$m
125,324
555
51
125,930
This analysis excludes loans and advances graded 1-5 that are contractually past due.
The HSBC Finance mortgage services portfolio of US$44.5 billion included in the above table is reported in grades 4 and 5.
Loans and advances which were past due but not impaired
(Audited)
Examples of exposures designated past due but not
considered impaired include loans fully secured by
cash collateral, residential mortgages in arrears more
than 90 days, but where the value of collateral is
sufficient to repay both the principal debt and all
potential interest for at least one year, and short-term
trade facilities past due more than 90 days for
technical reasons such as delays in documentation,
but where there is no concern over the
creditworthiness of the counterparty.
Past due up to 29 days ..................................................
Past due 30 – 59 days ...................................................
Past due 60 – 89 days ...................................................
Past due 90 – 179 days .................................................
Past due over 180 days but less than 1 year .................
At 31 December 2006
At 31 December 2005
Loans and
advances to
customers
US$m
Loans and
advances to
banks
US$m
Loans and
advances to
customers
US$m
Loans and
advances to
banks
US$m
6,625
1,875
822
9,322
1,764
159
11,245
72
–
–
72
–
–
72
4,837
1,743
583
7,163
1,368
266
8,797
22
–
–
22
–
–
22
This ageing analysis includes past due loans and advances that have collective impairment allowances set aside to cover credit losses on
loans which are in the early stages of arrears.
193
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Credit quality > Loans and advances > 2006
Impaired loans and advances
(Audited)
Total impaired loans and advances to:
– banks ...........................................................................................................................................
– customers ....................................................................................................................................
At 31 December
2006
US$m
15
13,785
13,800
Total allowances cover as a percentage of impaired loans and advances ........................................
98.4%
Impaired customer loans and impairment allowances by geographical region
(Audited)
2005
US$m
22
11,446
11,468
99.1%
Europe ...........................................................................
Hong Kong ...................................................................
Rest of Asia-Pacific ......................................................
North America ..............................................................
Latin America ...............................................................
At 31 December 2006
At 31 December 2005 (restated1)
Impaired
loans
US$m
5,847
454
1,184
4,822
1,478
13,785
Impairment
allowances
US$m
3,676
365
901
7,247
1,389
13,578
Impaired
loans
US$m
Impairment
allowances
US$m
5,068
506
936
3,710
1,226
3,491
398
836
5,349
1,283
11,446
11,357
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13 on the Financial Statements.
The total gross amount of impaired loans and
advances to customers as at 31 December 2006 was
US$13,785 million (2005: US$11,446 million), of
which US$5,833 million (2005: US$4,960 million)
related to individually impaired loans and advances
and US$7,952 million (2005: US$6,486 million)
related to portfolios of homogeneous loans and
advances. The following table presents an analysis of
individually impaired loans by industry sector and
by geographical region:
Individually impaired loans and advances to customers
(Audited)
Europe
US$m
Hong
Kong
US$m
Rest of
Asia-
Pacific
US$m
North
America
US$m
Gross
impaired
loans and
advances to
customers
US$m
% of total
gross
impaired
loans1
%
Latin
America
US$m
At 31 December 2006 .................
Individually impaired loans and
advances to customers:
– personal ...............................
– commercial and corporate ...
At 31 December 2005 (restated2).
Individually impaired loans and
advances to customers:
– personal ...............................
– commercial and corporate ...
975
3,056
4,031
655
2,562
3,217
231
176
407
256
198
454
118
531
649
119
629
748
173
248
421
–
330
330
1
324
325
5
206
211
1,498
4,335
5,833
1,035
3,925
4,960
25.7
74.3
100.0
20.9
79.1
100.0
1 Gross impaired loans by industry sector as a percentage of total gross impaired loans.
2 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13 on the Financial Statements.
194
some US$340 million. In the Middle East, the 8 per
cent rise in impaired loans reflected lending growth.
Impaired loans declined in most other countries,
reflecting buoyant regional economies.
In North America there was a rise of 30 per
cent in impaired loans, to US$4,822 million at
31 December 2006. Growth was substantially driven
by credit deterioration in second lien, some portions
of first lien and adjustable-rate mortgages in the US
mortgage services book, as detailed on page 189.
This was partly offset by the non-recurrence of
significant loan impairment allowances which were
raised in 2005 as a result of hurricane Katrina and
increased levels of bankruptcy filings in the fourth
quarter of the year. As a consequence of this latter
factor, HSBC experienced bankruptcies significantly
below long-term trends in the first half of 2006.
Continuing assessments of the financial impact of
hurricane Katrina on HSBC Finance’s customers
living in the Katrina Federal Emergency
Management Agency designated Individual
Assistance disaster areas resulted in a downwards
revision of the estimate of credit loss exposure in the
first half of 2006.
In contrast to the accelerated credit weakness
witnessed in the mortgage services business, the
trend of credit delinquency across the majority of the
other portfolios, including mortgage balances
originated through the branch-based consumer
lending business, rose modestly, driven by growing
portfolio maturity and a higher mix of credit card
receivables following the Metris acquisition.
In Canada, impaired loans increased as a
small number of commercial customers in the
manufacturing sector were adversely affected by
the stronger Canadian dollar.
In Latin America, impaired loans increased by
14 per cent to US$1,478 million, partly due to
acquisitions in 2006 and partly to a higher amount of
personal lending. Growth was mainly in Mexico and
Brazil. In Mexico, impaired loans rose through
strong growth in lending to personal and commercial
customers, particularly the small and middle market
sectors. In Brazil, impaired loans rose by 6 per cent,
reflecting lending growth and some continuing credit
stress, in part mitigated through tightened
underwriting criteria introduced during 2005 and
2006.
Year ended 31 December 2006 compared
with year ended 31 December 2005
(Unaudited)
Total impaired loans to customers were
US$13,785 million at 31 December 2006, an
increase of 20 per cent since the end of 2005. At
constant currency the growth was 14 per cent and, at
31 December 2006, impaired loans as a percentage
of gross customer loans and advances were 1.56 per
cent (2005: 1.52 per cent). The US represented
9 percentage points of overall growth and 33 per
cent of total impaired customer loans at
31 December 2006.
The commentary that follows is based on
constant exchange rates.
In Europe, impaired loans rose by 4 per cent to
US$5,847 million in 2006. In the UK, impaired
loans grew by 11 per cent over the same period. The
UK market remained challenging, with pressure on
consumers through high levels of personal
indebtedness, compounded by interest rate rises.
These effects were to an extent masked by the
growing prevalence of personal bankruptcies and
IVAs, at the completion of which any unpaid
balances are written off. UK commercial and
corporate lending remained broadly stable. In
France, impaired loans fell mainly as a result of
more active portfolio management, including the
sale of a portfolio of substantially impaired debt and,
in Turkey, higher impaired balances were broadly in
line with growth in customer advances; the credit
environment in these countries was relatively stable.
Impaired loans in Hong Kong were 10 per cent
lower at US$454 million at 31 December 2006.
HSBC responded to moderate volatility in its loan
portfolio by launching a number of initiatives to
strengthen credit management and risk monitoring
procedures, in order to improve the credit quality of
its portfolio. As a result, the number of newly
impaired loans fell and an increased number of loans
were written off.
In the Rest of Asia-Pacific, impaired loans
increased by 23 per cent to US$1,184 million. In
Taiwan, delinquency problems emerged in the
middle of 2005, centred on a relatively small number
of highly leveraged consumers. This prompted a
range of regulatory changes aimed at avoiding a
financial crisis, the most significant being the
introduction of a government debt negotiation
mechanism by which banks were instructed to make
available deferred repayment terms at discounted
rates. The consequence of this was to widen
considerably the group of debtors seeking relief and
increase substantially HSBC’s impaired loans to
195
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Credit quality / Impairment allowances and charges
Interest forgone on impaired loans
(Audited)
Interest income that would have been recognised
under the original terms of impaired and restructured
loans amounted to approximately US$104 million in
2006, compared with US$275 million in 2005 and
US$280 million in 2004. Interest income from such
loans of approximately US$276 million was
recorded in 2006, compared with US$120 million
in 2005.
Renegotiated loans
(Audited)
Restructuring activity is designed to manage
customer relationships, maximise collection
opportunities and, if possible, avoid foreclosure or
repossession. Such activities include extended
payment arrangements, approved external debt
management plans, deferring foreclosure,
modification, loan rewrites and/or deferral of
payments pending a change in circumstances.
Following restructuring, an overdue consumer
account is normally reset from delinquent to current
status. Restructuring policies and practices are based
on indicators or criteria which, in the judgement of
local management, indicate that repayment will
probably continue. These policies are required to be
kept under continual review and their application
varies according to the nature of the market, the
product, and the availability of empirically based
data. When empirical evidence indicates an
increased propensity to default on restructured
accounts, the use of roll rate methodology ensures
this factor is taken into account when calculating
impairment allowances.
Renegotiated loans that would otherwise be
past due or impaired totalled US$20.7 billion at
31 December 2006 (2005: US$18.1 billion).
Restructuring is most commonly applied to
consumer finance portfolios. The largest
concentration is in the US, and amounts to
US$16.7 billion (2005: US$14.2 billion) or
81 per cent (2005: 79 per cent) of the total
renegotiated loans. The increase was substantially
driven by credit deterioration in second lien, some
portions of first lien, and adjustable-rate mortgages
in the US mortgage services book as detailed on
page 189. The majority of restructured amounts arise
from secured lending.
Collateral and other credit enhancements
obtained
(Audited)
HSBC obtained assets by taking possession of
collateral held as security, or calling upon other
credit enhancements, as follows:
(Audited)
Nature of assets
Residential property .................
Commercial and industrial
property ................................
Other ........................................
Carrying amount
obtained in:
2006
US$m
2005
US$m
1,716
1,171
6
215
26
138
1,937
1,335
Repossessed properties are made available for
sale in an orderly fashion, with the proceeds used to
reduce or repay the outstanding indebtedness. Where
excess funds are available after the debt has been
repaid, they are available either for other secured
lenders with lower priority or are returned to the
customer. HSBC does not generally occupy
repossessed properties for its business use. The
majority of repossessed properties arose in HSBC
Finance.
196
Impairment allowances and charges
Movement in allowance accounts for total loans and advances
(Audited)
Individually
Collectively
assessed
US$m
assessed
US$m
At 1 January 2006 ............................................................................................
Amounts written off ........................................................................................
Recoveries of loans and advances written off in previous years ....................
Charge to income statement ............................................................................
Exchange and other movements ......................................................................
At 31 December 2006 .....................................................................................
At 1 January 2005 ............................................................................................
Amounts written off ........................................................................................
Recoveries of loans and advances written off in previous years ....................
Charge to income statement ............................................................................
Exchange and other movements ......................................................................
At 31 December 2005 ......................................................................................
2,679
(1,023)
128
458
330
2,572
3,728
(1,102)
199
518
(664)
2,679
Impairment allowances as a percentage of loans and advances to customers
(Unaudited)
Total impairment allowances to gross lending1
Individually assessed impairment allowances ..................................................................................
Collectively assessed impairment allowances ..................................................................................
1 Net of reverse repo transactions, settlement accounts and stock borrowings.
8,687
(8,450)
651
10,089
36
11,013
8,906
(7,941)
295
7,342
85
8,687
At 31 December
2006
%
0.30
1.28
1.58
Total
US$m
11,366
(9,473)
779
10,547
366
13,585
12,634
(9,043)
494
7,860
(579)
11,366
2005
%
0.36
1.18
1.54
197
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Impairment allowances > 2006 / 2005
Movement in impairment allowances by industry segment and by geographical region
The following tables show details of the movements
in HSBC’s impairment allowances by location of
lending office for each of the past five years.
A discussion of the material movements in the
loan impairment charges by region follows these
tables.
(Audited)
Impairment allowances at 1 January (restated3) .
Amounts written off
Commercial, industrial and international trade
Real estate .......................................................
Non-bank financial institutions .......................
Other commercial ............................................
Residential mortgages .....................................
Other personal .................................................
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 .................................................
Charge to income statement1
Banks ...............................................................
Commercial, industrial and international trade
Real estate .......................................................
Non-bank financial institutions .......................
Governments ...................................................
Other commercial ............................................
Residential mortgages .....................................
Other personal .................................................
Foreign exchange and other movements ............
Impairment allowances at 31 December ............
Europe
US$m
3,499
(454)
(70)
(20)
(116)
(2)
(2,044)
(2,706)
25
15
1
24
3
357
425
–
246
41
(7)
(13)
23
24
1,826
2,140
325
3,683
Impairment allowances against banks:
– individually assessed ....................................
7
Impairment allowances against customers:
– individually assessed ....................................
– collectively assessed2 ...................................
Impairment allowances at 31 December ............
Impairment allowances against customers
as a percentage of loans and advances to
customers:
– individually assessed ....................................
– collectively assessed ....................................
At 31 December ..................................................
1,725
1,951
3,683
%
0.44
0.49
0.93
2006
Rest of
Asia-
Pacific
US$m
North
Latin
America
US$m
America
US$m
837
5,349
1,283
Total
US$m
11,366
(782)
(111)
(39)
(260)
(628)
(7,653)
(9,473)
88
21
11
54
19
586
779
(3)
503
75
(6)
(37)
86
1,096
8,833
10,547
366
(97)
(21)
(1)
(31)
(595)
(4,188)
(4,933)
20
3
10
9
7
36
85
–
107
19
(4)
(1)
18
1,039
5,620
6,798
(52)
7,247
(96)
(6)
–
(103)
(21)
(827)
(1,053)
27
–
–
19
–
90
136
(2)
124
6
6
(23)
66
29
734
940
83
1,389
13,585
–
–
7
109
7,138
7,247
%
238
1,151
1,389
%
2,565
11,013
13,585
%
(79)
(8)
(11)
(7)
(7)
(454)
(566)
11
3
–
2
1
77
94
(1)
(14)
3
(1)
–
(19)
–
544
512
24
901
–
362
539
901
%
Hong
Kong
US$m
398
(56)
(6)
(7)
(3)
(3)
(140)
(215)
5
–
–
–
8
26
39
–
40
6
–
–
(2)
4
109
157
(14)
365
–
131
234
365
%
0.15
0.28
0.43
0.46
0.69
1.15
0.04
2.50
2.54
0.64
3.10
3.74
0.29
1.25
1.54
1 See table below ‘Net impairment charge to income statement by geographical region’.
2 Collectively assessed impairment allowances are allocated to geographical segments based on the location of the office booking the
allowance. Consequently, the collectively assessed impairment allowances 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 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13 on the Financial Statements.
198
(Audited)
Impairment allowances at 1 January ..................
4,851
Europe
US$m
Amounts written off
Commercial, industrial and international trade
Real estate .......................................................
Non-bank financial institutions ......................
Other commercial ...........................................
Residential mortgages ....................................
Other personal ................................................
Recoveries of amounts written off in previous
years
Commercial, industrial and international trade
Real estate .......................................................
Other commercial ...........................................
Residential mortgages ....................................
Other personal ................................................
Net charge/(release) to income statement1
Banks ..............................................................
Commercial, industrial and international trade
Real estate .......................................................
Non-bank financial institutions ......................
Governments ..................................................
Other commercial ...........................................
Residential mortgages ....................................
Other personal ................................................
Foreign exchange and other movements ............
Impairment allowances at 31 December ............
(345)
(67)
(3)
(108)
(14)
(2,267)
(2,804)
10
5
6
1
62
84
(5)
354
59
(14)
4
(21)
5
1,602
1,984
(616)
3,499
Impairment allowances against banks:
– individually assessed ...................................
8
Impairment allowances against customers:
– individually assessed ...................................
– collectively assessed2 ..................................
Impairment allowances at 31 December ............
Impairment allowances against customers
as a percentage of loans and advances to
customers:
– individually assessed ...................................
– collectively assessed ....................................
At 31 December ..................................................
1,575
1,916
3,499
%
0.50
0.61
1.11
Hong
Kong
US$m
504
(157)
(23)
–
–
(2)
(112)
(294)
4
–
1
9
31
45
–
199
–
(1)
–
(32)
(25)
5
146
(3)
398
–
173
225
398
%
2005 (restated3)
Rest of
Asia-
Pacific
US$m
North
America
US$m
Latin
America
US$m
Total
US$m
960
5,231
1,088
12,634
(79)
(11)
–
(6)
(6)
(227)
(329)
17
1
2
1
61
82
(2)
(72)
1
–
–
(1)
7
203
136
(12)
837
1
500
336
837
%
(81)
(14)
(10)
(14)
(456)
(4,338)
(4,913)
37
2
38
–
70
147
–
32
(6)
9
2
(18)
592
4,308
4,919
(35)
5,349
(11)
(2)
–
(66)
(30)
(594)
(703)
8
1
42
7
78
136
–
75
2
–
–
46
26
526
675
87
(673)
(117)
(13)
(194)
(508)
(7,538)
(9,043)
76
9
89
18
302
494
(7)
588
56
(6)
6
(26)
605
6,644
7,860
(579)
1,283
11,366
–
–
9
221
5,128
5,349
%
0.09
1.99
2.08
214
1,069
1,283
%
0.93
4.65
5.58
2,683
8,674
11,366
%
0.36
1.16
1.52
0.21
0.27
0.48
0.71
0.47
1.18
1 See table below ‘Net impairment charge to income statement by geographical region’.
2 Collectively assessed impairment allowances are allocated to geographical segments based on the location of the office booking the
allowance. Consequently, the collectively assessed impairment allowances 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 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13 on the Financial Statements.
199
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Provisions for bad and doubtful debts > 2004 / 2003
Movement in provisions by industry segment and by geographical region
(Unaudited)
Provisions at 1 January .......................................
IFRSs transition adjustment at 1 January ...........
Amounts written off
Commercial, industrial and international trade
Real estate .......................................................
Non-bank financial institutions ......................
Other commercial ...........................................
Residential mortgages ....................................
Other personal ................................................
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 ................................................
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 ..........................................
Foreign exchange and other movements ............
Provisions at 31 December .................................
Europe
US$m
4,435
(2)
(298)
(30)
(14)
(209)
(10)
(770)
(1,331)
27
3
3
5
1
97
136
(7)
180
21
18
–
(65)
3
1,035
(162)
1,023
551
4,812
Provisions against banks:
– specific provisions .......................................
14
Provisions against customers:
– specific provisions .......................................
– general provisions2 ......................................
Provisions at 31 December .................................
:
Provisions against customers as a percentage
of loans and advances to customers
– specific provisions .......................................
– general provisions .......................................
At 31 December ..................................................
4,036
762
4,812
%
1.43
0.27
1.70
Hong
Kong
US$m
1,055
(34)
(35)
(55)
(2)
(33)
(52)
(125)
(302)
10
–
–
3
12
22
47
–
(56)
(15)
(3)
–
(29)
(14)
120
(223)
(220)
(24)
522
–
320
202
522
%
0.40
0.25
0.65
2004 (restated3)
Rest of
Asia-
Pacific
US$m
North
America
US$m
1,181
(21)
5,665
–
Latin
America
US$m
1,379
(1)
Total
US$m
13,715
(58)
(623)
(106)
(20)
(498)
(561)
(7,036)
(8,844)
118
17
3
85
31
659
913
(10)
179
(22)
15
1
(168)
482
6,216
(498)
6,195
638
(65)
(1)
(185)
(28)
(404)
(683)
39
–
–
45
9
63
156
(2)
12
1
–
–
(35)
(5)
303
(2)
272
(53)
1,070
12,559
–
770
300
1,070
%
4.58
1.79
6.37
17
10,017
2,525
12,559
%
1.46
0.37
1.83
(164)
(17)
(1)
(42)
(8)
(171)
(403)
4
10
–
14
1
41
70
(1)
52
(28)
(1)
–
(18)
4
142
(48)
102
14
943
3
785
155
943
%
1.27
0.25
1.52
(61)
(3)
(3)
(29)
(463)
(5,566)
(6,125)
38
4
–
18
8
436
504
–
(9)
(1)
1
1
(21)
494
4,616
(63)
5,018
150
5,212
–
4,106
1,106
5,212
%
1.67
0.45
2.12
1 See table below ‘Net charge to the profit and loss account for bad and doubtful debts by geographical region’.
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 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13 on the Financial Statements.
200
(Unaudited)
Provisions at 1 January .......................................
Amounts written off
Commercial, industrial and international trade
Real estate .......................................................
Non-bank financial institutions .......................
Other commercial ............................................
Residential mortgages .....................................
Other personal .................................................
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 .................................................
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 ..........................................
Foreign exchange and other movements2 ...........
Europe
US$m
3,668
(338)
(31)
(3)
(54)
(4)
(472)
(902)
25
3
2
49
1
62
142
(6)
286
15
(1)
–
216
–
482
(118)
874
653
Hong
Kong
US$m
1,143
(71)
(12)
(13)
(65)
(121)
(302)
(584)
16
–
–
4
6
16
42
–
(3)
(18)
1
–
78
102
271
(31)
400
54
2003 (restated4)
Rest of
Asia-
Pacific
US$m
North
America
US$m
Latin
America
US$m
1,496
642
2,191
(201)
(18)
(21)
(42)
(16)
(147)
(445)
18
4
5
11
1
35
74
3
(45)
(8)
(17)
1
(4)
23
116
16
85
(29)
(102)
(3)
–
(80)
(292)
(3,992)
(4,469)
20
2
4
10
2
292
330
–
77
(1)
(5)
–
55
422
3,950
59
4,557
4,605
5,665
(304)
(115)
(30)
(54)
(242)
(311)
(1,056)
3
–
–
7
3
9
22
–
61
1
(1)
–
(6)
5
164
(47)
177
45
Total
US$m
9,140
(1,016)
(179)
(67)
(295)
(675)
(5,224)
(7,456)
82
9
11
81
13
414
610
(3)
376
(11)
(23)
1
339
552
4,983
(121)
6,093
5,328
Provisions at 31 December .................................
4,435
1,055
1,181
1,379
13,715
Provisions against banks:
– specific provisions .......................................
20
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 ........................................
At 31 December ..................................................
3,554
861
4,435
%
1.65
0.40
2.05
–
629
426
4
981
196
1,055
1,181
–
–
24
4,660
1,005
5,665
1,054
325
1,379
10,878
2,813
13,715
%
%
%
%
%
0.84
0.57
1.41
1.99
0.40
2.39
2.47
0.53
3.00
6.97
2.15
9.12
2.00
0.52
2.52
1 See table below ‘Net charge to the profit and loss account for bad and doubtful debts by geographical region’.
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$116 million in Latin America transferred in on the acquisition of Lloyds TSB
Group’s Brazilian businesses and assets.
3 General provisions are allocated to geographical segments based on the location of the office booking the provision. Consequently, the
general provision booked in Hong Kong may cover assets booked in branches located outside Hong Kong, principally in the Rest of
Asia-Pacific, as well as those booked in Hong Kong.
4 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13 on the Financial Statements.
201
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Provisions for bad and doubtful debts > 2002 / Impairment charges > 2006 / 2005
Movement in provisions by industry segment and by geographical region (continued)
(Unaudited
Provisions at 1 January .......................................
3,067
Europe
US$m
Amounts written off
Banks ...............................................................
Commercial, industrial and international trade
Real estate ........................................................
Non-bank financial institutions .......................
Governments ...................................................
Other commercial ............................................
Residential mortgages .....................................
Other personal .................................................
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 .................................................
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 ...........................................
Foreign exchange and other movements2 ...........
–
(161)
(31)
(4)
(1)
(54)
(2)
(199)
(452)
15
6
–
7
1
29
58
(2)
345
(4)
3
(1)
50
–
243
(65)
569
426
Hong
Kong
US$m
1,408
–
(59)
(18)
(11)
–
(11)
(109)
(328)
(536)
1
–
–
3
7
14
25
–
(22)
9
(14)
–
(22)
70
322
(97)
246
–
–
(255)
(88)
(2)
–
(116)
(7)
(132)
(600)
4
2
1
14
–
31
52
–
38
(11)
(29)
–
(22)
11
93
9
89
3
2002 (restated4)
Rest of
Asia-
Pacific
US$m
North
America
US$m
Latin
America
US$m
1,952
708
1,048
Total
US$m
8,183
(1)
(595)
(150)
(31)
(1)
(352)
(130)
(851)
(1)
(34)
(4)
(2)
–
(22)
(10)
(96)
(169)
(2,111)
2
–
–
–
–
8
28
14
1
33
8
96
10
180
–
41
2
11
4
178
10
96
(166)
176
1,126
2,191
(2)
480
1
(11)
(2)
299
87
820
(351)
1,321
1,567
9,140
–
23
–
(86)
(9)
(12)
–
(149)
(2)
(96)
(354)
6
6
–
9
–
14
35
–
78
5
18
(5)
115
(4)
66
(32)
241
12
642
–
222
420
642
Provisions at 31 December .................................
3,668
1,143
1,496
Provisions against banks:
– specific provisions ........................................
23
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 ........................................
At 31 December ..................................................
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
1,601
590
2,191
%
%
0.32
0.61
0.93
11.25
4.15
15.40
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 by geographical region’.
2 Other movements include amounts transferred in on the acquisition of HSBC Mexico of US$1,704 million.
3 General provisions are allocated to geographical segments based on the location of the office booking the provision. Consequently, the
general provision booked in Hong Kong may cover assets booked in branches located outside Hong Kong, principally in the Rest of
Asia-Pacific, as well as those booked in Hong Kong.
4 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13 on the Financial Statements.
202
Net loan impairment charge to the income statement by geographical region
(Unaudited)
Year ended 31 December 2006
Europe
US$m
Hong
Kong
US$m
Rest of
Asia-
Pacific
US$m
North
America
US$m
Latin
America
US$m
Individually assessed impairment allowances
New allowances ..............................................
Release of allowances no longer required .....
Recoveries of amounts previously written off
Collectively assessed impairment allowances
New allowances net of allowance releases ....
Recoveries of amounts previously written off
Total charge for impairment losses ....................
Banks .............................................................
Customers ......................................................
Charge for impairment losses
as a percentage of closing gross loans
and advances ..................................................
31 December 2006
Impaired loans ....................................................
Impairment allowances .......................................
715
(439)
(33)
243
2,285
(388)
1,897
2,140
–
2,140
%
93
(45)
(14)
34
150
(27)
123
157
–
157
%
138
(130)
(28)
(20)
599
(67)
532
512
(1)
513
%
229
(61)
(39)
129
6,715
(46)
6,669
6,798
–
6,798
122
(36)
(14)
72
991
(123)
868
940
(2)
942
%
%
%
0.45
0.12
0.48
2.24
1.89
0.99
US$m
US$m
US$m
US$m
US$m
US$m
5,858
3,683
454
365
1,188
901
4,822
7,247
1,478
1,389
13,800
13,585
(Unaudited)
Year ended 31 December 2005 (restated1)
Individually assessed impairment allowances
New allowances ..............................................
Release of allowances no longer required .....
Recoveries of amounts previously written off
Collectively assessed impairment allowances
New allowances ..............................................
Release of allowances no longer required .....
Recoveries of amounts previously written off
Total charge for impairment losses ....................
Banks .............................................................
Customers ......................................................
Charge for impairment losses
as a percentage of closing gross loans
and advances ..................................................
31 December 2005
Impaired loans ....................................................
Impairment allowances .......................................
Europe
US$m
1,029
(648)
(21)
360
2,013
(326)
(63)
1,624
1,984
(5)
1,989
%
Hong
Kong
US$m
200
(123)
(18)
59
159
(45)
(27)
87
146
–
146
%
Rest of
Asia-
Pacific
US$m
North
America
US$m
Latin
America
US$m
299
(42)
(101)
156
5,072
(264)
(45)
4,763
4,919
–
4,919
56
(19)
(25)
12
842
(67)
(112)
663
675
–
675
131
(166)
(34)
(69)
339
(86)
(48)
205
136
(2)
138
%
%
%
%
0.55
0.12
0.15
1.83
2.11
0.90
US$m
US$m
US$m
US$m
US$m
US$m
5,081
3,499
506
398
945
837
3,710
5,349
1,226
1,283
11,468
11,366
Total
US$m
1,297
(711)
(128)
458
10,740
(651)
10,089
10,547
(3)
10,550
Total
US$m
1,715
(998)
(199)
518
8,425
(788)
(295)
7,342
7,860
(7)
7,867
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13 on the Financial Statements.
203
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Charge to P&L Account > 2004 to 2002 / Impairment charges > 2006
Net charge to the profit and loss account for bad and doubtful debts by geographical region (continued)
(Unaudited)
Specific provisions
New provisions ...............................................
Release of provisions no longer required ......
Recoveries of amounts previously written off
General provisions ..............................................
Total bad and doubtful debt charge ....................
Banks .............................................................
Customers ......................................................
Bad and doubtful debt charge
as a percentage of closing gross loans
and advances ..................................................
31 December 2004
Non-performing loans ........................................
Provisions ...........................................................
(Unaudited)
Specific provisions
New provisions ...............................................
Release of provisions no longer required ......
Recoveries of amounts previously written off
General provisions ..............................................
Total bad and doubtful debt charge ....................
Banks .............................................................
Customers ......................................................
Bad and doubtful debt charge
as a percentage of closing gross loans
and advances ..................................................
31 December 2003
Non-performing loans ........................................
Provisions ...........................................................
Year ended 31 December 2004 (restated1)
Hong
Kong
US$m
237
(187)
(47)
3
(223)
(220)
–
(220)
%
Rest of
Asia-
Pacific
US$m
419
(199)
(70)
150
(48)
102
(1)
103
%
North
America
US$m
Latin
America
US$m
5,690
(105)
(504)
5,081
(63)
5,018
–
5,018
479
(49)
(156)
274
(2)
272
(2)
274
Total
US$m
8,872
(1,266)
(913)
6,693
(498)
6,195
(10)
6,205
%
%
%
Europe
US$m
2,047
(726)
(136)
1,185
(162)
1,023
(7)
1,030
%
0.36
(0.28)
0.17
1.88
1.20
0.91
US$m
US$m
US$m
US$m
US$m
US$m
6,039
4,798
696
522
1,160
940
3,555
5,212
977
1,070
12,427
12,542
Year ended 31 December 2003 (restated1)
Europe
US$m
Hong Kong
US$m
1,485
(351)
(142)
992
(118)
874
(6)
880
%
655
(182)
(42)
431
(31)
400
–
400
%
Rest of
Asia-
Pacific
US$m
412
(269)
(74)
69
16
85
3
82
%
North
America
Latin
America
US$m
US$m
4,907
(80)
(329)
4,498
59
4,557
–
4,557
318
(71)
(23)
224
(47)
177
–
177
Total
US$m
7,777
(953)
(610)
6,214
(121)
6,093
(3)
6,096
%
%
%
0.41
0.53
0.17
2.33
0.79
1.12
US$m
US$m
US$m
US$m
US$m
US$m
5,701
4,415
1,671
1,055
1,538
1,177
4,889
5,665
1,251
1,379
15,050
13,691
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13 on the Financial Statements.
204
(Unaudited)
Specific provisions
New provisions ...............................................
Release of provisions no longer required ......
Recoveries of amounts previously written off
General provisions
Argentine additional provision ...........................
Other ...................................................................
Total bad and doubtful debt charge ....................
Customers .......................................................
Bad and doubtful debt charge
as a percentage of closing gross loans
and advances ..................................................
31 December 2002
Non-performing loans ........................................
Provisions ...........................................................
Year ended 31 December 2002 (restated1)
Europe
US$m
Hong Kong
US$m
963
(271)
(58)
634
–
(65)
(65)
569
569
%
528
(160)
(25)
343
–
(97)
(97)
246
246
%
Rest of
Asia-
Pacific
US$m
400
(268)
(52)
80
–
9
9
89
89
%
North
America
Latin
America
US$m
US$m
380
(72)
(35)
273
–
(32)
(32)
241
241
407
(55)
(10)
342
(196)
30
(166)
176
176
Total
US$m
2,678
(826)
(180)
1,672
(196)
(155)
(351)
1,321
1,321
%
%
%
0.34
0.35
0.23
0.32
0.83
0.36
US$m
US$m
US$m
US$m
US$m
US$m
4,495
3,645
1,724
1,143
2,055
1,496
508
642
1,741
2,191
10,523
9,117
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13 on the Financial Statements.
Year ended 31 December 2006 compared
with year ended 31 December 2005
(Unaudited)
Loan impairment charges increased by
US$2,687 million, or 34 per cent, compared with
2005. Acquisitions accounted for US$309 million of
the rise, mainly Metris in the US. On an underlying
basis the increase was 30 per cent. Personal
Financial Services continued to dominate loan
impairments, representing 94 per cent of the Group’s
charge. On a constant currency basis, the key trends
were as follows.
New allowances for loan impairment charges of
US$12,037 million increased by 27 per cent
compared with 2005. Releases and recoveries of
allowances were broadly in line with 2005.
In Europe, new loan impairment charges rose
by 9 per cent compared with 2005 to
US$3,000 million. A challenging credit environment
in UK unsecured lending, which began to deteriorate
in the middle of 2005, was the primary cause of the
increase, although this was partly mitigated by
continued benign corporate and commercial
impairment experience. Personal bankruptcies and
the use of IVAs have been on a rising trend since the
introduction of legislation in 2004 that eased filing
requirements, and this was further exacerbated by
205
the recent active marketing of bankruptcy and IVA
relief through the media by debt advisors.
Additionally, a rise in unemployment, which began
in the middle of 2005, and modest rises in interest
rates added to the strain on some personal customers.
In response, HSBC tightened underwriting controls
in the second half of 2005, reduced its market share
of unsecured personal lending and changed the
product mix of new business towards lower-risk
customers. In 2006 there were early signs of
improvement in more recent unsecured lending. New
loan impairment charges also rose in Turkey, by
30 per cent, mainly due to growth in unsecured
credit card and personal lending as overall credit
quality remained stable. In France, new charges fell,
reflecting a stable credit environment and the
reduction in charges following the sale of a
consumer finance business in the second half of
2005.
Releases and recoveries in Europe of
US$860 million were 17 per cent higher than in
2005. Increases in the UK were partially offset by a
decline in France. In the UK, increased resources
deployed on collection activities combined with a
rise in sales of delinquent debt were reflected in
significantly higher recoveries. The non-recurrence
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Impairment charges > 2006 / 2005
of several significant recoveries in 2005 led to a
large fall in France.
In Hong Kong, new loan impairment charges
declined by 22 per cent to US$243 million,
reflecting the non-recurrence of an individual charge
in 2005 for a large commercial customer. This was
partly offset by a rise in credit card impairments as a
result of a rise in balances. Overall, credit quality
remained stable as strong economic growth and low
levels of unemployment continued.
Releases and recoveries fell by 49 per cent to
US$86 million, again mainly as a result of fewer
individual impairment releases in the corporate and
commercial sector and the non-recurrence of
mortgage lending recoveries in 2005, following
improvement in the property market since 2004.
In the Rest of Asia-Pacific, there was an 88 per
cent rise in new impairment charges to
US$737 million. This was an improvement on the
situation in the first half of 2006, when new
impairment charges were 111 per cent higher than in
the first half of 2005. The year-on-year increase was
largely due to Taiwan and, to a lesser extent,
Indonesia. During the first half of 2006, new
government regulations placing restrictions on
collection activity, combined with the popularity of
renegotiation schemes offering the opportunity to
waive interest and postpone principal payments, led
to a sharp rise in credit card defaults, for which a full
year charge of US$200 million was recorded. In the
second half of 2006, this problem had begun to
moderate and new impairment charges were 31 per
cent lower than in the first half. In Indonesia,
increased loan impairment charges in the personal
sector reflected legislation which introduced higher
minimum payment rules and a reduction in fuel
subsidies. There were further rises in the Middle
East, largely due to loan growth. Elsewhere in the
region, credit quality was stable.
Releases and recoveries in the region fell by
11 per cent to US$225 million. The fall was mainly
in Malaysia and was partly offset by a rise in
commercial releases and recoveries in the Middle
East.
In North America, new loan impairment
charges rose by 36 per cent. Excluding Metris, new
charges increased by 30 per cent. Credit
deterioration, mainly in second lien, some portions
of first lien and adjustable-rate mortgages acquired
from third party correspondents through HSBC’s
mortgage services business, were the primary cause
of the rise in new charges. As the housing market in
the US slowed through 2006 and interest rates rose,
delinquency trends on both second lien and portions
206
of first lien mortgages originated in 2005 and 2006
were higher than for loans made in previous years. In
addition, the extra payment obligations arising from
the repricing of adjustable-rate mortgages to higher
rates added to the assessed impairment of the
correspondent portfolio, in particular in respect of
second lien mortgages ranking behind adjustable-
rate first lien mortgages.
As interest rate adjustments will be occurring
in an environment of lower home value
appreciation and tightening credit, it is estimated
that the probability of default on adjustable-rate
first mortgages subject to repricing, and on any
second lien mortgage loans that are subordinate to
an adjustable-rate first lien, will be greater than
has been experienced in the past. As a result, loan
impairment charges relating to the mortgage
services portfolio have increased significantly.
In the second half of 2006, HSBC took action to
tighten credit criteria in the mortgage services
operation as detailed on page 189. As a consequence,
balances in mortgage services declined compared
with 30 June 2006.
Notwithstanding the credit weakness witnessed
in the mortgage services business, credit delinquency
in the majority of the other portfolios, including
mortgage balances originated through the branch-
based consumer lending business, rose modestly,
driven by portfolio ageing and an increased
proportion of credit card loans following the Metris
acquisition. Partially offsetting factors included the
effects of a decline in bankruptcy filings, especially
in the first half of 2006 following the spike in the
fourth quarter of 2005, low unemployment and the
non-recurrence of charges relating to hurricane
Katrina.
HSBC in the US closely monitors the two-
month-and-over contractual delinquency ratio (being
the ratio of two or more months delinquent accounts
to gross loans and advances), as management views
this as an important indicator of future write-offs.
Details are disclosed below. The rise in the total ratio
was chiefly as a result of the mortgage services
business.
The increase in the US was partly offset by a
small decline in new loan impairment charges in
Canada, as the strong economy continued to
underpin good credit quality.
Releases and recoveries in North America
decreased by 23 per cent to US$146 million due to
the non-recurrence of recoveries in the US.
In Latin America, new impairment charges
rose by 24 per cent to US$1,113 million in 2006.
This increase was chiefly attributable to Mexico and,
to a lesser extent, Brazil. Strong growth in personal
and commercial lending in Mexico resulted in higher
new charges. In Brazil, new charges rose by 11 per
cent, a significant reduction from the 52 per cent rise
reported in 2005, as credit quality improved
following enhancements made to underwriting
procedures during 2005 and 2006.
Latin American releases and recoveries went up
by 7 per cent, largely in Mexico as a result of more
stable political and economic conditions.
Year ended 31 December 2005 compared
with year ended 31 December 2004
(Unaudited)
Loan impairment charges were US$7,860 million, an
increase of 27 per cent compared with 2004.
Acquisitions accounted for US$107 million of the
rise and US$498 million reflected the non-recurrence
of the general provision release in 2004. The total
charge remained dominated by the personal sector,
with losses in these portfolios representing 92 per
cent of the Group’s net loan impairment charge. On
a constant currency basis, the trends were as follows.
New allowances for loan impairment charges
were US$10,140 million, an increase of 13 per cent
compared with 2004. Releases and recoveries of
allowances increased by 4 per cent to
US$2,280 million. Including a general provision
release of US$498 million in 2004, releases and
recoveries decreased by 15 per cent.
In Europe, growth in UK personal lending and
a weakening in credit quality were the principal
causes of a 50 per cent increase in new loan
impairment charges to US$3,042 million in 2005.
Slower economic growth and weaker employment
conditions were compounded by a change in
legislation in 2004 that relaxed conditions for
personal bankruptcies, which rose to record highs by
the final quarter of 2005. In response to these trends
in the personal portfolio, HSBC tightened
underwriting controls, focusing more on existing
relationships and changing the product mix towards
lower risk customers. These actions, together with
further centralisation of underwriting approvals and
revised reward programmes, assisted in mitigating
the rate of growth in new impairment charges
towards the end of 2005. In the commercial sector,
there were a number of individually significant new
charges raised in the fourth quarter, as well as a
higher rate of new allowances. Although credit
charges remained low by historic standards, the trend
is progressively moving back to more normal levels.
Elsewhere in Europe, France and Italy saw declines
in new allowances, due to the sale of a consumer
207
finance subsidiary during the year and the non-
recurrence of corporate charges, respectively. In
Turkey, new allowances have increased in line with
the growth in the personal loan portfolio.
Releases and recoveries in Europe were
US$1,058 million, an increase of 23 per cent.
Including a general provision release of
US$162 million in 2004, releases and recoveries
were broadly in line. Increased releases in Turkey,
largely reflecting higher volumes offset the non-
recurrence of the general provision release in
Switzerland.
New impairment allowances in Hong Kong
were US$359 million, a rise of 51 per cent. This was
partially attributable to a small number of individual
allowances for corporate and commercial customers.
However, overall credit quality improved, evidenced
by a decline in impaired loans as a proportion of
gross advances, reflecting a strong economy with
low unemployment.
Releases and recoveries in Hong Kong declined
by 53 per cent, including the non-recurrence of a
general provision release of US$223 million in 2004.
Excluding this, releases and recoveries fell by 9 per
cent to US$213 million as the significant number of
large corporate releases in 2004 was not repeated.
The general provision release last year reflected a
review of historical loss experience and the
improved market environment.
The effect of strong growth in advances in the
Rest of Asia-Pacific produced an 11 per cent rise in
new impairment allowances to US$470 million. In
particular, increased allowances in Taiwan were
driven by a combination of loan growth and an
increase in credit card delinquency. There were
further increases in Indonesia and the Philippines
due to growth in advances, with credit quality stable
in both countries. These were partially offset by
declines in mainland China and Singapore. In
general, across the region, advances to customers
rose and credit quality improved. Non-performing
assets, as a percentage of advances, fell across most
major countries.
In the Rest of Asia-Pacific, releases and
recoveries rose by 6 per cent to US$334 million,
including the US$48 million general provision
release in 2004. Excluding this, releases and
recoveries were 24 per cent higher than 2004. There
were higher releases and recoveries across most
countries in the region reflecting the strong
economic environment, although in Malaysia and
Singapore there were declines, due to the non-
recurrence of the general provision releases in 2004.
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Impairment charges > 2005 / Loan delinquency in the US
New loan impairment allowances in North
America declined by 6 per cent. This was despite
loan growth, and the additional credit allowances
raised in relation to hurricane Katrina, and
accelerated bankruptcy filings in the second half of
the year ahead of new legislation in the US. A
portion of the increase in bankruptcies was an
acceleration of write-offs that would have otherwise
been experienced in future periods. In an effort to
assist customers affected by hurricane Katrina,
HSBC initiated various programmes, including
extended payment arrangements. The reduction in
the charge also reflected the non-recurrence of a
US$47 million charge in 2004, following the
adoption of FFIEC write-off policies relating to
retail and credit card balances. Excluding these
factors, credit quality improved year on year,
reflecting an improving economic environment. This
contributed to the fall in new impairment
allowances, which was only partially offset by
increased requirements due to loan growth. HSBC
has benefited from the shift in the balance of the
consumer lending business towards higher credit
quality customers. HSBC Finance monitors the two-
month-and-over contractual delinquency ratio
closely, as management views it as an important
indicator of future write-offs. The ratio declined
from 4.0 per cent at 31 December 2004 to 3.6 per
cent at 30 June 2005, rising to 3.7 per cent at
31 December 2005. Lending in the US is primarily
in the personal sector. Credit quality in the
commercial portfolio was stable in 2005. The
favourable trends in the US were partially offset by
rises in new allowances in Canada which were
largely driven by personal loan growth in recent
years, with an improvement in underlying credit
quality.
Releases and recoveries in North America were
modestly lower than in 2005. Including the 2004
general provision release of US$45 million, releases
and recoveries declined by 31 per cent. In the US, a
rise in releases reflected an improved credit
environment and a strong economy. Under IFRSs,
from 1 January 2005 certain recoverable amounts
were incorporated into the loan impairment charge
directly resulting in lower reported recoveries. There
were further decreases in Bank of Bermuda,
following the non-recurrence of the general
provision release in 2004. These declines were offset
by a more than five-fold increase in releases in
Canada, where better credit quality was driven by
improved economic conditions, particularly in the
resource-driven economy of western Canada.
In Latin America, new impairment allowances
in Brazil were the principal cause of a 60 per cent
rise in new charges to US$898 million in 2005. In
Brazil, significant growth of 24 per cent in gross
advances, coupled with deteriorating credit quality in
the consumer finance business, were the main
contributing factors to this increase. Lending growth
combined with a move into the low-income segment,
where finances have been stretched by higher
interest rates, drove higher delinquency. Changes
were made to underwriting procedures during the
year, to improve the credit quality of new business.
This resulted in a falling impairment charge to asset
ratio towards the end of the year. In Mexico, new
allowances also rose, chiefly due to lending growth.
New allowances in Argentina were in line with
2004.
Releases and recoveries in Latin America were
broadly in line with 2004. Recoveries in Brazil rose
as a result of improved collections, compounded by
higher releases as a result of greater volumes of
advances. In Mexico, releases and recoveries
declined following the non-recurrence of a large
number of recoveries in 2004. Releases in Argentina
fell as impaired loans reduced. The combined fall in
Argentina and Mexico offset the rise in Brazil.
208
Loan delinquency in the US
(Unaudited)
The following table summarises two-months-and-over contractual delinquency (as a percentage of loans and
advances) within Personal Financial Services in the US:
(Unaudited)
31
December
2006
30
September
2006
%
%
Residential mortgages ...
Second lien mortgage
lending .......................
Vehicle finance1 .............
Credit card2 ....................
Private label ...................
Personal non-credit card
Total2 ..............................
2.59
2.24
4.02
3.16
4.48
2.83
9.05
3.70
2.74
3.21
4.46
2.88
8.23
3.30
Quarter ended
31
March
2006
%
31
December
2005
%
30
September
2005
%
30
June
2005
%
31
March
2005
%
1.86
1.79
2.27
4.28
2.60
7.70
2.84
2.06
1.62
3.28
3.46
2.41
8.58
2.99
1.76
1.67
1.65
1.38
3.10
4.06
2.54
8.28
2.81
1.53
3.12
3.67
2.52
7.99
2.71
1.68
2.76
3.91
2.70
8.18
2.75
30
June
2006
%
1.95
1.88
2.82
4.09
2.84
7.56
2.91
Residential mortgages and second lien mortgage lending two-months-and-over contractual delinquency (as a per
cent of loans and advances) for the mortgage services and consumer lending portfolios comprised the following:
(Unaudited)
31
December
2006
30
September
2006
%
%
Mortgage services:
– first lien .....................
– second lien ...............
Total mortgage services .
Consumer lending:
– first lien .....................
– second lien ...............
Total consumer lending .
4.52
5.71
4.76
2.08
3.08
2.22
3.76
3.67
3.74
1.92
2.03
1.93
Quarter ended
30
June
2006
%
31
March
2006
%
31
December
2005
%
3.11
2.35
2.94
1.87
1.76
1.86
2.90
1.83
2.68
1.90
2.61
2.00
3.20
1.91
2.97
2.31
2.07
2.28
30
September
2005
%
2.78
1.46
2.57
2.27
2.04
2.24
30
June
2005
%
2.68
1.66
2.55
2.32
2.37
2.32
31
March
2005
%
2.60
2.02
2.54
2.41
2.45
2.42
1 In December 2006, the vehicle finance business changed its write-off policy to provide that the principal balance of vehicle loans in
excess of the estimated net realisable value will be written-off 30 days (previously 90 days) after the financed vehicle has been
repossessed if it remains unsold, unless it becomes 150 days contractually delinquent, at which time such excess will be written off. This
resulted in a one-time acceleration of write-off which totalled US$24 million in December 2006. In connection with this policy change
the vehicle finance business also changed its methodology for reporting two-months-and-over contractual delinquency to include loan
balances associated with repossessed vehicles which have not yet been written down to net realisable value. This resulted in an increase
of 42 basis points to the vehicle finance delinquency ratio and an increase of 3 basis points to the total consumer delinquency ratio.
Prior period amounts have been restated to conform to the current year presentation.
2 In December 2005, the acquisition of Metris was completed which included loans and advances of US$5.3 billion. This event had a
significant impact on this ratio. Excluding the loans and advances from the Metris acquisition from the December 2005 calculation, the
consumer delinquency ratio for the credit card portfolio was 3.71 per cent and total consumer delinquency was 3.00 per cent.
209
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Impairment losses / HSBC Holdings / Risk elements
Charge for impairment losses as a percentage of average gross loans and advances to customers
(Unaudited)
Europe
%
Hong Kong
%
Rest of
Asia-Pacific
%
North
America
Latin
America
%
%
Year ended 31 December 2006
New allowances net of allowance releases ........
Recoveries............................................................
0.87
(0.14)
0.23
(0.05)
0.80
(0.13)
Impairment allowances .......................................
Total charge for impairment losses ....................
Amount written off net of recoveries .................
0.73
0.73
0.77
0.18
0.18
0.20
0.67
0.67
0.62
Year ended 31 December 2005 (restated1)
New allowances net of allowance releases ........
Recoveries............................................................
Impairment allowances .......................................
Total charge for impairment losses ....................
Amount written off net of recoveries .................
Year ended 31 December 2004 (restated1)
New provisions ...................................................
Releases and recoveries ......................................
Net charge for specific provisions ......................
Total provisions charged ....................................
Amount written off net of recoveries .................
Year ended 31 December 2003 (restated1)
New provisions ...................................................
Releases and recoveries ......................................
0.76
(0.03)
0.24
(0.06)
0.33
(0.13)
0.73
0.73
1.00
0.78
(0.33)
0.45
0.39
0.46
0.18
0.18
0.31
0.31
(0.30)
0.01
(0.29)
0.33
0.20
0.20
0.37
0.77
(0.49)
0.28
0.19
0.61
0.76
(0.25)
0.89
(0.30)
0.96
(0.80)
Net charge for specific provisions ......................
Total provisions charged ....................................
Amount written off net of recoveries .................
0.51
0.45
0.39
0.59
0.54
0.73
0.16
0.20
0.86
Year ended 31 December 2002 (restated1)
New provisions ...................................................
Releases and recoveries ......................................
0.62
(0.21)
0.75
(0.26)
1.13
(0.90)
Net charge for specific provisions ......................
Total provisions charged ....................................
Amount written off net of recoveries .................
0.41
0.37
0.25
0.49
0.35
0.72
0.23
0.25
1.55
2.52
(0.03)
2.49
2.49
1.77
2.15
(0.07)
2.08
2.08
2.02
2.61
(0.28)
2.33
2.31
2.57
3.06
(0.25)
2.81
2.84
2.58
0.50
(0.14)
0.36
0.32
0.42
3.95
(0.50)
3.45
3.45
3.36
3.97
(0.68)
3.29
3.29
2.77
3.09
(1.32)
1.77
1.64
3.41
2.22
(0.65)
1.57
1.23
7.20
7.05
(1.13)
5.92
3.05
2.74
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13 on the Financial Statements.
Total
%
1.49
(0.10)
1.39
1.39
1.15
1.25
(0.09)
1.16
1.16
1.26
1.41
(0.35)
1.06
0.99
1.26
1.60
(0.32)
1.28
1.25
1.40
0.78
(0.29)
0.49
0.38
0.56
210
HSBC Holdings
(Audited)
HSBC Holdings manages its credit risk by limiting
its exposure to transactions with its subsidiary
undertakings.
HSBC Holdings’ maximum exposure to credit
risk at 31 December 2006, excluding collateral or
other credit enhancements, was as tabulated below.
No collateral or other credit enhancements were
held by HSBC Holdings in respect of its transactions
with subsidiary undertakings.
HSBC Holdings’ financial assets are held with
subsidiaries of HSBC, primarily those domiciled in
Europe and North America.
2006
Off-balance
sheet
exposure
US$m
Carrying
value
US$m
Maximum
exposure
US$m
2005
Off-balance
sheet
Carrying
value
US$m
exposure
US$m
Maximum
exposure
US$m
1,599
–
1,599
968
–
968
Derivatives ..........................................................
Loans and advances to HSBC
undertakings ...................................................
14,456
3,967
18,423
14,092
3,663
17,755
Financial investments – debt securities of
HSBC undertakings .......................................
Guarantees ..........................................................
3,316
–
19,371
–
17,605
21,572
3,316
17,605
40,943
3,256
–
18,316
–
36,877
40,540
3,256
36,877
58,856
attributable to the US and, to a lesser extent, Mexico.
In the US, the credit deterioration in the mortgage
services business was the principal cause of the rise
and in Mexico the increase was partly volume
driven.
Impaired loans
(Unaudited)
In accordance with IFRSs, interest income continues
to be recognised on assets that have been written
down as a result of an impairment loss. In the
following tables, HSBC presents information on its
impaired loans and advances which are designated in
accordance with the policy described above.
Impaired loans are consistent with the ‘non-
accrual basis’ classification used in US GAAP and in
prior years. For further information on impaired
loans refer to page 174.
Potential problem loans
(Unaudited)
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, and as discussed in ‘areas of special interest’
above, including ARMs and stated income products.
Risk elements in the loan portfolio
(Unaudited)
The disclosure of credit risk elements under the
following headings 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.
Troubled debt restructurings
(Unaudited)
US GAAP requires separate disclosure of any loans
whose terms have been modified because of
problems with the borrower to grant concessions
other than are warranted by market conditions.
These are classified as ‘troubled debt restructurings’
and are distinct from the normal restructuring
activities in personal loan portfolios described in
‘Renegotiated loans’ on page 196. Disclosure of
troubled debt restructurings may be discontinued
after the first year if the debt performs in accordance
with the new terms.
Troubled debt restructurings were broadly in
line with 2005.
Unimpaired loans past due 90 days or more
(Unaudited)
Unimpaired loans contractually past due 90 days or
more increased by 18 per cent. The rise was largely
211
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Credit risk > Risk elements / Liquidity and funding > Policies / Primary sources of funding
Risk elements
(Unaudited)
The following table provides an analysis of risk elements in the loan portfolios at 31 December for the past five years:
Impaired loans
Europe .........................................................
Hong Kong .................................................
Rest of Asia-Pacific ....................................
North America ............................................
Latin America .............................................
Troubled debt restructurings
Europe .........................................................
Hong Kong .................................................
Rest of Asia-Pacific ....................................
North America ............................................
Latin America .............................................
Unimpaired loans contractually past due
90 days or more as to principal or
interest
Europe .........................................................
Hong Kong .................................................
Rest of Asia-Pacific ....................................
North America ............................................
Latin America .............................................
Risk elements on loans
Europe .........................................................
Hong Kong .................................................
Rest of Asia-Pacific ....................................
North America ............................................
Latin America .............................................
Assets held for resale
Europe .........................................................
Hong Kong .................................................
Rest of Asia-Pacific ....................................
North America ............................................
Latin America ..............................................
Total risk elements
Europe .........................................................
Hong Kong .................................................
Rest of Asia-Pacific ....................................
North America ............................................
Latin America .............................................
2006
US$m
5,858
454
1,188
4,822
1,478
At 31 December (restated1)
2005
US$m
5,081
506
945
3,710
1,226
2004
US$m
6,053
696
1,172
3,600
932
2003
US$m
5,680
1,670
1,519
4,177
1,170
2002
US$m
4,479
1,707
2,008
491
1,657
13,800
11,468
12,453
14,216
10,342
360
189
73
1,712
915
3,249
237
79
78
1,364
165
1,923
6,455
722
1,339
7,898
2,558
239
198
121
1,417
878
2,853
592
74
40
924
4
1,634
5,912
778
1,106
6,051
2,108
213
436
56
1,600
830
3,135
68
67
56
1,171
–
1,362
6,334
1,199
1,284
6,371
1,762
335
571
68
1,569
1,041
41
396
89
3
670
3,584
1,199
34
205
45
1,252
2
1,538
6,049
2,446
1,632
6,998
2,213
16
193
33
40
9
291
4,536
2,296
2,130
534
2,336
18,972
15,955
16,950
19,338
11,832
30
42
17
916
91
1,096
6,485
764
1,356
8,814
2,649
205
49
31
571
103
959
6,117
827
1,137
6,622
2,211
27
75
21
664
44
831
6,361
1,274
1,305
7,035
1,806
32
2
30
720
74
858
6,081
2,448
1,662
7,718
2,287
26
17
54
17
84
198
4,562
2,313
2,184
551
2,420
Loan impairment allowances as a
percentage of risk elements on loans .....
71.6
71.2
74.1
70.9
%
%
%
%
%
77.2
20,068
16,914
17,781
20,196
12,030
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13 on the Financial Statements.
212
Liquidity and funding management
(Audited)
Liquidity risk is the risk that HSBC does not have
sufficient financial resources to meet its obligations
when they fall due, or will have to do so at excessive
cost. This risk can arise from mismatches in the
timing of cash flows. Funding risk (a particular form
of liquidity risk) arises when the necessary liquidity
to fund illiquid asset positions cannot be obtained at
the expected terms and when required.
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, and that wholesale market access is
co-ordinated and cost effective. It is HSBC’s
objective to maintain a diversified and stable funding
base comprising core retail and corporate customer
deposits and institutional balances. This is
augmented by wholesale funding and portfolios of
highly liquid assets which are diversified by
currency and maturity, with the objective of enabling
HSBC to respond quickly and smoothly to
unforeseen liquidity requirements.
HSBC requires operating entities to maintain a
strong liquidity position and to manage the liquidity
profile of their assets, liabilities and commitments
with the objective of ensuring that cash flows are
appropriately balanced and all obligations are met
when due.
Policies and procedures
(Audited)
The management of liquidity and funding is
primarily carried out locally in the operating
companies of HSBC in accordance with practices
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 regards 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 clearly defined 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.
213
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 ensuring a satisfactory overall
funding mix; and
• maintaining liquidity and funding contingency
plans. These plans identify early indicators of
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
(Audited)
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 maintaining the stability of these
deposits.
The stability of deposits, which are a primary
source of funding, depends upon maintaining
depositor confidence in HSBC’s capital strength and
liquidity, and on competitive and transparent
deposit-pricing strategies.
HSBC also 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, which funds itself
principally through taking term funding in the
professional markets and through the securitisation
of assets. At 31 December 2006, US$150 billion
(2005: US$132 billion) of HSBC Finance’s liabilities
were drawn from professional markets, utilising a
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Liquidity and funding > Primary sources of funding / HSBC Holdings
range of products, maturities and currencies to avoid
undue reliance on any particular funding source.
Of total liabilities of US$1,746 billion at
31 December 2006 (2005: US$1,404 billion),
funding from customers amounted to US$911 billion
(2005: US$810 billion), of which US$872 billion
(2005: US$773 billion) was contractually repayable
within one year. However, although the contractual
repayments of many customer accounts are on
demand or at short notice, in practice short-term
deposit balances remain stable as inflows and
outflows broadly match.
Cash flows payable by HSBC under financial liabilities by remaining contractual maturities
(Audited)
At 31 December 2006
Deposits by banks .........................................................
Customer accounts ........................................................
Financial liabilities designated at fair value .................
Debt securities in issue .................................................
Subordinated liabilities .................................................
Other financial liabilities ..............................................
At 31 December 2005
Deposits by banks .........................................................
Customer accounts ........................................................
Financial liabilities designated at fair value .................
Debt securities in issue .................................................
Subordinated liabilities .................................................
Other financial liabilities ..............................................
On
demand
US$m
29,609
535,695
8,990
919
–
14,824
590,037
21,672
424,880
6,258
1,487
–
12,922
467,219
Due
within 3
months
US$m
55,239
301,847
1,103
80,288
285
35,494
474,256
29,937
254,354
1,365
64,824
714
14,871
366,065
Due
between
3 and 12
months
US$m
Due
between
1 and 5
years
US$m
8,462
47,560
2,855
38,831
1,296
1,978
100,982
11,026
40,813
4,603
51,538
2,453
971
111,404
6,356
25,155
36,194
102,069
11,221
1,543
182,538
7,619
29,619
34,244
118,109
14,583
109
204,283
Due
after 5
years
US$m
4,893
5,420
52,222
51,171
30,764
878
145,348
4,259
6,531
73,534
24,823
30,555
689
140,391
For information on the contractual maturity of gross loan commitments, see Note 41 on the Financial Statements.
The balances in the above table will not agree
directly to the balances in the consolidated balance
sheet as the table incorporates all cash flows, on an
undiscounted basis, related to both principal as well
as those associated with all future coupon payments.
Liabilities in trading portfolios have not been
analysed by contractual maturity because trading
assets and liabilities are typically held for short
periods of time.
Assets available to meet these liabilities, and to
cover outstanding commitments (2006:
US$715 billion; 2005: US$642 billion), included
cash, central bank balances, items in the course of
collection and treasury and other bills (2006:
US$87 billion; 2005: US$75 billion); loans to banks
(2006: US$237 billion; 2005: US$156 billion),
including US$179 billion (2005: US$121 billion)
repayable within one year; and loans to customers
(2006: US$940 billion; 2005: US$793 billion),
including US$360 billion (2005: US$313 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$336 billion (2005:
US$273 billion). Of these assets, some US$93
billion (2005: US$98 billion) of debt securities and
treasury and other bills were pledged to secure
liabilities.
HSBC would meet unexpected net cash
outflows by selling securities and accessing
additional funding sources such as interbank or
asset-backed markets.
A key measure used by the Group for managing
liquidity risk is the ratio of net liquid assets to
customer liabilities. Generally, liquid assets
comprise cash balances, short-term interbank
deposits and highly-rated debt securities available
for immediate sale and for which a deep and liquid
market exists. Net liquid assets are liquid assets less
all wholesale market funds, and all funds provided
by customers deemed to be professional, maturing in
the next 30 days. The definition of a professional
customer takes account of the size of the customer’s
total deposits.
Minimum liquidity ratio limits are set for each
bank operating entity. Limits reflect the local market
214
place, the diversity of funding sources available, and
the concentration risk from large depositors.
Compliance with entity level limits is monitored by
Group Finance in Head Office and reported regularly
to the Risk Management Meeting.
Ratio of net liquid assets to customer
liabilities
(Unaudited)
Although consolidated data is not utilised in the
management of HSBC’s liquidity, the consolidated
liquidity ratio figures of net liquid assets to customer
liabilities shown in the following table provide a
useful insight into the overall liquidity position of
the Group’s banking entities.
Year ended 31 December
2005
%
2006
%
Year-end ......................................
Maximum ....................................
Minimum ....................................
Average .......................................
20.6
22.1
17.1
19.3
17.1
17.5
14.4
16.3
HSBC Holdings
(Audited)
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
paid by subsidiaries 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 usual
circumstances, HSBC Holdings has full access to
capital markets on normal terms.
Cash flows payable by HSBC Holdings under financial liabilities by remaining contractual maturities
(Audited)
At 31 December 2006
Amounts owed to HSBC undertakings ...................
Financial liabilities designated at fair value ............
Subordinated liabilities ............................................
Other financial liabilities .........................................
At 31 December 2005
Amounts owed to HSBC undertakings ...................
Financial liabilities designated at fair value ............
Subordinated liabilities ............................................
Other financial liabilities .........................................
On
demand
US$m
Due
within 3
months
US$m
Due
between
3 and 12
months
US$m
Due
between
1 and 5
years
US$m
109
–
–
13
122
664
–
–
13
677
221
177
158
1,608
2,164
176
140
107
1,278
1,701
88
532
473
–
1,093
1,060
420
321
–
1,801
3,025
4,039
2,525
–
9,589
1,654
3,442
2,771
–
7,867
Due
after 5
years
US$m
5
21,029
23,327
8
44,369
521
20,382
15,638
7
36,548
At 31 December 2006, the short-term liabilities of
HSBC Holdings totalled US$1,919 million (2005:
US$3,191 million), including US$1,507 million in
respect of the proposed third interim dividend for
2006 (2005: US$1,193 million). Short-term assets of
US$7,738 million (2005: US$5,599 million)
consisted mainly of cash at bank of US$729 million
(2005: US$756 million) and loans and advances to
HSBC undertakings of US$6,886 million (2005:
US$4,661 million).
215
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Market risk > Value at risk
Market risk management
(Audited)
Value at risk (‘VAR’)
(Audited)
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
risk factors, including foreign exchange rates and
commodity prices, interest rates, credit spreads and
equity prices will reduce HSBC’s income or the
value of its portfolios. Credit risk is discussed
separately in the Credit risk section on page 171.
HSBC separates exposures to market risk into
either trading or non-trading portfolios. Trading
portfolios include those positions arising from
market-making, proprietary position-taking and
other marked-to-market positions so designated. The
contribution of the marked-to-market positions so
designated but not held with trading intent is
disclosed separately.
Non-trading portfolios primarily arise from the
interest rate management of HSBC’s retail and
commercial banking assets and liabilities.
The management of market risk is principally
undertaken in Global Markets using risk limits
approved by the Group Management Board. Limits
are set for portfolios, products and risk types, with
market liquidity being a principal factor in
determining the level of limits set. Traded Credit and
Market 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 Credit and Market 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 supervision 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 manage such risks professionally.
One of the principal tools used by HSBC to monitor
and limit market risk exposure 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.
The VAR models used by HSBC are
predominantly based on historical simulation. The
historical simulation models derive plausible future
scenarios from historical market rate time series,
taking account of inter-relationships between
different markets and rates, for example, between
interest rates and foreign exchange rates. The models
also incorporate the impact of option features in the
underlying exposures.
The historical simulation models used by HSBC
incorporate the following features:
•
•
potential market movements are calculated with
reference to data from the last two years;
historical market rates and prices are calculated
with reference to foreign exchange rates and
commodity prices, interest rates, equity prices
and the associated volatilities;
• VAR is calculated to a 99 per cent confidence
level; and
• VAR is calculated for a one-day holding period.
HSBC routinely validates the accuracy of its
VAR models by backtesting the actual daily profit
and loss results, adjusted to remove non-modelled
items such as fees and commissions, against the
corresponding VAR numbers. Statistically, HSBC
would expect to see losses in excess of VAR only
one per cent of the time over a one-year period. The
actual number of excesses over this period can
therefore be used to gauge how well the models are
performing.
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 1-day holding period assumes that
all positions can be liquidated or hedged in one
day. This may not fully reflect the market risk
216
arising at times of severe illiquidity, when a
1-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;
and
• 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 financial impact of identified extreme events on
the market risk exposures of HSBC.
The VAR, for both trading and non-trading
portfolios, for Global Markets was as follows:
Value at risk
(Audited)
At 31 December ..............................
Average ...........................................
Minimum .........................................
Maximum.........................................
2006
US$m
67.3
74.3
39.4
137.5
2005
US$m
128.5
174.1
108.2
248.8
Total VAR at 31 December 2006 fell compared
with 31 December 2005. The major cause of this was
a reduction in risk positions arising from the Group’s
balance sheet management activities.
The daily VAR, for both trading and non-trading
portfolios, for HSBC Global Markets was as follows:
Daily total VAR for Global Markets (US$m)
(Unaudited)
The histograms below illustrate the frequency of
daily revenue arising from Global Markets’ trading,
balance sheet management and other trading
activities. The average daily revenue earned
therefrom in 2006 was US$21.3 million, compared
with US$18.7 million in 2005. The standard
deviation of these daily revenues was
US$11.4 million compared with US$10.4 million in
2005. 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 revenue during 2006 and three days in
2005. The most frequent result was a daily revenue
of between US$16 million and US$20 million with
46 occurrences.
Daily distribution of Global Markets’ trading,
balance sheet management and other trading
revenues
(Unaudited)
Year ended 31 December 2006
Number of days
Revenues (US$m)
(cid:31) Profit and loss frequency
Year ended 31 December 2005
Number of days
(cid:31) Profit and loss frequency
Revenues (US$m)
217
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Market risk > Value at risk / Trading portfolios / Non-trading portfolios
Fair value and price verification control
(Audited)
Where certain financial instruments are carried on
the Group’s balance sheet at fair values, the
valuation and the related price verification processes
are subject to independent validation across the
Group. Financial instruments which are accounted
for on a fair value basis include assets held in the
trading portfolio, financial instruments designated at
fair value, obligations related to securities sold short,
all derivative financial instruments and available-for-
sale securities.
The determination of fair values is therefore a
significant element in the reporting of the Group’s
Global Markets activities.
Responsibility for determining accounting
policies and procedures governing valuation and
validation ultimately rests with independent finance
functions which report functionally 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 financial statements,
and for ensuring that the Group’s policies comply
with all relevant accounting standards.
Trading portfolios
(Audited)
HSBC’s control of market risk is based on a policy
of restricting individual operations to trading within
Total trading VAR by risk type
(Audited)
a list of permissible instruments authorised for each
site by Traded Credit and Market Risk, enforcing
rigorous new product approval procedures, and of
restricting trading in the more complex derivative
products only to offices with appropriate levels of
product expertise and robust control systems.
In addition, at both portfolio and position levels,
market risk in trading portfolios is monitored and
controlled using a complementary set of techniques.
These include VAR and, for interest rate risk, present
value of a basis point movement in interest rates,
together with stress and sensitivity testing and
concentration limits. These techniques quantify the
impact on capital of defined market movements.
Total trading VAR for Global Markets at
31 December 2006 was US$32.6 million (2005:
US$32.7 million). The VAR from positions taken
without trading intent was US$4.7 million (2005:
US$6.9 million), the principal components of which
were hedges that failed to meet the strict
documentation and testing requirements of IAS 39
(i.e. ‘non-qualifying’ hedges) and other positions
transacted as economic hedges but which also did
not qualify for hedge accounting. HSBC’s policy on
hedging is to manage economic risk in the most
appropriate way without regard as to whether hedge
accounting is available, within limits regarding the
potential volatility of reported earnings.
Trading VAR is further analysed below by risk
type, by positions taken with trading intent and by
positions taken without trading intent:
At 31 December 2006 ..................................................
At 31 December 2005 ...................................................
Average
2006 ..........................................................................
2005 ..........................................................................
Minimum
2006 ..........................................................................
2005 ..........................................................................
Maximum
2006 ..........................................................................
2005 ..........................................................................
Interest
rate
US$m
26.0
33.8
33.9
37.3
18.3
24.3
53.6
76.9
Equity
US$m
11.8
4.7
6.5
5.5
2.6
2.3
11.8
10.9
Total
US$m
32.6
32.7
33.3
37.3
20.9
23.5
52.3
73.2
Foreign
exchange and
commodity
US$m
7.3
4.6
6.3
6.9
2.6
2.9
12.7
12.4
218
Positions taken with trading intent – VAR by risk type
(Audited)
At 31 December 2006 ..................................................
At 31 December 2005 ...................................................
Average
2006 ..........................................................................
2005 ..........................................................................
Minimum
2006 ..........................................................................
2005 ..........................................................................
Maximum
2006 ..........................................................................
2005 ..........................................................................
Foreign
exchange and
commodity
US$m
7.3
4.6
6.3
6.9
2.6
2.9
12.7
12.4
Positions taken without trading intent – VAR by risk type
(Audited)
Foreign
exchange and
commodity
US$m
–
–
–
–
–
–
–
–
At 31 December 2006 ..................................................
At 31 December 2005 ...................................................
Average
2006 ..........................................................................
2005 ..........................................................................
Minimum
2006 ..........................................................................
2005 ..........................................................................
Maximum
2006 ..........................................................................
2005 ..........................................................................
Non-trading portfolios
(Audited)
The principal objective of market risk management
of non-trading portfolios is to optimise net interest
income.
Market risk in non-trading portfolios arises
principally from mismatches between the future
yield on assets and their funding cost, as a result of
interest rate changes. Analysis of this risk is
complicated by having to make assumptions on
optionality in certain product areas, for example,
mortgage prepayments, and from behavioural
assumptions regarding the economic duration of
liabilities which are contractually repayable on
demand, for example, current accounts. The
prospective change in future net interest income
from non-trading portfolios will be reflected in the
current realisable value of these positions, should
they be sold or closed prior to maturity. In order to
manage this risk optimally, market risk in non-
trading portfolios is transferred to Global Markets or
to separate books managed under the supervision of
the local ALCO.
219
Interest
rate
US$m
27.9
28.4
31.7
33.3
18.3
25.5
49.6
49.0
Interest
rate
US$m
4.7
6.9
5.6
8.6
2.5
1.4
10.5
24.5
Equity
US$m
11.8
4.7
6.5
5.5
2.6
2.3
11.8
10.9
Total
US$m
30.2
30.1
31.6
33.5
19.9
25.7
48.2
46.7
Equity
US$m
Total
US$m
–
–
–
–
–
–
–
–
4.7
6.9
5.6
8.6
2.5
1.4
10.5
24.5
The transfer of market risk to books managed by
Global Markets or supervised by ALCO is usually
achieved by a series of internal deals between the
business units and these books. When the
behavioural characteristics of a product differ from
its contractual characteristics, the behavioural
characteristics are assessed to determine the true
underlying interest rate risk. Local ALCOs are
required to regularly monitor all such behavioural
assumptions and interest rate risk positions, to ensure
they comply with interest rate risk limits established
by the Group Management Board.
As noted above, in certain cases, the non-linear
characteristics of products cannot be adequately
captured by the risk transfer process. For example,
both the flow from customer deposit accounts to
alternative investment products and the precise
prepayment speeds of mortgages will vary at
different interest rate levels. In such circumstances,
simulation modelling is used to identify the impact
of varying scenarios on valuations and net interest
income.
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Market risk > Non-trading portfolios / Sensitivity of NII
Once market risk has been consolidated in
Global Markets or ALCO-managed books, the net
exposure is typically managed through the use of
interest rate swaps within agreed limits.
The principal non-trading risks which are not
included in VAR for Global Markets (see ‘Value at
risk’ above) are detailed below.
Non-trading risks not included in Global Markets VAR
(Audited)
HSBC
Finance
US$m
Mortgage
servicing
rights
US$m
Capital
instruments
US$m
At 31 December 2006 .............................................................................................
At 31 December 2005 ..............................................................................................
Average
2006 .....................................................................................................................
2005 .....................................................................................................................
Minimum
2006 ......................................................................................................................
2005 .....................................................................................................................
Maximum
2006 ......................................................................................................................
2005 .....................................................................................................................
11.6
13.5
15.5
13.4
6.8
6.2
23.9
41.6
3.2
3.9
2.9
3.2
2.5
2.4
3.9
4.0
87.4
65.0
72.1
70.3
58.8
62.3
87.4
78.2
Market risk within HSBC Finance primarily
arises from mismatches between future
behaviouralised asset yields and their funding costs
and associated derivatives. The sub-prime mortgage
portfolio is a sub-set of this portfolio of
behaviouralised assets. This non-trading risk is
principally managed by controlling the sensitivity of
projected net interest income under varying interest
rate scenarios.
hedge the economic exposure arising from MSRs are
always measured at fair value, but the MSRs
themselves are measured for accounting purposes at
the lower of amortised cost and valuation. 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 MSRs cannot
be revalued above cost to reflect the related profit.
HSBC’s policy is to hedge the economic risk.
VAR limits are set to control the total market
VAR limits are set to control the exposure to
risk exposure of HSBC Finance.
MSRs and MSRs hedges.
Market risk arising in the prime residential
mortgage business of HSBC Bank USA is primarily
managed by a specialist function within the 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. The key element of market risk within
the US prime mortgage business relates to the
prepayment options embedded in US prime
mortgages, which affect the sensitivity of the value
of mortgage servicing rights (‘MSRs’) to interest
rate movements and the net interest margin on
mortgage assets. MSRs represent the economic value
of the right to receive fees for performing specified
residential mortgage servicing activities. They are
sensitive to interest rate movements because lower
rates accelerate the prepayment speed of the
underlying mortgages and therefore reduce the value
of the MSRs. The reverse is true for rising rates.
HSBC uses a combination of interest rate-sensitive
derivatives and debt securities to help protect the
economic value of MSRs. An accounting asymmetry
can arise in this area because the derivatives used to
Market risk arises on fixed-rate securities issued
by HSBC. These securities are managed as capital
instruments and include non-cumulative preference
shares, non-cumulative perpetual preferred securities
and fixed rate subordinated debt.
Market risk arising in HSBC’s insurance
businesses is discussed in ‘Risk management of
insurance operations’ on pages 228 to 242.
Market risk also arises within HSBC’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, together with the trustees
who act on behalf of the pension scheme
beneficiaries, assess the level of this risk using
reports prepared by independent external actuaries.
220
The present value of HSBC’s defined benefit
pension plans’ liabilities was US$32.2 billion at
31 December 2006, compared with US$27.7 billion
at 31 December 2005. Assets of the defined benefit
schemes at 31 December 2006 comprised: equity
investments 30 per cent (46 per cent at 31 December
2005); debt securities 56 per cent (33 per cent at
31 December 2005) and other (including property)
14 per cent (21 per cent at 31 December 2005). (See
Note 7 on the Financial Statements).
Sensitivity of net interest income
(Unaudited)
A principal part of HSBC’s management of market
risk in non-trading portfolios is to monitor the
sensitivity of projected net interest income under
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, while
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 and standard scenarios which are
Sensitivity of projected net interest income
(Unaudited)
required throughout HSBC. The standard scenarios
are consolidated to illustrate the combined pro forma
effect on HSBC’s consolidated portfolio valuations
and net interest income.
The table below sets out the impact on future net
interest income of an incremental 25 basis points
parallel fall or rise in all yield curves worldwide at
the beginning of each quarter during the 12 months
from 1 January 2007. Assuming no management
actions, a series of such rises would decrease
planned net interest income for 2007 by
US$578 million (2006: US$525 million), while
a series of such falls would increase planned
net interest income by US$511 million
(2006: US$474 million). These figures incorporate
the impact of any option features in the underlying
exposures.
Instead of assuming that all interest rates move
together, HSBC groups its interest rate exposures
into currency blocs whose interest rates are
considered likely to move together. The sensitivity
of projected net interest income, on this basis, is as
follows:
US dollar
bloc
US$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 2007 projected net
interest income arising from a
shift in yield curves of:
+25 basis points at the beginning
of each quarter ......................
–25 basis points at the beginning
of each quarter ......................
Change in 2006 projected net
interest income arising from a
shift in yield curves of:
+25 basis points at the beginning
of each quarter ......................
–25 basis points at the beginning
of each quarter ......................
(342)
249
(448)
402
53
(53)
74
(72)
(32)
52
(18)
20
18
(14)
28
(39)
(163)
(112)
(578)
164
113
511
(47)
51
(114)
(525)
112
474
The interest rate sensitivities set out in the table
above are illustrative only and are based on
simplified scenarios. 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 would be
taken by Global Markets or in the business units to
mitigate the impact of this interest rate risk. In
reality, Global Markets seeks proactively to change
the interest rate risk profile to minimise losses and
optimise net revenues. The projections above also
assume that interest 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 make other simplifying assumptions too,
including that all positions run to maturity.
221
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Market risk > Sensitivity of NII / Structural foreign exchange / HSBC Holdings
HSBC’s exposure to the effect of movements in
interest rates on its net interest income arise in three
main areas: core deposit franchises, HSBC Finance
and Global Markets.
• Core deposit franchises: these are exposed to
changes in the value of deposits raised and
spreads on wholesale funds. In a low interest
rate environment, the value of core deposits
increases as interest rates rise and decreases as
interest rates fall. This risk is asymmetrical in a
very low interest rate environment, however, as
there is limited room to lower deposit pricing in
the event of interest rate reductions.
• HSBC Finance offsets the sensitivity of the core
deposit franchises to interest rate reductions.
This arises from the fact that HSBC Finance has
a substantial fixed rate, real estate secured,
lending portfolio which is primarily funded with
interest rate sensitive short-term liabilities.
• Residual interest rate risk is managed within
Global Markets. This reflects the Group’s policy
of transferring all interest rate risk to Global
Markets to be managed within defined limits
and with flexibility as to the instruments used.
The main influences on the sensitivity of the
Group’s net interest income to the changes in interest
rates tabulated above are as follows:
• Global Markets decreased its exposure to US
dollar assets in non-trading portfolios and the
average life of certain assets in HSBC Finance
fell as they neared expected maturity, both of
which contributed to the decreased sensitivity in
this currency to both rising and falling rates.
• Growth in sterling net trading assets, the
funding for which is generally sourced from
short-term retail deposits and recorded in net
interest income but the income from which is
recorded in net trading income, has contributed
to the increased sensitivity to both rising and
falling rates in this currency.
• Global Markets also reduced its exposure to
euro assets in non-trading portfolios which
decreased the net interest income sensitivity in
this currency. However, this decrease was offset
by an increase in euro net trading assets.
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.
HSBC monitors the sensitivity of reported
reserves to interest rate movements on a monthly
basis by assessing the expected reduction in
valuation of available-for-sale portfolios and cash
flow hedges due to parallel movements of plus or
minus 100 basis points in all yield curves. The table
below describes the sensitivity of HSBC’s reported
reserves to these movements at the end of 2006 and
2005 and the maximum and minimum month-end
figures during these years:
Sensitivity of reported reserves to interest rate movements
(Unaudited)
At 31 December 2006
+ 100 basis point parallel move in all yield curves..........................................
As a percentage of total shareholders’ equity .................................................
- 100 basis point parallel move in all yield curves...........................................
As a percentage of total shareholders’ equity .................................................
At 31 December 2005
+ 100 basis point parallel move in all yield curves..........................................
As a percentage of total shareholders’ equity .................................................
- 100 basis point parallel move in all yield curves...........................................
As a percentage of total shareholders’ equity .................................................
Maximum
impact
US$m
Minimum
impact
US$m
(2,015)
(1.9%)
1,944
1.8%
(2,655)
(2.8%)
2,543
2.7%
(1,358)
(1.3%)
1,270
1.2%
(1,918)
(2.0%)
1,877
2.0%
US$m
(1,558)
(1.4%)
1,456
1.3%
(1,918)
(2.0%)
1,877
2.0%
222
The sensitivities are illustrative only and are
these hedges in the year ended 31 December 2006.
based on simplified scenarios. The table shows
interest rate risk exposures arising in available-for-
sale portfolios and from cash flow hedges which
are marked-to-market through reserves. These
particular exposures form only a part of the
Group’s overall interest rate exposures. The
accounting treatment under IFRSs of the Group’s
remaining interest rate exposures, while
economically largely offsetting the exposures
shown in the above table, does not require
revaluation movements to go to reserves.
Structural foreign exchange exposures
(Unaudited)
Structural foreign exchange exposures represent net
investments in subsidiaries, branches or associated
undertakings, the functional currencies of which
are currencies other than the US dollar.
Exchange differences on structural exposures
are recorded in the consolidated statement of
recognised income and expense. 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 exchange
differences between the US dollar and all the non-
US dollar functional currencies of underlying
subsidiaries.
HSBC hedges structural foreign exchange
exposures only in limited circumstances. HSBC’s
structural foreign exchange exposures are managed
with the primary objective of ensuring, where
practical, that HSBC’s consolidated capital ratios,
and the capital 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 capital ratio of the subsidiary
in question.
Selective hedges were in place during 2006.
Hedging is undertaken using forward foreign
exchange contracts which are accounted for under
IFRSs as hedges of a net investment in a foreign
operation, or by financing with borrowings in the
same currencies as the functional currencies
involved. There was no ineffectiveness arising from
223
There was no material effect from exchange
differences on HSBC’s capital ratios during the
year.
HSBC Holdings
(Audited)
As a financial services holding company, HSBC
Holdings has limited market risk activity. Its
activities predominantly involve maintaining
sufficient capital resources to support the Group’s
diverse activities; allocating these capital resources
across the Group’s businesses; earning dividend
and interest income on its investments in the
Group’s businesses; providing dividend payments
to HSBC Holdings’ equity shareholders and interest
payments to providers of debt capital; and
maintaining a supply of short-term cash resources.
It does not take proprietary trading positions.
The objectives of HSBC Holdings’ market risk
management are to minimise income statement
volatility arising from short-term cash balances and
funding positions; to minimise the market risk
arising from long-term investments and long-term
liabilities; and to protect distributable reserves from
any adverse market risk variables.
Market risk for HSBC Holdings is monitored
by its Structural Positions Review Group.
The main market risks to which HSBC
Holdings is exposed are interest rate risk and
foreign currency risk.
HSBC Holdings is exposed to interest rate risk
on debt capital investments in, and loans to,
subsidiary undertakings; on debt capital issues; and
on short-term cash resources.
Certain loans to subsidiary undertakings of a
capital nature that are not denominated in the
functional currency of either the provider or the
recipient are accounted for as financial assets.
Changes in the carrying amount of these assets due
to exchange differences are taken directly to the
income statement. These loans, and the associated
foreign exchange exposures, are eliminated on a
Group consolidated basis.
Revaluations due to foreign exchange rate
movements affecting loans to subsidiary
undertakings of a capital nature which are
denominated in the functional currency of either
the borrower or the recipient, are taken directly to
reserves. Equity investments in subsidiary
undertakings are accounted for on a cost basis and
are not revalued following movements in exchange
rates.
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Market risk > HSBC Holdings / Residual value risk / Operational risk > Legal litigation risk
Total VAR arising within HSBC Holdings in
2006 and 2005 was as follows:
net interest income to future changes in yield
curves.
(Audited)
Foreign
exchange
US$m
Interest
rates
US$m
Total
US$m
At 31 December 2006
At 31 December 2005
30.8
26.1
61.4
36.1
Average
2006 ......................
2005 ......................
27.4
24.0
43.6
33.7
Minimum
2006 ......................
2005 ......................
23.2
22.0
30.7
29.6
Maximum
2006 ......................
2005 ......................
32.0
26.1
61.4
45.9
66.4
51.4
49.2
48.9
34.8
42.6
66.4
56.6
The increase in Total VAR during 2006 is due
mainly to fixed rate debt capital issues in the
period.
(Unaudited)
A principal tool in the management of market
risk is the projected sensitivity of HSBC Holdings’
(Unaudited)
Change in 2007 projected net interest income arising
from a shift in yield curves of:
+ 25 basis points at the beginning of each quarter ..
– 25 basis points at the beginning of each quarter ..
Change in 2006 projected net interest income arising
from a shift in yield curves of:
+ 25 basis points at the beginning of each quarter...
– 25 basis points at the beginning of each quarter...
HSBC Holdings’ principal exposure to changes
in its net interest income from movements in interest
rates arises on short-term cash balances, floating rate
loans advanced to subsidiary undertakings and fixed
rate debt capital securities in issue which have been
swapped to floating rate.
The interest rate sensitivities tabulated above are
illustrative only and are based on simplified
scenarios. The figures represent the effect of pro
forma movements in net interest income based on
the projected yield curve scenarios and HSBC
Holdings’ current interest rate risk profile. They do
not take into account the effect of actions that could
be taken to mitigate this interest rate risk, however.
Although new fixed rate capital issues have
caused an increase in VAR as disclosed above, the
new issues have not materially impacted the net
interest income sensitivity for the 12 months from
The table below sets out the effect on HSBC
Holdings’ future net interest income of an
incremental 25 basis point parallel fall or rise in all
yield curves worldwide at the beginning of each
quarter during the 12 months from 1 January 2006.
Assuming no management action, a series of
such rises would increase HSBC Holdings’ planned
net interest income for 2007 by US$8 million
(2006: decrease of US$7 million) while a series of
such falls would decrease planned net interest
income by US$8 million (2006: increase of
US$7 million). These figures incorporate the
impact of any option features in the underlying
exposures.
