30th Jul 2007 11:39
HSBC Holdings PLC30 July 2007 PART 2 Residential Mortgage Loans Held for Sale to an HSBC Affiliate In 2005, HUSI began acquiring residential mortgage loans from unaffiliated thirdparties with the intent of selling these loans to an HSBC affiliate, HSBCMarkets (USA) Inc. (HMUS). HMUS in turn is selling these loans to securitizationvehicles. During 2006, HUSI also began acquiring residential mortgage loans fromHSBC Finance Corporation under this program. These loans, which primarilyinclude sub-prime residential mortgage loans, are recorded by HUSI at the lowerof their aggregate cost or market value, with adjustments to market value beingrecorded as a valuation allowance. The loans are generally held on HUSI'sbalance sheet for 30-90 days, resulting in activity that affects variousconsolidated financial statement line items, as summarized in the table below.HUSI maintains a portfolio of derivatives and securities, which are used aseconomic hedges to offset changes in market values of the loans held for sale toHMUS. Gains on sales associated with these loans result from incremental valuerealized on pools of loans sold to HMUS for securitization. Activity recorded as a result of acquiring, holding and selling these loans issummarized in the following tables. Lower results and activity for this programfor the second quarter and the first six months of 2007 primarily resulted fromthe overall weakness in the U.S. residential mortgage market. -----------------------------------------------------------------------------------------------------------Three months ended June 30 2007 2006----------------------------------------------------------------------------------------------------------- (in millions) Residential mortgage loans held for sale to HMUS: Balance at beginning of period ..................................................... $ 3,745 $ 4,497 Loans acquired from originators .................................................... 1,564 4,784 Loans sold to HMUS ................................................................. (2,096) (4,413) Other, primarily loans resold to originators and other third parties ............... (154) (61) ------- ------- Balance at end of period ........................................................... $ 3,059 $ 4,807 ======= ======= Valuation allowance for changes in market value of loans held for sale to HMUS: Balance at beginning of period ..................................................... $ (24) $ (50) Valuation allowance increase for changes in market value ........................... (65) (73) Releases of valuation allowance for loans sold to HMUS ............................. 40 40 ------- ------- Balance at end of period ........................................................... $ (49) $ (83) ======= ======= Impact on income before income taxes: Net interest income associated with loans held for sale to HMUS (1) ................ $ 15 $ 18 Gains on sale of residential mortgage loans sold to HMUS, recorded in HSBC affiliate income ................................................................ 7 52 Valuation allowance increase for changes in market value of loans held for sale to HMUS, recorded in other income .................................................. (65) (73) Trading revenues recognized from economic hedges held to offset changes in market values of loans held for sale to HMUS (1) ....................................... 40 52 Net program costs included in other expenses ....................................... (4) (2) ------- ------- Net impact on income before income taxes ........................................... $ (7) $ 47 ======= ======= (1) Refer to trading revenues commentary beginning on page 43 of this Form 10-Q. 39 -----------------------------------------------------------------------------------------------------------Six months ended June 30 2007 2006----------------------------------------------------------------------------------------------------------- (in millions) Residential mortgage loans held for sale to HMUS: Balance at beginning of period ..................................................... $ 3,116 $ 2,907 Loans acquired from originators .................................................... 5,029 10,130 Loans sold to HMUS ................................................................. (4,688) (8,156) Other, primarily loans resold to originators and other third parties ............... (398) (74) ------- ------- Balance at end of period ........................................................... $ 3,059 $ 4,807 ======= ======= Valuation allowance for changes in market value of loans held for sale to HMUS: Balance at beginning of period ..................................................... $ (26) $ (11) Valuation allowance increase for changes in market value ........................... (75) (152) Releases of valuation allowance for loans sold to HMUS ............................. 52 80 ------- ------- Balance at end of period ........................................................... $ (49) $ (83) ======= ======= Impact on income before income taxes: Net interest income associated with loans held for sale to HMUS (1) ................ $ 32 $ 38 Gains on sale of residential mortgage loans sold to HMUS, recorded in HSBC affiliate income ................................................................ 8 64 Valuation allowance increase for changes in market value of loans held for sale to HMUS, recorded in other income .................................................. (75) (152) Trading revenues recognized from economic hedges held to offset changes in market values of loans held for sale to HMUS (1) ....................................... 