As filed with the Securities and Exchange Commission on March 5, 2004.
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549
FORM 20-F
For the transition period from N/A to N/ACommission file number: 1-14930
HSBC Holdings plc(Exact name of Registrant as specified in its charter)
8 Canada SquareLondon E14 5HQUnited Kingdom(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:
Securities registered or to be registered pursuant to Section 12(g) of the Securities Exchange Act of 1934:
None
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Securities Exchange Act of 1934:
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the period covered by the annual report:
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark which financial statements Item the registrant has elected to follow:
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H S B C H O L D I N G S P L C
Table of Contents
Financial Highlights
HSBC judges its own performance by comparing returns before goodwill amortisation on cash invested as HSBC believes this gives an important measure of its underlying performance and facilitates comparison with its peer group. Profit before goodwill amortisation is derived by adjusting reported earnings to eliminate the impact of the amortisation of goodwill arising on acquisitions. The derivation of non-GAAP measures from the equivalent reported measures is explained in the ‘Footnotes to Financial Highlights’ on page 4.
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FinancialHighlights(continued)
For the above footnotes, see ‘Footnotes to Financial Highlights’ on page 4.
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Cautionary Statement Regarding Forward-Looking Statements
This Annual Report contains certain forward-looking statements with respect to the financial condition, results of operations and business of HSBC.
Statements that are not historical facts, including statements about HSBC’s beliefs and expectations, are forward-looking statements. Words such as ‘expects’, ‘anticipates’, ‘intends’, ‘plans’, ‘believes’, ‘seeks’, ‘estimates’, ‘potential’, ‘reasonably possible’ and variations of these words and similar expressions are intended to identify forward-looking statements. These statements are based on current plans, estimates and projections, and therefore undue reliance should not be placed on them. Forward-looking statements speak only as of the date they are made, and it should not be assumed that they have been revised or updated in the light of new information or future events.
Written and/or oral forward-looking statements may also be made in the periodic reports to the US Securities and Exchange Commission, summary financial statements to shareholders, proxy statements, offering circulars and prospectuses, press releases and other written materials, and in oral statements made by HSBC’s Directors, officers or employees to third parties, including financial analysts.
Forward-looking statements involve inherent risks and uncertainties. Readers are cautioned that a number of factors could cause actual results to differ, in some instances materially, from those anticipated or implied in any forward-looking statement. These factors include, among others:
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Cautionary Statement Regarding Forward-Looking Statements (continued)
Information About the Enforceability of Judgements made in the United States
HSBC Holdings is a public limited company incorporated in England and Wales. Most of HSBC Holdings’ Directors and executive officers live outside the United States. As a result, it may not be possible to serve process on such persons or HSBC Holdings in the United States or to enforce judgements obtained in US courts against them or HSBC Holdings based on civil liability provisions of the securities laws of the United States. There is doubt as to whether English courts would enforce:
in original actions; or
In addition, awards of punitive damages in actions brought in the United States or elsewhere may be unenforceable in the United Kingdom. The enforceability of any judgement in the United Kingdom will depend on the particular facts of the case as well as the laws and treaties in effect at the time.
Exchange Controls and Other Limitations Affecting Equity Security Holders
There are currently no UK laws, decrees or regulations which would prevent the transfer of capital or remittance of distributable profits by way of dividends and other payments to holders of HSBC Holdings’ equity securities who are not residents of the United Kingdom. There are also no restrictions
under the laws of the United Kingdom or the terms of the Memorandum and Articles of Association of HSBC Holdings concerning the right of non-resident or foreign owners to hold HSBC Holdings’ equity securities or, when entitled to vote, to do so.
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Description of Business
HSBC is one of the largest banking and financial services organisations in the world, with a market capitalisation of US$172 billion at 31 December 2003.
Headquartered in London, HSBC operates through long-established businesses and has an international network of over 9,500 offices in 79 countries and territories in five regions: Europe; Hong Kong; the rest of Asia-Pacific, including the Middle East and Africa; North America; and South America. Within these geographical regions, a comprehensive range of financial services is offered to personal, commercial, corporate, institutional, investment and private banking clients. HSBC manages its business through the following customer groups: Personal Financial Services; Commercial Banking; Corporate, Investment Banking and Markets; and Private Banking. Whilst part of Personal Financial Services, the consumer finance operations of Household are currently a distinct business and have been separately identified accordingly. Services are delivered through businesses which usually operate as domestic banks, typically with large retail deposit bases and strong liquidity and capital ratios. In North America, Household is one of the largest consumer finance companies in the US, and is substantially funded in the wholesale market. By using HSBC’s extensive technological links, businesses are able to access its wide range of products and services and adapt them to local customer needs.
The establishment of HSBC and its hexagon symbol as a uniform, international brand has ensured that it has become an increasingly familiar sight across the world.
The founding member of HSBC, The Hongkong and Shanghai Banking Corporation Limited (‘The Hongkong and Shanghai Banking Corporation’), was established in Hong Kong and Shanghai in 1865. The bank expanded rapidly, with an emphasis on building up representation in China and the rest of the Asia-Pacific region, whilst also establishing a presence in the major financial and trading centres in Europe and America.
In the mid-1950s, The Hongkong and Shanghai Banking Corporation embarked on a strategy of pursuing profitable growth through acquisition as well as organic development – a combination that has remained a key feature of HSBC’s approach ever since.
As each acquisition has been made, HSBC has focused on integrating its newly acquired operations with its existing businesses with a view to maximising the synergy between the various components. Key to this integration process is to blend local and international expertise.
The most significant developments are described below. Other acquisitions in 2003 are discussed in the section headed ‘Business highlights in 2003’ under the relevant geographical region on pages 15 to 26.
The Hongkong and Shanghai Banking Corporation purchased The Mercantile Bank of India Limited and The British Bank of the Middle East (now HSBC Bank Middle East Limited) in 1959. In 1965, The Hongkong and Shanghai Banking Corporation acquired a 51 per cent interest (subsequently increased to 62.14 per cent) in Hang Seng Bank Limited (‘Hang Seng Bank’), consolidating its position in Hong Kong. Hang Seng Bank is the second-largest listed bank in Hong Kong by market capitalisation.
From the beginning of the 1980s, The Hongkong and Shanghai Banking Corporation began to focus its acquisition strategy on the UK. In 1987, it purchased a 14.9 per cent interest in Midland Bank plc, now HSBC Bank plc (‘HSBC Bank’), one of the UK’s principal clearing banks. In 1991, HSBC Holdings plc was established as the parent company of HSBC and, in 1992, HSBC Holdings purchased the remaining interests in HSBC Bank. In connection with this acquisition, HSBC’s head office was transferred from Hong Kong to London in January 1993. To expand its base in the euro zone, in October 2000 HSBC completed its acquisition of 99.99 per cent of the issued share capital of CCF S.A. (‘CCF’), a major French banking group.
The Hongkong and Shanghai Banking Corporation entered the US market in 1980 by acquiring a 51 per cent interest in Marine Midland Banks, Inc. (now HSBC USA Inc.). The remaining interest was acquired in 1987.
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Description of Business (continued)
In 1981, The Hongkong and Shanghai Banking Corporation incorporated its extant Canadian operations. HSBC Bank Canada has since made numerous acquisitions, expanding rapidly to become the largest foreign-owned bank in Canada and the seventh-largest overall at 31 December 2003.
In 1997, HSBC assumed selected assets, liabilities and subsidiaries of Banco Bamerindus do Brasil S.A. following the intervention of the Central Bank of Brazil, and completed the acquisition of Grupo Roberts in Argentina.
In December 1999, HSBC acquired Republic New York Corporation, subsequently merged with HSBC USA Inc., and Safra Republic Holdings S.A. (together ‘Republic’).
In 2002, HSBC made further steps in expanding its presence in North America, completing the acquisition of 99.59 per cent of Grupo Financiero Bital S.A. de C.V. (now ‘HSBC Mexico’), the fifth-largest banking group in Mexico measured by deposits and assets.
Mainland China remains a critical long-term growth area for the Group. In 2002, HSBC completed the acquisition of a 10 per cent equity stake in Ping An Insurance Company of China Limited. Ping An Insurance is the second-largest life insurer and the third-largest insurer in mainland China.
In March 2003, HSBC acquired Household International, Inc. (‘Household’) for a consideration of approximately US$14.8 billion. The acquisition has significantly increased the contribution from HSBC’s North American business. In particular, Household offers HSBC national coverage in the US for consumer lending, credit cards and credit insurance through varied distribution channels, including over 1,300 branch offices in 45 states.
In October 2003, HSBC agreed to acquire The Bank of Bermuda Limited for US$1.3 billion, adding a strong position in the local banking market in Bermuda and significant scale and geographical spread to HSBC’s existing international fund administration, private banking, trust and payments, and cash management businesses. The acquisition was completed on 18 February 2004.
In December 2003, HSBC acquired substantially all of Lloyds TSB Group plc’s onshore and offshore businesses and assets related to Brazil for US$745 million. Included in the transaction was the
acquisition of all the shares of Banco Lloyds TSB S.A. – Banco Múltiplo and a consumer finance company, Losango Promotora de Vendas (‘Losango’).
In 2004, the Group has already seen growth in consumer spending and borrowing, in increased merger and acquisition activity, and a modest resumption of growth in demand for equity investment products. The Group also sees improving prospects for economic growth and private sector employment, particularly in the US and in Hong Kong.
In emerging markets, such as Brazil, Mexico and the ASEAN countries, relatively stable currencies and historically low interest rates are promoting consumer activity, fuelling domestic growth and reducing export dependence. China plays an increasingly important role, not only through its export growth, but also as the fastest growing market for commodity producing countries and for those developed countries which are supplying the technology, equipment and services to support its economic expansion.
The Group is conscious of the changing nature of the global economy and the speed of change and continues to monitor the impact on sentiment and consumer spending of globally strong property prices, which continue to rise faster than underlying wage growth in many developed markets. While such rises are understandable in the context of low interest rates and limited appetite for alternative investment opportunities, in the long run property prices have to be linked to income growth.
The picture for 2004 therefore is one of improving sentiment and stronger growth prospects in the near term, but with the potential risk of an unexpected shock as a result of circumstances which would cause a spike in either short-term interest rates or commodity prices.
Against this backdrop HSBC expects to concentrate on building its businesses steadily. HSBC expects to see lending to consumers around the world rise as a proportion of our total lending, with the emphasis on real estate secured lending. The Group also expect to see business in the US grow in importance to HSBC as the potential of the
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Household acquisition is realised and as the US economy shows its flexibility and responds to the lower value of the dollar.
At the end of 1998, HSBC launched Managing for Value, a five-year plan to take the Group into the 21st Century. Over the life of the plan, HSBC made significant progress against the eight strategic imperatives included therein.
Under Managing for Value, HSBC established HSBC and its hexagon symbol as a globally recognised brand and greatly increased the scope and penetration of its wealth management services in a number of key markets. Corporate, Investment Banking and Markets operations were completely integrated, enabling the Group to pursue a strategy of seamlessly servicing the needs of the largest international companies and institutions, and build corporate origination and cross-selling capabilities. A risk adjusted cost of capital methodology was introduced and applied. (For the application of economic profit in HSBC and its results for 2003 see page 58.) Good progress was made against the other strategic imperatives announced under the initiative.
In financial terms, HSBC achieved its objective of doubling Total Shareholder Return (‘TSR’) and beating the TSR performance of a peer group of leading banks over the period. TSR is a measure of the growth in the value of a share over a specific period with dividends reinvested. Starting with a benchmark of 100 on 31 December 1998, HSBC’s TSR more than doubled to 211 on 31 December 2003, while that of its peer group stood at 126.
As HSBC worked on its strategic plan for the next five years it was clear that there were many opportunities to develop HSBC’s businesses further, and also that HSBC could build more from the structural and business changes achieved in the recent past. For instance, during the five years of Managing for Value, HSBC made investments in the US (Republic and Household), France (CCF) and Mexico (HSBC Mexico), as a result of which an additional 100,000 employees joined the Group. This expansion changed the profile of HSBC’s business, increased the complexity of the Group and brought new management and business challenges as well as exciting opportunities.
The new plan, developed to build on the achievements of the Managing for Value strategy and take the Group forward, is now being implemented. This plan, called Managing for Growth, was launched at the end of 2003. It provides HSBC with a blueprint for growth and development during the next five years. The plan is an evolutionary, not revolutionary, strategy. It builds on HSBC’s strengths and it addresses the areas where further improvement is considered both desirable and attainable.
Management’s vision for the Group remains unchanged: HSBC aims to be the world’s leading financial services company. In this context, ‘leading’ means preferred, admired and dynamic, and being recognised for giving the customer a fair deal. HSBC will strive to secure and maintain a leading position within each of its customer groups in selected markets.
HSBC will remain focused on growing its TSR. In an era of low interest rates and low nominal growth rates, HSBC remains committed to exceeding a benchmark based on peer group comparison. For full details of the benchmark, see page 217. The peer group of banks has been updated to include HSBC’s current principal competitors, and HSBC will chart its TSR progress on a three-year rolling basis and over the five-year plan period.
HSBC’s core values are integral to its strategy, and communicating them to shareholders, customers and employees is intrinsic to the plan. These values comprise a preference for long-term, ethical client relationships; high productivity through teamwork; a confident and ambitious sense of excellence; being international in outlook and character; prudence; creativity and strong marketing.
In the plan, HSBC also recognises its corporate social responsibility (‘CSR’), which is essential to sustaining the Group’s long-term success in the community. HSBC has always had a strong sense of corporate social responsibility, and believes that there is no fundamental conflict between being a good corporate citizen and being sustainably profitable. Moreover, the pressures to comply with public expectations across a wide spectrum of social, ethical and environmental issues are growing rapidly. The strategy therefore calls for a renewed recognition of HSBC’s wider obligations to society and for increased external communication of the Group’s CSR policies and performance, particularly on education and the environment, which will remain
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the principal beneficiaries of HSBC’s philanthropic activities.
HSBC’s new plan is led by customer groups, and specific strategies will be implemented for each of them. The expression ‘customer group’ is new in 2003. Previously ‘customer groups’ were called ‘lines of business’, but HSBC believes the new term reinforces more accurately to all its employees the Group’s customer focus.
The acquisition of Household in 2003 highlighted the importance within Personal Financial Services of a distinctive customer group, Consumer Finance, to augment HSBC’s existing activities in Personal Financial Services. HSBC’s other customer groups are Corporate, Investment Banking and Markets; Commercial Banking; and Private Banking.
Key elements in achieving HSBC’s objectives for its customer groups will be accelerating the rate of growth of revenue; developing the brand strategy further; improving productivity; and maintaining the Group’s prudent risk management and strong financial position. Developing the skills of HSBC’s staff will also be critical and it will be necessary to ensure that all employees understand how they can contribute to the successful achievement of the Group’s objectives. Employees who achieve this contribution will be rewarded accordingly.
Operating management will continue to be organised geographically under four regional intermediate head offices, with business activities concentrated in locations where growth and critical mass are to be found.
At 31 December 2003, HSBC’s customers were served by 232,000 employees (including part-time employees) worldwide, compared with 192,000 at 31 December 2002 and 180,000 at 31 December 2001. The main centres of employment are the UK with 56,000 employees, the US (43,000), Hong Kong (24,000), Brazil (25,000), Mexico (18,500) and France (14,000). HSBC negotiates with recognised unions, and estimates that approximately 44 per cent of its employees are unionised. The highest concentrations of union membership are in Brazil, France, India, Malaysia, Malta, Mexico, the Philippines, Singapore and the UK. HSBC has not experienced any material disruptions to its operations from labour disputes during the past five years.
In support of its new strategy, HSBC continues to focus on attracting, developing and motivating the very best individuals. Emphasis is therefore given to performance management; reward; talent management, including graduate recruitment and international secondments; diversity; and learning and development. Ensuring that employee satisfaction with the working experience is kept as high as possible is seen as beneficial to shareholders, employees and customers alike.
HSBC is proud of its diverse workforce, which is able to communicate with HSBC’s customers in local languages and dialects across 79 countries and territories. A continuing focus on policies that encourage an inclusive working environment and the development of career opportunities for all, regardless of ethnicity, gender or grade, is a key part of positioning HSBC as an employer of choice.
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HSBC operates in a highly competitive and international business environment and as such is obliged to manage its costs realistically, responding to the availability of talent pools which are proven to be both efficient and cost effective. This can lead to the migration of tasks to different geographical locations as education levels improve, and as investments in technology and telecommunications facilitate access to those locations. As a result, job losses can arise. HSBC has a good record of communicating openly and sensitively in these circumstances and of reassigning employees and minimising compulsory redundancies, wherever possible.
The quality of HSBC’s employees represents a significant competitive advantage. The international mix of staff, working in a meritocracy, enables HSBC to resource operations with employees who have a detailed knowledge of local markets, whilst maintaining a global perspective. To maintain this balance, international mobility is seen as vital to sharing best practice and is actively encouraged and managed. HSBC promotes and recruits the most able and attaches great importance to cultivating its own talent. It values teamwork and collective management. Senior management succession is planned to be as seamless as possible.
Profit before tax by customer group
Year ended 31 December 2003
Total assets by customer groupYear ended 31 December 2003
Personal Financial Services provides some 39 million individual and self-employed customers with a wide range of banking and related financial services. Customer Relationship Management (‘CRM’) systems and processes are used by HSBC employees to recognise and fulfil customer needs by identifying appropriate products and services and delivering them to the customer through their channel of preference. Examples include current, cheque and savings accounts; loans and home finance; cards; payments; insurance; and investment services, including securities trading. Insurance products sold and distributed by HSBC through its branch networks include loan and health protection; life, property, casualty and health insurance; and pensions. HSBC acts as both a broker and an underwriter, and sees continuing opportunities to deliver insurance products to its personal customer base.
Personal Financial Services are increasingly delivered via self-service terminals, the telephone and the internet. 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 segment.
The most valuable of the 39 million Personal Financial Service customers worldwide are offered HSBC Premier. HSBC currently has more than 880,000 HSBC Premier customers, who have access to more than 250 specialised Premier centres located in 31 countries. In addition to the standard range of personal banking products and services, HSBC Premier customers receive dedicated relationship
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management and 24 hour priority telephone access and global travel assistance. In 2003 HSBC Premier International Services were introduced in eight countries, providing seamless account opening and credit history transfer across borders for HSBC Premier customers.
Consumer Finance
Within Personal Financial Services, Household’s operations in the US, the UK and Canada make credit available to customer groups not well catered for by traditional banking operations, facilitate point of sale credit in support of retail trading purchases and support major affiliate credit card programmes. At 31 December 2003 Household had over 60 million customers with total gross advances of US$121.7 billion. Consumer Finance products are offered through the following businesses:
Household’s consumer lending business is one of the largest sub-prime home equity originators in the US, marketed under the HFC and Beneficial brand names through a network of over 1,300 branches in 45 states, direct mail, telemarketing, strategic alliances and the internet. ‘Sub-prime’ is a US categorisation which describes customers who have limited credit histories, modest incomes, high debt-to-income ratios, high loan-to-value ratios (for real estate secured products) or have experienced credit problems caused by occasional delinquencies, prior charge-offs, bankruptcy or other credit related actions. Consumer lending products include secured and unsecured loans such as first and second lien closed-end mortgages, open-ended home equity loans, personal loans and retail finance contracts.
Household’s mortgage services business purchases first and second lien residential mortgage loans from a network of over 200 unaffiliated third party lenders (‘correspondents’) in the US. Purchases are either of pools of loans (‘bulk acquisitions’) or individual loan portfolios (‘flow acquisitions’) made under predetermined underwriting guidelines. Forward commitments are offered to selected correspondents to strengthen relationships and create a sustainable growth channel for this business. Household, through its subsidiary Decision One, also offers mortgage loans referred by mortgage brokers.
Household’s retail services business is one of the largest providers of third party private label credit cards (or store cards) in the US based on receivables
outstanding, with over 60 merchant relationships and 14 million active customer accounts.
In addition to originating and refinancing motor vehicle loans, Household’s motor vehicle finance business purchases retail instalment contracts of US customers who do not have access to traditional prime based lending sources. The loans are largely sourced from a network of approximately 5,000 motor dealers.
Household’s credit card services business is the seventh largest issuer of MasterCard1 and Visa1 credit cards in the US, and also includes affiliation cards such as the GM Card ® and the AFL-CIO Union Plus2 ® credit card. Also, credit cards issued in the name of Household’s Household Bank and Orchard Bank brands ar e offered to customers under-served by traditional providers, or are marketed primarily through merchant relationships established by the retail services business.
A wide range of insurance services is offered by Household to customers in the US, the UK and Canada who are typically under-insured by traditional sources. The purchase of insurance is never a condition of any loan or credit advanced by Household.
The refund lending business accelerates access to funds for US taxpayers who are entitled to tax refunds. The business is seasonal with most revenues generated in the first three months of the year.
Household’s business in the UK provides mid-market consumers with mortgages, secured and unsecured loans, insurance products, credit cards and retail finance products. It concentrates on customer service through its 216 HFC Bank and Beneficial branches, and finances consumer electronics through its retail finance operations. In Canada, similar products are offered and, deposits are taken through Household’s trust operations there.
Commercial Banking
HSBC is one of the world’s leading banks in the
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provision of financial services and products to small and medium-sized businesses, with over 2 million business customers including sole proprietors, partnerships, clubs and associations, incorporated businesses and publicly quoted companies.
At 31 December 2003, HSBC had total commercial customer deposits of US$111.5 billion and total commercial customer loans and advances, net of suspended interest and provisions for bad and doubtful debts, of US$103.5 billion.
The Commercial Banking segment places particular emphasis on multi-disciplinary and geographical collaboration in meeting its commercial customers’ needs. This differentiated service allows HSBC to broaden and enhance its offering to its Commercial Banking customers. The range of products includes:
Payments and cash management: HSBC is a leading provider of payments, collections, liquidity management and account services worldwide, enabling financial institutions and corporate customers to manage their cash efficiently on a global basis. HSBC’s extensive network of offices and strong domestic capabilities in many countries, including direct access to local clearing systems, enhance its ability to provide high-quality cash management services.
e-banking: A key component of HSBC’s provision of financial services to commercial customers is continuing innovation and flexibility in electronic delivery solutions.
Wealth management services: These include advice and products related to savings and investments. They are provided to commercial banking customers and their employees through HSBC’s worldwide network of branches and business banking centres.
Insurance: HSBC offers insurance protection, employee benefits programmes and pension schemes designed to meet the needs of businesses and their employees, and to help fulfill the applicable statutory obligations of client companies. These products are provided by HSBC either as an intermediary (broker, agent or consultant) or as a supplier of in-house or third party offerings. Products and services include a full range of commercial insurance, including pension schemes; healthcare schemes; ‘key man’ life insurance; car fleet; goods in transit; trade credit protection; risk management and insurance due
diligence reviews; and actuarial/employee benefit consultancy.
Trade services: HSBC has more than 130 years of experience in trade services. A complete range of traditional documentary credit, collections and financing products is offered, as well as specialised services such as insured export finance, international factoring and forfaiting. HSBC’s expertise is supported by highly automated systems.
Leasing, finance and factoring: HSBC provides leasing, finance (including instalment and invoice finance) and domestic factoring services, primarily to commercial customers in the UK, Hong Kong and France. Special divisions have been established to finance vehicles, plant and equipment, materials handling, machinery and large complex leases.
Corporate, Investment Banking and Markets
HSBC’s Corporate, Investment Banking and Markets business provides tailored financial solutions to major government, corporate and institutional clients worldwide. Managed as a global business, this customer group operates a long-term relationship management approach to build a full understanding of clients’ financial requirements. Sectoral client service teams comprising relationship managers and product specialists develop financial solutions to meet individual client needs. With dedicated offices in over 50 countries and with access to HSBC’s worldwide presence and capabilities, this business serves subsidiaries and offices of these clients on a global basis.
Products and services offered include:
Global Markets: HSBC’s operations in Global Markets consist of treasury and capital markets services for supranationals, central banks, corporations, institutional and private investors, financial institutions and other market participants. Products include:
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trading for institutional, corporate, private clients and asset management services, including global investment advisory and fund management services; and
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Description of Business(continued)
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serves. It competes in the provision of commercial banking products and services with other major financial institutions, including commercial banks; savings and loan associations; credit unions; consumer finance companies; major retailers; brokerage firms; and investment companies. In investment banking, HSBC faces competition from both pure investment banks and the investment banking operations of other commercial banks.
Global factors
Consolidation in the banking industry: There is an increasing trend towards bank consolidation, at both national and international levels, creating more banks capable of competing directly with HSBC across a broader range of services.
Limited market growth: In HSBC’s largest current markets, the UK, US and Hong Kong, there is limited market growth in the provision of basic financial and banking services. There is, however, growth potential in the provision of a wider range of financial services to existing customers and also through expansion into new market segments.
Advances in technology: The rapid convergence of information and communication technologies is altering radically HSBC’s range of competitors. Specialist providers and non-financial organisations are now able to deliver a diverse range of financial services across a variety of electronic channels without the need for a traditional branch network. These innovations increase the pressure on established banks to enhance service quality while also investing in the provision of similar services. HSBC continues to adapt its business to provide customers with access to its full range of services in the manner they most prefer, with internet, interactive TV, mobile phone, WAP and telephone banking all complementing the branch system.
Regional factors
Europe
UK
Overall market growth in the UK has remained relatively limited. However, the expanding demand for consumer credit in recent years has led to greater competition and the introduction of a wide array of new channels, products and entrants. Traditional banks now face competition in the retail market from
a variety of non-financial institutions including supermarkets, clothing and grocery retailers, car manufacturers and utilities, as well as from internet banks and specialist market providers.
The Competition Commission Report on the supply of banking services to small and medium-sized businesses came into effect during the year. In response, HSBC introduced an enhanced package of services for small and medium-sized customers and paid interest on all qualifying current accounts from 1 January 2003. Further initiatives included the introduction of a new instant access savings account and improved terms for start-up businesses.
On 11 February 2003, the Office of Fair Trade (‘OFT’) announced its preliminary conclusion that an agreement between MasterCard’s UK members, which includes HSBC Bank plc, on a common interchange fee charged on transactions made in the UK by credit and charge cards, infringed the Competition Act 1998. The OFT gave MasterCard a further opportunity to justify the existing agreement or suggest changes to it so that it will meet the conditions for an exemption under the Act. This matter is still under review.
In May, the OFT reported its initial findings from its review of payment systems in the UK. The review welcomed industry progress to agree proposals to shorten clearing cycles and stated that the OFT will continue to monitor the progress of these initiatives.
The OFT launched a study into store cards in September in response to concerns raised by the Treasury Select Committee. The study, which is expected to be released in early 2004, will review the application of competition law, marketing and sales practices, transparency issues and interest rates.
France
Like the other economies in the eurozone, the French banking sector was affected in 2003 by the poor economic environment but benefited from high volumes of sight deposits and slightly improved lending margins.
Consolidation in the banking industry saw one significant combination during the year and this trend is expected to continue. Non-bank competitors encroached further into traditional banking sectors with, as an example, the Post Office being granted approval to expand its mortgage activities.
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The rule forbidding the payment of interest on demand deposits was challenged in 2003 through the European Court of Justice in Luxembourg. While the outcome of the challenge is currently uncertain, it opens the possibility that this restriction could be lifted in the near future, potentially raising the cost of deposits.
A number of new tax efficient pension products were approved in a pension reform act which was enacted during the year. The expansion of the retirement market is likely to introduce both new opportunities for personal banking and new sources of competition.
Hong Kong
Banks in Hong Kong faced pressure on traditional core products due to the low interest rate environment and fierce pricing competition. To diversify income streams and enhance fee-based business, financial institutions actively promoted investment and insurance products, and increased public awareness of insurance protection products following the outbreak of SARS.
Competition for credit card, mortgage and consumer assets business remained intense in a highly liquid but relatively subdued lending market. An improvement in the economic outlook and proactive debt-restructuring by lenders led to a welcome drop in the level of bankruptcies in the second half of the year.
Several regulatory changes, including the new Securities and Futures Ordinance, deregulation of minimum brokerage commission, and consumer credit data-sharing, occurred in 2003. These changes opened the market further and intensified competition for quality customers and assets.
To pave the way for the full opening of mainland China’s financial sector, Hong Kong banks were active in key mainland cities and maintained regular dialogue with Chinese financial institutions. Various government announcements regarding the CEPA and the introduction of personal renminbi business in Hong Kong are expected to drive demand from mainland China and boost Hong Kong’s GDP.
As market leaders in Hong Kong, The Hongkong and Shanghai Banking Corporation and Hang Seng Bank are well placed to meet these competitive challenges.
Rest of Asia-Pacific (including Middle East)
The Asia-Pacific economies experienced mixed fortunes in the first half of 2003, due mainly to the impact of SARS, although growth rebounded in the second half of the year. The competitive environment varied greatly across the region, depending on the level of regulation, number of entrants, and the maturity of the markets. However, competition remained intense throughout Asia-Pacific across all customer groups served by HSBC. Additionally, in many countries in the region, the relatively young population and its increasing sophistication in financial services continued to provide further growth opportunities for HSBC.
North America
In the US, continuing mergers and acquisitions in the banking, insurance and securities industries are bringing consolidation and a blending of services. HSBC Bank USA also faced vigorous competition from a large number of non-bank suppliers of financial services that have found new and effective ways to meet the financial demands of customers. Many of these institutions are not subject to the same laws and regulations imposed on HSBC Bank USA.
These continuing trends will increase competitive pressures. Commercial banks appear to have recovered from portfolio credit problems experienced in 2001 and 2002, particularly in the technology, energy and telecommunications sectors.
Household competes with non-bank lenders for sub-prime and other consumers who do not conform to US banking industry requirements. Household’s consumer finance businesses are highly regulated, and are subject to laws relating to consumer protection, discrimination in extending credit, use of credit reports, privacy matters, disclosure of credit terms and correction of billing errors. They are also subject to regulations and legislation that limit operations in certain jurisdictions. Failure to comply with laws and regulations may limit the ability of Household’s licensed lenders to collect or enforce loan agreements made with consumers and may leave Household liable for damages and penalties.
There has been a significant amount of legislative activity in the US, nationally, locally and at the state level, aimed at curbing lending practices deemed to be ‘predatory’. In addition, states have sought to alter lending practices through consumer
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protection actions. Household continues to work with regulators and consumer groups to create appropriate safeguards to eliminate abusive practices while allowing middle-market borrowers to continue to have unrestricted access to credit for personal purposes. During 2003 Household implemented all the actions required under its 2002 settlement with the Attorneys General of 50 States and the District of Columbia.
The Canadian financial services industry continues to be dominated by the five largest banks in the country. However, the market remains highly competitive as other banks, insurance companies and financial institutions offer comparable products and services. This was aided by reform of the Bank Act of Canada in late 2001 which provided the stimulus for more competition. One of the key changes concerned the access provided in the national payments system. This change allowed non-deposit taking institutions to participate in cheque payments, credit card systems, debit card networks and automated bank machine networks.
Whilst merger activity amongst the largest banks in Canada remains a possibility, major financial institutions continue to look elsewhere for growth. During the year a number of Canadian banks and insurance companies completed strategic acquisitions of financial institutions in the US.
In Mexico, the banking industry has seen significant concentration in recent years with over 76 per cent of banking assets and 79 per cent of deposits owned by subsidiaries of five major foreign banks. Given that Mexico has a population of approximately 100 million, the majority of whom do not use the banking system, the growth opportunities in the retail sector are favourable in the medium to long term. With its extensive branch network and growing young customer base, HSBC is well positioned to take full advantage of this economic and competitive environment.
Currently there is strong regulatory pressure to reduce banking and pension management fees and commissions, constraining growth in non-funds income. Government regulators are also intent on increasing credit availability in the market, specifically lending for residential mortgages and small business loans.
Mexico’s economy is very closely linked to those of the US and Canada, and over 90 per cent of Mexico’s exports are to the North American market.
HSBC’s growing presence across the region provides a competitive advantage.
South America
There are over 165 banks in Brazil operating through a network of over 16,000 branches and offices. Consolidation in the banking industry continues, increasingly involving foreign banks (at the end of 2003 there were 45 banks in Brazil with foreign ownership interests). With a population of 178 million and an estimated 46 per cent of the eligible population ‘unbanked’, there are growth opportunities in the retail sector, in particular in the medium to long-term.
2003 saw continued consolidation in the Brazilian financial services industry, and HSBC Brazil, following its purchase of Lloyds TSB Group plc’s Brazilian businesses and assets, is well placed to take advantage of the economic development that is bringing new entrants to the financial system. This consolidation has heightened the focus on retail customer growth, and further highlighted the importance of customer service as a means of competitive differentiation. Competition at the top end of this retail market is particularly strong, and HSBC continues to focus on differentiating its product range and service quality.
In Argentina, international financial groups are HSBC’s main competitors, as most major banking and insurance players in the market are foreign controlled.
The fallout from the crisis in Argentina continues to have a profound impact on the financial services market. HSBC is one of a few participants providing a comprehensive range of financial services to its customers. The outlook for the financial services industry has improved but sustained improvement depends upon the resolution of outstanding government debt and, following that, the pending economic, fiscal and political reforms required to build confidence in the country’s prospects. HSBC will continue to monitor carefully developments to evaluate the opportunities and risks within the financial services industry in Argentina.
In 2003, competition between banks re-emerged as the economy started to grow and the population regained some confidence in the financial system. The local banks benefited from sharply increased deposits from the government who deposited surplus tax revenues in the system.
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Regulation and Supervision
HSBC’s operations throughout the world are regulated and supervised by approximately 370 different central banks and regulatory authorities in those jurisdictions in which HSBC has offices, branches or subsidiaries. HSBC estimates the cost of this regulation and supervision to be approximately US$400 million in 2003. These authorities impose certain reserve and reporting requirements and controls (for example, capital adequacy, depositor protection, and prudential supervision) on banks. In addition, a number of countries in which HSBC operates impose rules that affect, or place limitations on, foreign or foreign-owned or controlled banks and financial institutions. The rules include restrictions on the opening of local offices, branches or subsidiaries and the types of banking and non-banking activities that may be conducted by those local offices, branches or subsidiaries; restrictions on the acquisition of local banks or regulations requiri ng 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 UK Financial Services Authority (‘FSA’) supervises HSBC on a consolidated basis. In addition, each operating bank 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.
United Kingdom regulation and supervision
UK banking and financial institutions are subject to multiple regulations. The primary UK statute is the Financial Services and Markets Act 2000 (‘FSMA’). Other UK primary and secondary banking legislation is derived from European Union (‘EU’) directives relating to banking, securities, investment and sales of personal financial services.
The FSA is responsible for authorising and supervising UK banking institutions and regulates all investment business in the UK from retail life and pensions business to custody, branch share dealing, 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 investment 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. The FSA will periodically obtain independent reports, usually from the auditors of the authorised institution, as to the adequacy of systems governing internal control as well as systems governing records and accounting. 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 banking 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 meets regularly with HSBC’s senior executives to discuss HSBC’s adherence to the FSA’s prudential guidelines. The FSA and senior executives in the UK 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.
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 173 to 174.
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$3,600) of a claim plus 90 per cent of any further amount up to £33,000 (US$59,000) (the maximum amount payable being £31,700 (US$56,600)). Payments under the scheme in respect of investment business compensation are limited to 100 per cent of the first £30,000 (US$53,600) of a claim plus 90 per cent of any further amount up to £20,000 (US$35,700) (the maximum amount payable being £48,000 (US$85,700)).
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The European Union reached final agreement to a new directive regarding the taxation of savings income on 3 June 2003. Under the directive, each Member State, other than Austria, Belgium, and Luxembourg, will be required, beginning in 2005, to provide the tax authorities of each other Member State with details of payments of interest or other similar income paid by a person within its jurisdiction to individuals resident in such other Member State. Beginning on the same date, Austria, Belgium, and Luxembourg will impose a withholding tax on such income. The withholding tax rate will initially be 15 per cent, increasing to 20 per cent from 2008 and 35 per cent from 2011. Subject to future conditions being met, Austria, Belgium, and Luxembourg may cease to apply the withholding tax and instead comply with the automatic exchange of information rules applicable to the other Member States. Implementation of the directive is dependent upon Switzerland, Liechtenstein, San Marino and Andorra applying equivalent measures.
Hong Kong regulation and supervision
Banking in Hong Kong is subject to the provisions of the Banking Ordinance of Hong Kong (Chapter 155) (the ‘Banking Ordinance’), and to the powers, functions and duties ascribed by the Banking Ordinance to the Hong Kong Monetary Authority. The principal function of the Monetary Authority is to promote the general stability and effective working of the banking system in Hong Kong. The Monetary Authority is responsible for supervising compliance with the provisions of the Banking Ordinance. The Chief Executive of Hong Kong has the power to give directions to the Monetary Authority, which the Banking Ordinance requires the Monetary Authority and the Financial Secretary to follow.
The Monetary Authority has responsibility for authorising banks, and has discretion to attach conditions to its authorisation. The Monetary Authority requires that banks or their holding companies file regular prudential returns, and holds regular discussions with the management of the banks to review their operations. The Monetary Authority may also conduct ‘on site’ examinations of banks, and in the case of banks incorporated in Hong Kong, of any local and overseas branches and subsidiaries. The Monetary Authority requires all authorised institutions to have adequate systems of internal control and requires the institutions’ external
auditors, upon request, to report on those systems and other matters such as the accuracy of information provided to the Monetary Authority. In addition, the Monetary Authority may from time to time conduct tripartite discussions with banks and their external auditors.
The Monetary Authority, which may deny the acquisition of voting share capital of over 10 per cent in a bank, and may attach conditions to its approval thereof, can effectively control changes in the ownership and control of Hong Kong-incorporated financial institutions. In addition, the Monetary Authority has the power to divest controlling interests in a bank from a person if they are no longer deemed to be fit and proper, or if they may otherwise threaten the interests of depositors or potential depositors.
The Monetary Authority may revoke authorisation in the event of an institution's non-compliance with the provisions of the Banking Ordinance. These provisions require, among other things, the furnishing of accurate reports.
The Banking Ordinance requires that banks submit to the Monetary Authority certain returns and other information and establishes certain minimum standards and ratios relating to capital adequacy (see below), liquidity, capitalisation, limitations on shareholdings, exposure to any one customer, unsecured advances to persons affiliated with the bank and holdings of interests in land, with which banks must comply.
Hong Kong fully implemented the capital adequacy standards established by the Basel Accord in 1989. The Banking Ordinance currently provides that banks incorporated in Hong Kong maintain a capital adequacy ratio (calculated as the ratio, expressed as a percentage, of its capital base to its risk-weighted exposure) of at least 8 per cent. For banks with subsidiaries, the Monetary Authority is empowered to require that the ratio be calculated on a consolidated basis, or on both consolidated and unconsolidated bases. If circumstances require, the Monetary Authority is empowered to increase the minimum capital adequacy ratio (to up to 12 per cent for fully-licensed banks and 16 per cent for deposit-taking companies and restricted-licence banks), after consultation with the bank.
The marketing of, dealing in and provision of advice and asset management services in relation to securities in Hong Kong are subject to the provisions
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of the Securities and Futures Ordinance of Hong Kong (Chapter 571) (the ‘Securities and Futures Ordinance’). Entities engaging in activities regulated by the Securities and Futures Ordinance are required to be licensed. The Monetary Authority is the primary regulator for banks involved in the securities business, while the Securities and Futures Commission is the regulator for non-banking entities.
