As filed with the Securities and Exchange Commission on March 4, 2005.
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:
The number of outstanding shares of each of the issuer’s classes of capital or common stock as of December 31, 2004 was:
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
Certain Defined Terms
Financial Highlights
HSBC’s Financial Statements and Notes thereon, as set out on pages 237 to 356, are prepared in accordance with UK Generally Accepted Accounting Principles (‘UK GAAP’). HSBC uses the US dollar as its reporting currency because the US dollar and currencies linked to it form the major currency bloc in which HSBC transacts its business. As HSBC is listed on the New York Stock Exchange, it also reconciles certain financial information to US Generally Accepted Accounting Principles (‘US GAAP’), which differ in certain respects from UK GAAP as explained on page 322 and reconciled in Note 49 of the ‘Notes on the Financial Statements’. Unless otherwise stated, the numbers presented in this document have been prepared in accordance with UK GAAP.
HSBC judges its own performance by comparing returns before goodwill amortisation on cash invested as HSBC believes this gives an important measure of its underlying performance and facilitates comparison with its peer group. Profit before goodwill amortisation is derived by adjusting reported earnings to eliminate the impact of the amortisation of goodwill arising on acquisitions. The derivation of non-GAAP measures from the equivalent reported measures is explained in the ‘Footnotes to Financial Highlights’ on page 4.
For the above footnotes, see ‘Footnotes to Financial Highlights’ on page 4.
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FinancialHighlights(continued)
Constant currency
Constant currency comparatives in respect of 2003 and 2002, used in the 2004 and 2003 commentaries respectively, are computed by retranslating into US dollars:
No adjustment is made to the exchange rates used to translate foreign currency denominated assets and liabilities into the functional currency of any HSBC branches, subsidiary undertakings, joint ventures and associates.
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3
Five-year comparison (continued)
Amounts in accordance with US GAAP
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Cautionary Statement regarding Forward-Looking Statements
This Annual Reportcontains 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)
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Information about the Enforceability of Judgements made in the United States
In addition, awards of punitive damages in actions brought in the United States or elsewhere may be unenforceable in the United Kingdom. The enforceability of any judgement in the United Kingdom will depend on the particular facts of the case as well as the laws and treaties in effect at the time.
Exchange Controls and Other Limitations affecting Equity Security Holders
There are currently no UK laws, decrees or regulations which would prevent the import or export of capital or remittance of distributable profits by way of dividends and other payments to holders of HSBC Holdings’ equity securities who are not residents of the United Kingdom. There are also no restrictions under the laws of the United Kingdom or the terms of the Memorandum and Articles of Association of HSBC Holdings concerning the right of non-resident or foreign owners to hold HSBC Holdings’ equity securities or, when entitled to vote, to do so.
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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$190 billion at 31 December 2004.
Headquartered in London, HSBC operates through long-established businesses and has an international network of over 9,800 offices in 77 countries and territories in five geographical regions: Europe; Hong Kong; the rest of Asia-Pacific, including the Middle East and Africa; North America; and South America. Within these regions, a comprehensive range of financial services is offered to personal, commercial, corporate, institutional, investment and private banking clients. HSBC manages its business through the following customer groups: Personal Financial Services; Commercial Banking; Corporate, Investment Banking and Markets; and Private Banking. Although part of Personal Financial Services, the consumer finance business originated by HSBC Finance Corporation is treated as distinct and has accordingly been separately identified. Services are delivered through businesses which usually operate as domestic banks, typically with large retail deposit bases and strong liquidity and capital ratios. In North America, HSBC Finance Corporation is one of the largest consumer finance companies in the US, and is substantially funded in the wholesale market.
The establishment of HSBC and its hexagon symbol as a uniform, consumer brand name has ensured that it has become an increasingly familiar sight across the world.
The founding member of HSBC, The Hongkong and Shanghai Banking Corporation Limited (‘The Hongkong and Shanghai Banking Corporation’), was established in Hong Kong and Shanghai in 1865. The bank expanded rapidly, with an emphasis on building up representation in China and the rest of the Asia-Pacific region, while also establishing a presence in the major financial and trading centres in Europe and America.
In the mid-1950s, The Hongkong and Shanghai Banking Corporation embarked on a strategy of pursuing profitable growth through acquisition as well as organic development – a combination that has remained a key feature of HSBC’s approach ever since.
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 the blending of local and international expertise.
The most significant developments are described below. Other acquisitions in 2004 are discussed in the ‘Financial Review’ on pages 26 to 178.
The Hongkong and Shanghai BankingCorporation purchased The Mercantile Bank of India Limited and The British Bank of the Middle East, now HSBC Bank Middle East Limited (‘HSBC Bank Middle East’) in 1959. In 1965, The Hongkong and Shanghai Banking Corporation acquired a 51 per cent interest (subsequently increased to 62.14 per cent) in Hang Seng Bank Limited (‘Hang Seng Bank’), consolidating its position in Hong Kong. Hang Seng Bank is the second-largest listed bank in Hong Kong by market capitalisation.
The Hongkong and Shanghai Banking Corporation entered the US market in 1980 by acquiring a 51 per cent interest in Marine Midland Banks, Inc. now HSBC USA, Inc. The remaining interest was acquired in 1987.
In 1981, The Hongkong and Shanghai Banking Corporation incorporated its existing Canadian operations. HSBC Bank Canada has since made numerous acquisitions, expanding rapidly to become the largest foreign-owned bank in Canada and the seventh-largest overall at 31 December 2004.
From the early 1980s, The Hongkong and Shanghai Banking Corporation began to focus its acquisition strategy on the UK. In 1987, it purchased a 14.9 per cent interest in Midland Bank plc, now HSBC Bank plc (‘HSBC Bank’), one of the UK’s principal clearing banks. In 1991, HSBC Holdings plc was established as the parent company of the HSBC Group and, in 1992, it purchased the remaining interests in HSBC Bank. In connection with this acquisition, HSBC’s head office was transferred from Hong Kong to London in January 1993.
In 1997, HSBC assumed selected assets, liabilities and subsidiaries of Banco Bamerindus do Brasil S.A., now HSBC Bank Brasil S.A.-Banco Múltiplo (‘HSBC Bank Brazil’) following the intervention of the Central Bank of Brazil, and in Argentina completed the acquisition of Grupo Roberts, now part of HSBC Bank Argentina S.A. (‘HSBC Bank Argentina’).
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In December 1999, HSBC acquired Republic New York Corporation, subsequently merged with HSBC USA, Inc., and Safra Republic Holdings S.A. In July 2004, HSBC Bank USA, Inc. merged with HSBC Bank & Trust (Delaware) N.A. to form HSBC Bank USA.
To expand its base in the eurozone, in October 2000 HSBC completed its acquisition of 99.99 per cent of the issued share capital of Crédit Commercial de France S.A., now CCF S.A. (‘CCF’), a major French banking group.
In 2002, HSBC made further steps in expanding its presence in North America, completing the acquisition of 99.59 per cent of Grupo Financiero Bital, S.A. de C.V. (now Grupo Financiero HSBC, S.A. de C.V. (‘HSBC Mexico’)), the fifth-largest banking group in Mexico measured by assets and the third by customer deposits.
Mainland China remains a critical long-term growth area for the Group. In 2002, HSBC completed the acquisition of a 10 per cent equity stake in Ping An Insurance Company of China Limited (‘Ping An Insurance’). Ping An Insurance is the second-largest life insurer and the third-largest property and casualty insurer in mainland China. In June 2004 Ping An Insurance listed its shares through an initial public offering (‘IPO’) in Hong Kong. HSBC invested a further US$168 million, reducing its holding to 9.99 per cent.
In March 2003, HSBC acquired Household International, Inc. which, in December 2004, changed its name to HSBC Finance Corporation. HSBC Finance Corporation offers HSBC national coverage in the US for consumer lending, credit cards and credit insurance through various distribution channels.
Also in 2003, HSBC acquired assets in Brazil, including all the shares of Banco Lloyds TSB S.A.-Banco Múltiplo and a consumer finance company, Losango Promotora de Vendas Limitada (‘Losango’).
In February 2004, the acquisition of The Bank of Bermuda Limited (‘Bank of Bermuda’) was completed for US$1.2 billion, adding a strong position in the local banking market in Bermuda and significant scale and geographical spread to HSBC’s existing international funds administration, private banking, trust and payments and cash management businesses.
In May 2004, Hang Seng Bank acquired 15.98 per cent of Industrial Bank Co. Limited (‘Industrial Bank’) for US$208 million. With over 260 outlets in mainland China, Industrial Bank is one of only 10 national joint-stock banks, and had total assets of approximately US$23 billion at 31 December 2003.
In June 2004, HSBC acquired 14.62 per cent of UTI Bank in India for US$68 million. With over 250 branches, UTI has the second largest retail banking network amongst Indian private sector banks.
In August 2004, HSBC completed the largest single equity investment in a mainland China bank by a foreign bank when it acquired 19.9 per cent of Bank of Communications Limited (‘Bank of Communications’) for US$1,747 million. Bank of Communications is mainland China’s fifth largest bank, with assets of US$112 billion and approximately 2,700 branches in 137 cities in mainland China as at 31 December 2003.
In November 2004, HSBC completed the acquisition of 100 per cent of Marks and Spencer Retail Financial Services Holdings Limited, which trades as Marks and Spencer Money (‘M&S Money’) for US$1,044 million, M&S Money is one of the UK’s top 10 credit card providers.
In 2005, the Group expects consumer spending growth to slow across much of the Western world, bringing increased competition and pricing pressure on available business. The slowdown in consumer spending is expected to be reflected in a heightened focus on efficiency and economies of scale in the corporate sector, which may trigger increased merger and acquisition activity, a trend already evident in 2005. The pressure to reinforce personal long-term savings and tighten fiscal discipline, as government responsibility for pension and healthcare programmes is clarified, are likely to contribute to slower consumer spending in the western world.
By contrast, in emerging markets such as Brazil, Mexico, India and the Association of South East Asian Nations (‘ASEAN’) countries, relatively stable currencies and historically low interest rates are expected to continue to promote consumer activity, fuelling domestic growth and reducing export dependence. Mainland China is expected to continue to play an increasingly important role, not only through its burgeoning exports, but also as a major and growing market for commodity producing countries and for those developed countries that are supplying the technology, equipment and services to support its economic expansion.
The Group is alive to the changing nature of the global economy and the accelerating pace of change, and monitors the impact on sentiment and consumer spending of strong domestic property prices, which in many markets are proving resilient to rising interest rates. While such resilience is understandable in the context of historically low nominal interest rates and a generally limited appetite for alternative investment opportunities, in the long run property prices reflect income growth and, therefore, a correction in some markets cannot be discounted.
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Description of Business (continued)
Against this backdrop, HSBC expects to focus on building its businesses where it has comparative advantage. HSBC also expects its lending to consumers around the world to continue to rise as a proportion of total lending, partly reflecting domestic growth trends and credit demand in emerging markets, but also in response to the introduction of its US consumer finance model, with its emphasis on real estate secured lending and its scale advantages in credit card lending, to new geographical markets. In North America, HSBC expects its business to grow as the US economy demonstrates its flexibility and responds to the lower value of the dollar.
At the end of 2003, HSBC launched ‘Managing for Growth’, a strategic plan that provides HSBC with a blueprint for growth and development during the next five years. The strategy is evolutionary, not revolutionary. It builds on HSBC’s strengths and it addresses the areas where further improvement is considered both desirable and attainable.
Management’s vision for the Group remains consistent: HSBC aims to be the world’s leading financial services company. In this context, ‘leading’ means preferred, admired and dynamic, and being recognised for giving the customer a fair deal. HSBC will strive to secure and maintain a leading position within each of its customer groups in selected markets.
HSBC will concentrate on growing earnings over the long term at a rate which will place it favourably when compared with its peer group. It will also focus on investing in its delivery platforms, its technology, its people and its brand to support the future value of HSBC as reflected in its comparative stock market rating and total shareholder return (‘TSR’). HSBC remains committed to benchmarking its performance by comparison with a peer group. For full details of the benchmark, see footnote 6 in the ‘Footnotes to Financial Highlights’ on page 4.
HSBC’s core values are integral to its strategy, and communicating them to customers, shareholders and employees is intrinsic to the plan. These values comprise an emphasis on long-term, ethical client relationships; high productivity through teamwork; a confident and ambitious sense of excellence; being international in outlook and character; prudence; creativity and customer focused marketing.
The plan also reaffirms HSBC’s recognition of its corporate social responsibility (‘CSR’). HSBC has always aspired to the highest standards of conduct, recognises its wider obligations to society and believes there is a strong link between CSR and long-term success. Moreover, the pressures to comply with public expectations across a wide spectrum of social, ethical and environmental issues are growing rapidly. The strategy therefore calls for a renewed emphasis on CSR and for increased external communication of the Group’s CSR policies and performance, particularly on education and the environment, which will remain the principal beneficiaries of HSBC’s philanthropic activities.
HSBC’s new plan is led by customer groups, and specific strategies will be implemented for each of them. HSBC believes that by organising its internal and external reporting around customer groups, it reinforces to all its employees the Group’s customer focus.
Key elements in achieving HSBC’s objectives for its customer groups will be accelerating the rate of growth of revenue; developing the brand strategy further; improving productivity; and maintaining the Group’s prudent risk management and strong financial position. Developing the skills of HSBC’s staff will also be critical and it will be necessary to ensure that all employees understand how they can contribute to the successful achievement of the Group’s objectives. Employees who do make such a contribution will be rewarded accordingly.
Operational management will continue to be organised geographically under four regional intermediate head offices, with business activities concentrated in locations where growth and critical mass are to be found.
The plan contains eight strategic imperatives:
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At 31 December 2004, HSBC’s customers were served by 253,000 employees (including part-time employees) worldwide, compared with 232,000 at 31 December 2003 and 192,000 at 31 December 2002. The main centres of employment are the UK with 56,000 employees, the US 43,000, Brazil 28,000, Hong Kong 26,000, Mexico 20,000 and France 14,000. HSBC negotiates with recognised unions, and estimates that approximately 40 per cent of its employees are unionised. The highest concentrations of union membership are in Brazil, France, India, Malaysia, Malta, Mexico, the Philippines, Singapore and the UK. As a result of well-developed communications and consultation programmes, HSBC has not experienced any material disruptions to its operations from labour disputes during the past five years.
In support of its new strategy, HSBC focuses on attracting, developing and motivating the very best individuals, particularly graduates, and on encouraging talent internally. Emphasis is placed on performance management; differentiated rewards; succession planning; diversity; and learning and development, with priority accorded to enhancing sales and relationship management skills. HSBC continues to endeavour to ensure that employees’ engagement with the business is maximised as this is beneficial to shareholders, employees and customers alike.
HSBC’s diverse workforce represents a significant competitive advantage. The broad cultural mix and increasing cross-border mobility of its employees enables HSBC to resource operations with individuals who have detailed knowledge of local markets and of HSBC globally. This strengthens international networks and facilitates the sharing of best practices. In addition, a continuing focus on policies that encourage an inclusive working environment and the availability of career opportunities for all is critical to HSBC being an employer of choice. HSBC seeks to maintain an employee profile that reflects its customer base.
HSBC operates in a highly competitive and international business environment. Through its network of international operations, it has the advantage of being able to respond to the availability of talented employees wherever they are, in order to enhance customer service and improve productivity. As education levels improve globally and as investments in technology and telecommunications facilitate access at competitive cost to hitherto untapped resources, the balance of employment will change and global resource centres of excellence will emerge. Job losses may arise in some countries, but HSBC has a good record of communicating openly and sensitively in these circumstances, and of reassigning employees and minimising compulsory redundancies wherever possible.
HSBC seeks to promote and recruit the most able people and attaches great importance to cultivating its own talent. Resources have been set aside to ensure a supply of talented individuals to meet business succession needs, with support provided for these employees in the form of career enhancement and personal development programmes. In addition, HSBC recognises that there are lessons to be learned from other successful businesses, and will recruit from non-banking industries where appropriate.
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Description of Business(continued)
Profit before tax by customer group (reported basis)
Year ended 31 December 2004
Total assets1by customer group
Personal Financial Services
Personal Financial Services provides some 41 million individual and self-employed customers with a wide range of banking and related financial services. The precise nature of the products and services provided is, to some extent, driven by local regulations, market practices, and the market positioning of HSBC’s local business. Typically, products provided include current and savings accounts, mortgages and secured and unsecured personal loans, credit cards, and local payments services.
Personal Financial Services customers prefer to conduct their financial business at times convenient to them, using a range of delivery channels. The availability of a number of such channels, including traditional and automated branches and service centres, self-service terminals, call centres and internet capabilities, facilitates the exercise of choice increasingly effectively.
Delivering the right products and service propositions for particular target markets is a fundamental requirement in any retail service business, and market research and customer analysis is key to developing an in-depth understanding of significant customer segments and their needs. This understanding of the customer ensures that Customer Relationship Management (‘CRM’) systems are effectively used to identify and fulfil sales opportunities, and to manage the sales process.
HSBC Premier is a premium banking proposition for HSBC’s more valuable retail customers. HSBC Premier provides personalised relationship management, 24-hour priority telephone access, global travel assistance and cheque encashment facilities. There are now over one million HSBC Premier customers, who can use more than 250 specially designated Premier branches and centres in 33 countries and territories, either when visiting, or on a more permanent basis if they require a banking relationship in more than one country.
Insurance and investment products play an important need in meeting the requirements of customers. Insurance products sold and distributed by HSBC through its branch networks include loan and health protection life, property, casualty and health insurance, and pensions. HSBC acts both as a broker and an underwriter, and sees continuing opportunities to deliver insurance products to its personal customer base. HSBC also makes available a wide range of investment products through its branch networks. Third party funds and proprietary funds are available, and include traditional ‘long only’ equity and bond funds, structured funds that provide capital security as well as an opportunity for enhanced return, and ‘fund of funds’ products which offer customers the ability to diversify their investment across a range of best in class fund managers selected through a rigorous and objective selection process. Comprehensive financial planning services covering customers’ investment; retirement, personal and asset protection needs are offered through specialist financial planning managers.
High net worth individuals and their families who choose the differentiated services offered within Private Banking are not included in this customer group.
Consumer Finance
Within Personal Financial Services, HSBC Finance Corporation’s operations in the US, the UK and Canada make credit available to customer groups not well catered for by traditional banking operations, facilitate point-of-sale credit in support of retail purchases and support major affiliate credit card programmes. At 31 December 2004 HSBC Finance Corporation had over 57 million customers with total gross advances of US$141.9 billion. Consumer Finance products are offered through the following businesses of HSBC Finance Corporation:
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The consumer lending business is one of the largest sub-prime home equity originators in the US, marketed under the HFC and Beneficial brand names through a network of over 1,300 branches in 46 states, direct mail, telemarketing, strategic alliances and the internet. ‘Sub-prime’ is a US categorisation which describes customers who have limited credit histories, modest incomes, high debt-to-income ratios, high loan-to-value ratios (for real estate secured products) or have experienced credit problems caused by occasional delinquencies, prior charge-offs, bankruptcy or other credit-related actions. Consumer lending products include secured and unsecured loans such as first and second lien closed-end mortgages, open-ended home equity loans, personal loans and retail finance contracts. Consumer lending also offers a near-prime mortgage product which was first introduced in 2003 to broaden the range of customers to which its products are relevant.
The mortgage services business purchases first and second lien residential mortgage loans, including open-end home equity loans, from a network of over 200 unaffiliated third party lenders (‘correspondents’) in the US. Purchases are primarily of pools of loans (‘bulk acquisitions’), but also include individual loan portfolios (‘flow acquisitions’), made under predetermined underwriting guidelines. Forward commitments are offered to selected correspondents to strengthen relationships and create a sustainable growth channel for this business. HSBC Finance Corporation, through its subsidiary, Decision One Mortgage Company, also offers mortgage loans referred by mortgage brokers.
The retail services business is one of the largest providers of third party private label credit cards (or store cards) in the US based on receivables outstanding, with over 70 merchant relationships and 15.5 million active customer accounts.
In addition to originating and refinancing motor vehicle loans, HSBC Finance Corporation’s motor vehicle finance business purchases retail instalment contracts of US customers who do not have access to traditional prime-based lending sources. The loans are largely sourced from a network of approximately 5,200 motor dealers.
The credit card services business is the sixth largest issuer of MasterCard®1 and Visa®1 credit cards in the US, and also includes affiliation cards such as the GM Card® and the AFL-CIO Union Plus®2 credit card. Also, credit cards issued in the name of Household Bank and Orchard Bank brands are offered to customers under-served by traditional providers, or are marketed primarily through merchant relationships established by the retail services business.
A wide range of insurance services is offered by HSBC Finance Corporation to customers in the US, the UK and Canada who are typically not well served by traditional sources.
The taxpayer financial services business accelerates access to funds for US taxpayers who are entitled to tax refunds. The business is seasonal with most revenues generated in the first three months of the year.
HSBC Finance Corporation’s business in the UK provides mid-market consumers with mortgages, secured and unsecured loans, insurance products, credit cards and retail finance products. It concentrates on customer service through its 216 HFC Bank and Beneficial branches, and finances consumer electronic goods, through its retail finance operations. In Canada, similar products are offered, and deposits are taken, through HSBC Finance Corporation’s trust operations there.
Commercial Banking
HSBC is one of the world’s leading banks in the provision of financial services and products to small, medium-sized and middle market businesses, with over two million customers including sole proprietors, partnerships, clubs and associations, incorporated businesses and publicly quoted companies.
At 31 December 2004, HSBC had total commercial customer account balances of US$137.8 billion and total commercial customer loans and advances, net of suspended interest and provisions for bad and doubtful debts, of US$129.9 billion.
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Commercial Banking places particular emphasis on multi-disciplinary and geographical collaboration in meeting its commercial customers’ needs, thereby differentiating, broadening and enhancing its offering. The range of products includes:
Payments and cash management: HSBC is a leading provider of payments, collections, liquidity management and account services worldwide, enabling commercial customers to manage their cash efficiently on a global basis. HSBC’s extensive network of offices and strong domestic capabilities in many countries, including direct access to local clearing systems, enhance its ability to provide high-quality cash management services.
Treasury and capital markets: Commercial Banking customers have long been volume users of the Group’s foreign exchange capabilities. These are now being supplemented with more sophisticated currency and interest rate options.
Investment Banking: A small number of Commercial Banking customers need occasional investment banking advisory support. Co-operation with Corporate, Investment Banking and Markets ensures that in most key markets such requirements can be serviced internally.
Wealth management services: These include advice and products related to savings and investments. They are provided to Commercial Banking customers and their employees through HSBC’s worldwide network of branches and business banking centres.
Insurance: HSBC offers insurance protection, employee benefits programmes and pension schemes designed to meet the needs of businesses and their employees, and to help fulfill the applicable statutory obligations of client companies. These products are provided by HSBC either as an intermediary (broker, agent or consultant) or as a supplier of in-house or third party offerings. Products and services include a full range of commercial insurance, including pension schemes; healthcare schemes; ‘key man’ life insurance; car fleet; goods in transit; trade credit protection; risk management and insurance due diligence reviews; and actuarial/employee benefit consultancy.
Trade services: HSBC has more than 130 years of experience in trade services. A complete range of traditional documentary credit, collections and financing products is offered, as well as specialised services such as insured export finance, international factoring and forfaiting. HSBC’s expertise is supported by highly automated systems.
Leasing, finance and factoring: HSBC provides leasing, finance (including instalment and invoice finance) and domestic factoring services, 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.
primarily to commercial customers in the UK, Hong Kong and France. Special divisions have been established to finance vehicles, plant and equipment, materials handling, machinery and large complex leases.
Corporate, Investment Banking and Markets
HSBC’s Corporate, Investment Banking and Markets business provides tailored financial solutions to major government, corporate and institutional clients worldwide. Managed as a global business, this customer group operates a long-term relationship management approach to build a full understanding of clients’ financial requirements. Sectoral client service teams comprising relationship managers and product specialists develop financial solutions to meet individual client needs. With dedicated offices in over 50 countries and with access to HSBC’s worldwide presence and capabilities, this business serves subsidiaries and offices of its clients on a global basis.
Products and services offered include:
Global Markets: HSBC’s operations in Global Markets consist of treasury and capital markets services for supranationals, central banks, corporations, institutional and private investors, financial institutions and other market participants. Products include:
Global Transaction Banking: This includes international, regional and ‘in-country’ payments and cash management services; trade services, particularly the specialised ‘supply chain’ product; and securities services, where HSBC is one of the world’s leading custodians providing custody and clearing services and funds administration to both domestic and cross-border investors. Factoring and banknotes services are also provided by specialist units.
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leasing finance with an emphasis on ‘large ticket’ transactions; and
Private Banking
HSBC is one of the world’s leading international private banking groups with total client funds under management of US$178 billion at 31 December 2004. 2004 was the first year in which the name ‘HSBC Private Bank’ was used for worldwide marketing of its principal private banking business.
Drawing on the strength of the HSBC Group and utilising the best products from the marketplace, Private Banking works with its clients to offer both traditional and innovative ways to manage and preserve wealth whilst optimising returns. Products and services offered include: Investment services: These comprise both advisory and discretionary investment services. A wide range of investment vehicles is covered, including bonds, equities, derivatives, structured products, mutual funds and hedge funds. Supported by six major advisory centres in Hong Kong, Singapore, Geneva, New York, Paris and London, Private Banking seeks to select the most suitable investments for clients’ needs and investment strategies.
Global wealth solutions: These comprise inheritance planning, trustee and other fiduciary services designed to protect existing wealth and create tailored structures to preserve wealth for future generations. Areas of expertise include trusts, foundations, charitable trusts, private investment companies, insurance vehicles and offshore structures.
Specialist advisory services: Private Banking offers expertise in several specialist areas of wealth management including tax advisory, family office advisory, charities and foundations, media, diamonds and jewellery, and real estate. Specialist advisers are available to deliver products and services that are tailored to meet the full range of high net worth clients’ individual financial needs.
General banking services: These are the ancillary services necessary for the management of clients’ finances. They include treasury and foreign exchange, offshore and onshore deposits, tailor-made loans and internet banking. The skills and products available in HSBC’s other customer groups, such as corporate banking, investment banking and insurance, are also offered to Private Banking clients.
Private Banking services are also provided by HSBC Guyerzeller and HSBC Trinkaus & Burkhardt.
Profit before tax split by geographical region(reported basis)
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Total assets1split by geographical region
As at 31 December 2004
Additional information regarding business developments in 2004, as well as comparative information relating to developments in 2003, may be found in the ‘Financial Review’ on pages 26 to 178.
Europe
HSBC’s principal banking operations in Europe are HSBC Bank, CCF and HSBC Private Bank (Suisse). HSBC provides a wide range of banking, treasury and financial services to personal, commercial and corporate customers in the UK, France, and across continental Europe, with strong coverage in Turkey and Malta. HSBC’s strategy is to build long-term relationships, attracting customers through value-for-money products and high-quality service.
Hong Kong
HSBC’s principal banking subsidiaries in Hong Kong are The Hongkong and Shanghai Banking Corporation and Hang Seng Bank. The Hongkong and Shanghai Banking Corporation is the largest bank incorporated in Hong Kong and is HSBC’s flagship bank in the Asia-Pacific region. It is one of Hong Kong’s three note-issuing banks, accounting for more than 63 per cent by value of banknotes in circulation in 2004.
Rest of Asia-Pacific (including the Middle East)
The Hongkong and Shanghai Banking Corporation offers personal, commercial, corporate and investment banking and markets services in mainland China. The bank’s network spans 12 major cities, comprising ten branches, three sub-branches and two representative offices. Hang Seng Bank offers personal and commercial banking services and operates five branches, two sub-branches, and two representative offices in seven cities in mainland China.
Outside Hong Kong and mainland China, the HSBC Group conducts business in the Asia-Pacific region primarily through branches and subsidiaries of The Hongkong and Shanghai Banking Corporation, with particularly strong coverage in India, Indonesia, Korea, Singapore and Taiwan. HSBC’s presence in the Middle East is led by HSBC Bank Middle East, the largest foreign-owned bank in the region; in Australia by HSBC Bank Australia Limited; and in Malaysia by HSBC Bank Malaysia, which has the second largest presence of any foreign-owned bank in the country.
North America
HSBC’s North American business covers the United States, Canada, Mexico, Bermuda and Panama. Operations are primarily conducted in the US through HSBC Bank USA in New York State and HSBC Finance Corporation, based outside Chicago. HSBC’s Canadian and Mexican operations are run through HSBC Bank Canada and HSBC Mexico, respectively.
South America
HSBC’s operations in South America principally comprise HSBC Bank Brazil and HSBC Bank Argentina. HSBC operates the tenth largest insurance business in Brazil, and offers consumer finance products there through its subsidiary, Losango. HSBC also has one of the largest insurance businesses in Argentina, HSBC La Buenos Aires and, through HSBC Máxima and HSBC New York Life, offers pensions and life assurance in Argentina.
HSBC faces strong competition in all the markets it serves. It competes with other financial institutions, including commercial banks; consumer finance companies; savings and loan associations; credit unions; retailers; brokerage firms; and investment companies. In investment banking, HSBC faces competition from both investment banks and the investment banking operations of other commercial banks.
Global factors
Consolidation in the banking industry: Consolidation of banks and financial services companies has been a continuing trend over many years. This trend, at both local and international levels, has created a larger number of banks, financial services companies and mono-line providers capable of competing directly with HSBC across a wide range of services.
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Limited market growth: In HSBC’s largest markets, the UK, the US and Hong Kong, there is generally limited capacity for market growth in the provision of basic banking services. However, there is potential for growth in the provision of a wider array of financial services to both existing and new customers, and for expansion into new market and customer segments, particularly in the field of consumer finance.
Advances in technology: As the internet and related technologies has continued to mature, the delivery of financial services and banking products through both remote and automated delivery channels has introduced both new competitive challenges and opportunities for HSBC. While specialist providers and non-financial organisations can deliver a growing range of services across a wide variety of electronic channels, mainstream banks are also competing fiercely for the growing number of customers who now prefer to use this medium. As these technologies mature, brand differentiation becomes more difficult and costly. HSBC continues to offer customers access to its full range of services in the manner they most prefer. Internet, interactive TV, mobile phone, WAP and telephone banking all complement the more traditional branch network.
Regional factors
UK
While overall market growth has remained relatively limited the continuing demand for consumer credit in the past few years has intensified competition among the established players and attracted a number of new entrants, particularly from non financial services providers. Competition from mono-line providers of both consumer lending and savings products has grown in recent years often through the use of attractive pricing to capture market share.
Consolidation in the market for credit and charge cards has increased in recent years as retailers look to outsource their finance company operations to established players rather than running them in-house. This has led to a greater concentration of the industry in the hands of a relatively small number of providers and attracted the attention of the Office of Fair Trading (‘OFT’).
In March the OFT referred the supply of store card services to the Competition Commission following a study of the £4.8 billion industry. The study concluded that there were features of the sector, both in the supply of store card credit to consumers and in the supply of store card services, that appeared to prevent, restrict or distort competition.
The Competition Commission, which published its initial statement of issues in September, is expected to provide provisional findings in the first quarter of 2005 and publish its final report by early July.
In November, the OFT issued a statement of objections against the agreement between Mastercard’s UK members, which includes HSBC Bank, on the multilateral interchange fees charged on credit and charge card transactions in the UK. The statement alleged that parties to the agreement have infringed competition law and invites representations from members before the OFT makes a final decision.
In mid December the Department of Trade and Industry announced a new Consumer Credit Bill which seeks to create a clearer and more competitive market for credit by bringing in new rules to give consumers better protection and more rights.
France
The French government reformed the pension system in France in order to reduce the state’s long-term pension obligations. Retirement ages were increased and pension entitlements lowered. The changes are being introduced over a number of years to allow people to adapt to the new system. To encourage people to save for their retirement, the government has introduced both individual and collective pension plans with tax advantages for scheme members. With clarification of the rules at the start of 2005, these plans are now being marketed by financial institutions in France. HSBC will earn commissions on the sales of the pension plans and earn management fees from managing the funds.
The government also created Fonds de Reserve pour les Retraites, a pension body for state employees, and sought tenders for management of €16bn of funds. HSBC Asset Management Europe SA won two of the tenders to manage €1.2 billion of assets for a small caps fund and a bonds fund.
Caixa Bank won its case at the European Court of Justice against the French government on the law forbidding banks from paying interest on current accounts. As a result, the law will be withdrawn in 2005, allowing French banks to pay interest on these accounts. Major banks are examining the implications of the ruling.
The European Commission is investigating GIE Cartes Bancaire, the partnership operating the credit card system in France, and nine participating banks. Although a member of the GIE, CCF is not currently under investigation.
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Following a French government review of banking charges, banks adopted a new code of practice whereby they both stopped charging for the closure of accounts and became generally more transparent in the pricing of their services. CCF already notifies customers of its tariffs and the introduction of this code is expected to have little effect.
The Hong Kong economy in 2004 continued the strong growth seen in the second half of 2003, driven by regional trade flows, and the strength of the US economic recovery.
This resulted in falling unemployment and bankruptcies, and rising property prices, contributing to an increase in private consumption.
Other than in the trade sector, however, demand for credit remained muted, with individuals and enterprises slow to increase borrowings, reflecting nervousness about the sustainability of the economic recovery.
Interest rates in the economy remained low, as with loan demand subdued, the market was unable to absorb external funds.
Against this backdrop, there was fierce competition in traditional core banking products, particularly in the mortgage market, further depressing margins and prices.
To address these pressures, banks have sought to diversify revenue streams, and there has been significant growth in the development of wealth management and insurance products.
The introduction of a commercial credit reference agency in November 2004, is expected to further intensify competition for quality customers and assets.
Hong Kong banks continue to maintain a regular dialogue with Chinese financial institutions as the financial sector continues to liberalise ahead of WTO in 2006. It is expected that this will be a continued source of growth in 2005.
The competitive environment in the Rest of Asia Pacific varies greatly across the region. Depending
on the maturity of the markets, level of regulation and number of financial services providers, HSBC competes with a range of local banks, non-bank financial services companies, and the branches of foreign entities. An emerging trend in recent years has been the growth of pan-regional players, as the larger banks in several countries have expanded through acquisition and organic growth beyond their local markets. These emerging regional banks provide a new level of competition for HSBC as they build critical mass. Competition, therefore, remains intense throughout the region in all the customer groups served by HSBC. However, in many countries the increasing sophistication of the relatively young population continues to provide HSBC with further opportunities for growth.
In the US, continuing mergers and acquisitions in the banking, insurance and securities industries are bringing consolidation and a blending of services. Consolidation of the banking sector remained an issue throughout 2004, with a greater focus on national networks and retail branch banking. HSBC Bank USA also faced vigorous competition from a large number of non-bank suppliers of financial services, which have found new and effective ways to meet the financial demands of customers. Many of these institutions are not subject to the same laws and regulations imposed on HSBC Bank USA. These continuing trends will increase competitive pressures.
HSBC Finance Corporation competes with a wide array of banks, thrifts, insurance companies, credit unions, mortgage lenders and brokers and other providers of consumer credit for consumers who generally do not conform to US banking industry requirements. It competes by expanding its customer base through portfolio acquisitions or alliance and co-branding opportunities, by offering a variety of consumer loan products and by maintaining a strong service orientation.
In Canada, the financial services industry continues to be dominated by the five largest banks in the country. However, the market remains highly competitive as other banks, insurance companies and financial institutions offer a range of comparable products and services. While merger activity among the largest banks in Canada remains a possibility, major financial institutions continue to look elsewhere for growth.
Consolidation of the banking industry in Mexico has been a significant feature in recent years with over 76 per cent of banking assets and 79 per cent of
deposits owned by the subsidiaries of five major foreign banks. However, with a population of approximately 100 million, the majority of whom do not use the banking system, Mexico offers substantial growth opportunities in the retail sector in the medium to long term. HSBC, with its extensive branch network and growing young customer base, is well positioned to take full advantage of this economic and competitive environment.
The Brazilian banking industry remains dominated by a combination of large state-owned banks, privately-owned local banks, and subsidiaries of foreign institutions, including HSBC. The top ten banking groups account for around two thirds of total financial system assets.
Although 2004 saw little consolidation among the larger players, the year was characterised by continued positioning for growth in the consumer finance market. Lending to individuals grew by a third in 2004, and demand is expected to remain strong over the medium term, supported by a more buoyant economy. With a population of 183 million, and over 45 per cent of the economically active population estimated to be ‘unbanked’, banks are looking to increase their capacity to reach non-traditional segments, particularly through partnerships with retailers. HSBC Bank Brazil is at the forefront of this trend. There was strong competition among banks to agree alignments with retail stores, particularly those with their own in-house financing arrangements. HSBC experienced success in this area concluding an agreement with Panashop, a major electronic and white goods supplier.
Competition increased in this sector with competitors developing new, individually branded consumer finance propositions. Following the successful integration of Losango, HSBC Bank Brazil continued to expand and develop its leading position in the store and personal loan market through the acquisition of the Valeu and CrediMatone franchises.
Following the collapse of a medium sized Brazilian commercial bank, there was a flight to quality and smaller banks experienced increasing difficulties in funding their asset growth. There was a spate of alliances involving small banks, and HSBC boosted its presence in the payroll loan market through a partnership with Banco Schahin, announced in December 2004. Whilst the environment is expected to remain competitive, HSBC’s extensive network of branches and partner stores, and continuous investment in branding and service quality, will ensure that the Group is able to benefit from growth in the demand for financial services.
In Argentina, international financial groups provide the greatest competition in core banking services and insurance, with most of the major banks in significant foreign ownership. HSBC, with its branch network, sales force and substantial local insurance business, is one of the few companies capable of providing a comprehensive range of financial services to its clients.
Since the crisis in 2001, Argentina’s banking industry has consolidated with some institutions, generally smaller banks, leaving the country and a number of the larger foreign-owned financial institutions re-capitalising their local operations. As confidence has begun to return, the financial sector has seen growth in loans to the private sector and deposits. The insurance industry has also recovered, with a significant increase in premiums that has helped the industry to become profitable for the first time in a number of years.
HSBC continues to monitor progress being made with the economic and political reforms necessary to build confidence in Argentina, and evaluates carefully the opportunities and risks within the financial services industry there.
Governance, Regulation and Supervision
Governance
With the listings of its ordinary shares in London, Hong Kong, New York, Paris and Bermuda, HSBC Holdings complies with the relevant requirements for listing and trading on each of these exchanges. In the UK, these are the Listing Rules of the Financial Services Authority; in Hong Kong, The Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited; in the US, where the shares are traded in the form of ADS’s, HSBC Holdings’ shares are registered with the US Securities and Exchange Commission and it is subject to the reporting and other requirements of the US Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, and the New York Stock Exchange’s Listed Company Manual, in each case as applied to foreign private issuers. In France and Bermuda HSBC Holdings is subject to the listing rules of Euronext, Paris and the Bermuda Stock Exchange applicable to companies with secondary listings.
A statement of HSBC’s compliance with the code provisions of the Combined Code on corporate governance appended to the Listing Rules of the Financial Services Authority and with the provisions of Appendix 14 to the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited is set out in the Report of the Directors.
Regulation and Supervision
HSBC’s operations throughout the world are regulated and supervised by approximately 467 different central banks and regulatory authorities in those jurisdictions in which HSBC has offices, branches or subsidiaries. HSBC estimates the cost of this regulation and supervision to be approximately US$500 million in 2004. These authorities impose a variety of requirements and controls covering, inter alia, capital adequacy, depositor protection, market liquidity, governance standards, customer protection (for example, fair lending practices, product design, and marketing and documentation standards), and social responsibility obligations (for example, anti-money laundering and anti-terrorist financing measures). In addition, a number of countries in which HSBC operates impose rules that affect, or place limitations on, foreign or foreign-owned or controlled banks and financial institutions. The rules include restrictions on the opening of local offices, branches or subsidiaries and the types of banking and non-banking activities that may be conducted by those local offices, branches or subsidiaries; restrictions on the acquisition of local banks or regulations requiring a specified percentage of local ownership; and restrictions on investment and other
financial flows entering or leaving the country. The supervisory and regulatory regimes of the countries where HSBC operates will determine to some degree HSBC’s ability to expand into new markets, the services and products that HSBC will be able to offer in those markets and how HSBC structures specific operations.
The Financial Services Authority (‘FSA’) supervises HSBC on a consolidated basis. In addition, each operating bank, finance company or insurance operation within HSBC is regulated by local supervisors. The primary regulatory authorities are those in the UK, Hong Kong and the US, the Group’s principal areas of operation.
In June 2004, the Basel Committee on Banking Supervision issued a new capital adequacy framework to replace the Basel Accord of 1988 in the form of a final Accord (commonly known as ‘Basel II’). Details of how this will affect HSBC are set out on page 175.
United Kingdom regulation and supervision
UK banking and financial services institutions are subject to multiple regulations. The primary UK statute is the Financial Services and Markets Act 2000 (‘FSMA’). Other UK primary and secondary banking legislation is derived from European Union (‘EU’) directives relating to banking, securities, investment and sales of personal financial services.
The FSA is responsible for authorising and supervising UK financial services institutions and regulates all HSBC’s businesses in the UK which require authorisation under FSMA. This ranges from retail life and pensions business to custody, branch share dealing, and treasury and capital markets activity. In addition, from 31 October 2004 and 14 January 2005 respectively, mortgage business and general insurance business became regulated activities. HSBC Bank is HSBC’s principal authorised institution in the UK.
FSA rules establish the minimum criteria for authorisation for banks and financial services businesses in the UK. They also set out reporting (and, as applicable, consent) requirements with regard to large individual exposures and large exposures to related borrowers. In its capacity as supervisor of HSBC on a consolidated basis, the FSA receives information on the capital adequacy of, and sets requirements for, HSBC as a whole. Further details on capital measurement are included in ‘Capital Management’ on pages 176 to 177. The FSA has the right to object, on prudential grounds, to persons who hold, or intend to hold, 10 per cent or more of the voting power of a financial institution.
The regulatory framework of the UK financial services system has traditionally been based on co-operation between the FSA and authorised institutions. The FSA monitors authorised institutions through ongoing supervision and the review of routine and ad hoc reports relating to financial and prudential matters. The FSA may periodically obtain independent reports, usually from the auditors of the authorised institution, as to the adequacy of internal control procedures and systems as well as procedures and systems governing records and accounting. The FSA meets regularly with HSBC’s senior executives to discuss HSBC’s adherence to the FSA’s prudential guidelines. They also regularly discuss fundamental matters relating to HSBC’s business in the UK and internationally, including areas such as strategic and operating plans, risk control, loan portfolio composition and organisational changes, including succession planning.
UK depositors and investors are covered by the Financial Services Compensation Scheme which deals with deposits with authorised institutions in the UK, investment business and contracts of insurance. Institutions authorised to accept deposits and conduct investment business are required to contribute to the funding of the scheme. In the event of the insolvency of an authorised institution, depositors are entitled to receive 100 per cent of the first £2,000 (US$3,900) of a claim plus 90 per cent of any further amount up to £33,000 (US$63,800) (the maximum amount payable being £31,700 (US$61,300)). Payments under the scheme in respect of investment business compensation are limited to 100 per cent of the first £30,000 (US$58,000) of a claim plus 90 per cent of any further amount up to £20,000 (US$38,700) (the maximum amount payable being £48,000 (US$92,800)).
The EU reached final agreement on a new directive regarding the taxation of savings income on 3 June 2003. Under the directive, each member state, other than Austria, Belgium, and Luxembourg, will be required, beginning in 2005, to provide the tax authorities of each other member state with details of payments of interest or other similar income paid by a person within its jurisdiction to individuals resident in such other member state. Beginning on the same date, Austria, Belgium, and Luxembourg will impose a withholding tax on such income. The withholding tax rate will initially be 15 per cent, increasing to 20 per cent from 2008 and 35 per cent from 2011. Subject to future conditions being met, Austria, Belgium, and Luxembourg may cease to apply the withholding tax and instead comply with the automatic exchange of information rules applicable
to the other member states. Implementation of the directive is dependent upon Switzerland, Liechtenstein, San Marino and Andorra applying equivalent measures.
Hong Kong regulation and supervision
Banking in Hong Kong is subject to the provisions of the Banking Ordinance of Hong Kong (Chapter 155) (the ‘Banking Ordinance’), and to the powers, functions and duties ascribed by the Banking Ordinance to the Hong Kong Monetary Authority (the ‘Monetary Authority’). The principal function of the Monetary Authority is to promote the general stability and effective working of the banking system in Hong Kong. The Monetary Authority is responsible for supervising compliance with the provisions of the Banking Ordinance. The Banking Ordinance gives power to the Chief Executive of Hong Kong to give directions to the Monetary Authority and the Financial Secretary with respect to the exercise of their respective functions under the Banking Ordinance.
The Monetary Authority has responsibility for authorising banks, and has discretion to attach conditions to its authorisation. The Monetary Authority requires that banks or their holding companies file regular prudential returns, and holds regular discussions with the management of the banks to review their operations. The Monetary Authority may also conduct ‘on site’ examinations of banks, and in the case of banks incorporated in Hong Kong, of any local and overseas branches and subsidiaries. The Monetary Authority requires all authorised institutions to have adequate systems of internal control and requires the institutions’ external auditors, upon request, to report on those systems and other matters such as the accuracy of information provided to the Monetary Authority. In addition, the Monetary Authority may from time to time conduct tripartite discussions with banks and their external auditors.