25 116 Net program costs included in other expenses ....................................... (12) (3) ------- ------- Net impact on income before income taxes ........................................... $ (22) $ 63 ======= ======= (1) Refer to trading revenues commentary beginning on page 43 of this Form 10-Q. Credit Card Fees Higher credit card fees in 2007 from private label and co-brand credit cardportfolio activity included within the CF business segment were primarily due tothe following factors. o Credit card receivables included in off-balance sheet securitization transactions for the first six months of 2006 were included in on-balance sheet credit card receivables for the first six months of 2007. Late fees associated with these receivables, which were recorded in securitization revenue in 2006 (refer to other income commentary below), are recorded in credit card fees for 2007. o The number of accounts, volume of customer transaction activity and average receivable balances included within the private label portfolio all were higher for 2007, due to the addition of merchant and customer relationships and to expansion of credit card products offered. Product repricing also resulted in higher fees. o Higher late fees due to increased delinquencies within the private label portfolio. HSBC Affiliate Income Higher fees and commissions from HSBC affiliates was primarily due to increasedcustomer referral and other fees from HMUS and HSBC associated with currentexpansion of the payments and cash management business and previous expansion ofvarious trading businesses. Fees from HSBC Finance Corporation for loanservicing have also increased in 2007. Other Income HUSI recorded no securitization revenue in the first six months of 2007. In thethird quarter of 2006, the last remaining securitization trust agreement relatedto the private label credit card receivable portfolio was amended. As a result,the trust no longer qualified for sale treatment and all assets and liabilitiesof the trust were returned to HUSI's consolidated balance sheet. In addition,all new collateralized funding transactions have been structured as securedfinancings since the third quarter of 2004. The loss of securitization revenuefor 2007 was offset by higher net interest income and higher fee revenue (referto previous credit card fees commentary) from the receivables and liabilitiesthat were returned to the consolidated balance sheet. 40 The PB business segment includes an equity investment in a non-consolidatedforeign HSBC affiliate (the foreign equity investment). During the third quarterof 2006, the foreign equity investment sold a portion of its investment in aforeign equity fund to another HSBC affiliate. During the second quarter of2007, the foreign equity investment sold its remaining investment in the foreignequity fund, resulting in a gain from which HUSI recorded additional equityearnings of $7 million. Excluding the impact of this transaction, the decreasein equity investment holdings resulted in lower equity earnings for the firstsix months of 2007. In the second quarter of 2006, MasterCard International, Inc. completed aninitial public offering, which resulted in redemption of shares held by HUSI andby other financial institutions. Proceeds from this redemption were recorded asmiscellaneous income for 2006. Residential Mortgage Banking Revenue The following tables present the components of residential mortgage bankingrevenue. Net interest income includes interest earned/paid on assets andliabilities of the residential mortgage banking business, as well as the fundingcost or benefit associated with these balances. The net interest incomecomponent in the table is included in net interest income in the consolidatedstatement of income and reflects actual interest earned, net of cost of funds,and adjusted for corporate transfer pricing. ------------------------------------------------------------------------------------------------------- Increase (Decrease) -------------------Three months ended June 30 2007 2006 Amount %------------------------------------------------------------------------------------------------------- ($ in millions) Net interest income ...................................... $ 67 $ 87 $(20) (23) ---- ---- ---- ---Servicing related income: Servicing fee income .................................. 29 24 5 21 Changes in fair value of MSRs due to (1): Changes in valuation inputs or assumptions used in valuation model ............... 57 30 27 90 Realization of cash flows ........................... (22) (18) (4) (22) Trading - Derivative instruments used to offset changes in value of MSRs ........................... (51) (23) (28) (122) ---- ---- ---- --- 13 13 -- -- ---- ---- ---- ---Originations and sales related income: Gains on sales of residential mortgages ............... 22 8 14 175 Trading and fair value hedge activity ................. -- -- -- -- ---- ---- ---- --- 22 8 14 175 ---- ---- ---- ---Other mortgage income .................................... 7 6 1 17 ---- ---- ---- ---Total residential mortgage banking revenue included in other revenues ....................................... 42 27 15 56 ---- ---- ---- ---Total residential mortgage banking related revenue ....... $109 $114 $ (5) (4) ==== ==== ==== === ------------------------------------------------------------------------------------------------------- Increase (Decrease) -------------------Six months ended June 30 2007 2006 Amount %------------------------------------------------------------------------------------------------------- ($ in millions) Net interest income ...................................... $139 $182 $(43) (24) ---- ---- ---- ---Servicing related income: Servicing fee income .................................. 56 48 8 17 Changes in fair value of MSRs due to (1): Changes in valuation inputs or assumptions used in valuation model ............... 64 75 (11) (15) Realization of cash flows ........................... (46) (39) (7) (18) Trading - Derivative instruments used to offset changes in value of MSRs ........................... (54) (57) 3 5 ---- ---- ---- --- 20 27 (7) (26) ---- ---- ---- ---Originations and sales related income: Gains on sales of residential mortgages ............... 29 11 18 164 Trading and fair value hedge activity ................. -- 1 (1) * ---- ---- ---- --- 29 12 17 142 ---- ---- ---- ---Other mortgage income .................................... 14 11 3 27 ---- ---- ---- ---Total residential mortgage banking revenue included in other revenues ....................................... 