US regulation and supervision
HSBC is subject to extensive federal and state supervision and regulation in the US. Banking laws and regulations of the Federal Reserve Board, the Federal Deposit Insurance Corporation (‘FDIC’) and the State of New York Banking Department 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’) as a result of its ownership of HSBC Bank USA. HSBC Bank USA, is a New York state-chartered bank and a member of the Federal Reserve System. As such, HSBC Bank USA is subject to regulation, supervision and examination by both the Federal Reserve Board and the State of New York Banking Department. HSBC also owns Household Bank (SB), N.A. (‘Household Bank’), a nationally chartered ‘credit card bank’ subject to regulation, supervision and examination by the Office of the Comptroller of the Currency (‘OCC’). The deposits of HSBC Bank USA and Household Bank are insured by the FDIC and both banks are subject to relevant FDIC regulation.
The BHCA and the International Banking Act of 1978 (‘IBA’) impose certain limits and requirements on the US activities and investments of HSBC and certain companies in which it holds direct or indirect investments. As a ‘qualifying foreign banking organisation’ under Federal Reserve Board regulations, HSBC may engage in the United States in certain limited non-banking activities and hold certain investments that would otherwise not be permissible under US law. Prior to 13 March 2000, however, the BHCA generally prohibited HSBC from acquiring, directly or indirectly, ownership or control of more than 5 per cent of the voting shares of any company engaged in the United States in activities other than banking and certain activities closely related to banking. On that date HSBC became a financial holding company (‘FHC’) under
the Gramm-Leach-Bliley Act amendments to the BHCA, enabling it to offer a more complete line of financial products and services. HSBC’s ability to engage in expanded financial activities as an FHC depends upon HSBC continuing to meet certain criteria set forth in the BHCA, including requirements that its US depository institution subsidiaries, HSBC Bank USA and Household Bank be ‘well-capitalised’ and ‘well-managed’, and that they have achieved at least a satisfactory record in meeting community credit needs during their most recent examination pursuant to the Community Reinvestment Act. These requirements also apply to Wells Fargo HSBC Trade Bank, N.A., in which HSBC has a 20 per cent voting interest in equity capital and a 40 per cent economic interest. Each of these depository institution subsidiaries achieved at least the required rating during their most recent examinations. In general under the BHCA, an FHC would be required, upon notice by the Federal Reserve Board, to enter into an agreement with the Federal Reserve Board to correct any failure to comply with the requirements to maintain FHC status. Until such deficiencies are corrected, the Federal Reserve Board may impose limitations on the US activities of an FHC and its subsidiaries as it deems appropriate. If such deficiencies are not corrected, the Federal Reserve Board may require an FHC to divest its control of any subsidiary bank or to cease to engage in certain financial activities.
HSBC is generally prohibited under the BHCA from acquiring, directly or indirectly, ownership or control of more than 5 per cent of any class of voting shares of, or substantially all the assets of, or exercising control over, any US bank or bank holding company without the prior approval of the Federal Reserve Board.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the ‘Riegle-Neal Act’) permits a US bank holding company or foreign banking organisation, with Federal Reserve Board approval, to acquire a bank located in a state other than the organisation’s US ‘home’ state, subject to certain restrictions, and a national or state-chartered bank to merge across state lines or to establish or acquire branches in other states, subject to various state law requirements or restrictions. In general, the Riegle-Neal Act provides a non-US bank with interstate branching and expansion rights similar to those of a US national or state-chartered bank located in its ‘home’ state.
The US is a 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 bank 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 Reserve Board has determined that, as a general matter, a US bank holding company that is owned and controlled by a foreign bank with FHC status is not required to comply with the Federal Reserve Board’s capital adequacy guidelines. HSBC may rely on the Federal Reserve Board’s flexibility with respect to the capital adequacy requirements applicable to such intermediate US bank holding companies.
HSBC Bank USA, Wells Fargo HSBC Trade Bank, N.A. and Household Bank, 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 Federal Deposit Insurance Corporation Improvement Act of 1991 provides for extensive regulation of depository institutions (such as HSBC Bank USA, Wells Fargo HSBC Trade Bank, N.A. and Household Bank), including requiring federal banking regulators to take ‘prompt corrective action’ with respect to FDIC-insured banks that do not meet minimum capital requirements.
As at 31 December 2003, HSBC Bank USA, Wells Fargo HSBC Trade Bank, N.A. and Household Bank were each well-capitalised under Federal Reserve Board regulations.
The USA Patriot Act (‘Patriot Act’) signed into law in October 2001, imposes significant record keeping and customer identity requirements, expanded the US federal government’s powers to freeze or confiscate assets and increases the available penalties that may be assessed against financial institutions for failure to comply with obligations imposed on such institutions to detect, prevent and report money laundering and terrorist financing. Among other things, the Patriot Act requires the US
Treasury Secretary to develop and adopt final regulations with regard to the anti-money laundering compliance obligations of financial institutions (a term which, for this purpose, includes insured US depository institutions, US branches and agencies of foreign banks, US broker-dealers and numerous other entities). The US Treasury Secretary delegated this authority to a bureau of the US Treasury Department known as the Financial Crimes Enforcement Network (‘FinCEN’).
Many of the new anti-money laundering compliance requirements of the Patriot Act, as implemented by FinCEN, are generally consistent with the anti-money laundering compliance obligations previously imposed on HSBC Bank USA under the Bank Secrecy Act (which was amended in certain respects by the Patriot Act) and applicable Federal Reserve Board regulations. These include requirements to adopt and implement an anti-money laundering program, report suspicious transactions and implement due diligence procedures for certain correspondent and private banking accounts. Certain other specific requirements under the Patriot Act involve new compliance obligations. The passage of the Patriot Act and other recent events have resulted in heightened scrutiny of the Bank Secrecy Act and anti-money laundering compliance by federal and state bank examiners. On 30 April 2003, HSBC Bank USA entered into a written agreement with the Federal Reserve Bank of New York and the New York State Banking Department to enhance its compliance with anti-money laundering requirements. HSBC Bank USA has implemented certain improvements in its compliance, reporting, and review systems and procedures and is in the process of making additional improvements in these areas.
HSBC’s US consumer finance operations are also subject to extensive regulation in the US, and to laws relating to consumer protection; 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 branch lending offices are generally licensed in those jurisdictions in which they operate. Such licences
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have limited terms but are renewable, and are revocable for cause. Failure to comply with applicable laws and regulations may limit the ability of these licensed lenders to collect or enforce loan agreements made with consumers and may cause the consumer lending subsidiary to be liable for damages and penalties.
HSBC’s US credit insurance operations are subject to regulatory supervision under the laws of the states in which they operate. Regulations vary from state to state but generally cover licensing of insurance companies; premiums and loss rates; dividend restrictions; types of insurance that may be sold; permissible investments; policy reserve requirements; and insurance marketing practices.
Certain US source payments to foreign persons may be subject to US withholding tax unless the foreign person is a qualified intermediary. A qualified intermediary is a financial intermediary who is qualified under the Internal Revenue Code and has completed the Qualified Intermediary Withholding Agreement with the Internal Revenue Service. Various HSBC operations outside the US are qualified intermediaries.
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Description of Property
At 31 December 2003, HSBC had some 9,700 operational properties worldwide, of which approximately 3,300 were located in Europe, 600 in Hong Kong and the rest of Asia Pacific, 3,700 in North America (including 1,500 in Mexico) and 1,700 in Brazil. Additionally, properties with a net book value of US$715 million were held for investment purposes. Of the total net book value of
HSBC properties, more than 73 per cent were owned or held under long-term leases. Further details are included in Note 25 of the ‘Notes on the Financial Statements’.
HSBC values its properties on an annual basis and updates their balance sheet values accordingly.
Legal Proceedings
HSBC, together with a number of its subsidiary undertakings, is named in and is defending legal actions in various jurisdictions arising from its
normal business. None of the above proceedings is regarded as material litigation.
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Financial Review
Summary
Year ended 31 December 2003 compared with year ended 31 December 2002
In the sections which follow, analysis of these results highlights the contributions from Household, acquired at the end of March 2003, and HSBC Mexico, acquired in November 2002, together with the impact of a weaker US dollar on translating revenues and costs arising in other currencies. These factors are important to an understanding of HSBC’s performance in 2003. It is also important to recognise the structural effect on reported financial performance of the acquisition of Household. In 2004, HSBC’s results will reflect a full year’s contribution from Household.
The shape of the Group’s profit and loss account changed as a result of the Household acquisition, reflecting the nature of its business model. Household generally serves non-conforming and sub-prime customers who, for a variety of reasons, have a higher delinquency and credit loss probability. These customers are charged a higher rate of interest to compensate for this additional risk of loss. As a consequence, Household’s net interest income is a much higher proportion of its total revenues than in the rest of HSBC, and a much higher proportion of Household’s pre-provision profitability is absorbed in bad and doubtful debt charges than is normally the case in the rest of HSBC.
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In the following discussion, the phrase ‘on an underlying basis’ is used to describe performance excluding the acquisitions of Household and HSBC Mexico.
HSBC made a profit on ordinary activities before tax of US$12,816 million in 2003, an increase of US$3,166 million, or 33 per cent, compared with 2002. Household and HSBC Mexico accounted for over 70 per cent of this increase. Household contributed US$1,827 million in its first nine months, while HSBC Mexico contributed US$441 million in its first full year.
Excluding goodwill amortisation, Household and HSBC Mexico contributed US$2,208 million and US$534 million respectively to profit before tax, which grew by US$3,888 million or 37 per cent to US$14,401 million. Underlying growth, on a constant currency basis, was 7 per cent. Goodwill amortisation increased by US$722 million to US$1,585 million in 2003, reflecting acquisitions, currency movements and the write down of goodwill attributed to a fund management company previously acquired as part of the CCF acquisition.
Net interest income of US$25,598 million in 2003 was US$10,138 million, or 66 per cent, higher than in 2002. Of this increase, Household contributed US$8,305 million and HSBC Mexico US$874 million. Excluding these acquisitions, and in terms of constant currency, net interest income was marginally higher. This reflected a number of offsetting factors. The net interest margin benefited from the change in asset mix, with growth of over 80 per cent in the year in personal lending, mainly in the US (including Household) and in Europe. However, deposit margins fell as interbank placements matured and were redeployed at lower yields. Growth in the volume of deposits raised only partially compensated for this, while the impact of the Competition Commission ruling on paying interest on qualifying small business accounts in the UK cost US$136 million. Net interest income declined in Hong Kong, reflecting spread compression o n the value of deposits and continued pressure on mortgage margins.
Other operating income of US$15,474 million was US$4,339 million, or 39 per cent, higher than in 2002. Household contributed US$1,878 million and HSBC Mexico US$599 million of this increase. The acquisitions of Household and HSBC Mexico reduced the proportion of fee revenues exposed to
stock market levels by bringing into the Group significant levels of account service fees (HSBC Mexico) and credit card fee income (Household). Fees from credit cards now constitute close to 24 per cent of total fees receivable compared with 13 per cent in 2002. This will increase in 2004 as Household is consolidated for a full year. On an underlying basis, and at constant currency, the increase was 9 per cent. Strong growth in dealing profits in HSBC Markets benefited from investment made in 2002 and 2003 to upgrade dealing room capabilities in the major centres and broaden the range of products offered to customers. Debt trading benefited from favourable credit spread movements. Foreign exchange revenues increased due to currency volatility and increased levels of corporate sales. In addition, higher income was earned from increased demand from corporate customers for structured tailored products. In constant currency, fees and commission income increased by 4 per cent on an underlying basis, reflecting growth in income from card transactions, insurance and lending.
Operating expenses, excluding goodwill amortisation, rose US$6,128 million, or 41 per cent, of which Household contributed US$3,406 million and HSBC Mexico US$881 million. Excluding the effect of these acquisitions, and expressed in terms of constant currency, operating expenses increased by 5 per cent, primarily due to increased employment costs. Pension costs and social taxes, together with restructuring costs, added over US$300 million to employment costs in 2003. HSBC’s cost:income ratio, excluding goodwill amortisation, decreased to 51.3 per cent from 56.2 per cent in 2002.
The charge for bad and doubtful debts was US$6,093 million in 2003, US$4,772 million higher than in 2002. This was essentially all attributable to the acquisitions, with Household accounting for US$4,575 million and HSBC Mexico US$110 million. On an underlying basis, and in constant currency, the increase in provisioning was around 2 per cent. Credit charges increased in line with the growth in personal lending, and the commercial customer base continued to perform well. New corporate provisions increased in Europe in the engineering and power sectors, and in Hong Kong in the electronics sector, but these were partly offset by a lower charge in North America reflecting the improved credit environment.
Other charges of US$44 million in 2003 were US$63 million, or 59 per cent, lower than in 2002.
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Financial Review (continued)
Losses in Argentina, which continue to arise from judicial orders or ‘amparos’, were mitigated in 2003 following the receipt of ‘compensation bonds’ in part settlement of the original asymmetrical pesification. Amparos allow certain depositors relief from the mandatory pesification rules and recovery of their historical US dollar deposits at current exchange rates.
Amounts written off fixed asset investments of US$106 million were lower than in 2002, which was dominated by a US$143 million charge writing down the carrying value of HSBC’s stake in a major European life assurer.
The US$116 million share of operating losses in joint ventures principally reflected a write-down of HSBC’s share of goodwill attributed to a UK fund management company acquired as part of the CCF acquisition.
Gains on disposal of investments of US$451 million were US$81 million lower than in 2002. Gains on sales of investment debt securities were slightly lower than in the prior year. Gains in 2002 benefited from the sale of HSBC’s share of Lixxbail to its joint venture partner and the sale of HSBC’s 6.99 per cent share in Banco Santiago S.A.
Year ended 31 December 2002 compared with year ended 31 December 2001
The translation of revenues and costs arising in 2002, and consequently the results reported for the year, were affected by the weaker US dollar against other major currencies and significantly weaker South American currencies against all currencies. Both are important to an understanding of HSBC’s performance in 2002.
HSBC made a profit on ordinary activities before tax of US$9,650 million in 2002, an increase of US$1,650 million, or 21 per cent, compared with 2001. Profit before tax, excluding goodwill amortisation, increased by US$1,706 million, or 19 per cent.
Net interest income of US$15,460 million in 2002 was US$735 million, or 5 per cent, higher than in 2001. Net interest income in Europe and North America was higher than in 2001 by US$1.1 billion, of which US$0.2 billion arose from foreign exchange translation and US$85 million was contributed by HSBC Mexico. Underlying growth reflected higher levels of average interest-earning assets and the
benefits from lower funding costs. Net interest income in South America was US$0.4 billion lower than in 2001 of which US$0.3 billion was due to foreign exchange translation. Excluding this, the underlying reduction reflected a lower level of local debt securities in Brazil. In Argentina narrower spreads and the costs associated with the funding of the non-performing loan portfolio resulted in net interest expense in 2002.
Other operating income of US$11,135 million was in line with 2001 as growth in wealth management income was offset by falls in fees and commission income from securities market activities. Dealing profits were also lower against a backdrop of difficult trading conditions in the credit and equity markets.
Operating expenses, excluding goodwill amortisation, were US$349 million, or 2 per cent, higher than 2001 reflecting the cost structures of new acquisitions, investment in the expanding wealth management business, and costs associated with the enhancement of business processes. In constant currency, operating expenses were 4 per cent higher. HSBC’s cost:income ratio, excluding goodwill amortisation, decreased to 56.2 per cent from 56.4 per cent in 2001.
The charge for bad and doubtful debts was US$1,321 million in 2002, US$716 million lower than in 2001. The main component of the charge, which related to the personal sector, amounted to US$857 million, a rise of US$113 million, largely as a result of growth in lending and higher credit card provisioning in Hong Kong. New corporate provisions also increased in Europe but this was more than offset in Asia as the economic conditions in some Asian countries improved. The substantial reduction in the total charge in 2002 reflected the US$600 million general provision against Argentine exposure charged in 2001.
Other charges of US$107 million in 2002 were US$1,062 million, or 91 per cent, lower than in 2001. The 2001 charges included the loss of US$520 million arising from the foreign currency redenomination in Argentina and a charge of US$575 million in respect of the Princeton Note matter. The 2002 charge included US$68 million in losses in Argentina arising from judicial orders or ‘amparos’ (allowing certain depositors relief from the mandatory pesification rules and recovery of their historic US dollar deposits at current exchange rates),
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government decrees and renegotiation of banking contracts.
Amounts written off fixed asset investments were dominated by a US$143 million charge writing down the carrying value of a major European life assurer in which CCF had for some time held a strategic minority stake.
The US$28 million share of operating losses in joint ventures principally reflected HSBC’s share of the ongoing costs of Merrill Lynch HSBC for the first half of 2002. Following the acquisition by
HSBC of its joint venture partner’s share on 28 June 2002, these results were consolidated fully on a line by line basis.
Gains on disposal of investments ofUS$532 million included profit on the sale of CCF’s stake in Lixxbail to its joint venture partner, and HSBC’s 6.99 per cent stake in Banco Santiago S.A. In addition, disposal gains of US$170 million were realised from sales of investment debt securities made to adjust to changes in interest rate conditions. In aggregate, disposal gains on investments were US$222 million lower than in 2001.
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Net interest income
Net interest income in 2003 was US$10,138 million, or 66 per cent higher than 2002, at US$25,598 million. Of this increase, Household contributed US$8,305 million, and HSBC Mexico US$874 million. Excluding these acquisitions, and at constant exchange rates, net interest income was only marginally higher than in 2002, as the impact of growth in interest-earning assets was offset by continuing margin compression from the effect of low interest rates worldwide. This impact is expected to continue in 2004 unless interest rates rise ahead of market expectations.
In Europe, net interest income wasUS$1,197 million, or 19 per cent, higher than in 2002. HFC Bank contributed US$438 million of this increase. Excluding this acquisition and at constant exchange rates, net interest income was slightly higher than in 2002, reflecting strong growth in average interest-earning assets. This was partly offset by the cost of paying interest on small and medium-sized business accounts in the UK and the impact of liquidity being redeployed at lower yields as assets matured. In North America, net interest income
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increased by US$9,045 million. On an underlying basis, the growth was US$304 million, or 11 per cent, primarily reflecting the benefits of strong growth in mortgage lending and savings products, and good balance sheet management, which improved the mix of lending by exiting less profitable business. Benefit was also gained from the elimination of funding costs following the closure of certain arbitrage trading activities in the US. In Hong Kong, net interest income declined by 6 per cent, largely due to spread compression on the value of deposits and continued pressure on margins in the mortgage business. Continued pressure on margins depressed mortgage yields in an environment of very low credit demand. This was partly offset by a 7 per cent growth in average interest-earning assets, increased customer deposits and the redeployment of interbank placements in holdings of debt securities. Credit card lending also grew by 6 per cent, improving the m ix of assets.
In the rest of Asia-Pacific, net interest income increased by 8 per cent. In constant currency, this increase was 5 per cent, driven by growth in mortgages and credit card lending, and the beneficial effect of the acquisition of the retail deposit and loan
business of AMP Bank Limited in the first half of 2003.
In South America, net interest income was broadly in line with last year. In constant currency, net interest income grew by 10 per cent. In Brazil, net interest income was marginally higher than in 2002, benefiting from the acquisition of the Brazilian businesses and assets of Lloyds TSB Group plc in December 2003. Excluding this, the favourable effect of higher levels of customer lending and deposits were fully offset by reduced spreads as interest rates fell during the year. Argentina recorded net interest income of US$14 million in 2003 compared with a net interest expense last year. As the domestic economy began to recover and the trade surplus grew, interest rates fell. The effect of the continuing reduction in average interest-earning assets was more than offset by the lower cost of funding the non-performing loan portfolio.
Overall, average interest-earning assets increased by US$169.7 billion, or 28 per cent, compared with 2002. Of the increase, Household contributed US$92.0 billion and HSBC Mexico US$17.8 billion. At constant exchange rates, underlying average interest-earning assets increased by 4 per cent. This growth was driven principally by higher mortgage balances and personal lending in the UK, France, the US, Canada, Malaysia, Australia and Singapore, and an increase in holdings of long-term securities in the US and debt securities in Hong Kong.
HSBC’s net interest margin was 3.29 per cent in 2003, compared with 2.54 per cent in 2002. The acquisitions of Household and HSBC Mexico increased net interest margin by 77 and 6 basis points respectively. On an underlying basis, HSBC’s net interest margin fell by 8 basis points to 2.46 per cent.
In Europe, the fall in net interest margin was primarily due to a decline in the benefit of net free funds, mainly as a result of paying interest on current account balances belonging to small and medium sized enterprises in the UK. In Hong Kong, HSBC’s net interest margin also declined because of lower spreads on deposits and lower yields on redeployed interbank placements. In Hang Seng Bank, net interest margin narrowed due to lower mortgage yields, narrower spreads on deposits and debt securities, and a lower contribution from net free funds, partly offset by switching liquidity from interbank placements to debt securities. In the rest of
Asia-Pacific, net interest margin fell in several countries, mainly from narrower spreads on deposits, lower yields on mortgages, the maturing of higher yielding assets, and a reduced contribution from net free funds. In the US, growth in mortgage balances and a shift in the treasury portfolio to higher yielding fixed rate investments led to an improvement in net interest margin.
Net interest income in 2002 was US$735 million, or 5 per cent, higher than 2001, at US$15,460 million. At constant exchange rates, net interest income was 6 per cent higher than 2001 reflecting growth in HSBC’s operations in Europe, North America and the rest of Asia Pacific, as well as the acquisition of HSBC Mexico at the end of November 2002.
In Europe, net interest income was US$780 million, or 14 per cent, higher than in 2001, mainly reflecting the growth in average interest-earning assets and the benefits of lower funding costs. In constant currency, growth was 10 per cent. In North America, net interest income increased by US$282 million, or 12 per cent, due to a combination of the increased level of average interest-earning assets, primarily residential mortgages, and wider margins on treasury activities as a steeper yield curve led to reduced funding costs. In addition, HSBC Mexico contributed US$85 million of net interest income to the North American region. In Hong Kong, notwithstanding modest loan growth and a reduced contribution from net free funds, net interest income was largely maintained as a strong performance in Global Markets, together with growth in credit card lending and in low cost deposits, offset continuing margin compression in the mortgage business.
In the rest of Asia-Pacific net interest income growth of 8 per cent was driven by higher credit card and personal lending together with the full year impact of the acquisition of NRMA Building Society (‘NRMA’) in Australia in 2001.
In South America the unsettled economic environment caused net interest income to fall by US$420 million to US$645 million. In Brazil, underlying net interest income was in line with 2001 as the benefit from higher levels of customer lending was offset by the impact of HSBC’s decision to reduce the level of local debt securities and to
41
position the balance sheet more conservatively. In Argentina, the combination of narrower spreads and the high cost of local funding of the non-performing loan portfolio resulted in net interest expense in 2002.
Average interest-earning assets at US$609 billion increased by US$29 billion, or 5 per cent. Adjusting for the impact of foreign exchange translation and acquisitions, underlying growth was 3 per cent, driven principally by the placement of customer deposits in the UK, Taiwan, India, Korea, mainland China and the Middle East, together with personal lending growth in the UK, France, US, Canada, Singapore, Malaysia, Korea, Taiwan and India. The increase in average interest-earning assets from acquisitions was US$4 billion.
HSBC was able to maintain its net interest margin at 2.54 per cent, unchanged from 2001, as an 18 basis point widening in interest spread was offset by a similar reduction in the contribution from net free funds. Interest spreads benefited from a change in asset mix, with a higher proportion of personal lending, and from the increasing investment of surplus liquidity in higher yielding investment grade corporate debt securities, instead of interbank placements. In addition, margins benefited from the fall in short-term interest rates as relative returns earned on liquidity deployed in longer dated assets by Global Markets increased as the yield curve steepened. A reduced benefit from a higher level of net free funds mitigated this effect on the net interest margin.
In the UK, net interest margin fell as an improved contribution from Global Markets activities and the benefit of higher levels of personal customer lending were more than offset by reduced earnings from net free funds. In Hong Kong, The Hongkong and Shanghai Banking Corporation maintained its margin through improved Global Markets performance, higher net recoveries of suspended interest and an increased proportion of higher yielding credit card advances. These factors offset the impact of reduced spreads on deposits, a lower contribution from net free funds and narrower spreads in the competitive mortgage market. Hang Seng Bank suffered a fall in net interest margin, primarily from a combination of lower earnings on net free funds as interest rates fell and narrower spreads on mortgages. For Hang Seng Bank these drivers were much more significant than for The Hongkong and Shanghai Banking Corporation. In the US, t he net interest margin improved as the result of a strong performance in Global Markets activities, as a steeper yield curve reduced funding costs, and growth in average mortgage balances.
HSBC moved increasingly to differentiated product pricing in 2002. This competitive approach reflected the value to HSBC of its loyalest customers, but resulted in narrower spreads on a number of products, particularly mortgages and savings. The benefit of this strategy was seen in the mix and volume of HSBC’s core current account and savings products, particularly in the UK, Hong Kong and the US.
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FinancialReview (continued)
Analysis of fees and commissions receivable and payable
Other operating income of US$15,474 million, was US$4,339 million, or 39 per cent, higher than in 2002. Of this increase, Household contributed US$1,878 million and HSBC Mexico contributed US$599 million. On an underlying basis, and at constant exchange rates, growth in other operating income was 9 per cent, principally as a result of higher dealing profits throughout HSBC’s operations.
The acquisitions of Household and HSBC Mexico reduced the proportion of fee revenues exposed to stock market fluctuations by bringing into the Group significant levels of account service fees (HSBC Mexico) and credit card fee income (Household). Fees from credit cards now constitute close to 24 per cent of total fees receivable compared with 13 per cent in 2002.
Fees and commission income, excluding Household and HSBC Mexico and at constant exchange rates, increased by 4 per cent compared with 2002. In Europe, fee income increased by US$664 million, or 15 per cent, of which HFC Bank contributed US$49 million. Excluding this acquisition and at constant exchange rates, fee income increased by 2 per cent, mainly from growth in sales of creditor protection insurance, cards
transactions and loan fees. Within the UK, personal loan protection premiums grew by 19 per cent, reflecting growth in mortgages and personal loans. However, this was partly offset by a decline in sales of investment and pension products, mainly reflecting uncertainty in the equity markets.
In North America, excluding US$1,167 million and US$453 million relating to Household and HSBC Mexico respectively, fee income was marginally higher than in 2002. Growth in income from securities advisory services, deposit-related service charges and card fees were partly offset by lower earnings from mortgage servicing.
In Hong Kong, fee income increased by US$119 million, primarily due to higher revenues from wealth management services. There was strong growth in fees from sales of unit trusts and capital guaranteed funds, which increased by US$1.6 billion in 2003. HSBC expanded its range of structured deposit products, further benefiting fee income. Revenues from securities and stockbroking also increased in line with a buoyant stock market in the second half of the year and increased market share. In addition, the insurance business generated strong results reflecting growth in new individual life business written.
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HSBC’s operations in the rest of Asia-Pacific increased fee income by US$81 million with strong growth in wealth management income, reflecting higher unit trust sales and funds under management. Fee income from credit cards rose in a number of countries.
In South America, fee income increased by 10 per cent at constant exchange rates, mainly in Brazil. The increase reflected good growth in credit-related revenue, account service fees and cards. In Argentina a decline in fee income was recorded.
Dealing profits of US$2,178 million were US$865 million, or 66 per cent, higher than in 2002 and reflected investment in and refocusing of HSBC’s markets businesses, primarily in the US and in Europe. In Asia a wider range of structured solutions were offered to customers which boosted revenues. Acquisitions were not significant contributors to growth in this area with HSBC Mexico contributing US$103 million. Within dealing profits, there was strong growth in fixed income earnings, predominantly in Europe and Hong Kong, as a result of favourable credit spreads and strong investor demand for yield enhancement products. Foreign exchange revenues increased in both Europe and North America, with volatility in the major currencies driving sales of hedging products and sales activity generally. In Hong Kong, a greater focus on tailored solutions generated a significant increase in corporate sales during the year.
Other operating income further benefited from expansion of the insurance businesses in Argentina and Hong Kong and growth in the rail leasing business in the UK.
Other operating income of US$11,135 million was in line with that of 2001, both in nominal terms and in constant currency. In both Europe and South America the nominal movements in other operating income were primarily due to currency translation. With the exception of equity market-related activities, namely broking income and custody fees, growth was achieved in virtually all elements of other operating income.
Net fees and commissions, at US$7,824 million, were US$354 million, or 5 per cent, higher than in 2001 and represented 29 per cent of total operating income in both 2002 and 2001. At constant exchange
rates, net fees and commissions were 4 per cent higher than in 2001.
In Europe, fee income increased byUS$318 million, or 8 per cent (3 per cent in constant currency), as growth in wealth management income, particularly in general and life insurance, private client, pensions and investment advisory business more than offset the lower levels of equity market-related fees. In the UK, growth of 17 per cent was achieved in HSBC branded life, pensions and investment products sold through the tied salesforce. Sales of life protection products grew by 4 per cent and creditor protection insurance by 29 per cent.
In North America, fee income wasUS$24 million higher than in 2001, excluding the US$47 million increase arising from the acquisition of HSBC Mexico. Growth in fee income from the sale of annuities and mutual funds, and across a range of banking services, more than offset a lower level of broking income.
In Hong Kong, where the demand for credit products was muted, emphasis was placed on generating fee income. A combination of initiatives meant fee income was US$92 million higher than in 2001. This was primarily due to strong growth in fees from the sale of unit trusts, including the sale of US$2.8 billion of HSBC’s capital guaranteed funds, and fees from credit cards, insurance and underwriting business. In addition, higher levels of fee income were earned from structured finance transactions.
HSBC’s operations in the rest of Asia-Pacific grew fee income by US$43 million, with strong contributions from credit cards in Taiwan, Malaysia, Indonesia, the Middle East, Thailand and India.
In South America, fee income fell nominally by US$170 million, though by only US$27 million at constant exchange rates. Fee earning opportunities contracted in the subdued economic environment and, in addition, the Brazilian Government moved to prohibit the charging of fees against certain accounts.
Dealing profits at US$1,313 million were US$372 million, or 22 per cent, lower than in 2001. Within this category foreign exchange earnings grew 4 per cent to US$1,167 million and continued to demonstrate resilience across all market conditions. The deterioration was primarily in the area of interest rate trading, with earnings from debt securities
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US$236 million lower as credit spreads on corporate bonds widened sharply in response to an erosion of market confidence caused by low earnings growth and news of corporate scandals in the United States. Dealing profits were also affected by weaknesses in the equity markets.
Fees in debt capital markets grew strongly by 30 per cent, or US$40 million, as HSBC improved its position in European markets.
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Operating expenses
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Growth in operating expenses of US$6,724 million, or 43 per cent, principally reflected the acquisitions of Household, US$3,787 million, and HSBC Mexico, US$964 million. Excluding the impact of these acquisitions and expressed in terms of constant currency, underlying operating expenses, excluding goodwill amortisation, were 5 per cent higher than in 2002. Virtually all of this growth was in staff costs, reflecting restructuring costs, higher social taxes and pension costs. In addition, Corporate, Investment Banking and Markets incurred higher costs reflecting expansion of the business and increased profitability. Notwithstanding this growth, the cost:income ratio of Corporate, Investment Banking and Markets improved by 3 per cent to 48.9 per cent. HSBC’s cost:income ratio excluding goodwill amortisation was 51.3 per cent for 2003, compared with 56.2 in 2002. Excluding Household, the cost:income ratio was 57.2 per cent.
In 2003, HSBC’s Group Service Centre in Malaysia became operational. Overall, the Group’s Global Resource centres now employ in excess of 7,000 employees.
In Europe, costs excluding goodwill amortisation increased by US$1,651 million compared with 2002, of which Household contributed US$299 million. At constant exchange rates and excluding Household and goodwill amortisation, expenses were 5 per cent higher than in 2002. This increase in expenses was primarily due to higher pension provision and employment costs, particularly in the UK, where social taxes were raised. Redundancy and property provisioning costs also increased, as HSBC restructured and relocated positions to the Group Service Centres in order to reduce its long-term staff costs. In addition, higher bonus accruals reflected stronger Global Markets revenues.
Operating expenses in Hong Kong, excluding goodwill amortisation, were marginally higher than in 2002. Increased staff costs were mainly attributable to higher performance-related bonuses, reflecting strong Global Markets performance, and provisions for restructuring costs. Marketing expenses also rose in Personal Financial Services as Hong Kong’s economy rebounded after SARS abated. These increases were partly offset by reductions in staff numbers in Hong Kong as HSBC
continued its policy of migrating back office processing functions to the Group Service Centres.
In the rest of Asia-Pacific, costs in 2003, excluding goodwill amortisation, increased by US$213 million, or 14 per cent, compared with 2002. At constant exchange rates, the increase was 9 per cent, primarily from recruitment to support business expansion, branch opening costs, acquisitions and provisions for restructuring. In addition, the continued migration of processing activities from other regions to the Group Service Centres in India, Malaysia and mainland China added to costs.
In North America, operating expenses, excluding goodwill amortisation, increased by US$284 million, or 11 per cent, in 2003 excluding Household and HSBC Mexico. This increase was largely driven by higher staff costs, namely pension and healthcare provisions, performance-related incentives, and expenses associated with long-term restructuring programmes. In the US during 2003, severance costs of US$47 million were recorded for expense reduction initiatives, global resourcing moves and Household integration efforts, a US$28 million increase over the prior year. In addition, costs rose from the first full year inclusion of HSBC’s high net worth personal tax advisory business. These increases were partly offset by the benefits obtained from discontinuing certain of HSBC’s government and agency securities arbitrage operations in the US, and from business disposals.
In South America, operating expenses, excluding goodwill amortisation, were broadly in line with 2002. At constant exchange rates and excluding goodwill amortisation, costs were 6 per cent higher than in 2002. The rise in Brazil was due to higher staff costs, driven by increases in labour claims, together with higher marketing costs and increased transaction taxes on higher operating income as the personal lending portfolio was expanded. In addition, the Group’s newly acquired businesses in Brazil added to cost growth. Costs in Argentina were down on 2002, mainly because of lower severance costs.
Operating expenses in 2002 were US$404 million, or 3 per cent, higher than in 2001. The increase reflected organic growth, acquisitions made during 2002, and the full year effect of acquisitions and the expansion of business activities in 2001, particularly
48
in North America and the rest of Asia Pacific. In constant currency, excluding acquisitions made in 2002 and goodwill amortisation, cost growth was 2 per cent. Goodwill amortisation increased by US$55 million, of which US$10 million was goodwill amortised on GFBital for the one month of its ownership, and US$20 million was a non-recurring charge to write-off the balance of purchased goodwill on the Group’s insurance activities in Argentina.
In Europe, costs excluding goodwill amortisation increased by US$590 million in 2002 compared with 2001. At constant exchange rates, costs in 2002, excluding goodwill amortisation, were US$265 million or 3 per cent higher than in 2001. US$165 million of this increase was attributable to acquisitions and changes in Group structure. These comprised the full consolidation of the Merrill Lynch HSBC business from July 2002 (US$45 million), and the acquisition of Demirbank and the Benkar card business in Turkey (US$120 million). The move to the Group’s new headquarters in Canary Wharf, together with consequent increases in vacant space provisioning, added US$76 million. Costs in the UK based investment banking operations were lower as headcount was adjusted to reflect market conditions.
In Hong Kong, costs in 2002, excluding goodwill amortisation, were in line with 2001. A fall in staff costs, following the transfer of back office processing functions to Group Service Centres in
India and mainland China, and the non-recurrence of a pension top-up in Hang Seng Bank, offset increases in costs associated with business expansion.
In the rest of Asia-Pacific, costs excluding goodwill amortisation increased by US$131 million, or 9 per cent, in 2002 compared with 2001. This growth in costs primarily reflected a higher staff complement in Group Service Centres in India and mainland China, and the expansion of business in several countries in the region, in particular mainland China, Taiwan, the Middle East and Australia, the latter through the acquisition of NRMA.
Operating expenses in North America, excluding goodwill amortisation, increased by US$135 million, or 5 per cent, in 2002. This increase largely arose from the acquisition of GFBital and the costs associated with the establishment of the Wealth and Tax Advisory Services (‘WTAS’) business in the US. A reduction in the costs associated with ongoing development of hsbc.com offset additional costs from the closure of the institutional equity business in Canada and the restructuring of the merchant banking business in the US.
In South America, operating expenses, excluding goodwill amortisation, fell by US$437 million, or 29 per cent, during 2002. At constant exchange rates, operating expenses excluding goodwill amortisation were 4 per cent higher than in 2001. The increase related to industry-wide salary adjustments agreed with unions in Brazil and costs of severance as headcount reductions were made in the recessionary environment.
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The acquisition of Household significantly affected the geographical and customer segment distribution of the Group’s lending activities and, more markedly, the distribution of its credit costs. At 31 December 2003, 76 per cent of customer lending was located, fairly equally, in Europe and North America, compared with 69 per cent in 2002, with Europe two-thirds of that total. At 31 December 2003, personal lending accounted for 56 per cent of the customer loan portfolio compared with 42 per cent at 31 December 2002.
Excluding the effect of foreign exchange translation and the acquisition of Household, over 90 per cent of loan growth in 2003, excluding the financial sector, was generated in personal lending, predominantly mortgages, credit cards and other personal products.
Over 90 per cent of the charge for bad and doubtful debts in 2003 related to lending to the personal sector, including consumer finance, compared with 65 per cent in 2002. Similarly, over 90 per cent of the charge related to lending in the US and Europe, compared with 66 per cent in 2002.
The charge for specific bad and doubtful debts adjusts the specific balance sheet provisions to the level that management deems adequate to absorb actual and inherent losses in the Group’s loan portfolio from homogenous portfolios of assets and individually identified customer loans. Following the acquisition of Household, the majority of specific
provisions are now determined on a portfolio basis. In addition, the acquisition of Household has resulted in a significant increase in the extent to which HSBC employs statistical calculations using roll rate methodology to determine specific provisions for bad and doubtful debts. Other than this, there have been no significant changes to HSBC’s procedures in determining the various components of the charge for specific bad and doubtful debts. The charge for specific provisions in 2003 was US$6,214 million compared with US$1,672 million in 2002, an increase of US$4,542 million. New specific provisions, which increased by US$5,099 million, principally reflected the acquisitions of Household (US$4,773 million) and HSBC Mexico (US$47 million). Excluding the effect of the acquisitions, new specific provisions rose by US$249 million, or 9 per cent, compared with 2002.
General provisions augment specific provisions and provide cover for loans which are impaired at the balance sheet date but which will not be individually identified as such until some time in the future. In determining the level of general provisions management takes into account historical loss experience, the estimated period between a loss occurring and that loss being identified and use their judgement as to whether current economic and credit conditions are likely to increase or reduce the actual level of inherent losses. There was a net general provision release of US$121 million in 2003, US$230 million lower than the net release of US$351 million in 2002. In Household and HSBC Mexico, general provisions were augmented by US$191 million due to growth in personal lending.
Excluding this, the net release of general provisions of US$312 million was in line with that of 2002. This reflected improved underlying economic conditions, and progress made with refinancing and restructuring problem credits.
The aggregate customer bad and doubtful debt provisions at 31 December 2003 of US$13.7 billion represented 2.66 per cent of gross customer advances (net of suspended interest, reverse repos and settlement accounts) compared with 2.68 per cent at 31 December 2002. As in 2003, HSBC cross-border exposures did not necessitate significant provisions.
Non-performing loans (net of suspended interest) of US$15 billion at 31 December 2003 included US$5 billion relating to Household’s loan book. Excluding Household, and at constant exchange rates, there was a decrease in the level of non-performing loans (net of suspended interest) in 2003 compared with 2002 mainly as a result of the write-off of loans from the legacy portfolio acquired on the acquisition of HSBC Mexico.