The Monetary Authority, which may deny the acquisition of voting power of over 10 per cent in a bank, and may attach conditions to its approval thereof, can effectively control changes in the ownership and control of Hong Kong-incorporated financial institutions. In addition, the Monetary Authority has the power to divest controlling interests in a bank from a person if they are no longer deemed to be fit and proper, if they may otherwise threaten the interests of depositors or potential depositors, or if they have contravened any conditions specified by the Monetary Authority.
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Governance, Regulation and Supervision (continued)
The Monetary Authority may revoke authorisation in the event of an institution's non-compliance with the provisions of the Banking Ordinance. These provisions require, among other things, the furnishing of accurate reports.
The Banking Ordinance requires that banks submit to the Monetary Authority certain returns and other information and establishes certain minimum standards and ratios relating to capital adequacy (see below), liquidity, capitalisation, limitations on shareholdings, exposure to any one customer, unsecured advances to persons affiliated with the bank and holdings of interests in land, with which banks must comply.
Hong Kong fully implemented the capital adequacy standards established by the Basel Accord in 1989. The Banking Ordinance currently provides that banks incorporated in Hong Kong maintain a capital adequacy ratio (calculated as the ratio, expressed as a percentage, of its capital base to its risk-weighted exposure) of at least 8 per cent. For banks with subsidiaries, the Monetary Authority is empowered to require that the ratio be calculated on a consolidated basis, or on both consolidated and unconsolidated bases. If circumstances require, the Monetary Authority is empowered to increase the minimum capital adequacy ratio (to up to 12 per cent for fully-licensed banks and 16 per cent for deposit-taking companies and restricted-licence banks), after consultation with the bank.
The marketing of, dealing in and provision of advice and asset management services in relation to securities in Hong Kong are subject to the provisions of the Securities and Futures Ordinance of Hong Kong (Chapter 571) (the ‘Securities and Futures Ordinance’). Entities engaging in activities regulated by the Securities and Futures Ordinance are required to be licensed. The Monetary Authority is the primary regulator for banks involved in the securities business, while the Securities and Futures Commission is the regulator for non-banking entities.
US regulation and supervision
HSBC is subject to extensive federal and state supervision and regulation in the US. Banking laws and regulations of the Federal Reserve Board, the Federal Deposit Insurance Corporation (‘FDIC’) and the Office of the Comptroller of Currency (‘OCC’) govern many aspects of HSBC’s US business.
HSBC and its US operations are subject to supervision, regulation and examination by the Federal Reserve Board because HSBC is a bank holding company under the US Bank Holding
Company Act of 1956 (the ‘BHCA’) as a result of its ownership of HSBC Bank USA. HSBC Bank USA is a nationally-chartered commercial bank and a member of the Federal Reserve System. HSBC Bank USA is the surviving institution of the 1 July 2004 merger of HSBC Bank USA and HSBC Bank & Trust (Delaware) N.A. HSBC also owns Household Bank (SB), N.A. (‘Household Bank’), a nationally chartered ‘credit card bank’ which is also a member of the Federal Reserve System. Both HSBC Bank USA and Household Bank are subject to regulation, supervision and examination by the OCC. The deposits of HSBC Bank USA and Household Bank are insured by the FDIC and both banks are subject to relevant FDIC regulation. On 1 January 2004, HSBC formed a new company to hold all of its North American operations, including these two banks. This company, called HSBC North America Holdings Inc. (‘HNAH’) is also a ‘bank holding company’ ; under the BHCA, by virtue of its ownership and control of HSBC Bank USA.
The BHCA and the International Banking Act of 1978 (‘IBA’) impose certain limits and requirements on the US activities and investments of HSBC, HNAH, and certain companies in which they hold direct or indirect investments. HSBC is also a ‘qualifying foreign banking organisation’ under Federal Reserve Board regulations, and as such, may engage within the United States in certain limited non-banking activities and hold certain investments that would otherwise not be permissible under US law. Prior to 13 March 2000, the BHCA generally prohibited HSBC from acquiring, directly or indirectly, ownership or control of more than 5 per cent of the voting shares of any company engaged in the US in activities other than banking and certain activities closely related to banking. On that date HSBC became a financial holding company (‘FHC’) under the Gramm-Leach-Bliley Act (‘GLBA’) amendments to the BHCA, enabling it to offer a more complete line of financial products and services. Upon its formation, HNSH also registered as an FHC. HSBC and HNAH’s ability to engage in expanded financial activities as FHCs depend upon HSBC and HNAH continuing to meet certain criteria set forth in the BHCA, including requirements that its US depository institution subsidiaries, HSBC Bank USA and Household Bank, be ‘well-capitalised’ and ‘well-managed’, and that such institutions have achieved at least a satisfactory record in meeting community credit needs during their most recent examinations pursuant to the Community Reinvestment Act. These requirements also apply to Wells Fargo HSBC Trade Bank, N.A., in which HSBC and HNAH have a 20 per cent voting interest in equity capital and a 40 per cent
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economic interest. Each of these depository institutions achieved at least the required rating during their most recent examinations. In general under the BHCA, an FHC would be required, upon notice by the Federal Reserve Board, to enter into an agreement with the Federal Reserve Board to correct any failure to comply with the requirements to maintain FHC status. Until such deficiencies are corrected, the Federal Reserve Board may impose limitations on the US activities of an FHC and depository institutions under its control. If such deficiencies are not corrected, the Federal Reserve Board may require an FHC to divest its control of any subsidiary depository institution or to desist from certain financial activities in the US.
HSBC and HNAH are generally prohibited under the BHCA from acquiring, directly or indirectly, ownership or control of more than 5 per cent of any class of voting shares of, or substantially all the assets of, or exercising control over, any US bank or bank holding company without the prior approval of the Federal Reserve Board.
The US is party to the 1988 Basel Capital Accord and US banking regulatory authorities have adopted risk-based capital requirements for US banks and bank holding companies that are generally consistent with the Accord. In addition, US regulatory authorities have adopted ‘leverage’ capital requirements that generally require US banks and bank holding companies to maintain a minimum amount of capital in relation to their balance sheet assets (measured on a non-risk weighted basis).
The Federal Deposit Insurance Corporation Improvement Act of 1991 provides for extensive regulation of depository institutions (such as HSBC Bank USA, Household Bank and Wells Fargo HSBC Trade Bank, N.A.), including requiring federal banking regulators to take ‘prompt corrective action’ with respect to FDIC-insured banks that do not meet minimum capital requirements.
HSBC Bank USA, Household Bank and Wells Fargo HSBC Trade Bank, N.A., like other FDIC-insured banks, may be required to pay assessments to the FDIC for deposit insurance under the FDIC’s Bank Insurance Fund. Under the FDIC’s risk-based system for setting deposit insurance assessments, an institution’s assessments vary according to the level of capital an institution holds, its deposit levels and other factors.
At 31 December 2004, HSBC Bank USA, Household Bank and Wells Fargo HSBC Trade Bank, N.A. were each well-capitalised under Federal Reserve Board regulations.
The USA Patriot Act (‘Patriot Act’) signed into law in October 2001, imposes significant record keeping and customer identity requirements, expanded the US federal government’s powers to freeze or confiscate assets and increases the available penalties that may be assessed against financial institutions for failure to comply with obligations imposed on such institutions to detect, prevent and report money laundering and terrorist financing. Among other things, the Patriot Act requires the US Treasury Secretary to develop and adopt final regulations with regard to the anti-money laundering compliance obligations of financial institutions (a term which, for this purpose, includes insured US depository institutions, US branches and agencies of foreign banks, US broker-dealers and numerous other entities). The US Treasury Secretary delegated certain authority to a bureau of the US Treasury Department known as the Financial Crimes Enforcement Network (‘FinCEN’).
Many of the anti-money laundering compliance requirements of the Patriot Act, as implemented by FinCEN, are generally consistent with the anti-money laundering compliance obligations previously imposed on the then HSBC Bank USA and Household Bank under the Bank Secrecy Act (which was amended in certain respects by the Patriot Act) and applicable regulations. These include requirements to adopt and implement an anti-money laundering programme, report suspicious transactions and implement due diligence procedures for certain correspondent and private banking accounts. Certain other specific requirements under the Patriot Act involve new compliance obligations. The passage of the Patriot Act and other recent events have resulted in heightened scrutiny of the Bank Secrecy Act and anti-money laundering compliance by federal and state bank examiners. On 30 April 2003 the then HSBC Bank USA entered into a written agreement with the Federal Reserve Bank of New York and the New York State Banking Department to enhance its compliance with anti-money laundering requirements. HSBC Bank USA implemented certain improvements in its compliance, reporting, and review systems and procedures to comply with this agreement. When HSBC Bank USA merged with HSBC Bank & Trust (Delaware) N.A. on 1 July 2004, the OCC made the merger conditional on HSBC Bank USA’s continuing compliance with the requirements of the written agreement.
HSBC’s US consumer finance operations are also subject to extensive regulation in the US, and to laws relating to consumer protection; (both in general, and in respect of so-called ‘subprime’ lending operations, which have been subject to
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enhanced regulatory scrutiny); discrimination in extending credit; use of credit reports; privacy matters; disclosure of credit terms; and correction of billing errors. They also are subject to regulations and legislation that limit operations in certain jurisdictions. For example, limitations may be placed on the amount of interest or fees that a loan may bear, the amount that may be borrowed, the types of actions that may be taken to collect or foreclose upon delinquent loans or the information about a customer that may be shared. HSBC’s US consumer finance branch lending offices are generally licensed in those jurisdictions in which they operate. Such licences have limited terms but are renewable, and are revocable for cause. Failure to comply with applicable laws and regulations may limit the ability of these licensed lenders to collect or enforce loan agreements made with consumers and may cause the consumer finance lending subsidiary to be liable for damages and penalties.
HSBC’s US credit insurance operations are subject to regulatory supervision under the laws of the states in which they operate. Regulations vary from state to state but generally cover licensing of insurance companies; premiums and loss rates; dividend restrictions; types of insurance that may be sold; permissible investments; policy reserve requirements; and insurance marketing practices.
Certain US source payments to foreign persons may be subject to US withholding tax unless the foreign person is a qualified intermediary. A qualified intermediary is a financial intermediary which is qualified under the Internal Revenue Code and has completed the Qualified Intermediary Withholding Agreement with the Internal Revenue Service. Various HSBC operations outside the US are qualified intermediaries.
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Description of Property
At 31 December 2004, HSBC had some 9,500 operational properties worldwide, of which approximately 3,200 were located in Europe, 600 in Hong Kong and the rest of Asia Pacific, 3,800 in North America (including 1,600 in Mexico) and 1,700 in Brazil. Additionally, properties with a net book value of US$1,163 million were held for investment purposes. Of the total net book value of
HSBC properties, more than 73 per cent were owned or held under long-term leases. Further details are included in Note 24 of the ‘Notes on the Financial Statements’.
HSBC values its properties on an annual basis and updates their balance sheet values accordingly.
Legal Proceedings
HSBC, together with a number of its subsidiary undertakings, is named in and is defending legal actions in various jurisdictions arising out of its
normal business operations. None of the above proceedings is regarded as material litigation.
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Financial Review
Summary
Year ended 31 December 2004 compared with year ended 31 December 2003
‘HSBC Finance’ is defined for this purpose as HSBC Finance Corporation’s consumer finance, insurance and commercial banking operations together with the US residential mortgages and private label credit cards acquired by HSBC Bank USA from HSBC Finance Corporation and its correspondents since December 2003. Where the word ‘underlying’ is used, disclosures are adjusted for the additional quarter’s contribution from HSBC Finance by deducting HSBC Finance’s results for the first quarter of 2004, and for all other significant acquisitions affecting the comparison of 2004 with 2003 in respect of which the most significant was the Bank of Bermuda, acquired in February 2004.
HSBC made a profit on ordinary activities before tax of US$17,608 million, a rise of US$4,792 million, or 37 per cent, on 2003. Of this increase, US$987 million was attributable to an additional quarter’s profit of HSBC Finance in 2004. In the ten months since becoming part of the Group, Bank of Bermuda contributed US$90 million. Excluding goodwill amortisation, HSBC Finance
contributed US$1,113 million, and Bank of Bermuda US$118 million to the US$5,025 million, or 35 per cent, rise in profit before tax to US$19,426 million. Of the growth, 4 per cent related to currency movements. On a constant currency basis, underlying growth was 21 per cent, driven by broadly based revenue growth and improved credit conditions which enabled a lower level of new provisions for bad and doubtful debts in both the personal and corporate sectors. Productivity also improved, notwithstanding the planned growth in costs to build broader capabilities within the Corporate, Investment Banking and Markets business. Goodwill amortisation (excluding that in respect of associates) increased by US$364 million to US$1,814 million in 2004, reflecting the additional quarter’s charge in respect of HSBC Finance, the significant acquisitions in 2004 and currency movements.
Year ended 31 December 2003 compared with year ended 31 December 2002
In the sections which follow, analysis of these results highlights the contributions from HSBC Finance Corporation, acquired at the end of March 2003, and
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HSBC Mexico, acquired in November 2002, together with the impact of a weaker US dollar on translating revenues and costs arising in other currencies. These factors are important to an understanding of HSBC’s performance in 2003. It is also important to recognise the structural effect on reported financial performance of the acquisition of HSBC Finance Corporation.
The shape of the Group’s profit and loss account changed as a result of the HSBC Finance Corporation acquisition, reflecting the nature of its business model. HSBC Finance generally serves non-conforming and sub-prime customers who, for a variety of reasons, have a higher delinquency and credit loss probability. These customers are charged a higher rate of interest to compensate for this additional risk of loss. As a consequence, HSBC Finance’s net interest income is a much higher proportion of its total revenues than in the rest of HSBC, and a much higher proportion of HSBC Finance’s pre-provision profitability is absorbed in bad and doubtful debt charges than is normally the case in the rest of HSBC.
HSBC made a profit on ordinary activities before tax of US$12,816 million in 2003, an increase of US$3,166 million, or 33 per cent, compared with 2002. HSBC Finance and HSBC Mexico accounted for over 70 per cent of this increase. HSBC Finance contributed US$1,827 million in its first nine months, while HSBC Mexico contributed US$441 million in its first full year.
Excluding goodwill amortisation, HSBC Finance and HSBC Mexico contributed US$2,208 million and US$534 million respectively to profit before tax, which grew by US$3,888 million or 37 per cent to US$14,401 million. Underlying growth, on a constant currency basis, was 7 per cent. Goodwill amortisation increased by US$722 million to US$1,585 million in 2003, reflecting acquisitions, currency movements and the write down of goodwill attributed to a fund management company previously acquired as part of the CCF acquisition.
Net interest income
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Financial Review (continued)
Net interest income was US$5,426 million, or 21 per cent higher than 2003, at US$31,024 million. US$2,745 million of this increase was attributable to an additional quarter of HSBC Finance compared with 2003, while Bank of Bermuda contributed US$154 million in the ten months since acquisition. On an underlying basis and in terms of constant currency, net interest income increased by 5 per cent, as the impact of strong growth in interest-earning assets was partly offset by continuing margin compression in major markets and lower returns on treasury assets.
In Europe, net interest income was US$1,522 million, or 20 per cent, higher than in 2003, with US$158 million of the increase coming from an additional quarter of HFC Bank in the UK and US$35 million from the acquisition of M&S Money in November 2004. On an underlying basis and expressed in constant currency, net interest income increased by 6 per cent, reflecting strong growth in mortgages and consumer lending (funded by corresponding growth in lower-costing deposits and current accounts), particularly in the UK. This was partly offset by competitive pricing pressure, particularly in UK mortgages, and the redeployment of liquidity at lower yields as assets matured.
In North America, net interest income increased by US$3,136 million, with HSBC Finance contributing US$2,587 million of the increase. On an underlying basis, the rise was US$393 million, or 3 per cent, primarily from a strong performance in Mexico, which benefited from growth in low cost deposits. In the US, an increase in mortgage lending flowed through to net interest income, though the benefit was partly offset by competitive pressure on pricing, a change in asset mix towards lower yielding but higher quality assets, and the effect of funding costs on larger trading positions.
In Hong Kong, net interest income declined by 7 per cent, largely due to spread compression on the value of deposits and pressure on lending margins, particularly in mortgages. Foreign funds investing in the buoyant stock market, and inflows from investors anticipating an upward realignment of the currency as US dollar weakened, boosted liquidity in the market, depressing Hong Kong dollar interest rates and reducing spreads on deposits. Net interest income was further reduced by competitive pressure on mortgage yields and corporate spreads, a fall in average mortgage balances and the run-off of higher yielding treasury assets with less attractive reinvestment opportunities, given the flat Hong
Kong dollar yield curve. These adverse developments were partly offset by a 10 per cent rise in average interest-earning assets, and continued growth in customer deposits.
In the Rest of Asia-Pacific, net interest income increased by 18 per cent. In constant currency terms, the rise was 15 per cent, driven by growth in mortgages, consumer lending and international trade across the region, offset partly by competitive pressure on pricing.
In South America, net interest income rose sharply, reflecting the full-year benefit of acquiring Losango in December 2003 and the effect of falls in Brazilian interest rates in the latter part of 2003 and early 2004, which translated into lower funding costs on large fixed rate positions and widening spreads on deposits. The effect was accentuated by strong growth in both personal and commercial lending in Brazil. Argentina similarly benefited from growth in consumer lending as the economy grew and the outcome of the external debt restructuring became increasingly apparent.
Overall, average interest-earning assets increased by US$185.9 billion, or 24 per cent, compared with 2003. At constant exchange rates, underlying average interest-earning assets increased by 13 per cent. This growth was driven principally by higher mortgage balances and personal lending in the US, the UK, and across Asia-Pacific.
HSBC’s net interest margin was 3.22 per cent in 2004, compared with 3.29 per cent in 2003.
Net interest income in 2003 was US$10,138 million, or 66 per cent higher than 2002, at US$25,598 million. Of this increase, HSBC Finance contributed US$8,305 million, and HSBC Mexico US$874 million. Excluding these acquisitions, and at constant exchange rates, net interest income was only marginally higher than in 2002, as the impact of growth in interest-earning assets was offset by continuing margin compression from the effect of low interest rates worldwide. This effect was expected to continue in 2004 unless interest rates rose ahead of market expectations.
In Europe, net interest income was US$1,197 million, or 19 per cent, higher than in 2002. HFC Bank contributed US$438 million of this increase. Excluding this acquisition and at constant exchange rates, net interest income was slightly higher than in 2002, reflecting strong growth in average interest-earning assets. This was partly
28
offset by the cost of paying interest on small and medium-sized business accounts in the UK and the impact of liquidity being redeployed at lower yields as assets matured.
In North America, net interest income increased by US$9,045 million. On an underlying basis, the growth was US$304 million, or 11 per cent, primarily reflecting the benefits of strong growth in mortgage lending and savings products, and good balance sheet management, by which the lending mix was improved by exiting less profitable business. Benefit was also gained from the elimination of funding costs following the closure of certain arbitrage trading activities in the US.
In Hong Kong, net interest income declined by 6 per cent, largely due to spread compression on the value of deposits and continued pressure on margins in the mortgage business. Continued pressure on margins depressed mortgage yields in an environment of very low credit demand. This was partly offset by a 7 per cent growth in average interest-earning assets, increased customer deposits and the redeployment of interbank placements in holdings of debt securities. Credit card lending also grew by 6 per cent, improving the mix of assets.
In the Rest of Asia-Pacific, net interest income increased by 8 per cent. In constant currency, this increase was 5 per cent, driven by growth in mortgages and credit card lending, and the beneficial effect of the acquisition of the retail deposit and loan business of AMP Bank Limited in the first half of 2003.
In South America, net interest income was broadly in line with last year. In constant currency, net interest income grew by 10 per cent. In Brazil, net interest income was marginally higher than in 2002, benefiting from the acquisition of the Brazilian businesses and assets of Lloyds TSB Group plc in December 2003. Excluding this, the favourable effect of higher levels of customer lending and deposits were fully offset by reduced spreads as interest rates fell during the year. Argentina recorded net interest income of US$14 million in 2003 compared with a net interest expense in 2002. As the domestic economy began to recover and the trade
surplus grew, interest rates fell. The effect of the continuing reduction in average interest-earning assets was more than offset by the lower cost of funding the non-performing loan portfolio.
Overall, average interest-earning assets increased by US$169.7 billion, or 28 per cent, compared with 2002. Of the increase, HSBC Finance contributed US$92.0 billion and HSBC Mexico US$17.8 billion. At constant exchange rates, underlying average interest-earning assets increased by 4 per cent. This growth was driven principally by higher mortgage balances and personal lending in the UK, France, the US, Canada, Malaysia, Australia and Singapore, and an increase in holdings of long-term securities in the US and debt securities in Hong Kong.
HSBC’s net interest margin was 3.29 per cent in 2003, compared with 2.54 per cent in 2002. The acquisitions of HSBC Finance Corporation and HSBC Mexico increased net interest margin by 77 and 6 basis points respectively. On an underlying basis, HSBC’s net interest margin fell by 8 basis points to 2.46 per cent.
In Europe, the fall in net interest margin was primarily due to a decline in the benefit of net free funds, mainly as a result of paying interest on current account balances belonging to small and medium sized enterprises in the UK. In Hong Kong, HSBC’s net interest margin also declined because of lower spreads on deposits and lower yields on redeployed interbank placements. In Hang Seng Bank, net interest margin narrowed due to lower mortgage yields, narrower spreads on deposits and debt securities, and a lower contribution from net free funds, partly offset by switching liquidity from interbank placements to debt securities. In the rest of Asia-Pacific, net interest margin fell in several countries, mainly from narrower spreads on deposits, lower yields on mortgages, the maturing of higher yielding assets, and a reduced contribution from net free funds. In the US, growth in mortgage balances and a shift in the treasury portfolio to higher yielding fixed rate investments led to an improvement in net interest margin.
29
Other operating income
Analysis of fees and commissions receivable and payable
30
Other operating income of US$19,563 million, was US$4,089 million, or 26 per cent, higher than in 2003. Of this increase, US$836 million was attributable to an additional quarter from HSBC Finance while Bank of Bermuda contributed US$325 million. On an underlying basis, and at constant exchange rates, growth in other operating income was 12 per cent, driven principally by strong growth in fee and commission income across all operations.
Net fees and commissions rose by US$2,699 million, or 26 per cent, with the additional quarter of HSBC Finance and acquisitions accounting for US$1,003 million of this increase. On a constant currency basis, the underlying increase of 10 per cent was underpinned by lending fees from strong growth in consumer lending in the UK and the US, sales of investment products in Asia and a general upturn in funds management income.
In Europe, fee income increased by US$1,103 million, or 21 per cent, of which US$107 million came from an extra quarter’s result from HFC Bank and the acquisitions of Bank of Bermuda and M&S Money. At constant currencies, fee income rose by 8 per cent driven by strong growth in funds under management in Private Banking, and by the strength of both mortgage and consumer lending, particularly in the UK where growth in loan fees and cards income was augmented by sales of credit protection products. The increase in loan fee income also reflected strong demand for commercial lending products in the UK.
Excluding the US$617 million contribution from an additional quarter of HSBC Finance and US$126 million from Bank Bermuda, fees and commissions in North America increased by US$324 million, or 4 per cent. On a comparable basis, HSBC Finance saw strong growth in fees from loan sales and sales of credit protection policies. In Mexico, strong growth in the Afore pension funds business complemented higher fee income from credit cards, deposit services and international remittances.
In Hong Kong, fee income rose strongly as a rise in stock market activity sparked demand for investment products. Unit trust, custody and broking income all benefited from strong customer demand, while strong growth in funds under management was reflected in a sharp rise in discretionary mandate fees. An improvement in consumer confidence in the second half of the year flowed through to a rise in
cardholder spending, and credit card fee income rose by 13 per cent.
HSBC’s operations in the Rest of Asia-Pacific similarly benefited from an upturn in regional financial markets, with strong sales of investment products reflected in growth in fees from funds under management and global custody. Further growth came from an expansion of HSBC’s credit card base in the region, where cards in issue grew by 929,000 or 25 per cent and from strong growth in trade related income, particularly in the Middle East, where the benefit of higher oil prices boosted local economies. Overall, fee income rose by 26 per cent at constant currencies.
In South America, net fees and commissions were 42 per cent higher than in 2003. The bulk of the increase came in Brazil, which benefited both from the integration of Losango, and strong organic growth in consumer and commercial lending.
Dealing profits of US$2,566 million were US$388 million, or 18 per cent, higher than in 2003 with US$49 million of the increase coming from acquisitions. Strong growth in foreign exchange and interest rate derivatives trading offset lower income from debt securities, while dealing losses on equity swaps trading were offset by the related dividend income. Customer flows were strongly ahead of 2003, driven largely by the expansion of business capabilities during the year. This was reflected in increases in both foreign exchange trading and derivatives income, particularly in Europe and Hong Kong, while retail sales of structured products further boosted income in Hong Kong and Singapore. However, fixed income revenues fell, particularly in the UK, Brazil, Mexico and the US, as movements in credit spreads adversely affected debt trading income.
Other operating income benefited from an expansion of HSBC’s insurance business in the UK and Hong Kong and growth in the asset finance business in the UK.
Other operating income of US$15,474 million, was US$4,339 million, or 39 per cent, higher than in 2002. Of this increase, HSBC Finance contributed US$1,878 million and HSBC Mexico contributed US$599 million. On an underlying basis, and at constant exchange rates, growth in other operating income was 9 per cent, principally as a result of higher dealing profits throughout HSBC’s operations.
31
The acquisitions of HSBC Finance Corporation and HSBC Mexico reduced the proportion of fee revenues exposed to stock market fluctuations by bringing into the Group significant levels of account service fees (HSBC Mexico) and credit card fee income (HSBC Finance). Fees from credit cards now constitute close to 24 per cent of total fees receivable compared with 13 per cent in 2002.
Fee and commission income, excluding HSBC Finance and HSBC Mexico, and at constant exchange rates, increased by 4 per cent compared with 2002. In Europe, fee income increased by US$664 million, or 15 per cent, of which HFC Bank contributed US$49 million. Excluding this acquisition and at constant exchange rates, fee income increased by 2 per cent, mainly from growth in sales of creditor protection insurance, cards transactions and loan fees. Within the UK, personal loan protection premiums grew by 19 per cent, reflecting growth in mortgages and personal loans. However, this was partly offset by a decline in sales of investment and pension products, mainly reflecting uncertainty in the equity markets.
In North America, excluding US$1,167 million and US$453 million relating to HSBC Finance and HSBC Mexico respectively, fee income was marginally higher than in 2002. Growth in income from securities advisory services, deposit-related service charges and card fees was partly offset by lower earnings from mortgage servicing.
In Hong Kong, fee income increased by US$119 million, primarily due to higher revenues from wealth management services. There was strong growth in fees from sales of unit trusts and capital-guaranteed funds, which increased by US$1.6 billion in 2003. HSBC expanded its range of structured deposit products, further benefiting fee income. Revenues from securities and stockbroking also increased in line with a buoyant stock market in the second half of the year and increased market share. In addition, the insurance business generated strong results reflecting growth in new individual life business written.
HSBC’s operations in the rest of Asia-Pacific increased fee income by US$81 million with strong growth in wealth management income, reflecting higher unit trust sales and funds under management. Fee income from credit cards rose in a number of countries.
In South America, fee income increased by 10 per cent at constant exchange rates, mainly in Brazil. The increase reflected good growth in credit-related revenue, account service fees and cards. In Argentina a decline in fee income was recorded.
Dealing profits of US$2,178 million were US$865 million, or 66 per cent, higher than in 2002 and reflected investment in and refocusing of HSBC’s markets businesses, primarily in the US and in Europe. In Asia, a wider range of structured solutions was offered to customers which boosted revenues. Acquisitions were not significant contributors to growth in this area with HSBC Mexico generating US$103 million. Within dealing profits, there was strong growth in fixed income earnings, predominantly in Europe and Hong Kong, as a result of favourable credit spreads and strong investor demand for yield enhancement products. Foreign exchange revenues increased in both Europe and North America, with volatility in the major currencies driving sales of hedging products and sales activity generally. In Hong Kong, a greater focus on tailored solutions generated a significant increase in corporate sales during the year.
Other operating income further benefited from expansion of the insurance businesses in Argentina and Hong Kong and growth in the rail leasing business in the UK.
32
Operating expenses
Operating expenses increased by US$5,157 million, or 23 per cent, with an additional quarter’s costs in HSBC Finance accounting for US$1,302 million and acquisitions US$745 million of the increase. Excluding these acquisitions and expressed in terms of constant currency, operating expenses, excluding goodwill amortisation, were 8 per cent higher than in 2003. Staff costs, which, on the same basis, rose by 7 per cent, accounted for less than half of the
increase, and largely reflected restructuring and expansion costs in Corporate Investment Banking and Markets, higher performance-related bonuses, and growth in staff numbers in support of rising business volumes. Higher advertising and marketing costs to stimulate product sales, and expenditure on IT infrastructure, largely accounted for the US$1,020 million, or 11 per cent, increase in non-staff costs. HSBC’s cost:income ratio excluding goodwill amortisation fell to 51.1 per cent in 2004 from 51.3 per cent in 2003, reflecting the inclusion
33
Financial Review(continued)
of an additional quarter’s result of HSBC Finance Corporation. Excluding this effect, the cost:income ratio increased to 52.5 per cent.
In Europe, costs excluding goodwill amortisation increased by US$2,041 million compared with 2003, of which the additional quarter’s costs in HSBC Finance and acquisitions accounted for US$270 million. On an underlying basis and at constant exchange rates, expenses were US$766 million, or 7 per cent, higher than in 2003. Higher marketing and IT infrastructure costs added US$169 million while staff costs rose by US$245 million, reflecting restructuring and incentive compensation within Corporate Investment Banking and Markets, higher performance-related remuneration and staff pay increments.
Operating expenses in Hong Kong, excluding goodwill amortisation, rose by US$312 million, 14 per cent higher than in 2003, with US$56 million of the increase attributable to acquisitions. On an underlying basis staff costs rose by 9 per cent, largely due to higher performance-related bonuses, reflecting improved results in a number of businesses, and increased headcount in support of business expansion across a number of business segments. Marketing expenses also rose, particularly in Personal Financial Services, in contrast to the significant cut back in 2003 following the outbreak of SARS.
In the Rest of Asia-Pacific, costs excluding goodwill amortisation increased by US$339 million, or 19 per cent, compared with 2003, with acquisitions accounting for US$10 million of the increase. At constant exchange rates, the increase was 15 per cent, as staff were recruited to support business expansion in most business segments across the region and additional marketing costs were incurred to support business growth. Incentive-based staff costs also rose in line with improved business performance. The continued migration of processing activities from other regions to the Group Service Centres meant additional staff and IT infrastructure costs were incurred.
In North America, operating expenses, excluding goodwill amortisation, increased by US$1,940 million, or 28 per cent, with acquisitions and an additional quarter’s costs from HSBC Finance contributing US$1,301 million of the increase. The underlying rise of 9 per cent largely reflected a significant expansion in Corporate Investment Banking and Markets in the US, where some 300 staff were added during the year and staff and incentive-based compensation saw significant increases. Investment was also made in a number of
related technology projects. Staff were recruited for the branch networks in both Mexico and the US to support business growth, and marketing costs rose by US$93 million in support of a number of personal banking and consumer finance products.
In South America, operating expenses, excluding goodwill amortisation, rose by US$369 million, or 34 per cent. US$189 million of this increase related to acquisitions in 2004, and the underlying rise in cost at constant currencies was 12 per cent. Staff costs increased by 2 per cent, with higher levels of performance-related bonuses, particularly in Corporate, Investment Banking and Markets and higher social taxes. Transactional taxes in Brazil increased sharply and additional processing, communications and outsourcing costs were incurred to support business growth.
Growth in operating expenses of US$6,724 million, or 43 per cent, principally reflected the acquisitions of HSBC Finance Corporation, US$3,787 million, and HSBC Mexico, US$964 million. Excluding the effect of these acquisitions and expressed in terms of constant currency, underlying operating expenses excluding goodwill amortisation were 5 per cent higher than in 2002. Virtually all of this growth was in staff costs, reflecting restructuring costs, higher social taxes and pension costs. In addition, Corporate, Investment Banking and Markets incurred higher costs reflecting expansion of the business and increased profitability. Notwithstanding this growth, the cost:income ratio of Corporate, Investment Banking and Markets improved by 3 per cent to 48.9 per cent. HSBC’s cost:income ratio excluding goodwill amortisation was 51.3 per cent for 2003, compared with 56.2 in 2002. Excluding HSBC Finance, the cost:income ratio was 57.3 per cent.
In 2003, HSBC’s Group Service Centre in Malaysia became operational. Overall, the Group Service Centres now employ in excess of 8,000 employees worldwide.
In Europe, costs excluding goodwill amortisation increased by US$1,651 million compared with 2002, of which HSBC Finance contributed US$299 million. At constant exchange rates and excluding HSBC Finance and goodwill amortisation, expenses were 5 per cent higher than in 2002. This increase in expenses was primarily due to higher pension provision and employment costs, particularly in the UK, where social taxes were raised. Redundancy and property provisioning costs
34
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 HSBC Finance and HSBC Mexico. This increase was largely driven by higher staff costs, namely pension and healthcare provisions, performance-related incentives, and expenses associated with long-term restructuring programmes. In the US during 2003, severance costs of US$47 million were recorded for expense reduction initiatives, global resourcing moves and the integration of HSBC Finance, a US$28 million increase over the previous year. In addition, costs rose from the first full year’s inclusion of HSBC’s high net worth personal tax advisory business. These increases were partly offset by the benefits obtained from discontinuing certain of HSBC’s government and agency securities arbitrage operations in the US, and from business disposals.
In South America, operating expenses, excluding goodwill amortisation, were broadly in line with 2002. At constant exchange rates and excluding goodwill amortisation, costs were 6 per cent higher than in 2002. The rise in Brazil was due to higher staff costs, driven by increases in labour claims, together with higher marketing costs and increased transaction taxes on higher operating income as the personal lending portfolio was expanded. In addition, the Group’s newly acquired businesses in Brazil added to cost growth. Costs in Argentina were down on 2002, mainly because of lower severance costs.
Bad and doubtful debts
35
At 31 December 2004, 78 per cent of customer lending was located in Europe and North America, with 12 per cent in Hong Kong. Personal lending accounted for 57 per cent of the customer loan portfolio, a marginal increase on the position at 31 December 2003.
Excluding the effect of foreign exchange translation, over 70 per cent of loan growth in 2004, excluding the financial sector, was generated in personal lending, with particularly strong growth in mortgages and consumer lending.
Over 100 per cent of the net charge for bad and doubtful debts in 2004 related to lending to the personal sector, including consumer finance, compared with 90 per cent in 2003. Similarly, some 95 per cent of the charge related to lending in the US and Europe, compared with 88 per cent in 2003.
The charge for specific bad and doubtful debts adjusts the specific balance sheet provisions to the level that management deems adequate to absorb actual and inherent losses in the Group’s loan portfolio from homogeneous portfolios of assets and individually identified customer loans. The majority of specific provisions are determined on a portfolio basis employing statistical calculations using roll rate methodology to determine specific provisions for bad and doubtful debts. There were no significant changes to the procedures used by HSBC in determining the various components of the charge for specific bad and doubtful debts during the year. The charge for specific provisions in 2004 was US$6,793 million compared with US$6,214 million in 2003, an increase of US$579 million. With the additional quarter’s charge from HSBC Finance and the acquisitions during the year together adding US$1,433 million to the overall charge, the
underlying movement at constant currencies was a decrease of US$979 million. New specific provisions increased by US$1,212 million, reflecting the additional quarter’s charge for HSBC Finance of US$1,367 million and the US$205 million effect of acquisitions during the year. Excluding these and at constant currencies, new specific provisions fell by US$537 million, or 7 per cent, compared with 2003 with lower new provisions in Hong Kong and the US combined with higher releases and recoveries in Europe, North America and South America.
General provisions augment specific provisions and provide cover for loans which are impaired at the balance sheet date but which will not be individually identified as such until some time in the future. In determining the level of general provisions, management takes account of historical loss experience, the estimated period between a loss occurring and that loss being identified, and use their judgement to decide whether current economic conditions are likely to produce credit default rates and loss severity in line with historical precedent. There was a net general provision release of US$436 million in 2004, US$315 million greater than the net release of US$121 million in 2003. Releases increased in all geographical regions except South America. This reflected improved underlying economic conditions, driving lower loss expectations, and progress made with refinancing and restructuring problem credits.
The aggregate customer bad and doubtful debt provisions at 31 December 2004 of US$12.7 billion represented 1.98 per cent of gross customer advances (net of suspended interest, reverse repos and settlement accounts) compared with 2.65 per cent at 31 December 2003. As in 2003, HSBC’s cross-border exposures did not necessitate significant provisions.
36
Non-performing loans (net of suspended interest) were US$13.3 billion at 31 December 2004. At constant exchange rates, there was a decrease in the level of non-performing loans (net of suspended interest) in 2004 compared with 2003, with falls in all geographical regions. Hong Kong and North America experienced a substantial fall in the level of loans categorised as non-performing.
The acquisition of HSBC Finance Corporation significantly affected the geographical and customer segment distribution of the Group’s lending activities and, more markedly, the distribution of its credit costs. At 31 December 2003, 76 per cent of customer lending was located, fairly equally, in Europe and North America, compared with 69 per cent in 2002, with Europe two-thirds of that total. At 31 December 2003, personal lending accounted for 56 per cent of the customer loan portfolio compared with 42 per cent at 31 December 2002.
Excluding the effect of foreign exchange translation and the acquisition of HSBC Finance Corporation, over 90 per cent of loan growth in 2003, excluding the financial sector, was generated in personal lending, predominantly mortgages, credit cards and other personal products.
Over 90 per cent of the charge for bad and doubtful debts in 2003 related to lending to the personal sector, including consumer finance, compared with 65 per cent in 2002. Similarly, over 88 per cent of the charge related to lending in the US and Europe, compared with 66 per cent in 2002.
The charge for specific bad and doubtful debts adjusts the specific balance sheet provisions to a level that management deems adequate to absorb actual and inherent losses in the Group’s loan portfolio from homogeneous portfolios of assets and individually identified customer loans. Following the acquisition of HSBC Finance Corporation, the majority of specific provisions were determined on a portfolio basis. In addition, the acquisition of HSBC Finance Corporation resulted in a significant increase in the extent to which HSBC employed statistical calculations using roll rate methodology to determine specific provisions for bad and doubtful debts. Other than this, there were no significant changes to HSBC’s procedures in determining the various components of the charge for specific bad
and doubtful debts. The charge for specific provisions in 2003 was US$6,214 million compared with US$1,672 million in 2002, an increase of US$4,542 million. New specific provisions, which increased by US$5,099 million, principally reflected the acquisitions of HSBC Finance Corporation (US$4,773 million) and HSBC Mexico (US$47 million). Excluding the effect of the acquisitions, new specific provisions rose by US$249 million, or 9 per cent, compared with 2002.
General provisions augment specific provisions and provide cover for loans which are impaired at the balance sheet date but which will not be individually identified as such until some time in the future. In determining the level of general provisions, management takes into account historical loss experience, the estimated period between a loss occurring and that loss being identified and use their judgement to decide whether current economic and credit conditions are likely to increase or reduce the actual level of inherent losses. There was a net general provision release of US$121 million in 2003, US$230 million lower than the net release of US$351 million in 2002. In HSBC Finance and HSBC Mexico, general provisions were augmented by US$191 million due to growth in personal lending. Excluding this, the net release of general provisions of US$312 million was in line with that of 2002. This reflected improved underlying economic conditions, and progress made with refinancing and restructuring problem credits.
The aggregate customer bad and doubtful debt provisions at 31 December 2003 of US$13.7 billion represented 2.66 per cent of gross customer advances (net of suspended interest, reverse repos and settlement accounts) compared with 2.68 per cent at 31 December 2002. As in 2003, HSBC’s cross-border exposures did not necessitate significant provisions.
Non-performing loans (net of suspended interest) of US$15 billion at 31 December 2003 included US$5 billion relating to HSBC Finance’s loan book. Excluding HSBC Finance, and at constant exchange rates, there was a decrease in the level of non-performing loans (net of suspended interest) in 2003 compared with 2002, mainly as a result of the write-off of loans from the legacy portfolio acquired on the acquisition of HSBC Mexico.
37
Gains on disposal of investments
During the year, HSBC made 15 business acquisitions and completed 13 business disposals. HSBC’s profit on disposal of investments was US$770 million, US$319 million higher than in 2003. The gain on disposal of associates included a gain on the exchange of HSBC’s interest in World Finance International Limited for a 7 per cent interest in Bergesen Worldwide.
The substantial increase in other disposals comprises the sale of venture capital investments in France and the US and the disposal of an investment in NYCE Corporation in the US. Realised gains on the sale of debt and equity investment securities during the year were 24 per cent higher than in 2003.
During 2003, HSBC made 26 business acquisitions and completed 14 business disposals.
HSBC’s profit on disposal of investments was US$451 million, US$81 million lower than in 2002. The profits in 2002 included gains of US$39 million on the sale of HSBC’s 50 per cent share of Lixxbail to its joint venture partner, and US$38 million on the sale of HSBC’s 6.99 per cent share in Banco Santiago S.A.
Realised gains on the sale of debt and equity investment securities during the year were broadly in line with 2002. The reductions in interest rates and improvement in equity markets drove growth of US$59 million in the unrecognised gains on HSBC’s debt and equity investment portfolios.
38
Taxation
HSBC Holdings and its subsidiary undertakings in the UK provided for UK corporation tax at 30 per cent, the rate for the calendar year 2004 (2003: 30 per cent).
HSBC’s effective tax rate of 25.6 per cent in 2004 was lower than the corporation tax rate of 30 per cent. The main factors which reduced the rate were: the geographical mix of profits and, in particular, the lower rate of tax on profits generated in Hong Kong; fair value accounting adjustments, which under UK GAAP affect pre-tax profits but are ignored for tax purposes; the tax-deductibility of the cost of servicing the Group’s innovative Tier 1 capital, which under UK GAAP is shown as a minority interest; and prior period adjustments, which by definition are unrelated to earnings in the current year. These were partially offset by the effect of goodwill amortisation, which is also ignored for
tax purposes and therefore increases the effective tax rate.
Overseas tax included Hong Kong profits tax of US$539 million (2003: US$483 million) provided at a rate of 17.5 per cent (2003: 17.5 per cent) on the profits assessable in Hong Kong. Other overseas taxation was provided for in the countries of operation at the appropriate rates.
Profits arising in North America represented a higher percentage of HSBC’s profits in 2004 than in 2003, largely because of the effect of an additional quarter’s results of HSBC Finance Corporation. US profits are taxed at a higher rate than the average for the rest of the Group and this change in mix raised the effective tax rate.
A number of fair value acquisition accounting adjustments relating to HSBC Finance Corporation and HSBC Mexico resulted in net credits to the profit and loss account with no corresponding tax charge. A more detailed explanation of the
39
FinancialReview(continued)
acquisition accounting adjustments is disclosed in Note 7 of the ‘Notes on the Financial Statements’.
Certain prior period adjustments arose in 2004 which reduced HSBC’s overall tax charge. These related to the recognition of deferred tax assets on losses, which became more likely to be utilised. The Group also reached agreement on a number of settlements in respect of outstanding matters on prior year computations at a lower cost than had originally been estimated in establishing provisions.
Goodwill amortisation was higher than in the previous year, mainly due to an additional three months charge for HSBC Finance Corporation.
At 31 December 2004, there were potential future tax benefits of US$973 million (2003: US$963 million). The potential benefits are in respect of trading losses, allowable expenditure charged to the profit and loss account but not yet allowable for tax, and capital losses which have not been recognised because realisation of the benefits is not considered more likely than not.
HSBC Holdings and its subsidiary undertakings in the UK provided for UK corporation tax at 30 per cent, the rate for the calendar year 2003 (2002: 30 per cent).
HSBC’s effective tax rate of 24.3 per cent in 2003 was lower than the corporation tax rate of 30 per cent. The geographic mix of profits; fair value accounting adjustments, which are ignored for tax purposes; and prior period adjustments were the main factors which reduced the rate. These were partially offset by the effect of goodwill amortisation, which is also ignored for tax purposes and which increased the rate.
Overseas tax included Hong Kong profits tax of US$483 million (2002: US$408 million) provided at
a rate of 17.5 per cent (2002: 16 per cent) on the profits assessable in Hong Kong. Other overseas taxation was provided for in the countries of operation at the appropriate rates of taxation.
Profits arising in North America represented a higher percentage of HSBC’s profits in 2003 compared with 2002 largely because of the acquisition of HSBC Finance Corporation. US profits are taxed at a higher rate than the average for the rest of the Group and this change in mix raised the effective tax rate.