63 50 13 26 ---- ---- ---- ---Total residential mortgage banking related revenue ....... $202 $232 $(30) (13) ==== ==== ==== === * Not meaningful. 41 Net Interest Income Decreased net interest income for the second quarter and first six months of2007 resulted from lower average residential mortgage loans outstanding as wellas a slight narrowing of interest rate spreads. During 2007, HUSI continued tosell the majority of new loan originations to government sponsored enterprisesand private investors and to allow existing loans to runoff. The held loansportfolio is expected to continue to decline for the remainder of 2007 as aresult of this initiative. Servicing Related Income Higher servicing fee income for the second quarter and first six months of 2007resulted from a higher volume of loans included within the average servicedloans portfolio. The average serviced portfolio increased approximately 13% inthe second quarter and first six months of 2007 due to the following factors: o HUSI sold a larger volume of loans in the second quarter and first six months of 2007 as compared to the same timeframes in 2006; and o in the first six months of 2007, HUSI commenced servicing a portfolio of loans previously serviced by a third party. The increased serviced loans portfolio, and its positive impact on service feeincome, was partially offset by a decrease in value of the hedged MSRs portfolioincluding an increase in realization of cash flows on the growing portfolio ofloans serviced for others for the second quarter and the first six months of2007. Originations and Sales Related Income Higher originations and sales related income for the second quarter and firstsix months of 2007 resulted from: o higher basis point gains on individual sales of residential mortgages; and o increased volume of residential mortgages originated with the intention to sell, which increased 4% for the first six months of 2007. 42 Trading Revenues Trading revenues are generated by HUSI's participation in the foreign exchange,credit derivative and precious metal markets; from trading derivative contracts,including interest rate swaps and options; from trading securities; and as aresult of certain residential mortgage banking activities. The following table summarizes trading related revenues by business. The data inthe table includes net interest income earned on trading instruments, as well asan allocation of the funding benefit or cost associated with the tradingpositions. The trading related net interest income component is included in netinterest income on the consolidated income statement. Trading revenues relatedto the mortgage banking business are included in residential mortgage bankingrevenue. ------------------------------------------------------------------------------------------------------- Increase (Decrease) ------------------- 2007 2006 Amount %------------------------------------------------------------------------------------------------------- ($ in millions) Three months ended June 30:Trading revenues ......................................... $312 $269 $ 43 16Net interest expense ..................................... (5) (17) 12 71 ---- ---- ---- ----Trading related revenues ................................. $307 $252 $ 55 22 ==== ==== ==== ==== Business: Derivatives instruments ............................... $181 $ 83 $ 98 118 Economic hedges of loans held for sale to HMUS ........ 55 70 (15) (21) Treasury (primarily securities) ....................... 6 4 2 50 Foreign exchange and banknotes ........................ 59 52 7 13 Precious metals ....................................... 8 36 (28) (78) Other trading ......................................... (2) 7 (9) (123) ---- ---- ---- ----Trading related revenues ................................. $307 $252 $ 55 22 ==== ==== ==== ==== Six months ended June 30:Trading revenues ......................................... $449 $548 $(99) (18)Net interest expense ..................................... (29) (31) 2 6 ---- ---- ---- ----Trading related revenues ................................. $420 $517 $(97) (19) ==== ==== ==== ==== Business: Derivatives instruments ............................... $233 $173 $ 60 35 Economic hedges of loans held for sale to HMUS ........ 57 154 (97) (63) Treasury (primarily securities) ....................... (6) 9 (15) 167 Foreign exchange and banknotes ........................ 114 95 19 20 Precious metals ....................................... 23 71 (48) (68) Other trading ......................................... (1) 15 (16) (107) ---- ---- ---- ----Trading related revenues ................................. $420 $517 $(97) (19) ==== ==== ==== ==== During the first half of 2006, a wider range of product offerings and enhancedsales capabilities within the CIBM business segment, along with favorable marketconditions in certain sectors, drove significant trading gains across all majorclient-related activities. Successful launches of new products and increasedsales of structured products that are tailored to specific customer needs led tostrong derivatives trading revenues. Gains in the precious metals businessreflected volume growth driven by a surge in demand arising from strongcommodities markets. Income streams in the foreign exchange business remainedrobust against the backdrop of a weakening U.S. dollar. The first half of 2007 was bolstered by strong derivatives revenues resultingfrom previous expansion of product capabilities in structured credit andemerging markets derivatives. This performance was partially offset by thecredit weakness in the sub-prime lending market which impacted mortgage backedsecurities. In addition, the CIBM business segment experienced a decline inprecious metals revenue related to lower price volatility. Effective during the second quarter of 2006, HUSI maintains a portfolio ofMasterCard International, Inc. Class B shares (the MasterCard B shares) as partof a structured product transaction for a customer. In addition, HUSI usesderivative instruments to offset changes in the fair value of