HSBC’s customer loan portfolio continued to be well-spread both geographically and across personal and industrial sectors during 2002. The loan portfolio at constant exchange rates and excluding loans to the financial sector, grew by US$31.5 billion, or 11 per cent, during 2002 of which US$9.4 billion, or 3 per cent, arose from the acquisition of HSBC Mexico. The personal loan sector of the Group’s loan portfolio increased to 42 per cent of the aggregate at the end of 2002 compared with 40 per cent at the end of 2001. At constant exchange rates, there was growth of US$19.5 billion, mainly in Europe, North America and Asia. Of this increase, US$14.2 billion arose from residential mortgage lending.
Changes in the concentration risk and asset quality of HSBC’s loan portfolio arose from the incorporation of the domestic loan book of HSBC Mexico. 13 per cent of HSBC Mexico’s loan book of US$9.7 billion was non-performing, including significant proportions of residential mortgage loans
and unsecured personal loans. These assets became impaired during the Mexican economic crisis in the late 1990s. In addition, approximately 40 per cent of HSBC Mexico’s loan exposure was peso-denominated Mexican Government risk. HSBC Mexico also had impaired assets in the agricultural and other government-supported sectors. These loan assets were critically reviewed and provisions restated where necessary to conform with the requirements of both UK GAAP and US GAAP during the fair value exercise undertaken as at the date of acquisition of HSBC Mexico.
Excluding HSBC Mexico, there was a decrease in the level of non-performing loans during 2002 of US$350 million. This was due to a combination of write-offs, recoveries and upgradings in Hong Kong and a number of other Asian countries, partly offset by a rise of US$813 million in non-performing loans in Europe. The European increase came primarily from a small number of individual corporate loans in the telecommunications, private healthcare, leisure and manufacturing sectors and was not indicative of a general trend. Importantly, credit quality on consumer lending remained stable. In South America, in local currency terms, there was a sharp increase in the level of individual Argentinian non-performing loans as the effects of the economic crisis manifested themselves. By the end of 2002, almost three-quarters of the non-government loan book was classified as non-performing. The impact of this was recognised in the gen eral provision established at the end of 2001.
Aggregate customer bad and doubtful debt provisions at 31 December 2002 of US$9.1 billion represented 2.52 per cent of gross customer advances compared with 2.57 per cent at 31 December 2001.
As in 2001, HSBC’s cross-border exposures did not necessitate significant provisions.
There were no significant changes to the Group’s procedures for determining the various components of the provision for bad and doubtful debts.
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Gains on disposal of investments
During 2003, HSBC made 26 business acquisitions and completed 14 business disposals.
HSBC’s profit on disposal of investments was US$451 million, US$81 million lower than in 2002. The profits in 2002 included gains of US$39 million on the sale of HSBC’s 50 per cent share of Lixxbail to its joint venture partner, and US$38 million on the sale of HSBC’s 6.99 per cent share in Banco Santiago S.A..
Realised gains on the sale of debt and equity investment securities during the period were broadly in line with 2002. The reductions in interest rates and improvement in equity markets drove growth of US$59 million in the unrecognised gains on HSBC’s debt and equity investment portfolios.
During 2002, HSBC made 23 business acquisitions and completed 20 business disposals.
HSBC’s European results includedUS$213 million of profits on the sales of securities from investment portfolios, principally as HSBC adjusted its exposure to changes in interest rates. HSBC also disposed of its 50 per cent stake in Lixxbail to its joint venture partner, generating a profit of US$39 million.
In the US, gains were taken in the first half of the year on the sale of a number of mortgage-backed and other debt securities as long-term portfolios were adjusted in response to exposures to interest rates and sovereign credit.
HSBC’s South American results included a gain of US$38 million on the sale of HSBC’s 6.99 per cent stake in Banco Santiago S.A..
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Taxation
HSBC Holdings and its subsidiary undertakings in the United Kingdom provided for UK corporation tax at 30 per cent, the rate for the calendar year 2003 (2002: 30 per cent).
HSBC’s effective tax rate of 24.3 per cent in 2003 was lower than the corporation tax rate of 30 per cent. The geographic mix of profits; fair value accounting adjustments, which are ignored for tax purposes; and prior period adjustments were the main factors which reduced the rate. These were partially offset by the effect of goodwill amortisation, which is also ignored for tax purposes, which increased the rate.
Overseas tax included Hong Kong profits tax of US$483 million (2002: US$408 million) provided at a rate of 17.5 per cent (2002: 16 per cent) on the profits assessable in Hong Kong. Other overseas taxation was provided for in the countries of operation at the appropriate rates of taxation.
Profits arising in North America represented a higher percentage of HSBC’s profits in 2003 compared with 2002 largely because of the acquisition of Household. US profits are taxed at a higher rate than the average for the rest of the Group and this change in mix raised the effective tax rate.
A number of fair value acquisition accounting adjustments relating to Household and HSBC Mexico resulted in net credits to the profit and loss account with no corresponding tax charge. A more detailed explanation of the acquisition accounting adjustments is disclosed in Note 8 of the ‘Notes to the Financial Statements’.
Prior period adjustments arose in 2003 which reduced HSBC’s overall tax charge. These related mainly to the recognition of deferred tax assets on losses, which became more likely to be utilised. The Group also reached agreement on a number of settlements. in respect of outstanding matters on prior year computations which allowed contingency reserves to be released.
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Goodwill amortisation was higher than in the previous year, mainly due to the acquisition of Household.
At 31 December 2003 there were potential future tax benefits of US$963 million (2002: US$885 million). The potential benefits are in respect of trading losses, allowable expenditure charged to the profit and loss account but not yet allowable for tax, and capital losses which had not been recognised because realisation of the benefits was not considered more likely than not.
HSBC Holdings and its subsidiary undertakings in the United Kingdom provided for UK corporation tax at 30 per cent, the rate for the calendar year 2002 (2001: 30 per cent).
Overseas tax included Hong Kong profits tax of US$408 million (2001: US$450 million) provided at a rate of 16 per cent (2001: 16 per cent) on the profits assessable in Hong Kong. Other overseas taxation was provided for in the countries of operation at the appropriate rates of taxation.
HSBC’s effective tax rate of 26.3 per cent in 2002 was higher than that for 2001 (24.9 per cent), mainly as a result of changes in the geographic mix of profits and certain non-recurring items occurring in 2001 which reduced the 2001 rate.
In particular, profits arising in North America represented a higher percentage of HSBC’s profits in 2002 compared with 2001 because profits in the US were abnormally suppressed in 2001 by the provision relating to the Princeton Note settlement. US profits were taxed at a higher rate than the average for the rest of the Group and thus this change in mix raised the overall tax rate of the Group.
One-off tax-free gains arising in 2002 were less than those in 2001.
Partly offsetting these factors, no tax relief was assumed in respect of the bad debt provision and other losses relating to Argentina. These losses and provisions were lower in 2002 than in 2001. This had the effect of increasing the aggregate tax rate in both 2002 and 2001, though to a lesser extent in 2002.
In 2002, prior year adjustments which resulted in a reduction in the tax rate, mainly relating to audit settlements, were less than similar adjustments in 2001.
At 31 December 2002 there were potential future tax benefits of US$885 million (2001: US$906 million). The potential benefits were in respect of trading losses, allowable expenditure charged to the profit and loss account but not yet allowable for tax, and capital losses which had not been recognised because realisation of the benefits was not considered more likely than not.
Asset deployment
HSBC’s total assets (excluding Hong Kong Government certificates of indebtedness) at 31 December 2003 were US$1,023 billion, an increase of US$274 billion, or 37 per cent, since 31 December 2002. Of this increase, US$131 billion were assets (including the related goodwill) added as
at the date of the acquisition of Household. Excluding this and at constant exchange rates, total assets grew by US$92 billion or 11 per cent.
The impact of Household on asset mix by geography and customer type, which was operating primarily in North America in personal financial services, is also significant and is illustrated in the table below.
At 31 December 2003, HSBC’s balance sheet remained highly liquid, reflecting continued strong growth in customer deposits. Notwithstanding the acquisition of Household, the proportion of assets deployed in customer advances rose modestly from 47 per cent to 52 per cent. As a result of the Household acquisition, lending in Europe and North America rose to over 75 per cent of the total lending portfolio.
Foreign exchange translation had a significant impact on reported growth within the balance sheet, as the US dollar weakened by 9.7 per cent and by 16.8 per cent over the year against sterling and the euro respectively.
At constant exchange rates, gross loans and advances to customers (excluding loans to the financial sector and settlement accounts) were US$145 billion higher than at 31 December 2002. Of this growth, US$108 billion related to loans outstanding at the time Household was acquired.
Growth in lending in 2003 was concentrated in the personal sector. Excluding loans outstanding at the time Household was acquired, and at constant exchange rates, personal lending increased by US$34 billion, or 21 per cent, compared with 31 December 2002. This was mainly as a result of increased mortgage lending in the UK and the US, the acquisitions in Brazil and New Zealand, and post-acquisition growth in Household, where lending grew at an annualised 11 per cent following acquisition.
Commercial and corporate lending, excluding lending to governments, grew by under 2 per cent as corporate demand for credit remained subdued and HSBC maintained its cautious lending criteria. Surplus funds from increased customer deposits in most geographic regions were increasingly deployed in investment securities in order to diversify risk concentration away from interbank lending.
In Europe, growth in assets was driven primarily by increased mortgage lending in the UK, the post-acquisition growth in personal lending in HFC Bank and higher balances from trading activities in the UK and France. In addition, there was strong growth in consumer credit in the UK and secured lending in Switzerland driven by private banking customers seeking to maximise the overall earnings potential of their investments by borrowing to reinvest in higher returning securities.
In Hong Kong there was only modest growth in customer lending against a backdrop of weak consumer demand, the impact of SARS and intense competition in the mortgage market. Additionally, loan balances under the Hong Kong Government Home Ownership Scheme continued to fall following the suspension of this programme in 2001. Encouragingly, however, there was a 5 per cent growth in commercial and corporate lending, particularly in the second half of the year, as business confidence improved post-SARS, and initiatives announced by the mainland government to eliminate restrictions on tourists entering Hong Kong took effect.
In the rest of Asia-Pacific, growth in assets was also driven by increased personal customer advances. At constant exchange rates, personal lending increased by 33 per cent compared with 31 December 2002, mainly as a result of increased mortgage lending in Australia and New Zealand, where HSBC acquired the AMP Bank’s mortgage
business, and in Korea, Singapore, India, Malaysia and Taiwan. Other personal lending increased in most countries in the region.
In North America, the increase in total assets (excluding that relating to the acquisition of Household) was primarily in residential mortgages and other personal lending in both the US and Canada, as customers took the opportunity to consolidate their debt and re-mortgage at the lower prevailing interest rates.
In South America, growth in total assets reflected the inclusion of the consumer lending portfolios of Losango and the ex-Lloyds TSB corporate lending portfolio.
At 31 December 2003, assets held by the Group as custodian amounted to US$1,869 billion. Custody is the safekeeping and administration of securities and financial instruments on behalf of others. Funds under management amounted to US$399 billion at 31 December 2003.
Debt securities and equity sharesDebt securities held on an accruals basis in the investment book at 31 December 2003 showed an aggregate unrecognised gain, net of off-balance sheet hedges, of US$1,160 million compared with an unrecognised gain of US$1,278 million at 31 December 2002. Equity shares included US$5,390 million held on investment account, compared with US$4,284 million at 31 December 2002, on which there was an unrecognised gain of US$827 million, compared with a gain of US$473 million at 31 December 2002.
Funds under management
Funds under management of US$399 billion were US$47 billion, or 13 per cent, higher than at 30 June 2003 and US$93 billion, or 30 per cent, higher than at the end of 2002. During the year both the asset management and private banking businesses reported net fund inflows. The weakening of the US dollar benefited the translation of sterling and euro-denominated funds, and contributed to the positive market performance which resulted from the upturn in global equity markets. As at 31 December 2003, HSBC’s asset management business, including affiliates, reported funds under management of US$193 billion, and the private banking business reported funds under management of US$169 billion.
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Economic profitHSBC’s internal performance measures include economic profit, a measure which compares the return on the financial capital invested in HSBC by its shareholders with the cost of that capital. HSBC prices its cost of capital internally and the difference between that cost and post-tax profit attributable to ordinary shareholders represents the amount of economic profit generated. Economic profit is used by management as one of the measures to decide where to allocate resources so that they will be most productive. Internally HSBC emphasises the trend in economic profit within business units rather than
absolute amounts in order to concentrate on external factors rather than measurement bases. As a result of this, HSBC has consistently used a benchmark cost of capital of 12.5 per cent on a consolidated basis. Given recent changes in interest rates and in the composition of HSBC, HSBC believes that its true cost of capital on a consolidated basis is now approximately 10 per cent, and this rate will be adopted from 2004 onwards within the Group’s new strategic plan. HSBC has used the figure of 12.5 per cent for the duration of the current five year strategic plan period, which expired at the end of last year, in order to ensure consistency and to help comparability.
On this basis, economic profit increased fourfold to US$934 million, compared with 2002, reflecting the benefit of Household and HSBC Mexico in 2003 as well as organic improvement. Measurement of economic profit involves a number of assumptions and, therefore, management believes that the trend over time is more relevant than the absolute economic profit reported for a single period.
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By customer group:
Profit/(loss) excluding goodwill amortisation
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Profit/(loss) excluding goodwill amortisation (continued)
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HSBC HOLDINGS PLC
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Personal Financial Services
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Financial Review(continued)
Commercial Banking and Corporate, Investment Banking and Markets
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Private Banking and Other
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By geographical region:
In the analysis of profit by geographical region which follows, operating income and operating expenses include intra-HSBC items of US$422 million in 2003, US$326 million in 2002 and US$257 million in 2001.
Profit/(loss) on ordinary activities before tax
Profit/(loss) on ordinary activities before tax excluding goodwill amortisation
Total assets
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Basis of preparation and Footnotes to ‘Analysis by customer group and by geographical region’
Basis of preparation
The results are presented in accordance with the accounting policies used in the preparation of HSBC’s consolidated financial statements. HSBC’s operations are closely integrated and, accordingly, the presentation of customer group data includes internal allocations of certain items of income and expense. These allocations include the costs of certain support services and head office functions, to the extent that these can be meaningfully attributed to operational business lines. While such allocations
have been made on a systematic and consistent basis, they necessarily involve a degree of subjectivity.
Where relevant, income and expense amounts presented include the results of intra-segment funding as well as inter-company and inter-business line transactions. All such transactions are undertaken on arm’s-length terms. Intra-segment funding and placements of surplus funds are generally undertaken at market interest rates.
Footnotes to ‘Analysis by customer group and by geographic region’
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The UK economy expanded by 2.3 per cent in 2003. After a slow first six months, growth accelerated in the third quarter and that momentum continued into the final months of the year. Growth in consumer spending slowed during the course of the year but nevertheless remained robust and, in particular, the housing market and household appetite to borrow remained strong. However, low real income growth, together with the expectation of further rises in interest rates, are expected to dampen household activity in the forthcoming months. Elsewhere, there are a few encouraging signs that industrial activity in particular and corporate confidence in general is starting to improve from a low base. Going forward, stronger global demand, if maintained, should provide a boost to the corporate sector.
Having slipped into recession in the first half of the year, the eurozone economy returned to growth in the second half, expanding by 0.4 per cent quarter-on-quarter in the third quarter and by 0.3 per cent in the fourth quarter. Once again, however, it was stronger exports that drove the third quarter improvement, while the domestic economies remained subdued. Consumer spending was flat and investment contracted for the third consecutive quarter. The pick-up in exports occurred despite the appreciating euro, which rose more than 16 per cent against the dollar during the course of the year. In the fourth quarter, growth seemed to have been largely the result of inventory build up, with exports falling back after the strength of the third quarter, and with limited growth in consumer spending. Interest rates were cut twice during 2003, with the European Central Bank’s repo rate dropping by 75 basis points to 2 per cent. By contrast, however, longer-term interest rates have moved higher, rising by about 80 basis points between June and the end of December, as the bond market anticipated economic recovery.
In 2003, personal credit expansion in the UK was the major growth area as consumers took advantage of historically low interest rates, enabling HSBC to generate strong growth in mortgages and consumer lending. Conversely, sales of investment and pension products fell, reflecting a lack of confidence in equity markets. In this environment, HSBC grew its deposit base as customers sought flexibility and security for their savings, notwithstanding the low interest rates available. The
low interest rate environment also meant that the value of HSBC’s maturing liquidity reduced as it was redeployed in lower yielding assets.
The same factors, low interest rates and weak equity markets, increased the cost of pension provision by US$96 million in the UK. Employment costs also grew, notably in the UK, as social taxes were raised. In order to adjust for this higher cost environment, HSBC took steps to reduce its staff costs, announcing both 1,400 redundancies in the UK and the shift over the next three years of 4,000 positions to the Group Service Centres. In the short term these actions incurred both redundancy and excess property provisioning costs totalling over US$176 million.
European operations contributed pre-tax profit of US$3,969 million in 2003 compared with US$3,500 million last year. Excluding goodwill amortisation, European operations contributed pre-tax profit of US$4,862 million and represented around one-third of HSBC’s total profit on this basis. At constant exchange rates, and excluding the US$157 million contribution from HFC, which was the only major change in the composition of the Group in Europe, pre-tax profit, excluding goodwill amortisation, was 2 per cent higher than last year. Goodwill amortisation of US$893 million increased by US$233 million compared with 2002, mainly reflecting a goodwill write-down in respect of a UK fund management company previously acquired as part of the CCF acquisition, and exchange rate movements.
The commentaries that follow are based on constant exchange rates.
Pre-tax profit, before goodwill amortisation, of US$1,267 million in Personal Financial Services, excluding Consumer Finance, was 16 per cent higher than in 2002, reflecting strong growth in UK mortgage and consumer lending, and in deposit-taking activities.
Net interest income increased by 10 per cent, driven by strong growth in mortgages and personal lending in the UK and, to a lesser extent, in France. The net interest margin fell modestly as rates remained at historically low levels. However, balance sheet growth more than compensated for this. UK mortgage balances increased by 25 per cent to US$37.4 billion, as borrowers continued to take advantage of the low interest rate environment to refinance their mortgages. In France, a similar
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pattern was seen, and CCF’s mortgage balances increased by 11 per cent over 2002. Gross new mortgage lending in the UK grew by 12 per cent to US$17.9 billion. First Direct contributed to this growth with a US$280 million, or 14 per cent, increase over 2002, reflecting the continuing success of its Offset mortgage product. Both HSBC and First Direct continued to win major awards for their mortgage products in 2003.
In the UK, personal lending balances, excluding mortgages and credit cards, grew by 15 per cent reflecting the success of targeted marketing campaigns and improved utilisation of customer relationship management systems. Card balances grew by 18 per cent to US$4.2 billion, due to strong consumer expenditure and targeted marketing campaigns, resulting in an overall increase in fee income from cards of 13 per cent.
HSBC’s Premier service was further enhanced and the number of customers using this service in the UK grew by 57 per cent to over 280,000. Significant growth was achieved in HSBC Premier savings accounts in 2003, which contributed to an overall increase in UK personal savings balances of 20 per cent to US$35.7 billion. UK personal current account balances grew by 13 per cent to US$18.0 billion.
Other operating income was broadly in line with 2002. The strong growth in mortgages and personal loans boosted sales of repayment protection products in the UK, producing a 19 per cent increase in personal loan protection premiums. HSBC maintained its position as the leading provider of income protection products in the UK, with a market share of 17 per cent at the end of September 2003. Lack of customer confidence in equity markets led to a decline in sales of investments and pension products. This trend also adversely affected the value of HSBC’s long-term assurance business in the UK. However, weakness in investment product sales reflected market conditions rather than competitive positioning and the bank was awarded the coveted ‘Five Star Award’ from Money Management magazine for its regular premium stakeholder pensions in the UK again in 2003.
HSBC Turkey benefited from additional card fee income following the acquisition of Benkar in September 2002, contributing to an overall increase in its other operating income of 51 per cent.
Operating expenses, excluding goodwill amortisation, increased by 2 per cent. This was
largely due to restructuring costs and external factors in the UK, including higher social taxes and the amortisation of the UK pension scheme deficit reported at the end of 2002. The relocation of the bank’s headquarters to Canary Wharf contributed to higher premises costs, following the upgrade of equipment and infrastructure. Additional costs were also incurred migrating the card issuing business in the UK to the more efficient platform used by Household in the US. Costs in France were largely unchanged compared with 2002.
Low interest rates, stable employment and a gradual upturn in economic conditions in the UK provided the environment for continuing low levels of credit charges. The charge for bad and doubtful debts at US$267 million was 14 per cent higher than in 2002, a satisfactory performance in view of the growth of over 20 per cent in UK personal lending. Overall, credit quality improved.
In Consumer Finance, HFC Bank, which joined HSBC in the UK in March as part of the Household acquisition, contributed US$157 million to pre-tax profit, before goodwill amortisation, in its first nine months of ownership. Integration with the HSBC Group is running on schedule.
In Commercial Banking, pre-tax profits, before amortisation of goodwill, declined by 13 per cent compared with 2002 mainly reflecting lower net interest income and a higher cost base.
Net interest income decreased by 3 per cent to US$1,961 million. Following the recommendations of the UK’s Competition Commission, HSBC applied credit interest to all qualifying small and medium-sized customer accounts, increasing interest expense by US$136 million. The move did, however, lead HSBC to strengthen its product proposition within those market segments in the UK, and business current account balances consequently rose by 21 per cent to just over US$10 billion. In addition, HSBC’s popular ‘Start-up Stars’ competition continued to raise the profile of the bank’s small business proposition in the UK and helped to attract over 102,000 new business start-ups and over 23,000 customer transfers. Enhanced customer targeting and the introduction of risk-based relationship pricing improved HSBC’s competitive position in the UK market, increasing lending balances by over US$2.2 billio n and net interest income by 10 per cent.
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Overall, deposit balances in the UK grew by 9 per cent to just over US$9 billion, increasing market share and partly offsetting the effects of reduced deposit book spreads. Balances grew as a consequence of the introduction of the new Business Money Manager account, launched in response to customer demand for flexible savings accounts. The new product attracted an average of 1,700 new accounts per week and generated US$95 million of net interest income.
In France, overall net interest income was broadly in line with 2002. The subdued economic climate saw businesses adopt a more conservative investment policy that was reflected in a 3 per cent rise in sight deposits. Short-term higher spread lending fell by 8 per cent, but was partly offset by growth in medium and longer-term lending, which increased by 4 per cent.
In the UK, other operating income was marginally higher than 2002. Overdraft fees rose by 12 per cent, or US$19 million, reflecting the further benefit of improved account management initiatives introduced last year, whilst loan fees increased significantly in line with the growth in customer numbers.
In France, higher income was generated through a volume-led increase in banking transaction fees and the introduction of a variety of guaranteed investment funds during the year. The former was achieved after specific initiatives directed towards middle market enterprises (‘MME’s). The successful launch of several structured financial products led to higher trading fees within CCF and the take-up of Asset Management products increased by 9 per cent.
Overall, wealth management income declined as continued uncertainty in equity markets led to a fall in sales of savings and investment products.
Operating expenses, excluding goodwill amortisation, were 7 per cent higher than last year at US$2,113 million. This was largely due to an increase in staff costs in the UK. Pension costs rose to compensate for the scheme deficit and one-off redundancy costs were incurred as migration was planned to the Group’s global processing capabilities. The costs of distributing and supporting business services and products within the UK increased in line with the growth in volumes and continued investment was made in electronic delivery channels across Europe.
At US$204 million, the overall charge for bad and doubtful debts was 9 per cent lower than in 2002. In the UK there was a release of general provision which recognised the gradual improvement in the economic outlook for businesses over the year. Offsetting this there was a higher specific charge, reflecting a number of large provisions across various industries. Additionally, the charge in France increased due to lower recoveries in two of the regional banks. Underlying credit quality in France remained stable.
Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$1,623 million, an increase of 2 per cent compared with last year. In Global Markets Europe, performance was strong. This reflected income growth in foreign exchange, derivatives and debt securities, partly offset by higher bad debt provisions in Corporate Banking. HSBC also absorbed the costs of restructuring and repositioning the equities and investment banking businesses.
In Global Markets UK, earnings from deploying the excess liquidity of the bank declined as long-term assets matured and proceeds were reinvested at lower rates. Overall, net interest income was 5 per cent lower than in 2002.
Other operating income increased by 9 per cent, reflecting a substantial growth in dealing profits that more than offset lower fee and commission income. Foreign exchange revenues remained strong as volatility in the major currency pairs prompted customers to hedge their currency exposures. Continued weakening of the US dollar provided a clear trend in the markets for position taking. Fixed income earnings showed a strong year-on-year growth reflecting a combination of tightening credit spreads and strong investor demand for yield in the low interest rate environment, which boosted sales of corporate bonds. In line with a greater business focus on risk management products, revenues from trading increased, reflecting the benefit successful interest rate positioning and continued growth in customer mandates from corporate customers. Additional growth in revenue resulted from a strong presence in each of the euro vani lla and structured derivatives markets.
Fees and commission income decreased by 6 per cent. Difficult operating conditions in equity markets resulted in lower commissions and new-issue fees, but these were partly offset by higher fees from
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merger and advisory business as greater focus was given to HSBC’s core customer sectors and regions. Fees from debt capital markets activities were also strong. Generally, fees benefited from the high level of activity in the primary markets, as customers sought long-term financing at low interest rates.
Staff costs rose, with higher bonuses reflecting increased profitability in specific product lines. Restructuring and research costs of US$24 million were also incurred to build and reshape HSBC’s investment banking and equities businesses. Premises and equipment expenses were lower as a result of savings in rental payments from the London office move to Canary Wharf.
Credit experience was generally satisfactory although new specific provisions were higher, mainly due to a single name in the engineering sector which was extensively restructured in the second half of the year. Corporate weakness in the power generation sector was also dealt with through raising additional specific provisions, although these were partly offset by recoveries in the transport and telecommunications sectors, as balance sheets were strengthened.
Gains on investment disposals were lower than in 2002, mainly due to a reduction in profits from the disposal of venture capital investments in CCF.
Against the background of a recovery from recent lows in European stock markets, Private Banking activities continued to grow during 2003. Pre-tax profit, excluding goodwill amortisation, increased by 48 per cent as a result of strong growth in dealing income, lower costs and the non-recurrence of contingencies and write downs in 2002.
Net interest income was broadly in line with 2002. A 30 per cent increase in lending balances was driven by clients seeking to maximise the overall earnings potential of their investments by borrowing to reinvest in higher returning securities. These additional earnings were mostly offset by a decline in yield on free funds as lower interest rates prevailed throughout the year.
Net fees and commissions increased by 2 per cent to US$556 million. The low interest rate environment improved the attractiveness of investment markets, particularly for sophisticated investors with access to structured products which
offered potentially higher returns than from cash deposits. Consequently, funds under management increased by US$20 billion to US$91 billion, with a move by clients away from liquid positions bringing in some US$9 billion of new client funds. A strong rise in discretionary mandates together with client demand for structured products and Household’s commercial paper contributed to the increase. Transaction and safe custody fees rose in line with the growth in client funds while an increased focus on product enrichment produced strong growth in income from structured products. In Germany, fee income was boosted by the placement of two new property funds. However, income in France was weaker as stock market activity remained subdued.
Volatility in the major currencies resulted in higher volumes of client transactions in the foreign exchange markets, and combined with proprietary equity gains in 2003, contributed to the 37 per cent improvement in dealing profits to US$94 million.
Total operating expenses, before goodwill amortisation, fell by 4 per cent to US$709 million. This was achieved through cost savings realised following the merger of three banks in Switzerland in 2002 and lower property expenses.
Provisions for contingent liabilities and commitments were lower than in 2002, which included amounts provided for litigation. Amounts written off fixed asset investments were lower than in 2002 following a specific write down of a debt security in 2002. Gains on disposal of investments and tangible fixed assets increased by 22 per cent to US$61 million, principally reflecting a gain on a long-term private placement transaction.
The UK registered strong consumer-led GDP growth of 1.7 per cent in 2002. Structural disparities within the UK economy widened further as consumer and government spending masked an industrial recession. A combination of low interest rates, and a rising incidence of equity withdrawal as house prices rose, boosted consumer expenditure, particularly in the latter half of the year. Unemployment remained low as the jobs shake-out in manufacturing was absorbed by growth in the public sector.
Economic activity slowed further in 2002, as early indicators pointing to a standard cyclical recovery in economic activity diminished and the
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momentum from rate cuts in 2001 was lost.Industrial production and investment contracted in all major economies, although this was offset to varying degrees by consumer and government expenditure. Initial optimism that the fourth quarter of 2001 marked the low point in the eurozone’s economic cycle was largely misplaced as constraints imposed by the EMU’s growth and stability pact limited the degree of fiscal loosening available to members.
European operations contributed US$3,500 million to HSBC’s pre-tax profit in 2002. Europe’s pre-tax profits, before goodwill amortisation, were US$4,160 million, and represented 40 per cent of HSBC’s profits on this basis. Goodwill amortisation of US$660 million was broadly in line with 2001. Operating performance was strong with pre-provision profit rising 9 per cent to US$4,737 million before goodwill amortisation. In constant currency terms, the growth was 6 per cent. This growth was driven essentially by the core personal and commercial banking businesses in the UK and France and by Global Markets UK’s performance. There was no material benefit in 2002 from disposal gains as after making provisions for amounts to be written off fixed asset investments, the net gain was only US$21 million. The comparable figure in 2001 was US$351 million, a result dominated by the sale of the Group’s stake in British Interactive Broadcasting.
The impact of acquisitions on the 2002 profit before tax was modest at US$51 million. The acquisitions of Demirbank in October 2001 and Benkar in September 2002, however, represented a major expansion of HSBC’s business in Turkey. These businesses were successfully integrated during 2002, and by the end of the year over 500,000 customers in Turkey were being served through a combination of call centres, internet banking and a network of 163 branches.
Internal restructuring took place to enhance operational efficiency. In June 2002, HSBC acquired Merrill Lynch’s 50 per cent share of the Merrill Lynch HSBC joint venture. The business was integrated into HSBC Bank in December 2002.
The commentaries on the Europe results that follow are based on constant exchange rates.
In Personal Financial Services, pre-tax profit, before goodwill amortisation, of US$987 million was 13 per cent lower than in 2001. However, after adjusting for the US$200 million profit from the sale
of the Group’s stake in British Interactive Broadcasting in 2001, profit increased by 6 per cent. The underlying increase was driven by strong growth in lending and savings products and increased spreads, as funding costs reflected the low interest rate environment across Europe. Higher operating expenses, due in part to the full year impact of acquisitions, one-off property costs and vacant space provisions, partly offset the growth in income.
Net interest income, at US$2,541 million, was 14 per cent higher than in 2001. UK mortgage balances increased by 24 per cent and gross new lending by 57 per cent as HSBC increased its market share from 4 per cent to 6 per cent in a buoyant housing market. HSBC’s UK mortgage balances have almost doubled over the past five years through a combination of innovative products and competitive pricing. ‘HomeStart’, an innovative mortgage allowing first time buyers to pay only the interest costs during the first three years, was a major contributor to growth during the year.
In the UK, personal current account balances increased by 11 per cent as customers preferred to hold cash in the uncertain investment climate. The launch of a new Bonus Savings Account, and improved utilisation of customer relationship management systems, contributed to growth of 19 per cent in personal savings balances and 16 per cent in personal lending balances.
In France, CCF’s net interest income of US$386 million was 7 per cent higher than in 2001. Net interest income grew strongly, driven by growth in personal lending and sight deposits as customers preferred liquidity and security in the face of falling equity markets. In Turkey, net interest income increased substantially reflecting the full year’s contribution of Demirbank and the acquisition of Benkar in September 2002.
Other operating income at US$1,767 million was 3 per cent lower than in 2001. This reflected lower income from equity market-related activity and sales of investment products, largely offset by strong growth in sales of life, critical illness and income protection products. Credit card income particularly benefited from the inclusion of a full year’s income for Demirbank, and three months contribution from Benkar.
In the UK, sales of HSBC branded life, critical illness and income protection products, through the tied sales-force, were 7 per cent higher than in 2001.
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Life protection sales grew by 42 per cent on the back of strong mortgage growth and there was a 26 per cent rise in sales of creditor protection insurance, driven by the growth in personal lending. The bank continued to deepen customer relationships through a broader range of products with particular focus on wealth management. The bank’s combined market share for its principal investment products, Open Ended Investment Companies and ISAs, was maintained at over 5 per cent during the year despite the difficult investment market conditions. However, overall wealth management income fell, principally as a result of the fall in the investment markets and adjustments to the value of long-term assurance business. In France, a similar pattern was seen. Good growth was achieved in fee income on credit facilities, cards and from sales of investment protection products. This was partly offset by lower stockbroking fees.
Operating expenses, excluding goodwill amortisation, increased by 8 per cent, and included a full year’s costs for Demirbank, the acquisition of Benkar and the integration of Merrill Lynch HSBC. Excluding these, costs rose by 3 per cent, due in part to one-off property and vacant space costs relating to the relocation of the bank’s headquarters to Canary Wharf in the second half of 2002, and increased marketing and IT costs, as further investment was made in both front office and customer contact systems. Non-staff costs increased, reflecting the cost of outsourcing HSBC Bank’s cash and cheque processing services and the impact of offshore processing. Utilisation of HSBC’s service centres in China and India increased with some 700 staff positions and 20 new processes transferred to India during the year. In France, CCF’s staff costs were broadly unchanged on 2001, despite the full year impact of Banque Hervet, and was achieved in part through a small reduction in headcount.
The charge for bad and doubtful debts at US$215 million was 3 per cent higher than in 2001. Increased provisions in CCF were partly offset by a lower charge in the UK where credit quality remained stable and improved debt counselling services proved effective.
Losses from joint ventures fell significantly, reflecting the full consolidation of Merrill Lynch HSBC from the second half of 2002.
Commercial Banking reported pre-tax profit, before goodwill amortisation, of US$1,344 million,
an increase of 32 per cent compared with 2001. The increase reflected higher net interest income and fee income together with lower provisions for bad and doubtful debts.
Net interest income rose by 11 per cent. Term lending balances grew by 9 per cent, with a corresponding increase in income of 10 per cent, as a result of customer segmentation and the introduction of tiered pricing in the UK. A general move away from equity investments towards deposits helped increase balances by 9 per cent. The customer base rose by 7 per cent, on the back of an increased share of the business start-up market and relatively low attrition levels. During 2002, over 87,000 business start-up accounts were opened, an increase on last year of some 26,000 accounts or 42 per cent. This was attributed to effective marketing, particularly the ‘Start-Up Stars’ campaign.
CCF’s net interest income also grew with the rise in customer stocks, leading to an increase in sight deposits of 8 per cent and growth in the loan book of 4 per cent, combined with an improvement in spreads.
Other operating income increased by 11 per cent. UK overdraft fees rose by 28 per cent, reflecting improved account management. Fee income from UK invoice financing activities grew by 7 per cent, with an increase of 13 per cent in the number of clients opting for credit protection. This reflected greater economic uncertainty, particularly in the manufacturing sector. Along with other specialisms, such as vehicle and equipment finance, the invoice finance salesforce was integrated into the network, improving the level of cross sale introductions and contributing to a 10 per cent increase in its client base. Sales of business protection products such as key man insurance and partnership protection grew by 11 per cent in the UK. These were sold along with pension and inve stment products aimed at assisting businesses in managing wealth and offering protection.
Underlying operating expenses rose by 5 per cent in 2002. The UK experienced increased premises costs with the opening of the new headquarters at Canary Wharf in the latter half of 2002 and the rationalisation of the property portfolio, resulting in one-off property and vacant space costs. IT costs increased Europe-wide from the systems modifications necessitated by the introduction of the Euro.
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In order to increase customer choice, further investment was made in alternative sales channels such as business telephone banking and business internet banking. A business outbound centre was established at Leicester in the UK. January 2002 saw the launch of business internet banking (www.bib.hsbc.com) to the UK’s business customers, with 35,000 registering in its first year. Dedicated business-banking centres were set-up in Swansea, Edinburgh and Hyderabad, handling calls from approximately 134,000 registered users.
The net charge for bad and doubtful debts reduced by 23 per cent, mainly due to a fall in CCF, where lower provisions combined with higher releases and recoveries in 2002. The UK saw an improvement in the risk profile of commercial customers leading to a net release of the general provisions held. Against this, new specific provisions were required in the private health, leisure and manufacturing sectors and the overall charge remained flat.
Gains on disposal of investments of US$40 million mainly reflected the sale of CCF’s holding in Lixxbail.
2002 included full year contributions from Banque Hervert in France and Demirbank in Turkey. Both performed in line with expectations and integrated well into HSBC.
Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$1,438 million in 2002, unchanged from 2001. Growth in net interest income was offset by lower dealing profits and a higher charge for bad debts.
Net interest income increased by 15 per cent compared with 2001, primarily because of earnings on money market business, which benefited from the steeper yield curve following interest rate cuts during 2002. The impact of this diminished during the second half of the year as maturing liquidity was redeployed in lower yielding assets. Net interest income also grew as Global Markets increased the proportion of liquid assets held in high quality corporate and institutional bonds relative to interbank placement. Increased equity swap activity also generated additional cash deposits.
Net fees and commissions were broadly in line with 2001. Markets in global new equity issues and financial advisory services continued to be
depressed, and trading volumes on stock markets remained at subdued levels, adversely affecting commission revenues. However, fee income from fixed income products designed for corporate clients increased, and HSBC achieved the number one ranking in bond issuance for UK and French corporates in all currencies.
Dealing profits decreased by 38 per cent. Dealing losses were generated on interest rate derivatives undertaken to hedge the interest rate risk arising on holdings of corporate bonds, although this was offset by increased net interest income on the bonds. Also, foreign exchange revenues grew by 11 per cent following expansion in emerging markets business and currency options. In the UK, increased activity in equity swap transactions generated dealing losses, which were offset by a rise in dividend income.
Operating expenses were in line with 2001. Increased revenue-related costs in Global Markets were offset by a significant reduction in staff costs following a restructuring of Investment Banking to reflect market conditions.
The charge for bad and doubtful debts, at US$153 million, reflected an increase in specific provisions for a small number of telecommunications related exposures in the UK.
In Private Banking, HSBC continued to restructure and strengthen its operations with the integration of HSBC Guyerzeller and CCF’s private banking operations outside France with HSBC Private Banking Holdings (Suisse). The comments below assume that this structure was in place during 2001.
Despite the decline in the European stock markets, growth in clients’ funds under management continued, in part due to a significant increase in client referrals from Personal Financial Services.
Net interest income fell by 10 per cent compared with 2001 as lower interest rates reduced earnings on Private Banking’s investment portfolio and free funds. Part of the portfolio was repositioned at the beginning of the year into lower yielding but higher grade securities in anticipation of difficult credit markets.
Transaction and safe custody fees increased in line with the US$4 billion growth in funds under management to US$71 billion, despite falls in world stock markets. Investment fees benefited strongly
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from the success of the Hermitage Fund, which offered clients access to Russian investment opportunities. In France, fee income was affected by lower stock market indices while interest arbitrage activities on securities boosted net interest income at the expense of dealing income. The latter was further undermined by mark-to-market losses.
Dealing profits fell by 13 per cent compared with 2001, mainly in France and HSBC Guyerzeller, reflecting difficult market conditions.
Underlying operating expenses excluding goodwill amortisation were in line with last year.