A number of fair value acquisition accounting adjustments relating to HSBC Finance Corporation and HSBC Mexico resulted in net credits to the profit and loss account with no corresponding tax charge. A more detailed explanation of the acquisition accounting adjustments is disclosed in Note 8 of the ‘Notes on the Financial Statements’ in the 2003 Annual Report and Accounts.
Prior period adjustments arose in 2003 which reduced HSBC’s overall tax charge. These related mainly to the recognition of deferred tax assets on losses, which became more likely to be utilised. The Group also reached agreement on a number of settlements in respect of outstanding matters on prior year computations which allowed contingency reserves to be released.
Goodwill amortisation was higher than in the previous year, mainly due to the acquisition of HSBC Finance Corporation.
At 31 December 2003, there were potential future tax benefits of US$963 million (2002: US$885 million). The potential benefits are in respect of trading losses, allowable expenditure charged to the profit and loss account but not yet allowable for tax, and capital losses which had not been recognised because realisation of the benefits was not considered more likely than not.
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Asset deployment
HSBC’s total assets (excluding Hong Kong Government certificates of indebtedness) at 31 December 2004 were US$1,264.9 billion, an increase of US$241.7 billion or 24 per cent since 31 December 2003. At constant exchange rates, total assets grew by US$203.8 billion or 19 per cent.
At 31 December 2004, HSBC’s balance sheet remained highly liquid, reflecting strong growth in customer deposits. The proportion of assets deployed in customer advances rose to 53 per cent. Customer advances increased by 27 per cent, marginally higher than the growth in total assets, driven essentially by lending to finance consumer spending and strong growth in mortgage financing, reflecting the buoyant housing markets in the US, the UK and parts of Asia-Pacific. Growth in corporate lending was concentrated in the Commercial Banking customer group, while increased financial lending largely reflected expansion of the euro government bond trading portfolios in France.
At constant exchange rates, gross loans and advances to customers (excluding loans to the financial sector) were US$101.4 billion higher than at the end of December 2003. US$50.5 billion of this increase related to mortgages, with strong growth in the US and the UK. At constant exchange rates, other personal lending increased by US$22.9 billion or 17 per cent compared with December 2003, mainly as a result of strong growth in credit card and other unsecured personal lending in all of HSBC’s
markets, particularly in the UK. Underlying commercial and corporate lending, excluding lending to governments, grew by 14 per cent, with notable growth in Hong Kong and in the Rest of Asia-Pacific on the back of higher trade volumes.
In Europe, growth in assets was driven by increased mortgage and consumer lending in the UK and demand from private banking clients for secured funding to finance investment activity. Lending to small and middle market companies also increased, although lending to major corporate customers remained subdued.
In Hong Kong, lending to commercial customers improved as Hong Kong’s economy recovered from the impact of SARS and trade flows with mainland China increased. Competition in the mortgage market remained intense and the portfolio declined slightly. Surplus funds from increased customer deposits were deployed in investment securities to enhance HSBC’s yields.
In the Rest of Asia-Pacific, the increase in assets was driven by higher mortgage, consumer lending and strong regional trade flows.
The rise in assets in North America was driven substantially by strong growth in mortgage lending and demand for consumer credit.
In South America, growth was concentrated in consumer lending in Brazil, which also benefited from an expansion in lending to the Brazilian retail sector.
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At 31 December 2004, assets held by HSBC as custodian amounted to US$2,819 billion. Custody is the safekeeping and administration of securities and financial instruments on behalf of others, and the inclusion of Bank of Bermuda was responsible for much of the increase.
Debt securities and equity shares
Funds under management
Economic profit
On this basis, economic profit increased by US$3,773 million compared with 2003, reflecting both the lower cost of capital rate and improved profitability.
Analysis by Customer Group and by Geographical Region
Profit/(loss) excluding goodwill amortisation
45
Profit/(loss) excluding goodwill amortisation (continued)
46
Profit excluding goodwill amortisation
Business highlights
General
47
Rest of Asia-Pacific
48
For other footnotes, see page 59.
49
50
51
52
53
54
55
Asia
56
Other6
57
By Geographical Region:
In the analysis of profit by geographical region that follows, operating income and operating expenses include intra-HSBC items of US$630 million (2003: US$422 million; 2002: US$326 million).
Profit on ordinary activities before tax excluding goodwill amortisation
Total assets
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.
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Footnotes to ‘Analysis by customer group and by geographical region’
59
Profit/(loss) before tax excluding goodwill amortisation
3Intra-group charges previously netted between countries are reported gross in 2004. Figures for 2003 and 2002 have been restated on a comparable basis.
60
Profit before tax
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The UK economy expanded by 3.0 per cent during 2004, although after a strong first half, growth decelerated from the third quarter across most sectors. The rate of growth in consumer spending also slowed during the year. Growing uncertainty surrounding the outlook for house prices contributed to a slowdown in housing transactions in the second half of the year and an associated easing in domestic appetite for further credit. However, HSBC expects an increase in real income growth compared with 2003 and stability in levels of employment to continue to provide support for resilient consumer spending in the coming months. In the UK industrial sector, companies were generally cautious about their employment and investment intentions, with some nervousness over the state of the global and domestic recover y and the outlook for oil prices. Although confidence within the industrial sector appeared to be growing, the official data showed that manufacturing activity continued to contract, lagging the global recovery.
The eurozone recovery, which got underway in the middle of 2003, continued in the first half of 2004. However, the year-on-year growth rate began to fall in the latter six months of the year from an expected peak of 2.1 per cent in the second quarter to 1.8 per cent in the third quarter. Exports were strong, particularly in the first half of 2004, with year-on-year growth of 7.6 per cent in the second quarter, but export growth slowed in the second half when there was little evidence of benefits feeding through into consumer spending and fixed investment. Companies were reluctant to take on extra workers and, in Germany, concerns about the economic reform process seemed to encourage higher household savings. Companies also appeared reluctant to invest, possibly because o f the debt build-up in the late 1990s. Eurozone inflation moved back above the European Central Bank’s (‘ECB’) 2 per cent target in the spring, reaching 2.5 per cent by May and remaining above 2 per cent in the remainder of the year. However, the headline inflation rate was boosted by higher oil prices, health charges and tobacco duties. Excluding these factors, underlying inflation was little changed at around 1.6 per cent.
The ECB kept its key interest rate constant at 2 per cent throughout the year. On a trade-weighted basis, the euro fell back in February and March but rose sharply in the autumn, and by December had moved above its January 2004 peak. Also in December, the euro reached record highs against the US dollar since its introduction in 1999. Eurozonebond yields fell during 2004 for 10-year bunds from 4.3 per cent to 3.7 per cent.
European operations reported a pre-tax profit of US$5,225 million, compared with US$3,969 million in 2003. Excluding goodwill amortisation, pre-tax profit was US$6,172 million and represented around 32 per cent of HSBC’s total profit on this basis. The effect of the weakening US dollar was significant in 2004 and the adjustment to prior year figures to provide a like for like basis of comparison added approximately 11 per cent to both reported revenues and costs.
At constant exchange rates, the growth in pre-tax profit before goodwill amortisation was 15 per cent, all of which came from existing businesses. The commentary that follows is based on constant exchange rates.
Personal Financial Services reported a pre-tax profit, before goodwill amortisation, of US$1,719 million, an increase of 22 per cent compared with 2003. Revenue growth was encouraging, and this, combined with disciplined cost control, increased pre-provision profitability by 37 per cent over 2003. Total operating income grew by 15 per cent compared with cost growth of 5 per cent, of which M&S Money added 1 per cent.
The cost:income ratio excluding goodwill, improved by 6.0 percentage points to 62.8 per cent.
The UK was the principal driver of increased profitability. Strong growth in UK consumer lending and mortgages was achieved, from brand-led awareness, marketing campaigns and competitive pricing. The same factors also contributed to increased earnings on savings and deposit accounts, and HSBC increased its current account base by 6.5 per cent.
Net interest income increased by US$506 million, of which US$35 million was attributable to M&S Money. Personal unsecured lending revenues grew strongly on the back of marketing and price initiatives, and an increase in the average loan size, contributed to growth of 22 per cent in UK personal loans. Market share increased by 66 basis points to 6.92 per cent. The credit cards business continued to expand, due partly to the continued strength of consumer expenditure and to the success of a series of promotional campaigns, pricing initiatives and improved sales. Average card balances grew by 19 per cent to US$5.5 billion, contributing US$17 million to the growth in net interest income.
UK average mortgage balances increased by 20 per cent, to US$50.4 billion and gross new
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lending by 23 per cent to US$24.7 billion as HSBC increased its market share in the buoyant housing market. A number of new products were introduced, including two fixed rate mortgage offers in the first half of the year, contributing to sales of over US$3.5 billion. Mortgage pricing remained competitive and HSBC deferred passing several of the Bank of England’s base rate rises on to its customers during the year. As a consequence, spreads narrowed, offsetting the benefit to net interest income of the growth in mortgage balances although the effect of this was mitigated by an increase in related fee income.
The expansion of HSBC’s Premier banking service in the UK increased the number of customers using this service by 29 per cent. A combination of marketing and pricing initiatives, together with enhanced relationship management, contributed to significant growth in Premier savings accounts, and overall UK savings balances grew by 7 per cent to US$41.8 billion. First Direct launched a new on-line e-Savings Account for new and existing customers. Income improvement through growth in savings balances was further enhanced by widening spreads as interest rates rose.
Continued strong recruitment of new customers supported growth in UK current account balances of 12 per cent to US$20.1 billion. However, the benefit of higher balances was partly offset by a 14 basis point reduction in spreads.
Consumer lending revenues in Turkey grew by 55 per cent following the success of a number of initiatives taken to enhance customer relationship systems and distribution channels in the branch network. Effective marketing initiatives and advertising campaigns contributed to strong recruitment of new customers. Card balances grew by US$0.3 billion and the number of cards in force increased by 33 per cent to 1.7 million.
In France, net interest income grew by 6 per cent. CCF continued its record of strong growth in sight deposits in each year since acquisition, with these deposits growing by just under 10 per cent in 2004, and special regulated savings accounts by a further 9 per cent. Driven by strong sales activity, CCF achieved accelerated growth in personal loans and mortgage sales during 2004, with mortgage loans in particular rising by close to 15 per cent.
Other operating income rose by 15 per cent, of which M&S Money added 1 per cent. The strong growth in UK personal lending, mortgages and credit cards was reflected in an increase in fee income, and boosted sales of credit protection products by 9 per cent. Similarly, the increased lending activity inTurkey contributed to growth in related fee income. In France, fee income from sales of life protection and assurance products grew by 11 per cent, driven by increased customer lending. Brokerage fees benefited from an increase in privatisation and flotation activity, while sales of investment protection products benefited from a series of marketing campaigns.
Operating expenses, excluding goodwill amortisation, increased by 5 per cent. In the UK, operating expenses included US$39 million in respect of the period during which M&S Money was in the Group, and US$89 million of restructuring costs in 2004, compared with US$63 million in 2003. Excluding M&S Money and restructuring costs, operating expenses in the UK were broadly flat. An increase in IT costs reflected development of HSBC Finance Corporation’s WHIRL credit card system for application in the UK, and expenditure on installing HSBC’s universal banking system, HUB, in France. Marketing expenditure increased to support product promotions and expand TV brand advertising. In the UK, ongoing initiatives to simplify product offerings and management structures, along with a greater customer use of direct banking channels and the Group’s Service Centres, led to a reduction in staff numbers.
M&S Money added US$61 million to the bad debt charge of US$615 million. The rise in the charge for bad and doubtful debts of US$256 million in the UK unsecured personal lending portfolio was effected by growth in account balances of US$3,370 million, higher levels of UK personal bankruptcies, following legislative changes in 2004, and weakening credit quality as interest rates rose. As part of its commitment to responsible lending practices, HSBC already uses industry-wide positive customer data in some of its UK portfolios and will implement positive data sharing across the remaining UK portfolios from April 2005. This will improve HSBC’s assessment of customer finances.
The rise in contingent liability provisions primarily reflects an updated assessment of the likely compensation due to UK customers for shortfalls on certain mortgage endowment policies and investment products.
Consumer Finance in Europe contributed a pre-tax profit, before goodwill amortisation, of US$91 million in 2004. Profit was 64 per cent lower than for the comparable period in the previous year, mainly because of an increase in operating expenses, as staff were recruited to support an expansion of telemarketing, and the cost of developing business in the John Lewis Partnership joint venture. The charge
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for bad debts also increased sharply, reflecting growth in lending balances and a deterioration in credit quality, particularly in the second half of the year, driven by a rise in delinquencies and personal bankruptcies, notably in the credit cards business.
Commercial Banking reported pre-tax profits, before goodwill amortisation, of US$1,749 million, an increase of 21 per cent over 2003, driven mainly by strong revenue growth in the UK. Transfer of business from Corporate Banking in Germany to this segment contributed 2 per cent of the growth. In aggregate, revenue grew by 10 per cent and costs by 2 per cent, a marked improvement in productivity which reduced the cost:income ratio by over 4 percentage points. The performance in the UK was even stronger where the cost:income ratio improved by 7 percentage points.
Net interest income increased by 8 per cent as new customer acquisition and a growth in demand for credit increased loans and deposits during the year. In the UK, liability growth contributed US$82 million to net interest income. This, in part, reflected the continued popularity of the business money manager product, where deposit balances grew by 16 per cent. Spreads achieved on customer deposits were moderated as customers migrated to this account from current accounts. In order to offset this effect, a number of successful promotions were launched, which increased current account customer numbers in the UK by 8 per cent in 2004. A rise in customer recommendations also contributed to the increase.
HSBC attracted over 100,000 new customers in 2004 and now holds just under 20 per cent of startup business accounts in the UK. In addition to the rise in customer numbers, average current account balances increased by 17 per cent.
The UK saw renewed demand for lending products in 2004. Commercial lending grew by 22 per cent to US$21.9 billion, reflecting an increased share of a growing market, although competitive pressure led to narrower spreads as new business margins tightened. As the UK economy improved and customer confidence returned, the commercial mortgage product was updated and relaunched, and HSBC’s return to a market segment it had hitherto downplayed led to an increase in commercial mortgages of 46 per cent. In aggregate, growth in UK commercial lending added US$50 million to the overall increase in net interest income.
In France, net interest income fell by 4 per cent, reflecting reduced demand for credit and a resulting decrease in lending balances. In Turkey, net interest
income fell by 12 per cent, as a result of lower earnings on free funds, partly offset by liability growth.
Other operating income grew by 12 per cent to US$2,062 million. In the UK, increased lending activity, together with some targeted price increases delivered a US$28 million, or 42 per cent, increase in loan fee income. Credit card fee income increased by 26 per cent as a result of a rise in transaction volumes, reflecting higher consumer spending in the UK, a reduction in the interchange rate and recruitment of new merchant customers. Revised fee structures and improved collection processes contributed to a 14 per cent increase in overdraft fees in the UK. A change in strategic focus to concentrate on growing the commercial wealth management business led to the recruitment of a number of independent financial advisors. These advisors, together with an increase in marketing activity, contributed to an 18 per cent increase in income from wealth management products to US$138 million.
Operating expenses, excluding goodwill amortisation, increased by 2 per cent. Outside the UK processing and administrative costs rose in line with increased business volumes, and system development costs rose in France, again attributable to the introduction of HUB. Lower costs in the UK reflected headcount reductions in support functions, despite US$55 million of redundancy expenses incurred as part of continuing efficiency improvements. In 2003, redundancy costs were US$21million. UK operating expenses, excluding redundancy costs, decreased by 3 per cent.
The charge for bad and doubtful debts, US$305 million, rose by 35 per cent, compared with the modest charge in 2003. Underlying credit quality in the UK was stable and movements in provisions across other European countries were minimal.
Contingent liability releases of US$34 million mainly reflected a reduction in provisions against legal claims in France.
Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$1,772 million, was broadly in line with 2003. Bank of Bermuda contributed US$17 million to the pre-tax profits. The transfer of certain corporate customers to Commercial Banking referred to above reduced pre-tax profits by 2 per cent.
A 29 per cent decrease in operating profit before provisions was driven by a modest fall in revenues coupled with a significant increase in costs as part of
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the planned programme to upgrade critical infrastructure and staff skills.
Net interest income was 16 per cent lower than in 2003, in part reflecting the costs of funding a higher level of equity swaps, the trading impact and dividend benefit from which is reported in other operating income. Global Markets earnings declined as higher yielding assets ran off and were replaced by investments at lower prevailing money market rates. Market concerns over future interest rate increases, oil prices at record highs, and the Iraq crisis all drove down demand for credit. A reduction in the level of customer activity led to a fall in corporate and institutional account balances. In Turkey, significant reductions in local interest rates resulted in lower income streams from net free funds.
Other operating income rose by 6 per cent to US$3,210 million of which 2 per cent arose in Bank of Bermuda's European operations. Adjusting for the Bank of Bermuda acquisition, operating income increased by US$76 million or 4 per cent. In the UK, a US$414 million rise in dividends from equity swaps activity reflected an increase in volumes and size of trades, primarily driven by the growth in the equity swaps market. This gain was partly offset by a related decrease in dealing profits and higher fees payable of US$354 million and funding costs of US$38 million, reported under net interest income. Fixed income revenues fell, mainly from lower volatility in credit spreads and a reduced level of corporate debt issuance. Foreign exchange and derivatives revenue increased due to higher customer volumes across a wider range of products, with supplementary gains from the continued weakening of the US dollar. Improved perform ance in structured derivatives reflected the successful investment in additional execution capabilities, while Global Markets in Turkey experienced a boost in revenues from foreign exchange gains and securities trading following its integration with HSBC’s other dealing rooms in Europe. In Germany, higher fees and commissions were generated from investment banking advisory business and improved volumes on derivatives.
Costs increased by 18 per cent, of which 3 per cent represented Bank of Bermuda. The remaining costs reflected the restructuring of the business, with extensive expenditure on systems and people to improve client coverage. Overall, these developments saw the departure of 856 staff and the recruitment of 1,051 during the course of the year, improving levels of proficiency and customer delivery. Key appointments included global sector heads for certain industry teams based in the UK and
additional senior hires in investment banking advisory, while staff were also recruited to support the expansion of the cash equities, options, structured products and derivatives businesses. The planned development of global research continued, with the recruitment of people across a variety of sectors and products. The restructuring of regional research franchises into a globally managed business, encompassing all research across all product areas, was completed. Non-staff costs also increased, reflecting the continued investment in technology, including US$19 million for the development of HSBCnet. HSBC Securities Services incurred additional costs to develop insourcing capabilities for third party processing.
The net release of provisions for bad and doubtful debts, compared with a net charge in 2003, reflected the benefit of a number of recoveries and releases of certain provisions resulting from successful refinancing during the year. Corporate lending weakness in the power generation sector, which adversely affected 2003, was not repeated. The recoveries included sizeable amounts for a single name in the industrial sector in France.
Gains on investment disposals were US$210 million, reflecting the disposal of HSBC’s interest in a number of private equity investments in the UK and France.
Private Banking contributed a pre-tax profit, before goodwill amortisation, of US$432 million, an increase of 26 per cent compared with 2003.
Growth of 19 per cent in net interest income was driven by a 27 per cent increase in lending balances, predominantly in the UK and Switzerland, where clients leveraged their wealth by borrowing on a secured basis in the low interest environment to reinvest in higher-yielding securities or in alternative investments. Income also benefited from a shift in the profile of investment securities to higher-yielding HSBC Finance Corporation paper.
Net fees and commissions increased by 11 per cent to US$658 million. Performance fees included US$24 million increase in fees from the Hermitage Fund, one of the world’s leading public equity funds dedicated to Russia in which HSBC Private Bank has been invested from its inception. In the UK, commission income in HSBC’s residential property advisory business grew strongly, supported by the generally buoyant housing market, and increased client referrals.
Funds under management grew by 13 per cent to US$107.8 billion, as clients moved cash liquidity to higher-yielding investment products in the low
65
interest rate environment, and rising equity markets increased the value of the extant book. Net new money invested was US$8.6 billion. A number of new funds were launched in 2004, including several hedge funds, and the Household European Commercial Paper and Floating Rate Notes programmes attracted over US$2.5 billion of client investments. Higher transaction and portfolio fees, in line with this growth, were partly offset by weaker income in France, where transaction volumes and funds under management both fell during the year.
Operating expenses, before goodwill amortisation, increased by 5 per cent, reflecting front office recruitment, the acquisition of Bank of Bermuda, and higher performance-related remuneration. In France, lower costs reflected the merger of HSBC’s four private banks in 2003.
A US$33 million net provision for bad debts in France, arising from a small number of specific accounts, was offset by net releases in the UK and Switzerland, following a review of historic loss trends and current economic conditions, which led to release of general provisions.
Profits on disposal in 2004 included a gain on sale of a former head office building following the restructuring of HSBC’s four private banks in France. In 2003 there was a gain on a long-term private placement transaction.
Included in Other are interest earnings on cash held and interest costs of debt issued by HSBC Holdings, and the effect of corporate items not allocated to customer groups, including gains on the sale of an insurance company and releases of centrally managed litigation provisions.
The UK economy expanded by 2.3 per cent in 2003. After a slow first six months, growth accelerated in the third quarter and that momentum continued into the final months of the year. Growth in consumer spending slowed during the course of the year but nevertheless remained robust and, in particular, the housing market and household appetite to borrow remained strong. However, low real income growth, together with the expectation of further rises in interest rates, was expected to dampen household activity in the forthcoming months. Elsewhere, there were a few encouraging signs that industrial activity in particular and corporate confidence in general was starting to improve from a low base. Stronger global demand, if maintained, was expected to provide a boost to the corporate sector.
Having slipped into recession in the first half of the year, the eurozone economy returned to growth in the second half, expanding by 0.4 per cent quarter-on-quarter in the third quarter and by 0.3 per cent in the fourth quarter. Once again, however, it was stronger exports that drove the third quarter improvement, while the domestic economies remained subdued. Consumer spending was flat and investment contracted for the third consecutive quarter. The pick-up in exports occurred despite the appreciating euro, which rose more than 16 per cent against the US dollar during the course of the year. In the fourth quarter, growth seemed to have been largely the result of inventory build up, with exports falling back after the strength of the third quarter, and with limited growth in consumer spending. Interest rates were cut twice during 2003, with the European Central Bank’s repo rate dropping by 75 basis points to 2 p er cent. By contrast, however, longer-term interest rates moved higher, rising by about 80 basis points between June and the end of December, as the bond market anticipated economic recovery.
In 2003, personal credit expansion in the UK was the major growth area as consumers took advantage of historically low interest rates, enabling HSBC to generate strong growth in mortgages and consumer lending. Conversely, sales of investment and pension products fell, reflecting a lack of confidence in equity markets. In this environment, HSBC grew its deposit base as customers sought flexibility and security for their savings, notwithstanding the low interest rates available. The low interest rate environment also meant that the value of HSBC’s maturing liquidity reduced as it was redeployed in lower yielding assets.
The same factors, low interest rates and weak equity markets, increased the cost of pension provision by US$96 million in the UK. Employment costs also grew, notably in the UK, as social taxes were raised. In order to adjust for this higher cost environment, HSBC took steps to reduce its staff costs, announcing both 1,400 redundancies in the UK and the shift over the next three years of 4,000 positions to the Group Service Centres. In the short term these actions incurred both redundancy and excess property provisioning costs totalling over US$176 million.
European operations contributed pre-tax profit of US$3,969 million in 2003 compared with US$3,500 million in 2002. Excluding goodwill amortisation, European operations contributed pre-tax profit of US$4,862 million and represented around one-third of HSBC’s total profit on this basis. At constant exchange rates, and excluding the
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US$157 million contribution from HFC Bank, which was the only major change in the composition of the Group in Europe, pre-tax profit, excluding goodwill amortisation, was 2 per cent higher than in 2002. Goodwill amortisation of US$893 million increased by US$233 million compared with 2002, mainly reflecting a goodwill write-down in respect of a UK fund management company previously acquired as part of the CCF acquisition, and exchange rate movements.
The commentaries that follow are based on constant exchange rates.
Pre-tax profit, before goodwill amortisation, of US$1,267 million in Personal Financial Services, excluding Consumer Finance, was 16 per cent higher than in 2002, reflecting strong growth in UK mortgage and consumer lending, and in deposit-taking activities.
Net interest income increased by 10 per cent, driven by strong growth in mortgages and personal lending in the UK and, to a lesser extent, in France. The net interest margin fell modestly as rates remained at historically low levels. However, balance sheet growth more than compensated for this. UK mortgage balances increased by 25 per cent to US$37.4 billion, as borrowers continued to take advantage of the low interest rate environment to refinance their mortgages. In France, a similar pattern was seen, and CCF’s mortgage balances increased by 11 per cent over 2002. Gross new mortgage lending in the UK grew by 12 per cent to US$17.9 billion. First Direct contributed to this growth with a US$280 million, or 14 per cent, increase over 2002, reflecting the continuing success of its Offset mortgage product. Both HSBC and First Direct continued to win major awards for their mortgage products in 2003.
In the UK, personal lending balances, excluding mortgages and credit cards, grew by 15 per cent, reflecting the success of targeted marketing campaigns and improved utilisation of customer relationship management systems. Card balances grew by 18 per cent to US$4.2 billion, due to strong consumer expenditure and targeted marketing campaigns, resulting in an overall increase in fee income from cards of 13 per cent.
HSBC’s Premier service was further enhanced and the number of customers using this service in the UK grew by 57 per cent to over 280,000. Significant growth was achieved in HSBC Premier savings accounts in 2003, which contributed to an overall increase in UK personal savings balances of 20 per cent to US$35.7 billion. UK personal current
account balances grew by 13 per cent to US$18.0 billion.
Other operating income was broadly in line with 2002. The strong growth in mortgages and personal loans boosted sales of repayment protection products in the UK, producing a 19 per cent increase in personal loan protection premiums. HSBC maintained its position as the leading provider of income protection products in the UK, with a market share of 17 per cent at the end of September 2003. Lack of customer confidence in equity markets led to a decline in sales of investments and pension products. This trend also adversely affected the value of HSBC’s long-term assurance business in the UK. However, weakness in investment product sales reflected market conditions rather than competitive positioning and the bank was awarded the coveted ‘Five Star Award’ from Money Management magazine for its regular premium stakeholder pensions in the UK again in 2003.
HSBC Bank A.S. in Turkey benefited from additional card fee income following the acquisition of Benkar in September 2002, contributing to an overall increase in its other operating income of 51 per cent.
Operating expenses, excluding goodwill amortisation, increased by 2 per cent. This was largely due to restructuring costs and external factors in the UK, including higher social taxes and the amortisation of the UK pension scheme deficit reported at the end of 2002. The relocation of HSBC Bank’s headquarters to Canary Wharf contributed to higher premises costs, following the upgrade of equipment and infrastructure. Additional costs were also incurred migrating the card issuing business in the UK to the more efficient platform used by HSBC Finance Corporation in the US. Costs in France were largely unchanged compared with 2002.
Low interest rates, stable employment and a gradual upturn in economic conditions in the UK provided the environment for continuing low levels of credit charges. The charge for bad and doubtful debts at US$267 million was 14 per cent higher than in 2002, a satisfactory performance in view of the growth of over 20 per cent in UK personal lending. Overall, credit quality improved.
In Consumer Finance, HFC Bank, which joined HSBC in the UK in March as part of the HSBC Finance Corporation acquisition, contributed US$157 million to pre-tax profit, before goodwill amortisation, in its first nine months of ownership. Integration with the HSBC Group was running on schedule.
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In Commercial Banking, pre-tax profits, before amortisation of goodwill, declined by 13 per cent compared with 2002, mainly reflecting lower net interest income and a higher cost base.
Net interest income decreased by 3 per cent to US$1,961 million. Following the recommendations of the UK’s Competition Commission, HSBC applied credit interest to all qualifying small and medium-sized customer accounts, increasing interest expense by US$136 million. The move did, however, lead HSBC to strengthen its product proposition within those market segments in the UK, and business current account balances consequently rose by 21 per cent to just over US$10 billion. In addition, HSBC’s popular ‘Start-up Stars’ competition continued to raise the profile of the bank’s small business proposition in the UK and helped to attract over 102,000 new business start-ups and over 23,000 customer transfers. Enhanced customer targeting and the introduction of risk-based relationship pricing improved HSBC’s competitive position in the UK market, increasing lending balances by over US$2.2 billion and net interest income by 10 per cent.
Overall, deposit balances in the UK grew by 9 per cent to just over US$9 billion, increasing market share and partly offsetting the effects of reduced deposit book spreads. Balances grew as a consequence of the introduction of the new Business Money Manager account, launched in response to customer demand for flexible savings accounts. The new product attracted an average of 1,700 new accounts per week and generated US$95 million of net interest income.
In France, overall net interest income was broadly in line with 2002. The subdued economic climate saw businesses adopt a more conservative investment policy that was reflected in a 3 per cent rise in sight deposits. Short-term higher spread lending fell by 8 per cent, but was partly offset by growth in medium and longer-term lending, which increased by 4 per cent.
In the UK, other operating income was marginally higher than 2002. Overdraft fees rose by 12 per cent, or US$19 million, reflecting the further benefit of improved account management initiatives introduced last year, whilst loan fees increased significantly in line with the growth in customer numbers.
In France, higher income was generated through a volume-led increase in banking transaction fees and the introduction of a variety of guaranteed investment funds during the year. The former was achieved after specific initiatives directed towards
middle market enterprises (‘MMEs’). The successful launch of several structured financial products led to higher trading fees within CCF and the take-up of Asset Management products increased by 9 per cent.
Overall, wealth management income declined as continued uncertainty in equity markets led to a fall in sales of savings and investment products.
Operating expenses, excluding goodwill amortisation, were 7 per cent higher than last year at US$2,113 million. This was largely due to an increase in staff costs in the UK. Pension costs rose to compensate for the scheme deficit and one-off redundancy costs were incurred as migration was planned to the Group Service Centres’ capabilities. The costs of distributing and supporting business services and products within the UK increased in line with the growth in volumes and continued investment was made in electronic delivery channels across Europe.
At US$204 million, the overall charge for bad and doubtful debts was 9 per cent lower than in 2002. In the UK there was a release of general provision which recognised the gradual improvement in the economic outlook for businesses over the year. Offsetting this there was a higher specific charge, reflecting a number of large provisions across various industries. Additionally, the charge in France increased due to lower recoveries in two of the regional banks. Underlying credit quality in France remained stable.
Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$1,623 million, an increase of 2 per cent compared with last year. In Global Markets Europe, performance was strong. This reflected income growth in foreign exchange, derivatives and debt securities, partly offset by higher bad debt provisions in Corporate Banking. HSBC also absorbed the costs of restructuring and repositioning the equities and investment banking businesses.
In Global Markets UK, earnings from deploying the excess liquidity of the bank declined as long-term assets matured and proceeds were reinvested at lower rates. Overall, net interest income was 5 per cent lower than in 2002.
Other operating income increased by 9 per cent, reflecting a substantial growth in dealing profits that more than offset lower fee and commission income. Foreign exchange revenues remained strong as volatility in the major currency pairs prompted customers to hedge their currency exposures. Continued weakening of the US dollar provided a clear trend in the markets for position taking. Fixed
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income earnings showed a strong year-on-year growth reflecting a combination of tightening credit spreads and strong investor demand for yield in the low interest rate environment, which boosted sales of corporate bonds. In line with a greater business focus on risk management products, revenues from trading increased, reflecting the benefit successful interest rate positioning and continued growth in customer mandates from corporate customers. Additional growth in revenue resulted from a strong presence in each of the euro vanilla and structured derivatives markets.
Fees and commission income decreased by 6 per cent. Difficult operating conditions in equity markets resulted in lower commissions and new-issue fees, but these were partly offset by higher fees from merger and advisory business as greater focus was given to HSBC’s core customer sectors and regions. Fees from debt capital markets activities were also strong. Generally, fees benefited from the high level of activity in the primary markets, as customers sought long-term financing at low interest rates.
Staff costs rose, with higher bonuses reflecting increased profitability in specific product lines. Restructuring and research costs of US$24 million were also incurred to build and reshape HSBC’s investment banking and equities businesses. Premises and equipment expenses were lower as a result of savings in rental payments from the London office move to Canary Wharf.
Credit experience was generally satisfactory although new specific provisions were higher, mainly due to a single name in the engineering sector which was extensively restructured in the second half of the year. Corporate weakness in the power generation sector was also dealt with through raising additional specific provisions, although these were partly offset by recoveries in the transport and telecommunications sectors, as balance sheets were strengthened.
Gains on investment disposals were lower than in 2002, mainly due to a reduction in profits from the disposal of venture capital investments in CCF.
Against the background of a recovery from recent lows in European stock markets, Private Bankingactivities continued to grow during 2003. Pre-tax profit, excluding goodwill amortisation, increased by 48 per cent as a result of strong growth in dealing income, lower costs and the non-recurrence of contingencies and write downs in 2002.
Net interest income was broadly in line with 2002. A 30 per cent increase in lending balances was driven by clients seeking to maximise the overall earnings potential of their investments by borrowing to reinvest in higher returning securities. These additional earnings were mostly offset by a decline in yield on free funds as lower interest rates prevailed throughout the year.
Net fees and commissions increased by 2 per cent to US$556 million. The low interest rate environment improved the attractiveness of investment markets, particularly for sophisticated investors with access to structured products which offered potentially higher returns than from cash deposits. Consequently, funds under management increased by US$20 billion to US$91 billion, with a move by clients away from liquid positions bringing in some US$9 billion of new client funds. A strong rise in discretionary mandates together with client demand for structured products and HSBC Finance Corporation’s commercial paper contributed to the increase. Transaction and safe custody fees rose in line with the growth in client funds while an increased focus on product enrichment produced strong growth in income from structured products. In Germany, fee income was boosted by the placement of two new property funds. However, income in France was weaker as stock market activity remained subdued.
Volatility in the major currencies resulted in higher volumes of client transactions in the foreign exchange markets, and combined with proprietary equity gains in 2003, contributed to the 37 per cent improvement in dealing profits to US$94 million.
Total operating expenses, before goodwill amortisation, fell by 4 per cent to US$709 million. This was achieved through cost savings realised following the merger of three banks in Switzerland in 2002 and lower property expenses.
Provisions for contingent liabilities and commitments were lower than in 2002, which included amounts provided for litigation. Amounts written off fixed asset investments were lower than in 2002 following a specific write down of a debt security in 2002. Gains on disposal of investments and tangible fixed assets increased by 22 per cent to US$61 million, principally reflecting a gain on a long-term private placement transaction.
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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 expanded rapidly in 2004. Despite rising US interest rates and mainland China’s cooling-off measures, Hong Kong continued to benefit from robust re-export trade with mainland China. The positive outlook for Hong Kong, together with the re-emergence of inflation, helped sustain a recovery in local confidence which began in late 2003. Hong Kong’s domestic demand also grew steadily, supported by reviving asset prices and falling unemployment. The continued inflow of liquidity suppressed local interest rates, which in turn encouraged a flow of local funds into asset markets. Rising property prices stimulated private consumption and alleviated past concerns over negative equity in residential mortgages. The unemployment rate fell from 7.3 per cent to 6.5 per cent, with strong growth in the trade and retail sectors helping to sustain consumer spending, though the rate of job creation slowed in the second half of the year as China’s cooling-off measures took effect on the trade sector. Investment revived in the robust tourism industry, which continued to benefit from the liberalisation of regulations governing visits by residents of mainland China.
In the second half of 2004, inflation re-emerged in Hong Kong after a nearly six year-long period of deflation. Stimulated by a weak US dollar, recovering property prices and rising local confidence, prices rose from a year ago when the economy was suffering from the effect of the severe acute respiratory syndrome (‘SARS’) epidemic. Significant inflows of liquidity from foreign investors left the Hong Kong market flush with surplus funds. This caused Hong Kong dollar and US dollar interest rates to diverge, with the already cash-rich local economy slow to absorb external funds. Moreover, demand for credit remained muted, other than in the trade sector, with individuals and enterprises slow to increase borrowings, reflecting nervousness regarding the sustainability of the recovery. The improving economy helped to ease concerns over Hong Kong’s fiscal position as it
resulted in a significant narrowing in the budget deficit in 2004.
HSBC’s operations in Hong Kong reported a pre-tax profit of US$4,744 million, an increase of US$1,016 million, or 27 per cent, over 2003. Excluding goodwill amortisation, pre-tax profit also grew by 27 per cent to US$4,753 million, representing 24 per cent of HSBC’s total profit on this basis.
Personal Financial Services in Hong Kong reported a pre-tax profit, before goodwill amortisation, of US$2,097 million, 21 per cent higher than in 2003. This improvement was largely driven by strong growth in other operating income, within which fee and commission income was 27 per cent higher. This, together with a significant reduction in the net bad debt charge, more than offset an 8 per cent reduction in net interest income.
During 2004, the Hong Kong banking sector was characterised by high levels of surplus liquidity as foreign funds entered Hong Kong to invest in the buoyant stock market, and there were inflows from investors anticipating an upward realignment of the currency as the US dollar weakened. This excess liquidity depressed Hong Kong dollar interest rates and so reduced spreads on deposits, as banks were unable to pass on the full effect of the reduction in rates to depositors. The lower Hong Kong dollar interest rates contributed to the overall reduction in net interest income of US$186 million. Net interest income was further reduced by the continued pressure on yields in the mortgage business, where market competition remained intense. Average mortgage balances fell by 2 per cent compared with last year due to a reduction in balances under the Government Home Ownership Scheme (‘GHOS’), which remained suspended during the year. With plenty of low cost funding in the market, and fierce competition for quality mortgage business, the average yield on the mortgage portfolio, excluding GHOS loans, fell by 25 basis points to 202 basis points below HSBC’s best lending rate.
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HSBC maintained its position as the largest credit card issuer in Hong Kong. An attractive rewards programme, successful cross-sales to both existing and new customers, and customer acquisition, helped grow the number of cards in circulation by 14 per cent to 3.5 million. Cardholder spending increased by 32 per cent compared with 2003, reflecting the successful promotion of credit card internet bill payment services, and promotional campaigns launched in conjunction with retail merchants. Average credit card balances grew by 11 per cent against a backdrop of an overall reduction in outstanding balances in the market. Fee income from credit cards rose by 12 per cent compared with 2003.
Other operating income increased by 24 per cent to US$1,466 million, largely driven by the continued strong performance from the insurance and investment businesses.
During the year, strong emphasis was placed on growing the insurance business. A series of promotional campaigns was launched, and the number of financial planning managers was increased by 24 per cent to 742. The insurance product range was also enhanced as new products designed to meet customers’ needs were introduced. In 2004, HSBC recorded growth of 40 per cent in new regular premium life sales, driven by the success of flexible products tailored to customers’ specific needs, such as the Target Protection Plus product. Income from the insurance business, including the Mandatory Provident Fund also grew by 31 per cent to US$441 million.
Income from sales of unit trusts and structured products grew by 43 per cent to US$183 million, reflecting the successful deployment of customer relationship management systems, an increase in the number of HSBC Premier relationship managers, and a rise in stock market activity. New products, including a range of structured treasury products, capital-guaranteed funds, open-ended funds and certificates of deposit, were launched to broaden the range of investment options. Overall, sales of unit trusts and structured products grew by US$609 million, or 9 per cent, compared with 2003.
Higher fee income also came from stockbroking and custody services, which grew by 49 per cent to US$185 million, reflecting increased levels of stock market activity and IPO-related services. Sixty eight per cent of all securities transactions were processed on-line in 2004, 5 percentage points higher than in 2003.
Operating expenses, excluding goodwill amortisation, were 4 per cent higher than in 2003.
Performance-related staff costs increased in line with sales of investment and insurance products and the general improvement in profits. Excluding the impact of incentive payments, staff costs fell by 5 per cent, reflecting greater operational efficiencies and higher utilisation of the Group Service Centres. The various income growth initiatives also involved higher marketing costs, particularly for credit cards, insurance and investment products.
Credit conditions improved markedly as the economy recovered, with falling unemployment, lower bankruptcies, higher residential property prices and stronger GDP growth. The charge for bad and doubtful debts fell by US$312 million to US$54 million. New specific provisions declined by over 74 per cent to US$95 million, as provisions for credit card, mortgage and unsecured personal lending portfolios all fell. There was also a US$41 million release of general provisions following a review of historical loss experience and the improved market environment, in particular a reduction in mortgage loans with negative equity.
Pre-tax profits, before goodwill amortisation, in Commercial Banking rose by 29 per cent to US$914 million, driven by a 14 per cent rise in operating income and significant releases and recoveries in provisions.
Operating income benefited from the success of a series of initiatives designed to enhance the service offered to middle market customers. The introduction of a greater number of experienced relationship managers to service key accounts contributed significantly to income growth, while a number of dedicated business development relationship managers were appointed to focus on new customers, leading to a 3 per cent increase in customer numbers. Small and medium-sized enterprises (‘SME’s) benefited from the opening of five new business banking centres offering a comprehensive range of bespoke services, while an SME start-up marketing campaign, launched in October, promoted these services with specific reference to the BusinessVantage all-in-one account. These initiatives, together with call centre expansion, contributed to an increase in income arising from SME business.
Net interest income increased by 13 per cent as strong growth in both lending balances and customer deposits reflected the impact of the relationship managers and business banking centres. Spreads on deposits narrowed during the year in the continued low interest rate environment.
Other operating income rose by 16 per cent to US$525 million due largely to a significant rise in
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trade finance activity and trade-related income. Economic expansion in mainland China, the consumer spending recovery in the US and an increase in commodity prices contributed to strong regional trade flows. Business activity with mainland China benefited from the secondment of key relationship managers to HSBC offices there, and a regional advertising campaign demonstrating HSBC’s ability to offer integrated solutions across Greater China.
Increased lending to middle market customers, together with the launch of several new lending products for SMEs and related marketing campaigns, boosted credit facility fee income. Continued investment in sales resources and training, marketing and incentive campaigns led to higher insurance income. The introduction of income protection, unit trust and structured investment products to HSBC’s range of commercial wealth management products also contributed to the increase in non-funds income, resulting in a 20 per cent rise in investment and protection income.
Operating expenses, before goodwill amortisation, were 7 per cent higher than in 2003. The increase reflected growth in headcount, higher recruitment-related costs, and training costs. Marketing spend also rose in support of business development initiatives with mainland China, and to increase sales to existing customers and raise insurance income. Further costs arose from the launch of a number of efficiency initiatives, including a new Customer Relationship Management System, which is expected to lead to both improved sales and cost savings. As part of an ongoing process, credit support and trade services processes were migrated to the Group Service Centre in Shanghai.
The net release for bad and doubtful debts increased by US$87 million. There were specific provision releases reflecting the improved economic environment and stronger property market, and a release of general provisions following a review of the impact of the improved economic conditions and historical loan loss experience.
Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$1,584 million, 24 per cent higher than in 2003, driven by strong growth in dealing profits, a significant increase in fees and commissions and a net release of provisions for bad and doubtful debts. In January, management responsibility for a corporate trust business was transferred from Private Banking, contributing US$18 million to pre-tax profits. While comparative
numbers have not been restated, the comments that follow exclude the impact of this business transfer unless stated.
Net interest income was 14 per cent lower than in 2003, reflecting continued pressure on corporate spreads and lower treasury income resulting from the run-off of higher yielding assets, coupled with limited reinvestment opportunities against a flat Hong Kong dollar yield curve. This shortfall in revenue was partly mitigated by growth in corporate loan balances and higher deposit balances, driven by the roll-out of an upgraded payments and cash management product set.
Other operating income grew by 67 per cent, of which 9 per cent came from the inclusion of Bank of Bermuda’s operations in Hong Kong. Underlying growth reflected a significant increase in fees and commissions and dealing income. Foreign exchange profits increased, benefiting from strong customer flows and growing cross-sales opportunities to corporate clients. These gains were further amplified by the non-recurrence of losses resulting from a strengthening Hong Kong dollar in the latter part of 2003. Derivatives trading reported higher profits as Global Markets provided structured investment solutions to support the growth in the sale of wealth management products to personal and commercial customers. A combination of successful positioning and improved customer flows also contributed to profitability as clients sought to lock in funding requirements at historically low rates. Fee income increased from structured solutions and yield enhancement products, and sales of securities and unit trusts. Structured finance also generated an increased contribution compared with 2003. Equity capital markets benefited from an active IPO market, while private equity revenues were boosted by an improvement in management fees, as the launch of a US$700 million regional fund was completed. In asset management, higher sales of investment products and strong growth in funds under management generated increases in distribution revenues and advisory fees, as customers pursued higher returns in a low interest rate environment.
Operating expenses, excluding goodwill amortisation, increased by 36 per cent, of which 10 per cent arose in Bank of Bermuda. Staff costs were 18 per cent higher, driven by the recruitment of additional staff, and higher performance-related incentives in line with strong Global Markets results. In Global Markets, staff were recruited to support the increased product range, while in Global Investment Banking, further expenditure was incurred in recruiting corporate finance executives and a number of senior relationship managers to extend coverage
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along industry sector lines. Business expansion and new front office initiatives in Global Markets resulted in the recruitment of an additional 45 people. Other general cost increases reflected higher technology expenditure, including a US$10 million charge for the development of HSBCnet and, a rise in travel and communication spending, all driven by business expansion and increased sophistication of the product range.