Instead of assuming that all interest rates move
together, HSBC groups its interest rate exposures
into currency blocs whose interest rates are
considered likely to move together. The sensitivity
of projected net interest income, on this basis, is
described as follows:
US dollar
bloc
US$m
Sterling
bloc
US$m
Euro
bloc
US$m
Total
US$m
(7)
7
(18)
18
6
(6)
5
(5)
9
(9)
6
(6)
8
(8)
(7)
7
1 January 2007 as the funds received have generally
been used to increase long-term investments in
subsidiaries.
Residual value risk management
(Unaudited)
A significant part of a lessor’s return from operating
leases is dependent upon its management of residual
value risk. This arises from operating lease
transactions to the extent that the values recovered
from disposing of leased assets or re-letting them at
the end of the lease terms (the ‘residual values’)
differ from those projected at the inception of the
leases. The business regularly monitors residual
value exposure by reviewing the recoverability of
the residual value projected at lease inception. This
entails considering the potential of re-letting of
operating lease assets and their projected disposal
224
proceeds at the end of their lease terms. Provision is
made to the extent that the carrying values of leased
assets are impaired through residual values not being
fully recoverable.
The net book value of equipment leased to
customers on operating leases by the Group includes
projected residual values at the end of current lease
terms, to be recovered through re-letting or disposal
in the following periods:
(Unaudited)
Within 1 year .............................
Between 1-2 years .....................
Between 2-5 years .....................
More than 5 years ......................
Total exposure ...........................
2006
US$m
200
414
379
1,996
2,989
2005
US$m
355
152
313
1,684
2,504
Operational risk management
(Unaudited)
Operational risk is the risk of loss arising from fraud,
unauthorised activities, error, omission, inefficiency,
systems failure or external events. It is inherent in
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 industry 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, supplemented by more detailed formal
guidance. 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 to senior management within each
business operation;
•
information systems are used to record the
identification and assessment of operational
225
risks and to generate appropriate, regular
management reporting;
assessments are undertaken of the operational
risks facing each business and the risks inherent
in its processes, activities and products. Risk
assessment incorporates a regular review of
identified risks to monitor significant changes;
operational risk loss data is collected and
reported to senior management at the business
unit level. Aggregate operational risk losses are
recorded and details of incidents above a
materiality threshold are reported to Group
Head Office. A regular report on operational
losses is made to Group Audit Committee and
the Risk Management Meeting; and
risk mitigation, including insurance, is
considered where this is cost-effective.
•
•
•
In each of HSBC’s subsidiaries, local
management is responsible for implementing HSBC
standards on operational risk throughout their
operations and, where deficiencies are evident,
rectifying them within a reasonable timeframe.
Subsidiaries acquired by HSBC are required to
assess, plan and implement the standard’s
requirements within an agreed timescale.
HSBC maintains and tests contingency facilities
to support operations in the event of disasters.
Additional reviews and tests are conducted in the
event that any HSBC office is affected by a business
disruption event to incorporate lessons learned in the
operational recovery from those circumstances.
HSBC has requested all country managers to prepare
plans for the operation of their businesses, with
reduced staffing levels, should a flu pandemic occur.
Legal litigation risk
(Unaudited)
Each operating company is required to implement
policies, procedures and guidelines in respect of the
management and control of legal risk which conform
to HSBC standards. Legal risk falls within the
definition of operational risk and includes
contractual risk, legislative risk, intellectual property
risk and litigation risk. Litigation risk is the risk of:
•
•
failing to act appropriately in response to a
claim made against any HSBC company; or
being unable to successfully defend a claim
brought against any HSBC company; or
• HSBC being unable to take action to enforce its
rights through the courts.
HSBC has a dedicated global legal function
which is responsible for managing legal risk. This
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Operational risk > Legal litigation risk / Pension risk / Reputational risk / Sustainability risk
comprises the provision of legal advice and support
in resisting claims and legal proceedings against
HSBC companies, including analysis of legal issues
and the management of any litigation, as well as in
respect of non-routine debt recoveries or other
litigation against third parties.
The Head Office Legal department oversees the
global legal function and is headed by a Group
General Manager who reports to the Group
Chairman. There are Legal departments in 40 of the
countries in which HSBC operates which have
primary responsibility for identifying and assessing
legal risk and advising local management in their
respective jurisdictions on these matters. There is
also a regional level Legal function in each of
Europe, North America, Latin America, the Middle
East and Asia-Pacific.
HSBC policy requires operating companies to
notify the appropriate in-house Legal department
immediately any litigation is either threatened or
commenced against the Group or an employee.
Claims which exceed US$1.5 million, must be
advised immediately to the appropriate regional
Legal department. Claims where the amount exceeds
US$5 million, where the action is by the regulatory
authority, the proceedings are criminal, or any claim
that might materially affect the Group’s reputation
must immediately be advised to the Head Office
Legal department. Such matters are then advised to
the Risk Management Meeting of the Group
Management Board in a monthly paper.
HSBC policy also requires that an exception
report must be made to the local compliance function
and escalated to the Head of Group Compliance in
respect of any breach which has given rise to a fine
and/or costs levied by a court of law or regulatory
body where the amount is US$1,500 or more and
material or significant issues are reported to the Risk
Management Meeting of the Group Management
Board and/or the Group Audit Committee.
In addition, operating companies are required to
submit returns detailing outstanding claims which
exceed US$10 million or which may be sensitive to
the reputation of HSBC for reporting to the Group
Audit Committee and the Board of HSBC Holdings,
and disclosure in the Interim Report and Annual
Report and Accounts if appropriate.
Pension risk
(Unaudited)
HSBC operates a number of pension plans
throughout the world, as described in Note 7 on the
Financial Statements. Some of these pension plans
226
are defined benefit plans, of which the largest is the
HSBC Bank (UK) Pension Scheme.
The benefits payable under the defined benefit
plans are typically a function of salary and length of
service. In order to fund these benefits, sponsoring
group companies (and in some instances, employees)
make regular contributions in accordance with
advice from actuaries and in consultation with the
scheme’s Trustees (where relevant). The defined
benefit plans invest these contributions in a range of
investments designed to meet their long-term
liabilities.
A deficit in a defined benefit plan may arise
from a number of factors, including:
•
•
•
investments delivering a return below that
required to provide the projected plan benefits.
This could arise, for example, when there is a
fall in the market value of equities, or when
increases in long-term interest rates cause a fall
in the value of fixed income securities held;
a change in either interest rates or inflation
which causes an increase in the value of the
scheme liabilities; and
scheme members living longer than expected
(known as longevity risk).
The plan’s investment strategy is determined
in the light of the market risk inherent in the
investments and the consequential impact on
potential future contributions.
Ultimate responsibility for investment strategy
rests with either the Trustees or, in certain
circumstances, a Management Committee. The
degree of independence of the Trustees from HSBC
differs in different jurisdictions. For example, the
HSBC Bank (UK) Pension Scheme, which accounts
for over 80 per cent of the net liability of the
Group’s pension plans, is overseen by a corporate
Trustee. To assist this scheme’s Trustee, HSBC has
proposed a number of techniques for applying the
Group’s existing asset and liability management
strategy and related monitoring mechanisms to the
market risks inherent in the scheme.
These techniques include:
•
•
•
•
regular assessments of funding positions;
regular reviews of investment performance
against market benchmarks;
half-yearly reviews of the pension schemes’
effect on the Group’s financial statements;
alignment of investment strategy with the
liability profile of the pension scheme; and
•
hedging strategies to address inflation and the
interest rate risk inherent within the schemes.
In order to mitigate the risk of investments
under-performing and the adverse effect of changes
in long-term interest rates and inflation, the Trustee
has agreed to a programme of initiatives including
changing the asset mix and entering into long-term
interest rate and inflation swaps.
Reputational risk management
(Unaudited)
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
environmental, social and governance (‘ESG’) 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. Reputational risks
can arise from ESG 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. The training
of Directors on appointment includes reputational
matters.
Reputational risks, including ESG matters, 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 HSBC standards.
Standards on all major aspects of business are set for
HSBC and for individual subsidiaries, 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
ESG 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 responsibility practices.
227
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.
Sustainability risk management
(Unaudited)
Sustainability risks arise from the provision of
financial services to companies or projects which run
counter to the needs of sustainable development; in
effect this risk arises when the environmental and
social effects outweigh economic benefits. Within
Group Head Office, a separate function, Group
Sustainable Development, is mandated to manage
these risks globally. Its risk management
responsibilities include:
•
•
•
•
formulating sustainability risk policies. This
includes oversight of HSBC’s Sustainability
Risk Standards, management of the Equator
Principles for project finance lending, and
sector-based sustainability policies covering
those sectors with high environmental or social
impacts (forestry, freshwater infrastructure,
chemicals, energy, mining and metals, and
defence-related lending);
undertaking an independent review of
transactions where sustainability risks are
assessed to be high, and supporting HSBC’s
operating companies to assess similar risks of a
lower magnitude;
building and implementing systems-based
processes to ensure consistent application of
policies, reduce the costs of sustainability risk
reviews and capture management information to
measure and report on the effect of HSBC’s
lending and investment activities on sustainable
development; and
providing training and capacity building within
HSBC’s operating companies to ensure
sustainability risks are identified and mitigated
on a consistent basis and to either HSBC’s own
standards, or international standards or local
regulations, whichever the higher.
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Insurance operations > Life insurance / Non-life insurance / Insurance risk
Risk management of insurance
operations
(Audited)
Within its service proposition, HSBC offers its
customers a wide range of insurance products, many
of which complement other bank and consumer
finance products.
Both life and non-life insurance is underwritten,
principally in the UK, Hong Kong, Mexico, Brazil,
the US and Argentina.
Life insurance business
(Audited)
There are a number of major sub-categories of life
assurance business, of which the main ones are
discussed below:
Life insurance contracts with discretionary
participation features allow policyholders to
participate in the profits generated from such
business in addition to providing cover on death. The
largest portfolio, which is in Hong Kong, is a book
of endowment and whole-life policies, with annual
bonuses awarded to policyholders. Market risk is
managed in conjunction with other risks through the
investment policy and adjustment to bonus rates. In
practice this means that the majority of the market
risk is borne by policyholders. The main risk
associated with this product is the value of assigned
assets falling below that required to support benefit
payments. HSBC manages this risk by conducting
regular actuarial investigations on the sustainability
of the bonus rates.
Credit life insurance provides protection in the
event of death or unemployment. Credit life
insurance business is written for banking and finance
products. The insurance risk relates to mortality and
morbidity risk which is restricted to the duration of
the loans advanced. Claims experience is required to
be monitored and premium rates adjusted
accordingly.
Annuities are contracts providing regular
payments of income from capital investment for
either a fixed period or during the annuitant’s
lifetime. Deferred annuities are those whose
payments to the annuitant begin at a designated
future date while, for immediate annuities, payments
begin on inception of the policy. The principal risks
of annuity business relate to mortality and market
risk, the latter arising from the need to match
investments to the anticipated cash flow profile of
the policies. The investment strategy seeks to match
the anticipated cash flow profile, and the mortality
risk is regularly monitored.
228
Term assurance provides cover in the event of
death. Critical illness cover provides cover in the
event of critical illness. The major components of
the ‘Term assurance and other long-term contracts’
category are term assurance and critical illness
policies written in the UK. The principal risks are in
respect of mortality and morbidity. These risks are
managed through a combination of underwriting
practices, premium adjustment in light of changes in
experience and reinsurance.
Linked life insurance business pays benefits to
the policyholder which is typically determined by
reference to the value of the investments supporting
the policy. For linked life insurance business, the
market risk is substantially borne by policyholders.
The principal risk retained by HSBC relates to
expenses incurred in managing this product. They
are recovered by management charges deducted
from the policyholder over the lifetime of the policy.
However, if the policy is terminated early,
deductions made to that point may be less than the
costs incurred for managing the product. This risk is
mitigated by retaining the ability to apply charges on
early surrender. Mortality, disability and morbidity
risks can also arise with this product and are
managed by applying the techniques set out above
for non-linked lines of business.
Non-life insurance business
(Audited)
Non-life insurance contracts include motor, fire and
other damage, accident and health, repayment
protection and commercial and liability business.
Within accident and health insurance, potential
accumulations of personal accident risks are
mitigated by the purchase of catastrophe reinsurance.
Motor insurance business covers vehicle
damage and liability for personal injury. Reinsurance
protection is required to be arranged where
necessary to avoid excessive exposure to larger
losses, particularly those relating to personal injury
claims.
Fire and other damage business is written in all
major markets, most significantly in Europe. The
predominant focus in most markets is insurance for
home and contents while cover for selected
commercial customers is largely written in Asian
and Latin American markets. Portfolios at risk from
catastrophic losses are required to be protected by
reinsurance in accordance with information obtained
from professional risk-modelling organisations.
A very limited portfolio of liability business is
written in major markets.
Following the disposal of the non-life insurance
portfolio in Brazil in 2005, credit non-life business
now represents the largest single class and is
concentrated in the US and the UK. This business is
originated in conjunction with the provision of loans.
Insurance risk
(Audited)
The principal insurance risk faced by HSBC is that
the cost of claims combined with acquisition and
administration costs may exceed the aggregate
amount of premiums received and investment
income. HSBC manages its insurance risks through
the application of formal underwriting, reinsurance
and claims procedures designed to ensure
compliance with regulations.
The Group manages insurance risk by
diversifying insurance business by type and
geography and by focusing on risks that are
straightforward to manage which, in the main, are
related to core underlying banking activities (for
example, credit life products). The following tables
provide an analysis of the insurance risk exposures
by geography and by type of business. These tables
demonstrate the Group’s diversification of risk.
Personal lines tend to be higher volume and with
lower individual value than commercial lines, which
further diversifies the risk. Compared to non-life
business, life business tends to be longer term in
nature and frequently involves an element of savings
and investment in the contract. Separate tables are
therefore provided for life and non-life business,
reflecting their very distinct risk characteristics. The
life insurance risk table provides an analysis of
insurance liabilities as the best available overall
measure of the insurance exposure. The table for
non-life business uses written premiums as
representing the best available measure of risk
exposure.
Both life and non-life business insurance risks
are controlled through high level procedures set
centrally, and can be supplemented with procedures
set locally which take account of specific local
market conditions and regulatory requirements. For
example, central authorisation is required to write
certain classes of business, with restrictions applying
particularly to commercial and liability non-life
insurance. For life business in particular, local
ALCOs monitor the risk exposures.
As indicated in the specific comments relating
to particular classes, use is also made of reinsurance
as a means of further mitigating exposure, in
particular to aggregations of catastrophe risk.
Analysis of life insurance risk – policyholder liabilities
(Audited)
At 31 December 2006
Life (non-linked)
Insurance contracts with DPF1 .......................
Credit life ........................................................
Annuities ........................................................
Term assurance and other long-term
contracts .....................................................
Total life (non-linked) ........................................
Life (linked) ........................................................
Investment contracts with DPF1 .........................
Europe
US$m
195
130
271
1,134
1,730
1,270
–
Hong
Kong
US$m
6,001
–
–
75
6,076
765
–
Life insurance policyholders’ liabilities .............
3,000
6,841
At 31 December 2005 (restated2)
Life (non-linked)
Insurance contracts with DPF1 ...........................
Credit life ........................................................
Annuities ........................................................
Term assurance and other long-term
contracts .....................................................
Total life (non-linked) ........................................
Life (linked) ........................................................
Investment contracts with DPF1 .........................
155
156
202
1,063
1,576
1,201
–
3,886
–
–
68
3,954
536
–
Life insurance policyholders’ liabilities .............
2,777
4,490
229
Rest of
Asia-
Pacific
US$m
North
Latin
America
US$m
America
US$m
Total
US$m
193
–
26
89
308
402
20
730
152
–
22
82
256
332
9
597
–
200
1,106
–
1,306
–
–
–
–
1,370
236
1,606
1,248
–
6,389
330
2,773
1,534
11,026
3,685
20
1,306
2,854
14,731
–
196
1,075
–
1,271
–
–
–
–
1,091
221
1,312
826
–
4,193
352
2,390
1,434
8,369
2,895
9
1,271
2,138
11,273
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Insurance operations > Insurance risk
1 Insurance contracts and investment contracts with discretionary participation features (‘DPF’) give policyholders the contractual right
to receive, as a supplement to their guaranteed benefits, additional benefits that may be a significant portion of the total contractual
benefits, but whose amount and timing is determined by HSBC. These additional benefits are contractually based on the performance of
a specified pool of contracts or assets, or the profit of the company issuing the contracts.
2 In 2006, Mexico and Panama were reclassified from the North America segment to Latin America. Comparative information has been
restated accordingly. See Note 13 on the Financial Statements.
(Audited)
The above table of life insurance policyholders’
liabilities provides an overall summary of the life
insurance activity across the Group. For life
insurance business, insurance risk varies
considerably depending on the type of business.
The principal risks are mortality, morbidity, lapse
and surrender, investment/market risk and expense
levels. As indicated above, the geographic and
product diversity of HSBC’s life insurance business
assists in mitigating the exposure to insurance risk.
This can be supplemented at the operating subsidiary
level by additional underwriting and claims handling
procedures.
Mortality and morbidity risks are primarily
mitigated through medical underwriting and the
ability in a number of cases to amend the premium in
light of changes in experience. The risk associated
with lapses and surrenders is generally mitigated by
the application of surrender charges. Market risk is
usually mitigated through a combination of directing
the investment policy to match liabilities and sharing
risk with policyholders. In the case of unit-linked
business, market risk is generally borne by
policyholders, while for life business with a
discretionary participation feature, it is shared with
policyholders through the management of bonuses.
Analysis of non-life insurance risk – net written insurance premiums1
(Audited)
Europe
US$m
Hong
Kong
US$m
Rest of
Asia-
Pacific
US$m
North
Latin
America
US$m
America
US$m
Total
US$m
2006
Accident and health ............................................
Motor ..................................................................
Fire and other damage ........................................
Liability ...............................................................
Credit (non-life) ..................................................
Marine, aviation and transport ............................
Other non-life insurance contracts .....................
Total net written insurance premiums ................
2005 (restated2)
Accident and health ............................................
Motor ..................................................................
Fire and other damage ........................................
Liability ...............................................................
Credit (non-life) ..................................................
Marine, aviation and transport ............................
Other non-life insurance contracts .....................
Total net written insurance premiums ................
26
185
221
1
264
1
13
711
33
192
251
229
225
–
10
940
97
15
22
13
–
11
24
182
67
20
34
17
–
16
29
183
5
13
5
2
–
3
–
28
3
11
3
2
–
4
–
23
–
–
2
8
173
–
37
220
3
4
5
91
202
–
17
322
10
157
9
24
–
12
20
232
6
302
61
14
–
22
12
417
138
370
259
48
437
27
94
1,373
112
529
354
353
427
42
68
1,885
1 Net written insurance premiums represent gross written premiums less gross written premiums ceded to reinsurers.
2 In 2006, Mexico and Panama were reclassified from the North America segment to Latin America. Comparative information has been
restated accordingly. See Note 13 on the Financial Statements.
(Audited)
The above table of non-life net written insurance
premiums provides an overall summary of the
non-life insurance activity of the Group.
The main risks associated with non-life business
are underwriting risk and claims experience risk.
Underwriting risk is the risk that HSBC does not
charge premiums appropriate to the cover provided
and claims experience risk is the risk that portfolio
experience is worse than expected. HSBC manages
these risks through pricing (for example, imposing
restrictions and deductibles in the policy terms and
conditions), product design, risk selection, claims
handling, investment strategy and reinsurance
policy. The majority of non-life insurance contracts
230
are renewable annually and the underwriters have
the right to refuse renewal or to change the terms and
conditions of the contract at the time.
A key aspect of risk management in the
insurance business, in particular the life insurance
business, is the need to match assets and liabilities.
Models are used to assess the impact of a range of
future scenarios on the value of financial assets and
associated liabilities. The results of the modelling are
used by ALCOs to determine how the assets should
be matched with liabilities. Of particular importance
for a number of lines of business, such as annuities,
is the need to match the expected pattern of cash
flow which, in some cases, can extend for many
years. The following table shows the composition of
assets and liabilities and demonstrates that there was
an appropriate level of matching at the end of 2006.
It may not always be possible to achieve complete
matching of asset and liability durations, partly
because there is uncertainty over the receipt of all
future premiums and partly because the duration of
liabilities may exceed the duration of the longest
available dated fixed interest investments.
Balance sheet of insurance operations by type of contract
(Audited)
Insurance contracts
Investment contracts
Contracts
with
DPF1
US$m
Unit-
linked Annuities
US$m
US$m
Term
assurance2
US$m
Non-life
US$m
Unit-
linked
US$m
Other
US$m
Other
assets3
US$m
Total
US$m
At 31 December 2006
Financial assets:
– trading assets ............
– financial assets
designated at fair value
– derivatives ................
– financial investments
– other assets ...............
Total financial assets .........
Reinsurance assets .............
PVIF ..................................
Other assets and
–
–
–
–
117
–
–
39
156
1,418
96
3,842
794
6,150
2
–
2,998
417
–
52
3,467
58
–
366
–
1,223
719
2,308
271
–
950
–
390
138
1,478
773
–
94
–
1,554
712
2,477
665
–
10,041
363
–
222
10,626
–
–
1,597
3
1,441
428
3,469
–
–
974
–
2,173
632
3,818
48
1,549
18,438
879
10,623
3,697
33,793
1,817
1,549
investment properties ....
538
203
395
356
215
154
204
614
2,679
Total assets ........................
6,690
3,728
2,974
2,607
3,357
10,780
3,673
6,029
39,838
Financial liabilities
designated at fair value .
Liabilities under investment
contracts carried at
amortised cost ...............
Liabilities under insurance
contracts ........................
Deferred tax ......................
Other liabilities .................
–
–
–
–
6,389
–
–
3,685
–
–
Total liabilities ..................
6,389
3,685
Shareholders’ equity .........
Total liabilities and
shareholders’ equity4 ....
–
–
–
–
2,773
–
–
2,773
–
–
–
1,864
–
–
1,864
–
–
10,003
3,275
–
13,278
–
2,939
–
–
–
–
–
–
216
–
216
20
–
–
–
403
2,322
17,670
403
2,322
2,939
10,003
3,511
2,725
33,889
–
–
–
5,949
5,949
6,389
3,685
2,773
1,864
2,939
10,003
3,511
8,674
39,838
231
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Insurance operations > Insurance risk / Financial risks
Insurance contracts
Investment contracts
Contracts
with
DPF1
US$m
Unit-
linked
US$m
Annuities
US$m
Term
assurance2
US$m
Non-life
US$m
Unit-
linked
US$m
Other
US$m
Other
assets3
US$m
Total
US$m
–
–
–
1,005
57
2,581
635
4,278
2
–
2,132
426
–
268
2,826
69
–
52
–
1,272
828
2,152
193
–
49
947
–
339
182
1,517
612
–
58
–
–
170
277
14
–
1,230
619
1,921
669
–
6,995
1
–
174
7,170
–
–
1,415
4
1,527
376
3,322
–
–
1,488
–
1,896
1,098
4,652
40
1,400
14,048
488
8,845
4,180
27,838
1,585
1,400
At 31 December 2005
Financial assets:
– trading assets ............
– financial assets
designated at fair value
– derivatives ................
– financial investments
– other assets ...............
Total financial assets .........
Reinsurance assets .............
PVIF ..................................
Other assets and
investment properties ...
18
9
45
33
329
1
–
760
1,195
Total assets ........................
4,298
2,904
2,390
2,162
2,919
7,171
3,322
6,852
32,018
Financial liabilities
designated at fair value .
Liabilities under insurance
contracts ........................
Deferred tax ......................
Other liabilities .................
Total liabilities ..................
Shareholders’ equity .........
Total liabilities and
shareholders’ equity4 ....
–
–
–
–
–
7,156
3,289
–
10,445
4,193
–
–
4,193
–
2,895
–
–
2,895
–
2,390
–
–
2,390
–
1,786
–
–
1,786
–
2,871
–
–
2,871
–
–
–
–
9
–
–
–
322
2,125
14,144
322
2,125
7,156
3,298
2,447
27,036
–
–
4,982
4,982
4,193
2,895
2,390
1,786
2,871
7,156
3,298
7,429
32,018
1 Discretionary participation features.
2 Term assurance includes credit life insurance.
3 Other assets comprise solvency and unencumbered assets.
4 Excludes assets, liabilities and shareholders’ funds of associate insurance companies Erisa S.A. and Ping An Insurance.
Balance sheet of insurance underwriting operations by geographical region
(Audited)
At 31 December 2006
Financial assets:
– trading assets ...............................................
– financial assets designated at fair value ......
– derivatives ...................................................
– financial investments ...................................
– other assets ..................................................
Total financial assets ..........................................
Reinsurance assets
PVIF ....................................................................
Other assets and investment properties ..............
Europe
US$m
–
11,750
720
1,190
689
14,349
1,560
798
619
Hong
Kong
US$m
–
4,120
159
5,621
1,312
11,212
47
697
1,297
Rest of
Asia-
Pacific
US$m
North
Latin
America
America
US$m
US$m
Total
US$m
–
733
–
67
108
908
25
54
34
–
–
–
2,433
940
3,373
93
–
273
156
1,835
–
1,312
648
3,951
92
–
456
Total assets .........................................................
17,326
13,253
1,021
3,739
4,499
Financial liabilities designated at fair value .......
Liabilities under investment contracts
carried at amortised cost .................................
Liabilities under insurance contracts ..................
Deferred tax ........................................................
Other liabilities ...................................................
9,069
4,164
–
4,624
251
1,475
–
7,084
123
337
Total liabilities ....................................................
15,419
11,708
Shareholders’ equity ...........................................
1,907
1,545
45
–
790
10
20
865
156
Total liabilities and shareholders’ equity1 ..........
17,326
13,253
1,021
–
–
–
2,010
–
195
2,205
1,534
3,739
216
3,162
19
295
3,692
807
4,499
232
156
18,438
879
10,623
3,697
33,793
1,817
1,549
2,679
39,838
13,278
216
17,670
403
2,322
33,889
5,949
39,838
At 31 December 2005 (restated2)
Financial assets:
– trading assets ...............................................
– financial assets designated at fair value ......
– derivatives ...................................................
– financial investments ...................................
– other assets ..................................................
Europe
US$m
–
9,276
386
1,053
886
Total financial assets ..........................................
11,601
Reinsurance assets
PVIF ....................................................................
Other assets and investment properties ..............
1,293
796
307
Hong
Kong
US$m
–
3,164
102
4,429
1,512
9,207
48
557
64
Total assets .........................................................
13,997
9,876
Financial liabilities designated at fair value .......
Liabilities under insurance contracts ..................
Deferred tax ........................................................
Other liabilities ...................................................
6,375
4,284
237
1,374
Total liabilities ....................................................
12,270
Shareholders’ equity ...........................................
Total liabilities and shareholders’ equity1 ..........
1,727
13,997
3,874
4,724
83
123
8,804
1,072
9,876
Rest of
Asia-
Pacific
US$m
North
Latin
America
America
US$m
US$m
Total
US$m
–
545
–
60
157
762
24
47
19
852
42
655
9
21
727
125
852
–
–
–
2,334
1,133
3,467
153
–
244
277
1,063
–
969
492
2,801
67
–
561
277
14,048
488
8,845
4,180
27,838
1,585
1,400
1,195
3,864
3,429
32,018
–
2,102
(17)
335
2,420
1,444
3,864
154
2,379
10
272
2,815
614
3,429
10,445
14,144
322
2,125
27,036
4,982
32,018
1 Excludes assets, liabilities and shareholders’ funds of associate insurance companies Erisa S.A. and Ping An Insurance.
2 In 2006, Mexico and Panama were reclassified from the North America segment to Latin America. Comparative information has been
restated accordingly. See Note 13 on the Financial Statements.
Financial risks
(Audited)
HSBC’s insurance businesses are exposed to a range
of financial risks, including market risk, credit risk
and liquidity risk. The nature and management of
these risks is described below.
Underwriting subsidiaries are exposed to
financial risk, for example, when the proceeds from
financial assets are not sufficient to fund the
obligations arising from non-linked insurance and
investment contracts. Certain insurance-related
activities undertaken by HSBC subsidiaries such as
insurance broking, insurance management (including
captive management), and insurance, pensions and
annuities administration and intermediation, are
exposed to financial risk but not to a significant
extent.
In addition to policies provided for Group-wide
application, insurance underwriting subsidiaries may
have risk management procedures which reflect local
market conditions and regulatory requirements.
Where appropriate they should also comply with
HSBC’s banking risk management procedures,
though, like the use of one day VAR measures, they
are not all suitable for insurance and, therefore, are
not applied.
Most of HSBC’s insurance underwriting
subsidiaries are owned and primarily managed by
banking subsidiaries. Their activities are subject to a
variety of central and local level controls, and to
external regulatory monitoring. In many
jurisdictions, local regulatory requirements prescribe
the type, quality and concentration of assets that
HSBC’s insurance underwriting subsidiaries must
maintain to meet insurance liabilities. Within each
subsidiary, ALCOs are responsible for the
management of financial risks within local
requirements and ensure compliance with the control
framework and risk appetite established centrally.
The following table analyses the assets held in
HSBC’s insurance underwriting subsidiaries at
31 December 2006 by type of liability, and provides
a view of the exposure to financial risk:
233
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Insurance operations > Financial risks / Market risk
Financial assets held by insurance underwriting operations
(Audited)
Life linked Life non-linked
insurance1
US$m
insurance2
US$m
insurance3
US$m
Other assets4
US$m
At 31 December 2006
Non-life
Trading assets
Debt securities ......................................
–
–
117
Financial assets designated at fair value
Treasury bills ........................................
Debt securities ......................................
Equity securities ...................................
Financial investments
Held-to-maturity:
Treasury bills and similar ................
Debt securities ..................................
Available-for-sale:
Treasury bills ....................................
Other eligible bills ............................
Debt securities ..................................
Equity securities ...............................
54
4,304
8,681
13,039
–
–
–
–
–
–
–
–
Derivatives.................................................
Other financial assets6 ..............................
780
274
24
2,492
1,815
4,331
–
5,585
5,585
14
–
1,284
13
1,311
99
2,079
14,093
13,405
55
32
7
94
44
279
323
102
355
738
36
1,231
–
712
2,477
Life linked Life non-linked
At 31 December 2005
Non-life
insurance3
US$m
insurance2
US$m
(Audited)
Trading assets
Treasury bills.........................................
Debt securities ......................................
Financial assets designated at fair value
Treasury bills ........................................
Debt securities ......................................
Equity securities ...................................
Financial investments
Held-to-maturity:
Debt securities ..................................
Available-for-sale:
Treasury bills ....................................
Other eligible bills ............................
Debt securities ..................................
Equity securities ...............................
Derivatives.................................................
Other financial assets ................................
insurance1
US$m
–
–
–
9
2,374
6,744
9,127
–
–
–
–
–
–
–
427
442
9,996
–
49
49
26
2,118
1,275
3,419
4,603
4,603
–
–
1,116
–
1,116
61
2,021
11,269
21
37
58
–
4
10
14
157
157
70
447
556
–
1,073
–
619
1,921
1 Comprises life linked insurance contracts and linked long-term investment contracts.
2 Comprises life non-linked insurance contracts and non-linked long-term investment contracts.
3 Comprises non-life insurance contracts.
234
39
–
934
40
974
–
333
333
141
145
1,415
139
1,840
–
632
3,818
Other assets4
US$m
103
67
170
17
745
726
1,488
226
226
101
116
1,437
16
1,670
–
1,098
4,652
Total5
US$m
156
133
7,762
10,543
18,438
44
6,197
6,241
257
500
3,437
188
4,382
879
3,697
33,793
Total5
US$m
124
153
277
52
5,241
8,755
14,048
4,986
4,986
171
563
3,109
16
3,859
488
4,180
27,838
4 Comprises solvency and unencumbered assets.
5 Excludes financial assets of insurance underwriting associates, Erisa, S.A. and Ping An Insurance.
6 Comprises mainly loans and advances to banks and cash.
In life linked insurance, premium income less
charges levied is invested in unit-linked funds.
HSBC manages the financial risk of this product by
holding appropriate assets in segregated funds or
portfolios to which the liabilities are linked. This
substantially transfers the financial risk to the
policyholder. The assets held to support life linked
liabilities represented 41.7 per cent of the total
financial assets of HSBC’s insurance underwriting
subsidiaries at the end of 2006 (2005: 35.9 per cent).
Market risk
(Audited)
Market risk can be further sub-categorised into
interest rate risk, equity risk and foreign exchange
risk. Each of these categories is discussed further
below.
Interest rate risk
(Audited)
HSBC’s insurance underwriting subsidiaries are
exposed to interest rate risk when there is a
mismatch in terms of duration or yields between the
assets and liabilities. Examples of interest rate risk
exposure are as follows:
•
a fall in market interest rates results in lower
yields on the assets supporting guaranteed
investment returns payable to policyholders;
and
•
a rise in market interest rates results in a
reduction in the value of the fixed income
securities portfolio which may result in losses if,
as a result of an increase of the level of
surrenders, the corresponding fixed income
securities have to be sold.
HSBC manages the interest rate risk arising
from its insurance underwriting subsidiaries by
establishing limits centrally. These govern the
sensitivity of the net present values of expected cash
flows from subsidiaries’ assets and liabilities to a
one basis point parallel upward shift in the discount
curve used to calculate values. Adherence to these
limits is monitored by local ALCOs.
Interest rate risk is also assessed by measuring
the impact of defined movements in interest yield
curves on the profits after tax and net assets of the
insurance underwriting subsidiaries. An immediate
and permanent movement in interest yield curves as
at 31 December 2006 in all territories in which
HSBC’s insurance subsidiaries operate would have
the following impact on the profit for the year and
net assets at that date:
(Audited)
2006
2005
+ 100 basis points shift in yield curves ........................
– 100 basis points shift in yield curves .........................
The interest rate sensitivities set out above are
illustrative only and employ simplified scenarios. It
should be noted that the effects may not be linear
and therefore the results cannot be extrapolated. The
sensitivities do not incorporate actions that could be
taken by management to mitigate the effect of the
interest rate movements, nor do they take account of
any resultant changes in policyholder behaviour.
Impact on
profit for
the year
US$m
(13)
24
Impact on
net assets
US$m
(111)
103
Impact on
profit for
the year
US$m
(46)
63
Impact on
net assets
US$m
(122)
181
held to liability requirements. In addition, a
provision is established when analysis indicates that,
over the life of the contracts, the returns from the
designated assets may not be adequate to cover the
related liabilities.
The guarantees offered to policyholders in
respect of certain insurance products are divided into
broad categories as follows:
The majority of interest rate exposure arises
within insurance underwriting subsidiaries in the
UK, the US and Hong Kong.
•
•
HSBC’s insurance underwriting subsidiaries are
also exposed to the risk that the yield on assets held
may fall short of the return guaranteed on certain
contracts issued to policyholders. This investment
return guarantee risk is managed by matching assets
annuities in payment;
deferred annuities: these consist of two phases –
the savings and investing phase, and the
retirement income phase;
235
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Insurance operations > Market risk / Credit risk
•
•
annual return: the annual return is guaranteed to
be no lower that a specified rate. This can be the
investment return credited to the policyholder
every year (referred to as a ‘hard’ guarantee), or
the average annual investment return credited to
the policyholder over the life of the policy,
which can be either the maturity date or the
surrender date of the contract (referred to as a
‘soft’ guarantee);
capital: policyholders are guaranteed to receive
no less than the premiums paid less expenses, or
a cash payment or series of cash payments
whose amounts are at least equal to those
defined within the policy; and
Policyholders’ liabilities
(Audited)
• market performance: policyholders receive an
investment return which is guaranteed to be
within a prescribed range of average investment
returns earned by predetermined market
participants on the specified product.
The table below shows, in respect of each
category of guarantee, the total policyholders’
liabilities established for guaranteed products, the
range of investment returns implied by the
guarantees, and the range of current yields of the
investment portfolios supporting the guarantees.
2006
Investment
returns
implied by
guarantee1
%
Policy-
holders’
liabilities
US$m
1,240
420
640
6,379
508
1,196
3,723
0.0 – 7.0
0.0 – 6.0
6.0 – 9.0
0.0 – 3.0
3.0 – 6.0
0.0
n/a
Current
yields
%
5.2 – 18.6
3.9 – 8.6
5.7
3.3 – 4.5
3.8 – 7.9
2.9 – 4.1
n/a
2005
Investment
returns
implied by
guarantee1
%
Policy-
holders’
liabilities
US$m
Current
yields
%
1,063
408
674
4,362
581
1,168
2,938
0.0 – 4.2 4.0 – 13.0
6.1 – 8.6
0.0 – 6.0
6.0 – 9.0
5.7
0.0 – 3.0
3.5 – 5.6
3.0 – 6.0 3.5 – 11.5
2.9 – 5.6
n/a
0.0
n/a
Annuities in payment ..........................................
Deferred annuities ..............................................
Deferred annuities ..............................................
Annual return ......................................................
Annual return ......................................................
Capital .................................................................
Market performance2 ..........................................
1 Excluding guarantees from associate insurance companies Erisa, S.A. and Ping An Insurance.
2 There is no specific investment return implied by market performance guarantees because the guarantees are expressed as lying within
prescribed ranges of average market returns.
HSBC manages the annual return and capital
guarantees of annuities by seeking to match their risk
exposure with bonds which produce a return at least
equal to the investment return implied by the
guarantee. Provision is made for anticipated
shortfalls, generally calculated by recourse to stress
testing of the likely outcomes.
The main risk arising from these guarantees is
reinvestment risk, which arises primarily when the
duration of the policy extends beyond the maturity
dates of the available bonds. Future reinvestment
yields may be less than the investment rates implied
by the guarantee.
A certain number of these products have been
discontinued, including the deferred annuity
portfolio in HSBC Finance where, as highlighted in
the above table, the current portfolio yield is less
than the guarantee. For this block of business, a
purchase accounting reserve was made when HSBC
Finance was acquired to mitigate the impact of the
disparity in yields. In addition, in the UK there is an
annuity portfolio where the risk is fully reinsured.
For market performance guarantee business in
the table above, HSBC seeks to match the
composition of the investment portfolio with the
composition of the average investment portfolio of
the other market participants. These are published by
the regulator monthly. Liabilities have also been
established to cover any potential shortfall.
Equity risk
(Audited)
HSBC manages the equity risk arising from its
holdings of equity securities centrally by setting
limits on the maximum market value of equities that
each insurance underwriting subsidiary may hold.
Equity risk is also monitored by estimating the effect
of predetermined movements in equity prices on the
profit and total net assets of the insurance
underwriting subsidiaries.
The following table illustrates the impact on the
aggregated profit for the year and net assets of a
reasonably possible 10 per cent variance in equity
prices:
236
(Audited)
2006
2005
10 per cent increase in equity prices ............................
10 per cent decrease in equity prices ............................
Impact on
profit for
the year
US$m
93
(86)
Impact on
net assets
US$m
95
(87)
Impact on
profit for
the year
US$m
61
(45)
Impact on
net assets
US$m
62
(46)
These equity sensitivities are illustrative only
other than the currencies of the liabilities.
and employ simplified scenarios. It should be noted
that the effects may not be linear and therefore the
results cannot be extrapolated. They do not allow for
the effect of management actions which may
mitigate the equity price decline, nor for any
resultant changes, such as in policyholder behaviour,
that might accompany such a fall.
Foreign exchange risk
(Audited)
HSBC’s insurance underwriting subsidiaries are
exposed to this risk when the assets supporting
insurance liabilities are denominated in currencies
(Audited)
10 per cent increase in US dollar exchange rate ..........
10 per cent decrease in US dollar exchange rate .........
These sensitivities to movements in the US
dollar are for illustrative purposes only and employ
simplified scenarios applied to US dollar positions
only. It should be noted that the effects may not be
linear and therefore the results of the stress testing
cannot be extrapolated. They do not allow for
actions that could be taken by management to
mitigate the effect of exchange differences, nor for
any subsequent changes in policyholder behaviour.
Credit risk
(Audited)
In the context of the Group’s insurance underwriting
business, the exposure to credit risk primarily arises
from the invested assets held and the reinsurance
contracts. HSBC’s insurance underwriting
subsidiaries are exposed to credit risk in respect of
their investment portfolios and their reinsurance
transactions.
Management of HSBC’s underwriting insurance
subsidiaries is responsible for the quality and
HSBC manages the foreign exchange risk
arising from its insurance underwriting subsidiaries
centrally, by establishing limits on the net positions
by currency and the total net short position that each
insurance subsidiary may hold. The risk is also
monitored by tracking the effect of predetermined
exchange differences on the total profit and net
assets of the insurance underwriting subsidiaries.
The following table illustrates the impact on the
aggregated profit for the year and net assets of a
reasonably possible 10 per cent variance in the US
dollar exchange rate:
2006
2005
Impact on
profit for
the year
US$m
(10)
10
Impact on
net assets
US$m
(10)
10
Impact on
profit for
the year
US$m
5
(5)
Impact on
net assets
US$m
5
(5)
performance of the investment portfolios. Investment
guidelines are set at Group level. Local subsidiary
ALCOs set investment parameters appropriate to the
local environment within the framework of the
Group guidelines and review investment
performance and compliance with the guidelines.
The assessment of the creditworthiness of issuers
and counterparties is based primarily upon
internationally recognised credit ratings and other
publicly available information. In addition, to reduce
the impact of individual entity or industry sector
failures, centrally determined issuer and industry
sector concentration limits are complied with.
Investment credit exposures are aggregated and
reported to HSBC’s Group Credit and Risk function.
Credit quality
(Audited)
The following table presents the analysis of treasury
bills, other eligible bills and debt securities within
HSBC’s insurance business by rating agency
designation based on Standard and Poor’s ratings or
equivalent:
237
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Insurance operations > Credit risk
Treasury
bills
US$m
Other eligible
bills
US$m
Debt
securities
US$m
(Audited)
At 31 December 2006
Supporting liabilities under non-linked insurance
contracts
AAA .........................................................................
AA– to AA+ .............................................................
A– to A+ ...................................................................
Lower than A– ..........................................................
Unrated .....................................................................
Supporting shareholders’ funds1
AAA .........................................................................
AA– to AA+ .............................................................
A– to A+ ...................................................................
Lower than A– ..........................................................
Unrated .....................................................................
Total2
AAA .........................................................................
AA– to AA+ .............................................................
A– to A+ ...................................................................
Lower than A– ..........................................................
Unrated .....................................................................
Of which issued by:
– government ............................................................
– local authorities .....................................................
– corporates ..............................................................
– other .......................................................................
Of which classified as:
– trading assets .........................................................
– financial instruments designated at fair value .......
– available-for-sale securities ...................................
– held-to-maturity investments ................................
Total
US$m
4,238
4,204
1,880
667
132
11,121
1,174
911
692
201
29
3,007
5,412
5,115
2,572
868
161
3,876
3,994
1,880
667
110
10,527
918
903
692
180
28
2,721
4,794
4,897
2,572
847
138
13,248
14,128
2,825
69
9,740
614
13,248
156
3,458
3,437
6,197
13,248
3,205
69
10,240
614
14,128
156
3,537
4,194
6,241
14,128
145
210
–
–
–
355
137
8
–
–
–
145
282
218
–
–
–
500
–
–
500
–
500
–
–
500
–
500
217
–
–
–
22
239
119
–
–
21
1
141
336
–
–
21
23
380
380
–
–
–
380
–
79
257
44
380
238
(Audited)
At 31 December 2005
Supporting liabilities under non-linked insurance
contracts
AAA .........................................................................
AA– to AA+ .............................................................
A– to A+ ...................................................................
Lower than A– ..........................................................
Unrated .....................................................................
Supporting shareholders’ funds1
AAA .........................................................................
AA– to AA+ .............................................................
A– to A+ ...................................................................
Lower than A– ..........................................................
Unrated .....................................................................
Total2
AAA .........................................................................
AA– to AA+ .............................................................
A– to A+ ...................................................................
Lower than A– ..........................................................
Unrated .....................................................................
Of which issued by:
– government ............................................................
– local authorities .....................................................
– corporates ..............................................................
– other .......................................................................
Of which classified as:
– trading assets .........................................................
– financial instruments designated at fair value .......
– available-for-sale securities ...................................
– held-to-maturity investments ................................
Treasury
bills
US$m
Other eligible
bills
US$m
Debt
securities
US$m
117
–
–
–
–
117
221
–
–
–
–
221
338
–
–
–
–
338
338
–
–
–
338
124
43
171
–
338
224
223
–
–
–
447
109
7
–
–
–
116
333
230
–
–
–
563
–
–
–
563
563
–
–
563
–
563
3,367
3,372
1,459
382
60
8,640
892
606
787
183
7
2,475
4,259
3,978
2,246
565
67
11,115
2,224
76
8,424
391
11,115
153
2,867
3,109
4,986
11,115
Total
US$m
3,708
3,595
1,459
382
60
9,204
1,222
613
787
183
7
2,812
4,930
4,208
2,246
565
67
12,016
2,562
76
8,424
954
12,016
277
2,910
3,843
4,986
12,016
1 Shareholders’ funds comprise solvency and unencumbered assets.
2 Excludes treasury bills, other eligible bills and debt securities held by insurance underwriting associates Erisa, S.A. and Ping An
Insurance.
(Audited)
Credit risk also arises when part of the insurance
risk incurred by HSBC is assumed by reinsurers. The
credit risk exposure for reinsurers is monitored
centrally.
The split of liabilities ceded to reinsurers and
outstanding reinsurance recoveries, analysed by Standard
and Poor’s reinsurance credit rating data or their
equivalent, was as follows:
239
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Insurance operations > Credit risk / Liquidity risk / PVIF
(Audited)
At 31 December 2006
AAA ..............................................................................
AA– to AA ....................................................................
A– to A+ .......................................................................
Lower than A– ..............................................................
Unrated .........................................................................
Total1 .............................................................................
At 31 December 2005
AAA ..............................................................................
AA– to AA ....................................................................
A– to A+ .......................................................................
Lower than A– ..............................................................
Unrated .........................................................................
Total1 .............................................................................
Reinsurers’ share of liabilities under
insurance contracts
Linked
insurance
contracts
US$m
Non-linked
insurance
contracts
US$m
Total
US$m
Reinsurance
debtors
US$m
10
33
–
15
–
58
7
29
8
25
–
69
106
812
586
37
170
116
845
586
52
170
1,711
1,769
61
735
536
68
76
68
764
544
93
76
1,476
1,545
–
37
5
3
3
48
–
5
27
2
6
40
1 Excludes reinsurers’ share of liabilities under insurance contracts and reinsurance debtors of insurance underwriting associates Erisa,
S.A. and Ping An Insurance.
Liquidity risk
(Audited)
It is an inherent characteristic of almost all insurance
contracts that there is uncertainty over the amount
and the timing of settlement of claims liabilities that
may arise, and this leads to liquidity risk. As part of
the management of this exposure, estimates are
prepared for most lines of insurance business of cash
flows expected to arise from insurance funds at the
balance sheet date. The estimates always include
future renewal premiums and new business cash
flows. As indicated by the asset and liability table for
insurance business, and the analysis of insurance risk
of the Group, a significant proportion of the Group’s
non-life insurance business is viewed as short term,
Expected maturity of insurance contract liabilities
(Audited)
with the settlement of claims expected to occur
within one year of the period of risk. There is a
greater spread of anticipated duration for the life
business where, in a large proportion of cases, the
liquidity risk is borne in conjunction with
policyholders (wholly in the case of unit-linked
business). To ensure adequate cash resources are
available to meet short-term requirements that can
arise as a consequence of large claims events, the
insurance operations have an objective to manage
liquidity on a prudent basis.
The following table shows the expected
maturity of insurance contract liabilities at
31 December 2006.
At 31 December 2006
Non-life insurance ....................................
Life insurance (non-linked) ......................
Life insurance (linked) .............................
Investment contracts with DPF ................
At 31 December 2005
Non-life insurance ....................................
Life insurance (non-linked) ......................
Life insurance (linked) .............................
Investment contracts with DPF ................
Expected cash flows (undiscounted)
Within 1 year
US$m
1-5 years
US$m
5-15 years Over 15 years
US$m
US$m
1,679
387
236
–
2,302
1,422
401
145
(1)
1,967
1,136
1,258
793
20
3,207
1,149
786
628
11
2,574
118
5,034
1,517
–
6,669
130
3,779
1,205
–
5,114
6
5,191
1,172
1
6,370
170
4,208
947
–
5,325
Total
US$m
2,939
11,870
3,718
21
18,548
2,871
9,174
2,925
10
14,980
240
Remaining contractual maturity of long-term investment contract liabilities
(Audited)
At 31 December 2006
Remaining contractual maturity:
– due within 1 year ......................................................................................
– due between 1 and 5 years .......................................................................
– due between 5 and 10 years .....................................................................
– due after 10 years .....................................................................................
– undated2 ....................................................................................................
At 31 December 2005
Remaining contractual maturity:
– due within 1 year ......................................................................................
– due between 1 and 5 years .......................................................................
– due between 5 and 10 years .....................................................................
– due after 10 years .....................................................................................
– undated2 ....................................................................................................
Liabilities under investment contracts by
insurance underwriting subsidiaries1
Linked
investment
contracts
US$m
Non-linked
investment
contracts
US$m
274
1,238
856
3,312
4,323
10,003
118
1,043
683
2,431
2,881
7,156
265
45
–
–
3,181
3,491
11
185
–
–
3,093
3,289
Total
US$m
539
1,283
856
3,312
7,504
13,494
129
1,228
683
2,431
5,974
10,445
1 Excludes investment contracts by insurance underwriting associates Erisa, S.A. and Ping An Insurance.
2 In most cases, policyholders have the option to terminate their contracts at any time and receive the surrender values of their policies.
These may be significantly lower than the amounts shown above.
Present value of in-force long-term
insurance business (‘PVIF’)
(Audited)
The HSBC life insurance business is accounted for
using the embedded value approach, which, inter
alia, provides a comprehensive framework for the
evaluation of insurance and related risks. The value
of the PVIF asset at 31 December 2006 was
US$1,549 million (2005: US$1,400 million). The
present value of the shareholders’ interest in the
profits expected to emerge from the book of in-force
policies at 31 December can be stress-tested to
Sensitivity of PVIF to changes in economic assumptions
(Audited)
assess the ability of the life business book to
withstand adverse developments. A key feature of
the life insurance business is the importance of
managing the assets, liabilities and risks in a
coordinated fashion rather than individually. This
reflects the greater interdependence of these three
elements for life insurance than is generally the case
for non-life insurance.
The following table shows the effect on the
PVIF of reasonably possible changes in the main
economic assumptions across all insurance
underwriting subsidiaries:
+ 100 basis points shift in risk-free rate ............................................................................................
– 100 basis points shift in risk-free rate ............................................................................................
+ 100 basis points shift in risk discount rate .....................................................................................
– 100 basis points shift in risk discount rate .....................................................................................
PVIF at 31 December
2006
US$m
130
(141)
(64)
70
2005
US$m
90
(100)
(54)
57
(Audited)
The effects on PVIF shown above are
illustrative only and employ simplified scenarios. It
should be noted that the effects may not be linear
and so the results of the stress-testing cannot be
extrapolated. In calculating the various scenarios, all
other assumptions are left unchanged except for
testing the effect of the shift in the risk-free rate,
when consequential changes to investment returns,
risk discount rate and bonus rates are also
incorporated. In practice, certain correlations
between the above items may be observed. In
addition the scenarios do not incorporate actions that
could be taken by management to mitigate effects
nor do they take account of consequential changes in
policyholder behaviour.
241
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Insurance operations > PVIF / Capital management and allocation
The following table shows the movements
recorded during the year in respect of PVIF and the
net assets of insurance operations:
Movements in PVIF and net assets of insurance operations
(Audited)
At 1 January ........................................................
Value of new business written during the year1 .
Movements arising from in-force business:
– expected return ............................................
– experience variances2 ..................................
– change in operating assumptions ................
Investment return variances ................................
Changes in investment assumptions ...................
Return on net assets ............................................
Exchange differences and other .........................
Capital transactions ............................................
2006
Net assets
of insurance
operations
US$m
3,582
–
–
–
–
–
–
752
95
(29)
PVIF
US$m
1,400
254
(233)
31
(17)
13
3
–
98
–
Total
US$m
4,982
254
(233)
31
(17)
13
3
752
193
(29)
2005
Net assets
of insurance
operations
US$m
PVIF
US$m
1,493
289
(181)
15
(121)
19
–
–
(114)
–
2,695
–
–
–
–
–
–
1,062
(90)
(85)
3,582
Total
US$m
4,188
289
(181)
15
(121)
19
–
1,062
(204)
(85)
4,982
At 31 December ..................................................
1,549
4,400
5,949
1,400
1 Value of net new business during the year is the present value of the projected stream of profits from the business.
2 Experience variances include the effect of the difference between demographic, expense and persistency assumptions used in the
previous PVIF calculation and actual experience observed during the year.
Non-economic assumptions
(Audited)
The sensitivity of profit for the year to, and net
assets at, 31 December 2006 to reasonably possible
changes in conditions at 31 December 2006 across
all insurance underwriting subsidiaries was as
follows:
2006
Impact on
profit for
the year
US$m
Impact on
net assets
US$m
2005
Impact on
profit for
the year
US$m
Impact on
net assets
US$m
20% increase in claims costs ........................................
20% decrease in claims costs .......................................
10% increase in mortality and/or morbidity rates ........
10% decrease in mortality and/or morbidity rates .......
50% increase in lapse rates ...........................................
50% decrease in lapse rates ..........................................
10% increase in expense rates ......................................
10% decrease in expense rates .....................................
(118)
118
(8)
15
10
22
(23)
23
(118)
118
(8)
15
10
22
(23)
23
(82)
81
(8)
18
(17)
56
(20)
19
(78)
78
(9)
18
(14)
51
(20)
19
242
Capital management and allocation
Capital management
(Audited)
It is HSBC’s policy to maintain a strong capital base
to support the development of its business and to
meet regulatory capital requirements at all times. In
addition, the level of capital held by HSBC Holdings
and other major subsidiaries, particularly HSBC
Finance, is determined by its rating targets. HSBC
currently uses a benchmark minimum tier 1 capital
ratio of 8.25 per cent for the purposes of its long-
term capital planning. 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.
An annual Group capital plan is prepared and
approved by the Board with the objective of
maintaining both the optimal amount of capital and
the mix between the different components of capital.
The Group’s policy is to hold capital in a range of
different forms and from diverse sources and all
capital raising is agreed with major subsidiaries as
part of their individual and the Group’s capital
management process. Major subsidiaries would
usually raise their own non-equity tier 1 capital and
subordinated debt in accordance with the Group’s
guidelines regarding market and investor
concentration, cost, market conditions, timing and
maturity profile. The subordinated debt requirements
of other HSBC companies are met internally.
Each subsidiary manages its own capital within
the context of the approved annual Group capital
plan, which determines levels of risk-weighted asset
growth and the optimal amount and mix of capital
required to support planned business growth. As part
of HSBC’s capital management policy, capital
generated in excess of planned requirements is
returned to HSBC Holdings, normally by way of
dividends.
HSBC Holdings is primarily a provider of
equity capital to its subsidiaries. These investments
are substantially funded by HSBC Holdings’ own
capital issuance and profit retentions. HSBC
Holdings seeks to maintain a prudent balance
between the composition of its capital and that of its
investment in subsidiaries.
The principal forms of capital are included in
the following balances on the consolidated balance
sheet: called up share capital, share premium
account, other reserves, retained earnings, and
243
subordinated liabilities. Capital also includes the
collective impairment allowances held in respect of
loans and advances.
Capital measurement and allocation
(Audited)
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, who set and monitor their capital
adequacy requirements. In most jurisdictions, non-
banking financial subsidiaries are also 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, known as the
Basel Capital Accord (Basel I), the banking
supervisors of HSBC’s major banking subsidiaries
have exercised capital adequacy supervision within a
broadly similar framework.
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
Capital Adequacy Directive, the FSA allows banks
to calculate capital requirements for market risk in
the trading book using VAR techniques. HSBC
complied with the FSA’s capital adequacy
requirements throughout 2006 and 2005.
HSBC’s capital is divided into two tiers:
• Tier 1 capital comprises shareholders’ funds,
innovative tier 1 securities and minority
interests in tier 1 capital, after adjusting for
items reflected in shareholders’ funds which are
treated differently for the purposes of capital
adequacy. The book values of goodwill and
intangible assets are deducted in arriving at
tier 1 capital.
• Tier 2 capital comprises qualifying subordinated
loan capital, collective impairment allowances,
minority and other interests in tier 2 capital and
unrealised gains arising on the fair valuation of
equity instruments held as available-for-sale.
Tier 2 capital also includes reserves arising from
the revaluation of properties.
Various limits are applied to elements of the
capital base. 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
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Capital management and allocation > Capital measurement > Future developments
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
collective impairment allowances which may be
included as part of tier 2 capital. From the total of
tier 1 and tier 2 capital are deducted the carrying
amounts of unconsolidated investments, investments
in the capital of banks, and certain regulatory items.
Changes to the definition of capital came into force
on 1 January 2007 and further details are provided
under ‘Future developments’ below.
Banking operations are categorised as either
trading book or banking book 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
Basel II
(Audited)
The Basel Committee on Banking Supervision (‘the
Basel Committee’) has published a new framework
for calculating minimum capital requirements.
Known as ‘Basel II’, it will replace the 1988 Basel
Capital Accord. Basel II is structured around three
‘pillars’: minimum capital requirements, supervisory
review process and market discipline. The
supervisory objectives for Basel II are to promote
safety and soundness in the financial system and
maintain at least the current overall level of capital
in the system; enhance competitive equality;
constitute a more comprehensive approach to
addressing risks; and focus on internationally active
banks.
With respect to pillar one minimum capital
requirements, Basel II provides three approaches, of
increasing sophistication, to the calculation of credit
risk regulatory capital. The most basic, the
standardised approach, requires banks to use external
credit ratings to determine the risk weightings
applied to rated counterparties, and groups other
counterparties into broad categories and applies
standardised risk weightings to these categories. In
the next level, the internal ratings-based foundation
approach, allows banks to calculate their credit risk
244
regulatory capital requirement on the basis of their
internal assessment of the probability that a
counterparty will default, but with quantification of
exposure and loss estimates being subject to standard
supervisory parameters. Finally, 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
exposure at default and loss given default.
Basel II also introduces capital requirements for
operational risk and, again, contains three levels of
sophistication. The capital required under the basic
indicator approach will be a simple percentage of
gross revenues, whereas under the standardised
approach it will be one of three different percentages
of gross revenues allocated to each of eight defined
business lines. Finally, the advanced measurement
approach uses banks’ own statistical analysis and
modelling of operational risk data to determine
capital requirements.
The EU Capital Requirements Directive
(‘CRD’) recast the Banking Consolidation Directive
and the Capital Adequacy Directive and will be the
means by which Basel II will be implemented in the
EU. The CRD was formally adopted by the Council
and European Parliament on 14 June 2006 and it
requires EU Member States to bring implementing
provisions into force on 1 January 2007. In the case
of the provisions relating to the implementation of
the internal ratings-based advanced approach to
credit risk and the advanced measurement approach
to operational risk, implementation becomes
available 1 January 2008.
In October 2006, the FSA published the General
Prudential Sourcebook (‘GENPRU’) and the
Prudential Sourcebook for Banks, Building Societies
and Investment Firms (‘BIPRU’), which take effect
from 1 January 2007 and implement the CRD in the
UK. GENPRU introduces changes to the definition
of capital and the methodology for calculating
capital ratios. Changes include relaxation of the rules
regarding the deduction of investments in other
banks capital and proportional rather than full
consolidation of associates. In addition, certain
deductions from capital, previously taken from total
capital will be deducted 50 per cent each from tier 1
and tier 2 for Pillar 3 disclosure purposes.
BIPRU introduces the Basel II requirements for
the calculation of capital requirements as well as
changes to the consolidation regime, the trading
book definition and various ancillary provisions. In
respect of counterparty risk in the trading book,
certain changes have been introduced with effect
from 1 January 2007. Otherwise, transitional
provisions regarding the implementation of capital
requirements calculations mean that, in general,
unless firms notify the FSA to the contrary, they
continue to apply the existing capital requirements
calculations until 1 January 2008. Thereafter, HSBC
proposes to adopt the IRB advanced approach for the
majority of its business. A rollout plan is in place to
extend coverage of the advanced approach over the
succeeding three years, leaving a small residue of
exposures on the standardised approach. For
individual banking subsidiaries, the timing and
manner of implementation of Basel II varies by
jurisdiction and the requirements are set by local
banking supervisors. The application of Basel II
across HSBC’s geographically diverse businesses,
which operate in a large number of different
regulatory environments, represents a significant
logistical and technological challenge, and an
extensive programme of implementation projects is
currently in progress. Basel II permits local
discretion in a number of areas for determination by
local regulators. The extent to which requirements
will diverge, coupled with how the FSA and the
local host regulators in the other countries in which
Source and application of tier 1 capital
(Unaudited)
HSBC operates interact will be key factors in
completing implementation of Basel II. As these
factors emerge, HSBC continues to assess the effect
of Basel II on its capital ratios.
One example of continuing regulatory
uncertainty relates to the US, where banking
supervisory authorities have yet to produce final
rules. They are now expected to be published in
2007. The US authorities have decided to apply the
advanced credit and operational risk methodologies
of Basel II only to the largest US banks and holding
companies, although other banks may decide to opt
in. HSBC North America Holdings Inc. (HSBC’s
highest level US bank holding company in the US,
which holds all HSBC’s major US operating
subsidiaries and HSBC Canada) has been mandated
to comply with these rules. For smaller US banks,
the US banking authorities are considering applying
an updated version of the existing Basel I rules
(dubbed Basel Ia). The Basel Ia rules may also be
used in the determination of Basel II capital floors
during the transition period (2009-11).
Movement in tier 1 capital
At 1 January .........................................................................................................................................
Consolidated profits attributable to shareholders of the parent company ..........................................
Dividends .............................................................................................................................................
Add back: shares issued in lieu of dividends ..................................................................................
Increase in goodwill and intangible assets deducted ..........................................................................
Preference shares issued ......................................................................................................................
Ordinary shares issued .........................................................................................................................
Other (including exchange differences) ..............................................................................................
At 31 December ...................................................................................................................................
Movement in risk-weighted assets
At 1 January .........................................................................................................................................
Movements ..........................................................................................................................................
At 31 December ...................................................................................................................................
2006
US$m
74,403
15,789
(8,769)
2,525
(3,668)
–
1,015
6,547
87,842
827,164
111,514
938,678
2005
US$m
67,259
15,081
(7,750)
1,811
(1,631)
1,405
690
(2,462)
74,403
759,210
67,954
827,164
245
H S B C H O L D I N G S P L C
Report of the Directors: The Management of Risk (continued)
Capital management and allocation > Capital measurement
Capital structure
(Unaudited)
Composition of regulatory capital
Tier 1 capital
Shareholders’ funds .........................................................................................................................
Minority interests and preference shares ........................................................................................
Innovative tier 1 securities ..............................................................................................................
Less :
Goodwill capitalised and intangible assets .................................................................................
Other regulatory adjustments ......................................................................................................
Total qualifying tier 1 capital ..........................................................................................................
Tier 2 capital
Reserves arising from revaluation of property and unrealised gains on
available-for-sale equities ...........................................................................................................
Collective impairment allowances ..................................................................................................
Perpetual subordinated liabilities ....................................................................................................
Term subordinated liabilities ..........................................................................................................
Minority interests in tier 2 capital ...................................................................................................
Total qualifying tier 2 capital ..........................................................................................................
Unconsolidated investments ...........................................................................................................
Investments in other banks ..............................................................................................................
Other deductions .............................................................................................................................
2006
US$m
108,352
7,413
9,932
(36,489)
(1,366)
87,842
2,982
11,077
3,396
30,677
425
48,557
(7,512)
(1,419)
(394)
2005
US$m
92,432
6,741
9,383
(32,821)
(1,332)
74,403
1,593
8,749
3,640
24,519
425
38,926
(6,437)
(1,147)
(296)
Total regulatory capital ...................................................................................................................
127,074
105,449
Risk-weighted assets
Banking book .......................................................................................................................................
Trading book ........................................................................................................................................
Total .....................................................................................................................................................
Risk-weighted assets were included in the totals above in respect of:
– contingent liabilities .....................................................................................................................
– commitments ................................................................................................................................
Capital ratios
Total capital .........................................................................................................................................
Tier 1 capital ........................................................................................................................................
857,198
81,480
938,678
44,704
58,569
%
13.5
9.4
762,037
65,127
827,164
43,333
51,288
%
12.8
9.0
The above figures were computed in accordance
with the EU Banking Consolidation Directive.
Tier 1 capital increased by US$13.4 billion.
Retained profits contributed US$7.0 billion, shares
issued, including shares issued in lieu of dividends,
contributed US$3.5 billion and exchange differences
added US$4.6 billion. These increases were partly
offset by an increase in goodwill and intangible
assets, which are deducted from capital, of
US$3.7 billion, and is mainly due to the acquisition
of Grupo Banistmo as well as the weakening of the
US dollar against the pound sterling and the euro.
Total risk-weighted assets increased by
US$112 billion, or 13.5 per cent. The increase
mainly reflects growth in the loan book and trading
positions. At constant currency, risk-weighted asset
growth was 8.9 per cent.
246
Risk-weighted assets by principal subsidiary
(Unaudited)
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.
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) ........................................................................................
HSBC France .....................................................................................................................................
HSBC Bank and other subsidiaries ...................................................................................................
HSBC Bank .......................................................................................................................................
HSBC Finance ...................................................................................................................................
HSBC Bank Canada ..........................................................................................................................
HSBC Bank USA and other subsidiaries ..........................................................................................
HSBC North America ........................................................................................................................
HSBC Mexico ....................................................................................................................................
HSBC Bank Middle East ...................................................................................................................
HSBC Bank Malaysia ........................................................................................................................
HSBC Latin American operations .....................................................................................................
Grupo Banistmo .................................................................................................................................
Bank of Bermuda ...............................................................................................................................
HSBC Holdings sub-group ................................................................................................................
Other ..................................................................................................................................................
2006
US$m
43,607
137,685
181,292
26,476
60,406
273,146
360,028
141,589
35,674
140,062
317,325
15,406
17,977
7,201
20,236
6,434
4,370
876
7,533
938,678
2005
US$m
45,525
123,906
169,431
21,224
54,684
221,355
297,263
129,282
30,275
123,829
283,386
13,166
14,682
5,991
15,736
–
4,195
780
22,534
827,164
247
H S B C H O L D I N G S P L C
Report of the Directors: Governance
Biographies > Directors
Corporate Governance Report ......................
Directors .......................................................
Adviser to the Board ....................................
Secretary .......................................................
Group Managing Directors ...........................
Group General Managers .............................
Board of Directors ........................................
The Board .................................................
Corporate governance codes ....................
Board committees .....................................
Internal control .........................................
Directors’ interests ....................................
Employees ....................................................
Employee involvement ..............................
Employment of disabled persons ..............
Remuneration policy..................................
Employee share plans ...............................
Subsidiary company share plans ...............
Employee compensation and benefits .......
Corporate responsibility ...............................
Investing in sustainability .........................
Community involvement ............................
Health and safety ......................................
Supplier payment policy ...........................
Donations .................................................
Corporate responsibility reporting ...........
Shareholders .................................................
Dividends for 2006 ...................................
Dividends for 2007 ...................................
Communication with shareholders ...........
Notifiable interests in share capital ..........
Dealings in HSBC Holdings shares ..........
Annual General Meeting ...........................
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Corporate Governance Report
The information set out on pages 248 to 290 and
information incorporated by reference constitutes the
Corporate Governance Report of HSBC Holdings.
Directors
S K Green, Group Chairman
Age 58. An executive Director since 1998; Group
Chief Executive from 2003 to 26 May 2006. Joined
HSBC in 1982. Chairman of HSBC Bank plc, HSBC
North America Holdings Inc. and HSBC Private
Banking Holdings (Suisse) SA. Deputy Chairman of
HSBC Trinkaus & Burkhardt AG. A Director of
HSBC France and The Hongkong and Shanghai
Banking Corporation Limited. Group Treasurer from
1992 to 1998. Executive Director, Corporate,
Investment Banking and Markets from 1998 to 2003.
Chairman of The British Bankers’ Association.
* The Baroness Dunn, DBE, Deputy Chairman and
senior non-executive Director
Age 67. 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 Patron of
the UK Foundation of the University of British
Columbia, a registered charity. A member of the
Asia Task Force. 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 68. 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. From the conclusion of the
Annual General Meeting in 2007, will cease to be
the senior independent non-executive Director, a
member and Chairman of the Group Audit
Committee and the Chairman of the Nomination
Committee. A non-executive Director of Macsteel
Global BV. Former Chairman of Corus Group plc
and a former member of the Court of the Bank of
England.
M F Geoghegan, CBE, Group Chief Executive
Age 53. An executive Director since 2004. Joined
HSBC in 1973. Chairman of HSBC Bank USA, N.A.
and HSBC USA Inc. and HSBC Bank Canada. A
Director and, since 6 March 2006, Deputy Chairman
of HSBC Bank plc. A Director of The Hongkong
and Shanghai Banking Corporation Limited, HSBC
France, HSBC North America Holdings Inc. and
HSBC National Bank USA. President of HSBC
Bank Brasil S.A.-Banco Múltiplo from 1997 to 2003
248
and responsible for all of HSBC’s business
throughout South America from 2000 to 2003. Chief
Executive of HSBC Bank plc from 2004 to 6 March
2006. A non-executive Director and Chairman of
Young Enterprise.
† The Rt Hon the Lord Butler of Brockwell,
KG, GCB, CVO
Age 69. Master, University College, Oxford. A non-
executive Director since 1998. Chairman of the
Corporate Responsibility Committee and the HSBC
Global Education Trust. A member of the
Nomination Committee until the conclusion of the
Annual General Meeting in 2007. A non-executive
Director of Imperial Chemical Industries plc. A
member of the International Advisory Board of
Marsh McLennan Inc. Chaired the UK Government
Review of Intelligence on Weapons of Mass
Destruction in 2004. 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
(retiring on 25 May 2007)
Age 55. Chairman of CDC Corporation and of its
subsidiary, China.com Inc. 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 61. Chairman of Hogg Robinson plc. A non-
executive Director since March 2005. A member of
the Group Audit Committee and, since 1 June 2006,
a member of the Remuneration Committee. A non-
executive Director of Home Retail Group plc and a
member of the Supervisory Board of Siemens AG. A
member of The Code Committee of the Panel on
Takeovers and Mergers. A trustee of the Royal
Academy Trust. Former executive Director and
Chief Financial Officer of GlaxoSmithKline plc. A
former Chairman of The Hundred Group of Finance
Directors and a former member of the Accounting
Standards Board.
† R A Fairhead
Age 45. Chief Executive Officer and Director of the
Financial Times Group Limited and a Director of
Pearson plc. A non-executive Director since 2004. A
member, and from the conclusion of the Annual
General Meeting in 2007, Chairman of the Group
Audit Committee. A non-executive Director of The
Economist Newspaper Limited. Finance Director of
Pearson plc until 12 June 2006. Former Executive
Vice President, Strategy and Group Control of
Imperial Chemical Industries plc.
D J Flint, CBE, Group Finance Director
Age 51. Joined HSBC as an executive Director in
1995. Non-executive Chairman of HSBC Finance
Corporation. A non-executive Director of BP p.l.c.
and a member of the Consultative Committee of the
Large Business Advisory Board of HM Revenue &
Customs. Chaired 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 58. Group Managing Director of Li & Fung
Limited. A non-executive Director since 1998. A
member of the Corporate Responsibility Committee
and, until the conclusion of the Annual General
Meeting in 2007, of the Remuneration Committee. A
non-executive Director and, since May 2005, Deputy
Chairman of The Hongkong and Shanghai Banking
Corporation Limited. A non-executive Director of
CLP Holdings Limited, Integrated Distribution
Services Group Limited, Convenience Retail Asia
Limited, Shui On Land Limited and VTech Holdings
Limited. A member of the Hong Kong Trade
Development Council. A former non-executive
Director of Bank of Communications Co. Ltd.
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.
† S Hintze
(retiring on 25 May 2007)
Age 62. Former Chief Operating Officer of Barilla
S.P.A. A non-executive Director since 2001. A
member of the Corporate Responsibility Committee
and of the Remuneration Committee. A non-
executive Director of Premier Foods plc. A former
non-executive Director of Safeway plc and the
Society of Genealogists, a registered charity. A
249
H S B C H O L D I N G S P L C
Report of the Directors: Governance (continued)
Biographies > Directors / Senior management
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.
† J W J Hughes-Hallett
Age 57. Chairman of John Swire & Sons Limited. A
non-executive Director since 1 March 2005. A
member of the Group Audit Committee since 1 June
2006 and, from the conclusion of the Annual
General Meeting in 2007, a member of the
Nomination Committee. 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. A
director of China Festival 2008. A trustee of the
Dulwich Picture Gallery, the Hong Kong Maritime
Museum and the Esmée Fairbairn Foundation. A
member of the Governing Body of the School of
Oriental and African Studies, University of London.
† Sir Mark Moody-Stuart, KCMG
Age 66. Chairman of Anglo American plc. A non-
executive Director since 2001. Chairman of the
Remuneration Committee and a member of the
Corporate Responsibility Committee. A non-
executive Director of Accenture Limited, a Governor
of Nuffield Hospitals and President of the Liverpool
School of Tropical Medicine. Chairman of the
Global Business Coalition on HIV/AIDS and the
Global Compact Foundation. A former Director and
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.
† G Morgan
Age 61. A non-executive Director since 1 October
2006 and, from the conclusion of the Annual General
Meeting in 2007, a member of the Remuneration
Committee. A Director of SNC-Lavalin Group Inc.,
and Alcan Inc. A member of the Board of Trustees
of The Fraser Institute and the Energy Advisory
Board of Accenture Limited. A non-executive
Director of HSBC Bank Canada until 18 April 2006.
Founding President and Chief Executive Officer of
EnCana Corporation until December 2005 and Vice
Chairman from December 2005 to 24 October 2006.
† S W Newton
Age 65. Chairman of The Real Return Group
Company Limited. A non-executive Director since
2002 and, from the conclusion of the Annual
General Meeting in 2007, a member of the Group
Audit Committee. A Member of the Advisory Board
of the East Asia Institute and of the Investment
Board at Cambridge University. A Member of The
Wellcome Trust Investment Committee. Founder of
Newton Investment Management, from which he
retired in 2002.
† S M Robertson
Age 66. Non-executive Chairman of Rolls-Royce
Group plc and the founder member of Simon
Robertson Associates LLP. A non-executive
Director since 3 January 2006. From the conclusion
of the Annual General Meeting in 2007, to be the
senior independent non-executive Director and a
member of the Nomination Committee. A non-
executive Director of Berry Bros. & Rudd Limited,
The Economist Newspaper Limited and The Royal
Opera House Covent Garden Limited. Chairman of
Trustees of the Royal Academy Trust and the Ernest
Kleinwort Charitable Trust. A trustee of the Eden
Project and of the Royal Opera House Endowment
Fund. A former Managing Director of Goldman
Sachs International. Former Chairman of Dresdner
Kleinwort Benson and a former non-executive
Director of Inchcape plc, Invensys plc and the
London Stock Exchange.
* H Sohmen, OBE
(retiring on 25 May 2007)
Age 67. Chairman of Bergesen Worldwide Limited,
Bergesen Worldwide Offshore Limited and
Bergesen Worldwide Gas ASA. Chairman and
President of BW Corporation Limited (formerly
World-Wide Shipping Group Limited). A non-
executive Director since 1990. A non-executive
Director of The Hongkong and Shanghai Banking
Corporation Limited from 1984 to 2005 and Deputy
Chairman from 1996 to May 2005. Former
Chairman of The International Tanker Owners
Pollution Federation Limited.
† Sir Brian Williamson, CBE
Age 62. Chairman of Electra Private Equity plc. A
non-executive Director since 2002. A member and,
from the conclusion of the Annual General Meeting
in 2007, Chairman of the Nomination Committee. A
non-executive Director of Resolution plc. A member
of the Supervisory Board of Euronext NV. A senior
adviser to Fleming Family and Partners. Former
Chairman of London International Financial Futures
and Options Exchange, Gerrard Group plc and
Resolution Life Group Limited. A former non-
executive Director of the Financial Services
Authority and of the Court of The Bank of Ireland.
250
Adviser to the Board
A A Flockhart
D J Shaw
Age 60. 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,
HSBC Private Banking Holdings (Suisse) SA and,
since May 2006, a non-executive Director of Shui
On Land Limited.
Secretary
R G Barber
Age 56. Group Company Secretary. Appointed a
Group General Manager on 1 October 2006. Joined
HSBC in 1980. Company Secretary of HSBC
Holdings plc since 1990. Corporation Secretary of
The Hongkong and Shanghai Banking Corporation
Limited from 1986 to 1992 and Company Secretary
of HSBC Bank plc from 1994 to 1996.
* Non-executive Director
† Independent non-executive Director
Group Managing Directors
C C R Bannister
Age 48. Group Managing Director, Insurance. A
Group Managing Director since 1 August 2006.
Joined HSBC in 1994. Appointed a Group General
Manager in 2001. Chairman of HSBC Insurance
Holdings Limited since November 2006. Deputy
Chief Executive Officer, HSBC Securities (USA)
Inc. from 1996 to 1998 and Chief Executive Officer,
Group Private Banking from 1998 to 2006.
V H C Cheng, OBE
Age 58. Chairman of The Hongkong and Shanghai
Banking Corporation Limited. A Group Managing
Director since May 2005. Joined HSBC in 1978.
Appointed a Group General Manager in 1995.
Deputy Chairman and Chief Executive Officer of
Hang Seng Bank Limited from 1998 to 2005.
C-H Filippi
Age 54. Chairman and Chief Executive Officer of
HSBC France. A Group Managing Director since
2004. A Director of HSBC Bank plc. A member of
the Supervisory Board of HSBC Trinkaus &
Burkhardt AG. Joined HSBC France in 1987 having
previously held senior appointments in the French
civil service. Appointed a Group General Manager in
2001. Global Head of Corporate and Institutional
Banking from 2001 to 2004.
251
Age 55. President and Group Managing Director,
Latin America and the Caribbean. A Group
Managing Director since 1 October 2006. Joined
HSBC in 1974. Appointed a Group General Manager
and Chief Executive Officer, Mexico in 2002. Chief
Executive Officer HSBC Thailand from 1992 to
1994. Managing Director of The Saudi British Bank
from 1997 to 1999 and Senior Executive Vice-
President, Commercial Banking, HSBC Bank USA,
N.A. from 1999 to 2002.
S T Gulliver
Age 47. Head of Corporate, Investment Banking and
Markets and Group Investment Businesses. A Group
Managing Director since 2004. Director of HSBC
Bank plc, HSBC USA Inc. and The Hongkong and
Shanghai Banking Corporation Limited. Joined
HSBC in 1980. Appointed a Group General Manager
in 2000. Head of Treasury and Capital Markets in
Asia-Pacific from 1996 to 2002, Head of Global
Markets from 2002 to 2003, and Co-Head of
Corporate, Investment Banking and Markets from
2003 to May 2006.
D H Hodgkinson
Age 56. Group Chief Operating Officer. A Group
Managing Director since 26 May 2006 and
Chairman of HSBC Bank Middle East Limited since
24 July 2006. Joined HSBC in 1969. Appointed a
Group General Manager in 2003. Managing Director
of The Saudi British Bank from 1999 to 2003.
Deputy Chairman and Chief Executive Officer of
HSBC Bank Middle East Limited from 2003 to
May 2006.
D D J John
Age 56. Chief Executive, HSBC Bank plc. A Group
Managing Director since 6 March 2006. Joined
HSBC Bank plc in 1971. Appointed a Group
General Manager in 2000. Deputy Chairman and
Chief Executive Officer, HSBC Bank Malaysia
Berhad from 1999 to 2002. Chief Operating Officer
of HSBC Bank plc from 2003 to May 2005 and
Deputy Chief Executive from May 2005 to
6 March 2006.
Y A Nasr
Age 52. Group Managing Director, Strategic
Investments since 1 October 2006. A Director of
HSBC Private Banking Holdings (Suisse) SA. A
Group Managing Director since 2004. Joined HSBC
in 1976. Appointed a Group General Manager in
1998. President and Chief Executive Officer of
H S B C H O L D I N G S P L C
Report of the Directors: Governance (continued)
Biographies > Senior management
HSBC Bank Canada from 1997 to 1999. President
and Chief Executive Officer of HSBC USA Inc. and
HSBC Bank USA from 1999 to 2003. President,
HSBC Bank Brasil S.A.-Banco Múltiplo from 2005
to 2006.
Group General Managers
E Alonso
Age 51. President and Chief Executive Officer,
HSBC Bank Brasil S.A.-Banco Múltiplo. Joined
HSBC in 1997. Appointed a Group General Manager
on 1 October 2006.
P Y Antika
Age 46. Chief Executive Officer, HSBC Turkey.
Joined HSBC in 1990. Appointed a Group General
Manager in August 2005.
R J Arena
Age 58. Group General Manager, Global e-business.
Joined HSBC in 1999. Appointed a Group General
Manager in 2000.
R E T Bennett
Age 55. Group General Manager, Legal and
Compliance. Joined HSBC in 1979. Appointed a
Group General Manager in 1998.
N S K Booker
Age 48. Deputy Chairman and Chief Executive
Officer, HSBC Bank Middle East Limited. Joined
HSBC in 1981. Appointed a Group General Manager
in 2004.
T M Detelich
Age 50. President, Consumer and Mortgage
Lending, HSBC Finance Corporation. Joined HSBC
Finance Corporation in 1976. Appointed a Group
General Manager on 1 October 2006.
J D Garner
Age 37. Group General Manager, Personal Financial
Services and Direct Businesses, HSBC Bank plc.
Joined HSBC in 2004. Appointed a Group General
Manager on 1 October 2006.
J L Gordon
Age 54. President and Chief Executive Officer,
HSBC Bank Canada. Joined HSBC in 1987.
Appointed a Group General Manager in August
2005.
K M Harvey
Age 46. Group General Manager and Group Chief
Information Officer. Joined HSBC Finance
Corporation in 1989. Appointed a Group General
Manager in 2004.
A M Keir
Age 48. Global Co-Head Commercial Banking.
Joined HSBC in 1981. Appointed a Group General
Manager on 1 October 2006.
N L Kidwai
Age 49. Chief Executive Officer, HSBC India.
Joined HSBC in 2002. Appointed a Group General
Manager on 1 October 2006.
P W Boyles
M J W King
Age 51. Group General Manager, Human Resources.
Joined HSBC in 1975. Appointed a Group General
Manager on 1 January 2006.
Age 50. Group General Manager, Internal Audit.
Joined HSBC in 1986. Appointed a Group General
Manager in 2002.
D C Budd
P J Lawrence
Age 53. Chief Operating Officer and Executive
Director, HSBC Bank plc. Joined HSBC in 1972.
Appointed a Group General Manager in May 2005.
Z J Cama
Age 59. Deputy Chairman and Chief Executive
Officer, HSBC Bank Malaysia Berhad. Joined
HSBC in 1968. Appointed a Group General Manager
in 2001.
Age 45. Head of Corporate, Investment Banking and
Markets, USA. President and Chief Executive
Officer, HSBC Bank USA, N.A. and HSBC USA
Inc. Joined HSBC in 1982. Appointed a Group
General Manager in August 2005.
M Leung
Age 54. Global Co-Head Commercial Banking.
Joined HSBC in 1978. Appointed a Group General
Manager in August 2005.
252
A M Mahoney
B Robertson
Age 52. Group General Manager, Credit and Risk.
Joined HSBC in 1975. Appointed a Group General
Manager in 2003.
M R P Smith, OBE
Age 50. Chief Executive Officer, The Hongkong and
Shanghai Banking Corporation Limited. Chairman,
Hang Seng Bank Limited. Joined HSBC in 1978.
Appointed a Group General Manager in 2000.
P A Thurston
Age 53. Chief Executive Officer, HSBC Mexico.
Joined HSBC in 1975. Appointed a Group General
Manager in 2003.
P T S Wong
Age 55. Executive Director, Hong Kong and
Mainland China, The Hongkong and Shanghai
Banking Corporation Limited. Joined HSBC in
February 2005. Appointed a Group General Manager
in April 2005.
Age 44. Group General Manager and Head of
Network, HSBC Bank plc. Joined HSBC in 1983.
Appointed a Group General Manager on
24 November 2006.
B P McDonagh
Age 48. Chief Executive Officer, HSBC Finance
Corporation and Chief Operating Officer, HSBC
North America Holdings Inc. Joined HSBC in 1979.
Appointed a Group General Manager in August
2005.
C M Meares
Age 49. Chief Executive Officer, Group Private
Banking. Joined HSBC in 1980. Appointed a Group
General Manager on 1 November 2006.
W G Menezes
Age 61. Group Executive, Card Services, HSBC
Finance Corporation. Joined HSBC in 1996.
Appointed a Group General Manager on 1 October
2006.
K Newman
Age 49. Senior Executive Vice President, Personal
Financial Services, HSBC Bank USA, N.A. Joined
HSBC in 1989. Appointed a Group General Manager
on 1 October 2006.
R C F Or
Age 57. Vice-Chairman and Chief Executive, Hang
Seng Bank Limited and Director, The Hongkong and
Shanghai Banking Corporation Limited. Joined
HSBC in 1972. Appointed a Group General Manager
in 2000.
K Patel
Age 58. Group General Manager, Chief Executive
Officer, Africa. Joined HSBC in 1984. Appointed a
Group General Manager in 2000.
R C Picot
Age 49. Group Chief Accounting Officer. Joined
HSBC in 1993. Appointed a Group General Manager
in 2003.
M J Powell
Age 45. Head of Global Markets. Joined HSBC in
1984. Appointed a Group General Manager on
1 October 2006.
253
H S B C H O L D I N G S P L C
Report of the Directors: Governance (continued)
Board of Directors > The Board
Board of Directors
The Board
The objective of the management structures within
HSBC, headed by the Board of Directors of HSBC
Holdings and led by the Group Chairman, is 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.
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 5 March 2007 the Board comprises the
Group Chairman, Group Chief Executive, Group
Finance Director and 15 non-executive Directors.
The names and brief biographical particulars of the
Directors are listed on pages 248 to 250. The Group
Chairman, Group Chief Executive and Group
Finance Director 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 bring an external perspective,
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 non-
executive Directors have a wealth of experience
across a number of industries and business sectors,
including the leadership of large, complex
multinational enterprises. The roles of non-executive
Directors as members of Board committees are set
out on pages 259 to 262. 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 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, the authority or the delegation
of authority to approve credit, market risk limits,
acquisitions, disposals, investments, capital
expenditure or realisation or creation of a new
venture, specified senior appointments, and any
254
substantial change in balance sheet management
policy.
The Directors who served during the year were
Sir John Bond, Lord Butler, R K F Ch’ien,
J D Coombe, Baroness Dunn, R A Fairhead,
D J Flint, W K L Fung, M F Geoghegan, S K Green,
S Hintze, J W J Hughes-Hallett, A W Jebson, Sir
John Kemp-Welch, Sir Brian Moffat, Sir Mark
Moody-Stuart, G Morgan, S W Newton,
S M Robertson, H Sohmen and Sir Brian
Williamson.