The credit for provisions for bad and doubtful debts in 2002 was smaller than in 2001, when a larger reduction in general provisions was booked following a reassessment of provisions required.
Amounts written off fixed asset investments were higher than last year following a write down of a specific debt instrument of a company in the telecommunications sector.
The share of loss in associated undertakings of US$10 million in 2002 reflected a drop in the value of a partially owned private equity company.
The gain on disposal of investments and tangible assets increased to US$48 million. The increase reflected debt instruments sold during the year and the liquidation of a Russian Recovery fund established in 2000 to manage previously written down Russian debt instruments.
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Profit/(loss) excluding goodwill amortisation by customer group
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Profit/(loss) excluding goodwill amortisation by customer group (continued)
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The Hong Kong economy faced challenging conditions during the first half of 2003. Slower growth in major export markets, rising unemployment and a weak property market dampened consumer demand, whilst the outbreak of the SARS virus had a significant adverse impact on the entertainment, leisure and tourism sectors. However, by the third quarter there was clear evidence of a bounce-back with GDP growing 6.4 per cent quarter-on-quarter, more than reversing the 3.7 per cent dip in the second quarter of 2003. The growth rate benefited significantly from the release of demand deferred during the SARS period. Growth also drew support from stronger export demand and improving sentiment after the central government unveiled a series of economic measures to help Hong Kong, including the relaxation of controls on mainland residents travelling to Hong Kong. Local consumer spending grew for the first time in two years and even more encouraging was a pick-up in investment reflecting an improved business outlook.
HSBC’s operations in Hong Kong performed well in these circumstances and reported a pre-tax profit of US$3,728 million, broadly in line with 2002. Excluding goodwill amortisation, profit before tax was US$3,730 million and represented 26 per cent of HSBC’s total profit on that basis. Goodwill amortisation was US$2 million in 2003.
Personal Financial Services in Hong Kong reported a pre-tax profit, before goodwill amortisation, of US$1,740 million, 2 per cent higher than in 2002. Given the pressure on net interest income as a consequence of muted credit demand and the impact of lower interest rates on the value of deposits, there was continued focus on the insurance business and wealth management. Sales of unit trusts and of capital guaranteed funds were particularly successful.
Net interest income fell by US$161 million or 7 per cent compared with 2002, largely due to a reduction in spreads on the value of deposits taken in the low interest rate environment and continued pressure on yields in the mortgage business, although there was some benefit from lower cost of funds.
Partly offsetting the decline in net interest income, other operating income at US$1,182 million was 13 per cent higher than in 2002. HSBC’s
position as one of Hong Kong’s leading providers of insurance and wealth management services was sustained amid keen competition. Income from wealth management initiatives, including commissions on sales of unit trust products, funds under management, and securities transactions, grew by 38 per cent to US$408 million. This was achieved by strong growth in sales of unit trusts and capital guaranteed funds, which increased by US$1.6 billion, or 32 per cent, over 2002.
Net fee income from credit cards was broadly in line with 2002. Despite fierce competition in the market, HSBC maintained its position as the largest credit card issuer in Hong Kong with some 3.1 million cards in circulation, 9 per cent higher than in 2002.
During the year, HSBC continued to place significant emphasis upon the growth and development of its insurance business. HSBC increased sales of regular premium individual life insurance by 59 per cent, growing its market share from 13.9 per cent to 18.6 per cent. Income from the insurance business, including the Mandatory Provident Fund, grew by 53 per cent or US$118 million.
Operating expenses, excluding goodwill amortisation, were 5 per cent lower than in 2002, with savings in staff costs partly offset by higher marketing costs. Headcount reduced as HSBC continued to migrate a wide range of back office and call centre functions to the Group Service Centres in Guangzhou and Shanghai. The Group Service Centres in mainland China now provide about half the operational support for credit card operations in Hong Kong.
Provisions for bad and doubtful debts were broadly in line with last year. The charge for specific provisions for bad and doubtful debts decreased compared with 2002, mainly due to a reduced charge for unsecured lending (including credit cards), in line with lower personal bankruptcy filings and improved economic conditions in the latter half of the year. This was partly offset by higher provisions against mortgage lending. 2002 benefited from a higher release of general provision. As the economy grows and property prices stop falling the environment for personal credit is expected to improve in 2004.
Commercial Banking in Hong Kong contributed a pre-tax profit, before amortisation of
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goodwill, of US$711 million, a fall of US$22 million, or 3 per cent.
Net interest income declined by 7 per cent largely due to lower recoveries of suspended interest and the effect of lower spreads on deposits. There was good volume growth in the loan book, despite the impact of SARS and the war in Iraq. This was offset by narrower spreads caused by limited local investment and market pressure as banks competed for quality business. Loan growth was driven by increased demand for finance to support record trade flows between mainland China and the rest of the world, especially in the US. This was particularly evidenced in the manufacturing and transportation sectors. Several new business banking/trade service centres were opened to focus on the business needs of small and medium-sized customers and start-ups.
Other operating income rose by US$57 million, or 14 per cent, reflecting growth in cash management and trade services. Both benefited from the increase in trade flows and closer liaison between branches of the bank in Hong Kong and mainland China. This was developed in order to service the growth of investment in the Pearl River delta by Hong Kong-based customers. Additionally, Hang Seng Bank opened its first branch in Macau aimed at assisting customers setting-up offices in the territory. Results of this alignment were particularly successful, with referrals significantly higher than anticipated. Trade finance benefited from a campaign specifically aimed at the increase in export trade business which occurs during the peak summer season. Insurance income rose as a consequence of business expansion, increasing by 36 per cent.
Operating expenses were in line with 2002. Staff costs increased marginally as headcount rose to support the insurance business expansion. This was offset by lower legal and professional fees.
Overall, credit quality remained stable reflecting improved economic conditions in the latter part of the year. There was a lower release in general provisions in 2003 as last year benefited from a reduction in latent losses.
Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$1,275 million, 4 per cent higher than in 2002. Exceptional Global Markets performance was partly offset by a shift from net recovery to net charge for bad and doubtful debts.
Net interest income of US$1,157 million was broadly in line with last year. Reduced corporate lending spreads, which remained under pressure throughout the year, and weak loan demand, were mitigated by a strong Global Markets performance. Global Markets benefited from successful interest rate positioning and an increased value of funds was switched to debt securities from interbank placements in order to enhance yields.
Other operating income grew strongly to US$648 million, an increase of US$184 million or 40 per cent. This was achieved through a significant increase in dealing profits to US$205 million. HSBC significantly expanded its derivatives capabilities and higher income was earned from both successful positioning and a growing demand from corporate customers for structured tailored solutions. Increased sales of structured transactions, offering yield enhancement products to retail clients, generated further revenue. Debt securities trading achieved a strong turnaround in income during the year, as losses caused by widening credit spreads in 2002 did not recur. Foreign exchange profits rose compared with 2002, with a significant increase in corporate sales. Trading profits were generated as the bank took advantage of US dollar volatility, and the general weakening of the US dollar during the year. This was partly offset by lower Corporate and Investment Banking fees and commissions reflecting a decrease in income from credit facilities.
Operating expenses, before goodwill amortisation, increased by 5 per cent to US$491 million, with the significant increase in Global Markets’ profitability reflected in higher performance-related staff costs.
There was a net charge for bad and doubtful debts of US$52 million compared with a release of US$68 million in 2002. This was primarily due to new specific provisions raised against two corporate accounts.
HSBC’s Private Banking activities in Hong Kong reported pre-tax profit, before goodwill amortisation, of US$127 million, an increase of 19 per cent over 2002. Funds under management grew by 12 per cent to US$56 billion, benefiting from US$7 billion of net new funds as clients moved away from liquid positions into the investment markets.
Net interest income declined by US$7 million, or 8 per cent, to US$84 million. Lower margins from
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free funds and the investment portfolio reflected falling interest rates while the flattening of the yield curve during the year meant that the significant income earned on longer dated assets in 2002 was not repeated. This more than offset the impact of an increase in lending balances as clients borrowed on margin against their investments to reinvest in higher returning securities.
A general improvement in investment markets in the second half of the year saw greater client activity across a range of products. Brokerage, trust services and safekeeping all benefited from the upturn in the markets, and associated fee and commission income increased by 19 per cent to US$87 million. Greater market activity also stimulated higher sales of tailored structured products for clients and higher volumes of debt securities and derivatives transactions, resulting in a 68 per cent increase in dealing profits. Overall, other operating income increased by 31 per cent to US$164 million.
Total operating expenses grew by US$9 million or 8 per cent, reflecting a rise in headcount to support increased client activity and the migration of regional support from Singapore to Hong Kong during the year. There was also higher performance-related remuneration in line with increased profits.
Hong Kong continued to suffer from deflation in 2002 and domestic demand remained subdued. An improvement in trade failed to stimulate demand, as unemployment increased and salaries fell.
Against this backdrop, HSBC’s operations in Hong Kong reported an operating profit, before provisions, of US$3,911 million, an increase of US$34 million, or 1 per cent, compared with 2001, largely through income growth from wealth management products. Pre-tax profit of US$3,710 million was US$173 million, or 4 per cent, lower than in 2001 due to a higher bad debt charge and lower investment disposal gains and represented 35 per cent of HSBC’s pre-tax profit on this basis. There was no goodwill amortisation in Hong Kong during 2002 and 2001.
Personal Financial Services reported pre-tax profit, before goodwill amortisation, of US$1,705 million, US$74 million, or 5 per cent, higher than 2001. The improvement was driven by growth in revenues from wealth management products and
increased card fee income. Significantly higher personal bankruptcy filings during the year resulted in additional provisions for credit card accounts compared with 2001.
Net interest income at US$2,364 million was broadly in line with 2001. The benefits of increased credit card and mortgage lending together with improved spreads from lower funding costs were largely offset by competitive pricing on residential mortgages and a lower benefit from free funds.
In another year of fierce competition for quality assets and increasing consumer loan write-offs in Hong Kong, HSBC maintained a strong performance. Including cards issued by Hang Seng Bank, HSBC remained the largest personal credit card issuer in Hong Kong with 2.8 million cards in circulation and led the market in cardholder spending and balances. The implementation in 2001 of an enhanced card processing system and continued migration of work to HSBC’s Group Service Centres in Guangzhou enabled operational efficiency to be further improved.
Other operating income at US$1,048 million grew by 19 per cent, compared with 2001, driven by growth in revenues from initiatives related to investment products and the insurance business. Sales of unit trusts and capital guaranteed funds were strong, including the sale of over US$4.9 billion of funds during the year, a rise of 36 per cent compared with 2001. Revenues from insurance and underwriting also increased significantly.
HSBC had grown to be one of the leading distributors of retail funds in Hong Kong by the end of the year. In 2002’s uncertain investment market, HSBC achieved significant growth in the sale of unit trusts through the promotion of 14 guaranteed/capital secured funds designed to meet customers’ demands for capital protection. In the low interest rate environment, HSBC also introduced a range of alternative deposit products. There was strong growth in funds under management, which rose 68 per cent compared with 2001.
The insurance business remained a key focus in HSBC’s strategy in Hong Kong. Significant growth in personal insurance was achieved, outpacing market growth and giving HSBC a larger market share of new business.
Costs in Hong Kong were in line with 2001. The increased cost of continuing marketing initiatives and
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higher IT costs supporting business growth were funded by a reduction in staff costs. Costs fell as back office processing functions were transferred to HSBC’s Group Service Centres in India and China, and pension top-up fees in Hang Seng Bank in 2001 were not repeated.
Customer demand for remote services continue to grow and the bank responded with further investment in internet banking. According to various surveys in 2002, HSBC has the largest online banking market share in Hong Kong, with over 470,000 registered users. The e-channel proposition was enhanced during 2002 introducing a number of new solutions and a new investment page. Online@hsbc won a number of awards in 2002, offering more than 50 services, including a range of insurance personal loans, and payment services. Hang Seng Bank’s comprehensive range of internet banking services had similarly become an important part of its multi-channel delivery network. By the end of 2002, more than 250,000 customers had registered for its Personal e-Banking Services, and internet transactions had grown to more than 14 per cent of total transactions.
The provision for bad and doubtful debts rose by 44 per cent to US$362 million as significantly higher personal bankruptcy filings resulted in a higher charge for both credit cards and other retail lending. However, provisions against the mortgage portfolio fell as delinquency rates reduced.
Commercial Banking in Hong Kong contributed a pre-tax profit, before amortisation of goodwill, of US$733 million, broadly in line with 2001.
Net interest income decreased byUS$69 million, or 10 per cent, as low interest rates reduced the value of interest-free balances. In addition, there were lower balances and reduced spreads on deposits, partly offset by a higher release of suspended interest.
Net fees and commissions increased by US$16 million, or 6 per cent, due to higher levels of fee income on investment funds as a result of cross-selling initiatives with HSBC Asset Management and Treasury. Insurance and trade services income also increased. Operating expenses were US$33 million, or 8 per cent, lower than 2001 due to rationalisation of sales teams within the area and the transfer of back office processing functions to Group Service Centres.
The net release of provisions for bad and doubtful debts was higher than 2001 mainly due to releases of general provisions reflecting a reduction in latent losses.
Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$1,226 million, broadly in line with 2001.
Net interest income was 5 per cent higher than in 2001 reflecting the benefit of a strong performance in Global Markets as the accrual books were well positioned for the low interest rate environment. This was partly offset by lower net interest income from Corporate and Institutional Banking business, as lower spreads on deposits in HSBC combined with reduced spreads on lending and subdued loan demand in Hang Seng Bank. There was also a considerable reduction in the benefit of net free funds as average interest rates fell.
Other operating income was US$83 million, or 15 per cent, lower as growth in fee income was more than offset by lower dealing profits. Dealing profits fell by US$108 million as debt securities used for interest rate trading purposes generated net interest income while corresponding derivative positions produced dealing losses in the current low interest rate environment. In addition, there were dealing losses on debt securities trading due to widening credit spreads following a series of corporate scandals in the US. Growth in fee income reflected higher income from structured finance and from corporate finance transactions.
Operating expenses were in line with 2001.
The net release of provisions during 2002 was US$68 million, reflecting releases of specific provisions against corporate customers. In addition, there was a release of general provisions reflecting a reduction in latent losses.
HSBC’s Private Banking activities in Hong Kong reported pre-tax profits, before goodwill amortisation, in 2002 of US$107 million, an increase of 27 per cent over 2001. Funds under management grew by 23 per cent to US$50 billion at 31 December 2002, benefiting from net new funds from clients, which more than offset the effect of falling stock prices.
Net interest income at US$91 million was 17 per cent higher than in 2001. The steeper yield curve, reflecting the fall in short-term interest rates
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compared with long-term rates, increased margins as surplus funds were deployed in longer-dated assets. Higher income also resulted from the growth of the investment portfolio.
Other operating income increased by 18 per cent to US$125 million. Fees and commission income for the period was US$73 million, an increase of 9 per cent over 2001. This growth was driven by higher insurance referral fees and fund management income. Dealing income rose to US$44 million, an
increase of US$11 million, primarily due to a higher volume of client transactions in the debt securities and derivatives markets and increased sales of client-tailored structured products.
Operating expenses, excluding goodwill amortisation, of US$109 million increased by US$12 million, or 12 per cent, compared with 2001. The increase was predominantly driven by costs associated with the reorganisation of Private Banking activities in Hong Kong.
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The rest of the Asia-Pacific economies experienced mixed fortunes in the first half of 2003 but performed better in the second half of the year on the back of strong exports (particularly to China), strong commodity prices and improving domestic demand. Inflation and interest rates remained very low and many of the region’s central banks implemented programmes to limit currency appreciation against the US dollar.
HSBC’s operations in the rest of Asia-Pacific region reported pre-tax profit of US$1,391 million, an increase of US$131 million, or 10 per cent, over 2002. Excluding goodwill amortisation, pre-tax profit was US$1,426 million and represented 10 per cent of HSBC’s total equivalent profit. At constant exchange rates, pre-tax profit, before goodwill amortisation, increased by 8 per cent over 2002. Goodwill amortisation of US$35 million was marginally higher than last year due to an acquisition in Singapore.
In Personal Financial Services pre-tax profit, before goodwill amortisation, of US$158 million, increased by 25 per cent compared with 2002 and was broadly double that achieved in 2001.
Net interest income grew by 15 per cent compared with 2002, reflecting strong asset growth in a number of countries across the region. The impact on deposit taking business of lower margins in generally low interest rate environments was more than offset by increased customer deposits and the growth in mortgage lending. The latter increased by 38 per cent mainly due to growth in Korea, Singapore, Malaysia and India. Net interest income also benefited from the acquisition of the mortgage business of AMP Bank Limited in New Zealand in the first half of 2003. Strong growth in card balances contributed to a 34 per cent increase in net interest income in Indonesia.
Other operating income grew by 25 per cent to US$345 million. The acquisition of Keppel Insurance, which was renamed HSBC Insurance (Singapore) Pte Ltd, contributed US$17 million to this increase during the year. HSBC continued to expand its wealth management initiatives and a number of structured deposit products were launched
across the region. Wealth management income grew by 10 per cent, reflecting strong growth in unit trust sales and funds under management, particularly in Taiwan, Korea, Indonesia and India, while fee income from credit cards rose in a number of markets across the region. At 31 December 2003, the bank’s card base in Asia, outside Hong Kong, exceeded 3.7 million, 20 per cent higher than at the end of 2002. An enhanced credit card processing system was implemented in five countries in the region, applying state-of-the-art technology to risk and fraud management.
Operating expenses, excluding goodwill amortisation, of US$835 million were 18 per cent higher than in 2002. This reflected increased costs to support business expansion and provisions for restructuring costs of US$34 million. The acquisition of HSBC Insurance (Singapore) Pte Ltd in the year accounted for US$6 million of the increase. Headcount in the region increased by 2,500 compared with last year, as HSBC continued to migrate a number of processing activities to the Group Service Centres in India, Malaysia and mainland China, and as a result of business expansion in the region.
Provisions for bad and doubtful debts were 38 per cent higher than in 2002. Provisions against personal lending increased in Singapore, India, Korea and Australia in line with growth in advances.
Commercial Banking reported pre-tax profits, before goodwill amortisation, of US$450 million, an increase of 4 per cent, compared with 2002.
Net interest income was in line with 2002. There were lower margins in most countries across the region, in particular Malaysia, Indonesia and Singapore. Consolidation in the financial services sector increased competition in Singapore, whilst Indonesia was impacted by a lower interest rate environment. In addition, Malaysia suffered lower margins on lending. These effects were offset by increased income in both the Middle East and Australia. In the Middle East an intensive marketing campaign led to an expansion in term lending in addition to a growth in overdraft balances. Net interest income in Australia was boosted by the full year contribution from the acquisition of State Street Bank’s trade finance portfolio in July 2002.
Other operating income rose by 12 per cent to US$296 million. HSBC Bank Middle East reported a strong performance despite a subdued first quarter as
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a result of the war in Iraq. In addition, insurance income in Singapore increased as a result of the acquisition of Keppel Insurance, as detailed previously.
Operating expenses increased by 5 per cent to US$334 million, mainly due to restructuring costs in India and Singapore and the impact of the acquisition in Singapore.
Credit experience continued to be very good, benefiting from ongoing success in recovering historical troubled debt. The net release of provisions increased 46 per cent to US$52 million in 2003 with higher net releases of specific provisions in Malaysia than last year. This was partly offset by an increase in specific provisions in Indonesia.
Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$732 million, which was broadly in line with 2002.
Net interest income fell by 7 per cent compared with last year, with reductions in Singapore, and to a lesser extent in the Middle East, as higher yielding assets matured and the proceeds were reinvested at lower rates. This was partly offset by an increase in net interest income from corporate banking business in India, Korea and mainland China.
Dealing profits increased, primarily in Taiwan, Japan and Thailand, reflecting a broader product offering, more customer-focused sales activity and successful positioning to take advantage of directional trends in the generally more volatile market conditions. Higher fee income was generated from brokerage and corporate finance transactions in the Middle East.
Operating expenses, before goodwill amortisation, of US$526 million, increased by 3 per cent, mainly due to restructuring costs in India and Singapore.
There was a net release of US$5 million for bad and doubtful debts compared with a net charge of US$26 million in 2002, at constant exchange rates. A specific provision raised against a New Zealand corporate customer in 2002 was recovered during the year.
HSBC’s Private Banking activities in the rest of Asia-Pacific reported pre-tax profit, before goodwill amortisation, of US$36 million in 2003, an increase of 46 per cent, compared with 2002. This
was achieved through strong growth in dealing profits, which rose by 55 per cent to US$38 million, and more than compensated for a reduction of 7 per cent in net interest income.
The fall in net interest income reflected significant income earned in 2002 from the deployment of liquidity into longer dated assets which benefited from the fall in short-term interest rates. With the flattening of the yield curve this was not repeated in 2003.
Dealing profits benefited from a higher volume of client transactions in the debt securities and derivatives markets and increased sales of client-tailored structured products.
Operating expenses, excluding goodwill amortisation, increased by 25 per cent to US$47 million, primarily to support business growth.
Following the slowdown across the region in 2001, the growth in mainland China, Malaysia and South Korea was export-led, whilst consumer spending drove growth in Australia and New Zealand. Interest rates and inflationary pressures remained low across the region. Improving economic fundamentals in Thailand, Malaysia and Singapore positioned those economies to benefit from a recovery in direct investment in the future. The Japanese economy remained fragile, with consumer growth rates slowing during the year despite an improvement in GDP during the second half of 2002 driven by increased exports and domestic consumption.
HSBC’s operations in the rest of the Asia-Pacific region contributed US$1,220 million to operating profit before provisions, broadly in line with 2001. Pre-tax profit, before goodwill amortisation, of US$1,293 million was 18 per cent higher than in 2001. This amounted to 12 per cent of HSBC’s pre-tax profit, before goodwill amortisation. The increase in pre-tax profit resulted largely from lower bad debt charges, particularly in the Middle East and Indonesia. Goodwill amortisation increased from US$8 million to US$33 million in 2002 reflecting acquisitions in Taiwan and Indonesia.
Pre-tax profit, before goodwill amortisation, of US$127 million for Personal Financial Services
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was 59 per cent higher than in 2001, driven by significant growth in credit cards and other personal lending, partly offset by increased costs due to business expansion and global processing costs.
Net interest income grew by 21 per cent, generated by strong growth in credit card advances and personal lending across the region, in particular in Taiwan, Singapore and India. In Malaysia, growth resulted from acquisition of the ABN AMRO mortgage portfolio in the first half of 2002, together with a significant increase in credit card advances. In Australia, the inclusion of a full year’s income from the acquisition of NRMA in November 2001 contributed to the increase in net interest income.
HSBC’s credit card business recorded a 25 per cent increase in balances in 2002. In the difficult economic environment, HSBC’s focus switched from the acquisition of customers to their retention. Investment was made in staff, training and systems to support expected growth in the credit card business in 2003.
Other operating income rose by 30 per cent over 2001. Net fees grew by 25 per cent to US$211 million, largely due to the significant increase in credit card income, principally in Malaysia, the Middle East and Indonesia, and growth in account service fees. In Australia, fee income for 2002 more than doubled, following HSBC’s acquisition of NRMA Building Society in 2001 and the acquisition of HSBC Stockbroking Australia. The financial planning services team in the Middle East, which provides savings, retirement education and protection planning services throughout the region, reported a 19 per cent growth in fee and commission income.
HSBC’s strong presence in mainland China was supported by a wide range of business capabilities. With further liberalisation of China’s financial market, banking regulations were relaxed to permit foreign banks to provide foreign currency services to mainland Chinese companies and citizens, and HSBC became the first foreign bank to offer them, at 10 locations across the country. In December 2002, HSBC launched online personal banking services to local citizens and international customers in mainland China.
Operating costs, before goodwill amortisation, increased by 20 per cent compared with 2001. This growth primarily reflected a higher staff complement in the Group Service Centres in India and mainland
China and business expansion in the Middle East, Australia and Taiwan. During the year, The Hongkong and Shanghai Banking Corporation opened eight new branches in the region.
The year saw continued expansion of internet banking services across the region, with substantial increases in both online customer activity and the range of services offered. The number of personal internet banking customers rose to over 249,000, covering 8 per cent of the personal banking customer base in 12 countries.
Provisions for bad and doubtful debts increased by 13 per cent to US$104 million, following increased credit card lending in India, Indonesia and Taiwan, partly offset by lower provisioning requirements in Indonesia and the Middle East, led by improved credit control procedures.
Commercial Banking reported pre-tax profits, before goodwill amortisation, of US$423 million, an increase of 58 per cent, compared with 2001.
Net interest income declined by 11 per cent compared with 2001, as a result of subdued commercial loan demand and lower lending margins, particularly in Mauritius, Singapore and Indonesia. Net fees and commissions were slightly higher than in 2001, reflecting the acquisition of the trade finance portfolio from State Street Bank Australia in July.
Operating expenses, excluding goodwill amortisation, were in line with 2001. HSBC continued to expand its utilisation of Group Service Centres, with new centres opening in Shanghai and Bangalore in addition to existing facilities in Hyderabad and Guangzhou. By the end of the year, 12,400 calls from UK business telephone banking customers were being answered each week in the Bangalore call centre.
There was a net release of provisions for bad and doubtful debts in 2002, mainly in Indonesia, Singapore, Taiwan and Thailand. These releases were partly offset by additional provisions in India and Mauritius. In 2001, significant specific provisions were raised in Indonesia in view of the deteriorating political and economic environment.
Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$706 million, broadly in line with 2001.
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Net interest income grew by 16 per cent, to US$561 million, due to strong Global Markets performance in most areas across the region. In particular, the accrual books were well positioned for the low interest rate environment.
Other operating income was 7 per cent lower, mainly due to reduced dealing profits. In the Philippines and Singapore, income from interest rate derivatives and debt securities trading was lower. Operating expenses were broadly in line with 2001.
With the exception of a significant recovery relating to a historic Olympia and York exposure in 2001, the overall charge for bad and doubtful debts was essentially unchanged in 2002 as business responded to the economic upturn, though provisioning experience differed across the region. There was a release of provisions for contingent liabilities in Japan and Thailand in 2002, while a provision was raised in respect of a customer in Australia in 2001.
HSBC’s Private Banking activities in the rest of Asia-Pacific reported pre-tax profits, before goodwill amortisation, of US$25 million, compared with losses of US$16 million reported in 2001.
Most of the improvement arose from the non-recurrence of a US$31 million provision in 2001 for contingent liabilities and commitments in Lebanon, relating to an operation which was subsequently closed.
Operating income rose by 16 per cent to US$65 million, driven by strong growth in dealing profits. An active Eurobond market in the first half of the year stimulated customer trades.
Operating expenses, excluding goodwill amortisation, decreased by 14 per cent to US$37 million. While higher staff costs reflected higher bonuses in line with the growth in operating income, this was more than offset by lower costs following the reorganisation of Private Banking’s activities in Asia.
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Fuelled by fiscal stimuli and a further interest rate reduction, the US economy steadily gained momentum in 2003. GDP expanded at an annualised rate of 8.2 per cent in the third quarter, the strongest rate since 1984. A strong revival in profits growth boosted investment spending while consumer spending remained strong, supported by tax cuts, a buoyant housing market, and equity releases from refinancing mortgages at record low interest rates. By the end of the year there was some evidence of the long-awaited recovery in the labour market, with the economy adding jobs, albeit modestly. In June the Federal Reserve cut its Fed Funds rate by 25 basis points to 1 per cent. Subsequently, 10-year bond yields rose by 100 basis points from their mid-June low of 3.1 per cent. Equity markets recovered strongly following the end of the Iraq war: by the end of December the S&P 500 had risen by 39 per cent from its March low and was at its highest level si nce July 2002. This supported consumer confidence. However, with the US current account deficit continuing to deteriorate, the US dollar remained under downward pressure, falling to US$1.26 against the euro by the end of the year.
Canada’s central bank was the first of the G7 countries to embark on a policy of raising interest rates in 2003. In response to inflationary pressures in the early part of the year, overnight lending rates were raised on two occasions, by a total of 50 basis points. However, with the Canadian dollar strengthening against the US dollar, inflation worries easing, and concerns about subdued GDP growth, the Central Bank reversed the earlier interest rate rises to take the overnight rate back down to 2.75 per cent in September. Many of the reasons for the disappointing growth were temporary, such as SARS, BSE, forest fires and the Ontario power blackout, and their immediate impact abated. Consumer spending growth remained robust all year, but the ongoing impact of the strong Canadian dollar appears set to continue, restraining export growth.
The Mexican economy continued to lag behind the US recovery, largely because, apart from technology, the US manufacturing sector remained subdued. However, the impact of stronger US growth is expected to benefit Mexico in the near term, boosting exports and growth. Meanwhile, political conflicts delayed the passage of critical reform legislation, threatening approval of the 2004 budget.
This notwithstanding, a solid macro-economic foundation has been established and is expected to be maintained.
On 28 March 2003, HSBC completed its acquisition of Household for a consideration of US$14.8 billion, expanding significantly its existing North American business. The addition of Household’s substantial consumer lending portfolio increased the proportion of HSBC’s assets in North America from 19 per cent to 28 per cent of the Group.
Household’s results for the period from 29 March to 31 December 2003 are tabulated separately under Consumer Finance in order to highlight their significance to HSBC’s overall performance in North America. HSBC’s results at the pre-tax level and before amortising goodwill also benefited from a US$534 million contribution from HSBC Mexico in its first full year. The integration of both Household and HSBC Mexico progressed well, with synergy benefits and business opportunities generally meeting or exceeding expectations.
The following discussion of HSBC’s North American performance highlights the impact of the additions of Household and HSBC Mexico. The phrase ‘on an underlying basis’ is used to describe performance excluding these acquisitions.
HSBC’s operations in North America contributed US$3,613 million to HSBC’s profit before tax, an increase of US$2,375 million, compared with 2002. Excluding goodwill amortisation, pre-tax profit was US$4,257 million, compared with US$1,384 million in 2002, which was equivalent to 30 per cent of HSBC’s total pre-tax profit on this basis. On an underlying basis, HSBC’s pre-tax profit, before goodwill amortisation, of US$1,672 million was US$320 million, or 24 per cent, higher than in 2002. Goodwill amortisation was US$644 million in 2003, compared with US$146 million last year, predominantly reflecting the acquisition of Household and, to a lesser extent, HSBC Mexico.
Personal Financial Services, excluding Consumer Finance, generated pre-tax profit, before goodwill amortisation, of US$870 million in 2003, 40 per cent higher than last year. HSBC Mexico contributed US$350 million to pre-tax profit for the
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year. On an underlying basis, pre-tax profit, before goodwill amortisation, was 13 per cent lower than in 2002 mainly due to lower earnings from mortgage servicing and higher staff costs.
Net interest income increased by 53 per cent to US$2,116 million mainly as a result of the inclusion of HSBC Mexico. The first full year’s result for HSBC Mexico was strong and ahead of expectations. Growth in Mexico from a relatively weak performance in 2002 reflected an improvement in net interest income driven by a greater level of low cost deposits and an expanding consumer loan portfolio. Interest spreads benefited from a change in asset mix, with over 25 per cent growth in higher yielding assets, including motor vehicle finance, credit cards and payroll loans.
On an underlying basis, growth in net interest income of 7 per cent was mainly driven by growth of US$2.5 billion in residential mortgage balances in the US and Canada. In both countries, the low interest rate environment proved attractive to new homebuyers and encouraged existing homeowners to refinance their mortgages. In the US, net interest income further benefited from improved spreads on mortgages and an improved mix of loans and savings deposits.
Other operating income of US$825 million was 62 per cent higher than in 2002. Operations in Mexico contributed US$461 million to other operating income in the year. Transaction volumes on core banking related products, such as credit cards, deposit-related services and ATMs, grew significantly. HSBC Mexico led the market with a 34 per cent share in domestic interbank ATM transactions across Mexico, delivering fee revenue of US$92 million. In addition, a growing level of fee income was generated from bancassurance sales and international remittances.
On an underlying basis, other operating income fell by 23 per cent. This was primarily caused by a fall in mortgage banking-related income in the US. Total servicing-related income decreased by US$210 million compared with 2002. This decrease was driven by accelerated amortisation and large write-downs of mortgage servicing rights (‘MSR’s) as many customers refinanced mortgages in order to take advantage of the low interest rate environment. MSR income also declined as a result of significant losses on derivative instruments used to protect the economic value of MSRs.
In addition, the June/July time period was one of the more difficult periods related to derivative activity. Specifically, in June, positions were taken in derivative instruments to further reduce HSBC’s exposure to these losses as mortgage rates continued to fall. However, in July extreme interest rate volatility ensued and there was a significant rise in interest rates resulting in a substantial loss in the value of the derivative instruments. These losses were only partly offset by subsequent falls in interest rates, and gains from the sale of certain mortgage-backed securities available-for-sale that were used as on-balance sheet economic hedges of the MSRs.
While the value of MSRs generally declines in a falling interest rate environment as mortgages are repaid, the effect of this decline is often mitigated by income from refinancing mortgage loans and subsequent sales to mortgage agencies. Total loan volumes sold in 2003 were US$20.1 billion compared with US$12.4 billion in 2002. Market conditions during 2003 permitted favourable pricing which allowed HSBC to earn higher gains on loans sold as well as a higher spread on refinanced loans. As a result, sales-related income for 2003 increased by US$82 million compared with 2002.
Overall, the US mortgage banking business contributed US$210 million to pre-tax profit in 2003, compared with US$251 million in 2002. In the US, HSBC generated increases in deposit-related service charges and in card fees, though sales of investment products fell reflecting a lack of confidence in the equity markets. Increased fees in Canada reflected higher insurance sales and increased commissions from retail broking activities as the equity markets rebounded in 2003.
Growth in operating expenses, excluding goodwill amortisation, of 65 per cent to US$1,965 million was substantially attributable to the addition of HSBC Mexico, which contributed US$758 million to the overall cost base in 2003. In Mexico, savings in operating expenses were achieved from merging HSBC Mexico with HSBC’s existing operations in the country. These savings funded investment to improve technology support for HSBC Mexico’s branch network.
On an underlying basis, operating expenses, excluding goodwill amortisation, increased by 7 per cent. Pension costs rose due to falls in the long-term rates of return on assets, and higher profitability drove increased staff incentive payments. Following
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the integration with Household, long-term restructuring programmes, including the rationalisation of staff functions, were initiated, adding US$20 million of costs in the year.
Operations in Mexico contributedUS$67 million to the overall net charge for bad and doubtful debts of US$142 million. On an underlying basis, credit provisions in Personal Financial Services were broadly in line with the prior year, a good performance in view of strong growth in personal lending. Overall credit quality improved, reflecting the improved economic environment.
Consumer Finance contributedUS$2,068 million to pre-tax profit, before goodwill amortisation, in the nine months since Household became a member of HSBC. The integration of Household into HSBC delivered anticipated benefits in improved funding costs, and technology and administrative cost savings. Significant progress has been made in exporting Household’s core skills, particularly in the areas of credit risk management, sales-focused organisation and customer-centred technology, to other parts of the Group. Further synergies are planned in card processing, IT contingency rationalisation, purchasing, call-centre operations and the shared use of HSBC’s Group Service Centres. Household’s business model is being taken to selected markets overseas and established alongside existing HSBC operations to meet the growing global demand for consumer finance.
Net interest margin benefited by US$531 million from purchase accounting adjustments relating to the acquisition of Household in the nine months in which Household was part of the HSBC Group. This comprised of a US$946 million benefit in respect of debt funding, offset by the amortisation of purchase accounting adjustments relating to loans and advances to customers totalling US$415 million. Purchase accounting adjustments restated the book value of debt to fair value at that date and, therefore, reflected the improvement in spread already in the market as well as falling interest rates. They are being amortised in line with the residual maturity of the debt. Assuming credit spreads remain consistent, savings on future debt issues will replace the fair value adjustments relating to credit spreads. Since acquisition, Household’s funding costs on new issues have, in fact, fallen as the credit spreads sought by the market decreased, reflecting the improvement in Household’s credit rating on joining the HSBC
Group. During 2003, net interest income benefited by US$124 million as a result of such savings.
All consumer portfolios grew during the year, except for personal unsecured loans, with the strongest growth in the real estate secured and private label portfolios. The secured real estate portfolio growth was driven by the correspondent business while the private label portfolio benefited from a number of new relationships added during the year. Growth in MasterCard and Visa loans benefited from portfolio acquisitions made during the year in advantageous circumstances and growth in the General Motors portfolio. The motor vehicle finance business also benefited from new originations from strategic alliances during the year.
Included within operating expenses were one-off retention payments arising on the change of control amounting to US$52 million. Headcount increased to support business expansion, particularly in the consumer lending and mortgage services businesses.
The charge for bad and doubtful debts in 2003 reflected receivables growth, increases in personal bankruptcy filings and the weak US economy. However, in the second half of the year credit quality stabilised and improvement was seen in a number of key indicators, including early stage delinquency, charge-offs, bankruptcy filings and collection activities. The improvement reflected resumed domestic economic growth which is forecast to continue into 2004.
Commercial Banking in North America reported pre-tax profit, before goodwill amortisation, of US$595 million, an increase of 32 per cent, compared with 2002. On an underlying basis, HSBC generated pre-tax profit, before goodwill amortisation, of US$498 million, 12 per cent higher than last year.
Net interest income on an underlying basis was marginally lower than 2002. In Canada, income growth was generated from increased balances on loans and deposits. There were increases in commercial real estate lending where growth in market share was concentrated primarily in New York. Service delivered to SMEs was enhanced as part of the strategy to focus on that market. Notably, the credit application process was re-engineered to make it easier for customers and the number of relationship managers doubled. As a result, lending to SMEs increased by 17 per cent. Net interest income further benefited from steady growth in
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deposit balances and lower funding costs. Offsetting this was the impact of business disposals as HSBC disposed of its equipment leasing portfolio in the first half of 2003 following a re-evaluation of its core businesses.
On an underlying basis, other operating income rose by 20 per cent, reflecting income on the sale of the factoring business and increases in fees related to commercial real estate lending, deposit taking and trade.
The inclusion of Household’s commercial portfolio reduced other operating income by US$17 million. These losses were more than offset by tax credits, resulting in an overall benefit to post tax profits of US$40 million.
HSBC Mexico contributed US$325 million to total operating income in the Commercial Banking segment in North America, reflecting a strong position in customer deposits. In addition, a growing level of fee income was generated from payments and cash management, loan and credit card fees.
Of the total increase in operating expenses, US$163 million was attributable to HSBC Mexico. Underlying operating expenses, excluding goodwill amortisation, increased by 9 per cent to US$614 million. This was driven by higher pension and incentive compensation expenses. In Canada, staff costs increased, primarily due to increased variable incentive payments.
Credit quality remained satisfactory. On an underlying basis, provisions for bad and doubtful debts fell by 40 per cent to US$88 million, reflecting the improved credit environment in North America in 2003. Low interest rates, declining credit spreads and positive economic sentiment all contributed to this improvement.
Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$837 million, an increase of 70 per cent, compared with 2002. On an underlying basis, the Corporate, Investment Banking and Markets business generated pre-tax profit, before amortisation of goodwill, of US$772 million, 58 per cent higher than in 2002. In generally favourable trading conditions, Global Markets achieved higher customer sales from structured finance and hedging products as institutional and corporate borrowers took advantage of low interest rates to raise finance or fix the cost of existing facilities.