There was a net recovery of bad and doubtful debts, particularly from the property, industrial and telecommunications sectors, following a number of successful restructurings and refinancings, reflecting an improved economic environment in Hong Kong and across the region.
Private Banking contributed a pre-tax profit, before goodwill amortisation, of US$135 million, an increase of 6 per cent compared with 2003. A trust business was reclassified as Rest of Asia Pacific during the year, and Corporate, Investment Banking and Markets took over management responsibility for the corporate trust business from Private Banking. These transfers reduced growth in profit before tax by 17 per cent.
Excluding the corporate trust transfer mentioned above, funds under management increased by 19 per cent. Growth benefited from the introduction of new products, expansion of the client base, and continued strong growth in Strategic Investment Solutions, which was launched in July 2003 and contributed to a US$2.9 billion inflow in net new funds. The recruitment of front office staff, and a general improvement in market conditions, also contributed to growth in funds under management.
Total revenue was 5 per cent higher than last year. Underlying growth of US$57 million, including US$10 million from the Bank of Bermuda, was largely offset by the changes noted above. Recovering equity markets, coupled with historically low interest rates, encouraged a marked increase in client investment activity. Fees and commissions benefited from a higher volume of equity transactions, unit trust sales, and portfolio management fees on increased funds under discretionary management. Higher client volumes also boosted dealing income from foreign exchange, options, and structured products. Revenue from sales of structured products increased by nearly 70 per cent compared with 2003, while commissions on sales of unit trusts rose by over 90 per cent, and from funds under discretionary management by over 120 per cent.
Operating expenses, excluding goodwill amortisation, increased by 8 per cent, including 6 per cent
growth attributable to Bank of Bermuda and a 25 per cent decrease resulting from the changes noted above. Underlying growth of 27 per cent mainly reflected the recruitment of 49 front office staff. Performance-related remuneration increased as a result of the strong growth in revenue, while a rise in marketing expenditure reflected the new brand advertising campaign.
A US$4 million net release of bad debts reflected a release of general provisions, following a review of historical loss trends and current economic conditions.
Gains on the exchange of an investment in World Finance International Limited, an associated company, for a 7 per cent stake in Bergesen Worldwide, contributed to an improved performance in Other. Gains on equity sales and profits on the disposal of a residential property also contributed to the increase.
The Hong Kong economy faced challenging conditions during the first half of 2003. Slower growth in major export markets, rising unemployment and a weak property market dampened consumer demand, whilst the outbreak of the SARS virus had a significant adverse impact on the entertainment, leisure and tourism sectors. However, by the third quarter there was clear evidence of a bounce-back with GDP growing 6.4 per cent quarter-on-quarter, more than reversing the 3.7 per cent dip in the second quarter of 2003. The growth rate benefited significantly from the release of demand deferred during the SARS period. Growth also drew support from stronger export demand and improving sentiment after the central government unveiled a series of economic measures to help Hong Kong, including the relaxation of controls on mainland residents travelling to Hong Kong. Local consumer spending grew for the first time in two years and even more encouraging was a pick-up in investment reflecting an improved business outlook.
HSBC’s operations in Hong Kong performed well in these circumstances and reported a pre-tax profit of US$3,728 million, broadly in line with 2002. Excluding goodwill amortisation, profit before tax was US$3,730 million and represented 26 per cent of HSBC’s total profit on that basis. Goodwill amortisation was US$2 million in 2003. Of this growth, just under 4 per cent arose from acquisitions during the period.
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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 goodwill, of US$711 million, a fall of US$22 million, or 3 per cent.
Net interest income declined by 7 per cent largely due to lower recoveries of suspended interest and the effect of lower spreads on deposits. There was good volume growth in the loan book, despite the impact of SARS and the war in Iraq. This was offset by narrower spreads caused by limited local investment and market pressure as banks competed for quality business. Loan growth was driven by increased demand for finance to support record trade flows between mainland China and the rest of the world, especially the US. This was particularly evidenced in the manufacturing and transportation sectors. Several new business banking/trade service centres were opened to focus on the business needs of small and medium-sized customers and start-ups.
Other operating income rose by US$57 million, or 14 per cent, reflecting growth in cash management and trade services. Both benefited from the increase in trade flows and closer liaison between branches of the bank in Hong Kong and mainland China. This was developed in order to service the growth of investment in the Pearl River delta by Hong Kong-based customers. Additionally, Hang Seng Bank opened its first branch in Macau aimed at assisting customers setting-up offices in the territory. Results of this alignment were particularly successful, with referrals significantly higher than anticipated. Trade finance benefited from a campaign specifically aimed at the increase in export trade business which occurs during the peak summer season. Insurance income rose as a consequence of business expansion, increasing by 36 per cent.
Operating expenses were in line with 2002. Staff costs increased marginally as headcount rose to support the insurance business expansion. This was offset by lower legal and professional fees.
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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 lo wer 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 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.
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Profit before tax excluding goodwill amortisation
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Driven primarily by external demand, growth in Asia-Pacific was strong in the first half of 2004 and the positive export performance, in turn, provided the necessary income growth to support consumption demand. However, the surging growth seen in most Asian economies appeared to peak in the middle of 2004 and slow, primarily for two reasons. The first was the erosion of purchasing power from the high level of oil prices, and the second was the start of a policy-induced slowdown in mainland China’s
investment demand, designed to slow China’s domestic economy. HSBC estimates that, excluding Japan, Asian economies grew by 7.1 per cent throughout 2004, with growth of 8.3 per cent in the first half down to 6 per cent in the second half of the year. The slowdown is expected to persist in 2005.
The mainland China economy dominated economic activity in Asia in 2004, with concerns over whether the authorities would be able to slow growth in a manageable fashion from the unsustainably high levels of 2003 and first half of 2004, and continued speculation regarding a possible
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revaluation of the renminbi. Evidence to date suggests that the Chinese economy is likely to achieve a soft landing with the investment slowdown being cushioned by strong exports and rising consumption. However, Asian exports to China are being affected by this re-balancing of growth. The Chinese authorities have resisted revaluation speculation and indicated that the status quo will remain in the foreseeable future.
Elsewhere, capital flows put Asian currencies under pressure to appreciate in value. In some countries, policy measures were reasonably successful in resisting the pressure, with the result that floating Asian currencies, while gaining on the US dollar, lost ground to the yen and the euro. Inflationary pressures remained modest and Asian central banks did not need to fully match increases in US interest rates during the year. Indeed, the Bank of Korea cut rates by 25 basis points at both its August and November meetings.
Energy producing economies in the Middle East continued to benefit from high global oil prices, and the region's current account surplus in 2004 is expected to easily exceed the 2003 surplus of US$52 billion. In the context of relatively low inflation, the Middle East’s strong balance of payments position should ensure that domestic interest rates remain relatively low, which in turn should continue to stimulate domestic demand. Altogether, this means that the GDP growth rate in 2004 in the Middle East should be close to 2003’s 5.4 per cent. The level of public debt relative to GDP remains high in the region compared with other emerging markets, but HSBC considers it unlikely that there will be financing problems there.
HSBC’s operations in the rest of the Asia-Pacific region contributed US$1,805 million to HSBC’s pre-tax profit, an increase of US$414 million compared with 2003. Excluding goodwill amortisation, pre-tax profit was US$1,877 million, and represented 10 per cent of HSBC’s total profit on this basis. At constant exchange rates, pre-tax profit before goodwill amortisation increased by 29 per cent over the same period in 2003. Three per cent of this growth arose from acquisitions during the period. The comments which follow are based on constant exchange rates.
In Personal Financial Services pre-tax profit, before goodwill amortisation, of US$350 million increased by 117 per cent compared with prior year.
Net interest income grew by 22 per cent, reflecting strong asset growth in a number of countries across the region, particularly in the
Middle East, Australia, Korea, India, Singapore, Malaysia and Taiwan.
Mortgage balances increased by 29 per cent to US$13.6 billion, following strong sales drives and a series of promotional campaigns in a number of countries. Lower pricing to achieve this growth led to lower yields. The cards business continued to expand and a number of new products were introduced. Acquisition strategies, including a wide variety of promotional campaigns and the launch of an enhanced rewards programme in 12 countries across the region, led to a 25 per cent increase in cards in circulation. At the end of 2004, HSBC’s card base in the region exceeded 4.6 million, with particularly strong growth in India, Malaysia, Singapore, the Philippines and the Middle East. Utilisation of this expanded card base contributed to a 21 per cent increase in average credit card balances compared with 2003.
Other operating income grew by 27 per cent to US$403 million, driven by sales of investment products across the region. Commissions from sales of unit trusts and funds under management were particularly strong in Taiwan, Korea, India, and Malaysia, where HSBC Bank Malaysia is the leading international institutional unit trust agent. Brokerage and custody fees increased by 143 per cent with particularly strong growth in Australia reflecting increased marketing, buoyant stock market activity and higher stock prices.
HSBC continued to grow its insurance business across the region and income grew by 86 per cent as the number of policies in force increased by 25 per cent. Fee income also benefited from the strong growth in the credit card base, increased account service fees and growth in sales of structured products.
Operating expenses, excluding goodwill amortisation, of US$947 million increased by 15 per cent, mainly from a 24 per cent increase in other administrative expenses. Significant emphasis was placed on promoting brand awareness in mainland China to generate additional business and to reinforce HSBC’s position as the leading international bank in mainland China. The launch of a number of credit card and mortgage advertising campaigns also fed through to a rise in marketing costs. Investment in systems development across the region was reflected in higher technology costs. In 2004 magnetic stripe cards and ATM cards were replaced by chip based cards in Malaysia. Elsewhere in Asia, progress was made in upgrading point-of-sale terminals and ATM’s to enhance fraud protection and prepare for the eventual pan-regional
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implementation of chip cards. Other general expenses, including professional fees and communications costs, increased to support business expansion. Within the region HSBC expanded the scale and range of services offered by the Group Service Centres and additional staff were recruited to support increased workflow. As new business and cross-sales across the region grew HSBC increased investment in sales support.
At US$117 million, the overall charge for bad and doubtful debts was 21 per cent lower than in 2003. There was a release of general provision in Malaysia which reflected the improvement in economic outlook, and higher releases and recoveries of specific provisions in several countries across the region. New specific provisions raised were 9 per cent higher than in 2003, notably in the Middle East, Indonesia and Australia, reflecting lending growth.
Commercial Banking reported pre-tax profits, before goodwill amortisation, of US$496 million for 2004, 9 per cent ahead of 2003. A turnaround in provisions, from a credit of US$52 million to a charge of US$16 million, was more than offset by additional income arising from growth in international trade. Pre-provision profit before tax increased by US$81 million, or 21 per cent. The results also included, for the first time, a contribution of US$24 million from the group’s 19.9 per cent stake in Bank of Communications.
Net interest income increased by 11 per cent, compared with 2003, reflecting growth in the Middle East, mainland China, Australia, New Zealand and Singapore. The Middle East benefited from the expansion of international trade, increased lending to infrastructure projects, which took off on the back of strong oil prices, and growth in current accounts. In mainland China, HSBC benefited from increased cross-referrals from Hong Kong, while a Taiwan team seconded to mainland China helped to capture substantial business from Taiwanese customers investing there.
The expansion of trade business was also reflected in other operating income, which grew by 18 per cent to US$347 million. Growth was particularly strong in the Middle East, which also benefited from increased fees associated with higher lending, and in mainland China and Malaysia, where dealing profits from foreign currency transactions and trade services fees were both higher.
Operating expenses, before amortisation of goodwill, were 6 per cent higher than last year. Additional relationship managers, business development and sales staff, credit analysts and
support staff were recruited in the latter part of 2004 in order to benefit from anticipated business opportunities in 2005 arising from strong regional economies. The continued migration of back office work from Singapore, Australia, New Zealand and Taiwan to the Global Service Centres contributed to cost savings.
Provisions for bad and doubtful debts were US$16 million, reversing a net release in 2003. New provisions increased in mainland China, largely on a single account and in the Middle East, reflecting growth in lending. There were lower net recoveries in Malaysia, while net recoveries and releases increased in Indonesia and Singapore.
Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$940 million, an increase of 26 per cent compared with 2003.
Net interest income of US$592 million grew by 7 per cent, in part reflecting strong Global Markets performance from increased treasury earnings in India and higher holdings of debt securities in China. Corporate and Institutional Banking benefited from a 55 per cent increase in customer advances in mainland China and a 58 per cent increase in the Middle East. These gains were partly offset by a decline in treasury interest income in Singapore as higher yielding assets matured, and a reduction in interest income in Japan from lower holdings of debt securities.
Fees and commissions grew by 24 per cent to US$421 million including a 3 per cent increase resulting from Bank of Bermuda. Corporate and Institutional Banking fee income rose in India, Singapore, Taiwan and Japan, as client demand grew for more sophisticated capital markets and related risk management products. Performance in these countries was improved further as an expansion in business capabilities increased investment banking advisory revenues and boosted Global Transaction Banking volumes. In the Middle East, increases in private equity revenues and corporate finance and advisory fees reflected the expansion of the private equity business and an enhancement of HSBC’s advisory function. In Malaysia, higher fees were attributable to an increase in global custody and transactional fees and an improvement in debt origination and loan syndication activity. The realignment of Corporate and Institutional Banking business with Global Markets capabilities enabled debt finance advisory to double the number of bond and syndicated loan transactions, following effective marketing initiatives and the identification of capital market opportunities.
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The custody and clearing business benefited from renewed capital inflows, generating higher fees in India, Taiwan and Korea, while improved revenues in institutional funds services reflected the expansion of HSBC’s capabilities into Indonesia, Korea, India and Saudi Arabia.
Foreign exchange, derivatives and securities trading income streams were all supported by favourable market opportunities in the region. A 10 per cent increase in dealing income was driven by sales of tailored structured products in Singapore, in part reflecting cross-sales to HSBC’s personal, commercial and corporate customers. In India, higher foreign exchange gains resulted from successful positioning and growing corporate volumes, against a backdrop of an appreciating Indian rupee. The falling interest rate environment in Korea created proprietary trading and cross-currency arbitrage opportunities while interest rate volatility contributed to strong performance in Global Markets Malaysia. In the Middle East, generally volatile market conditions prompted a higher level of hedging activity and an improvement in the volume of customer transactions.
Excluding the impact of Bank of Bermuda, operating expenses, excluding goodwill amortisation, increased by 8 per cent, driven primarily by higher performance-related incentives in the Middle East, Korea, Singapore and mainland China. In India, a 20 per cent rise in staff costs, reflecting higher incentives was more than offset by a reduction in restructuring costs compared with 2003. In Singapore, mainland China and the Middle East, an additional 68 people were recruited to upgrade their corporate and support teams, adding to staff costs.
There was a higher net release for bad and doubtful debts reflecting the benign credit environment across the region, largely due to releases and recoveries in the chemical and property sectors.
Private Banking reported a pre-tax profit, before goodwill amortisation, of US$59 million, an increase of 59 per cent compared with 2003, which reflected the expansion of Private Banking activities in the region, and strong growth in fee income and dealing profits in more positive market conditions. 16 per cent of the growth arose from the transfer of a trust business from Hong Kong during 2004.
A 24 per cent increase in net interest income was primarily due to the deployment of liquidity into longer-dated assets, which benefited from the differential between long and short-term interest rates. Customer loans grew in Singapore and Japan,
as clients leveraged their wealth to re-invest in higher yielding assets. Deposits grew by over US$1.2 billion in Singapore, as new clients deposited cash for investment.
Funds under management grew by 18 per cent, with the introduction of new clients and products contributing to an inflow of US$0.5 billion in net new funds.
Other operating income increased by 85 per cent, of which 30 per cent arose from the trust business transfer referred to above. Elsewhere, increased activity in the equity markets and the successful launch of new products boosted fees and commissions. Higher volumes of equity transactions, sales of unit trusts, and portfolio fees on higher funds under discretionary management were all reflected in the rise in fees and commissions income. Dealing income rose by 21 per cent, as a result of higher client transaction volumes in foreign exchange, options, and structured products.
Operating expenses, excluding goodwill amortisation, increased by 55 per cent, of which 18 per cent was the trust business transfer referred to above. Higher staff costs reflected the recruitment of 32 additional front office staff in Singapore. Performance-related remuneration increased as a result of the strong growth in profitability, while marketing expenditure increased to support the brand at a time of strong wealth creation across Asia.
The rest of the Asia-Pacific economies experienced mixed fortunes in the first half of 2003 but performed better in the second half of the year on the back of strong exports (particularly to mainland China), strong commodity prices and improving domestic demand. Inflation and interest rates remained very low and many of the region’s central banks implemented programmes to limit currency appreciation against the US dollar.
HSBC’s operations in the rest of Asia-Pacific region reported pre-tax profit of US$1,391 million, an increase of US$131 million, or 10 per cent, over 2002. Excluding goodwill amortisation, pre-tax profit was US$1,426 million and represented 10 per cent of HSBC’s total equivalent profit. At constant exchange rates, pre-tax profit, before goodwill amortisation, increased by 8 per cent over 2002. Goodwill amortisation of US$35 million was marginally higher than last year due to an acquisition in Singapore.
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FinancialReview (continued)
In Personal Financial Services pre-tax profit, before goodwill amortisation, of US$158 million, increased by 25 per cent compared with 2002 and was broadly double that achieved in 2001.
Net interest income grew by 15 per cent compared with 2002, reflecting strong asset growth in a number of countries across the region. The impact on deposit taking business of lower margins in generally low interest rate environments was more than offset by increased customer deposits and the growth in mortgage lending. The latter increased by 38 per cent mainly due to growth in Korea, Singapore, Malaysia and India. Net interest income also benefited from the acquisition of the mortgage business of AMP Bank Limited in New Zealand in the first half of 2003. Strong growth in card balances contributed to a 34 per cent increase in net interest income in Indonesia.
Other operating income grew by 20 per cent to US$314 million. The acquisition of Keppel Insurance, which was renamed HSBC Insurance (Singapore) Pte Ltd, contributed US$17 million to this increase during the year. HSBC continued to expand its wealth management initiatives and a number of structured deposit products were launched across the region. Wealth management income grew by 10 per cent, reflecting strong growth in unit trust sales and funds under management, particularly in Taiwan, Korea, Indonesia and India, while fee income from credit cards rose in a number of markets across the region. At 31 December 2003, the bank’s card base in Asia, outside Hong Kong, exceeded 3.7 million, 20 per cent higher than at the end of 2002. An enhanced credit card processing system was implemented in five countries in the region, applying state-of-the-art technology to risk and fraud management.
Operating expenses, excluding goodwill amortisation, of US$804 million were 16 per cent higher than in 2002. This reflected increased costs to support business expansion and provisions for restructuring costs of US$34 million. The acquisition of HSBC Insurance (Singapore) Pte Ltd in the year accounted for US$6 million of the increase.
Provisions for bad and doubtful debts were 38 per cent higher than in 2002. Provisions against personal lending increased in Singapore, India, Korea and Australia in line with growth in advances.
Commercial Banking reported pre-tax profits, before goodwill amortisation, of US$450 million, an increase of 4 per cent, compared with 2002.
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 10 per cent to US$286 million. HSBC Bank Middle East reported a strong performance despite a subdued first quarter as a result of the war in Iraq. In addition, insurance income in Singapore increased as a result of the acquisition of Keppel Insurance, as detailed previously.
Operating expenses increased by 3 per cent to US$324 million, mainly due to restructuring costs in India and Singapore and the impact of the acquisition in Singapore.
Credit experience continued to be very good, benefiting from ongoing success in recovering historical troubled debt. The net release of provisions increased 46 per cent to US$52 million in 2003 with higher net releases of specific provisions in Malaysia than last year. This was partly offset by an increase in specific provisions in Indonesia.
Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$732 million, which was broadly in line with 2002.
Net interest income fell by 7 per cent compared with last year, with reductions in Singapore, and to a lesser extent in the Middle East, as higher yielding assets matured and the proceeds were reinvested at lower rates. This was partly offset by an increase in net interest income from corporate banking business in India, Korea and mainland China.
Dealing profits increased, primarily in Taiwan, Japan and Thailand, reflecting a broader product offering, more customer-focused sales activity and successful positioning to take advantage of directional trends in the generally more volatile market conditions. Higher fee income was generated from brokerage and corporate finance transactions in the Middle East.
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Operating expenses, before goodwill amortisation, of US$521 million, increased by 2 per cent, mainly due to restructuring costs in India and Singapore.
There was a net release of US$5 million for bad and doubtful debts compared with a net charge of US$26 million in 2002, at constant exchange rates. A specific provision raised against a New Zealand corporate customer in 2002 was recovered during the year.
HSBC’s Private Banking activities in the rest of Asia-Pacific reported pre-tax profit, before goodwill amortisation, of US$36 million in 2003, an increase of 46 per cent, compared with 2002. This was achieved through strong growth in dealing profits, which rose by 55 per cent to US$38 million, and more than compensated for a reduction of 7 per cent in net interest income.
The fall in net interest income reflected significant income earned in 2002 from the deployment of liquidity into longer dated assets which benefited from the fall in short-term interest rates. With the flattening of the yield curve this was not repeated in 2003.
Dealing profits benefited from a higher volume of client transactions in the debt securities and derivatives markets and increased sales of client-tailored structured products.
Operating expenses, excluding goodwill amortisation, increased by 25 per cent to US$47 million, primarily to support business growth.
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The expansion of the US economy was robust in early 2004, with GDP growth of 4.5 per cent in the first quarter. The labour market improved significantly in the spring, with nearly 1 million jobs added between March and May, though in the second half of the year, output growth moderated and payroll gains slowed. This was partly due to substantially higher energy prices, which also contributed to an increase in inflation in the first half
of 2004. However, by the end of the year the Federal Reserve’s favoured inflation measure, the PCE (personal consumption expenditure) deflator, was well contained at about 1.5 per cent. The Federal Reserve raised its Fed Funds rate from 1 per cent to 2.25 per cent between June and December. After reaching a peak of 4.87 per cent in June, 10-year bond yields declined through most of the third quarter and drifted only slightly higher in the fourth, ending the year at just 4.2 per cent. Equity markets were lacklustre for most of the year prior to a rally in November and December, by the end of which the
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S&P500 was up about 9 per cent from the beginning of the year. Over approximately the same period, the value of the US dollar fell, reaching US$1.36 to the euro by the end of December.
In Canada, annualised GDP growth slowed to 2.7 per cent in the first quarter of 2004 from 3.3 per cent in the final quarter of 2003, largely because of a fall in stockbuilding. Consumer spending and investment growth began the year strongly. However, the Bank of Canada (‘BoC’) cut interest rates three times in the first half of 2004 in response to low inflation and currency appreciation. With the global economy recovering and Canadian GDP growth having rebounded to 3.9 per cent in the second quarter, the BoC started to reverse its policy, raising rates by 25 basis points in both September and October. Growth remained robust in the second half of the year with consumer spending accelerating. Import growth was significant, partly reflecting a very large build-up of inventory in the third quarter, much of it related to the auto sector. Although inflation picked up a little, the BoC kept rates on hold in November and December, because of concerns about the impact of a stronger Canadian dollar. This left the overnight rate at 2.5 per cent, still below the rate at which it started the year.
Mexico’s macro-economic fundamentals remained strong in 2004, with year-on-year GDP growth of 4.4 per cent in line with that of the US. At year-end, the fiscal accounts were showing relatively low deficits helped by the windfall of high oil prices. Driven by oil receipts and an unprecedented level of workers´ remittances, the current account deficit shrank to a figure below the level of reinvested earnings from existing foreign direct investment. Inflation increased from 4.0 per cent at the end of 2003 to 5.2 per cent in 2004, as a result of increases in external energy and food prices, but remained manageable. HSBC anticipates that inflation will be reduced in 2005 due to a restrictive monetary policy, and that moderate to strong GDP growth will continue with a mildly appreciating currency.
On 1 July 2004, HSBC Bank USA, Inc. consolidated its banking operations under a single national charter, following approval from the Office of Comptroller of Currency. This enabled the newly formed HSBC Bank USA to serve its customers more efficiently and effectively across the US and provide an expanded range of products. It also put HSBC Bank USA on the same footing as other major US banks.
HSBC’s operations in North America reported a pre-tax profit of US$5,419 million, compared with US$3,613 million in 2003. Excluding goodwill
amortisation, pre-tax profit was US$6,180 million, compared with US$4,257 million in 2003, and represented 32 per cent of HSBC’s total pre-tax profit on this basis.
Within these figures HSBC Finance reported a pre-tax profit, before goodwill amortisation, of US$3,576 million in 2004, an increase of US$1,524 million, of which US$1,084 million was an additional quarter’s contribution. Profit was 21 per cent higher than for the comparable period in the prior year.
Bank of Bermuda, acquired in February 2004, contributed US$73 million to pre-tax profit, before goodwill amortisation, in the North American segment.
At constant exchange rates, and on an underlying basis, HSBC’s pre-tax profit, before goodwill amortisation, was 17 per cent higher than in 2003.
The detailed customer group commentary that follows is based on constant exchange rates.
Excluding Consumer Finance, Personal Financial Services generated a pre-tax profit, before goodwill amortisation, of US$1,164 million, 35 per cent higher than in 2003. Approximately 22 per cent of this growth arose from the acquisition of Bank of Bermuda and certain insurance interests in Mexico.
Growth in net interest income was 19 per cent. This was driven mainly by a 34 per cent increase in Mexico, where growth in low cost deposits and consumer loans, and higher interest income from the insurance business, contributed to the rise. Acquisitions in Mexico accounted for 17 per cent of the overall improvement. HSBC attracted 359,000 net new deposit customers in Mexico during the year, and this contributed to the US$1.6 billion rise in average deposit balances. Despite an increasingly competitive marketplace, market share in deposits rose to 14.4 per cent, driven by the bank’s extensive branch and ATM network. Consumer loan growth was robust in the second half of the year, particularly in pre-approved payroll loans offered through the ATM network, and residential mortgages.
Net interest income in the US grew by 10 per cent, reflecting a US$10.9 billion, or 58 per cent, increase in average residential mortgage balances and the widening of spreads on savings and deposits, as interest rates rose. Sales of residential mortgages remained strong following an expansion of the sales force and the development of the correspondent network, competitive pricing and increased marketing. In 2004, customers generally favoured variable rate products over fixed. Several new
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products, including a range of adjustable rate mortgages, were launched during the year contributing to an overall increase in gross new lending of 3 per cent to US$32.6 billion. The income benefit of this growth, however, was partly offset by pressure on spreads. Competitive pricing in a contracting market forced a general downward trend in mortgage yields in 2004 compared with the levels seen in 2003.
Other operating income rose by US$164 million or 20 per cent to US$979 million, of which US$82 million came from acquisitions. Growth was largely attributable to the strong performance in Mexico, where expansion of the pension funds business, acquired in the last quarter of 2003, complemented higher fee income from credit cards, deposit-related services and international remittances. Sales of pension and bancassurance products grew strongly, attracting some 270,000 new customers, following an expansion of the sales force. An enhanced customer relationship management system and the employment of WHIRL helped the number of credit cards in circulation in Mexico to rise by 29 per cent to 568,000. Fee income from credit cards rose by 20 per cent compared with 2003. Operations in Canada benefited from a rise in retail broking volumes, as market activity revived. In the US, a revised fee structure and improved collection processes produced a 9 per cent increase in fee income from cards and deposit-related services.
The US mortgage banking business contributed a pre-tax profit of US$270 million, in line with 2003, despite a fall in other operating income. Lower origination and sales-related income in the secondary market was only partly offset by a reduction in net servicing expenses. There was a net loss of US$4 million from sale of mortgage loans in 2004 compared with a net gain of US$117 million in 2003. This was mainly driven by lower gains on sales of mortgages, as narrower spreads combined with a fall in the volume of loans originated for sale. As interest rates increased in 2004 from the historically low levels experienced in 2003, prepayments of residential mortgages, mostly in the form of loan refinancing, reduced significantly and residential mortgages originated for sale declined by 64 per cent compared with 2003, despite an overall increase in mortgage lending. Loan refinancing activity represented 50 per cent of the total loan originations, compared with 74 per cent in 2003. Pricing also fell from the unusually high levels seen in 2003 and, as a result, HSBC earned lower returns on loans sold.
The net cost of servicing mortgages fell, improved primarily as a result of lower amortisation
expenses on mortgage servicing rights (‘MSR’) and increased income associated with the derivatives used to offset the changes in the economic value of the MSRs. The reduction in amortisation expenses was also partly affected by lower MSR balances in 2004. The cost reduction was partly offset by higher temporary impairment reserves.
Operating expenses, excluding goodwill amortisation, were 16 per cent higher than in 2003. This was due mainly to a 15 per cent increase in costs in Mexico, where the expansion of the pension funds business and the inclusion of the insurance business acquired in the last quarter of 2003 contributed to generally higher salaries and performance-related bonuses. Staff numbers increased in the Mexican branch network to support growth in business volumes, improve customer service, and support the rollout of HSBC Premier. The introduction of the WHIRL credit card system in Mexico and the US, at a cost of US$23 million, was completed by the end of October. In the US, expansion in the mortgage sales force and higher performance-related bonuses led to higher staff costs, while the launch of advertising campaigns for mortgages and deposits added to marketing costs. Additional staff were recruited in the branch network to support business expansion and to improve customer service. Costs in Canada increased by 4 per cent, principally due to higher performance-related staff costs in the brokerage business and restructuring expenses arising from the integration of Intesa Bank Canada, acquired in May.
The net bad debts charge fell by 29 per cent to US$99 million. Recoveries of amounts previously written-off in Mexico more than offset the US$11 million increase in new specific provisions in the US, predominantly for the credit cards portfolio within HSBC Bank USA. There was also a US$28 million release of general provisions in Mexico following a review of historical loss experience, reflecting a general improvement in the credit quality of consumer loan portfolios, and the improved market environment.
Consumer Finance contributed a pre-tax profit, before goodwill amortisation, of US$3,576 million in 2004, an increase of US$1,508 million of which US$1,097 million was an additional quarter’s contribution. On an underlying basis, pre-tax profit, before goodwill amortisation, grew by 20 per cent to US$2,479 million.
The integration of HSBC Finance Corporation into HSBC continued to deliver funding benefits in line with those anticipated. Since December 2003, HSBC Finance Corporation has sold US$3.7 billion
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of residential mortgages and US$15.6 billion of its domestic private label assets to HSBC Bank USA, the latter in December 2004. Under various service level agreements, HSBC Finance Corporation will continue to maintain the related customer account relationships for the assets transferred. By the end of 2004, HSBC had provided a total of US$35.6 billion in direct and client funding to HSBC Finance Corporation, and cash savings realised in 2004 were in excess of US$400 million.
Following receipt of regulatory approval for the sale of the private label portfolio, and prior to the sale, HSBC Finance Corporation adopted charge-off and account management policies in accordance with the Uniform Retail Credit Classification and Account Management Policy issued by the Federal Financial Institutions Examination Council (‘FFIEC policies’), for its domestic private label, MasterCard and Visa credit card portfolios. The main effect of this was on the private label credit card portfolio, where the FFIEC policies resulted in accounts being charged-off earlier. Certain pools of accounts were already following FFIEC policies, and so their adoption improved conformity across all relevant portfolios. The FFIEC account management practices change the delinquency and roll rates applicable to these portfolios, and resulted in a one-off charge to pre-tax profit, before goodwill amortisation, of US$154 million, which is expected to be offset by future funding benefits in the region of US$47 million per annum.
Net interest income of US$10,541 million was US$2,690 million higher than in 2003, although on an underlying basis adjusting for the additional quarter in 2004, it was only marginally higher. Average customer loan balances increased by 11 per cent to US$120.6 billion. Lower funding costs gave HSBC Finance Corporation the opportunity to expand its prime and near-prime customer base, particularly in the mortgage business. Average mortgage balances grew by 23 per cent to US$54.1 billion. Some US$3.9 billion of gross new lending balances were originated from a single correspondent relationship, while balances of US$1.6 billion were originated following the launch in 2003 of the ‘Secured Plus’ mortgage product.
Organic growth of 16 per cent to US$9.6 billion in vehicle finance loans was primarily achieved through a network of 5,200 motor dealers, extensive alliance relationships and direct sales channels.
Loans in the MasterCard and Visa credit card portfolios grew by 3 per cent to US$18 billion, driven largely by growth in the sub-prime portfolio. Spreads widened reflecting the change in product
mix towards the sub-prime market. The private label business also achieved growth in average loan balances, 5 per cent higher than in 2003, through new and existing merchant agreements.
The benefit of strong growth in loan balances was reduced significantly by lower yields. A greater than normal run-off of older, higher-yielding loans, product expansion into near-prime customer segments, and competitive pricing pressures from excess capacity, particularly in the mortgage market, contributed to an overall decline in loan yields. The decline was only partly offset by increased pricing of variable-rate products in line with interest rate movements, and continued growth in sub-prime credit cards. Also, the adoption of the FFIEC policies reduced net interest income by US$57 million.
Other operating income rose by US$895 million, or 52 per cent, to US$2,602 million, largely reflecting the additional quarter’s income. On an underlying basis, and excluding the effect of adopting the FFIEC policies, the increase was 10 per cent, predominantly reflecting strong growth in fee income from credit cards, and increased revenue from sales of value added products.
Operating expenses, excluding goodwill amortisation, of US$4,470 million were 44 per cent higher than in 2003. On an underlying basis, operating expenses, excluding goodwill amortisation, increased by 10 per cent to US$3,422 million due mainly to increased staff costs and higher IT and marketing expenditure. Additional staff were recruited in the branch network and in the mortgage services business to support growth in volumes and to improve customer service. Increased business volumes also led to higher performance-related bonuses and higher IT costs. Marketing costs increased, largely due to changes in contractual obligations associated with the General Motors co-branded credit card portfolio, but were partly offset by lower account origination costs. Marketing expenses were also incurred in support of income growth initiatives in the sub-prime market. In September 2004, HSBC rebranded a number of its Consumer Finance businesses at a cost of US$8 million.
The charge for bad and doubtful debts rose by 17 per cent to US$5,136 million. On an underlying basis and excluding the effect of adopting the FFIEC policies, the charge fell by 12 per cent. This reflected a marked improvement in credit quality, driven by the economic upturn, improved origination, growth in the proportion of secured lending, improved
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collections, and the move into prime and near-prime markets. Improvements in delinquency were seen across most products and in a number of key indicators, including early stage delinquency, charge-offs and year-on-year bankruptcy filings. The rate of improvement declined in the second half of the year reflecting seasonality, a slowdown in employment growth and rising energy prices.
Commercial Banking reported pre-tax profits, before amortisation of goodwill, of US$845 million for 2004, an improvement of 41 per cent over 2003.
Net interest income increased by 8 per cent, of which 3 per cent was attributable to the acquisition of Bank of Bermuda. Adjusting for the loss of net interest income following the disposal of the US equipment-leasing portfolio last year, underlying growth was 7 per cent.
In the US, the recruitment of 50 additional relationship managers, focusing on the SME market, contributed to a 12 per cent rise in lending balances and a 17 per cent increase in commercial deposits. Improved economic conditions and stronger consumer confidence also led to increased demand for credit, but spreads suffered in the competitive marketplace. Commercial real estate lending increased by 11 per cent, largely as a result of expansion into the US West Coast and Miami.
In Canada, net interest income increased by 16 per cent. Growth in lending reflected stronger demand for credit in the low interest rate environment, improved market conditions and additional income following the integration of Intesa Bank. In Mexico, competitors displaying a greater appetite for risk enabled HSBC to selectively reduce loan balances. This, together with the effect of lower interest rates on deposit spreads and a restructuring of prices, which emphasised fees at the expense of margin, led to an 11 per cent reduction in Mexican net interest income.
Other operating income was US$13 million or 3 per cent higher than in 2003. Excluding the disposal of the US factoring and equipment leasing businesses, which in 2003 contributed other operating income of US$109 million, the underlying growth was 25 per cent. The impact of acquisitions during 2004 was not material.
In Mexico, fees and commissions grew by US$10 million or 11 per cent. Fees earned from payments and cash management and electronic banking both increased. The Mexican authorities changed the tax regulations to require all companies to make tax payments via electronic banking channels from January 2004. HSBC seized the
opportunities presented by this change to increase both the number of clients using electronic banking, and the number of transactions and income per client. Earnings from new trade services products and increased loan fees (from the price restructuring) also contributed.
Operating expenses declined by 6 per cent compared with 2003 as a result of the disposal of the factoring and equipment leasing businesses in the US. Adjusting for this, there was a 3 per cent rise in expenses reflecting additional costs from the restructuring and integration of Intesa Bank, the inclusion of Bank of Bermuda, and the effect of increased transaction volumes and business flows between Mexico and the US.
The charge for bad and doubtful debts fell by 90 per cent to US$13 million, reflecting an improved economic environment and falling corporate default rates. In 2003, the charge included US$33 million in the US factoring and leasing businesses which were sold during that year.
Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$750 million, 11 per cent lower than in 2003.
Net interest income was 11 per cent lower than in 2003, notwithstanding the first contribution from Bank of Bermuda, which added US$31 million, or 4 per cent to the total. In part this reflected the cost of funding trading strategies where the offsetting income arises within dealing revenues. The return on investments held for liquidity fell and the yield on loans dropped as re-financing reached record levels following the reductions in interest rates in the latter part of 2003 and early 2004. The lower interest rates resulted in large early redemptions of mortgage-backed securities. Reinvestment opportunities, however, failed to match the yields given up on these redemptions. In Canada, a combination of interest rate cuts in the early part of 2004 and lower corporate loan balances reduced net interest income. However, in Mexico, investment portfolios profited from having locked into higher long-term interest rate str uctures.
Other operating income improved by 15 per cent, of which 7 per cent was attributable to Bank of Bermuda, which improved its market share in funds administration following its acquisition. A 23 per cent increase in fees and commissions in the US was driven by increased underwriting fees from debt issues and syndication, coupled with higher deal execution revenues. Increased revenues from customers reflected improved client coverage. The growing use of electronic trading by clients resulted
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in increased commissions from futures transactions, while structured finance and HSBC Amanah benefited from higher transaction fees and new deals. In Global Transaction Banking, higher payment and cash management revenues reflected an increase in volumes. Dealing profits benefited from a reduced level of losses in respect of mortgage hedging activities transacted on behalf of other HSBC customer groups. These transactions resulted in an offsetting reduction in other income. Although credit spread volatility was relatively low, movements in individual corporate spreads, primarily in the industrials sector, adversely affected corporate bond trading revenues. Global Markets continued to benefit from the previous year’s expansion of derivatives capabilities and higher profits from improved marketing and delivery of structured solutions. Proprietary trading revenues increased, mainly through profits on long futures positions and foreign exchang e gains which arose from successful positioning against the weakening US dollar. Foreign exchange also benefited from a higher volume of customer transactions.
In Mexico, earnings from debt trading fell as interest rates rose during the year, while in Canada, higher fees from securities sales and corporate finance reflected improved market sentiment in local equity markets. Foreign exchange income in Canada grew by 10 per cent in response to the continued volatility of the Canadian and US dollars.
Operating expenses, before goodwill amortisation, of US$1,014 million rose by 31 per cent, of which 12 per cent related to costs in Bank of Bermuda. In New York, the significant expansion of the Corporate Investment Banking and Markets’ business resulted in an increase of some 300 in headcount and a corresponding rise in salary costs. Incentive compensation also rose, largely due to the costs of recruiting and retaining the high quality staff needed to deliver the business strategy. Key hires within the expanded complement included the establishment of a mergers and acquisitions and advisory group, and product teams to develop asset-backed and mortgage-backed securitisation and trading. Non-staff costs grew correspondingly and included investment in technology to support the new business streams and the related control environment.
A net release of provisions for bad and doubtful debts reflected a significant improvement in credit quality as corporate restructuring and refinancing was facilitated by the better economic conditions. This resulted in releases and recoveries across a number of sectors.
Private Banking contributed a pre-tax profit, before goodwill amortisation, of US$66 million, an increase of 6 per cent on the result achieved in 2003. Good progress was made in the integration of Bank of Bermuda’s Private Client Services business, which added an onshore banking capability in Bermuda, and complementary offshore and trust products and services to HSBC’s North American operations. In aggregate, Bank of Bermuda’s North American Private Banking operations added US$2 million to pre-tax profits, before goodwill amortisation, in 2004.
Net interest income increased by 37 per cent, due largely to balance sheet growth. Strong growth in customer loans, which were 50 per cent higher than in 2003, reflected the success of the insurance premium financing business, an expanded customer base, and growth in secured borrowing by clients to invest in higher-yielding assets or funds. The larger customer base resulted from an expansion of Private Banking’s geographical presence, and cross-referrals generated through the alignment of Private Banking’s operations with other customer groups. This contributed to an increase in average customer deposits.
Other operating income was 4 per cent below that achieved in 2003 but was 23 per cent lower excluding the Bank of Bermuda. The fall in other operating income was mainly driven by client anticipation of interest rate rises, which reduced demand for interest-rate-linked structured products, and sales of fixed interest bonds. WTAS increased revenue despite subdued demand for tax planning services. As a consequence of restrictions placed on the personal tax practices in the major accounting firms engaged in providing audit services, WTAS increased both its customer base and the number of fee-generating staff. Cross-referrals also grew.
Operating expenses, before goodwill amortisation and excluding Bank of Bermuda, were broadly flat compared with 2003. Savings were generated from the continuing alignment of international and domestic client servicing units and from operational efficiencies in WTAS.
The gain on disposal of investments and tangible fixed assets reflected the sale of seed capital holdings.
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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 since July 2002. This supported consumer confidence. However, with the US current account deficit continuing to deteriorate, the US dollar remained under downward pressure, falling to US$1.26 against the euro by the end of the year.
Canada’s central bank was the first of the G7 countries to embark on a policy of raising interest rates in 2003. In response to inflationary pressures in the early part of the year, overnight lending rates were raised on two occasions, by a total of 50 basis points. However, with the Canadian dollar strengthening against the US dollar, inflation worries easing, and concerns about subdued GDP growth, the Central Bank reversed the earlier interest rate rises to take the overnight rate back down to 2.75 per cent in September. Many of the reasons for the disappointing growth were temporary, such as SARS, BSE, forest fires and the Ontario power blackout, and their immediate impact abated. Consumer spending growth remained robust all year, but the ongoing impact of the strong Canadian dollar appeared set to continue, restraining export growth.
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 macroeconomic foundation had been established and was expected to be maintained.
On 28 March 2003, HSBC completed its acquisition of HSBC Finance Corporation for a consideration of US$14.8 billion, expanding significantly its existing North American business. The addition of HSBC Finance Corporation’s substantial consumer lending portfolio increased the proportion of HSBC’s assets in North America from 19 per cent to 28 per cent of the total Group.
The results of HSBC Finance Corporation’s consumer finance business for the period from 29 March to 31 December 2003 are tabulated separately under Consumer Finance in order to highlight their significance to HSBC’s overall performance in North America. HSBC’s results at the pre-tax level and before amortising goodwill also benefited from a US$534 million contribution from HSBC Mexico in its first full year. The integration of both HSBC Finance Corporation and HSBC Mexico progressed well, with synergy benefits and business opportunities generally meeting or exceeding expectations.
The following discussion of HSBC’s North American performance highlights the impact of the additions of HSBC Finance Corporation and HSBC Mexico. The phrase ‘on an underlying basis’ is used to describe performance excluding these acquisitions.
HSBC’s operations in North America contributed US$3,613 million to HSBC’s profit before tax, an increase of US$2,375 million, compared with 2002. Excluding goodwill amortisation, pre-tax profit was US$4,257 million, compared with US$1,384 million in 2002, which was equivalent to 30 per cent of HSBC’s total pre-tax profit on this basis. On an underlying basis, HSBC’s pre-tax profit, before goodwill amortisation, of US$1,672 million was US$320 million, or 24 per cent, higher than in 2002. Goodwill amortisation was US$644 million in 2003, compared with US$146 million last year, predominantly reflecting the acquisition of HSBC Finance Corporation and, to a lesser extent, HSBC Mexico.
Personal Financial Services, excluding Consumer Finance, generated pre-tax profit, before goodwill amortisation, of US$870 million in 2003, 40 per cent higher than last year. HSBC Mexico contributed US$350 million to pre-tax profit for the year. On an underlying basis, pre-tax profit, before goodwill amortisation, was 13 per cent lower than in 2002 mainly due to lower earnings from mortgage servicing and higher staff costs.
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Net interest income increased by 53 per cent to US$2,116 million mainly as a result of the inclusion of HSBC Mexico. The first full year’s result for HSBC Mexico was strong and ahead of expectations. Growth in Mexico from a relatively weak performance in 2002 reflected an improvement in net interest income driven by a greater level of low cost deposits and an expanding consumer loan portfolio. Interest spreads benefited from a change in asset mix, with over 25 per cent growth in higher yielding assets, including motor vehicle finance, credit cards and payroll loans.
On an underlying basis, growth in net interest income of 7 per cent was mainly driven by growth of US$2.5 billion in residential mortgage balances in the US and Canada. In both countries, the low interest rate environment proved attractive to new homebuyers and encouraged existing homeowners to refinance their mortgages. In the US, net interest income further benefited from improved spreads on mortgages and an improved mix of loans and savings deposits.