Sir John Bond, A W Jebson and Sir John Kemp-
Welch retired as Directors at the conclusion of the
Annual General Meeting held on 26 May 2006.
S M Robertson was appointed a Director on
3 January 2006, G Morgan was appointed a Director
on 1 October 2006 and J F Gil Díaz was appointed a
Director on 2 January 2007 and resigned on 5 March
2007.
The Board of Directors meets regularly and
Directors receive information between meetings
about the activities of committees and developments
in HSBC’s business.
Seven Board meetings were held during 2006.
Lord Butler, R K F Ch’ien, J D Coombe, Baroness
Dunn, D J Flint, M F Geoghegan, S K Green,
S Hintze, Sir Brian Moffat, S M Robertson,
H Sohmen and Sir Brian Williamson attended all of
the Board meetings. R A Fairhead, W K L Fung,
J W J Hughes-Hallett, Sir Mark Moody-Stuart and
S W Newton attended six of the Board meetings. Sir
John Bond and A W Jebson attended the four Board
meetings held before they ceased to be Directors. Sir
John Kemp-Welch attended three of the four Board
meetings held before he ceased to be a Director.
G Morgan attended the one Board meeting held
following his appointment.
During 2006, the non-executive Directors and
the Group Chairman met twice without the presence
of the Group Chief Executive and Group Finance
Director. In addition, the non-executive Directors
met once without Sir John Bond when he was Group
Chairman to discuss his performance and on one
other occasion without S K Green, following his
appointment as Group Chairman.
In addition to the meetings of the principal
Committees referred to in the following pages,
eleven other meetings of Committees of the Board
were held during the year to discharge business
delegated by the Board.
All Directors attended the 2006 Annual General
Meeting.
Group Chairman and Group Chief Executive
The roles of Group Chairman and Group Chief
Executive are separated and held by experienced
full-time Directors. S K Green succeeded Sir John
Bond as Group Chairman at the conclusion of the
Annual General Meeting on 26 May 2006 and
M F Geoghegan succeeded S K Green as Group
Chief Executive. Sir Brian Moffat, the senior
independent non-executive Director and the
Chairman of the Nomination Committee, wrote to
shareholders regarding these appointments.
He explained that the decision by the Board to
appoint S K Green as Group Chairman was made
after a thorough selection process. This was
conducted by the Nomination Committee, assisted
by external advisers, and included extensive
benchmarking against external candidates. The
Committee considered carefully the requirements of
the position in terms of HSBC’s size, geographical
spread and complexity; the need for full time
executive commitment and experience of
international banking at the highest level; and took
account of the need for the Group Chairman to have
a wide range of skills, the capacity for strategic
thinking and the ability to sustain and enhance the
Group’s corporate character. The Committee also
took into consideration the need for the Group
Chairman to be able to work closely and effectively
with the Group Chief Executive, to have the
authority to run the Board and to have the personal
standing to represent HSBC externally at the highest
level. Job specifications for the Group Chairman and
the Group Chief Executive, setting out their
respective authorities and responsibilities, have been
agreed by the Board. The Nomination Committee
came to the unanimous conclusion that S K Green
was the outstanding candidate.
S K Green joined HSBC in 1982. He was Group
Treasurer from 1992 to 1998, and Executive
Director, Corporate, Investment Banking and
Markets from 1998 to 2003, when he was appointed
Group Chief Executive. He has worked in Hong
Kong, New York, the Middle East and London, and
has immense international experience and
knowledge of HSBC. The Committee concluded that
S K Green is superbly well qualified to serve as
Group Chairman. His principal commitment outside
HSBC is as Chairman of The British Bankers’
Association.
S K Green’s successor as Group Chief
Executive was M F Geoghegan, who led HSBC
Bank, HSBC’s principal subsidiary in the UK, from
2004 to March 2006. He too is highly qualified for
his position as Group Chief Executive and his
255
appointment also had the unanimous support of the
Board. Mr Geoghegan has over 33 years’ experience
with HSBC and has worked in 10 countries in North
and South America, Asia, the Middle East and
Europe.
The Directors believed strongly that these
appointments were in the best interests of the
shareholders. The appointments had the unanimous
support of the Directors and were made after
consulting with representatives of major institutional
investors and explaining the succession planning and
independent external search process. S K Green and
M F Geoghegan stood for re-election at the 2006
Annual General Meeting and were both re-elected
ahead of taking up their new roles from the
conclusion of that meeting.
Nowadays, success in financial services depends
in a large measure on the relative strengths of
competing management teams. Planning
management succession is key to this, has long been
established in the Group and the plan is regularly
reviewed by the non-executive Directors.
Furthermore, HSBC is a remarkable organisation
with a distinctive character and culture. The business
is managed through international teamwork and
HSBC believes this is best achieved by management
continuity and amongst colleagues who have similar
values. By way of example, the top 45 executives
have a combined service of over 1,000 years with
HSBC, although four of these executives have joined
the Group in the last six years, thus ensuring there is
a balance of new talent to help run the business.
Board balance and independence of
Directors
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
Brian Moffat, Sir Mark Moody-Stuart, G Morgan,
S W Newton, S M Robertson, 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 a Director’s judgement and any relationships
or circumstances which could appear to do so were
considered not to be material. From the conclusion
of the Annual General Meeting in 2007, Lord Butler,
H S B C H O L D I N G S P L C
Report of the Directors: Governance (continued)
Board of Directors > The Board / Corporate governance codes
W K L Fung and Sir Brian Moffat will each have
served on the Board for more than nine years and, in
that respect only, will not meet the usual criteria for
independence set out in the UK Combined Code on
corporate governance.
When determining independence the Board
considers that calculation of the length of service of
a non-executive Director begins on the date of his or
her first election by shareholders as a Director of
HSBC Holdings. Given the complexity and
geographical spread of HSBC’s business, the
experience of previous service on a subsidiary
company board can be a considerable benefit to
HSBC and does not detract from a Director’s
independence.
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 an annual confirmation of his or her
independence to HSBC Holdings.
Information, induction and ongoing
development
The Board regularly reviews reports on progress
against financial objectives, on business
developments and on investor and external relations
and receives reports from the Chairmen of Board
Committees and from the Group Chief Executive.
The Board receives regular reports and presentations
on strategy and developments in the customer groups
and principal geographical areas. Regular reports are
also provided to the Board, the Group Audit
Committee and the Group Management Board on
credit exposures and the loan portfolio, asset and
liability management, liquidity, litigation and
compliance and reputational issues. The agenda and
supporting papers are distributed in advance of all
Board and Committee meetings to allow time for
appropriate review and to facilitate full discussion at
the meetings. All Directors have full and timely
access to all relevant information and may take
independent professional advice if necessary.
The Directors have free and open contact with
management at all levels. Group Managing Directors
and Group General Managers meet informally with
Directors after Board meetings. Board offsite visits
are made each year to enable Directors to see at first
hand the operations of subsidiary companies in local
environments and to meet management, employees
and customers. In 2006 the Board visited Istanbul,
Hong Kong and Shenzhen.
Full, formal and tailored induction programmes,
with particular emphasis on internal controls, are
256
arranged for newly appointed Directors. The
programmes consist of a series of meetings with
other Directors and senior executives to enable new
Directors to receive information and familiarise
themselves with HSBC’s strategy, operations and
internal controls. Prior to their appointment, each
Director receives comprehensive guidance on the
duties and liabilities of a Director of HSBC
Holdings. Opportunities to update and develop skills
and knowledge, through externally run seminars and
through briefings by senior executives, are provided
to all Directors.
Performance evaluation
MWM Consulting was commissioned to undertake
an independent performance evaluation of the Board,
its committees and individual Directors. The
evaluation examined those key areas where the
Board requires clarity in order to provide high level
oversight, including: the strategic process; key
business drivers and performance milestones; the
global economic environment and competitive
context in which HSBC operates; the risks faced by
the business; board dynamics, capability and
alignment; reputation; and information flows. The
report on the evaluation has been reviewed by the
Board and has been used by the non-executive
Directors, led by Sir Brian Moffat, in their
evaluation of the performance of the Group
Chairman. The review concluded that the Board and
its committees were functioning effectively. It is the
intention of the Board of HSBC Holdings to
continue to review its performance and that of its
Directors annually.
Retirement and re-election of Directors
Lord Butler, R K F Ch’ien, Baroness Dunn,
R A Fairhead, W K L Fung, S Hintze, Sir
Brian Moffat, G Morgan and H Sohmen will retire at
the forthcoming Annual General Meeting. With the
exception of R K F Ch’ien, S Hintze and H Sohmen,
who are to retire, they offer themselves for
re-election.
Following the performance evaluation of the
Board, 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.
Brief biographical particulars of all Directors
including those seeking re-election at the Annual
General Meeting, are given on pages 248 to 250.
Relations with shareholders
The Board ensures all Directors, including non-
executive Directors, develop an understanding of the
views of major shareholders through attendance at
analyst presentations and other meetings with
institutional investors and their representative
bodies. The Board also met with representatives of
institutional shareholders in 2006 to discuss
corporate governance matters.
The Group Chairman, Group Chief Executive
and the Group Finance Director hold regular
meetings with institutional investors and report to
the Board on those meetings.
Sir Brian Moffat, Deputy Chairman and, until
the conclusion of the Annual General Meeting in
2007, 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. From
the conclusion of the Annual General Meeting in
2007, S M Robertson will be senior independent
non-executive Director. The senior independent non-
executive Director may be contacted through the
Group Company Secretary at 8 Canada Square,
London E14 5HQ.
Indemnification of Directors, relevant audit
information and contracts of significance
The Articles of Association of HSBC Holdings
provide that Directors are entitled to be indemnified
out of the assets of the Company against claims from
third parties in respect of certain liabilities arising in
connection with the performance of their functions,
in accordance with the provisions of the UK
Companies Act 1985. Such indemnity provisions of
this nature have been in place during the financial
year but have not been utilised by the Directors.
Each person who is a director at the date of
approval of this report confirms that so far as the
director is aware, there is no relevant audit
information of which the Company's auditor is
unaware; and the director has taken all the steps that
he or she ought to have taken as a director in order to
make himself or herself aware of any relevant audit
information and to establish that the Company's
auditor is aware of that information. This
confirmation is given pursuant to section 234ZA of
the UK Companies Act 1985 and should be
interpreted in accordance therewith and subject to
the provisions thereof.
257
None of the Directors had, during the year or at
the end of the year, a material interest, directly or
indirectly, in any contract of significance with HSBC
Holdings or any of its subsidiary undertakings.
Corporate Governance Codes
HSBC is committed to high standards of corporate
governance. HSBC Holdings has complied with the
applicable code provisions of the Combined Code on
Corporate Governance issued by the Financial
Reporting Council (‘the Combined Code’)
throughout the year, save for code provision A.2.2 as
the Group Chairman did not on appointment meet
the Combined Code’s independence criteria. On 26
May 2006 S K Green, who had previously served as
Group Chief Executive, became Group Chairman. In
accordance with the provisions of the Combined
Code, the Board consulted major shareholders in
advance of the appointment. Sir Brian Moffat, the
senior independent non-executive Director and the
Chairman of the Nomination Committee, wrote to all
shareholders to explain the Board’s decision and the
reasons for the appointment. These are described on
page 255.
HSBC Holdings has complied with all
applicable code provisions of the Code on Corporate
Governance Practices in Appendix 14 to the Rules
Governing the Listing of Securities on The Stock
Exchange of Hong Kong Limited throughout the
year.
The Board of HSBC Holdings has adopted a
code of conduct for transactions in HSBC Group
securities by Directors that complies with The Model
Code in the Listing Rules of the Financial Services
Authority and 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, save that The Stock Exchange
of Hong Kong Limited has granted certain waivers
from strict compliance with the Hong Kong Model
Code, primarily 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 HSBC
Group securities throughout the year.
Differences in HSBC Holdings/New York
Stock Exchange corporate governance
practices
Under the New York Stock Exchange’s (‘NYSE’)
corporate governance rules for listed companies, as a
NYSE-listed foreign private issuer, HSBC Holdings
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Report of the Directors: Governance (continued)
Board of Directors > Corporate governance codes / Board committees
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
Services Authority require each listed company
incorporated in the UK to include in its Annual
Report and Accounts a narrative statement of how it
has applied the principles of the 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 2006
with the applicable code provisions of the Combined
Code, save with respect to the appointment of the
current Group Chairman, as referred to above. 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
258
without management present and independent
directors must meet separately at least once per year.
During 2006, HSBC Holdings’ non-executive
Directors met twice as a group with the Group
Chairman, but without the Group Chief Executive or
Group Finance Director present, and met twice as a
group without the Group Chairman, Group Chief
Executive or Group Finance Director 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 page 256) and it provides extensive
information regarding Directors’ compensation in
the Directors’ Remuneration Report (on pages 280 to
289). The terms of reference of HSBC Holdings’
Audit, Nomination and Remuneration Committees
are available at www.hsbc.com/boardcommittees.
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 and the Group
Chief Executive, as the principal executive officers,
and to the Group Finance Director and Group Chief
Accounting Officer. HSBC Holdings’ Code of Ethics
is available on www.hsbc.com/codeofethics or from
the Group Company Secretary at 8 Canada Square,
London E14 5HQ. 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 2006 HSBC Holdings made
no amendments to its Code of Ethics and granted no
waivers from its provisions. The Group Business
Principles and Values are available on
www.hsbc.com/businessprinciplesandvalues.
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.
Since July 2005 HSBC Holdings has been
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.
Board committees
The Board has appointed a number of committees
consisting of certain Directors, Group Managing
Directors and, in the case of the Corporate
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 objective of
the Group Management Board is to maintain a
reporting and control structure whereby all of the
line operations of HSBC are accountable to
individual members of the Group Management
Board who report to the Group Chief Executive who
in turn reports to the Group Chairman. The members
of the Group Management Board are
M F Geoghegan (Chairman) and D J Flint, both of
whom are executive Directors, and C C R Bannister,
V H C Cheng, C-H Filippi, A A Flockhart,
S T Gulliver, D H Hodgkinson, D D J John and
259
Y A Nasr, 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 Holdings in accordance with such
policies and directions as the Board may from time
to time determine. Matters reserved for approval by
the Board are described on page 254.
Following each meeting the Group Chief
Executive reports to the Board on the Group
Management Board’s activities.
Group Audit Committee
The Group Audit Committee meets regularly with
HSBC’s senior financial, internal audit, credit, 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 2006 were Sir Brian Moffat
(Chairman), R K F Ch’ien, J D Coombe and
R A Fairhead. J W J Hughes-Hallett was appointed a
member of the Committee on 1 June 2006. Sir John
Kemp-Welch ceased to be a member of the
Committee on 26 May 2006. From the conclusion of
the Annual General Meeting in 2007, Sir Brian
Moffat will cease to be Chairman and a member of
the Committee, R A Fairhead will become Chairman
of the Committee and S W Newton will become a
member of the Committee. All members of the
Committee are independent non-executive Directors.
The Board has determined that Sir Brian Moffat,
R K F Ch’ien, R A Fairhead, J D Coombe and
J W J Hughes-Hallett are independent according to
SEC criteria, and that Sir Brian Moffat,
R A Fairhead, J D Coombe and J W J Hughes-Hallett
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.
Appointments to the Committee are 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 2006. R K F Ch’ien, J D Coombe,
H S B C H O L D I N G S P L C
Report of the Directors: Governance (continued)
Board of Directors > Board committees
R A Fairhead and Sir Brian Moffat attended all of the
meetings; Sir John Kemp-Welch attended two of the
three meetings held before his retirement and
J W J Hughes-Hallett attended each of the four
meetings held following his appointment.
At each meeting, the Committee has the
opportunity to meet 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 at
www.hsbc.com/boardcommittees. To ensure
consistency of scope and approach by subsidiary
company audit committees, the Group Audit
Committee has established core terms of reference to
guide subsidiary company boards when adopting
terms of reference for their audit committees. The
Committee receives bi-annual confirmations from
subsidiary company audit committees relating to the
financial statements and internal control procedures
of those subsidiaries.
The Group Audit Committee is accountable to
the Board and assists it in meeting its responsibilities
for maintaining 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 the Group General
Manager Credit and Risk, 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.
Regular comprehensive reports on the work of
the internal audit function are submitted to the
Committee. These reports include reports on frauds
and special investigations and summaries of internal
audit findings, regulatory reports and external
auditors’ reports. The Committee monitors and
reviews the effectiveness of the internal audit
function and receives summaries of periodic peer
reviews of HSBC’s internal audit functions around
the world. HSBC has adopted the Principles of the
International Institute of Internal Auditors, which
include a periodic external quality assurance review
of the internal audit function. The first such review
will be undertaken in 2007.
260
The Committee undertakes an annual review of
the effectiveness of HSBC’s system of internal
control. This is described on page 262. The
Committee receives regular updates on changes in
law, regulations and accounting standards and
practices and the preparations being made to respond
to those requirements. During 2006, the Committee
received regular updates on the preparations for the
review of internal financial reporting controls
required by section 404 of the Sarbanes-Oxley Act,
the implementation of the Basel 2 capital adequacy
requirements and the actions taken to implement the
recommendations of the Corrigan Report on
reducing the risks of, and limiting the damage
caused by, systemic financial shocks. The report,
issued by the Counterparty Risk Management Policy
Group focused on risk management, risk monitoring
and enhanced transparency in financial institutions.
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 handling of complaints
regarding accounting, internal accounting controls
and 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 reviews the strategy and
approves the terms for the engagement of the
external auditor for the audit of the Annual Report
and Accounts. Regular reports on the progress of the
audit facilitate the Committee’s assessment of the
effectiveness of the audit.
The Committee receives reports from the
external auditor on its own policies and procedures
regarding independence and quality control and
oversees the appropriate rotation of audit partners
within the external auditor. The external auditor
provides the Committee with an annual confirmation
of its independence in accordance with industry
standards.
On the recommendation of the Committee the
Board has approved a policy for the employment by
HSBC of former employees of the external auditor
or its affiliates. The Committee monitors this policy
through the receipt of periodic reports of those
former employees of the external auditor employed
by HSBC and the number of former employees of
the external auditor currently employed in senior
positions in HSBC. The reports enable the
Committee to consider whether there has been any
impairment, or appearance of impairment, of the
auditor’s judgement or independence in respect of
the audit.
The Group Audit Committee has established
policies for the pre-approval of specific services that
may be provided by the principal auditor, KPMG
Audit Plc and its affiliates (‘KPMG’). 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 influenced the choice of
KPMG. All services entered into with KPMG during
2006 were pre-approved by the Committee or were
entered into under pre-approval policies established
by the Committee. A quarterly update on non-audit
services provided by KPMG is presented to the
Committee.
The pre-approved services relate to regulatory
reviews, agreed-upon procedures reports, other types
of attestation reports, the provision of advice and
other non-audit services allowed under SEC
independence rules. They fall into the categories of
audit services, audit-related services, tax services
and other services.
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.
An analysis of the remuneration paid in respect
of audit and non-audit services provided by KPMG
for each of the last three years is disclosed in Note 8
on the Financial Statements on page 331.
The Committee has recommended to the Board
that KPMG Audit Plc be reappointed 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 280.
Nomination Committee
The Nomination Committee is responsible for
leading the process for Board appointments and for
identifying and nominating, for approval by 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. Prospective Directors are asked to
identify any significant other commitments and
confirm they have sufficient time to discharge what
is expected of them. 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 2006 were
Sir Brian Moffat (Chairman), Lord Butler, Baroness
Dunn and Sir Brian Williamson.
From the conclusion of the Annual General
Meeting in 2007, Sir Brian Williamson will become
Chairman of the Committee in succession to Sir
Brian Moffat, Lord Butler will cease to be a member
of the Committee and J W J Hughes-Hallett and
S M Robertson will become members of the
Committee.
There were four Nomination Committee
meetings during 2006, each of which was attended
by all members.
Following each meeting the Committee reports
to the Board on its activities.
The terms of reference of the Committee are
available at www.hsbc.com/boardcommittees.
The appointments of J F Gil Díaz, G Morgan
and S M Robertson as non-executive Directors were
made on the advice and recommendation of the
Nomination Committee. J F Gil Díaz, former
Secretary of Finance and Public Credit in Mexico,
and G Morgan, a director of HSBC Bank Canada for
nine years, were identified by the Nomination
Committee and so neither an external consultancy
nor open advertising was used in connection with
their appointments.
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.
261
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Report of the Directors: Governance (continued)
Board of Directors > Board committees / Internal control
As set out on page 255, the Committee
conducted the selection process which recommended
to the Board that S K Green succeed Sir John Bond
as Group Chairman at the conclusion of the 2006
Annual General Meeting and that M F Geoghegan
succeed S K Green as Group Chief Executive.
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 non-executive 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 committees 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 appointments and re-
appointments to the Boards of Directors of major
subsidiary companies as appropriate.
The 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. It 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 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 Responsibility Committee
The Corporate Responsibility Committee is
responsible for overseeing corporate 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 at
www.hsbc.com/boardcommittees. The members of
the Committee throughout 2006 were Lord Butler
(Chairman), W K L Fung, S Hintze and Sir Mark
Moody-Stuart, each of whom is an independent non-
executive Director, and G V I Davis, E M Diggory
and Lord May, who are non-director members of the
Committee.
There were five meetings of the Corporate
Responsibility Committee during 2006. Following
262
each meeting the Committee reports to the Board on
its activities.
Further information will be in HSBC’s
Corporate Responsibility Report 2006, available in
May 2007.
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 misstatement, 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: Revised Guidance for Directors on the
Combined Code issued by the Financial Reporting
Council. Such procedures for the ongoing
identification, evaluation and management of the
significant risks faced by HSBC have been in place
throughout the year and up to 5 March 2007, the date
of approval of the Annual Report and Accounts
2006. In the case of companies acquired during the
year, the internal controls in place are being
reviewed against HSBC’s benchmarks and integrated
into HSBC’s processes.
HSBC’s key internal control procedures include
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. Sub-delegation of
authority from the 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
committees, 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 risk management
committees, asset and liability committees and
executive committees in subsidiaries and by the
Group Management Board for HSBC as a
whole. A risk management meeting of the Group
Management Board, chaired by the Group
Finance Director, is held each month. These risk
management meetings address asset and liability
management issues. Minutes of the risk
management meetings of the Group
Management Board are submitted to the
Group Audit Committee and to the Board of
Directors.
• A Disclosure Committee has been established to
review material disclosures made by HSBC
Holdings for any errors, misstatements or
omissions. The membership of the Disclosure
Committee, which is chaired by the Group
Company Secretary, includes the heads of the
finance, legal, credit and risk, compliance,
corporate communications, investor relations
and internal audit functions.
• Processes are in place to identify new risks from
changes in market practices or customer
behaviours which could expose HSBC to
heightened risk of loss or reputational damage.
During 2006 additional attention was directed
towards evolving best practice in the areas of
internet banking, counterparty risk management
policy following the publication of the Corrigan
report in July 2005; best practice guidance
emerging on liquidity management from the
Institute of International Finance; the
implications of a slowing housing market in the
US coupled with rising payment obligations
under adjustable rate mortgages; and the
implications of changed customer behaviour in
the UK regarding seeking protection from credit
obligations.
• Periodic strategic plans are prepared for
customer groups, global product groups, key
263
support functions and certain geographies within
the framework of the Group Strategic Plan.
Operating plans are prepared and adopted by all
HSBC companies 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 for
similar business processes wherever practicable.
Credit and market risks are measured and
reported on in subsidiaries and aggregated for
review of risk concentrations on a Group-wide
basis.
• Responsibilities for financial performance
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 is responsible for setting
policies, procedures and standards in the
following areas of risk: credit risk; market risk;
liquidity risk; operational risk; IT risk; insurance
risk; accounting risk; tax risk; legal and
regulatory compliance risk; human resources
risk; reputational risk and purchasing risk; and
for certain global product lines.
• Policies 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 and
the Group Management Board, subsidiary
company boards, board committees or senior
management. Reputational risks can arise from
environmental, social or governance 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 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.
• Management is responsible for ensuring that
recommendations made by the internal audit
function are implemented within an appropriate
and agreed timetable. Confirmation to this effect
must be provided to internal audit. Management
H S B C H O L D I N G S P L C
Report of the Directors: Governance (continued)
Board of Directors > Internal control / Directors’ interests / Employees
must also confirm annually to internal audit that
offices under their control have taken or are in
the process of taking the appropriate actions to
deal with all significant recommendations made
by external auditors in management letters or by
regulators following regulatory inspections.
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 business
and operational risk assessments; regular reports
from the heads of key risk functions including
Internal Audit and Compliance; 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; semi-annual
confirmations from chief executives of principal
subsidiary companies as to whether there have been
any material losses, contingencies or uncertainties
caused by weaknesses in internal controls; internal
audit reports; external audit reports; prudential
reviews; and regulatory reports. In addition, where
unexpected losses have arisen or where incidents
have occurred which indicate gaps in the control
HSBC Holdings ordinary shares of US$0.50
framework or in adherence to Group policies, the
Group Audit Committee has reviewed special
reports, prepared at the instigation of management,
which analyse the cause of the issue, the lessons
learned and the actions proposed by management to
address the issue.
The Directors, through the Group Audit
Committee, have conducted an annual review of the
effectiveness of HSBC’s system of internal control
covering all material controls, including financial,
operational and compliance controls and risk
management systems. The Group Audit Committee
has received confirmation that management has
taken or is taking the necessary action to remedy any
failings or weaknesses identified through the
operation of HSBC’s framework of controls.
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 2006
At
1 January
2006
Beneficial
owner
Child
under 18
or spouse
49,835
42,195
170,210
81,726
328,000
73,536
295,148
2,037
2,119,229
11,632
10,840
5,391
33,7993
3,370,147
52,055
6,000
147,875
76,984
328,000
113,525
356,441
2,037
–
–
5,000
5,631
5,177
–
–
–
–
–
–
–
–
–
–
–
840
–
–
1,326,278
Trustee
–
33,7992
28,6502
27,963
–
–
–
–
1,668,9862
–
5,0002
–
33,7992
–
16,543
17,281
–
–
R K F Ch’ien ........
J D Coombe .........
Baroness Dunn .....
D J Flint ...............
W K L Fung .........
M F Geoghegan ...
S K Green .............
S Hintze ................
J W J Hughes-
Hallett ................
Sir Brian Moffat ...
Sir Mark
Moody-Stuart ....
S W Newton .........
S M Robertson .....
H Sohmen ............
Sir Brian
Williamson ........
Jointly
with
another
person
–
–
–
–
–
–
45,355
–
–
12,149
Percentage
of ordinary
shares
in issue
Total
interests1
Other
–
–
–
–
–
–
–
–
–
–
52,055
39,799
176,525
104,947
328,000
113,525
401,796
2,037
1,668,986
12,149
–
–
–
–
–
–
–
–
2,105,9894
10,840
5,631
38,976
3,432,267
–
17,281
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.02
0.00
0.00
0.00
0.00
0.03
0.00
1 Details of executive Directors’ other interests in HSBC Holdings ordinary shares of US$0.50 arising from employee share plans are set
out in the Directors’ Remuneration Report on pages 288 to 289. At 31 December 2006, the aggregate interests under the Securities and
Futures Ordinance of Hong Kong of D J Flint, M F Geoghegan and S K Green in HSBC Holdings ordinary shares of US$0.50 (each of
which represents less than 0.02 per cent of the shares in issue), including interests arising through employee share plans are: D J Flint –
817,055; M F Geoghegan – 778,298; and S K Green – 1,405,974.
2 Non-beneficial.
3 Interests at 3 January 2006 – date of appointment.
4 Interests held by private investment companies.
264
S K Green has an interest as beneficial owner in
€75,000 of HSBC Holdings plc 5½ per cent
Subordinated Notes 2009 which he held throughout
the year.
As a Director of HSBC Private Banking
Holdings (Suisse), S K Green has an interest as
beneficial owner in one share of CHF1,000, which
he held throughout the year. S K Green has waived
his rights to receive dividends on the share and has
undertaken to transfer the share to HSBC on ceasing
to be a Director of HSBC Private Banking Holdings
(Suisse).
As Directors of HSBC France, S K Green and
M F Geoghegan each have an interest as beneficial
owner in one share of €5 in that company, which
they held throughout the year. The Directors have
waived their rights to receive dividends on these
HSBC Holdings ordinary shares of US$0.50
shares and have undertaken to transfer these shares
to HSBC on ceasing to be Directors of HSBC
France.
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 HSBC or any
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:
R K F Ch’ien ....................................................................................................
J D Coombe .....................................................................................................
Baroness Dunn .................................................................................................
D J Flint ...........................................................................................................
M F Geoghegan ...............................................................................................
S K Green ........................................................................................................
Sir Brian Moffat................................................................................................
S W Newton......................................................................................................
S M Robertson .................................................................................................
Sir Brian Williamson........................................................................................
Beneficial
owner
4161
471
1,1821
6422
–
2,8774
–
451
411
1381
Jointly with
another person
Beneficiary
of a trust
–
–
–
2231
–
–
971
–
–
–
–
–
–
5,6733
5,3143
8,0073
–
–
–
–
1 Scrip dividend.
2 Comprises scrip dividend on shares held as beneficial owner (568 shares), the acquisition of shares in the HSBC Holdings UK Share
Ownership Plan through regular monthly contributions (27 shares), the automatic reinvestment of dividend income on shares held in the
plan (8 shares) and by the automatic reinvestment of dividend income by an Individual Savings Account and Personal Equity Plan
manager (39 shares).
3 Scrip dividend on awards held under The HSBC Share Plan and the HSBC Holdings Restricted Share Plan 2000.
4 Comprises scrip dividend on shares held as beneficial owner (2,842 shares), the acquisition of shares in the HSBC Holdings UK Share
Ownership Plan through normal monthly contributions (27 shares) and the automatic reinvestment of dividend income on shares held in
the plan (8 shares).
There have been no other changes in Directors’
interests from 31 December 2006 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 2006, Directors and Senior
Management held, in aggregate, beneficial interests
in 17,333,485 HSBC Holdings ordinary shares
(0.2 per cent of the issued ordinary shares).
At 31 December 2006, executive Directors and
Senior Management held, in aggregate, options to
subscribe for 4,585,589 HSBC Holdings ordinary
shares under the HSBC Holdings Executive Share
Option Scheme, HSBC Holdings Group Share
Option Plan, HSBC Holdings savings-related share
option plans and HSBC Finance 1996 Long-Term
Executive Incentive Compensation Plan. These
options are exercisable between 2007 and 2014 at
prices ranging from £5.3496 to £9.1350 per share,
and US$10.66 to US$21.37 per share.
Employees
At 31 December 2006, HSBC’s customers were
served by 312,000 full and part-time employees
worldwide, compared with 284,000 at 31 December
2005 and 253,000 at 31 December 2004. The main
centres of employment are the UK with
approximately 57,000 employees; the US 50,000;
Brazil 29,000; Hong Kong 28,000; India 27,000;
Mexico 24,000 and France 15,000. HSBC negotiates
with recognised unions. The highest concentrations
265
H S B C H O L D I N G S P L C
Report of the Directors: Governance (continued)
Employees > Remuneration policy / Share plans
of union membership are in Brazil, France, India,
Malaysia, Malta, Mexico, the Philippines, Singapore
and the UK. It is the policy to maintain 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 strategy, HSBC focuses on
attracting, developing and motivating the very best
individuals and on encouraging talent internally.
HSBC places employees’ engagement with the
business central to people management. With a
proven link to superior business performance, this is
beneficial to shareholders, colleagues and customers
alike. Emphasis is placed on performance
management and differentiated rewards that are
competitive in their market, valuing those who
contribute over time. 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 and 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, in order to enhance
customer service and improve productivity. HSBC
recruits from a broad cross-section of society and
encourages the sharing of individual perspectives
and ideas through collective leadership development
events, training and global secondments.
Increasingly HSBC recognises its role as an
employer in a wider context and is developing its
commitment to employee health issues, involvement
in community and not-for-profit organisations and
flexible working opportunities. As rising global
education levels and advances in technology
improve, the Group’s access to previously untapped
resources and the profile of HSBC’s employees
continues to change. Job losses in some countries
may arise but HSBC has a good record of
communicating honestly and openly, treating people
with respect and reassigning people wherever
possible.
HSBC attaches great importance to cultivating
its own talent. Resources have been set aside to
ensure a supply of talented individuals to meet
business needs, with support provided for these
employees in the form of career enhancement and
266
personal development programmes. HSBC invests in
succession planning and developing a talent pipeline
from graduate hires through to senior management.
In addition, HSBC recognises that there are lessons
to be learned from other successful businesses, and
will recruit from other organisations where
appropriate.
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.
Remuneration policy
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.
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.
In line with the overall principles applied by the
Remuneration Committee as described on page 280
in the Directors’ Remuneration Report:
•
•
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. Variable bonus plans emphasise
revenue growth whilst retaining a strong link to
expense control; other key measures taken into
account in determining individual bonus levels
include customer relationships; employee
engagement; full utilisation of professional
skills; and adherence to HSBC’s ethical
standards, lending guidelines, 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.
Employee share plans
To help align the interests of employees with those
of shareholders, share options are granted under all-
employee share plans and discretionary awards of
Performance Shares and Restricted Shares are made
under The HSBC Share Plan. There have been no
awards of discretionary share options since
30 September 2005.
Set out on pages 267 to 275 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
267
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.
Employee share plans are subject to the
following limits on the number of HSBC Holdings
ordinary shares that may be subscribed for. In any
10-year period not more than 10 per cent of the
HSBC Holdings ordinary shares in issue from time
to time (approximately 1,159 million HSBC
Holdings ordinary shares at 5 March 2007) may in
aggregate become issuable pursuant to the grant of
options or be issued other than pursuant to options
under all-employee share plans. In any 10-year
period not more than 5 per cent of the HSBC
Holdings ordinary shares in issue from time to time
(approximately 579 million HSBC Holdings
ordinary shares on 5 March 2007) may in aggregate
be put under option under The HSBC Share Plan or
be issuable pursuant to the HSBC Holdings Group
Share Option Plan, the HSBC Executive Share
Option Scheme, the HSBC Holdings Restricted
Share Plan 2000 or The HSBC Share Plan. The
number of HSBC Holdings ordinary shares that may
be issued on exercise of all options granted on or
after 27 May 2005 under The HSBC Share Plan and
any other plans must not exceed 1,119,000,000
HSBC Holdings ordinary shares. Under the HSBC
Holdings savings-related share option plans, The
HSBC Share Plan, HSBC Holdings Group Share
Option Plan and the HSBC Holdings Executive
Share Option Scheme there were options outstanding
over 277,129,598 HSBC Holdings ordinary shares at
31 December 2006. Particulars of options over
HSBC Holdings shares held by Directors of HSBC
Holdings are set out on page 288 of the Directors’
Remuneration Report.
The impact on earnings per share 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 income statement, with
further details disclosed in Note 12 on the Financial
Statements on page 339. The effect on basic earnings
per share of exercising all outstanding share options
would be to dilute it by 0.58 per cent.
All-employee share option plans
The HSBC Holdings Savings-Related Share Option
Plan and the HSBC Holdings Savings-Related Share
Option Plan: International are all-employee share
plans under which eligible HSBC employees (those
employed within the Group on the first working day
of the year of grant) may be granted options to
H S B C H O L D I N G S P L C
Report of the Directors: Governance (continued)
Employees > Share plans
acquire HSBC Holdings ordinary shares. Employees
may make contributions of up to £250 (or
equivalent) each month over a period of one, three or
five years which may be used on the first, third or
fifth anniversary of the commencement of the
relevant savings contract, at the employee’s election,
to exercise the options. Alternatively, the employee
may elect to have the savings, plus (where
applicable) any interest or bonus, repaid in cash.
Options granted over a one-year period will be
exercisable within three months following the first
anniversary of the commencement of the savings
contract. Options granted over three or five-year
periods will be 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-
HSBC Holdings Savings-Related Share Option Plan
HSBC Holdings ordinary shares of US$0.50
Related Share Option Plan: International 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 (except for the options awarded before
2001 and the one-year options awarded under the US
sub-plan where a 15 per cent discount is applied).
The exercise period of the options awarded under
all-employee share plans may be advanced to an
earlier date in certain circumstances, for example on
retirement, and may be extended in certain
circumstances, for example on the death of a
participant, the executors may exercise the option up
to six months beyond the normal exercise period.
The closing price per HSBC Holdings ordinary share
on 25 April 2006, the day before options were
awarded in 2006 under the HSBC Holdings
Savings-Related Share Option Plan and the HSBC
Holdings Savings-Related Share Option Plan:
International, was £9.51. The all-employee share
option plans will terminate on 27 May 2015 unless
the Directors resolve to terminate the plans at an
earlier date.
Date of
award
Exercise
price (£)
Exercisable
from
Exercisable
until
Options at
1 January
2006
Options
awarded
during year
Options
exercised
during year1
Options
lapsed
during year
Options at
31 December
2006
10 Apr 2000
11 Apr 2001
2 May 2002
2 May 2002
23 Apr 2003
23 Apr 2003
21 Apr 2004
21 Apr 2004
24 May 2005
24 May 2005
26 April 2006
26 April 2006
6.0299 1 Aug 2005 31 Jan 2006
6.7536 1 Aug 2006 31 Jan 2007
6.3224 1 Aug 2005 31 Jan 2006
6.3224 1 Aug 2007 31 Jan 2008
5.3496 1 Aug 2006 31 Jan 2007
5.3496 1 Aug 2008 31 Jan 2009
6.4720 1 Aug 2007 31 Jan 2008
6.4720 1 Aug 2009 31 Jan 2010
6.6792 1 Aug 2008 31 Jan 2009
6.6792 1 Aug 2010 31 Jan 2011
7.6736 1 Aug 2009 31 Jan 2010
7.6736 1 Aug 2011 31 Jan 2012
158,530
3,328,356
31,777
3,806,022
6,880,460
11,791,276
3,550,033
5,728,480
4,582,892
5,753,115
–
–
–
–
–
–
–
–
–
–
–
–
4,921,297
3,657,158
122,451
3,218,343
21,408
89,337
6,507,643
189,669
88,312
57,961
48,556
22,598
2,866
495
36,079
50,592
10,369
164,249
194,905
600,452
351,525
374,733
574,736
400,587
265,285
105,978
–
59,421
–
3,552,436
177,912
11,001,155
3,110,196
5,295,786
3,959,600
5,329,930
4,653,146
3,550,685
1 The weighted average closing price of the shares immediately before the dates on which options were exercised was £9.68.
HSBC Holdings Savings-Related Share Option
Plan: International
To encourage greater participation in the HSBC
Holdings Savings-Related Share Option Plan:
International, two amendments were approved at the
2005 Annual General Meeting. The first was the
introduction of the facility to save and have option
prices expressed in US dollars, Hong Kong dollars
and euros as well as in pounds sterling. Where
applicable in the tables below, the US dollars, Hong
Kong dollars and euro exercise prices were
converted from the sterling exercise price at the
prevailing exchange rates. The second amendment
gives individuals the choice of options over one year
in addition to three and five year terms. The
weighted average closing price of the shares
immediately before the dates on which options were
exercised was £9.70.
268
HSBC Holdings ordinary shares of US$0.50
Date of
award
Exercise
price (£)
Exercisable
From
Exercisable
until
Options at
1 January
2006
Options
awarded
during year
Options
exercised
during year
Options
lapsed
during year
Options at
31 December
2006
10 Apr 2000
11 Apr 2001
2 May 2002
2 May 2002
23 Apr 2003
23 Apr 2003
8 May 2003
8 May 2003
21 Apr 2004
21 Apr 2004
10 May 2004
10 May 2004
24 May 2005
24 May 2005
26 Apr 2006
26 Apr 2006
26 Apr 2006
6.0299 1 Aug 2005 31 Jan 2006
6.7536 1 Aug 2006 31 Jan 2007
6.3224 1 Aug 2005 31 Jan 2006
6.3224 1 Aug 2007 31 Jan 2008
5.3496 1 Aug 2006 31 Jan 2007
5.3496 1 Aug 2008 31 Jan 2009
5.3496 1 Aug 2006 31 Jan 2007
5.3496 1 Aug 2008 31 Jan 2009
6.4720 1 Aug 2007 31 Jan 2008
6.4720 1 Aug 2009 31 Jan 2010
6.4720 1 Aug 2007 31 Jan 2008
6.4720 1 Aug 2009 31 Jan 2010
6.6792 1 Aug 2008 31 Jan 2009
6.6792 1 Aug 2010 31 Jan 2011
7.6736 1 Aug 2007 31 Oct 2007
7.6736 1 Aug 2009 31 Jan 2010
7.6736 1 Aug 2011 31 Jan 2012
460,231
1,275,370
121,795
1,099,581
10,459
10,488
15,488,310
6,009,197
49,524
12,365
9,235,596
3,096,929
11,986,110
3,949,607
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
903,056
2,390,318
537,775
143,034
1,058,761
30,328
8,016
3,312
–
13,601,113
26,376
–
–
54,635
5,144
25,562
7,422
1,156
500
317,197
175,756
91,467
28,044
7,147
–
1,576,819
155,787
2,454
–
567,666
138,309
1,004,484
198,269
41,291
65,039
–
40,853
–
1,063,521
–
10,488
310,378
5,827,034
47,070
12,365
8,613,295
2,953,476
10,956,064
3,743,916
860,609
2,324,779
–
19,663
518,112
Date of
award
Exercise
price (US$)
Exercisable
From
Exercisable
until
26 Apr 2006
26 Apr 2006
26 Apr 2006
26 Apr 2006
14.16211
1 Aug 2007 31 Oct 2007
13.3290 1 Aug 2007 31 Oct 2007
13.3290 1 Aug 2009 31 Jan 2010
13.3290 1 Aug 2011 31 Jan 2012
Options at
1 January
2006
Options
awarded
during
year
Options
exercised
during
year
–
–
–
–
636,783
117,957
1,832,362
505,502
–
–
–
–
Options
lapsed
during
year
44,965
5,297
83,216
27,026
Options at
31 December
2006
591,818
112,660
1,749,146
478,476
1 Exercisable at a 15 per cent discount to the average market value of the ordinary shares on the five business days immediately
preceding the invitation date.
Date of
award
Exercise
price (€)
Exercisable
From
Exercisable
until
Options at
1 January
2006
26 Apr 2006
26 Apr 2006
26 Apr 2006
11.0062 1 Aug 2007 31 Oct 2007
11.0062 1 Aug 2009 31 Jan 2010
11.0062 1 Aug 2011 31 Jan 2012
–
–
–
Date of
award
Exercise
price (HK$)
Exercisable
From
Exercisable
until
Options at
1 January
2006
Options
awarded
during
year
43,261
191,017
40,967
Options
awarded
during
year
26 Apr 2006
26 Apr 2006
26 Apr 2006
103.4401 1 Aug 2007 31 Oct 2007
103.4401 1 Aug 2009 31 Jan 2010
103.4401 1 Aug 2011 31 Jan 2012
–
–
–
1,368,901
4,337,651
1,142,709
Options
exercised
during
year
–
–
–
Options
exercised
during
year
34
570
322
Options
lapsed
during
year
1,215
2,160
1,397
Options
lapsed
during
year
73,021
81,320
31,996
Options at
31 December
2006
42,046
188,857
39,570
Options at
31 December
2006
1,295,846
4,255,761
1,110,391
Performance Share awards and Restricted
Share awards
Note 9 on the Financial Statements on pages 332 to
338 gives details about share-based payments,
including awards of Performance Shares and
Restricted Shares made in 2006.
The HSBC Share Plan was approved at the 2005
Annual General Meeting. Awards of Performance
Shares are made under this Plan to executive
Directors and other senior executives. The
performance conditions for awards of Performance
Shares are described under ‘Long-term incentive
plan’ on page 281. The Remuneration Committee
has determined that for awards made from 2007,
Performance Share awards will be directed to those
senior executives who can influence the performance
conditions, being the Group Chairman and members
and attendees of the Group Management Board.
269
Holdings Group Share Option Plan. In 2006 there
were still some 35,000 high performing employees
(approximately the top 20 per cent of performers)
below senior management who had received share
option awards under the HSBC Holdings Group
Share Option Plan in 2003. Further details were
given on page 216 of the Annual Report and
Accounts 2005.
The Remuneration Committee favours the use
of Performance Shares and Restricted Shares and,
following the introduction of The HSBC Share Plan
in 2005, has not granted discretionary share options
on any widespread basis. There are locations, and
there may be particular circumstances in the future,
however, where option grants may be appropriate.
No options were awarded in 2006. The maximum
value of options which may be granted to an
employee in any one year under The HSBC Share
Plan (when taken together with any Performance
Share awards made under The HSBC Share Plan) is
700 per cent of the employee’s annual salary at the
date of grant.
The exercise price of options granted under The
HSBC Share Plan, and previously under the HSBC
Holdings Group Share Option Plan, is 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 exercise price of options
granted under the HSBC Holdings Executive Share
Option Scheme was the market value of the ordinary
shares on the business day prior to the grant of the
option. The HSBC Share Plan will terminate on
27 May 2015 unless the Directors resolve to
terminate the Plan at an earlier date.
The exercise period of the options awarded
under discretionary share incentive plans may be
advanced to an earlier date in certain circumstances,
for example on retirement and may be extended in
certain circumstances, for example on the death of a
participant the executors may exercise the option up
to twelve months beyond the normal exercise period.
H S B C H O L D I N G S P L C
Report of the Directors: Governance (continued)
Employees > Share plans / Subsidiary company share plans
Awards of Restricted Shares are made to other
employees below the level of the Group
Management Board based on performance, potential
and retention requirements or as part of deferral of
annual bonus. Restricted Share awards comprise a
number of shares to which the employee will
become entitled, normally after three years, subject
to the individual remaining in employment. All
awards of Performance Shares and Restricted Shares
will be satisfied by the transfer of existing shares.
Discretionary share option plans
Prior to 2005, awards of discretionary share options
were made under the HSBC Holdings Group Share
Option Plan and the HSBC Holdings Executive
Share Option Scheme to employees, based on
performance criteria and potential. The vesting of
these options was subject to the attainment of pre-
determined relative TSR performance criteria, except
within HSBC France (which was acquired in 2000)
where performance criteria were phased in. Under
the HSBC Holdings Group Share Option Plan the
maximum value of options which could have been
granted to an employee in any one year (together
with any Performance Share awards under the HSBC
Holdings Restricted Share Plan 2000) was 150 per
cent of the employee’s annual salary at the date of
grant plus any bonus paid for the previous year (or in
exceptional circumstances 225 per cent). Under the
HSBC Executive Share Option Scheme the
maximum value of options which could have been
granted to an employee in any one year was four
times the employee’s relevant earnings. Subject to
attainment of the relative TSR performance
condition where applicable, 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 or the HSBC Holdings Executive
Share Option Scheme within six or twelve months
respectively of the sale or transfer regardless of
whether the performance condition is met. Subject to
the attainment of relative TSR performance
conditions the options are exercisable up to the tenth
anniversary of the date of grant.
In light of the sustained performance and
shareholder returns over the three year period to
March 2006, the Remuneration Committee exercised
its discretion to waive the relative TSR performance
condition in respect of the 2003 awards under the
HSBC Holdings Group Share Option Plan. This
waiver did not apply to awards with relative TSR
performance conditions which were granted to senior
executives under the French sub-plan of the HSBC
270
HSBC Holdings Executive Share Option Scheme1
HSBC Holdings ordinary shares of US$0.50
Date of
award
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
from
Exercisable
until
1 Apr 1999
1 Apr 2006
3.3334
5.0160 24 Mar 2000 24 Mar 2007
7.7984 12 Aug 2000 12 Aug 2007
6.2767 16 Mar 2001 16 Mar 2008
6.3754
3 Apr 2002 29 Mar 2009
7.4210 10 Aug 2002 10 Aug 2009
7.8710 31 Aug 2002 31 Aug 2009
3 Apr 2010
7.4600
3 Apr 2003
Options at
1 January
2006
208,269
572,819
14,625
1,063,611
17,004,786
117,908
4,000
13,268,990
Options
exercised
during
year2
182,769
366,745
5,625
376,177
5,059,192
5,850
–
3,770,744
Options
lapsed
during
year
25,500
18,000
–
9,000
136,624
12,000
–
249,677
Options at
31 December
2006
–
188,074
9,000
678,434
11,808,970
100,058
4,000
9,248,569
1 The HSBC Holdings Executive Share Option Scheme expired on 26 May 2000. No options have been granted under the Scheme since
that date.
2 The weighted average closing price of the shares immediately before the dates on which options were exercised was £9.72.
HSBC Holdings Group Share Option Plan1
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
20 Apr 2005
Exercise
price (£)
Exercisable
from
Exercisable
until
9.6420
8.7120
8.2280
8.4050
7.4550
6.9100
8.1300
9.1350
8.2830
8.6500
8.3620
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
30 Apr 2008
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
20 Apr 2015
Options at
1 January
2006
371,885
39,241,828
262,955
44,268,052
410,625
52,831,030
555,080
4,069,800
60,216,608
337,760
7,416,895
Options
exercised
during
year2
43,406
9,285,643
80,762
11,008,002
48,025
17,190,284
100,186
–
61,500
–
–
Options
lapsed
during
year
Options at
31 December
2006
7,303
555,716
3,000
758,353
1,000
1,099,160
9,000
814,000
2,227,604
5,290
56,100
321,176
29,400,469
179,193
32,501,697
361,600
34,541,586
445,894
3,255,800
57,927,504
332,470
7,360,795
1 The HSBC Holdings Group Share Option Plan expired on 26 May 2005. No options have been granted under the Plan since that date.
2 The weighted average closing price of the shares immediately before the dates on which options were exercised was £9.69.
The HSBC Share Plan
HSBC Holdings ordinary shares of US$0.50
Date of
award
21 Jun 2005
30 Sep 2005
Exercise
price (£)
Exercisable
from
Exercisable
until
Options at
1 January
2006
8.794 21 Jun 2008 21 Jun 2009
9.170 30 Sep 2008 30 Sep 2015
552,526
74,985
Options
exercised
during
year
–
–
Options
lapsed
during
year
Options at
31 December
2006
–
–
552,526
74,985
Subsidiary company share plans
HSBC France and its subsidiaries
When it was acquired in 2000, HSBC France and its
subsidiary company, HSBC Private Bank France,
operated employee share option plans under which
options could be granted over their respective shares.
No further options will be granted under either of
these companies’ plans. The following are details of
options to acquire shares in HSBC France and HSBC
Private Bank France.
271
H S B C H O L D I N G S P L C
Report of the Directors: Governance (continued)
Employees > Subsidiary company share plans
HSBC France
shares of €5
Date of
award
9 May 1996
7 May 1997
29 Apr 1998
7 Apr 1999
12 Apr 2000
Exercise
price (€)
Exercisable
Exercisable
Options at
1 January
from
until
2006
Options
exercised
during year1
Options
lapsed
during year
Options at
31 December
20061
35.52 9 May 1998 9 May 2006
7 Jun 2000 7 May 2007
37.05
7 Jun 2000 29 Apr 2008
73.50
7 Jun 2000
81.71
7 Apr 2009
1 Jan 2002 12 Apr 2010
142.50
44,500
162,000
285,244
475,502
765,750
44,500
96,000
93,090
91,900
119,625
–
–
–
–
–
–
66,000
192,154
383,602
646,125
1 Following exercise of the options, the HSBC France shares will be exchanged for HSBC Holdings ordinary shares in the same ratio as
for the acquisition of HSBC France (13 HSBC Holdings ordinary shares for each HSBC France share). At 31 December 2006, The
HSBC Holdings Employee Benefit Trust 2001 (No. 1) held 15,316,328 HSBC Holdings ordinary shares which may be exchanged for
HSBC France shares arising from the exercise of these options.
HSBC Private Bank France
shares of €2
Date of
award
21 Dec 1999
9 Mar 2000
15 May 2001
1 Oct 2002
Exercise
price (€)
Exercisable
Exercisable
Options at
1 January
from
until
2006
Options
exercised
during year1
Options
lapsed
during year
Options at
31 December
20061
10.84 21 Dec 2000 21 Dec 2009
12.44 27 Jun 2004 31 Dec 2010
20.80 15 May 2002 15 May 2011
1 Oct 2012
2 Oct 2005
22.22
91,150
82,160
229,275
195,075
34,020
54,534
74,250
32,000
–
–
–
–
57,130
27,626
155,025
163,075
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 2006, The CCF Employee
Benefit Trust 2001 held 1,085,323 HSBC Holdings ordinary shares which may be exchanged for HSBC Private Bank France shares
arising from the exercise of these options.
HSBC Finance and its subsidiaries
Following the acquisition of HSBC Finance in 2003,
all outstanding options and equity-based awards over
HSBC Finance 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 (2.675 HSBC
Holdings ordinary shares for each HSBC Finance
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 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.
The following are details of options and equity-
based awards to acquire shares in HSBC Holdings.
At 31 December 2006, the HSBC (Household)
Employee Benefit Trust 2003 and the HSBC
(Household) Employee Benefit Trust 2003 (No.2)
held 8,670,335 HSBC Holdings ordinary shares and
198,665 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.
272
HSBC Finance: 1996 Long-Term Executive Incentive Compensation Plan
HSBC Holdings ordinary shares of US$0.50
Date of
award
11 Nov 1996
14 May 1997
10 Nov 1997
15 Jun 1998
1 Jul 1998
9 Nov 1998
17 May 1999
3 Jun 1999
31 Aug 1999
8 Nov 1999
30 Jun 2000
8 Feb 2000
13 Nov 2000
12 Nov 2001
20 Nov 2002
Exercise
Exercisable
Exercisable
Options at
1 January
price (US$)
from
until
2006
Options
exercised
during year1
Options
lapsed
during year
Options at
31 December
2006
1 Jul 2008
1 Jul 1999
11.43 11 Nov 1997 11 Nov 2006
11.29 14 May 1998 14 May 2007
14.60 10 Nov 1998 10 Nov 2007
17.08 15 Jun 1999 15 Jun 2008
19.21
13.71 9 Nov 1999 9 Nov 2008
16.99 17 May 2000 17 May 2009
16.32
3 Jun 2009
3 Jun 2000
13.96 31 Aug 2000 31 Aug 2009
16.96 8 Nov 2000 8 Nov 2009
15.70 30 Jun 2001 30 Jun 2010
8 Feb 2010
13.26
18.40 13 Nov 2001 13 Nov 2010
21.37 12 Nov 2002 12 Nov 2011
10.66 20 Nov 20032
20 Nov 2012
8 Feb 2001
607,225
180,567
3,388,670
802,500
80,250
4,543,154
334,375
200,625
345,077
4,869,841
26,846
66,875
6,379,208
7,571,322
6,357,805
607,225
60,189
2,781,413
–
–
2,501,013
–
200,625
8,026
86,939
–
–
30,094
–
3,219,228
–
20,063
33,573
–
–
26,750
–
–
5,350
53,500
–
–
53,500
56,978
13,375
–
100,315
573,684
802,500
80,250
2,015,391
334,375
–
331,701
4,729,402
26,846
66,875
6,295,614
7,514,344
3,125,202
1 The weighted average closing price of the shares immediately before the dates on which options were exercised was £9.77.
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.
HSBC Finance: 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
Vesting
from2
Vesting
until2
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
2006
Rights
vested
during year3
Rights
lapsed
during year
Rights at
31 December
2006
4,817
1,132,606
7,137
23,902
91,853
1,338
31,432
9,501
147,393
1,338
2,408
562,572
3,121
11,771
–
445
10,473
3,157
49,128
445
–
31,007
893
357
3,567
–
–
–
–
–
2,409
539,027
3,123
11,774
88,286
893
20,959
6,344
98,265
893
1 Awards of Restricted Stock Rights which represent a right to receive shares for nil consideration if the employee remains in the
employment of HSBC Finance 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. 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 vested was £9.83.
Beneficial Corporation: 1990 Non-Qualified Stock Option Plan
HSBC Holdings ordinary shares of US$0.50
Date of
award
20 Nov 1996
14 Nov 1997
19 Nov 1997
1 Dec 1997
Exercise
Exercisable
Exercisable
Options at
1 January
price (US$)
from
until
2006
Options
exercised
during year1
Options
lapsed
during year
Options at
31 December
2006
7.86
9.20
9.39
9.68
20 Nov 1997 20 Nov 2006
14 Nov 1998 14 Nov 2007
19 Nov 1998 19 Nov 2007
1 Dec 1998 1 Dec 2007
244,175
131,248
383,946
49,218
244,175
–
74,721
–
–
–
–
–
–
131,248
309,225
49,218
1 The weighted average closing price of the shares immediately before the dates on which options were exercised was £9.77.
273
H S B C H O L D I N G S P L C
Report of the Directors: Governance (continued)
Employees > Subsidiary company share plans / Employee compensation
Beneficial Corporation: BenShares Equity Participation Plan
HSBC Holdings ordinary shares of US$0.50
Date of
award
31 Jan 1997
15 Nov 1997
Exercise
Exercisable
Exercisable
Options at
1 January
price (US$)
from
until
2006
Options
exercised
during year1
Options
lapsed
during year
Options at
31 December
2006
9.87 31 Jan 1998 31 Jan 2007
11.04 15 Nov 1998 15 Nov 2007
36,391
48,719
15,457
12,312
821
821
20,113
35,586
1 The weighted average closing price of the shares immediately before the dates on which options were exercised was £9.73.
Renaissance Holdings, Inc: Amended and Restated 1997 Incentive Plan
HSBC Holdings ordinary shares of US$0.50
Date of
award
31 Oct 1997
1 Jan 1998
1 Oct 1998
1 Jan 1999
Exercise
Exercisable
Exercisable
Options at
1 January
price (US$)
from
until
2006
Options
exercised
during year
Options
lapsed
during year
Options at
31 December
2006
1.25 31 Oct 1998 31 Oct 2007
1 Jan 2008
1.25
1 Oct 2008
1.74
1 Jan 2009
2.24
1 Jan 1999
1 Oct 1999
1 Jan 2000
1,325
1,424
803
5,024
–
–
–
–
–
–
–
–
1,325
1,424
803
5,024
Bank of Bermuda plans
Following the acquisition of Bank of Bermuda in
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 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. The
following are details of options to acquire shares in
HSBC Holdings. At 31 December 2006, the HSBC
(Bank of Bermuda) Employee Benefit Trust 2004
held 2,266,949 HSBC Holdings ordinary shares
which may be used to satisfy the exercise of these
options.
Bank of Bermuda: Executive Share Option Plan 1997
HSBC Holdings ordinary shares of US$0.50
Date of
award
Exercise
price (US$)
Exercisable
from
Exercisable
until
Options at
1 January
2006
Options
exercised
during year1
Options
lapsed
during year
Options at
31 December
2006
1 Jul 1998
23 Feb 1999
3 Aug 1999
4 Feb 2000
1 Jun 2000
31 Jul 2000
11 Jan 2001
1 Jul 1999
9.61
1 Jul 2008
7.40 23 Feb 2000 23 Feb 2009
7.10 3 Aug 2000 3 Aug 2009
4 Feb 2001
4 Feb 2010
7.21
1 Jun 2010
1 Jun 2001
7.04
10.11 31 Jul 2001 31 Jul 2010
14.27 11 Jan 2002 11 Jan 2011
67,813
11,684
9,331
57,136
61,649
46,239
161,829
–
–
–
16,951
–
18,495
–
–
–
–
–
–
–
–
67,813
11,684
9,331
40,185
61,649
27,744
161,829
1 The weighted average closing price of the shares immediately before the dates on which options were exercised was £9.61.
274
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
1 January
2006
Options
exercised
during year1
Options
lapsed
during year
Options at
31 December
2006
11 Jan 2001
6 Feb 2001
29 Mar 2001
16 Apr 2001
6 Jun 2001
16 Jul 2001
28 Aug 2001
26 Sep 2001
30 Jan 2002
5 Feb 2002
5 Feb 2002
10 Jul 2002
4 Feb 2003
21 Apr 2003
14.27 11 Jan 2002 11 Jan 2011
6 Feb 2011
6 Feb 2002
16.41
15.39 29 Mar 2002 29 Mar 2011
15.57 16 Apr 2002 16 Apr 2011
18.35
6 Jun 2011
6 Jun 2002
16.87 16 Jul 2002 16 Jul 2011
15.39 28 Aug 2002 28 Aug 2011
12.79 26 Sep 2002 26 Sep 2011
15.60 30 Jan 2003 30 Jan 2012
5 Feb 2012
5 Feb 2003
16.09
16.41
5 Feb 2012
5 Feb 2003
15.84 10 Jul 2003 10 Jul 2012
10.69
4 Feb 2013
4 Feb 2004
11.85 21 Apr 2004 21 Apr 2013
134,857
799,334
270
539
8,091
158,485
13,486
448,945
1,226
1,051,814
1,383
12,260
199,345
48,853
–
140,524
–
–
–
81,438
–
10,360
–
172,382
1,383
–
59,687
28,013
–
28,164
–
–
–
62,117
–
–
–
14,050
–
–
–
–
134,857
630,646
270
539
8,091
14,930
13,486
438,585
1,226
865,382
–
12,260
139,658
20,840
1 The weighted average closing price of the shares immediately before the dates on which options were exercised was £9.68.
Bank of Bermuda: Directors’ Share Option Plan
HSBC Holdings ordinary shares of US$0.50
Date of
award
Exercise
price (US$)
Exercisable
from
Exercisable
until
Options at
1 January
2006
Options
exercised
during year
Options
lapsed
during year
Options at
31 December
2006
22 Sep 1999
20 Sep 2000
28 Mar 2001
3 Apr 2002
30 Apr 2003
8.02 22 Sep 2000 22 Sep 2009
11.31 20 Sep 2001 20 Sep 2010
15.76 28 Mar 2002 28 Mar 2011
3 Apr 2012
3 Apr 2003
16.01
12.23 30 Apr 2004 30 Apr 2013
7,706
9,440
15,508
29,424
9,808
–
–
–
–
–
4,624
5,394
2,697
4,904
4,904
3,082
4,046
12,811
24,520
4,904
Number of
Employees
1
1
1
1
1
£4,500,001 – £4,600,000 .............................
£5,900,001 – £6,000,000 .............................
£6,400,001 – £6,500,000 .............................
£7,900,001 – £8,000,000 .............................
£10,400,001 – £10,500,000 ..........................
The aggregate remuneration of Directors and
Senior Management for the year ended 31 December
2006 was US$84,316,000.
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 2006 was US$2,862,389.
Executive Directors and members of Senior
Management are generally subject to notice periods
of up to 12 months and a normal retirement age
of 65.
The new UK pensions tax regime introduced by
the Finance Act 2004 means that the current pension
arrangements may cease to be tax effective for some
UK employees. The changes became effective on
6 April 2006. In anticipation of these changes, the
Employee compensation and benefits
Note 7 on the Financial Statements on pages 320 to
331 gives details about employee compensation and
benefits including pension plans.
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 2006.
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 ...........................................
Total .............................................................
Total (US$000) ............................................
£000
1,708
226
19,847
2,012
11,521
35,314
65,001
Their emoluments are within the following
bands:
275
H S B C H O L D I N G S P L C
Report of the Directors: Governance (continued)
Corporate Responsibility
Remuneration Committee established some
principles when formulating its policy response:
assist the Group’s customers to embrace
sustainability in their businesses;
1
the cost of pension provision should not
increase;
2 HSBC should not compensate individuals for
changes in the tax regime; and
3 HSBC should make available an effective
alternative form of reward where current
pension provision is no longer tax effective.
Corporate Responsibility
Corporate Responsibility is the term used at HSBC
to describe the Group’s approach to meeting a wide
range of non-financial responsibilities which,
although not generally enshrined as legal or
regulatory requirements, constitute behaviour
expected of the Group by its stakeholders, including
shareholders, customers and employees. Insofar as
these expectations concern HSBC’s impact on the
environmental, social and economic well-being of
the world at large, Corporate Responsibility
influences the Group’s response to encouraging
sustainable development.
Investing in sustainability
HSBC seeks to meet society’s expectations by
managing all aspects of its business ethically,
responsibly and in an increasingly sustainable way.
The Group’s key business values include a
commitment to the highest personal standards of
integrity at all levels and to honesty, transparency
and fair dealing in all its business activities. In recent
years HSBC has intensified its efforts to embed
sustainability into the way it manages risk and
business development opportunities. This
acknowledges that HSBC’s continuing financial
success depends, in part, on its ability to identify and
address non-financial considerations which are
material to the business.
Recognising that HSBC’s core financial services
businesses have the potential to exert the most
influence over sustainability issues, a Group
Sustainable Development unit was formed in 2005 to
work closely with these businesses in all customer
groups to help them to manage sustainability risks
and to pursue opportunities in environmental
markets worldwide. The unit reports directly to the
Group Chief Operating Officer.
Group Sustainable Development has three main
objectives:
•
business development – helping HSBC to
identify and develop business opportunities that
276
•
•
risk management – providing a policy
framework to manage and reduce sustainability
risks arising from HSBC’s lending and
investment businesses; and
advice – providing policy and guidance for
management on sustainability issues as they
affect HSBC’s corporate real estate portfolio
and supply chain.
HSBC aims for consistency in the
implementation of its sustainable development
strategy across all Group businesses. The United
Nations set Millennium Development Goals of
resisting climate change, achieving water purity,
encouraging biodiversity and alleviating poverty.
HSBC has identified four themes as relevant to its
response. These are risk management (policies and
processes); business development (carbon, water,
forestry and microfinance); operations (buildings,
travel, suppliers and IT); and philanthropy
(education and environment).
In pursuing its strategy, HSBC Holdings
expanded the Group Sustainable Development unit
in 2006 to build on existing initiatives and focus on
business development opportunities related to the
United Nation’s four development goals.
In 2005, HSBC was the first major banking
organisation in the world to become carbon neutral.
This was achieved by a three-stage carbon
management plan: to manage and reduce the
Group’s direct emissions; to reduce the carbon
intensity of the electricity HSBC uses by buying
‘green’ electricity where feasible; and to offset the
remaining carbon dioxide
emissions by purchasing
carbon credits.
During 2006, HSBC’s leadership position in
managing its carbon footprint attracted wide-ranging
public interest and led to a marked growth in
business opportunities presented to the Group in
areas such as energy efficiency, low carbon
technologies and renewable energy. In recognition of
this, and to help clients respond to the challenges and
opportunities of creating a lower carbon economy,
HSBC launched its carbon finance strategy in 2006.
In essence, HSBC will continue to support fossil fuel
electricity generation (within the parameters of the
Equator Principles and sector-specific risk policies)
while working with clients to promote clean energy
generation and energy-efficient/renewable energy
technologies.
HSBC’s approach to business opportunity is
complemented by its management of risk. The
Group’s Sustainable Risk Advisory Unit has
published policies laying down minimum standards
for lending and investment covering relationships
with clients in energy, forest land and products,
freshwater infrastructure and the chemicals industry,
all focusing on how HSBC’s involvement in these
environmentally sensitive industries can contribute
to sustainable development.
Community involvement
HSBC sees value and opportunity from aligning its
longstanding commitment to the environment with
its core strategic themes. In 2006, for example, the
HSBC Global Education Trust launched ‘Future
First’, a five-year programme designed to help street
children, children in care and orphans, under which
HSBC’s operations around the world will collaborate
with local charitable organisations to make a lasting
and beneficial difference by supporting projects that
bring these children into the mainstream of society.
The programme complements HSBC’s sustainable
business development focus on poverty, for which a
microfinance strategy was developed during 2006.
In recognition of its leadership in merging
social, environmental and business objectives,
HSBC was named as overall winner in the first
Financial Times Sustainable Banking Awards in
2006. The awards, in association with the
International Finance Corporation, drew 90 entries
from 48 financial institutions around the world. In
addition to initiatives noted above, HSBC
highlighted ‘Investing in Nature’, its US$50 million,
five-year eco-partnership with Earthwatch Institute,
WWF and Botanic Gardens Conservation
International.
Also in 2006, HSBC’s Group Head Office
building in London achieved an overall rating of
‘Excellent’ for site management and operation under
the Environmental Assessment Method run by the
Building Research Establishment, the UK’s leading
environmental standards authority.
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 managing actively 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 Corporate Real Estate
and are implemented by Health, Safety and Fire
277
Co-ordinators based in each country in which HSBC
operates.
Despite the considerable international pressure
on terrorist networks over the past few years, the
global threat from terrorism persists. HSBC remains
committed to maintaining its preparedness and to
ensuring the highest standards of health and safety
wherever in the world it operates.
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.
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, HSBC Bank.
Included in the balance with HSBC Bank is the
amount due to trade creditors which, at 31 December
2006, represented 20 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.
Donations
During the year, HSBC made charitable donations
totalling US$86.3 million. Of this amount,
US$32.8 million was given for charitable purposes
in the UK.
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
H S B C H O L D I N G S P L C
Report of the Directors: Governance (continued)
Corporate Responsibility / Shareholders
in light of the wide definitions in The Political
Parties, Elections and Referendums Act 2000. These
authorities have not been used.
Corporate responsibility reporting
HSBC provides information in its Corporate
Responsibility Report 2006 and website
(www.hsbc.com/cr) on the extent to which it has
complied with its environmental, social and ethical
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 Corporate Responsibility Report 2006.
Third party scrutiny of the assertions made in the
report is provided through an assurance process
conducted by Den Norske Veritas. HSBC also
participates in the Dow Jones Sustainability Index,
FTSE4Good and Business in the Community’s
Environment Index. HSBC’s Corporate
Responsibility Report 2006 will be available at
www.hsbc.com/crreport from May 2007.
Shareholders
Dividends for 2006
First, second and third interim dividends for 2006,
each of US$0.15 per ordinary share, were paid on
6 July 2006, 4 October 2006, and 18 January 2007
respectively. Note 11 on the Financial Statements
gives more information on the dividends declared in
2006. On 5 March 2007, the Directors declared a
fourth interim dividend for 2006 of US$0.36 per
ordinary share in lieu of a final dividend, which will
be payable to ordinary shareholders on 10 May 2007
in cash in US dollars, or in sterling or Hong Kong
dollars at exchange rates to be determined on
30 April 2007, with a scrip dividend alternative. As
the fourth interim dividend for 2006 was declared
after the balance sheet date it has not been included
as a creditor at 31 December 2006. The reserves
available for distribution at 31 December 2006 are
US$12,045 million.
A quarterly dividend of US$15.50 per 6.20 per
cent non-cumulative US dollar preference share,
Series A (‘Series A dollar preference share’),
equivalent to a dividend of US$0.3875 per Series A
American Depositary Share, each of which
represents one-fortieth of a Series A dollar
preference share was paid on 15 March, 15 June,
15 September and 15 December 2006.
Dividends for 2007
The proposed timetables for the interim dividends in
respect of 2007 on the ordinary shares of US$0.50
are given in the Shareholder Information section on
page 436.
A quarterly dividend of US$15.50 per Series A
dollar preference share equivalent to a dividend of
US$0.3875 per Series A American Depositary Share,
each of which represents one-fortieth of a Series A
dollar preference share was declared on 12 February
2007 for payment on 15 March 2007.
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 are available on
www.hsbc.com. There is regular dialogue with
institutional investors and enquiries from individuals
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.
Notifiable interests in share capital
According to the register maintained by HSBC
Holdings up to 20 January 2007 pursuant to section
211 of the Companies Act 1985:
• Legal and General Investment Management
Limited gave notice on 11 June 2002 that it had
an interest on 10 June 2002 in 284,604,788
HSBC Holdings ordinary shares, representing
3.01 per cent of the ordinary shares in issue at
that date; and
• Barclays PLC gave notice on 6 December 2006
that it had an interest on 29 November 2006 in
438,557,151 HSBC Holdings ordinary shares,
representing 3.79 per cent of the ordinary shares
in issue at that date.
Since 20 January 2007, no disclosures of major
shareholdings have been made to the Company
pursuant to the requirements of the Financial
Services Authority Disclosure and Transparency
Rule 5.
278
There are no notifiable interests in the equity
Resolutions to receive the Annual Report
share capital 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 2006 and up to the
date of this Report.
Dealings in HSBC Holdings shares
Except for dealings as intermediaries by HSBC
Bank, HSBC Financial Products (France) and The
Hongkong and Shanghai Banking Corporation,
which are members of a European Economic Area
exchange, neither HSBC Holdings nor any
subsidiary undertaking has bought, sold or redeemed
any securities of HSBC Holdings during the year
ended 31 December 2006.
Annual General Meeting
The Annual General Meeting of HSBC Holdings
will be held at the Barbican Hall, Barbican Centre,
London EC2 on Friday 25 May 2007 at 11.00am.
and Accounts and to approve the Directors’
Remuneration Report, the re-election of Directors
and the reappointment of KPMG Audit Plc as
Auditor will be submitted to the Annual General
Meeting. KPMG Audit Plc has expressed its
willingness to continue in office and the Group
Audit Committee and the Board have recommended
that they be reappointed. Resolutions will also be
submitted to the Annual General Meeting to renew
the authorities for the allotment of shares, the
disapplication of pre-emption rights, the purchase of
ordinary shares, the scrip dividend alternative,
political donations and expenditure, and to seek
approval for shareholder electronic communications
pursuant to the Companies Act 2006 and for changes
to the articles of association.
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
2007 a recording of the proceedings will be available
on www.hsbc.com.
On behalf of the Board
S K Green, Group Chairman
5 March 2007
279
H S B C H O L D I N G S P L C
Directors’ Remuneration Report
Remuneration Committee / Principles / Executive Directors
Page
Remuneration policy (not audited)
Remuneration Committee .............................
Overall principles ..........................................
Executive Directors .......................................
Salary .........................................................
Annual cash bonus .....................................
Long-term incentive plan ...........................
2007 awards ...........................................
Performance conditions .........................
Arrangements from 2001-2004 ..............
Total Shareholder Return .......................
Pensions .....................................................
Service contracts ........................................
Other directorships ....................................
Non-executive Directors ...............................
Fees ...........................................................
Remuneration review (audited)
Directors’ emoluments ..................................
Pensions ........................................................
Share plans ....................................................
280
280
280
281
281
281
281
281
283
283
284
284
284
285
285
286
286
287
Moody-Stuart attended all of these meetings and
W K L Fung attended six meetings. Sir John Kemp-
Welch attended three of the four meetings held
before his retirement. J D Coombe attended each of
the three meetings held following his appointment.
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 has no
connection with HSBC. Other consultants are used
from time to time on specific issues. During the year
the Group Chief Executive provided regular
briefings to the Remuneration Committee. The
Committee received advice from the Group General
Manager, Human Resources, P W Boyles, the Senior
Executive, Group Reward Management, P M Wood
and the Head of Group Performance and Reward,
J Beadle.
Remuneration Committee
Overall principles
The Remuneration Committee meets regularly to
consider human resource issues, particularly terms
and conditions of employment, remuneration,
retirement benefits, the development of high
potential employees and key succession planning.
Within the authority delegated by the Board, the
Committee is responsible for approving 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.
Following each meeting the Committee reports to
the Board on its activities. The terms of reference of
the Committee are available at www.hsbc.com/
boardcommittees.
The members of the Remuneration Committee
throughout 2006 were Sir Mark Moody-Stuart
(Chairman), W K L Fung and S Hintze. Sir John
Kemp-Welch was a member of the Committee until
26 May 2006. J D Coombe was appointed a member
of the Committee on 1 June 2006. From the
conclusion of the Annual General Meeting to be held
in 2007, W K L Fung and S Hintze will retire as
members of the Committee and G Morgan will
become a member of the Committee.
There were seven meetings of the Remuneration
Committee during 2006. S Hintze and Sir Mark
In carrying out its responsibilities, 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 markets
in which HSBC operates;
to offer fair and realistic salaries with an
important element of variable pay, differentiated
by performance;
through awards of shares to recognise high
performance, retain key talent and provide
alignment with the interests of shareholders; and
to follow a policy of moving progressively from
defined benefit to defined contribution pension
schemes.
Executive Directors
Consistent with the principles applied by the
Committee, there are four key components to
executive Directors’ remuneration:
•
•
•
•
salary;
annual cash bonus;
long-term incentives; and
pension.
280
To ensure that the executive Directors’
remuneration packages are competitive having
regard to the broad international nature of the Group
and the scope of its activities, the Remuneration
Committee considers market data on senior
executive remuneration arrangements within
organisations that are considered key competitors.
As far as the executive Directors are concerned,
these are FTSE30 companies with significant
international operations and other major European
and where appropriate US parented banks.
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 policy adopted in 2006 will also apply in
2007. It is however, kept under regular review and
where appropriate, shareholders will be consulted
about any proposed changes in policy for subsequent
years. Any such changes will also be described in
future reports on Directors’ remuneration.
Performance against these key measures may
result in discretionary cash bonuses of up to 250 per
cent of basic salary for executive Directors. The
table below shows the awards made to the current
executive Directors in 2006 in respect of 2005 and in
2007 in respect of 2006.
D J Flint ........................
M F Geoghegan ............
S K Green ......................
2007
£000
500
1,750
1,750
2006
£000
500
1,819
1,750
Long-term incentive plan
In 2005 the vesting of Performance Share awards
was made more challenging and highly geared to
performance than under the previous arrangements.
Under The HSBC Share Plan vesting is now based
on two independent measures, relative TSR and
growth in earnings per share, both of which are
considered by the Remuneration Committee to be
key measures of the Group’s overall business
success.
Awards under The HSBC Share Plan can be up
to a maximum of seven times salary. Individual
awards being made in 2007 are set out in the table
below.
Each component of executive Directors’
remuneration is explained below.
2007 awards
Salary
The Committee reviews salary levels for executive
Directors each year and any adjustments made take
into account the individual’s performance in the job
as well as competitive rates of pay found in
comparator organisations.
The table below shows base salaries in 2006 and
with effect from 1 March 2007 or, in the case of M F
Geoghegan, 1 June 2007.
2007
£000
700
1,070
1,250
2006
£000
575
1,000
1,250
D J Flint ........................
M F Geoghegan ............
S K Green .....................
Annual cash bonus
Cash bonuses for executive Directors are based
primarily upon performance measured against a
number of key financial targets for the Group. An
assessment of individual performance, customer
satisfaction and measures of employee engagement
are also factors taken into account in determining
bonuses for executive Directors.
D J Flint ..........................
M F Geoghegan ..............
S K Green ........................
Face value
2007
£000
2,200
5,000
3,750
Total ................................
10,950
2006
£000
1,600
2,000
2,500
6,100
It is to be noted that all of the shares will only
be released to participants if both performance
conditions are fully met. The ‘expected value’ of
these awards is 44 per cent of the face value.
Performance conditions
Awards of Performance Shares under The HSBC
Share Plan are divided into two equal parts subject to
separate performance conditions measured over a
three-year performance period (‘the performance
period’):
•
the Total Shareholder Return award (‘TSR
award’): one half of the award of Performance
Shares will be subject to a relative TSR
measure. TSR is defined as the growth in share
value and declared dividend income during the
relevant period. In calculating TSR, dividend
income is assumed to be reinvested in the
281
H S B C H O L D I N G S P L C
Directors’ Remuneration Report (continued)
Executive Directors
•
underlying shares. As the comparator group
includes companies listed on overseas markets,
a common currency is used to ensure that TSR
is measured on a consistent basis; and
the earnings per ordinary share award (‘EPS
award’): the other half of the Performance Share
award will be based upon the absolute growth in
EPS achieved by HSBC Holdings. For this
purpose, EPS means the profit attributable to the
shareholders (expressed in US dollars), divided
by the weighted average number of ordinary
shares in issue and held outside the Group
during the year in question.
The TSR award is 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, but also having regard to the
geographic spread and the nature of the activities of
each bank. The Remuneration Committee will use
these 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 TSR comparator group during 2006 and
also at 5 March 2007 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., Crédit 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, UniCredito
Italiano S.p.A., US Bancorp, Wachovia Corporation,
Wells Fargo & Company and Westpac Banking
Corporation.
The extent to which the TSR award will vest
will be determined on a sliding scale based on HSBC
Holdings’ relative TSR ranking against the
comparator group.
For TSR performance in line with the bank
ranked 14th, only 30 per cent of the conditional TSR
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
282
list. In simple terms, the percentage vesting will start
at 30 per cent and 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 HSBC’s
TSR performance relative to the banks immediately
above and below it. For example, if HSBC’s TSR
falls half way between the bank ranked 12th (where,
a release of 50 per cent of the TSR award would
occur) and the bank ranked 13th (where a release of
40 per cent of the TSR award would occur), then the
actual proportion of the TSR award released would
be 45 per cent, i.e. half way between 40 per cent and
50 per cent.
For the EPS award, the base measure will be
EPS for the financial year preceding that in which
the award is made (‘the base year’). EPS will then be
compared with the base year over three consecutive
financial years commencing with the year in which
the award is made. Incremental EPS will be
calculated by expressing as a percentage of the EPS
of the base year the difference each year of the three-
year performance period between the EPS of that
year and the EPS of the base year (with a negative
percentage for any year in which the EPS is less than
the EPS of the base year). These percentages will
then be aggregated to arrive at the total incremental
EPS for the performance period. In the event that the
published EPS for the base year is restated during
the performance period to adjust for changes in
accounting standards, that restated EPS will be used
for the purposes of the EPS performance condition.
The percentage of the conditional EPS award
vesting will depend upon the absolute growth in EPS
achieved over the three years. 30 per cent of the EPS
award will vest if the incremental EPS over the
performance period is 24 per cent or more.
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.
No element of the TSR award will vest if over
the three-year performance period HSBC’s TSR is
below that of the bank ranked 14th in the comparator
group 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.
To the extent that the performance conditions
have not been met at the third anniversary, the shares
awarded will be forfeited.
of award. The test is due to be applied again in
March 2007 in respect of the 2003 awards. If it is
passed, full vesting and transfer of the shares will
take place on the fifth anniversary of the date of
grant, i.e. in March 2008. If it fails it will be subject
to a final test in March 2008. For awards made in
2004 the performance conditions are the same but, if
the performance test is not passed at the third
anniversary, i.e. in March 2007, 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 sustained
growth. The Remuneration Committee retains
discretion to recommend early release of shares
awarded in certain circumstances, for example,
retirement, redundancy or ill health.
When events occur which cause the
Remuneration Committee to consider that the
performance conditions have become unfair or
impractical, the right is reserved for the Committee
to amend or substitute the performance conditions.
Whilst the Committee decided that options granted
in 2003 under the HSBC Holdings Group Share
Option Plan to employees below senior executive
level could vest in March 2006 notwithstanding the
failure to achieve the TSR performance condition,
the awards of Performance Shares made in 2003
under the HSBC Holdings Restricted Share Plan
2000 to the 400 or so most senior executives of the
Group continue to be subject to the pre-established
TSR benchmark performance conditions, as set out
above.
Total Shareholder Return
Graphs 1 to 4 below show HSBC Holdings’ TSR
performance against the following:
• Graph 1: the benchmark TSR for Performance
Shares awarded in March 2003;
• Graph 2: The Financial Times-Stock Exchange
FTSE 100;
• Graph 3: The Morgan Stanley Capital
International (‘MSCI’) World Index; and
• Graph 4: The MSCI Financials Index.
In addition, awards will not vest unless the
Remuneration Committee is satisfied that HSBC
Holdings’ financial performance has shown a
sustained improvement in the period since the award
date.
In determining whether HSBC has achieved a
sustained improvement in performance the
Remuneration Committee will take account of all
relevant factors but in particular comparisons against
the comparator group in areas such as revenue
growth and mix, cost efficiency, credit performance,
cash return on cash invested, dividend performance
and total shareholder return.
Following the three-year performance period,
the conditions applying to awards of Performance
Shares under The HSBC Share Plan will be tested
and vesting will take place shortly afterwards. Shares
released will include additional shares equivalent to
the value of the dividends payable on the vested
shares over the performance period, where permitted
by the laws of the relevant jurisdiction.
If events occur which cause the Remuneration
Committee to consider that a performance condition
has become unfair or impractical, the right is
reserved to the Remuneration Committee, if it
considers it appropriate to do so, to amend, relax or
waive the condition.
Awards will vest in full immediately in cases of
death. In the event of redundancy, retirement on
grounds of injury or ill health, early retirement by
agreement, normal retirement and where a
participant ceases to be employed by HSBC, awards
will normally vest at the end of the vesting period on
a time-apportioned basis to the extent that the
performance conditions have been satisfied. In the
event of a change of control, awards will normally
vest immediately and on a time-apportioned basis to
the extent that the TSR performance condition has
been satisfied. Awards will normally be forfeited if
the participant is dismissed for cause or resigns from
HSBC. In all these circumstances the Committee
retains discretion to ensure fair and reasonable
treatment.
Arrangements from 2001-2004
Between 2001 and 2004, awards of Performance
shares were made under the HSBC Holdings
Restricted Share Plan 2000. Vesting was linked to
the attainment of predetermined TSR targets over a
three-year period from the date of the award.
For awards made in 2003 the initial performance
period was three years but the performance target
was not achieved at the third anniversary of the date
283
H S B C H O L D I N G S P L C
Directors’ Remuneration Report (continued)
Executive Directors / Non-executive Directors
Graph 1: HSBC TSR and Benchmark TSR
Graph 5: HSBC TSR and FTSE 100 Index
Graph 2: HSBC TSR and FTSE 100 Index
Source: Datastream
Pensions
Graph 3: HSBC TSR and MSCI World Index
The normal retirement age for executive Directors
is 65.
The pension entitlements earned by the
executive Directors during the year are set out on
pages 286 and 287.
Service contracts
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.
Each executive Director has a rolling service
contract with a notice period of 12 months for either
party save that D J Flint’s contract provides for nine
months notice to be given by Mr Flint. There are no
provisions for compensation upon early termination
of any executive Directors’ service contracts.
The dates of executive Directors’ service
Graph 4: HSBC TSR and MSCI Financials Index
contracts are as follows:
Contract date
Sir John Bond1 ...................................
14 July 1994
D J Flint ............................................. 29 September 1995
25 May 2004
M F Geoghegan .................................
9 March 1998
S K Green ...........................................
A W Jebson1 .......................................
14 January 2000
1 Retired as a Director on 26 May 2006.
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
Pursuant to the Directors’ Remuneration Report
Regulations 2002, graph 5 below shows HSBC
Holdings’ TSR performance against the FTSE 100
Index, for the five-year period ended 31 December
2006. The FTSE 100 has been chosen as this is a
recognised broad equity market index of which
HSBC Holdings is a member.
284
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 HSBC, unless
otherwise approved by the Remuneration
Committee.
Sir John Bond retained his fees as a non-
executive Director of the Ford Motor Company,
which were provided partly in the form of restricted
shares, which become unrestricted over a period of
five years. During the period from 1 January to
26 May 2006, when Sir John Bond retired as a
Director of HSBC Holdings, the fees received were
US$32,000 in cash and US$48,000 deferred into
Ford common stock units. In addition, Ford provided
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.
Non-executive Directors
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 2007,
R K F Ch’ien, S Hintze and H Sohmen; in 2008,
Lord Butler, Baroness Dunn, J D Coombe,
W K L Fung, J W J Hughes-Hallett and Sir Brian
Moffat; in 2009, S W Newton, S M Robertson and
Sir Brian Williamson; and in 2010, R A Fairhead, Sir
Mark Moody-Stuart and G Morgan.