HSBC’s North American securities trading and debt capital markets business was substantially restructured and refocused towards the end of 2002 and this was reflected positively in its 2003 financial performance. Government and agency securities arbitrage activities were wound down. Corporate bond trading returned to profitability, contrasting with the heavy losses suffered in 2002 as a result of widening credit spreads, particularly in the telecommunications and auto sectors. The turnaround in performance added US$67 million to profit before tax. Investment in relationship management generated new business from major institutional and corporate clients. Global Markets also expanded its structured credit derivatives trading in response to the evolving requirements of its institutional customer base, allowing these clients to risk manage their portfolios more actively, thereby generating fees and trading revenues for HSBC.
Underlying net interest income of US$685 million, increased by 28 per cent, compared with 2002. This was partly attributable to the restructuring initiatives in the securities trading and debt capital markets business. As part of this restructuring, large arbitrage trading portfolios, which had historically contributed dealing profits but incurred significant funding costs, were eliminated. Net interest income further benefited from good balance sheet management and effective interest rate positioning in the US and Canada.
Underlying total other operating income, at US$738 million improved by 32 per cent. Strong foreign exchange and domestic dollar book trading activity contributed to increased revenues, driven by historically low interest rates and volatile currency markets. Derivatives trading revenues increased, reflecting the growth in demand for the structuring of tailored products for corporate and institutional customers.
HSBC Mexico generated other operating income of US$90 million, of which US$64 million was accounted for by dealing profits. Volatility in the Mexican markets enabled the Group to increase trading volumes and capitalise on favourable market movements. These positive market conditions led to increased profits from foreign exchange and fixed income.
Underlying operating expenses, before goodwill amortisation, of US$706 million, increased by 9 per cent. Investment in the core business added to the
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expenditure but was partly funded by lower costs in the securities trading and debt capital markets business, elements of which were wound down.
Credit experience on major corporate customers in the US was better in 2003. Many accounts which were potentially problematic at the end of 2002 were successfully refinanced and restructured in the strong debt market at the start of 2003. Elsewhere, credit quality remained satisfactory and consequently, on an underlying basis, there was a net release of US$7 million for bad and doubtful debts.
Profits on disposal of investments, on an underlying basis, were US$57 million, a decline of 53 per cent compared with 2002, which included a higher level of securities disposals arising from the restructuring of investment portfolios.
HSBC’s Private Banking operations in North America contributed US$63 million to pre-tax profits, before goodwill amortisation, an increase of 11 per cent compared with 2002.
During the year the North American business continued its evolution from a deposit-based business to broader wealth advisory service, with a resulting shift from net interest income to fees and commissions. Despite this, net interest income was 3 per cent higher than 2002, reflecting an improved funding environment in 2003.
An increase in net fees and commissions and other income of US$52 million, or 37 per cent, mainly reflected the benefit from increased investment activity by clients and a greater emphasis on fee-based non-discretionary advisory and structured products. In addition, WTAS (HSBC’s tax advisory service for high net-worth clients), in its first full year of operation, contributed to this increase.
The inclusion of WTAS was the principal contributor to the US$48 million increase in operating expenses, before goodwill amortisation. Cost savings from the alignment of international and domestic client servicing units offset higher staff and restructuring costs. Excluding this operating expenses were essentially flat year-on-year.
The United States economy showed signs of improvement in 2002 following a deterioration in 2001, as low interest rates and fiscal stimulus helped
to boost the housing, manufacturing and consumer sectors. GDP growth was 2.4 per cent compared with 1.1 per cent in 2001. However, growth prospects remained unclear, as equity markets remained subdued, and levels of corporate and consumer debt remained high. The dollar weakened throughout the year, reflecting investor concerns about investment returns from the US.
The Canadian economy continued to outperform its fellow G7 members, with GDP growth of 3.3 per cent in 2002. This was driven by strong growth in employment, and increased levels of retail sales. However, in response to fears about strong consumer spending and increasing inflation, interest rates showed upward pressure. It was expected that the Canadian economy would be slowed by the performance of the US economy during 2003.
Economic growth in Mexico also remained subdued, relying on the US economy for 25 per cent of its GDP. However, growth in industrial output was an encouraging sign for Mexico’s future prospects. Although the devaluation in the value of the peso had increased inflationary pressures, the economic indicators in 2002 did not appear to present cause for concern with regard to Mexico’s creditworthiness.
HSBC’s operations in North America contributed US$1,413 million to operating profit before provisions, up US$153 million, or 12 per cent, compared with 2001. Profit before tax increased by US$735 million to US$1,238 million. Goodwill amortisation at US$146 million was in line with 2001. Operating performance was driven by strong growth in net interest income in 2002, which benefited from low funding costs as interest rates remained at historically low levels. The 2001 results bore the exceptional costs of the Princeton Note Settlement.
Personal Financial Services in North America reported a pre-tax profit, before goodwill amortisation, of US$605 million, 3 per cent higher than in 2001. The continued growth in the mortgage business and higher brokerage and insurance sales contributed to a significant increase in operating income. This was partially offset by higher IT costs reflecting increased business volumes and systems development.
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Net interest income rose by 8 per cent to US$1,352 million of which US$60 million reflected the inclusion of HSBC Mexico for the period following its acquisition. Excluding HSBC Mexico, the rise in net interest income reflected growth in deposits and record mortgage banking activity. Customers sought to minimise risks from volatile equity markets, while homeowners took advantage of the low interest rate environment to re-mortgage at lower rates. The increase in spreads arising from lower funding costs was partly offset by a lower benefit from net free funds.
Excluding HSBC Mexico, which contributed US$40 million, other operating income was 15 per cent higher than in 2001, driven by growth in brokerage and wealth management products and successful re-pricing of account service charges. Brokerage revenues increased by 32 per cent over 2001, due in part to sales of annuity products and increased transaction volumes. Insurance revenue also grew strongly. By the end of 2002, more than 1,500 professionals were licensed to sell insurance and a number of annuity products through the retail network in the US.
HSBC in Canada was rated highest for overall quality of customer service among the banks included in the ‘2002 Customer Service Index’, an independent study conducted annually by Market Facts of Canada. HSBC Bank Canada introduced ‘clientCONNECT’, a sales and service initiative designed to improve client relationships. The bank also completed the rollout of a Call Management programme designed to remove routine tasks from branches and enable staff to concentrate on deepening relationships with customers.
Operating expenses, before goodwill amortisation, increased by 19 per cent to US$1,172 million, of which US$72 million reflected the impact of HSBC Mexico. The underlying increase of 11 per cent was mainly due to increased revenue-related staff costs and higher IT and marketing expenses. As part of its strategy of providing customers with multiple choices for product and service delivery, HSBC offered a comprehensive internet banking service in the US. By the end of the year, more than 405,000 customers had registered, up from approximately 275,000 at the end of 2001. The HSBC Bank USA website, us.hsbc.com, where customers can apply for accounts, conduct financial planning and link to online services, received approximately 50,000 visits every day during 2002.
Commercial Banking in North America reported pre-tax profit, before goodwill amortisation, of US$435 million, an increase of 6 per cent, compared with 2001. HSBC Mexico accounted for US$6 million of this increase.
Net interest income was broadly in line with 2001. The effect of including HSBC Mexico was offset by reduced net interest income in the US, reflecting lower lending levels. On an underlying basis, other operating income rose 8 per cent to US$287 million, as a result of higher fees from deposit services, credit and trade finance activity. A repricing initiative on deposit account services resulted in higher fee income in both the US and Canada. Dealing profits fell in HSBC’s Mexican operation following a decline in gains on exchange valuations on the loan portfolio.
Operating expenses, on an underlying basis, were slightly lower than in 2001 in both the US and Canada, mainly due to operating cost controls and one-off costs incurred in 2001. Provisions for bad and doubtful debts were broadly in line with last year. Despite the uncertain economic climate, the US and Canada experienced fewer problem credits for larger companies, though this was partly offset by higher provisions in Panama.
Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$494 million, an increase of 15 per cent, compared with 2001. This was primarily driven by improved spreads in Global Markets in the low interest rate environment. HSBC’s US securities trading and debt capital markets business reported a pre-tax loss of US$100 million. A significant widening of credit spreads in the first half of the year resulted in losses on bond holdings.
Net interest income increased by 53 per cent to US$539 million. The principal driver of growth was significantly reduced funding costs as the steeper yield curve led to a 54 basis point increase in spread. Global Markets benefited from the lower funding costs. Net interest income in the debt capital markets business weakened due to increased funding costs on corporate bond trading portfolios.
Other operating income at US$557 million was 17 per cent lower than in 2001, mainly due to dealing losses. Difficult conditions in the capital markets prevented a recurrence of 2001’s strong dealing profits and profits on domestic US dollar trading fell. Partially offsetting the dealing losses were higher
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levels of other income from bank note servicing and increased numbers of structured transactions for corporate customers. In Canada, HSBC's operations reported reduced equity market-related fees. HSBC withdrew from the institutional equity trading and research business in the first half of 2002. Other operating income in the debt capital markets business fell by US$46 million, largely resulting from losses on corporate bond trading.
Total operating expenses, before amortisation of goodwill, were broadly in line with 2001. In the US securities trading and debt capital markets business, revenue-related pay decreased due to the losses incurred in 2002.
Provisions for bad and doubtful debts decreased by 18 per cent. HSBC Bank USA’s charge for bad and doubtful debts fell, predominantly due to the non-recurrence of specific provisions raised in 2001
against corporate customers. The charge in Canada increased following a provision for an exposure in the telecommunications sector.
Profits on the disposal of investments declined by 10 per cent reflecting reduced sales of securities.
HSBC’s Private Banking operations in North America contributed US$57 million to pre-tax profits before goodwill amortisation. Net interest income at US$117 million was US$10 million lower than in 2001 as lower interest rates reduced the benefit of free funds. Other operating income, including fees and commissions, increased by US$20 million, or 16 per cent, reflecting the inclusion of WTAS, which became operational in the second half of 2002. Operating expenses, before goodwill amortisation, increased by US$52 million, partly as a result of the launch of WTAS.
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2003 was a year of recovery across the region following the economic and political uncertainty experienced during 2002.
In Brazil, the turnaround in 2003 was noteworthy. After a difficult start, the new Government demonstrated prudent control of macroeconomic policy including, importantly, inflation. A difficult and costly disinflationary programme was put into effect with the central bank’s reference rate reaching 26.5 per cent in June. The programme was successful within a surprisingly short time horizon. Inflation fell from 17.3 per cent to 9.3 per cent, and reference interest rates ended the year at 16.5 per cent. Actions to reduce Brazil’s two key vulnerabilities, its fiscal and external deficits, were effective. On the fiscal front, Brazil’s Congress approved public sector social security reforms and 2003 was the fifth consecutive year IMF fiscal targets were achieved. On the external front, Brazil is expected to register its first current account surplus in over a decade.
Buoyed by a surge in exports and large trade surpluses, the Argentinian economy recovered at a fast pace. Inflation remained under control and the Argentine peso appreciated from 3.60 to the US dollar in May 2002 to 2.93 at December 2003. Unemployment fell and tax revenues and collections increased.
Fundamental legal uncertainty persists, particularly regarding the position of pension fund assets following pesification, the ability of utilities to raise prices, and the position of holders of pesified and defaulted government bonds. Although the financial system is emerging slowly from near collapse, questions about the sustainability of the recovery persist and a resolution of the historic sovereign debt default is a pre-condition for stability and sustained new investment.
HSBC’s operations in South America reported a pre-tax profit of US$115 million, compared with a loss of US$58 million in 2002. Excluding goodwill amortisation, pre-tax profit was US$126 million, compared with a loss of US$34 million in 2002. Key to this improvement was a turnaround in Argentina, from a loss of US$210 million to a modest profit of US$48 million. This followed the release of part of the general provision previously raised against customer advances, as the economy improved and, in
December 2003, compensation bonds with a face value of US$109 million were received from the Argentine government. These have been included at an estimated fair value of US$63 million in the results of the Other segment. Goodwill amortisation at US$11 million was US$13 million lower than in 2002, which included a goodwill write-off relating to the purchase of insurance subsidiaries.
In Personal Financial Services there was a pre-tax loss, before goodwill amortisation, of US$27 million, an improvement against the loss suffered in 2002. The acquisition of Lloyds TSB Group’s businesses and assets in Brazil contributed US$7 million to this overall improvement. Lending growth was stronger in Brazil, while higher bad debt recoveries benefited operations in Argentina.
Net interest income was broadly in line with last year. The benefit from higher personal lending balances in Brazil was offset by lower interest income from the insurance businesses in Argentina, largely due to lower CER, an inflation adjustment applied to all pesified loans.
Other operating income of US$316 million was 51 per cent higher than in 2002, largely due to a strong performance in Brazil. Growth in customer lending volumes generated an increase in credit-related fee income and account service fees. Following strong marketing support, fee income from cards in Brazil grew by 24 per cent, driven by a 30 per cent increase in cards in circulation to 1.4 million. Other operating income also improved in Argentina, reflecting a strong performance in the insurance business.
Operating expenses, excluding goodwill amortisation, were broadly in line with 2002. In Brazil, costs increased by 15 per cent, largely due to higher staff costs, notably labour claims, together with higher costs from marketing initiatives taken in 2003 and an increase in the transactional taxation charge on higher operating income. Costs in Argentina were significantly lower than prior year, mainly due to lower severance costs.
The provision for bad and doubtful debts of US$138 million was 50 per cent higher than in 2002. In Brazil, specific provisions increased, predominantly in the first half of 2003, reflecting the prevailing economic conditions. High inflation,
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interest rates and unemployment reduced customers’ repayment capacity. However, credit quality began to show signs of improvement in the second half of the year.
Commercial Banking in South America contributed pre-tax profit, before amortisation of goodwill, of US$99 million, 23 per cent higher than in 2002.
Net interest income increased by 39 per cent, to US$168 million. In Argentina, net interest income benefited from lower Argentine peso rates paid on deposits and recoveries of interest suspended on non-performing loans. In Brazil, successful marketing campaigns led to a significant growth in income from overdrafts and working capital products. Other growth areas included discounted receivables and vehicle leasing, supported by the introduction of pre-approved facilities.
Other operating income increased by 23 per cent to US$115 million. Credit related fee income in Brazil increased, reflecting the expansion in the current account customer base by 8 per cent. Fees earned on foreign exchange rose from a higher volume of transactions. In response to aggressive pricing by competitors, the introduction of a new fee pricing structure in the first half of 2003 stimulated an increase in the volume of loan fees and funds under management leading to higher fee income.
At US$173 million, total operating expenses, before goodwill amortisation, were 25 per cent higher than 2002. The cost increases partly reflected increased business volumes as well as the impact of various initiatives which had been delayed pending evidence of improvement in economic conditions. These included increased advertising, the implementation of a sales structure to support business development, and investment in new products and delivery channels. These were partly funded by the centralisation of support processes which resulted in a reduction of associated costs and reduced the administrative workload for relationship managers, leaving them more time for their customers.
Corporate, Investment Banking and Markets reported a loss, before amortisation of goodwill, of US$24 million, broadly in line with 2002, at constant exchange rates. Profit before tax and amortisation of goodwill in Brazil was US$49 million, compared with US$104 million in 2002. Argentina recorded a
loss of US$72 million compared with a loss of US$143 million in 2002.
Net interest expense was US$51 million, an increase of 16 per cent compared with 2002. In Brazil, net interest income decreased due to lower spreads in Global Markets, partly offset by the impact of downward yield curve movements which allowed the funding of long positions at lower rates. In corporate banking, a lack of attractive risks restricted lending growth. In Argentina, the lower cost of funding non-performing assets and a lower level of suspended interest resulted in a decrease in net interest expense.
Dealing profits were broadly in line with 2002. In Brazil, higher dealing profits reflected gains resulting from a fall in interest rates. Brokerage, custody and clearing businesses also grew significantly, taking advantage of market opportunities. These factors were offset in part by lower foreign exchange income in Argentina.
Staff costs were higher than in 2002, mainly in Brazil, reflecting improved performance in specific products.
Provisions for bad and doubtful debts rose in difficult market conditions. Higher interest rates, currency weakness, and a reduced availability of foreign currency funding all contributed to problems encountered by corporate customers in the first half of 2003 in Brazil. Although the situation improved during the year, new specific provisions were raised against two sizeable corporate accounts as a consequence of business failure in one case and fraud in the other.
Private Banking’s pre-tax loss, before goodwill amortisation, of US$2 million compared with a loss of US$12 million in 2002. A lower bad debt charge reflected an improvement in the overall credit quality of the segment.
Within the Other customer group, there was a US$113 million release of general provision raised in respect of Argentina. This release followed a period of improved market conditions and collections within the lending portfolios.
Provisions for contingent liabilities and commitments reflected court decisions (amparos) relating to formally frozen US dollar denominated customer deposits required to be settled at the prevailing market rate.
2002 was a year of uncertainty in both Brazil and Argentina. Although the Argentine government had been in talks with the International Monetary Fund and World Bank for over a year, an agreement on the resumption of lending had yet to be reached. The Argentine economy experienced its fourth successive year of recession with a large contraction in GDP, falling 12 per cent, and unemployment continuing to rise. However, some stability was introduced towards the end of 2002, as the peso began to appreciate from its lows as fears of hyperinflation began to recede and a significant trade surplus emerged. Elections were expected to take place in the second quarter of 2003.
Brazil avoided major fall-out from the collapse of the Argentine economy and steadily improved its current account position by growing its trade surplus with the rest of the world. Uncertainty over the outcome of presidential elections held in the second half of 2002 led to a sharp depreciation in the value of the real and upward pressure on interest rates in the first half of the year. The newly elected government quickly stated its commitment to fiscal discipline, leading to improved stability, lower interest rates and a stronger currency towards the end of 2002.
HSBC’s operations in South America reported an operating profit before provisions, of US$157 million, compared with US$434 million in 2001. Excluding goodwill amortisation, operating profit before provisions was US$181 million, compared with US$448 million in 2001. At constant exchange rates, operating profit before provisions and excluding goodwill amortisation was 43 per cent lower than in 2001. Losses before tax excluding goodwill amortisation improved substantially to US$34 million, compared with a loss of US$1,002 million in 2001. Goodwill amortisation was US$24 million compared with US$14 million. The increase reflects the write-off by HSBC of the remaining goodwill that arose on the purchase of its insurance subsidiaries.
In Personal Financial Services there was a pre-tax loss, before goodwill amortisation, of US$33 million, compared with a profit of US$62 million in 2001.
Net interest income of US$539 million was 31 per cent higher than in 2001. Competitive pricing initiatives and targeted marketing campaigns led to strong growth in personal lending products in Brazil, particularly personal overdrafts and credit cards. In Argentina, margins deteriorated reflecting the effect of the severe economic conditions and the impact of non-performing loans.
Other operating income decreased by 12 per cent compared with 2001. In Brazil, the decline in fee income reflected competitive pricing initiatives and the loss of revenue from account fees, as the Brazilian government had outlawed the levying of fees on certain accounts. This was partly offset by strong growth in credit-related fee income. Net revenues from the insurance businesses in Argentina fell considerably as HSBC was obliged to renegotiate a number of contracts as a result of the mismatch between premiums and claims arising from the pesification of assets and liabilities.
Operating expenses, before goodwill amortisation, rose by 33 per cent to US$691 million, as savings from a reduction in headcount were offset by related severance payments. Staff costs were higher in Brazil, partly due to an increase in inflation-linked pension costs and an industry-wide union-agreed salary increase. Other administration expenses increased as a result of higher levels of transactional taxation, including an additional tax imposed on foreign companies.
The provision for bad and doubtful debts of US$100 million was slightly lower than in 2001. New provisions raised in Brazil to reflect the increased level of personal lending were more than offset by a number of releases, particularly in the credit card portfolio, reflecting the bank’s pro-active management of its personal loan book.
Commercial Banking in South America contributed pre-tax profit, excluding goodwill amortisation, of US$79 million, compared with a small reported loss in 2001.
Net interest income was broadly in line with 2001. Other operating income increased, reflecting strong growth in credit-related fee income in Brazil. Total operating expenses before goodwill amortisation rose by 36 per cent, to US$147 million, in 2002. Staff costs increased, mainly due to higher pension and salary costs in Brazil and severance payments in Argentina.
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The favourable movement in provisions for bad and doubtful debts reflected improved economic conditions in Argentina together with releases in Brazil.
Corporate, Investment Banking and Markets reported pre-tax profit, excluding goodwill amortisation, of US$32 million.
In Brazil, profit before tax, excluding goodwill amortisation was US$125 million, an increase of 15 per cent at constant exchange rates. In Argentina, loss before tax was US$101 million, compared with a small profit in 2001.
The net interest expense was attributable to the high cost of funding non-performing assets in Argentina, and a reduction in government bond securities in Brazil, as HSBC sought to minimise its exposure in the uncertain economic climate. Dealing profits increased, primarily due to income from interest rate derivatives trading and foreign exchange trading in Brazil. In Argentina, foreign exchange dealing profits improved as some resumption in
activity was permitted. Fee income declined in investment banking services in Brazil.
Operating expenses rose in constant currency terms, reflecting higher pension contributions in Brazil and severance payments in Argentina. Provisions for bad and doubtful debts mainly reflected a specific provision in Brazil against a corporate exposure.
Private Banking’s operations recorded a pre-tax loss, before goodwill amortisation, of US$12 million compared with a loss of US$3 million in 2001. Adverse economic conditions in Uruguay, combined with the deterioration in the Argentine peso, were primarily responsible for the increased loss.
Within the Other customer group, provisions for contingent liabilities and commitments reflected court decisions (amparos) which required formerly frozen US dollar denominated customer deposits to be settled at the prevailing market rate.
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Introduction
The results of HSBC Holdings are sensitive to the accounting policies, assumptions and estimates that underlie the preparation of its consolidated financial statements. The accounting policies used in the preparation of the consolidated financial statements are described in detail in Note 2 in the ‘Notes on the Financial Statements’ on pages 239 to 366 of theAnnual Report and Accounts 2003.
When preparing the financial statements, it is the directors’ responsibility under UK company law to select suitable accounting policies and to make judgements and estimates that are reasonable and prudent. Under UK GAAP, Financial Reporting Standard (‘FRS’) 18 ‘Accounting policies’ requires the Group to adopt the most appropriate accounting policies in order to give a true and fair view.
HSBC also provides details of its net income and shareholders’ equity calculated in accordance with US GAAP. US GAAP differs in certain respects from UK GAAP. Details of these differences are set out in Note 50 in the ‘Notes on the Financial Statements’ on pages 327 to 365.
The accounting policies that are deemed critical to the Group’s UK GAAP results and financial position, in terms of materiality and the degree of judgement and estimation involved, are discussed below.
Provisions for bad and doubtful debts
HSBC’s accounting policy for provisions for bad and doubtful debts on customer loans is described in Note 2(b) in the ‘Notes on the Financial Statements’ on pages 241 to 243 of the Annual Report and Accounts 2003.
Charges for provisions for bad and doubtful debts are reflected in HSBC’s profit and loss account under the caption ‘Provision for bad and doubtful debts’. Any increase in these provisions has the effect of lowering HSBC’s profit on ordinary activities by a corresponding amount (while any decrease in provisions or release of provisions would have the opposite effect).
Specific provisions
Specific provisions are established either on a portfolio basis or on a case-by-case basis depending
on the nature of the exposure and the manner in which risks inherent in that exposure are managed. In addition, provisions for the sovereign risk inherent in cross-border credit exposures are established for certain countries; this element is not currently significant.
When specific provisions are raised on a portfolio basis, the most important factors in calculating the quantum of the required provision are:
The factor over which management has most discretion are the periods used in the various roll and loss rate calculations. If management were to take a more conservative view and increase the embedded periods, this would have the effect of increasing the provisions charged and lowering HSBC’s profit on ordinary activities.
The portfolio basis is applied to overdue accounts in Household’s consumer portfolios and in the following in the rest of HSBC:
When establishing specific provisions on a case-by-case basis, the most important factors are:
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In many cases, the determination of these factors will be judgemental, because either the security may not be readily marketable or the cashflows will require an assessment of the customer’s future performance or the impact of litigation. HSBC’s practice is to make estimates against these factors and to review and update them regularly. If management were to take a more cautious view of the customer’s future cash flows (either by being less optimistic of the ability of the customer to generate profits or general economic conditions) or the availability or value of any security, the provision charge would be higher and HSBC’s profit on ordinary activities would be lower.
This method of determining provisions is applied to most corporate loans and, with the exception of Household, which utilises portfolio analysis, to residential mortgages 90 days or more overdue.
HSBC has no individual loans where changes in the underlying factors upon which specific bad and doubtful debt provisions have been established could cause a material change to the Group’s reported results.
General provisions
General provisions augment specific provisions and provide cover for loans which are impaired at the balance sheet date but which will not be identified as such until some time in the future. HSBC requires each operating company to maintain a general provision which is determined by taking into account the structure and risk characteristics of each company’s loan portfolios. Provisions held against homogenous portfolios of assets which are not overdue and which have neither been restructured nor are in bankruptcy are classified as general rather than specific.
The most important factors in determining general loan loss provisions are:
The main areas of judgement are in determining the periods during which latent losses emerge and assessing whether current economic conditions are likely to produce credit default rates and loss severity in line with historical precedent. These factors are kept under review based on an analysis of economic forecasts, industry sector performance, insolvency and bankruptcy statistics, together with details of the rate and nature of losses experienced.
If management were to take a more conservative view of economic conditions or increase the loss emergence periods, the provisions charged would increase and HSBC’s profit on ordinary activities would be lower.
Goodwill impairment
HSBC’s accounting policy for goodwill is described in Note 2(e) in the ‘Notes on the Financial Statements’ on page 244 of the Annual Report and Accounts 2003.
Amortisation of goodwill is recorded on HSBC’s profit and loss account under the caption ‘Depreciation and Amortisation – Goodwill’. Any impairments or reductions of goodwill are also charged to the profit and loss account (hence reducing HSBC’s operating profit on ordinary activities after tax by a corresponding amount) and also result in a corresponding reduction of ‘Goodwill’ on the balance sheet.
In accordance with the requirements of FRS 10 ‘Goodwill and intangible assets’, HSBC reviews goodwill which has arisen on the acquisition of subsidiary undertakings, joint ventures and interests in associates at the end of the first full year after an acquisition, and whenever there is an indication that impairment may have taken place. Impaired goodwill is accounted for in accordance with FRS 11 ‘Impairment of fixed assets and goodwill’.Indications of impairment include any events or changes in circumstance that cast doubt on the recoverability of the carrying amount of goodwill.
If management believes that a possible impairment is indicated in respect of a particular entity, the valuations of each of the entity’s relevant ‘Income Generating Units’ (IGUs) are compared with their respective carrying values (including
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related goodwill). The IGU valuations are derived from discounted cashflow models. Significant management judgement is involved in two elements of the process of identifying and evaluating goodwill impairment.
First, the cost of capital assigned to an individual IGU and used to discount its future cashflows can have a significant effect on its valuation. The cost of capital percentage is generally derived from an appropriate capital asset pricing model, which itself depends on a number of financial and economic variables which are established on the basis of management’s judgement.
Second, management judgement is required in deriving discounted cashflow valuations of IGUs. These valuations are sensitive to the cashflows in the initial periods for which detailed forecasts are available, and to assumptions regarding the long-term sustainable growth rates of cashflows 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 cashflow forecasts necessarily reflect management’s view of future business prospects.
Where management’s judgement is that the expected cashflows of an IGU have declined and/or that its cost of capital has increased, the effect will be to reduce the estimated fair value of the IGU. If this results in an estimated fair value that is lower than the carrying value of the IGU, an impairment of goodwill will be recorded and HSBC’s profit on ordinary activities will be lower.
Valuation of unquoted and illiquid debt and equity securities
HSBC’s accounting policy for these instruments is described in Note 2(c) in the ‘Notes on the Financial Statements’ on page 243 in the Annual Report and Accounts 2003.
HSBC carries debt and equity securities held for trading purposes at fair value. For those debt and equity securities not held for trading purposes, and carried in the accounts at amortised historical cost, consideration as to whether any such asset should be written down to reflect a permanent impairment takes into account the fair value of the relevant security. Changes in the value of securities held for
trading purposes are reflected in ‘Dealing profits’ and hence directly impact HSBC’s profit on ordinary activities. Any permanent impairment in the value of debt and equity securities not held for trading purposes is reported in ‘Amounts written off fixed asset investments’ and hence reduces HSBC’s profit on ordinary activities.
The fair value determined for unquoted and illiquid debt and equity securities reflects management’s assessment of the value of these securities. This assessment may look to a valuation of comparable securities for which an independent price can be established or use a discounted cashflow model (particularly for debt securities) or model the valuation of complex illiquid securities based on a components approach where independent pricing is available for the underlying components.
The main factors which management considers when applying a cashflow model are:
When valuing instruments by reference to comparable securities, management takes into account the maturity, structure and rating of the security to which the position held is being compared.
When valuing instruments on a model basis using the fair value of underlying components, management additionally takes into account model tracking error and liquidity.
In assessing the valuation of securities, management also takes account of the size of the position held relative to market liquidity and prevailing market conditions. When considered appropriate, the assessed fair value of the securities is reduced to reflect the amount which management estimates could be realised on their sale.
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Changes in any of the assumptions used in the management valuation will give rise to changes in the recorded fair value of unquoted securities where the securities affected are carried in the accounts at fair value. For securities carried at amortised cost a permanent diminution in value may result from changes in their estimated fair value if management changes its assumptions regarding the above variables. In such circumstances, it will also be necessary for management to exercise judgement as to whether or not the indicative change in estimated fair value arising from revisions to the underlying valuation assumptions are only temporary.
HSBC has no individual unquoted or illiquid securities where changes in assumptions used in the management valuation of such securities could cause a material change to the Group’s reported results.
The Accounting Standards Board (‘ASB’) (UK GAAP) and the Financial Accounting Standards Board (‘FASB’) (US GAAP) have issued the following accounting standards, which become fully effective in future financial statements.
UK GAAP
FRS 17 ‘Retirement benefits’ was issued in December 2000. If applied in full, FRS 17 would replace SSAP 24 ‘Accounting for pension costs’. There are also amendments to other accounting standards and UITF Abstracts.
Under FRS 17 as originally issued, the primary statement impact was to have been recognised from 1 January 2003. In November 2002, the ASB issued
an amendment to FRS 17 which defers the full accounting impact of FRS 17 until 1 January 2005. As such, it will be superseded by the transition to International Financial Reporting Standards.
FRS 17, if adopted in full, would require that financial statements report at fair value the assets and liabilities arising from an employer’s retirement benefit obligations and any related funding. The operating costs of providing retirement benefits to employees are recognised in the accounting periods in which the benefits are earned by the employees, and the related finance costs and any changes in value of the assets and liabilities are recognised in the accounting periods in which they arise.
In the period until full implementation the transitional disclosures required by FRS 17 are included in the ‘Notes on the Financial Statements’ in the Annual Report and Accounts 2003. The effect on reserves at 31 December 2003, if the FRS 17 pension liability were to be recognised, would be a reduction of US$2,398 million.
US GAAP
Statement of Financial Accounting Standards (‘SFAS’) 132 (revised 2003) ‘Employers’ disclosures about pensions and other post-retirement benefits’ was issued in December 2003. This statement is effective for HSBC’s UK (domestic) pension and post-retirement benefit schemes for fiscal years ending after 15 December 2003, except for future benefit payments, which together with all non-domestic schemes, is required for fiscal years ending after 15 June 2004. The disclosures in respect of HSBC’s UK (domestic) pension schemes are set out in Note 50 of the ‘Notes on the Financial Statements’.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (‘VIEs’) (FIN 46). FIN 46 requires a VIE to be consolidated by a company if that company’s variable interests absorb a majority of the VIE’s expected losses, or is entitled to receive a majority of VIEs residual returns, or both. FIN 46 increases required disclosures by a company consolidating a VIE and also requires disclosures about VIEs that the company is not required to consolidate, but in which it has a significant variable interest. HSBC has adopted the requirements of FIN 46 at 31 December 2003 for all entities created after
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31 January 2003. As a foreign private issuer that does not file quarterly accounts, HSBC is permitted to defer adoption of FIN 46 for entities created before 1 February 2003 until 2004.
A modified version of FIN 46 was issued in December 2003 by the FASB (‘FIN 46R’). FIN 46R addresses certain implementation issues that arose under FIN 46 and changes some of the criteria used to determine whether HSBC is the primary beneficiary of an entity. HSBC has applied FIN 46R to its assessment of certain entities where the impact of the modifications in FIN 46R is known. However, HSBC is still assessing the impact of FIN 46R on other entities. HSBC is required to adopt FIN 46R for all interests in VIEs for accounting periods ending after 15 March 2004.
Further information regarding HSBC’s interest in VIEs under FIN 46 is provided in Note 50 to the financial statements.
The American Institute of Certified Public Accountants (‘AICPAs’) Accounting Standards Executive Committee issued Statement of Position (‘SOP’) 03-1, ‘Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts’ on 7 July 2003. The SOP provides guidance on accounting and reporting by insurance enterprises for certain non-traditional long-duration contracts and for separate accounts. SOP 03-1 is effective for financial statements occurring in fiscal years beginning after 15 December 2003. Restatement of previously issued annual financial statements is not permitted. HSBC is still assessing the impact of this SOP on its US GAAP financial statements.
In December 2003, the AICPA released SOP 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer: The SOP addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable to credit quality. This SOP is effective for loans acquired in accounting periods beginning after 15 December 2004. HSBC is still assessing the impact of this SOP on its US GAAP financial statements.
Transition to International Financial Reporting Standards (‘IFRS’)
HSBC has established a project steering committee to co-ordinate the transition to IFRS and since 2002 has been following a transition plan that has three phases – preliminary assessment, detailed impact study and implementation.
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Average balance sheet and net interest income
Average balances and the related interest are shown for the domestic operations of HSBC’s principal
commercial banks by geographic region with all other commercial banking and investment banking balances and transactions included in ‘Other operations’. Additional information on the basis of preparation is set out in the notes on page 131.
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Figures for 2002 and 2001 have been restated to reflect the adoption of UITF Abstracts 37 ‘Purchases and sales of own shares’, and 38 ‘Accounting for ESOP trusts’, details of which are set out in Note 1 in the ‘Notes on the FinancialStatements’ on pages 239 to 240.
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H S BC H O L D I N G S P L C
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Analysis of changes in net interest income
The following table allocates changes in net interest income between volume and rate for 2003 compared
with 2002, and for 2002 compared with 2001. Changes due to a combination of volume and rate are allocated to rate.
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133
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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 cross-border risk), liquidity risk, market risk and operational risk. Market risk includes foreign exchange, interest rate and equity price risks.
HSBC’s risk management policy is designed to identify and analyse these risks, to set appropriate risk limits and controls, and to monitor the risks and limits continually by means of reliable and up-to-date administrative and information systems. HSBC continually modifies and enhances its risk management policies and systems to reflect changes in markets and products and in best practice risk management processes. Training, individual responsibility and accountability together with a disciplined, cautious and conventional culture of control lie at the heart of HSBC’s management of risk.
The Group Management Board (formerly the Group Executive Committee), under authority delegated by the Board of Directors, formulates high level risk management policy. A separately constituted Risk Management Meeting monitors risk and receives reports which allow it to review the effectiveness of HSBC’s risk management policies.
Credit risk management
Credit risk is the risk that financial loss arises from the failure of a customer or counterparty to meet its obligations under a contract. It arises principally from lending, trade finance, treasury and leasing activities. HSBC has dedicated standards, policies and procedures to control and monitor all such risks.
Within Group Head Office, a separate function, Group Credit and Risk, is mandated to provide high-level centralised management of credit risk for HSBC on a worldwide basis. Group Credit and Risk is headed by a Group General Manager who reports to the Group Chief Executive, and its responsibilities include the following:
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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 who, in most cases, reports to his local Chief Executive Officer on credit-related issues. In the case of Household, the Chief Credit Officer reports to the Chief Operating Officer of that business, in line with historic practice. All Chief Credit Officers have a functional reporting line to the Group General Manager, Group Credit and Risk.
Each operating company is responsible for all assets in its portfolio, including those subject to central approval by Group Credit and Risk, and for managing its own risk concentrations on market sector, geographical and product bases. Local systems are in place throughout the Group to enable operating companies to control and monitor exposures by customer and counterparty.
Special attention is paid to problem loans. When appropriate, specialist units are established by HSBC’s operating companies to provide customers with intensive management and control support in order to help them avoid default wherever possible and maximise recoveries. Regular audits of operating companies’ credit processes are undertaken by HSBC’s Internal Audit function. Audits include consideration of the completeness and adequacy of credit manuals and lending guidelines, an in-depth analysis of a representative sample of accounts, an overview of homogenous portfolios of similar assets to assess the quality of the loan book and other exposures, and adherence to Group standards and policies in the extension of credit facilities. Individual accounts are reviewed to ensure that facility grades are appropriate, that credit and collection procedures have been properly followed and that, where an account or portfolio evidences deterioration, adequate provisions are raised in accordance with the Group’s established processes. Internal Audit will discuss with management facility gradings they consider to be inappropriate, and their subsequent recommendations for revised grades must then be assigned to the facilities concerned.
It is HSBC policy that each operating company makes provision for bad and doubtful debts promptly when required and on a consistent basis in
accordance with established Group guidelines.
HSBC’s grading process for credit facilities extended by members of the Group is designed to highlight exposures requiring greater management attention based on a higher probability of default and potential loss. Management particularly focuses on the appropriateness of grades assigned to facilities to those borrowers and portfolio segments classified below satisfactory grades. Amendments, where necessary, are required to be undertaken promptly. Management also regularly performs an assessment of the adequacy of the established provisions for bad and doubtful debts by conducting a detailed review of the loan portfolio, comparing performance and delinquency statistics against historical trends and undertaking an assessment of current economic conditions.
There are two types of provision, specific and general, as discussed below.
Specific provisions represent the quantification of actual and inherent losses from homogenous portfolios of assets and individually identified accounts. Specific provisions are deducted from loans and advances in the balance sheet. Following the acquisition of Household, the majority of specific provisions are now determined on a portfolio basis.
Portfolios
Where homogenous groups of assets are reviewed on a portfolio basis (e.g. credit cards, other unsecured consumer lending, motor vehicle financing and residential mortgage loans), two alternative methods are used to calculate specific provisions:
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These portfolio provisions are generally reassessed monthly and charges for new provisions, or releases of existing provisions, are calculated for each separately identified portfolio.
The Group’s intention is to extend the use of the roll rate and model methodologies to all homogenous portfolios of assets for calculating specific provisions as information becomes available.
Individually assessed accounts
Specific provisions on individually assessed accounts are determined by an evaluation of the exposures on a case-by-case basis. This procedure is applied to all accounts that do not qualify for, or are not subject to, a portfolio based approach (typically those with facilities of more than US$15,000 and, in some jurisdictions, all house mortgage loans and motor vehicle finance facilities). In determining such provisions on individually assessed accounts, the following factors are considered:
Group policy requires a review of the level of specific provisions on individual facilities above materiality guidelines at least half-yearly, or more regularly where individual circumstances require. This will normally include a review of collateral held (including reconfirmation 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 markets are used. In management’s view, utilising this expertise enables likely losses on significant individual exposures to be assessed more accurately. Releases on individually calculated specific provisions are recognised whenever the Group has reasonable evidence that the established estimate of loss has been reduced.
Cross-border exposures
Specific provisions are established in respect of cross-border exposures to countries assessed by management to be vulnerable to foreign currency payment restrictions. This assessment includes analysis of both economic and political factors. Economic factors include the level of external indebtedness, the debt service burden and access to external sources of funds to meet the debtor country’s financing requirements. Political factors taken into account include assessment of the stability of the country and its government, potential threats to security and the quality and independence of the legal system.