Other operating income of US$825 million was 62 per cent higher than in 2002. Operations in Mexico contributed US$461 million to other operating income in the year. Transaction volumes on core banking related products, such as credit cards, deposit-related services and ATMs, grew significantly. HSBC Mexico led the market with a 34 per cent share in domestic interbank ATM transactions across Mexico, delivering fee revenue of US$92 million. In addition, a growing level of fee income was generated from bancassurance sales and international remittances.
On an underlying basis, other operating income fell by 23 per cent. This was primarily caused by a fall in mortgage banking-related income in the US. Total servicing-related income decreased by US$210 million compared with 2002. This decrease was driven by accelerated amortisation and large write-downs of mortgage servicing rights (‘MSRs’) as many customers refinanced mortgages in order to take advantage of the low interest rate environment. MSR income also declined as a result of significant losses on derivative instruments used to protect the economic value of MSRs.
In addition, the June/July time period was one of the more difficult periods related to derivative activity. Specifically, in June, positions were taken in derivative instruments to further reduce HSBC’s exposure to these losses as mortgage rates continued to fall. However, in July extreme interest rate volatility ensued and there was a significant rise in interest rates resulting in a substantial loss in the
value of the derivative instruments. These losses were only partly offset by subsequent falls in interest rates, and gains from the sale of certain mortgage-backed securities available-for-sale that were used as on-balance sheet economic hedges of the MSRs.
While the value of MSRs generally declines in a falling interest rate environment as mortgages are repaid, the effect of this decline is often mitigated by income from refinancing mortgage loans and subsequent sales to mortgage agencies. Total loan volumes sold in 2003 were US$20.1 billion compared with US$12.4 billion in 2002. Market conditions during 2003 permitted favourable pricing which allowed HSBC to earn higher gains on loans sold as well as a higher spread on refinanced loans. As a result, sales-related income for 2003 increased by US$82 million compared with 2002.
Overall, the US mortgage banking business contributed US$210 million to pre-tax profit in 2003, compared with US$251 million in 2002. In the US, HSBC generated increases in deposit-related service charges and in card fees, though sales of investment products fell reflecting a lack of confidence in the equity markets. Increased fees in Canada reflected higher insurance sales and increased commissions from retail broking activities as the equity markets rebounded in 2003.
Growth in operating expenses, excluding goodwill amortisation, of 65 per cent to US$1,965 million was substantially attributable to the addition of HSBC Mexico, which contributed US$758 million to the overall cost base in 2003. In Mexico, savings in operating expenses were achieved from merging HSBC Mexico with HSBC’s existing operations in the country. These savings funded investment to improve technology support for HSBC Mexico’s branch network.
On an underlying basis, operating expenses, excluding goodwill amortisation, increased by 7 per cent. Pension costs rose due to falls in the long-term rates of return on assets, and higher profitability drove increased staff incentive payments. Following the integration with HSBC Finance Corporation, long-term restructuring programmes, including the rationalisation of staff functions, were initiated, adding US$20 million of costs in the year.
Operations in Mexico contributed US$67 million to the overall net charge for bad and doubtful debts of US$142 million. On an underlying basis, credit provisions in Personal Financial Services were broadly in line with the prior year, a good performance in view of strong growth in personal lending. Overall credit quality improved, reflecting the improved economic environment.
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Consumer Finance contributedUS$2,068 million to pre-tax profit, before goodwill amortisation, in the nine months since HSBC Finance Corporation became a member of HSBC. The integration of HSBC Finance Corporation into HSBC delivered anticipated benefits in improved funding costs, and technology and administrative cost savings. Significant progress has been made in exporting HSBC Finance Corporation’s core skills, particularly in the areas of credit risk management, sales-focused organisation and customer-centred technology, to other parts of the Group. Further synergies are planned in card processing, IT contingency rationalisation, purchasing, call-centre operations and the shared use of HSBC’s Group Service Centres. HSBC Finance Corporation’s business model is being taken to selected markets overseas and established alongside existing HSBC operations to meet the growing global demand for consumer finance.
Net interest margin benefited by US$531 million from purchase accounting adjustments relating to the acquisition of HSBC Finance Corporation in the nine months in which HSBC Finance Corporation was part of the HSBC Group. This comprised of a US$946 million benefit in respect of debt funding, offset by the amortisation of purchase accounting adjustments relating to loans and advances to customers totalling US$415 million. Purchase accounting adjustments restated the book value of debt to fair value at that date and, therefore, reflected the improvement in spread already in the market as well as falling interest rates. They are being amortised in line with the residual maturity of the debt. Assuming credit spreads remain consistent, savings on future debt issues will replace the fair value adjustments relating to credit spreads. Since acquisition, HSBC Finance Corporation’s funding costs on new issues have, in fact , fallen as the credit spreads sought by the market decreased, reflecting the improvement in HSBC Finance Corporation’s credit rating on joining the HSBC Group. During 2003, net interest income benefited by US$124 million as a result of such savings.
All consumer portfolios grew during the year, except for personal unsecured loans, with the strongest growth in the real estate secured and private label portfolios. The secured real estate portfolio growth was driven by the correspondent business while the private label portfolio benefited from a number of new relationships added during the year. Growth in MasterCard and Visa loans benefited from portfolio acquisitions made during the year in advantageous circumstances and growth in the General Motors portfolio. The motor vehicle finance
business also benefited from new originations from strategic alliances during the year.
Included within operating expenses were one-off retention payments arising on the change of control amounting to US$52 million. Headcount increased to support business expansion, particularly in the consumer lending and mortgage services businesses.
The charge for bad and doubtful debts in 2003 reflected growth in receivables, increases in personal bankruptcy filings and the weak US economy. However, in the second half of the year credit quality stabilised and improvement was seen in a number of key indicators, including early stage delinquency, charge-offs, bankruptcy filings and collection activities. The improvement reflected resumed domestic economic growth which is forecast to continue into 2004.
Commercial Banking in North America reported pre-tax profit, before goodwill amortisation, of US$595 million, an increase of 32 per cent, compared with 2002. On an underlying basis, HSBC generated pre-tax profit, before goodwill amortisation, of US$498 million, 12 per cent higher than last year.
Net interest income on an underlying basis was marginally lower than 2002. In Canada, income growth was generated from increased balances on loans and deposits. There were increases in commercial real estate lending where growth in market share was concentrated primarily in New York. Service delivered to SMEs was enhanced as part of the strategy to focus on that market. Notably, the credit application process was re-engineered to make it easier for customers and the number of relationship managers doubled. As a result, lending to SMEs increased by 17 per cent. Net interest income further benefited from steady growth in deposit balances and lower funding costs. Offsetting this was the impact of business disposals as HSBC disposed of its equipment leasing portfolio in the first half of 2003 following a re-evaluation of its core businesses.
On an underlying basis, other operating income rose by 20 per cent, reflecting income on the sale of the factoring business and increases in fees related to commercial real estate lending, deposit taking and trade.
The inclusion of HSBC Finance Corporation’s commercial portfolio reduced other operating income by US$17 million. These losses were more than offset by tax credits, resulting in an overall benefit to post tax profits of US$40 million.
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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 ofUS$685 million, increased by 28 per cent, compared with 2002. This was partly attributable to the restructuring initiatives in the securities trading and debt capital markets business. As part of this restructuring, large arbitrage trading portfolios, which had historically contributed dealing profits but incurred significant funding costs, were eliminated. Net interest income further benefited from good balance sheet management and effective interest rate positioning in the US and Canada.
Underlying total other operating income, at US$738 million improved by 32 per cent. Strong foreign exchange and domestic dollar book trading activity contributed to increased revenues, driven by historically low interest rates and volatile currency markets. Derivatives trading revenues increased, reflecting the growth in demand for the structuring of tailored products for corporate and institutional customers.
HSBC Mexico generated other operating income of US$90 million, of which US$64 million was accounted for by dealing profits. Volatility in the Mexican markets enabled the Group to increase trading volumes and capitalise on favourable market movements. These positive market conditions led to increased profits from foreign exchange and fixed income.
Underlying operating expenses, before goodwill amortisation, of US$706 million, increased by 9 per cent. Investment in the core business added to the expenditure but was partly funded by lower costs in the securities trading and debt capital markets business, elements of which were wound down.
Credit experience on major corporate customers in the US was better in 2003. Many accounts which were potentially problematic at the end of 2002 were successfully refinanced and restructured in the strong debt market at the start of 2003. Elsewhere, credit quality remained satisfactory and consequently, on an underlying basis, there was a net release of US$7 million for bad and doubtful debts.
Profits on disposal of investments, on an underlying basis, were US$57 million, a decline of 53 per cent compared with 2002, which included a higher level of securities disposals arising from the restructuring of investment portfolios.
HSBC’s Private Banking operations in North America contributed US$63 million to pre-tax profits, before goodwill amortisation, an increase of 11 per cent compared with 2002.
During the year the North American business continued its evolution from a deposit-based
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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.
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Profit/(loss) before tax
Reaping the rewards of measures taken in 2003 and helped by a buoyant external environment, Brazil enjoyed an outstanding economic performance in 2004. Annualised GDP growth topped 4 per cent in each of the first three quarters of 2004 and, for the year as a whole, HSBC expects growth to exceed 5
per cent, driven by external demand. The 2004 trade surplus reached US$34 billion and the current account surplus US$12 billion. Employment and real wages both expanded in 2004. Faster than anticipated growth and some unexpected consequences of tax changes pushed fiscal revenues to record highs allowing the public sector to produce a consolidated primary surplus in excess of 4 per
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cent of GDP in 2004. This, together with the growth in the economy and an appreciating currency, reduced the ratio of debt to GDP, ushering in a virtuous circle of declining risk spreads, growing confidence and a return of investment. This was despite the rekindling of inflationary pressures from rising commodity prices early in 2004, adjustments in administered prices and a very rapidly narrowing output gap. Core inflation remained in excess of 7 per cent throughout the year, and the Central Bank raised interest rates and tightened monetary policy in an attempt to avert higher inflation in 2005. The combined effect of the global slowdown and local policy restrictions is slowing the Brazilian economy. Nevertheless, the short-term outlook remains encouragingly positive.
In Argentina, the recovery from the crisis of 2001 continued in 2004, helped by the favourable external environment and the absence of effective pressure to improve the exchange offer on defaulted debt. Year-on-year GDP growth was 8.8 per cent. Employment in the formal economy in October was up by 6.8 per cent on the year before, continuing the trend of the past two years. By the end of 2004, the stock market index had surpassed the levels last achieved in August 2001, and stood almost 12 per cent above the minimum reached in September 2002, when the economy began its current expansionary phase. Inflation appeared to be under control and the government, buoyed by revenues from exports, was able to post large fiscal surpluses, with a primary surplus in excess of 5 per cent of GDP. By contrast, the progress on debt restructuring was slow. Though the rate of investment returned to the pre-crisis level of 20 per cent of GDP – arguably, too low to sustain growth in excess of 3 to 4 per cent per annum – it is likely that the re-investment cycle will falter without a workable solution to the debt crisis. To that extent, the outlook for Argentina remains uncertain.
HSBC’s operations in South America reported a pre-tax profit of US$415 million, substantially ahead of the US$115 million achieved in 2003. Excluding goodwill amortisation, pre-tax profit was US$444 million compared with US$126 million in 2003, and represented 2 per cent of HSBC’s total pre-tax profit on this basis. The 2004 results include the first full year’s contribution from the Brazilian consumer finance company, Losango, acquired in December 2003, along with contributions from CreditMatone S.A., acquired in November 2004, and Valeu Promotora de Vendas, the consumer finance operations of Indusval Multistock Group, acquired in August 2004. Together, these three businesses contributed US$72 million to pre tax profits before goodwill amortisation, representing 23 per cent of
the growth. There were no significant exchange rate impacts in 2004.
The commentary that follows is based on constant exchange rates.
Personal Financial Services’ pre-tax profit, before goodwill amortisation, of US$47 million predominantly reflected the Losango consumer finance business acquired in December 2003, which contributed US$72 million. It was pleasing to note that, in its first full year in HSBC, Losango’s full-year profitability doubled compared with 2003. Excluding Losango at constant exchange rates, the pre-tax loss before goodwill amortisation improved by 50 per cent on the previous year.
The integration of Losango progressed extremely well. There was strong growth across the product portfolios during the period, notably in store loans and personal lending products. Good progress was made in delivering anticipated operational synergies. Plans to embed Losango branches within the HSBC Brazil network are well advanced. In the second half of the year, Losango benefited from the acquisition of the two consumer finance portfolios noted above.
Excluding the impact of the acquired businesses, net interest income grew by 15 per cent, reflecting good asset growth in Brazil, partly offset by reduced spreads on credit cards in Argentina.
Auto finance loans in Brazil grew by 69 per cent, reflecting the success of a number of initiatives taken to enhance the distribution channels in the branch network, and effective marketing promotions and incentive campaigns. Market share increased from 3.1 per cent to 4.1 per cent. The income benefit arising from the increase in balances was only partly offset by narrower spreads.
Competitive pricing was used to grow the cards business to take advantage of strong growth in consumer spending: this generated an 11 per cent increase in balances. Growth in demand deposits was augmented by a widening of spreads. However, the benefit was partly offset by narrower spreads on savings accounts, where rates are set by the Brazilian Government, and on time deposits.
Other operating income rose by 32 per cent, of which 17 per cent came from Losango and its consumer lending acquisitions. The remaining 15 per cent arose principally from growth in fee income in Brazil driven by increased lending activity and higher revenues from the life insurance business in Argentina.
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Excluding Losango, credit-related fee income grew by 44 per cent in Brazil, as a result of growth in customer lending and the introduction of a new pricing structure. Greater use of a new automated collection service and revised fee charging led to a 19 per cent increase in account service fees. Strong growth in the cards business, where cards in circulation rose by 30 per cent, generated a significant increase in fee income of 27 per cent. Higher consumer lending also contributed to an overall increase in brokerage fees from insurance operations.
Operating expenses, excluding goodwill amortisation, increased by 38 per cent, of which 25 per cent was attributable to Losango and its acquisitions. Marketing expenditure increased by 58 per cent as HSBC sought to build and reinforce brand awareness in Brazil. Transactional taxes increased by 26 per cent in line with operating income growth. Prices also increased on the renewal of a number of service contracts. Costs in Argentina were 21 per cent higher, largely from increased staff costs, notably pensions and labour claims, together with higher marketing expenditure and regulatory fees.
The provision for bad and doubtful debts increased by 88 per cent or US$126 million, of which US$107 million or 75 per cent arose in Losango. The remaining increase was driven by the growth in unsecured lending in Brazil. Credit quality in both Brazil and Argentina was relatively stable throughout 2004 as unemployment and inflation rates declined and domestic economic growth strengthened.
Commercial Banking reported pre-tax profits, before goodwill amortisation, of US$165 million, an increase of 62 per cent over 2003, due largely to higher net interest income in Brazil.
Net interest income of US$234 million was US$59 million or 34 per cent higher than in 2003. In Brazil, overdraft balances increased by 44 per cent as a result of strong growth in the demand for credit and the introduction of a new pricing structure for SME customers. This led to a 22 per cent increase in income despite a marginal fall in spreads and this, together with strong growth in Giro fácil, a combined loan and overdraft product, contributed US$26 million of additional income. Total commercial lending balances increased by 58 per cent to US$1.4 billion and, following product development expenditure in 2003, lending backed by discounted receivables increased by 81 per cent. Spreads on deposit balances benefited from a reduction in the compulsory deposit rate and lower
rural loans, while deposit balances increased by 29 per cent, contributing further to the increase in net interest income. In Argentina, net interest income declined as the low interest rate environment led to reduced spreads on deposits.
Other operating income increased by 14 per cent to US$136 million. In Brazil, the growth in lending balances resulted in higher arrangement fee income, while current account fees rose by 15 per cent following the introduction of the new SME pricing structure. Income in Argentina was in line with 2003.
Operating expenses of US$203 million were 12 per cent higher than in 2003. In Brazil, growth in staff numbers in support of business expansion and increased transactional tax costs contributed to a 17 per cent rise in costs. Marketing expenses also increased reflecting the SME initiatives taken during the year. In Argentina, cost control initiatives resulted in a 7 per cent reduction in operating expenses.
Provisions for bad and doubtful debts were 82 per cent lower than in 2003. Recoveries and releases in Argentina reflected the improved economic conditions. These were partly offset by higher specific provisions raised in Brazil, in line with growth in the small business portfolio.
Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$150 million, compared with a small loss in 2003.
Net interest income of US$165 million contrasted with a net interest expense in 2003. In Brazil, sharp falls in interest rates in the latter part of 2003 and into early 2004 resulted in lower funding costs, which enabled Global Markets to benefit from large fixed rate positions taken in anticipation of interest rate reductions. Argentina also benefited from a significant decline in interest rates, as a lower interest expense reflected the reduced cost of funding non-performing loans.
The more stable political and interest rate environment led to lower volatility in the value of the Brazilian real and interest rates, resulting in fewer opportunities for arbitrage. As a consequence, other operating income declined, mainly through reduced dealing profits in Brazil.
Operating expenses, excluding goodwill amortisation, increased as transactional taxes rose in line with improved revenues in Brazil. In addition, bonuses increased in line with significantly higher profits.
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There was a small net release for bad and doubtful debts compared with a net charge in 2003, mainly due to lower provisions in the consumer brands sector and higher releases in the energy and utilities sector in Brazil.
Amounts written-off fixed assets fell, mainly due to lower provisions for certain Argentine government bonds which rose in value as the timing and nature of the external debt exchange offer were clarified.
Private Banking reported a pre-tax profit, before goodwill amortisation, of US$1 million, compared with a small loss of US$2 million in 2003. An increase in net interest income was driven by higher time deposits in Brazil, while operating expenses, excluding goodwill amortisation, reduced following a reorganisation of the business.
Other includes the ongoing impact of the pesification in Argentina. In 2004, higher earnings from compensation bonds, lower litigation provisions and increased gains on the sale of government securities were largely offset by lower general provision releases.
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
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30 per cent increase in cards in circulation to 1.4 million. Other operating income also improved in Argentina, reflecting a strong performance in the insurance business.
Operating expenses, excluding goodwill amortisation, were broadly in line with 2002. In Brazil, costs increased by 15 per cent, largely due to higher staff costs, notably labour claims, together with higher costs from marketing initiatives taken in 2003 and an increase in the transactional taxation charge on higher operating income. Costs in Argentina were significantly lower than prior year, mainly due to lower severance costs.
The provision for bad and doubtful debts of US$138 million was 50 per cent higher than in 2002. In Brazil, specific provisions increased, predominantly in the first half of 2003, reflecting the prevailing economic conditions. High inflation, interest rates and unemployment reduced customers’ repayment capacity. However, credit quality began to show signs of improvement in the second half of the year.
Commercial Banking in South America contributed pre-tax profit, before amortisation of goodwill, of US$99 million, 23 per cent higher than in 2002.
Net interest income increased by 39 per cent, to US$168 million. In Argentina, net interest income benefited from lower Argentine peso rates paid on deposits and recoveries of interest suspended on non-performing loans. In Brazil, successful marketing campaigns led to a significant growth in income from overdrafts and working capital products. Other growth areas included discounted receivables and vehicle leasing, supported by the introduction of pre-approved facilities.
Other operating income increased by 23 per cent to US$115 million. Credit related fee income in Brazil increased, reflecting the expansion in the current account customer base by 8 per cent. Fees earned on foreign exchange rose from a higher volume of transactions. In response to aggressive pricing by competitors, the introduction of a new fee pricing structure in the first half of 2003 stimulated an increase in the volume of loan fees and funds under management leading to higher fee income.
At US$173 million, total operating expenses, before goodwill amortisation, were 25 per cent higher than 2002. The cost increases partly reflected increased business volumes as well as the impact of various initiatives which had been delayed pending evidence of improvement in economic conditions. These included increased advertising, the
implementation of a sales structure to support business development, and investment in new products and delivery channels. These were partly funded by the centralisation of support processes which resulted in a reduction of associated costs and reduced the administrative workload for relationship managers, leaving them more time for their customers.
Corporate, Investment Banking and Markets reported a loss, before amortisation of goodwill, of US$24 million, broadly in line with 2002, at constant exchange rates. Profit before tax and amortisation of goodwill in Brazil was US$49 million, compared with US$104 million in 2002. Argentina recorded a loss of US$72 million compared with a loss of US$143 million in 2002.
Net interest expense was US$51 million, an increase of 16 per cent compared with 2002. In Brazil, net interest income decreased due to lower spreads in Global Markets, partly offset by the impact of downward yield curve movements which allowed the funding of long positions at lower rates. In corporate banking, a lack of attractive risks restricted lending growth. In Argentina, the lower cost of funding non-performing assets and a lower level of suspended interest resulted in a decrease in net interest expense.
Dealing profits were broadly in line with 2002. In Brazil, higher dealing profits reflected gains resulting from a fall in interest rates. Brokerage, custody and clearing businesses also grew significantly, taking advantage of market opportunities. These factors were offset in part by lower foreign exchange income in Argentina.
Staff costs were higher than in 2002, mainly in Brazil, reflecting improved performance in specific products.
Provisions for bad and doubtful debts rose in difficult market conditions. Higher interest rates, currency weakness, and a reduced availability of foreign currency funding all contributed to problems encountered by corporate customers in the first half of 2003 in Brazil. Although the situation improved during the year, new specific provisions were raised against two sizeable corporate accounts as a consequence of business failure in one case and fraud in the other.
Private Banking’s pre-tax loss, before goodwill amortisation, of US$2 million compared with a loss of US$12 million in 2002. A lower bad debt charge reflected an improvement in the overall credit quality of the segment.
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Within the Othercustomer group, there was a US$113 million release of the special general provision raised in respect of Argentina. This release followed a period of improved market conditions and collections within the lending portfolios.
Provisions for contingent liabilities and commitments reflected court decisions (amparos) relating to formally frozen US dollar denominated customer deposits required to be settled at the prevailing market rate.
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115
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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 243 to 356.
When preparing the financial statements, it is the directors’ responsibility under UK company law to select suitable accounting policies and to make judgements and estimates that are reasonable and prudent. Under UK GAAP, Financial Reporting Standard (‘FRS’) 18 ‘Accounting policies’ requires the Group to adopt the most appropriate accounting policies in order to give a true and fair view.
HSBC also provides details of its net income and shareholders’ equity calculated in accordance with US GAAP. US GAAP differs in certain respects from UK GAAP. Details of these differences are set out in Note 49 in the ‘Notes on the Financial Statements’ on pages 322 to 356.
The accounting policies that are deemed critical to HSBC’s UK GAAP results and financial position, in terms of materiality and the degree of judgement and estimation involved, are discussed below.
Provisions for bad and doubtful debts
HSBC’s accounting policy for provisions for bad and doubtful debts on customer loans is described in Note 2(c) in the ‘Notes on the Financial Statements’ on pages 244 to 246.
Charges for provisions for bad and doubtful debts are reflected in HSBC’s profit and loss account under the caption ‘Provision for bad and doubtful debts’. Any increase in these provisions has the effect of lowering HSBC’s profit on ordinary activities by a corresponding amount (while any decrease in provisions or release of provisions would have the opposite effect).
Specific provisions
Specific provisions are established either on a portfolio basis or on a case-by-case basis depending on the nature of the exposure and the manner in which risks inherent in that exposure are managed. In addition, provisions for the sovereign risk inherent in cross-border credit exposures are established for certain countries; this element is not currently significant.
When specific provisions are raised on a portfolio basis, the most important factors in calculating the quantum of the required provision are:
The portfolio basis is applied to overdue accounts in HSBC Finance Corporation’s consumer portfolios and to the following portfolios in the rest of HSBC:
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 HSBC Finance Corporation, which utilises portfolio analysis, to residential mortgages 90 days or more overdue.
HSBC has no individual loans where changes in the underlying factors upon which specific bad and doubtful debt provisions have been established could cause a material change to the Group’s reported results.
General provisions
General provisions augment specific provisions and provide cover for loans which are impaired at the balance sheet date but which will not be identified as such until some time in the future. HSBC requires each operating company to maintain a general provision which is determined by taking into account the structure and risk characteristics of each company’s loan portfolios. Provisions held against homogeneous portfolios of assets which are not overdue and which have neither been restructured nor are in bankruptcy are classified as general rather than specific.
The most important factors in determining general loan loss provisions are:
The main areas of judgement are in determining the periods during which latent losses emerge and assessing whether current economic conditions are likely to produce credit default rates and loss severity in line with historical precedent. These factors are kept under review based on an analysis of economic forecasts, industry sector performance, insolvency and bankruptcy statistics, together with details of the rate and nature of losses experienced.
If management were to take a more conservative view of economic conditions or increase the loss emergence periods, the provisions charged would increase and HSBC’s profit on ordinary activities would be lower.
Goodwill impairment
HSBC’s accounting policy for goodwill is described in Note 2(f) in the ‘Notes on the Financial Statements’ on page 247.
Amortisation of goodwill is recorded on HSBC’s profit and loss account under the caption ‘Depreciation and Amortisation – Goodwill’. Any impairments or reductions of goodwill are also charged to the profit and loss account (hence reducing HSBC’s operating profit on ordinary activities after tax by a corresponding amount) and also result in a corresponding reduction of ‘Goodwill’ on the balance sheet.
In accordance with the requirements of FRS 10 ‘Goodwill and intangible assets’, HSBC reviews goodwill which has arisen on the acquisition of subsidiary undertakings, joint ventures and interests in associates at the end of the first full year after an acquisition, and whenever there is an indication that impairment may have taken place. Impaired goodwill is accounted for in accordance with FRS 11 ‘Impairment of fixed assets and goodwill’. Indications of impairment include any events or changes in circumstance that cast doubt on the recoverability of the carrying amount of goodwill.
If management believes that a possible impairment is indicated in respect of a particular entity, the valuations of each of the entity’s relevant ‘Income Generating Units’ (‘IGUs’) are compared with their respective carrying values (including related goodwill). The IGU valuations are derived from discounted cashflow models. Significant management judgement is involved in two elements of the process of identifying and evaluating goodwill impairment.
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First, the cost of capital assigned to an individual IGU and used to discount its future cash flows can have a significant effect on its valuation. The cost of capital percentage is generally derived from an appropriate capital asset pricing model, which itself depends on a number of financial and economic variables which are established on the basis of management’s judgement.
Second, management judgement is required in deriving discounted cash flow valuations of IGUs. These valuations are sensitive to the cash flows in the initial periods for which detailed forecasts are available, and to assumptions regarding the long-term sustainable growth rates of cash flows thereafter. While the acceptable range within which underlying assumptions can be applied is governed by the requirement for resulting forecasts to be compared with actual performance and verifiable economic data in future years, the cash flow forecasts necessarily reflect management’s view of future business prospects.
Where management’s judgement is that the expected cash flows of an IGU have declined and/or that its cost of capital has increased, the effect will be to reduce the estimated fair value of the IGU. If this results in an estimated fair value that is lower than the carrying value of the IGU, an impairment of goodwill will be recorded and HSBC’s profit on ordinary activities will be lower.
Valuation of securities and derivatives
HSBC’s accounting policy for these instruments is described in Note 2 (d) and Note 2 (l) in the ‘Notes on the Financial Statements’ on pages 246 and 248.
HSBC carries debt and equity securities and derivatives held for trading purposes at fair or ‘mark-to-market’ value. The mark-to-market of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. For those debt and equity securities not held for trading purposes, and carried in the accounts at amortised historical cost, consideration as to whether any such asset should be written down to reflect impairment takes into account the fair value of the relevant security. Non-trading derivatives (which are primarily interest rate swaps) are accounted for on an accruals basis. Changes in the value of securities and derivatives held for trading purposes are reflected in ‘Dealing profits’ and hence directly impact HSBC’s profit on ordinary activities. Any impairment in the value of debt and equity securities not held for trading purposes is reported in ‘Amounts written of fixed
asset investments’ and hence reduces HSBC’s profit on ordinary activities.
The majority of the Group’s financial instruments held for trading purposes are valued based on quoted market prices. Where quoted market prices are not available, the fair value reflects management’s assessment of the value of these financial instruments. This assessment may look to a valuation of comparable instruments for which an independent price can be established or use a discounted cash flow model (particularly for debt securities and derivatives) or model the valuation of complex instruments based on a components approach where independent pricing is available for the underlying components, including interest rate yield curves, option volatilities and currency rates.
The main factors which management considers when applying a cash flow model are:
When valuing instruments by reference to comparable instruments management takes into account the maturity, structure and rating of the instrument to which the position held is being compared.
When valuing instruments on a model basis using the fair value of underlying components, management additionally considers the need for adjustments to take account of counterparty creditworthiness, model uncertainty and the future costs of servicing the portfolio. These adjustments are based on defined policies which are applied consistently across the Group.
For derivatives where market observable data are not available, the initial increase in fair value indicated by the valuation model, but based on unobservable inputs, is not recognised immediately in the profit and loss account. This amount is held back and recognised over the life of the transaction in a systematic manner where appropriate, or released to the profit and loss account when the inputs become observable, or, when the transaction matures or is closed out.
For securities carried at amortised cost impairment may result from changes in their estimated fair value if management changes its assumptions regarding the above variables. In such circumstances, it will also be necessary for management to exercise judgement as to whether or not the indicative change in estimated fair value
arising from revisions to the underlying valuation assumptions are only temporary.
The table below summarises HSBC’s trading portfolios by valuation methodology at 31 December 2004:
For a discussion of market risk management, see Market Risk Management on pages 167 to 172.
Differences in net income and shareholders’ equity are explained in Note 49 of the ‘Notes on the Financial Statements on pages 322 to 356.
Transition to International Financial Reporting Standards
The adoption of International Financial Reporting Standards (‘IFRS’) from 1 January 2005 is the most significant accounting development for HSBC.
The European Union (‘EU’) requires that listed European companies prepare their 2005 financial statements in accordance with EU-endorsed IFRS. HSBC’s 2005 interim financial statements will, therefore, be prepared in accordance with IFRS. The European Union endorsement process for IFRS is ongoing but the majority of standards are now endorsed including IAS 32 ‘Financial Instruments: Disclosure and Presentation’ and most of IAS 39 ‘Financial Instruments: Recognition and Measurement’ with the exception of the deletion of a limited number of words and paragraphs in IAS 39
including those relating to the use of the ‘fair value option’ for financial liabilities.
HSBC has substantially completed its transition to IFRS. The process of refining systems and processes in order to collect data on a fully IFRS-compliant basis for 2005 reporting is well advanced.
On 9 December 2004, HSBC filed with the US Securities and Exchange Commission a summary of the applicable significant differences between UK GAAP and IFRS. This should be referred to for details of the major IFRS effects on HSBC Group, and is included as Annex A to this annual report.
IFRS will also impact HSBC Holdings’ individual accounts. Investments in subsidiary undertakings will be carried at cost rather than net asset value, including attributable goodwill, adjusted for shares held by subsidiaries in HSBC Holdings. Under IFRS, in addition to the balance sheet, HSBC Holdings will publish an income statement and other primary financial statements.
HSBC currently intends to file 2004 comparative data and the 2005 opening balance sheet on an IFRS basis in the second quarter of 2005.
FRS 27 ‘Life Assurance’ was issued by the UK Accounting Standards Board (‘ASB’) in December 2004. This standard is effective under UK GAAP for 2005 reporting and thus should not ostensibly be applicable to companies adopting IFRS for 2005. However, FRS 27 adds to the requirements of IFRS 4 ‘Insurance contracts’ with regard to further requirements in relation to measurement of realistic liabilities and disclosure of capital position. HSBC continues to assess the likely impact of this accounting standard.
US GAAP
The Financial Accounting Standards Board (‘FASB’) (US GAAP) has issued the following accounting standards, which become fully effective in future financial statements.
In December 2003, the American Institute of Certified Public Accountants (‘AICPA’) released Statement of Position 03-3, ‘Accounting for Certain Loans or Debt Securities Acquired in a Transfer’ (‘SOP 03-3’). SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable to credit quality. SOP 03-3 is effective for loans acquired in fiscal years beginning after 15 December 2004. Adoption is not expected to have a material impact on the US GAAP information in HSBC’s financial statements.
In March 2004, the FASB reached a consensus on Emergent Issues Task Force (‘EITF’) 03-1, ‘The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments’. EITF 03-1 provides guidance for determining when an investment is impaired and whether the impairment is other than temporary. EITF 03-1 also incorporates into its consensus the required disclosures about unrealised losses on investments announced by the EITF in late 2003 and adds new disclosure requirements relating to cost-method investments. The new disclosure requirements are effective for annual reporting periods ending after June 15, 2004 and the new impairment accounting guidance was to become effective for reporting periods beginning after June 15, 2004. In September 2004, the FASB delayed the effective date of EITF 03-1 for measurement and recognition of impairment losses until implementation guidance is iss ued. In December 2004, the FASB decided to reconsider in
its entirety all guidance on disclosing, measuring and recognising other-than-temporary impairments of debt and equity securities and requires companies to continue to comply with existing accounting literature. Until the new guidance is finalised, the impact on HSBC’s financial position and results of operations cannot be determined.
SFAS 123 (revised 2004) ‘Share-Based Payment’ (‘SFAS 123R’) was issued in December 2004 to replace SFAS 123 ‘Accounting for Stock Based Compensation’ (‘SFAS 123’). SFAS 123R requires a fair value method of accounting for stock-based compensation plans. Under the fair value method, compensation cost is measured at the date of grant based on the value of the award and is recognised over the service period. HSBC had already elected to follow the fair value method encouraged by SFAS 123. Where annual bonuses are awarded in restricted shares, and the employee must remain with HSBC for a fixed period in order to receive the shares, HSBC has, to date, interpreted the service period as being the year to which the bonus relates. HSBC has fully expensed the share award in that year under US GAAP, consistent with the UK GAAP treatment. Under SFAS 123R, the service period is presumed to be the vesting period, i.e. the period the employee must remain with HSBC. Accordingly, for awards granted after the effective date of SFAS 123R, the expense of such awards will be spread forward over the vesting period. HSBC will adopt SFAS 123R from 1 July 2005.
The effect of adopting this new accounting treatment will be that 2005 bonuses paid in restricted shares will be excluded from staff costs for 2005 and instead will be expensed over the vesting period with a corresponding increase in net income. The amount of these awards is dependent on 2005 performance. 2004 bonuses that will be paid in restricted shares were approximately US$130 million.
Average balances and the related interest are shown for the domestic operations of HSBC’s principal
commercial banks by geographic region with all other commercial banking and investment banking balances and transactions included in ‘Other operations’. Additional information on the basis of preparation is set out in the notes on page 130.
123
124
125
126
127
128
InterestexpenseUS$m
129
Balances and transactions with fellow subsidiaries are reported gross in the principal commercial banking and consumer finance entities within ‘Other interest-earning assets’ and ‘Other interest-bearing liabilities’ as appropriate and the elimination entries are included within ‘Other operations’ in those two categories.
130
Analysis of changes in net interest income
The following table allocates changes in net interest income between volume and rate for 2004 compared with 2003, and for 2003 compared with 2002. Changes due to a combination of volume and rate are allocated to rate.
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132
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 country and cross-border risk), liquidity risk, market risk, reputational risk and operational risk. Market risk includes foreign exchange, interest rate and equity price risks.
HSBC’s risk management policies are designed to identify and analyse these risks, to set appropriate risk limits and controls, and to monitor the risks and limits continually by means of reliable and up-to-date administrative and information systems. HSBC continually modifies and enhances its risk management policies and systems to reflect changes in markets and products and in best practice risk management processes. Training, individual responsibility and accountability, together with a disciplined, conservative and constructive culture of control, lie at the heart of HSBC’s management of risk.
The Group Management Board, under authority delegated by the Board of Directors, formulates high level Group risk management policy. A separately constituted Risk Management Meeting monitors risk and receives reports which allow it to review the effectiveness of HSBC’s risk management policies.
Credit risk management
Credit risk is the risk that financial loss arises from the failure of a customer or counterparty to meet its obligations under a contract. It arises principally from lending, trade finance, treasury and leasing activities. HSBC has dedicated standards, policies and procedures to control and monitor all such risks.
Within Group Head Office, a separate function, Group Credit and Risk, is mandated to provide high-level centralised management of credit risk for HSBC worldwide. Group Credit and Risk is headed by a Group General Manager who reports to the Group Chief Executive, and its responsibilities include the following:
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place throughout the Group to enable operating companies to control and monitor exposures by customer and counterparty.
Special attention is paid to problem loans. When appropriate, specialist units are established by HSBC’s operating companies to provide customers with intensive management and control support in order to help them avoid default wherever possible thereby maximising recoveries for HSBC.
Regular audits of operating companies’ credit processes are undertaken by HSBC’s Internal Audit function. Audits include consideration of the completeness and adequacy of credit manuals and lending guidelines, an in-depth analysis of a representative sample of accounts, an overview of homogeneous portfolios of similar assets to assess the quality of the loan book and other exposures, and adherence to Group standards and policies in the extension of credit facilities. Individual accounts are reviewed to ensure that facility grades are appropriate, that credit and collection procedures have been properly followed and that, where an account or portfolio evidences deterioration, adequate provisions are raised in accordance with the Group’s established processes. Internal Audit will discuss with management facility gradings they consider to be inappropriate, and their subsequent recommendations for revised g rades must then be assigned to the facilities concerned.
It is HSBC’s policy that each operating company make provision for bad and doubtful debts promptly when required and on a consistent basis in accordance with established Group guidelines.
HSBC’s grading process for credit facilities extended by members of the Group is designed to highlight exposures requiring greater management attention based on a higher probability of default and potential loss. Management particularly focuses on facilities to those borrowers and portfolio segments classified below satisfactory grades. Amendments to facility grades, where necessary, are required to be undertaken promptly. Management also regularly evaluates the adequacy of the established provisions for bad and doubtful debts by conducting a detailed review of the loan portfolio, comparing performance and delinquency statistics to historical trends and assessing the impact of current economic conditions.
Two types of provision are in place: specific and general. These are discussed below.
Specific provisions represent the quantification of actual and inherent losses from homogeneous portfolios of assets and individually identified accounts. In addition, specific provisions for the sovereign risk inherent in cross-border credit exposures are established for certain countries. Specific provisions are deducted from loans and advances in the balance sheet.
Portfolios
Where homogeneous groups of assets are reviewed on a portfolio basis, for example credit cards, other unsecured consumer lending, motor vehicle financing and residential mortgage loans, two alternative methods are used to calculate specific provisions:
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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.
Individually assessed accounts
Specific provisions on individually assessed accounts are determined by an evaluation of the exposures case-by-case. This procedure is applied to all accounts that do not qualify for, or are not subject to, a portfolio-based approach outlined above. In determining such provisions on individually assessed accounts, the following factors are considered:
insolvency and specific market sectors are used. This expertise enables likely losses on significant individual exposures to be assessed more accurately. Releases on individually calculated specific provisions are recognised whenever the Group has reasonable evidence that the established estimate of loss has been reduced.
Cross-border exposures
Specific provisions are established in respect of cross-border exposures to countries assessed by management to be vulnerable to foreign currency payment restrictions. This assessment includes analysis of both economic and political factors. Economic factors include the level of external indebtedness, the debt service burden and access to external sources of funds to meet the debtor country’s financing requirements. Political factors taken into account include the stability of the country and its government, potential threats to security and the quality and independence of the legal system.
Provisions are applied to all qualifying exposures within these countries unless these exposures:
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:
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historical experience.
The estimated period between a loss occurring and its identification (as evidenced by the establishment of a specific provision for this loss) is determined by local management for each identified portfolio. In general, the periods used vary between four and twelve months.
In normal circumstances, historical experience is the most objective and accurate framework used to assess inherent loss within each portfolio. Historical loss experience is generally benchmarked against the weighted average annual rate of losses over a five-year period.
In certain circumstances, economic conditions are such that historical loss experience provides insufficient evidence of the inherent loss in a given portfolio. In such circumstances, management uses its judgement, supported by relevant experience from similar situations, to determine an appropriate general provision.
The basis used to establish the general provision within each reporting entity is documented, and is reviewed by senior Group credit management for conformity with Group policy.
Suspended and non-accrual interest
For individually assessed accounts, loans are designated as non-performing as soon as management has doubts as to the ultimate collectibility of principal or interest, or when contractual payments of principal or interest are 90 days overdue. When a loan is designated as non-performing, interest is not normally credited to the profit and loss account and either interest accruals will cease (‘non-accrual loans’) or interest will be credited to an interest suspense account in the balance sheet which is netted against the relevant loan (‘suspended interest’).
Within portfolios of low value, high volume, homogeneous loans, interest will normally be suspended on facilities 90 days or more overdue. In certain operating subsidiaries, interest income on credit cards may continue to be included in earnings after the account is 90 days overdue, provided that a suitable provision is raised against the portion of accrued interest which is considered to be irrecoverable.
The designation of a loan as non-performing and the suspension of interest may be deferred for up to 12 months in either of the following situations:
is legally sound; or
Charge-offs
Loans (and the related provisions) are normally charged off, either partially or in full, when there is no realistic prospect of recovery of these amounts and when the proceeds from the realisation of security have been received. Unsecured consumer facilities are charged off between 150 and 210 days overdue. In the case of HSBC Finance, this period is generally extended to 300 days overdue (270 days for real estate secured products). There are no cases where the charge-off period exceeds 360 days except for the UK where certain consumer finance accounts are still deemed collectible beyond this point. In the case of bankruptcy, charge-off can occur earlier.
US banks typically write off problem lending more quickly than is the practice in the UK. This means that HSBC’s reported levels of credit risk elements and associated provisions are likely to be higher than those of comparable US banks.
Restructuring of loans
Restructuring activity is designed to manage customer relationships, maximise collection opportunities and avoid foreclosure or repossession, if possible. Following restructuring, an overdue consumer account will normally be reset to current status. Restructuring policies and practices are based on indicators or criteria which, in the judgement of local management, evidence the probability that payment will continue. These policies are continually reviewed and their application varies depending upon the nature of the market, the product and the availability of empirically based data. Where empirical evidence indicates an increased propensity to default on restructured accounts, the use of roll rate methodologies for the calculation of provisions results in the increased default propensity being reflected in provisions.
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Restructuring activity is used most commonly within consumer finance portfolios. The largest concentration is domiciled in the US in HSBC Finance Corporation. The majority of restructured accounts relate to secured lending.
In addition to restructuring, HSBC’s consumer lending businesses, principally HSBC Finance Corporation’s, use other account management techniques on a more limited basis, such as extended payment arrangements, approved external debt management plans, deferring foreclosure, modification, loan rewrites and/or deferral of payments pending a change in circumstances. When using such techniques, accounts may be treated as current, although if payment difficulties are subsequently experienced they will be re-designated as delinquent.
At 31 December 2004, the total value of accounts which have been either restructured or subject to other account management techniques in HSBC Finance was US$15 billion, representing 12 per cent of the HSBC Finance loan book, compared with US$18 billion or some 15 per cent at 31 December 2003.
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$101.4 billion or 20 per cent, during 2004. On the same basis, personal lending comprised 63 per cent of HSBC’s loan portfolio and over 72 per cent of the growth in loans in 2004 related to personal and consumer lending.
Overall, including the finance sector and settlement accounts, personal lending represented 57 per cent of total advances to customers at 31 December 2004.
Gross loans and advances to customers
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The commentary below is on a constant currency basis.
Residential mortgages increased by 28 per cent to US$227.9 billion and comprised 33 per cent of total gross loans to customers at 31 December 2004. Growth was particularly strong in North America where residential mortgages rose by 44 per cent to US$112.9 billion. A combination of low unemployment and low interest rates encouraged both growth in new lending and the refinancing of existing mortgages. HSBC Finance also introduced a number of new products and activated a new correspondent relationship in the first half of the year. Residential mortgages in Europe increased by 26 per cent, predominantly in the UK, reflecting the success of a number of marketing initiatives, competitive pricing and continued buoyancy in the housing market. Mortgage balances in Hong Kong were marginally lower than in 2003 as a 14 per cent fall in GHOS, which remained suspended during the year, offset a small rise in non-scheme mortgages. In the rest of Asia-Pacific, residential mortgages grew by US$2.0 billion, or 16 per cent, with particularly strong growth in China, the Middle East, India, South Korea, Taiwan and Singapore.
Other personal lending, which represented 23 per cent of total gross loans to customers at 31 December 2004, increased by 17 per cent to US$160.0 billion. Excluding the impact of the acquisition of M&S Money in the UK in November 2004, the increase was 13 per cent. In Europe, excluding this acquisition, other personal lending grew by 18 per cent as consumer expenditure remained strong, particularly in the UK, while
lending to European Private Banking clients rose by 22 per cent as customers took advantage of low interest rates to finance higher returning securities. Hong Kong and the rest of Asia-Pacific also benefited from improved consumer sentiment and other personal lending in Hong Kong increased by 23 per cent. In the rest of Asia-Pacific, an expansion of consumer credit and growth in the credit cards base contributed to a 25 per cent increase in other personal lending while the US benefited from strong growth in both the cards base and balances, and an expansion of auto finance lending.