Fees
Non-executive Directors’ fees are regularly reviewed
and compared with other large international
companies. The current fee, which was approved by
shareholders in 2006, is £65,000 per annum.
In addition, non-executive Directors receive the
following fees:
Chairman, Audit Committee ......................
Member, Audit Committee .........................
£50,000 p.a.
£20,000 p.a.
During 2006, seven meetings of the Group Audit Committee
were held.
Chairman, Remuneration Committee .........
Member, Remuneration Committee ...........
£40,000 p.a.
£20,000 p.a.
During 2006, seven meetings of the Remuneration Committee
were held.
Chairman, Nomination Committee ............
Member, Nomination Committee ...............
£30,000 p.a.
£20,000 p.a.
During 2006, four meetings of the Nomination Committee
were held.
Chairman, Corporate Responsibility
Committee ..............................................
£30,000 p.a.
Member, Corporate Responsibility
Committee ..............................................
£20,000 p.a.
During 2006, five meetings of the Corporate Responsibility
Committee were held.
285
H S B C H O L D I N G S P L C
Directors’ Remuneration Report (continued)
Directors emoluments / Pensions / Share plans
Directors’ emoluments
(Audited)
The emoluments of the Directors of HSBC Holdings for 2006 were as follows:
Fees
£000
Salary Allowance1
£000
£000
Benefits
in kind2
£000
Bonuses3
£000
–
–
–
–
–
115
200
97
85
85
136
105
77
44
145
125
16
65
65
–
85
602
563
939
1,170
227
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
275
375
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
16
17
19
14
7
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
1,458
500
1,5356
1,750
573
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
Total
2006
£000
2,076
1,355
2,868
2,934
807
115
200
97
85
85
136
105
77
44
145
125
16
65
65
–
85
Total
2005
£000
4,479
1,190
671
2,529
1,547
90
187
53
70
70
117
85
46
85
115
85
–
55
–
16
70
Executive Directors4
Sir John Bond5 .................
D J Flint ...........................
M F Geoghegan ...............
S K Green ........................
AW Jebson5 .....................
Non-executive Directors
Lord Butler ......................
R K F Ch’ien7 ..................
J D Coombe .....................
Baroness Dunn .................
R A Fairhead ....................
W K L Fung8 ....................
S Hintze ...........................
J W J Hughes-Hallett .......
Sir John Kemp-Welch5 ....
Sir Brian Moffat ...............
Sir Mark Moody-Stuart ...
G Morgan9 .......................
S W Newton .....................
S M Robertson10 ..............
H Sohmen11 ......................
Sir Brian Williamson .......
Total12 ..............................
Total (US$000) ................
1,445
2,660
3,501
6,444
650
1,196
73
134
5,816
10,705
11,485
21,139
15,541
28,233
1 Executive allowance paid to fund personal pension arrangements.
2 Benefits in kind for executive Directors include provision of company car, medical insurance, other insurance cover, accountancy
advice and travel assistance.
3 These discretionary bonuses are in respect of 2006.
4 Each of the executive Directors waived their right to receive a fee from HSBC Holdings (2006: £27,083; 2005: £55,000).
5 Retired as a Director on 26 May 2006.
6 In return for the prior waiver of part of his bonus, an employer contribution has been made into a pension arrangement for
M F Geoghegan equal to £215,000 (2005: £1,818,750) which would otherwise have been paid.
7 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.
8 Includes fee as a non-executive Director of The Hongkong and Shanghai Banking Corporation.
9 Appointed as a Director on 1 October 2006.
10 Appointed as a Director on 3 January 2006.
11 H Sohmen has elected to waive any fees payable to him by HSBC Holdings (2006: £65,000; 2005: £55,000).
12 Total emoluments for 2005 include the emoluments of Directors who retired in that year.
Pensions
(Audited)
S K Green ceased membership of the HSBC Bank
(UK) Pension Scheme on 5 April 2006. From 6 April
2006 Mr Green has been entitled to receive benefits
from an Employer-Funded Retirement Benefits
Scheme (EFRBS). The benefits from the HSBC
Bank (UK) Pension Scheme will be calculated based
on completed service to the date of opting out and on
pensionable salary calculated at the date employment
with HSBC Holdings plc ceases. The intention of
this arrangement is to provide benefits to Mr Green
that would be broadly comparable to an accrual rate
of one-thirtieth of pensionable salary for each year of
pensionable service.
M F Geoghegan ceased membership of the
HSBC International Staff Retirement Benefits
Scheme on 31 March 2006. From 1 April 2006 Mr
Geoghegan transferred all past service benefits into
the HSBC Asia Holdings Pension Plan, on a defined
contribution basis (see below). An employer
contribution was made to the HSBC Asia Holdings
Pension Plan in respect of 2006 of £215,000 (2005:
£1,818,750) arising entirely from a bonus sacrifice.
There were no other employer contributions made to
this plan. From 1 April 2006 Mr Geoghegan has
286
received an executive allowance of 50 per cent of
annual basic salary to fund personal pension
arrangements.
From 1 January 2006 to 31 March 2006
D J Flint received an executive allowance of 30 per
cent of annual basic salary which was paid to fund
personal pension arrangements. In addition, for the
same period, Mr Flint participated in the HSBC
Holdings plc Funded Unapproved Retirement
Benefits Scheme (FURBS) on a defined
contribution basis with an employer contribution of
£26,594 (2005: £92,500). The intention of this
arrangement was to provide benefits broadly
comparable to an accrual rate of one-thirtieth of
pensionable salary for each year of pensionable
service. From 1 April 2006 the FURBS was closed
and, to ensure that pension arrangements for Mr
Flint remain broadly comparable, the executive
allowance was increased to 55 per cent of annual
basic salary.
Accrued
annual
pension at
31 December
Increase in
accrued
pension
during
Sir John Bond2 .....
M F Geoghegan4 .
S K Green ...........
A W Jebson2 ........
2006
£000
494
–
586
214
Increase in
accrued
pension
during 2006,
excluding
any increase
for inflation
£000
2006
£000
Transfer
value
of accrued
pension at
31 December
20051
£000
Transfer
value
of accrued
pension at
31 December
20061
£000
Increase of
transfer value
of accrued
pension (less
personal
contributions)
in 20061
£000
Transfer value
(less personal
contributions) at
31 December 2006
relating to increase
in accrued pensions
during 2006,
excluding any
increase for inflation1
£000
583
14
251
13
49
–
239
10
10,667
12,495
5,758
3,231
11,4103
–
11,0825
5,287
743
–
5,324
2,056
947
–
4,513
254
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 Sir John Bond and A W Jebson retired as employees on 31 May 2006. The accrued annual pension at 31 December 2006 is the same
amount as was put into payment on 31 May 2006 following their retirement. Sir John Bond elected to receive a lump sum payment on his
retirement, as allowed under the rules of the HSBC Bank (UK) Pension Scheme. The accrued pension at 31 December 2006 for Sir John
Bond is therefore lower than would have been the case had he not opted to receive a lump sum payment.
3 The increase in accrued pension during 2006 has been calculated as the difference between the accrued pension as at 31 December
2006 (ignoring the reduction to the accrued pension due to the exchange of some pension for a lump sum payment on retirement) and
the accrued pension as at 31 December 2005. The actual post commutation pension in payment at the year end is lower than the accrued
pension at the start of the year due to the exchange of pension for a lump sum payment on retirement.
4 As noted above, on 31 March 2006 M F Geoghegan ceased membership of, and the accrual of benefits under, the HSBC International
Staff Retirement Benefits Scheme. As required by the rules of the HSBC International Staff Retirement Benefits Scheme, M F Geoghegan
made personal contributions towards his pension of £4,308 in respect of 2006. At 31 December 2005 M F Geoghegan was entitled to a
pension of £557,000 per annum and at 31 March 2006 he was entitled to a pension of £571,000 per annum, an increase in accrued
pension entitlement during the period of £14,000 per annum (£10,000 per annum excluding any increase for inflation). The increase in
the transfer value of the accrued pension (less personal contributions) from 31 December 2005 to 31 March 2006 was £419,000. The
transfer value (less personal contributions) at 31 March 2006 relating to the increase in accrued pension during 2006, excluding any
increase for inflation, was £216,000. M F Geoghegan transferred all his benefits out of the HSBC International Staff Retirement Benefits
Scheme on 31 March 2006 with a transfer payment from the Scheme of £12,918,000 into the HSBC Asia Holdings Pension Plan on a
defined contribution basis. There were no pension liabilities under the HSBC International Staff Retirement Benefits Scheme for
M F Geoghegan at 31 December 2006.
5 Increase in transfer value reflects increase in base salary in 2006, following S K Green’s new role as Group Chairman.
The following unfunded pension payments, in
respect of which provision has been made, were
made during 2006 to five former Directors of HSBC
Holdings:
B H Asher ..................................
C F W de Croisset ......................
R Delbridge ................................
Sir Brian Pearse .........................
Sir William Purves .....................
2006
£
93,812
183,652
134,934
56,269
99,310
567,977
2005
£
90,465
178,344
130,120
54,261
95,767
548,957
The payments in respect of R Delbridge and Sir
Brian Pearse were made by HSBC Bank plc as
former Directors of that bank. The payment in
respect of C F W de Croisset was made by HSBC
France as a former Director of that bank.
Share plans
(Audited)
At 31 December 2006, the undernamed Directors
held Performance Share awards and options to
acquire the number of HSBC Holdings ordinary
shares set against their respective names.
The options awarded under the HSBC Holdings
Savings-Related Share Option Plan before 2001
were exercised at a 15 per cent discount to the
average market value of the ordinary shares on the
five business days immediately preceding the
287
H S B C H O L D I N G S P L C
Directors’ Remuneration Report (continued)
Share plans
invitation date and those awarded since 2001 are
exercisable 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’. No options were awarded or
lapsed during the year and except as otherwise
indicated, no options were exercised during the year.
There are no performance criteria conditional upon
which the outstanding options are exercisable.
The market value of the ordinary shares at
29 December 2006 was £9.31. The highest and
HSBC Holdings Savings-Related Share Option Plan
HSBC Holdings ordinary shares of US$0.50
(Audited)
lowest market values during the year were
£10.28 and £9.14. Market value is the mid-market
price derived from the London Stock Exchange
Daily Official List on the relevant date.
Under the Securities and Futures Ordinance of
Hong Kong, Performance Share awards under The
HSBC Share Plan and the HSBC Holdings
Restricted Share Plan 2000 are categorised as ‘the
interests of a beneficiary of a Trust’.
Date of
award
Exercise
price (£)
Exercisable
from1
Exercisable
until
Options at
1 January
2006
Options
exercised
during year
Options
lapsed
during year
Options at
31 December
2006
D J Flint ................. 2 May 2002
M F Geoghegan ..... 10 Apr 2000
S K Green .............. 23 Apr 2003
6.3224 1 Aug 2007
6.0299 1 Aug 2005
5.3496 1 Aug 2008
31 Jan 2008
31 Jan 2006
31 Jan 2009
2,617
559
3,070
–
5332
–
–
262
–
2,617
–
3,070
1 May be advanced to an earlier date in certain circumstances, e.g. retirement.
2 Options over 533 shares were exercised on 31 January 2006 and options over 26 shares lapsed on that date. At the date of exercise, the
market value per share was £9.34.
The HSBC Share Plan
HSBC Holdings ordinary shares of US$0.50
(Audited)
Year in
which
awards
may vest
Awards at
1 January
2006
Date of
award
Sir John Bond .........
27 May 2005
D J Flint ..................
M F Geoghegan ......
S K Green ...............
27 May 2005
6 Mar 2006
27 May 2005
6 Mar 2006
27 May 2005
6 Mar 2006
A W Jebson .............
27 May 2005
2008
2008
2009
2008
2009
2008
2009
2008
474,353
177,883
–
237,177
–
296,471
–
167,803
Awards
made
during
year1
–
–
161,458
–
201,823
–
252,278
–
Monetary
value of
awards made
during year
£000
Awards at
31 December
20062
–
–
1,600
–
2,000
–
2,500
–
495,521
185,821
167,220
247,761
209,025
309,701
261,280
175,291
Vesting of these Performance Share awards is subject to the performance conditions described on page 281 being satisfied.
1 At the date of the award, 6 March 2006, the market value per share was £9.895.
2 Includes additional shares arising from scrip dividends.
HSBC Holdings Restricted Share Plan 2000
HSBC Holdings ordinary shares of US$0.50
(Audited)
Sir John Bond ............
Date of
award
12 Mar 2001
8 Mar 2002
5 Mar 2003
4 Mar 2004
Year in
which
awards
may vest
2006
2007
2008
2009
Awards at
1 January
2006
91,276
136,679
182,406
263,574
Awards
vested
during
year1
92,0632
141,5973
188,9694
273,0584
Monetary
value of
awards vested
during year
£000
Awards at
31 December
20061
914
1,318
1,759
2,583
–
–
–
–
288
D J Flint .....................
M F Geoghegan .........
S K Green ..................
A W Jebson ................
Date of
award
12 Mar 2001
8 Mar 2002
5 Mar 2003
4 Mar 2004
12 Mar 2001
8 Mar 2002
5 Mar 2003
4 Mar 2004
12 Mar 2001
8 Mar 2002
5 Mar 2003
4 Mar 2004
12 Mar 2001
8 Mar 2002
5 Mar 2003
4 Mar 2004
Year in
which
awards
may vest
Awards at
1 January
2006
Awards
vested
during
year1
Monetary
value of
awards vested
during year
£000
Awards at
31 December
20061
2006
2007
2008
2009
2006
2007
2008
2009
2006
2007
2008
2009
2006
2007
2008
2009
65,198
86,324
124,367
130,532
39,119
43,162
58,040
97,899
91,276
107,905
124,367
179,481
78,237
100,712
124,368
130,532
65,7602
–
–
–
39,4562
–
–
–
92,0632
–
–
–
78,9112
104,3353
–
–
653
–
–
–
392
–
–
–
914
–
–
–
783
993
–
–
–
90,176
129,917
136,357
–
45,089
60,630
102,268
–
112,720
129,917
187,490
–
–
127,7545
134,0865
Vesting of these Performance Share awards is subject to the attainment of predetermined TSR targets over a three-year period from the date
of the award. Full vesting and transfer of the shares will not generally occur until the fifth anniversary of the date of award. 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 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 (1) above, weighted by market
capitalisation; and (3) the banking sector of the Morgan Stanley Capital International World Index, excluding any within (1) or (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 (1), 25 per cent is applied to (2) and 25 per cent is applied to (3), a single TSR benchmark for market
comparison was determined. The benchmark was chosen to reward the delivery of sustained financial growth of HSBC Holdings and to
align the interests of participants with those of shareholders. The extent to which each award will vest will be determined by reference to
HSBC Holdings’ TSR measured against the TSR benchmark. 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 (base salary and bonus in respect of the
previous performance year), 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, will vest at this level of performance. If HSBC Holdings’ TSR over the
performance period places it within the upper quartile of the ranked list of the banks comprising 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. If the upper quartile
performance level is achieved at the third anniversary of the date of award then 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.
Includes additional shares arising from scrip dividends.
1
2 The performance tests set out above were met in 2004 and the shares have vested. At the date of vesting, 13 March 2006, the market
value per share was £9.925. The market value per share at the date of the award, 12 March 2001, was £8.62.
3 Retired as a Director on 26 May 2006. The awards held at the date of retirement that had passed the performance condition set out
above vested immediately. Consequently, the 2002 awards were released to Sir John Bond on 14 June 2006 when the market value per
share was £9.31 and to A W Jebson on 30 June 2006 when the market value per share was £9.515. The market value per share at the
date of the award, 8 March 2002, was £8.34.
In line with the previous practice for executives who had worked significantly beyond retirement age, and where the awards had passed
the performance condition at the time of originally planned retirement, the Remuneration Committee agreed that the Performance
Share awards held by Sir John Bond at retirement should vest in full without time prorating. Consequently, the 2003 award vested on
14 June 2006 when the market value per share was £9.31. The 2004 award vested in two tranches: the first on 16 June 2006
(200,000 shares) when the market value per share was £9.37; and the second on 31 July 2006 (73,058 shares) when the market value
per share was £9.71. The market values per share at the dates of the awards, 5 March 2003 and 4 March 2004, were £6.70 and £8.515
respectively.
Interests at date of retirement as a Director (26 May 2006).
4
5
On behalf of the Board
5 March 2007
Sir Mark Moody-Stuart, Chairman of Remuneration Committee
289
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 291 and 292, 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 responsible for preparing the Annual Report, the consolidated financial statements of HSBC
Holdings and its subsidiaries (the ‘Group’) and holding company financial statements for HSBC Holdings (the
‘parent company’) in accordance with applicable law and regulations.
Company law requires the Directors to prepare Group and parent company financial statements for each
financial year. The Directors are required to prepare the Group financial statements in accordance with IFRSs as
adopted by the EU and have elected to prepare the parent company financial statements on the same basis.
The Directors 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 Group and parent company financial statements are required by law and IFRSs as adopted by the EU to
present fairly the financial position of the Group and the parent company and the performance for that period; the
Companies Act 1985 provides in relation to such financial statements that references in the relevant part of that Act
to financial statements giving a true and fair view are references to their achieving a fair presentation.
In preparing each of the Group and parent company financial statements, the Directors are required to:
•
select suitable accounting policies and then apply them consistently;
• make judgments and estimates that are reasonable and prudent; and
•
state whether they have been prepared in accordance with IFRSs as adopted by the EU.
The Directors are required to prepare the financial statements on the going concern basis unless it is not
appropriate. Since the Directors are satisfied that the Group 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 have responsibility for ensuring that sufficient accounting records are kept that disclose with
reasonable accuracy at any time the financial position of the parent company and enable them to ensure that its
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 the Group and to prevent and detect fraud and other irregularities.
Under applicable law and regulations, the Directors also have responsibility for preparing a Directors’ Report,
Directors’ Remuneration Report and the Corporate Governance statement on pages 248 to 289 that comply with that
law and those regulations.
The Directors have responsibility for the maintenance and integrity of the Annual Report and Accounts as
they appear on the company’s website. Legislation in the UK governing the preparation and dissemination of
financial statements may differ from legislation in other jurisdictions.
On behalf of the Board
R G Barber, Secretary
5 March 2007
290
H S B C H O L D I N G S P L C
Independent Auditor’s Report to the Members of HSBC Holdings plc
We have audited the Group and parent company financial statements (the ‘financial statements’) of HSBC Holdings
plc for the year ended 31 December 2006 which comprise the Group Income Statement, the Group and parent
Company Balance Sheets, the Group and parent Cash Flow Statements, the Group Statement of Recognised Income
and Expense, the Company Statement of Changes in Equity and the related notes. These financial statements have
been prepared under the accounting policies set out therein. 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 company’s members, 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 company’s members 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 the company and the company’s members 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’ responsibilities for preparing the Annual Report, the Directors Remuneration Report and the financial
statements in accordance with applicable law and International Financial Reporting Standards (IFRSs) as adopted by
the EU are set out in the Statement of Directors’ Responsibilities on page 290.
Our responsibility is to audit the financial statements and the part of the Directors’ Remuneration Report to be
audited in accordance with relevant legal and regulatory requirements and International Standards on Auditing (UK
and Ireland).
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 and, as regards the group financial statements, Article 4 of the IAS
Regulation. We also report to you whether in our opinion the information given in the Directors’ Report is consistent
with the financial statements.
In addition we report to you if, in our opinion, the company 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 other transactions is not disclosed.
We review whether the Corporate Governance Statement reflects the company’s compliance with the nine
provisions of the 2003 Combined Code specified for our review by the Listing Rules of the Financial Services
Authority, 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 the group’s corporate governance
procedures or its risk and control procedures.
We read the other information contained in the Annual Report and Accounts 2006 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. Our responsibilities do not
extend to any other information.
Basis of audit opinion
We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) 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 judgments made by the directors in the preparation of the
financial statements, and of whether the accounting policies are appropriate to the group’s and company’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.
291
H S B C H O L D I N G S P L C
Independent Auditor’s Report to the Members of HSBC Holdings plc (continued)
Opinion
In our opinion:
•
•
•
•
the Group financial statements give a true and fair view, in accordance with IFRSs as adopted by the EU, of the
state of the Group’s affairs as at 31 December 2006 and of its profit for the year then ended;
the parent company financial statements give a true and fair view, in accordance with IFRSs as adopted by the
EU as applied in accordance with the provisions of the Companies Act 1985, of the state of the parent
company’s affairs as at 31 December 2006;
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 and, as regards the group financial statements, Article 4 of
the IAS Regulation; and
the information given in the Directors' Report is consistent with the financial statements.
KPMG Audit Plc
Chartered Accountants
Registered Auditor
5 March 2007
292
32 Subordinated liabilities ..........................
33 Fair value of financial instruments ........
34 Maturity analysis of assets and
Page
378
382
liabilities .............................................
35 Foreign exchange exposures ..................
36 Assets charged as security for
liabilities and collateral accepted as
security for assets ...............................
37 Minority interests ...................................
38 Called up share capital ...........................
39 Equity ....................................................
40 Notes on the cash flow statement ..........
41 Contingent liabilities, contractual
commitments and financial
guarantee contracts .............................
42 Lease commitments ...............................
43 Litigation ...............................................
44 Related party transactions ......................
45 Events after the balance sheet date ........
46 UK and Hong Kong accounting
383
385
386
387
387
392
395
396
398
399
399
402
requirements .......................................
403
47 Differences between IFRSs and US
GAAP ................................................
403
H S B C H O L D I N G S P L C
Financial Statements
Page
Financial Statements
Consolidated income statement .....................
Consolidated balance sheet ...........................
Consolidated statement of recognised
income and expenses .................................
Consolidated cash flow statement .................
HSBC Holdings balance sheet ......................
HSBC Holdings statement of changes in
total equity .................................................
HSBC Holdings cash flow statement ............
Notes on the Financial Statements
1 Basis of preparation ...............................
2 Summary of significant accounting
294
295
296
297
298
299
300
301
policies ...............................................
304
3 Net income from financial instruments
designated at fair value .......................
4 Net earned insurance premiums .............
5 Net insurance claims incurred and
movement in policyholders’
liabilities .............................................
6 Net operating income .............................
7 Employee compensation and benefits ....
8 Auditors’ remuneration ..........................
9 Share-based payments ...........................
10 Tax expense ...........................................
11 Dividends ...............................................
12 Earnings per share ..................................
13 Segment analysis ...................................
By geographical region ......................
By customer group .............................
14 Analysis of financial assets and
financial liabilities by
measurement value .............................
15 Trading assets ........................................
16 Financial assets designated at fair
value ...................................................
17 Derivatives .............................................
18 Financial investments ............................
19 Securitisations and other structured
317
318
318
319
320
331
332
338
339
339
340
340
344
346
350
351
352
356
transactions .........................................
359
20 Interests in associates and joint
ventures ..............................................
21 Goodwill and intangible assets ..............
22 Impairment of assets other than
financial instruments ..........................
23 Property, plant and equipment ...............
24 Investments in subsidiaries ....................
25 Other assets ............................................
26 Trading liabilities ...................................
27 Financial liabilities designated at fair
value ...................................................
28 Debt securities in issue ..........................
29 Other liabilities ......................................
30 Liabilities under insurance contracts .....
31 Provisions ..............................................
360
362
364
366
368
371
371
372
372
373
374
377
293
H S B C H O L D I N G S P L C
Financial Statements (continued)
Consolidated income statement for the year ended 31 December 2006
Notes
Interest income ....................................................................................
Interest expense ...................................................................................
Net interest income ..............................................................................
Fee income ...........................................................................................
Fee expense ..........................................................................................
Net fee income .....................................................................................
Trading income excluding net interest income ...................................
Net interest income on trading activities .............................................
Net trading income ..............................................................................
Net income from financial instruments designated at fair value ........
Net investment income on assets backing policyholders’ liabilities ..
Gains less losses from financial investments ......................................
Dividend income ..................................................................................
Net earned insurance premiums ..........................................................
Other operating income .......................................................................
3
4
2006
US$m
75,879
(41,393)
34,486
21,080
(3,898)
17,182
5,619
2,603
8,222
657
–
969
340
5,668
2,546
2005
US$m
60,094
(28,760)
31,334
17,486
(3,030)
14,456
3,656
2,208
5,864
1,034
–
692
155
5,436
2,733
2004
US$m
50,471
(19,372)
31,099
15,902
(2,954)
12,948
2,786
–
2,786
–
1,012
540
622
5,368
1,613
Total operating income .....................................................................
70,070
61,704
55,988
Net insurance claims incurred and movement in policyholders’
liabilities .........................................................................................
5
(4,704)
(4,067)
(4,635)
Net operating income before loan impairment charges and
other credit risk provisions ..........................................................
Loan impairment charges and other credit risk provisions .................
Net operating income ........................................................................
Employee compensation and benefits .................................................
General and administrative expenses ..................................................
Depreciation and impairment of property, plant and equipment ........
Amortisation and impairment of intangible assets...............................
6
7
8
23
Total operating expenses ...................................................................
Operating profit .................................................................................
Share of profit in associates and joint ventures ...................................
20
Profit before tax .................................................................................
Tax expense .........................................................................................
10
Profit for the year ..............................................................................
Profit attributable to shareholders of the parent company ..................
Profit attributable to minority interests ...............................................
Basic earnings per ordinary share .......................................................
Diluted earnings per ordinary share ....................................................
Dividends per ordinary share ..............................................................
12
12
11
65,366
(10,573)
54,793
(18,500)
(12,823)
(1,514)
(716)
(33,553)
21,240
846
22,086
(5,215)
16,871
15,789
1,082
US$
1.40
1.39
0.76
57,637
(7,801)
49,836
(16,145)
(11,183)
(1,632)
(554)
(29,514)
20,322
644
20,966
(5,093)
15,873
15,081
792
US$
1.36
1.35
0.69
51,353
(6,191)
45,162
(14,523)
(9,739)
(1,731)
(494)
(26,487)
18,675
268
18,943
(4,685)
14,258
12,918
1,340
US$
1.18
1.17
0.63
The accompanying notes on pages 301 to 434, the audited sections of the ‘Report of the Directors: The Management of Risk’ on pages 165
to 247, and the ‘Critical accounting policies’ on pages 111 to 115 form an integral part of these financial statements.
294
Consolidated balance sheet at 31 December 2006
Notes
2006
US$m
ASSETS
Cash and balances at central banks ........................................................................................
Items in the course of collection from other banks ................................................................
Hong Kong Government certificates of indebtedness ...........................................................
Trading assets .........................................................................................................................
Financial assets designated at fair value ................................................................................
Derivatives ..............................................................................................................................
Loans and advances to banks .................................................................................................
Loans and advances to customers ..........................................................................................
Financial investments .............................................................................................................
Interests in associates and joint ventures ...............................................................................
Goodwill and intangible assets ...............................................................................................
Property, plant and equipment ................................................................................................
Other assets .............................................................................................................................
Prepayments and accrued income ..........................................................................................
15
16
17
33
33
18
20
21
23
25
12,732
14,144
13,165
328,147
20,573
103,702
185,205
868,133
204,806
8,396
37,335
16,424
33,444
14,552
2005
US$m
13,712
11,300
12,554
232,909
15,046
73,928
125,965
740,002
182,342
7,249
33,200
15,206
26,596
11,961
Total assets .............................................................................................................................
1,860,758
1,501,970
LIABILITIES AND EQUITY
Liabilities
Hong Kong currency notes in circulation ..............................................................................
Deposits by banks ...................................................................................................................
Customer accounts ..................................................................................................................
Items in the course of transmission to other banks ................................................................
Trading liabilities ....................................................................................................................
Financial liabilities designated at fair value ...........................................................................
Derivatives ..............................................................................................................................
Debt securities in issue ...........................................................................................................
Retirement benefit liabilities ..................................................................................................
Other liabilities .......................................................................................................................
Liabilities under insurance contracts ......................................................................................
Accruals and deferred income ................................................................................................
Provisions ................................................................................................................................
Subordinated liabilities ...........................................................................................................
Total liabilities ........................................................................................................................
Equity
Called up share capital ............................................................................................................
Share premium account ..........................................................................................................
Other reserves .........................................................................................................................
Retained earnings ...................................................................................................................
Total shareholders’ equity ......................................................................................................
Minority interests ....................................................................................................................
Total equity .............................................................................................................................
33
33
26
27
17
28
7
29
30
31
32
38
39
39
39
37
13,165
99,694
896,834
12,625
226,608
70,211
101,478
230,325
5,555
29,824
17,670
16,310
2,859
22,672
12,554
69,727
739,419
7,022
174,365
61,829
74,036
188,072
4,869
26,515
14,144
12,689
1,966
16,537
1,745,830
1,403,744
5,786
7,789
29,380
65,397
108,352
6,576
114,928
5,667
6,896
23,646
56,223
92,432
5,794
98,226
Total equity and liabilities ......................................................................................................
1,860,758
1,501,970
The accompanying notes on pages 301 to 434, the audited sections of the ‘Report of the Directors: The Management of Risk’ on pages 165
to 247, and the ‘Critical accounting policies’ on pages 111 to 115 form an integral part of these financial statements.
S K Green, Group Chairman
295
H S B C H O L D I N G S P L C
Financial Statements (continued)
Consolidated statement of recognised income and expense for the year ended 31 December 2006
Available-for-sale investments:
– fair value gains/(losses) taken to equity .................................................
– fair value gains transferred to income statement on disposal or
impairment ..............................................................................................
Cash flow hedges:
– fair value gains/(losses) taken to equity .................................................
– fair value gains transferred to income statement ....................................
Share of changes in equity of associates and joint ventures ...........................
Exchange differences .......................................................................................
Actuarial losses on defined benefit plans ........................................................
Tax on items taken directly to equity ..............................................................
Total income and expense taken to equity during the year .............................
Profit for the year .............................................................................................
Total recognised income and expense for the year .........................................
Effect of change in accounting policy
IFRSs transition adjustment at 1 January 20051 .........................................
Total recognised income and expense for the year attributable to:
– shareholders of the parent company .......................................................
– minority interests ....................................................................................
2006
US$m
1,582
(644)
1,554
(2,198)
20
4,675
(78)
4,911
(44)
4,867
16,871
21,738
–
21,738
20,527
1,211
21,738
2005
US$m
2004
US$m
(400)
(240)
(92)
(106)
161
(4,257)
(812)
(5,746)
437
(5,309)
15,873
10,564
(8,824)
1,740
9,912
652
10,564
–
–
–
–
–
3,720
(731)
2,989
319
3,308
14,258
17,566
–
17,566
15,743
1,823
17,566
1 For an explanation of the IFRSs transition adjustment at 1 January 2005, see Note 46 on the Financial Statements in the Annual Report
and Accounts 2005.
The accompanying notes on pages 301 to 434, the audited sections of the ‘Report of the Directors: The Management of Risk’ on pages 165
to 247, and the ‘Critical accounting policies’ on pages 111 to 115 form an integral part of these financial statements.
296
Consolidated cash flow statement for the year ended 31 December 2006
Cash flows from operating activities
Profit before tax ..........................................................................................
22,086
20,966
18,943
Notes
2006
US$m
2005
US$m
2004
US$m
Adjustments for:
– non-cash items included in profit before tax ...................................... 40
– change in operating assets ................................................................... 40
– change in operating liabilities ............................................................. 40
– elimination of exchange differences1 ..................................................
– net gain from investing activities ........................................................
– share of profits in associates and joint ventures .................................
– dividends received from associates .....................................................
– contribution paid to defined benefit pension schemes ........................
– tax paid ................................................................................................
Net cash from operating activities ..............................................................
Cash flows from investing activities
Purchase of financial investments ..............................................................
Proceeds from the sale of financial investments ........................................
Purchase of property, plant and equipment ................................................
Proceeds from the sale of property, plant and equipment ..........................
Net purchase of intangible assets ...............................................................
Net cash outflow from acquisition of and increase in stake of
subsidiaries .............................................................................................
Net cash inflow from disposal of subsidiaries ...........................................
Net cash outflow from acquisition of and increase in stake
of associates ............................................................................................
Proceeds from disposal of associates .........................................................
Net cash used in investing activities ..........................................................
Cash flows from financing activities
Issue of ordinary share capital ....................................................................
Issue of preference shares ...........................................................................
Net purchases and sales of own shares for market-making and
investment purposes ...............................................................................
Purchases of own shares to meet share awards and share
option awards .........................................................................................
On exercise of share options ......................................................................
Increase in non-equity minority interests ...................................................
Subordinated loan capital issued ................................................................
Subordinated loan capital repaid ................................................................
Dividends paid to shareholders of the parent company .............................
Dividends paid to minority interests:
– equity ...................................................................................................
– non-equity ............................................................................................
Net cash used in financing activities ..........................................................
Net increase/(decrease) in cash and cash equivalents ...........................
Cash and cash equivalents at 1 January .....................................................
Exchange differences in respect of cash and cash equivalents ..................
Cash and cash equivalents at 31 December ............................................... 40
14,956
(173,269)
237,378
(12,114)
(2,014)
(846)
97
(547)
(4,946)
80,781
(286,316)
273,774
(2,400)
2,504
(852)
(1,185)
62
(585)
874
(14,124)
1,010
374
46
(575)
173
–
5,948
(903)
(5,927)
(710)
–
(564)
66,093
141,307
8,086
215,486
11,404
(91,753)
72,212
2,580
(692)
(644)
114
(2,547)
(4,619)
7,021
(378,103)
368,696
(2,887)
620
(849)
(1,662)
705
(2,569)
422
(15,627)
690
1,298
(55)
(766)
277
–
2,093
(1,121)
(5,935)
(508)
–
(4,027)
(12,633)
160,956
(7,016)
141,307
11,406
(133,143)
175,503
(7,783)
(540)
(268)
127
(564)
(3,784)
59,897
(330,917)
315,437
(2,830)
371
(108)
(2,431)
27
(2,122)
212
(22,361)
581
–
98
(345)
159
1,480
6,021
(1,740)
(4,425)
(664)
(548)
617
38,153
117,558
5,245
160,956
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.
The accompanying notes on pages 301 to 434, the audited sections of the ‘Report of the Directors: The Management of Risk’ on pages 165
to 247, and the ‘Critical accounting policies’ on pages 111 to 115 form an integral part of these financial statements.
297
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 2006
Notes
2006
US$m
2005
US$m
ASSETS
Cash at bank and in hand:
– balances with HSBC undertakings .................................................................................
Derivatives ..............................................................................................................................
Loans and advances to HSBC undertakings ..........................................................................
Financial investments .............................................................................................................
Investments in subsidiaries .....................................................................................................
Property, plant and equipment ................................................................................................
Other assets .............................................................................................................................
Prepayments and accrued income ..........................................................................................
Total assets .............................................................................................................................
LIABILITIES AND EQUITY
Liabilities
Amounts owed to HSBC undertakings ..................................................................................
Financial liabilities designated at fair value ...........................................................................
Derivatives ..............................................................................................................................
Other liabilities .......................................................................................................................
Accruals and deferred income ................................................................................................
Deferred tax ............................................................................................................................
Subordinated liabilities ...........................................................................................................
Total liabilities ........................................................................................................................
Equity
Called up share capital ............................................................................................................
Share premium account ..........................................................................................................
Merger reserve and other reserves .........................................................................................
Other reserves .........................................................................................................................
Retained earnings ...................................................................................................................
Total equity .............................................................................................................................
Total equity and liabilities ......................................................................................................
17
33
24
33
27
17
29
31
32
38
729
1,599
14,456
3,614
62,356
1
91
41
82,887
3,100
14,070
177
1,517
111
–
8,423
27,398
5,786
7,789
28,942
2,384
10,588
55,489
82,887
756
968
14,092
3,517
58,038
1
171
19
77,562
4,075
13,370
286
1,203
95
70
5,236
24,335
5,667
6,896
28,942
2,221
9,501
53,227
77,562
The accompanying notes on pages 301 to 434, the audited sections of the ‘Report of the Directors: The Management of Risk’ on pages 165
to 247, and the ‘Critical accounting policies’ on pages 111 to 115 form an integral part of these financial statements.
S K Green, Group Chairman
298
HSBC Holdings statement of changes in total equity for the year ended 31 December 2006
2006
US$m
2005
US$m
5,667
5,587
Called up share capital
At 1 January ..................................................................................................................................
Shares issued in connection with the early settlement of HSBC Finance 8.875 per cent
Adjustable Conversion-Rate Equity Security Units ..................................................................
Shares issued under employee share plans ...................................................................................
Shares issued in lieu of dividends .................................................................................................
2
38
79
At 31 December ............................................................................................................................
5,786
Share premium account
At 1 January ..................................................................................................................................
Shares issued under employee share plans ...................................................................................
Shares issued in lieu of dividends and amounts arising thereon ..................................................
New share capital subscribed, net of costs ...................................................................................
At 31 December ............................................................................................................................
6,896
975
(82)
–
7,789
–
28
52
5,667
4,881
662
(52)
1,405
6,896
Merger reserve and other reserves
At 1 January and 31 December .....................................................................................................
28,942
28,942
Other reserves
Available-for-sale fair value reserve
At 1 January ..................................................................................................................................
IFRSs transition adjustments at 1 January 20051 ..........................................................................
Fair value changes taken to equity2 ...............................................................................................
Tax on items taken directly to equity2 ..........................................................................................
At 31 December ............................................................................................................................
Share-based payment reserve
At 1 January ..................................................................................................................................
Exercise of HSBC share options ...................................................................................................
Charge to the income statement in respect of equity settled share-based
payment transactions .................................................................................................................
Shares/options granted to employees of subsidiaries under employee share awards ...................
Other movements ...........................................................................................................................
At 31 December ............................................................................................................................
Other paid-in capital
At 1 January ..................................................................................................................................
Exercise of HSBC share options ...................................................................................................
At 31 December ............................................................................................................................
Total other reserves at 31 December .................................................................................................
Retained earnings
At 1 January ..................................................................................................................................
IFRSs transition adjustments at 1 January 20051 ..........................................................................
Profit for the year attributable to shareholders .............................................................................
Dividends to shareholders of the parent company ........................................................................
Amounts arising on shares in lieu of dividends ............................................................................
Own shares adjustments ................................................................................................................
Tax on share based payments ........................................................................................................
Exchange differences and other movements2 ...............................................................................
At 31 December3 ...........................................................................................................................
337
–
(121)
30
246
1,234
(381)
58
293
(2)
1,202
650
286
936
2,384
9,501
–
7,139
(8,769)
2,528
157
9
23
10,588
–
464
(184)
57
337
1,329
(328)
12
219
2
1,234
411
239
650
2,221
8,959
(317)
6,816
(7,750)
1,811
87
–
(105)
9,501
1 For an explanation of the IFRSs transition adjustment at 1 January 2005, see Note 46 on the Financial Statements in the Annual Report
and Accounts 2005.
2 The total net expense taken directly to equity during the year was US$59 million (2005: US$232 million).
3 Retained earnings include 35,639,856 (US$544 million) of own shares held to fund employee share plans (2005: 49,217,589,
US$701 million).
The accompanying notes on pages 301 to 434, the audited sections of the ‘Report of the Directors: The Management of Risk’ on pages 165
to 247, and the ‘Critical accounting policies’ on pages 111 to 115 form an integral part of these financial statements.
299
H S B C H O L D I N G S P L C
Financial Statements (continued)
HSBC Holdings cash flow statement for the year ended 31 December 2006
Cash flows from operating activities
Profit before tax ......................................................................................................................
6,974
6,541
Notes
2006
US$m
2005
US$m
Adjustments for:
– non-cash items included in profit before tax ..................................................................
– change in operating assets ...............................................................................................
– change in operating liabilities .........................................................................................
– elimination of exchange differences1 ..............................................................................
– net gain from investing activities ....................................................................................
– tax received .....................................................................................................................
40
40
40
Net cash from operating activities ..........................................................................................
Cash flows from investing activities
Proceeds from the sale of financial investments ....................................................................
Net cash outflow from acquisition of and increase in stake of subsidiaries ..........................
Net cash inflow from disposal of subsidiaries .......................................................................
Net cash used in investing activities ......................................................................................
Cash flows from financing activities
Issue of ordinary share capital ................................................................................................
Issue of preference shares .......................................................................................................
Purchases of own shares to meet share awards and share option awards ..............................
On exercise of share options ..................................................................................................
Subordinated loan capital issued ............................................................................................
Subordinated loan capital repaid ............................................................................................
Dividends paid ........................................................................................................................
Net cash used in financing activities ......................................................................................
Net increase/(decrease) in cash and cash equivalents .......................................................
Cash and cash equivalents at 1 January .................................................................................
Cash and cash equivalents at 31 December ............................................................................
40
58
(1,827)
1,056
(29)
(8)
219
6,443
–
(4,440)
–
(4,440)
1,010
–
(46)
127
2,806
–
(5,927)
(2,030)
(27)
756
729
13
3,563
(4,400)
(123)
–
158
5,752
303
(4,093)
1,063
(2,727)
690
1,405
(39)
67
1,647
(350)
(5,935)
(2,515)
510
246
756
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.
The accompanying notes on pages 301 to 434, the audited sections of the ‘Report of the Directors: The Management of Risk’ on pages 165
to 247, and the ‘Critical accounting policies’ on pages 111 to 115 form an integral part of these financial statements.
300
H S B C H O L D I N G S P L C
Notes on the Financial Statements
Note 1
1 Basis of preparation
(a) Compliance with International Financial Reporting Standards
The consolidated financial statements of HSBC and the separate financial statements of HSBC Holdings have
been prepared in accordance with International Financial Reporting Standards (‘IFRSs’) as endorsed by the EU.
EU-endorsed IFRSs may differ from IFRSs as published by the International Accounting Standards Board
(‘IASB’) if, at any point in time, new or amended IFRSs have not been endorsed by the EU. At 31 December
2006, there were no unendorsed standards effective for the year ended 31 December 2006 affecting these
consolidated and separate financial statements, and there was no difference in application to HSBC between
IFRSs endorsed by the EU and IFRSs issued by the IASB.
IFRSs comprise accounting standards issued by the IASB and its predecessor body and interpretations issued by
the International Financial Reporting Interpretations Committee (‘IFRIC’) and its predecessor body.
The significant accounting policies applied in the preparation of these financial statements are set out below.
They have been applied consistently, except for:
•
IAS 32 ‘Financial Instruments: Presentation’ (‘IAS 32’), IAS 39 ‘Financial Instruments: Recognition and
Measurement’ (‘IAS 39’) and IFRS 4 ‘Insurance Contracts’ (‘IFRS 4’) have been applied for the first time
from 1 January 2005. Where disclosed, the 2004 comparative information has been prepared on the basis of
HSBC’s previous accounting policies disclosed in Note 46g on the Financial Statements in the Annual
Report and Accounts 2005;
• HSBC has adopted ‘Amendment to IAS 39: The Fair Value Option’, ‘Amendment to IAS 19 Employee
Benefits: Actuarial Gains and Losses, Group Plans and Disclosures’, ‘Amendment to IAS 1 Presentation of
Financial Statements: Capital Disclosures’ and IFRIC 4 ‘Determining whether an Arrangement contains a
Lease’ with effect from 1 January 2005;
• No comparative information for disclosures required by IFRS 7 ‘Financial Instruments: Disclosures’ has
been presented for 2004 as permitted for entities applying the standard for annual periods beginning before
1 January 2006; and
• During 2006, HSBC changed how certain of its geographical operating segments are managed and their
performance assessed. As a result, a new segment, Latin America and the Caribbean (‘Latin America’), was
formed from the Group’s businesses previously reported under South America, and those in Mexico and
Panama which had been previously reported as part of the North America geographical segment. All prior
period comparative data have been restated to conform to the current year presentation.
On 1 January 2006, HSBC adopted ‘Amendments to IAS 39 and IFRS 4 – Financial Guarantee Contracts’,
‘Amendment to IAS 21 The Effects of Changes in Foreign Exchange Rates – Net Investment in a Foreign
Operation’, and ‘Amendment to IAS 39 – Cash Flow Hedge Accounting of Forecast Intragroup Transactions’.
The application of these amendments had no significant effect on the consolidated or separate financial
statements.
On 1 January 2006, HSBC adopted ‘IFRIC 7: Applying the Restatement Approach under IAS 29 Financial
Reporting in Hyperinflationary Economies’, ‘IFRIC 8 Scope of IFRS 2’ and ‘IFRIC 9 Reassessment of
Embedded Derivatives’ ahead of their effective dates. The application of these interpretations had no significant
effect on the consolidated or separate financial statements.
(b) Differences between IFRSs and US GAAP, and Hong Kong Financial Reporting Standards
A discussion of the significant differences between IFRSs and US GAAP and a reconciliation to US GAAP of
certain amounts is contained in Note 47. As stated in Note 46, there are no significant differences between IFRSs
and Hong Kong Financial Reporting Standards. The Notes on the Financial Statements, taken together with the
Report of the Directors, include the aggregate of all disclosures necessary to satisfy IFRSs, Hong Kong and US
reporting requirements.
(c) Presentation of information
Disclosures under IFRS 4 and IFRS 7 relating to the nature and extent of risks have been included in the audited
sections of the ‘Report of the Directors: The Management of Risk’ on pages 165 to 247.
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H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 1
Capital disclosures under IAS 1 ‘Presentation of Financial Statements’ have been included in the audited
sections of ‘Capital management and allocation’ on pages 243 to 247.
As a result of the Companies (Disclosure of Auditor Remuneration) Regulations 2005 coming into force, the
presentation and the level of detail of the information disclosed in Note 8 has changed compared with the prior
year. Comparative information has been provided on a consistent basis with the current year presentation as
required by IAS 1 ‘Presentation of Financial Statements’.
In publishing the parent company financial statements here together with the Group financial statements, HSBC
Holdings has taken advantage of the exemption in section 230 of the Companies Act 1985 not to present its
individual income statement and related notes that form a part of these financial statements.
HSBC has taken advantage of the exemption under Regulation 7 of the Partnerships and Unlimited Companies
(Accounts) Regulations 1993 from certain partnerships that are consolidated by HSBC presenting their own
individual financial statements under IFRSs.
The functional currency of HSBC Holdings plc is US dollars, which is also the presentational currency of the
consolidated financial statements of HSBC.
(d) Comparative information
As required by US GAAP, these consolidated financial statements include two years of comparative information
for the consolidated income statement, consolidated cash flow statement, consolidated statement of recognised
income and expense, and related notes on the financial statements, with certain exceptions in respect of the 2004
comparative information, as explained in (a) Compliance with International Financial Reporting Standards
above.
(e) Use of estimates and assumptions
The preparation of financial information requires the use of estimates and assumptions about future conditions.
Use of available information and application of judgement are inherent in the formation of estimates. Actual
results in the future may differ from those reported. In this regard, management believes that the critical
accounting policies where judgement is necessarily applied are those which relate to loan impairment, goodwill
impairment and the valuation of financial instruments (see Critical Accounting Policies on pages 111 to 115).
Further information about key assumptions concerning the future, and other key sources of estimation
uncertainty, are set out in the notes on these financial statements.
(f) Consolidation
The consolidated financial statements of HSBC comprise the financial statements of HSBC Holdings and its
subsidiaries 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 their audited interim financial statements, drawn up to 31 December annually.
Newly acquired subsidiaries are consolidated from the date that HSBC gains control. The purchase method of
accounting is used to account for the acquisition of subsidiaries by HSBC. The cost of an acquisition is measured
at the fair value of the consideration given at the date of exchange, together with costs directly attributable to that
acquisition. The acquired identifiable assets, liabilities and contingent liabilities are measured at their fair values
at the date of acquisition. Any excess of the cost of acquisition over the fair value of HSBC’s share of the
identifiable assets, liabilities and contingent liabilities acquired is recorded as goodwill. If the cost of acquisition
is less than the fair value of HSBC’s share of the identifiable assets, liabilities and contingent liabilities of the
business acquired, the difference is recognised immediately in the income statement.
Entities that are controlled by HSBC are consolidated until the date that control ceases.
In the context of Special Purpose Entities (‘SPEs’), the following circumstances may indicate a relationship in
which, in substance, HSBC controls and, consequently, consolidates an SPE:
•
the activities of the SPE are being conducted on behalf of HSBC according to its specific business needs so
that HSBC obtains benefits from the SPE’s operation;
• HSBC has the decision-making powers to obtain the majority of the benefits of the activities of the SPE or,
302
by setting up an ‘autopilot’ mechanism, HSBC has delegated these decision-making powers;
• HSBC has rights to obtain the majority of the benefits of the SPE and therefore may be exposed to risks
incident to the activities of the SPE; or
• HSBC retains the majority of the residual or ownership risks related to the SPE or its assets in order to
obtain benefits from its activities.
All intra-HSBC transactions are eliminated on consolidation.
The consolidated financial statements of HSBC also include the attributable share of the results and reserves of
joint ventures and associates. These are based on financial statements made up to 31 December, with the
exception of the Bank of Communications Limited, Ping An Insurance (Group) Company of China, Limited, and
Industrial Bank Company Limited which are included on the basis of financial statements made up for the twelve
months to 30 September. These are equity accounted three months in arrears in order to meet the requirements
of the Group’s reporting timetable. HSBC has taken into account changes in the period from 1 October to
31 December that would have materially affected its results.
(g) Future accounting developments
IFRSs
At 31 December 2006, HSBC had adopted all IFRSs and Interpretations that had been issued by the IASB and
IFRIC, and endorsed by the EU. There are currently no IFRSs or Interpretations that have been issued by the
IASB and endorsed by the EU which become effective after 31 December 2006 that have not been adopted by
HSBC.
Standards and Interpretations issued by the IASB but not endorsed by the EU
IFRS 8 ‘Operating Segments’ (‘IFRS 8’), which replaces IAS 14 ‘Segment Reporting’ (‘IAS 14’), was issued on
30 November 2006 and is effective for annual periods beginning on or after 1 January 2009. This standard
specifies how an entity should report information about its operating segments, based on information about the
components of the entity that management uses to make operating decisions. HSBC currently presents two sets
of segments in accordance with IAS 14, one geographical and one based on customer groups, which reflect the
way the businesses of the Group are managed. HSBC currently expects to adopt IFRS 8 with effect from
1 January 2009, and will accordingly present segmental information which reflects the operating segments used
to make operating decisions at that time.
IFRIC 10 ‘Interim Financial Reporting and Impairment’ (‘IFRIC 10’) was issued on 20 July 2006 and is
effective for annual periods beginning on or after 1 November 2006. IFRIC 10 states that any impairment losses
recognised in an interim financial statement in respect of goodwill under IAS 36 ‘Impairment of Assets’, or
certain financial assets under IAS 39 ‘Financial Instruments: Recognition & Measurement’ must not be reversed
in subsequent interim or annual financial statements. HSBC will adopt IFRIC 10 from 1 January 2007, though it
is not expected to have a significant effect.
IFRIC 11 ‘Group and Treasury Share Transactions’ (‘IFRIC 11’) was issued on 30 November 2006 and is
effective for annual periods beginning on or after 1 March 2007. IFRIC 11 requires a share-based payment
arrangement in which an entity receives goods or services as consideration for its own equity-instruments to be
accounted for as an equity-settled share-based payment transaction, regardless of how the equity instruments
required are obtained. The Interpretation also provides guidance on whether share-based payment arrangements
in which suppliers of goods or services of an entity are provided with equity instruments of the entity’s parent,
should be accounted for as cash-settled or equity-settled in the entity’s financial statements. HSBC applies IFRS
2 ‘Share-based Payment’ in the same manner as set out in IFRIC 11, therefore there will be no impact for HSBC.
IFRIC 12 ‘Service Concession Arrangements’ (‘IFRIC 12’) was issued on 30 November 2006 and is effective
for annual periods beginning on or after 1 January 2008. IFRIC 12 provides guidance on service concession
arrangements by which a government or other public sector entity grants contracts for the supply of public
services to private sector operators. IFRIC 12 addresses how service concession operators should apply existing
IFRSs to account for the obligations they undertake and the rights they receive in service concession
arrangements. IFRIC 12 is unlikely to have a material effect on HSBC.
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H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 2
US GAAP
Future accounting developments in respect of US GAAP are set out on page 433.
2 Summary of significant accounting policies
(a) Interest income and expense
Interest income and expense for all financial instruments except for those classified as held for trading or
designated at fair value (other than debt securities issued by HSBC and derivatives managed in conjunction with
such debt securities issued) are recognised in ‘Interest income’ and ‘Interest expense’ in the income statement
using the effective interest method. The effective interest method is a way of calculating the amortised cost of a
financial asset or a financial liability (or groups of financial assets or financial liabilities) and of allocating the
interest income or interest expense over the relevant period.
The effective interest rate is the rate that exactly discounts estimated future cash receipts or payments through
the expected life of the financial instrument or, where appropriate, a shorter period, to the net carrying amount of
the financial asset or financial liability. When calculating the effective interest rate, HSBC estimates cash flows
considering all contractual terms of the financial instrument but not future credit losses. The calculation includes
all amounts paid or received by HSBC that are an integral part of the effective interest rate of a financial
instrument, including transaction costs and all other premiums or discounts.
Interest on impaired financial assets is calculated by applying the original effective interest rate of the financial
asset to the carrying amount as reduced by any allowance for impairment.
(b) Non interest income
Fee income
HSBC earns fee income from a diverse range of services provided to its customers. Fee income is accounted for
as follows:
−
−
−
income earned on the execution of a significant act is recognised as revenue when the act is completed (for
example, fees arising from negotiating, or participating in the negotiation of, a transaction for a third party,
such as the arrangement for the acquisition of shares or other securities);
income earned from the provision of services is recognised as revenue as the services are provided (for
example, asset management, portfolio and other management advisory and service fees); and
income which forms an integral part of the effective interest rate of a financial instrument is recognised as
an adjustment to the effective interest rate (for example, certain loan commitment fees) and recorded in
‘Interest income’ (Note 2a).
Net trading income
Net trading income comprises all gains and losses from changes in the fair value of financial assets and financial
liabilities held for trading, together with related interest income, expense and dividends.
Net income from financial instruments designated at fair value
‘Net income from financial instruments designated at fair value’ includes all gains and losses from changes in
the fair value of financial assets and financial liabilities designated at fair value through profit or loss. Interest
income and expense and dividend income arising on these financial instruments are also included, except for
debt securities issued and derivatives managed in conjunction with debt securities issued. Interest on these
instruments is presented in ‘Interest expense’.
Dividend income
Dividend income is recognised when the right to receive payment is established. This is the ex-dividend date for
equity securities.
304
(c) Segment reporting
HSBC is organised into five geographical regions, Europe, Hong Kong, Rest of Asia-Pacific, North America and
Latin America, and manages its business through four customer groups: Personal Financial Services;
Commercial Banking, Corporate, Investment Banking and Markets; and Private Banking. The main items
reported in the ‘Other’ segment 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. Segment income and expenses include transfers between
geographical regions and transfers between customer groups. These transfers are conducted on arm’s length
terms and conditions.
(d) Determination of fair value
All financial instruments are recognised initially at fair value. The fair value of a financial instrument on initial
recognition is normally the transaction price, i.e. the fair value of the consideration given or received. In certain
circumstances, however, the initial fair value may be based on other observable current market transactions in
the same instrument, without modification or repackaging, or on a valuation technique whose variables include
only data from observable markets.
Subsequent to initial recognition, the fair values of financial instruments measured at fair value that are quoted in
active markets are based on bid prices for assets held and offer prices for liabilities issued. When independent
prices are not available, fair values are determined by using valuation techniques which refer to observable
market data. These include comparison with similar instruments where market observable prices exist,
discounted cash flow analysis, option pricing models and other valuation techniques commonly used by market
participants.
For certain derivatives, fair values may be determined in whole or in part using valuation techniques based on
assumptions that are not supported by prices from current market transactions or observable market data.
A number of factors such as bid-offer spread, credit profile and model uncertainty are taken into account, as
appropriate, when fair values are calculated using valuation techniques.
If the fair value of a financial asset measured at fair value becomes negative, it is recorded as a financial liability
until its fair value becomes positive, at which time it is recorded as a financial asset, or it is extinguished.
(e) Loans and advances to banks and customers
Loans and advances to banks and customers include loans and advances originated by HSBC which are not
classified either as held for trading or designated at fair value. Loans and advances are recognised when cash is
advanced to borrowers. They are derecognised when either borrowers repay their obligations, or the loans are
sold or written off, or substantially all the risks and rewards of ownership are transferred. They are initially
recorded at fair value plus any directly attributable transaction costs and are subsequently measured at amortised
cost using the effective interest method, less impairment losses.
(f) Loan impairment
Losses for impaired loans are recognised promptly when there is objective evidence that impairment of a loan or
portfolio of loans has occurred. Impairment losses are calculated on individual loans and on loans assessed
collectively. Losses expected from future events, no matter how likely, are not recognised.
Individually assessed loans
At each balance sheet date, HSBC assesses on a case-by-case basis whether there is any objective evidence that a
loan is impaired. This procedure is applied to all accounts that are considered individually significant. In
determining impairment losses on these loans, the following factors are considered:
– HSBC’s aggregate exposure to the customer;
–
the viability of the customer’s business model and their capability to trade successfully out of financial
difficulties and generate sufficient cash flow to service debt obligations;
–
the amount and timing of expected receipts and recoveries;
305
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 2
–
–
–
–
–
–
the likely dividend available on liquidation or bankruptcy;
the extent of other creditors’ commitments ranking ahead of, or pari passu with, HSBC 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 realisable value of security (or other credit mitigants) and likelihood of successful repossession;
the likely deduction of any costs involved in recovery of amounts outstanding;
the ability of the borrower to obtain, and make payments in, the currency of the loan if not denominated in
local currency; and
– when available, the secondary market price of the debt.
Impairment losses are calculated by discounting the expected future cash flows of a loan at its original effective
interest rate, and comparing the resultant present value with the loan’s current carrying amount. Any loss is
charged in the income statement. The carrying amount of impaired loans on the balance sheet is reduced through
the use of an allowance account.
Collectively assessed loans
Impairment is assessed on a collective basis in two circumstances:
–
to cover losses which have been incurred but have not yet been identified on loans subject to individual
assessment; and
–
for homogeneous groups of loans that are not considered individually significant.
Incurred but not yet identified impairment
Individually assessed loans for which no evidence of loss has been specifically identified on an individual basis
are grouped together according to their credit risk characteristics for the purpose of calculating an estimated
collective loss. This reflects impairment losses incurred at the balance sheet date which will only be individually
identified in the future.
The collective impairment allowance is determined after taking into account:
–
–
historical loss experience in portfolios of similar credit risk characteristics (for example, by industry sector,
loan grade or product);
the estimated period between impairment occurring and the loss being identified and evidenced by the
establishment of an appropriate allowance against the individual loan; and
– management’s experienced judgement as to whether 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 period between a loss occurring and its identification is estimated by local management for each identified
portfolio.
Homogeneous groups of loans
For homogeneous groups of loans that are not considered individually significant, two alternative methods are
used to calculate allowances on a portfolio basis:
− When appropriate empirical information is available, HSBC utilises roll rate methodology. This
methodology employs statistical analyses of historical trends of delinquency and default to estimate the
likelihood that loans will progress through the various stages of delinquency and ultimately prove
irrecoverable. The estimated loss is the difference between the present value of expected future cash flows,
discounted at the original effective interest rate of the portfolio, and the carrying amount of the portfolio.
Current economic conditions are also evaluated when calculating the appropriate level of allowance required
to cover inherent loss. In certain highly developed markets, sophisticated models also take into account
behavioural and account management trends as revealed in, for example, bankruptcy and rescheduling
statistics.
306
−
In other cases, when the portfolio size is small or when information is insufficient or not reliable enough to
adopt a roll rate methodology, HSBC adopts a formulaic approach which allocates progressively higher
percentage loss rates the longer a customer’s loan is overdue. Loss rates are calculated from the discounted
expected future cash flows from a portfolio.
In normal circumstances, historical experience provides the most objective and relevant information from which
to assess inherent loss within each portfolio. In certain circumstances, historical loss experience provides less
relevant information about the inherent loss in a given portfolio at the balance sheet date, for example, where
there have been changes in economic, regulatory or behavioural conditions, such that the most recent trends in
the portfolio risk factors are not fully reflected in the statistical models. In these circumstances, such risk factors
are taken into account when calculating the appropriate level of impairment allowances by adjusting the
impairment allowances derived solely from historical loss experience.
Roll rates, loss rates and the expected timing of future recoveries are regularly benchmarked against actual
outcomes to ensure they remain appropriate.
Loan write-offs
Loans (and the related impairment allowance accounts) are normally written off, either partially or in full, when
there is no realistic prospect of recovery of these amounts and, for collateralised loans, when the proceeds from
realising the security have been received.
Reversals of impairment
If the amount of an impairment loss decreases in a subsequent period, and the decrease can be related objectively
to an event occurring after the impairment was recognised, the excess is written back by reducing the loan
impairment allowance account accordingly. The reversal is recognised in the income statement.
Assets acquired in exchange for loans
Non-financial assets acquired in exchange for loans as part of an orderly realisation are recorded as assets held
for sale and reported in ‘Other assets’. The asset acquired is recorded at the lower of its fair value (less costs to
sell) and the carrying amount of the loan (net of impairment allowance) at the date of exchange. No depreciation
is charged in respect of assets held for sale. Any subsequent write-down of the acquired asset to fair value less
costs to sell is recognised in the income statement, in ‘Other operating income’. Any subsequent increase in the
fair value less costs to sell, to the extent this does not exceed the cumulative write down, is also recognised in
‘Other operating income’, together with any realised gains or losses on disposal.
Renegotiated loans
The impairment of personal loans is generally subject to collective assessment. Personal loans whose terms have
been renegotiated are no longer considered past due but are treated as new loans only after the minimum
required number of payments required under the new arrangements has been received.
Loans subject to individual impairment assessment, whose terms have been renegotiated, are subject to ongoing
review to determine whether they remain impaired or should be considered past due.
(g) Trading assets and trading liabilities
Treasury bills, debt securities, equity shares and short positions in securities are classified as held for trading if
they have been acquired principally for the purpose of selling or repurchasing in the near term, or they form part
of a portfolio of identified financial instruments that are managed together and for which there is evidence of a
recent pattern of short-term profit-taking. These financial assets or financial liabilities are recognised on trade
date, when HSBC enters into contractual arrangements with counterparties to purchase or sell securities, and are
normally derecognised when either sold (assets) or extinguished (liabilities). Measurement is initially at fair
value, with transaction costs taken to the income statement. Subsequently, their fair values are remeasured, and
all gains and losses from changes therein are recognised in the income statement in ‘Net trading income’ as they
arise.
307
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 2
(h) Financial instruments designated at fair value
Financial instruments, other than those held for trading, are classified in this category if they meet one or more of
the criteria set out below, and are so designated by management. HSBC may designate financial instruments at
fair value when the designation:
–
eliminates or significantly reduces valuation or recognition inconsistencies that would otherwise arise from
measuring financial assets or financial liabilities, or recognising gains and losses on them, on different
bases. Under this criterion, the main classes of financial instruments designated by HSBC are:
Long-term debt issues – The interest payable on certain fixed rate long-term debt securities issued has been
matched with the interest on ‘receive fixed/pay variable’ interest rate swaps as part of a documented interest
rate risk management strategy. An accounting mismatch would arise if the debt securities issued were
accounted for at amortised cost, because the related derivatives are measured at fair value with changes in
the fair value recognised in the income statement. By designating the long-term debt at fair value, the
movement in the fair value of the long-term debt will also be recognised in the income statement.
Financial assets and financial liabilities under investment contracts – Liabilities to customers under linked
contracts are determined based on the fair value of the assets held in the linked funds, with changes
recognised in the income statement. Liabilities to customers under other types of investment contracts would
be measured at amortised cost. If no designation was made for the assets relating to the customer liabilities
they would be classified as available-for-sale and the changes in fair value would be recorded directly in
equity. These financial instruments are managed on a fair value basis and management information is also
prepared on this basis.
Designation at fair value of the financial assets and liabilities under investment contracts allows the changes
in fair values to be recorded in the income statement and presented in the same line.
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applies to groups of financial assets, financial liabilities or combinations thereof that are managed, and their
performance evaluated, on a fair value basis in accordance with a documented risk management or
investment strategy, and where information about the groups of financial instruments is reported to
management on that basis. Under this criterion, certain financial assets held to meet liabilities under
insurance contracts are the main class of financial instrument so designated. HSBC has documented risk
management and investment strategies designed to manage such assets at fair value, taking into
consideration the relationship of assets to liabilities in a way that mitigates market risks. Reports are
provided to management on the fair value of the assets. Fair value measurement is also consistent with the
regulatory reporting requirements under the appropriate regulations for these insurance operations.
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relates to financial instruments containing one or more embedded derivatives that significantly modify the
cash flows resulting from those financial instruments, including certain debt issues and debt securities held.
The fair value designation, once made, is irrevocable. Designated financial assets and financial liabilities are
recognised when HSBC enters into the contractual provisions of the arrangements with counterparties, which is
generally on trade date, and are normally derecognised when sold (assets) or extinguished (liabilities).
Measurement is initially at fair value, with transaction costs taken directly to the income statement.
Subsequently, the fair values are remeasured, and gains and losses from changes therein are recognised in ‘Net
income from financial instruments designated at fair value’. The amount of change during the period, and
cumulatively, in the fair value of designated financial liabilities and loans and advances that is attributable to
changes in their credit risk is determined as the amount of change in the fair value that is not attributable to
changes in market conditions that give rise to market risk.
(i) Financial investments
Treasury bills, debt securities and equity shares intended to be held on a continuing basis, other than those
designated at fair value (Note 2h), are classified as ‘available-for-sale’ or ‘held-to-maturity’. Financial
investments are recognised on trade date, when HSBC enters into contractual arrangements with counterparties
to purchase securities, and are normally derecognised when either the securities are sold or the borrowers repay
their obligations.
(i) Available-for-sale securities are initially measured at fair value plus direct and incremental transaction costs.
They are subsequently remeasured at fair value, and changes therein are recognised in equity in the
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‘Available-for-sale reserve’ (Note 39) until the securities are either sold or impaired. When available-for-
sale securities are sold, cumulative gains or losses previously recognised in equity are recognised in the
income statement as ‘Gains less losses from financial investments’.
Interest income is recognised on available-for-sale securities using the effective interest rate method,
calculated over the asset’s expected life. Premiums and/or discounts arising on the purchase of dated
investment securities are included in the calculation of their effective interest rates. Dividends are
recognised in the income statement when the right to receive payment has been established.
At each balance sheet date an assessment is made of whether there is any objective evidence of impairment
in the value of a financial asset or group of assets. This usually arises when circumstances are such that an
adverse effect on future cash flows from the asset or group of assets can be reliably estimated. If an
available-for-sale security is impaired, the cumulative loss (measured as the difference between the asset’s
acquisition cost (net of any principal repayments and amortisation) and its current fair value, less any
impairment loss on that asset previously recognised in the income statement) is removed from equity and
recognised in the income statement. Reversals of impairment losses are subject to contrasting treatments
depending on the nature of the instrument concerned:
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if the fair value of a debt instrument classified as available-for-sale increases in a subsequent period,
and the increase can be objectively related to an event occurring after the impairment loss was
recognised in the income statement, the impairment loss is reversed through the income statement;
impairment losses recognised in the income statement on equity instruments are not reversed through
the income statement.
(ii) Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and
fixed maturities that HSBC positively intends, and is able, to hold until maturity. Held-to-maturity
investments are initially recorded at fair value plus any directly attributable transaction costs, and are
subsequently measured at amortised cost using the effective interest rate method, less any impairment
losses.
(j) Sale and repurchase agreements (including stock lending and borrowing)
When securities are sold subject to a commitment to repurchase them at a predetermined price (‘repos’), they
remain on the balance sheet and a liability is recorded in respect of the consideration received. Securities
purchased under commitments to sell (‘reverse repos’) 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’ as
appropriate. The difference between the sale and repurchase price is treated as interest and recognised over the
life of the agreement.
Securities lending and borrowing transactions are generally secured, with collateral taking the form of securities
or cash advanced or received. The transfer of securities to counterparties is not normally reflected on the balance
sheet. Cash collateral advanced or received is recorded as an asset or a liability respectively.
Securities borrowed are not recognised on the balance sheet. If they are sold on to third parties, an obligation to
return the securities is recorded as a trading liability and measured at fair value, and any gains or losses are
included in ‘Net trading income’.
(k) Derivatives and hedge accounting
Derivatives are recognised initially, and are subsequently remeasured, at fair value. Fair values of exchange-
traded derivatives are obtained from quoted market prices. Fair values of over-the-counter derivatives are
obtained using valuation techniques, including discounted cash flow models and option pricing models.
In the normal course of business, the fair value of a derivative on initial recognition is the transaction price (that
is, the fair value of the consideration given or received). In certain circumstances, however, the fair value will be
based on other observable current market transactions in the same instrument, without modification or
repackaging, or on a valuation technique whose variables include only data from observable markets, such as
interest rate yield curves, option volatilities and currency rates. When such evidence exists, HSBC recognises a
trading gain or loss on inception of the derivative. When unobservable market data have a significant impact on
the valuation of derivatives, the entire initial difference in fair value indicated by the valuation model from the
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H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 2
transaction price is not recognised immediately in the income statement but is recognised over the life of the
transaction on an appropriate basis, or when the inputs become observable, or the transaction matures or is
closed out.
Derivatives may be embedded in other financial instruments, for example, a convertible bond with an embedded
conversion option. Embedded derivatives are treated as separate derivatives when their economic characteristics
and risks are not clearly and closely related to those of the host contract; the terms of the embedded derivative
are the same as those of a stand-alone derivative; and the combined contract is not held for trading or designated
at fair value. These embedded derivatives are measured at fair value with changes therein recognised in the
income statement.
Derivatives are classified as assets when their fair value is positive, or as liabilities when their fair value is
negative. Derivative assets and liabilities arising from different transactions are only offset if the transactions are
with the same counterparty, a legal right of offset exists, and the parties intend to settle the cash flows on a net
basis.
The method of recognising fair value gains and losses depends on whether derivatives are held for trading or are
designated as hedging instruments, and if the latter, the nature of the risks being hedged. All gains and losses
from changes in the fair value of derivatives held for trading are recognised in the income statement. When
derivatives are designated as hedges, HSBC classifies them as either: (i) hedges of the change in fair value of
recognised assets or liabilities or firm commitments (‘fair value hedges’); (ii) hedges of the variability in highly
probable future cash flows attributable to a recognised asset or liability, or a forecast transaction (‘cash flow
hedges’); or (iii) hedges of net investments in a foreign operation (‘net investment hedges’). Hedge accounting is
applied to derivatives designated as hedging instruments in a fair value, cash flow or net investment hedge
provided certain criteria are met.
Hedge accounting
At the inception of a hedging relationship, HSBC documents the relationship between the hedging instruments
and the hedged items, its risk management objective and its strategy for undertaking the hedge. HSBC also
requires a documented assessment, both at hedge inception and on an ongoing basis, of whether or not the
hedging instruments, primarily derivatives, that are used in hedging transactions are highly effective in offsetting
the changes attributable to the hedged risks in the fair values or cash flows of the hedged items. Interest on
designated qualifying hedges is included in ‘Net interest income’.
Fair value hedge
Changes in the fair value of derivatives that are designated and qualify as fair value hedging instruments are
recorded in the income statement, along with changes in the fair value of the hedged assets, liabilities or group
thereof that are attributable to the hedged risk.
If a hedging relationship no longer meets the criteria for hedge accounting, the cumulative adjustment to the
carrying amount of the hedged item is amortised to the income statement based on a recalculated effective
interest rate over the residual period to maturity, unless the hedged item has been derecognised, in which case, it
is released to the income statement immediately.
Cash flow hedge
The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow
hedges is recognised in equity within the cash flow hedging reserve. Any gain or loss in fair value relating to an
ineffective portion is recognised immediately in the income statement.
Amounts accumulated in equity are recycled to the income statement in the periods in which the hedged item
will affect profit or loss. However, when the forecast transaction that is hedged results in the recognition of a
non-financial asset or a non-financial liability, the gains and losses previously deferred in equity are transferred
from equity and included in the initial measurement of the cost of the asset or liability.
When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting,
any cumulative gain or loss existing in equity at that time remains in equity until the forecast transaction is
eventually recognised in the income statement. When a forecast transaction is no longer expected to occur, the
cumulative gain or loss that was reported in equity is immediately transferred to the income statement.
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Net investment hedge
Hedges of net investments in foreign operations are accounted for in a similar way to cash flow hedges. A gain
or loss on the effective portion of the hedging instrument is recognised in equity; a gain or loss on the ineffective
portion is recognised immediately in the income statement. Gains and losses accumulated in equity are included
in the income statement on the disposal of the foreign operation.
Hedge effectiveness testing
To qualify for hedge accounting, HSBC requires that at the inception of the hedge and throughout its life, each
hedge must be expected to be highly effective (prospective effectiveness), and demonstrate actual effectiveness
(retrospective effectiveness) on an ongoing basis.
The documentation of each hedging relationship sets out how the effectiveness of the hedge is assessed. The
method an HSBC entity adopts for assessing hedge effectiveness will depend on its risk management strategy.
For prospective effectiveness, the hedging instrument must be expected to be highly effective in offsetting
changes in fair value or cash flows attributable to the hedged risk during the period for which the hedge is
designated. For actual effectiveness to be achieved, the changes in fair value or cash flows must offset each other
in the range of 80 per cent to 125 per cent.
Hedge ineffectiveness is recognised in the income statement in ‘Net trading income’.
Derivatives that do not qualify for hedge accounting
All gains and losses from changes in the fair values of derivatives that do not qualify for hedge accounting are
recognised immediately in the income statement. These gains and losses are reported in ‘Net trading income’,
except where derivatives are managed in conjunction with financial instruments designated at fair value (other
than derivatives managed in conjunction with debt securities issued by the Group), in which case gains and
losses are reported in ‘Net income from financial instruments designated at fair value’. The interest on
derivatives managed in conjunction with debt securities issued by the Group which are designated at fair value is
recognised in ‘Interest expense’. All other gains and losses on these derivatives are reported in ‘Net income from
financial instruments designated at fair value’.
(l) Derecognition of financial assets and liabilities
Financial assets are derecognised when the right to receive cash flows from the assets has expired; or when
HSBC has transferred its contractual right to receive the cash flows of the financial assets, and either
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substantially all the risks and rewards of ownership have been transferred; or
substantially all the risks and rewards have neither been retained nor transferred but control is not retained.
Financial liabilities are derecognised when they are extinguished, that is when the obligation is discharged,
cancelled or expires.
(m) Offsetting financial assets and financial liabilities
Financial assets and financial liabilities are offset and the net amount reported in the balance sheet when there is
a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis, or
realise the asset and settle the liability simultaneously.
(n) Subsidiaries, associates and joint ventures
HSBC Holdings’ investments in subsidiaries are stated at cost less any impairment losses. Reversals of
impairment losses are recognised in the income statement if there has been a change in the estimates used to
determine the recoverable amount of the investment.
Investments in associates and interests in joint ventures are recognised using the equity method, initially stated at
cost, including attributable goodwill, and are adjusted thereafter for the post-acquisition change in HSBC’s share
of net assets.
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H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 2
Profits on transactions between HSBC and its associates and joint ventures are eliminated to the extent of
HSBC’s interest in the respective associates or joint ventures. Losses are also eliminated to the extent of HSBC’s
interest in the associates or joint ventures unless the transaction provides evidence of an impairment of the asset
transferred.
(o) Goodwill and intangible assets
(i) Goodwill arises on business combinations, including the acquisition of subsidiaries, and interests in joint
ventures and associates, when the cost of acquisition exceeds the fair value of HSBC’s share of the
identifiable assets, liabilities and contingent liabilities acquired. By contrast, if HSBC’s interest in the fair
value of the identifiable assets, liabilities and contingent liabilities of an acquired business is greater than the
cost of acquisition, the excess is recognised immediately in the income statement.
Intangible assets are recognised separately from goodwill when they are separable or arise from contractual
or other legal rights, and their fair value can be measured reliably.
Goodwill is allocated to cash-generating units for the purpose of impairment testing, which is undertaken at
the lowest level at which goodwill is monitored for internal management purposes. Impairment testing is
performed at least annually by comparing the present value of the expected future cash flows from a
business with the carrying amount of its net assets, including attributable goodwill. Goodwill is stated at cost
less accumulated impairment losses which are charged to the income statement.
Goodwill on acquisitions of interests in joint ventures and associates is included in ‘Interests in associates
and joint ventures’.
At the date of disposal of a business, attributable goodwill is included in HSBC’s share of net assets in the
calculation of the gain or loss on disposal.
(ii) Intangible assets include the value of in-force long-term insurance business, computer software, trade
names, mortgage servicing rights, customer lists, core deposit relationships, credit card customer
relationships and merchant or other loan relationships. 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.
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Intangible assets that have an indefinite useful life, or are not yet ready for use, are tested for
impairment annually. This impairment test may be performed at any time during the year, provided it is
performed at the same time every year. An intangible asset recognised during the current period is
tested before the end of the current year.
Intangible assets that have a finite useful life, except for the value of in-force long-term insurance
business, are stated at cost less amortisation and accumulated impairment losses and are amortised over
their estimated useful lives. Estimated useful life is the lower of legal duration and expected useful life.
The amortisation of mortgage servicing rights is included within ‘Net fee income’.
For the accounting policy governing the value of in-force long-term insurance business see Note 2(x).
(iii) Intangible assets are amortised over their finite useful lives, generally on a straight line basis, as follows:
Trade names .........................................................................................................................................
Mortgage servicing rights ....................................................................................................................
Purchased software ...............................................................................................................................
Internally generated software ...............................................................................................................
Customer/merchant relationships .........................................................................................................
Other .....................................................................................................................................................
10 years
between 5 and 30 years
between 3 and 5 years
between 3 and 5 years
between 3 and 10 years
generally 10 years
(p) Property, plant and equipment
Land and buildings are stated at historical cost, or fair value at the date of transition to IFRSs (‘deemed cost’),
less any impairment losses and depreciation calculated to write off the assets over their estimated useful lives as
follows:
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freehold land is not depreciated;
freehold buildings are depreciated at the greater of two per cent per annum on a straight-line basis or over
their remaining useful lives; and
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leasehold buildings are depreciated over the unexpired terms of the leases, or over their remaining useful
lives.
Equipment, fixtures and fittings (including equipment on operating leases where HSBC is the lessor) are stated at
cost less any impairment losses and depreciation calculated on a straight-line basis to write off the assets over
their useful lives, which run to a maximum of 35 years but are generally between five years and 20 years.
Property, plant and equipment is subject to an impairment review if there are events or changes in circumstances
which indicate that the carrying amount may not be recoverable.
HSBC holds certain properties as investments to earn rentals or for capital appreciation, or both. Investment
properties are included in the balance sheet at fair value with changes therein recognised in the income statement
in the period of change. Fair values are determined by independent professional valuers who apply recognised
valuation techniques.
(q) Finance and operating leases
Agreements which transfer to counterparties substantially all the risks and rewards incidental to the ownership of
assets, but not necessarily legal title, are classified as finance leases. When 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’ as appropriate. Finance income receivable is recognised in ‘Net
interest income’ over the periods of the leases so as to give a constant rate of return on the net investment in the
leases.
When HSBC is a lessee under finance leases, the leased assets are capitalised and included in ‘Property, plant
and equipment’ and the corresponding liability to the lessor is included in ‘Other liabilities’. A finance lease and
its corresponding liability are recognised initially at the fair value of the asset or, if lower, the present value of
the minimum lease payments. Finance charges payable are recognised in ‘Net interest income’ over the period of
the lease based on the interest rate implicit in the lease so as to give a constant rate of interest on the remaining
balance of the liability.
All other leases are classified as operating leases. When acting as lessor, HSBC includes the assets subject to
operating leases in ‘Property, plant and equipment’ and accounts for them accordingly. Impairment losses are
recognised to the extent that residual values are not fully recoverable and the carrying value of the equipment is
thereby impaired. When HSBC is the lessee, leased assets are not recognised on the balance sheet. Rentals
payable and receivable under operating leases are accounted for on a straight-line basis over the periods of the
leases and are included in ‘General and administrative expenses’ and ‘Other operating income’ respectively.
(r) Income tax
Income tax on the profit or loss for the year comprises current tax and deferred tax. Income tax is recognised in
the income statement except to the extent that it relates to items recognised directly in shareholders’ equity, in
which case it is recognised in shareholders’ equity.
Current tax is the tax expected to be payable on the taxable profit for the year, calculated using tax rates enacted
or substantively enacted by the balance sheet date, and any adjustment to tax payable in respect of previous
years. Current tax assets and liabilities are offset when HSBC intends to settle on a net basis and the legal right
to offset exists.
Deferred tax is recognised on temporary differences between the carrying amounts of assets and liabilities in the
balance sheet and the amounts attributed to such assets and liabilities for tax purposes. Deferred tax liabilities are
generally recognised for all taxable temporary differences and deferred tax assets are recognised to the extent
that it is probable that future taxable profits will be available against which deductible temporary differences can
be utilised.
Deferred tax is calculated using the tax rates expected to apply in the periods in which the assets will be realised
or the liabilities settled, based on tax rates and laws enacted, or substantively enacted, by the balance sheet date.
Deferred tax assets and liabilities are offset when they arise in the same tax reporting group and relate to income
taxes levied by the same taxation authority, and when a legal right to offset exists in the entity.
Deferred tax relating to actuarial gains and losses on post-employment benefits is recognised directly in equity.
From 1 January 2005, deferred tax relating to fair value remeasurement of available-for-sale investments and
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H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 2
cash flow hedging instruments which are charged or credited directly to equity, is also credited or charged
directly to equity and is subsequently recognised in the income statement when the deferred fair value gain or
loss is recognised in the income statement.
(s) Pension and other post-employment benefits
HSBC operates a number of pension and other post-employment benefit plans throughout the world. These plans
include both defined benefit and defined contribution plans and various other post-employment benefits such as
post-employment health-care.
Payments to defined contribution plans and state-managed retirement benefit plans, where HSBC’s obligations
under the plans are equivalent to a defined contribution plan, are charged as an expense as they fall due.
The costs recognised for funding defined benefit plans are determined using the Projected Unit Credit Method,
with annual actuarial valuations performed on each plan. Actuarial differences that arise are recognised in
shareholders’ equity and presented in the Statement of Recognised Income and Expense in the period in which
they arise. Past service costs are recognised immediately to the extent that the benefits have vested, and are
otherwise recognised on a straight-line basis over the average period until the benefits vest. Current service costs
and any past service costs, together with the unwinding of the discount on plan liabilities less the expected return
on plan assets, are charged to operating expenses.
The defined benefit liability recognised in the balance sheet represents the present value of defined benefit
obligations adjusted for unrecognised past service costs and reduced by the fair value of plan assets. Any net
defined benefit surplus is limited to unrecognised past service costs plus the present value of available refunds
and reductions in future contributions to the plan.
The costs of providing other defined post-employment benefits, such as post-employment health-care, are
accounted for on the same basis as defined benefit pension plans.
(t) Equity compensation plans
Shares awarded to an employee on joining HSBC that are made available immediately, with no vesting period
attached to the award, are expensed immediately. When an inducement is awarded to an employee on
commencement of employment with HSBC, and the employee must complete a specified period of service
before the inducement vests, the expense is spread over the period to vesting.
The expense of share options is recognised over the vesting period, and is determined by reference to the fair
value of the options on grant date, and the effect of any non-market vesting conditions such as option lapses. An
option may lapse if, for example, an employee ceases to be employed by HSBC before the end of the vesting
period. Estimates of future such employee departures are taken into account when accruing the cost during the
service period.
The expense relating to shares awarded as bonuses in respect of past service, by which an employee is required
to complete a specified period of future service to be entitled to the award, is spread over the period of service
rendered to the vesting date.
The compensation expense charged to the income statement is credited to the share-based payment reserve over
the vesting period of the shares and options. If awards of shares and options lapse during the vesting period due
to an employee leaving employment with HSBC, the charge to date is reversed to the income statement. If an
award lapses due to an employee leaving a plan but not employment with HSBC or due to HSBC cancelling or
modifying a plan, this is accounted for as an acceleration of vesting with full immediate recognition of the
outstanding charge in the income statement. If awards of shares or options lapse after they have fully vested, the
amount in respect of the award charged to the share-based payment reserve is transferred to retained earnings.
(u) Foreign currencies
Items included in the financial statements of each of HSBC’s entities are measured using the currency of the
primary economic environment in which the entity operates (‘the functional currency’). The consolidated
financial statements of HSBC are presented in US dollars, which is the Group’s presentation currency.
Transactions in foreign currencies are recorded in the functional currency at the rate of exchange prevailing on
the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated into
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the functional currency at the rate of exchange ruling at the balance sheet date. Any resulting exchange
differences are included in the income statement. Non-monetary assets and liabilities that are measured at
historical cost in a foreign currency are translated into the functional currency using the rate of exchange at the
date of the initial transaction. Non-monetary assets and liabilities measured at fair value in a foreign currency are
translated into the functional currency using the rate of exchange at the date the fair value was determined. Any
exchange component of a gain or loss on a non-monetary item is recognised directly in equity if the gain or loss
on the non-monetary item is recognised directly in equity. Any exchange component of a gain or loss on a non-
monetary item is recognised directly in the income statement if the gain or loss on the non-monetary item is
recognised in the income statement.
In the consolidated financial statements, the assets, including related goodwill where applicable, and liabilities of
branches, subsidiaries, joint ventures and associates whose functional currency is not US dollars, are translated
into the Group’s presentation currency at the rate of exchange ruling at the balance sheet date. The results of
branches, subsidiaries, joint ventures and associates whose functional currency is not US dollars are translated
into US dollars at the average rates of exchange for the reporting period. Exchange differences arising from the
retranslation of opening foreign currency net investments, and exchange differences arising from retranslation of
the result for the reporting period from the average rate to the exchange rate prevailing at the period end, are
recognised in equity in the ‘foreign exchange reserve’. Exchange differences on a monetary item that is part of a
net investment in a foreign operation are recognised in the income statement of the separate financial statements.
In consolidated financial statements these exchange differences are recognised in the foreign exchange reserve in
shareholders’ equity. On disposal of a foreign operation, exchange differences relating thereto and previously
recognised in reserves are recognised in the income statement.
(v) Provisions
Provisions are recognised when it is probable that an outflow of economic benefits will be required to settle a
current legal or constructive obligation as a result of past events, and a reliable estimate can be made of the
amount of the obligation.
Contingent liabilities, which include certain guarantees and letters of credit pledged as collateral security, are
possible obligations that arise from past events whose existence will be confirmed only by the occurrence, or
non-occurrence, of one or more uncertain future events not wholly within the control of HSBC. Contingent
liabilities are not recognised in the financial statements but are disclosed unless they are remote.
(w) Financial guarantee contracts
Liabilities under financial guarantees contracts which are not classified as insurance contracts, are recorded
initially at their fair value, which is generally the fee received or receivable. Subsequently, the financial
guarantee liabilities are measured at the higher of the initial fair value, less cumulative amortisation, and the
best estimate of the expenditure required to settle the obligations.
HSBC Holdings has issued financial guarantees to other Group entities. Where these guarantees have been
classified as insurance contracts, they are measured consistently with insurance liabilities.
