28th Feb 2005 11:31
HSBC Holdings PLC28 February 2005 Part 5 DERIVATIVE FINANCIAL INSTRUMENTS The following table summarizes derivativefinancial instrument activity: EXCHANGE TRADED NON-EXCHANGE TRADED ------------------------------- ------------------------------------------ INTEREST RATE FOREIGN EXCHANGE FUTURES CONTRACTS INTEREST RATE CONTRACTS ------------------- OPTIONS RATE CURRENCY -------------------- PURCHASED SOLD PURCHASED SWAPS SWAPS PURCHASED SOLD------------------------------------------------------------------------------------------------------ (IN MILLIONS)2004Notional amount, 2003... $ - $ - $ 1,900 $ 41,312 $16,538 $ 1,223 $ (594)New contracts........... - - - - - 1,628 (1,432)New contracts purchased from subsidiaries of HSBC.................. - - 3,491 29,607 11,457 17,988 (8,778)Matured or expired contracts............. - - (3,700) (7,568) (1,407) (14,343) 4,840Terminated contracts.... - - - (7,211) (5,333) - -In-substance maturities(1)......... - - - - - (5,350) 5,350Assignment of contracts to subsidiaries of HSBC.................. - - - (10,887) (3,105) - - -------- ------- ------- -------- ------- -------- --------Notional amount, 2004... $ - $ - $ 1,691 $ 45,253 $18,150 $ 1,146 $ (614) ======== ======= ======= ======== ======= ======== ========Fair value, 2004(3): Fair value hedges..... $ - $ - $ - $ (46) $ $ - $ (2) Cash flow hedges...... - - - 12 403 24 - Net investment in foreign operations.......... - - - - - - - Non-hedging derivatives......... - - - (81) 3,670 - - -------- ------- ------- -------- ------- -------- -------- Total................. $ - $ - $ - $ (115) $ 4,073 $ 24 $ (2) ======== ======= ======= ======== ======= ======== ========2003Notional amount, 2002... $ - $ - $ 3,400 $ 44,506 $11,661 $ 376 $ (2,525)New contracts........... 600 (600) - 7,601 1,219 20,102 (17,548)New contracts purchased from subsidiaries of HSBC.................. - - 3,385 25,369 10,399 3,144 (642)Matured or expired contracts............. - - (4,404) (15,137) (1,401) (3,190) 912Terminated contracts.... - - (481) (11,984) (146) - -In-substance maturities(1)......... (600) 600 - - - (19,209) 19,209Assignment of contracts to subsidiaries of HSBC.................. - - - (9,043) (5,194) - -Loss of shortcut accounting(2): Terminated contracts........... - - - (26,530) - - - New contracts......... - - - 26,530 - - - -------- ------- ------- -------- ------- -------- --------Notional amount, 2003... $ - $ - $ 1,900 $ 41,312 $16,538 $ 1,223 $ (594) ======== ======= ======= ======== ======= ======== ========Fair value, 2003 (Restated)(3): Fair value hedges..... $ - $ - $ - $ 138 $ 101 $ - $ (23) Cash flow hedges...... - - - (147) 419 41 - Net investment in foreign operations.......... - - - - - - - Non-hedging derivatives......... - - - (162) 2,500 - - -------- ------- ------- -------- ------- -------- -------- Total................. $ - $ - $ - $ (171) $ 3,020 $ 41 $ (23) ======== ======= ======= ======== ======= ======== ======== NON-EXCHANGE TRADED ------------------------------ INTEREST RATE FORWARD CONTRACTS CAPS -------------------- AND PURCHASED SOLD FLOORS TOTAL------------------------ ----------------------------------------- (IN MILLIONS)2004Notional amount, 2003... $ 174 $ - $ 6,627 $ 68,368New contracts........... - - - 3,060New contracts purchased from subsidiaries of HSBC.................. 1,643 - 444 73,408Matured or expired contracts............. (1,443) - (2,691) (35,992)Terminated contracts.... - - - (12,544)In-substance maturities(1)......... - - - (10,700)Assignment of contracts to subsidiaries of HSBC.................. - - - (13,992) ------- ---- ------- --------Notional amount, 2004... $ 374 $ - $ 4,380 $ 71,608 ======= ==== ======= ========Fair value, 2004(3): Fair value hedges..... $ - $ - $ - $ (48) Cash flow hedges...... - - - 439 Net investment in foreign operations.......... - - - - Non-hedging derivatives......... - - - 3,589 ------- ---- ------- -------- Total................. $ - $ - $ - $ 3,980 ======= ==== ======= ========2003Notional amount, 2002... $ 159 $ - $ 7,221 $ 69,848New contracts........... 906 - - 48,576New contracts purchased from subsidiaries of HSBC.................. 174 - 4,333 47,446Matured or expired contracts............. (506) - (4,927) (30,477)Terminated contracts.... (559) - - (13,170)In-substance maturities(1)......... - - - (39,618)Assignment of contracts to subsidiaries of HSBC.................. - - - (14,237)Loss of shortcut accounting(2): Terminated contracts........... - - - (26,530) New contracts......... - - - 26,530 ------- ---- ------- --------Notional amount, 2003... $ 174 $ - $ 6,627 $ 68,368 ======= ==== ======= ========Fair value, 2003 (Restated)(3): Fair value hedges..... $ - $ - $ - $ 216 Cash flow hedges...... - - - 313 Net investment in foreign operations.......... - - - - Non-hedging derivatives......... - - - 2,338 ------- ---- ------- -------- Total................. $ - $ - $ - $ 2,867 ======= ==== ======= ======== 146 EXCHANGE TRADED NON-EXCHANGE TRADED ------------------------------- ------------------------------------------ INTEREST RATE FOREIGN EXCHANGE FUTURES CONTRACTS INTEREST RATE CONTRACTS ------------------- OPTIONS RATE CURRENCY -------------------- PURCHASED SOLD PURCHASED SWAPS SWAPS PURCHASED SOLD------------------------------------------------------------------------------------------------------ (IN MILLIONS)2002Notional amount, 2001... $ 1,419 $(9,000) $ 2,000 $ 30,483 $ 8,694 $ 109 $ (1,202)New contracts........... 