Loans and advances to the large corporate sector remained subdued but commercial lending in Hong Kong and in the rest of Asia-Pacific expanded as regional trade volumes grew. International trade balances in Hong Kong increased by 26 per cent to US$7.8 billion, as economic expansion in mainland China, and buoyant consumer spending in the US encouraged business expansion. Inter-regional trade volumes also grew across the rest of Asia-Pacific and trade finance lending in the region increased by 30 per cent with particularly strong growth in the Middle East, where oil producing countries benefited from high global oil prices, Singapore, Korea and Japan.
The following tables analyse loans by industry sector and by the location of the principal operations of the lending subsidiary or, in the case of the operations of The Hongkong and Shanghai Banking Corporation, HSBC Bank, HSBC Bank Middle East and HSBC Bank USA, by the location of the lending branch.
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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 HSBC Finance, 92 per cent of which relate to North America:
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Customer loans and advances by industry sector (continued)
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145
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Customer loans and advances by principal area within rest of Asia-Pacific and South America
Analysis of loans and advances to banks by geographical region
Provisions against total loans and advances
Provisions against loans and advances to customers
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.
150
151
Year ended 31 December 2001
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153
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 HSBC Finance includes charges for:
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1 Since the date of acquisition.
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Net charge to the profit and loss account for bad and doubtful debts (continued)
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This commentary discusses the movements in the numbers reported on pages 142 to 156. In cases where exchange rate changes have contributed significantly to the movements, the exchange rate effect is quantified and the underlying movements are explained in terms of constant currency.
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In aggregate, releases and recoveries increased by US$557 million compared with 2002. HSBC Finance Corp. contributed US$311 million of the increase due to collections and sales of written-off accounts. In Europe, excluding HSBC Finance Corporation’s UK consumer finance business, releases and recoveries were US$139 million higher, mainly the result of a recovery from an exposure in the transport sector and the upgrading of corporate exposures in the telecommunications and retail sectors.
There was a net release of general provisions of US$121 million in 2003 compared with a release of US$351 million in 2002. There were general provision charges of US$113 million in HSBC Finance and US$78 million in HSBC Mexico, reflecting growth in lending. In Europe, excluding HSBC Finance Corporation’s UK consumer finance business, a net release of general provision of US$131 million reflected an improved economic outlook and successful restructuring and refinancing activity in industry sectors which had been causing concern. In Argentina, a net release of US$122 million reflected success in collections and the improved environment and hence quality of the remaining loan book. At 31 December 2003, specific and general provisions together covered about 47 per cent of non-government loans (net of suspended interest) in Argentina.
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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
Group advances to personal customers
The charge for bad and doubtful debts in 2004 was dominated by the charge relating to the personal sector, this figure representing more than 100 per cent of the Group total after taking account of the Group’s commercial lending activities. Within this total, losses on residential mortgages remained modest.
Lending to personal customers has increased substantially in recent years as a result of both organic growth and acquisitions, most notably HSBC Finance Corporation in March 2003. At 31 December 2004, HSBC’s lending to the personal sector amounted to US$388 billion, or 57 per cent of total gross advances to customers, compared with US$306 billion at 31 December 2003. The main attributes of this portfolio and the economic influences affecting it are outlined below.
Secured residential mortgages accounted for US$228 billion or 59 per cent of total lending to the personal sector compared with US$172 billion, or 56 per cent, at 31 December 2003. The main areas of growth in 2004 were the US and the UK, which together accounted for US$54 billion of the increase.
The unsecured element of the portfolio consisted of credit and charge card advances, personal loans, car finance facilities and other varieties of instalment finance. At 31 December 2004, the combined portfolios totalled US$160 billion, or 41 per cent of total lending to the personal sector, compared with US$134 billion, or 44 per cent, at 31 December 2003. Growth in these portfolios reflected continued growth in consumer spending within the main economies in which HSBC operates.
Geographically, total lending to personal customers was dominated by the diverse and mature portfolios in the US (US$173 billion), the UK (US$107 billion), and Hong Kong (US$38 billion). Collectively, these books accounted for 82 per cent of total lending to the personal sector, unchanged from the position at 31 December 2003.
Account management within HSBC’s personal lending portfolios in both Personal Financial Services and Consumer Finance is supported by sophisticated statistical techniques, which are enhanced by the availability of credit reference data in key local markets. The expansion of an increasingly analytical approach to the management of these portfolios across the Group remains an ongoing objective.
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In view of the high levels of personal indebtedness in many of the world’s leading economies, guidelines for the restructuring of customer facilities in the event of financial difficulty have been reinforced.
In the US, the strength of the housing market continued unabated, driven mainly by affordability. Low interest rates, lower transaction costs and increased availability of credit all fuelled the rise in demand. However, recent rises in interest rates are likely to affect growth adversely and add pressure to some borrowers, particularly in certain overpriced locations. The portfolios, however, remain geographically diverse and are secured largely by senior lien positions.
Although increased mortgage borrowing has contributed to the record level of consumer debt, levels have largely stabilised and are expected to decline gradually, as incomes rise sufficiently to pay down debt, notwithstanding higher interest rates. Against this background, delinquency rates fell across the majority of portfolios during 2004 and trends in lending quality showed an improvement.
Personal lending in the UK also continued to grow strongly, particularly in the mortgage market. This secured portfolio, representing 55 per cent of total lending to personal customers in the UK, continued to suffer negligible delinquency and losses. The unsecured portfolio also continued to expand both through organic growth and with the acquisition of Marks and Spencer Financial Services, which added US$5.3 billion to the portfolio in November 2004. Underwriting criteria were regularly reviewed to ensure that they remained appropriate in prevailing market conditions, which have seen a steady rise in personal bankruptcies and delinquencies over the course of the year.
With consumer spending rising in Hong Kong and the levels of bankruptcies and unemployment both falling, the improvement in the personal portfolios, which first became evident during the second half of 2003, continued throughout 2004. With ongoing property price increases a feature of 2004, the most notable trend was the continued reduction in the level of negative equity on mortgage balances, which is now at modest levels.
Across the other geographical regions the position remained relatively stable, although HSBC continued to monitor carefully those portfolios that have the greatest potential for future economic stress. Delinquency and loss trends differed across jurisdictions, reflecting these varied conditions.
Risk elements in the loan portfolio
The following disclosure of credit risk elements reflects US accounting practice and classifications:
In accordance with UK accounting practice, a number of operating companies suspend interest rather than ceasing to accrue. This additional category is also reported below, as are assets acquired in exchange for advances.
Non-performing loans and advances1
Non-performing customer loans1 and related specific provisions outstanding by geographical segment
Total non-performing loans to customers decreased by US$1,791 million during the year. At 31 December 2004, non-performing loans represented 1.9 per cent of total lending compared
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with 2.8 per cent at 31 December 2003. At constant exchange rates, non-performing loans decreased by US$2.3 billion, or 15 per cent. Improved economic conditions in most geographical regions were the main driver for the fall in non-performing loans.
Across Europe, at constant exchange rates, non-performing loans declined marginally with underlying credit quality in the UK and France remaining stable. In the UK, releases and recoveries in the corporate sector, primarily as a result of the restructuring of a number of non-performing loans, were partly offset by a rise in delinquencies across most unsecured personal loan products, in line with the broader target markets now being served.
In Hong Kong, non-performing loans decreased by US$0.9 billion, or 54 per cent, during 2004 due to the improved economic climate and rising real estate prices. These factors enabled certain corporate customers to increase repayments through the disposal of assets or improved debt servicing.
In the rest of Asia-Pacific, non-performing loans fell by US$0.4 billion, or 23 per cent, during the year, as a general improvement in the economic environment across the region was reflected in a rise in recoveries and releases of provisions.
The level of non-performing loans in North America decreased by US$0.9 billion, in line with the continued improvement in economic conditions; HSBC Finance’s business particularly benefited from a continued improvement in delinquencies and default trends. In Mexico, there were further write-offs of US$285 million during 2004 in the commercial and consumer loan books, as management continued to reduce the acquired workout portfolio.
South America experienced a modest reduction in non-performing loans in 2004 arising mainly in Argentina as credit quality improved in line with a general upturn in the local economy.
Troubled debt restructurings
US GAAP requires separate disclosure of any loans where terms have been modified to grant
concessions other than warranted by market conditions due to problems with the borrower. These are classified as ‘troubled debt restructurings’ and are distinct from the normal restructuring activities described above. Disclosure of troubled debt restructurings may be discontinued after the first year if the debt is performing in accordance with the new terms.
Troubled debt restructurings decreased significantly in Europe where a number of corporate exposures were regularised, in Hong Kong where balances were repaid on certain restructured borrowings, and in South America.
Accruing loans past due 90 days or more
Accruing loans past due 90 days decreased as the overall credit environment improved, particularly in Hong Kong and the US. HSBC Finance’s business benefited from a continued improvement in delinquency and default trends as the US economy recovered. In common with other card issuers, including other parts of HSBC, HSBC Finance continues to accrue interest on credit cards past 90 days until charged off at 180 days past due. Appropriate provisions are raised against the proportion judged to be irrecoverable.
Potential problem loans
Credit risk elements also cover potential problem loans. These are loans where information about borrowers’ possible credit problems causes management serious doubts about the borrowers’ ability to comply with the loan repayment terms. There are no potential problem loans other than those identified in the table of risk elements set out below.
Risk elements
The following table provides an analysis of risk elements in the loan portfolios at 31 December for the past five years:
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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$300 million in 2004 compared with US$380 million in 2003 and US$406 million in 2002. Interest income of approximately US$184 million from such loans was recorded in 2004, compared with US$230 million in 2003 and US$258 million in 2002.
Country distribution of outstandings and cross-border exposures
HSBC controls the risks associated with cross-border lending, essentially the risk of foreign currency required for payments not being available to local residents, through a central process of internal country limits which are determined by taking into account both economic and political risks. Exposure to individual countries and cross-border exposure in aggregate is kept under continuous review.
The following tables analyse the aggregate of in-country foreign currency and cross-border outstandings by type of borrower to countries which individually represent in excess of 1 per cent of
HSBC’s total assets. Classification is based upon the country of residence of the borrower but recognises the transfer of country risk in respect of third party guarantees, eligible collateral held or residence of the head office where the borrower is a branch. In accordance with the Bank of England Country Exposure Report (Form CE) guidelines, outstandings comprise loans and advances (excluding settlement accounts), amounts receivable under finance leases, acceptances, commercial bills, certificates of deposit and debt and equity securities (net of short positions), and exclude accrued interest and intra-HSBC exposures. Comparative figures for 2003 and 2002 were calculated under the requirements of the Bank of England’s Form C1, which was replaced by Form CE from 31 December 2004 reporting. The requirements of Form CE differ from those of Form C1 in a number of ways, none of which materially affects the exposures reported below. For 200 3, outstandings to counterparties in the UK were collected on a comparable basis to that required for Form C1 for the first time. For 2002, the UK outstandings, which are not recorded on Form C1 because the UK is HSBC’s country of domicile, have not been collected or disclosed.
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At 31 December 2004, HSBC had in-country foreign currency and cross-border outstandings to counterparties in Australia and Canada of between 0.75 per cent asnd 1 per cent of total assets. The aggregate in-country foreign currency and cross-border outstandings were: Australia: US$12.7 billion; Canada: US$11.8 billion.
At 31 December 2003, HSBC had in-country foreign currency and cross-border outstandings to counterparties in Australia and Japan of between
0.75 per cent and 1 per cent of total assets. The aggregate in-country foreign currency and cross-border outstandings were: Australia: US$9.1 billion; Japan: US$7.9 billion.
At 31 December 2002, HSBC had in-country foreign currency and cross-border outstandings to counterparties in Belgium of between 0.75 per cent and 1 per cent of total assets. The aggregate in-country foreign currency and cross-border outstandings were US$5.9 billion.
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Liquidity and funding management
HSBC maintains a diversified and stable funding base of core retail and corporate customer deposits as well as portfolios of highly liquid assets. The objective of HSBC’s liquidity and funding management is to ensure that all foreseeable funding commitments and deposit withdrawals can be met when due.
The management of liquidity and funding is primarily carried out locally in the operating companies of HSBC in accordance with practice and limits set by the Group Management Board. These limits vary by local financial unit to take account of the depth and liquidity of the market in which the entity operates. It is HSBC’s general policy that each banking entity should be self-sufficient with regard to funding its own operations. Exceptions are permitted to facilitate the efficient funding of certain short-term treasury requirements and start-up operations or branches which do not have access to local deposit markets, all of which are funded under strict internal and regulatory guidelines and limits from HSBC’s largest banking operations. These internal and regulatory limits and guidelines serve to place formal limitations on the transfer of resources between HSBC entities and are necessary to reflect the bro ad range of currencies, markets and time zones within which HSBC operates.
HSBC requires operating entities to maintain a strong liquidity position and to manage the liquidity profile of their assets, liabilities and commitments so that cash flows are appropriately balanced and all funding obligations are met when due.
The Group’s liquidity and funding management process includes:
Primary sources of funding
Current accounts and savings deposits payable on demand or at short notice form a significant part of HSBC’s funding. HSBC places considerable importance on the stability of these deposits. Stability depends upon maintaining depositor confidence in HSBC’s capital strength and liquidity, and on competitive and transparent deposit-pricing strategies. HSBC actively supports this confidence by consistently reinforcing HSBC’s brand values of trust and solidity across the Group’s geographically diverse retail banking network.
HSBC accesses professional markets in order to provide funding for non-banking subsidiaries that do not accept deposits, to maintain a presence in local money markets and to optimise the funding of asset maturities not naturally matched by core deposit funding. In aggregate, HSBC’s banking entities are liquidity providers to the inter-bank market, placing significantly more funds with other banks than they borrow.
The main operating subsidiary that does not accept deposits is HSBC Finance Corporation, which funds itself principally through taking term funding in the professional markets and through the securitisation of assets. At 31 December 2004, US$112 billion of HSBC Finance Corporation’s liabilities were drawn from professional markets, utilising a range of products, maturities and currencies to avoid undue reliance on any particular funding source. Since becoming a member of the HSBC Group, HSBC Finance Corporation’s access to funding has improved in respect of both the breadth of available sources and the pricing thereof.
Of total liabilities of US$1,277 billion at 31 December 2004, funding from customers amounted to US$694 billion, of which US$671 billion was contractually repayable within one year. However, although the contractual repayments of many customer accounts are on demand or at short notice, in practice short-term deposit balances remain stable as inflows and outflows broadly match.
Other liabilities, including deposits by banks and securities in issue, are set forth in the table on page 167.
Assets available to meet these liabilities, and to cover outstanding commitments to lend
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(US$568 billion), included cash, central bank balances, items in the course of collection and treasury and other bills (US$47 billion); loans to banks (US$143 billion, including US$138 billion repayable within one year); and loans to customers (US$670 billion, including US$271 billion repayable within one year). In the normal course of business, a proportion of customer loans contractually repayable within one year will be extended. In addition, HSBC held debt securities marketable at a value of US$242 billion. Of these assets, some US$57 billion of debt securities and treasury and other bills have been pledged to secure liabilities.
HSBC would meet unexpected net cash outflows by selling securities and accessing additional funding sources such as interbank markets or securitisations.
Although not utilised in the management of HSBC’s liquidity, the consolidated figures shown in the following table provide a useful insight into the structure of the Group’s overall funding position.
Debt securities in issue, customer accounts and deposits by banks
HSBC Holdings
HSBC Holdings’ primary sources of cash are interest and capital receipts from its subsidiaries, which it deploys in short-term bank deposits or liquidity funds. HSBC Holdings’ primary uses of cash are investments in subsidiaries, interest payments to debt holders and dividend payments to shareholders. On an ongoing basis, HSBC Holdings replenishes its
liquid resources through the receipt of interest on, and repayment of, intra-group loans, from dividends, and from interest earned on its own liquid funds. The ability of its subsidiaries to pay dividends or advance monies to HSBC Holdings depends, among other things, on their respective regulatory capital requirements, statutory reserves, and financial and operating performance.
HSBC actively manages the cash flows from its subsidiaries to optimise the amount of cash held at the holding company level, and expects to continue doing so in the future. The wide range of HSBC’s activities means that HSBC Holdings is not dependent on a single source of profits to fund its dividends. Together with its accumulated liquid assets, HSBC Holdings believes that planned dividends and interest from subsidiaries will enable it to meet anticipated cash obligations. Also, in normal circumstances, HSBC Holdings has full access to capital markets on normal terms.
At 31 December 2004, the short-term liabilities of HSBC Holdings totalled US$5.3 billion, including US$1.2 billion in respect of the proposed third interim dividend for 2004 and US$3.0 billion in respect of the proposed fourth interim dividend for 2004. In practice, the full amount of the proposed dividend may not be paid out as shareholders can elect to receive their dividend entitlement in scrip rather than in cash. Short-term assets of US$12.4 billion, consisting mainly of cash at bank and money market deposits of US$7.3 billion and other amounts (including dividends) due from HSBC undertakings of US$5.1 billion, exceeded short-term liabilities.
Market risk management
The objective of HSBC’s market risk management is to manage and control market risk exposures in order to optimise return on risk while maintaining a market profile consistent with the Group’s status as a premier provider of financial products and services.
Market risk is the risk that movements in market rates, including foreign exchange rates, interest rates, credit spreads and equity and commodity prices will reduce HSBC’s income or the value of its portfolios.
HSBC separates exposures to market risk into either trading or non-trading portfolios. Trading portfolios include those positions arising from market-making and proprietary position-taking. Non-trading portfolios primarily arise from the management of the commercial banking assets and liabilities.
The management of market risk is principally
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undertaken in Global Markets using risk limits approved by the Group Management Board. Limits are set for each portfolio, product and risk type, with market liquidity being a principal factor in determining the level of limits set. Traded Markets Development and Risk, an independent unit within Corporate, Investment Banking and Markets, develops the Group’s market risk management policies and measurement techniques. Each major operating entity has an independent Market Risk Control function which is responsible for measuring market risk exposures in accordance with the policies defined by Traded Markets Development and Risk, and monitoring and reporting these exposures against the prescribed limits on a daily basis.
Each operating entity is required to assess the market risks which arise on each product in its business and to transfer these risks to either its local Global Markets unit for management, or to separate books managed under the auspices of the local Asset and Liability Management Committee (‘ALCO’). The aim is to ensure that all market risks are consolidated within operations which have the necessary skills, tools, management and governance to professionally manage such risks.
Fair value and price verification control
Where certain financial instruments are carried on the Group’s balance sheet at their mark-to-market values, the mark-to-market valuation and the related price verification processes are subject to careful governance across the Group. Financial instruments which are accounted for on a fair value basis include assets held in the trading portfolio, obligations related to securities sold short and derivative financial instruments (excluding non-trading derivatives accounted for on an accruals basis).
The determination of mark-to-market values is therefore a significant element in the reporting of the Group’s Global Markets activities.
The responsibility for the determination of accounting policies and procedures governing valuation and validation ultimately rests with the Group Finance and the Corporate, Investment Banking and Markets Finance functions, which report to the Group Finance Director. All significant valuation policies, and any changes thereto, must be approved by senior finance management. HSBC’s governance of financial reporting requires that Financial Control departments across the Group are independent of the risk-taking businesses, with the Finance functions having ultimate responsibility for the determination of fair values included in the
financial statements, and for ensuring that the Group’s policies and relevant accounting standards are adhered to. Both senior management and the Group Audit Committee assess the resourcing and expertise of Finance functions within the Group on a regular basis to ensure that the Group’s financial control and price verification processes are properly staffed to support the required control infrastructure.
Trading
Market risk in trading portfolios is monitored and controlled at both portfolio and position levels using a complementary set of techniques, such as value at risk and present value of a basis point (‘PVBP’), together with stress and sensitivity testing and concentration limits. These techniques quantify the impact on capital of defined market movements.
Other controls include restricting individual operations to trading within a list of permissible instruments authorised for each site by Traded Markets Development and Risk, and enforcing rigorous new product approval procedures. In particular, trading in the more complex derivative products is concentrated in offices with appropriate levels of product expertise and robust control systems.
Trading value at risk (‘VAR’)
One of the principal tools used by HSBC to monitor and limit market risk exposure in its trading portfolios is VAR. VAR is a technique that estimates the potential losses that could occur on risk positions as a result of movements in market rates and prices over a specified time horizon and to a given level of confidence (for HSBC, 99 per cent). HSBC calculates VAR daily. During the year, HSBC refined its basis of calculating VAR from one predominantly based on variance / co-variance to one predominantly based on historical simulation. This latter calculation was introduced because it better captures the non-linear characteristics of certain market risk positions. Historical simulation uses scenarios derived from historical market rates, and takes account of the relationships between different markets and rates, for example, interest rates and foreign exchange rates. Movements in market prices are calculated by reference to market data from the last two years.
Although a valuable guide to risk, VAR should always be viewed in the context of its limitations. For example:
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HSBC recognises these limitations by augmenting its VAR limits with other position and sensitivity limit structures. Additionally, HSBC applies a wide range of stress testing, both on individual portfolios and on the Group’s consolidated positions. HSBC’s stress-testing regime provides senior management with an assessment of the impact of identified extreme events on the market risk exposures of HSBC.
Trading VAR for HSBC is summarised in Note 39(a) in the ‘Notes on the Financial Statements’ on page 308.
The daily revenue earned from market risk-related treasury activities includes accrual book net interest income and funding related to dealing positions. The histogram below illustrates the frequency of daily revenue arising from such market risk-related activities.
The average daily revenue earned from market risk-related treasury activities in 2004 was US$18.3 million, compared with US$17.1 million for 2003. The standard deviation of these daily revenues was US$8.0 million compared with US$12.5 million for 2003. The standard deviation measures the variation of daily revenues about the mean value of those revenues.
An analysis of the frequency distribution of daily revenue shows that there were two days with negative revenues during 2004 compared with 12 days in 2003. The most frequent result was a daily revenue of between US$16 million and US$20 million with 70 occurrences.
Daily distribution of market risk revenues in 2004Number of days
Profit and loss frequency
Daily distribution of market risk revenues in 2003Number of days
Non-trading
The principal objective of market risk management of non-trading portfolios is to optimise net interest income.
Market risk in non-trading portfolios arises principally from mismatches between the future yield on assets and their funding cost as a result of interest rate changes. Analysis of this risk is complicated by having to make assumptions on optionality in certain product areas, for example, mortgage prepayments, and from behavioural assumptions regarding the economic duration of liabilities which are contractually repayable on demand, for example, current accounts. This prospective change in future net interest income from non-trading portfolios will be reflected in the current realisable value of these positions should they be sold or closed prior to maturity. In order to manage this risk optimally, market risk in non-trading portfolios is transferred to Global Markets or to separate books managed under the auspices of the local ALCO.
The transfer of market risk to trading books managed by Global Markets or ALCO is usually achieved by a series of internal deals between the business units and these trading books. When the
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behavioural characteristics of a product differ from its contractual characteristics, the behavioural characteristics are assessed to determine the true underlying interest rate risk. Local ALCOs regularly monitor all such behavioural assumptions and interest rate risk positions, to ensure they comply with interest rate risk limits established by the Group Management Board.
As noted above, in certain cases, the non-linear characteristics of products cannot be adequately captured by the risk transfer process. For example, both the flow from customer deposit accounts to more attractive investment products and the precise repayment levels of mortgages will vary at different interest rate levels. In such circumstances simulation modelling is used to identify the impact of varying scenarios on valuations and net interest income.
Once market risk has been consolidated in Global Markets or ALCO-managed books, the net exposure is typically managed through the use of interest rate swaps within agreed limits.
In the US, market risk arising within HSBC’s residential mortgage business is primarily managed by a specialist function within the mortgage business under guidelines established by HSBC Bank USA’s ALCO. A range of risk management tools is applied to hedge the sensitivity arising from movements in interest rates. A key element of risk management within the US mortgage business is dealing with the sensitivity of Mortgage Servicing Rights (‘MSRs’) to market risks. MSRs represent the economic value of the right to perform specified residential mortgage servicing activities. They are sensitive to interest rates movements, which change the prepayment speed of the underlying mortgages and therefore the value of the MSRs. HSBC uses a combination of interest-rate-sensitive derivative financial instruments and debt securities to help protect the economic value of MSRs. An accounting asymmetry can arise in this area because the derivative instruments used to hedge the economic exposure arising from MSRs are marked to market, but the MSRs themselves are measured for accounting purposes at the lower of cost or market value. It is, therefore, possible for an economically hedged position not to be shown as such in the accounts, when the hedge shows a loss but the MSR cannot be revalued above cost to reflect an associated profit. HSBC’s policy is to hedge the economic risk.
VAR limits are set to control the exposure to MSRs and MSR hedges. The VAR on MSRs and MSR hedges at 31 December 2004 was US$10 million.
Market risk also arises in the Group’s insurance businesses within their portfolios of investments and policyholder liabilities. The principal market risks are interest rate risk and equity risk which primarily arise where guaranteed investment return policies have been issued. The insurance businesses have a dedicated head office market risk function which oversees management of this risk.
Market risk also arises within the Group’s defined benefit pension schemes to the extent that the obligations of the schemes are not fully matched by assets with determinable cash flows. This risk principally derives from the pension schemes holding equities against their future pension obligations. The risk is that market movements in equity prices could result in assets which are insufficient over time to cover the level of projected liabilities. Management and trustees, who act on behalf of the pension scheme beneficiaries, assess the level of this risk using reports prepared by independent external actuaries.
The present value of the Group’s defined benefit pension schemes liabilities was US$25.8 billion at 31 December 2004 compared with US$21.7 billion at 31 December 2003. Assets of the defined benefit schemes at 31 December 2004 comprised equity investments 53.3 per cent, debt securities 29.1 per cent and other (including property) 17.6 per cent.
Future net interest income is affected by movements in interest rates. A principal part of the Group’s management of market risk in non-trading portfolios is to monitor the sensitivity of projected net interest income at varying interest rate scenarios (simulation modelling). HSBC aims, through its management of market risk in non-trading portfolios, to mitigate the impact of prospective interest rate movements which could reduce future net interest income, whilst balancing the cost of such hedging activities on the current net revenue stream.
For simulation modelling, businesses use a combination of scenarios relevant to local businesses and local markets as well as standard scenarios required to be used across the Group. The Group standard scenarios are consolidated to illustrate the combined pro-forma impact on Group consolidated portfolio valuations and net interest income.
The table below sets out the impact on future net interest income of an immediate hypothetical 100 basis points parallel fall or rise in all yield curves worldwide on 1 January 2005. Assuming no management actions, a 100 basis points parallel fall in all yield curves would increase planned net
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interest income for the 12 months to 31 December 2005 by US$495 million while a hypothetical 100 basis points parallel rise in all yield curves would decrease planned net interest income by US$908 million.
Instead of assuming that all interest rates move together, HSBC groups its interest rate exposures into currency blocs whose interest rates are considered likely to move together. The sensitivity of projected net interest income for 2005, on this basis, is described as follows:
The interest rate sensitivities set out in the table above are illustrative only and are based on a single simplified scenario. The figures represent the effect of the pro forma movements in net interest income based on the projected yield curve scenarios and the Group’s current interest rate risk profile. This effect, however, does not incorporate actions that could be taken by Global Markets or in the business units to mitigate the impact of this interest rate risk. In reality, Global Markets would seek to proactively change the interest rate risk profile to minimise losses and optimise net revenues. The projections above also assume that rates of all maturities move by the same amount and, therefore, do not reflect the potential impact on net interest income of some rates changing while others remain unchanged. The projections also make other simplifying assumptions, including that all positions run to maturity.
The Group’s exposure to changes in its net interest income arising from movements in interest rates falls into three areas: core deposit franchises, HSBC Finance Corporation and Global Markets.
The best way of illustrating the active management of this interest rate risk is to highlight the major drivers of the changes shown in the projected effect of interest rate moves in the above table.
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It can be seen from the above that projecting the movement in net interest income from prospective changes in interest rates is a complex interaction of structural and managed exposures. In a rising rate environment, the most critical exposures are those managed within Global Markets.
Structural foreign exchange exposures
Structural foreign exchange exposures represent net investments in subsidiaries, branches or associated undertakings, the functional currencies of which are currencies other than US dollars.
Revaluation gains and losses on structural exposures are recorded in the statement of total consolidated recognised gains and losses. The main operating (or functional) currencies in which HSBC’s business is transacted are the US dollar, the Hong Kong dollar, sterling, the euro, the Mexican peso, the Brazilian real, and the Chinese renminbi. As the US dollar and currencies linked to it form the dominant currency bloc in which HSBC’s operations transact business, HSBC Holdings prepares its consolidated financial statements in US dollars. HSBC’s consolidated balance sheet is therefore affected by movements in exchange rates between the US dollar and all the non-US dollar functional currencies of underlying subsidiaries.
HSBC hedges structural foreign currency exposures only in limited circumstances. HSBC’s structural foreign currency exposures are managed with the primary objective of ensuring, where practical, that HSBC’s consolidated tier 1 ratio and the tier 1 ratios of individual banking subsidiaries are protected from the effect of changes in exchange rates. This is usually achieved by ensuring that, for each subsidiary bank, the ratio of structural exposures in a given currency to risk-weighted assets denominated in that currency is broadly equal to the tier 1 ratio of the subsidiary in question.
Selective hedges were in place during 2004. Hedging is undertaken using forward foreign exchange contracts or by financing with borrowings in the same currencies as the functional currencies involved. There was no material effect from foreign currency exchange rate movements on HSBC’s tier 1 capital ratio during the period.
Management of insurance and financial risk
HSBC’s insurance underwriting operations, inter alia, issue contracts that accept the transfer of insurance risk, or accept financial risk, or both. This section summarises these risks and the way that HSBC manages them.
Insurance risk
The principal risk that HSBC faces under the insurance risk transfer contracts that it underwrites is that the eventual claims and benefit payments, together with the costs of managing the business and claims handling, exceed the aggregate amount of premia received and investment income earned thereon, pending settlement of claims. HSBC controls this risk by modelling outcomes using statistical techniques and by holding a diversified portfolio of relatively homogeneous contracts which is considered unlikely to be significantly different from the expected outcome.
HSBC manages the risk of unexpectedly large underwriting losses through its underwriting strategy, reinsurance arrangements and claims handling.
In conjunction with Group Credit and Risk, the central management of HSBC’s insurance operations places reinsurance contracts with the world’s larger reinsurance companies. HSBC assesses the financial strength and creditworthiness of all reinsurers by reviewing publicly available financial information such as credit grades provided by rating agencies. HSBC also takes into account details of recent payment history and the status of any ongoing negotiations between HSBC’s insurance operations and these third parties. Individual operating units maintain records of the payment history of contract holders with whom they conduct regular business.
Financial risk
HSBC’s insurance operations are also exposed to financial risk in circumstances when the proceeds from financial assets are not sufficient to fund the obligations arising from insurance and investment contracts.
The framework for the management of these
risks seeks to integrate the financial risks associated with HSBC’s insurance operations with similar risks arising from other financial assets and liabilities not directly associated with insurance and investment liabilities.
Investment credit risk is the risk that financial loss arises from the failure of an issuer of an investment product or a counterparty to an investment transaction to meet its obligations. Local management of HSBC’s operating insurance companies are responsible for the quality and performance of their respective investment portfolios. Investment guidelines are set at a Group level and refined by local ALCOs which review, on a quarterly basis, investment management performance and compliance with the guidelines. Assessments of the creditworthiness of issuers and counterparties are based primarily upon rating agency and other publicly available information together with investment concentrations. Investment credit exposures are aggregated and reported to HSBC’s Group Credit and Risk function on a quarterly basis.
Operational risk management
Operational risk is the risk of loss arising through fraud, unauthorised activities, error, omission, inefficiency, systems failure or from external events. It is inherent to every business organisation and covers a wide spectrum of issues.
HSBC manages this risk through a controls-based environment in which processes are documented, authorisation is independent and transactions are reconciled and monitored. This is supported by an independent programme of periodic reviews undertaken by Internal Audit, and by monitoring external operational risk events, which ensure that HSBC stays in line with best practice and takes account of lessons learned from publicised operational failures within the financial services industry.
HSBC has codified its operational risk management process by issuing a high level standard. This explains how HSBC manages operational risk by identifying, assessing, monitoring, controlling and mitigating the risk, rectifying operational risk events, and implementing any additional procedures required for compliance with local regulatory requirements. The processes undertaken to manage operational risk are determined by reference to the scale and nature of each HSBC operation. The HSBC standard covers the following:
In each of HSBC’s subsidiaries, local management is responsible for implementation of the HSBC standard on operational risk throughout their operations and, where deficiencies are evident, these are required to be rectified within a reasonable timeframe. Subsidiaries acquired by HSBC since the standard was issued are required to assess and plan the implementation of the standard’s requirements.
HSBC maintains and tests contingency facilities to support operations in the event of disasters. Additional reviews and tests were conducted following the terrorist incidents of 11 September 2001 and, more recently, the two bomb blasts which damaged two of HSBC’s buildings in Istanbul, to incorporate lessons learned in the operational recovery from those circumstances.
Reputational risk management
The reputation of HSBC is paramount to its success. Reputational risks can arise from social, ethical or environmental issues, or as a consequence of operational risk events. As a banking group, HSBC’s good reputation depends upon the way in which it conducts its business, but it can also be affected by the way in which clients, to whom it provides financial services, conduct themselves.
Reputational risks are considered and assessed by the Board, the Group Management Board, the Risk Management Meeting, subsidiary company boards, board committees and/or senior management during the formulation of policy and the establishment of standards. Standards on all major
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aspects of business are set for HSBC and for individual subsidiaries, businesses and functions. These are communicated through manuals and statements of policy, and promulgated through internal communications and training. The policies set out operational procedures in all areas of reputational risk, including treating customers fairly, conflicts of interest, money laundering deterrence, environmental impact, anti-corruption measures and employee relations.
Management in all operating entities is required to establish a strong internal control structure to minimise the risk of operational and financial failure, and to ensure that a full appraisal of reputational implications is made before strategic decisions are taken. The Group internal audit function monitors compliance with policies and standards.
Capital management and allocation
Capital measurement and allocation
The FSA supervises HSBC on a consolidated basis and, as such, receives information on the capital adequacy of, and sets capital requirements for, HSBC as a whole. Individual banking subsidiaries are directly regulated by their local banking supervisors, which set and monitor their capital adequacy requirements. In some jurisdictions, certain non-banking subsidiaries are subject to the supervision and capital requirements of local regulatory authorities. Since 1988, when the governors of the Group of Ten central banks agreed to guidelines for the international convergence of capital measurement and standards, the banking supervisors of HSBC’s major banking subsidiaries have exercised capital adequacy supervision in a broadly similar framework. The guidelines agreed in 1988, referred to as the Basel Accord, are applied on a consistent basis across the European Union through directives, which are then implemented by member states.
In implementing the EU’s Banking Consolidation Directive, the FSA requires each bank and banking group to maintain an individually prescribed ratio of total capital to risk-weighted assets taking into account both balance sheet assets and off-balance sheet transactions. Under the EU’s Amending Directive to the Capital Adequacy Directive, the FSA allows banks to calculate capital requirements for market risk in the trading book using VAR techniques.
HSBC’s capital is divided into two tiers: tier 1, comprising shareholders’ funds, innovative tier 1 securities and minority interests in tier 1 capital, but excluding revaluation reserves; and tier 2,
comprising general loan loss provisions, revaluation reserves, qualifying subordinated loan capital and minority and other interests in tier 2 capital. The amount of innovative tier 1 securities cannot exceed 15 per cent of overall tier 1 capital, qualifying tier 2 capital cannot exceed tier 1 capital, and qualifying term subordinated loan capital may not exceed 50 per cent of tier 1 capital. There are also limitations on the amount of general provisions which may be included in tier 2 capital. The book values of goodwill, intangible assets and own shares held are deducted in arriving at tier 1 capital. Total capital is calculated by deducting the book values of unconsolidated investments, investments in the capital of banks, and certain regulatory items from the total of tier 1 and tier 2 capital.
Banking operations are categorised as either trading book (broadly, marked-to-market activities) or banking book (all other activities) and risk-weighted assets are determined accordingly. Banking book risk-weighted assets are measured by means of a hierarchy of risk weightings classified according to the nature of each asset and counterparty, taking into account any eligible collateral or guarantees. Banking book off-balance-sheet items giving rise to credit, foreign exchange or interest rate risk are assigned weights appropriate to the category of the counterparty, taking into account any eligible collateral or guarantees. Trading book risk-weighted assets are determined by taking into account market-related risks such as foreign exchange, interest rate and equity position risks, and counterparty risk.
Future developments
In October 2004, the FSA published a consultation paper CP04/17 ‘Implications of a changing accounting framework’. This paper sets out the FSA’s proposed approach to assessing banks’ capital adequacy after implementation of IFRS. In the absence of the FSA’s final rules on capital adequacy reporting under IFRS, which may be different from the proposals set out in CP04/17, HSBC will follow its proposals with effect from 1 January 2005.
Under the consultation paper, there will be changes to the measurement of banks’ capital adequacy in a number of ways, the most significant of which for HSBC are set out below.
The remainder of the proposals in CP04/17 will have a smaller impact on HSBC. They include the reversal of the recognition of the assets and liabilities of defined benefit pension schemes. Instead, banks will deduct from capital their best estimate of the funds that will need to be paid into the schemes in addition to normal contributions over the next five years.
In June 2004, the Basel Committee on Banking Supervision (‘the Basel Committee’) issued a new capital adequacy framework to replace the Basel Accord of 1988 in the form of a final Accord (commonly known as ‘Basel II’). The new capital framework consists of three ‘pillars’: minimum capital requirements, supervisory review process and market discipline. The supervisory objectives of the Basel Committee are for Basel II to promote safety and soundness in the financial system and, as such, at least maintain the current overall level of capital in the system; to enhance competitive equality; to constitute a more comprehensive approach to addressing risks; and to focus on internationally active banks.
With respect to pillar one, Basel II provides three approaches, of increasing sophistication, to the credit risk regulatory capital calculation. The most basic approach is the standardised approach, which uses external credit ratings to determine the risk weighting applied to rated counterparties and groups other counterparties into broad categories and applies standardised risk weightings to these categories. Moving to the internal ratings based foundation approach will allow banks to calculate their credit risk regulatory capital requirement on the basis of their internal assessment of the probability that the counterparty will default. The internal ratings-based advanced approach will allow banks to use their own internal assessment of not only the probability of default, but also the quantification of the exposure to a counterparty and the percentage loss suffered if the counterparty defaults. Pillar one will also introduce capital requirements for operational risk and again three levels of sophistication are available. The capital requirement
under the basic indicator approach is a simple percentage of gross revenues; under the standardised approach it is one of three different percentages of gross revenues applicable to each of eight business lines; and under advanced measurement approaches it is an amount determined using banks’ own statistical analysis techniques on operational risk data.
In Europe, Basel II will be given effect by applying the ‘re-casting technique’ (Interinstitutional Agreement 2002/C 77/01) enabling substantive amendments to existing legislation without a self-standing amending directive. The proposal for recasting of the Banking Consolidation Directive and the Capital Adequacy Directive was published in July 2004. It largely incorporates the requirements set out in Basel II, but there are also a number of differences. This proposal will now be subject to a formal EU co-decision legislative process involving the Council of Ministers and the European Parliament, during which further changes may be made.
In January 2005, the FSA published a consultation paper CP05/3 ‘Strengthening capital standards’. This paper sets out the FSA’s proposed approach to implementing the requirements of the recast EU directives. The FSA proposes that the new requirements will be applied from 1 January 2007, except that under pillar 1 firms may elect to continue to apply the existing capital adequacy framework until 1 January 2008.
HSBC continues to participate actively in the industry consultations surrounding the development and implementation of Basel II and the re-cast EU directives and fully supports a more risk-sensitive regulatory capital framework than the 1988 Basel Accord. The implementation of Basel II across HSBC’s geographically diverse businesses operating in a large number of different regulatory environments represents a significant challenge, and a major programme of projects is in progress. Basel II allows extensive scope for interpretation by regulators and the range of such variation and the interaction of HSBC’s home and host regulators, which is still being developed, will be key factors. In view of this, it is still too early to assess what the impact of Basel II on HSBC’s capital ratios will be. One example of the uncertainty in interpretation by regulators is that the US banking agencies are likely to propose that, in the United States, certain institutions continue to be subject to the 1988 Basel Accord while others be subject to the ‘advanced’ risk and capital methodologies of Basel II. In this latter context, the Federal Reserve Board has determined that HNAH, HSBC’s highest level US bank holding
company in the US, which holds all HSBC’s US operating subsidiaries and HSBC Canada, will be expected to qualify for, and comply with, the Federal Reserve Board’s ‘advanced’ risk and capital methodologies of Basel II. These guidelines are still in development and may not be finalised before the second quarter of 2006.
Capital management
It is HSBC’s policy to maintain a strong capital base to support the development of its business. HSBC seeks to maintain a prudent balance between the different components of its capital and, in HSBC Holdings, between the composition of its capital and that of its investment in subsidiaries. This is achieved by each subsidiary managing its own capital within the context of an approved annual plan which determines the optimal amount and mix of capital required to support planned business growth and meet local regulatory capital requirements and, in the case of HSBC Finance Corporation, its ratings targets. Capital generated in excess of planned requirements is paid up to HSBC Holdings, normally
by way of dividends, and represents a source of strength for HSBC.
HSBC Holdings is primarily a provider of equity capital to its subsidiaries. These investments are substantially funded by HSBC Holdings’ own equity issuance and profit retentions. Major subsidiaries usually raise their own non-equity tier 1 capital and subordinated debt in accordance with HSBC guidelines regarding market and investor concentration, cost, market conditions, timing and the effect on the composition and maturity profile of HSBC’s capital. The subordinated debt requirements of other HSBC companies are met internally.
HSBC recognises the impact on shareholder returns of the level of equity capital employed within HSBC and seeks to maintain a prudent balance between the advantages and flexibility afforded by a strong capital position and the higher returns on equity possible with greater leverage. In the current environment, HSBC uses a benchmark tier 1 capital ratio of 8.25 per cent in considering its long-term capital planning.
Source and application of tier 1 capital
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$12.4 billion. Retained profits (excluding goodwill amortisation) contributed US$6.4 billion. Shares issued in lieu of dividends and innovative tier 1 securities issued contributed US$2.6 billion and US$2.0 billion, respectively. Exchange movements on reserves and other movements also added US$1.4 billion to tier 1 capital.
The increase of US$6.4 billion in tier 2 capital mainly reflects the proceeds of capital issues, net of redemption and regulatory amortisation.
Total risk-weighted assets increased by US$141 billion. This increase was driven by significant growth in loans and advances to customers in North America, the UK and Hong Kong. In constant currency, risk-weighted asset growth was 17 per cent.
Risk-weighted assets by principal subsidiary
In order to give an indication of how HSBC’s capital is deployed, the table below analyses the disposition of risk-weighted assets by principal subsidiary. The risk-weighted assets are calculated using FSA rules and exclude intra-HSBC items.
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Other information
At 31 December 2004, the geographical analysis of loan maturity and interest sensitivity by loan type on a contractual repayment basis was as follows. All amounts are net of suspended interest.
Fixed interest rate
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Other information (continued)
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.
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At 31 December 2004, 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 certain 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.
HSBC uses credit derivatives through the dealing operations of certain Group companies, acting as a principal counterparty to a broad range of users, structuring deals to produce risk management products for its customers, or making markets in certain products. Risk is typically controlled through entering into an offsetting credit derivative contract with another counterparty. HSBC also manages its own exposure to industry segments and individual counterparties using credit derivatives. For a more detailed description of credit derivatives and information regarding their carrying amounts in 2004 and 2003, refer to Note 37(a) of the ‘Notes on Financial Statements’ on page 299.
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Other information(continued)
The table below provides details of HSBC’s material contractual obligations as at 31 December 2004.
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 2004. Based upon that evaluation, the Group Chairman and Group Finance Director concluded that HSBC’s disclosure controls and procedures as of 31 December 2004 were effective to provide reasonable assurance that information required to be disclosed in the reports which the company files and submits under the US Securities Exchange Act of 1934, as amended, is recorded, processed, summarised and reported as and when required. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.
In making that evaluation, the Group Chairman and Group Finance Director took into account the fact that the management of HSBC Finance Corporation had concluded that there had been a material weakness in HSBC Finance Corporation’s internal controls over financial reporting under US GAAP relating to the documentation of hedge accounting under Statement of Financial Accounting Standard No. 133, ‘Accounting for Derivative Instruments and Hedging Activities’, (‘SFAS 133’) which had come to light late in 2004 as part of HSBC Finance Corporation’s preparation for the transition from UK GAAP to International Financial Reporting Standards in 2005. This weakness related to deficiencies in documentation designed to re-establish hedge accounting following the acquisition of HSBC Finance Corporation by HSBC and not from the original or economic management of this hedging activity. HSBC
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Finance Corporation is taking a number of immediate remedial actions to address these weaknesses and the accounting function has already been strengthened. HSBC Holdings, the Group Chairman and Group Finance Director do not believe that the weaknesses identified by HSBC Finance Corporation management are material to the Group's overall disclosure controls and procedures or evaluation of their effectiveness.
There has been no change in HSBC Holdings’ internal control over financial reporting during the year ended 31 December 2004 that has materially affected, or is reasonably likely to materially affect, HSBC Holdings’ internal control over financial reporting.