(x) Insurance contracts
Through its insurance subsidiaries, HSBC issues contracts to customers that contain insurance risk, financial risk
or a combination thereof. A contract under which HSBC accepts significant insurance risk from another party by
agreeing to compensate that party on the occurrence of a specified uncertain future event, is classified as an
insurance contract. An insurance contract may also transfer financial risk, but is accounted for as an insurance
contract if the insurance risk is significant.
Insurance contracts are accounted for as follows:
Premiums
Gross insurance premiums for non-life insurance business are reported as income over the term of the insurance
contracts based on the proportion of risks borne during the accounting period. The unearned premium (the
proportion of the business underwritten in the accounting year relating to the period of risk after the balance
sheet date) is calculated on a daily or monthly pro rata basis.
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Notes on the Financial Statements (continued)
Notes 2 and 3
Premiums for life insurance contracts are accounted for when receivable, except in unit-linked insurance
contracts where premiums are accounted for when liabilities are established.
Reinsurance premiums are accounted for in the same accounting period as the premiums for the direct insurance
contracts to which they relate.
Claims and reinsurance recoveries
Gross insurance claims for non-life insurance contracts include paid claims and movements in outstanding
claims liabilities.
Gross insurance claims for life insurance contracts reflect the total cost of claims arising during the year,
including claim handling costs and any policyholder bonuses allocated in anticipation of a bonus declaration.
Claims arising during the year include maturities, surrenders and death claims.
Maturity claims are recognised when due for payment. Surrenders are recognised when paid or at an earlier date
on which, following notification, the policy ceases to be included within the calculation of the related insurance
liabilities. Death claims are recognised when notified.
Reinsurance recoveries are accounted for in the same period as the related claim.
Liabilities under insurance contracts
Outstanding claims liabilities for non-life insurance contracts are based on the estimated ultimate cost of all
claims incurred but not settled at the balance sheet date, whether reported or not, together with related claim-
handling costs and a reduction for the expected value of salvage and other recoveries. Liabilities for claims
incurred but not reported are made on an estimated basis, using appropriate statistical techniques.
Liabilities under non-linked life insurance contracts are calculated by each life insurance operation based on
local actuarial principles.
Liabilities under unit-linked life insurance contracts are at least equivalent to the surrender or transfer value
which is calculated by reference to the value of the relevant underlying funds or indices.
Present value of in-force long-term insurance business
The value placed on insurance contracts that are classified as long-term insurance business and are in force at the
balance sheet date is recognised as an asset.
The present value of in-force long-term insurance business is determined by discounting future cash flows
expected to emerge from business currently in force using appropriate assumptions in assessing factors such as
future mortality, lapse rates and levels of expenses and a risk discount rate that reflects the risk premium
attributable to the respective long-term insurance business. Movements in the present value of in-force long-term
insurance business are included in ‘Other operating income’ on a gross of tax basis.
(y) Investment contracts
Customer liabilities under non-linked and unit-linked investment contracts and the linked financial assets are
designated at fair value, and the movements in fair value are recognised in the income statement in ‘Net income
from financial investments designated at fair value’. Premiums receivable and amounts withdrawn are accounted
for as increases or decreases in the liability recorded in respect of investment contracts.
Liabilities under unit-linked investment contracts are at least equivalent to the surrender or transfer value which
is calculated by reference to the value of the relevant underlying funds or indices.
Investment management fees receivable are recognised in the income statement over the period of the provision
of the investment management services, in ‘Net fee income’.
The incremental costs directly related to the acquisition of new investment contracts or renewing existing
investment contracts are deferred and amortised over the period during which the investment management
services are provided.
316
(z) Debt securities issued and deposits by customers and banks
Financial liabilities are recognised when HSBC enters into the contractual provisions of the arrangements with
counterparties, which is generally on trade date, and initially measured at fair value, which is normally the
consideration received net of directly attributable transaction costs incurred. Subsequent measurement of
financial liabilities, other than those measured at fair value through profit or loss and financial guarantees, is at
amortised cost, using the effective interest rate method to amortise the difference between proceeds net of
directly attributable transaction costs and the redemption amount over the expected life of the debt.
(aa)Share capital
Shares are classified as equity when there is no contractual obligation to transfer cash or other financial assets.
Incremental costs directly attributable to the issue of equity instruments are shown in equity as a deduction from
the proceeds, net of tax.
HSBC Holdings plc shares held by HSBC are recognised in ‘Total shareholders’ equity’ as a deduction from
retained earnings until they are cancelled. When such shares are subsequently sold, reissued or otherwise
disposed of, any consideration received is included in ‘Total shareholders’ equity’, net of any directly
attributable incremental transaction costs and related income tax effects.
(ab)Cash and cash equivalents
For the purpose of the cash flow statement, cash and cash equivalents include highly liquid investments that are
readily convertible to known amounts of cash and which are subject to an insignificant risk of change in value.
Such investments are normally those with less than three months’ maturity from the date of acquisition, and
include cash and balances at central banks, treasury bills and other eligible bills, loans and advances to banks,
items in the course of collection from or in transmission to other banks, and certificates of deposit.
3 Net income from financial instruments designated at fair value
Net income from financial instruments designated at fair value includes:
•
•
•
all gains and losses from changes in the fair value of financial assets and liabilities designated at fair value,
including liabilities under investment contracts;
all gains and losses from changes in the fair value of derivatives that are managed in conjunction with financial
assets and liabilities designated at fair value; and
interest income, interest expense and dividend income in respect of:
–
–
financial assets and liabilities designated at fair value; and
derivatives managed in conjunction with the above,
except for interest expense arising on HSBC’s issued debt securities, together with the interest element of
derivatives managed in conjunction with them, which are recognised in ‘Interest expense’.
Net income/(expense) arising on:
– financial assets held to meet liabilities under insurance and investment contracts .............
– other financial assets designated at fair value ......................................................................
– derivatives managed in conjunction with financial assets designated at fair value .............
– liabilities to customers under investment contracts ..............................................................
– HSBC’s issued debt securities1 .............................................................................................
– derivatives managed in conjunction with HSBC’s issued debt securities ...........................
– other financial liabilities designated at fair value .................................................................
– derivatives managed in conjunction with other financial liabilities designated at
fair value ...............................................................................................................................
Net income from financial instruments designated at fair value ..............................................
2006
US$m
1,552
217
57
1,826
(1,008)
(277)
242
(125)
(1)
(1,169)
657
2005
US$m
1,760
90
17
1,867
(1,126)
1,795
(1,392)
(112)
2
(833)
1,034
317
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 4, 5 and 6
1 Gains and losses from changes in the fair value of HSBC’s issued debt securities may arise from changes in HSBC’s own credit risk. In
2006, HSBC recognised a US$388 million loss on changes in the fair value of these instruments arising from changes in HSBC’s own
credit risk (2005: loss US$70 million).
4 Net earned insurance premiums
Non-life
insurance
US$m
Life
insurance
(non-linked)
US$m
Life
insurance
(linked)
US$m
Investment
contracts with
discretionary
participation
features
US$m
2006
Gross written premiums ............................
Movement in unearned premiums ............
Gross earned premiums ............................
Gross written premiums ceded to
reinsurers ..............................................
Reinsurers’ share of movement in
unearned premiums ..............................
Reinsurers’ share of gross earned
premiums ..............................................
Net earned insurance premiums ...............
2005
Gross written premiums ............................
Movement in unearned premiums ............
Gross earned premiums ............................
Gross written premiums ceded to
reinsurers ..............................................
Reinsurers’ share of movement in
unearned premiums ..............................
Reinsurers’ share of gross earned
premiums ..............................................
Net earned insurance premiums ...............
1,824
122
1,946
(451)
(48)
(499)
1,447
2,364
(225)
2,139
(479)
60
(419)
1,720
3,640
14
3,654
(274)
–
(274)
3,380
3,441
2
3,443
(277)
–
(277)
3,166
848
(1)
847
(14)
–
(14)
833
768
(210)
558
(20)
–
(20)
538
8
–
8
–
–
–
8
12
–
12
–
–
–
12
5 Net insurance claims incurred and movement in policyholders’ liabilities
Non-life
insurance
US$m
Life
insurance
(non-linked)
US$m
Life
insurance
(linked)
US$m
Investment
contracts with
discretionary
participation
features
US$m
2006
Claims, benefits and surrenders paid ........
Movement in liabilities .............................
Gross claims incurred and movement in
liabilities ...............................................
Reinsurers’ share of claims, benefits and
surrenders paid .....................................
Reinsurers’ share of movement in
liabilities ...............................................
Reinsurers’ share of claims incurred and
movement in liabilities ..........................
Net insurance claims incurred and
movement in policyholders’
liabilities ...............................................
889
10
899
(228)
57
(171)
814
2,207
495
651
3,021
1,146
(154)
(54)
(208)
(9)
20
11
728
2,813
1,157
–
6
6
–
–
–
6
Total
US$m
6,320
135
6,455
(739)
(48)
(787)
5,668
6,585
(433)
6,152
(776)
60
(716)
5,436
Total
US$m
2,198
2,874
5,072
(391)
23
(368)
4,704
318
2005
Claims, benefits and surrenders paid ........
Movement in liabilities .............................
Gross claims incurred and movement in
Non-life
insurance
US$m
Life insurance
(non-linked)
US$m
966
72
621
1,683
liabilities ...............................................
1,038
2,304
Investment
contracts with
discretionary
participation
features
US$m
Life
insurance
(linked)
US$m
357
445
802
(11)
(11)
(22)
(146)
2
(144)
(111)
191
80
894
2,384
780
Total
US$m
1,944
2,209
4,153
(268)
182
(86)
4,067
–
9
9
–
–
–
9
Reinsurers’ share of claims, benefits and
surrenders paid .....................................
Reinsurers’ share of movement in
liabilities ...............................................
Reinsurers’ share of claims incurred and
movement in liabilities ..........................
Net insurance claims incurred and
movement in policyholders’
liabilities ...............................................
6 Net operating income
Net operating income is stated after the following items of income, expense, gains and losses:
Income
Interest recognised on impaired financial assets ...............................................................................
Fees earned on financial assets or liabilities not held for trading nor designated at fair value,
other than fees included in effective interest rate calculations on these types of assets and
liabilities ........................................................................................................................................
Fees earned on trust and other fiduciary activities where HSBC holds or invests assets on
behalf of its customers ...................................................................................................................
Income from listed investments1 .......................................................................................................
Income from unlisted investments2 ...................................................................................................
2006
US$m
2005
US$m
284
120
11,182
2,909
7,304
9,192
9,077
2,912
6,819
5,001
Expense
Interest on financial instruments, excluding interest on financial liabilities held for trading
or designated at fair value .............................................................................................................
(38,158)
(26,627)
Fees payable on financial assets or liabilities not held for trading nor designated at fair value,
other than fees included in effective interest rate calculations on these types of assets and
liabilities ........................................................................................................................................
Fees payable relating to trust and other fiduciary activities where HSBC holds or invests
assets on behalf of its customers ...................................................................................................
Gains/(losses)
Gain /(loss) on disposal or settlement of loans and advances ...........................................................
Net impairment loss on loans and advances ......................................................................................
Net (charge)/reversal of impairment allowances in respect of available-for-sale financial investments
........................................................................................................................................................
Gains on disposal of property, plant and equipment and non-financial investments .......................
1 Income from listed investments at 31 December 2004 was US$5,166 million.
2 Income from unlisted investments at 31 December 2004 was US$3,521 million.
(1,826)
(103)
24
(10,547)
(21)
781
(1,357)
(238)
(12)
(7,860)
42
703
319
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 7
7 Employee compensation and benefits
Wages and salaries ...........................................................................................
Social security costs .........................................................................................
Post-employment benefits ...............................................................................
2006
US$m
16,186
1,194
1,120
18,500
2005
US$m
14,008
1,072
1,065
16,145
2004
US$m
12,374
973
1,176
14,523
The average number of persons employed by HSBC during the year was as follows:
Europe ..............................................................................................................
Hong Kong ......................................................................................................
Rest of Asia-Pacific .........................................................................................
North America .................................................................................................
Latin America ..................................................................................................
2006
84,170
27,328
68,182
57,654
58,863
2005
(restated1)
2004
(restated1)
82,638
25,699
50,605
51,518
54,825
80,930
25,070
37,211
49,832
51,684
Total .................................................................................................................
296,197
265,285
244,727
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13.
Post-employment benefit plans
HSBC pension plans
HSBC operates some 166 pension plans throughout the world, covering 76 per cent of HSBC’s employees, with a
total pension cost of US$1,058 million (2005: US$1,007 million; 2004: US$1,111 million), of which US$668 million
(2005: US$546 million; 2004: US$485 million) relates to plans outside the UK.
Progressively, HSBC has been moving to defined contribution plans for all new employees. The pension cost for
defined contribution plans, which cover 35 per cent of HSBC’s employees, was US$456 million (2005:
US$389 million; 2004: US$351 million).
Both HSBC’s and, where relevant and appropriate, the trustees’ long-term investment objectives for defined benefit
plans are:
•
•
to limit the risk of the assets failing to meet the liability of the plans over the long-term; and
to maximise returns consistent with an acceptable level of risk so as to control the long-term costs of the defined
benefit plans.
Both HSBC and, where relevant and appropriate, the trustees, consider that the investment policy should be
consistent with meeting their mutual overall long-term investment objectives. In pursuit of these long-term
objectives, an overall benchmark is established for the allocation of the defined benefit plan assets between asset
classes. 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 actuarial valuation is made, or more frequently if circumstances or local
legislation so require. The process generally involves an extensive asset and liability review.
The Group’s defined benefit plans, which cover 41 per cent of HSBC’s employees, are predominantly funded plans
with assets which, in the case of most of the larger plans, are held in trust or similar funds separate from HSBC. The
plans are reviewed at least annually or in accordance with local practice and regulations by qualified actuaries. The
actuarial assumptions used to calculate the defined benefit obligations and related current service costs vary
according to the economic conditions of the countries in which they are situated.
The largest plan exists in the UK, where the HSBC Bank (UK) Pension Scheme covers employees of HSBC Bank plc
and certain other employees of HSBC. This plan comprises a funded defined benefit plan (‘the principal plan’) which
is closed, and a defined contribution plan which was established on 1 July 1996 for new employees. In 2006, HSBC
and the Trustee of the principal plan agreed to change the investment strategy in order to reduce the investment risk.
This involved switching from a largely equity-based strategy to a strategy largely based on holding bonds together
with a more diverse range of investments. At the same time the principal plan entered into swap arrangements
320
whereby the principal plan is committed to making LIBOR related interest payments in exchange for cash flows paid
into the plan, based on a projection of the future benefit payments from the principal plan. The asset allocation for the
new strategy is:
Equities ................................................................................................................................................................................
Bonds ...................................................................................................................................................................................
Alternative assets1 ................................................................................................................................................................
Property ................................................................................................................................................................................
Cash .....................................................................................................................................................................................
%
12.5
50.0
12.5
10.0
15.0
100.0
1 Alternative assets include emerging market bonds, loans, and infrastructure assets.
At 31 December 2006, significant progress had been made towards the new strategy and swap arrangements were in
place.
The latest actuarial investigation of the principal plan was made at 31 December 2005, by C G Singer, Fellow of the
Institute of Actuaries, of Watson Wyatt Limited. At that date, the market value of the HSBC Bank (UK) Pension
Scheme’s assets was US$18,072 million (including assets relating to the defined benefit plan, the defined
contribution plan, and additional voluntary contributions). The market value of the plan assets represented 89 per cent
of the amount expected to be required, on the basis of the assumptions adopted, to provide the benefits accrued to
members after allowing for expected future increases in earnings, and the resulting deficit amounted to
US$2,065 million. The method adopted for this investigation was the projected unit method. The expected cash flows
from the plan were projected by reference to the Retail Price Index (‘RPI’) swap break-even curve at 31 December
2005. Salary increases were assumed to be 1 per cent per annum above RPI and inflationary pension increases,
subject to a minimum of 0 per cent and a maximum of 5 per cent, were assumed to be in line with RPI. The projected
cash flows were discounted at the LIBOR swap curve at 31 December 2005 plus a margin for the expected return on
the investment strategy of 110 basis points per annum. The mortality experience of the plan’s pensioners over the
three year period since the previous valuation was analysed and the mortality assumption set on the basis of this with
allowances for medium cohort improvements on the PA92 series of tables from the valuation date.
In anticipation of the results of the 2005 investigation, on 22 December 2005 HSBC Bank plc made an additional
contribution of US$1,746 million to the principal plan in order to reduce the deficit of the plan. Following receipt of
the valuation results, HSBC agreed with the Trustee to meet a schedule of additional future funding payments, as set
out below:
2007 .....................................................................................................................................................................................
2012 .....................................................................................................................................................................................
2013 ......................................................................................................................................................................................
2014 ......................................................................................................................................................................................
US$m
589
913
913
913
HSBC considers that the contributions set out above are sufficient to meet the deficit as at 31 December 2005 over
the agreed period.
HSBC also decided to make ongoing contributions to the principal plan in respect of the accrual of benefits of
defined benefit section members at the rate of 36 per cent of pensionable salaries from 1 January 2007, until the
completion of the next actuarial valuation, due at 31 December 2008. During 2006 HSBC paid contributions at the
rate of 20 per cent of pensionable salaries. A further 2 per cent of pensionable salaries is being paid over the period
1 January 2007 to 31 December 2014 to make good the difference in contributions during 2006.
As part of the 31 December 2005 valuation, calculations were also carried out as to the amount of assets that might be
needed to meet the liabilities if the plan was discontinued and the members’ benefits bought out with an insurance
company (although in practice this may not be possible for a plan of this size) or the Trustee continued to run the plan
without the support of HSBC. The amount required under this approach is estimated to be US$26,700 million as at 31
December 2005. In estimating the solvency position for this purpose, a more prudent assumption about future
mortality was made than for the assessment of the ongoing position and it was assumed that the Trustee would alter
the investment strategy to be an appropriately matched portfolio of cash and interest and inflation swaps. An explicit
allowance for expenses was also included.
321
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 7
The benefits payable from the defined benefit plan are expected to be as shown in the chart below:
Benefit payments (US$m)
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 plan comprises a funded
defined benefit plan (which provides a lump sum on retirement but which is now closed to new members) and a
defined contribution plan. The latter was established on 1 January 1999 for new employees. The latest valuation of
the defined benefit plan 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 plan’s assets was US$942 million. On an ongoing basis, the
actuarial value of the plan’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 plan’s assets represented 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 per cent per annum and
long-term salary increases of 3 per cent per annum (with short-term deviation from 2005 to 2008).
The HSBC North America (U.S.) Retirement Income Plan was formed with effect from the close of business on
31 December 2004 by the merger of the HSBC Bank USA Pension Plan and the Household International Retirement
Income Plan. This plan covers employees of HSBC Bank USA, HSBC Finance, and certain other employees of
HSBC. It comprises a final average pay plan (now closed to new participants) and a cash balance plan. All new
employees participate in the cash balance plan. The first full actuarial valuation of the merged plan was made at
1 January 2005 by Pedro Nebres, Fellow of the Society of Actuaries and Dan Kutliroff, Enrolled Actuary, of Mercer
Human Resource Consulting. Both are members of the American Academy of Actuaries. At that date, the market
value of the merged plan’s assets was US$2,305 million. The actuarial value of the assets represented 137 per cent of
the benefits accrued to members, after allowing for expected future increases in earnings. The resulting surplus
amounted to US$622 million. The method employed for this valuation was the projected unit credit method and the
main assumptions used were a discount rate of 8 per cent per annum and average salary increases of 3.75 per cent per
annum. The Internal Revenue Service granted formal approval for changes in funding method due to the merger of
pension plans on 23 August 2006.
The HSBC Bank (UK) Pension Scheme, The HSBC Group Hong Kong Local Staff Retirement Benefit Scheme, and
the HSBC North America (U.S.) Retirement Income Plan cover 37 per cent of HSBC’s employees.
HSBC healthcare benefits plans
HSBC also provides post-employment healthcare benefits under plans in the UK, the US, Canada, Mexico, France
and Brazil, the majority of which are unfunded. Post-employment healthcare benefits plans are accounted for in the
same manner as defined benefit pension plans. The plans are reviewed at least annually or in accordance with local
practice and regulations by qualified actuaries. The actuarial assumptions used to calculate the defined benefit
obligation and related current service cost vary according to the economic conditions of the countries in which they
are situated. Total healthcare cost was US$62 million (2005: US$58 million; 2004: US$65 million).
322
Year of
ultimate
rate
n/a
n/a
2014
n/a
n/a
2016
n/a
2012
n/a
n/a
rate
%
7.0
n/a
5.0
n/a
6.75
5.5
6.0
4.9
n/a
n/a
Year of
ultimate
rate
n/a
n/a
2013
n/a
n/a
2016
n/a
2009
n/a
n/a
rate
%
6.7
n/a
5.0
n/a
7.3
6.5
6.0
4.5
n/a
n/a
Post-employment defined benefit plans’ principal actuarial financial assumptions
The principal actuarial financial assumptions used to calculate the Group’s obligations under its defined benefit
pension and post-employment healthcare plans at 31 December 2006, were as follows. These assumptions will also
form the basis for measuring periodic costs under the plans in 2007:
Healthcare cost trend
Discount
rate
Inflation
rate
Rate of
increase for
pensions1
Rate
of pay
increase
Initial
rate
Ultimate
UK ..........................................
Hong Kong .............................
US ..........................................
Jersey ......................................
Mexico ...................................
Brazil ......................................
France .....................................
Canada ...................................
Switzerland ............................
Germany .................................
%
5.1
3.75
5.9
5.1
8.0
10.75
4.5
5.19
2.25
4.5
%
3.0
n/a
2.5
3.0
3.5
4.5
2.0
2.5
1.5
2.0
%
3.0
n/a
n/a
3.0
2.0
4.5
2.0
n/a
n/a
2.0
%
4.0
3.0
3.75
4.75
4.0
4.5
3.0
3.47
2.25
3.0
%
7.0
n/a
10.5
n/a
6.75
11.0
6.0
9.9
n/a
n/a
1 Rate of increase for pensions in payment and deferred pension.
The principal actuarial financial assumptions used to calculate the Group’s obligations under its defined benefit
pension and post-employment healthcare plans at 31 December 2005, were as follows. These assumptions also
formed the basis for measuring periodic costs under the plans in 2006:
Healthcare cost trend
Discount
rate
Inflation
rate
Rate of
increase for
pensions1
Rate
of pay
increase
Initial
rate
Ultimate
UK ..........................................
Hong Kong .............................
US ..........................................
Jersey ......................................
Mexico ...................................
Brazil ......................................
France .....................................
Canada ...................................
Switzerland ............................
Germany .................................
%
4.75
4.2
5.7
4.75
8.90
11.75
4.1
5.25
2.25
4.0
%
2.7
n/a
2.5
2.7
3.75
5.5
2.0
2.5
1.5
2.0
%
2.7
n/a
n/a
2.7
3.75
5.5
2.0
n/a
n/a
2.0
%
3.72
5.0
3.75
4.45
4.5
5.5
3.0
3.0
2.25
3.0
%
6.7
n/a
10.4
n/a
7.3
12.5
6.0
7.3
n/a
n/a
1 Rate of increase for pensions in payment and deferred pension.
2 The 2005 and 2004 rate of pay increase assumptions disclosed have been increased from 3.2 per cent to 3.7 per cent to reflect an age-
related promotional salary scale that was included in the obligation calculation but not in the disclosed assumption.
HSBC determines the discount rates to be applied to its obligations in consultation with the plans’ local actuaries, on
the basis of current average yields of high quality (AA rated or equivalent) debt instruments, with maturities
consistent with those of the defined benefit obligations. The expected rate of return on plan assets is based on
historical market returns adjusted for additional factors such as the current rate of inflation and interest rates.
The principal actuarial financial assumptions used to calculate the Group’s obligations under its defined benefit
pension and post-employment healthcare plans at 31 December 2004, which formed the basis for measuring the 2005
periodic costs, were as follows:
323
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 7
Healthcare cost trend
Discount
rate
Inflation
rate
Rate of
increase for
pensions1
Rate
of pay
increase
Initial
rate
Ultimate
UK ..........................................
Hong Kong ............................
US ..........................................
Jersey .....................................
Mexico ...................................
Brazil ......................................
France ....................................
Canada ...................................
Switzerland ............................
Germany .................................
%
5.3
4.0
6.0
5.3
10.75
11.75
4.5
6.0
3.25
4.5
%
2.7
n/a
2.5
2.7
5.0
5.0
2.0
2.5
1.5
1.5
%
2.7
n/a
n/a
2.7
5.0
5.0
2.0
n/a
n/a
1.5
%
3.72
5.0
3.75
4.45
6.50
5.0
3.5
3.0
2.25
2.5
%
7.7
n/a
11.6
n/a
8.68
10.5
6.0
7.7
n/a
n/a
Year of
ultimate
rate
n/a
n/a
2009
n/a
n/a
2015
n/a
2009
n/a
n/a
rate
%
7.7
n/a
5.9
n/a
8.68
6.0
6.0
4.6
n/a
n/a
1 Rate of increase for pensions in payment and deferred pension.
2 The 2005 and 2004 rate of pay increase assumptions disclosed have been increased from 3.2 per cent to 3.7 per cent to reflect an age-
related promotional salary scale that was included in the obligation calculation but not in the disclosed assumption.
Mortality assumptions are increasingly significant in measuring the Group’s obligations under its defined benefit
pension and post-employment healthcare plans, particularly given the maturity of the plans. The mortality tables and
average life expectancy at 65 used at 31 December 2006 were as follows:
Mortality table
UK .......................................................................... PA921
Hong Kong ............................................................ n/a
US .......................................................................... RP 2000 projected to
2005
Jersey ..................................................................... PA921
Mexico ................................................................... GAM83
Brazil ...................................................................... RP 2000 imp 2006
France .................................................................... TG 05
Canada pension plans ............................................ Between UP94 C2015
and UP94 C2027
Canada healthcare plan .......................................... UP94 C2025
Switzerland ............................................................ EVK2000 and
BVG2000
Life expectancy at
age 65 for a male
member currently:
Aged 65
Aged 45
Life expectancy at
age 65 for a female
member currently:
Aged 65
Aged 45
20.3
n/a
21.6
n/a
23.3
n/a
24.6
n/a
18.7
20.3
16.6
18.9
22.8
19.0
and 20.0
19.8
17.6
and 17.8
18.7
21.6
16.6
20.5
25.6
19.0
and 20.0
19.8
17.6
and 17.8
20.9
23.3
16.6
21.0
26.3
21.6
and 22.1
22.0
20.4
and 21.1
20.9
24.6
16.6
21.9
29.1
21.6
and 22.1
22.0
20.4
and 21.1
24.9
Germany ................................................................. Heubeck 2005 G
18.1
20.8
22.2
1 PA92 with standard improvements to 2005 and medium cohort improvements thereafter.
The mortality tables and average life expectancy at 65 used at 31 December 2005 were as follows:
Mortality table
UK .......................................................................... PA92U2005
Hong Kong ............................................................ n/a
US .......................................................................... RP 2000 imp 2005
Jersey ..................................................................... PA92C2036
Mexico ................................................................... GAM83
Brazil ...................................................................... AT83
France .................................................................... TPG93
Canada pension plans ............................................ UP94 C2012
Canada healthcare plan .......................................... GAM94M/F
Switzerland ............................................................ EVK2000
Germany ................................................................. Heubeck 2005 G
and UP94 C2027
Life expectancy at
age 65 for a male
member currently:
Life expectancy at
age 65 for a female
member currently:
Aged 65
Aged 45
Aged 65
Aged 45
19.53
n/a
17.90
20.83
16.56
18.51
23.02
18.65
and 19.84
17.88
17.6
18.06
20.89
n/a
17.90
20.83
16.56
18.51
25.32
18.65
and 19.84
17.88
17.6
20.84
22.57
n/a
20.25
23.75
16.56
21.89
23.02
21.37
and 22.00
21.32
20.4
22.20
23.86
n/a
20.25
23.75
16.56
21.89
25.32
21.37
and 22.00
21.32
20.4
24.85
324
Actuarial assumption sensitivities
The discount rate is sensitive to changes in market conditions arising during the reporting period. The mortality rates
used are sensitive to experience from the plan member profile. The following table shows the effect of changes in
these and the other key assumptions on the principal plan:
Discount rate
Change in pension obligation at 31 December 2006 from a 25bps increase ......................................................................
Change in pension obligation at 31 December 2006 from a 25bps decrease .....................................................................
Change in 2007 pension cost from a 25bps increase ..........................................................................................................
Change in 2007 pension cost from a 25bps decrease ..........................................................................................................
Rate of inflation
Change in pension obligation at 31 December 2006 from a 25bps increase ......................................................................
Change in pension obligation at 31 December 2006 from a 25bps decrease .....................................................................
Change in 2007 pension cost from a 25bps increase ..........................................................................................................
Change in 2007 pension cost from a 25bps decrease ..........................................................................................................
Rate of increase for pensions in payment and deferred pensions
Change in pension obligation at 31 December 2006 from a 25bps increase ......................................................................
Change in pension obligation at 31 December 2006 from a 25bps decrease .....................................................................
Change in 2007 pension cost from a 25bps increase ..........................................................................................................
Change in 2007 pension cost from a 25bps decrease ..........................................................................................................
Rate of pay increase
Change in pension obligation at 31 December 2006 from a 25bps increase ......................................................................
Change in pension obligation at 31 December 2006 from a 25bps decrease .....................................................................
Change in 2007 pension cost from a 25bps increase ..........................................................................................................
Change in 2007 pension cost from a 25bps decrease ..........................................................................................................
Mortality
Change in pension obligation from each additional year of longevity assumed ................................................................
HSBC Bank
(UK) Pension
Scheme
US$m
(1,086)
1,147
(20)
22
1,147
(1,086)
88
(77)
909
(872)
57
(55)
287
(275)
31
(27)
756
The following table shows the effect of changes in the discount rate and in mortality rates on plans other than the
principal plan:
Change in pension obligations at 31 December 2006 from a 25bps increase in discount rate ..........................................
Change in 2007 pension cost from a 25bps increase in discount rate ................................................................................
Increase in pension obligation from each additional year of longevity assumed ...............................................................
(276)
(5)
167
Other plans
US$m
325
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 7
Defined benefit pension plans
The calculation of the net liability under the Group’s defined benefit pension plans is set out below together with the
expected rates of return and plan assets used to measure the net defined benefit pension costs in each subsequent year.
HSBC Bank (UK) Pension Scheme
Other plans
At 31 December 2006
Equities .........................................................................
Bonds ............................................................................
Property .........................................................................
Other .............................................................................
Fair value of plan assets ...............................................
Present value of funded obligations .............................
Present value of unfunded obligations .........................
Defined benefit obligation ............................................
Effect of limit on plan surpluses ...................................
Unrecognised past service cost .....................................
Net liability ...................................................................
Equities .........................................................................
Bonds ............................................................................
Property .........................................................................
Other .............................................................................
Fair value of plan assets ...............................................
Present value of funded obligations .............................
Present value of unfunded obligations .........................
Defined benefit obligation ............................................
Effect of limit on plan surpluses ...................................
Unrecognised past service cost .....................................
Net liability ...................................................................
Expected
rates of
return
%
8.0
5.3
7.0
4.3
Expected
rates of
return
%
8.1
5.7
7.0
4.6
Value
US$m
5,046
12,189
2,056
1,296
20,587
(24,332)
–
(24,332)
–
–
(3,745)
HSBC Bank (UK) Pension Scheme
Other plans
At 31 December 2005
Expected
rates of
return
%
8.0
4.3
6.5
3.6
Expected
rates of
return
%
8.6
5.2
6.5
4.6
Value
US$m
8,181
5,234
1,540
2,441
17,396
(20,587)
–
(20,587)
–
–
(3,191)
Value
US$m
3,209
3,302
138
467
7,116
(7,534)
(382)
(7,916)
(9)
1
(808)
Value
US$m
2,749
2,539
97
971
6,356
(6,687)
(415)
(7,102)
(7)
3
(750)
Plan assets include US$87 million (2005: US$80 million) of equities issued by HSBC and US$188 million (2005:
US$53 million) of other assets issued by HSBC. Additionally, the fair value of plan assets include derivatives entered
into with the HSBC Bank (UK) Pension Scheme with a negative fair value of US$273 million at 31 December 2006
(2005: nil).
The principal plan holds a diversified portfolio of investments to meet future cash flow liabilities arising from
accrued benefits as they fall due to be paid. The Trustee of the principal plan is required to produce a written
statement of investment principles (‘SIP’). The SIP sets out the principles governing how decisions about investments
are made.
326
Changes in the present value of defined benefit obligations
2006
2005
At 1 January ..................................................................
Current service cost ......................................................
Interest cost ...................................................................
Contributions by employees .........................................
Actuarial losses .............................................................
Benefits paid .................................................................
Past service cost – vested immediately .........................
Past service cost – unvested benefits ............................
Acquisitions ..................................................................
Reduction in liabilities resulting from curtailments .....
Liabilities extinguished on settlements ........................
Exchange differences ....................................................
At 31 December ............................................................
Changes in the fair value of plan assets
HSBC Bank
(UK) Pension
Scheme
US$m
20,587
456
1,055
–
30
(696)
–
–
–
–
–
2,900
24,332
Other
plans
US$m
7,102
304
366
28
211
(386)
9
–
10
(5)
(21)
298
7,916
HSBC Bank
(UK) Pension
Scheme
US$m
19,988
383
981
–
1,968
(540)
–
–
84
–
–
(2,277)
20,587
2006
2005
At 1 January ..................................................................
Expected return on plan assets ......................................
Contributions by HSBC ................................................
– normal ....................................................................
– special ....................................................................
Contributions by employees .........................................
Experience gains ...........................................................
Benefits paid .................................................................
Acquisitions ..................................................................
Assets distributed on curtailments ................................
Assets distributed on settlements ..................................
Exchange differences ....................................................
HSBC Bank
(UK) Pension
Scheme
US$m
17,396
1,169
240
240
–
–
–
(696)
–
–
–
2,478
At 31 December ............................................................
20,587
Other
plans
US$m
6,356
421
193
160
33
28
203
(343)
–
(4)
(14)
276
7,116
HSBC Bank
(UK) Pension
Scheme
US$m
15,105
954
1,986
240
1,746
–
1,623
(540)
58
–
–
(1,790)
17,396
Other
plans
US$m
6,501
283
333
14
506
(338)
(3)
3
–
(4)
(6)
(187)
7,102
Other
plans
US$m
5,823
401
448
156
292
14
78
(287)
–
–
(3)
(118)
6,356
The actual return on plan assets for the year ended 31 December 2006 was US$1,793 million (2005:
US$3,056 million). HSBC expects to make US$1,229 million of contributions to defined benefit pension plans during
2007. Benefits expected to be paid from the plans to retirees over each of the next five years, and in aggregate for the
five years thereafter, are:
HSBC Bank (UK) Pension Scheme ...................
Other significant plans ........................................
2007
US$m
662
344
2008
US$m
693
361
2009
US$m
707
380
2010
US$m
750
389
2011
US$m
2012-2017
US$m
779
422
4,865
2,385
327
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 7
Total expense recognised in the income statement in ‘Employee compensation and benefits’
2006
2005
2004
HSBC Bank
(UK) Pension
Scheme
US$m
Current service cost ....................
Interest cost .................................
Expected return on plan assets ...
Past service cost ..........................
(Gains)/losses on curtailments ....
Total expense ..............................
456
1,055
(1,169)
–
–
342
Summary
Other
plans
US$m
304
366
(421)
11
–
260
HSBC Bank
(UK) Pension
Scheme
US$m
383
981
(954)
–
–
410
Other
plans
US$m
283
333
(401)
(3)
(4)
208
HSBC Bank
(UK) Pension
Scheme
US$m
348
921
(927)
–
242
584
2006
2005
2004
HSBC Bank
(UK) Pension
Scheme
US$m
Defined benefit obligation...........
Fair value of plan assets ..............
(24,332)
20,587
Net deficit ...................................
(3,745)
Experience gains/(losses) on
plan liabilities .........................
Experience gains on plan assets .
Losses from changes in
540
–
actuarial assumptions .............
(570)
Total net actuarial gains/
Other
plans
US$m
(7,916)
7,116
(800)
(167)
203
(44)
HSBC Bank
(UK) Pension
Scheme
US$m
(20,587)
17,396
(3,191)
70
1,623
(2,038)
(losses) ....................................
(30)
(8)
(345)
Other
plans
US$m
(7,102)
6,356
(746)
(113)
78
(393)
(428)
HSBC Bank
(UK) Pension
Scheme
US$m
(19,988)
15,105
(4,883)
401
506
(1,357)
(450)
Other
plans
US$m
257
326
(382)
(8)
(17)
176
Other
plans
US$m
(6,501)
5,823
(678)
(42)
3
(243)
(282)
Actuarial gains and losses represent experience adjustments on plan assets and liabilities as well as adjustments
arising from changes in actuarial assumptions. Total cumulative actuarial losses recognised in equity at 31 December
2006 were US$1,543 million (2005: US$1,505 million).
The total effect of the limit on plan surpluses recognised within actuarial losses in equity during 2006 was a
US$2 million loss (2005: US$4 million gain).
Post-employment healthcare benefits plans
Equities .........................................................................
Bonds ............................................................................
Fair value of plan assets ...............................................
Present value of funded obligations .............................
Present value of unfunded obligations .........................
Defined benefit obligation ............................................
Unrecognised past service cost .....................................
Net liability ...................................................................
2006
Expected rates
of return
%
14.5
8.5
2005
Expected rates
of return
%
12.0
8.5
Value
US$m
40
93
133
(219)
(887)
(1,106)
(29)
(1,002)
Value
US$m
32
75
107
(178)
(826)
(1,004)
(31)
(928)
328
Changes in the present value of defined benefit obligations
At 1 January .......................................................................................................................................
Current service cost ...........................................................................................................................
Interest cost ........................................................................................................................................
Contributions by employees ..............................................................................................................
Actuarial losses ..................................................................................................................................
Benefits paid ......................................................................................................................................
Past service cost:
– vested immediately .....................................................................................................................
– unvested benefits ........................................................................................................................
Reduction in liabilities resulting from curtailments ..........................................................................
Liabilities extinguished on settlements .............................................................................................
Exchange differences .........................................................................................................................
2006
US$m
1,004
19
64
2
37
(52)
1
–
(9)
(1)
41
2005
US$m
982
18
63
6
44
(50)
(13)
(29)
–
–
(17)
At 31 December .................................................................................................................................
1,106
1,004
Changes in the fair value of plan assets
2006
US$m
2005
US$m
At 1 January .......................................................................................................................................
Expected return on plan assets ..........................................................................................................
Contributions by HSBC .....................................................................................................................
Experience gains/(losses) ..................................................................................................................
Benefits paid ......................................................................................................................................
Assets distributed on curtailments .....................................................................................................
Exchange differences .........................................................................................................................
At 31 December .................................................................................................................................
107
11
39
(1)
(20)
(1)
(2)
133
79
10
19
1
(7)
–
5
107
The actual return on plan assets for the year ended 31 December 2006 was US$10 million (2005: US$11 million).
HSBC expects to make US$19 million of contributions to post-employment healthcare benefit plans during 2007.
Benefits expected to be paid from the plans to retirees over each of the next five years, and in aggregate for the five
years thereafter, are:
2007
US$m
2008
US$m
2009
US$m
2010
US$m
2011
US$m
2012-2017
US$m
Significant plans .................................................
47
49
53
55
57
320
Total expense recognised in the income statement in ‘Employee compensation and benefits’
2006
US$m
2005
US$m
2004
US$m
Current service cost .........................................................................................
Interest cost ......................................................................................................
Expected return on plan assets ........................................................................
Past service cost ...............................................................................................
Losses on curtailments .....................................................................................
Losses on settlements ......................................................................................
Total expense ...................................................................................................
19
64
(11)
(1)
(8)
(1)
62
18
63
(10)
(13)
–
–
58
17
58
(8)
(2)
–
–
65
329
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 7 and 8
Summary
Defined benefit obligation ...............................................................................
Fair value of plan assets ..................................................................................
Net deficit ........................................................................................................
Experience gains/(losses) on plan liabilities ...................................................
Experience gains/(losses) on plan assets .........................................................
Gains/(losses) from changes in actuarial assumptions ....................................
Total net actuarial gains/(losses) ......................................................................
2006
US$m
(1,106)
133
(973)
(12)
(1)
(25)
(38)
2005
US$m
(1,004)
107
(897)
19
1
(63)
(43)
2004
US$m
(982)
79
(903)
(15)
–
20
5
Actuarial gains and losses represent experience adjustments on plan assets and liabilities as well as adjustments
arising from changes in actuarial assumptions. Total cumulative net actuarial losses recognised in equity at
31 December 2006 were US$76 million (2005: US$38 million).
The actuarial assumptions of the healthcare cost trend rates have a significant effect on the amounts recognised. A
one percentage point change in assumed healthcare cost trend rates would have the following effects on amounts
recognised in 2006:
1% increase
US$m
1% decrease
US$m
Increase/(decrease) of the aggregate of the current service cost and interest cost ...........................
Increase/(decrease) of defined benefit obligation .............................................................................
8
103
(6)
(111)
HSBC Holdings
Employee compensation and benefit expense in respect of HSBC Holdings’ employees in 2006 amounted to
US$193 million (2005: US$166 million). The average number of persons employed by HSBC Holdings during 2006
was 505 (2005: 433).
Employees of HSBC Holdings who are members of defined benefit pension plans are principally members of either
the HSBC Bank (UK) Pension Scheme or the HSBC International Staff Retirement Benefit Scheme. There is no
contractual or stated policy for charging the net defined benefit cost to HSBC Holdings, which is recognised in the
consolidated accounts of HSBC in the note above. HSBC Holdings pays contributions to plans in accordance with
schedules determined by the Trustees following consultation with qualified actuaries.
Directors’ emoluments
The aggregate emoluments of the Directors of HSBC Holdings, computed in accordance with Part I of Schedule 6 of
the Companies Act, were:
Fees ..................................................................................................................
Salaries and other emoluments ........................................................................
Bonuses ............................................................................................................
Gains on the exercise of share options ............................................................
Vesting of Restricted Share Plan awards ........................................................
2006
US$000
2,660
7,774
10,705
21,139
3
18,975
2005
US$000
2,100
12,869
13,264
28,233
17
24,221
2004
US$000
2,713
9,721
17,288
29,722
14,078
9,598
In addition, there were payments under retirement benefit agreements with former Directors of US$1,045,448 (2005:
US$996,098). The provision at 31 December 2006 in respect of unfunded pension obligations to former Directors
amounted to US$17,759,454 (2005: US$16,458,975).
During the year, aggregate contributions to pension schemes in respect of Directors were US$889,241 (2005:
US$4,819,759), including US$395,740 (2005: US$3,304,081) arising from a Director’s waiver of bonus.
Discretionary bonuses for Directors are based on a combination of individual and corporate performance and are
determined by the Remuneration Committee. Details of Directors’ remuneration, share options and conditional
330
awards under the Restricted Share Plan 2000 and The HSBC Share Plan are included in the ‘Directors’ Remuneration
Report’ on pages 280 to 289.
8 Auditors’ remuneration
Auditors’ remuneration in relation to statutory audit amounted to US$44.7 million (2005: US$47.0 million; 2004:
US$41.7 million).
The following fees were payable by HSBC to the Group’s principal auditor, KPMG Audit Plc and its associates
(together ‘KPMG’):
Audit fees for HSBC Holdings’ statutory audit:
– fees relating to current year .....................................................................
– fees relating to prior year ........................................................................
Fees payable to KPMG for other services provided to HSBC:
– audit of HSBC’s subsidiaries, pursuant to legislation ............................
– other services pursuant to legislation1 ....................................................
– tax services ..............................................................................................
– services relating to information technology ............................................
– services related to corporate finance transactions ..................................
– all other services ......................................................................................
Total fees payable ............................................................................................
2006
US$m
2005
US$m
2004
US$m
2.7
–
2.7
40.4
15.4
2.0
0.6
1.6
4.1
64.1
66.8
2.8
0.2
3.0
42.5
29.2
2.6
–
0.3
5.0
79.6
82.6
2.3
0.7
3.0
36.6
13.4
6.2
–
1.6
4.7
62.5
65.5
1 Including fees paid to KPMG in respect of work relating to preparation for reporting under section 404 of the Sarbanes-Oxley Act of
US$2.2 million (2005: US$11.7 million; 2004: US$4.1 million). Other accounting firms have been paid a total of US$8.3 million (2005:
US$16.7 million; 2004: US$6.6 million) for work on this project.
No fees were payable by HSBC to KPMG for the following types of services: internal audit services, valuation and
actuarial services, services related to litigation, and services related to recruitment and remuneration.
‘Audit fees for HSBC Holdings’ statutory audit’ are fees payable to KPMG Audit Plc for the statutory audit of the
consolidated financial statements of HSBC and the separate financial statements of HSBC Holdings. They exclude
amounts payable for the statutory audit of HSBC Holdings’ subsidiaries which have been included in ‘Fees payable
to KPMG for other services provided to HSBC’.
The following is a description of the types of services included in ‘Fees payable to KPMG for other services provided
to HSBC’:
Audit related services
–
–
‘Audit of HSBC’s subsidiaries pursuant to legislation’ includes fees payable to KPMG for the statutory audit of
HSBC’s subsidiaries.
‘Other services pursuant to legislation’ include services for assurance and other services that are in relation to
statutory and regulatory filings, including comfort letters and interim reviews.
Tax services
–
‘Tax services’ include tax compliance services and tax advisory services.
Other services
–
–
–
‘Services relating to information technology’ include advice on IT security and business continuity and
performing agreed upon IT testing procedures.
‘Services related to corporate finance transactions’ include fees payable to KPMG for transaction-related work,
including US debt issuances.
‘All other services’ include other assurance and advisory services such as translation services, ad-hoc accounting
advice and review of financial models.
331
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 8 and 9
The following fees were payable by HSBC’s associated pension schemes to KPMG:
Audit fees .........................................................................................................
Tax services .....................................................................................................
All other services .............................................................................................
Total fees payable ............................................................................................
2006
US$’000
2005
US$’000
2004
US$’000
581
23
23
627
550
17
5
572
536
11
5
552
No fees were payable by HSBC’s associated pension schemes to KPMG for the following types of services: other
services pursuant to legislation, services relating to information technology, internal audit services, valuation and
actuarial services, services related to litigation, services related to recruitment and remuneration, and services related
to corporate finance transactions.
In addition to the above, KPMG estimate they have been paid fees of US$2.1 million (2005: US$4.5 million; 2004:
US$4.0 million) by parties other than HSBC but where HSBC is connected with the contracting party and therefore
may be involved in appointing KPMG. These fees arise from services such as auditing mutual funds managed by
HSBC and reviewing the financial position of corporate concerns which borrow from HSBC.
Fees payable to KPMG for non-audit services for HSBC Holdings are not disclosed separately because such fees are
disclosed on a consolidated basis for HSBC Group.
9 Share-based payments
During 2006, US$854 million was charged to the income statement in respect of equity-settled share-based payment
transactions (2005: US$540 million; 2004: US$450 million). This expense was based on the fair value of the share-
based payment transactions when contracted. All of the expense arose under employee share awards made within
HSBC’s reward structures.
Calculation of fair values
Fair values of share options/awards, measured at the date of grant of the option/award, are calculated using a
binomial lattice model 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. The fair values calculated are inherently subjective and uncertain due to the assumptions made and
the limitations of the model used.
The significant weighted average assumptions used to estimate the fair value of the options granted were as follows:
HSBC
Holdings
Group Share
Option Plan
2006
Risk-free interest rate1 (%) ...............
Expected life2 (years) ........................
Expected volatility3 (%) ....................
Share price at grant date (£) ..............
2005
Risk-free interest rate1 (%) ...............
Expected life2 (years) ........................
Expected volatility3 (%) ....................
Share price at grant date (£) ..............
–
–
–
–
4.6
7.8
20
8.30
1-year
Savings-
Related
Share Option
Plan
4.7
1
17
9.54
–
–
–
–
3-year
Savings-
Related
Share Option
Plans
5-year
Savings-
Related Share
Option
Plans
The
HSBC
Share Plan
4.8
3
17
9.54
4.3
3
20
8.68
4.7
5
17
9.54
4.3
5
20
8.68
–
–
–
–
4.3
5
20
8.37
1 The risk-free rate was determined from the UK gilts yield curve for the HSBC Holdings Group Share Option Plan awards and UK
Savings-Related Share Option Plans. A similar yield curve was used for the International Savings-Related Share Option Plans.
2 Expected life is not a single input parameter but a function of various behavioural assumptions.
3 Expected volatility is estimated by considering both historic average share price volatility and implied volatility derived from traded
options over HSBC shares of similar maturity to those of the employee options.
332
Expected dividends have been incorporated into the valuation model for options and shares, where applicable. The
expected US dollar denominated dividend growth was determined to be 9 per cent for the first year (2005: 12 per
cent) and 8 per cent thereafter (2005: 8 per cent), consistent with consensus analyst forecasts.
The HSBC Share Plan
The HSBC Share Plan was adopted by HSBC Holdings in 2005. Under this Plan Performance Share awards,
Restricted Share awards and Share Option awards may be made. The aim of The HSBC Share Plan is to align the
interests of executives to the creation of shareholder value and recognise individual performance and potential.
Awards are also made under this plan for recruitment and retention purposes.
Performance Share awards
Performance Share awards are made to executive Directors and other senior executives taking into account individual
performance in the prior year. Performance Share awards are divided into two equal parts for testing attainment
against pre-determined benchmarking. One half of the award is subject to a Total Shareholder Return measure, based
on HSBC’s ranking against a comparator group of 28 major banks. The other half of the award is subject to an
earnings per share target. For each element of the award, shares would be released to the employee according to a
sliding scale from 30 to 100 per cent of the award, dependent upon the scale of achievement against the benchmarks
and provided that the minimum criteria for each performance measure has been met. Shares will be released after
three years to the extent that the performance conditions are satisfied.
Outstanding at 1 January ...................................................................................................................
Additions during the year1 ..................................................................................................................
Forfeited in the year ...........................................................................................................................
2006
Number
(000’s)
5,077
5,312
(22)
Outstanding at 31 December .............................................................................................................
10,367
1 Additions during the year include 1,413,650 shares awarded to employees of HSBC Holdings (2005: 3,453,884).
2005
Number
(000’s)
–
5,077
–
5,077
The weighted average fair value of shares awarded by HSBC for Performance Share awards in 2006 was US$9.72
(2005: US$9.02).
Restricted Share awards
Restricted Share awards are made to other employees based on performance, potential and retention requirements, for
recruitment or as part of deferral of annual bonus. The awards vest between one and three years from date of award.
Outstanding at 1 January ...................................................................................................................
Additions during the year1 ..................................................................................................................
Released in the year ...........................................................................................................................
Forfeited in the year ...........................................................................................................................
2006
Number
(000’s)
5,106
41,440
(1,685)
(1,441)
Outstanding at 31 December .............................................................................................................
43,420
1 Additions during the year include 324,884 shares awarded to employees of HSBC Holdings (2005: 823).
2005
Number
(000’s)
–
5,285
(179)
–
5,106
The weighted average fair value of shares awarded by HSBC for Restricted Share Awards in 2006 was US$17.65
(2005: US$16.66).
333
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 9
Share options
Share options were granted in 2005 under the Rules of The HSBC Share Plan to employees in France based on their
performance in the previous year. The share options are subject to the corporate performance condition, which
consists of an absolute earnings per share measure and a Total Shareholder Return measure, based on HSBC
Holdings’ ranking against a comparator group of 28 major banks. The options vest after three years and are
exercisable up to the tenth anniversary of the date of grant, after which they will lapse.
Outstanding at 1 January ..............................................
Granted in the year .......................................................
Forfeited in the year ......................................................
Outstanding at 31 December ........................................
2006
2005
Weighted
average
exercise
price
£
8.84
–
–
8.84
Number
(000’s)
628
–
–
628
Weighted
average
exercise
price
£
–
8.84
–
8.84
Number
(000’s)
–
628
–
628
The fair value of options granted in 2005 was US$2.29. No options were awarded in 2006. The weighted average
remaining contractual life of options outstanding at the balance sheet date is 3.3 years (2005: 4.3 years). None of
these options are exercisable at the balance sheet date.
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 (or equivalent in US dollars, Hong Kong dollars or euros), 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 three months following the first anniversary of the commencement of a one-year savings contract
or within six months following either the third or the fifth anniversary of the commencement of three-year or five-
year savings contracts. The exercise price is set at a 20 per cent (2005: 20 per cent) discount to the market value at
the date of grant (except for the one-year options granted under the US sub-plan where a 15 per cent discount is
applied).
Outstanding at 1 January ..............................................
Granted in the year .......................................................
Exercised in the year......................................................
Forfeited in the year ......................................................
Outstanding at 31 December ........................................
2006
2005
Weighted
average
exercise
price
£
6.07
7.63
5.61
6.26
6.58
Number1
(000’s)
98,416
22,627
(25,336)
(7,870)
87,837
Weighted
average
exercise
price
£
5.92
6.68
6.06
6.06
6.07
Number1
(000’s)
109,722
26,995
(29,693)
(8,608)
98,416
1 The above includes HSBC Holdings employee options of 606,205 outstanding at 1 January 2006 (2005: 599,322), 112,181 options
granted in the year (2005: 136,100) and 689,603 options outstanding at 31 December 2006 (2005: 606,205).
The weighted average fair value of options granted in the year as at the date of grant was US$3.45 (2005: US$3.76).
The exercise price range and weighted average remaining contractual life for options outstanding at the balance sheet
date, were as follows:
Exercise price range (£)......................................................................................................................
Weighted average remaining contractual life (years) .......................................................................
Of which exercisable:
Number (000’s) .............................................................................................................................
Weighted average exercise price (£) .............................................................................................
2006
2005
5.35 – 8.07
1.76
5.35 - 6.75
1.89
671
5.35
772
6.09
The weighted average share price at the date the share options were exercised was US$17.55 (2005: US$16.56).
334
HSBC Holdings Restricted Share Plan 2000
Performance Share awards made under the HSBC Holdings Restricted Share Plan 2000 (the ‘Restricted Share
Plan’)
Performance Share awards under the Restricted Share Plan were granted to Senior Executives from 2000 to 2004.
The aim of the plan was to align the interests of executives to the creation of shareholder value. This was achieved by
setting certain Total Shareholder Return targets against a peer group of major banks which must normally be attained
in order for the awards to vest. No further awards will be made under this Plan following adoption of The HSBC
Share Plan in 2005 other than from reinvested scrip dividends.
Outstanding at 1 January ...................................................................................................................
Additions during the year1 .................................................................................................................
Released in the year ...........................................................................................................................
Forfeited in the year ...........................................................................................................................
Outstanding at 31 December .............................................................................................................
2006
Number
(000’s)
14,970
520
(3,050)
(112)
12,328
2005
Number
(000’s)
17,044
710
(2,455)
(329)
14,970
1 Additions during the year comprise reinvested scrip dividends, and include nil shares awarded to employees of HSBC Holdings (2005:
321,279).
The weighted average remaining vesting period as at 31 December 2006 was 1.53 years (2005: 2.14 years).
Restricted share awards made under the HSBC Holdings Restricted Share Plan 2000
Restricted shares were awarded to eligible employees after taking into account the employee’s performance in the
prior year, potential and retention requirements. Restricted shares are also awarded as part deferral of annual bonus or
for recruitment purposes. Shares are awarded without corporate performance conditions and are generally released to
employees between one and three years after the award was made, providing the employees have remained
continuously employed by HSBC for this period.
Outstanding at 1 January ...................................................................................................................
Additions during the year1 .................................................................................................................
Released in the year ...........................................................................................................................
Forfeited in the year ...........................................................................................................................
Outstanding at 31 December .............................................................................................................
2006
Number
(000’s)
58,427
1,499
(19,224)
(2,032)
38,670
2005
Number
(000’s)
46,021
34,439
(21,007)
(1,026)
58,427
1 Additions during the year comprise reinvested scrip dividends, and include 41,951 shares awarded to employees of HSBC Holdings
(2005: 384,797).
The weighted average fair value of shares awarded by HSBC for Restricted Share Awards in 2005 was US$15.88. No
awards were made in 2006.
The weighted average remaining vesting period as at 31 December 2006 was 0.84 years (2005: 1.09 years).
HSBC Holdings Group Share Option Plan
The HSBC Holdings Group Share Option Plan was a long-term incentive plan under which certain HSBC employees
between 2000 and 2005 were awarded share options. The aim of the plan was to align the interests of those higher
performing employees to the creation of shareholder value. This was achieved by setting certain Total Shareholder
Return targets which must normally be attained in order for the awards to vest. Options were granted at market value
and are normally exercisable between the third and tenth anniversaries of the date of grant, subject to vesting
conditions. Any options granted after May 2005 will be made under the Rules of The HSBC Share Plan.
335
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 9
Outstanding at 1 January ..............................................
Granted in the year .......................................................
Exercised in the year .....................................................
Forfeited in the year ......................................................
Outstanding at 31 December ........................................
2006
2005
Weighted
average
exercise
price
£
8.06
–
7.80
8.29
8.09
Number1
(000’s)
209,982
–
(37,817)
(5,537)
166,628
Weighted
average
exercise
price
£
8.07
8.36
8.49
8.00
8.06
Number1
(000’s)
220,670
7,470
(11,764)
(6,394)
209,982
1 The above includes HSBC Holdings employee awards of 2,537,647 options outstanding at 1 January 2006 (2005: 2,624,133), zero
options granted in the year (2005:3,775) and 2,189,156 options outstanding at 31 December 2006 (2005: 2,537,647).
The weighted average fair value of options granted in 2006 was US$3.09. No options were granted in 2006. 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, were as follows:
2006
2005
Exercise price range (£).................................................
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 (£) ........................
34,903
6.92
4.74
34,903
6.92
131,725
8.40
7.17
66,104
8.58
53,242
6.91
5.63
411
7.46
156,741
8.45
7.05
84,145
8.55
The weighted average share price at the date the share options were exercised was US$17.65 (2005: US$16.18).
After consideration of the performance and shareholder returns over the period between 2003 and 2005, the
Remuneration Committee exercised its discretion to waive the Total Shareholder Return performance condition in
respect of the awards made under this plan in 2003.
As a result, a charge of US$135 million was recognised in 2006, reflecting the incremental fair value granted
measured at the date the performance condition was waived. This was measured using a binomial lattice model
methodology that is based on the underlying assumptions of the Black-Scholes model, as described above in
‘Calculation of fair values’. A risk-free interest rate of 4.3 per cent was used, with all other inputs to the model
consistent with those used to value the other share options and awards made during 2006.
HSBC Holdings Executive Share Option Scheme
The HSBC Holdings Executive Share Option Scheme was a long-term incentive scheme under which certain senior
HSBC employees were awarded share options before the adoption of the HSBC Holdings Group Share Option Plan
in 2000. The aim of the plan was to align the interests of those higher performing senior employees to the creation of
shareholder value. This was achieved by setting certain Total Shareholder Return targets to be attained in order for
the awards to vest. Options were granted at market value and were exercisable between the third and tenth
anniversaries of the date of grant, subject to vesting conditions. No awards have been made under this plan since
2000 and the remaining unexercised options are summarised below:
Outstanding at 1 January ..............................................
Exercised in the year .....................................................
Forfeited in the year ......................................................
Outstanding at 31 December ........................................
2006
2005
Weighted
average
exercise
price
£
6.78
6.69
5.94
6.82
Number1
(000’s)
32,255
(9,767)
(451)
22,037
Weighted
average
exercise
price
£
6.76
6.67
7.31
6.78
Number1
(000’s)
43,977
(11,206)
(516)
32,255
1 The above includes HSBC Holdings employee awards of 712,922 options outstanding at 1 January 2006 (2005: 864,327) and 751,936
options outstanding at 31 December 2006 (2005: 712,922).
336
The weighted average fair value of options as at the last date of grant during 2000 was US$5.26.
The weighted average share price at the date the share options were exercised was US$17.65 (2005: US$16.18).
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, were as follows:
2006
2005
Exercise price range (£) .................................................
2.17 – 6.00
6.01 – 7.87
2.17 – 6.00
6.01 – 7.87
Number (000’s) .............................................................
Weighted average exercise price (£) ............................
Weighted average remaining contractual life (years) ...
Of which exercisable:
Number (000’s) ........................................................
Weighted average exercise price (£) ........................
252
5.02
–
252
5.02
22,234
6.84
2.64
22.234
6.84
781
4.57
0.97
781
4.57
31,474
6.83
3.64
31,474
6.83
HSBC France and subsidiary company plans
Before its acquisition by HSBC in 2000, HSBC France and certain of its subsidiaries operated employee share plans
under which share options were granted over their respective shares.
Options over HSBC France shares granted between 1994 and 1999 vested upon announcement of HSBC’s intent to
acquire HSBC France and were therefore included in the valuation of HSBC France.
HSBC France 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 HSBC France 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 HSBC France share). Options were granted at market value and are exercisable within
10 years of the date of grant.
Outstanding at 1 January ..............................................
Exercised in the year .....................................................
Outstanding at 31 December ........................................
2006
2005
Number
(000’s)
766
(120)
646
Exercise
price
€
142.5
142.5
142.5
Number
(000’s)
860
(94)
766
Exercise
price
€
142.5
142.5
142.5
The remaining contractual life for options outstanding at the balance sheet date was 3.3 years (2005: 4.3 years).
The weighted average share price at the date the share options were exercised was US$17.64 (2005: US$16.18).
At the date of its acquisition in 2000, certain of HSBC France’s subsidiary companies also operated employee share
option plans under which options could be granted over their respective shares. On exercise of certain of these
options, the subsidiary shares are exchanged for HSBC ordinary shares. The total number of HSBC ordinary shares
exchanged under such arrangements in 2006 was 356,491 (2005: 821,466).
HSBC Finance Corporation
Upon acquisition, HSBC Finance Corporation share options previously granted were converted to share options over
HSBC ordinary shares of US$0.50 each at a rate of 2.675 HSBC share options (the same ratio as the Exchange Offer
for HSBC Finance Corporation) for each HSBC Finance Corporation share option. Options granted under HSBC
Finance Corporation’s own share option schemes prior to the announcement of the acquisition by HSBC in
November 2002 vested as options over HSBC shares upon acquisition by HSBC. Options granted after the
announcement of the acquisition in November 2002 but prior to its completion on 28 March 2003, generally vest
equally over 4 years and expire 10 years from the date of grant.
Information with respect to share options granted under the HSBC Finance Corporation’s pre-acquisition scheme was
as follows:
337
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 9, 10, 11 and 12
HSBC Finance Corporation share options
outstanding at 1 January ...........................................
Exercised in the year .....................................................
Forfeited in the year ......................................................
Outstanding at 31 December ........................................
Of which exercisable ....................................................
2006
2005
Number
(000’s)
6,358
(3,219)
(13)
3,126
3,126
Exercise
price
US$
10.66
10.66
10.66
10.66
10.66
Number
(000’s)
7,112
(754)
–
6,358
5,520
Exercise
price
US$
10.66
10.66
–
10.66
10.66
The weighted average share price at the date the share options were exercised was US$17.65 (2005: US$16.18).
10 Tax expense
Current tax
United Kingdom corporation tax charge – on current year profit ..................
United Kingdom corporation tax charge – adjustments in respect of
prior years ....................................................................................................
Overseas tax – on current year profit ..............................................................
Overseas tax – adjustments in respect of prior years ......................................
Deferred tax
Origination and reversal of temporary differences .........................................
Effect of changes in tax rates ..........................................................................
Adjustments in respect of prior years ..............................................................
2006
US$m
772
(122)
4,600
(48)
5,202
(51)
–
64
13
Tax expense .....................................................................................................
5,215
2005
US$m
663
29
4,103
(110)
4,685
506
8
(106)
408
5,093
2004
US$m
848
(132)
2,877
(21)
3,572
1,204
(15)
(76)
1,113
4,685
The UK corporation tax rate applying to HSBC Holdings and its subsidiary undertakings was 30 per cent (2005:
30 per cent; 2004: 30 per cent). Overseas tax included Hong Kong profits tax of US$751 million (2005:
US$639 million; 2004: US$539 million). Subsidiaries in Hong Kong provided for Hong Kong profits tax at the rate
of 17.5 per cent (2005: 17.5 per cent; 2004: 17.5 per cent) on the profits for the year assessable in Hong Kong. Other
overseas subsidiaries and overseas branches provided for taxation at the appropriate rates in the countries in which
they operate.
The following table reconciles the tax expense which would apply if all profits had been taxed at the UK corporation
tax rate:
Analysis of tax expense
Taxation at UK corporation tax rate of
30% (2005 and 2004: 30% ) ..................
6,626
30.0
6,290
30.0
5,683
30.0
2006
US$m
%
2005
US$m
%
2004
US$m
%
Effect of taxing overseas profits in
principal locations at different rates .......
Tax-free gains .............................................
Adjustments in respect of prior period
liabilities ..................................................
Low income housing tax credits1 ...............
Other items ..................................................
Deductible innovative tier 1 capital
expense presented below profit before
tax ...........................................................
Effect of profit in associates and joint
ventures ..................................................
Tax expense ................................................
(568)
(199)
(106)
(108)
(177)
(2.6)
(0.9)
(0.5)
(0.5)
(0.8)
(342)
(220)
(187)
(110)
(145)
(1.6)
(1.0)
(0.9)
(0.5)
(0.8)
(347)
(64)
(229)
(95)
9
(1.8)
(0.3)
(1.2)
(0.5)
(0.1)
–
–
–
–
(192)
(1.0)
(253)
5,215
(1.1)
23.6
(193)
(0.9)
5,093
24.3
(80)
4,685
(0.4)
24.7
1 Low income housing tax credits arise in the US and are designed to encourage the provision of rental housing for low income
households.
338
In addition to the amount charged to the income statement, the aggregate amount of current and deferred tax, relating
to items that are taken directly to equity, was a US$44 million reduction in equity (2005: US$437 million; 2004:
US$319 million – both increases in equity).
11 Dividends
Dividends to shareholders of the parent company were as follows:
2006
2005
2004
Per
share
US$
Total
US$m
Settled
in scrip
US$m
Per
share
US$
Total
US$m
Settled
in scrip
US$m
Per
share
US$
Total
US$m
Settled
in scrip
US$m
Dividends declared on ordinary shares
Fourth interim dividend in respect of
previous year ..........................................
0.310
3,513
1,542
0.270
3,007
431
–
–
–
First interim dividend in respect of
current year .............................................
0.150
1,712
248
0.140
1,563
677 0.130
1,425
747
Second interim dividend in respect of
current year .............................................
0.150
1,724
515
0.140
1,574
311 0.130
1,436
746
Third interim dividend in respect of
current year .............................................
Third interim dividend in respect of previous
year .........................................................
Quarterly dividends on preference
share capital
March dividend ...........................................
June dividend ...............................................
September dividend .....................................
December dividend......................................
0.150
1,730
223
0.140
1,585
392 0.130
1,444
255
–
–
–
–
–
– 0.240
2,627
346
0.760
8,679
2,528
0.690
7,729
1,811 0.630
6,932
2,094
15.50
15.50
15.50
15.50
62.00
22
23
22
23
90
–
–
–
14.29
14.29
–
–
–
21
21
–
–
–
–
–
–
–
–
–
–
The Directors declared after the end of the year a fourth interim dividend in respect of the financial year ended
31 December 2006 of US$0.36 per ordinary share, a distribution of US$4,171 million. The fourth interim dividend
will be payable on 10 May 2007 to shareholders on the Register at the close of business on 23 March 2007. No
liability is recorded in the financial statements in respect of the fourth interim dividend.
12 Earnings per share
Basic earnings per ordinary share was calculated by dividing the earnings of US$15,699 million
(2005: US$15,060 million; 2004: US$12,918 million) by the weighted average number of ordinary shares, excluding
own shares held, outstanding in 2006 of 11,210 million (2005: 11,038 million; 2004: 10,907 million).
Profit attributable to shareholders of the parent company ..............................
Dividend payable on preference shares classified as equity ...........................
Profit attributable to the ordinary shareholders of the parent company ..........
2006
US$m
15,789
(90)
15,699
2005
US$m
15,081
(21)
15,060
2004
US$m
12,918
–
12,918
Diluted earnings per ordinary share was calculated by dividing the basic earnings, which require no adjustment for
the effects of dilutive potential ordinary shares (including share options outstanding not yet exercised), 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 in 2006
of 11,320 million (2005: 11,171 million; 2004: 11,054 million). The effect of dilutive share options and share awards
on the weighted average number of ordinary shares in issue was as follows:
339
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 12 and 13
Average number of shares in issue ..................................................................
Dilutive share options and share awards .........................................................
– Savings-related Share Option Plan ..........................................................
– Executive Share Option Scheme ..............................................................
– Group Share Option Plan .........................................................................
– Restricted and performance share awards ................................................
– HSBC France share options .....................................................................
– HSBC Finance share options ...................................................................
Average number of shares in issue assuming dilution ....................................
Number of shares (millions)
2006
11,210
110
27
10
28
32
8
5
11,320
2005
11,038
133
22
11
14
70
10
6
11,171
2004
10,907
147
38
12
13
63
13
8
11,054
Of the total number of employee share options and share awards existing at 31 December 2006, 20 million were anti-
dilutive (2005: 121 million; 2004: 70 million).
13 Segment analysis
In the following segmental analysis, the benefit of shareholders’ funds impacts the analysis only to the extent that
these funds are actually allocated to businesses in the segment by way of intra-HSBC capital and funding structures.
By geographical region
Geographical information is classified by the location of the principal operations of the subsidiary undertaking, or,
for The Hongkong and Shanghai Banking Corporation, HSBC Bank, HSBC Bank Middle East, HSBC Finance and
HSBC Bank USA, by the location of the branch responsible for reporting the results or advancing the funds. Due to
the nature of HSBC’s structure, the analysis of profits shown below includes intra-HSBC items between geographical
regions with the elimination shown in a separate column. The Rest of Asia-Pacific geographical segment includes the
Middle East, India and Australasia. Shared costs are included in segments on the basis of the actual recharges made.
During 2006, HSBC changed how certain of its geographical segments are managed and their performance assessed.
As a result, a new segment, Latin America and the Carribean (‘Latin America’), was formed from the Group’s
businesses previously reported under South America, and those in Mexico and Panama which had been previously
reported as part of the North America geographical segment. All prior period comparative data have been restated to
conform to the current year presentation.
Total assets
Europe ..............................................................................................................
Hong Kong ......................................................................................................
Rest of Asia-Pacific .........................................................................................
North America .................................................................................................
Latin America ..................................................................................................
Total liabilities
Europe ..............................................................................................................
Hong Kong ......................................................................................................
Rest of Asia-Pacific .........................................................................................
North America .................................................................................................
Latin America ..................................................................................................
At 31 December 2006
US$m
828,701
272,428
167,668
511,190
80,771
%
44.6
14.6
9.0
27.5
4.3
At 31 December 2005
(restated)
US$m
%
636,703
235,376
142,014
432,490
55,387
42.4
15.7
9.4
28.8
3.7
1,860,758
100.0
1,501,970
100.0
At 31 December 2006
US$m
778,635
258,028
161,388
477,310
70,469
%
44.7
14.8
9.2
27.3
4.0
At 31 December 2005
(restated)
US$m
%
594,953
223,093
136,892
401,686
47,120
42.4
15.9
9.8
28.5
3.4
1,745,830
100.0
1,403,744
100.0
340
Profit before tax
Interest income ............................
Interest expense ..........................
Net interest income .....................
Fee income ..................................
Fee expense .................................
Net fee income ............................
Trading income excluding net
interest income ........................
Net interest income/(expense)
on trading activities ................
Net trading income .....................
Net income/(expense) from
financial instruments
designated at fair value ...........
Gains less losses from financial
investments .............................
Dividend income .........................
Net earned insurance premiums ..
Other operating income ..............
Europe
US$m
25,249
(16,960)
8,289
9,583
(2,475)
7,108
2,842
1,687
4,529
144
624
183
1,298
1,428
Hong
Kong
US$m
11,097
(6,412)
4,685
2,448
(392)
2,056
924
(307)
617
260
162
61
2,628
834
Year ended 31 December 2006
Rest of
Asia-
Pacific
US$m
North
America
US$m
Latin
America
US$m
7,693
(4,646)
3,047
1,912
(290)
1,622
935
246
27,959
(13,691)
14,268
5,611
(845)
4,766
617
741
1,181
1,358
79
41
5
174
765
(63)
58
85
492
922
7,289
(3,092)
4,197
1,975
(345)
1,630
301
236
537
237
84
6
1,076
91
7,858
Intra-
HSBC
items
US$m
(3,408)
3,408
–
(449)
449
–
–
–
–
–
–
–
–
(1,494)
(1,494)
Total
US$m
75,879
(41,393)
34,486
21,080
(3,898)
17,182
5,619
2,603
8,222
657
969
340
5,668
2,546
70,070
Total operating income ............
23,603
11,303
6,914
21,886
Net insurance claims incurred
and movement in policy-
holders’ liabilities ...................
Net operating income before
loan impairment charges
and other credit risk
provisions ...............................
Loan impairment charges and other
credit risk provisions ..............
Net operating income1 ..............
Total operating expenses
(excluding depreciation and
amortisation) ...........................
Depreciation of property, plant
and equipment ........................
Amortisation of intangible
assets .......................................
(531)
(2,699)
(192)
(259)
(1,023)
–
(4,704)
23,072
8,604
6,722
21,627
6,835
(1,494)
65,366
(2,155)
20,917
(172)
8,432
(512)
6,210
(6,796)
14,831
(938)
5,897
–
(10,573)
(1,494)
54,793
(12,811)
(3,002)
(3,412)
(9,669)
(3,923)
1,494
(31,323)
(173)
(70)
(4,166)
1,731
4
1,735
2,017
84
–
–
(1,514)
(716)
1,494
(33,553)
–
–
–
–
–
21,240
846
22,086
4,983
8,396
(124)
(12)
(284)
(240)
(3,548)
(10,193)
2,662
4,638
30
4,668
899
541
865
3,527
235
6,322
5,592
618
15,694
(863)
5,873
24
–
(1,494)
54,793
–
(762)
(298)
Total operating expenses ..........
(13,871)
Operating profit ........................
7,046
Share of profit/(loss) in
associates and joint ventures ..
(72)
Profit before tax ........................
6,974
Other disclosures:
Capital expenditure incurred2 .....
Investment in associates and
joint ventures ..........................
1,508
1,321
(171)
(96)
(3,269)
5,163
19
5,182
324
128
1 Net operating income:
External ..................................
Inter-segment ..........................
19,664
1,253
7,970
462
2 Expenditure incurred on property, plant and equipment and intangible assets.
341
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 13
Europe
US$m
Interest income ............................
Interest expense ..........................
21,023
(12,802)
Net interest income .....................
8,221
Fee income ..................................
Fee expense .................................
8,081
(1,782)
Net fee income ............................
6,299
Trading income excluding net
interest income .......................
1,660
Net interest income/(expense)
on trading activities ................
1,376
Net trading income .....................
Net income/(expense) from
financial instruments
designated at fair value ...........
Gains less losses from financial
investments .............................
Dividend income .........................
Net earned insurance premiums .
Other operating income ..............
3,036
362
439
63
1,599
1,603
Total operating income ...............
21,622
Year ended 31 December 2005 (restated)
Rest of
Asia-
Pacific
US$m
5,673
(3,261)
2,412
1,619
(279)
1,340
753
107
860
58
18
5
155
335
North
America
US$m
Latin
America
US$m
22,189
(8,894)
13,295
4,605
(653)
3,952
250
635
885
434
47
41
477
642
6,133
(2,791)
3,342
1,481
(290)
1,191
220
317
537
186
80
5
871
286
5,183
19,773
6,498
Hong
Kong
US$m
7,419
(3,355)
4,064
1,967
(293)
1,674
773
(227)
546
(6)
108
41
2,334
805
9,566
Intra-
HSBC
items
US$m
(2,343)
2,343
–
(267)
267
–
–
–
–
–
–
–
–
(938)
(938)
Total
US$m
60,094
(28,760)
31,334
17,486
(3,030)
14,456
3,656
2,208
5,864
1,034
692
155
5,436
2,733
61,704
Net insurance claims incurred
and movement in policy-
holders’ liabilities ...................
Net operating income before
loan impairment charges and
other credit risk provisions .....
Loan impairment charges and other
credit risk provisions ..............
Net operating income1 ................
Total operating expenses
(excluding depreciation and
amortisation) ...........................
Depreciation of property, plant
and equipment ........................
Amortisation of intangible
assets .......................................
(912)
(234)
Total operating expenses ............
(12,639)
Operating profit ..........................
6,236
Share of profit in associates
and joint ventures ...................
Profit before tax ..........................
Other disclosures:
Capital expenditure incurred2 .....
Investment in associates and
joint ventures ..........................
1 Net operating income:
120
6,356
1,892
1,733
(818)
(2,059)
(166)
(232)
(792)
–
(4,067)
20,804
7,507
5,017
19,541
5,706
(938)
57,637
(1,929)
18,875
(146)
7,361
(134)
4,883
(4,916)
14,625
(676)
5,030
–
(938)
(7,801)
49,836
(11,493)
(2,586)
(2,648)
(8,276)
(3,263)
938
(27,328)
(168)
(113)
(2,867)
4,494
23
4,517
249
108
(107)
(7)
(2,762)
2,121
453
2,574
(307)
(175)
(8,758)
5,867
48
5,915
191
1,826
5,362
43
(138)
(25)
(3,426)
1,604
–
1,604
315
3
–
–
(1,632)
(554)
938
(29,514)
–
–
–
–
–
20,322
644
20,966
4,473
7,249
External ..................................
Inter-segment ..........................
18,300
575
7,001
360
4,636
247
14,860
(235)
5,039
(9)
–
(938)
49,836
–
2 Expenditure incurred on property, plant and equipment and intangible assets.
342
Interest income ............................
Interest expense ..........................
Net interest income .....................
Fee income ..................................
Fee expense .................................
Net fee income ............................
Trading income ...........................
Net investment income on
assets backing
policyholders’ liabilities .........
Gains less losses from financial
investments .............................
Dividend income .........................
Net earned insurance premiums
Other operating income ..............
Europe
US$m
18,360
(9,262)
9,098
7,546
(1,566)
5,980
997
571
154
558
1,875
1,175
Total operating income ...............
20,408
Year ended 31 December 2004 (restated)
Rest of
Asia-
Pacific
US$m
4,149
(2,089)
2,060
1,287
(246)
1,041
494
32
17
3
97
146
North
America
US$m
Latin
America
US$m
19,483
(5,696)
13,787
4,115
(918)
3,197
509
–
147
32
450
341
4,174
(1,658)
2,516
1,226
(199)
1,027
127
95
47
2
699
46
3,890
18,463
4,559
Hong
Kong
US$m
5,133
(1,495)
3,638
1,964
(261)
1,703
659
314
175
27
2,247
536
9,299
Intra-
HSBC
items
US$m
(828)
828
–
(236)
236
–
–
–
–
–
–
(631)
(631)
Total
US$m
50,471
(19,372)
31,099
15,902
(2,954)
12,948
2,786
1,012
540
622
5,368
1,613
55,988
Net insurance claims incurred
and movement in policy-
holders’ liabilities ...................
Net operating income before
loan impairment charges and
other credit risk provisions .....
Loan impairment charges and other
credit risk provisions ..............
Net operating income1 ................
Total operating expenses
(excluding depreciation and
amortisation) ...........................
Depreciation of property, plant
(1,628)
(2,154)
(82)
(236)
(535)
–
(4,635)
18,780
7,145
3,808
18,227
4,024
(631)
51,353
(1,033)
17,747
220
7,365
(89)
3,719
(5,036)
13,191
(253)
3,771
–
(631)
(6,191)
45,162
(10,783)
(2,256)
(1,984)
(7,448)
(2,422)
631
(24,262)
and equipment ........................
(1,095)
Amortisation of intangible
assets .......................................
(150)
Total operating expenses ............
(12,028)
Operating profit ..........................
5,719
Share of profit/(loss) in
associates and joint ventures ..
Profit before tax ..........................
Other disclosures:
Capital expenditure incurred2 .....
Investment in associates and
joint ventures ..........................
1 Net operating income:
37
5,756
2,001
896
(168)
(134)
(2,558)
4,807
23
4,830
234
97
(99)
(4)
(2,087)
1,632
215
1,847
(266)
(201)
(7,915)
5,276
(8)
5,268
114
1,913
2,392
46
(103)
(5)
(2,530)
1,241
1
1,242
366
9
–
–
(1,731)
(494)
631
(26,487)
–
–
–
–
–
18,675
268
18,943
4,628
3,440
External ..................................
Inter-segment ..........................
17,463
284
7,052
313
3,569
150
13,261
(70)
3,817
(46)
–
(631)
45,162
–
2 Expenditure incurred on property, plant and equipment and intangible assets.
343
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 13
By customer group
HSBC’s operations include a number of shared support services and head office functions. The costs of these
functions are allocated to customer groups, where appropriate, on a systematic and consistent basis. In addition, a
number of income and expense items include the effect of financial transactions entered into in the ordinary course of
business between customer groups co-operating within the integrated HSBC Group. The following analysis includes
inter-segment amounts within each customer group with the elimination shown in a separate column.
Total assets
Personal Financial Services .............................................................................
Commercial Banking .......................................................................................
Corporate, Investment Banking and Markets ..................................................
Private Banking ...............................................................................................
Other ................................................................................................................
At 31 December 2006
US$m
546,568
213,450
994,436
73,026
33,278
%
29.4
11.5
53.5
3.9
1.7
At 31 December 2005
US$m
%
484,314
175,120
755,056
59,827
27,653
32.2
11.7
50.3
4.0
1.8
Total assets .......................................................................................................
1,860,758
100.0
1,501,970
100.0
Profit before tax
Year ended 31 December 2006
Personal
Financial
Services
US$m
Commercial
Banking
US$m
Corporate,
Investment
Banking
& Markets
US$m
Net interest income/(expense) ....
26,076
Net fee income ............................
8,762
7,514
3,207
Trading income/(expense)
excluding net interest income .
Net interest income/(expense)
on trading activities ................
Net trading income/(expense) .....
Net income/(expense) from
financial instruments
designated at fair value ...........
Gains less losses from financial
investments .............................
Dividend income .........................
Net earned insurance premiums .
Other operating income ..............
391
220
611
739
78
31
5,130
782
204
20
224
(22)
44
6
258
250
3,168
3,718
4,890
(379)
4,511
20
534
235
73
1,378
Private
Banking
US$m
1,011
1,323
362
2
364
1
166
5
–
61
Total operating income ............
42,209
11,481
13,637
2,931
Intra-
HSBC
items
US$m
(2,658)
–
–
2,658
2,658
Other
US$m
(625)
172
(228)
82
(146)
(81)
–
147
63
207
3,254
2,991
–
–
–
(3,179)
(3,179)
Total
US$m
34,486
17,182
5,619
2,603
8,222
657
969
340
5,668
2,546
70,070
Net insurance claims incurred
and movement in policy-
holders’ liabilities ...................
Net operating income1 ...............
Loan impairment (charges)/
recoveries and other credit
risk provisions ........................
Net operating income2 ..............
(9,949)
27,895
Operating expenses .....................
(18,818)
Operating profit/(loss) ..............
9,077
Share of profit in associates
and joint ventures ...................
Profit/(loss) before tax ..............
Capital expenditure incurred3 .....
380
9,457
2,150
(4,365)
37,844
(96)
(62)
11,385
13,575
–
2,931
(181)
2,810
–
(3,179)
(4,704)
65,366
(697)
10,688
(4,979)
5,709
288
5,997
1,083
119
13,694
(7,991)
5,703
103
5,806
1,021
(33)
2,898
(1,685)
1,213
1
1,214
45
(13)
2,797
(3,259)
(462)
74
(388)
684
–
(3,179)
(10,573)
54,793
3,179
(33,553)
–
–
–
–
21,240
846
22,086
4,983
1 Net operating income before loan impairment (charges)/recoveries and other credit risk provisions.
2 Net operating income:
External ..................................
Inter-segment ..........................
23,238
4,657
9,692
996
20,034
(6,340)
1,661
1,237
168
2,629
–
(3,179)
54,793
–
3 Expenditure incurred on property, plant and equipment and intangible assets.
344
Year ended 31 December 2005
Personal
Financial
Services
US$m
Commercial
Banking
US$m
Corporate,
Investment
Banking
& Markets
US$m
Net interest income/(expense) ....
23,351
Net fee income ............................
7,313
6,310
2,876
Trading income/(expense)
excluding net interest income .
Net interest income/(expense)
on trading activities ................
Net trading income/(expense) .....
Net income/(expense) from
financial instruments
designated at fair value ...........
Gains less losses from financial
investments .............................
Dividend income .........................
Net earned insurance premiums ..
Other operating income ..............
360
214
574
574
19
16
4,864
729
150
(3)
147
(12)
9
9
236
327
3,001
2,967
2,919
306
3,225
67
475
79
76
1,621
Private
Banking
US$m
848
1,080
317
–
317
(1)
45
9
–
68
Total operating income ...............
37,440
9,902
11,511
2,366
Intra-
HSBC
items
US$m
(1,704)
–
–
1,704
1,704
–
–
–
–
(2,646)
(2,646)
Total
US$m
31,334
14,456
3,656
2,208
5,864
1,034
692
155
5,436
2,733
61,704
Other
US$m
(472)
220
(90)
(13)
(103)
406
144
42
260
2,634
3,131
Net insurance claims incurred
and movement in policy-
holders’ liabilities ...................
Net operating income1 ................
Loan impairment (charges)/
recoveries and other credit
risk provisions ........................
Net operating income2 ................
(7,537)
26,187
Operating expenses .....................
(16,427)
Operating profit/(loss) ................
9,760
Share of profit in associates
and joint ventures ...................
Profit before tax ..........................
Capital expenditure incurred3 .....
144
9,904
1,583
(3,716)
33,724
(118)
9,784
(54)
11,457
–
2,366
(179)
2,952
–
(2,646)
(4,067)
57,637
(547)
9,237
(4,453)
4,784
177
4,961
411
272
11,729
(6,838)
4,891
272
5,163
1,783
12
2,378
(1,466)
912
–
912
102
(1)
2,951
(2,976)
(25)
51
26
594
–
(2,646)
(7,801)
49,836
2,646
(29,514)
–
–
–
–
20,322
644
20,966
4,473
1 Net operating income before loan impairment (charges)/recoveries and other credit risk provisions.
2 Net operating income:
External ..................................
Inter-segment ..........................
25,000
1,187
8,258
979
13,998
(2,269)
1,668
710
912
2,039
–
(2,646)
49,836
–
3 Expenditure incurred on property, plant and equipment and intangible assets.
345
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 13 and 14
Year ended 31 December 2004
Personal
Financial
Services
US$m
Commercial
Banking
US$m
Corporate,
Investment
Banking
& Markets
US$m
Private
Banking
US$m
Net interest income .....................
21,422
Net fee income ............................
Trading income ...........................
Net investment income on
assets backing policy-
holders’ liabilities ...................
Gains less losses from financial
investments .............................
Dividend income .........................
Net earned insurance premiums .
Other operating income ..............
6,406
320
635
79
16
3,652
360
Total operating income ...............