23,113 (8,218) 8,800 30,375 4,416 23,572 (24,350)Matured or expired contracts............. (7,932) 618 (3,400) (10,385) (917) (1,609) 1,363Terminated contracts.... - - (4,000) (5,967) (532) (30) -In-substance maturities(1)......... (16,600) 16,600 - - - (21,665) 21,665 -------- ------- ------- -------- ------- -------- --------Notional amount, 2002... $ - $ - $ 3,400 $ 44,506 $11,661 $ 377 $ (2,524) ======== ======= ======= ======== ======= ======== ========Fair value, 2002(3): Fair value hedges..... $ - $ - $ - $ 1,819 $ 22 $ - $ - Cash flow hedges...... - - - (514) 369 - - Net investment in foreign operations.......... - - - - - 1 (31) Non-hedging derivatives......... - - - 5 - - - -------- ------- ------- -------- ------- -------- -------- Total................. $ - $ - $ - $ 1,310 $ 391 $ 1 $ (31) ======== ======= ======= ======== ======= ======== ======== NON-EXCHANGE TRADED ------------------------------ INTEREST RATE FORWARD CONTRACTS CAPS -------------------- AND PURCHASED SOLD FLOORS TOTAL------------------------ ----------------------------------------- (IN MILLIONS)2002Notional amount, 2001... $ 500 $ - $ 3,013 $ 56,420New contracts........... 968 (39) 6,161 130,012Matured or expired contracts............. (1,160) 39 (1,945) (29,368)Terminated contracts.... (149) - (8) (10,686)In-substance maturities(1)......... - - - (76,530) ------- ---- ------- --------Notional amount, 2002... $ 159 $ - $ 7,221 $ 69,848 ======= ==== ======= ========Fair value, 2002(3): Fair value hedges..... $ - $ - $ - $ 1,841 Cash flow hedges...... - - - (145) Net investment in foreign operations.......... - - - (30) Non-hedging derivatives......... - - $ 6 11 ------- ---- ------- -------- Total................. $ - $ - $ 6 $ 1,677 ======= ==== ======= ======== --------------- (1) Represent contracts terminated as the market execution technique of closing the transaction either (a) just prior to maturity to avoid delivery of the underlying instrument or (b) at the maturity of the underlying items being hedged. (2) Under the Financial Accounting Standards Board's interpretations of SFAS 133, the shortcut method of accounting was no longer allowed for interest rate swaps which were outstanding at the time of the merger. During 2003, we restructured our interest rate swap portfolio to regain use of the shortcut method for a substantial number of our fair value hedges and to reduce the potential volatility of future earnings. (3) (Bracketed) unbracketed amounts represent amounts to be (paid) received by us had these positions been closed out at the respective balance sheet date. Bracketed amounts do not necessarily represent risk of loss as the fair value of the derivative financial instrument and the items being hedged must be evaluated together. See Note 25, "Fair Value of Financial Instruments," for further discussion of the relationship between the fair value of our assets and liabilities. 147We operate in three functional currencies, the U.S. dollar, the British poundand the Canadian dollar. The U.S. dollar is the functional currency forexchange-traded interest rate futures contracts and options. Non-exchange tradedinstruments are restated in U.S. dollars by country as follows: FOREIGN EXCHANGE INTEREST RATE INTEREST RATE CONTRACTS FORWARD OTHER RISK RATE CURRENCY ------------------- CONTRACTS MANAGEMENT SWAPS SWAPS PURCHASED SOLD PURCHASED INSTRUMENTS------------------------------------------------------------------------------------------------------- (IN MILLIONS)2004United States................. $42,365 $17,543 $1,146 $ (599) $ - $4,345Canada........................ 582 - - (15) 374 -United Kingdom................ 2,306 607 - - - 35 ------- ------- ------ ------- ---- ------ $45,253 $18,150 $1,146 $ (614) $374 $4,380 ======= ======= ====== ======= ==== ======2003United States................. $39,653 $14,995 $1,223 $ (593) $ - $6,595Canada........................ 405 - - (1) 174 -United Kingdom................ 1,254 1,543 - - - 32 ------- ------- ------ ------- ---- ------ $41,312 $16,538 $1,223 $ (594) $174 $6,627 ======= ======= ====== ======= ==== ======2002United States................. $42,682 $10,211 $ 351 $(2,524) $ - $7,194Canada........................ 270 - - - 159 -United Kingdom................ 1,554 1,450 26 - - 27 ------- ------- ------ ------- ---- ------ $44,506 $11,661 $ 377 $(2,524) $159 $7,221 ======= ======= ====== ======= ==== ====== The table below reflects the items hedged using derivative financial instrumentswhich qualify for hedge accounting at December 31, 2004. The critical terms ofthe derivative financial instruments have been designed to match those of therelated asset or liability. INTEREST FOREIGN RATE CURRENCY EXCHANGE RATE SWAPS SWAPS CONTRACTS------------------------------------------------------------------------------------------------- (IN MILLIONS)Investment securities....................................... $ - $ - $ -Commercial paper, bank and other borrowings................. 2,306 - 1,200Long term debt.............................................. 37,625 8,415 -Advances to foreign subsidiaries............................ - - 560 ------- ------- ------Total items hedged using derivative financial instruments... $39,931 $ 8,415 $1,760 ======= ======= ====== 148The following table summarizes the maturities and related weighted-averagereceive/pay rates of interest rate swaps outstanding at December 31, 2004: 2005 2006 2007 2008 2009 2010 THEREAFTER TOTAL------------------------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS)PAY A FIXED RATE/RECEIVE A FLOATING RATE: Notional value................ $8,159 $7,662 $1,042 $ 306 $ 569 $ - $ 589 $18,327 Weighted-average receive rate........................ 2.75% 1.65% 2.09% 2.46% 4.19% - 5.21% 2.37% Weighted-average pay rate..... 2.78 2.10 2.36 3.93 3.84 - 4.82 2.59 ------ ------ ------ ------ ------ ------ ------- -------PAY A FLOATING RATE/RECEIVE A FIXED RATE: Notional value................ $ - $ - $1,847 $5,552 $4,833 $1,568 $13,156 $26,926 Weighted-average receive rate........................ - - 2.94% 3.49% 4.05% 4.05% 4.87% 4.26% Weighted-average pay rate..... - - 2.14 2.25 2.49 1.90 2.39 2.32 ------ ------ ------ ------ ------ ------ ------- -------Total notional value............ $8,159 $7,662 $2,889 $5,828 $5,402 $1,568 $13,745 $45,253 ====== ====== ====== ====== ====== ====== ======= =======TOTAL WEIGHTED-AVERAGE RATES ON SWAPS: Receive rate.................. 2.75% 1.65% 2.63% 3.44% 4.06% 4.05% 4.88% 3.49% Pay rate...................... 2.78 2.10 2.22 2.34 2.63 1.90 2.49 2.43 The floating rates that we pay or receive are based on spot rates fromindependent market sources for the index contained in each interest rate swapcontract, which generally are based on either 1, 3 or 6-month LIBOR. Thesecurrent floating rates are different than the floating rates in effect when thecontracts were initiated. Changes in spot rates impact the variable rateinformation disclosed above. However, these changes in spot rates also impactthe interest rate on the underlying assets or liabilities. We use derivativefinancial instruments as either qualifying hedging instruments under SFAS 133 oreconomic hedges to hedge the volatility of earnings resulting from changes ininterest rates on the underlying hedged items. Use of interest rate swaps whichqualify as effective hedges under SFAS 133 increased our net interest income by77 basis points in 2004, 64 basis points in 2003 and 31 basis points in 2002. 17. INCOME TAXES-------------------------------------------------------------------------------- Total income taxes were: MARCH 29 JANUARY 1 YEAR ENDED THROUGH THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 28, DECEMBER 31, 2004 2003 2003 2002------------------------------------------------------------------------------------------------------ (RESTATED) (IN MILLIONS)Provision for income taxes related to operations.................................. $1,000 $690 $182 $695Income taxes related to adjustments included in common shareholder's(s') equity: Unrealized gains (losses) on investments and interest-only strip receivables, net..... (71) 105 (13) 53 Unrealized gains (losses) on cash flow hedging instruments...................... 61 (9) 57 (23) Minimum pension liability................... (2) - - (16) Foreign currency translation adjustments.... 12 - (7) (49) Exercise of stock based compensation........ (18) (15) (2) (12) ------ ---- ---- ----Total......................................... $ 982 $771 $217 $648 ====== ==== ==== ==== 149Provisions for income taxes related to operations were: MARCH 29 JANUARY 1 YEAR ENDED THROUGH THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 28, DECEMBER 31, 2004 2003 2003 2002------------------------------------------------------------------------------------------------------ (RESTATED) (IN MILLIONS)CURRENTUnited States................................. $ 593 $ 688 $ 74 $731Foreign....................................... 59 85 19 83 ------ ----- ---- ----Total current................................. 652 773 93 814 ------ ----- ---- ----DEFERREDUnited States................................. 348 (87) 91 (125)Foreign....................................... - 4 (2) 6 ------ ----- ---- ----Total deferred................................ 348 (83) 89 (119) ------ ----- ---- ----Total income taxes............................ $1,000 $ 690 $182 $695 ====== ===== ==== ==== The significant components of deferred income tax provisions attributable toincome from operations were: MARCH 29 JANUARY 1 YEAR ENDED THROUGH THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 28, DECEMBER 31, 2004 2003 2003 2002------------------------------------------------------------------------------------------------------ (RESTATED) (IN MILLIONS)Deferred income tax provision (excluding the effects of other components)................ $348 $ (83) $89 $(136)Adjustment of valuation allowance............. - - - 13Change in operating loss carryforwards........ - - - 4 ---- ----- --- -----Deferred income tax provision................. $348 $ (83) $89 $(119) ==== ===== === ===== Income before income taxes were: MARCH 29 JANUARY 1 YEAR ENDED THROUGH THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 28, DECEMBER 31, 2004 2003 2003 2002------------------------------------------------------------------------------------------------------ (RESTATED) (IN MILLIONS)United States................................. $2,786 $1,801 $379 $1,932Foreign....................................... 