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Board of Directors and Senior Management
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Board of Directors and Senior Management (continued)
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R E T Bennett
Age 53. Group General Manager, Legal and Compliance. Joined HSBC in 1979. Appointed a Group General Manager in 1998.
N S K Booker
Age 46. Group General Manager and Chief Executive Officer, India. Joined HSBC in 1981. Appointed a Group General Manager in January 2004.
G P S Calvert, OBE
Age 52. Group General Manager and Managing Director, The Saudi British Bank. Joined HSBC in 1974. Appointed a Group General Manager in June 2004.
Z J Cama
Age 57. 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 56. Executive Director and Chairman designate, The Hongkong and Shanghai Banking Corporation Limited and Chief Executive Officer, Hang Seng Bank Limited. Joined HSBC in 1978. Appointed a Group General Manager in 1995.
A A Flockhart
Age 53. Group General Manager, Chief Executive Officer and Chairman, Grupo Financiero HSBC, S.A. de C.V. and HSBC Mexico, S.A. Joined HSBC in 1971. Appointed a Group General Manager in 2002.
M J G Glynn
Age 53. Group General Manager, President and Chief Executive Officer, HSBC Bank USA, N.A. Joined HSBC in 1982. Appointed a Group General Manager in 2001.
K M Harvey
Age 44. Group General Manager and Group Chief Information Officer. Joined HSBC Finance Corporation in 1989. Appointed a Group General Manager in August 2004.
D H Hodgkinson
Age 54. Group General Manager, Chief Executive Officer and Deputy Chairman, HSBC Bank Middle East Limited. Joined HSBC in 1969. Appointed a Group General Manager in 2003.
A P Hope
Age 58. Group General Manager, Insurance. Joined HSBC in 1971. Appointed a Group General Manager in 1996.
D D J John
Age 54. Chief Operating Officer and Director, HSBC Bank plc. Joined HSBC Bank plc in 1971. Appointed a Group General Manager in 2000.
M J W King
Age 48. Group General Manager, Internal Audit. Joined HSBC in 1986. Appointed a Group General Manager in 2002.
R C F Or
Age 55. Executive Director, The Hongkong and Shanghai Banking Corporation Limited. Joined HSBC in 1972. Appointed a Group General Manager in 2000.
K Patel
Age 56. Group General Manager and Head of Corporate, Investment Banking and Markets, Emerging Europe & Africa. Joined HSBC in 1984. Appointed a Group General Manager in 2000.
R C Picot
Age 47. Group Chief Accounting Officer. Joined HSBC in 1993. Appointed a Group General Manager in 2003.
J C S Rankin
Age 63. Group General Manager, Human Resources. Joined HSBC in 1960. Appointed a Group General Manager in 1990.
B Robertson
Age 50. Group General Manager, Credit and Risk. Joined HSBC in 1975. Appointed a Group General Manager in 2003.
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M R P Smith, OBE
Age 48. President and Chief Executive Officer, The Hongkong and Shanghai Banking Corporation Limited. Joined HSBC in 1978. Appointed a Group General Manager in 2000.
I A Stewart
Age 46. Group General Manager and Head of Transaction Banking, Corporate, Investment Banking and Markets. Joined HSBC in 1980. Appointed a Group General Manager in 2000.
P E Stringham
Age 55. Group General Manager, Marketing. Joined HSBC in 2001. Appointed a Group General Manager in 2001.
P A Thurston
Age 51. Group General Manager, Personal Financial Services, Asia-Pacific. Joined HSBC in 1975. Appointed a Group General Manager in 2003.
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Report of the Directors
Results for 2004
HSBC reported operating profit before provisions of US$22,898 million. Profit attributable to shareholders of HSBC Holdings was US$11,840 million, a 14.4 per cent return on shareholders’ funds. The retained profit transferred to reserves was US$4,539 million.
First, second and third interim dividends, each of US$0.13 per ordinary share, were paid on 7 July 2004, 6 October 2004 and 20 January 2005 respectively. The Directors have declared a fourth interim dividend of US$0.27 per ordinary share in lieu of a final dividend, making a total distribution for the year of US$7,301 million. The fourth interim dividend will be payable on 4 May 2005 in cash in United States dollars, or in sterling or Hong Kong dollars at exchange rates to be determined on 25 April 2005, with a scrip dividend alternative. The reserves available for distribution before accounting for the third and fourth interim dividends of US$1,444 million and US$2,996 million respectively are US$10,927 million.
Further information about the results is given in the consolidated profit and loss account on page 237.
Principal activities and business review
Through its subsidiary and associated undertakings, HSBC provides a comprehensive range of banking and related financial services. HSBC operates through long-established businesses and has an international network of over 9,800 offices in 77 countries and territories in Europe; the Asia-Pacific region, the Americas, the Middle East and Africa and serves over 110 million customers. Taken together, the five largest customers of HSBC do not account for more than one per cent of HSBC’s income.
In February 2004, The Bank of Bermuda Limited was acquired for US$1,224 million.
In April 2004, 15.98 per cent of Industrial Bank Co. Limited was acquired by Hang Seng Bank Limited for US$209 million.
In May 2004, 100 per cent of Intesa Bank Canada was acquired for US$88 million.
In June 2004, 14.62 per cent of UTI Bank Limited was acquired for US$68 million.
In August 2004, 19.9 per cent of Bank of Communications Limited was acquired for US$1,747 million.
In November 2004, 100 per cent of Marks andSpencer Retail Financial Services Holdings Limited was acquired for US$1,044 million.
A review of the development of the business of HSBC undertakings during the year and an indication of likely future developments are given in the 'Description of Business' on pages 10 and 11.
Capital and reserves
The following events in relation to the HSBC Holdings ordinary shares of US$0.50 each occurred during the year:
Scrip dividends
All-Employee share plans
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Report of the Directors (continued)
Discretionary share incentive plans
HSBC Finance Corporation
Authority to allot shares
Authority to repurchase shares
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granted at nil consideration. No options have been granted to substantial shareholders, suppliers of goods or services, or in excess of the individual limit for each share plan. No options were cancelled during the year. Under the authority granted by shareholders at the Annual General Meeting in 2000, the maximum number of new HSBC Holdings ordinary shares that may be issued or become issuable under all the share option plans in any ten year period is 848,847,000 HSBC Holdings ordinary shares (approximately 7.6 per cent of HSBC Holdings’ issued ordinary share capital on 28 February 2005). Within this limit not more than 5 per cent of the issued ordinary share capital of HSBC Holdings from time to time may be put under option under the HSBC Holdings Group Share Option Plan and the HSBC Holdings Restricted Share Plan 2000 (approximately 560,000,000 HSBC Holdings ordinary shares on 28 February 2005). Under the HSBC Holdings savings-related share option plans, HSBC Holdings Group Share Option Plan, HSBC Holdings Executive Share Option Scheme and the HSBC Holdings Restricted Share Plan 2000 there were options outstanding over 374,369,127 HSBC Holdings ordinary shares at 31 December 2004. Particulars of options over HSBC Holdings shares held by Directors of HSBC Holdings are set out on pages 229 to 233 of the Directors’ Remuneration Report. Following a comprehensive review of share-based remuneration arrangements in 2004, resolutions relating to employee share plans will be submitted to the forthcoming Annual General Meeting.
The HSBC Holdings Savings-Related Share Option Plan, HSBC Holdings Savings-Related Share Option Plan: Overseas Section, and previously the HSBC Holdings Savings-Related Share Option Scheme: USA Section, are all-employee share plans under which eligible HSBC employees (those with six months continuous service from July to December of the year preceding the date of grant) are granted options to acquire HSBC Holdings ordinary shares. Employees may make overall contributions of up to £250 (or equivalent) each month over a period of three or five years which may be used on the third or fifth anniversary of the commencement of the relevant savings contract, at their election, to exercise the options; alternatively the employee may elect to have the savings (plus interest) repaid in cash. The options are exercisable within six months following the third or fifth anniversary of the commencement of the relevant savings contract. In the case of redund ancy, retirement on grounds of injury or ill health, retirement at or after normal retirement age, the transfer of the employing business to another party, or a change of control of the employing company, options may be exercised before completion of the relevant savings contract. Under the HSBC Holdings Savings-Related Share Option Plan and the HSBC Holdings Savings-Related Share Option Plan: Overseas Section the option exercise price is determined by reference to the average market value of the ordinary shares on the five business days immediately preceding the invitation date, then applying a discount of 20 per cent. The all-employee share plans will terminate on 26 May 2010 unless the Directors resolve to terminate the plans at an earlier date.
HSBC Holdings Savings-Related Share Option PlanHSBC Holdings ordinary shares of US$0.50
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HSBC Holdings Savings-Related Share Option Plan: Overseas SectionHSBC Holdings ordinary shares of US$0.50
HSBC Holdings Savings-Related Share Option Scheme: USA SectionHSBC Holdings ordinary shares of US$0.50
No options were granted during the period.
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 of the sale or transfer regardless of whether the performance condition is met.
The terms of the HSBC Holdings Group Share Option Plan were amended in 2001 so that the exercise price of options granted under the Plan in 2002 and beyond would be the higher of the average market value of the ordinary shares on the five business days prior to the grant of the option or the market value of the ordinary shares on the date of grant of the option. The HSBC Holdings Group Share Option Plan will terminate on 26 May 2005 unless the Directors resolve to terminate the plan at an earlier date.
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HSBC Holdings Executive Share Option SchemeHSBC Holdings ordinary shares of US$0.50
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 PlanHSBC Holdings ordinary shares of US$0.50
CCF and subsidiary company plans
When it was acquired in 2000, CCF and certain of its subsidiary companies operated employee share option plans under which options could be granted over their respective shares.
No further options will be granted under any of these subsidiary company plans. The following are outstanding options to acquire shares in CCF and its subsidiaries.
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CCFshares of €5
Banque Chaixshares of €16
Banque de Baecque Beaushares of no par value
Banque de Savoieshares of €16
Banque Dupuy de Parsevalshares of €20
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Crédit Commercial du Sud Ouest shares of €15.25
HSBC Private Bank Franceshares of €2
Netvalorshares of €415
Sinopia Asset Managementshares of €0.50
Union de Banques à Parisshares of €16
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Report of the Directors(continued)
HSBC Finance Corporation and subsidiary company plans
Following the acquisition of HSBC Finance Corporation in 2003, all outstanding options and equity-based awards over HSBC Finance Corporation common shares were converted into rights to receive HSBC Holdings ordinary shares in the same ratio as the share exchange offer for the acquisition of HSBC Finance Corporation (2.675 HSBC Holdings ordinary shares for each HSBC Finance Corporation common share) and the exercise prices per share were adjusted accordingly. No further options will be granted under any of these plans.
HSBC Finance Corporation1984 Long-Term Executive Incentive Compensation PlanHSBC Holdings ordinary shares of US$0.50
All outstanding options and other equity-based awards over HSBC Finance Corporation common shares granted before 14 November 2002, being the date the transaction was announced, vested on completion of the acquisition. Options and equity-based awards granted on or after 14 November 2002 will be exercisable on their original terms, save that they have been adjusted to reflect the exchange ratio.
At 31 December 2004, the HSBC (Household) Employee Benefit Trust 2003 held 5,645,439 HSBC Holdings ordinary shares and 2,200,000 American Depositary Shares (‘ADSs’), each of which represents five HSBC Holdings ordinary shares, which may be used to satisfy the exercise of employee share options.
HSBC Finance Corporation1996 Long-Term Executive Incentive Compensation PlanHSBC Holdings ordinary shares of US$0.50
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HSBC Finance Corporation 1996 Long-Term Executive Incentive Compensation Plan1HSBC Holdings ordinary shares of US$0.50
HSBC Finance Corporation Deferred Fee Plan for Directors
Prior to 28 March 2003, HSBC Finance Corporation directors could choose to defer all or a portion of their cash compensation under the Deferred Fee Plan for Directors. At the end of the deferred period selected by the director, all accumulated amounts will be paid in shares in one or more instalments. Following the acquisition of HSBC Finance Corporation the rights to receive HSBC Finance Corporation common shares under the plan were
converted into rights to receive HSBC Holdings ordinary shares. No further awards will be granted under this plan. A summary of the rights to receive HSBC Holdings ordinary shares under this plan is set out below. Full details are available on www.hsbc.com by selecting ‘Investor Relations’, then ‘Share plans’ or can be obtained upon request from the Group Company Secretary, 8 Canada Square, London E14 5HQ.
HSBC Holdings ordinary shares of US$0.50
HSBC Finance Corporation Deferred Phantom Stock Plan for Directors
In 1995, the HSBC Finance Corporation Directors’ Retirement Income Plan was discontinued and the present value of each director’s accrued benefit was exchanged for a deferred right to receive HSBC Finance Corporation common shares. Following the acquisition of HSBC Finance Corporation the rights to receive HSBC Finance Corporation common shares under the plan were converted into rights to receive HSBC Holdings ordinary shares. When a director dies or leaves the Board due to retirement or
resignation, all accumulated amounts will be released in HSBC Holdings ordinary shares in one or more instalments. No further awards will be granted under this plan. A summary of the rights to receive HSBC Holdings ordinary shares under this plan is set out below. Full details are available on www.hsbc.com by selecting ‘Investor Relations’, then ‘Share plans’ or can be obtained upon request from the Group Company Secretary, 8 Canada Square, London E14 5HQ.
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HSBC Finance Corporation Non-Qualified Deferred Compensation Plan for Restricted Stock Rights HSBC Holdings ordinary shares of US$0.50
HSBC Finance Corporation Non-Qualified Deferred Compensation Plan for Stock Option Exercises HSBC Holdings ordinary shares of US$0.50
Beneficial Corporation 1990 Non-Qualified Stock Option Plan HSBC Holdings ordinary shares of US$0.50
Beneficial Corporation BenShares Equity Participation Plan HSBC Holdings ordinary shares of US$0.50
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Renaissance Holdings, Inc.Amended and Restated 1997 Incentive PlanHSBC Holdings ordinary shares of US$0.50
Bank of Bermuda plans
Following the acquisition of Bank of Bermuda on 18 February 2004, all outstanding options over Bank of Bermuda shares were converted into rights to receive HSBC Holdings ordinary shares based on the consideration of US$40 for each Bank of Bermuda share and the average closing price of HSBC Holdings ordinary shares, derived from the London Stock Exchange Daily Official List, for the five business days preceding the closing date of the acquisition. No further options will be granted under any of these plans.
All outstanding options over Bank of Bermuda shares vested on completion of the acquisition. At 31 December 2004, the HSBC (Bank of Bermuda) Employee Benefit Trust 2004 held 3,255,273 HSBC Holdings ordinary shares which may be used to satisfy the exercise of these options.
Bank of Bermuda Executive Share Option Plan 1997 HSBC Holdings ordinary shares of US$0.50
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Bank of BermudaShare Option Plan 2000HSBC Holdings ordinary shares of US$0.50
Bank of BermudaDirectors’ Share Option PlanHSBC Holdings ordinary shares of US$0.50
Valuation of freehold and leasehold land and buildingsHSBC’s freehold and long leasehold properties, together with all leasehold properties in Hong Kong, were revalued in September 2004 in accordance with HSBC’s policy of annual valuation. As a result of this revaluation, the net book value of land and buildings has increased by US$1,246 million.
Further details are included in Note 24 of the ‘Notes on the Financial Statements’ on page 275.
Corporate Governance Report
The information set out on pages 186 to 234 and information incorporated by reference constitutes the Corporate Governance Report of HSBC Holdings.
Board of Directors
The Board sets the strategy for HSBC through the five-year strategic plan and approves the annual operating plans presented by management for the achievement of the strategic objectives. The annual operating plans ensure the efficient disposition of HSBC’s resources for the achievement of these objectives. The Board delegates the management and day to day running of HSBC to the Group Management Board but retains to itself approval of certain matters including annual plans and performance targets, procedures for monitoring and
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control of operations, specified senior appointments, acquisitions and disposals above predetermined thresholds and any substantial change in balance sheet management policy.
The Board of Directors meets regularly and Directors receive information between meetings about the activities of committees and developments in HSBC’s business. All Directors have full and timely access to all relevant information and may take independent professional advice if necessary.
HSBC Holdings has a unitary Board of Directors. The authority of each Director is exercised in Board Meetings where the Board acts collectively as a unit. At 1 March 2005 the Board will comprise seven executive and 15 non-executive Directors. The roles of Group Chairman and Group Chief Executive are separated and held by experienced executive Directors. The division of responsibilities between the Group Chairman and the Group Chief Executive is clearly established, set out in writing and agreed by the Board. Before assuming the role of Group Chairman in 1998 Sir John Bond had been the Group Chief Executive for five years. The Group Chairman’s knowledge of HSBC’s complex and widespread geographical business from his previous service as Group Chief Executive has been a considerable benefit to HSBC.
Executive Directors are employees who carry out executive functions in HSBC in addition to their duties as Directors. Non-executive Directors are not HSBC employees and do not participate in the daily business management of HSBC. Non-executive Directors constructively challenge and help develop proposals on strategy, scrutinise the performance of management in meeting agreed goals and objectives and monitor the reporting of performance. The roles of non-executive Directors as members of Board committees are set out below. It is estimated that non-executive Directors spend 24 days per annum on HSBC business after an induction phase, with Committee members devoting significant additional time. The names and brief biographical particulars of the Directors are listed on pages 186 to 188.
The Board considers all of the non-executive directors to be independent in character and judgement. Baroness Dunn and H Sohmen have served on the Board for more than nine years, however, and in that respect only, do not meet the usual criteria for independence set out in the UK Combined Code on corporate governance. The Board has therefore determined Lord Butler, R K F Ch’ien, J D Coombe, R A Fairhead, W K L Fung, S Hintze, J W J Hughes-Hallett, Sir John Kemp-Welch, Sir Brian Moffat, Sir Mark Moody-Stuart, S
W Newton, C S Taylor and Sir Brian Williamson to be independent. In reaching its determination of each non-executive Director’s independence the Board has concluded that there are no relationships or circumstances which are likely to affect the Director’s judgement and any relationships or circumstances which could appear to do so were considered not to be material. In accordance with the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited each non-executive Director determined by the Board to be independent has provided confirmation of his or her independence to HSBC Holdings.
The Directors who served during the year were W F Aldinger, Sir John Bond, Lord Butler, R K F Ch’ien, C F W de Croisset, W R P Dalton, Baroness Dunn, D G Eldon, R A Fairhead, D J Flint, W K L Fung, M F Geoghegan, S K Green, S Hintze, A W Jebson, Sir John Kemp-Welch, Lord Marshall, Sir Brian Moffat, Sir Mark Moody-Stuart, S W Newton, H Sohmen, C S Taylor and Sir Brian Williamson.
C F W de Croisset retired as a Director on 27 February 2004 and W R P Dalton and Lord Marshall retired as Directors on 28 May 2004. R A Fairhead and M F Geoghegan were appointed Directors with effect from 1 March 2004.
J D Coombe and J W J Hughes-Hallett have been appointed Directors with effect from 1 March 2005. Having been appointed since the Annual General Meeting in 2004, they will retire at the forthcoming Annual General Meeting and offer themselves for re-election.
W F Aldinger is to retire as a Director on 29 April 2005.
Sir John Bond, R K F Ch’ien, Baroness Dunn, D G Eldon, D J Flint, Sir Brian Moffat, S W Newton and H Sohmen will retire by rotation at the forthcoming Annual General Meeting. With the exception of D G Eldon, who is to retire, they will offer themselves for re-election.
The Board has undertaken an evaluation of its performance and that of its committees. This evaluation covered board structure; dynamics; capabilities and processes; corporate governance; strategic clarity and alignment; and the performance of individual Directors. In undertaking this review the Group Chairman held structured meetings with each Director using a similar framework to that employed by MWM Consulting, who prepared an independent performance evaluation of the Board and its committees in January 2004. The report on the evaluation of the Board and its committees has been reviewed by the Board and has been used by
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the non-executive Directors, led by Sir Brian Moffat, in their evaluation of the performance of the Group Chairman. The Group Audit Committee, the Remuneration Committee, the Nomination Committee and the Corporate Social Responsibility Committee have also each undertaken a review of their terms of reference and their own effectiveness during 2004.
Following this review the Group Chairman has confirmed that the Directors standing for re-election at the Annual General Meeting continue to perform effectively and to demonstrate commitment to their roles. It is the intention of the Board of HSBC Holdings to continue to review its performance and that of its Directors annually.
Seven regular Board meetings were held during 2004. W F Aldinger, Sir John Bond, Lord Butler, Baroness Dunn, D G Eldon, D J Flint, W K L Fung, S K Green, S Hintze, A W Jebson, Sir John Kemp-Welch, Sir Brian Moffat, S W Newton, C S Taylor and Sir Brian Williamson attended all of the Board meetings. R K F Ch’ien, Sir Mark Moody-Stuart and H Sohmen attended six of the Board meetings. C F W de Croisset attended the two Board meetings held before his retirement. W R P Dalton attended all four Board meetings held before his retirement and Lord Marshall attended three of the four meetings held before his retirement. R A Fairhead attended four, and M F Geoghegan attended all, of the five Board meetings held following their appointment.
During 2004 the non-executive Directors and the Group Chairman met twice to discuss Board performance and succession planning, and the non-executives met once without the Group Chairman to discuss his performance.
In addition to the meetings of the principal committees referred to below, 12 other meetings of committees of the Board were held during the year to discharge business delegated by the Board.
The Board ensures all Directors, including non-executive Directors, develop an understanding of the views of major shareholders through attendance at analyst meetings following results announcements and other ad hoc meetings with investors and their representative bodies. In April 2004 the Board held an informal meeting with representatives of institutional shareholders to discuss corporate governance matters. An Investor Day, attended by executive and non-executive Directors, was held in September 2004 to articulate HSBC’s Managing for Growth strategy.
The Group Chairman, Group Chief Executive and the Group Finance Director hold regular
meetings with institutional investors and report to the Board on those meetings.
All Directors attended the 2004 Annual General Meeting. At the Annual General Meeting shareholders may ask questions and are invited to meet with Directors after the conclusion of the Meeting.
Sir Brian Moffat, Deputy Chairman and senior independent non-executive Director, is available to shareholders should they have concerns which contact through the normal channels of Group Chairman, Group Chief Executive, Group Finance Director or other executives has failed to resolve or for which such contact would be inappropriate. Sir Brian Moffat may be contacted through the Group Company Secretary at 8 Canada Square, London E14 5HQ.
The Group Chairman’s principal commitments outside HSBC are as a non-executive Director of Ford Motor Company and, since January 2005, as a non-executive Director of Vodafone Group plc. During 2004, he ceased to be a member of the Court of the Bank of England.
Full, formal and tailored induction programmes are arranged for newly appointed Directors and opportunities to update and develop skills and knowledge are provided to all Directors. The terms and conditions of appointments of non-executive Directors are available for inspection at 8 Canada Square, London E14 5HQ and will be made available for 15 minutes before the Annual General Meeting and during the Meeting itself.
The Board of HSBC Holdings has adopted a code of conduct for transactions in Group securities by Directors and their connected persons that complies with The Model Code in the Listing Rules of the Financial Services Authority and, except as noted below, with The Model Code for Securities Transactions by Directors of Listed Issuers (‘Hong Kong Model Code’) set out in the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited. The Stock Exchange of Hong Kong has granted certain waivers from strict compliance with the Hong Kong Model Code, largely to take into account accepted practices in the UK, particularly in respect of employee share plans. Following a specific enquiry, each Director has confirmed he or she has complied with the code of conduct for transactions in Group securities throughout the year.
None of the Directors had, during the year or at the end of the year, a material interest, directly or
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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 meets regularly and operates as a general management committee under the direct authority of the Board. The members of the Group Management Board are S K Green (Chairman), Sir John Bond, W F Aldinger, D G Eldon, D J Flint, M F Geoghegan and A W Jebson, all of whom are executive Directors, and C-H Filippi, S T Gulliver, Y A Nasr and J J Studzinski, all of whom are Group Managing Directors.
The Group Management Board exercises the powers, authorities and discretions of the Board in so far as they concern the management and day to day running of HSBC in accordance with such policies and directions as the Board may from time to time determine. Matters reserved for approval by the Board include annual plans and performance targets, procedures for monitoring and control of operations, specified senior appointments, acquisitions and disposals above predetermined thresholds and any substantial change in balance sheet management policy. The Group Management Board sub-delegates credit, investment and capital expenditure authorities to its members.
Group Audit Committee
The Group Audit Committee meets regularly with HSBC’s senior financial, internal audit, legal and compliance management and the external auditor to consider HSBC Holdings’ financial reporting, the nature and scope of audit reviews and the effectiveness of the systems of internal control and compliance. The members of the Group Audit Committee throughout 2004 were Sir Brian Moffat (Chairman), R K F Ch’ien and Sir John Kemp-Welch. R A Fairhead was appointed a member of the Committee with effect from 1 March 2004 and J D Coombe has been appointed a member of the Committee with effect from 1 July 2005. All members of the Committee are independent non-executive Directors.
The Board has determined that Sir Brian Moffat, R A Fairhead and, with effect from 1 July 2005,
J D Coombe may be regarded as audit committee financial experts for the purposes of section 407 of the Sarbanes Oxley Act and as having recent and relevant financial experience.
Since 2004 appointments to the Committee have been made for periods of up to three years, extendable by no more than two additional three-year periods, so long as members continue to be independent.
Formal and tailored induction programmes are held for newly appointed Committee members and appropriate training is provided on an ongoing and timely basis.
There were seven meetings of the Group Audit Committee during 2004. Sir John Kemp-Welch and Sir Brian Moffat attended all of the meetings and R K F Ch’ien attended five. R A Fairhead attended each of the five meetings held following her appointment.
At the beginning of each meeting the Committee meets with the external auditor, without management present, to facilitate the discussion of any matter relating to its remit and any issue arising from the audit. Similar arrangements have been adopted for the Committee to meet with the internal auditor.
The terms of reference of the Committee, which are reviewed annually, are available on www.hsbc.com by selecting ‘Investor Relations’, then ‘Corporate Governance’, then ‘Board Committees’.
The Group Audit Committee is accountable to the Board and assists the Board in meeting its responsibilities in ensuring an effective system of internal control and compliance and for meeting its external financial reporting obligations. The Committee is directly responsible on behalf of the Board for the selection, oversight and remuneration of the external auditor. The Committee receives frequent comprehensive reports from each of the Head of Group Compliance, the Group General Manager Legal and Compliance, the Group General Manager Internal Audit and the Head of Group Security and receives periodic presentations from other functional heads and line management.
The Committee monitors the integrity of the financial statements of HSBC Holdings, reviewing significant financial reporting judgements contained in them. During 2004 the Committee reviewed the HSBC Holdings 2003 Results Announcement, the Annual Report and Accounts 2003, the Annual Review 2003, Interim Results 2004 Announcement and the Interim Report 2004 before they were submitted to the Board.
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During 2004 the Committee received presentations on the implications of the introduction of International Financial Reporting Standards and the plans for implementing the standards within HSBC in 2005.
In undertaking its annual review of its own effectiveness the Committee discussed with the external auditor the effectiveness of the internal audit function. The Committee also receives summaries of periodic peer reviews of the internal audit functions around HSBC.
The Committee undertakes an annual review of the effectiveness of HSBC’s system of internal control, as set out on page 209.
The Committee reports on its activities at each Board meeting and, twice annually, produces a written summary of its activities.
The Committee has approved procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls and auditing matters, and the confidential and anonymous submission by employees of concerns regarding questionable accounting or auditing matters. The Committee receives regular reports regarding the nature, investigation and resolution of material complaints and concerns from the Head of Group Compliance.
The Committee reviews and monitors the external auditor's independence and objectivity and the effectiveness of the audit process, taking into consideration relevant professional and regulatory requirements. The Committee receives reports from the external auditor on their own policies and procedures regarding independence and quality control and oversees the appropriate rotation of audit partners with the external auditor.
The Group Audit Committee has adopted policies for the pre-approval of specific services that may be provided by the principal auditor, KPMG Audit Plc and its affiliates (‘KPMG’), since 2003. These policies are kept under review and amended as necessary to meet the dual objectives of ensuring that HSBC benefits in a cost effective manner from the cumulative knowledge and experience of its auditor whilst also ensuring that the auditor maintains the necessary degree of independence and objectivity. These pre-approval policies apply to all services where HSBC Holdings or any of its subsidiaries pays for the service, or is a beneficiary or addressee of the service and has selected, or influences the choice of, KPMG. In two instances in 2004, services provided by KPMG were inadvertently not pre-approved individually or
entered into pursuant to the pre-approval policies but were subsequently approved by the Group Audit Committee after the services had been rendered. Total fees billed for such services were US$15,000, which represents less than 0.01 per cent of the total non-audit fees billed by KPMG during 2004. All other services entered into with KPMG during 2004 were pre-approved by the Group Audit Committee or were entered into under pre-approval policies established by the Group Audit Committee.
The pre-approved services relate to the provision of objective advice, attestation type services or opinions on areas such as controls and are used as an input into management decision making. They fall into the following four categories:
Audit services
In addition to the statutory audit appointments, which are approved by the Group Audit Committee, this category includes services that are normally provided by the independent auditor in connection with statutory and regulatory filings or engagements, such as reviews of interim financial information, letters to securities underwriters in connection with debt or equity offerings, the inclusion of auditors’ reports in filings with the SEC and certain reports on internal control over financial reporting.
Audit-related services
These services are those provided by the principal auditor that are reasonably related to the performance of the audit or review of the Group’s financial statements. Examples of such services are due diligence services provided in connection with potential acquisitions, audits or reviews of employee benefit plans, ad hoc attestation or agreed-upon procedures reports (including reports requested by regulators), and accounting and regulatory advice on actual or contemplated transactions.
Tax services
This category includes both tax advice and compliance services. Examples of such services are advice on national and local income taxation matters, (including assistance in data gathering for preparation, review and submission as agent of tax filings), advice on tax consequences of management-proposed transactions and assistance in responding to tax examinations by governmental authorities. The pre-approved tax services explicitly exclude proposals for tax structures unconnected with a contemplated transaction and whose main motive is to reduce taxation.
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Other services
This category includes various other assurance and advisory services such as training or advice or assurance provided on specific elements of financial data and models, IT security and advice, and providing due diligence on financial reviews of HSBC customers and private equity investments.
All services provided by KPMG relating to the implementation of section 404 of the Sarbanes-Oxley Act were specifically pre-approved by the Group Audit Committee.
The remuneration paid to KPMG for each of the last three years is disclosed in Note 5(d) on page 258 of the ‘Notes on the Financial Statements’.
The Committee has recommended to the Board that KPMG Audit Plc be reappointed as Auditor at the forthcoming Annual General Meeting.
Remuneration Committee
The role of the Remuneration Committee and its membership are set out in the Directors’ Remuneration Report on page 216.
Nomination Committee
The Nomination Committee is responsible for leading the process for Board appointments and for identifying and nominating, for approval of the Board, candidates for appointment to the Board. Before recommending an appointment to the Board the Committee evaluates the balance of skills, knowledge and experience on the Board and, in the light of this identifies the role and capabilities required for a particular appointment. Candidates are considered on merit against these criteria. Care is taken to ensure that appointees have enough time to devote to HSBC. All Directors are subject to election by shareholders at the Annual General Meeting following their appointment and to re-election at least every three years. The members of the Nomination Committee throughout 2004 were Sir Brian Moffat (Chairman), Lord Butler and Baroness Dunn. Sir Brian Williamson was appointed a Member of the Committee on 1 October 2004.
There were two Nomination Committee meetings during 2004, each of which was attended by Sir Brian Moffat, Lord Butler and Baroness Dunn. There have been no meetings of the Committee since Sir Brian Williamson was appointed a member.
Following each meeting the Committee reports to the Board on its activities.
The terms of reference of the Committee are available on www.hsbc.com by selecting ‘Investor Relations’, then ‘Corporate Governance’, then ‘Board Committees’.
The appointments of R A Fairhead, J D Coombe and J W J Hughes-Hallett as non-executive Directors and M F Geoghegan as an executive Director were made on the advice and recommendation of the Nomination Committee. An external consultancy was used in connection with the appointments of R A Fairhead, J D Coombe and J W J Hughes-Hallett.
The Committee makes recommendations to the Board concerning plans for succession for both executive and non-executive directors; the appointment of any director to executive or other office; suitable candidates for the role of senior independent director; the re-election by shareholders of directors retiring by rotation; the renewal of the terms of office of non-executive directors; membership of Board Committees, in consultation with the Group Chairman and the chairman of such committee as appropriate; any matters relating to the continuation in office of any director at any time; directors’ fees and committee fees for the Company and any of its subsidiaries as appropriate; and appointments and re-appointments to the Boards of Directors of major subsidiary companies as appropriate.
The Committee regularly reviews the structure, size and composition of the Board and keeps under review the leadership needs of HSBC with a view to ensuring the continued ability of HSBC to compete effectively in the marketplace.
The Nomination Committee regularly reviews the structure, size and composition (including the skills, knowledge and experience) required of the Board and makes recommendations to the Board as appropriate. The Board has satisfied itself that the Nomination Committee has in place appropriate plans for orderly succession to the Board and Senior Management positions as well as procedures to ensure an appropriate balance of skills and experience within HSBC and on the Board.
Corporate Social Responsibility Committee
The Corporate Social Responsibility Committee is responsible for overseeing Corporate Social Responsibility and Sustainability policies, principally environmental, social and ethical matters and for advising the Board, committees of the Board and executive management on such matters. The terms of reference of the Committee are available on www.hsbc.com by selecting ‘Investor Relations’,
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then ‘Corporate Governance’ then ‘Board Committees’. The members of the Committee throughout 2004 were Lord Butler (Chairman), W K L Fung, S Hintze, C S Taylor, each of whom is an independent non-executive Director, and G V I Davis and Lord May, who are non-Director members of the Committee. Baroness Brigstocke was a non-Director member of the Committee until her untimely death in April 2004. E M Diggory was appointed as a non-Director member of the Committee on 26 November 2004.
There were four meetings of the Corporate Social Responsibility Committee during 2004. Following each meeting the Committee reports back to the Board on its activities.
Further information is available in HSBC’s Corporate Social Responsibility Report 2004, available in April 2005.
Appendix 14 to the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited was substantially revised during 2004. The new provisions of Appendix 14 will apply for subsequent reporting periods.
Differences in HSBC Holdings/New York Stock Exchange corporate governance practices
In November 2003, the US Securities and Exchange Commission approved the New York Stock Exchange’s (‘NYSE’) new corporate governance rules for listed companies. Under these new rules, as a NYSE-listed foreign private issuer, HSBC Holdings must disclose any significant ways in which its corporate governance practices differ from those followed by US companies subject to NYSE listing standards. HSBC Holdings believes the following to be the significant differences between its corporate governance practices and NYSE corporate governance rules applicable to US companies.
US companies listed on the NYSE are required to adopt and disclose corporate governance guidelines. The Listing Rules of the UK Financial
Services Authority require each listed company incorporated in the United Kingdom to include in its Annual Report and Accounts a narrative statement of how it has applied the principles of the Combined Code on Corporate Governance appended to the Listing Rules (‘Combined Code’) and a statement as to whether or not it has complied with the code provisions of the Combined Code throughout the accounting period covered by the Annual Report and Accounts. A company that has not complied with the Code provisions, or complied with only some of the Code provisions or (in the case of provisions whose requirements are of a continuing nature) complied for only part of an accounting period covered by the report, must specify the Code provisions with which it has not complied, and (where relevant) for what part of the reporting period such non-compliance continued, and give reasons for any non-compliance. As stated above, HSBC Holdings complied throug hout 2004 with the code provisions of the Combined Code. The Combined Code does not require HSBC Holdings to disclose the full range of corporate governance guidelines with which it complies.
Under NYSE standards, companies are required to have a nominating/corporate governance committee, composed entirely of independent directors. In addition to identifying individuals qualified to become board members, this committee must develop and recommend to the board a set of corporate governance principles. HSBC’s Nomination Committee, which follows the requirements of the Combined Code, includes a majority of members who are independent. All members of the Committee are non-executive Directors and three of the four members, including the Committee chairman, are independent non-executive Directors. The Committee’s terms of reference do not require the Committee to develop and recommend corporate governance principles for HSBC Holdings. As stated above, HSBC Holdings is subject to the corporate governance principles of the Combined Code.
Pursuant to NYSE listing standards, non-management directors must meet on a regular basis without management present and independent directors must meet separately at least once per year. During 2004, HSBC Holdings’ non-executive Directors met twice as a group with the Group Chairman, but with no other executive Directors present, and met once as a group without the Group Chairman or other executive Directors present. HSBC Holdings’ practice, in this regard, complies with the Combined Code.
In accordance with the requirements of the Combined Code, HSBC Holdings discloses in its annual report how the Board, its committees and the Directors are evaluated and the results of the evaluation (on pages 217 to 222) and it provides extensive information regarding Directors’ compensation in the Directors’ Remuneration Report (on pages 216 to 233). The terms of reference of HSBC Holdings’ Audit, Nomination and Remuneration Committees are available on www.hsbc.com by selecting ‘Investor Relations’ then ‘Corporate Governance’ then ‘Board Committees’.
NYSE listing standards require US companies to adopt a code of business conduct and ethics for directors, officers and employees, and promptly disclose any waivers of the code for directors or executive officers. In addition to the Group Business Principles and Values, which apply to the employees of all HSBC companies, pursuant to the requirements of the Sarbanes-Oxley Act the Board of HSBC Holdings has adopted a Code of Ethics applicable to the Group Chairman, the Group Finance Director and Group Chief Accounting Officer. HSBC Holdings’ Code of Ethics is available on www.hsbc.com by selecting ‘Investor Relations’, then ‘Corporate Governance’, then ‘Obligations of Senior Financial Officers’. If the Board amends or waives the provisions of the Code of Ethics, details of the amendment or waiver will appear at the same website address. During 2004 HSBC Holdings made no amendments to it s Code of Ethics and granted no waivers from its provisions. The Group Business Principles and Values is available on www.hsbc.com by selecting ‘About HSBC’, then ‘HSBC in Society’, then ‘Living Our Values’, then ‘Our People’.
Under NYSE listing rules applicable to US companies, independent directors must comprise a majority of the board of directors. Currently, over half of HSBC Holdings’ Directors are independent.
Under the Combined Code the HSBC Holdings Board determines whether a director is independent in character and judgement and whether there are relationships or circumstances which are likely to affect, or could appear to affect, the director’s judgement. Under the NYSE rules a director cannot qualify as independent unless the board affirmatively determines that the director has no material relationship with the listed company; in addition the NYSE rules prescribe a list of circumstances in which a director cannot be independent. The Combined Code requires a company’s board to assess director independence by affirmatively concluding that the director is independent of management and free from any business or other
relationship that could materially interfere with the exercise of independent judgement.
Lastly, a chief executive officer of a US company listed on the NYSE must annually certify that he or she is not aware of any violation by the company of NYSE corporate governance standards. In accordance with NYSE listing rules applicable to foreign private issuers, HSBC Holdings’ Group Chairman is not required to provide the NYSE with this annual compliance certification. However, in accordance with rules applicable to both US companies and foreign private issuers, the Group Chairman is required promptly to notify the NYSE in writing after any executive officer becomes aware of any material non-compliance with the NYSE corporate governance standards applicable to HSBC Holdings.
From July 2005 HSBC Holdings will be required to submit annual and interim written affirmations of compliance with applicable NYSE corporate governance standards, similar to the affirmations required of NYSE listed US companies.
The key procedures that the Directors have established are designed to provide effective internal control within HSBC and accord with the Internal Control Guidance for Directors on the Combined Code issued by the Institute of Chartered Accountants in England and Wales. Such procedures have been in place throughout the year and up to 28 February 2005, the date of approval of the Annual Report and Accounts 2004. In the case of companies acquired during the year, including Bank of Bermuda and Marks and Spencer Retail Financial Services Holdings Limited, the internal controls in place are being reviewed against HSBC’s benchmarks and integrated into HSBC’s systems.
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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 and operational risks. This is an evolutionary process which takes account of The Association of British Insurers’ guidance on best practice when responding to social, ethical and environmental (‘SEE’) risks.
The safeguarding of HSBC’s reputation is of paramount importance to its continued prosperity and is the responsibility of every member of staff. HSBC has always aspired to the highest standards of conduct and, as a matter of routine, takes account of reputational risks to its business. The training of Directors on appointment includes reputational matters.
Reputational risks, including SEE matters, are considered and assessed by the Board, the Group Management Board, subsidiary company boards, board committees and/or senior management during the formulation of policy and the establishment of HSBC standards. Standards on all major aspects of business are set for HSBC and for individual subsidiary companies, businesses and functions. These policies, which form an integral part of the internal control systems, are communicated through manuals and statements of policy and are promulgated through internal communications and training. The policies cover SEE issues and set out operational procedures in all areas of reputational risk, including money laundering deterrence, environmental impact, anti-corruption measures and employee relations. The policy manuals address risk issues in detail and co-operation between head office departments and businesses is required to ensure a strong adherence to HSBC’s risk management system and its corporate social responsibility practices.
Internal controls are an integral part of how HSBC conducts its business. HSBC’s manuals and statements of policy are the foundation of these internal controls. There is a strong process in place to ensure controls operate effectively. Any significant failings are reported through the control mechanisms, internal audit and compliance functions to subsidiary company audit committees and to the Group Audit Committee, which keeps under review the effectiveness of the system of internal controls and reports regularly to HSBC Holdings’ Board. In
addition, all HSBC businesses and major functions are required to review their control procedures and to make regular reports about any losses arising from operational risks.
HSBC provides information in its Corporate Social Responsibility Report and website (www.hsbc.com/csr) on the extent to which it has complied with its risk management policies. Aspects covered include: how HSBC is implementing and applying the Equator Principles to manage the environmental and social risks in project finance; employee diversity; environmental management and health and safety. HSBC is using the guidelines of the Global Reporting Initiative in producing its 2004 report.
HSBC’s internal risk management procedures are supported by third party scrutiny and assurance. A commentary by The Corporate Citizenship Company in the Corporate Social Responsibility Report and website includes both assurance and forward-looking recommendations on HSBC’s SEE reporting. HSBC also provides external assurance through its participation in the Dow Jones Sustainability Index and Business in the Community’s Environment Index (HSBC’s feedback reports from which are included on our website) and FTSE4Good. Further details are contained in HSBC’s Corporate Social Responsibility Report 2004, available in April 2005.
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 Coordinators based in each country in which HSBC operates.
HSBC faces a range of threats from terrorists and criminals across the world. In particular, over recent years the threat from international terrorism has become significant in a number of areas where HSBC operates. This threat has mainly manifested itself in bomb attacks such as the one in Istanbul in 2003 in which HSBC’s Turkish headquarters building was attacked. Despite suffering tragic loss of life and major damage, existing security measures and well-managed contingency procedures ensured
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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 and the Interim Report which are sent to shareholders and on www.hsbc.com. There is regular dialogue with institutional investors and enquiries from individuals
on matters relating to their shareholdings and the business of HSBC are welcomed and are dealt with in an informative and timely manner. All shareholders are encouraged to attend the Annual General Meeting or the informal meeting of shareholders held in Hong Kong to discuss the progress of HSBC.
According to the registers of Directors’ interests maintained by HSBC Holdings pursuant to section 325 of the Companies Act 1985 and section 352 of the Securities and Futures Ordinance of Hong Kong, the Directors of HSBC Holdings at the year-end had the following interests, all beneficial unless otherwise stated, in the shares and loan capital of HSBC and its associated corporations:
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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 Securities, which he held throughout the year.
D G Eldon has an interest as beneficial owner in 300 Hang Seng Bank ordinary shares of HK$5.00 each, which he held throughout the year.
S K Green has an interest as beneficial owner in €75,000 of HSBC Holdings plc 5½ per cent Subordinated Notes 2009 and in £100,000 of HSBC Bank plc 9 per cent Subordinated Notes 2005, which he held throughout the year.
H Sohmen has a corporate interest in £1,200,000 of HSBC Bank plc 9 per centSubordinated Notes 2005 which he held throughout the year. During the year, his spouse ceased to have an interest in US$3,000,000 of HSBC Bank plc Senior Subordinated Floating Rate Notes 2009.
As Directors of CCF, S K Green and M F Geoghegan each have an interest as beneficial owner in one share of €5 in that company, which Mr Green held throughout the year and Mr Geoghegan acquired during the year. The Directors have waived their rights to receive dividends on these shares and have undertaken to transfer these shares to HSBC on ceasing to be Directors of CCF.
As Directors of HSBC Private Banking Holdings (Suisse), S K Green and M F Geoghegan each have an interest as beneficial owner in one share of CHF1,000, which Mr Green held throughout the year and Mr Geoghegan acquired during the year. The Directors have waived their
rights to receive dividends on these shares and have undertaken to transfer these shares to HSBC on ceasing to be Directors of HSBC Private Banking Holdings (Suisse).