the MasterCard Bshares. The decrease in value of the derivative instruments, which totaled $69million and $77 million for the second quarter and first half of 2007, isreflected in trading revenue from derivative instruments. There were no fairvalue adjustments recorded for the first half of 2006 related to thesederivative instruments. Under U.S. GAAP, the increased value of the MasterCardClass B shares is not recognized until they are sold. 43 HUSI also maintains a portfolio of derivative instruments that are utilized aseconomic hedges to offset changes in market values of loans held for sale toHMUS. Lower revenues from economic hedges of loans held for sale to HMUSresulted from the overall weakness of the U.S. housing market, which impactedresidential mortgage related revenues. Lower trading results related to thisprogram are generally offset by the changes in the valuation allowance relatedto loans held for sale to HMUS, which is recorded in other revenues. Furtheranalysis and commentary regarding these loans and the associated hedges isprovided beginning on page 39 of this Form 10-Q. HUSI recognizes gain or loss at the inception of derivative transactions onlywhen the fair value of the transaction can be verified to market transactions orif all significant pricing model assumptions can be verified to observablemarket data. Gain or loss not recognized at inception is recorded in tradingassets and recognized over the term of the derivative contract, or when marketdata becomes observable. The availability of observable market data resulted inrecognition of $7 million and $35 million in trading revenues for the first sixmonths of 2007 and 2006, respectively. Securities Gains, Net HUSI maintains various securities portfolios as part of its overall balancesheet diversification and risk management strategies. The following tablesummarizes net securities gains resulting from various strategies. -------------------------------------------------------------------------------- 2007 2006-------------------------------------------------------------------------------- (in millions)Three months ended June 30:Balance sheet diversity and reduction of risk ................ $ 1 $--Management of Latin American investment exposure ............. 15 --Other ........................................................ -- 6 --- ---Securities gains, net ........................................ $16 $ 6 === === Six months ended June 30:Balance sheet diversity and reduction of risk ................ $ 9 $ 4Management of Latin American investment exposure ............. 20 --Sales of securities to an HSBC affiliate (1) ................. 8 --Other ........................................................ -- 6 --- ---Securities gains, net ........................................ $37 $10 === === (1) Represents net gains realized from transfers of various available for sale securities, other non-marketable securities and equity investments as part of a strategy to consolidate certain investments into common HSBC entities. 44 Operating Expenses The components of operating expenses are summarized in the following tables. ---------------------------------------------------------------------------------------------- Increase (Decrease) -------------------Three months ended June 30 2007 2006 Amount %---------------------------------------------------------------------------------------------- ($ in millions) Salaries and employee benefits: Salaries .......................................... $ 245 $ 218 $ 27 12 Employee benefits ................................. 96 103 (7) (7) ------- ------- ---- --- Total salaries and employee benefits .............. 341 321 20 6 ------- ------- ---- --- Occupancy expense, net ............................... 59 57 2 4 ------- ------- ---- --- Support services from HSBC affiliates: Fees paid to HSBC Finance Corporation for loan servicing and other administrative support ..... 113 109 4 4 Fees paid to HMUS ................................. 66 52 14 27 Fees paid to HTSU for technology services ......... 62 49 13 27 Fees paid to other HSBC affiliates ................ 45 37 8 22 ------- ------- ---- --- Total support services from HSBC affiliates ....... 286 247 39 16 ------- ------- ---- --- Other expenses: Equipment and software ............................ 15 18 (3) (17) Marketing ......................................... 31 25 6 24 Outside services .................................. 42 31 11 35 Professional fees ................................. 16 14 2 14 Telecommunications ................................ 6 5 1 20 Postage, printing and office supplies ............. 9 9 -- -- Insurance business ................................ 4 6 (2) (33) Miscellaneous ..................................... 69 42 27 64 ------- ------- ---- --- Total other expenses .............................. 192 150 42 28 ------- ------- ---- ---Total operating expenses ............................. $ 878 $ 775 $103 13 ======= ======= ==== ===Personnel - average number ........................... 12,325 12,110 215 2 ---------------------------------------------------------------------------------------------- Increase (Decrease) -------------------Six months ended June 30 2007 2006 Amount %---------------------------------------------------------------------------------------------- ($ in millions) Salaries and employee benefits: Salaries .......................................... $ 490 $ 437 $ 53 12 Employee benefits ................................. 188 199 (11) (6) ------- ------- ---- --- Total salaries and employee benefits .............. 678 636 42 7 ------- ------- ---- --- Occupancy expense, net ............................... 118 108 10 9 ------- ------- ---- --- Support services from HSBC affiliates: Fees paid to HSBC Finance Corporation for loan servicing and other administrative support ..... 232 225 7 3 Fees paid to HMUS ................................. 123 107 16 15 Fees paid to HTSU for technology services ......... 123 106 17 16 Fees paid to other HSBC affiliates ................ 87 73 14 19 ------- ------- ---- --- Total support services from HSBC affiliates ....... 