154 246 49 321 ------ ------ ---- ------Total income before income taxes.............. $2,940 $2,047 $428 $2,253 ====== ====== ==== ====== 150Effective tax rates are analyzed as follows: MARCH 29 JANUARY 1 YEAR ENDED THROUGH THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 28, DECEMBER 31, 2004 2003 2003 2002------------------------------------------------------------------------------------------------------ (RESTATED) (IN MILLIONS)Statutory federal income tax rate............. 35.0% 35.0% 35.0% 35.0%Increase (decrease) in rate resulting from: State and local taxes, net of federal benefit.................................. 1.4 1.4 1.9 1.4 Tax credits................................. (2.9) (3.0) (5.1) (3.8) Noncurrent tax requirements................. - (1.5) (3.0) (2.2) Nondeductible acquisition costs............. - - 11.0 - Other....................................... .5 1.8 2.7 .5 ---- ---- ---- ----Effective tax rate............................ 34.0% 33.7% 42.5% 30.9% ==== ==== ==== ==== Provision for U.S. income taxes had not been made on net undistributed earningsof foreign subsidiaries of $643 million at December 31, 2004 and $604 million atDecember 31, 2003. Determination of the amount of unrecognized deferred taxliability related to investments in foreign subsidiaries is not practicable. On October 22, 2004, the American Jobs Creation Act (the "AJCA") was signed intolaw. The AJCA includes a deduction of 85% of certain foreign earnings that arerepatriated, as defined in the AJCA. We may elect to apply this provision toqualifying earnings repatriations in 2005. We have started an evaluation of theeffects of the repatriation provision; however, we do not expect to be able tocomplete this evaluation until after Congress or the Treasury Department provideadditional clarifying language on key elements of the provision. We expect tocomplete our evaluation of the effects of the repatriation provision within areasonable period of time following the publication of the additional clarifyinglanguage. The range of possible amounts that we are considering for repatriationunder this provision is between $0 and $500 million. The related potential rangeof income tax is between $0 and $30 million. In addition, provision for U.S. income taxes had not been made at December 31,2004 on $80 million of undistributed, untaxed earnings of our life insurancesubsidiary's accumulated in its Policyholders' Surplus Account under tax laws ineffect prior to 1984. This amount would generally be subject to taxation in theevent our life insurance subsidiary made distributions in excess of itsShareholders' Surplus Account (generally undistributed accumulated after-taxearnings) and certain other events. If our life insurance subsidiary weresubject to tax on the full amount of its Policyholders' Surplus Account, theadditional income tax payable would be approximately $28 million. Unlike priorlaw provisions which treated distributions by a life insurance company as firstcoming out of its Shareholders' Surplus Account and then out of itsPolicyholders' Surplus Account, the AJCA contains provisions that would reversesuch order and treat distributions as first coming out of Policyholders' SurplusAccount and then Shareholders' Surplus Account. These new provisions alsoeliminate the imposition of the income tax on any such distributions from aPolicyholders' Surplus Account. Such provisions apply only to distributions madeby a life insurance company after December 31, 2004 and before January 1, 2007.At this time, management is evaluating the provisions of this law and isexpecting to use these provisions to eliminate some, if not all, of thePolicyholders' Surplus Account of our life insurance subsidiary. Household Bank, f.s.b., our U.S. savings and loan subsidiary which was disposedof in the fourth quarter of 2002, previously had credit loss reserves for taxpurposes that arose in years beginning before December 31, 1987 in the amount of$55 million. A deferred tax liability was not established previously since wedid not expect the amount to become taxable in the future. However, the sale ofsubstantially all of its assets and deposits in 2002 caused this amount tobecome taxable resulting in a $20 million tax liability. 151At December 31, 2004, we had net operating loss carryforwards of $865 millionfor state tax purposes which expire as follows: $320 million in 2005-2009; $145million in 2010-2014; $305 million in 2015-2019 and $95 million in 2020-2024. Temporary differences which gave rise to a significant portion of deferred taxassets and liabilities were as follows: AT DECEMBER 31, ------------------- 2004 2003--------------------------------------------------------------------------------- (RESTATED) (IN MILLIONS)DEFERRED TAX LIABILITIESIntangibles................................................. $ 934 $1,058Receivables sold............................................ 413 793Fee income.................................................. 375 475Receivables................................................. 231 337Deferred loan origination costs............................. 189 91Leveraged lease transactions, net........................... 129 202Other....................................................... 