At 31 December 2004, the aggregate interests of the executive Directors in HSBC Holdings ordinary shares of US$0.50 (each of which represents less than 0.005 per cent of the shares in issue, unless otherwise stated) under the Securities and Futures Ordinance of Hong Kong, including interests arising through share option plans, the Restricted Share Plan and, in the case of W F Aldinger, through an employee benefit trust as detailed in the Directors' Remuneration Report on pages 216 to 233, are: W F Aldinger – 16,324,412 (0.15 per cent of shares in issue); Sir John Bond – 1,194,046 (0.01 per cent of shares in issue); D G Eldon – 441,417; D J Flint – 511,862; M F Geoghegan – 300,775; S K Green – 771,599 (0.01 per cent of shares in issue); and A W Jebson – 533,659.
No directors held any short positions as defined in the Securities and Futures Ordinance of Hong Kong. Save as stated above and in the Directors' Remuneration Report, none of the Directors had an interest in any shares or debentures of any HSBC or associated corporation at the beginning or at the end of the year, and none of the Directors or members of their immediate family was awarded or exercised any right to subscribe for any shares or debentures during the year.
Since the end of the year, the interests of each of the following Directors have increased by the number of HSBC Holdings ordinary shares shown against their name:
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There have been no other changes in Directors’ interests from 31 December 2004 to the date of this Report. Any subsequent changes up to the last practicable date before the publication of the ‘Notice of Annual General Meeting’ will be set out in the notes to that Notice.
At 31 December 2004, Directors and Senior Management held, in aggregate, beneficial interests in 24,333,045 HSBC Holdings ordinary shares (0.2 per cent of the issued ordinary shares).
HSBC Holdings continues to regard communication with its employees as a key aspect of its policies. Information is given to employees about employment matters and about the financial and economic factors affecting HSBC’s performance through management channels, an intranet site accessible to all HSBC’s employees worldwide, in-house magazines and by way of attendance at internal seminars and training programmes. Employees are encouraged to discuss operational and strategic issues with their line management and to make suggestions aimed at improving performance. The involvement of employees in the performance of HSBC is further encouraged through participation in bonus and share plans as appropriate.
About half of all HSBC employees now participate in one or more of HSBC’s employee share plans.
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; and the internet at www.dti.gov.uk/publications.
It is HSBC Holdings’ practice to organise payment to its suppliers through a central accounts function operated by its subsidiary undertaking, HSBC Bank. Included in the balance with HSBC Bank is the amount due to trade creditors which, at 31 December 2004, represented 16 days’ average daily purchases of goods and services received from such creditors, calculated in accordance with the Companies Act 1985, as amended by Statutory Instrument 1997/571.
According to the register maintained under section 211 of the Companies Act 1985, Legal and General Investment Management Limited notified HSBC Holdings on 13 June 2002 that it had an interest on 11 June 2002 in 284,604,788 HSBC Holdings ordinary shares, representing 3.01 per cent of the ordinary shares in issue at that date.
Credit Suisse First Boston notified HSBC Holdings on 8 February 2005 that it had an interest on 1 February 2005 in 482,122,209 HSBC Holdings ordinary shares, representing 4.31 per cent of the ordinary shares in issue at that date.
No substantial interest, being 5 per cent or more, in any of the equity share capital is recorded in the register maintained under section 336 of the Securities and Futures Ordinance of Hong Kong.
In compliance with the Rules Governing the Listing of Securities on The Stock Exchange of
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Hong Kong Limited at least 25 per cent of the total issued share capital of HSBC Holdings has been held by the public at all times during 2004 and up to the date of this Report.
Except for the dealings as intermediaries by HSBC Bank, HSBC CCF Financial Products (France) SNC and The Hongkong and Shanghai Banking Corporation, which are members of a European Economic Area exchange in market-making and other dealing activities, neither HSBC Holdings nor any subsidiary undertaking has bought, sold or redeemed any securities of HSBC Holdings during the year ended 31 December 2004.
During the year, HSBC made charitable donations totalling US$69.2 million. Of this amount, US$21.1 million was given for charitable purposes in the United Kingdom.
No political donations were made during the year.
At the Annual General Meeting in 2003 shareholders gave authority for HSBC Holdings and HSBC Bank to make EU political donations and incur EU political expenditure up to a maximum aggregate sum of £250,000 and £50,000 respectively over a four-year period as a precautionary measure in light of the wide
definitions in The Political Parties, Elections and Referendums Act 2000. These authorities have not been used.
The Annual General Meeting of HSBC Holdings will be held at the Barbican Hall, Barbican Centre, London EC2 on Friday 27 May 2005 at 11.00 am.
An informal meeting of shareholders will be held at Level 28, 1 Queen’s Road Central, Hong Kong on Tuesday 24 May 2005 at 4.30pm.
A live webcast of the Annual General Meeting will be available on www.hsbc.com. From shortly after the conclusion of the Meeting until 30 June 2005 a recording of the proceedings will be available on www.hsbc.com.
KPMG Audit Plc has expressed its willingness to continue in office. The Group Audit Committee and the Board recommend that it be reappointed. A resolution proposing the reappointment of KPMG Audit Plc as auditor of HSBC Holdings and giving authority to the Group Audit Committee to determine its remuneration will be submitted to the forthcoming Annual General Meeting.
Directors’ Remuneration Report
The Remuneration Committee meets regularly to consider human resource issues, particularly terms and conditions of employment, remuneration, retirement benefits, development of high potential employees and key succession planning. The Remuneration Committee seeks to respond to the variety of environments and circumstances which are faced by different businesses in different markets at different times and has in place appropriate policies and procedures to monitor the size of the potential remuneration awards. The members of the Remuneration Committee throughout 2004 were Sir Mark Moody-Stuart (Chairman), W K L Fung and Sir John Kemp-Welch. S Hintze was appointed a member of the Committee on 30 January 2004.
There were seven meetings of the Remuneration Committee during 2004. Sir Mark Moody-Stuart and Sir John Kemp-Welch attended all of these meetings, W K L Fung attended five meetings and S Hintze attended five of the six meetings following her appointment. Following each meeting the Committee reports back to the Board on its activities. The terms of reference of the Committee are available on www.hsbc.com by selecting ‘Investor Relations’, then ‘Corporate Governance’, then ‘Board Committees’.
Towers Perrin, a firm of specialist human resources consultants, has been appointed by the Committee to provide independent advice on executive remuneration issues. As a global firm, Towers Perrin also provides other remuneration, actuarial and retirement consulting services to various parts of HSBC. Other than the provision of expert advice in these areas to the Remuneration Committee and to HSBC, Towers Perrin have no connection with HSBC. Other consultants are used from time to time to validate their findings. The Remuneration Committee also receives advice from the Group General Manager, Human Resources, J C S Rankin, and the Senior Executive, Group Reward Management, P M Wood.
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 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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During 2004, a comprehensive review of share-based remuneration arrangements was conducted. This review was undertaken in light of changing business needs, taking into account HSBC’s expansion in certain markets and an evolving external environment.
Approval for The HSBC Share Plan will be sought at the forthcoming Annual General Meeting. The proposed arrangements for the most senior executives of HSBC are described under ‘Long-term incentive plan’ on page 219. Shareholders and their representatives were consulted and the proposed arrangements reflect feedback that has been received.
Below the senior executive level and in the context of an employee’s total remuneration package, the practice of awarding share options at all levels within HSBC has been reconsidered. In future and commencing with awards to be made in 2005, restricted shares will be granted to a substantially smaller number of executives than those who previously received share options, with awards focused on those individuals who bring key talents and high levels of performance to the Group. These awards will normally vest after three years, subject to the individual remaining in employment. Awards of share options will only be granted in limited circumstances. For those who will normally no longer be eligible to receive awards of shares or share options, variable bonus arrangements have been reviewed and enhanced, as appropriate, taking account of local markets. Such changes may include an element of deferral.
To encourage greater participation in the HSBC Holdings Savings-Related Share Option Plan: (International), two amendments to existing arrangements will be proposed for approval at the forthcoming Annual General Meeting. The first is the introduction of the facility to save in US dollars, Hong Kong dollars and euros as well as in pounds
sterling. The maximum savings limit of £250 per month will continue to apply but be converted to the other currencies on a consistent and appropriate date. The second proposal is to offer individuals the choice of options over one year in addition to the existing three and five year terms. This change will carry tax advantages in certain jurisdictions.
The impact on existing equity of granting share options which are to be satisfied by the issue of new shares is shown in diluted earnings per share on the face of the consolidated profit and loss account, with further details disclosed in Note 10 of the ‘Notes on the Financial Statements’ on page 261. The effect on basic earnings per share of exercising all outstanding share options would be to dilute it by 0.6 per cent.
At the Annual General Meeting in 2000, shareholders approved a limit of 848,847,000 ordinary shares (approximately 10 per cent of the ordinary shares then in issue), which may be issued or become issuable under all employee share plans in any ten year period. Within this limit, not more than 5 per cent of the ordinary shares in issue from time to time (approximately 560,000,000 ordinary shares at 28 February 2005) may be put under option under the HSBC Holdings Group Share Option Plan and the HSBC Holdings Restricted Share Plan 2000. In the ten year period to 31 December 2004, less than 650 million ordinary shares had been issued or could become issuable under all employee share plans and less than 350 million ordinary shares had been issued or could become issuable under discretionary employee share plans, including the HSBC Holdings Group Share Option Plan and the HSBC Holdings Restricted Share Plan 2000. At the forthcoming Annual General Meeting, revised limits on the number of shares that may be issued or become issuable under employee share plans will be proposed to reflect the increase in share capital since 2000.
HSBC’s operations are substantial, diverse and international; for example, over 73 per cent of profit before tax is derived from outside the United Kingdom.
With effect from 1 March 2005 the HSBC Holdings’ Board will comprise 15 non-executive Directors and seven executive Directors. With businesses in 77 countries and territories, HSBC aims to attract Directors with a variety of experience, both in its key areas of activity and internationally. The Board currently includes nationals of five different countries. The seven executive Directors, four Group Managing Directors and 23 Group
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Directors’ Remuneration Report (continued)
General Managers have in total more than 793 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 2004, is £55,000 per annum. With effect from 1 January 2005 Sir John Bond, D J Flint, M F Geoghegan, S K Green and A W Jebson waived their rights to receive a Director’s fee from HSBC Holdings: an appropriate adjustment has been made to their basic salaries which, when taken with the consequent impact on bonuses, long-term incentive awards and pension benefits, will deliver a similar value to the fee that has been waived. W F Aldinger and D G Eldon had previously elected to waive any fees payable by HSBC Holdings.
In addition, non-executive Directors receive the following fees:
Executive Directors
The executive Directors are experienced executives with detailed knowledge of the financial services business in various countries. In most cases there has been a need to attract them from abroad to work in the United Kingdom.
Consistent with the principles applied by the Committee to employees generally, there are four key components to the executive Directors’ remuneration:
To ensure that the executive Directors’ remuneration packages are competitive having regard to the broad international nature of the Group, each year the Remuneration Committee considers market data on senior executive remuneration arrangements within primarily:
The level of awards available to the executive Directors under the annual cash bonus scheme and as Performance Shares is entirely dependent on performance. Remuneration policy for executive Directors is intended to provide competitive rates of base salary but with the potential for the majority of the value of the remuneration package to be delivered in the form of both short and long-term incentives. This typically results in base salary comprising around 30 per cent of total direct pay and the remaining 70 per cent split between annual bonus and the expected value of Performance Share awards. The remuneration package of W F Aldinger has a smaller proportion of fixed salary and a higher proportion of annual bonus and Restricted Share awards. The awards are in accordance with the minimum level of awards set out under his employment agreement entered into on 14 November 2002 at the time of the acquisition of HSBC Finance Corporation (‘the 2002 employment agreement’).
It was noted by the Committee that the three-year term, and certain other terms, of the 2002 employment agreement represented an exception to HSBC’s normal policy for executive Directors’ service contracts, but that the background and reasons for this were explained in detail at the time of the acquisition and that the terms of the 2002 employment agreement were consistent with practice in the United States.
Since 31 December 2004, the Remuneration Committee has reviewed the financial and other
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terms proposed in connection with W F Aldinger’s retirement on 29 April 2005 which are reflected in the amendment agreement dated 26 February 2005 between HSBC Finance Corporation and Mr Aldinger, details of which are summarised below. The Committee, having reviewed the relevant factors and circumstances, considered that these financial and other terms were appropriate and in order and in the best interests of the Group.
Each component of executive Directors’ remuneration is explained in detail below.
Salary
The Committee reviews salary levels for executive Directors each year in the same context as other employees. With reference to market practice and taking account of the international nature of the Group, the Committee benchmarks the salary of each Director and member of Senior Management against those of comparable executives in large, diverse companies.
Base salaries with effect from January 2005 willbe:
Excluding the effect of adjustments to salaries following the waivers by Sir John Bond, D J Flint, M F Geoghegan, S K Green and A W Jebson of their HSBC Holdings Director’s fee, this represents an average increase from 2004 of 5.02 per cent.
As an International Manager, D G Eldon’s current base salary, shown above, is calculated on a net basis.
Annual cash bonus
Cash bonuses for executive Directors are based on two key factors: individual performance, taking into account, as appropriate, results against plan of the business unit or performance of the support function for which the individual is responsible; and Group performance, measured by comparing operating profit before tax with plan. The Remuneration Committee has discretion to eliminate extraordinary items when assessing bonuses, if the main cause did not arise during the current bonus year.
Measurement against these key performance factors may result in discretionary cash bonuses of up to 250 per cent of basic salary for executive Directors.
Long-term incentive plan
Long-term incentive plans are designed to reward the delivery of sustained financial growth of HSBC. So as to align the interests of the Directors and senior employees more closely with those of shareholders, the vesting of Performance Share awards is subject to the attainment of predetermined performance criteria.
The Remuneration Committee has generally provided, on a discretionary basis and reflective of individual performance, long-term share incentives to executive Directors and members of Senior Management through conditional awards of Performance Shares under the HSBC Holdings Restricted Share Plan 2000, rather than through the HSBC Holdings Group Share Option Plan.
As part of a comprehensive review of share-based remuneration, the Remuneration Committee considered whether the continued use of Performance Shares was appropriate. The Committee considered several other types of arrangement but concluded that Performance Shares remain the most appropriate vehicle for HSBC’s executive Directors and Senior Management. However, the Committee recognised that there were a number of aspects to the current plan that could be improved to ensure the plan encouraged and rewarded growth and outperformance.
Accordingly, the adoption of The HSBC Share Plan, to replace the HSBC Holdings Restricted Share Plan 2000 and the HSBC Holdings Group Share Option Plan, will be proposed at the forthcoming Annual General Meeting. For executive Directors and members of Senior Management The HSBC Share Plan will:
The effect of these proposals is that the vesting of Performance Share awards will be more challenging and highly geared to performance than under the previous arrangements. To maintain the same approximate expected value (which takes into account factors such as the probability of vesting and risk of forfeiture for early departure) of Performance Share awards under The HSBC Share Plan as previously made under the HSBC Holdings Restricted Share Plan 2000, the face value of conditional awards under The HSBC Share Plan will be greater (as shown under ‘2005 Awards’ below) than those previously made under the HSBC
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Holdings Restricted Share Plan 2000. It is proposed that awards under The HSBC Share Plan will be up to a maximum of seven times salary. Whilst having flexibility to make awards at this level in certain exceptional circumstances, the Remuneration Committee does not intend seven times salary to be the normal level of award. The average face value of the awards proposed for executive Directors is just over three times base salary; proposed individual awards are set out in the table below. Awards proposed for 2005 for Group Managing Directors and Group General Managers will generally be below two times salary.
Further details of the performance conditions and vesting arrangements for The HSBC Share Plan are set out below. A summary of the arrangements relevant to previous awards of Performance Shares under The HSBC Holdings Restricted Share Plan 2000 is also given. Subject to approval at the forthcoming Annual General Meeting, all future awards of Performance Shares, including the 2005 awards, will be made under The HSBC Share Plan.
2005 Awards
The Remuneration Committee is proposing that the conditional awards shown in the table below should be made to executive Directors in 2005. The table shows the face value of the full conditional awards and their approximate expected value.
As set out above, the higher face value of these awards than in previous years is balanced by the significantly more challenging vesting schedule of The HSBC Share Plan where maximum value will only be released to the individual if Group performance is at a very high level.
The Trustee to the Plan will be provided with funds to acquire HSBC Holdings ordinary shares at an appropriate time after the announcement of the annual results.
Under the terms of the 2002 employment agreement entered into at the time of the acquisition of HSBC Finance Corporation, W F Aldinger is entitled to receive an award of US$5.5 million which was to be used to purchase Restricted Shares in
HSBC Holdings. However, as referred to below, Mr Aldinger is to retire on 29 April 2005 and it has been agreed that this award will not be made.
C F W de Croisset and W R P Dalton, who retired during 2004, did not receive a long-term incentive award in 2004.
D G Eldon, who is to retire at the forthcoming Annual General Meeting, will not receive a long-term incentive award in 2005.
Performance conditions
Subject to approval of The HSBC Share Plan at the forthcoming Annual General Meeting, awards of Performance Shares, commencing in 2005, will be divided into two equal parts to be subject to separate performance conditions measured over a three-year performance period:
The TSR element of the award will be based on HSBC’s ranking against a comparator group of 28 major banks. The comparator group will generally comprise the largest banks in the world measured in terms of market capitalisation, having regard to the geographic spread and the nature of the activities of each bank. The Remuneration Committee will use this criteria in selecting any replacements to the comparator group that may be necessary during the performance period, for example because a bank ceases to exist or to be quoted or if its relevance to HSBC as a comparator significantly diminishes.
The comparator group at 28 February 2005 comprises ABN AMRO Holding N.V., Banco Bilbao Vizcaya Argentaria S.A, Banco Santander Central Hispano S.A., Bank of America Corporation, The Bank of New York Company, Inc., Barclays PLC, BNP PARIBAS S.A., Citigroup Inc., Credit Agricole S.A., Credit Suisse Group, Deutsche Bank AG, HBOS plc, JPMorgan Chase & Co., Lloyds TSB Group plc, Mitsubishi Tokyo Financial Group, Inc., Mizuho Financial Group, Inc., Morgan Stanley, National Australia Bank Limited, Royal Bank of
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Canada, The Royal Bank of Scotland Group plc, Société Générale, Standard Chartered PLC, UBS AG, UniCredito Italiano Bank plc, US Bancorp, Wachovia Corporation, Wells Fargo & Company and Westpac Banking Corporation.
The extent to which awards will vest will be determined by reference to HSBC Holdings’ TSR measured against the comparator TSR. The calculation of the share price component within HSBC Holdings’ TSR will be the average market price over the 20 trading days commencing on the day when the annual results are announced, which in 2005 is 28 February. The starting point will be, therefore, the average over the period 28 February to 29 March inclusive. TSR for comparator group constituents will be calculated on the same basis.
For TSR performance in line with the bank ranked 14th, only 30 per cent of the conditional award will vest; if HSBC’s performance is in line with or above the bank ranked 7th in the ranked list all of the TSR award shares will vest.
Vesting between the 14th and 7th ranked banks will be based on HSBC’s position against the ranked list. In simple terms, the percentage vesting will rise in 10 per cent increments for each position that HSBC achieves higher than the 14th bank in the ranked list until full vesting is achieved for TSR performance equal to or greater than the 7th bank in the ranked list. Where HSBC’s performance falls between these incremental steps, account will be taken of how far above or below the next ranked bank HSBC’s TSR performance is positioned.
For example, if HSBC’s TSR falls half way between the bank ranked 12th (where, a release of 50 per cent of the award would occur) and the bank ranked 13th (where a release of 40 per cent of the award would occur), then the actual award released would be 45 per cent, i.e. half way between 40 per cent and 50 per cent.
For the EPS element of the award, the base measure shall be EPS for the financial year preceding that in which the award is made (‘the base year’). Absolute growth in EPS will then be compared with the base year over three consecutive financial years commencing with the year in which the award is made. The EPS growth element will be the absolute level of EPS achieved during the three-year performance period. For this purpose, EPS means the profit attributable to the shareholders (expressed in US dollars), excluding goodwill amortisation, divided by the weighted average number of ordinary shares in issue and held outside the Group during the year in question. In the event that the 2004 published EPS is restated to adjust for
accounting standards changes during the performance period, the restated published EPS will be used for the EPS performance condition for awards made in 2005 under The HSBC Share Plan.
The percentage of the conditional award vesting will depend upon the absolute growth in EPS achieved over the three years (‘the performance period’). 30 per cent of the conditional shares will vest if the incremental EPS over the performance period is 24 per cent or more of EPS in the base year.
The percentage of shares vesting will rise on a straight line proportionate basis to 100 per cent if HSBC’s incremental EPS over the performance period is 52 per cent or more of EPS in the base year.
No element of the ‘TSR award’ will vest if HSBC’s performance is below that of the bank ranked 14th in the ranked list and no element of the ‘EPS award’ will vest if HSBC’s incremental EPS over the performance period is less than 24 per cent of EPS achieved in the base year.
To the extent that the performance conditions have not been met at the third anniversary, the shares will be forfeited.
In addition, awards will only vest if the Remuneration Committee is satisfied that HSBC Holdings’ financial performance has shown a sustained improvement in the period since the date of grant.
In determining whether HSBC has achieved a sustained improvement in performance the Remuneration Committee will take account of, among other factors, the comparison against history and the peer group in the following areas:
Following the three-year performance period, awards of Performance Shares under The HSBC Share Plan will be tested and vesting will take place shortly afterwards.
Where events occur which cause the Remuneration Committee to consider that the performance condition has become unfair or impractical, the right is reserved to the Remuneration Committee to make such adjustments as in its absolute discretion it deems appropriate to make.
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Awards will vest immediately in cases of death. In the event of redundancy, retirement on grounds of injury or ill health, early retirement, normal retirement and where a participant ceases to be employed by HSBC due to a company ceasing to be part of HSBC, awards will normally vest at the end of the vesting period on a time-apportioned basis to the extent that performance conditions have been satisfied. Awards will normally be forfeited if the participant is dismissed or resigns from HSBC. In all of these circumstances the Committee retains discretion to ensure fair and reasonable treatment.
Arrangements from 1999-2004
From 1999 to 2004, the vesting of awards was linked to the attainment of predetermined TSR targets over a three-year period from date of grant as set out below.
The TSR performance condition for awards of Performance Shares remained the same from 1999 to 2003. For awards made in 2004, changes were made to the peer group and re-testing provisions were eliminated such that awards will lapse if the performance condition is not satisfied after the initial three-year performance period.
A benchmark for HSBC Holdings’ TSR, weighted by market capitalisation, was established which takes account of the TSR performance of:
By combining the weighted average TSR for each of the above three groups and weighting that average so that 50 per cent is applied to paragraph 1, 25 per cent is applied to paragraph 2 and 25 per cent is applied to paragraph 3, a single TSR benchmark for market comparison was determined.
The extent to which each award will vest will be determined by reference to HSBC Holdings’ TSR measured against the TSR benchmark. For each award the calculation of the share price component within HSBC Holdings’ TSR was the average market price over the 20 trading days commencing on the day when the annual results were announced. TSR for the benchmark constituents was based on their published share prices on the 20th trading day after the annual results were announced.
If HSBC Holdings’ TSR over the performance period exceeds the benchmark TSR, awards with a value, at the date of grant, of up to 100 per cent of the individual’s earnings, will vest. For higher value awards, the greater of 50 per cent of the award or the number of shares equating at the date of grant to 100 per cent of the individual’s earnings (base salary and bonus in respect of the previous performance year), will vest at this level of performance. If HSBC Holdings’ TSR over the performance period places it within the upper quartile in the ranked list against the benchmark, these higher value awards will vest in full. For performance between the median and the upper quartile, vesting will be on a straight-line basis.
For awards made in 2004, if the upper quartile performance target is achieved then, as before, an additional award equal to 20 per cent of the initial Performance Share award will be made and will vest at the same time as the original award to which it relates. However, regardless of whether the upper quartile is achieved, full vesting and transfer of the shares will not generally occur until the fifth anniversary of the date of grant. If the performance test is not passed at the third anniversary, the shares will be forfeited.
In addition to these performance conditions, none of the outstanding awards will vest unless the Remuneration Committee is satisfied that, during the performance period, HSBC has achieved a sustained improvement in performance. The Remuneration Committee retains discretion to recommend early release of shares awarded in certain circumstances, for example, redundancy and ill health.
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The Performance Shares awarded in 2000 passed their three-year TSR performance condition in March 2003 and will vest on the fifth anniversary of the award, 10 March 2005.
Total Shareholder Return
The graphs below show HSBC Holdings’ TSR performance against the benchmark TSR (graph 1), the Financial Times-Stock Exchange (‘FTSE’) 100 Index (graph 2), the Morgan Stanley Capital International (‘MSCI’) World Index (graph 3) and MSCI Financials Index (graph 4) over the three-year period to March 2004. These measures have been chosen as they are the main published indices against which HSBC monitors its performance.
Graph 1: HSBC TSR and Benchmark TSR
Graph 2: HSBC TSR and FTSE 100 Index
Graph 3: HSBC TSR and MSCI World Index
Graph 4: HSBC TSR and MSCI Financials Index
Pursuant to the Directors’ Remuneration Report Regulations 2002, graph 5 below shows HSBC Holdings’ TSR performance against a broad equity market index, the Financial Times-Stock Exchange (‘FTSE’) 100 Index, for the five-year period ended 31 December 2004.
Graph 5: HSBC TSR and FTSE 100 Index
Source: Datastream
Pensions
The pension entitlements earned by the executive Directors during the year are set out on pages 228 and 229.
Service contracts and terms of appointment
HSBC’s policy is to employ executive Directors on one-year rolling contracts although, on recruitment, longer initial terms may be approved by the Remuneration Committee. The Remuneration Committee will, consistent with the best interests of the Group, seek to minimise termination payments.
No executive Director has a service contract with HSBC Holdings or any of its subsidiaries with a notice period in excess of one year or with provisions for predetermined compensation on termination which exceeds one year’s salary and benefits in kind, save as referred to below. There are
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no provisions for compensation upon early termination of executive Directors’ service contracts save for W F Aldinger, details of which are set out below.
As referred to above, Mr Aldinger entered into a new employment agreement with HSBC Finance Corporation on 14 November 2002 for a term of three years, such term to commence on the effective date of the acquisition of HSBC Finance Corporation by HSBC. Full details of the agreement were set out in the Discloseable Transaction Circular relating to the acquisition of HSBC Finance Corporation sent to shareholders on 26 February 2003 in advance of the Extraordinary General Meeting to approve the acquisition. The effective date of the acquisition, and commencement date of the 2002 employment agreement, was 28 March 2003. The terms of the 2002 employment agreement, were amended by an agreement (‘amendment agreement’) entered into between HSBC Finance Corporation and Mr Aldinger, as referred to below.
During the term of the 2002 employment agreement Mr Aldinger is entitled to be paid an annual base salary equal to his annual base salary as at the date of the merger agreement between HSBC Finance Corporation and HSBC (US$1 million) and an annual bonus in an amount at least equal to the annual average of Mr Aldinger’s bonuses earned with respect to the three-year period ended 2001 (pro rated for any partial year) (US$4 million). Within 30 days of the effective date of the acquisition, Mr Aldinger received a one-time special retention grant of HSBC Holdings ordinary shares under the HSBC Holdings Restricted Share Plan 2000 with a value equal to US$10 million on terms that these Restricted Shares will vest in three equal instalments on each of the first three anniversaries of the effective date, as set out on page 232. After each of the first and second anniversaries of the effective date, subject to the approval of the Trustee of the HSBC Holdings Restricted Share Plan 2000, Mr Aldinger is entitled to receive an additional grant of HSBC Holdings ordinary shares with a value equal to at least US$5.5 million. The purpose of these arrangements was to retain the services of Mr Aldinger through the initial integration of HSBC Finance Corporation. HSBC considered it essential that the experience, knowledge and skills of Mr Aldinger be retained for the benefit of HSBC shareholders.
Under the 2002 employment agreement, if Mr Aldinger’s employment is terminated by him during its term for ‘good reason’, or by HSBC
Finance Corporation for reasons other than ‘cause’ or disability, he is entitled to: a pro rata target annual bonus for the financial year of the date of termination; a payment equal to his annual base salary, plus the average of his annual bonuses with respect to the three-year period ended 2001, times the number of full and partial months from the date of termination until the third anniversary of the effective date, divided by 12; the immediate vesting and exercisability of each stock option, restricted stock award and other equity-based award or performance award (or cash equivalent) that is outstanding as at the date of termination and treatment as retirement eligible for purposes of exercising any such award; for the remainder of his life and that of his current spouse, continued medical and dental benefits at HSBC Finance Corporation’s cost; and his retirement benefits (as set out on page 228) in a lump sum.
Following discussion with Mr Aldinger, it has been agreed that Mr Aldinger will retire as Chairman and Chief Executive of HSBC Finance Corporation and HSBC North America Holdings Inc on 29 April 2005 and will retire as a director of HSBC Holdings on the same date and resign from his directorships and other appointments with Group companies. As indicated above, the original purpose of the 2002 employment agreement was to retain the services of Mr Aldinger before the initial integration of HSBC Finance Corporation with the Group’s other North American businesses. The discussions with Mr Aldinger about his retirement before the expiry of the three-year term took into account that the integration process has now been completed successfully and faster than expected.
Under the amendment agreement, Mr Aldinger will be entitled to receive, on termination of the 2002 employment agreement on 29 April 2005, the same terms and benefits (summarised above) as if his employment had been terminated by him for ‘good reason’ or by HSBC Finance Corporation for reasons other than ‘cause’ or disability, except that he will not be entitled to receive the 2005 restricted share award (or cash equivalent) with a value to at least US$5.5 million that he would have been entitled to receive on or before 28 April 2005. Mr Aldinger will, however, receive a payment of US$4.6 million in lieu of salary and bonus in respect of the remainder of the three-year period. The amendment agreement also provides that the ‘non-competition’ provision in the 2002 employment agreement for a period of one year after termination of his employment, and certain other restrictions, will continue to apply. Under this provision he may not become associated with
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certain competitive entities that are actively engaged in the consumer lending business (including mortgage and credit card lending).
Sir John Bond, who is to stand for re-election at the forthcoming Annual General Meeting, is employed on a rolling contract dated 14 July 1994 which requires 12 months’ notice to be given by either party.
W R P Dalton, who retired as a Director on 28 May 2004, was employed on a rolling contract dated 5 January 1998 that required 12 months’ notice to be given by either party.
D G Eldon is employed on a rolling contract dated 1 January 1968 which requires three months’ notice to be given by either party. D G Eldon will retire as a Director at the conclusion of the forthcoming Annual General Meeting.
D J Flint, who is to stand for re-election at the forthcoming Annual General Meeting, is employed on a rolling contract dated 29 September 1995 which requires 12 months’ notice to be given by the Company and nine months’ notice to be given by Mr Flint.
M F Geoghegan is employed on a rolling contract dated 25 May 2004 which requires 12 months’ notice to be given by either party.
S K Green is employed on a rolling contract dated 9 March 1998 which requires 12 months’ notice to be given by either party.
A W Jebson is employed on a rolling contract dated 14 January 2000 which requires 12 months’ notice to be given by either party.
Members of Senior Management are employed on service contracts which generally provide for a term of service expiring at the end of a period of up to two years, or the individual’s sixtieth birthday, whichever is earlier.
Non-executive Directors are appointed for fixed terms not exceeding three years, subject to their re-election by shareholders at subsequent Annual General Meetings. Non-executive Directors have no service contract and are not eligible to participate in HSBC’s share plans. Non-executive Directors’ terms of appointment will expire as follows: in 2006, Baroness Dunn, Sir John Kemp-Welch, S W Newton, H Sohmen, C S Taylor and Sir Brian Williamson; in 2007, Lord Butler, R K F Ch’ien, R A Fairhead, W K L Fung, S Hintze, Sir
Brian Moffat and Sir Mark Moody-Stuart; and (assuming re-election at the 2005 Annual General Meeting) in 2008, J D Coombe and J W J Hughes-Hallett.
Other directorships
Executive Directors, if so authorised by either the Nomination Committee or the Board, may accept appointments as non-executive Directors of suitable companies which are not part of HSBC. Approval will not be given for executive Directors to accept a non-executive directorship of more than one FTSE 100 company. When considering a non-executive appointment, the Nomination Committee or Board will take into account the expected time commitment of such appointment. The time commitment for executive Directors’ external appointments will be reviewed as part of the annual Board review. Any remuneration receivable in respect of an external appointment is normally paid to the HSBC company by which the executive Director is employed, unless otherwise approved by the Remuneration Committee.
Sir John Bond retains his fees as a non-executive director of the Ford Motor Company, which are provided partly in the form of restricted shares, which become unrestricted over a period of five years. During 2004 the fees received were US$82,500 in cash and US$77,500 deferred into Ford common stock units. In addition, Ford provides US$200,000 of life assurance and US$500,000 of accidental death or dismemberment insurance. The life assurance can be continued after retirement from the Board or Sir John Bond could elect to have it reduced to US$100,000 and receive US$15,000 a year for life. The accidental death or dismemberment insurance ends upon retirement from the Board.
W F Aldinger retains his fees as a non-executive director of Illinois Tool Works, Inc. and as a non-executive director of AT&T Corp. During 2004 the fee received from Illinois Tool Works, Inc. was US$67,000 in the form of deferred stock and the fee received from AT&T Corp. was US$84,500 in cash and US$7,785 in cash instead of dividend due on deferred shares. In addition, AT&T Corp. provide travel accident insurance when on AT&T Corp. company business and US$100,000 of life assurance.
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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 2004.
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 2004 was US$118,290,000.
The aggregate amount set aside or accrued to provide pension, retirement or similar benefits for Directors and Senior Management for the year ended 31 December 2004 was US$6,261,000.
At 31 December 2004, executive Directors and Senior Management held, in aggregate, options to subscribe for 11,398,184 HSBC Holdings ordinary shares under the HSBC Holdings Executive Share Option Scheme, HSBC Holdings Group Share Option Plan and HSBC Holdings savings-related share option plans. These options are exercisable between 2005 and 2014 at prices ranging from £3.3334 to £8.2830.
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Directors’ emoluments
The emoluments of the Directors of HSBC Holdings for 2004 were as follows:
These discretionary bonuses are in respect of 2004 and will be paid in 2005.
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There are separate schemes for UK-based and overseas-based employees: the UK scheme has a normal retirement age of 60; retirement ages for overseas schemes vary in accordance with local legislation and practice. Save as stated below no other Director participated in any HSBC pension schemes, none of the Directors participating in HSBC’s UK ‘approved’ pension schemes is subject to the earnings cap introduced by the 1989 Finance Act and only basic salary is pensionable. With two exceptions (see paragraphs below on W F Aldinger and D J Flint), the current executive Directors are members of defined benefit pension schemes, having joined HSBC at a time when these were the norm.
Before commencement of the 2002 employment agreement on 28 March 2003, W F Aldinger participated in HSBC Finance Corporation’s ‘qualified’ and ‘non-qualified’ defined benefit pension plans. The annual pension benefit under these arrangements was a function of service and a percentage of Final Average Earnings (which included bonus). The ‘non-qualified plans’ were enhanced before commencement of the 2002 employment agreement. The benefits under the ‘qualified’ and ‘non-qualified’ defined benefit pension plans were then frozen and will be payable in a lump sum on the earlier of the termination of Mr Aldinger’s employment or on Mr Aldinger’s retirement (these benefits will be payable in a lump sum following Mr Aldinger’s retirement on 29 April 2005, referred to above). No further benefits have accrued under these arrangements since 28 March 2003.
Since commencement of the 2002 employment agreement on 28 March 2003, Mr Aldinger has continued to participate in the HSBC Finance Corporation Tax Reduction Investment Plan (‘TRIP’), which is a ‘qualified’ funded deferred profit-sharing and savings plan for eligible employees. Employer contributions of US$10,250 were made to this plan on behalf of Mr Aldinger in 2004 (2003: Nil). On 1 January 2005 the plan name was changed to HSBC-North America (U.S.) Tax Reduction Investment Plan (TRIP). Mr Aldinger also participated in Supplemental TRIP (a ‘non-qualified’ plan), which is an unfunded arrangement under which additional employer provision of US$289,749 has been made for 2004 (2003: US$41,539).
The pension arrangements for Sir John Bond, S K Green and A W Jebson to contractual retirement age of 60 are provided under the HSBC Bank (UK) Pension Scheme. The pensions accrue at a rate ofone-thirtieth of pensionable salary per year of pensionable service in the UK.
Until his retirement from CCF on 29 February 2004, C F W de Croisset was eligible for pension benefits which were supplementary to those accrued under the French State and Compulsory arrangements. The amount of this supplementary pension, payable from age 60, accrued at the rate of €6,098 per annum for each year of service (maximum 18 years) as an executive Director of CCF. Consequent upon Mr de Croisset’s early retirement from CCF and following a review of market practice, it was agreed to provide a total pension of €341,467 per annum (equivalent to 32.5 per cent of his average total cash compensation over a three-year period) payable from 1 March 2004.In 2004, CCF paid €213,003 to Mr de Croisset under this arrangement.
The pension arrangements for W R P Dalton to contractual retirement age of 60 were provided on a defined benefit basis (details of which are set out in the table below) under the HSBC Canada Pension Plan A, at an accrual rate of one-thirtieth of pensionable salary per year of pensionable service until his transfer to the UK in 1998. On taking up his appointment in the UK, he joined the HSBC Holdings Overseas (No.1) Pension Plan on a defined contribution basis, with an employer contribution in respect of 2004 of £129,000 (2003: £1,379,000 inclusive of a bonus waiver of £1,250,000).
The pension arrangements for D J Flint to contractual retirement age of 60 are provided through an executive allowance paid to fund personal pension arrangements set at 30 per cent of basic salary. This is supplemented through the HSBC Holdings plc Funded Unapproved Retirement Benefits Scheme on a defined contribution basis with an employer contribution during 2004 of £86,013 (2003: £81,943). The intention of these arrangements is to provide benefits broadly comparable to an accrual rate of one-thirtieth of pensionable salary for each year of pensionable service.
The pension arrangements for D G Eldon and M F Geoghegan are provided under the HSBC International Staff Retirement Benefits Scheme. The pensions accrue at a rate of one twenty-seventh of pensionable salary per year of pensionable service. In addition, Mr Geoghegan has joined the HSBC Asia Holdings Pension Plan, on a defined contribution basis, with an employer contribution in respect of 2004 of £1,200,000, arising entirely from a bonus sacrifice. There were no other employer contributions made to this plan.
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In addition to the unfunded pension payments as from 1 March 2004 to C F W de Croisset referred to above, the following unfunded pension payments, in respect of which provision has been made, were made during 2004 to four former Directors of HSBC Holdings:
The payments in respect of R Delbridge and Sir Brian Pearse were made by HSBC Bank plc as former Directors of the bank.
Share options
At 31 December 2004, the undernamed Directors held options to acquire the number of HSBC Holdings ordinary shares set against their respective names. The options were awarded for nil consideration at exercise prices equivalent to the market value at the date of award, except that options awarded under the HSBC Holdings savings-related share option plans before 2001 are exercisable at a 15 per cent discount to the market value at the date of award and those awarded since 2001 at a 20 per cent discount. Under the Securities and Futures Ordinance of Hong Kong the options are categorised as unlisted physically settled equity derivatives.
Except as otherwise indicated, no options were exercised or lapsed during the year and there are no remaining performance criteria conditional upon which the outstanding options are exercisable. The market value of the ordinary shares at 31 December 2004 was £8.79. The highest and lowest market values during the year were £9.535 and £7.84. Market value is the mid-market price derived from the London Stock Exchange Daily Official List on the relevant date.
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At 27 February 2004, the date he retired as a Director, C F W de Croisset held the following options to acquire CCF shares of €5 each. On exercise of these options each CCF share will be exchanged for 13 HSBC Holdings ordinary shares. The options were granted by CCF for nil consideration at a 5 per cent discount to the market
value at the date of award. There are no remaining performance criteria conditional upon which the outstanding options are exercisable. Save as indicated in the following table no options over CCF shares were awarded to or exercised by Mr de Croisset during 2004.
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CCFshares of €
At 31 December 2004, W F Aldinger held options to acquire HSBC Holdings ordinary shares as set out in the table below. These options arise from options he held over shares of Household International (now HSBC Finance Corporation) before its acquisition, which were converted into options over HSBC Holdings ordinary shares in the same ratio as the offer for HSBC Finance Corporation (2.675 HSBC
Holdings ordinary shares for each HSBC Finance Corporation common share) and the exercise prices per share adjusted accordingly. The HSBC Finance Corporation options were granted at nil consideration.
No options over HSBC Holdings ordinary shares were awarded to Mr Aldinger during 2004.
As a beneficiary of an employee benefit trust W F Aldinger has an interest in the HSBC Holdings ordinary shares held by the trust which may be used to satisfy exercises of his share options. Under the Securities and Futures Ordinance of Hong Kong, the interest is categorised as a ‘beneficiary of a trust’. At 31 December 2004, the trust held 1,525,850 HSBC
Holdings ordinary shares and 500,000 ADSs.
Save as stated above, none of the Directors, or members of their immediate families, were awarded or exercised any right to subscribe for any shares or debentures during the year.
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Restricted Share PlanHSBC Holdings ordinary shares of US$0.50
Unless otherwise indicated, vesting of these shares is subject to the performance tests set out in the section headed ‘Arrangements from 1999-2004’ on pages 222 to 223.
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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 pages 235 and 236, is made with a view to distinguishing for shareholders the respective responsibilities of the Directors and of the Auditors in relation to the financial statements.
The Directors are required by the Companies Act 1985 to prepare financial statements for each financial year which give a true and fair view of the state of affairs of HSBC Holdings plc together with its subsidiary undertakings as at the end of the financial year and of the profit or loss for the financial year. They are also required to present additional information for US shareholders. Accordingly, these financial statements are framed to meet both UK and US requirements to give a consistent view to all shareholders. The Directors are required to prepare these financial statements on the going concern basis unless it is not appropriate. Since the Directors are satisfied that HSBC has the resources to continue in business for the foreseeable future, the financial statements continue to be prepared on the going concern basis. The Directors consider that in preparing the financial statements on pages 237 to 356, HSBC Holdings has used appropriate accounting policies, consistently applied, save as disclosed in the ‘Notes on the Financial Statements’, and supported by reasonable and prudent judgements and estimates, and that all accounting standards which they consider to be applicable have been followed.
The Directors have responsibility for ensuring that HSBC Holdings keeps accounting records which disclose with reasonable accuracy at any time the financial position of HSBC Holdings and which enable them to ensure that the financial statements comply with the Companies Act 1985.
The Directors have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of HSBC and to prevent and detect fraud and other irregularities.
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Report of Independent registered public accounting firm to the Board of Directors andshareholders of HSBC Holdings plc
We have audited the accompanying consolidated financial statements of HSBC Holdings plc and its subsidiary undertakings (together ‘HSBC’) on pages 237 to 356 which comprise the consolidated balance sheets as at 31 December 2004 and 2003, 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 2004. 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 the standards of the Public Company Accounting Oversight Board (United States). 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, 2004 and 2003, and the results of its operations and its cash flows for each of the years in the three-year period ended 31 December 2004 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 accounting principles generally accepted in the United States. Information relating to the nature and effect of such differences is presented in Note 49 to the consolidated financial statements.
KPMG Audit Plc
London, England
28thFebruary 2005
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FinancialStatements
Consolidated profit and loss account for the year ended 31 December 2004
Movements in reserves are set out in Note 35.The accompanying notes are an integral part of the Consolidated Financial Statements.All results are from continuing operations.
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Financial Statements(continued)
Consolidated balance sheet at 31 December 2004
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FinancialStatements(continued)
HSBC Holdings balance sheet at 31 December 2004
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Statement of total consolidated recognised gains and losses for the year ended 31 December 2004
Reconciliation of movements in consolidated shareholders’ funds for the year ended 31 December 2004
No note of historical cost profits and losses has been presented as there is no material difference between HSBC’s results as disclosed in the consolidated profit and loss account and the results on an unmodified historical cost basis.
The accompanying notes are an integral part of the Consolidated Financial Statements.
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Consolidated cash flow statement for the year ended 31 December 2004
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Notes on the Financial Statements
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Notes on the Financial Statements (continued)
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balance sheet, which is netted against the relevant loan.
In other subsidiaries and in any event where the probability of receiving interest payments is remote, interest is no longer accrued and any suspended interest balance is written off.
On receipt of cash (other than from the realisation of security), the overall risk is re-evaluated and, if appropriate, suspended or non-accrual interest is recovered and taken to the profit and loss account. A specific provision of the same amount as the interest receipt is then raised against the principal balance. Amounts received from the realisation of security are applied to the repayment of outstanding indebtedness, with any surplus used to recover any specific provisions and then suspended interest.
Loans are not reclassified as accruing until interest and principal payments are up-to-date and future payments are reasonably assured.
Loan write-offs
Loans (and the related provisions) are normally written off, either partially or in full, when there is no realistic prospect of recovery of these amounts and when the proceeds from the realisation of security have been received.
Assets acquired in exchange for advances
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Interests in associates are stated at HSBC’s share of net assets, including attributable goodwill.
Accounting for these instruments is dependent upon whether the transactions are undertaken for trading or non-trading purposes.
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Notes onthe Financial Statements(continued)
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