32,890
4,875
2,645
234
324
6
37
1,072
513
9,706
3,994
2,764
1,935
9
197
548
86
1,029
718
962
257
–
39
5
–
24
10,562
2,005
Intra-
HSBC
items
US$m
–
–
–
–
–
–
–
(2,363)
(2,363)
Total
US$m
31,099
12,948
2,786
1,012
540
622
5,368
1,613
55,988
Other
US$m
90
171
40
44
219
16
558
2,050
3,188
Net insurance claims incurred
and movement in
policyholders’ liabilities .........
Net operating income1 ................
Loan impairment (charges)/
recoveries and other credit
risk provisions ........................
Net operating income2 ................
(6,500)
23,437
Operating expenses .....................
(15,009)
Operating profit ..........................
8,428
Share of profit in associates
and joint ventures ...................
Profit before tax ..........................
Capital expenditure incurred3 .....
69
8,497
1,415
(2,953)
29,937
(1,264)
8,442
(59)
–
10,503
2,005
(359)
2,829
–
(4,635)
(2,363)
51,353
(200)
8,242
(4,220)
4,022
35
4,057
614
499
11,002
(5,809)
5,193
95
5,288
1,919
11
2,016
(1,319)
697
–
697
142
(1)
–
(6,191)
2,828
(2,363)
45,162
(2,493)
2,363
(26,487)
335
69
404
538
–
–
–
–
18,675
268
18,943
4,628
1 Net operating income before loan impairment (charges)/recoveries and other credit risk provisions.
2 Net operating income:
External ..................................
Inter-segment ..........................
22,760
677
7,419
823
12,239
(1,237)
1,704
312
1,040
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–
(2,363)
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–
3 Expenditure incurred on property, plant and equipment and intangible assets.
14 Analysis of financial assets and liabilities by measurement basis
Financial assets and financial liabilities are measured on an ongoing basis either at fair value or at amortised cost. The
summary of significant accounting policies in Note 2 describes how the classes of financial instruments are measured,
and how income and expenses, including fair value gains and losses, are recognised. The following table analyses the
carrying amounts of the financial assets and liabilities by category as defined in IAS 39 and by balance sheet heading.
346
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347
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 14
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348
HSBC Holdings
Financial Assets
Cash at bank and in hand ....................................
Derivatives ..........................................................
Loans and advances to HSBC undertakings ......
Financial investments .........................................
Other assets .........................................................
Total financial assets ..........................................
Financial Liabilities
Amounts owed to HSBC undertakings ..............
Financial liabilities designated at fair value .......
Derivatives ..........................................................
Subordinated liabilities .......................................
Other liabilities ...................................................
Accruals ..............................................................
Total financial liabilities .....................................
Financial Assets
Cash at bank and in hand ....................................
Derivatives ..........................................................
Loans and advances to HSBC undertakings ......
Financial investments .........................................
Other assets .........................................................
Total financial assets ..........................................
Financial Liabilities
Amounts owed to HSBC undertakings ..............
Financial liabilities designated at fair value .......
Derivatives ..........................................................
Subordinated liabilities .......................................
Other liabilities ...................................................
Accruals ..............................................................
Total financial liabilities .....................................
At 31 December 2006
Held for
trading
US$m
Designated
at fair value
US$m
Loans and
receivables
US$m
Financial
assets and
liabilities at
amortised
cost
US$m
Available-
for-sale
securities
US$m
–
1,599
–
–
–
1,599
–
–
177
–
–
–
177
–
–
–
–
–
–
–
–
14,456
–
–
14,456
–
14,070
–
–
–
–
14,070
–
–
–
–
–
–
–
–
–
–
3,614
–
3,614
–
–
–
–
–
–
–
729
–
–
–
25
754
3,100
–
–
8,423
1
111
11,635
At 31 December 2005
Held for
trading
US$m
Designated
at fair value
US$m
Loans and
receivables
US$m
–
968
–
–
–
968
–
–
286
–
–
–
286
–
–
–
–
–
–
–
–
14,092
–
–
14,092
–
13,370
–
–
–
–
13,370
–
–
–
–
–
–
–
Financial
assets and
liabilities at
amortised
cost
US$m
Available-
for-sale
securities
US$m
–
–
–
3,517
–
3,517
–
–
–
–
–
–
–
756
–
–
–
25
781
4,075
–
–
5,236
3
95
9,409
Total
US$m
729
1,599
14,456
3,614
25
20,423
3,100
14,070
177
8,423
1
111
25,882
Total
US$m
756
968
14,092
3,517
25
19,358
4,075
13,370
286
5,236
3
95
23,065
349
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 15 and 16
15 Trading assets
Trading assets:
– not subject to repledge or resale by counterparties ........................................................................
– which may be repledged or resold by counterparties .....................................................................
Treasury and other eligible bills ........................................................................................................
Debt securities ...................................................................................................................................
Equity securities ................................................................................................................................
Loans and advances to banks ............................................................................................................
Loans and advances to customers .....................................................................................................
2006
US$m
273,507
54,640
328,147
21,759
155,447
27,149
204,355
52,006
71,786
328,147
2005
US$m
171,274
61,635
232,909
12,746
117,659
20,203
150,608
29,806
52,495
232,909
The following table provides an analysis of trading securities which are valued at market value and the net gains/
(losses) resulting from trading activities:
US Treasury and US Government agencies .................
UK Government ............................................................
Hong Kong Government ..............................................
Other government .........................................................
Asset-backed securities ................................................
Corporate debt and other securities ..............................
Equity securities ...........................................................
2006
Fair
value
US$m
Gains/
(losses)
US$m
8,348
6,176
8,759
70,747
15,781
67,395
27,149
204,355
91
77
4
232
3
(27)
(30)
350
2005
Fair
value
US$m
12,094
3,225
6,529
49,852
3,361
55,344
20,203
150,608
Gains/
(losses)
US$m
(21)
2
(16)
280
(24)
324
(117)
428
Included within the above figures are debt securities issued by banks and other financial institutions of US$36,153 million (2005:
US$16,888 million).
The following table analyses trading securities between those listed on a recognised exchange and those that are
unlisted:
Fair value at 31 December 2006
Listed on a recognised exchange1 ................................
Unlisted .........................................................................
Fair value at 31 December 2005
Listed on a recognised exchange1 ................................
Unlisted .........................................................................
Treasury
and other
eligible bills
US$m
1,373
20,386
21,759
7,174
5,572
12,746
Debt
securities
US$m
112,403
43,044
155,447
95,994
21,665
117,659
Equity
securities
US$m
25,337
1,812
27,149
17,728
2,475
20,203
Total
US$m
139,113
65,242
204,355
120,896
29,712
150,608
1 Included within listed investments are US$4,309 million (2005: US$2,049 million) of investments listed in Hong Kong.
350
The following table summarises HSBC’s trading portfolios by valuation methodology:
Assets
Liabilities
Trading
securities
%
Derivatives
%
Trading
securities –
short positions
%
Derivatives
%
At 31 December 2006
Fair value based on:
Quoted market prices ................................................
Internal models with significant observable
market parameters ................................................
Internal models with significant unobservable
market parameters ................................................
At 31 December 2005
Fair value based on:
Quoted market prices ................................................
Internal models with significant observable
market parameters ................................................
Internal models with significant unobservable
market parameters ................................................
16 Financial assets designated at fair value
82.2
17.8
–
100.0
87.6
12.4
–
100.0
1.9
96.3
1.8
100.0
6.0
91.5
2.5
100.0
Treasury and other eligible bills ........................................................................................................
Debt securities ...................................................................................................................................
Equity securities .................................................................................................................................
Loans and advances to banks ............................................................................................................
Loans and advances to customers ......................................................................................................
Fair value at 31 December 2006
Listed on a recognised exchange1 .................................
Unlisted .........................................................................
Fair value at 31 December 2005
Listed on a recognised exchange1 .................................
Unlisted .........................................................................
Treasury
and other
eligible bills
US$m
Debt
securities
US$m
133
–
133
41
12
53
4,939
4,510
9,449
3,012
2,693
5,705
93.2
6.8
–
100.0
96.0
4.0
–
100.0
2006
US$m
133
9,449
10,602
236
153
20,573
Equity
securities
US$m
9,212
1,390
10,602
7,192
1,341
8,533
1 Included within listed investments are US$1,014 million of investments listed in Hong Kong (2005: US$932 million).
2.6
96.5
0.9
100.0
5.7
92.4
1.9
100.0
2005
US$m
53
5,705
8,533
124
631
15,046
Total
US$m
14,284
5,900
20,184
10,245
4,046
14,291
351
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 16 and 17
The following table provides an analysis of securities designated at fair value:
US Treasury and US Government agencies ......................................................................................
UK Government .................................................................................................................................
Hong Kong Government ...................................................................................................................
Other government ..............................................................................................................................
Asset-backed securities .....................................................................................................................
Corporate debt and other securities ...................................................................................................
Equities ..............................................................................................................................................
Market value
2006
US$m
92
1,359
216
2,131
274
5,510
10,602
20,184
2005
US$m
86
1,164
171
1,358
193
2,786
8,533
14,291
Included within the above figures are debt securities issued by banks and other financial institutions of US$2,438 million (2005: US$1,703
million).
17 Derivatives
Fair values of derivatives by product contract type held by HSBC
At 31 December 2006
Foreign exchange ................................................
Interest rate .........................................................
Equities ...............................................................
Credit derivatives ................................................
Commodity and other .........................................
Gross total fair values .........................................
Netting ................................................................
Total ....................................................................
At 31 December 2005
Foreign exchange ................................................
Interest rate .........................................................
Equities ...............................................................
Credit derivatives ................................................
Commodity and other .........................................
Gross total fair values .........................................
Netting ................................................................
Total ....................................................................
Trading
US$m
30,648
52,664
10,767
8,237
1,304
103,620
21,082
44,323
4,833
3,585
1,077
74,900
Assets
Hedging
US$m
2,399
1,551
–
–
–
3,950
263
3,414
–
–
–
3,677
Total
US$m
33,047
54,215
10,767
8,237
1,304
107,570
(3,868)
103,702
21,345
47,737
4,833
3,585
1,077
78,577
(4,649)
73,928
Trading
US$m
(28,837)
(52,927)
(11,647)
(8,611)
(1,636)
(103,658)
(20,794)
(46,580)
(4,713)
(3,509)
(1,442)
(77,038)
Liabilities
Hedging
US$m
(394)
(1,287)
(7)
–
–
(1,688)
(81)
(1,566)
–
–
–
(1,647)
Total
US$m
(29,231)
(54,214)
(11,654)
(8,611)
(1,636)
(105,346)
3,868
(101,478)
(20,875)
(48,146)
(4,713)
(3,509)
(1,442)
(78,685)
4,649
(74,036)
Fair values of derivatives by product contract type held by HSBC Holdings with subsidiaries
Foreign exchange ..........................................................
Interest rate ...................................................................
Gross total fair values ...................................................
Year ended 31 December
2006
Trading
Assets
US$m
1,557
42
1,599
Liabilities
US$m
–
177
177
2005
Trading
Assets
US$m
896
72
968
Liabilities
US$m
144
142
286
Derivatives are financial instruments that derive their value from the price of underlying items such as equities,
bonds, interest rates, foreign exchange, credit spreads, commodities and equity or other indices. Derivatives enable
users to increase, reduce or alter exposure to credit or market risks. HSBC makes markets in derivatives for its
customers and uses derivatives to manage its exposure to credit and market risks.
Derivatives are carried at fair value and shown in the balance sheet as separate totals of assets and liabilities. Asset
values represent the cost to HSBC of replacing all transactions with a fair value in HSBC’s favour assuming that all
352
HSBC’s relevant counterparties default at the same time, and that transactions can be replaced instantaneously.
Liability values represent the cost to HSBC’s counterparties of replacing all their transactions with HSBC with a fair
value in their favour if HSBC were to default. Derivative assets and liabilities on different transactions are only set
off if the transactions are with the same counterparty, a legal right of set-off exists and the cash flows are intended to
be settled on a net basis.
Use of derivatives
HSBC transacts 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. Derivatives (except for derivatives which
are designated as effective hedging instruments as defined in IAS 39) are held for trading. The held for trading
classification includes two types of derivatives: those used in sales and trading activities, and those used for risk
management purposes but which for various reasons do not meet the qualifying criteria for hedge accounting. The
second category includes derivatives managed in conjunction with financial instruments designated at fair value.
These activities are described more fully below.
HSBC’s derivative activities give rise to significant open positions in portfolios of derivatives. These positions are
managed constantly to ensure that they remain within acceptable risk levels, with matching deals being utilised to
achieve this where necessary. When entering into derivative transactions, HSBC employs the same credit risk
management procedures to assess and approve potential credit exposures that are used for traditional lending.
Trading derivatives
Most of HSBC’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 exchange rates, interest rates, equity prices or other market parameters. Trading includes
market-making, positioning and arbitrage activities. Market-making entails quoting bid and offer prices to other
market participants for the purpose of generating revenues based on spread and volume; positioning means managing
market risk positions in the expectation of benefiting from favourable movements in prices, rates or indices; arbitrage
involves identifying and profiting from price differentials between markets and products.
As mentioned above, other derivatives classified as held for trading include non-qualifying hedging derivatives,
ineffective hedging derivatives and the components of hedging derivatives that are excluded from assessing hedge
effectiveness. Non-qualifying hedging derivatives are entered into for risk management purposes but do not meet the
criteria for hedge accounting. These include derivatives managed in conjunction with financial instruments
designated at fair value.
Gains and losses from changes in the fair value of derivatives that do not qualify for hedge accounting are reported in
‘Net trading income’, except for derivatives managed in conjunction with financial instruments designated at fair
value, where gains and losses are reported in ‘Net income from financial instruments designated at fair value’,
together with the gains and losses on the hedged items. Changes in the fair values of trading derivatives are inclusive
of contractual interest. Changes in the fair value of derivatives managed in conjunction with financial instruments
designated at fair value are included in ‘Net income from financial instruments designated at fair value’ inclusive of
contractual interest unless the derivatives are managed with debt securities in issue, in which case the contractual
interest is shown in interest payable with the interest payable on the issued debt. Substantially all of HSBC Holdings’
derivatives entered into with HSBC undertakings are managed in conjunction with financial liabilities designated at
fair value.
353
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 17
Contract amounts of derivatives held for trading purposes by product type
Foreign exchange ..........................................................
Interest rate ...................................................................
Equities .........................................................................
Credit derivatives ..........................................................
Commodity and other ....................................................
HSBC
HSBC Holdings
2006
US$m
2,182,005
9,843,601
207,016
1,109,828
30,532
13,372,982
2005
US$m
1,721,456
6,731,721
101,364
511,741
38,458
9,104,740
2006
US$m
9,869
5,304
–
–
–
15,173
2005
US$m
10,224
5,304
–
–
–
15,528
Derivatives valued using models with unobservable inputs
The amount that has yet to be recognised in the consolidated income statement relating to the difference between the
fair value at initial recognition (the transaction price) and the amount that would have arisen had valuation techniques
used for subsequent measurement been applied at initial recognition, less subsequent releases, is as follows:
Unamortised balance at 1 January .....................................................................................................
Deferral on new transactions .............................................................................................................
Recognised in the income statement during the period:
– amortisation ................................................................................................................................
– subsequent to unobservable inputs becoming observable .........................................................
– maturity or termination ...............................................................................................................
Exchange differences .........................................................................................................................
Unamortised balance at 31 December ...............................................................................................
2006
US$m
252
283
(59)
(226)
(53)
17
214
2005
US$m
73
340
(56)
(64)
(25)
(16)
252
Hedging instruments
HSBC uses derivatives (principally interest rate swaps) for hedging purposes in the management of its own asset and
liability portfolios and structural positions. This enables HSBC to optimise the overall cost to the Group of accessing
debt capital markets, and to mitigate the market risk which would otherwise arise from structural imbalances in the
maturity and other profiles of its assets and liabilities.
The accounting treatment of hedge transactions varies according to the nature of the instrument hedged and the type
of hedge transactions. Derivatives may qualify as hedges for accounting purposes if they are fair value hedges, cash
flow hedges, or investment hedges. These are described under the relevant headings below:
Contract amounts of derivatives held for hedging purposes by product type
Foreign exchange ..........................................................
Interest rate ...................................................................
Equities ..........................................................................
At 31 December 2006
At 31 December 2005
Cash flow
hedge
US$m
21,765
201,635
–
223,400
Fair value
hedge
US$m
2,985
24,279
30
27,294
Cash flow
hedge
US$m
16,940
174,875
–
191,815
Fair value
hedge
US$m
2,699
19,745
–
22,444
With respect to exchange rate and interest rate contracts, the notional or contractual amounts of these instruments
indicate the nominal value of transactions outstanding at the balance sheet date; they do not represent amounts at risk.
Fair value hedges
HSBC’s fair value hedges principally consist of interest rate swaps that are used to protect against changes in the fair
value of fixed-rate long-term financial instruments due to movements in market interest rates. For qualifying fair
value hedges, all changes in the fair value of the derivative and in the fair value of the item in relation to the risk
being hedged are recognised in income. If the hedge relationship is terminated, the fair value adjustment to the
hedged item continues to be reported as part of the basis of the item and is amortised to income as a yield adjustment
over the remainder of the hedging period.
354
The fair values of outstanding derivatives designated as fair value hedges at 31 December 2006 were assets of
US$201 million (2005: US$149 million) and liabilities of US$315 million (2005: US$471 million).
Gains or losses arising from fair value hedges
Gains/(losses):
– on hedging instruments .............................................................................................................
– on the hedged items attributable to the hedged risk .................................................................
2006
US$m
8
8
16
2005
US$m
81
(67)
14
Cash flow hedges
HSBC’s cash flow hedges consist principally of interest rate and cross-currency swaps that are used to protect against
exposures to variability in future interest cash flows on non-trading assets and liabilities which bear interest at
variable rates or which are expected to be re-funded or reinvested in the future. The amounts and timing of future
cash flows, representing both principal and interest flows, are projected for each portfolio of financial assets and
liabilities on the basis of their contractual terms and other relevant factors, including estimates of prepayments and
defaults. The aggregate principal balances and interest cash flows across all portfolios over time form the basis for
identifying gains and losses on the effective portions of derivatives designated as cash flow hedges of forecast
transactions. Gains and losses are initially recognised directly in equity, in the cash flow hedging reserve, and are
transferred to the income statement when the forecast cash flows affect the income statement.
At 31 December 2006, the fair values of outstanding derivatives designated as cash flow hedges of forecast
transactions were assets of US$3,749 million (2005: US$3,528 million) and liabilities of US$1,364 million (2005:
US$1,062 million).
The schedule of forecast principal balances on which the expected interest cash flows arise as at 31 December 2006 is
as follows:
At 31 December 2006
Cash inflows from assets ..............................................
Cash outflows from liabilities ......................................
Net cash outflows .........................................................
At 31 December 2005
Cash inflows from assets ..............................................
Cash outflows from liabilities ......................................
Net cash outflows .........................................................
3 months
or less
US$m
More than 3
months but less
than 1 year
US$m
5 years or less
but more than
1 year
US$m
More than
5 years
US$m
61,649
(96,852)
(35,203)
54,355
(80,744)
(26,389)
51,471
(91,868)
(40,397)
37,270
(64,622)
(27,352)
22,271
(60,712)
(38,441)
31,664
(47,918)
(16,254)
496
(8,093)
(7,597)
1,474
(1,799)
(325)
This table reflects the interest rate refixing profile of the underlying hedged items and 2005 balances have been adjusted to ensure
consistency with the 2006 balances for this disclosure.
The gains and losses on ineffective portions of such derivatives are recognised immediately in the income statement.
During the year to 31 December 2006, a loss of US$122 million (2005: US$96 million) was recognised due to hedge
ineffectiveness.
Hedges of net investments in foreign operations
HSBC’s consolidated balance sheet is affected by exchange differences between the US dollar and all the non-US
dollar functional currencies of subsidiaries. HSBC hedges structural foreign exchange exposures only in limited
circumstances. Hedging is undertaken using forward foreign exchange contracts which are accounted for as hedges of
a net investment in a foreign operation, or by financing with borrowings in the same currencies as the functional
currencies involved.
355
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 17 and 18
At 31 December 2006, the fair values of outstanding financial instruments designated as hedges of net investments in
foreign operations were liabilities of US$254 million (2005: US$114 million).
The ineffectiveness recognised in ‘Net trading income’ in the year ended 31 December 2006 that arose from hedges
in foreign operations was nil (2005: nil).
Sensitivity of fair values to changing significant assumptions to reasonably possible alternatives
Fair values of certain derivatives recognised in the financial statements may be determined in whole or in part using
valuation techniques based on assumptions that are not supported by prices from current market transactions or
observable market data. In these instances, the net fair value recorded in the financial statements is the sum of three
components:
–
–
–
the value given by application of a valuation model, based upon HSBC’s best estimate of the most appropriate
model inputs;
any fair value adjustments to account for market features not included within the valuation model (for example,
bid-mid spreads, counterparty credit spreads and/or market data uncertainty); and
inception profit, or an unamortised element thereof, not recognised immediately in the income statement in
accordance with Note 2(k).
As the valuation models are based upon assumptions, changing the assumptions changes the resultant estimate of fair
value. HSBC performs various sensitivity analyses on its valuation assumptions. The potential effect of using
reasonably possible alternative assumptions in valuation models has been quantified as a reduction in assets of
approximately US$72 million (2005: US$77 million) using less favourable assumptions, and an increase in assets of
approximately US$69 million (2005: US$73 million) using more favourable assumptions. The ranges of reasonably
possible alternative assumptions are established by application of professional judgement to an analysis of the data
available to support each assumption.
The total amount of the change in fair value estimated using a valuation technique that was recognised in the year
ended 31 December 2006 was a loss of US$195 million (2005: US$129 million).
18 Financial investments
HSBC
Financial investments:
– not subject to repledge or resale by counterparties ...................................................................
– which may be repledged or resold by counterparties ...............................................................
2006
US$m
197,055
7,751
204,806
Treasury and other eligible bills ...................................
– available-for-sale ..................................................
– held-to-maturity ....................................................
Debt securities ..............................................................
– available-for-sale ..................................................
– held-to-maturity ....................................................
Equity securities ...........................................................
– available-for-sale ..................................................
2006
2005
Carrying
amount
US$m
25,313
25,268
45
171,196
161,870
9,326
8,297
8,297
Fair
value
US$m
25,313
25,268
45
171,498
161,870
9,628
8,297
8,297
Carrying
amount
US$m
25,042
24,834
208
149,781
141,699
8,082
7,519
7,519
2005
US$m
176,301
6,041
182,342
Fair
value
US$m
25,042
24,834
208
149,962
141,699
8,263
7,519
7,519
Total financial investments ...........................................
204,806
205,108
182,342
182,523
356
Amortised
cost
US$m
Gross
unrealised
gains
US$m
Gross
unrealised
losses
US$m
At 31 December 2006
US Treasury ...................................................................
US Government agencies ..............................................
US Government sponsored entities ..............................
UK Government ............................................................
Hong Kong Government ..............................................
Other government .........................................................
Asset-backed securities .................................................
Corporate debt and other securities ..............................
Equities .........................................................................
At 31 December 2005
US Treasury ...................................................................
US Government agencies ..............................................
US Government sponsored entities ..............................
UK Government ............................................................
Hong Kong Government ..............................................
Other government .........................................................
Asset-backed securities .................................................
Corporate debt and other securities ..............................
Equities .........................................................................
At 31 December 2004
US Treasury ...................................................................
US Government agencies ..............................................
US Government sponsored entities ..............................
UK Government ............................................................
Hong Kong Government ..............................................
Other government .........................................................
Asset-backed securities .................................................
Corporate debt and other securities ..............................
Equities .........................................................................
10,219
6,004
14,010
7,515
1,085
37,828
26,752
93,217
6,295
202,925
9,015
4,173
16,099
7,658
4,429
34,623
2,893
96,018
6,414
181,322
7,998
9,657
10,093
11,510
5,274
36,393
13,367
84,477
6,563
185,332
5
40
74
10
1
475
9
363
2,010
2,987
5
52
82
83
2
317
8
452
1,111
2,112
25
91
133
1
88
543
28
1,061
1,136
3,106
(21)
(76)
(285)
(23)
(6)
(105)
(11)
(269)
(8)
(804)
(23)
(52)
(292)
(1)
(23)
(87)
(12)
(415)
(6)
(911)
(22)
(94)
(48)
(2)
–
(290)
(6)
(136)
(10)
(608)
Fair
value
US$m
10,203
5,968
13,799
7,502
1,080
38,198
26,750
93,311
8,297
205,108
8,997
4,173
15,889
7,740
4,408
34,853
2,889
96,055
7,519
182,523
8,001
9,654
10,178
11,509
5,362
36,646
13,389
85,402
7,689
187,830
Included within the above figures are debt securities issued by banks and other financial institutions of
US$86,649 million (2005: US$68,954 million). The fair value of these was US$86,596 million (2005:
US$68,933 million).
Carrying amount at 31 December 2006
Listed on a recognised exchange ........................
Unlisted ...............................................................
Carrying amount at 31 December 2005
Listed on a recognised exchange ........................
Unlisted ...............................................................
Treasury
and other
eligible bills
available-
for-sale
US$m
Treasury
and other
eligible bills
held-to-
maturity
US$m
Debt
securities
available-
for-sale
US$m
Debt
securities
held-to-
maturity
US$m
1,861
23,407
25,268
6,610
18,225
24,835
45
–
45
207
–
207
58,216
103,654
161,870
62,187
79,512
141,699
3,590
5,736
9,326
4,022
4,060
8,082
Equity
securities
US$m
2,937
5,360
8,297
Total
US$m
66,649
138,157
204,806
3,394
4,125
76,420
105,922
7,519
182,342
The fair value of listed held-to-maturity debt securities as at 31 December 2006 was US$3,663 million (2005:
US$4,143 million). Included within listed investments were US$1,179 million (2005: US$1,246 million) of
investments listed in Hong Kong.
357
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 18 and 19
The maturities of investment securities at carrying value are analysed as follows:
Remaining contractual maturity of total debt securities:
1 year or less ..................................................................................................................................
5 years or less but over 1 year .......................................................................................................
10 years or less but over 5 years ...................................................................................................
over 10 years .................................................................................................................................
63,932
55,145
12,015
40,104
At 31 December
2006
US$m
2005
US$m
50,991
56,956
10,902
30,932
Remaining contractual maturity of debt securities available for sale:
1 year or less ..................................................................................................................................
5 years or less but over 1 year .......................................................................................................
10 years or less but over 5 years ...................................................................................................
over 10 years .................................................................................................................................
Remaining contractual maturity of debt securities held to maturity:
1 year or less ..................................................................................................................................
5 years or less but over 1 year .......................................................................................................
10 years or less but over 5 years ...................................................................................................
over 10 years .................................................................................................................................
171,196
149,781
63,382
53,497
8,827
36,164
50,559
55,531
8,636
26,973
161,870
141,699
550
1,648
3,188
3,940
9,326
432
1,425
2,266
3,959
8,082
The following table provides an analysis of contractual maturities and weighted average yields of investment debt
securities as at 31 December 2006:
Within one year
Amount Yield
%
US$m
After one year but
within five years
Amount Yield
%
US$m
After five years but
within ten years
Amount Yield
%
US$m
After ten years
Amount Yield
%
US$m
199
409
3.95
4.81
1,463
461
3.65
5.30
125
100
4.38
5.10
22
4,449
4.97
5.13
145
769
265
11,790
4,554
2.97
3.87
2.22
4.06
4.79
927
1,324
205
11,907
1,228
2.78
5.26
2.75
8.00
5.65
1,533
–
194
2,175
1,928
2.66
–
4.88
7.07
5.24
9,560
–
–
1,274
19,042
4.85
–
–
7.54
5.45
Available-for-sale
US Treasury agencies ....................
US Government agencies ..............
US Government-sponsored
agencies .....................................
UK Government .............................
Hong Kong Government ...............
Other governments ........................
Asset-backed securities .................
Corporate debt and other
securities ....................................
44,875
3.93
36,046
5.41
2,512
4.53
2,487
5.18
Total amortised cost .......................
Total carrying value .......................
63,006
63,382
53,561
53,497
8,567
8,827
36,834
36,164
Held-to-maturity
US Treasury agencies ....................
US Government agencies ..............
US Government-sponsored
agencies .....................................
UK Government .............................
Hong Kong Government ...............
Other governments ........................
Asset-backed securities .................
Corporate debt and other
securities ....................................
Total amortised cost .......................
Total carrying value .......................
3
1
5.88
7.05
2
–
6
126
–
6.99
–
8.01
4.20
–
3
9
5.06
6.98
26
4
4.23
8.66
77
570
5.11
6.49
8
–
21
135
–
7.35
–
3.95
5.95
–
93
–
–
130
–
6.10
–
–
4.84
–
1,741
–
8
594
–
5.90
–
5.21
4.94
–
412
3.96
1,472
4.73
2,935
4.83
950
4.92
550
550
1,648
1,648
3,188
3,188
3,940
3,940
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 2006 by the book amount of available-for-sale debt
securities at that date. The yields do not include the effect of related derivatives.
358
19 Securitisations and other structured transactions
HSBC enters into transactions in the normal course of business by which it transfers recognised financial assets
directly to third parties or to special purpose entities. These transfers may give rise to the full or partial derecognition
of the financial assets concerned.
–
–
Full derecognition occurs when HSBC transfers its contractual right to receive cash flows from the financial
assets, or retains the right but assumes an obligation to pass on the cash flows from the asset, and transfers
substantially all the risks and rewards of ownership. The risks include credit, interest rate, currency, prepayment
and other price risks.
Partial derecognition occurs when HSBC sells or otherwise transfers financial assets in such a way that some but
not substantially all of the risks and rewards of ownership are transferred but control is retained. These financial
assets are recognised on the balance sheet to the extent of HSBC’s continuing involvement.
The majority of financial assets that do not qualify for derecognition are (i) debt securities held by counterparties as
collateral under repurchase agreements or (ii) equity securities lent under securities lending agreements. The
following table analyses the carrying amount of financial assets that did not qualify for derecognition during 2006
and 2005, and their associated financial liabilities:
Nature of transaction
Repurchase agreements ................................................
Securities lending agreements ......................................
2006
2005
Carrying
amount of
transferred
assets
US$m
67,558
12,908
80,466
Carrying
amount of
associated
liabilities
US$m
66,127
12,469
78,596
Carrying
amount of
transferred
assets1
US$m
62,663
4,138
66,801
Carrying
amount of
associated
liabilities1
US$m
62,880
4,281
67,161
1 2005 amounts for repurchase agreements and securities lending agreements have been reclassified to ensure a consistent presentation
with 2006 balances for this disclosure.
A small proportion of financial assets that do not qualify for derecognition relate to loans, credit cards, debt securities
and trade receivables that have been securitised under arrangements by which HSBC retains a continuing
involvement in such transferred assets. Continuing involvement may entail retaining the rights to future cash flows
arising from the assets after investors have received their contractual terms (for example, interest rate strips);
providing subordinated interest; liquidity support; continuing to service the underlying asset; or entering into
derivative transactions with the securitisation vehicles. As such, HSBC continues to be exposed to risks associated
with these transactions.
The rights and obligations that HSBC retains from its continuing involvement in securitisations are initially recorded
as an allocation of the fair value of the financial asset between the part that is derecognised and the part that continues
to be recognised on the date of transfer. The following analyses the carrying amount of financial assets to the extent
of HSBC’s continuing involvement that qualified for partial derecognition during the year, and their associated
liabilities:
Carrying amount of assets (original) .................................................................................................
Carrying amount of assets (currently recognised) .............................................................................
Carrying amount of associated liabilities ..........................................................................................
Securitisations at 31 December
2006
US$m
20,095
599
306
2005
US$m
6,731
256
256
359
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 20
20 Interests in associates and joint ventures
Principal associates of HSBC
Listed
Bank of Communications Co., Limited ........................
Ping An Insurance (Group) Company of
China, Limited ..........................................................
The Saudi British Bank Limited ...................................
At 31 December 2006
Carrying
amount
US$m
2,710
2,037
978
5,725
Fair
value
US$m
11,065
6,825
4,700
22,590
At 31 December 2005
Carrying
amount
US$m
2,480
1,837
772
5,089
Fair
value
US$m
4,143
2,274
8,800
15,217
Issued
equity
capital
At 31 December 2006
HSBC’s
interest in
equity capital
Country of
incorporation
Listed
PRC1
Bank of Communications Co., Limited ...............................................................
PRC1
Ping An Insurance (Group) Company of China, Limited ....................................
The Saudi British Bank Limited .......................................................................... Saudi Arabia
Unlisted
Barrowgate Limited2,3...........................................................................................
British Arab Commercial Bank Limited .............................................................
Hong Kong
England
France
Erisa S.A. .............................................................................................................
Mexico
Financiera Independencia S.A. de C.V. ..............................................................
Industrial Bank Company Limited3,4 ...................................................................
PRC1
Wells Fargo HSBC Trade Bank, N.A5 ................................................................ United States
19.90%
19.90%
40.00%
RMB45,804m
RMB6,195m
SR3,750m
24.64%
46.51%
49.99%
19.90%
15.98%
20.00%
–
US$81m
£32m fully paid
£5m nil paid
€115m
MXP64m
RMB3,999m
–
AEA Investors (Cayman) I LP6,7
HSBC PE European No. 2 LP7,8
Montagu III LP7,8
Ortigas & Company LP9
Private Equity Portfolio (Investment) LP Inc7,8
1 People’s Republic of China.
2 Issued equity capital is less than HK$1 million.
3 Investment held through Hang Seng Bank Limited, a 62.14 per cent owned subsidiary of HSBC.
4 Industrial Bank Company Limited listed on the Shanghai Stock Exchange on 5 February 2007.
5 Issued equity capital is less than US$1 million.
6 Venture Capital Limited partnership. Address of principal place of business is c/o Walkers SPV Limited, Walker House, 87 Mary Street,
PO Box 908GT, George Town, Grand Cayman, Cayman Islands.
7 Limited partnership where the group owns more than 50 per cent but does not have control due to the limitations within these types
of entities.
8 Limited partnership. Address of principal place of business is 68 Upper Thames Street, London EC4V 3PE.
9 Limited partnership. Address of principal place of business is 9/F Ortigas Building, Ortigas Avenue, Pasig City, Philippines.
All the above investments in associates are owned by subsidiaries of HSBC Holdings. On 6 February 2006, HSBC
disposed of its 21.16 per cent shareholding in the Cyprus Popular Bank Limited (trading as Laiki Group).
HSBC had US$4,747 million (2005: US$4,317 million) of investments in associates and joint ventures listed in Hong
Kong.
For the year ended 31 December 2006, HSBC’s share of associates and joint ventures tax on profit was
US$279 million (2005: US$225 million), which is included within share of profit in associates and joint ventures in
the income statement.
360
Summarised aggregate financial information on associates
HSBC’s share of:
– assets ...........................................................................................................................................
– liabilities .....................................................................................................................................
– revenues ......................................................................................................................................
– profit after tax ..............................................................................................................................
2006
US$m
83,096
77,446
5,521
823
2005
US$m
63,347
58,883
3,330
546
HSBC’s share of associates’ contingent liabilities amounted to US$13,824 million at 31 December 2006 (2005:
US$7,818 million). No matters arose where HSBC was severally liable.
HSBC’s 15.98 per cent investment in Industrial Bank Company Limited was equity accounted with effect from
May 2004, reflecting HSBC’s significant influence over this associate. HSBC’s significant influence was established
as a result of representation on the Board of Directors, and in accordance with the Technical Support and Assistance
Agreements, HSBC is assisting in the development of financial and operating policies.
HSBC’s 19.9 per cent investment in Ping An Insurance (Group) Company of China, Limited was equity accounted
with effect from 31 August 2005, reflecting HSBC’s significant influence over this associate. HSBC’s significant
influence was established as a result of the acquisition of an additional participation of 9.91 per cent on 31 August
2005, for a consideration of US$1,039 million.
HSBC’s significant influence on Bank of Communications Co., Limited was established as a result of representation
on the Board of Directors, and in accordance with the Technical Support and Assistance Agreements, HSBC is
assisting in the development of financial and operating policies and a number of staff have been seconded to assist in
this process.
The statutory accounting reference date of Bank of Communications Co., Limited, Ping An Insurance (Group)
Company of China, Limited and Industrial Bank Company Limited is 31 December. For the year ended 31 December
2006, these companies were included on the basis of financial statements made up for the twelve months to
30 September 2006, taking into account changes in the subsequent period from 1 October 2006 to 31 December 2006
that would have materially affected their results.
HSBC also has a 100 per cent interest in the issued preferred stock (less than US$1 million) of Wells Fargo HSBC
Trade Bank, N.A. HSBC has a 40 per cent economic interest in Wells Fargo HSBC Trade Bank, N.A. by virtue of the
joint agreement under which HSBC’s equity capital and preferred stock interests are being held.
HSBC acquired 19.9 per cent of Financiera Independencia S.A. de C.V. on 20 June 2006. The investment was equity
accounted from that date, reflecting HSBC’s significant influence over this associate.
Principal interests in joint ventures
HSBC Saudi Arabia Limited .........................................
Saudi Arabia
Country of
incorporation
At 31 December 2006
Principal
activity
Investment
banking
HSBC’s
interest in
equity
capital
Issued
equity
capital
60%
SR50m
HSBC Saudi Arabia Limited has been established as a joint venture between HSBC and The Saudi British Bank,
operating from July 2006. The ownership of HSBC Saudi Arabia Limited is split between HSBC, with 60 per cent,
and The Saudi British Bank, with 40 per cent. The strategic financial and operating decisions of HSBC Saudi Arabia
Limited require unanimous consent of HSBC and The Saudi British Bank.
361
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 20 and 21
Summarised aggregate financial information on joint ventures
2006
US$m
2005
US$m
HSBC’s share of:
– current assets ..............................................................................................................................
– non-current assets .......................................................................................................................
– current liabilities .........................................................................................................................
– non-current liabilities .................................................................................................................
– income ........................................................................................................................................
– expenses ......................................................................................................................................
125
107
98
87
102
79
95
55
34
107
118
20
21 Goodwill and intangible assets
Goodwill and intangible assets includes goodwill arising on business combinations, the present value of in-force
long-term insurance business, and other intangible assets.
Goodwill
Europe
US$m
Hong Kong
US$m
Rest of
Asia-
Pacific
US$m
North
America
US$m
Latin
America
US$m
Cost
At 1 January 2006 .......................................
Additions ....................................................
Exchange differences ..................................
Other changes .............................................
At 31 December 2006 .................................
Cost (restated1)
At 1 January 2005 .......................................
Additions ....................................................
Disposals .....................................................
Exchange differences ..................................
Other changes .............................................
At 31 December 2005 .................................
13,777
29
1,428
–
15,234
15,873
108
(70)
(2,137)
3
13,777
120
–
4
–
124
120
1
–
(1)
–
120
270
34
25
(4)
325
284
4
–
(17)
(1)
270
12,424
55
–
48
12,527
11,594
534
(3)
328
(29)
12,424
2,634
1,608
20
–
4,262
2,491
13
–
185
(55)
2,634
1 In 2006, Mexico and Panama were reclassified from the North America segment to the Latin America segment. Comparative
information has been restated accordingly. See Note 13.
The addition to goodwill in Latin America related principally to the acquisition of Grupo Banistmo, S.A. on
23 November 2006.
The present value of in-force long-term insurance business (‘PVIF’)
Movement on the PVIF
At 1 January .......................................................................................................................................
IFRSs transition adjustment at 1 January 20051 ................................................................................
Addition from current year new business .........................................................................................
Movement from in-force business .....................................................................................................
Exchange differences and other movements .....................................................................................
At 31 December .................................................................................................................................
2006
US$m
1,400
–
254
(203)
98
1,549
Total
US$m
29,225
1,726
1,477
44
32,472
30,362
660
(73)
(1,642)
(82)
29,225
2005
US$m
1,877
(384)
289
(268)
(114)
1,400
1 For an explanation of the IFRSs transition adjustment at 1 January 2005, see Note 46 on the Financial Statements in the Annual Report
and Accounts 2005.
362
PVIF-specific assumptions
The key assumptions used in the computation of PVIF for HSBC’s main life insurance operations were:
Risk free rate .................................................................
Risk discount rate .........................................................
Expenses inflation..........................................................
2006
UK
%
Hong Kong
%
4.30
8.00
3.40
3.73
11.00
3.00
2005
UK
%
3.90
8.00
3.20
Hong Kong
%
4.19
11.00
3.00
The PVIF represents the value of the shareholder’s interest in the in-force business of the life insurance operations.
The calculation of the PVIF is based upon assumptions that take into account risk and uncertainty. To project these
cash flows, a variety of assumptions regarding future experience is made by each insurance operation which reflect
local market conditions and management’s judgement of local future trends. Some of the Group’s insurance
operations incorporate risk margins separately into the projection assumptions for each product, while others
incorporate risk margins into the overall discount rate. This is reflected in the wide range of risk discount rates
applied.
Other intangible assets
The analysis of the movement of intangible assets, excluding the PVIF, was as follows:
Trade
names
US$m
Mortgage
servicing
rights
US$m
Internally
generated
software
US$m
Purchased
software
US$m
Customer/
merchant
relation-
ships
US$m
Other
US$m
Total
US$m
43
–
15
–
–
(1)
–
57
(15)
(7)
–
–
–
1
–
(21)
979
99
–
–
–
–
–
1,078
(560)
(59)
–
–
–
–
–
(619)
2,094
589
–
(3)
–
150
41
2,871
(1,301)
(345)
(25)
–
–
(97)
(4)
(1,772)
295
70
6
(21)
–
17
278
645
(170)
(107)
(3)
20
–
(13)
(153)
(426)
1,034
96
195
–
(71)
28
373
1,655
(173)
(137)
(56)
–
71
(1)
(24)
(320)
373
3
114
(1)
–
39
(349)
179
(24)
(36)
–
–
–
(4)
51
(13)
4,818
857
330
(25)
(71)
233
343
6,485
(2,243)
(691)
(84)
20
71
(114)
(130)
(3,171)
36
459
1,099
219
1,335
166
3,314
Cost
At 1 January 2006 .......................
Additions1 ...................................
Acquisition of subsidiaries .........
Disposals .....................................
Amounts written-off ...................
Exchange differences ..................
Other changes .............................
At 31 December 2006..................
Accumulated amortisation
At 1 January 2006 .......................
Charge for the year2 ....................
Impairment ..................................
Disposals .....................................
Amounts written-off ...................
Exchange differences ..................
Other changes .............................
At 31 December 2006 .................
Net carrying amount at
31 December 2006 ..................
363
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 21 and 22
Trade
names
US$m
Mortgage
servicing
rights
US$m
Internally
generated
software
US$m
Purchased
software
US$m
Customer/
merchant
relation-
ships
US$m
Cost
At 1 January 2005 .......................
Additions1 ...................................
Acquisition of subsidiaries .........
Disposals .....................................
Exchange differences ..................
Other changes .............................
At 31 December 2005 .................
Accumulated amortisation
At 1 January 2005 .......................
Charge for the year2 ....................
Disposals .....................................
Exchange differences ..................
Other changes .............................
41
–
–
–
2
–
43
(8)
(6)
–
(1)
–
At 31 December 2005 .................
(15)
Net carrying amount at
791
136
–
–
2
50
979
(474)
(27)
–
1
(60)
(560)
1,823
420
–
–
(104)
(45)
2,094
(1,064)
(354)
–
123
(6)
(1,301)
210
49
–
(63)
(19)
118
295
(115)
(76)
29
(37)
29
(170)
764
13
271
(15)
(72)
73
1,034
(95)
(99)
–
5
16
(173)
Other
US$m
393
8
–
(1)
(44)
17
373
(7)
(19)
–
2
–
(24)
Total
US$m
4,022
626
271
(79)
(235)
213
4,818
(1,763)
(581)
29
93
(21)
(2,243)
31 December 2005 .................
28
419
793
125
861
349
2,575
1 At 31 December 2006, HSBC had US$23 million (2005: US$56 million) of contractual commitments to acquire intangible assets.
2 The amortisation charge for the year is recognised within the income statement under ‘Amortisation and impairment of intangible
assets’, with the exception of the amortisation of mortgage servicing rights that is charged to net fee income.
22 Impairment of assets other than financial instruments
During 2006 there was no impairment of goodwill (2005: nil; 2004: nil). Impairment testing in respect of goodwill is
performed annually by comparing the recoverable amount of cash generating units (‘CGUs’) determined at 1 July
2006 based on a value in use calculation. That calculation uses cash flow estimates based on management’s cash flow
projections, extrapolated in perpetuity using a nominal long-term growth rate based on current GDP and inflation for
the countries within which the CGU operates. Cash flows are extrapolated in perpetuity due to the long-term
perspective within the Group of the business units making up the CGUs. The discount rate used is based on the cost
of capital HSBC allocates to investments in the countries within which the CGU operates.
The cost of capital assigned to an individual CGU 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 inputs reflecting a number of financial and economic variables including the risk-free
rate in the country concerned and a premium to reflect the inherent risk of the business being evaluated. These
variables are established on the basis of management judgement.
Management judgement is required in estimating the future cash flows of the CGUs. These values are sensitive to the
cash flows projected for the periods for which detailed forecasts are available, and to assumptions regarding the long-
term sustainable pattern 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 and appropriately reflect management’s
view of future business prospects.
The following CGUs include in their carrying value goodwill that is a significant proportion of total goodwill
reported by HSBC. These CGUs do not carry on their balance sheets any intangible assets with indefinite useful
lives, other than goodwill.
364
2006
2005
Goodwill at
1 July
2006
US$m
Discount
rate
%
Nominal
growth rate
beyond
initial
cash flow
projections
%
Goodwill at
1 July
2005
US$m
Discount
rate
%
Nominal
growth rate
beyond
initial
cash flow
projections
%
Cash Generating Unit
Personal Financial Services – Europe ................
Commercial Banking – Europe ..........................
Private Banking – Europe ...................................
Corporate, Investment Banking and Markets –
Europe .............................................................
Personal Financial Services – North America ....
4,149
2,948
4,417
3,792
12,205
10.6
10.2
10.0
8.2
10.0
5.0
4.5
4.2
4.5
5.8
Total goodwill in the CGUs listed above ...........
27,511
3,515
2,913
3,701
3,694
10,451
24,274
10.2
9.9
10.0
10.1
10.0
4.3
3.9
3.2
4.0
6.1
There was no evidence of impairment arising from this review. The only circumstances where a reasonably possible
change in key assumptions might have caused an impairment loss to be recognised was in respect of Private Banking
Europe where a fall of 0.9 per cent in the long-term growth rate beyond the initial cash flow projections, or an
increase of 0.8 per cent in the discount rate would have caused an impairment loss to be recognised. Recognising this,
the calculation of the value in use for Private Banking – Europe, based on discounted projected cash flows, has been
additionally benchmarked against market transactions in private banking companies in Europe to ensure the carrying
value is supportable.
At 1 July 2006, aggregate goodwill of US$2,833 million had been allocated to CGUs that were not considered
individually significant. These CGUs do not carry on their balance sheets any intangible assets with indefinite useful
lives, other than goodwill.
365
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 23
23 Property, plant and equipment
HSBC
Property, plant and equipment
Freehold
land and
buildings
US$m
Long
leasehold
land and
buildings
US$m
Short
leasehold
land and
buildings1
US$m
Equipment,
fixtures
and fittings2
US$m
Equipment
on
operating
leases
US$m
Cost or fair value
At 1 January 2006 ...............................................
Additions at cost4 ................................................
Acquisition of subsidiaries .................................
Fair value adjustments ........................................
Disposals .............................................................
Transfers .............................................................
Exchange differences ..........................................
Other changes .....................................................
At 31 December 2006 .........................................
Accumulated depreciation
At 1 January 2006 ...............................................
Depreciation charge for the year ........................
Disposals .............................................................
Transfers .............................................................
Exchange differences ..........................................
Other changes .....................................................
At 31 December 2006 .........................................
4,828
376
189
64
(407)
–
287
(6)
5,331
(252)
(85)
30
–
(28)
(7)
(342)
2,235
24
–
77
(421)
(38)
102
(43)
1,936
(132)
(46)
2
1
(8)
15
(168)
2,265
253
17
23
(66)
38
65
(21)
2,574
(604)
(131)
59
(1)
(40)
(6)
(723)
Net carrying amount at 31 December 2006 ........
4,989
1,768
1,851
Cost or fair value
At 1 January 2005 ...............................................
Additions at cost4 ................................................
Acquisition of subsidiaries .................................
Fair value adjustments ........................................
Disposals .............................................................
Transfers .............................................................
Exchange differences ..........................................
Other changes .....................................................
At 31 December 2005 .........................................
Accumulated depreciation
At 1 January 2005 ...............................................
Depreciation charge for the year ........................
Disposals .............................................................
Exchange differences ..........................................
Other changes .....................................................
At 31 December 2005 .........................................
4,384
601
10
48
(224)
30
(245)
224
4,828
(204)
(76)
6
18
4
(252)
Net carrying amount at 31 December 2005 ........
4,576
2,153
142
–
95
(87)
–
(82)
14
2,235
(74)
(55)
–
5
(8)
(132)
2,103
2,252
124
5
58
(77)
(30)
(55)
(12)
2,265
(590)
(101)
51
35
1
(604)
1,661
8,639
1,473
55
–
(972)
–
633
(126)
9,702
(5,418)
(1,075)
915
–
(401)
5
(5,974)
3,728
8,722
1,269
14
–
(542)
–
(445)
(379)
8,639
(5,375)
(1,082)
431
285
323
(5,418)
3,221
Total3
US$m
22,931
2,400
262
164
(1,894)
–
1,561
42
25,466
(7,725)
(1,514)
1,095
–
(667)
(231)
(9,042)
4,964
274
1
–
(28)
–
474
238
5,923
(1,319)
(177)
89
–
(190)
(238)
(1,835)
4,088
16,424
6,117
751
–
–
(359)
–
(660)
(885)
4,964
(1,761)
(318)
243
182
335
(1,319)
23,628
2,887
29
201
(1,289)
–
(1,487)
(1,038)
22,931
(8,004)
(1,632)
731
525
655
(7,725)
3,645
15,206
Leasehold land and buildings are considered to be held under finance lease contracts where the value of the land cannot reliably be
separated from the value of the lease, and the respective contracts do not meet the criteria for classification as operating leases.
1 Including assets held on finance leases with a net book value of US$11 million (2005: US$7 million).
2 Including assets held on finance leases with a net book value of US$450 million (2005: US$327 million).
3 Including assets with a net book value of US$425 million (2005: US$13 million) pledged as security for liabilities.
4 At 31 December 2006, HSBC had US$1,380 million (2005: US$1,256 million) of contractual commitments to acquire property,
plant and equipment.
366
Included within ‘Short leasehold land and buildings’ are the following amounts in respect of assets classed as
improvements to buildings, which are carried at depreciated historical cost:
2006
Cost
US$m
Accumulated
depreciation
US$m
2005
Cost
US$m
Accumulated
depreciation
US$m
At 1 January ..................................................................
Additions ......................................................................
Disposals .......................................................................
Depreciation charge for the year ..................................
Impairment loss recognised ..........................................
Exchange differences ....................................................
Other changes ...............................................................
At 31 December ............................................................
Net carrying amount at 31 December ...........................
Investment properties
1,026
218
(67)
–
–
63
37
1,277
926
(315)
–
47
(35)
(3)
(37)
(8)
(351)
993
124
(58)
–
–
(52)
19
1,026
711
The composition of the investment properties at fair value in the year was as follows:
Freehold
land and
buildings
US$m
Long
leasehold
land and
buildings
US$m
Short
leasehold
land and
buildings
US$m
Fair value
At 1 January 2006 ..........................................................
Additions at cost ............................................................
Disposals ........................................................................
Fair value adjustments ...................................................
Exchange differences .....................................................
Other changes ................................................................
At 31 December 2006 ....................................................
At 1 January 2005 ..........................................................
Additions at cost ............................................................
Disposals ........................................................................
Fair value adjustments ...................................................
Exchange differences .....................................................
Other changes ................................................................
1,438
179
(178)
64
42
(12)
1,533
704
455
(47)
48
(8)
286
At 31 December 2005 ....................................................
1,438
477
–
(371)
77
12
(21)
174
250
137
(3)
95
(4)
2
477
255
–
(8)
23
–
(28)
242
209
–
(12)
58
–
–
255
(347)
–
36
(22)
–
32
(14)
(315)
Total
US$m
2,170
179
(557)
164
54
(61)
1,949
1,163
592
(62)
201
(12)
288
2,170
Investment properties are valued on an open market value basis as at 31 December each year by independent
professional valuers who have recent experience in the location and type of properties. Investment properties in Hong
Kong, the Macau Special Administrative Region and mainland China, which represent 25 per cent by value of
HSBC’s investment properties subject to revaluation, were valued by DTZ Debenham Tie Leung Limited, which is a
member of the Hong Kong Institute of Surveyors.
As a result of the revaluation, the net book value of investment properties increased by US$164 million (2005:
surplus of US$201 million), which was credited to the income statement for the year ended 31 December 2006.
HSBC Holdings had no investment properties at 31 December 2006 or 2005.
Included within ‘Other operating income’ was rental income of US$153 million (2005: US$116 million) earned by
HSBC on its investment properties. Direct operating expenses of US$61 million (2005: US$39 million) incurred in
respect of the investment properties during the year were recognised in ‘General and administrative expenses’. Direct
operating expenses arising in respect of investment properties that did not generate rental income during 2006
amounted to nil (2005: US$3 million).
HSBC recognised US$144 million (2005: US$10 million) as contractual obligations to purchase, construct, develop,
maintain or enhance investment properties.
367
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 23 and 24
HSBC properties leased to customers
HSBC properties leased to customers included US$470 million at 31 December 2006 (2005: US$646 million) let
under operating leases, net of accumulated depreciation of US$53 million (2005: US$42 million). None was held by
HSBC Holdings.
24 Investments in subsidiaries
Principal subsidiary undertakings of HSBC Holdings
At 31 December 2006
HSBC’s
interest in
equity capital
%
Country of
incorporation
or registration
Issued equity
capital
Europe
HFC Bank Limited ..........................................................................................
HSBC Investments (UK) Limited ...................................................................
HSBC Asset Finance (UK) Limited ................................................................
HSBC Bank A.S. .............................................................................................
HSBC Bank Malta p.l.c. ..................................................................................
HSBC Bank Middle East Limited ...................................................................
HSBC Bank plc ................................................................................................
HSBC France ...................................................................................................
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 ..................................................................
HSBC Trinkaus & Burkhardt AG ...................................................................
Hong Kong
Hang Seng Bank Limited ................................................................................
HSBC Insurance (Asia) Limited ......................................................................
HSBC Life (International) Limited .................................................................
The Hongkong and Shanghai Banking Corporation Limited .........................
Rest of Asia-Pacific
HSBC Bank Australia Limited ........................................................................
HSBC Bank Egypt S.A.E. ...............................................................................
HSBC Investments (Taiwan) Limited .............................................................
HSBC Bank Malaysia Berhad .........................................................................
North America
The Bank of Bermuda Limited ........................................................................
HSBC Bank Canada ........................................................................................
HSBC Bank USA, N.A. ...................................................................................
HSBC Finance Corporation .............................................................................
HSBC Securities (USA) Inc. ...........................................................................
HSBC Technology & Services (USA) Inc. .....................................................
Latin America
HSBC Bank Argentina S.A. ............................................................................
HSBC Bank Brasil S.A. – Banco Múltiplo .....................................................
HSBC La Buenos Aires Seguros S.A. .............................................................
HSBC Mexico S.A. ..........................................................................................
HSBC Seguros (Brasil) S.A. ............................................................................
Maxima S.A. AFJP ..........................................................................................
Primer Banco del Istmo, S.A. ..........................................................................
England
England
England
Turkey
Malta
Jersey
England
France
Switzerland
England
England
Guernsey
Switzerland
England
Germany
Hong Kong
Hong Kong
Bermuda
Hong Kong
Australia
Egypt
Taiwan
Malaysia
Bermuda
Canada
United States
United States
United States
United States
Argentina
Brazil
Argentina
Mexico
Brazil
Argentina
Panama
100
100
100
100
70.03
100
100
99.99
100
100
100
100
100
100
78.60
£109m
£37m
£265m
TRL277m
Lm36m
US$431m
£797m
€378m
SFr95m
£2.8m
£94m
US$22m
SFr683m
£177m
€70m
62.14
100
100
100
HK$9,559m
HK$125m
HK$327m
HK$22,494m
100
94.53
100
100
100
100
100
100
100
100
A$811m
E£1,073m
TWD788m
RM$114m
US$30m
C$1,125m
US$2m
US$3,038m
–1
–1
99.99
100
99.53
99.99
97.94
59.99
99.39
ARS1,103m
BRL2,147m
ARS44m
MXP3,930m
BRL350m
ARS200m
US$576m
1 Issued equity capital is less than US$1 million.
2 Details of the debt, subordinated debt and preference shares issued by the principal subsidiaries to parties external to the Group are
included in the Notes 28 ‘Debt securities in issue’, 32 ‘Subordinated liabilities’ and 37 ‘Minority interests’ respectively.
All the above subsidiaries are included in the HSBC consolidated financial statements.
368
Details of all HSBC companies will be annexed to the next Annual Return of HSBC Holdings filed with the UK
Registrar of Companies.
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 Maxima 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.
Subsidiaries which experience significant restrictions on their ability to transfer funds to HSBC in the form of
cash dividends or to repay loans and advances
During 2006 and 2005, none of the Group’s subsidiaries has experienced significant restrictions on paying dividends
or repaying loans and advances.
Subsidiaries where HSBC owns less than 50 per cent of the voting rights
Subsidiary
2006
Beijing HSBC Insurance Brokers Limited
HSBC’s
interest in
equity capital
%
Description of relationship
that gives HSBC control
24.9
HSBC has the right to appoint the majority of the board,
therefore has management control.
HSBC Insurance Brokers (India) Private Limited
25.9
HSBC has the right to appoint the majority of the board,
HSBC Private Equity Fund 3
HSBC Global Technology Alpha Fund
2005
Beijing HSBC Insurance Brokers Limited
therefore has management control.
38.8
23.9
HSBC is the fund manager and controls the fund.
The fund is a ‘Wider Purpose Fund’ and consolidation is
required under IAS 27 ‘Consolidated and Separate Financial
Statements’.
24.9
HSBC has the right to appoint the majority of the board,
therefore has management control.
HSBC Insurance Brokers (India) Private Limited
25.9
HSBC has the right to appoint the majority of the board,
HSBC Private Equity Fund 3
HSBC Continental European Alpha Fund
therefore has management control.
38.8
6.1
HSBC is the fund manager and controls the fund.
The fund is a ‘Wider Purpose Fund’ and consolidation is
required under IAS 27.
HSBC Global Technology Alpha Fund
48.7
The fund is a ‘Wider Purpose Fund’ and consolidation is
required under IAS 27.
Investments where HSBC owns 20 per cent or more of the voting rights but does not classify the investment as
a subsidiary, joint venture or associate
Investment
2005
Zhong-Run Company Limited
HSBC’s
interest in
equity capital
%
Description of relationship that results in HSBC accounting
for entity as an investment
25.0
Entity is held by a venture capital organisation which is exempt
from classifying investments as associates under IAS 28.
In 2006 there were no significant investments where HSBC owned 20 per cent or more of the voting rights but did
not classify the investment as a subsidiary, joint venture or associate.
Acquisitions
HSBC made the following acquisitions of subsidiaries or business operations in 2006, which were accounted for
using the purchase method:
On 23 November 2006 HSBC acquired 99.98 per cent of Grupo Banistmo, S.A. (‘Banistmo’) for a total consideration
of US$1,968 million, comprising US$1,773 million in cash and US$195 million in contingent consideration. The
contingent consideration is in respect of a binding offer to preference shareholders for the purchase of their
369
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 24, 25 and 26
preference shares within one year after acquisition. Banistmo is a leading banking group in Central America and has
operations in Panama, Colombia, Costa Rica, El Salvador, Honduras and Nicaragua. The post-acquisition profit of
Banistmo was US$1 million.
Goodwill of US$1,450 million arose from this acquisition. The goodwill on the Banistmo acquisition represents value
obtainable from synergies with HSBC, expertise HSBC brings to the proposition and the access to the Central
American market that the acquisition provides to the Group.
HSBC also made the following acquisitions of significant subsidiaries or business operations in 2006, which were
accounted for using the purchase method:
(i) On 30 April 2006 HSBC acquired the entire share capital of BNL Inversiones Argentinas S.A., the holding
company of the bank Banca Nazionale del Lavoro S.A., which had net liabilities of US$3 million, for a cash
consideration of US$155 million. Goodwill of US$158 million arose on acquisition.
(ii) On 4 October 2006 HSBC acquired the entire share capital of Solstice Capital Group Inc. for a cash
consideration of US$50 million. Goodwill of US$46 million arose on acquisition.
(iii) On 4 September 2006 HSBC acquired the Australian custody business from Westpac Banking Corporation for a
total consideration of US$105 million, comprising US$91 million in cash and US$14 million contingent
consideration. Goodwill of US$32 million arose on acquisition.
The fair values of the assets, liabilities and contingent liabilities of the companies acquired during the year, which
relate principally to Banistmo, were as follows:
At date of acquisition
Cash and balances at central banks ...............................................................................................
Items in the course of collection from other banks .......................................................................
Trading assets ................................................................................................................................
Loans and advances to banks ........................................................................................................
Loans and advances to customers .................................................................................................
Financial investments ....................................................................................................................
Interests in associates and joint ventures ......................................................................................
Intangible assets ............................................................................................................................
Property, plant and equipment ......................................................................................................
Prepayments and accrued income .................................................................................................
Other assets ....................................................................................................................................
Deposits by banks ..........................................................................................................................
Customer accounts ........................................................................................................................
Items in the course of transmission to other banks .......................................................................
Debt securities in issue ..................................................................................................................
Retirement benefit liabilities .........................................................................................................
Provisions ......................................................................................................................................
Other liabilities ...............................................................................................................................
Liabilities under insurance contracts issued ..................................................................................
Accruals and deferred income .......................................................................................................
Subordinated liabilities ..................................................................................................................
Less: minority interests .................................................................................................................
Net assets acquired ........................................................................................................................
Goodwill attributable:
Subsidiaries (Note 21) ...............................................................................................................
Total consideration including costs of acquisition .......................................................................
Carrying value
immediately
prior to
acquisition
US$m
244
91
29
1,473
7,031
1,227
16
169
260
111
575
(1,706)
(7,652)
(119)
(238)
(10)
(72)
(550)
(72)
(73)
(93)
(134)
507
Fair
value
US$m
244
91
29
1,473
7,031
1,224
16
330
262
111
582
(1,706)
(7,652)
(119)
(238)
(10)
(154)
(550)
(72)
(73)
(93)
(134)
592
1,686
2,278
Included within provisions above are US$46 million of contingent liabilities recognised on acquisition.
In addition to the above, there were other minor acquisitions and increases in investment in subsidiaries which
increased goodwill by US$40 million.
370
In addition to cash and balances at central banks, items in the course of collection from other banks and items in the
course of transmission to other banks, included in the assets and liabilities acquired above are cash and cash
equivalents of US$736 million.
25 Other assets
Bullion ...............................................................................................................................................
Assets held for sale ............................................................................................................................
Reinsurers’ share of liabilities under insurance contracts (Note 30) .................................................
Current taxation recoverable .............................................................................................................
Deferred taxation (Note 31) ...............................................................................................................
Endorsements and acceptances ..........................................................................................................
Other accounts ...................................................................................................................................
Assets held for sale
Disposal groups and non-current assets held for sale
Interests in associates ........................................................................................................................
Property, plant and equipment ...........................................................................................................
Receivables ........................................................................................................................................
Other ..................................................................................................................................................
Total assets classified as held for sale ...............................................................................................
2006
US$m
3,145
1,826
1,769
380
3,241
9,577
13,506
33,444
2006
US$m
25
1,149
634
18
1,826
2005
US$m
2,358
959
1,545
496
2,665
7,973
10,600
26,596
2005
US$m
162
774
23
–
959
Property, plant and equipment
The property, plant and equipment classified as held for sale is the result of repossession of property that had been
pledged as collateral by customers. These assets are disposed of within 12 months of acquisition. Neither a gain nor
loss was recognised on reclassifying these assets as held for sale. The majority arose within the geographical segment
North America.
Receivables
The receivables classified as held for sale in 2006 relate mainly to a residential mortgage book in New Zealand for
which an agreement to negotiate the sale was entered into in January 2007. Neither a gain nor loss was recognised on
reclassifying these assets as held for sale. These assets are presented within the geographical segment Rest of
Asia-Pacific.
26 Trading liabilities
Deposits by banks ..............................................................................................................................
Customer accounts .............................................................................................................................
Other debt securities in issue .............................................................................................................
Other liabilities – net short positions .................................................................................................
2006
US$m
32,040
89,166
34,115
71,287
2005
US$m
20,829
59,864
26,976
66,696
226,608
174,365
371
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 27, 28 and 29
27 Financial liabilities designated at fair value
HSBC
Deposits by banks and customer accounts ........................................................................................
Liabilities to customers under investment contracts .........................................................................
Debt securities in issue (Note 28) ......................................................................................................
Subordinated liabilities (Note 32) .....................................................................................................
Preference shares (Note 32) ...............................................................................................................
2006
US$m
577
13,278
33,167
18,503
4,686
70,211
2005
US$m
253
10,445
28,338
18,447
4,346
61,829
The carrying amount at 31 December 2006 of financial liabilities designated at fair value was US$1,257 million
(2005: US$1,899 million) higher than the contractual amount at maturity. At 31 December 2006, the accumulated
amount of the change in fair value attributable to changes in credit risk was US$1,535 million (2005:
US$1,144 million).
HSBC Holdings
Subordinated liabilities (Note 32):
– owed to third parties ...................................................................................................................
– owed to HSBC undertakings ......................................................................................................
2006
US$m
9,839
4,231
14,070
2005
US$m
9,315
4,055
13,370
The carrying amount at 31 December 2006 of financial liabilities designated at fair value was US$551 million (2005:
US$910 million) higher than the contractual amount at maturity. At 31 December 2006, the accumulated amount of
the change in fair value attributable to changes in credit risk was US$335 million (2005: US$398 million).
28 Debt securities in issue
Bonds and medium term notes ..........................................................................................................
Other debt securities in issue .............................................................................................................
Of which debt securities in issue reported as:
– trading liabilities .........................................................................................................................
– financial liabilities designated at fair value (Note 27) ...............................................................
2006
US$m
203,404
94,203
297,607
(34,115)
(33,167)
230,325
2005
US$m
165,773
77,613
243,386
(26,976)
(28,338)
188,072
Certain debt securities in issue are managed on a fair value basis as part of HSBC’s interest rate risk management
policies. The hedged portion of these debt securities is presented within the balance sheet caption ‘Financial liabilities
designated at fair value’, with the remaining portion included within ‘Trading liabilities’.
The following table analyses the carrying amount of bonds and medium term notes in issue at 31 December with
original maturities greater than one year:
372
Fixed rate
Debentures – 8.375%: due 2007 .......................................................................................................
Secured financing:
1.14% to 3.99%: due 2007 ............................................................................................................
4.00% to 4.99%: due 2007 to 2010 ...............................................................................................
5.00% to 5.99%: due 2007 to 2011 ...............................................................................................
6.00% to 6.99%: due 2007 to 2011 ...............................................................................................
7.00% to 7.99%: due 2007 to 2011 ...............................................................................................
8.00% to 8.99%: due 2007 to 2011 ...............................................................................................
Other fixed rate senior debt:
2.15% to 3.99%: due 2007 to 2066 ...............................................................................................
4.00% to 4.99%: due 2007 to 2046 ...............................................................................................
5.00% to 5.99%: due 2007 to 2016 ...............................................................................................
6.00% to 6.99%: due 2007 to 2036 ...............................................................................................
7.00% to 7.99%: due 2007 to 2032 ...............................................................................................
8.00% to 9.99%: due 2007 to 2015 ...............................................................................................
10.00% or higher: due 2007 to 2010 .............................................................................................
Variable interest rate
Secured financings – 5.00% to 9.99%: due 2007 to 2009 ................................................................
FHLB advances – 5.00% to 5.99%: due 2007 to 2036 .....................................................................
Other variable interest rate senior debt – 2.16% to 9.99%: due 2007 to 2036 .................................
Structured notes
Interest rate linked .............................................................................................................................
Equity, equity index or credit linked .................................................................................................
2006
US$m
100
195
1,730
6,096
–
98
215
17,326
17,759
34,191
16,196
6,692
1,665
399
2005
US$m
101
1,669
5,090
843
41
141
–
10,527
32,295
21,302
25,356
12,450
2,743
890
102,662
113,448
23,212
5,000
63,504
91,716
379
8,647
9,026
15,601
5,000
24,374
44,975
2,748
4,602
7,350
Total bonds and medium term notes .................................................................................................
203,404
165,773
29 Other liabilities
Amounts due to investors in funds consolidated
by HSBC ...................................................................
Current taxation ............................................................
Obligations under finance leases ..................................
Dividend declared and payable by HSBC Holdings ....
Endorsements and acceptances .....................................
Other liabilities .............................................................
Obligations under finance leases falling due:
– within 1 year ..........................................................
– between 1 and 5 years ...........................................
– over 5 years ...........................................................
HSBC
2006
US$m
966
1,805
707
1,507
9,577
15,262
29,824
41
21
645
707
2005
US$m
683
1,640
639
1,193
8,033
14,327
26,515
25
54
560
639
HSBC Holdings
2006
US$m
2005
US$m
–
–
–
1,507
–
10
1,517
–
–
–
–
–
–
–
1,193
–
10
1,203
–
–
–
–
373
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 30
30 Liabilities under insurance contracts
Non-life insurance liabilities
Unearned premium provision ..........................................................................
Notified claims .................................................................................................
Claims incurred but not reported .....................................................................
Other ................................................................................................................
Life insurance policyholders’ liabilities
Life (non-linked) ..............................................................................................
Investment contracts with discretionary participation features1 ......................
Life (linked) .....................................................................................................
Total liabilities under insurance contracts .......................................................
Non-life insurance liabilities
Unearned premium provision ..........................................................................
Notified claims .................................................................................................
Claims incurred but not reported .....................................................................
Other ................................................................................................................
Life insurance policyholders’ liabilities
Life (non-linked) ..............................................................................................
Investment contracts with discretionary participation features1 ......................
Life (linked) .....................................................................................................
Total liabilities under insurance contracts .......................................................
2006
Reinsurers’
share
US$m
(176)
(355)
(58)
(76)
(665)
(1,046)
–
(58)
(1,104)
(1,769)
2005
Reinsurers’
share
US$m
(202)
(335)
(130)
(2)
(669)
(807)
–
(69)
(876)
(1,545)
Gross
US$m
1,262
949
460
268
2,939
11,026
20
3,685
14,731
17,670
Gross
US$m
1,346
872
424
229
2,871
8,369
9
2,895
11,273
14,144
Net
US$m
1,086
594
402
192
2,274
9,980
20
3,627
13,627
15,901
Net
US$m
1,144
537
294
227
2,202
7,562
9
2,826
10,397
12,599
1 Though investment contracts with discretionary participation features are financial instruments, HSBC continued to treat them as
insurance contracts as permitted by IFRS 4.
374
The movement of liabilities under insurance contracts during the year ended 31 December 2006 was as follows:
Non-life insurance liabilities
Unearned premium provision
At 1 January .....................................................................................................
Gross written premiums ...................................................................................
Gross earned premiums ...................................................................................
Exchange differences and other movements ...................................................
At 31 December ...............................................................................................
Notified and incurred but not reported claims
At 1 January .....................................................................................................
Notified claims ............................................................................................
Claims incurred but not reported .................................................................
Claims paid in current year ..............................................................................
Claims incurred in respect of current year ......................................................
Claims incurred in respect of prior years ........................................................
Exchange differences and other movements ...................................................
At 31 December ...............................................................................................
Notified claims ............................................................................................
Claims incurred but not reported .................................................................
Other ................................................................................................................
Total non-life insurance liabilities ...................................................................
Unearned premium provision
At 1 January .....................................................................................................
Gross written premiums ...................................................................................
Gross earned premiums ...................................................................................
Exchange differences and other movements ...................................................
At 31 December ...............................................................................................
Notified and incurred but not reported claims
At 1 January .....................................................................................................
Notified claims ............................................................................................
Claims incurred but not reported .................................................................
Claims paid in current year ..............................................................................
Claims incurred in respect of current year ......................................................
Claims incurred in respect of prior years ........................................................
Exchange differences and other movements ...................................................
At 31 December ...............................................................................................
Notified claims ............................................................................................
Claims incurred but not reported .................................................................
Other ................................................................................................................
Total non-life insurance liabilities ...................................................................
2006
Reinsurers’
share
US$m
(202)
(451)
499
(22)
(176)
(465)
(335)
(130)
228
(147)
(24)
(5)
(413)
(355)
(58)
(76)
(665)
2005
Reinsurers’
share
US$m
(217)
(479)
419
75
(202)
(463)
(408)
(55)
146
(150)
6
(4)
(465)
(335)
(130)
(2)
(669)
Gross
US$m
1,346
1,824
(1,946)
38
1,262
1,296
872
424
(889)
680
219
103
1,409
949
460
268
2,939
Gross
US$m
1,250
2,364
(2,139)
(129)
1,346
1,360
871
489
(966)
1,070
(32)
(136)
1,296
872
424
229
2,871
Net
US$m
1,144
1,373
(1,447)
16
1,086
831
537
294
(661)
533
195
98
996
594
402
192
2,274
Net
US$m
1,033
1,885
(1,720)
(54)
1,144
897
463
434
(820)
920
(26)
(140)
831
537
294
227
2,202
375
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 30 and 31
Life insurance policyholders’ liabilities
Life (non-linked)
At 1 January .....................................................................................................
Benefits paid ....................................................................................................
Claims incurred ................................................................................................
Exchange differences and other movements ...................................................
2006
Reinsurers’
share
US$m
(807)
154
(208)
(185)
Gross
US$m
8,369
(814)
3,021
450
At 31 December ...............................................................................................
11,026
(1,046)
Investment contracts with discretionary participation features
At 1 January .....................................................................................................
Claims incurred ................................................................................................
Foreign exchange and other movements .........................................................
At 31 December ...............................................................................................
Life (linked)
At 1 January .....................................................................................................
Benefits paid ....................................................................................................
Claims incurred ................................................................................................
Exchange differences and other movements ...................................................
At 31 December ...............................................................................................
9
6
5
20
2,895
(495)
1,146
139
3,685
–
–
–
–
(69)
9
11
(9)
(58)
Net
US$m
7,562
(660)
2,813
265
9,980
9
6
5
20
2,826
(486)
1,157
130
3,627
Total policyholders’ liabilities .........................................................................
14,731
(1,104)
13,627
Life (non-linked)
At 1 January .....................................................................................................
Benefits paid ....................................................................................................
Claims incurred ................................................................................................
Exchange differences and other movements ...................................................
At 31 December ...............................................................................................
Investment contracts with discretionary participation features
At 1 January .....................................................................................................
Claims incurred ................................................................................................
At 31 December ...............................................................................................
Life (linked)
At 1 January .....................................................................................................
Benefits paid ....................................................................................................
Claims incurred ................................................................................................
Exchange differences and other movements ...................................................
At 31 December ...............................................................................................
2005
Reinsurers’
share
US$m
(1,049)
111
80
51
(807)
–
–
–
(73)
11
(22)
15
(69)
Gross
US$m
6,860
(621)
2,304
(174)
8,369
–
9
9
2,523
(357)
802
(73)
2,895
Net
US$m
5,811
(510)
2,384
(123)
7,562
–
9
9
2,450
(346)
780
(58)
2,826
Total policyholders’ liabilities .........................................................................
11,273
(876)
10,397
The claims incurred represent the aggregate of all events giving rise to additional policyholders’ liabilities in the year.
These include death claims, surrenders, lapses, the setting up of liability to policyholders at the initial inception of the
policy, the declaration of bonuses and other amounts attributable to policyholders.
376
31 Provisions
Total provisions at 31 December 2006 were US$2,859 million (2005: US$1,966 million), of which US$1,096 million
(2005: US$530 million) relates to deferred tax and US$1,763 million (2005: US$1,436 million) relates to other
provisions.
Deferred taxation
HSBC
Temporary differences:
– retirement benefits .......................................
– loan impairment allowances ........................
– assets leased to customers ...........................
– revaluation of property ................................
– accelerated capital allowances ....................
– other short-term timing differences .............
Unused tax losses ...............................................
Provision for tax on profit remitted from
overseas ..........................................................
Total
US$m
1,599
2,775
(1,676)
(469)
(80)
(71)
180
(112)
2,146
2006
Deferred
tax asset
US$m
Deferred
tax liability
US$m
169
2,607
(82)
(166)
91
657
59
1,430
168
(1,594)
(303)
(171)
(728)
121
Total
US$m
1,621
2,220
(1,342)
(339)
(55)
(107)
223
2005
Deferred
tax asset
US$m
Deferred
tax liability
US$m
1,537
1,899
(1,250)
61
(5)
247
176
84
321
(92)
(400)
(50)
(354)
47
(86)
(530)
(93)
(19)
(86)
–
3,242
(1,096)
2,135
2,665
The amount of temporary differences for which no deferred tax asset is recognised in the balance sheet is
US$1,067 million (2005: US$835 million). Of this amount, US$876 million (2005: US$458 million) has no expiry
date and US$191 million (2005: US$377 million) is scheduled to expire within 10 years.
HSBC Holdings
Temporary differences:
– short-term timing differences .......................................................................................................
– fair valued assets and liabilities ...................................................................................................
– share-based payments ...................................................................................................................
Provision for tax on profit remitted from overseas .............................................................................
Deferred tax asset/(liability)
2006
US$m
2005
US$m
1
10
24
–
35
(5)
–
–
(65)
(70)
The deferred tax asset at 31 December 2006 is included within ‘Other assets’ on the balance sheet.
Deferred tax is not recognised on temporary differences associated with investments in subsidiaries and branches
because earnings are intended to be indefinitely reinvested in the case of subsidiaries and no further tax is expected to
arise in the foreseeable future in the case of branches. The total of such relevant temporary differences amounted to
US$22,424 million (2005: US$15,367 million).
There are no deductible temporary differences, unused tax losses and unused tax credits for which no deferred tax
asset is recognised in the balance sheet.
Other provisions
At 1 January .......................................................................................................................................
IFRSs transition adjustment at 1 January 20051 ................................................................................
Additional provisions/increase in provisions2 ...................................................................................
Acquisition of subsidiaries ................................................................................................................
Provisions utilised .............................................................................................................................
Amounts reversed ..............................................................................................................................
Exchange differences and other movements .....................................................................................
At 31 December .................................................................................................................................
2006
US$m
1,436
–
652
54
(379)
(154)
154
1,763
2005
US$m
2,636
(1,033)
637
–
(327)
(310)
(167)
1,436
377
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 31 and 32
1 For an explanation of the IFRSs transition adjustment at 1 January 2005, see Note 46 on the Financial Statements in the Annual Report
and Accounts 2005.
2 The increase in ‘other provisions’ includes unwinding of discounts of US$8 million (2005: US$11 million) in relation to vacant space
provisions and US$19 million (2005: US$23 million) in relation to Brazilian provisions for civil and fiscal labour claims.
Included within ‘Other provisions’ are:
(i) Provisions for onerous property contracts of US$106 million (2005: US$149 million), of which US$71 million
(2005: US$74 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 while finding new
tenants, shortfalls in expected rent receivable compared with rent payable, and the cost of refurbishing the
buildings to attract tenants. Uncertainties arise from movements in market rents, delays in finding new tenants
and the timing of rental reviews.
(ii) Labour, civil and fiscal litigation provisions in HSBC’s Brazil operations of US$282 million (2005:
US$235 million). These relate to labour and overtime litigation claims brought by employees after leaving the
bank. The provisions are based on the expected number of departing employees, their individual salaries and
historical trends. The timing of the settlement of these claims is uncertain.
(iii) Provisions of US$749 million (2005: US$652 million) have been made in respect of costs arising from
contingent liabilities and contractual commitments (Note 41), including guarantees of US$64 million
(2005: US$55 million) and commitments of US$93 million (2005: US$122 million).
32 Subordinated liabilities
HSBC
Subordinated liabilities
At amortised cost ...........................................................................................................................
– subordinated liabilities ..............................................................................................................
– preferred securities ....................................................................................................................
Designated at fair value (Note 27) ................................................................................................
– subordinated liabilities ..............................................................................................................
– preferred securities ....................................................................................................................
Subordinated liabilities
HSBC Holdings .............................................................................................................................
Other HSBC ...................................................................................................................................
Carrying amount
2006
US$m
22,672
17,296
5,376
23,189
18,503
4,686
45,861
14,271
31,590
45,861
2005
US$m
16,537
11,546
4,991
22,793
18,447
4,346
39,330
10,765
28,565
39,330
378
HSBC’s subordinated borrowings
Amounts owed to third parties by HSBC Holdings (see below) .................................................
Other HSBC subordinated borrowings
€1,400m
£700m
US$1,350m
US$1,200m
£600m
US$1,250m
€800m
US$1,000m
£500m
€750m
US$1,000m
US$1,000m
£500m
£500m
US$900m
€600m
€600m
US$750m
£350m
£350m
US$750m
£350m
€500m
£300m
£300m
US$500m
US$450m
£225m
US$300m
US$300m
£150m
US$300m
BRL608m
US$250m
BRL500m
US$250m
US$200m
US$200m
US$200m
US$200m
US$200m
US$500m
US$300m
£150m
US$200m
US$200m
5.3687% Non-cumulative Step-up Perpetual Preferred Securities1 .....................
5.844% Non-cumulative Step-up Perpetual Preferred Securities2 .......................
9.547% Non-cumulative Step-up Perpetual Preferred Securities, Series 11 ........
Primary capital subordinated undated floating rate notes ....................................
4.75% subordinated notes 2046 ............................................................................
4.61% Non-cumulative Step-up Perpetual Preferred Securities1 .........................
Callable subordinated floating rate notes 20163 ...................................................
5.875% subordinated notes 2034 ..........................................................................
5.375% subordinated notes 2033 ..........................................................................
5.13% Non-cumulative Step-up Perpetual Preferred Securities1 .........................
4.625% subordinated notes 2014 ..........................................................................
5.911% trust preferred securities 20355 ................................................................
8.208% Non-cumulative Step-up Perpetual Preferred Securities1 .......................
4.75% callable subordinated notes 20204 .............................................................
10.176% Non-cumulative Step-up Perpetual Preferred Securities, Series 21 ......
4.25% Callable subordinated notes 20169 ............................................................
8.03% Non-cumulative Step-up Perpetual Preferred Securities1 .........................
Undated floating rate primary capital notes ..........................................................
5.375% Callable subordinated step-up notes 20306 .............................................
5% Callable subordinated notes 20238 .................................................................
5.625% subordinated notes 2035 ..........................................................................
Callable subordinated variable coupon notes 20177 .............................................
Callable subordinated floating rate notes 202010 ..................................................
5.862% Non-cumulative Step-up Perpetual Preferred Securities2 .......................
6.5% subordinated notes 2023 ..............................................................................
Undated floating rate primary capital notes ..........................................................
Callable subordinated floating rate notes 20163 ...................................................
6.25% subordinated notes 2041 ............................................................................
7.65% subordinated notes 202511 ..........................................................................
6.95% subordinated notes 2011 ............................................................................
8.625% step-up undated subordinated notes12 ......................................................
Undated floating rate primary capital notes Series 3 ............................................
Subordinated debentures 2008 ..............................................................................
5.875% subordinated notes 2008 ..........................................................................
Subordinated Certificates of Deposits 2016 .........................................................
7.20% subordinated debentures 2097 ...................................................................
7.53% capital securities 2026 ...............................................................................
7.75% subordinated notes 2009 ............................................................................
7.808% capital securities 2026 .............................................................................
6.625% subordinated notes 2009 ..........................................................................
8.38% capital securities 2027 ...............................................................................
7.625% subordinated notes 2006 ..........................................................................
7% subordinated notes 2006 .................................................................................
9.25% step-up undated subordinated notes ..........................................................
7.50% trust preferred securities 2031 ...................................................................
8.25% trust preferred securities 2031 ...................................................................
Other subordinated liabilities each less than US$200m .......................................
2006
US$m
14,271
2005
US$m
10,765
1,918
1,374
1,336
1,205
1,160
1,158
1,052
1,048
1,043
1,011
998
991
982
942
900
801
790
750
701
687
685
675
658
599
585
501
448
438
373
326
304
300
285
243
234
217
209
205
200
197
191
–
–
–
–
–
2,870
1,653
1,205
1,350
1,207
–
1,250
–
1,017
940
885
997
990
861
861
900
731
708
752
647
613
737
635
588
558
509
502
–
384
358
326
277
302
261
240
–
216
202
207
200
198
200
507
300
268
202
200
2,621
31,590
45,861
28,565
39,330
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, and, where relevant, the local banking
regulator, and 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
10.176 per cent.
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.
379
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 32
3 The interest margin on the €800m and US$450m callable subordinated floating rate notes 2016 increases by 0.5 per cent from March
2011 and July 2011, respectively.
4 The interest rate on the 4.75 per cent callable subordinated notes 2020 changes in September 2015 to three-month sterling LIBOR plus
0.82 per cent.
5 The distributions on the trust preferred securities change in November 2015 to three-month dollar LIBOR plus 1.926 per cent.
6 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.
7 The interest rate on the callable subordinated variable coupon notes 2017 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.
8 The interest rate on the 5 per cent callable subordinated notes 2023 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.
9 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.
10 The interest margin on the callable subordinated floating notes 2020 increases by 0.5 per cent from September 2015.
11 The 7.65 per cent subordinated notes 2025 are repayable at the option of each of the holders in May 2007.
12 The interest rate on the 8.625 per cent step-up updated 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.
Footnotes 3 to 12 (excluding footnote 11) 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 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, 2015, 2030 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.
(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 two issues of 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 apply to HSBC Bank as to HSBC, as
described above. HSBC Bank has provided a similar covenant to that provided by HSBC Holdings, also as
described above.
380
If (i) any of the two issues of 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.
HSBC Holdings
Subordinated liabilities:
– at amortised cost .........................................................................................................................
– designated at fair value ...............................................................................................................
HSBC Holdings subordinated borrowings
Amounts owed to third parties
€2,000m
US$2,000m
US$1,400m
€1,000m
£650m
US$1,000m
€700m
US$750m
US$750m
£250m
US$488m
€300m
US$222m
Callable subordinated floating rate notes 20141 ...................................................
6.5% subordinated notes 2036 ..............................................................................
5.25% subordinated notes 2012 ............................................................................
5.375% subordinated notes 2012 ..........................................................................
5.75% subordinated notes 2027 ............................................................................
7.5% subordinated notes 2009 ..............................................................................
3.625% callable subordinated notes 20202 ............................................................
Callable subordinated floating rate note 20161 ....................................................
Callable subordinated floating rate notes 20151 ...................................................
9.875% subordinated bonds 20183 ........................................................................
7.625% subordinated notes 2032 ..........................................................................
5.5% subordinated notes 2009 ..............................................................................
7.35% subordinated notes 2032 ............................................................................