191 152 ------ ------Total deferred tax liabilities.............................. 2,462 3,108 ------ ------DEFERRED TAX ASSETSCredit loss reserves........................................ 1,497 2,035Market value adjustment..................................... 214 175Debt........................................................ 162 486Other....................................................... 470 539 ------ ------Total deferred tax assets................................... 2,343 3,235Valuation allowance......................................... (28) - ------ ------Total deferred tax assets net of valuation allowance........ 2,315 3,235 ------ ------Net deferred tax liability (asset).......................... $ 147 $ (127) ====== ====== During 2004, a review of the deferred tax balances was completed and, as aresult, the 2003 deferred tax assets and liabilities were realigned with theirunderlying tax and financial accounting basis differences. Additionally, anincrease to total 2003 deferred tax assets of $6 million was recorded with areduction to goodwill. 18. PREFERRED STOCK-------------------------------------------------------------------------------- In conjunction with the HSBC merger, our 7.625%, 7.60%, 7.50% and 8.25%preferred stock was converted into the right to receive cash which totaledapproximately $1.1 billion. In consideration of HSBC transferring sufficientfunds to make these payments, we issued the Series A cumulative preferred stockto HSBC on March 28, 2003. Also on March 28, 2003, we called for redemption our$4.30, $4.50 and 5.00% preferred stock. As of December 31, 2004, there were 1,100 shares of the Series A cumulativepreferred stock outstanding. Through a series of transactions which concluded inOctober 2004, the Series A preferred shares were transferred from HSBC HINO. SeeNote 20, "Related Party Transactions," for further discussion. Dividends arecumulative and payable annually at a rate of 6.5 percent. The Series A preferredstock may be redeemed at our option after March 31, 2008. The redemption andliquidation value is $1 million per share plus accrued and unpaid dividends. Theholder of the Series A preferred stock is entitled to payment before any capitaldistribution is made to the common shareholder and is entitled to vote with theholder of our common stock on matters including the dissolution, liquidation orsale of our assets or business. 15219. ACCUMULATED OTHER COMPREHENSIVE INCOME-------------------------------------------------------------------------------- As a result of push-down accounting resulting from our merger with HSBC, thebalances associated with the components of accumulated other comprehensiveincome (loss) on a "predecessor" basis were eliminated effective March 28, 2003when the "successor" period began. Accumulated other comprehensive income (loss)includes the following: DECEMBER 31, DECEMBER 31, MARCH 28, DECEMBER 31, DECEMBER 31, 2004 2003 2003 2002 2001----------------------------------------------------------------------------------------------------------- (SUCCESSOR) (SUCCESSOR) (PREDECESSOR) (PREDECESSOR) (RESTATED) (PREDECESSOR) (IN MILLIONS)Unrealized gains (losses) on cash flow hedging instruments................. $119 $(11) $(636) $(737) $(699)Unrealized gains on investments and interest-only strip receivables: Gross unrealized gains...... 88 273 462 500 352 Income tax expense.......... 34 105 168 181 128 ---- ---- ----- ----- -----Net unrealized gains.......... 54 168 294 319 224Minimum pension liability..... (4) - (30) (30) -Foreign currency translation adjustments................. 474 286 (271) (247) (257) ---- ---- ----- ----- -----Total accumulated other comprehensive income (loss)...................... $643 $443 $(643) $(695) $(732) ==== ==== ===== ===== ===== The table below shows the changes in each component of accumulated othercomprehensive income. TAX (EXPENSE) BEFORE-TAX BENEFIT NET-OF-TAX------------------------------------------------------------------------------------------------- (IN MILLIONS)YEAR ENDED DECEMBER 31, 2002 (PREDECESSOR)Unrealized gains (losses) on cash flow hedging instruments: Net losses arising during the period...................... $(712) $ 261 $(451) Less: Reclassification adjustment for losses realized in net income............................................. 652 (238) 414 ----- ----- ----- Net losses on cash flow hedging instruments............... (60) 23 (37)Unrealized gains (losses) on investments and interest-only strip receivables: Net unrealized holding gains arising during the period.... 156 (55) 101 Less: Reclassification adjustment for gains realized in net income............................................. (7) 2 (5) ----- ----- ----- Net unrealized gains on investments and interest-only strip receivables...................................... 149 (53) 96Minimum pension liability................................... (47) 16 (31)Foreign currency translation adjustments.................... (40) 49 9 ----- ----- -----Other comprehensive income.................................. $ 2 $ 35 $ 37 ===== ===== ===== 153 TAX (EXPENSE) BEFORE-TAX BENEFIT NET-OF-TAX------------------------------------------------------------------------------------------------- (IN MILLIONS)JANUARY 1 THROUGH MARCH 28, 2003 (PREDECESSOR)Unrealized gains (losses) on cash flow hedging instruments: Net gains arising during the period....................... $ 29 $ (10) $ 19 Less: Reclassification adjustment for losses realized in net income............................................. 