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Provisions are applied to all qualifying exposures within these countries unless these exposures:
General provisions augment specific provisions and provide cover for loans which are impaired at the balance sheet date but which will not be individually identified as such until some time in the future. HSBC requires each operating company to maintain a general provision which is determined after taking into account:
The estimated period between a loss occurring and its identification (as evidenced by the establishment of a specific provision for this loss) is determined by local management for each identified portfolio. In general, the periods used vary between four and twelve months.
In normal circumstances, historical experience is the most objective and accurate framework used to assess inherent loss within each portfolio. Historical loss experience is generally benchmarked against the weighted average annual rate of provisions over a five-year period.
In certain circumstances, such as in Argentina in 2001, economic conditions are such that it is clear that historical loss experience provides insufficient evidence of the inherent loss in a given portfolio. In
such circumstances, management uses its judgement, supported by relevant experience from similar situations, to determine an appropriate general provision.
The basis used to establish the general provision within each reporting entity is documented and reviewed by senior Group credit management for conformity with Group policy.
Suspended and non-accrual interest
For individually assessed accounts, loans are designated as non-performing as soon as management has doubts as to the ultimate collectability of principal or interest, or when contractual payments of principal or interest are 90 days overdue. When a loan is designated as non-performing, interest is not normally credited to the profit and loss account and either interest accruals will cease (‘non-accrual loans’) or interest will be credited to an interest suspense account in the balance sheet which is netted against the relevant loan (‘suspended interest’).
Within portfolios of low value, high volume, homogenous loans, interest will normally be suspended on facilities 90 days or more overdue. In certain operating subsidiaries, interest income on credit cards may continue to be included in earnings after the account is 90 days overdue, provided that a suitable provision is raised against the portion of accrued interest which is considered to be irrecoverable.
The designation of a loan as non-performing and the suspension of interest may be deferred for up to 12 months in either of the following situations:
On receipt of cash (other than from the realisation of security), the overall risk is reevaluated and, if appropriate, suspended or non-accrual interest is recovered and taken to the profit and loss account. Amounts received from the realisation of security are applied to the repayment of outstanding indebtedness, with any surplus used to
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recover specific provisions and then suspended interest.
Charge-offs
Loans (and the related provisions) are normally charged off, either partially or in full, when there is no realistic prospect of recovery of these amounts and when the proceeds from the realisation of security have been received. Unsecured consumer facilities are charged off between 150 and 210 days overdue. In the case of Household, this period is generally extended to 300 days overdue (270 days for secured products) and collections can continue for up to 360 days post default where it is expected to improve recovery rates. In the case of bankruptcy, charge-off can occur earlier.
US banks typically write off problem lending more quickly than is the practice in the UK. This approach means that HSBC’s reported level of credit risk elements and associated provisions are likely to be higher than for comparable US banks.
Restructuring of loans
Restructuring activity is designed to maximise cash recovery on accounts which are overdue, by slowing down the formal steps in collection management to allow qualifying customers to repair or renegotiate satisfactory maintenance of their accounts. This will normally involve resetting an overdue consumer account to current status following an agreed restructuring. Restructuring is typically utilised to assist customers who have suffered from a lifestyle event such as redundancy, divorce or illness, to manage their obligations while they adjust to their new circumstances. Restructuring policies and practices are based on indicators, or criteria, which, in the judgement of local management, evidence continued payment probability. These policies are continually reviewed and their application varies depending upon the nature of the market, the product and the availability of empirically based data. Where empirical evidence indicates an increased propensity to default on restructured accounts, and roll rate methodologies are deployed in the calculation of
provisions, the provisioning methodology reflects the increased propensity of such accounts to default.
Restructuring activity is used most commonly within consumer finance portfolios. The largest concentration is domiciled in the US in Household. The majority of restructured amounts related to secured lending.
In addition to restructuring, HSBC’s consumer lending businesses, principally Household, use other account management techniques on a more limited basis, such as extended payment arrangements, approved external debt management plans, deferring foreclosure, modification, loan rewrites and/or deferral of payments pending a change in circumstances. When using such techniques, accounts may be treated as current, although if payment difficulties are subsequently experienced, they will be redesignated as delinquent. At 31 December 2003, the total value of accounts which have been either restructured or subject to other account management techniques was US$18 billion or some 15 per cent of the Household loan book.
Assets acquired
Assets acquired in exchange for advances in order to achieve an orderly realisation continue to be reported as advances. The asset acquired is recorded at the carrying value of the advance disposed of at the date of the exchange and subsequent provisions are based on any further deterioration in value.
Loan portfolio
Loans and advances to customers are well spread across the various industrial sectors, as well as geographically.
At constant exchange rates, loans and advances to customers (excluding the finance sector and settlement accounts) grew by US$145 billion, or 41 per cent, during 2003 of which US$108 billion, or 31 per cent, related to the acquisition of Household. As a result, personal lending comprised 56 per cent of HSBC’s loan portfolio and over 90 per cent of the growth in loans in 2003 (excluding the financial sector) related to personal and consumer lending.
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The commentary below is on a constant currency basis and excludes the impact of the acquisition of Household except where stated.
Residential mortgages increased by US$22.3 billion, of which US$7 billion arose in Household post-acquisition. Including Household, mortgages comprised 31 per cent of total gross loans to customers at 31 December 2003. Residential mortgages in Europe increased by US$9 billion, of which US$8 billion arose in UK Banking, reflecting the success of a number of marketing initiatives, including competitive pricing and First Direct’s Offset mortgage product, as well as the continuing high level of mortgage refinancing activity in the market. Residential mortgage lending in Hong Kong declined as the property market weakened and demand fell, although there were tentative signs of recovery towards the end of the year. The suspension of the sale of new homes under the Hong Kong Government Home Ownership Scheme in 2001 resulted in lower outstanding balances on these loans.
In the rest of Asia-Pacific, residential mortgages grew by US$4 billion, with strong growth in Korea, Singapore, Australia and New Zealand, the latter from the acquisition of AMP Bank’s mortgage business.
Other personal lending increased by US$12.8 billion, or 24 per cent, of which US$6 billion arose in Household post-acquisition. Including Household, other personal lending increased to 25 per cent of total gross loans to customers at 31 December 2003. There was strong growth in the UK, with credit card balances increasing by 18 per cent. European Private Banking customers increased other personal lending by 25 per cent taking advantage of interest rates to finance higher returning securities. Across the rest of Asia-Pacific loan increase was about 18 per cent. In South America other personal lending nearly doubled primarily due to the acquisition of Losango. In Hong Kong, the improving economic conditions saw growth of 5 per cent in other personal lending which rose to US$7,420 million.
Loans and advances to the corporate and commercial lending (excluding settlement accounts) grew by less than 2 per cent reflecting subdued corporate loan demand.
The following tables analyse loans by industry sector and by the location of the principal operations of the lending subsidiary or, in the case of The Hongkong and Shanghai Banking Corporation, HSBC Bank plc, HSBC Bank Middle East and HSBC Bank USA operations, by the location of the lending branch.
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Customer loans and advances by industry sector
Included in gross loans and advances to customers are the following numbers in respect of Household, 93 per cent of which relate to North America:
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Customer loans and advances by industry sector (continued)
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Customer loans and advances by principal area within rest of Asia-Pacific and South America
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Analysis of loans and advances to banks by geographical region
Provisions against total loans and advances
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The following tables show details of the movements in HSBC’s provisions for bad and doubtful debts by location of lending office for each of the past five
years. A discussion of the material movements in the charge for provisions by region follows these tables.
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Net charge to the profit and loss account for bad and doubtful debts
The charge for bad and doubtful debts and non-performing customer loans and related customer provisions can be analysed as follows:
The total bad and doubtful debt charge for Household includes charges for:
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The increase in the level of new specific provisions was principally driven by:
In aggregate, releases and recoveries increased by US$557 million compared with 2002. Household contributed US$311 million of the increase due to collections and sales of written-off accounts. In Europe, excluding Household, releases and recoveries were US$139 million higher, mainly the result of a recovery from an exposure in the transport sector and the upgrading of corporate exposures in the telecommunications and retail sectors.
There was a net release of general provisions of US$121 million in 2003 compared with a release of US$351 million in 2002. There were general provision charges of US$113 million in Household and US$78 million in HSBC Mexico, reflecting growth in lending. In Europe, excluding Household’s UK consumer finance business, a net release of general provision of US$131 million reflected an improved economic outlook and successful restructuring and refinancing activity in industry sectors which had been causing concern. In Argentina, a net release of US$122 million reflected success in collections and the improved environment and hence quality of the remaining loan book. At 31 December 2003, specific and general provisions together covered about 47 per cent of
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non-government loans (net of suspended interest) in Argentina.
The main factors contributing to the decrease in the bad debt charge against customer loans were:
New specific provisions increased by US$112 million, or 4 per cent, principally driven by:
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Provisions for bad and doubtful debts as a percentage of average gross loans and advances to customers
Areas of special interest
Telecommunications industry exposure
Telecommunications industry exposure is a designated special category of exposure and is controlled under agreed caps. The exposure analysed below is well spread across geographical markets reflecting HSBC’s international footprint.
Group exposure to the sector as a percentage of total loans and advances was 0.72 per cent as at 31 December 2003 compared with 1.34 per cent at 31 December 2002. This exposure had the following characteristics:
Argentina
The exposure of HSBC’s banking operations to Argentina at 31 December 2003 amounted to US$1.8 billion (31 December 2002: US$1.7 billion). Of this amount, US$1.5 billion was in-country exposure including US$0.6 billion of loan exposures to the Argentine Government received in exchange for debt
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securities. These figures are prepared in accordance with the Bank of England Country Exposure Report (Form C1) guidelines and therefore exclude the exposures of insurance subsidiaries. HSBC’s insurance subsidiaries’ exposures to Argentina as at 31 December 2003 amounted to total assets of US$0.7 billion, of which US$0.5 billion related to long-term assurance assets attributable to policyholders, mainly comprising loans to the Argentine Government received in exchange for debt securities. Overall, in-country provisions of US$198 million were held against gross customer non-government loans of US$456 million. There were also cross-border provisions of US$118 million held against exposures to customers in Argentina.
During 2003, HSBC recovered some US$122 million equivalent of general credit provisions raised in 2001 as the credit portfolio stabilised and non-performing accounts fell due to success in collections and a better environment. The improved environment reflects both political and economic progress in the period. The return of a democratically elected president substantially improved the political scene and economically the country began to grow again, driven by improved sentiment and the impact on the export sector of the massive devaluation suffered since 2001.
Argentina, however, continues to face, and must resolve, fundamental structural challenges including reaching a settlement with its international creditors. HSBC continues to monitor developments in Argentina closely and plans to continue to operate there and contribute to a revitalised financial sector. However, HSBC is prepared to take the necessary actions if required to protect the value of its shareholders’ interests in the event of unforeseen political or economic events.
Risk elements in the loan portfolio
The SEC requires disclosure of credit risk elements under the following headings that reflect US accounting practice and classifications:
rather than ceasing to accrue. This additional category is also reported below, as are assets acquired in exchange for advances.
Non-performing loans and advances1
Non-performing customer loans1 and related specific provisions outstanding by geographical segment
1,538
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Total non-performing loans to customers increased by US$4,527 million during 2003, largely as a consequence of the Household acquisition. At 31 December 2003, non-performing loans represented 2.8 per cent of total lending compared with 2.9 per cent at 31 December 2002.
Portfolio provisioning methodologies for unsecured personal finance (using roll rates or loss rates) normally leads to a provision coverage of non-performing loans in excess of 100 per cent, as significant loss or roll rates are applied to performing loans. As a consequence, therefore, of the acquisition of Household, the overall coverage of non-performing loans has risen from 86.7 per cent at 31 December 2002 to 91.0 per cent at 31 December 2003. The overall specific provision coverage of non-performing loans similarly increased from 62.8 per cent to 72.3 per cent. Excluding the impact of Household, the coverage percentage declined to 60.8 per cent. This was due to
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US$936 million of write-offs of largely provided non-performing loans in HSBC Mexico, partly offset by an increase in the percentage coverage in South America as unsecured personal finance loans grew faster than corporate and commercial lending.
In both the UK and France, underlying credit quality remained stable. Household’s European operations added US$326 million to non-performing loans. Excluding this, and at constant exchange rates, non-performing loans increased by US$264 million, or 5 per cent. The rise in the level of non-performing loans reflected the deterioration of a small number of corporate accounts. In value terms, this was concentrated in the energy, engineering, and telecommunications sectors.
In Hong Kong, non-performing loans decreased slightly during 2003, largely due to recoveries and loan repayments.
In the rest of Asia-Pacific, non-performing loans decreased by US$517 million during 2003 due mainly to write-offs and recoveries in Malaysia, New Zealand, Indonesia and Singapore.
The level of non-performing loans in North America increased significantly due to the acquisition of Household. In Mexico, non-performing loans fell following write-offs of US$936 million in the commercial and consumer loan books as management continued to review critically the acquired loan assets. The level of non-performing loans elsewhere in North America remained in line with the level at 31 December 2002.
In South America, there was a decrease in non-performing loans in 2003 in Argentina as recoveries were made on a number of accounts; about 56 per cent of the non-government customer loan book is now classified as non-performing compared with 74 per cent at 31 December 2002. In Brazil, the level of non-performing loans increased as the relatively high prevailing interest rates resulted in higher delinquencies in both the personal and commercial/corporate portfolios.
Troubled debt restructurings
US GAAP requires separate disclosure of any loans whose terms have been modified to grant concessions other than warranted by market conditions due to problems with the borrower. These are classified as ‘troubled debt restructurings’ and are distinct from the normal restructuring activities
described above. Disclosure of troubled debt restructurings may be discontinued after the first year if the debt is performing in accordance with the new terms.
Troubled debt restructurings increased in Mexico from restructuring of commercial accounts, and in Europe arising from the restructuring of a corporate borrower in the telecommunications equipment sector. The reduction in Hong Kong reflected the full repayment of balances on certain restructured borrowings.
Accruing loans past due 90 days or more
Accruing loans past due 90 days increased as a result of the acquisition of Household. In common with other card issuers including other parts of HSBC, Household continues to accrue interest on credit cards past 90 days until charged off at 180 days past due. Appropriate provisions are raised against the proportion of interest thought to be irrecoverable.
Potential problem loans
Credit risk elements also cover potential problem loans. These are loans where known information about possible credit problems of borrowers causes management serious doubts as to the borrowers’ ability to comply with the loan repayment terms. At 31 December 2003, all loans and advances in Argentina and all cross-border loans to Argentina which were not otherwise included as part of total risk elements, have been designated as potential problem loans.
At 31 December 2003, there were potential problem loans of US$701 million (31 December 2002: US$599 million) in respect of Argentine loans.
Risk elements
The following table provides an analysis of risk elements in the loan portfolios at 31 December for the past five years:
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Interest foregone on non-performing lendings
Interest income that would have been recognised under the original terms of the non-accrual, suspended interest and restructured loans amounted to approximately US$380 million in 2003 compared with US$406 million in 2002, US$640 million in 2001 and US$955 million in 2000. Interest income of approximately US$230 million in 2003 from such loans was recorded in 2003, compared with US$258 million in 2002, US$261 million in 2001, US$324 million in 2000.
Country distribution of outstandings and cross-border exposures
HSBC controls the risks associated with cross-border lending, essentially the risk of foreign currency required for payments not being available to local residents, through a central process of internal country limits which are determined by taking into account both economic and political risks. Exposure to individual countries and cross-border exposure in aggregate is kept under continuous review.
The following tables analyse the aggregate of in-country foreign currency and cross-border outstandings by type of borrower to countries which individually represent in excess of 1 per cent of HSBC’s total assets. Classification is based upon the country of residence of the borrower but recognises the transfer of country risk in respect of third party guarantees or residence of the head office where the borrower is a branch. In accordance with the Bank of England Country Exposure Report (Form C1) guidelines, outstandings comprise loans and advances (excluding settlement accounts), amounts receivable under finance leases, acceptances, commercial bills, certificates of deposit and debt and equity securities (net of short positions), and exclude accrued interest and intra-HSBC exposures. For 2003, outstandings to counterparties in the UK were collected on a comparable basis to that required for the Form C1 for the first time. For 2002 and 2001, the UK outstandings, which are not recorded on Form C1 because the UK is HSBC’s country of domicile, have not been collected or disclosed.
As at 31 December 2003, HSBC had in-country foreign currency and cross-border outstandings to counterparties in Australia and Japan of between 0.75 per cent and 1 per cent of total assets. The aggregate in-country foreign currency and cross-border outstandings were: Australia:US$9.1 billion; Japan:US$7.9 billion.
As at 31 December 2002, HSBC had in-country foreign currency and cross-border outstandings to counterparties in Belgium of between 0.75 per cent
and 1 per cent of total assets. The aggregate in-country foreign currency and cross-border outstandings were US$5.9 billion.
At 31 December 2001, HSBC had in-country foreign currency and cross-border outstandings to counterparties in Australia, of between 0.75 per cent and 1 per cent of total assets. The aggregate in-country foreign currency and cross-border outstandings were: US$6.0 billion.
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Liquidity and funding management
In HSBC, liquidity policy is designed to ensure that all commitments, both contractual and those expended on the basis of behavioural patterns, which are required to be funded, can be met out of readily available and secure sources of funding. In addition, excess liquid assets are held in each market which, together with recourse to available funding facilities, provide further sources of funding in the event of stress conditions. Funding policy seeks to ensure that the necessary sources of funds are available at an optimised cost.
The management of liquidity and funding is carried out locally in the operating companies of HSBC and is not centralised. This is because it is HSBC policy that each legal entity should be self sufficient with regard to funding its own operations, except for certain short-term treasury requirements and small start-up operations which are funded under strict guidelines from HSBC’s largest banking operations. There are also regulatory restrictions and limitations on the transfer of resources between HSBC entities to meet liquidity and funding needs across the range of currencies, markets, regulatory jurisdictions and time zones within which HSBC operates.
It is the responsibility of local management to ensure compliance with local regulatory and Group Management Board (formerly Group Executive Committee) requirements on liquidity management. The latter vary by entity and take account of the depth and liquidity of the market in which the local financial unit operates. HSBC requires operating entities to maintain a strong liquidity position and to manage the liquidity profile of their assets, liabilities and commitments so that cash flows are appropriately balanced and all funding obligations are met when due. Liquidity is managed on a daily basis by local treasury functions, with the larger regional treasury sites providing support to smaller entities as required and where regulations permit.
HSBC accesses professional markets in order to provide funding for operating subsidiaries that do not accept deposits, to maintain a presence in local money markets and to optimise funding of asset maturities not naturally matched by core deposit funding.
Compliance with liquidity and funding requirements is monitored by local Asset and Liability Management Committees which report to Group Head Office on a regular basis. This process includes:
HSBC
Current accounts and savings deposits payable on demand or at short notice form a significant part of HSBC’s funding for the majority of operating companies. HSBC places considerable importance on the stability of these deposits. This is achieved through enhancing HSBC’s brand value in terms of trust and stability across the Group’s geographically diverse retail banking network and by maintaining depositor confidence in HSBC’s capital strength.
With the exception of Household, limited use is made of wholesale market funding. In fact, in aggregate, HSBC is a liquidity provider to financial markets placing significantly more funds with other banks than it borrows.
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Household funds itself principally through taking term funding in the professional markets and through securitisation of assets. At 31 December 2003, US$106 billion of Household’s liabilities were drawn from professional markets, utilising a range of products, maturities and currencies to avoid undue reliance on any particular funding source. Since Household became a member of the HSBC Group, its access to funding improved in terms of both the breadth of available sources and the pricing.
Although not utilised in the management of HSBC’s liquidity, consolidated figures provide a useful insight into the elements comprising the Group’s overall liquidity position.
In aggregate, 51 per cent (2002: 46 per cent) of HSBC’s balance sheet is lent to customers and some 33 per cent (2002: 38 per cent) is held in liquid assets, namely interbank lending and debt securities.
Of total liabilities of US$1,034 billion at 31 December 2003, funding from customers amounted to US$573 billion, of which US$558 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 deposit balances remain stable with deposits and withdrawals offsetting each other as customers remain confident that their funds will be available when required. Other liabilities included US$70 billion of deposits by banks (US$65 billion repayable within one year), US$30 billion of short positions in securities and US$154 billion of securities in issue (against which US$34 billion of loans and advances to customers have been pledged).
Assets available to meet these liabilities, and to cover outstanding commitments to lend (US$429 billion), included cash, central bank balances, items in the course of collection and treasury and other bills (US$46 billion); loans to banks (US$117 billion, including US$ 113 billion repayable within one year); and loans to customers (US$529 billion, including US$218 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$206 billion. Of these assets, some US$73 billion of debt securities and treasury and other bills have been pledged to secure liabilities.
HSBC would meet unexpected net cash outflows by selling securities and accessing additional funding sources such as interbank markets or securitisations.
Customer accounts and deposits by banks
HSBC Holdings
HSBC Holdings’ primary source of cash is from its deployment in short term bank deposits of capital receipts from its subsidiaries which have not been distributed to shareholders. On an ongoing basis HSBC Holdings replenishes its liquid resources through interest on and repayment of intragroup loans, from interest earned on its own liquid funds and, most importantly, through dividends from its directly and indirectly held subsidiaries. The ability of these 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. With its accumulated liquid assets, HSBC Holdings believes that dividends and interest from subsidiaries will enable it to meet anticipated cash obligations. HSBC Holdings also has, in normal circumstances, full access on favourable terms to debt capital markets.
At 31 December 2003, the short-term liabilities of HSBC Holdings totalled US$4.9 billion, including US$1.3 billion in respect of the proposed second interim dividend for 2003 and US$2.6 billion in respect of the proposed third interim dividend for
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2003. In practice, the full amount of the proposed dividend may not be paid out as shareholders can elect to receive their dividend entitlement in scrip rather than in cash. Short-term assets of US$12.9 billion, consisting mainly of cash at bank and money market deposits of US$7.9 billion and other amounts (including dividends) due from HSBC undertakings of US$2.5 billion, exceeded short-term liabilities.
Market risk management
Market risk is the risk that foreign exchange rates, interest rates, credit spreads, or equity and commodity prices will move and result in profits or losses to HSBC. Market risk arises on financial instruments which are valued at current market prices (mark-to-market basis) and those valued at cost plus any accrued interest (accruals basis). The main valuation sources are securities prices, foreign exchange rates, interest rate yield curves and volatilities.
HSBC makes markets in exchange rate and interest rate instruments, as well as in debt, equities and other securities. Trading risks arise either from customer-related business or from position taking. Trading positions are valued on a mark-to-market basis.
In liquid portfolios, market values are determined by reference to independently sourced mid-market prices where it is reasonable to assume the positions could be sold at those prices. In less liquid markets and/or where positions have been held for extended periods, portfolios are valued by reference to bid or offer prices as appropriate.
For certain products, such as over-the-counter derivative instruments, there are no independent prices quoted in the markets. In these cases, reference is made to standard industry models, which typically utilise discounted cash flow techniques to derive market values. The models may be developed in-house or may be software vendor packages.
Where applicable, prices are amended if the transaction involves an illiquid position, particularly if its size is considered significant in comparison with the normal market trading volume in that product.
The vast majority of HSBC’s derivative transactions are in plain vanilla instruments, primarily comprising interest rate and foreign exchange contracts, where market values are readily
determinable by reference to independent prices and valuation quotes, as described above.
Occasionally, when standard industry models are not available, and there is no directly relevant market quotation, HSBC will develop its own proprietary models for performing valuations. This situation normally arises when HSBC has tailored a transaction to meet a specific customer need. All such models are checked independently and are subject additionally to internal audit review on a periodic basis to ensure that the assumptions underlying the models remain valid over the lives of the transactions, which are generally less than five years.
The management of market risk is principally undertaken in Global Markets through risk limits approved by Group Management Board. Traded Markets Development and Risk, an independent unit within the Corporate, Investment Banking and Markets operation, develops risk management policies and measurement techniques, and reviews limit utilisation on a daily basis.
Risk limits are determined for each location and, within location, for each portfolio. Limits are set by product and risk type, with market liquidity being a principal factor in determining the level of limits set. Only those offices which management deem to have sufficient derivative product expertise and appropriate control systems are authorised to trade derivative products. Limits are set using a combination of risk measurement techniques, including position limits, sensitivity limits, and value at risk limits at a portfolio level. Options risks are controlled through full revaluation limits in conjunction with limits on the underlying variables that determine each option’s value.
Additionally, market risk related to the residential mortgage business in the USA is primarily managed by the mortgage business under guidelines established by its Asset and Liability Policy Committee.
Trading value at risk (‘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.
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HSBC’s VAR is calculated daily. It is predominantly calculated on a variance/co-variance basis, uses historical movements in market rates and prices, a 99 per cent confidence level and a 10-day holding period, and takes account of correlations between different markets and rates within the same risk type. The movement in market prices is calculated by reference to market data from the last two years. Aggregation of VAR from different risk types is based upon the assumption of independence between risk types.
HSBC’s VAR should be viewed in the context of the limitations of the methodology used. For example:
HSBC recognises these limitations by augmenting the VAR limits with other position and sensitivity limit structures, as well as with stress testing, both on individual portfolios and on a consolidated basis. HSBC’s stress-testing regime provides senior management with an assessment of the impact of extreme events on the market risk exposures of HSBC.
Trading VAR for HSBC is analysed in Note 40 in the ‘Notes on the Financial Statements’.
Market-risk related revenues
The average daily revenue earned from market risk-related activities in 2003, including accrual book net interest income, funding of dealing positions, and hedging of mortgage servicing rights, was US$17.1 million compared with US$14.6 million in 2002. The standard deviation of these daily revenues was US$12.5 million compared with US$8.9 million in 2002.
The increase in the standard deviation of daily revenues and the maximum daily loss and profit over the corresponding figures for 2002, reflects the impact of the volatility of the HKD against the USD during the second half of the year on the long USD position which the Group carries in Hong Kong.
This position arises from the significant surplus that has arisen in recent years between the increasing levels of HKD deposits placed with the Group, and the limited opportunities for the deployment of those deposits in HKD assets.
The Group has, accordingly, in recent years, placed a proportion of these surplus HKD deposits into highly liquid USD assets, and it is the resultant foreign exchange exposures, coupled with increased volatility in the USD:HKD exchange rate that has resulted in the profit and loss revenues being more widely dispersed than in prior years.
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Daily distribution of market risk revenues in 2003
Daily distribution of market risk revenues in 2002
Foreign exchange exposure
HSBC’s foreign exchange exposures comprise trading exposures and structural foreign currency translation exposure.
Trading exposures
Foreign exchange trading exposures comprise those which arise from foreign exchange dealing within Global Markets, and currency exposures originated within HSBC’s commercial banking businesses. The latter exposures are transferred to local treasury units where they are managed together with exposures which result from dealing activities, within limits approved by the Group Management Board. VAR on foreign exchange trading positions is shown in Note 40 in the ‘Notes on the Financial Statements’ on page 310.
The average one-day foreign exchange revenue in 2003 was US$3.4 million compared with US$3.2 million for 2002.
Structural currency exposure
HSBC’s main operations are in the UK, the US, Hong Kong, France, Mexico and Brazil, although it also has operations elsewhere in Europe, the rest of Asia-Pacific, North America and South America. The main operating (or functional) currencies in which HSBC’s business is transacted are, therefore, sterling, the US dollar, the Hong Kong dollar, the euro, the Mexican peso and the Brazilian real.
As the US dollar and currencies linked to it form the dominant currency bloc in which HSBC’s operations transact business, HSBC Holdings prepares its consolidated financial statements in US dollars. HSBC’s consolidated balance sheet is therefore affected by movements in exchange rates between all other functional currencies and the US dollar. These currency exposures, which reflect the extent to which the Group’s capital is invested in non-US dollar denominated capital investments in subsidiaries, branches and associated undertakings, are referred to as structural currency exposures. Translation gains and losses arising from these exposures are recognised in the statement of total consolidated recognised gains and losses.
HSBC’s structural foreign currency exposures are managed with the primary objective of ensuring, where practical, that HSBC’s and individual banking subsidiaries’ tier 1 capital ratios are protected from the effect of changes in exchange rates. This is usually achieved by holding qualifying tier 1 capital broadly in proportion to the corresponding foreign-currency-denominated risk-weighted assets at a subsidiary bank level. HSBC considers hedging structural foreign currency exposures only in limited circumstances, to protect the tier 1 capital ratio or the US dollar value of capital invested. Such hedging would be undertaken using forward foreign exchange contracts or by financing with borrowings in the same currencies as the functional currencies involved.
As subsidiaries are generally able to balance adequately foreign currency tier 1 capital with foreign currency risk-weighted assets, HSBC’s foreign currency structural exposures are usually unhedged, including exposures due to foreign-currency-denominated profits arising during the year. Selective hedges were in place during 2003. There was no material effect from foreign currency exchange rate movements on HSBC’s tier 1 capital ratio during the period.
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Interest rate exposures
HSBC’s interest rate exposures comprise those originating in its Global Markets trading activities and structural interest rate exposures: both are managed under limits described on page 168. Interest rate risk arises on both trading positions and accrual books. The average daily revenue earned from these interest rate activities in 2003 was US$13.1 million compared with US$10.7 million for 2002.
The interest rate risk on interest rate trading positions is set out in the trading VAR table in Note 40 in the ‘Notes on the Financial Statements’.
Structural interest rate risk
Structural interest rate risk arises from the differing repricing characteristics of commercial banking assets and liabilities, including non-interest bearing liabilities such as shareholders’ funds and some current accounts. Each operating entity assesses the structural interest rate risks which arise on each product in its business and transfers the interest rate risks to either its local treasury unit for management or to separate books managed by the local Asset and Liability Management Committee (‘ALCO’). The aim is to ensure that all interest rate risks are managed by either the local treasury or ALCO.
The transfer of interest rate risk is usually achieved by a series of internal deals between the business units and the local treasury or ALCO managed books. When the behavioural characteristics of a product are different from its contractual characteristics, the behavioural characteristics are assessed to determine the true underlying interest rate risk. Local ALCOs regularly monitor all such interest rate risk positions, subject to interest rate risk limits agreed with Group Management Board. In the course of managing interest rate risk, quantitative techniques and simulation models are used where appropriate to identify and assess the potential net interest income and market value effects of these interest rate positions in different interest rate scenarios. Interest rate swaps are the principal product used to manage interest rate risk, adjust it to appropriate levels and contain it within agreed limits. The prima ry objective of this exercise is to limit potential adverse effects of interest rate movements on net interest income.
Assuming no management action in response to interest rate movements, an immediate hypothetical 100 basis points parallel fall in all yield curves worldwide on 1 January 2004 would decrease planned net interest income for the 12 months to 31 December 2004 by US$463 million while a hypothetical 100 basis points parallel rise in all yield curves would decrease planned net interest income by US$819 million.
Instead of assuming that all interest rates move together, HSBC’s interest rate exposures can be grouped into currency blocs whose interest rates are considered more likely to move together. The sensitivity of projected net interest income for January to December 2004 can then be described as follows:
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A fall of 100 basis points would adversely affectthe net interest income derived from customer deposits in the sterling, Hong Kong dollar, rest of Americas and rest of Asia blocs as this cut would not offer scope to reduce rates on current and savings accounts by as much as the full 100 basis points. Household does not face this risk as its portfolio is wholesale funded, and as a result would benefit from falling rates. By contrast the cost of Household’s wholesale funding would be adversely affected by rising rates. The exposure to interest rate movements is actively managed through treasury and local ALCOs to reflect the economic outlook.
The interest rate sensitivities set out in the table above are illustrative only and are based on a single simplified scenario. For example, the projections assume that rates of all maturities move by the same amount and, therefore, do not reflect the potential impact on net interest income of some rates changing while others remain unchanged. These projections do not capture the impact of changes in the value of instruments such as mortgage servicing rights, which are interest rate sensitive. The projections also make other simplifying assumptions, including that all positions run to maturity. In practice, these exposures are actively managed.
Equities exposure
HSBC’s equities exposure comprises those originating in its equities trading activities, forming the basis of VAR, and long-term equity investments. The latter are reviewed annually by the Group Management Board and are regularly monitored by the subsidiaries’ ALCOs. VAR on equities trading
positions is set out in Note 40 in the ‘Notes on the Financial Statements’.
Operational risk management
Operational risk is the risk of loss arising through fraud, unauthorised activities, error, omission, inefficiency, systems failure or from external events. It is inherent to every business organisation and covers a wide spectrum of issues.
HSBC manages this risk through a controls-based environment in which processes are documented, authorisation is independent and transactions are reconciled and monitored. This is supported by an independent programme of periodic reviews undertaken by internal audit, and by monitoring external operational risk events, which ensure that HSBC stays in line with best practice and takes account of lessons learned from publicised operational failures within the financial services industry.
HSBC codified its operational risk management process by issuing a high level standard in May 2002. 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:
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In each of HSBC’s subsidiaries local management is responsible for implementation of the HSBC standard on operational risk, throughout their operations and where deficiencies are evident these are required to be rectified within a reasonable timeframe. Subsidiaries acquired by HSBC since the standard was issued are in the process of assessing and planning the implementation of the requirements.
HSBC maintains and tests contingency facilities to support operations in the event of disasters. Additional reviews and tests were conducted following the terrorist events of 11 September 2001 and, more recently, the two bomb blasts in Istanbul, to incorporate lessons learned in the operational recovery from those circumstances.
Fair value and price verification control
Certain financial instruments are carried on the Group’s balance sheet at their mark-to-market values. These financial instruments comprise assets held in the trading portfolio, obligations related to securities short sold and derivative financial instruments (excluding non-trading derivatives accounted for on an accruals basis).
The determination of mark-to-markets value is a significant element in reporting of the Group’s Global Markets activities. Accordingly, the mark-to-
market valuation and the related price verification processes are subject to careful governance across the Group.
The responsibility for the determination of accounting policies and procedures governing valuation ultimately rests with the Group Finance and Corporate, Investment Banking and Markets Finance functions, which report to the Group Finance Director. All significant valuation policies, and changes thereto, must be approved by Senior Finance Management. HSBC’s policies stipulate 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 and relevant accounting standards are adhered to. Management assesses the resourcing and expertise of Finance functions on an ongoing basis to ensure that the financial control and price verification processes are properly staffed to support the control infrastructure.
Capital management and allocation
Capital measurement and allocation
The FSA supervises HSBC on a consolidated basis and, as such, receives information on the capital adequacy of, and sets capital requirements for, HSBC as a whole. Individual banking subsidiaries are directly regulated by their local banking supervisors, which set and monitor their capital adequacy requirements. In some jurisdictions, certain non-banking subsidiaries are subject to the supervision and capital requirements of local regulatory authorities. Since 1988, when the governors of the Group of Ten central banks agreed to guidelines for the international convergence of capital measurement and standards, the banking supervisors of HSBC’s major banking subsidiaries have exercised capital adequacy supervision in a broadly similar framework. The guidelines agreed in 1988, referred to as the Basel Accord, are applied on a consistent basis across the European Union through directives, which are then implemented by member states.
In implementing the European Union’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
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and off-balance-sheet transactions. Under the European Union’s Amending Directive to the Capital Adequacy Directive, the FSA allows banks to calculate capital requirements for market risk in the trading book using VAR techniques.
HSBC’s capital is divided into two tiers: tier 1, comprising shareholders’ funds, innovative tier 1 securities and minority interests in tier 1 capital, but excluding revaluation reserves; and tier 2, comprising general loan loss provisions, revaluation reserves, qualifying subordinated loan capital and minority and other interests in tier 2 capital. The amount of innovative tier 1 securities cannot exceed 15 per cent of overall tier 1 capital, qualifying tier 2 capital cannot exceed tier 1 capital, and term subordinated loan capital may not exceed 50 per cent of tier 1 capital. There are also limitations on the amount of general provisions which may be included in tier 2 capital. The book values of goodwill, intangible assets and, in 2002, own shares held are deducted in arriving at tier 1 capital. In 2003, no deduction is required for own shares held because of the changes to shareholders’ funds intro duced by Urgent Issues Task Force Abstract 37 ‘Purchases and sales of own shares’, details of which are set out in Note 1 of the ‘Notes on the Financial Statements’. Total capital is calculated by deducting the book values of unconsolidated investments, investments in the capital of banks, and certain regulatory items from the total of tier 1 and tier 2 capital.
Banking operations are categorised as either trading book (broadly, marked-to-market activities) or banking book (all other activities) and risk-weighted assets are determined accordingly. Banking book risk-weighted assets are measured by means of a hierarchy of risk weightings classified according to the nature of each asset and counterparty, taking into account any eligible collateral or guarantees. Banking book off-balance-sheet items giving rise to credit, foreign exchange or interest rate risk are assigned weights appropriate to the category of the counterparty, taking into account any eligible collateral or guarantees. Trading book risk-weighted assets are determined by taking into account market-related risks such as foreign exchange, interest rate and equity position risks, and counterparty risk.
Future developments
In June 1999, the Basel Committee on Banking Supervision (‘the Basel Committee’) issued a proposal for a new capital adequacy framework to
replace the Basel Accord of 1988. The new capital framework (commonly known as ‘Basel II’) consists of three ‘pillars’: minimum capital requirements, supervisory review process and market discipline. The supervisory objectives of the Basel Committee are for Basel II to promote safety and soundness in the financial system and, as such, at least maintain the current overall level of capital in the system; to enhance competitive equality; to constitute a more comprehensive approach to addressing risks; and to focus on internationally active banks.
With respect to pillar one, Basel II provides three approaches, of increasing sophistication, to the credit risk regulatory capital calculation. The most basic approach is the standardised approach, which uses external credit ratings to determine the risk weighting applied to rated counterparties and groups other counterparties into broad categories and applies standardised risk weightings to these categories. Moving to the internal ratings based foundation approach will allow banks to calculate their credit risk regulatory capital requirement on the basis of their internal assessment of the probability that the counterparty will default. The internal ratings based advanced approach will allow banks to use their own internal assessment of not only the probability of default, but also the percentage loss suffered if the counterparty defaults and the quantification of the exposure to the counterparty. Pillar one will al so introduce capital requirements for operational risk and again three levels of sophistication are available. The capital requirement under the basic indicator approach is a simple percentage of gross revenues, under the standardised approach it is one of three different percentages of gross revenues applicable to each of eight business lines and under advanced measurement approaches it is an amount determined using banks’ own statistical analysis techniques on operational risk data.
Since 1999, the Basel Committee has published a large number of further papers relating to Basel II, as well as two full Consultation Papers, entitled ‘The New Basel Capital Accord’ on 16 January 2001 and 29 April 2003. Most recently, it published three technical papers on 30 January 2004, one of which was entitled ‘Modifications to the capital treatment for expected and unexpected credit losses in the New Basel Accord’. This paper sets out significant changes to the calibration of the credit risk regulatory capital requirement and to regulatory capital. The Basel II proposals are still incomplete. The Basel Committee has stated that it intends to produce the final Basel II Accord by the middle of 2004 and that it will take effect from the end of 2006.
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In Europe, Basel II will be given effect by a new EU Directive. This Directive broadly follows the Basel II proposals and therefore cannot be finalised until Basel II is finalised. The new EU Directive will be required to undergo the same formal process as other EU Directives and the timescale which will be required for this is uncertain, although the intention is to match the implementation date for Basel II.
HSBC continues to participate actively in the industry consultations surrounding the development of Basel II and the new EU Directive and fully supports a more risk-sensitive regulatory capital framework than the 1988 Basel Accord. In view of the continuing changes to the proposals, it is too early to quantify the impact of the new proposals on HSBC’s capital ratios.