Amounts owed to HSBC undertakings
€1,400m
US$1,350m
US$1,250m
€750m
£500m
US$900m
€600m
5.3687% fixed/floating subordinated notes 2043 –
HSBC Capital Funding (Euro 2) LP .....................................................................
9.547% subordinated step-up cumulative notes 2040 –
HSBC Capital Funding (Dollar 1) LP ..................................................................
4.61% fixed/floating subordinated notes 2043 –
HSBC Capital Funding (Dollar 2) LP ..................................................................
5.13% fixed/floating subordinated notes 2044 –
HSBC Capital Funding (Euro 3) LP. ....................................................................
8.208% subordinated step-up cumulative notes 2040 –
HSBC Capital Funding (Sterling 1) LP ................................................................
10.176% subordinated step-up cumulative notes 2040 –
HSBC Capital Funding (Dollar 1) LP ..................................................................
8.03% subordinated step-up cumulative notes 2040 –
HSBC Capital Funding (Euro 1) LP .....................................................................
2006
US$m
8,423
14,070
22,493
2005
US$m
5,236
13,370
18,606
Amounts falling due after
more than 1 year
2006
US$m
2005
US$m
2,648
2,056
1,401
1,394
1,365
1,088
888
750
749
637
609
418
268
2,374
–
1,421
1,322
1,267
1,115
831
–
749
595
482
390
219
14,271
10,765
1,995
1,332
1,187
1,049
974
900
785
8,222
22,493
1,878
1,331
1,185
992
853
900
702
7,841
18,606
1 The interest margins on the callable subordinated floating rate notes 2014, 2015 and 2016 increase by 0.5 per cent from September
2009, March 2010 and October 2011 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 3.625 per cent callable subordinated notes 2020 changes in June 2015 to become three-month EURIBOR plus
0.93 per cent. The notes may be redeemed at par from June 2015 at the option of the borrower, subject to the prior consent of the
Financial Services Authority.
3 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.
381
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 33 and 34
33 Fair values of financial instruments
HSBC
The following table provides an analysis of the fair value of financial instruments not carried at fair value on the
balance sheet:
Assets
Loans and advances to banks .......................................
Loans and advances to customers .................................
Financial investments: Treasury and
other eligible bills .....................................................
Financial investments: debt securities ..........................
Liabilities
Deposits by banks .........................................................
Customer accounts ........................................................
Debt securities in issue .................................................
Subordinated liabilities .................................................
2006
Carrying
amount
US$m
185,205
868,133
45
9,326
99,694
896,834
230,325
22,672
Fair
value
US$m
185,151
864,320
45
9,628
99,691
896,429
231,189
22,468
2005
Carrying
amount
US$m
125,965
740,002
208
8,082
69,727
739,419
188,072
16,537
Fair
value
US$m
126,218
739,439
208
8,263
69,540
739,316
188,401
16,380
The methods used to determine fair values for financial instruments for the purpose of measurement and disclosure
are set out in Note 2(d). The majority of HSBC’s financial instruments carried at fair value are valued using quoted
market prices, or valuation techniques based on observable market data. Observable market prices are not, however,
available for many of HSBC’s financial assets and liabilities not carried at fair value. The fair values of the assets and
liabilities in the table above are determined as follows:
(i) Loans and advances to banks and customers
The fair values of personal and commercial loans and advances are estimated by discounting anticipated cash
flows (including interest at contractual rates).
Performing loans are grouped, as far as possible, into homogeneous pools segregated by maturity and coupon
rates. In general, cash flows are discounted using current market rates for instruments with similar maturity,
repricing and credit risk characteristics. For fixed rate loans, assumptions are made on the expected prepayment
rates appropriate to the type of loan.
Conforming residential mortgages in the US are treated differently because there is an established market for the
related asset-backed securities. In such cases, fair value is estimated by reference to quoted market prices for
loans with similar characteristics and maturities.
For impaired commercial loans, fair value is estimated by discounting the future cash flows over the time period
they are expected to be recovered.
(ii) Financial investments
Held-to-maturity treasury and other eligible bills and debt securities are initially recorded at fair value plus any
directly attributable transaction costs, and are subsequently measured at amortised cost using the effective
interest rate method, less any impairment losses.
The fair values of listed financial investments are determined using bid market prices. The fair values of unlisted
financial investments are determined using valuation techniques that take into consideration future earnings
streams and valuations of equivalent quoted securities.
(iii) Deposits by banks and customer accounts
Deposits by banks and customer accounts are grouped by residual maturity. Fair values are estimated using
discounted cash flows, applying either market rates, where applicable, or current rates offered for deposits of
similar remaining maturities.
382
(iv) Debt securities in issue and subordinated liabilities
Fair values are determined using quoted market prices at the balance sheet date where available, or by reference
to quoted market prices for similar instruments.
The fair values presented in the table above are stated 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 of the instruments. In many cases,
it would not be possible to realise immediately the estimated fair values. Accordingly, these fair values do not
represent the value of these financial instruments to HSBC as a going concern.
The fair values of intangible assets, such as values placed on portfolios of core deposits, credit card and customer
relationships, are not included above, because they are not financial instruments.
As other entities may use different valuation methodologies and assumptions in determining fair values, comparisons
of fair values between entities may not be meaningful and users are advised to exercise caution when using this data.
The following table lists those financial instruments for which their carrying amount is a reasonable approximation of
fair value because, for example, they are short term in nature or reprice to current market rates frequently:
Assets
Cash and balances at central banks
Items in the course of collection from other banks
Hong Kong Government certificates of indebtedness
Endorsements and acceptances
Short-term receivables within ‘Other assets’
Accrued income
Liabilities
Hong Kong Government currency notes in circulation
Items in the course of transmission to other banks
Endorsements and acceptances
Short-term payables within ‘Other liabilities’
Accruals
HSBC Holdings
Assets
Loans and advances to HSBC undertakings ................
Liabilities
Amounts owed to HSBC undertakings ........................
Subordinated liabilities .................................................
34 Maturity analysis of assets and liabilities
2006
Carrying
amount
US$m
Fair
value
US$m
2005
Carrying
amount
US$m
Fair
value
US$m
14,456
14,537
14,092
12,252
3,100
8,423
3,155
9,439
4,075
5,236
3,728
6,493
The following is an analysis, by remaining contractual maturities at the balance sheet date, of asset and liability line
items that represent amounts expected to be recovered or settled in under one year, and after one year.
Trading assets and liabilities are excluded because they are not held for collection or settlement over the period of
contractual maturity.
383
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 34 and 35
HSBC
Assets
Financial assets designated at fair value ..........................................................
Loans and advances to banks1 .........................................................................
Loans and advances to customers ....................................................................
Financial investments ......................................................................................
Other financial assets .......................................................................................
Liabilities
Deposits by banks ............................................................................................
Customer accounts ...........................................................................................
Financial liabilities designated at fair value ....................................................
Debt securities in issue ....................................................................................
Other financial liabilities .................................................................................
Subordinated liabilities ....................................................................................
Assets
Financial assets designated at fair value ..........................................................
Loans and advances to banks1 .........................................................................
Loans and advances to customers ....................................................................
Financial investments ......................................................................................
Other financial assets .......................................................................................
Liabilities
Deposits by banks ............................................................................................
Customer accounts ...........................................................................................
Financial liabilities designated at fair value ....................................................
Debt securities in issue ....................................................................................
Other financial liabilities .................................................................................
Subordinated liabilities ....................................................................................
At 31 December 2006
Due after
more than
one year
US$m
16,838
5,965
507,942
116,958
6,422
654,125
10,651
24,953
68,801
118,703
2,197
22,346
247,651
At 31 December 2005
Due after
more than
one year
US$m
13,509
4,578
438,821
103,103
134
560,145
8,864
27,102
54,975
87,436
799
16,224
Total
US$m
20,573
185,205
868,133
204,806
27,255
1,305,972
99,694
896,834
70,211
230,325
28,135
22,672
1,347,871
Total
US$m
15,046
125,965
740,002
182,342
12,723
1,076,078
69,727
739,419
61,829
188,072
11,364
16,537
195,400
1,086,948
Due within
one year
US$m
3,735
179,240
360,191
87,848
20,833
651,847
89,043
871,881
1,410
111,622
25,938
326
1,100,220
Due within
one year
US$m
1,537
121,387
301,181
79,239
12,589
515,933
60,863
712,317
6,854
100,636
10,565
313
891,548
1 Loans and advances to banks includes US$147,512 million (2005: US$100,527 million) which is repayable on demand or at short
notice.
384
HSBC Holdings
Assets
Loans and advances to HSBC undertakings ...................................................
Financial investments ......................................................................................
Other assets ......................................................................................................
Prepayments and accrued income ...................................................................
Liabilities
Amounts owed to HSBC undertakings ...........................................................
Financial liabilities designated at fair value ....................................................
Other liabilities ................................................................................................
Accruals and deferred income .........................................................................
Subordinated liabilities ....................................................................................
Assets
Loans and advances to HSBC undertakings ...................................................
Financial investments ......................................................................................
Other assets ......................................................................................................
Prepayments and accrued income ...................................................................
Liabilities
Amounts owed to HSBC undertakings ...........................................................
Financial liabilities designated at fair value ....................................................
Other liabilities ................................................................................................
Accruals and deferred income .........................................................................
Subordinated liabilities ....................................................................................
35 Foreign exchange exposures
Structural foreign exchange exposures
At 31 December 2006
Due within
one year
US$m
Due after
more than
one year
US$m
6,886
–
91
32
7,009
301
–
1,507
111
–
1,919
7,570
3,614
–
9
11,193
2,799
14,070
10
–
8,423
25,302
At 31 December 2005
Due after
more than
one year
US$m
Due within
one year
US$m
4,661
–
171
11
4,843
1,900
–
1,196
95
–
3,191
9,431
3,517
–
8
12,956
2,175
13,370
7
–
5,236
20,788
Total
US$m
14,456
3,614
91
41
18,202
3,100
14,070
1,517
111
8,423
27,221
Total
US$m
14,092
3,517
171
19
17,799
4,075
13,370
1,203
95
5,236
23,979
HSBC’s structural foreign exchange exposures are represented by the net asset value of its foreign exchange equity
and subordinated debt investments in subsidiary undertakings, branches, joint ventures and associates. Gains or losses
on structural foreign exchange exposures are taken to reserves. HSBC’s management of its structural foreign
exchange exposures is discussed in the ‘Report of the Directors: The Management of Risk’ on page 223.
In its separate financial statements, HSBC Holdings recognises its foreign exchange gains and losses on structural
foreign exchange exposures in the income statement.
385
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 35, 36, 37 and 38
Net structural foreign exchange exposures
Currency of structural exposure
Euros ..................................................................................................................................................
Sterling ...............................................................................................................................................
Chinese renminbi ...............................................................................................................................
Mexican pesos ...................................................................................................................................
Hong Kong dollars .............................................................................................................................
Canadian dollars ................................................................................................................................
Brazilian reais ....................................................................................................................................
Swiss francs .......................................................................................................................................
UAE dirhams .....................................................................................................................................
Indian rupees ......................................................................................................................................
Turkish lira .........................................................................................................................................
Malaysian ringgit ...............................................................................................................................
Korean won ........................................................................................................................................
Australian dollars ...............................................................................................................................
Singapore dollars ...............................................................................................................................
Japanese yen ......................................................................................................................................
Egyptian pounds ................................................................................................................................
Thai baht ............................................................................................................................................
Taiwanese dollars ..............................................................................................................................
Saudi riyals1 .......................................................................................................................................
Maltese lira ........................................................................................................................................
Philippine pesos .................................................................................................................................
Argentine pesos2 ................................................................................................................................
Chilean pesos .....................................................................................................................................
Costa Rican colon ..............................................................................................................................
New Zealand dollars ..........................................................................................................................
Indonesia rupiah .................................................................................................................................
Qatari rial ...........................................................................................................................................
Honduran lempira ..............................................................................................................................
Omani rial ..........................................................................................................................................
South African rand .............................................................................................................................
Others, each less than US$100 million ..............................................................................................
Total ...................................................................................................................................................
2006
US$m
21,202
18,562
5,678
4,536
4,461
3,284
2,684
2,495
1,647
1,575
970
876
769
692
411
338
325
305
299
286
269
213
211
189
162
158
155
150
148
114
106
839
74,109
2005
US$m
18,821
15,615
5,135
3,777
2,945
2,926
2,174
1,957
1,111
1,182
919
705
506
609
334
252
234
234
298
347
250
176
(85)
187
–
141
188
98
–
78
106
611
61,831
1 After deducting sales of Saudi riyals amounting to US$750 million (2005: US$480 million) in order to manage the foreign exchange risk
of the investments.
2 The negative net investment in Argentine pesos in 2005 reflects the deficiency in domestic net assets following the pesification of certain
balances formerly denominated in US dollars.
36 Assets charged as security for liabilities and collateral accepted as security for assets
Financial assets pledged to secure liabilities are as follows:
Treasury bills and other eligible securities ........................................................................................
Loans and advances to banks ............................................................................................................
Loans and advances to customers ......................................................................................................
Debt securities ...................................................................................................................................
Equity shares ......................................................................................................................................
Other ..................................................................................................................................................
6,480
934
63,956
106,652
11,634
390
190,046
Assets pledged at
31 December
2006
US$m
2005
US$m
7,607
1,310
36,590
89,973
5,137
537
141,154
These transactions are conducted under terms that are usual and customary to standard lending, and stock borrowing
and lending activities.
386
Collateral accepted as security for assets
The fair value of financial assets accepted as collateral that HSBC is permitted to sell or repledge in the absence of
default is US$188,008 million (2005: US$138,303 million).
The fair value of financial assets accepted as collateral that have been sold or repledged was US$135,998 million
(2005: US$97,113 million). HSBC is obliged to return equivalent securities.
These transactions are conducted under terms that are usual and customary to standard stock borrowing and lending
activities.
37 Minority interests
Minority interests attributable to holders of ordinary shares in subsidiaries ....................................
Preference shares issued by subsidiaries ...........................................................................................
Total minority interests ......................................................................................................................
Preference shares issued by subsidiaries
US$575m
US$518m
US$374m
US$374m
CAD175m
CAD175m
US$150m
US$150m
US$125m
6.36% non-cumulative preferred stock, Series B1 ..................................................
Floating rate non-cumulative preferred stock, Series F2 ........................................
Floating rate non-cumulative preferred stock, Series G3.........................................
6.50% non-cumulative preferred stock, Series H3 ..................................................
Non-cumulative redeemable class 1 preferred shares, Series C4.............................
Non-cumulative class 1 preferred shares, Series D4 ...............................................
Depositary shares each representing 25% interest in a share of
adjustable rate cumulative preferred stock, Series D5 .............................................
Cumulative preferred stock6 ....................................................................................
Dutch auction rate transferable securities preferred stock, Series A and B7...........
2006
US$m
4,026
2,550
6,576
2006
US$m
559
518
374
374
150
150
150
150
125
2005
US$m
3,618
2,176
5,794
2005
US$m
559
518
374
–
150
150
150
150
125
2,550
2,176
1 The series B preferred stock is redeemable, at the option of HSBC Finance Corporation, in whole or part, from 24 June 2010 at par.
2 The series F preferred stock is redeemable at par, at the option of HSBC USA Inc., in whole or part, on any dividend payment date on or
after 7 April 2010.
3 The series G and Series H preferred stock are redeemable at par, at the option of HSBC USA Inc., in whole or part, at any time from
1 January 2011 and 1 July 2011, respectively.
4 The Series C and Series D preferred stock are redeemable at a declining premium above par, at the option of HSBC Bank Canada, in
whole or part, from 30 June 2010 and 31 December 2010, respectively.
5 The preferred stock has been redeemable, at the option of HSBC USA Inc., in whole or part, from 1 July 1999 at par.
6 The preferred stock is redeemable, at the option of HSBC USA Inc., in whole or part, at any time on or after 1 October 2007 at par.
7 The preferred stock of each series is redeemable, at the option of HSBC USA Inc., in whole or part, on any dividend payment date at
par.
All redemptions are subject to the prior consent of the Financial Services Authority and, where relevant, the local
banking regulator.
38 Called up share capital
Authorised
The authorised ordinary share capital of HSBC Holdings at 31 December 2006 and 2005 was US$7,500 million
divided into 15,000 million ordinary shares of US$0.50 each.
At 31 December 2006 and 2005, 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$0.01 each, and
10 million non-cumulative preference shares of €0.01 each.
At 31 December 2006 and 2005, the authorised non-voting deferred share capital of HSBC Holdings was £301,500
divided into 301,500 non-voting deferred shares of £1 each.
387
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 38
Issued
HSBC Holdings ordinary shares .......................................................................................................
2006
US$m
5,786
Number
HSBC Holdings ordinary shares
At 1 January 2006 ..............................................................................................................................
Shares issued in connection with the maturity of HSBC Finance
8.875 per cent Adjustable Conversion-Rate Equity Security Units .............................................
Shares issued under HSBC Finance share plans ...............................................................................
Shares issued under HSBC employee share plans ............................................................................
Shares issued in lieu of dividends .....................................................................................................
11,333,603,942
3,424,742
643,520
75,956,784
158,578,747
At 31 December 2006 ........................................................................................................................
11,572,207,735
At 1 January 2005 ..............................................................................................................................
Shares issued in connection with the early settlement of HSBC Finance
8.875 per cent Adjustable Conversion-Rate Equity Security Units .............................................
Shares issued under HSBC Finance share plans ...............................................................................
Shares issued under HSBC employee share plans ............................................................................
Shares issued in lieu of dividends .....................................................................................................
11,172,075,550
324,726
878,224
56,363,536
103,961,906
2005
US$m
5,667
US$m
5,667
2
–
38
79
5,786
5,587
–
–
28
52
At 31 December 2005 ........................................................................................................................
11,333,603,942
5,667
All ordinary shares confer identical rights in respect of capital, dividends, voting and otherwise.
HSBC Holdings preference shares
At 1 January 2006 and 31 December 2006 .......................................................................................
1,450,000
At 1 January 2005 ..............................................................................................................................
Issue of non-cumulative preference shares of US$0.01 each ...........................................................
At 31 December 2005 ........................................................................................................................
–
1,450,000
1,450,000
–
–
–
–
Number
US$m
Dividends on HSBC Holdings non-cumulative dollar preference shares are paid quarterly at the sole and absolute
discretion of the Board of Directors. The Board of Directors will not declare a dividend on the preference shares if
payment of the dividend would cause HSBC Holdings not to meet the applicable capital adequacy requirements of
the FSA or the profit of HSBC Holdings available for distribution as dividends are not sufficient to enable HSBC
Holdings to pay in full both dividends on the preference shares and dividends on any other shares that are scheduled
to be paid on the same date and that have an equal right to dividends. HSBC Holdings may not declare or pay
dividends on any class of its shares ranking lower in the right to dividends than the preference shares nor redeem nor
purchase in any manner any of its other shares ranking equal with or lower than the preference shares unless it has
paid in full, or set aside an amount to provide for payment in full, the dividends on the preference shares for the then-
current dividend period. The preference shares carry no rights to conversion into ordinary shares of HSBC Holdings.
Holders of the preference shares will only be entitled to attend and vote at general meetings of shareholders of HSBC
Holdings if the dividend payable on the preference shares has not been paid in full for four consecutive dividend
payment dates. In such circumstances, holders of preference shares will be entitled to vote on all matters put to
general meetings until such time as HSBC Holdings shall have paid a full dividend on the preference shares. HSBC
Holdings may redeem the preference shares in whole at any time on or after 16 December 2010, with the consent of
the FSA.
The 301,500 non-voting deferred shares were in issue throughout 2005 and 2006 and are held by a subsidiary
undertaking of HSBC Holdings. Holders of the non-voting deferred shares are not entitled to receive dividends on
these shares. In addition, on winding-up or other return of capital, holders are entitled to receive the amount paid up
on their shares after distribution to ordinary shareholders of the amount of £10,000,000 in respect of each ordinary
share held by them.
Details of the options outstanding to subscribe for HSBC Holdings ordinary shares under the HSBC Holdings Group
Share Option Plan, HSBC Holdings Executive Share Option Scheme, the HSBC Share Plan and HSBC Holdings
savings-related share option plans are given in Note 9. In aggregate, options outstanding under these plans is as
follows:
388
31 December 2006 ...............................................
Number of
HSBC Holdings
ordinary shares
267,265,027
6,661,998
270,473
Period of exercise
Exercise price
2007 to 2015
2007 to 2012
2007 to 2012
£5.0160 – £9.642
HK$103.4401
€11.0062
US$13.3290 –
US$14.1621
2,932,100
2007 to 2012
31 December 2005 ................................................
31 December 2004 ................................................
341,281,540
374,369,127
2006 to 2015
2005 to 2014
£2.1727 – £9.642
£2.1727 – £9.642
Following the acquisition of HSBC France in 2000, outstanding employee share options over HSBC France shares
vested. On exercise of the options, the HSBC France shares are exchangeable for HSBC Holdings ordinary shares in
the same ratio as for the acquisition of HSBC France (13 HSBC Holdings ordinary shares for each HSBC France
share).
During 2006, 445,115 (2005: 435,784) HSBC France shares were issued following the exercise of employee share
options and exchanged for 5,786,495 HSBC Holdings ordinary shares, such shares being delivered from The HSBC
Holdings Employee Benefit Trust 2001 (No. 1) (2005: 5,665,192 HSBC Holdings ordinary shares). During 2006, no
options over HSBC France shares lapsed (2005: nil). During 2006, there were no (2005: 1,500) HSBC France shares
previously issued following the exercise of employee share options that were exchanged for HSBC Holdings ordinary
shares (2005: 19,500 HSBC Holdings ordinary shares). There were 1,287,881 HSBC France employee share options
exchangeable for HSBC Holdings ordinary shares outstanding at 31 December 2006 (2005: 1,732,996). At 31
December 2006, The HSBC Holdings Employee Benefit Trust 2001 (No. 1) held 15,316,328 (2005: 21,102,823)
HSBC Holdings ordinary shares which may be exchanged for HSBC France shares arising from the exercise of
options.
HSBC France options effectively outstanding over HSBC Holdings ordinary shares under this arrangement are as
follows:
Number of
HSBC France
shares exchangeable
for HSBC Holdings
31 December 2006 ...............................................
31 December 2005 ................................................
31 December 2004 ................................................
1,287,881
1,732,996
2,170,280
2007 to 2010
2006 to 2010
2005 to 2010
€37.05 – €142.50
€35.52 – €142.50
€32.78 – €142.50
ordinary shares
Period of exercise
Exercise price
There also exist outstanding options over the shares of HSBC Private Bank France, a subsidiary of HSBC France
which are exchangeable for HSBC Holdings ordinary shares, the details of which are set out in the Directors’ Report
on pages 271 and 272 and summarised below.
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 2006, 194,804 (2005: 473,400) HSBC Private Bank France shares were issued following
the exercise of employee share options and exchanged for 356,472 (2005: 841,291) HSBC Holdings ordinary shares,
such shares being delivered from The CCF Employee Benefit Trust 2001 (Private Banking France). During 2006, no
options over HSBC Private Bank France shares lapsed (2005: 59,875). During 2006, 6,000 (2005: 1,150) HSBC
Private Bank France shares previously issued following the exercise of employee share options were exchanged for
10,980 (2005: 2,104) HSBC Holdings ordinary shares. At 31 December 2006, 8,819 (2005: 14,819) HSBC Private
Bank France shares were in issue and will be exchanged for HSBC Holdings ordinary shares on the fifth anniversary
of the date of the awards of the options. There were 402,856 HSBC Private Bank France employee share options
exchangeable for HSBC Holdings ordinary shares outstanding at 31 December 2006 (2005: 597,660). At
31 December 2006, The CCF Employee Benefit Trust 2001 held 1,085,323 (2005: 1,452,775) 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 (including shares issued but not exchanged) effectively outstanding over HSBC
Holdings ordinary shares under this arrangement are as follows:
389
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 38
Number of HSBC
Private Bank France
shares exchangeable
for HSBC Holdings
ordinary shares
Period of exercise
Exercise price
31 December 2006 ...............................................
31 December 2005 ................................................
31 December 2004 .................................................
411,675
612,479
1,132,060
2007 to 2012
2006 to 2012
2005 to 2012
€10.84 – €22.22
€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 2006, 163,369 (2005: 7,670) Banque Hervet shares
were released in connection with the vesting of interests in the Plan d’Epargne Entreprise and exchanged for 565,151
(2005: 26,539) HSBC Holdings ordinary shares, such shares being delivered from The CCF Employee Benefit Trust
2001 (Banque Hervet). At 31 December 2006, The CCF Employee Benefit Trust 2001 (Banque Hervet) held no
(2005: 586,213) HSBC Holdings ordinary shares.
Banque Hervet shares to be exchanged for HSBC Holdings ordinary shares under this arrangement were as follows:
31 December 2006 ...............................................................................................
31 December 2005 ................................................................................................
31 December 2004 .................................................................................................
–
169,416
177,086
Number of Banque
Hervet shares
exchangeable for
HSBC Holdings
ordinary shares
Period of vesting
–
2006
2005 – 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 2006, options over 10,484,937 (2005: 3,563,020) HSBC Holdings ordinary shares were exercised and
9,781,228 (2005: 2,638,816) HSBC Holdings ordinary shares delivered from The HSBC (Household) Employee
Benefit Trust 2003 and the HSBC (Household) Employee Benefit Trust 2003 (No.2) to satisfy the exercise of these
options. During 2006, options over 300,555 (2005: 152,936) HSBC Holdings ordinary shares lapsed. At 31
December 2006, The HSBC (Household) Employee Benefit Trust 2003 and the HSBC (Household) Employee
Benefit Trust 2003 (No.2) held a total of 8,670,335 (2005: 9,173,100) HSBC Holdings ordinary shares and 198,665
(2005: 2,198,829) ADSs, each of which represents five HSBC Holdings ordinary shares, 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 2006 ...............................................
31 December 2005 ................................................
31 December 2004 ................................................
Number of
HSBC Holdings
ordinary shares
27,322,438
38,107,930
41,823,886
Period of exercise
Exercise price
2007 to 2012
2006 to 2012
2005 to 2021
nil – US$21.37
nil – US$21.37
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’) which included 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. Units exercised at maturity, 15 February 2006, entitled the
holder to receive a number of shares based on the market value of HSBC Holdings ordinary shares at the time, which
was 2.6041 HSBC Holdings ordinary shares for each Unit. During 2006, 3,424,742 (2005: 324,726) HSBC Holdings
ordinary shares were issued in connection with the maturity of 1,315,140 (2005: 124,698) Units.
390
The maximum number of Units outstanding over HSBC Holdings ordinary shares were as follows:
31 December 2006 ...............................................
31 December 2005 ................................................
31 December 2004 ................................................
Number of Units
exchangeable for
HSBC Holdings
ordinary shares
–
1,315,140
1,439,838
Period of exercise
Exercise price
–
2006
2005 to 2006
–
US$8.00 – US$9.60
US$8.00 – US$9.60
Following the acquisition of Bank of Bermuda in 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 2006, options over 529,233 HSBC Holdings ordinary shares were exercised (2005: 459,091) and
delivered from the HSBC (Bank of Bermuda) Employee Benefit Trust 2004 to satisfy the exercise of these options.
During 2006, options over 126,854 (2005: 744,421) HSBC Holdings ordinary shares lapsed. At 31 December 2006,
the HSBC (Bank of Bermuda) Employee Benefit Trust 2004 held 2,266,949 (2005: 2,796,182) HSBC Holdings
ordinary shares which may be used to satisfy the exercise of options.
Options outstanding over HSBC Holdings ordinary shares under the Bank of Bermuda share plans are as follows:
31 December 2006 ...............................................
31 December 2005 ................................................
31 December 2004 ................................................
Number of HSBC
Holdings
ordinary shares
2,710,368
3,366,455
4,569,967
Period of exercise
Exercise price
2007 to 2013
2006 to 2013
2005 to 2013
US$7.04 – US$18.35
US$7.04 – US$18.35
US$3.86 – US$18.35
The maximum obligation at 31 December 2006 to deliver HSBC Holdings ordinary shares under all of the above
option arrangements, together with Performance Share and Restricted Share awards under the HSBC Holdings
Restricted Share Plan 2000 and The HSBC Share Plan, was 404,348,508 (2005: 486,436,966). The total number of
shares at 31 December 2006 held by employee benefit trusts that may be used to satisfy such obligations to deliver
HSBC Holdings ordinary shares was 133,346,569 (2005: 130,812,676).
391
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
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40 Notes on the cash flow statement
Non-cash items included in profit before tax
Depreciation, amortisation and impairment ...............
Revaluations on investment property .........................
Share-based payment expense ....................................
Loan impairment losses gross of recoveries ...............
Provisions for liabilities and charges ..........................
Impairment of financial investments ..........................
Charge for defined benefit pension schemes ..............
Accretion of discounts and amortisation of premiums
Change in operating assets
2006
US$m
2,528
(164)
854
11,331
498
21
664
(776)
14,956
HSBC
2005
US$m
HSBC Holdings
2004
US$m
2006
US$m
2005
US$m
2,213
(201)
540
8,295
327
–
676
(446)
2,225
(99)
450
7,104
1,181
(105)
825
(175)
11,404
11,406
–
–
58
–
–
–
–
–
58
11
–
13
–
–
(11)
–
13
2006
US$m
HSBC
2005
US$m
HSBC Holdings
2004
US$m
2006
US$m
Change in loans to HSBC undertakings .....................
Change in prepayments and accrued income .............
Change in net trading securities and net derivatives ..
Change in loans and advances to banks .....................
Change in loans and advances to customers ..............
Change in financial assets designated at fair value ....
Change in other assets ................................................
–
(2,478)
(13,620)
(11,505)
(132,987)
(4,883)
(7,796)
(173,269)
–
7,121
4,940
307
(80,150)
(15,048)
(8,923)
–
(5,329)
2,695
10,825
(139,072)
–
(2,262)
(91,753)
(133,143)
(1,060)
(22)
(740)
–
–
–
(5)
(1,827)
2005
US$m
2,544
(14)
1,052
–
–
–
(19)
3,563
Change in operating liabilities
Change in accruals and deferred income ....................
Change in deposits by banks ......................................
Change in customer accounts .....................................
Change in debt securities in issue ...............................
Change in financial liabilities designated at fair value
Change in other liabilities ...........................................
Cash and cash equivalents
Cash at bank with HSBC undertakings ......................
Cash and balances at central banks ............................
Items in the course of collection from other banks ....
Loans and advances to banks of one month or less ...
Treasury bills, other bills and certificates of deposit
less than three months ............................................
Less: items in the course of transmission to other banks
.................................................................................
2006
US$m
3,549
28,378
149,849
42,253
8,382
4,967
237,378
2006
US$m
–
12,732
14,144
162,998
HSBC
2005
US$m
(3,810)
(14,328)
46,394
(19,047)
61,837
1,166
72,212
HSBC
2005
US$m
–
13,712
11,300
100,527
38,237
22,790
32,317
(12,625)
(7,022)
(5,301)
Total cash and cash equivalents .................................
215,486
141,307
160,956
395
HSBC Holdings
2004
US$m
2006
US$m
2,578
12,187
104,877
52,256
–
3,605
175,503
16
–
–
–
700
340
1,056
2005
US$m
(77)
–
–
–
12,448
(16,771)
(4,400)
HSBC Holdings
2004
US$m
2006
US$m
2005
US$m
–
9,944
6,338
117,658
729
–
–
–
–
–
729
756
–
–
–
–
–
756
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 40 and 41
Total interest paid by HSBC during the year was US$47,794 million (2005: US$33,974 million; 2004:
US$19,038 million). Total interest received by HSBC during the year was US$85,143 million (2005:
US$65,799 million; 2004: US$49,021 million). Total dividends received by HSBC during the year were
US$1,525 million (2005: US$808 million; 2004: US$640 million).
41 Contingent liabilities, contractual commitments and financial guarantee contracts
Contingent liabilities and financial guarantee
contracts
Guarantees and irrevocable letters of credit
pledged as collateral security1:
– 1 year and under ...............................................
– over 1 year ........................................................
Other contingent liabilities .......................................
Commitments
Documentary credits and short-term trade-related
transactions ...........................................................
Forward asset purchases and forward forward
deposits placed .....................................................
Undrawn note issuing and revolving
underwriting facilities ..........................................
Undrawn formal standby facilities, credit lines
and other commitments to lend:
– 1 year and under ...............................................
– over 1 year ........................................................
1 Including financial guarantee contracts.
HSBC
2006
US$m
2005
US$m
HSBC Holdings
2006
US$m
2005
US$m
42,427
34,983
330
77,740
9,659
2,077
213
584,167
118,514
714,630
28,152
29,323
152
57,627
8,090
2,179
468
527,506
103,398
641,641
–
17,605
–
17,605
–
–
–
2,920
1,047
3,967
–
36,877
–
36,877
–
–
–
2,517
1,146
3,663
The above table discloses the nominal principal amounts of third party off-balance sheet transactions, the amounts
relating to other contingent liabilities and the nominal principal amounts relating to financial guarantee contracts.
Contingent liabilities and commitments are mainly credit-related instruments which include non-financial guarantees
and commitments to extend credit. Contractual amounts represent the amounts at risk should contracts be fully drawn
upon and clients default. Since a significant portion of guarantees and commitments are expected to expire without
being drawn upon, the total of the contractual amounts is not representative of future liquidity requirements.
At 31 December 2006, HSBC had US$1,259 million (2005: US$1,218 million) of capital commitments contracted
but not provided for and US$289 million (2005: US$333 million) of capital commitments authorised but not
contracted for.
Guarantees (including financial guarantee contracts)
HSBC provides guarantees and similar undertakings on behalf of both third party customers and other entities within
the HSBC Group. These guarantees are generally provided in the normal course of HSBC’s banking business. The
principal types of guarantees provided, and the maximum potential amount of future payments which HSBC could be
required to make at 31 December 2006, were as follows:
396
At 31 December 2006
At 31 December 2005
Guarantees
by HSBC
Holdings
in favour of
other HSBC
Group entities
US$m
Guarantees
by HSBC
Holdings
in favour of
other HSBC
Group entities
US$m
Guarantees
in favour of
third parties
US$m
Guarantees in
favour of
third parties
US$m
22,746
17,605
19,080
36,877
4,535
5,514
8,070
592
7,301
28,627
25
77,410
–
–
–
–
–
–
–
17,605
3,649
5,302
6,355
595
6,640
15,709
145
57,475
–
–
–
–
–
–
–
36,877
Guarantee type
Financial guarantee contracts1 ......................................
Standby letters of credit which are financial
guarantee contracts2 ..................................................
Other direct credit substitutes3 ......................................
Performance bonds4 ......................................................
Bid bonds4 .....................................................................
Standby letters of credit related to particular
transactions4 ..............................................................
Other transaction-related guarantees4 ...........................
Other items ....................................................................
1 Financial guarantees are contracts that require the issuer to make specified payments to reimburse the holder for a loss incurred
because a specified debtor fails to make payment when due in accordance with the original or modified terms of a debt instrument. The
amounts in the above table are nominal principal amounts.
2 Standby letters of credit which are financial guarantee contracts are irrevocable obligations on the part of HSBC to pay third parties
when customers fail to make payments when due.
3 Other direct credit substitutes include re-insurance letters of credit and trade-related letters of credit issued without provision for the
issuing entity to retain title to the underlying shipment.
4 Performance bonds, bid bonds, standby letters of credit and other transaction-related guarantees are undertakings by which the
obligation on HSBC to make payment depends on the outcome of a future event.
The amounts disclosed in the above table 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 half of the above guarantees
have a term of less than one year. Guarantees with terms of more than one year are subject to HSBC’s annual credit
review process.
Joint ventures
HSBC and its operations are contingently liable with respect to lawsuits and other matters that arise in the normal
course of business. Management is of the opinion that while it is impossible to ascertain the ultimate legal and
financial liability with respect to these contingencies, their eventual outcome is not expected to materially affect the
Group’s financial position and operations.
In relation to joint ventures, HSBC had no contingent liabilities, incurred jointly or otherwise.
HSBC had no capital commitments incurred jointly or otherwise in relation to its interests in joint ventures.
Post-employment benefit obligations
HSBC had no contingent liabilities relating to post-employment benefits.
397
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 42, 43 and 44
42 Lease commitments
Finance lease commitments
HSBC leases land and buildings (including branches) and equipment from third parties under finance lease
arrangements to support its operations.
Total future minimum payments:
– no later than one year ................................................................................................................
– later than one year and no later than five years ........................................................................
– later than five years ...................................................................................................................
Less: future interest charges ..............................................................................................................
Present value of finance lease commitments .....................................................................................
2006
US$m
60
145
707
912
(205)
707
2005
US$m
50
152
630
832
(193)
639
At 31 December 2006, future minimum sublease payments of US$163 million (2005: US$26 million) are expected to
be received under non-cancellable subleases at the balance sheet date.
Operating lease commitments
At 31 December 2006, HSBC was obligated under a number of non-cancellable operating leases for properties, plant
and equipment on which the future minimum lease payments extend over a number of years.
Future minimum lease payments under non-cancellable
operating leases:
– no later than one year ...........................................
– later than one year and no later than five years ...
– later than five years ..............................................
2006
Land and
buildings
US$m
Equipment
US$m
2005
Land and
buildings
US$m
Equipment
US$m
789
2,290
1,198
4,277
10
21
–
31
712
1,730
1,452
3,894
32
24
–
56
In 2006, US$781 million (2005: US$704 million; 2004: US$588 million) was charged to ‘General and administrative
expenses’ in respect of lease and sublease agreements, of which US$762 million (2005: US$683 million; 2004:
US$567 million) related to minimum lease payments, US$19 million (2005: US$21 million; 2004: US$21 million) to
contingent rents, and nil (2005: nil; 2004: nil) to sublease payments.
The contingent rent represents escalation payments made to landlords for operating, tax and other escalation
expenses.
Finance lease receivables
HSBC leases a variety of assets to third parties under finance leases, including transport assets (such as aircraft),
property and general plant and machinery. At the end of lease terms, assets may be sold to third parties or leased for
further terms. Lessees may participate in any sales proceeds achieved. Lease rentals arising during the lease terms
will either be fixed in quantum or be varied to reflect changes in, for example, tax or interest rates. Rentals are
calculated to recover the cost of assets less their residual value, and earn finance income.
398
Lease receivables:
– no later than one year ......
– later than one year and
no later than five years ....
– later than five years .........
Total future
minimum
payments
US$m
2006
Unearned
finance
income
US$m
Present
value
US$m
Total future
minimum
payments
US$m
2005
Unearned
interest
income
US$m
Present
value
US$m
2,305
(460)
1,845
2,170
(266)
1,904
7,207
9,206
18,718
(1,400)
(2,944)
(4,804)
5,807
6,262
13,914
5,908
8,369
16,447
(1,329)
(3,109)
(4,704)
4,579
5,260
11,743
At 31 December 2006, unguaranteed residual values of US$212 million (2005: US$68 million) had been accrued, and
the accumulated allowance for uncollectible minimum lease payments receivable amounted to US$28 million
(2005: US$15 million).
During the year, a total of US$59 million (2005: nil) was received as contingent rents and recognised within ‘Other
operating income’.
Operating lease receivables
HSBC leases a variety of different assets to third parties under operating lease arrangements, including transport
assets (such as rolling stock), property and general plant and machinery.
Future minimum lease payments under
non-cancellable operating leases:
– no later than one year ...........................................
– later than one year and no later than five years ...
– later than five years ..............................................
43 Litigation
2006
Land and
buildings
US$m
Equipment
US$m
2005
Land and
buildings
US$m
Equipment
US$m
47
17
12
76
808
1,561
573
2,942
71
160
153
384
397
1,136
456
1,989
HSBC is party to legal actions in a number of jurisdictions including the UK, Hong Kong and the US, arising out of
its normal business operations. HSBC considers that none of the actions is regarded as material, and none is expected
to result in a significant adverse effect on the financial position of HSBC, either individually or in the aggregate.
Management believes that adequate provisions have been made in respect of such litigation. HSBC has not disclosed
any contingent liability associated with these legal actions because it is not practicable to do so.
44 Related party transactions
The Group’s related parties include associates, joint ventures, post-employment benefit plans for the benefit of HSBC
employees, key management personnel, close family members of key management personnel and entities which are
controlled, jointly controlled or significantly influenced, or for which significant voting power is held, by key
management personnel or their close family members.
Transactions with Directors and other key management personnel
Key management personnel are defined as those persons having authority and responsibility for planning, directing
and controlling the activities of HSBC Holdings, being the members of the Board of Directors of HSBC Holdings
and Group Managing Directors.
399
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 44
Compensation of Directors and other key management personnel
Short-term employee benefits ............................................................................................................
Post-employment benefits .................................................................................................................
Share-based payment .........................................................................................................................
HSBC
2006
US$m
76
3
61
140
2005
US$m
71
2
21
94
Transactions, arrangements and agreements involving Directors and others
Particulars of transactions, arrangements and agreements entered into by subsidiaries 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, were as follows:
Directors and connected persons and companies
controlled by them1 .................................................
Loans .............................................................................
Credit cards ...................................................................
Guarantees ....................................................................
Officers2,3 ......................................................................
Loans .............................................................................
Credit cards ...................................................................
Guarantees ....................................................................
2006
2005
Number of
persons
Balance at
31 December
US$000
Number of
persons
Balance at
31 December
US$000
85
12
407,176
317
21,751
16,706
687
23
76
37
279,297
250
10,622
42,857
352
164
Further information on related party transactions, disclosed pursuant to the requirements of IAS 24, is shown below.
The disclosure of the year-end balance and the highest amount outstanding during the year is considered the most
meaningful information to represent the amount of the transactions and the amount of outstanding balances during the
year.
1 All of the Directors are key management personnel of HSBC Holdings. The aggregate of the highest amounts outstanding during 2006
of loans, credit card transactions and guarantees with HSBC for the Directors and close members of their family and companies that
they control, jointly control or significantly influence, or for which significant voting power is held were US$550,175,512, US$696,444
and US$24,929,062 respectively (2005: US$495,990,427, US$617,259 and US$16,775,779 respectively).
2 Included within Officers are non-Director members of the key management personnel of HSBC Holdings. During 2006, 17 non-Director
key management personnel and close members of their family and companies that they control, jointly control or significantly influence,
or for which significant voting power is held entered into loan, credit card transactions and guarantees with HSBC (2005: 13 persons).
The aggregate of the highest amounts outstanding during 2006 of loans, credit card transactions and guarantees with HSBC for the
non-Director key management personnel and close members of their family and companies that they control, jointly control or
significantly influence, or for which significant voting power is held were US$32,429,961, US$941,114 and US$22,747 respectively
(2005: US$30,116,609, US$287,888 and US$20,385 respectively). The aggregate of the balances of loans and credit card transactions
and guarantees with HSBC outstanding at 31 December 2006 for the non-Director key management personnel and close members of
their family and companies that they control, jointly control or significantly influence, or for which significant voting power is held were
US$16,418,110, US$658,890 and US$22,747 respectively (2005: US$20,166,452, US$66,467 and US$20,385 respectively).
3 For 2006, Officers comprise ten Group Managing Directors, the Group Chief Accounting Officer and the Group Company Secretary.
For 2005, Officers comprised six Group Managing Directors, 30 Group General Managers and the Group Company Secretary.
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.
Some of the transactions were connected transactions, as defined by the Rules Governing The Listing of Securities on
The Stock Exchange of Hong Kong Limited but were exempt from any disclosure requirements under the provisions
of those Rules.
The above 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.
400
Shareholdings and options of Directors and other key management personnel
Number of options over HSBC Holdings ordinary shares made under employee share plans
held by Directors and other key management personnel ..............................................................
Number of HSBC Holdings ordinary shares held beneficially and non-beneficially by
Directors and other key management personnel ...........................................................................
At 31 December
2006
(000’s)
2005
(000’s)
4,563
20,912
25,475
14,217
24,304
38,521
Transactions with other related parties of HSBC
Associates and joint ventures
The Group provides certain banking and financial services to associates and joint ventures. Details of the interests in
associates and joint ventures are given in Note 20. Transactions and balances during the year with associates and joint
ventures were as follows:
Amounts due from joint ventures:
– unsubordinated ......................................................
Amounts due from associates:
– subordinated ..........................................................
– unsubordinated ......................................................
Amounts due to joint ventures ......................................
Amounts due to associates ............................................
2006
2005
Highest
balance during
the year1
US$m
Balance at
31 December1
US$m
Highest
balance during
the year1
US$m
Balance at
31 December1
US$m
746
52
586
1,384
1,490
892
2,382
80
15
376
471
58
506
564
539
63
1,133
1,735
1,382
161
1,543
539
29
333
901
1,382
133
1,515
1 The disclosure of the year-end balance and the highest balance during the year is considered the most meaningful information to
represent transactions during the year.
The above outstanding balances arose from the ordinary course of business and on substantially the same terms,
including interest rates and security, as for comparable transactions with third party counterparties.
Pension funds
At 31 December 2006, US$15.1 billion (2005: US$19.4 billion) of HSBC pension fund assets were under
management by HSBC companies. Fees of US$49 million (2005: US$50 million) were earned by HSBC
companies for these management services. HSBC’s pension funds had placed deposits of US$348 million
(2005: US$252 million) with its banking subsidiaries. The above outstanding balances arose from the ordinary course
of business and on substantially the same terms, including interest rates and security, as for comparable transactions
with third party counterparties.
HSBC Bank (UK) Pension Scheme entered into swap transactions with HSBC to manage the inflation and interest
rate sensitivity of the liabilities. At 31 December 2006, the gross notional value of the swaps was US$14.5 billion, the
swaps had a negative fair value of US$273 million to the scheme and HSBC had delivered collateral of
US$265 million to the scheme in respect of these swaps. All swaps were executed at prevailing market rates and
within standard market bid-offer spreads.
In order to satisfy diversification requirements, the Trustee has requested special collateral provisions for the swap
transactions between HSBC and the scheme. The collateral agreement stipulates that the scheme never posts
collateral to HSBC. Collateral is posted to the scheme by HSBC at an amount that the Trustee is highly confident
would be sufficient to replace the swaps in the event of default by HSBC Bank plc.
401
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Notes 44, 45, 46 and 47
With the exception of the special collateral arrangements detailed above, all other aspects of the swap transactions
between HSBC and the scheme are on substantially the same terms as comparable transactions with third party
counterparties.
HSBC International Staff Retirements Benefits Scheme entered into swap transactions with HSBC to manage the
inflation and interest rate sensitivity of the liabilities and selected assets. At 31 December 2006, the gross notional
value of the swaps was US$1.2 billion (2005: US$1.0 billion), and the swaps had a net positive fair value of
US$14 million to the scheme (2005: US$53 million).
HSBC Holdings
Details of HSBC Holdings’ principal subsidiaries are shown in Note 24.
Transactions and balances during the year with subsidiaries were as follows:
Subsidiaries
Assets
Cash at bank ..................................................................
Derivatives ....................................................................
Loans and advances ......................................................
Financial investments ...................................................
Investments in subsidiaries ...........................................
Total related party assets ..............................................
Liabilities
Amounts owed to HSBC undertakings ........................
Derivatives ....................................................................
Subordinated liabilities:
– cost .........................................................................
– fair value ................................................................
Total related party liabilities .........................................
Guarantees ....................................................................
2006
2005
Highest
balance during
the year1
US$m
Balance at
31 December1
US$m
Highest
balance during
the year1
US$m
Balance at
31 December1
US$m
784
1,599
14,935
3,426
62,356
83,100
4,279
385
3,991
4,231
12,886
36,877
729
1,599
14,456
3,316
62,356
82,456
3,100
177
3,991
4,231
11,499
17,605
756
1,795
17,282
6,240
58,038
84,111
7,352
286
3,997
4,498
16,133
41,455
756
968
14,092
3,256
58,038
77,110
4,075
286
3,786
4,055
12,202
36,877
1 The disclosure of the year-end balance and the highest balance during the year is considered the most meaningful information to
represent transactions during the year.
The above outstanding balances arose in the ordinary course of business and are on substantially the same terms,
including interest rates and security, as for comparable transactions with third party counterparties, with no
exceptions in respect of loans and advances to subsidiaries (exceptions in 2005: US$3,296 million), and exceptions of
US$640 million (2005: US$3,235 million) in respect of loans from HSBC undertakings to HSBC Holdings made at
an agreed zero per cent interest.
Some employees of HSBC Holdings are members of the HSBC Bank (UK) Pension Scheme, which is sponsored by a
separate Group company. HSBC Holdings incurs a charge for these employees equal to the contributions paid into
the scheme on their behalf. Disclosure in relation to the scheme is made in Note 7 to the accounts.
45 Events after the balance sheet date
As a consequence of inviting proposals for a sale and leaseback of 8 Canada Square, London, under an operating
lease arrangement, the property has been reclassified as a non-current asset held for sale after 31 December 2006.
This is in accordance with IFRS 5 ‘Non-current Assets Held for Sale and Discontinued Operations’. The
reclassification was made at carrying value, with no financial impact on the income statement. At 31 December 2006,
the carrying amount of the property, included in ‘Property, plant and equipment’, was US$742 million and the
carrying amount of the long leasehold land, included in ‘Prepayments and accrued income’, was US$210 million.
The building and leasehold interest are included in the assets of the Europe geographical segment and the ‘Other’
customer group segment.
402
On 1 March 2007, Ping An Insurance (Group) Company of China Limited (‘Ping An Insurance’), an associate of
HSBC, issued 1,150 million new shares for a total consideration of RMB38,870 million (approximately
US$4,920 million). HSBC did not subscribe for any additional shares and, as a result, its interest in the equity of Ping
An Insurance decreased from 19.9 per cent to 16.8 per cent. While the Group’s interest has reduced, the assets of
Ping An Insurance have substantially increased as a result of this issue. Consequently, it is expected that this
transaction would result in an increase in HSBC’s share of underlying net assets of Ping An Insurance.
A fourth interim dividend for 2006 of US$0.36 per share (US$4,171 million) (2005: US$0.31 per share,
US$3,513 million) was declared by the Directors after 31 December 2006.
These accounts were approved by the Board of Directors on 5 March 2007 and authorised for issue.
46 UK and Hong Kong accounting requirements
The financial statements have been prepared in accordance with IFRSs. There would be no significant differences
had they been prepared in accordance with Hong Kong Financial Reporting Standards.
47 Differences between IFRSs and US GAAP
The consolidated financial statements of HSBC are prepared in accordance with IFRSs which differ significantly in
certain respects from US GAAP. The following is a summary of the significant differences applicable to HSBC.
Shareholders’ interest in the long-term insurance fund
IFRSs
•
IFRS 4 permits entities to continue to account for insurance contracts under previous GAAP until a
comprehensive standard relating to the measurement of insurance liabilities is developed.
• Under UK GAAP and, hence, current IFRSs, the value placed on insurance contracts that are classified as long-
term insurance business and are in force at the balance sheet date is recognised as an asset. The present value of
in-force long-term insurance business is determined by discounting future cash flows expected to emerge from
business currently in force using appropriate assumptions in assessing factors such as future mortality, lapse
rates and levels of expenses and a risk discount rate that reflects the risk premium attributable to the respective
long-term insurance business.
• Movements in the present value of in-force long-term insurance business are included in ‘Other operating
income’ on a gross of tax basis.
US GAAP
• The net present value of future earnings is not recognised. Acquisition costs and fees are deferred and amortised
in accordance with Statement of Financial Accounting Standard (‘SFAS’) 97 ‘Accounting and Reporting by
Insurance Enterprises for Certain Long-duration Contracts and for Realised Gains and Losses from the Sale of
Investments’.
Impact
• Under US GAAP, shareholders' equity is lower than under IFRSs because the present value of in-force long-term
insurance business is not recognised.
• This effect is partly offset by the treatment of acquisition costs, which are deferred and amortised under US
GAAP but are written off immediately as an expense of long-term insurance business under IFRSs.
Pension costs
IFRSs
•
IAS 19 ‘Employee Benefits’ (‘IAS 19’) requires pension liabilities to be assessed on the basis of current actuarial
valuations performed on each plan, and pension assets to be measured at fair value. The net pension surplus or
deficit, representing the difference between plan assets and liabilities, is recognised on the balance sheet.
403
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 47
•
In accordance with IAS 19 (revised 2006), HSBC has elected to record all actuarial gains and losses on the
pension surplus or deficit in the year in which they occur within the ‘Consolidated statement of recognised
income and expense’.
US GAAP
• SFAS 87, ‘Employers’ Accounting for Pensions’, prescribes a similar method of actuarial valuation for pension
liabilities and requires the measurement of plan assets at fair value.
• SFAS 158 ‘Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an
amendment of FASB Statements No. 87, 88, 106 and 132(R)’ (SFAS 158), was adopted by HSBC as at
31 December 2006 and aligns the US GAAP balance sheet treatment with IFRSs by requiring the funded status
of HSBC’s benefit plan (the difference between plan assets at fair value and the plan benefit obligations) to be
recognised on the balance sheet.
•
In 2005, when the value of benefits accrued based on employee service up to the balance sheet date (the
accumulated benefit obligation) exceeded the value of plan assets, HSBC recognised an additional minimum
pension liability to the extent that the excess was greater than any accrual already established for unfunded
pension costs.
• SFAS 87 does not permit recognition of all actuarial gains and losses in a statement other than the primary
income statement. As permitted by US GAAP, HSBC uses the 'corridor method', whereby actuarial gains and
losses outside a certain range are recognised in the income statement in equal amounts over the remaining
service lives of current employees. That range is 10 per cent of the greater of plan assets and plan liabilities. The
remaining additional minimum pension liability and the transition to SFAS 158 are recognised directly in Other
comprehensive income (‘OCI’).
Impact
• Net income under US GAAP is lower than under IFRSs as a result of the amortisation of the amount by which
actuarial losses exceed gains beyond the 10 per cent 'corridor'.
Stock-based compensation
IFRSs
•
IFRS 2, ‘Share-based Payment’, requires that when annual bonuses are paid in restricted shares and the
employee must remain with the employer for a fixed period in order to receive the shares, the fair value of the
award is expensed over that period.
US GAAP
• For awards made before 1 July 2005, SFAS 123, ‘Accounting for Stock-based Compensation’, (‘SFAS 123’)
requires that compensation cost be recognised over the period(s) in which the related employee services are
rendered. HSBC has interpreted this service period as the period to which the bonus relates.
• For 2005 bonuses awarded in early 2006, HSBC will follow SFAS 123 (revised 2004) ‘Share-based Payment’
(‘SFAS 123R’). SFAS 123R is consistent with IFRS 2 in requiring that restricted bonuses are expensed over the
period the employee must remain with HSBC. However, SFAS 123R only applies to awards made after the date
of adoption, which for HSBC is 1 July 2005.
Impact
• Some of the bonuses awarded in respect of 2002, 2003 and 2004 were recognised over the relevant vesting
period and were, therefore, expensed in ‘Net income’ under IFRSs during 2005 and 2006. Under US GAAP,
these awards were expensed in the years for which they were granted. 2005 and 2006 bonuses will be expensed
over the vesting period under both IFRSs and US GAAP. Net income was, therefore, higher under US GAAP in
2005 and 2006.
•
IFRSs and US GAAP are now largely aligned and this transition difference will be eliminated over the next few
years.
404
Goodwill, purchase accounting and intangible assets
IFRSs
• Prior to 1998, goodwill under UK GAAP was written off against equity. HSBC did not elect to reinstate this
goodwill on its balance sheet upon transition to IFRSs. From 1 January 1998 to 31 December 2003, goodwill
was capitalised and amortised over its useful life. The carrying amount of goodwill existing at 31 December
2003 under UK GAAP was carried forward under the transition rules of IFRS 1 from 1 January 2004, subject to
certain adjustments.
•
IFRS 3 ‘Business Combinations’ requires that goodwill should not be amortised but should be tested for
impairment at least annually at the cash generating unit level by applying a test based on recoverable amounts.
• Quoted securities issued as part of the purchase consideration are valued for the purpose of determining the cost
of the acquisition at their market price on the date the transaction is completed.
US GAAP
• Up to 30 June 2001, goodwill acquired was capitalised and amortised over its useful life, which could not
exceed 25 years. The amortisation of previously acquired goodwill ceased with effect from 31 December 2001.
• Quoted securities issued as part of the purchase consideration are fair valued for the purpose of determining the
cost of acquisition at their average market price over a reasonable period before and after the date on which the
terms of the acquisition are agreed and announced.
Impact
• Total goodwill and shareholders’ equity are both higher under US GAAP than under IFRSs because, under US
GAAP, (i) pre-1998 goodwill is included on the balance sheet and (ii) the amortisation of goodwill ceased on
31 December 2001 compared with 31 December 2003 under IFRSs.
• However, goodwill on the acquisition of HSBC Finance in March 2003 is lower under US GAAP than under
IFRSs. This is principally the result of differences in the accounting for securitisations and intangibles. Under
IFRSs, previously recognised gains on the sale of assets to securitisation vehicles are eliminated and the
securitised assets are recognised on balance sheet. However, because HSBC elected not to restate business
combinations prior to 1 January 2004 on transition to IFRSs, a significant amount of intangible assets arising on
acquisition were not recognised for IFRSs purposes. Under US GAAP, recognition of these assets was required.
• Offsetting this was the recognition of a deferred tax liability under US GAAP in respect of these intangibles and
gains on sale of securitised assets.
• The effect of these items was further offset by the higher value under US GAAP of HSBC shares issued as part
of the purchase consideration. The HSBC share price fell between the time of the announcement of the
acquisition in November 2002 and its completion in March 2003, so the average price under US GAAP
exceeded the price on the date of acquisition under IFRSs.
Derivatives and hedge accounting
IFRSs
• Derivatives are recognised initially, and are subsequently remeasured, at fair value. Fair values of exchange-
traded derivatives are obtained from quoted market prices. Fair values of over-the-counter derivatives are
obtained using valuation techniques, including discounted cash flow models and option pricing models.
•
In the normal course of business, the fair value of a derivative on initial recognition is considered to be the
transaction price (that is the fair value of the consideration given or received). However, in certain circumstances
the fair value of an instrument will be evidenced by comparison with other observable current market
transactions in the same instrument (without modification or repackaging) or will be based on a valuation
technique whose variables include only data from observable markets, including interest rate yield curves, option
volatilities and currency rates. When such evidence exists, HSBC recognises a trading gain or loss on inception
of the derivative. When unobservable market data have a significant impact on the valuation of derivatives, the
entire initial difference in fair value indicated by the valuation model from the transaction price is not recognised
immediately in the income statement but is recognised over the life of the transaction on an appropriate basis, or
when the inputs become observable, or the transaction matures or is closed out.
405
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 47
• Derivatives may be embedded in other financial instruments; for example, a convertible bond has an embedded
conversion option. An embedded derivative is treated as a separate derivative when its economic characteristics
and risks are not clearly and closely related to those of the host contract, its terms are the same as those of a
stand-alone derivative, and the combined contract is not held for trading or designated at fair value. These
embedded derivatives are measured at fair value with changes in fair value recognised in the income statement.
• Derivatives are classified as assets when their fair value is positive, or as liabilities when their fair value is
negative. Derivative assets and liabilities arising from different transactions are only netted if the transactions are
with the same counterparty, a legal right of offset exists, and the cash flows are intended to be settled on a net
basis.
• The method of recognising the resulting fair value gains or losses depends on whether the derivative is held for
trading, or is designated as a hedging instrument and, if so, the nature of the risk being hedged. All gains and
losses from changes in the fair value of derivatives held for trading are recognised in the income statement.
When derivatives are designated as hedges, HSBC classifies them as either: (i) hedges of the change in fair value
of recognised assets or liabilities or firm commitments (‘fair value hedge’); (ii) hedges of the variability in highly
probable future cash flows attributable to a recognised asset or liability, or a forecast transaction (‘cash flow
hedge’); or (iii) hedges of net investments in a foreign operation (‘net investment hedge’). Hedge accounting is
applied to derivatives designated as hedging instruments in a fair value, cash flow or net investment hedge
provided certain criteria are met.
Hedge accounting
−
It is HSBC’s policy to document, at the inception of a hedge, the relationship between the hedging
instruments and the hedged items, as well as the risk management objective and strategy for undertaking the
hedge. The policy also requires documentation of the assessment, both at hedge inception and on an ongoing
basis, of whether the hedging instruments, primarily derivatives, that are used in the hedging transaction are
highly effective in offsetting changes in fair values or cash flows of hedged items attributable to the hedged
risks. Interest on designated qualifying hedges is included in ‘Net interest income’.
Fair value hedge
− Changes in the fair values of derivatives that are designated and qualify as fair value hedging instruments
are recorded in the income statement, together with changes in the fair values of the hedged assets or
liabilities or groups thereof that are attributable to the hedged risks.
−
If the hedging relationship no longer meets the criteria for hedge accounting, the cumulative adjustment to
the carrying amount of a hedged item is amortised to the income statement based on a recalculated effective
interest rate over the residual period to maturity, unless the hedged item has been derecognised, in which
case it is released to the income statement immediately.
Cash flow hedge
− The effective portion of changes in the fair values of derivatives that are designated and qualify as cash flow
hedges are recognised in equity within the cash flow hedging reserve. Any gain or loss relating to an
ineffective portion is recognised immediately in the income statement.
− Amounts accumulated in equity are recycled to the income statement in the periods in which the hedged
item will affect profit or loss. However, when the forecast transaction that is hedged results in the
recognition of a non-financial asset or a non-financial liability, the gains and losses previously deferred in
equity are transferred from equity and included in the initial measurement of the cost of the asset or liability.
− When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge
accounting, any cumulative gain or loss existing in equity at that time remains in equity until the forecast
transaction is eventually recognised in the income statement. When a forecast transaction is no longer
expected to occur, the cumulative gain or loss that was reported in equity is immediately transferred to the
income statement.
406
Net investment hedge
− Hedges of net investments in foreign operations are accounted for in a similar way to cash flow hedges. A
gain or loss on the effective portion of the hedging instrument is recognised in equity; a gain or loss on the
ineffective portion is recognised immediately in the income statement. Gains and losses accumulated in
equity are included in the income statement on the disposal of the foreign operation.
Hedge effectiveness testing
− To qualify for hedge accounting, IAS 39 requires that at inception of the hedge and throughout its life, each
hedge must be expected to be highly effective (prospective effectiveness), and demonstrate actual
effectiveness (retrospective effectiveness) on an ongoing basis.
− The documentation of each hedging relationship sets out how the effectiveness of the hedge is assessed. The
method HSBC entities adopt for assessing hedge effectiveness will depend on their risk management
strategies.
− For prospective effectiveness, the hedging instrument must be expected to be highly effective in offsetting
changes in fair value or cash flows attributable to the hedged risk during the period for which the hedge is
designated. For actual effectiveness to be achieved, the changes in fair value or cash flows must offset each
other in the range of 80 per cent to 125 per cent for the hedge to be deemed effective.
Derivatives that do not qualify for hedge accounting
− All gains and losses from changes in the fair value of derivatives that do not qualify for hedge accounting
are recognised immediately in the income statement. These gains and losses are reported in ‘Net trading
income’, except where derivatives are managed in conjunction with financial instruments designated at fair
value, in which case gains and losses are reported in ‘Net income from financial instruments designated at
fair value’, other than interest settlements on derivatives managed in conjunction with issued debt securities
designed at fair value which are reported in ‘Interest expense’. All other gains and losses on these
derivatives are reported in ‘Net income from financial instruments designated at fair value’.
From 1 January 2004 to 31 December 2004
• Derivative financial instruments comprised futures, forward, swap and option transactions undertaken by HSBC
in the foreign exchange, interest rate, equity, credit derivative, and commodity markets that were held off
balance sheet. Netting was applied where a legal right of set-off existed.
• Accounting for these instruments was dependent upon whether the transactions were undertaken for trading or
non-trading purposes.
Trading transactions
•
•
Trading transactions included transactions undertaken for market-making, to service customers’ needs and for
proprietary purposes, as well as any related hedges.
Transactions undertaken for trading purposes were marked to market and the net present value of any gain or
loss arising was recognised in the income statement as ‘Net trading income’, after appropriate deferrals for
unearned credit margins and future servicing costs. Derivative trading transactions were valued by reference to
an independent liquid price where this was available. For those transactions with no readily available quoted
prices, predominantly over the counter transactions, market values were determined by reference to
independently sourced rates, using valuation models. If market observable data was not available, the initial
increase in fair value indicated by the valuation model, but based on unobservable inputs, was not recognised
immediately in the income statement. This amount was held back and recognised over the life of the transaction
where appropriate, or released to the income statement when the inputs became observable, or when the
transaction matured or was closed out. Adjustments were made for illiquid positions when appropriate.
• Assets, including gains, resulting from derivative exchange rate, interest rate, equities, credit derivative and
commodity contracts which were marked to market were included in ‘Derivatives’ on the asset side of the
balance sheet. Liabilities, including losses, resulting from such contracts, were included in ‘Derivatives’ on the
liability side of the balance sheet.
407
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 47
Non-trading transactions
• Non-trading transactions, which were those undertaken for hedging purposes as part of HSBC’s risk
management strategy against cash flows, assets, liabilities or positions, were measured on an accrual basis.
Non-trading transactions included qualifying hedges and positions that synthetically altered the characteristics
of specified financial instruments.
• Non-trading transactions were accounted for on an equivalent basis to the underlying assets, liabilities or net
positions. Any gains or losses arising were recognised on the same basis as those arising from the related assets,
liabilities or positions.
•
To qualify as a hedge, a derivative was required effectively to reduce the price, foreign exchange or interest rate
risk of the asset, liability or anticipated transaction to which it was linked and be capable of designation as a
hedge at inception of the derivative contract. Accordingly, changes in the market value of the derivative were
required to be highly correlated to 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 were met, the derivative was accounted for on the
same basis as the underlying hedged item. Derivatives used for hedging purposes included swaps, forwards and
futures. Interest rate swaps were also used to alter synthetically the interest rate characteristics of financial
instruments. In order to qualify for synthetic alteration, a derivative instrument had to 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 had to achieve a result that was consistent with defined risk management objectives.
If these criteria were met, accruals based accounting was applied, i.e. income or expense was 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 was deferred and amortised to earnings
over the original life of the terminated contract. Where the underlying asset, liability or position was sold or
terminated, the qualifying derivative was immediately marked to market and any gain or loss arising was taken
to the income statement.
US GAAP
• The accounting under SFAS 133 ‘Accounting for derivative instruments and hedging activities’ is generally
consistent with that under IAS 39, which HSBC has followed in its IFRSs reporting from 1 January 2005, as
described above. However, specific assumptions regarding hedge effectiveness under US GAAP are not
permitted by IAS 39.
• The requirements of SFAS 133 have been effective from 1 January 2001.
• During 2006, HSBC’s US operating subsidiaries discontinued the use of the ‘shortcut method’. The US GAAP
‘shortcut method’ permits an assumption of zero ineffectiveness in hedges of interest rate risk with an interest
rate swap provided specific criteria have been met. IAS 39 does not permit such an assumption, requiring a
measurement of actual ineffectiveness at each designated effectiveness testing date.
• However, IFRSs allow greater flexibility in the designation of the hedged item. Under US GAAP, all contractual
cash flows must form part of the designated relationship, whereas IAS 39 permits the designation of identifiable
benchmark interest cash flows only.
• Certain issued structured notes are classified as trading liabilities under IFRSs, but not under US GAAP. Under
IFRSs, these notes will be held at fair value, with changes in fair value reflected in the income statement. Under
US GAAP, if the embedded derivative would otherwise require bifurcation, an irrevocable election may be made
to initially and subsequently measure the entire issued note at fair value, with changes in fair value recognised
through income. This election is made under US GAAP when the underlying issued notes are classified as
trading liabilities under IFRS. If the embedded derivative is clearly and closely related to the host contract, the
issued note will be held at amortised cost in its entirety, with changes in the amortised cost reflected in the
income statement.
• Under US GAAP, derivatives receivable and payable with the same counterparty may be reported net on the
balance sheet when there is an executed ISDA Master Netting Arrangement covering enforceable jurisdictions.
These contracts do not meet the requirements for offset under IAS 32 and hence are presented gross on the
balance sheet under IFRSs.
408
Impact
• Prior to 2006, HSBC’s North American subsidiaries followed the ‘shortcut method’ of hedge effectiveness
testing for certain transactions in their US GAAP reporting. Alternative hedge effectiveness testing
methodologies were sought under IFRSs for these hedging relationships.
• Apart from certain subsidiaries in North America, HSBC has chosen not to adopt hedge accounting for US
GAAP purposes as this would require a designated hedged item inconsistent with the approach adopted under
IFRSs. Qualifying IAS 39 hedging derivatives have been measured at fair value with the gain or loss recognised
in net income for US GAAP purposes.
Designation of financial assets and liabilities at fair value through profit and loss
IFRSs
• Under IAS 39, a financial instrument, other than one held for trading, is classified in this category if it meets the
criteria set out below, and is so designated by management. An entity may designate financial instruments at fair
value where the designation:
−
−
eliminates or significantly reduces a measurement or recognition inconsistency that would otherwise arise
from measuring financial assets or financial liabilities or recognising the gains and losses on them on
different bases; or
applies to a group of financial assets, financial liabilities or a combination of both that is managed and its
performance evaluated on a fair value basis, in accordance with a documented risk management or
investment strategy, and where information about that group of financial instruments is provided internally
on that basis to management; or
−
relates to financial instruments containing one or more embedded derivatives that significantly modify the
cash flows resulting from those financial instruments.
• Financial assets and financial liabilities so designated are recognised initially at fair value, with transaction costs
taken directly to the income statement, and are subsequently remeasured at fair value. The designation, once
made, is irrevocable in respect of the financial instruments to which it relates. Financial assets and financial
liabilities are recognised when HSBC enters into the contractual provisions of the arrangements with
counterparties, which is generally on trade date.
• Gains and losses from changes in the fair value of such assets and liabilities are recognised in the income
statement as they arise, together with related interest income and expense and dividends, within ‘Net income
from financial instruments designated at fair value’, except for interest on own debt issued by HSBC, and related
derivatives, which is reported in ‘Interest expense’.
US GAAP
• Generally, for financial assets to be measured at fair value with gains and losses recognised immediately in the
income statement, they must meet the definition of trading securities in SFAS 115 ‘Accounting for Certain
Investments in Debt and Equity Securities’ (‘SFAS 115’). Financial liabilities are usually reported at amortised
cost under US GAAP.
• Since 1 January 2006, HSBC has accounted for hybrid financial instruments under the provisions of SFAS 155
‘Hybrid Financial Instruments’. Hybrid financial instruments used that contain an embedded derivative that
would otherwise require bifurcation are, where so designated through an irrevocable election, initially and
subsequently measured at fair value, with changes in fair value recognised through income.
Impact
• HSBC has principally used the fair value designation option in the following cases:
−
for certain fixed rate long-term debt issues whose interest rate characteristic has been changed to floating
through interest rate swaps as part of a documented interest rate management strategy. In 2006,
approximately US$56 billion (2005: US$51 billion) of the Group’s debt issues have been accounted for
using this option. The movement in fair value of these debt issues includes the effect of changes in own
credit spread and any ineffectiveness in the economic relationship between the related swaps and own debt.
Such ineffectiveness arises from the different credit characteristics of the swap and own debt coupled with
409
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 47
the sensitivity of the floating leg of the swap to changes in short-term interest rates. In addition, the
economic relationship between the swap and own debt can be affected by relative movements in market
factors, such as bond and swap rates, and the relative bond and swap rates at inception. The size and
direction of the accounting consequences of changes in own credit spread and ineffectiveness can be volatile
from period to period, but do not alter the cash flows envisaged as part of the documented interest rate
management strategy.
−
−
certain financial assets held by insurance operations and managed at fair value to meet liabilities under
insurance contracts (in 2006, approximately US$6 billion; 2005: US$4 billion of assets);
financial liabilities under investment contracts and the related financial assets, when the change in value of
the assets is correlated with the change in value of the liabilities to policyholders (in 2006, approximately
US$12 billion; 2005: US$8 billion of liabilities and related assets).
• Under US GAAP, debt issues are generally reported at amortised cost. There are circumstances, by virtue of
different technical requirements and the transition arrangements to IFRSs, where derivatives providing an
economic hedge for an asset or liability, and so designated under IFRSs, are not so treated under US GAAP,
thereby creating a reconciliation difference and asymmetrical accounting between the asset and liability and the
offsetting derivative. Such derivatives result in an adjustment that is included in the reconciliations below, within
‘Derivatives and hedge accounting’.
• Prior to 1 January 2006, debt issues which had embedded derivatives were also reported at amortised cost with
any embedded derivatives bifurcated where required by SFAS 133.
• From 1 January 2006, as described above, the Group’s hybrid debt issues that contain an embedded derivative
that would otherwise require bifurcation are accounted for in a consistent manner under both IFRSs and US
GAAP, where such instruments are designated to be measured at fair value. On the US GAAP balance sheet,
such instruments are reclassified as ‘Financial liabilities designated at fair value’.
• Under US GAAP, assets held to meet insurance/investment contracts are reported as available-for-sale, with
gains and losses taken directly to ‘Other comprehensive income’. When the corresponding liability is reported at
fair value, with movements reported immediately in net income, this also results in asymmetrical accounting
being reflected in US GAAP net income.
• All these adjustments are included as ‘Derivatives and hedge accounting’ in the reconciliations below.
Available-for-sale securities
IFRSs
• Treasury bills, debt securities and equity shares intended to be held on a continuing basis are classified as
available-for-sale securities unless designated at fair value (see above) or classified as held-to-maturity.
• Available-for-sale securities are initially measured at fair value plus direct and incremental transaction costs.
They are subsequently remeasured at fair value. Changes in fair value are recognised in equity until the securities
are either sold or impaired. On the sale of available-for-sale securities, cumulative gains or losses previously
recognised in equity are recognised through the income statement and classified as ‘Gains less losses from
financial investments’. Interest income is recognised on such securities using the effective interest rate method,
calculated over the asset’s expected life. When dated available-for-sale securities are purchased at a premium or
a discount, the premiums and discounts are included in the calculation of the effective interest rate.
•
If an available-for-sale security is determined to be impaired, the cumulative loss (measured as the difference
between the acquisition cost, net of any principal repayments and amortisation, and the current fair value, less
any impairment loss on that financial asset previously recognised in the income statement) is removed from
equity and recognised in the income statement. If, in a subsequent period, the fair value of a debt instrument
classified as available-for-sale increases and the increase can be objectively related to an event occurring after
the impairment loss was recognised in the income statement, the impairment loss is reversed through the income
statement. Impairment losses recognised in the income statement on equity instruments are not reversed through
the income statement.
410
• Foreign exchange differences on available-for-sale monetary items, such as debt securities, denominated in
foreign currency are recognised in net income to the extent that they relate to the translation of the amortised cost
of the security.
1 January 2004 to 31 December 2004
• Debt securities and equity shares intended to be held on a continuing basis were classified as financial
investments and included in the balance sheet at cost less provision for any permanent diminution in value.
Other participating interests were accounted for on the same basis. Premiums or discounts on dated investment
securities purchased at other than face value were amortised through the income statement over the period from
date of purchase to date of maturity and included in ‘Interest income’. Any gain or loss on realisation of these
securities was recognised in the income statement as it arose and included in ‘Gains less losses from financial
investments’.
• Foreign exchange differences on foreign currency-denominated monetary items, including securities, were
recognised in the income statement.
US GAAP
• 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 as a separate component of shareholders’
funds.
• A decline in fair value below the cost of an available-for-sale or held-to-maturity security is treated as a realised
loss and included in earnings if it is considered ‘other than temporary’. The reduced fair value is then treated as
the cost basis for the security. A decline in fair value is generally considered other than temporary when
management does not intend or expect to hold the investment for sufficient time to enable the fair value to rise
back to the original cost of the investment.
• Foreign exchange differences on available-for-sale securities denominated in foreign currency are excluded from
earnings and recorded as part of a separate component of shareholders’ funds.
Impact
•
In 2005, certain assets have been reported at fair value for IFRSs purposes (see above). Under US GAAP, equity
shares that do not have a readily determinable fair value as defined in SFAS 115 are recorded at cost rather than
at fair value under IFRSs.
• Foreign exchange differences on available-for-sale securities denominated in foreign currency are recognised in
‘Net income’ under IFRSs. Under US GAAP, they are not reflected in net income but are deferred and
recognised on maturity or sale of the security.
Unquoted equity securities
HSBC holds certain equity securities whose market price is not quoted on a recognised exchange, but for which the
fair value can be reliably measured either through an active market, comparison to similar equity securities which are
quoted, or by using discounted cash flow calculations.
IFRSs
• Under IAS 39, equity securities which are not quoted on a recognised exchange, but for which fair value can be
reliably measured, are required to be measured at fair value. Accordingly, such securities are measured at fair
value and classified as either available-for-sale securities, with changes in fair value recognised in equity, or as
trading securities with changes in fair value recognised in the income statement.
US GAAP
• Under SFAS 115, equity securities that are not quoted on a recognised exchange are not considered to have a
readily determinable fair value and are required to be measured at cost (less any provisions for impairment).
Unquoted equity securities are reported within ‘Other assets’.
411
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 47
Impact
• Changes in fair value of equity securities for which IFRSs require recognition of the change in fair value and US
GAAP requires the securities to be held at amortised cost, affect net income and shareholders’ equity when the
security is classified as trading under IFRSs and affect shareholders’ equity when the security is classified as
available-for-sale under IFRSs.
Loan origination
IFRSs
From 1 January 2005
• Certain loan fee income and incremental directly attributable loan origination costs are amortised to the income
statement over the life of the loan as part of the effective interest calculation under IAS 39.
1 January 2004 to 31 December 2004
• Prior to 1 January 2005, fee and commission income was accounted for in the period when receivable, except
when charged to cover the costs of a continuing service to, or risk borne for, the customer, or was interest in
nature. In these cases, income was recognised on an appropriate basis over the relevant period. Loan costs
associated with origination were generally expensed as incurred.
US GAAP
• Certain loan fee income and direct but not necessarily incremental loan origination costs, including an
apportionment of compensation and related benefit costs, are deferred and amortised to the income statement
account over the life of the loan as an adjustment to interest income (SFAS 91, ‘Accounting for Non-refundable
Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases’.)
Impact
• More costs are deferred and amortised under US GAAP, such as an apportionment of base salaries, than under
IFRSs. Base salaries are written off in the period they are incurred under IFRSs. This difference in treatment
results in increased net income and shareholders’ equity under US GAAP because, in the years presented, the
extra cost deferral under US GAAP exceeds the amortisation of previously deferred costs.
Securitisations
IFRSs
• The continued recognition of securitised assets is governed by a three-step process, which may be applied to the
whole asset, or, in certain circumstances, a part of an asset:
−
−
−
If the rights to the cash flows arising from securitised assets have been transferred to a third party, and
substantially all the risks and rewards of the assets have been transferred, the assets concerned are
derecognised.
If, subject to certain detailed criteria, the rights to the cash flows are retained by HSBC but there is a
contractual obligation to pay them to another party, substantially all the risks and rewards of the assets have
been transferred, and the securitised assets concerned are derecognised.
If some significant risks and rewards of ownership have been transferred, but some have also been retained,
it must be determined whether or not control has been retained. If control has been retained, HSBC
continues to recognise the assets to the extent of its continuing involvement; if not, the assets are
derecognised.
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 (‘SPE’) and securitised can only be
derecognised and a gain or loss on sale recognised if the originator has surrendered control over the securitised
assets.
• Control is surrendered over transferred assets if and only if all of the following conditions are met:
412
− The transferred assets are put presumptively beyond the reach of the transferor and its creditors, even in
bankruptcy or other receivership.
− 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 continue to be consolidated.
• When HSBC retains an interest in 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 to the SPE.
Impact
• Gains on sale of assets to securitisation vehicles are recognised under US GAAP in cases when no such gain is
recognised under IFRSs. This results in higher US GAAP net income in periods in which there is significant
securitisation activity.
• Since early 2004, HSBC has reduced securitisation activity that results in ‘gain on sale’ accounting under US
GAAP. As a result, net income is lower under US GAAP because the amortisation of HSBC’s retained interest
in previous securitisations exceeds the gains on new transactions where a gain is recognised. The new
transactions largely replenish short-term loan assets held by existing vehicles.
• Note (l) on page 430 gives further details of transactions during the year where assets are derecognised under US
GAAP.
Loan impairment
IFRSs
• When statistical models, using historic loss rates adjusted for economic conditions, provide evidence of
impairment in portfolios of loans, their values are written down to their net recoverable amount. The net
recoverable amount is the present value of the estimated future recoveries discounted at the portfolio’s original
effective interest rate. The calculations include a reasonable estimate of recoveries on loans individually
identified for write-off pursuant to HSBC’s credit guidelines.
US GAAP
• When the delinquency status of loans in a portfolio is such that there is no realistic prospect of recovery, the
loans are written off in full, or to recoverable value where collateral exists. Delinquency depends on the number
of days payments is overdue. The delinquency status is applied consistently across similar loan products in
accordance with HSBC’s credit guidelines. When local regulators mandate the delinquency status at which
write-off must occur for different retail loan products and these regulations reasonably reflect estimated
recoveries on individual loans, this basis of measuring loan impairment is reflected in US GAAP accounting.
Cash recoveries relating to pools of such written-off loans, if any, are reported as loan recoveries upon
collection.
Impact
• Under both IFRSs and US GAAP, HSBC’s policy and regulatory instructions mandate that individual loans
evidencing adverse credit characteristics which indicate no reasonable likelihood of recovery, are written off.
When, on a portfolio basis, cash flows can reasonably be estimated in aggregate from these written-off loans, an
asset equal to the present value of the future cash flows is recognised under IFRSs.
• No asset for future recoveries arising from written-off assets was recognised in the balance sheet under IFRSs
prior to 1 January 2005.
413
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 47
Interest recognition
IFRSs
• The calculation of effective interest rates under IAS 39 requires an estimate of all fees and points paid or
received between parties to the contract that are an integral part of the effective interest rate be included.
US GAAP
• FAS 91 also generally requires all fees and costs associated with originating a loan to be recognised as interest
but, when the interest rate increases during the term of the loan, it prohibits the recognition of interest income to
the extent that the net investment in the loan would increase to an amount greater than the amount at which the
borrower could settle the obligation.
Impact
• When HSBC provides introductory incentives in the form of either a low or nil interest rate for the early period
of a loan, interest income on such products is recognised under IFRSs on the basis of the overall effective
interest rate over the expected life of the product. No interest income is recognised during the incentive period
under US GAAP.
Mortgage servicing rights
IFRSs
•
Intangible assets that have a finite useful life, such as mortgage servicing rights, are stated at cost less
amortisation and accumulated impairment losses and are amortised over their estimated useful lives. Estimated
useful life is the lower of legal duration and expected economic life.
US GAAP
• SFAS 156 ‘Accounting for Servicing of Financial Assets’ was issued by the FASB in March 2006. SFAS 156
amends SFAS 140 ‘Accounting for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities’ with respect to the accounting for separately recognised servicing assets and liabilities. SFAS 156
requires that all separately recognised servicing assets and liabilities be initially measured at fair value with
subsequent measurement at either fair value, with changes in fair value reported in the income statement when
they occur, or using the amortisation method. At the date of adoption, SFAS 156 permits a one-time
reclassification of available-for-sale securities to trading securities where those securities are identified as
offsetting exposure to changes in the fair value of servicing assets and liabilities that have been elected to be
subsequently measured at fair value. HSBC elected to adopt SFAS 156 from 1 January 2006.
• From 1 January 2006 HSBC elected to subsequently measure at fair value certain classes of mortgage servicing
rights held by its US subsidiaries.
Impact
• Prior to 1 January 2006 the amortisation method was used to account for mortgage servicing rights under US
GAAP and, therefore, no difference with IFRSs arose.
• Upon adoption of SFAS 156 the cumulative effect adjustment to US GAAP retained earnings, representing the
difference between the fair value and cost less amortisation of mortgage servicing rights, was immaterial.
• At 1 January 2006 an election was made to reclassify certain securities used by one of HSBC’s US subsidiaries
to offset changes in the fair value of mortgage servicing rights from available-for-sale financial investments to
trading assets. At 31 December 2005 those securities had a cost of US$115m and a fair value of US$111m.
This resulted in a transfer out of US GAAP other comprehensive income of the accumulated loss of US$4m at
1 January 2006, with an offsetting amount recorded as a cumulative effect adjustment to retained earnings.
•
In 2006 the net difference between the fair value adjustment of the mortgage servicing asset and the offsetting
changes in the fair value of mortgage servicing rights classified as trading assets is recorded as an adjustment to
US GAAP net income.
414
Unearned commission income
IFRSs
•
IFRS 4 permits entities that issue insurance contracts to continue their insurance accounting policies under their
previous GAAP. Under UK GAAP, certain sales commissions were regarded as a separate service and
recognised once the sale was made, taking into account expectations of policy terminations.
US GAAP
• Under Staff Accounting Bulletin No. 104 (SAB 104), revenue should be recognised when, along with other
criteria, the seller’s price to the buyer is fixed or determinable. Commissions which are earned when the
customer has the right to cancel and receive a proportionate refund are not considered to be fixed and
determinable under US GAAP until the cancellation privilege expires. Cancellation privileges generally expire
rateably over the contract.
• Under the American Institute of Certified Public Accountants (‘AICPA’) Audit and Accounting Guide for
Deposit and Lending Institutions; insurance commissions received from an independent insurer should be
deferred and systematically amortised to income over the life of the related insurance contract.
Impact
• The difference between recognising revenue based on the likelihood that future services will be rendered and
rateably over the life of the policy creates a timing difference in the recognition of revenue under IFRSs and US
GAAP. Net income under US GAAP will generally be lower, but would be higher if new commission revenue
decreased below the level of commissions earned from prior years policies.
• The liability for customers fees which have not been earned under US GAAP, net of amounts deferred under
IFRSs, decrease shareholders’ net assets under US GAAP.
Interests in own shares held
IFRSs
•
•
In accordance with IAS 32, long positions in HSBC Holdings’ shares are deducted from shareholders’ funds. No
gains or losses are recognised on own shares held.
IAS 32 also applies to derivatives over HSBC’s own shares, when they meet the definition of an equity
instrument, and HSBC shares held to meet liabilities under insurance and investment contracts.
US GAAP
• AICPA Accounting Research Bulletin 51, ‘Consolidated Financial Statements’ (‘ARB 51’), requires a reduction
in shareholders’ equity for own shares held. The rules in ARB 51 do not extend to derivatives over own shares.
• AICPA Accounting Research Bulletin 43 ‘Restatement and Revision of Accounting Research Bulletins’ also
requires a reduction in shareholders’ equity for own shares held. HSBC shares held as long-term insurance assets
attributable to policyholders are classified as an asset when the criteria for classification as ‘separate accounts’
are met.
Impact
• Certain HSBC insurance operations hold shares in HSBC as part of policyholder funds that qualify for
classification as ‘separate accounts’. These shares represent an addition to shareholders’ equity for US GAAP
purposes and are reported within ‘Other assets’ with gains and losses during the period reported in ‘Other
income’, where they are matched with corresponding movements in the amounts attributable to policyholders.
No such gains and losses are recognised under IFRSs and the cost of the shares is deducted from shareholders’
equity.