129 (47) 82 ----- ----- ----- Net gains on cash flow hedging instruments................ 158 (57) 101Reclassification adjustment for gains realized in net income on investments and interest-only strip receivables........ (38) 13 (25)Foreign currency translation adjustments.................... (31) 7 (24) ----- ----- -----Other comprehensive income.................................. $ 89 $ (37) $ 52 ===== ===== =====MARCH 29 THROUGH DECEMBER 31, 2003 (SUCCESSOR) (RESTATED)Unrealized gains (losses) on cash flow hedging instruments: Net gains arising during the period....................... $ (41) $ 19 $ (22) Less: Reclassification adjustment for losses realized in net income............................................. 21 (10) 11 ----- ----- ----- Net gains on cash flow hedging instruments................ (20) 9 (11)Unrealized gains (losses) on investments and interest-only strip receivables: Net unrealized holding gains arising during the period.... 290 (111) 179 Less: Reclassification adjustment for gains realized in net income............................................. (17) 6 (11) ----- ----- ----- Net unrealized gains on investments and interest-only strip receivables...................................... 273 (105) 168Foreign currency translation adjustments.................... 286 - 286 ----- ----- -----Other comprehensive income.................................. $ 539 $ (96) $ 443 ===== ===== =====YEAR ENDED DECEMBER 31, 2004 (SUCCESSOR)Unrealized gains (losses) on cash flow hedging instruments: Net gains arising during the period....................... $ 106 $ (34) $ 72 Less: Reclassification adjustment for losses realized in net income............................................. 85 (27) 58 ----- ----- ----- Net gains on cash flow hedging instruments................ 191 (61) 130Unrealized gains (losses) on investments and interest-only strip receivables: Net unrealized holding losses arising during the period... (173) 67 (106) Less: Reclassification adjustment for gains realized in net income............................................. (12) 4 (8) ----- ----- ----- Net unrealized losses on investments and interest-only strip receivables...................................... (185) 71 (114)Minimum pension liability................................... (6) 2 (4)Foreign currency translation adjustments.................... 200 (12) 188 ----- ----- -----Other comprehensive income.................................. $ 200 $ -- $ 200 ===== ===== ===== 20. RELATED PARTY TRANSACTIONS-------------------------------------------------------------------------------- In the normal course of business, we conduct transactions with HSBC and itssubsidiaries. These transactions include funding arrangements, purchases andsales of receivables, servicing arrangements, information technology services,item and statement processing services, banking and other miscellaneousservices. The 154following tables present related party balances and the income and (expense)generated by related party transactions: AT DECEMBER 31, ------------------ 2004 2003-------------------------------------------------------------------------------- (IN MILLIONS)ASSETS, (LIABILITIES) AND EQUITY:Derivative financial assets, net............................ $ 3,297 $ 1,789Other assets................................................ 604 1Due to affiliates........................................... (13,789) (7,589)Other liabilities........................................... (168) (26)Preferred stock............................................. 1,100 1,100INCOME/(EXPENSE):Interest expense on borrowings from HSBC and subsidiaries... $ (343) $ (73)Interest income on HSBC USA, Inc. advances.................. 5 -HSBC Bank USA, National Association: Real estate secured servicing revenues.................... 13 - Real estate secured sourcing, underwriting and pricing revenues............................................... 4 - Gain on bulk sale of domestic private label receivable portfolio.............................................. 663 - Gain on daily sale of domestic private label receivable originations........................................... 3 - Gain on sale of real estate secured and MasterCard/Visa receivables............................................ 36 16 Other servicing, processing, origination and support revenues............................................... 19 -Support services from HSBC affiliates....................... (750) -HTSU: Rental revenue............................................ 33 - Administrative services revenue........................... 18 -Other income from HSBC affiliates........................... 