565 511 54 11 ------- ------- ---- --- Other expenses: Equipment and software ............................ 29 38 (9) (24) Marketing ......................................... 63 46 17 37 Outside services .................................. 71 60 11 18 Professional fees ................................. 34 31 3 10 Telecommunications ................................ 10 10 - - Postage, printing and office supplies ............. 18 16 2 13 Insurance business ................................ 12 11 1 9 Miscellaneous ..................................... 123 93 30 32 ------- ------- ---- --- Total other expenses .............................. 360 305 55 18 ------- ------- ---- ---Total operating expenses ............................. $ 1,721 $ 1,560 $161 10 ======= ======= ==== ===Personnel - average number ........................... 12,322 12,033 289 2 45 Overview Increased expenses for the second quarter and for the first six months of 2007were largely driven by higher personnel, marketing, technology and other expensegrowth associated with continued rollout of various business growth initiativesaffecting all business segments. Salaries and Employee Benefits Higher salaries expenses for the first six months of 2007 are mainly due to: o higher staff counts and a changing mix of staffing to support various business growth initiatives, primarily within the PFS, CIBM and PB business segments; o higher average salaries and pay rates, due to normal annual pay increases; and o higher personnel costs within the CIBM segment associated with the expansion of various businesses that are better positioned to leverage HSBC's global markets capabilities, and with repositioning certain other businesses in order to focus on building a financing and emerging markets led wholesale banking business. During the second quarter of 2006, the HSBC Remuneration Committee exercised itsdiscretion to waive the Total Shareholder Return performance condition relatedto 2003 share option awards under the HSBC Group Share Option Plan (refer topage 141 of HUSI's 2006 Form 10-K for a description of this plan). Thismodification resulted in an additional charge to employee benefits expense of $9million for the second quarter of 2006. No similar charge was recorded during2007. Excluding this 2006 charge, higher employee benefits associated withincreased salaries expenses were offset by lower pension costs. Occupancy Expense, Net Expansion of the core banking and commercial lending networks within the PFS andCMB business segments has been a key component of recent business expansioninitiatives. New branches have been opened and lending operations have beenexpanded, which have resulted in higher rental expenses, depreciation ofleasehold improvements, utilities and other occupancy expenses during the firstsix months of 2007. Support Services from HSBC Affiliates HUSI has routinely purchased private label credit card receivables from HSBCFinance Corporation since December 2004. In addition, higher qualitynonconforming residential mortgage loans were acquired from HSBC FinanceCorporation's correspondent network from December 2003 until September 2005. Inmost cases, HSBC Finance Corporation retained the right to service theseportfolios. Fees charged by HSBC Finance Corporation for loan origination andservicing expenses, which are primarily recorded in the CF segment, haveincreased moderately for 2007 due to an increased number of private label creditcard accounts serviced. Fees charged by HMUS pursuant to service level agreements for broker dealer,loan syndication, treasury and traded markets related services are included insupport services from HSBC affiliates. Higher fees charged by HMUS for the firsthalf of 2007 primarily relate to increased loan syndication services. HSBC's technology services in North America are centralized within HSBCTechnology & Services (USA) Inc. (HTSU). Technology related assets and softwareacquired for HUSI are generally purchased and owned by HTSU. Pursuant to amaster service level agreement, HTSU charges HUSI for equipment related costsand technology services. Fees charged by HTSU to HUSI for technology servicesare higher in 2007, as HUSI continues to upgrade its technology environmentwithin all business segments. HUSI also utilizes other HSBC affiliates in support of global outsourcinginitiatives and, to a lesser extent, for treasury and traded markets services.Higher expense for 2007 primarily resulted from expanded data processing andother global outsourcing services. 46 Miscellaneous Expenses Higher marketing and promotional expenses resulted from continuing investment inHSBC brand activities, promotion of the internet savings account and marketingsupport for branch expansion initiatives, primarily within the PFS businesssegment. As a result of a decision to discontinue operations of HBUS's real estatesettlement services company, certain deferred start-up costs and othercontractual costs totaling $6 million were included in outside services for thesecond quarter of 2007. Employment agency and staff recruitment fees, alsoincluded in outside services, have increased in 2007, primarily to supportbusiness expansion and ongoing technology enhancement projects. Miscellaneous expenses for the second quarter and the first half of 2006 wereunusually low, mainly due to reversal of $13 million of accrued interest relatedto settlement of certain income tax liabilities during the second quarter of2006. In addition, $5 million of accruals to errors and losses expense relatedto periods prior to 2006 were also reversed in the second quarter of 2006.Excluding these 2006 adjustments, higher miscellaneous expenses for 2007 wereprimarily due to increased insurance costs and other expenses associated withbusiness expansion. Efficiency Ratio -------------------------------------------------------------------------------- Three months ended Six months ended June 30 June 30 ------------------ ----------------- 2007 2006 2007 2006--------------------------------------------------------------------------------Efficiency ratio (1)................ 