Capital management
It is HSBC’s policy to maintain a strong capital base to support the development of its business. HSBC seeks to maintain a prudent balance between the different components of its capital and, in HSBC Holdings, between the composition of its capital and that of its investment in subsidiaries. This is achieved by each subsidiary managing its own capital within the context of an approved annual plan which determines the optimal amount and mix of capital required to support planned business growth and meet local regulatory capital requirements and, in the case of Household, its ratings targets. Capital generated in excess of planned requirements is paid up to HSBC Holdings normally by way of dividends and represents a source of strength for HSBC.
HSBC Holdings is primarily a provider of equity capital to its subsidiaries. These investments are substantially funded by HSBC Holdings’ own equity issuance and profit retentions. Major subsidiaries usually raise their own non-equity tier 1 and subordinated debt in accordance with HSBC guidelines regarding market and investor concentration, cost, market conditions, timing and the effect on the composition and maturity profile of HSBC’s capital. The subordinated debt requirements of other HSBC companies are met internally.
HSBC recognises the impact on shareholder returns of the level of equity capital employed within HSBC and seeks to maintain a prudent balance between the advantages and flexibility afforded by a strong capital position and the higher returns on equity possible with greater leverage. In the current environment HSBC uses a benchmark tier 1 capital
ratio of 8.25 per cent in considering its long-term capital planning.
Source and application of tier 1 capital
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Capital structure
The table below sets out the analysis of regulatory capital.
The above figures were computed in accordance with the EU Banking Consolidation Directive.
Tier 1 capital increased by US$15.9 billion. Retained profits (excluding goodwill amortisation) contributed US$3.8 billion. Shares issued to fund the acquisition of Household, net of the increased goodwill, added US$3.4 billion to tier 1 capital at acquisition. The issue of tier 1 securities contributed US$4.3 billion and exchange movements on reserves and other movements also added US$4.4 billion to tier 1 capital.
The increase of US$2.9 billion in tier 2 capital mainly reflects the proceeds of capital issues, net of redemption and regulatory amortisation. Tier 2 capital also benefited from debt in issue in Household and higher levels of general provisions, mainly reflecting the acquisition of Household.
Total risk-weighted assets increased by US$188 billion. Household contributed US$113 billion to this increase. The remaining increase was largely due to currency translation differences together with the effect of growth in the loan book and trading positions. In constant currency, excluding Household, risk-weighted asset growth was 8 per cent.
Risk-weighted assets by principal subsidiary
In order to give an indication of how HSBC’s capital is deployed, the table below analyses the disposition of risk-weighted assets by principal subsidiary. The risk-weighted assets are calculated using FSA rules and exclude intra-HSBC items.
176
Other information
Loan maturity and interest sensitivity analys
At 31 December 2003, the geographical analysis of loan maturity and interest sensitivity by loan type on a contractual repayment basis was as follows. All amounts are net of suspended interest.
Excludes sight balances with central banks
177
178
Deposits
The following table analyses the average amount of bank and customer deposits and certificates of deposit (‘CDs’) and other money market instruments (which are included within ‘debt securities in issue’ in the balance sheet), together with the average interest rates paid thereon for each of the past three years. The geographical analysis of average deposits is based on the location of the office in which the deposits are recorded and excludes balances with HSBC companies. The ‘Other’ category includes securities sold under agreements to repurchase.
179
Other information (continued)
4,906
180
Certificates of deposit and other time deposits
At 31 December 2003, the maturity analysis of certificates of deposit and other wholesale time deposits, by remaining maturity, was as follows:
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.
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HSBC includes short-term borrowings within customer accounts, deposits by banks and debt securities in issue and does not show short-term borrowings separately on the balance sheet. Short-term borrowings are defined by the SEC as Federal funds purchased and securities sold under agreements to repurchase, commercial paper and other short-term borrowings. HSBC’s only significant short-term borrowings are securities sold under agreements to repurchase and debt securities in issue. Additional information on these is provided in the tables below.
HSBC enters into certain off-balance sheet arrangements with customers in the ordinary course of business, as described below.
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These SPEs, commonly referred to as asset-backed or multi-seller conduits, purchase interests in a diversified pool of receivables from customers or in the market using finance provided by a third party. The cash flows received by the SPE on the pool of receivables are used to service the finance provided by investors. HSBC administers this arrangement, which facilitates diversification of funding sources and the tranching of credit risk. HSBC also provides part of the liquidity facilities to the entities and secondary credit enhancement.
HSBC’s association with SPEs also includes interests in and management of investment funds, providing finance to public and private sector infrastructure projects, and capital funding through the issue of preference shares via partnerships.
The table below provides details of HSBC’s material contractual obligations as at 31 December 2003.
The Group Chairman and Group Finance Director, with the assistance of other members of management, carried out an evaluation of the effectiveness of the design and operation of HSBC Holdings’ disclosure controls and procedures as of 31 December 2003. Based upon and as of that evaluation, the Group Chairman and Group Finance Director concluded that the disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the reports the company files and submits under the US Securities Exchange Act is recorded, processed, summarised and reported as and when required.
There were no changes in HSBC Holdings’ internal control over financial reporting during the year ended 31 December 2003 that have materially affected, or are reasonably likely to materially affect, HSBC Holdings’ internal control over financial reporting.
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Board of Directors and Senior Management
184
185
186
R J Arena
Age 55. Group General Manager, Global e-business. Joined HSBC in 1999. Appointed a Group General Manager in 2000.
C C R Bannister
Age 45. Chief Executive Officer, Group Private Banking. Joined HSBC in 1994. Appointed a Group General Manager in 2001.
R E T Bennett
Age 52. Group General Manager, Legal and Compliance. Joined HSBC in 1979. Appointed a Group General Manager in 1998.
N S K Booker
Age 45. Group General Manager and Chief Executive Officer, India. Joined HSBC in 1981. Appointed a Group General Manager in January 2004.
Z J Cama
Age 56. Deputy Chairman and Chief Executive Officer, HSBC Bank Malaysia Berhad. Joined HSBC in 1968. Appointed a Group General Manager in 2001.
V H C Cheng, OBE
Age 55. Executive Director, The Hongkong and Shanghai Banking Corporation Limited and Chief Executive Officer, Hang Seng Bank Limited. Joined HSBC in 1978. Appointed a Group General Manager in 1995.
R J Duke
Age 53. General Manager Banking Services, HSBC Bank plc. Joined HSBC in 1971. Appointed a Group General Manager in October 2003.
A A Flockhart
Age 52. Group General Manager and Chief Executive Officer, Mexico. Joined HSBC in 1974. Appointed a Group General Manager in 2002.
M J G Glynn
Age 52. Group General Manager, President and Chief Executive Officer, HSBC Bank USA. Joined HSBC in 1982. Appointed a Group General Manager in 2001.
D H Hodgkinson
Age 53. Group General Manager and Deputy Chairman, HSBC Bank Middle East Limited. Joined HSBC in 1969. Appointed a Group General Manager in May 2003.
A P Hope
Age 57. Group General Manager, Insurance. Joined HSBC in 1971. Appointed a Group General Manager in 1996.
D D J John
Age 53. Chief Operating Officer and Director, HSBC Bank plc. Joined HSBC in 1971. Appointed a Group General Manager in 2000.
M J W King
Age 47. Group General Manager, Internal Audit. Joined HSBC in 1986. Appointed a Group General Manager in 2002.
M B McPhee
Age 62. Group General Manager, Credit and Risk. Joined HSBC in 1984. Appointed a Group General Manager in 1997.
T W O’Brien, OBE
Age 56. Group General Manager, Strategic Development. Joined HSBC in 1969. Appointed a Group General Manager in 1992.
R C F Or
Age 54. General Manager, The Hongkong and Shanghai Banking Corporation Limited. Joined HSBC in 1972. Appointed a Group General Manager in 2000.
187
K Patel
Age 55. Group General Manager and Head of Corporate, Investment Banking and Markets, Emerging Europe & Africa. Joined HSBC in 1984. Appointed a Group General Manager in 2000.
R C Picot
Age 46. Group Chief Accounting Officer. Joined HSBC in 1993. Appointed a Group General Manager in October 2003.
A F Rademeyer
Age 45. Group General Manager and Head of Corporate, Investment Banking and Markets, Asia-Pacific. Joined HSBC in 1982. Appointed a Group General Manager in March 2003.
J C S Rankin
Age 62. Group General Manager, Human Resources. Joined HSBC in 1960. Appointed a Group General Manager in 1990.
B Robertson
Age 49. Group General Manager and Head of Corporate, Investment Banking and Markets, HSBC Bank USA. Joined HSBC in 1975. Appointed a Group General Manager in March 2003.
Dr S Rometsch
Age 65. Chairman of the Managing Partners, HSBC Trinkaus & Burkhardt KGaA. Joined HSBC in 1983. Appointed a Group General Manager in 2001.
D A Schoenholz
Age 52. President and Chief Operating Officer, Household International, Inc. Joined HSBC in 1985. Appointed a Group General Manager in October 2003.
M R P Smith, OBE
Age 47. Chief Executive Officer, The Hongkong and Shanghai Banking Corporation Limited. Joined HSBC in 1978. Appointed a Group General Manager in 2000.
I A Stewart
Age 45. Group General Manager and Head of Transaction Banking, Corporate, Investment Banking and Markets. Joined HSBC in 1980. Appointed a Group General Manager in 2000.
P E Stringham
Age 54. Group General Manager, Marketing. Joined HSBC in 2001. Appointed a Group General Manager in 2001.
P A Thurston
Age 50. General Manager, Personal Financial Services, Asia-Pacific. Joined HSBC in 1975. Appointed a Group General Manager in October 2003.
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HSBC reported operating profit before provisions of US$18,540 million. Profit attributable to shareholders of HSBC Holdings was US$8,774 million, a 13.0 per cent return on shareholders’ funds. The retained profit transferred to reserves was US$2,242 million.
A first interim dividend of US$0.24 per ordinary share was paid on 7 October 2003 and a second interim dividend of US$0.12 per ordinary share was paid on 20 January 2004. The Directors have declared a third interim dividend of US$0.24 per ordinary share in lieu of a final dividend, making a total distribution for the year of US$6,532 million. The third interim dividend will be payable on 5 May 2004 in cash in United States dollars, or in sterling or Hong Kong dollars at exchange rates to be determined on 26 April 2004, with a scrip dividend alternative. The reserves available for distribution before accounting for the third interim dividend of US$2,627 million are US$11,598 million.
Further information about the results is given in the consolidated profit and loss account on page 233.
Through its subsidiary and associated undertakings, HSBC provides a comprehensive range of banking and related financial services. HSBC operates through long-established businesses and has an international network of over 9,500 offices in 79 countries and territories in five regions: Europe; Hong Kong; the rest of Asia-Pacific, including the Middle East and Africa; North America and South America. Taken together, the five largest customers of HSBC do not account for more than 2 per cent of HSBC’s income.
On 17 February 2003 HSBC acquired Keppel Insurance Pte Ltd, a Singapore-based insurer, for a consideration of US$91 million.
On 28 March 2003 HSBC acquired Household International, Inc. for a consideration of US$14,798 million.
On 28 October 2003 HSBC announced that it had entered into an agreement to acquire The Bank of Bermuda Limited for a consideration of US$1.3 billion. The acquisition was completed on 18 February 2004.
On 12 November 2003 HSBC acquired AFORE Allianz Dresdner S.A., a Mexican pension fund management company, for a consideration of US$175 million.
On 2 December 2003 HSBC entered into an agreement to acquire 14.71 per cent of UTI Bank Limited, a retail bank in India, for a consideration of US$66.42 million. In addition, HSBC has the option to acquire a further 5.37 per cent from an existing shareholder for US$24.26 million.
On 15 December 2003 HSBC completed the acquisition of Lloyds TSB Group plc’s onshore and offshore businesses and assets related to Brazil for an aggregate consideration of US$745 million.
On 17 December 2003 Hang Seng Bank Limited, a 62.14 per cent subsidiary of HSBC, entered into an agreement, subject to the approval of regulatory authorities and Industrial Bank shareholders to acquire 15.98 per cent of Industrial Bank Co Ltd, a mainland China commercial bank, for US$209 million.
A review of the development of the business of HSBC undertakings during the year and an indication of likely future developments are given in the ‘Description of Business’ on pages 7 to 29.
HSBC’s five-year strategy to 31 December 2003, Managing for Value, was designed to focus on shareholder value. The governing objective was to exceed the total shareholder return of a benchmark comprising a peer group of financial institutions, with a minimum objective of doubling shareholder return over the five-year period. Total shareholder return for the five-year period was 211 per cent, compared to 126 per cent for the benchmark (starting point 100 per cent on 31 December 1998). An explanation of the basis of calculation of total shareholder return can be found on page 217.
In order to build on the achievements of Managing for Value a new plan was launched in November 2003 to provide a blueprint for HSBC’s growth and development during the next five years. Key elements of the strategy are accelerating the rate of revenue growth, developing the brand strategy further, improving productivity and maintaining HSBC’s prudent risk management and strong financial position. Further details are given on pages 9 and 10.
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The following events in relation to the HSBC Holdings ordinary shares of US$0.50 each occurred during the year:
Acquisition of Household International, Inc.
Scrip dividends
All-Employee share plans
connection with the exercise of options under the HSBC Holdings Savings-Related Share Option Scheme: USA Section.
Discretionary share incentive plans
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In order to align the interests of staff with those of shareholders, share options are awarded to employees under all-employee share plans and discretionary share incentive plans. The following are particulars of outstanding employee share options, including those held by employees working under employment contracts that are regarded as “continuous contracts” for the purposes of the Hong Kong Employment Ordinance. The options are granted at nil consideration unless otherwise indicated. 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. The maximum number of new HSBC Holdings ordinary shares that may be issued or become issuable under all the share option plans in any ten year period is 848,847,000 HSBC Holdings ordinary shares (approximately 7.7 per cent of HSBC Holdings’ issued ordinary share capital on 1 March 2004). Within this limit not more than 5 per cent of the issued ordinary share capital of HSBC Holdings from time to time may be put under option under the HSBC Holdings Group Share Option Plan and the HSBC Holdings Restricted Share Plan 2000 in any ten year period (approximately 550,000,000 HSBC Holdings ordinary shares on 1 March 2004). Under these plans there were options outstanding over 347,007,843 HSBC Holdings ordinary shares at 31 December 2003. Particulars of options over HSBC Holdings shares held by Directors of HSBC Holdings are set out on pages 225 to 229 of the Directors’ Remuneration Report.
The HSBC Holdings Savings-Related Share Option Plan, HSBC Holdings Savings-Related Share Option Plan: Overseas Section, and previously the HSBC Holdings Savings-Related Share Option Scheme: USA Section, are all-employee share plans under which eligible HSBC employees (those with six months continuous service from July to December of the year preceding the date of grant) are granted options to acquire HSBC Holdings ordinary shares of US$0.50 each. Employees may make overall contributions of up to £250 (or equivalent) each month over a period of three or five years which may be used on the third or fifth anniversary of the commencement of the relevant savings contract, at their election, to exercise the options; alternatively
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Report of the Directors (continued)
the employee may elect to have the savings (plus interest) repaid in cash. The options are exercisable within six months following the third or fifth anniversary of the commencement of the relevant savings contract. In the case of redundancy, retirement on grounds of injury or ill health, retirement at normal retirement age or over, the transfer of the employing business to another party, or a change of control of the employing company, options may be exercised before completion of the relevant savings contract.
Under the HSBC Holdings Savings-Related Share Option Plan and the HSBC Holdings Savings-Related Share Option Plan: Overseas Section the option exercise price is determined by reference to the average market value of the ordinary shares on the five business days immediately preceding the invitation date, then applying a discount of 20 per cent. The all-employee share plans will terminate on 26 May 2010 unless the Directors resolve to terminate the plans at an earlier date.
HSBC Holdings Savings-Related Share Option Plan
HSBC Holdings ordinary shares of US$0.50 each
HSBC Holdings Savings-Related Share Option Plan: Overseas Section
192
HSBC Holdings Savings-Related Share Option Scheme: USA Section
The HSBC Holdings Group Share Option Plan, and previously the HSBC Holdings Executive Share Option Scheme, are discretionary share incentive plans under which HSBC employees, based on performance criteria and potential, are granted options to acquire HSBC Holdings ordinary shares. Since 1996 the vesting of these awards has been subject to the attainment of pre-determined performance criteria, except within CCF (which was acquired in 2000) where performance criteria are being phased in. The maximum value of options which may be granted to an employee in any one year (together with any Performance Share awards under the HSBC Holdings Restricted Share Plan 2000) is 150 per cent of the employee’s annual salary at the date of grant plus any bonus paid for the previous year. In exceptional circumstances this could be raised to 225 per cent. Subject to
achievement of the performance condition, options are generally exercisable between the third and tenth anniversary of the date of grant. Employees of a subsidiary that is sold or transferred out of HSBC may exercise options awarded under the HSBC Holdings Group Share Option Plan within six months regardless of whether the performance condition is met.
The terms of the HSBC Holdings Group Share Option Plan were amended in 2001 so that the exercise price of options granted under the Plan in 2002 and beyond would be the higher of the average market value of the ordinary shares on the five business days prior to the grant of the option or the market value of the ordinary shares on the date of grant of the option. The HSBC Holdings Group Share Option Plan will terminate on 26 May 2005 unless the Directors resolve to terminate the plan at an earlier date.
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HSBC Holdings Executive Share Option Scheme
The HSBC Holdings Executive Share Option Scheme was replaced by the HSBC Holdings Group Share Option Plan on 26 May 2000. No options have been granted under the Scheme since that date.
HSBC Holdings Group Share Option Plan
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CCF S.A. and subsidiary company plans
When it was acquired in July 2000 CCF and certain of its subsidiary companies operated employee share option plans under which options could be granted over their respective shares. No further options will
be granted under any of these subsidiary company plans. The following are outstanding options to acquire shares in CCF S.A. and its subsidiaries.
CCF S.A.
shares of €5
Banque Chaix
shares of €16
Banque de Baecque Beau
shares of no par value
Banque de Savoie
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Banque Dupuy de Parseval
shares of €20
Crédit Commercial du Sud Ouest
shares of € 15.25
HSBC Private Bank France
shares of €2
Netvalor
shares of €415
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Sinopia Asset Management
shares of €0.5
Union de Banques à Paris
Household International, Inc. and subsidiary company plans
Following the acquisition of Household on 28 March 2003, all outstanding options and equity-based awards over Household 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 Household (2.675 HSBC Holdings ordinary shares for each Household 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 Household common shares granted before 14 November 2002 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.
Household International, Inc.
1984 Long-Term Executive Incentive Compensation Plan
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1996 Long-Term Executive Incentive Compensation Plan
1996 Long-Term Executive Incentive Compensation Plan1
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Deferred Fee Plan for Directors
Prior to 28 March 2003, Household directors could choose to defer all or a portion of their cash compensation under the Deferred Fee Plan for directors. At the end of the deferred period selected by the director, all accumulated amounts will be paid in shares in one or more instalments. Following the acquisition of Household the rights to receive Household shares under the plan were converted into rights to receive HSBC Holdings ordinary shares. No further awards will be granted under this plan. A summary of the rights to receive HSBC Holdings ordinary shares under this plan is set out below. Full details are available on www.hsbc.com by selecting ‘Investor Centre’, then ‘Share Plans’.
1 The weighted average closing price of the shares immediately before the dates on which shares were delivered was £7.68.
Deferred Phantom Stock Plan for Directors
In 1995, the Household Directors’ Retirement Income Plan was discontinued and the present value of a director’s accrued benefit was exchanged for a deferred right to receive Household shares. Following the acquisition of Household the rights to receive Household shares under the plan were converted into rights to receive HSBC Holdings ordinary shares. When a director dies or leaves the Board due to retirement or resignation, all accumulated amounts will be released in HSBC Holdings ordinary shares in one or more instalments. No further awards will be granted under this plan. A summary of the rights to receive HSBC Holdings ordinary shares under this plan is set out below. Full details are available on www.hsbc.com by selecting ‘Investor Centre’, then ‘Share Plans’.
1 The weighted average closing price of the shares immediately before the dates on which shares were delivered was £7.06
Non-Qualified Deferred Compensation Plan for Restricted Stock Rights
HSBC Holdings ordinary shares of US $0.50 each
Non-Qualified Deferred Compensation Plan for Stock Option Exercises
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Beneficial Corporation 1990 Non-Qualified Stock Option Plan
1 The weighted average closing price of the shares immediately before the dates on which options were exercised was £7.95
Beneficial Corporation BenShares Equity Participation Plan
1 The weighted average closing price of the shares immediately before the dates on which options were exercised was £7.85
Renaissance Amended & Restated 1997 Incentive Plan
1 The weighted average closing price of the shares immediately before the dates on which options were exercised was £7.53.
Valuation of freehold and leasehold land and buildings
HSBC’s freehold and long leasehold properties, together with all leasehold properties in Hong Kong, were revalued in September 2003 in accordance with HSBC’s policy of annual valuation. As a result of this revaluation, the net book value of land and buildings has decreased by US$352 million.
Further details are included in Note 25 of the ‘Notes on the Financial Statements’.
Board of Directors
The objectives of the management structures within HSBC, headed by the Board of Directors of HSBC
Holdings and led by the Group Chairman, are to deliver sustainable value to shareholders. Implementation of the strategy set by the Board is delegated to the Group Management Board under the leadership of the Group Chief Executive.
The Board of Directors meets regularly and Directors receive information between meetings about the activities of committees and developments in HSBC’s business. All Directors have full and timely access to all relevant information and may take independent professional advice if necessary.
The names of the Directors serving at the date of this report, and brief biographical particulars for each, are listed on pages 184 to 186. There are eight executive Directors and 14 non-executive Directors, of whom the Board has determined 11 are
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independent. In reaching its determination of each non-executive Director’s independence the Board has concluded that there are no relationships or circumstances which are likely to affect the Director’s judgement and any relationships or circumstances which could appear to do so were considered not to be material.
The Directors who served during the year were W F Aldinger, Sir John Bond, Lord Butler, R K F Ch’ien, C F W de Croisset, W R P Dalton, Baroness Dunn, D G Eldon, D J Flint, W K L Fung, S K Green, S Hintze, A W Jebson, Sir John Kemp-Welch, Lord Marshall, Sir Brian Moffat, Sir Mark Moody-Stuart, S W Newton, H Sohmen, C S Taylor, Sir Keith Whitson and Sir Brian Williamson.
W F Aldinger was appointed a Director on 25 April 2003. Sir Keith Whitson retired as a Director on 30 May 2003 and C F W de Croisset retired as a Director on 27 February 2004.
R A Fairhead and M F Geoghegan were appointed Directors with effect from 1 March 2004. Having been appointed since the Annual General Meeting in 2003, they will retire at the forthcoming Annual General Meeting and offer themselves for re-election.
Lord Butler, W R P Dalton, Baroness Dunn, W K L Fung, S Hintze, Sir John Kemp-Welch, Lord Marshall, Sir Mark Moody-Stuart and H Sohmen will retire by rotation at the forthcoming Annual General Meeting. With the exception of W R P Dalton and Lord Marshall, who are to retire, they will offer themselves for re-election.
MWM Consulting was commissioned to undertake an independent performance evaluation of the Board and its committees. This evaluation covered board structure, dynamics, capabilities and processes; corporate governance; strategic clarity and alignment; and the performance of individual Directors, including that of the Group Chairman. The assessment report of the Board and its committees 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.
Following this review the Group Chairman has confirmed that the Directors standing for re-election at the Annual General Meeting continue to perform effectively and demonstrate commitment to their roles. It is the intention of the Board of HSBC
Holdings to continue to review its performance and that of its Directors annually.
Seven regular Board meetings were held during 2003. Sir John Bond, Baroness Dunn, Sir Brian Moffat, S K Green, A W Jebson, R K F Ch’ien, C F W de Croisset, W R P Dalton, D G Eldon, D J Flint, W K L Fung, S Hintze, Sir John Kemp-Welch, Sir Mark Moody-Stuart and S W Newton attended all of the Board meetings. Lord Butler, Lord Marshall, H Sohmen, C S Taylor and Sir Brian Williamson attended six of the Board meetings. Sir Keith Whitson attended all three Board meetings held before his retirement and W F Aldinger attended all four Board meetings held following his appointment.
During 2003 the Chairman held three meetings with the non-executive Directors without other executives being present and there was one meeting of the non-executive Directors without the Chairman being present. In addition an informal meeting of Directors relating to the acquisition of Household was held in March 2003.
In addition to the meetings of the principal committees referred to below, 18 meetings of committees of the Board were held during the year to discharge business delegated by the Board.
The Board ensures all Directors, including non-executive Directors, develop an understanding of the views of major shareholders through attendance at analyst meetings following results announcements and other ad hoc meetings with investors and their representative bodies. An Investor Day, attended by executive and non-executive Directors, was held in November 2003 to launch HSBC’s strategy for 2004 to 2008.
Sir Brian Moffat, Deputy Chairman and senior independent non-executive Director, is available to shareholders should they have concerns which contact through the normal channels of Group Chairman, Group Chief Executive, Group Finance Director or other executives has failed to resolve or for which such contact would be inappropriate. Sir Brian Moffat may be contacted through the Group Company Secretary at 8 Canada Square, London E14 5HQ.
The Group Chairman’s principal commitments outside HSBC are as a non-executive Director of Ford Motor Company and a member of the Court of the Bank of England. During 2003 he ceased to be Chairman of The Institute of International Finance, Inc.
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Full, formal and tailored induction programmes are arranged for newly appointed Directors and opportunities to update and develop skills and knowledge are provided to Directors. The terms and conditions of appointments of non-executive Directors are available for inspection at 8 Canada Square, London E14 5HQ and will be made available for 15 minutes before the Annual General Meeting and at the Meeting itself.
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.
The Board has appointed a number of committees consisting of certain Directors, Group Managing Directors and, in the case of the Corporate Social Responsibility Committee, certain co-opted non-Director members. The following are the principal committees:
Group Management Board
The Group Management Board (formerly called the Group Executive Committee) meets regularly and operates as a general management committee under the direct authority of the Board. The current members of the Group Management Board are S K Green (Chairman), Sir John Bond, W F Aldinger, W R P Dalton, D G Eldon, D J Flint, M F Geoghegan and A W Jebson, all of whom are executive Directors, and C-H Filippi, S T Gulliver, J J Studzinski and 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 in accordance with such policies and directions as the Board may from time to time determine. Matters reserved for approval by the Board include annual plans and performance targets, procedures for monitoring and control of operations, specified senior appointments, acquisitions and disposals above predetermined thresholds and any substantial change in balance sheet management policy. The Group Management Board sub-delegates credit, investment and capital expenditure authorities to its members.
Group Audit Committee
The Group Audit Committee meets regularly with HSBC’s senior financial, internal audit, legal and compliance management and the external auditor to consider HSBC Holdings’ financial reporting, the nature and scope of audit reviews and the effectiveness of the systems of internal control and compliance. The members of the Group Audit Committee during 2003 were Sir Brian Moffat (Chairman), R K F Ch’ien and Sir John Kemp-Welch, all of whom are independent non-executive Directors. R A Fairhead, an independent non-executive Director, was appointed a member of the Committee with effect from 1 March 2004.
The Board has determined that Sir Brian Moffat, a fellow of the Institute of Chartered Accountants, may be regarded as an audit committee financial expert for the purposes of section 407 of the Sarbanes-Oxley Act.
Appointments to the Committee are now made for periods 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.
All Group Audit Committee members attended each of the five meetings held during 2003.
At the beginning of each meeting the Committee meets with the external auditor, without management present, to facilitate the discussion of any matter relating to its remit and any issue arising from the audit. Similar arrangements have been adopted for the Committee to meet with the internal auditor.
The terms of reference of the Committee, which are reviewed annually, are available on www.hsbc.com by selecting ‘About HSBC’, then ‘Board of Directors’, then ‘Board Committees’.
The Group Audit Committee is accountable to the Board and assists the Board in meeting its responsibilities in ensuring an effective system of internal control and compliance and for meeting its external financial reporting obligations. The Committee is directly responsible on behalf of the Board for the selection, oversight and remuneration of the external auditor. At each meeting, the Committee receives comprehensive reports from
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each of the Head of Group Compliance, the Group General Manager Legal and Compliance, and the Group General Manager Internal Audit and receives periodic presentations from other functional heads and line management.
The key processes used to review the effectiveness of the system of internal control include the regular reports from the heads of key risk functions; the production and regular updating of summaries of key controls applied by subsidiary companies measured against HSBC benchmarks which cover all internal controls, both financial and non-financial; annual confirmations from chief executives of principal subsidiary companies that there have been no material losses; contingencies or uncertainties caused by weaknesses in internal controls; internal audit reports; external audit reports; prudential reviews; and regulatory reports.
The Committee reports on its activities at each Board meeting and, twice annually, produces a written summary of such activity.
The Committee has approved procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls and auditing matters, and the confidential and anonymous submission by employees of concerns regarding questionable accounting or auditing matters.
To ensure continuing auditor objectivity and to safeguard the independence of HSBC's auditors the Committee has determined a framework for the type and authorisation of non-audit services which KPMG may provide.
The Group Audit Committee has adopted policies for the pre-approval of specific services that may be provided by the principal auditor (KPMG) during 2003 and 2004. 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 auditors whilst also ensuring that the auditors maintain 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 the service provider, or influences the choice of service provider. All services entered into with KPMG Audit Plc and its affiliates (‘KPMG’) after 5 May 2003 were pre-approved by the Group Audit
Committee or were entered into under pre-approval policies established by the Group Audit Committee.
The pre-approved services relate to the provision of objective advice, attestation type services or opinions on areas such as controls and are an input into management decision making. They fall into the following four categories:
Audit services
In addition to the statutory audit appointments that are approved by the Group Audit Committee, this category includes services that are normally provided by the independent auditor in connection with statutory and regulatory filings or engagements, such as reviews of interim financial information, letters to securities underwriters in connection with debt or equity offerings, the inclusion of auditors’ reports in filings with the SEC and certain reports on internal control over financial reporting.
Audit-related services
These services are those provided by the principal auditor that are reasonably related to the performance of the audit or review of the Group’s financial statements. Examples of such services are due diligence services provided in connection with potential acquisitions, audits or reviews of employee benefit plans, ad hoc attestation or agreed-upon procedures reports (including reports requested by regulators), and accounting and regulatory advice on actual or contemplated transactions.
Tax services
This category includes both tax advice and compliance services. Examples of such services are advice on national and local income taxation matters, (including assistance in data gathering for preparation, review and submission as agent of tax filings), advice on tax consequences of management-proposed transactions and assistance in responding to tax examinations by governmental authorities. The pre-approved tax services explicitly exclude proposals for tax structures unconnected with a contemplated transaction whose main motive is to reduce taxation.
Other services
This category includes various other assurance and advisory services such as training or advice or assurance provided on specific elements of financial data and models, IT security and advice, and providing due diligence on financial reviews of HSBC customers and private equity investments.
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The remuneration paid to KPMG for each of the last three years is disclosed in Note 5(d) of the ‘Notes on the Financial Statements’.
Remuneration Committee
The role of the Remuneration Committee and its membership are set out in the Directors’ Remuneration Report on page 213.
Nomination Committee
The Nomination Committee carries out the process of nominating candidates to fill vacancies on the Board of Directors. Nominations are considered by the Board. 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 during 2003 were Baroness Dunn, Lord Butler, H Sohmen and Sir Brian Moffat. During 2003 Sir Brian Moffat succeeded Baroness Dunn as Chairman of the Committee and H Sohmen stepped down as a member of the Committee.
There was one Nomination Committee meeting during 2003 which all members attended.
The terms of reference of the Committee are available on www.hsbc.com by selecting ‘About HSBC’, then ‘Board of Directors’, then ‘Board Committees’.
The Nomination Committee is responsible for leading the process for Board appointments and for identifying and nominating, for approval of the Board, candidates for appointments to the Board.
The Committee makes recommendations to the Board concerning plans for succession for both executive and non-executive directors; the appointment of any director to executive or other office; suitable candidates for the role of senior independent director; the re-election by shareholders of directors retiring by rotation; the renewal of the terms of office of non-executive directors; membership of Board Committees, in consultation with the Group Chairman and the chairmen 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 any of its subsidiaries as appropriate; and appointments and re-appointments to the Boards of Directors of major subsidiary companies as appropriate.
The Committee regularly reviews the structure, size and composition of the Board and keeps under review the leadership needs of HSBC with a view to ensuring the continued ability of HSBC to compete effectively in the marketplace.
The Board has satisfied itself that the Nomination Committee has in place appropriate plans for orderly succession to the Board and Senior Management positions as well as procedures to ensure an appropriate balance of skills and experience within HSBC and on the Board.
Corporate Social Responsibility Committee
The Corporate Social Responsibility Committee held its first meeting in February 2004. The Committee is responsible for overseeing Corporate Social Responsibility and Sustainability policies, principally environmental, social and ethical matters and for advising the Board, committees of the Board and executive management on such matters. The terms of reference of the Committee are available on www.hsbc.com by selecting ‘About HSBC’, then ‘Board of Directors’ then ‘Board Committees’. The members of the Committee are Lord Butler (Chairman), W K L Fung, S Hintze, C S Taylor, all of whom are independent non-executive Directors, and Baroness Brigstocke, G V I Davis and Lord May, who are co-opted non-Director members of the Committee.
Since 1999 Lord Butler has, at the Board’s request, taken a policy overview of HSBC in the Community, the principal objectives of which are to support access to primary and secondary education for those who are disadvantaged, and the environment. Considerable progress continues to be made in these important areas. These responsibilities now come under the overview of the Corporate Social Responsibility Committee of which Lord Butler is Chairman.
Further information is available in the HSBC in Society: Corporate Social Responsibility Report 2003 brochure.
HSBC is committed to high standards of corporate governance. HSBC Holdings complied throughout the year with the best practice provisions of the Combined Code on corporate governance appended to the Listing Rules of the Financial Services Authority and with the provisions of Appendix 14 to
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the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong.
The Combined Code was substantially revised during the year. The new Code will apply for the next and subsequent reporting years.
Differences in UK/New York Stock Exchange corporate governance practices
In November 2003, the US Securities and Exchange Commission approved the New York Stock Exchange’s (‘NYSE’) new corporate governance rules for listed companies. Under these new rules, as a NYSE-listed foreign private issuer, HSBC Holdings must disclose any significant ways in which its corporate governance practices differ from those followed by US companies under 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 United Kingdom to include in its Annual Report and Accounts a narrative statement of how it has applied the principles of the Combined Code on Corporate Governance appended to the Listing Rules (‘Combined Code’) and a statement as to whether or not it has complied with the best practice 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 on page 204 above, HSBC Holdings complied throughout 2003 with the best practice provisions of the Combined Code. The Combined Code does not require HSBC Holdings to disclose the full range of corporate governance guidelines with which it complies.
Under NYSE standards, companies are required to have a nominating/corporate governance committee, composed entirely of independent
directors. In addition to identifying individuals qualified to become board members, this committee must develop and recommend to the board a set of corporate governance principles. HSBC’s Nomination Committee, which follows the requirements of the Combined Code, includes a majority of members who are independent. All members of the Committee are non-executive Directors and the Committee chairman is an independent non-executive Director. The Committee’s terms of reference do not require the Committee to develop and recommend corporate governance principles for HSBC Holdings. As stated above, HSBC Holdings is subject to the corporate governance principles of the Combined Code.
Pursuant to NYSE listing standards, non-management directors must meet on a regular basis without management present and independent directors must meet separately at least once per year. During 2003, HSBC Holdings’ non-executive Directors met three times as a group with the Group Chairman, but with no other executive Directors present, and met once as a group without the Group Chairman or other executive Directors present. HSBC Holdings’ practice, in this regard, complies with the Combined Code.
In accordance with the requirements of the Combined Code, HSBC Holdings discloses in its annual report how the Board, its committees and the Directors are evaluated and the results of the evaluation (on pages 214 to 218) and it provides extensive information regarding Directors’ compensation in the Directors’ Remuneration Report (on pages 223 to 229). The terms of reference of HSBC Holdings’ Audit, Nomination and Remuneration Committees are available on www.hsbc.com by selecting ‘About HSBC’, then ‘Board of Directors’, then ‘Board Committees’.
NYSE listing standards require US companies to adopt a code of business conduct and ethics for directors, officers and employees, and promptly disclose any waivers of the code for directors or executive officers. In addition to the Group Business Principles and Values, which apply to the employees of all HSBC companies, pursuant to the requirements of the Sarbanes-Oxley Act the Board of HSBC Holdings has adopted a Code of Ethics applicable to the Group Chairman, the Group Finance Director and Group Chief Accounting Officer. HSBC Holdings’ Code of Ethics is available on www.hsbc.com by selecting ‘Investor Centre’, then ‘Corporate
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Under NYSE listing rules applicable to US companies, independent directors must comprise a majority of the board of directors. Currently, half of HSBC Holdings’ Directors are independent. The NYSE rules include detailed tests for determining director independence while the Combined Code, which is followed by HSBC Holdings, prescribes a more general standard for determining director independence. 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 to promptly 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.
The Directors are responsible for internal control in HSBC and for reviewing its effectiveness. Procedures have been designed for safeguarding assets against unauthorised use or disposition; for maintaining proper accounting records; and for the reliability of financial information used within the business or for publication. Such procedures are designed to manage rather than eliminate the risk of failure to achieve business objectives and can only provide reasonable and not absolute assurance against material errors, losses or fraud. The procedures also enable HSBC Holdings to discharge its obligations under the Handbook of Rules and Guidance issued by the Financial Services Authority,
HSBC’s lead regulator.
The key procedures that the Directors have established are designed to provide effective internal control within HSBC and accord with the Internal Control Guidance for Directors on the Combined Code issued by the Institute of Chartered Accountants in England and Wales. Such procedures have been in place throughout the year and up to 1 March 2004, the date of approval of the Annual Report and Accounts. In the case of companies acquired during the year, including Household, the internal controls in place are being reviewed against HSBC’s benchmarks and integrated into HSBC’s systems. HSBC’s key internal contr ol procedures include the following:
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The Group Audit Committee has kept under review the effectiveness of this system of internal control and has reported regularly to the Board of Directors. The key processes used by the Committee in carrying out its reviews include: regular reports from the heads of key risk functions; the production and regular updating of summaries of key controls applied by subsidiary companies measured against HSBC benchmarks which cover all internal controls, both financial and non-financial; annual confirmations from chief executives of principal subsidiary companies that there have been no material losses, contingencies or uncertainties caused by weaknesses in internal controls; internal audit reports; external audit reports; prudential reviews; and regulatory reports.
The Directors, through the Group Audit Committee, have conducted an annual review of the effectiveness of HSBC’s system of internal control covering all controls, including financial, operational and compliance controls and risk management.
HSBC regularly updates its policies and procedures for safeguarding against reputational, strategic and operational risks. This is an evolutionary process which now takes account of The Association of British Insurers’ guidance on best practice when responding to social, ethical and environmental (SEE) risks.
The safeguarding of HSBC’s reputation is of paramount importance to its continued prosperity and is the responsibility of every member of staff. HSBC has always aspired to the highest standards of conduct and, as a matter of routine, takes account of reputational risks to its business. The training of Directors on appointment includes reputational matters.