3 - The notional value of derivative contracts outstanding with HSBC subsidiariestotaled $62.6 billion at December 31, 2004 and $39.7 billion at December 31,2003. Affiliate swap counterparties have provided collateral in the form ofsecurities which are not recorded on our balance sheet and totaled $2.2 billionat December 31, 2004 and $.5 billion at December 31, 2003. During the second quarter of 2004, we made advances to our immediate parent,HINO, totaling $266 million which were repaid during the third quarter of 2004. During the third quarter of 2004 we extended a line of credit of $1 billion toHSBC USA, Inc. During the fourth quarter of 2004, we increased the availablebalance on the line of credit to $2 billion. The balance outstanding under theline of credit at December 31, 2004 was $604 million and is included in otherassets. Interest income associated with this line of credit is recorded ininterest income and reflected as interest income on HSBC USA, Inc. advances inthe table above. Due to affiliates includes amounts owed to subsidiaries of HSBC (other thanpreferred stock). This funding was at interest rates (both the underlyingbenchmark rate and credit spreads) comparable to third-party rates for debt withsimilar maturities. At December 31, 2004, we had revolving credit facilities of $2.5 billion fromHSBC domestically and $7.5 billion from HSBC in the U.K., which was increased to$8.0 billion in January 2005. A $4.0 billion domestic revolving credit facilitywith HSBC Private Bank (Suisse) SA, which was new in 2004, expired on December30, 2004. As of December 31, 2004, $7.4 billion was outstanding under the U.K.lines and no balances were outstanding on the domestic lines. As of December 31,2003, $3.4 billion was outstanding on the U.K. lines and no balances wereoutstanding on the domestic lines. Annual commitment fee requirements to 155support availability of these lines totaled $2 million in 2004 and $2 million in2003 and are included as a component of interest expense. In the first quarter of 2004, we sold approximately $.9 billion of real estatesecured receivables from our mortgage services business to HSBC Bank USA andrecorded a pre-tax gain of $15 million on the sale. Under a separate servicingagreement, we have agreed to service all real estate secured receivables sold toHSBC Bank USA including all future business they purchase from ourcorrespondents. As of December 31, 2004, we were servicing $5 billion of realestate secured receivables for HSBC Bank USA. We also received fees from HSBCBank USA pursuant to a service level agreement under which we sourced,underwrote and priced $2.8 billion of real estate secured receivables purchasedby HSBC Bank USA during 2004. These revenues have been recorded as other incomeand are reflected as real estate secured servicing revenues and real estatesecured sourcing, underwriting and pricing revenues from HSBC Bank USA in theabove table. In December 2004 we sold our domestic private label receivable portfolio,including the retained interests associated with our securitized domesticprivate label receivables to HSBC Bank USA for $12.4 billion. We recorded anafter-tax gain on the sale of $423 million. See Note 5, "Sale of DomesticPrivate Label Receivable Portfolio and Adoption of FFIEC Policies." We willcontinue to service the sold private label receivables and will receiveservicing fee income from HSBC Bank USA for these services. Servicing fee incomefrom HSBC Bank USA received in December 2004 for servicing the domestic privatelabel credit card receivables subsequent to the initial bulk sale totaled $2.9million and is included in the table above as a component of other servicing,processing, origination and support revenues from HSBC Bank USA. We continue tomaintain the related customer account relationships and, therefore, will sellnew domestic private label receivable originations to HSBC Bank USA on a dailybasis. Gains on the daily sale of new domestic private label receivableoriginations of $3 million were recorded in December 2004 subsequent to theinitial bulk sale. Under various service level agreements, we also provide various services to HSBCBank USA. These services include credit card servicing and processing activitiesthrough our credit card services business, loan origination and servicingthrough our auto finance business and other operational and administrativesupport. Fees received for these services are reported as other income and areincluded in the table above as a component of other servicing, processing,origination and support revenues from HSBC Bank USA. During 2003, Household Capital Trust VIII issued $275 million in mandatorilyredeemable preferred securities to HSBC. The terms of this issuance were asfollows: (DOLLARS ARE IN MILLIONS)Junior Subordinated Notes: Principal balance...................................... $284 Redeemable by issuer................................... September 26, 2008 Stated maturity........................................ November 15, 2033Preferred Securities: Rate................................................... 6.375% Face value............................................. $275 Issue date............................................. September 2003 During 2004, our Canadian business began to originate and service auto loans foran HSBC affiliate in Canada. Fees received for these services are included inother income and are reflected in other income from HSBC affiliates in the abovetable. In preparation for the 2005 federal tax return preparation season, effectiveOctober 1, 2004 HSBC Bank USA became the originating lender for loans initiatedby our taxpayer financial services business for clients of various third partytax preparers. On July 1, 2004, Household Bank (SB), N.A. purchased the account relationshipsassociated with $970 million of MasterCard and Visa credit card receivables fromHSBC Bank USA for approximately $99 million which are included in intangibleassets. The receivables will continue to be owned by HSBC Bank 156USA. Originations of new accounts and receivables are made by Household Bank(SB), N.A. and new receivables are sold daily to HSBC Bank USA. Gains on thedaily sale of credit card receivables to HSBC Bank USA are recorded in otherincome. As part of ongoing integration efforts, HSBC has instituted certain changes toits North American organization structure. Among these initiatives was thecreation of a new technology services company, HSBC Technology and Services(USA) Inc. ("HTSU"). Effective January 1, 2004, our technology servicesemployees, as well as technology services employees from other HSBC entities inNorth America, were transferred to HTSU. In addition, technology related assetsand software purchased subsequent to January 1, 2004 are generally purchased andowned by HTSU. Technology related assets owned by HSBC Finance Corporation priorto January 1, 2004 currently remain in place and were not transferred to HTSU.In addition to information technology services, HTSU also provides certain itemprocessing and statement processing activities to us pursuant to a masterservice level agreement. As a result of these changes, operating expensesrelating to services provided by HTSU, which have previously been reported assalaries and fringe benefits, occupancy and equipment expenses or otherservicing and administrative expenses, are now reported as support services fromHSBC affiliates. Support services from HSBC affiliates includes servicesprovided by HTSU as well as banking services and other miscellaneous servicesprovided by HSBC Bank USA and other subsidiaries of HSBC. We also receiverevenue from HTSU for certain office space which we have rented to them, whichhas been recorded as a reduction of occupancy and equipment expenses, and forcertain administrative costs, which has been recorded as other income. In addition, we utilize a related HSBC entity to lead manage a majority of ourongoing debt issuances. Fees paid for such services totaled approximately $18million in 2004 and approximately $17 million for the period March 29 throughDecember 31, 2003. These fees are amortized over the life of the related debt asa component of interest expense. In consideration of HSBC transferring sufficient funds to make the paymentsdescribed in Note 4 with respect to certain HSBC Finance Corporation preferredstock, we issued the Series A preferred stock in the amount of $1.1 billion toHSBC on March 28, 2003. In September 2004, HNAH issued a new series of preferredstock totaling $1.1 billion to HSBC in exchange for our outstanding Series Apreferred stock. In October 2004, we paid the accrued dividend of $108 millionon our Series A preferred stock. Also in October 2004, our immediate parent,HINO, issued a new series of preferred stock to HNAH in exchange for our SeriesA preferred stock. 21. STOCK OPTION PLANS-------------------------------------------------------------------------------- STOCK OPTION PLANS The HSBC Holdings Group Share Option Plan (the "Group ShareOption Plan"), which replaced the former Household stock option plans, is along-term incentive compensation plan available to certain employees. Grants areusually made annually. Options granted to employees in 2004 vest 100% upon theattainment of certain performance conditions in either year 3, 4 or 5 and expire10 years from the date of grant. Options granted to employees in 2003 will vest75 percent in year three with the remaining 25 percent vesting in year four andexpire ten years from the date of grant. Options are granted at market value.Compensation expense related to the Group Share Option Plan, which is recognizedover the vesting period, totaled $8 million in 2004 and $1 million for theperiod March 29 through December 31, 2003. Beginning in 2005, no further optionswill be granted to employees although existing stock option grants will remainin effect subject to the same conditions as before. Instead employees willreceive grants of shares of HSBC stock subject to certain vesting conditions. 157Information with respect to the Group Share Option Plan is as follows: 2004 2003 --------------------- --------------------- WEIGHTED- WEIGHTED- HSBC AVERAGE HSBC AVERAGE ORDINARY PRICE PER ORDINARY PRICE PER SHARES SHARE SHARES SHARE-------------------------------------------------------------------------------------------------Outstanding at beginning of year.................. 4,069,800 $15.31 - $ -Granted........................................... 2,638,000 14.37 4,069,800 15.31Exercised......................................... - - - -Transferred....................................... (462,000) 14.69 - -Expired or canceled............................... - - - - --------- ------ --------- ------Outstanding at end of year........................ 6,245,800 14.96 4,069,800 15.31 ========= ====== ========= ======Exercisable at end of year........................ - $ - - $ -Related Shares:
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