55.45% 53.49% 57.21% 54.91% (1) Ratio of total operating expenses, reduced by minority interests, to the sum of net interest income and other revenues. Higher net interest income and other revenues were more than offset by increasedoperating expenses for the second quarter and the first half of 2007, resultingin an increase in the efficiency ratio for both periods. 47 SEGMENT RESULTS-------------------------------------------------------------------------------- HUSI has five distinct segments that are utilized for management reporting andanalysis purposes. The segments, which are based upon customer groupings as wellas products and services offered, are described on pages 19-20 of HUSI's Form10-Q for the quarterly period ended March 31, 2007. Effective January 1, 2007, corporate goals of HUSI are based upon resultsreported under International Financial Reporting Standards (IFRSs), which areutilized by HSBC to prepare its consolidated financial statements. Operatingresults for HUSI are now being monitored and reviewed, trends are beingevaluated, and decisions are being made about allocating certain resources on anIFRSs basis. As a result, effective with this Form 10-Q, business segmentresults are reported on an IFRSs basis to align with the revised internalreporting mechanism for monitoring performance. Results for 2007 and 2006 in thetables that follow are reflected on an IFRSs basis. Results for each business segment on an IFRSs basis are summarized in thefollowing tables. Personal Financial Services (PFS) Overview Additional resources continue to be directed towards expansion of the coreretail banking business, including investment in the HSBC brand, expansion ofthe core branch network in existing and new geographic areas, and continuedrollout of HSBC Direct, the internet banking business. Significant expensegrowth from these initiatives for the second quarter and the first half of 2007has been partially offset by related growth in other revenues. Net interestincome from core banking activities has also decreased in 2007 due to continuednarrowing of interest rate spreads, which was partially offset by the positiveimpact of new customers and products. Balance sheet growth for core retail banking for the first six months of 2007was highlighted by a 25% increase in average deposits, as compared with the same2006 period, resulting from successful strategy to build deposits acrossmultiple markets and business segments, utilizing multiple delivery systems. PFS business segment results for 2007 also have been impacted by lowerresidential mortgage banking revenue, primarily due to loan portfolio runoff.During 2007, as part of a continuing process to manage prepayment risk andliquidity, HUSI continues to sell a majority of its residential mortgage loanoriginations and allow the residential mortgage loan portfolio to run off. Operating Results The following table summarizes results for the PFS segment. -------------------------------------------------------------------------------- Increase (Decrease) ------------------- 2007 2006 Amount %-------------------------------------------------------------------------------- ($ in millions)Three months ended June 30:Net interest income ................... $274 $290 $(16) (6)Other revenues ........................ 113 106 7 7 ---- ---- ---- ---Total revenues ........................ 387 396 (9) (2)Provision for credit losses ........... 25 8 17 213 ---- ---- ---- --- 362 388 (26) (7)Operating expenses .................... 319 291 28 10 ---- ---- ---- ---Income before income tax expense ...... $ 43 $ 97 $(54) (56) ==== ==== ==== === Six months ended June 30:Net interest income ................... $560 $577 $(17) (3)Other revenues ........................ 263 242 21 9 ---- ---- ---- ---Total revenues ........................ 823 819 4 --Provision for credit losses ........... 29 24 5 21 ---- ---- ---- --- 794 795 (1) --Operating expenses .................... 611 580 31 5 ---- ---- ---- ---Income before income tax expense ...... $183 $215 $(32) (15) ==== ==== ==== === 48 Lower net interest income for the second quarter and the first half of 2007 waspartially due to lower interest earned and lower interest rate spreads on theresidential mortgage loan portfolio. Average residential mortgage loansdecreased 10% for the first six months of 2007, as compared with the same 2006period. Net interest income from core banking activities also decreased for the secondquarter and first six months of 2007. Although deposits continued to grow in2007, driven by the success of the Online Savings product and expansion of theretail branch network, the positive impact of the growing personal deposit basewas offset by a narrowing of deposit spreads as customers continue to migrate tohigher yielding deposit products, such as the Online Savings product. Refer topage 34 of this Form 10-Q for commentary regarding HUSI's deposit strategy andgrowth. Higher other revenues for the first six months of 2007 were due to $19 millionof gains realized on sales of branch premises to unaffiliated third parties,which was partially offset by decreased servicing related income included withinresidential mortgage banking revenue. Higher provision for credit losses primarily resulted from increaseddelinquencies within various consumer portfolios, which was partially offset bya $13 million reduction in allowance resulting from refinement of the allowancemethodology associated with MasterCard/Visa receivables. In addition, provisionexpense for the first half of 2006 was unusually low due to the impact ofbankruptcy legislation enacted in 2005, which resulted in accelerated consumercharge offs in the fourth quarter of 2005. Increased operating expenses primarily resulted from higher staff, marketing,occupancy and technology costs associated with branch expansion and developmentof the HSBC Direct online platform. Consumer Finance (CF) Overview The CF segment includes the private label receivable portfolio (the PLRP) andother loans acquired from HSBC Finance Corporation and its correspondents.Results of the CF segment have been positively impacted by lower amortization ofpremiums paid to HSBC Finance Corporation for those receivables, and by growthof private label credit card receivables, which are 14% higher at June 30, 2007compared with the prior year. Operating Results The following table summarizes results for the CF segment. ---------------------------------------------------------------------------- Increase (Decrease) ------------------- 2007 2006 Amount %---------------------------------------------------------------------------- ($ in millions)Three months ended June 30:Net interest income ................ $210 $176 $ 34 19Other revenues (1) ................. 59 29 30 103 ---- ---- ---- ----Total revenues ..................... 269 205 64 31Provision for credit losses ........ 214 154 60 39 ---- ---- ---- ---- 55 51 4 8Operating expenses ................. 9 7 2 29 ---- ---- ---- ----Income before income tax expense ... $ 46 $ 44 $ 2 5 ==== ==== ==== ==== Six months ended June 30:Net interest income ................ $409 $338 $ 71 21Other revenues (1) ................. 107 40 67 168 ---- ---- ---- ----Total revenues ..................... 516 378 138 37Provision for credit losses ........ 388 299 89 30 ---- ---- ---- ---- 128 79 49 62Operating expenses ................. 17 14 3 21 ---- ---- ---- ----Income before income tax expense ... $111 $ 65 $ 46 71 ==== ==== ==== ==== (1) For IFRSs reporting purposes, fees charged by HSBC Finance Corporation for servicing various loan and receivable portfolios are netted against other revenues. These fees totaled $102 million and $99 million for the second quarter of 2007 and 2006, respectively, and $207 million and $203 million for the first six months of 2007 and 2006, respectively. 49 The following table summarizes the impact of the PLRP on earnings for the CFsegment in comparison with the other portfolios. --------------------------------------------------------------------------------Three months ended June 30 Plrp Other Total-------------------------------------------------------------------------------- (in millions)2007 Net interest income ........................... $196 $14 $210 Other revenues ................................ 65 (6) 59 ---- --- ---- Total revenues ................................ 261 8 269 Provision for credit losses ................... 207 7 214 ---- --- ---- 54 1 55 Operating expenses ............................ 8 1 9 ---- --- ---- Income before income tax expense .............. $ 46 $ - $ 46 ==== === ==== 2006 Net interest income ........................... $157 $19 $176 Other revenues ................................ 27 2 29 ---- --- ---- Total revenues ................................ 184 21 205 Provision for credit losses ................... 148 6 154 ---- --- ---- 36 15 51 Operating expenses ............................ 6 1 7 ---- --- ---- Income before income tax expense .............. $ 30 $14 $ 44 ==== === ==== --------------------------------------------------------------------------------Six months ended June 30 Plrp Other Total-------------------------------------------------------------------------------- (in millions)2007 Net interest income ........................... $378 $31 $409 Other revenues ................................ 118 (11) 107 ---- --- ---- Total revenues ................................ 496 20 516 Provision for credit losses ................... 372 16 388 ---- --- ---- 124 4 128 Operating expenses ............................ 16 1 17 ---- --- ---- Income before income tax expense .............. $108 $ 3 $111 ==== === ==== 2006 Net interest income ........................... $289 $48 $337 Other revenues ................................ 42 (2) 40 ---- --- ---- Total revenues ............................... 331 46 377 Provision for credit losses ................... 287 12 299 ---- --- ---- 44 34 78 Operating expenses ............................ 12 2 14 ---- --- ---- Income before income tax expense .............. $ 32 $32 $ 64 ==== === ==== Higher net interest income for the second quarter and first six months of 2007resulted from: o higher interest income from increased credit card receivable balances, due to the addition of new private label merchant relationships during 2006 and 2007; and o lower amortization of premiums paid for purchases of receivables included within the PLRP. Although premiums associated with daily purchases of receivables from HSBC Finance Corporation continue to be recorded and amortized, the premium amortization associated with the initial portfolio acquisition in 2004 was $51 million lower for the first half of 2007. Higher other revenues for the PLRP are directly related to increased credit cardfees (refer to page 40 of this Form 10-Q). Higher provisions for credit losses for the PLRP resulted from higher allowancefor credit losses required for private label credit card receivable growth andfrom higher delinquencies within the portfolio. Additional portfolio transfers from HSBC Finance Corporation that are consistentwith HUSI's business and liquidity management strategies and objectives arecurrently being considered. 50 Commercial Banking (CMB) Overview Expansion of middle market activities in Chicago, Washington D.C. and the westcoast of the U.S. has contributed to strong growth in loans, deposits, andoverall performance within the CMB segment. Small business deposit growth alsocontinues to be a key growth driver for higher results in 2007. Overall, averagecommercial loans and deposits are 2% and 20% higher, respectively, for the firstsix months of 2007, as compared with the same period in 2006. Commercial realestate lending has been impacted by a slowdown in this sector, which haspartially offset overall growth. Operating Results The following table summarizes results for the CMB segment. -------------------------------------------------------------------------------- Increase (Decrease) -------------------- 2007 2006 Amount %-------------------------------------------------------------------------------- ($ in millions)Three months ended June 30:Net interest income .................... $202 $171 $ 31 18Other revenues ......................... 