415
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 47
Revaluation of property
IFRSs
• As allowed by the transition rules of IFRS 1, HSBC elected to adopt the value of all its properties held for its
own use as at 1 January 2004 as their ‘deemed cost’ at that date. Assets are carried at cost less any accumulated
depreciation and impairment losses. Freehold land is not depreciated.
•
Investment properties are carried at current market values with gains or losses thereon recognised in the income
statement for the period. Investment properties are not depreciated.
US GAAP
• US GAAP does not permit revaluations of property, including investment property, although it requires
recognition of asset impairment. Any realised surplus or deficit is, therefore, reflected in net income upon
disposal of the property. Depreciation is charged on all properties based on cost.
Impact
• Under IFRSs, the value of property held for own use reflects revaluation surpluses recorded prior to 1 January
2004. Consequently, the values of tangible fixed assets and shareholders' equity are lower under US GAAP than
under IFRSs.
• There is a correspondingly lower depreciation charge and higher net income under US GAAP, partially offset by
higher gains (or smaller losses) on the disposal of fixed assets.
• For investment properties, net income under US GAAP does not reflect the gain or loss recorded under IFRSs
for the period.
Restructuring provisions
IFRSs
•
In accordance with IAS 37, ‘Provisions, Contingent Liabilities and Contingent Assets’, provisions are made for
any direct costs arising from a business that management is committed to restructure, sell or terminate; has a
detailed formal plan and has raised a valid expectation of carrying out that plan.
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.
Impact
• The recognition of costs associated with plans to restructure and streamline operations is earlier under IFRSs
than under US GAAP, for example, where there is a time lag between developing and communicating a formal
plan, and putting it into practice. This resulted in marginally higher net income and shareholders’ equity under
US GAAP in 2005.
Consolidation of special purpose entities or variable interest entities
IFRSs
• Under the IASB’s Standing Interpretations Committee (‘SIC’) Interpretation 12 (‘SIC-12’), a special purpose
entity (‘SPE’) should be consolidated when the substance of the relationship between an enterprise and the SPE
indicates that the SPE is controlled by that entity.
US GAAP
• FASB Interpretation No. 46 (revised December 2003), ‘Consolidation of Variable Interest Entities’ (‘FIN 46R’),
requires consolidation of variable interest entities (‘VIE’s) 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 hold an investment that does not possess the characteristics of a
controlling financial interest or does not have sufficient equity at risk for the entity to finance its activities.
416
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.
Impact
• When HSBC is deemed the primary beneficiary under US GAAP, but does not consolidate the vehicle under
IFRSs, the assets and liabilities of that vehicle are consolidated on the US GAAP balance sheet. This results in a
grossing up of the balance sheet but does not have a material impact on net income for the period or on
shareholders’ equity.
• When HSBC is deemed not to be the primary beneficiary under US GAAP of a vehicle that is consolidated under
IFRSs, the assets and liabilities of that vehicle are de-consolidated in the US GAAP balance sheet. This results in
a reclassification in the 2004 balance sheet but does not have a material impact on shareholders' equity or on net
income for 2004 or 2005.
Long-term insurance assets and liabilities
IFRSs
• Long-term insurance fund assets, excluding own shares held, are classified in accordance with IAS 39, for
example, available-for-sale securities, or financial instruments designated at fair value. The accounting for these
financial assets is consistent with other holdings of similar assets.
• Liabilities attributable to policyholders under insurance contracts are recognised in accordance with IFRS 4 and
appropriate actuarial principles as ‘Liabilities under insurance contracts issued’. Liabilities attributable to
policyholders under linked investment contracts are recognised as financial liabilities designated at fair value and
classified under ‘Financial liabilities designated at fair value’.
US GAAP
• Under the Statement of Position issued by the AICPA 03-1 (‘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, when long-term insurance assets qualify for separate accounting they are
measured at fair value and are reported in the financial statements as a summary total, with an equivalent
summary total for related liabilities. Otherwise, assets that do not qualify for separate accounting and that
represent policyholders’ funds are accounted for and recognised as general account assets, that is consistent with
other holdings of similar assets. Any related liability is accounted for as a general account liability.
Impact
• Long-term insurance assets that are recorded in accounts meeting the definition of ‘separate accounts’ in SOP
03-1 are measured at fair value through net income and disclosed in a single line, ‘Other assets’, in the US
GAAP balance sheet.
417
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 47
Reconciliation of net income and shareholders’ equity under IFRSs and US GAAP
The following tables summarise the significant adjustments to consolidated net income and shareholders’ equity
which would result from the application of US GAAP:
Net income
Profit attributable to shareholders of the parent company
of HSBC (IFRSs) .........................................................................................
Shareholders’ interest in long-term insurance fund ........................................
Pension costs ....................................................................................................
Stock-based compensation ..............................................................................
Intangible assets ...............................................................................................
Purchase accounting adjustments ....................................................................
Derivatives and hedge accounting ...................................................................
Foreign exchange differences on available-for-sale securities .......................
Loan origination ...............................................................................................
Securitisations ..................................................................................................
Loan impairment ..............................................................................................
Interest recognition ..........................................................................................
Mortgage servicing rights ................................................................................
Unquoted equity securities ..............................................................................
Unearned commission income ........................................................................
Other ................................................................................................................
Taxation, including taxation on reconciling items ..........................................
Minority interest in reconciling items .............................................................
Net income (US GAAP) ..................................................................................
Per share amounts (US GAAP)
Basic earnings per ordinary share ...................................................................
Diluted earnings per ordinary share ................................................................
Year ended 31 December
2006
US$m
2005
US$m
15,789
(532)
(209)
119
(264)
(303)
514
1,203
156
(57)
(36)
2
14
(45)
(291)
92
81
125
16,358
15,081
88
(175)
225
(325)
(520)
(2,144)
2,235
249
(237)
20
(131)
–
–
–
(44)
578
(197)
14,703
Year ended 31 December
2006
US$
1.45
1.44
2005
US$
1.33
1.32
At 31 December
2006
US$m
Shareholders’ equity
Total shareholders’ equity (IFRSs) ...................................................................................................
Shareholders’ interest in long-term insurance fund ..........................................................................
Pension costs ......................................................................................................................................
Unquoted equity shares .....................................................................................................................
Goodwill ............................................................................................................................................
Revaluation of property .....................................................................................................................
Purchase accounting adjustments ......................................................................................................
Intangible assets .................................................................................................................................
Derivatives and hedge accounting .....................................................................................................
Loan origination .................................................................................................................................
Securitisations ....................................................................................................................................
Loan impairment ................................................................................................................................
Interest recognition ............................................................................................................................
Unearned commission income ..........................................................................................................
Mortgage servicing rights ..................................................................................................................
Other . .................................................................................................................................................
Taxation including taxation on reconciling items .............................................................................
Minority interest in reconciling items ...............................................................................................
Total shareholders’ equity (US GAAP) ............................................................................................
108,352
(1,678)
–
(1,311)
1,246
(1,490)
18
1,845
1,129
916
101
(372)
(257)
(291)
16
79
(51)
288
108,540
2004
US$m
12,918
(102)
(125)
(83)
(323)
(1,239)
244
1,069
143
(33)
–
–
–
–
–
74
(77)
40
12,506
2004
US$
1.15
1.13
2005
US$m
92,432
(1,077)
1,585
(597)
1,048
(1,530)
155
2,127
(58)
717
158
(327)
(259)
–
–
112
(1,213)
251
93,524
418
Movement in shareholders’ equity (US GAAP)
Balance brought forward (as previously published) .......................................
Adoption of SFAS 155 at 1 January 2006 ......................................................
Balance brought forward (restated) .................................................................
Net income .......................................................................................................
Dividends .........................................................................................................
Share options ...................................................................................................
Shares issued in lieu of dividends ...................................................................
New share capital subscribed net of costs .......................................................
Other, including movements in own shares held ............................................
Net change in net unrealised losses on available-for-sale securities,
net of tax effect ............................................................................................
Net change in net unrealised gains on derivatives classified as cash flow
hedges, net of tax effect ..............................................................................
Minimum pension liability adjustment, net of tax effect ................................
SFAS 158 transition adjustment, net of tax ....................................................
Exchange differences and other movements ...................................................
Total other comprehensive income .................................................................
2006
US$m
93,524
467
93,991
16,358
(8,769)
735
2,525
–
567
(450)
(255)
340
(1,406)
4,904
3,133
At 31 December ...............................................................................................
108,540
2005
US$m
90,082
14,703
(7,750)
450
1,811
1,405
94
(2,716)
1
(236)
–
(4,320)
(7,271)
93,524
2004
US$m
80,251
12,506
(6,932)
234
2,607
581
(148)
(837)
(349)
(195)
–
2,364
983
90,082
419
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 47
Consolidated US GAAP balance sheet
The following table provides an estimated summarised consolidated balance sheet for HSBC which incorporates the
adjustments arising from the application of US GAAP.
At 31 December
2006
Assets
Cash and balances at central banks ...................................................................................................
Items in the course of collection from other banks ...........................................................................
Hong Kong Government certificates of indebtedness ......................................................................
Trading assets ....................................................................................................................................
Derivatives .........................................................................................................................................
Loans and advances to banks ............................................................................................................
Loans and advances to customers .....................................................................................................
Financial investments ........................................................................................................................
Interest in associates and joint ventures ............................................................................................
Goodwill and intangible assets ..........................................................................................................
Property, plant and equipment ...........................................................................................................
Other assets (including prepayments and accrued income) ..............................................................
Total assets .........................................................................................................................................
Liabilities
Hong Kong currency notes in circulation .........................................................................................
Deposits by banks ..............................................................................................................................
Customer accounts .............................................................................................................................
Items in the course of transmission to other banks ...........................................................................
Trading liabilities ...............................................................................................................................
Derivatives .........................................................................................................................................
Debt securities in issue ......................................................................................................................
Financial liabilities designated at fair value ......................................................................................
Retirement benefit liabilities .............................................................................................................
Other liabilities (including accruals and deferred income) ...............................................................
Liabilities under insurance contracts issued ......................................................................................
Provisions ...........................................................................................................................................
Subordinated liabilities ......................................................................................................................
Total liabilities ...................................................................................................................................
Equity
Total shareholders’ equity .................................................................................................................
Minority interests ...............................................................................................................................
Total equity ........................................................................................................................................
Total equity and liabilities .................................................................................................................
US$m
12,725
14,626
13,165
325,149
43,083
185,081
798,534
212,233
7,915
39,003
13,580
47,533
1,712,627
13,165
99,089
846,647
12,625
164,744
40,837
279,859
28,368
5,555
27,993
17,672
16,601
45,031
1,598,186
108,540
5,901
114,441
1,712,627
2005
US$m
13,712
11,300
12,554
235,964
29,295
125,751
689,414
188,637
7,163
35,081
14,891
43,182
1,406,944
12,554
69,895
704,647
7,022
148,451
29,410
225,681
–
3,217
39,385
14,157
4,285
45,612
1,304,316
93,524
9,104
102,628
1,406,944
Net assets arising due to reverse repo transactions of US$45,019 million (2005: US$24,754 million),
US$18,755 million (2005: US$14,610 million) and US$74,344 million (2005: US$51,125 million) are included in
‘Loans and advances to banks’, ‘Loans and advances to customers’ and ‘Trading assets’ respectively.
Net liabilities arising due to repo transactions of US$18,094 million (2005: US$10,005 million), US$13,600 million
(2005: US$13,523 million) and US$65,445 million (2005: US$52,218 million) are included in ‘Deposits by banks’,
‘Customer accounts’ and ‘Trading liabilities’ respectively. Average repo liabilities during the year were
US$102,715 million (2005: US$74,143 million). The maximum quarter-end repo liability outstanding during the year
was US$109,689 million (2005: US$78,590 million).
At 31 December 2006, collateral received under reverse repo transactions which HSBC had the right to sell or
repledge amounted to US$161,638 million gross (2005: US$103,977 million). Approximately US$119 billion (2005:
approximately US$79 billion) of the collateral obtained from reverse repo transactions had been sold or repledged 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 2006, stock borrowing transactions where the securities borrowed
were subject to sale or repledge amounted to US$26,370 million (2005: US$25,783 million).
420
Approximately US$17 billion (2005: US$18 billion) of the consideration received has been sold or repledged in
connection with stock borrowing transactions.
(a) Pension and post-retirement costs
On 31 December 2006, HSBC adopted the recognition and disclosure provisions of SFAS 158 ‘Employers’
Accounting for Defined Benefit Pension and Other Post-retirement Plans – an amendment of FASB Statements
No. 87, 88, 106 and 132(R)’ (SFAS 158), SFAS 158 requires HSBC to recognise the funded status of its pension
plans in a manner similar to IAS 19.
The provisions of SFAS 87 ‘Employers’ accounting for pensions’ and SFAS 158 have been applied to HSBC’s
main defined benefit pension plans, which make up approximately 96 per cent of all HSBC’s schemes by plan
assets. For non-US schemes, HSBC has applied SFAS 87 with effect from 30 June 1992 as it was not feasible to
apply as at 1 January 1989, the date specified in the standard.
The transition adjustments for adoption of SFAS 158 for pensions and post-retirement costs were as follows:
Other assets (including prepayments and accrued income) ...................
Total assets ..............................................................................................
Retirement benefit liabilities ...................................................................
Provisions ................................................................................................
Total liabilities ........................................................................................
Total shareholders’ equity ......................................................................
Before
application of
Statement 158
Adjustments
US$m
47,589
1,712,683
7,555
15,951
1,596,836
109,946
US$m
56
56
2,000
(650)
(1,350)
1,406
After
application of
Statement 158
US$m
47,533
1,712,627
5,555
16,601
1,598,186
108,540
Components of net periodic benefit cost related to HSBC’s defined benefit pension plans and post-retirement
benefits other than pensions under US GAAP were as follows:
Components of net periodic benefit cost
Service cost .............................................................................................
Interest cost .............................................................................................
Expected return on plan assets ................................................................
Amortisation of transition obligation .....................................................
Amortisation of prior service cost ..........................................................
Amortisation of recognised net actuarial loss ........................................
Curtailment ..............................................................................................
Net periodic pension cost under US GAAP ...........................................
Net periodic pension cost under IFRSs ..................................................
2006
US$m
779
1,485
(1,601)
–
7
211
(8)
873
664
2005
US$m
684
1,377
(1,365)
8
(6)
165
(4)
859
684
2004
US$m
590
1,305
(1,317)
12
5
142
225
962
837
In 2007, components of net periodic benefit cost will include US$7 million for the amortisation of prior service
cost and US$164 million for amortisation of recognised net actuarial loss.
Under the provisions of SFAS 87, when a pension plan’s accumulated benefit obligation (the value of the
benefits accrued based on employee service up to the balance sheet date) exceeds the fair value of its assets, an
additional minimum pension liability equal to this excess is recognised by the employer to the extent that the
excess is greater than any accrual which has already been established for unfunded pension costs.
Simultaneously, an intangible asset is established equal to the lower of the liability recognised for the unfunded
benefit obligation and the amount of any unrecognised prior service cost.
At 31 December 2006, HSBC recognised an additional minimum pension liability of US$3,130 million prior to
adoption of FAS158 (2005: US$3,206 million) in respect of its unfunded accumulated benefit obligation.
421
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 47
Disclosures in 2005
Funded status as per IFRSs balance sheet (Note 7) ....................................................................................................
Unrecognised net actuarial loss ..................................................................................................................................
Unrecognised prior service cost ..................................................................................................................................
Accrued pension cost ..................................................................................................................................................
Additional minimum liability .....................................................................................................................................
Net amount recognised under US GAAP ...................................................................................................................
Amounts recognised under US GAAP in the balance sheet consist of:
– prepaid benefit cost .............................................................................................................................................
– accrued benefit liability ......................................................................................................................................
– additional minimum liability ..............................................................................................................................
US GAAP adjustment
Amount recognised under US GAAP .........................................................................................................................
Amounts recognised for these schemes under IFRSs .................................................................................................
2005
US$m
(3,941)
4,756
35
850
(3,206)
(2,356)
1,434
(584)
(3,206)
(2,356)
(2,356)
(3,941)
1,585
In 2005, plans with an aggregated accumulated benefit obligation of US$21,098 million and assets with an
aggregated fair value of US$18,444 million had an accumulated benefit obligation in excess of plan assets. Plans
with an aggregated projected benefit obligation of US$22,595 million and assets with an aggregated fair value of
US$18,795 million had a projected benefit obligation in excess of plan assets.
The projected benefit obligations at 31 December 2005 for HSBC’s main pension plans have been calculated
using the same financial assumptions as detailed in Note 7.
The accumulated benefit obligation in respect of the above schemes was:
HSBC Bank (UK) Pension Scheme ............................................................................................................................
Other schemes .............................................................................................................................................................
2005
US$m
19,709
5,241
The projected benefit obligations at 31 December 2006 and 2005 for HSBC’s main post-retirement healthcare
plans have been calculated using the same financial assumptions as detailed in Note 7.
(b) Goodwill
Goodwill arises on the acquisition of subsidiaries, investments in associates and interests in joint ventures when
the cost of acquisition exceeds the fair value of HSBC’s share of the identifiable assets, liabilities and contingent
liabilities acquired.
Under IFRSs (and before them, UK GAAP), goodwill arising on acquisitions made on or after 1 January 1998 is
included in the balance sheet in ‘Goodwill and intangible assets’ in respect of subsidiary undertakings, and in
‘Interests in associates and joint ventures’ in respect of associates and joint ventures. Capitalised goodwill was
amortised over its estimated useful life on a straight-line basis until the adoption of IFRSs on 1 January 2004,
since then it is not amortised but is subject to annual impairment testing. Goodwill arising on acquisitions prior
to 1 January 1998 was charged against reserves in the year of acquisition. This goodwill was not reinstated on
the balance sheet upon adoption of IFRSs.
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 2006, the cost of goodwill arising on the acquisition of subsidiaries on a US GAAP basis was
US$37,670 million (2005: US$34,147 million; 2004: US$36,084 million) and the accumulated amortisation of
goodwill was US$3,952 million (2005: US$3,873 million; 2004: US$4,385 million).
422
(c) Intangible assets
The following intangible assets were recognised under US GAAP:
Balance brought forward at 1 January ........................................................................................
Additions .....................................................................................................................................
On acquisition of subsidiaries .....................................................................................................
Amortisation charge ....................................................................................................................
Changes in fair value of mortgage servicing rights ....................................................................
Provision for impairment ............................................................................................................
Exchange differences and other movements ..............................................................................
Balance carried forward at 31 December ...................................................................................
2006
US$m
4,702
857
330
(840)
(44)
(84)
364
5,285
2005
US$m
4,608
580
271
(905)
–
34
114
4,702
Since 1 January 2004, the accounting treatment for intangible assets has generally been consistent between
IFRSs and US GAAP. The additional intangible assets recognised under US GAAP represent those acquired in
business combinations during the period between SFAS 141 ‘Business combinations’ becoming effective on
30 June 2001 and IFRSs being adopted on 1 January 2004. They primarily comprise credit card and other loan
relationships, merchant relationships and other intangibles assumed on the acquisition of HSBC Finance.
The provision for impairment in 2006 relates primarily to a write down of a merchant relationship. Provision for
impairment in 2005 relates to the release of a provision for the write-down of mortgage servicing rights, as
prepayment rates slowed. Changes in the value of mortgage servicing rights in 2006 follow the adoption of
SFAS 156 on 1 January 2006.
HSBC conducts an annual impairment test of intangible assets which are not subject to annual amortisation since
HSBC determines these assets have indefinite lives. As a result of this testing in 2006, no impairment charge was
recorded (2005: US$13 million was recorded relating to a trade name in the UK).
Weighted
average
amortisation
period
Months
98
60
109
61
210
60
Intangible assets subject to annual amortisation
Purchased credit card relationships and related
programmes .....................................................
Retail services merchant relationship ..................
Other loan related relationships ...........................
Technology, customer lists and other contracts ..
Core deposit relationships ....................................
Other .....................................................................
Intangible assets not subject to annual
amortisation
Trade name ...........................................................
Intangible assets measured at fair value
Mortgage servicing rights ....................................
At 31 December 2006
Accumulated
Amortisation
US$m
Cost
US$m
Carrying
Value
US$m
2,503
270
333
3,162
233
649
7,150
928
8,078
(636)
(203)
(135)
(2,056)
(144)
(80)
(3,254)
(13)
(3,267)
1,867
67
198
1,106
89
569
3,896
915
474
5,285
2011
US$m
411
The intangible asset amortisation expense under US GAAP for the next five years is estimated to be:
Amortisation charge..........................
(d) Derivatives and hedge accounting
2007
US$m
765
2008
US$m
662
2009
US$m
548
2010
US$m
515
Under IFRSs, all derivatives are recorded at fair value, consistent with US GAAP. Under IFRSs, HSBC has
elected either hedge accounting or fair value option for certain economic hedging relationships. With the
423
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 47
exception of US operating subsidiaries, HSBC has not elected hedge accounting in its US GAAP financial
statements.
HSBC’s US operating subsidiaries designate certain derivative financial instruments as qualifying hedging
instruments under SFAS 133.
HSBC utilised the shortcut method when the critical terms of the hedge instrument were identical to those of the
hedged item at the hedge inception date. HSBC’s US subsidiaries made use of the assumption of no
ineffectiveness in its fair value hedge accounting for short-cut hedges. As a result, no retrospective or
prospective assessment of effectiveness was required and no hedge ineffectiveness was recognised. All other
hedge relationships were accounted for under the 'long-haul' method whereby effectiveness is assessed and
ineffectiveness on effective hedges is recorded in the income statement.
During 2006, new designations of hedges were made using the long-haul method of accounting under SFAS 133
and certain relationships have been re-designated using this method. As a result, there were no longer any cash
flow hedges or fair value hedges using the shortcut method of accounting at 31 December 2006.
The following table summarises HSBC’s hedges of financial instruments that have been designated and qualify
as effective hedges under SFAS 133 at the end of the period.
Nominal values
Fair value
hedges
Cash flow
hedges
2006
US$bn
Fair value
hedges
2005
US$bn
Cash flow
hedges
2005
US$bn
Fair value
hedges
2006
2006
US$bn
Financial investments
Available for sale
debt securities
Shortcut ..........
Long-haul .......
Customer deposits
Shortcut ...........
Long-haul ........
Debt securities in
issue and
subordinated
liabilities
Shortcut ...........
Long-haul ........
Total ...................
Fair value hedges
–
1.8
–
–
–
–
–
10.9
–
33.0
34.8
–
52.1
63.0
–
0.2
–
–
3.0
18.2
21.4
–
–
–
6.8
–
46.8
53.6
–
52
–
2
–
112
166
Number of derivatives
Fair value
Cash flow
hedges
Cash flow
hedges
2005
hedges
2005
2006
–
–
–
24
1
10
–
1
–
–
–
17
–
160
184
16
45
73
–
165
182
HSBC’s US operating subsidiaries designate certain derivative financial instruments as qualifying fair value
hedges of certain fixed rate assets and liabilities under SFAS 133. In order to qualify initially, hedge
effectiveness is assessed and demonstrated on a prospective basis utilising statistical regression analysis.
Since 1 January 2005, almost all derivatives designated as fair value hedges under US GAAP in HSBC’s US
operating subsidiaries have been reported under the fair value option for IFRSs purposes, with movements in fair
value reported as ‘Net income from financial instruments designated as at fair value’. HSBC’s US operating
subsidiaries have also elected to record financial instruments at fair value for which fair value hedge accounting
is not utilised for US GAAP.
Reporting of these arrangements as fair value hedges under US GAAP resulted in increased net income for 2006
of US$194 million, which included US$348 million arising from elimination of losses due to movements in own
credit spread recorded in IFRS net income. Off-setting the increase to net income under US GAAP arising from
the elimination of losses due to own credit spread was a decrease in US GAAP net income of US$134 million
due to amortisation of hedge valuation adjustments for de-designated hedge relationships under US GAAP that
are accounted as FVO under IFRSs.
Reporting of these arrangements as fair value hedges under US GAAP resulted in decreased net income for 2005
of US$179 million, including US$7 million arising from elimination of gains due to movements in own credit
spread recorded in IFRSs net income and reduced ineffectiveness of US$172 million on shortcut fair value
424
hedges for US GAAP purposes. In addition, there were US$9 million of gains on such derivatives that did not
qualify for hedge accounting under US GAAP and amortisation of hedge valuation adjustments for de-
designated hedge relationships.
On electing to report under the fair value option under IAS 39, unamortised purchase accounting adjustments on
HSBC Finance Corporation's own debt were eliminated through retained earnings upon transition to IAS 39 on
1 January 2005. As a result, a US$27 million benefit (2005: US$298 million benefit) to US GAAP net income
was not recognised under IFRSs.
Cash flow hedges
HSBC’s US operating subsidiaries designate under SFAS 133 certain derivative financial instruments, including
interest rate swaps and cross-currency contracts, as qualifying cash flow hedges of the forecast repricing of
certain deposit liabilities and issues of debt. A number of variable rate commercial loans were also subject to
cash flow hedges up until 2004.
In order to qualify initially, hedge effectiveness is assessed and demonstrated on a prospective basis utilising
both statistical regression analysis and the cumulative dollar offset method. The latter is used in order to satisfy
the retrospective assessment of effectiveness for SFAS 133, and subsequent 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.
Since 1 January 2005, such hedging arrangements have been recognised as cash flow hedges for IFRSs purposes.
US GAAP net income for 2006 was lower than that under IFRSs by US$20 million (2005: US$6 million),
relating to differences in amortisation of other comprehensive income for de-designated hedge relationships
under US GAAP and IFRS and unrecorded ineffectiveness on shortcut cash flow hedges during 2005 for
US GAAP purposes.
Trading derivatives
From 1 January 2005, certain hedging relationships outside North America were elected and qualified as fair
value hedges, were designated under the fair value option, or were elected and qualified as cash flow hedges
under IAS 39, but were not elected as hedges under SFAS 133. The mark to market for these derivatives has
been reported directly in net income for US GAAP purposes.
For fair value hedges recognised under IFRSs, no corresponding, offsetting fair value movement of the hedged
item with respect to the hedged risk has been recorded for US GAAP purposes. For hedging relationships
designated as at fair value for IFRSs purposes, no fair value movement in respect of own debt is recorded under
US GAAP.
The effect of this was to increase US GAAP net income by US$214 million (2005: US$1,266 million reduction),
net of elimination of a loss under IFRS of US$41 million (2005: US$76 million loss) of own credit spread,
outside North America.
Fair value option
HSBC has also applied the fair value option under IFRSs to groups of financial assets and liabilities which are
managed and evaluated on a fair value basis, and to financial instruments containing embedded derivatives (see
Note 3). In addition, movements in the fair value of certain liabilities which meet the definition of ‘held for
trading’ under IAS 39 are taken through net income. US GAAP does not include a fair value election and does
not generally permit liabilities to be reported at fair value.
From 1 January 2006, with HSBC’s adoption of SFAS 155, the Group’s hybrid debt issues that contain an
embedded derivative that would otherwise require bifurcation, are accounted for in a consistent manner under
both IFRSs and US GAAP, where such instruments are designated to be measured at fair value. The elimination
of all other fair value option accounting increased US GAAP net income for 2006 by US$193 million (2005:
US$733 million reduction prior to the adoption of SFAS 155).
425
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 47
(e) Foreign exchange gains on available-for-sale securities
HSBC holds, in a number of different currencies, securities which are classified as available-for-sale. For
example, in the private bank in Switzerland, which has the US dollar as its reporting currency, HSBC holds euro-
denominated bonds 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 IFRSs
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 trading income. This reflects the economic
substance of holding currency assets financed by currency liabilities.
However, under US GAAP accounting rules, the change in value of the investments classified as available-for-
sale is taken directly to reserves while the offsetting change in US dollar terms of the borrowing is taken to
earnings. This leads to an accounting result which does not 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 when foreign currency exposures on foreign currency assets are covered using
forward contracts but HSBC does not manage these hedges to conform with the detailed US hedge designation
requirements.
The result is that for 2006, US GAAP net income was increased by US$1,203 million (2005: increased by
US$2,235 million; 2004: increased by US$1,069 million) compared with IFRSs profits. There was no difference
in shareholders’ equity between IFRSs and US GAAP as a result of this item.
Approximately 50 per cent of the adjustment for the year ended 2006 reflected the level of adjustments in prior
periods on the maturity or disposal of securities. The remainder of the adjustment reflected a weakening of the
US dollar, where a loss on US dollar denominated available-for-sale securities in subsidiaries with sterling as
their reporting currency was offset by gains on sterling and euro denominated available-for-sale securities in
subsidiaries with the US dollar and the Hong Kong dollar as their reporting currencies. This loss has been
recorded in IFRSs net income but is recorded directly in ‘Other comprehensive income’ under US GAAP. Any
gain on foreign currency liabilities funding the securities is recorded in net income under both IFRSs and US
GAAP.
(f) Financial investments
Under US GAAP, HSBC’s financial investments with a readily determinable market value 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 securities are categorised as trading securities.
The amortised cost of available-for-sale investment securities which are subject to the provisions of SFAS 115
was US$216,096 million (2005: US$188,868 million) under US GAAP. During the year, excluding the effects
of foreign exchange, US$910 million (2005: losses of US$899 million; 2004: gains of US$376 million) of
net unrealised gains on available-for-sale securities were included in ‘Other comprehensive income’.
US$644 million (2005: gains of US$626 million; 2004: gains of US$476 million) of net gains were reclassified
out of ‘Other comprehensive income’ and recognised as part of income for the year.
Available-for-sale
Unrealised losses on investment securities:
Under US GAAP, investment securities that had unrealised losses are summarised according to the length of
time the losses have existed:
426
Period investment has been in an unrealised loss position
Less than one year
Greater than or
equal to one year
Unrealised
Unrealised
Fair
value
US$m
At 31 December 2006
US Treasury ................................
US Government agencies ............
US Government sponsored
entities .....................................
UK Government ..........................
Hong Kong Government .............
Other governments ......................
Asset-backed securities ...............
Corporate debt and other
securities .................................
Debt securities .............................
Equity securities ..........................
Total ............................................
794
2,825
3,343
2,070
–
5,188
3,989
26,330
44,539
41
44,580
At 31 December 2005
US Treasury .................................
US Government agencies ............
US Government sponsored
entities .....................................
UK Government ..........................
Hong Kong Government .............
Other governments ......................
Asset-backed securities ...............
Corporate debt and other
securities .................................
Debt securities .............................
Equity securities ..........................
Total ............................................
1,136
1,385
8,955
56
1,259
3,457
1,522
32,423
50,193
52
50,245
losses
US$m
(12)
(41)
(114)
(23)
–
(56)
(5)
(43)
(294)
(8)
(302)
losses
US$m
(22)
(28)
(192)
–
(23)
(33)
(7)
(284)
(589)
(6)
(595)
Fair
value
US$m
618
1,339
6,009
–
631
5,472
1,252
17,943
33,264
–
33,264
Fair
value
US$m
78
570
2,811
225
126
6,187
367
8,726
19,090
–
19,090
Total
Fair
value
US$m
Unrealised
losses
US$m
1,412
4,164
9,352
2,070
631
10,660
5,241
44,273
77,803
41
77,844
(21)
(76)
(285)
(23)
(6)
(105)
(11)
(269)
(796)
(8)
(804)
Total
Fair
value
US$m
Unrealised
losses
US$m
1,214
1,955
11,766
281
1,385
9,644
1,889
41,149
69,283
52
69,335
(23)
(52)
(292)
(1)
(23)
(87)
(12)
(415)
(905)
(6)
(911)
losses
US$m
(9)
(35)
(171)
–
(6)
(49)
(6)
(226)
(502)
–
(502)
losses
US$m
(1)
(24)
(100)
(1)
–
(54)
(5)
(131)
(316)
–
(316)
Under US GAAP, 4,811 debt security investments and 37 investments in equity shares had unrealised losses at
31 December 2006.
Period investment has been in an unrealised loss position
Less than one year
Greater than or
equal to one year
Unrealised
Unrealised
Fair
value
US$m
Under US GAAP, 3,615 debt security investments and 15 investments in equity shares had unrealised losses at
31 December 2005.
It is HSBC’s policy, under both IFRSs and US GAAP, to recognise in the income statement an impairment if the
fair value of a financial investment significantly declines below its cost or if the decline is prolonged over a
period exceeding six months. The only exception to this policy is in respect of debt securities whose decline in
market value is due solely to an increase in underlying interest rates, and which HSBC has the ability and intent
to hold until recovery. None of the securities disclosed in the table above were considered ‘other-than-
temporarily’ impaired at 31 December 2006 or 2005.
427
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 47
(g) Taxation
The components of the net deferred tax liability calculated under SFAS 109 ‘Accounting for income taxes’, were
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
Loan impairment allowances ....................................................................................................
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 ......................................................
2006
US$m
1,681
310
112
1,334
4,227
7,664
3,011
847
1,349
5,664
10,871
(1,187)
9,684
2,020
2,592
(572)
2005
US$m
2,533
138
18
2,163
2,004
6,856
1,974
587
1,050
4,981
8,592
(794)
7,798
942
2,717
(1,775)
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 2006, HSBC had recognised deferred tax assets in respect of tax losses (net of valuation
allowances) totalling US$180 million (2005: US$223 million), of which US$4 million (2005: US$4 million)
expire within two to five years and US$176 million (2005: US$219 million) expire in 5 years or more.
(h) Loans and advances
Loans assessed under SFAS 114 ‘Accounting by creditors for impairment of a loan’
SFAS 114 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 2005, 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 IFRSs financial statements was such that no adjustment to net
income or total shareholders’ equity was required.
The value of impaired loans at 31 December 2006 was US$13,800 million (2005: US$11,535 million). Of this
total, loans which were included within the scope of SFAS 114 and for which a provision had been established
amounted to US$5,944 million (2005: US$5,082 million). The impairment reserve in respect of these loans
estimated in accordance with the provisions of SFAS 114 was US$2,572 million (2005: US$2,675 million).
During the year ended 31 December 2006, impaired loans, including those excluded from the scope of
SFAS 114, averaged US$11,791 million (2005: US$11,289 million) and interest income recognised on these
loans was US$276 million (2005: US$120 million).
428
Loans outside the scope of SFAS 114
For smaller-balance homogeneous loans for which future cash flows from written-off balances can reasonably be
estimated on a portfolio basis, an asset equal to the present value of the cash flows is recognised under IFRSs as
it was previously under UK GAAP. This asset is not recognised for US GAAP purposes. This divergence
resulted in lower net income in 2006 of US$45 million (2005: US$20 million higher) under US GAAP compared
with IFRSs, and a reduction in the carrying value of loans and advances to customers and shareholders’ equity at
31 December 2006 of US$372 million (2005: US$327 million).
(i) Earnings per share
Basic earnings per share under US GAAP, SFAS 128 ‘Earnings per Share’, is calculated by dividing net income
attributable to ordinary shareholders of the parent company of US$16,268 million (2005: US$14,703 million;
2004: US$12,506 million) by the weighted average number of ordinary shares in issue in 2006 of 11,214 million
(2005: 11,042 million; 2004: US$10,916 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 2006 of 11,324 million (2005: 11,175 million; 2004: 11,063 million).
(j) Variable interest entities (‘VIEs’)
Nature, purpose and activities of VIEs with which HSBC is involved
HSBC uses VIE structures in the normal course of business in a variety of activities (outlined below), but
primarily to facilitate client needs. HSBC’s involvement in VIEs is, therefore, commercially driven. VIEs are
only used after careful consideration is given to the most appropriate structure to achieve HSBC’s objectives
from control, risk allocation, taxation and regulatory perspectives. 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 thereby
provide HSBC with a cost-effective source of financing. Under both structures, commercial paper, notes, or
equity interests are issued to investors to fund the purchase of receivables, and cash received from the
receivables is used to service the finance provided by the 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 from commitments to provide back-up liquidity facilities for the
vehicles; interest-rate swaps in which HSBC is the counterparty; retained or acquired interests in the
receivables sold; or acquired interests in the vehicles themselves. In certain vehicles, the risk of loss to
HSBC is reduced by credit enhancements provided by the originator of the receivables or other parties.
In addition to these securitisation vehicles, HSBC (primarily through its North American subsidiaries)
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 IFRSs.
(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 dividing into
tranches the risk associated with such projects. HSBC’s exposure to loss generally arises from the provision
of subordinated or mezzanine debt finance to projects, either directly or through a consolidated investment
fund investing in infrastructure projects.
HSBC is deemed to be the primary beneficiary of an infrastructure project or fund when its investment in a
project’s equity, subordinated debt or mezzanine debt, or its interest in a fund, is at a level at which it
absorbs the majority of the expected losses or residual returns of the project or fund.
429
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 47
Application of FIN 46R
FIN 46R requires the consolidation of VIEs in which HSBC is the primary beneficiary, and disclosures in
respect of other VIEs in which HSBC has a significant variable interest.
Under IFRSs, HSBC consolidates entities in which it has a controlling interest. For SPEs, determination of the
entity that holds the controlling interest involves a balanced assessment of certain factors, including an analysis
of risks and rewards incidental to their activities. 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 .............................................................................................
Financial investments ................................................................................................................
Tangible fixed assets .................................................................................................................
Other assets ...............................................................................................................................
At 31 December
2006
US$m
23,937
27,715
1,617
876
54,145
2005
US$m
23,843
4,403
2,017
256
30,519
Of the 2006 total, US$48,699 million (2005: US$23,843 million) represented asset-backed commercial paper
conduits and securitisation vehicles, and US$2,683 million (2005: US$2,017 million) represented infrastructure
projects and funds. The remaining balance consisted of guaranteed pension funds, investment funds, and other
entities. Certain of these entities with assets of approximately US$54,145 million at 31 December 2006 (2005:
US$19,475 million) were consolidated by HSBC in its IFRSs financial statements. There was no significant
impact on net income under US GAAP for the year ended 31 December 2006 as a result of consolidating these
VIEs.
HSBC also had significant involvement in, but was not the primary beneficiary of, VIEs with total assets of
approximately US$104.9 billion (2005: US$86.2 billion), including asset-backed commercial paper conduits and
securitisation vehicles with assets of approximately US$32.5 billion (2005: US$14.7 billion), infrastructure
projects and funds of approximately US$6.0 billion (2005: US$6.2 billion), and 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 was estimated at
US$19.5 billion (2005: US$9.7 billion) which arose from guarantees, retained interests and recourse liabilities.
HSBC was also involved in other investment funds and similar entities that are considered VIEs for which its
involvement was limited to that of administrator, investment adviser, or other service provider.
In addition, HSBC had an interest in certain capital funding vehicles that are consolidated under IFRSs.
However, under US GAAP, these vehicles were not recognised on HSBC’s balance sheet because it was not the
primary beneficiary.
(k) Consolidated cash flow statement
HSBC prepares its cash flow statement in accordance with IAS 7 ‘Cash Flow Statements’, which is consistent
with the objectives and principles of SFAS 95 ‘Statement of 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’.
(l) Securitisations
HSBC Finance
Following the acquisition of HSBC Finance in 2003, HSBC increased its securitisation activity and the following
discussion relates only to HSBC Finance’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.
In the third quarter of 2004, HSBC began to structure all new collateralised funding transactions as secured
financings. In a secured financing, the underlying receivables and debt remain on HSBC’s balance sheet. HSBC
430
does not recognise a gain in a secured financing transaction. At 31 December 2006, secured financings of
US$23.9 billion included in long-term debt were secured by US$30.5 billion of customer loans.
Prior to the third quarter of 2004, HSBC sold MasterCard and Visa private label, personal non-credit card and
vehicle finance loans in various securitisation transactions. 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 interest-only strip receivables,
which represent 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-related 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.
The following table provides a summary of securitisation revenue:
Net initial gains .......................................................................................
Net replenishment gains from revolving securitisations ........................
Servicing revenue and excess spread ......................................................
Other ........................................................................................................
Total securitisation revenue ....................................................................
2006
US$m
–
30
169
–
199
2005
US$m
–
154
212
6
372
2004
US$m
25
414
569
–
1,008
Certain revolving securitisation trusts, such as credit cards, are established at fixed levels and require frequent
sales of new loan balances into the trusts to replace loans as they run off. These replenishments totalled
US$6 billion in 2006 (2005: US$17.5 billion). Cash flows received from securitisation trusts were as follows:
2006
Proceeds from initial securitisations ..........
Servicing fees received ..............................
Other cash flows received on retained
interests1 .................................................
2005
Proceeds from initial securitisations ..........
Servicing fees received ..............................
Other cash flows received on retained
interests1 .................................................
2004
Proceeds from initial securitisations ..........
Servicing fees received ..............................
Other cash flows received on retained
interests1 .................................................
Real estate
secured
US$m
Vehicle
finance
US$m
MasterCard
/Visa
US$m
Personal
non-credit
card
US$m
Private
label
US$m
–
–
–
–
–
–
–
1
4
–
16
97
–
45
40
–
86
(9)
–
22
108
–
97
243
550
185
705
–
45
11
–
50
109
190
93
252
–
10
18
–
46
52
–
161
80
Total
US$m
–
93
234
–
238
444
740
526
1,032
1 Other cash flows included all cash flows from interest-only strip receivables, excluding servicing fees.
At 31 December 2006, the sensitivity of the current fair value of the interest-only strip receivables to an
immediate 10 per cent and 20 per cent unfavourable change in assumptions are presented in the table below.
These sensitivities are based on assumptions used to value interest-only strip receivables at 31 December 2006.
431
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 47
Carrying value (fair value) of interest-only strip receivables
(US$ millions) ....................................................................................
Weighted average life (in years) .............................................................
Vehicle
finance
(4)
0.7
Credit
card
9
0.3
Personal
non-credit
card
1
0.3
Payment speed assumption (annual rate) ................................................
74.3%
98.9%
99.2%
Impact on fair value of 10% adverse change
(US$ millions) ................................................................................
Impact on fair value of 20% adverse change
(US$ millions) ................................................................................
–
(1)
(1)
(2)
–
–
Expected credit losses (annual rate) .......................................................
10.0%
3.7%
9.8%
Impact on fair value of 10% adverse change
(US$ millions) ................................................................................
Impact on fair value of 20% adverse change
(US$ millions) ................................................................................
(2)
(3)
–
(1)
–
(1)
Discount rate for residual cash flows (annual rate) ................................
10.0%
9.0%
11.0%
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) ................................................................................
–
(1)
–
–
–
–
–
–
–
4.7%
6.0%
(1)
(1)
–
(1)
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
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, 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 2006, static pool credit losses for vehicle
finance loans securitised in 2003 were estimated to be 10 per cent.
Activities of other North American subsidiaries
Through its North American operating subsidiaries, HSBC began acquiring residential mortgage loans from
unrelated third parties in the middle of 2005 with the intention of securitising those loans. In 2006, certain loans
originated by HSBC were also included in this securitisation program. HSBC does not service loans acquired
from third parties in connection with these securitisations.
In addition to securitising loans, HSBC also securitises the net interest margin (NIM) associated with certain
interests it retains from loan securitisations. A NIM securitisation is a structured finance transaction backed by
the cash flows on certain classes of retained interests in loan securitisations, primarily residual interests. The
notes issued in a NIM securitisation are collateralised by the excess spread left after absorbing any realised
losses and satisfying the required over collateralisation levels in the underlying securitisation deal.
HSBC recorded pre-tax gains of US$113 million (2005: US$3 million) from securitisation transactions. Proceeds
received from new securitisations were US$18 billion (2005: US$576 million), and cash flows from retained
interests were US$35 million and (2005: US$7 million).
432
In connection with the securitisations, HSBC’s retained interests include investment grade certificates of
US$316 million and other residual interests of US$176 million at 31 December 2006. Residual interests of
US$14 million were retained at 31 December 2005. Retained interests are recorded in trading assets and are
measured at fair value. Investment grade certificates are valued using quoted market prices. Key assumptions
used during 2006 and 2005 in measuring the fair value of residual interests at the date of securitisation are
presented in the table below.
Expected weighted average life (in years) ......................................................................................
2.1 – 2.7
Payment speed assumption (annual rate) ........................................................................................ 28.5 – 36.0%
Expected credit losses (annual rate) ................................................................................................
2.4 - 4.7%
Discount rate on residual cash flows (annual rate) ......................................................................... 15.0 – 25.0%
2006
2005
3
45.0%
6.0%
20.0%
Key economic assumptions used in measuring the fair value of residual interests in mortgage loans
securitisations and the sensitivity of the current fair values of residual interests to changes in those assumptions
are presented in the table below:
2006
Expected weighted average life (in years) ......................................................................................
1.7 – 2.5
Payment speed assumption (annual rate) ........................................................................................ 31.5 – 44.2%
Impact on fair value of 10% adverse change (US$ millions) .........................................................
(8)
Impact on fair value of 20% adverse change (US$ millions) .........................................................
(17)
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) .........................................................
1.2 – 6.9%
(25)
(41)
Discount rate on residual cash flows (annual rate) ......................................................................... 15.0 – 25.0%
Impact on fair value of 10% adverse change (US$ millions) .........................................................
(8)
Impact on fair value of 20% adverse change (US$ millions) .........................................................
(15)
2005
3
45.0 %
(1)
(2)
6.0%
–
–
20.0%
–
(1)
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 retained interests is
calculated independently from any change in another assumption. In reality, changes in one factor may
contribute to changes in another (for example, increases in market interest rates may result in lower
prepayments) which might magnify or counteract the sensitivities.
Future US GAAP accounting developments
The Financial Accounting Standards Board (‘FASB’) has issued the following accounting standards, which will
become fully effective in future financial statements.
In June 2006, the FASB issued Interpretation No. 48, ‘Accounting for Uncertainty in Income Taxes – an
Interpretation of FASB Statement No. 109’ (FIN 48). FIN 48 establishes threshold and measurement attributes for
financial statement measurement and recognition of tax positions taken or expected to be taken in a tax return.
FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods,
disclosure and transition. FIN 48 is effective for fiscal years beginning after 15 December 2006. Adoption of FIN 48
is not expected to have a material effect on the US GAAP information in HSBC’s financial statements.
In September 2006, the FASB issued SFAS 157 ‘Fair Value Measurements’. SFAS 157 defines fair value, establishes
a framework for measuring fair value in US GAAP and requires expanded disclosures about fair value
measurements. SFAS 157 applies under many other extant US GAAP accounting pronouncements which prescribe
that fair value is the relevant measurement, although the Statement does not extend the use of fair value for
measurement purposes. SFAS 157 is effective for fiscal years beginning after 15 November 2007. HSBC is currently
evaluating the impact that adoption of SFAS 157 will have on its US GAAP financial statements.
In February 2007, the FASB issued SFAS 159 ‘The Fair Value Option for Financial Assets and Financial Liabilities’.
SFAS 159 creates a fair value option under which an entity may irrevocably elect fair value as the initial and
subsequent measurement attribute for certain financial assets and liabilities on a contract-by-contract basis, with
433
H S B C H O L D I N G S P L C
Notes on the Financial Statements (continued)
Note 47 / Shareholder information
changes in fair value recognised in earnings as these changes occur. SFAS 159 is effective as of the beginning of the
first fiscal year beginning after 15 November 2007. HSBC is currently studying the effect that adoption of SFAS 159
will have on its US GAAP financial statements.
434
H S B C H O L D I N G S P L C
Shareholder Information
Information about the enforceability of
judgements made in the US .......................
435
Page
Exchange controls and other limitations
affecting equity security holders ................
Fourth interim dividend for 2006 ..................
Interim dividends for 2007 ............................
Dividends on the ordinary shares of HSBC
Holdings ....................................................
Nature of trading market ...............................
Shareholder profile ........................................
Memorandum and Articles of Association ....
Interim results ...............................................
Annual General Meeting ...............................
Shareholder enquiries and communications ..
Investor relations ...........................................
Where more information about HSBC is
available .....................................................
Taxation of shares and dividends ..................
History and development of HSBC ...............
Organisational structure ................................
435
435
436
436
436
438
438
438
438
439
440
440
440
443
445
Information about the enforceability
of judgements made in the US
HSBC Holdings is a public limited company
incorporated in England and Wales. Most of HSBC
Holdings’ Directors and executive officers live
outside the US. As a result, it may not be possible to
serve process on such persons or HSBC Holdings in
the US or to enforce judgements obtained in US
Fourth interim dividend for 2006
courts against them or HSBC Holdings based on
civil liability provisions of the securities laws of the
US. 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 US or elsewhere may be
unenforceable in the UK. The enforceability of any
judgement in the UK 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 UK. There are also no restrictions
under the laws of the UK 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.
The Directors have declared a fourth interim dividend of US$0.36 per ordinary share (in lieu of a final dividend).
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 3 April 2007. 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 2006 and/or Annual Review 2006, 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 ...................................................
Payment date: dividend warrants, new share certificates or transaction advices and notional tax vouchers mailed and
2007
21 March
23 March
26 March
3 April
26 April
30 April
shares credited to stock accounts in CREST ....................................................................................................................
10 May
435
H S B C H O L D I N G S P L C
Shareholder Information (continued)
Dividends / Nature of trading market
Interim dividends for 2007
The Board has adopted a policy of paying quarterly interim dividends on the ordinary shares. 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 2007 will be US$0.17 per ordinary share. The proposed timetables for the
dividends in respect of 2007 are:
Announcement ..........................................................
ADSs quoted ex-dividend in New York ...................
Shares quoted ex-dividend in London,
Interim dividends for 2007
First
Second
Third
Fourth
30 April 2007
16 May 2007
30 July 2007 5 November 2007
15 August 2007 20 November 2007
3 March 2008
19 March 2008
Hong Kong and Bermuda .....................................
16 May 2007
15 August 2007 21 November 2007
19 March 2008
Record date and closure of Hong Kong Overseas
Branch Register of shareholders for one day ........
Shares quoted ex-dividend in Paris ..........................
Payment date .............................................................
18 May 2007
21 May 2007
5 July 2007
17 August 2007 23 November 2007
20 August 2007 26 November 2007
16 January 2008
4 October 2007
25 March 2008
26 March 2008
7 May 2008
Dividends on the ordinary shares of HSBC Holdings
HSBC Holdings has paid dividends on its ordinary shares every year without interruption since it became the HSBC
Group holding company by a scheme of arrangement in 1991. The dividends declared, per ordinary share, for each of
the last five years were:
First
interim
Second
interim
Third
interim
Fourth
interim1
2006
2005
2004
2003
2002
US$ .......................................
£ ............................................
HK$ ......................................
US$ .......................................
£ ............................................
HK$ .......................................
US$ .......................................
£ ............................................
HK$ .......................................
US$ .......................................
£ ............................................
HK$ .......................................
US$ .......................................
£ ............................................
HK$ .......................................
0.150
0.082
1.164
0.140
0.077
1.088
0.130
0.071
1.013
0.240
0.146
1.860
0.205
0.130
1.599
0.150
0.079
1.167
0.140
0.079
1.086
0.130
0.072
1.014
0.120
0.065
0.931
0.325
0.204
2.535
0.150
0.078
1.168
0.140
0.079
1.085
0.130
0.069
1.013
0.240
0.135
1.871
–
–
–
0.360
0.183
2.799
0.310
0.169
2.403
0.270
0.141
2.104
–
–
–
–
–
–
Total2
0.810
0.422
6.298
0.730
0.404
5.662
0.660
0.353
5.144
0.600
0.345
4.654
0.530
0.334
4.134
1 The fourth interim dividend for 2006 of US$0.360 per share has been translated into pounds sterling and Hong Kong dollars at the
closing rate on 31 December 2006. The dividend will be paid on 10 May 2007.
2 The above dividends declared are accounted for as disclosed in Note 11 on the Financial Statements.
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 ordinary shares are listed or admitted to trading on the London Stock Exchange, the Hong Kong
Stock Exchange (‘HKSE’), Euronext Paris, the New York Stock Exchange (‘NYSE’) and the Bermuda Stock
Exchange. HSBC Holdings maintains its principal share register in England and overseas branch share registers in
Hong Kong and Bermuda (collectively, the ‘share register’).
As at 31 December 2006, there were a total of 205,958 holders of record of HSBC Holdings ordinary shares.
As at 31 December 2006, a total of 13,292,804 of the HSBC Holdings ordinary shares were registered in the
HSBC Holdings share register in the name of 11,525 holders of record with addresses in the US. These shares
represented 0.1149 per cent of the total HSBC Holdings ordinary shares in issue.
436
As at 31 December 2006, there were 11,079 holders of record of ADSs holding approximately 107 million
ADSs, representing approximately 535 million HSBC Holdings ordinary shares. 10,856 of these holders had
addresses in the US, holding approximately 106.9 million ADSs, representing 534.8 million HSBC Holdings
ordinary shares. As at 31 December 2006, approximately 4.5 per cent of the HSBC Holdings ordinary shares were
represented by ADSs held by holders of record with addresses in the US.
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.
High and low mid-market closing prices
London
US$0.50 shares
Hong Kong
US$0.50 shares
New York
ADSs1
Paris
US$0.50 shares
Bermuda2
US$0.50 shares
Low
HK$
High
US$
Low
US$
High
euro
Low
euro
High
US$
High
pence
1028
950
954
914
866
1028
975
985
995
950
936
895
907
Low
pence
914
825
784
631
643
High
HK$
151.2
133.5
136.5
122.5
97.5
124.5
120.1
109.5
80.3
78.8
916
942
914
924
151.2
142.2
142.2
134.0
140.3
134.8
130.6
124.5
873
885
825
832
126.5
129.2
127.0
133.5
120.1
123.0
122.5
122.5
98.4
85.8
87.8
78.8
64.4
98.4
91.8
92.1
86.6
81.6
83.2
81.4
85.8
80.5
77.5
70.0
51.1
50.3
90.2
86.6
84.2
80.5
77.5
79.0
78.6
78.3
15.4
13.9
13.6
13.4
13.9
15.4
14.5
14.4
14.6
13.9
13.6
13.5
13.3
13.3
12.0
11.8
9.3
10.2
13.6
13.7
13.3
13.4
12.8
13.0
12.0
12.2
19.6
17.1
17.3
–
–
19.6
18.4
18.1
17.4
16.5
16.6
16.2
17.1
Low
US$
16.4
15.7
14.5
–
–
18.1
17.3
16.7
16.4
15.7
16.0
15.8
15.9
953
914
145.4
139.0
93.1
90.0
14.4
13.9
18.8
18.0
937
1028
1017
975
970
974
916
938
968
949
942
942
144.6
151.2
147.2
142.1
142.2
140.2
140.3
142.8
141.8
138.1
137.9
134.8
93.4
98.4
95.8
91.8
91.4
91.0
90.2
92.9
91.6
89.2
89.2
86.6
14.1
15.4
15.2
14.5
14.3
14.3
13.6
14.0
14.3
14.0
13.9
13.7
18.7
19.6
19.1
18.4
18.4
18.3
18.1
18.7
18.2
17.9
17.9
17.3
2006 .......................
2005 .......................
2004 .......................
2003 ….. .................
2002 .......................
2006
4th Quarter ..............
3rd Quarter ..............
2nd Quarter ..............
1st Quarter ..............
2005
4th Quarter ..............
3rd Quarter ..............
2nd Quarter ..............
1st Quarter ..............
2007
January ...................
2006
December ...............
November ..............
October ..................
September ..............
August ....................
July .........................
1 In New York each ADS represents 5 underlying ordinary shares.
2 HSBC shares were not listed on the Bermuda Stock Exchange prior to 18 February 2004.
Stock symbols
HSBC Holdings ordinary shares trade under the following stock symbols:
London Stock Exchange
Hong Kong Stock Exchange
New York Stock Exchange (ADS)
Euronext Paris
Bermuda Stock Exchange
HSBA
5
HBC
HSB
HSBC
437
H S B C H O L D I N G S P L C
Shareholder Information (continued)
Profile / Memorandum and Articles / Interim results / AGM / Enquiries and communications
Shareholder profile
At 31 December 2006 the register of members recorded the following details:
Ordinary shares held
1-100 ..................................................................................................................................................
101-400 ..............................................................................................................................................
401-500 ..............................................................................................................................................
501-1,000 ...........................................................................................................................................
1,001-5,000 ........................................................................................................................................
5,001-10,000 ......................................................................................................................................
10,001-20,000 ....................................................................................................................................
20,001-50,000 ....................................................................................................................................
50,001-200,000 ..................................................................................................................................
200,001-500,000 ................................................................................................................................
500,001 and above .............................................................................................................................
Total
Memorandum and Articles of Association
Number of
shareholders
Total
shares held
30,596
33,550
9,364
32,037
67,024
15,430
8,599
5,139
2,559
670
990
978,960
8,491,949
4,246,168
24,073,397
155,123,482
109,211,328
119,423,901
157,408,088
237,501,911
208,679,627
10,547,068,924
205,958
11,572,207,735
The discussion under the caption ‘Memorandum and Articles of Association’ contained in HSBC Holdings’ Annual
Reports on Form 20-F for the years ended 31 December 2000 and 2001 is incorporated by reference herein.
Interim results
The interim results for the six months to 30 June 2007 will be announced on 30 July 2007.
Annual General Meeting
The 2007 Annual General Meeting will be held at the Barbican Hall, Barbican Centre, London EC2 on 25 May 2007
at 11 am.
All resolutions considered at the 2006 Annual General Meeting were passed on a poll as follows:
Resolution
1 To receive the Report and Accounts for 2005 ...........................................
2 To approve the Directors’ Remuneration Report for 2005 .......................
3 To re-elect the following as Directors:
(a) The Baroness Dunn ............................................................................
(b) M F Geoghegan .................................................................................
(c) S K Green ..........................................................................................
(d) Sir Mark Moody-Stuart ......................................................................
(e) S M Robertson ...................................................................................
(f) H Sohmen ..........................................................................................
(g) Sir Brian Williamson .........................................................................
4 To reappoint the Auditor.............................................................................
5 To authorise the Directors to allot shares ..................................................
6 To disapply pre-emption rights (Special Resolution) ................................
7 To authorise the Company to purchase its own Ordinary Shares .............
8 To increase fees payable to each non-executive Directors to £65,000 p.a.
1 Includes discretionary votes.
Total votes
For1
Against
Abstain
4,480,852,415
4,428,404,417
21,235,648
154,287,152
107,249,007
70,543,557
4,612,655,769
4,636,745,575
4,536,123,455
4,626,583,848
4,635,200,010
4,625,766,106
4,637,388,477
4,581,736,221
4,588,458,934
4,593,975,127
4,620,218,288
4,601,744,353
36,639,677
12,088,015
96,828,783
22,231,763
11,818,080
22,794,084
11,612,586
25,270,259
60,705,949
54,420,754
15,470,061
29,609,584
2,104,416
2,185,789
18,179,417
2,202,512
2,264,832
2,617,684
2,204,044
46,246,917
6,033,860
6,831,574
9,882,035
13,995,048
438
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
Telephone: 44 (0) 870 7020137
Email: web.queries@computershare.co.uk
Computershare Hong Kong Investor
Services Limited
Hopewell Centre, 46th Floor
183 Queen’s Road East
Wan Chai
Hong Kong
Telephone: 852 2862 8628
Email: hkinfo@computershare.com.hk
Corporate Shareholder Services
The Bank of Bermuda Limited
6 Front Street
Hamilton HM 11
Bermuda
Telephone: 1 441 299 6737
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
Telephone (US): 1 888 269 2377
Telephone (International): 001 610 382 7836
Email: shareowner-svcs@bankofny.com
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:
HSBC France
103, avenue des Champs Elysées
75419 Paris Cedex 08
France
Telephone: 33 1 40 70 22 56
Further copies of this Annual Report and Accounts 2006 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 Communications
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
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 3 April 2007 from the Registrars:
Computershare Hong Kong Investor Services Limited
Hopewell Centre, 46th Floor
183 Queen’s Road East
Wan Chai
Hong Kong
439
H S B C H O L D I N G S P L C
Shareholder Information (continued)
Investor relations / Where information is available / Taxation of shares and dividends
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
Director – Corporate Finance and
Senior Manager External
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
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 2006, and other
information on HSBC, may be viewed on HSBC’s
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, DC, which is
located at 100 F Street, Room 1580, Washington, DC
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 100 F Street, Mail
Stop 5100, Washington, DC 50549. 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.
Taxation of shares and dividends
Taxation – UK residents
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 UK 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 UK 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
440
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.
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 UK. 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
2004 fourth interim dividend and the first, second
and third interim dividends for 2006 was set out in
the Secretary’s letters to shareholders of 4 April,
1 June, 30 August and 5 December 2006. In each
case, the difference between the cash dividend
foregone and the market value of the scrip dividend
did not equal or exceed 15% of the market value 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.
441
Inheritance tax
Shares or ADSs held by an individual whose
domicile is determined to be the US 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 UK 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 US and was not a national of the UK), (ii) is part
of the business property of a UK permanent
establishment of an enterprise, or (iii) pertains to a
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 UK 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 the current practice of UK HM Revenue and
Customs 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 is generally
payable by the transferee.
Paperless transfers of shares within CREST, the
UK’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 income tax
H S B C H O L D I N G S P L C
Shareholder Information (continued)
Taxation of shares and dividends / History and development
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 US for the purposes of
the income tax convention between the US and the
UK (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 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. Under the current
income tax treaty between the UK and the US,
eligible US holders are no longer entitled to claim a
special foreign tax credit in respect of dividends.
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 Treaty
(and, therefore, will be an eligible US holder) if it is
(i) an individual resident of the US, a US corporation
meeting ownership criteria specified in the Treaty or
other entity meeting criteria specified in the Treaty;
and (ii) not also resident in the UK 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 UK.
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
receives 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 held for less than 61
days or are hedged, and subject to a foreign
442
corporation being considered a ‘qualified foreign
corporation’ (which includes not being classified for
US federal income tax purposes as a passive foreign
investment company), certain dividends (‘qualified
dividends’) received by an individual eligible US
holder before 2009 generally will be subject to US
taxation at a maximum rate of 15 per cent. Based on
the company’s audited financial statements and
relevant market and shareholder data, HSBC
Holdings believes that it was not treated as a passive
foreign investment company for US federal income
tax purposes with respect to its 2005 or 2006 taxable
year. In addition, based on the company’s audited
financial statements and current expectations
regarding the value and nature of its assets, and the
sources and nature of its income, HSBC Holdings
does not anticipate being classified as a passive
foreign investment company for its 2007 taxable
year. Accordingly, dividends paid on the shares or
ADSs generally should be treated as qualified
dividends.
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 UK 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 15 per cent.
Stamp duty and stamp duty reserve tax –
ADSs
If shares are transferred into a clearance service or
depository receipt (‘ADR’) 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 UK, and provided further that any such
transfer or written agreement to transfer is not
executed in the UK. 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 US,
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 US
or through certain financial intermediaries.
History and development of HSBC
1865 The founding member of the HSBC Group,
The Hongkong and Shanghai Banking
Corporation, is established in both Hong
Kong and Shanghai.
1959 The Mercantile Bank of India Limited and
The British Bank of the Middle East, now
HSBC Bank Middle East Limited, are
purchased.
Canadian operations. HSBC Bank Canada
subsequently makes numerous acquisitions,
expanding rapidly to become the largest
foreign-owned bank in Canada and the
seventh-largest overall at 31 December 2006.
1987 A 14.9 per cent interest in Midland Bank plc,
now HSBC Bank plc, one of the UK’s
principal clearing banks, is purchased.
1991 HSBC Holdings plc is established as the
parent company of the HSBC Group.
1992 HSBC purchases the remaining interest in
Midland Bank plc.
1993 As a consequence of the Midland acquisition,
HSBC’s head office is transferred from Hong
Kong to London in January.
1997 HSBC assumes selected assets, liabilities and
subsidiaries of Banco Bamerindus do Brasil
S.A., now HSBC Bank Brazil, following the
intervention of the Central Bank of Brazil,
and in Argentina completes the acquisition of
Grupo Roberts, now part of HSBC Bank
Argentina S.A.
1999 HSBC acquires Republic New York
Corporation, subsequently merged with
HSBC USA, Inc., and Safra Republic
Holdings S.A.
2000 HSBC completes its acquisition of 99.99 per
cent of the issued share capital of Crédit
Commercial de France S.A., now HSBC
France.
2002 HSBC acquires 99.59 per cent of Grupo
Financiero Bital, S.A. de C.V., the holding
company of what is now HSBC Mexico.
2003 HSBC acquires Household International, Inc.,
now HSBC Finance Corporation. HSBC
Finance brings to the Group national
coverage in the US for consumer lending,
credit cards and credit insurance through
multiple distribution channels.
1965 A 51 per cent interest (subsequently increased
2003 HSBC acquires Banco Lloyds TSB S.A.-
to 62.14 per cent) is acquired in Hang Seng
Bank Limited. Hang Seng Bank is the fourth-
largest listed bank in Hong Kong by market
capitalisation.
1980 A 51 per cent interest in Marine Midland
Banks, Inc., now HSBC USA, Inc, is acquired
(with the remaining interest acquired in
1987).
1981 The Hongkong and Shanghai Banking
Corporation incorporates its then existing
Banco Múltiplo in Brazil and the country’s
leading consumer finance company, Losango
Promotora de Vendas Limitada.
2004 HSBC Bank USA, Inc. merges with HSBC
Bank & Trust (Delaware) N.A. to form HSBC
Bank USA, N.A.
2004 The acquisition of The Bank of Bermuda
Limited is completed.
443
H S B C H O L D I N G S P L C
Shareholder Information (continued)
History and development / Organisational structure
2004 HSBC acquires Marks and Spencer Retail
Financial Services Holdings Limited, which
trades as Marks and Spencer Money (‘M&S
Money’) in the UK.
2004 HSBC acquires 19.9 per cent of Bank of
Communications, mainland China’s fifth-
largest bank by total assets, and Hang Seng
Bank acquires 15.98 per cent of Industrial
Bank.
2005 HSBC increases its holding in Ping An
Insurance to 19.9 per cent, having made its
initial investment in 2002. Ping An Insurance
is the second-largest life insurer and the third-
largest property and casualty insurer in
mainland China.
2005 HSBC Finance completes the acquisition of
Metris Companies Inc., making HSBC the
fifth-largest issuer of MasterCard and Visa
cards in the USA.
2006
In July, HSBC enters into an agreement with
Grupo Banistmo S.A. (‘Banistmo’), the
leading banking group in Central America, to
make a tender offer to acquire 99.98 per cent
of the outstanding shares of Banistmo for a
total consideration of US$1.97 billion. The
transaction is completed in November.
Banistmo’s principal area of operation is
Panama, but the group also has a significant
presence in five countries new to HSBC,
namely Costa Rica, Honduras, Colombia,
Nicaragua and El Salvador.
444
Organisational Structure
445
H S B C H O L D I N G S P L C
Glossary
Accounting terms used
US equivalent or brief description
Accounts
Articles of Association
Associates
Attributable profit
Balance sheet
Bills
Called up share capital
Capital allowances
Creditors
Debtors
Deferred tax
Depreciation
Finance lease
Freehold
Interests in associates and joint ventures
Loans and advances
Loan capital
Nominal value
One-off
Ordinary shares
Overdraft
Financial Statements
Bylaws
Long-term equity investments accounted for using the equity method
Net income
Statement of financial position
Notes
Ordinary shares, issued and fully paid
Tax depreciation allowances
Payables
Receivables
Deferred income tax
Amortisation
Capital lease
Ownership with absolute rights in perpetuity
Long-term equity investments accounted for using the equity method
Lendings
Long-term debt
Par value
Non-recurring
Common stock
A line of credit, contractually repayable on demand unless a fixed-term has
been agreed, established through a customer’s current account
Preference shares
Premises
Provisions
Share capital
Shareholders’ equity
Share premium account
Shares in issue
Write-offs
Preferred stock
Real estate
Allowances
Ordinary shares or common stock issued and fully paid
Stockholders’ equity
Additional paid-in capital
Shares outstanding
Charge-offs
446
Abbreviations used
Brief description
ABC
ABS
ADR
ADS
AICPA
AIEA
ALCO
ARB
ARM
ATM
Bank of Bermuda
Bank of Communications
Basel Committee
Basel II
Asset-backed conduits
Asset-backed securities
American depositary receipt
American depositary share
The American Institute of Certified Public Accountants
Average interest-earning assets
Asset and liability management committee
Accounting Research Bulletin (US)
Adjustable-rate mortgage
Automated teller machines
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 per cent interest in August 2004
The Basel Committee on Banking Supervision
The Final Accord of the Basel Committee on proposals for a new capital
adequacy framework
Brazilian operations
HSBC Bank Brasil S.A.-Banco Múltiplo and subsidiaries, plus HSBC
CCF
CGU
Combined Code
CRM
CSA
Decision One
DPF
EITF
EPS award
EU
FASB
FDIC
FFIEC
FHC
FIN
FSA
FSMA
FTSE
GAAP
GDP
GHOS
Global Markets
Group
Hang Seng Bank
HFC
HKMA
HKSE
Hong Kong
Serviços e Participações Limitada
CCF S.A., the former name of HSBC France
Cash generating unit
Combined Code on Corporate Governance issued by the Financial Reporting
Council
Customer relationship management
Credit support annex
Decision One Mortgage Company, HSBC Finance’s subsidiary which
originates loans referred by mortgage brokers
Discretionary participation feature of insurance and investment contracts
Emerging Issues Task Force (US)
Earnings per share measure applied to half of the award of Performance
Shares under The HSBC Share Plan
European Union
Financial Accounting Standards Board (US)
Federal Deposit Insurance Corporation (US)
Federal Financial Institution Examination Council
Financial holding company, as defined under the Gramm-Leach-Bliley Act
amendments to the BHCA
FASB Interpretation (US)
Financial Services Authority (UK)
Financial Services and Markets Act 2000 (UK)
Financial Times – Stock Exchange index
Generally Accepted Accounting Principles
Gross domestic product
Hong Kong Government Home Ownership Scheme
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 fourth 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
The Hong Kong Monetary Authority
The Stock Exchange of Hong Kong Limited
The Hong Kong Special Administrative Region of the People’s Republic of
China
447
H S B C H O L D I N G S P L C
Glossary (continued)
Abbreviations used
Brief description
HNAH
HSBC
HSBC Bank
HSBC Bank Argentina
HSBC Bank Brazil
HSBC North America Holdings Inc, the bank holding company formed on
1 January 2004 to hold all of HSBC’s North America operations
HSBC Holdings together with its 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 Delaware
HSBC Trust Company (Delaware), N.A., a US nationally chartered bank
HSBC Bank Malaysia
HSBC Bank Middle East
restricted to trust activities
HSBC Bank Malaysia Berhad
HSBC Bank Middle East Limited, formerly The British Bank of the Middle
East
HSBC Bank Nevada
HSBC Bank Nevada, NA, (formerly Household Bank (SB), N.A.) a nationally
HSBC Bank USA
HSBC’s retail bank in the US. From 1 July 2004, HSBC Bank USA, N.A.
chartered ‘credit card bank’ in the US which is a subsidiary of HSBC
Finance
HSBC Finance
HSBC France
HSBC Holdings
HSBC Mexico
(formerly HSBC Bank USA, Inc.)
HSBC Finance Corporation, the US consumer finance company acquired in
March 2003 (formerly Household International, Inc.)
HSBC’s French banking subsidiary, whose name was changed from CCF
S.A. (previously Crédit Commercial de France S.A.) in 2005
HSBC Holdings plc, the parent company of HSBC
HSBC México S.A., the commercial banking subsidiary of Grupo Financiero
HSBC, S.A. de C.V. and the fifth-largest bank in Mexico by deposits and
assets
HSBC Private Bank (Suisse)
HSBC Private Bank (Suisse) S.A., HSBC’s private bank in Switzerland
IAS
IFRSs
IFRIC
IGU
Industrial Bank
IPO
Key Management Personnel
KPMG
Losango
Mainland China
Metris
M&S Money
MMEs
MSCI
MSRs
NA
NIM
NYSE
OCC
OCI
OFT
Option ARMS
(formerly HSBC Republic Bank (Suisse) S.A.)
International Accounting Standard
International Financial Reporting Standards
International Financial Reporting Interpretations Committee
Income generating unit
Industrial Bank Co. Limited, a national joint-stock bank in mainland China of
which Hang Seng acquired a 15.98 per cent interest in 2004
Initial public offering
Directors and Group Managing Directors of HSBC Holdings
KPMG Audit plc and its affiliates
Losango Promotora de Vendas Limitada, the Brazilian consumer finance
company acquired in December 2003
People’s Republic of China excluding Hong Kong
Metris Companies Inc., US credit card issuer acquired in December 2005
Marks and Spencer Retail Financial Services Holdings Limited, acquired by
HSBC in November 2004
Middle market enterprises
Morgan Stanley Capital International index
Mortgage servicing rights
Nationally Chartered, a designation for certain categories of banks in the US
Net interest margin
New York Stock Exchange
Office of the Comptroller of the Currency (US)
Other comprehensive income
Office of Fair Trading (UK)
Adjustable-rate mortgage with alternative payment options
448
Abbreviations used
Patriot Act
Performance Shares
Brief description
The US Patriot Act of October 2001
Awards of HSBC Holdings ordinary shares under employee share plans that
are subject to corporate performance conditions
Pesification
The mandatory and asymmetrical conversion of onshore US dollar-
denominated assets and liabilities in Argentina
Ping An Insurance
Ping An Insurance (Group) Company of China, Limited, the second-largest
PVBP
PVIF
Repos
Restricted shares
Reverse repos
RMB
Seasoning
SEC
Senior Management
life insurer in the PRC, in which HSBC holds 16.8 per cent
Present value of a basis point
Present value of in-force long-term insurance business
Sale and repurchase transactions
Awards of HSBC Holdings ordinary shares to which the employee will
become entitled, normally after three years, subject to remaining an
employee
Securities purchased under commitments to sell
Renminbi, the currency of mainland China
The emergence of credit loss patterns in portfolios over time
Securities and Exchange Commission (US)
Group Managing Directors, the Group Chief Accounting Officer and the
Group Company Secretary
SFAS
SIC
SME
SOP
SPE
The Hongkong and Shanghai Banking
Statement of Financial Accounting Standards (US)
Standing Interpretations Committee (US)
Small and medium-sized enterprise
Statement of Position issued by the AICPA (US)
Special purpose entity
The Hongkong and Shanghai Banking Corporation Limited, the founding
Corporation
TSR
TSR award
UK
UK GAAP
US
US GAAP
VAR
VIE
WHIRL
WTAS
WWF
member of the HSBC Group
Total shareholder return
TSR measure applied to half of the award of Performance Shares under
The HSBC Share Plan
United Kingdom
UK Generally Accepted Accounting Principles
United States of America
US Generally Accepted Accounting Principles
Value at risk
Variable interest entity
Worldwide Household International Revolving Lending system
Wealth and Tax Advisory Services, Inc.
World Wide Fund for Nature
449
H S B C H O L D I N G S P L C
Index
Accounting
developments (future) 303, 433
policies (critical) 111
policies (significant) 304
requirements in UK and Hong Kong 403
Accounts
approval 403
basis of preparation 26, 301
Annual General Meeting 279, 438
Assets
by customer group 12, 344
by geographical region 26, 340
charged as security 386
deployment 144
held in custody and under administration 145
other 371
trading 144, 350
Associates and joint ventures
interests in 360
share of profit in 142
Audit committee (Group) 259
Auditors’ remuneration 331
Auditors’ Report 291
Balance sheet
average 147
consolidated 295
HSBC Holdings 298
US GAAP basis 420
Basel II 244
Borrowings (short-term) 158
Business highlights 13, 16, 18, 20
Business performance review
Europe 32, 39
Hong Kong 49, 53
Latin America 92, 98
North America 76, 83
Rest of Asia-Pacific 62, 67
Calendar (dividends) 435, 436
Capital
events 157
management and allocation 243
return on invested capital 1
structure 246
Capital and performance ratios 2
Cash flow
accounting policy 317
consolidated statement 297
HSBC Holdings 300
IFRSs/US GAAP differences 430
notes 395
payable under financial liabilities 214
Cautionary statement regarding forward-looking
statements 4
Certificates of deposit and other time deposits
(maturity analysis) 162
Collateral and credit enhancements 173, 196
Commercial Banking
business highlights 16
performance in Europe 35, 41
performance in Hong Kong 50, 54
performance in Latin America 95, 100
performance in North America 80, 86
performance in Rest of Asia-Pacific 64, 68
products and services 107
strategic direction 16
Committees (board) 259
Communication with shareholders 278
Community involvement 277
Comparison of financial information 111
Competitive environment 27
Constant currency 110
Contents inside front cover, 11, 110, 165, 248, 280,
293, 435
Contingent liabilities and contractual
commitments 396
Contractual obligations 158
Corporate governance
codes 257
report 248
Corporate, Investment Banking and Markets
business highlights 18
performance in Europe 36, 42
performance in Hong Kong 51, 56
performance in Latin America 97, 101
performance in North America 81, 86
performance in Rest of Asia-Pacific 65, 69
products and services 108
strategic direction 18
Corporate responsibility 276
committee 262
reporting 278
Cost efficiency ratio 1, 142
Credit exposure 176
Credit quality of loans and advances 192
Credit risk
management thereof 171
insurance 237
Critical accounting policies 111
Cross-border exposures 176, 191
Customer groups and global businesses 12
profit before tax 23
Dealings in HSBC Holdings plc shares 279
Debt securities in issue 372
accounting policy 317
rating agency designation 188
Defined terms inside front cover
Deposits
average balances and average rates 160
Derivatives 352
accounting policy 309
IFRSs/US GAAP differences 405, 423
Directors
biographies 248
board of directors 254
emoluments 286, 330
interests 264
non-executive 285
other directorships 284
pensions 284, 286
remuneration (executive) 280
responsibilities (statement of) 290
service contracts 284
Dividends 1, 278, 339, 435, 436
Donations 277
450
Earnings per share 1, 339
IFRSs/US GAAP differences 429
Economic briefing
Europe 31, 38
Hong Kong 49, 53
Latin America 91, 97
North America 75, 82
Rest of Asia-Pacific 60, 66
Economic profit 146
Employees 265
compensation and benefits 275, 320
disabled 266
involvement 266
remuneration policy 266
Enforceability of judgements made in the US 435
Enquiries (from shareholders) 439
Equity 392
Equity compensation plans
accounting policy 314
Europe
business performance 32, 39
competitive environment 28
economic briefing 31, 38
lending 179
loan impairment charges 205
profit/(loss) 31, 32, 45
regulation and supervision (UK) 166
Events after the balance sheet date 402
Exchange controls and other limitations affecting
equity security holders 435
Fee income (net) 125
Financial assets designated at fair value 351
Financial assets and liabilities
by measurement basis 346
IFRSs/US GAAP differences 409
Financial highlights 1
Financial instruments designated at fair value
accounting policy 308
fair value 382
net income from 129, 317
critical accounting policy (valuation) 114
Financial investments 356, 426
accounting policy 308
concentration of exposure 178
gains less losses from 131
Financial liabilities designated at fair value 372
Financial risks (insurance) 233
Financial statements 294
Five-year comparison 3
Fixed assets (intangible) 363
Foreign exchange exposures 223, 385, 426
accounting policy 314
Funds under management 145
Geographical regions 26
Glossary 446
Goodwill
accounting policy 312
and intangible assets 362
critical accounting policy 113
IFRSs/US GAAP differences 405, 422
Governance codes 257
HSBC Holdings/New York Stock Exchange
451
corporate governance differences 257
Group Chairman’s Statement 6
Health and safety 277
History and development of HSBC 443
Hong Kong
business performance 49, 53
competitive environment 29
economic briefing 49, 53
lending 179
loan impairment charges 206
profit/(loss) 48, 57
regulation and supervision 167
HSBC Holdings plc
balance sheet 298
cash flow 300
credit risk 211
dividends 435
employee emoluments 330
fair value of financial instruments 383
financial assets and liabilities 349
liquidity and funding management 215
maturity analysis of assets and liabilities 385
statement of changes in total equity 299
structural foreign exchange exposures 223
subordinated liabilities 381
Impairment
accounting policy 305
allowances and charges 197
assessment 174
charges 136, 197, 203
collectively assessed 175
critical accounting policy 111
IFRSs/US GAAP differences 413
impairment allowances 176
individually assessed 174
loan write-offs 176
movement by industry and geographical
region 198
of assets other than financial instruments 364
Income statement
consolidated 119, 294
Information on HSBC (availability thereof) 440
Insurance
accounting policy 315
assets and liabilities (long-term)
IFRSs/US GAAP differences 417
claims incurred (net) and movements in
policyholders’ liabilities 135, 318
insurance fund (shareholders interest in)
IFRSs/US GAAP differences 403
liabilities under contracts issued 374
net earned premiums 132, 318
risk management 228
Intangible assets
IFRSs/US GAAP differences 405, 423
Interest income (net) 122
accounting policy 304
analysis of changes in 154
average balance sheet 147
forgone on impaired loans 196
sensitivity 221
Interest recognition
H S B C H O L D I N G S P L C
Index (continued)
IFRSs/US GAAP differences 414
Interim results 438
Internal control 262
International Financial Reporting Standards
Hong Kong Financial Reporting Standards
comparison 301, 403
US GAAP comparison / differences 110, 301,
403, 418
Investment contracts
accounting policy 316
Investor relations 440
Key performance indicators
financial 115
non-financial 117
Latin America
business performance 92, 98
competitive environment 30
economic briefing 91, 97
lending 179
loan impairment charges 206
loans and advances to customers 186
profit/(loss) 91, 103
Lease commitments 398
accounting policy 313
Legal proceedings 109
litigation 399
litigation risk 225
Liabilities
by geographical regions 340
other 373
subordinated 378
trading 371
Life insurance business 228
Liquidity and funding
management thereof 213
insurance 240
Loans and advances
accounting policy 305
credit quality 192
concentration of exposure 177
delinquency in the US 209
by industry sector and geographic
region 178
IFRSs/US GAAP differences 428
impairment 194, 210
maturity and interest sensitivity 159
to banks by geographic region 187
Loan originations
IFRSs/US GAAP differences 412
Management Board (Group) 259
Market risk
management thereof 216
insurance 235
Maturity analysis of assets and liabilities 383
Maximum exposure to credit risk 176
Memorandum and Articles of Association 438
Minority interests 387
Mortgage lending
in the US 190
products 189
Mortgage servicing rights
IFRSs/US GAAP differences 414
452
Nomination committee 261
Non-life insurance business 228
Non-trading portfolios 219
North America
business performance 76, 83
competitive environment 29
economic briefing 75, 82
lending 179
loan delinquency in the US 209
loan impairment charges 206
mortgage lending 190
profit/(loss) 75, 76, 88
regulation and supervision (US) 168
Off-balance sheet arrangements 163
Operating expenses 139
Operating income
net 319
other 133
Operational risk management 225
Organisational structure chart 445
Other (notes) 22
in Europe 38, 44
in Hong Kong 52,56
in Latin America 97, 102
in North America 82, 87
in Rest of Asia-Pacific 66, 71
Own shares held
IFRSs/US GAAP differences 415
Pensions
accounting policy 314
for directors 284, 286
IFRSs/US GAAP differences 403, 421
risk 226
Personal Financial Services
business highlights 13
performance in Europe 33, 39
performance in Hong Kong 49, 53
performance in Latin America 93, 98
performance in North America 77, 83
performance in Rest of Asia-Pacific 62, 67
products and services 106
strategic direction 13
Principal activities 11
Private Banking
business highlights 20
performance in Europe 37, 43
performance in Hong Kong 52, 56
performance in Latin America 97, 102
performance in North America 82, 87
performance in Rest of Asia-Pacific 66, 70
products and services 108
strategic direction 20
Products and services 106
Profit before tax
by customer group 12, 13, 16, 18, 20, 22, 23,
344
by geographical region 26, 45, 57, 72, 88, 103
Property, plant and equipment 109, 366
accounting policy 312
IFRSs/US GAAP differences 416
valuation of land and buildings 109
Provisions 377
accounting policy 315
Purchase accounting
IFRSs/US GAAP differences 405
PVIF 241
Ratios
capital and performance 2
cost efficiency 142
net liquid assets to customer liabilities 215
Regulation and supervision 165
Related party transactions 399
Remuneration committee 261, 280
Renegotiated loans 196
Reputational risk 227
Residual value risk management 224
Rest of Asia-Pacific
business performance 62, 67
competitive environment 29
economic briefing 60, 66
lending 179
loan impairment charges 206
loans and advances to customers 186
profit/(loss) 60, 72
Restructuring provisions
IFRSs/US GAAP differences 416
Risk elements in loan portfolio 211
Risk management 170
capital management and allocation 243
credit 171
insurance operations 228
legal litigation 225
liquidity and funding management 213
market 216
operational 225
pension 226
reputational 227
residual value 224
sustainability 227
Risk-weighted assets
by principal subsidiary 247
Sale and repurchase agreements
accounting policy 309
Securities
available-for-sale
IFRSs/US GAAP differences 410, 426
held for trading (concentration of exposure)
178
unquoted equity
Share-based payments 332
Share capital 387
accounting policy 317
and reserves 157
notifiable interests in 278
Share information 2
Share option plans
Bank of Bermuda plans 274
discretionary plans 270
for directors 287
for employees 267
HSBC Finance and subsidiary plans 272, 337
HSBC France and subsidiary plans 271, 337
performance shares and restricted share
awards 269
Shareholder 278
profile 438
Special interest (areas of) 189
Staff numbers 139, 265
Statement of recognised income and expense 296
Stock-based compensation
IFRSs/US GAAP differences 404
Stock symbols 437
Strategic direction 11, 13, 16, 18, 20
Structural foreign exchange exposure 223
Subsidiaries 368
accounting policy 311
Supplier payment policy 277
Sustainability (investing in) 276
Sustainability risk management 227
Taxation
accounting policy 313
expense 338
IFRSs/US GAAP differences 428
UK residents 440
US residents 441
Total shareholder return 283
Trading assets and financial investments 144, 350
accounting policy 307
Trading income (net) 128
Trading liabilities 371
accounting policy 307
Trading market (nature of) 436
Trading portfolios 218
Troubled debt restructurings 211
Unearned commission income
IFRSs/US GAAP differences 415
IFRSs/US GAAP differences 411
US GAAP
Securitisations
and other structural transactions 359
IFRSs/US GAAP differences 412, 430
Segment analysis 340
Senior management
biographies 251
future accounting developments 433
IFRSs comparison/differences 110, 403, 418
selected financial data 4
Value at risk 216
Variable interest entities
IFRSs/US GAAP differences 416, 429
453
STOCKBROKERS
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HSBC Bank plc
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HSBC HOLDINGS PLC
Incorporated in England on 1 January 1959 with
limited liability under the UK Companies Act
Registered in England: number 617987
REGISTERED OFFICE AND
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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
USA
Telephone: 1 888 269 2377
Paying Agent (France)
HSBC France
103 avenue des Champs Elysées
75419 Paris Cedex 08
France
Telephone: 33 1 40 70 22 56
454
© Copyright HSBC Holdings plc 2007
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Published by Group Finances, HSBC Holdings plc,
London
Cover designed by Addison Corporate Marketing
Limited, London; text pages designed by Group Public
Affairs, The Hongkong and Shanghai Banking
Corporation Limited, Hong Kong
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Photography
Cover
Group Chairman
Philip Gostelow
Niall McDiarmid
HSBC Holdings plc
8 Canada Square, London E14 5HQ, United Kingdom
Telephone: 44 020 7991 8888 Facsimile: 44 020 7992 4880
www.hsbc.com