Reputational risks, including SEE matters, are considered and assessed by the Board, the Group Management Board, subsidiary company boards, board committees and/or senior management during the formulation of policy and the establishment of HSBC standards. Standards on all major aspects of business are set for HSBC Group and for individual subsidiary companies, businesses and functions. These policies, which form an integral part of the internal control systems, are communicated through
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manuals and statements of policy and are promulgated through internal communications. The policies cover SEE issues and set out operational procedures in all areas of reputational risk, including money laundering deterrence, environmental impact, anti-corruption measures and employee relations. The policy manuals address risk issues in detail and co-operation between head office departments and businesses is required to ensure a strong adherence to HSBC’s risk management system and its corporate social responsibility practices.
Internal controls are an integral part of how HSBC conducts its business. HSBC’s manuals and statements of policy are the foundation of these internal controls. There is a strong process in place to ensure controls operate effectively. Any significant failings are reported through the control mechanisms, internal audit and compliance functions to subsidiary company audit committees and to the Group Audit Committee, which keeps under review the effectiveness of the system of internal controls and reports regularly to HSBC Holdings’ Board. In addition, all HSBC businesses and major functions are required to review their control procedures and to make regular reports about any losses arising from operational risks.
KPMG continues to assist HSBC in its quantification of the key direct environmental impact of its principal operations around the world. This third party scrutiny of the environmental reporting system supports HSBC’s internal risk management procedures. HSBC is a participant in the Dow Jones Sustainability, FTSE4Good and Business in the Environment indices. Further details are contained in the HSBC in Society: Corporate Social Responsibility Report 2003.
The maintenance of appropriate health and safety standards throughout HSBC remains a key responsibility of all managers and HSBC is committed to actively managing all health and safety risks associated with its business. HSBC’s objectives are to identify, remove, reduce or control material risks of fires and of accidents or injuries to employees and visitors.
Health and Safety Policies, Group standards and procedures are set by Group Fire and Safety and are implemented by Health, Safety and Fire Co-
ordinators based in each country in which HSBC operates.
HSBC faces a range of threats from terrorists and criminals across the world. In particular, over the past year the threat from international terrorism has become significant in a number of areas where HSBC operates. This threat has mainly manifested itself in bomb attacks such as the one in Istanbul last year in which HSBC’s Turkish headquarters building was attacked. Despite suffering tragic loss of life and major damage, existing security measures and well-managed contingency procedures ensures the business was able to return to normal operations the following day.
Group Security provides regular risk assessments in areas of increased risk to assist management in judging the level of terrorist threat. In addition, Regional Security functions conduct regular security reviews to ensure measures to protect HSBC staff, buildings, assets and information are appropriate for the level of threat.
Communication with shareholders is given high priority. Extensive information about HSBC’s activities is provided in the Annual Report and Accounts, Annual Review, HSBC in Society: Corporate Social Responsibility Report 2003, and the Interim Report which are sent to shareholders. 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 mann er. 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.
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 in the shares and loan capital of HSBC, all beneficial unless otherwise stated.
Under the Securities and Futures Ordinance, share options and American Depositary Shares are classified as interests in equity derivatives and are disclosed as such in the following table.
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Sir John Bond has an interest as beneficial owner in £290,000 of HSBC Capital Funding (Sterling 1) L.P. 8.208 per cent Non-cumulative Step-up Perpetual Preferred Securities, which he held throughout the year.
D G Eldon has an interest as beneficial owner in 300 Hang Seng Bank Limited ordinary shares of HK$5.00 each, which he held throughout the year.
S K Green has an interest as beneficial owner in €75,000 of HSBC Holdings plc 5½ per cent Subordinated Notes 2009 and in £100,000 of HSBC Bank plc 9 per cent Subordinated Notes 2005, which he held throughout the year.
H Sohmen has a corporate interest in £1,200,000 of HSBC Bank plc 9 per cent Subordinated Notes 2005 and his spouse has an interest in US$3,000,000 of HSBC Bank plc Senior Subordinated Floating Rate Notes 2009, which were held throughout the year. H Sohmen’s spouse also has an interest in 107,800 ordinary shares of US$100 each in International United Shipping and Investment Company, an associated corporation of HSBC, representing 35 per cent of the ordinary shares in issue, which she held throughout the year. During the year, H Sohmen ceased to have an interest through a corporate body in US$3,000,000 of HSBC Capital Funding (Dollar 1) L.P. 9.547 per cent Non-cumulative Step-up Perpetual Preferred Securities, Series 1 and in US$2,900,000 of HSBC Finance Nederland BV 7.40 per cent securities 2003.
As Directors of CCF S.A., C F W de Croisset, W R P Dalton and S K Green each had an interest as beneficial owner in one share of €5 each in that company, which they held throughout the year. The Directors have waived their rights to receive dividends on these shares and have undertaken to transfer these shares to HSBC on ceasing to be Directors of CCF.
No directors held any short positions as defined in the Securities and Futures Ordinance of Hong Kong. Save as stated above and in the Directors' Remuneration Report, none of the Directors had an interest in any shares or debentures of any HSBC 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 period.
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:
There have been no other changes in Directors’ interests from 31 December 2003 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 2003, Directors and Senior Management held, in aggregate, beneficial interests in 17,038,126 HSBC Holdings ordinary shares (0.2 per cent of the issued ordinary shares).
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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 option plans as appropriate.
About half of all HSBC employees now participate in one or more of HSBC’s employee share plans.
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.
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.
It is HSBC Holdings’ practice to organise payment to its suppliers through a central accounts function operated by its subsidiary undertaking, HSBC Bank plc. Included in the balance with HSBC
Bank plc is the amount due to trade creditors which, at 31 December 2003, represented 15 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.
According to the register maintained under section 211 of the Companies Act 1985, Legal and General Investment Management Limited notified HSBC Holdings on 11 June 2002 that it had an interest at that date in 284,604,788 HSBC Holdings ordinary shares, representing 3.01 per cent of the ordinary shares in issue at that date.
No substantial interest, being 5 per cent or more, in any of the equity share capital is recorded in the register maintained under section 336 of the Securities and Futures Ordinance of Hong Kong.
On 8 May 2003, HSBC Life (International) Limited sold 20,902 HSBC Holdings ordinary shares of US$0.50 each on the London Stock Exchange at 708.26 pence per share. Save for this and dealings as intermediaries by HSBC Bank plc and HSBC CCF Financial Products (France) SNC, 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 12 months ended 31 December 2003.
The following constituted connected transactions under the rules of The Stock Exchange of Hong Kong Limited.
In March 2003 CCF, a subsidiary of HSBC Holdings, agreed to acquire 11.81 per cent of the capital of Banque Eurofin S.A. (‘Eurofin’) from Gérard de Bartillat (4.41 per cent) and a company owned by the Bartillat Family (7.40 per cent). Gérard de Bartillat was also a Director and the Chief Executive Officer of Eurofin. The consideration of €24.2 million in cash was paid on completion. In April 2003, CCF agreed to acquire 50.03 per cent of the capital of Société des Cadres Banque Eurofin S.A.S, which in turn owned 1.18 per cent of Eurofin, from a company owned by the Bartillat Family. The
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consideration of €1.43 million in cash was paid on completion.
In May 2003 HSBC Mexico (formerly GF Bital), a subsidiary of HSBC Holdings, agreed to acquire, subject to regulatory approval, 49 per cent of the capital of Seguros Bital, S.A. de C.V.(‘Seguros Bital’) held by ING Insurance International B.V. for a consideration of US$148 million. The transaction increased HSBC Mexico’s interest in Seguros Bital from 51 per cent to 100 per cent.
In September 2003 Elysées Gestion, a subsidiary of HSBC Holdings, agreed to acquire 49 per cent of the capital of Elysées Fonds from Médéric-Prévoyance and URRPIMMEC. The consideration of €14 million in cash was paid on completion. The transaction increased Elysées Gestion’s interest in Elysées Fonds from 51 per cent to 100 per cent.
In December 2003 HSBC Latin America BV, a subsidiary of HSBC Holdings, acquired 40 per cent of the capital of HSBC Salud (Argentina) S.A. from New York Life Inc. The consideration of US$30 million was paid in cash on completion. The transaction increased HSBC Latin America BV’s interest in HSBC Salud (Argentina) S.A. from 60 per cent to 100 per cent. The company was subsequently sold to a third party.
In January 2004 The Hongkong and Shanghai Banking Corporation Limited, a subsidiary of HSBC Holdings, exchanged a 50 per cent interest in the capital of World Finance International Limited for approximately 7 per cent of Bergesen Worldwide Limited. Bergesen Worldwide Limited is controlled by family interests of H Sohmen, a non-executive Director of HSBC Holdings and The Hongkong and Shanghai Banking Corporation Limited. The percentage interest in Bergesen Worldwide Limited was of an equivalent value to 50 per cent of the consolidated net asset value of World Finance International Limited and its subsidiaries as at 31 December 2003, estimated at approximately US$111 million.
During the year, HSBC made charitable donations totalling US$47,374,000. Of this amount, US$17,069,000 was given for charitable purposes in the United Kingdom.
Following its acquisition on 28 March 2003 and until 30 September 2003 to allow time for any commitments to be honoured, Household International continued its previous policy of making political donations in the United States. During that period donations totalling US$455,270 were made, comprising US$143,250 to 174 affiliates of the Democratic Party, US$197,000 to 271 affiliates of the Republican Party and US$115,020 to 18 non-affiliated organisations. Since 1 October 2003 Household International has adopted HSBC’s longstanding policy of not making contributions to any political party. Save for the donations made by Household International before 1 October 2003 no political donations were made by HSBC during the year.
At the Annual General Meeting in 2003 shareholders gave authority for HSBC Holdings and HSBC Bank plc to make EU political donations and incur EU political expenditure up to a maximum aggregate sum of £250,000 and £50,000 respectively over a four-year period as a precautionary measure in light of the wide definitions in The Political Parties, Elections and Referendums Act 2000. These authorities have not been used.
The Annual General Meeting of HSBC Holdings will be held at the Barbican Hall, Barbican Centre, London EC2 on Friday 28 May 2004 at 11.00 am.
An informal meeting of shareholders will be held at Level 28, 1 Queen’s Road Central, Hong Kong on Tuesday 25 May 2004 at 4.30pm.
A live webcast of the Annual General Meeting will be available on www.hsbc.com. From shortly after the conclusion of the Meeting until 30 June 2004 a recording of the proceedings will be available on www.hsbc.com.
KPMG Audit Plc has expressed its willingness to continue in office. The Group Audit Committee and the Board recommend that it be reappointed. A resolution proposing the reappointment of KPMG Audit Plc as auditor of HSBC Holdings and giving authority to the Directors to determine its remuneration will be submitted to the forthcoming Annual General Meeting.
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The Remuneration Committee meets regularly to consider human resource issues, particularly terms and conditions of employment, remuneration, retirement benefits, development of high potential employees and key succession planning. During 2003, the members of the Remuneration Committee were Sir Mark Moody-Stuart (Chairman), W K L Fung and Sir John Kemp-Welch, all of whom are independent non-executive Directors. S Hintze, an independent non-executive Director, was appointed a member of the Committee on 30 January 2004.
There were eight meetings of the Remuneration Committee during 2003. All of the members attended each of these meetings. The terms of reference of the Committee are available on www.hsbc.com by selecting ‘About HSBC’, then ‘Board of Directors’, then ‘Board Committees’.
During 2003, the Committee conducted a review of external specialist remuneration consultants. After a rigorous selection process, the Committee retained the services of Towers Perrin, a firm of specialist human resources consultants, who provide independent advice on executive remuneration issues. A further selection process will take place in 2006. As a global firm, Towers Perrin also provide other remuneration, actuarial and retirement consulting services to various parts of HSBC. Other than the provision of expert advice in these areas to the Remuneration Committee and to HSBC, Towers Perrin have no connection with HSBC. Other consultants are used from time to time to validate their findings. The Remuneration Committee also receives advice from the Group General Manager, Group Human Resources and the Senior Executive, Group Reward Management.
General Policy on Employees
As with most businesses, HSBC’s performance depends on the quality and commitment of its people. Accordingly, the Board’s stated strategy is to attract, retain and motivate the very best people.
In a business that is based on trust and relationships, HSBC’s broad policy is to look for people who want to make a long-term career with the organisation since trust and relationships are built over time.
Remuneration is an important component in people’s decisions on which company to join, but it is not the only one; it is HSBC’s experience that people are attracted to an organisation with good values, fairness, the potential for success and the scope to develop a broad, interesting career.
Within the authority delegated by the Board of Directors, the Remuneration Committee is responsible for determining the remuneration policy of HSBC including the terms of bonus plans, share option plans and other long-term incentive plans, and for agreeing the individual remuneration packages of executive Directors and other senior Group employees. No Directors are involved in deciding their own remuneration.
The Remuneration Committee applies the following key principles:
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Directors’ Remuneration Report (continued)
The impact on existing equity of granting share options which are to be satisfied by the issue of new shares is shown in diluted earnings per share on the face of the consolidated profit and loss account, with further details disclosed in Note 11 of the ‘Notes on the Financial Statements’. The effect on basic earnings per share of exercising all outstanding share options would be to dilute it by 0.40 per cent.
The Remuneration Committee seeks to respond to the variety of environments and circumstances which are faced by different businesses in different markets at different times.
During 2004, the Committee will conduct a comprehensive and fundamental review of all
share-based remuneration. Before presenting any proposed changes for shareholder approval, the Committee will ensure appropriate consultation is undertaken with shareholders and their representatives.
Directors and Senior Management
HSBC’s operations are substantial, diverse and international; for example, over 74 per cent of net income is derived from outside the United Kingdom.
HSBC Holdings’ Board is currently composed of 14 non-executive Directors and eight executive Directors. With businesses in 79 countries and territories, HSBC aims to attract Directors with a variety of experience, in both its key markets and internationally. The Board currently includes nationals of seven different countries. The eight executive Directors, four Group Managing Directors and 27 Group General Managers have in total more than 900 years of service with HSBC.
Directors’ fees
Directors’ fees are regularly reviewed and compared with other large international companies. The current fee, which was approved by shareholders in 2000, is £35,000 per annum. Recent developments in corporate governance and reporting obligations, and the expansion of HSBC’s business, continue to increase the commitment required of Directors. In accordance with the recommendations of an independent external review, the approval of shareholders will be sought at the 2004 Annual General Meeting for the basic fee to be increased to £55,000 per annum with effect from 1 January 2004.
In addition, non-executive Directors receive, with effect from 1 January 2004, the following fees:
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Executive Directors are normally permitted to retain only one Director’s fee from HSBC. For example, executive Directors who are also Directors of The Hongkong and Shanghai Banking Corporation Limited may elect to receive a fee from either HSBC Holdings or The Hongkong and Shanghai Banking Corporation Limited.
Executive Directors
The executive Directors are experienced executives with detailed knowledge of the financial services business in various countries. In most cases there has been a need to attract them from abroad to work in the United Kingdom.
Having regard to the broad international nature of the Group, the annual market survey of senior executive remuneration takes into account not only remuneration data in the UK but also in other overseas markets.
Consistent with the principles applied by the Committee to employees generally, there are four key components to the executive Directors’ remuneration:
The Committee generally provides, on a discretionary basis, long-term share incentives to executive Directors and members of senior management through conditional awards of Performance Shares under the HSBC Holdings Restricted Share Plan 2000 rather than through the HSBC Holdings Group Share Option Plan, as explained under ‘Long-term incentive plan’ below.
The level of awards available to the executive Directors under the annual cash bonus scheme and the HSBC Holdings Restricted Share Plan 2000 is
entirely dependent on performance. Remuneration policy for executive Directors is intended to provide competitive rates of base salary but with the potential for the majority of the value of the remuneration package to be delivered in the form of both short and long-term incentives. This typically results in base salary comprising around 40 per cent of total direct pay and the remaining 60 per cent split equally between annual bonus and the expected value of Performance Share awards. The remuneration package of W F Aldinger has a smaller proportion of fixed salary and a higher proportion of annual bonus and Restricted Share awards. The awards are in accordance with the minimum level of awards set out under his employment agreement entered into at the time of the acquisition of Household.
Each component of executive Directors’ remuneration is explained in detail below. The current approach and structure of remuneration has been in place since 2000 and the Committee believes it has served HSBC well. The Committee has, however, made the following modifications to the performance condition for future awards of Performance Shares under the HSBC Holdings Restricted Share Plan 2000 in order to make the condition more relevant and long-lasting:
The use of Performance Shares and the HSBC Holdings Restricted Share Plan 2000 will fall within the Committee’s review of share-based remuneration to be undertaken in 2004.
Salary
The Committee reviews salary levels for executive Directors each year in the same context as other employees. With respect to market practice and taking account of the international nature of the Group, the Committee benchmarks the salary of each Director and member of Senior Management against those of comparable executives in large, diverse companies.
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Base salaries with effect from April 2004 willbe:
This represents an average increase from 2003 of 18.9 per cent.
As an International Manager, D G Eldon’s current base salary, shown above, is calculated on a net basis and will be subject to a separate review in April 2004.
Annual cash bonus
Cash bonuses for executive Directors and members of Senior Management are based on two key factors: individual performance, taking into account, as appropriate, results against plan of the business unit or performance of the support function for which the individual is responsible; and Group performance, measured by comparing operating profit before tax with plan. The Remuneration Committee has discretion to eliminate extraordinary items when assessing bonuses, if the main cause did not arise during the current bonus year.
Measurement against these key performance factors may, exceptionally, result in discretionary cash bonuses up to 250 per cent of basic salary. For 2003, bonuses have ranged from 60 per cent to 250 per cent of base salary, with all but two of the executive Directors and members of Senior Management receiving discretionary bonuses of less than 110 per cent of base salary.
Long term incentive plan
The HSBC Holdings Restricted Share Plan 2000 is the principal long-term incentive plan used to reward the delivery of sustained financial growth of HSBC Holdings. So as to align the interests of the Directors and senior employees more closely with those of shareholders, the vesting of Performance Share awards is subject to the attainment of a predetermined TSR target.
Awards
In recent years the Remuneration Committee has adopted a policy that the face value of annual awards of Performance Shares to executive Directors and members of Senior Management will not as a general rule exceed 100 per cent of earnings (defined as base salary and bonus in respect of the previous performance year).
Additionally, executive Directors and members of Senior Management who participate in the HSBC Holdings Restricted Share Plan 2000 have not received awards under the HSBC Holdings Group Share Option Plan.
The Remuneration Committee has proposed to the Trustee of the HSBC Holdings Restricted Share Plan 2000 that the following conditional awards should be made to executive Directors in 2004:
The Trustee to the Plan will be provided with funds to acquire HSBC Holdings ordinary shares at an appropriate time after the announcement of the annual results. The 2004 conditional awards proposed for executive Directors and members of Senior Management in respect of 2003 will have an aggregate value at the date of award of £16.86 million.
Under the terms of his employment agreement entered into at the time of the acquisition of Household, W F Aldinger will receive an award of US$5.5 million which will be used to purchase Restricted Shares in HSBC Holdings. These Restricted Shares are not subject to the TSR performance conditions set out on pages 217 to 219. One-third of this award of Restricted Shares will vest on each of the three anniversaries following the date of grant.
C F W de Croisset, who retired from HSBC on 29 February 2004, has not received any awards of Performance Shares under the HSBC Holdings Restricted Share Plan since the acquisition of CCF in 2000. Rather, in accordance with the arrangements agreed with CCF in 2000, Mr de Croisset received share option awards under the
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HSBC Holdings Group Share Option Plan. The awards in 2001 and 2002 were not subject to performance conditions; 50 per cent of the award made in 2003 was subject to the TSR performance conditions set out below.
W R P Dalton, who is to retire at the Annual General Meeting on 28 May 2004, will not receive an award of Performance Shares under the HSBC Holdings Restricted Share Plan in 2004.
Performance conditions
From 1999, the vesting of awards has been linked to the attainment of predetermined TSR targets as set out below.
Particulars of executive Directors’ interests in shares held in the Restricted Share Plan are set out on page 228.
TSR is defined as the growth in share value and declared dividend income, measured in sterling, during the relevant period. In calculating TSR, dividend income is assumed to be reinvested in the underlying shares.
The TSR performance condition for awards of Performance Shares under the Restricted Share Plan remained the same from 1999 to 2003, the five years of the Managing for Value strategy. For awards made in 2004, changes have been made to the peer group (as described below) and re-testing provisions have been eliminated so that awards will lapse if the performance condition is not satisfied after the initial three-year performance period.
Having regard to HSBC Holdings’ size and status within the financial sector, a benchmark for HSBC Holdings’ TSR has been established which takes account of the TSR performance of:
By combining the weighted average TSR for each of the above three groups and weighting that average so that 50 per cent is applied to paragraph 1, 25 per cent is applied to paragraph 2 and 25 per cent is applied to paragraph 3, an appropriate single TSR benchmark for market comparison is determined.
The extent to which awards will vest will be determined by reference to HSBC Holdings’ TSR measured against the TSR benchmark. The calculation of the share price component within HSBC Holdings’ TSR will be the average market price over the 20 trading days commencing on the day when the annual results are announced, which in 2004 is 1 March. The starting point will be, therefore, the average over the period 1 to 26 March inclusive. TSR for the benchmark constituents will be based on their published share prices on 26 March 2004.
If HSBC Holdings’ TSR over the performance period exceeds the benchmark TSR, awards with a value, at the date of grant, of up to 100 per cent of the individual’s earnings, will vest. For higher value awards, the greater of 50 per cent of the award or the number of shares equating at the date of grant to 100 per cent of the individual’s earnings, will vest at this level of performance. If HSBC Holdings’ TSR over the performance period places it within the upper quartile in the ranked list against the benchmark, these higher value awards will vest in full. For performance between the median and the upper quartile, vesting will be on a straight line basis.
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For awards made in 2004 and thereafter, under the HSBC Holdings Restricted Share Plan 2000 only, the initial performance period will be three years from the date of grant. As before, if the upper quartile performance target is achieved, an additional award equal to 20 per cent of the initial Performance Share award will be made and will vest at the same time as the original award to which it relates. However, regardless of whether the upper quartile is achieved, full vesting and transfer of the shares will not generally occur until the fifth anniversary of the date of grant. If the performance test is not passed at the third anniversary, the shares will be forfeited.
As a secondary condition, options and awards will only vest if the Remuneration Committee is satisfied that HSBC Holdings’ financial performance has shown a sustained improvement in the period since the date of grant.
In determining whether HSBC has achieved a sustained improvement in performance the Remuneration Committee will take account of, among other factors, the comparison against history and the peer group in the following areas:
Awards will vest immediately in cases of death. The Remuneration Committee retains discretion to recommend early release of the shares to the plan Trustee in certain instances, e.g. in the event of redundancy, retirement on grounds of injury or ill health, early retirement, retirement on or after contractual retirement or if the business is no longer part of HSBC Holdings. Awards will normally be forfeited if the participant is dismissed or resigns from HSBC.
Where events occur which cause the Remuneration Committee to consider that the performance condition has become unfair or impractical, the right is reserved to the Remuneration Committee to make such adjustments as in its absolute discretion it deems appropriate to make.
Pension
The pension entitlements earned by the executive Directors during the year are set out on pages 224 and 225.
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Total Shareholder Return
Graph 1 below shows HSBC Holdings’ TSR performance against the benchmark TSR. Pursuant to the Directors’ Remuneration Report Regulations 2002, the following graphs show HSBC Holdings’ TSR performance against the Financial
Graph 1: HSBC TSR and TSR Benchmark
Graph 3: HSBC TSR and MSCI World Index
Times-Stock Exchange (FTSE) 100 Index (graph 2), the Morgan Stanley Capital International (MSCI) World Index (graph 3) and Morgan Stanley Capital International (MSCI) Financials Index (graph 4). These measures have been chosen as they are the main published indices against which HSBC monitors its performance.
Graph 2: HSBC TSR and FTSE 100 Index
Graph 4: HSBC TSR and MSCI Financials Index
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Service contracts and terms of appointment
HSBC’s policy is to employ executive Directors on one-year rolling contracts although, on recruitment, longer initial terms may be approved by the Remuneration Committee. The Remuneration Committee will, consistent with the best interests of the Group, seek to minimise termination payments.
No executive Director has a service contract with HSBC Holdings or any of its subsidiaries with a notice period in excess of one year or with provisions for predetermined compensation on termination which exceeds one year’s salary and benefits in kind, save as referred to below. There are no provisions for compensation upon early termination of executive Directors’ service contracts save for W F Aldinger and C F W de Croisset, details of which are set out below.
Mr Aldinger entered into a new employment agreement with Household on 14 November 2002 for a term of three years, such term to commence on the effective date of the acquisition of Household by HSBC. Full details of the agreement were set out in the Discloseable Transaction Circular relating to the acquisition of Household sent to shareholders on 26 February 2003 in advance of the Extraordinary General Meeting to approve the acquisition. The terms of the employment agreement, which were an integral part of the Household acquisition that shareholders approved at the Extraordinary General Meeting, are unchanged. The effective date of acquisition, and commencement date of the contract, was 28 March 2003.
During the term of the agreement Mr Aldinger will be paid an annual base salary equal to his annual base salary as at the date of the merger agreement between Household and HSBC (US$1 million) and an annual bonus in an amount at least equal to the annual average of Mr Aldinger’s bonuses earned with respect to the three-year period ended 2001 (pro rated for any partial year) (US$4 million). Within 30 days of the effective date, Mr Aldinger received a one-time special retention grant of HSBC Holdings ordinary shares under the HSBC Holdings Restricted Share Plan 2000 with a value equal to US$10 million. These Restricted Shares will vest in three equal instalments on each of the first three anniversaries
of the effective date, as set out on page 228. After each of the second and third anniversaries of the effective date, subject to the approval of the Trustee of the HSBC Holdings Restricted Share Plan 2000, Mr Aldinger will receive an additional grant of HSBC Holdings ordinary shares with a value equal to at least US$5.5 million. The purpose of these arrangements is to retain the services of Mr Aldinger through the initial integration of Household. HSBC considers it is essential that the experience, knowledge and skills of Mr Aldinger be retained for the benefit of HSBC shareholders.
If Mr Aldinger’s employment is terminated by him during its term for ‘good reason’, or by Household for reasons other than ‘cause’ or disability, he will be entitled to: a pro rata target annual bonus for the financial year of the date of termination; a payment equal to his annual base salary, plus the average of his annual bonuses with respect to the three-year period ended 2001, times the number of full and partial months from the date of termination until the third anniversary of the effective date, divided by twelve; the immediate vesting and exercisability of each stock option, restricted stock award and other equity-based award or performance award (or cash equivalent) that is outstanding as at the date of termination and treatment as ret irement eligible for purposes of exercising any such award; for the remainder of his life and that of his current spouse, continued medical and dental benefits at Household’s cost; and his retirement benefits (as set out on page 224) in a lump sum.
Sir John Bond is employed on a rolling contract dated 1 January 1993 which requires 12 months’ notice to be given by either party.
C F W de Croisset has a contract of employment dated 7 January 1980 that was in force before he joined the Board of CCF. The contract has no set term but provides for three months’ notice to be given by either party. Under the terms of the contract Mr de Croisset would be entitled to receive one month's salary for each year of service with CCF on termination of his employment with CCF. In accordance with French legal requirements and practice, this contract was suspended while he served as an executive Director of CCF. On 29 February 2004, Mr de Croisset took early retirement from the Group, relinquishing his role as Chairman and CEO of CCF. In light of French legal requirements a review of market
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practice was undertaken and it was agreed that a one-off payment of €2,427,000 would be made by CCF to Mr de Croisset, which is considered to be appropriate in all the circumstances. He will also receive a pension as set out on page 224.
W R P Dalton is employed on a rolling contract dated 5 January 1998 which requires 12 months’ notice to be given by either party.
D G Eldon is employed on a rolling contract dated 1 January 1968 which requires three months’ notice to be given by either party.
D J Flint is employed on a rolling contract dated 29 September 1995 which requires 12 months’ notice to be given by the Company and nine months’ notice to be given by Mr Flint.
M F Geoghegan, who is to stand for reelection at the forthcoming Annual General Meeting, is employed on a rolling contract which requires 12 months’ notice to be given by either party.
S K Green is employed on a rolling contract dated 9 March 1998 which requires 12 months’ notice to be given by either party.
A W Jebson is employed on a rolling contract dated 14 January 2000 which requires 12 months’ notice to be given by either party.
Members of Senior Management are employed on service contracts which generally provide for a term of service expiring at the end of a period of up to two years, or the individual’s sixtieth birthday, whichever is earlier.
Non-executive Directors are appointed for fixed terms not exceeding three years, subject to their re-election by shareholders at subsequent Annual General Meetings. Non-executive Directors have no service contract and are not eligible to participate in HSBC’s share plans. Non-executive Directors’ terms of appointment will expire as follows: in 2005 Baroness Dunn and H Sohmen; in 2006 Sir John Kemp-Welch, S W Newton, C S Taylor and Sir Brian Williamson; and in 2007 Lord Butler, R K F Ch’ien, R A Fairhead, W K L Fung, S Hintze, Sir Brian Moffat and Sir Mark Moody-Stuart.
Other directorships
Executive Directors, if so authorised by the Board, may accept appointments as non-executive Directors of suitable companies which are not part of HSBC. Executive Directors normally would be permitted to take on no more than one such appointment. Any remuneration receivable in respect of this appointment is normally paid to the HSBC company by which the executive Director is employed, unless otherwise approved by the Remuneration Committee.
Sir John Bond retains his fees as a non-executive director of the Ford Motor Company, which are provided partly in the form of restricted shares, which become unrestricted over a period of five years. During 2003 the fees received were US$83,000 in cash and US$35,000 deferred into Ford common stock units. In addition, Ford provides US$200,000 of life assurance and US$500,000 of accidental death or dismemberment insurance. The life assurance can be continued after retirement from the Board or Sir John Bond could elect to have it reduced to US$100,000 and receive US$15,000 a year for life. The accidental death or dismemberment insurance ends upon retirement from the Board.
W F Aldinger retains his fees as a non-executive director of Illinois Tool Works, Inc. and as a non-executive director of AT&T Corp. During 2003 the fee received from Illinois Tool Works, Inc. was US$60,800 in the form of deferred stock and the fee received from AT&T Corp. was US$26,500 in cash and US$15,000 in the form of deferred shares. In addition, AT&T Corp. provide travel accident insurance when on AT&T Corp. company business and US$100,000 of life assurance.
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Employees’ emoluments
Set out below is information in respect of the five individuals who are not Directors of HSBC Holdings whose emoluments (excluding commissions or bonuses related to the revenue or profits generated by employees individually or collectively with others engaged in similar activities) were the highest in HSBC for the year ended 31 December 2003.
Their emoluments are within the following bands:
The basic salaries of Group Managing Directors and Group General Managers are within the following bands:
The aggregate remuneration of Directors and Senior Management for the year ended 31 December 2003 was US$100,150,000.
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 2003 was US$4,321,000.
At 31 December 2003, executive Directors and Senior Management held, in aggregate, options to subscribe for 5,656,876 HSBC Holdings ordinary shares under the HSBC Holdings Executive Share Option Scheme, HSBC Holdings Group Share Option Plan and HSBC Holdings savings-related share option plans. These options are exercisable between 2004 and 2013 at prices ranging from £2.1727 to £9.642.
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Directors’ emoluments
The emoluments of the Directors of HSBC Holdings for 2003 were as follows:
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Pensions
There are separate schemes for UK-based and overseas-based employees: the UK scheme has a normal retirement age of 60; retirement ages for overseas schemes vary in accordance with local legislation and practice. Save as stated below no other Director participated in any HSBC pension schemes, none of the Directors participating in HSBC’s UK ‘approved’ pension schemes is subject to the earnings cap introduced by the 1989 Finance Act and only basic salary is pensionable. With four exceptions (see paragraphs below on W F Aldinger, C F W de Croisset, D J Flint and W R P Dalton), the executive Directors are members of defined benefit pension schemes, having joined HSBC at a time when these were the norm.
Before commencement of his new employment agreement on 28 March 2003, W F Aldinger participated in Household’s ‘qualified’ and ‘non-qualified’ defined benefit pension plans. The annual pension benefit under these arrangements was a function of service and a percentage of Final Average Earnings (which included bonus). The ‘non-qualified plans’ were enhanced before commencement of Mr Aldinger’s new employment agreement. The benefits under the ‘qualified’ and ‘non-qualified’ defined benefit pension plans were then frozen and will be payable in a lump sum on the earlier of the termination of Mr Aldinger’s employment or on Mr Aldinger’s retirement. No further benefits have accrued under these arrangements since 28 March 2003.
Since commencement of his new employment agreement on 28 March 2003, Mr Aldinger has continued to participate in the Household International Tax Reduction Investment Plan (TRIP), which is a ‘qualified’ funded deferred profit-sharing and savings plan for eligible employees, although no employer contributions have been made since 28 March 2003. Mr Aldinger also participated in Supplemental TRIP (a ‘non-qualified’ plan), which is an unfunded arrangement under which additional employer provision of US$41,539 has been made since 28 March 2003.
The pension arrangements for Sir John Bond, S K Green and A W Jebson to contractual retirement age of 60 are, and for Sir Keith Whitson were, provided under the HSBC Bank (UK) Pension
Scheme. The pensions accrue at a rate of one-thirtieth of pensionable salary per year of pensionable service in the UK.
Until his retirement from CCF on 29 February 2004, C F W de Croisset was eligible for pension benefits which were supplementary to those accrued under the French State and Compulsory arrangements. The amount of this supplementary pension, payable from age 60, accrued at the rate of €6,098 per annum for each year of service (maximum 18 years) as an executive Director of CCF. Consequent upon Mr de Croisset’s early retirement from CCF and following a review of market practice, it has been agreed to provide a total pension of €341,467 per annum (equivalent to 32.5 per cent of his average total cash compensation over a three-year period) payable from 1 March 2004. The whole cost of this pension is met by CCF.
The pension arrangements for W R P Dalton to contractual retirement age of 60 are provided on a defined benefit basis (details of which are set out in the table below) under the HSBC Canada Pension Plan A, at an accrual rate of one-thirtieth of pensionable salary per year of pensionable service until his transfer to the UK in 1998. Since taking up his appointment in the UK, he has joined the HSBC Holdings Overseas (No.1) Pension Plan on a defined contribution basis, with an employer contribution in respect of 2003 of £1,379,000 (2002: £529,000), including a bonus waiver of £1,250,000 (2002: £400,000).
The pension arrangements for D J Flint to contractual retirement age of 60 are provided through an executive allowance paid to fund personal pension arrangements set at 30 per cent of basic salary. This is supplemented through the HSBC Holdings plc Funded Unapproved Retirement Benefits Scheme on a defined contribution basis with an employer contribution during 2003 of £81,943 (2002: £80,092). The intention of these arrangements is to provide benefits broadly comparable to an accrual rate of one-thirtieth of pensionable salary for each year of pensionable service.
The pension arrangements for D G Eldon are provided under the HSBC International Staff Retirement Benefits Scheme. Pension accrues at a rate of one twenty-seventh of pensionable salary per year of pensionable service.
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The following unfunded pension payments, in respect of which provision has been made, were made during 2003 to four former Directors of HSBC Holdings:
The payments in respect of R Delbridge and Sir Brian Pearse were made by HSBC Bank plc as former Directors of the bank.
Share options
At 31 December 2003, the undernamed Directors held options to acquire the number of HSBC Holdings ordinary shares set against their respective names. The options were awarded for nil
consideration at exercise prices equivalent to the market value at the date of award, except that options awarded under the HSBC Holdings savings-related share option plans before 2001 are exercisable at a 15 per cent discount to the market value at the date of award and those awarded since 2001 at a 20 per cent discount. The options are categorised as unlisted physically settled share options under the Securities and Futures Ordinance of Hong Kong.
Except as otherwise indicated, no options were exercised or lapsed during the year and there are no remaining performance criteria conditional upon which the outstanding options are exercisable. The market value of the ordinary shares at 31 December 2003 was £8.78. The highest and lowest market values during the year were £9.135 and £6.31. Market value is the mid-market price derived from the London Stock Exchange Daily Official List on the relevant date.
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At 31 December 2003, W F Aldinger held options to acquire HSBC Holdings ordinary shares as set out in the table below. These options arise from the conversion of options he held over shares of Household International into options over HSBC Holdings ordinary shares in the same ratio as the offer for Household (2.675 HSBC Holdings ordinary
shares for each Household common share) and the exercise prices per share adjusted accordingly. The Household options were granted at nil consideration.
No options over HSBC Holdings ordinary shares were awarded to Mr Aldinger from 25 April to 31 December 2003.
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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 page 231 and 232, is made with a view to distinguishing for shareholders the respective responsibilities of the Directors and of the Auditors in relation to the financial statements.
The Directors are required by the Companies Act 1985 to prepare financial statements for each financial year which give a true and fair view of the state of affairs of HSBC Holdings plc together with its subsidiary undertakings as at the end of the financial year and of the profit or loss for the financial year. They are also required to present additional information for US shareholders. Accordingly, these financial statements are framed to meet both UK and US requirements to give a consistent view to all shareholders. The Directors are required to prepare these financial statements on the going concern basis unless it is not appropriate. Since the Directors are satisfied that HSBC has the resources to continue in business for the foreseeable future, the financial statements continue to be prepared on the going concern basis. The Directors consider that in preparing the financial statements on pages 233 to 366, HSBC Holdings has used appropriate accounting policies, consistently applied, save as disclosed in the ‘Notes on the Financial Statements’, and supported by reasonable and prudent judgements and estimates, and that all accounting standards which they consider to be applicable have been followed.
The Directors have responsibility for ensuring that HSBC Holdings keeps accounting records which disclose with reasonable accuracy at any time the financial position of HSBC Holdings and which enable them to ensure that the financial statements comply with the Companies Act 1985.
The Directors have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of HSBC and to prevent and detect fraud and other irregularities.
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Independent auditors’ report to the Board of Directors and shareholders of HSBC Holdings plc
We have audited the accompanying consolidated financial statements of HSBC Holdings plc and its subsidiary undertakings (together ‘HSBC’) on pages 233 to 366 which comprise the consolidated balance sheets as at 31 December 2003 and 2002, and the related consolidated profit and loss accounts, statements of total consolidated recognised gains and losses, reconciliations of movements in consolidated shareholders’ funds and consolidated cash flow statements for each of the years in the three-year period ended 31 December 2003. These consolidated financial statements are the responsibility of management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HSBC as at 31 December 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended 31 December 2003 in conformity with accounting principles generally accepted in the United Kingdom.
Accounting principles generally accepted in the United Kingdom vary in certain significant respects from generally accepted accounting principles in the United States. Information relating to the nature and effect of such differences is presented in Note 50 to the consolidated financial statements.
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Financial statements
Consolidated profit and loss account for the year ended 31 December 2003
US$
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Financial statements (continued)
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Sir John Bond, Group Chairman
The accompanying notes are an integral part of the Consolidated Financial Statements.
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HSBC Holdings balance sheet at 31 December 2003
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Statement of total consolidated recognised gains and losses for the year ended 31 December 2003
Reconciliation of movements in consolidated shareholders’ funds for the year to 31 December 2003
No note of historical cost profits and losses has been presented as there is no material difference between HSBC’s results as disclosed in the consolidated profit and loss account and the results on an unmodified historical cost basis.
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Consolidated cash flow statement for the year ended 31 December 2003
The accompanying notes are an integral part of the Consolidated Financial Statements
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Notes on the Financial Statements
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Notes on the Financial Statements (continued)
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There are two basic types of provision, specific and general, each of which is considered in terms of the charge and the amount outstanding.
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At 31 December 2002 the assumptions used to calculate scheme liabilities for HSBC’s main defined benefit pension schemes under FRS 17 were:
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Notes onthe Financial Statements (continued)
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