66 62 4 6 ---- ---- ---- ---Total revenues ......................... 268 233 35 15Provision for credit losses ............ 19 27 (8) (30) ---- ---- ---- --- 249 206 43 21Operating expenses ..................... 142 114 28 25 ---- ---- ---- ---Income before income tax expense ....... $107 $ 92 $ 15 16 ==== ==== ==== === Six months ended June 30:Net interest income .................... $398 $350 $ 48 14Other revenues ......................... 128 123 5 4 ---- ---- ---- ---Total revenues ......................... 526 473 53 11Provision for credit losses ............ 37 31 6 19 ---- ---- ---- --- 489 442 47 11Operating expenses ..................... 282 233 49 21 ---- ---- ---- ---Income before income tax expense ....... $207 $209 $ (2) (1) ==== ==== ==== === Higher net interest income for the second quarter and first six months of 2007primarily resulted from growth in small business deposits and middle-marketloans, which were partially offset by lower commercial real estate loans. Growthin net interest income continues to be partially offset by narrowing depositspreads, as customers migrate to higher yielding deposit products. Despite lower provision for credit losses for the second quarter of 2007,provisions have increased overall for the first half of the year, primarily dueto a specific charge off within the commercial real estate portfolio during thefirst quarter. In addition, growth in average commercial loan portfolio balanceshas resulted in moderately higher collective allowance requirements for thefirst six months of 2007. Additional commentary regarding credit quality beginson page 54 of this Form 10-Q. Higher operating expenses are primarily associated with business expansion,higher incentive compensation and increased community investment costs. Corporate, Investment Banking and Markets (CIBM) Overview Various treasury and traded markets activities were expanded in 2005 and 2006,resulting in new products offered to customers, increased marketing efforts forthose products, and an expanded infrastructure to support growth initiatives. Asa result of these initiatives, average commercial loans, trading assets andcommercial deposits are 18%, 7% and 40% higher, respectively, for the first sixmonths of 2007 in comparison with the same 2006 period. 51 The first half of 2007 was bolstered by strong derivatives revenues resultingfrom previous expansion of product capabilities in structured credit andemerging markets derivatives. Foreign exchange revenues remained strong during2007 against the backdrop of a weakening U.S. dollar. This performance waspartially offset by the credit weakness in the sub-prime lending market whichimpacted trading in mortgage backed securities. In addition, the CIBM businesssegment experienced a decline in precious metals revenue related to lower pricevolatility. Revenues from the recently expanded payments and cash management business weresignificantly higher for the second quarter and first six months of 2007, ascompared with the same 2006 periods, reflecting higher deposit balances andhigher associated transaction fee revenues. A relatively flat yield curve has reduced net interest income from balance sheetmanagement activities for the first half of 2007 and has continued to limitopportunities to generate additional net funds income within the CIBM businesssegment. During the first half of 2006, a wider range of product offerings and enhancedsales capabilities within the CIBM business segment drove significant tradinggains across all major client-related activities. Favorable market conditions incertain sectors also enhanced trading profits. Successful launches of newproducts and increased sales of structured products that are tailored tospecific customer needs led to strong derivatives trading revenues. Gains in theprecious metals business reflected volume growth driven by a surge in demandarising from strong commodities markets. Income streams in the foreign exchangebusiness remained robust against the backdrop of a weak U.S. dollar. Operating Results The following table summarizes results for the CIBM segment. ----------------------------------------------------------------------------- Increase (Decrease) ------------------- 2007 2006 Amount %----------------------------------------------------------------------------- ($ in millions)Three months ended June 30:Net interest income ................... $141 $112 $ 29 26Other revenues ........................ 321 270 51 19 ---- ---- ---- ---Total revenues ........................ 462 382 80 21(Credit) provision for credit losses .. (5) (14) 9 64 ---- ---- ---- --- 467 396 71 18Operating expenses .................... 198 184 14 8 ---- ---- ---- ---Income before income tax expense ...... $269 $212 $ 57 27 ==== ==== ==== ===Six months ended June 30:Net interest income ................... $138 $137 $ 1 1Other revenues ........................ 575 559 16 3 ---- ---- ---- ---Total revenues ........................ 713 696 17 2(Credit) provision for credit losses .. (10) (12) 2 17 ---- ---- ---- --- 723 708 15 2Operating expenses .................... 387 355 32 9 ---- ---- ---- ---Income before income tax expense ...... $336 $353 $(17) (5) ==== ==== ==== === Lower revenues primarily resulted from lower balance sheet management income andlower trading related revenues (refer to pages 27 and 43 of this Form 10-Q),which were partially offset by higher gains realized from sales of securities(refer to page 44 of this Form 10-Q). Higher operating expenses for the first six months of 2007, as compared with thesame 2006 period, resulted from higher personnel costs associated with expansionof various businesses that are better positioned to leverage HSBC's globalmarkets capabilities. Expenses for 2007 also included incremental costsassociated with repositioning certain other non-strategic businesses in order tofocus on building a financing and emerging markets led wholesale bankingbusiness. 52 Private Banking (Pb) Overview During 2005 and 2006, additional resources have been allocated to expandproducts and services provided to high net worth customers served by the PBbusiness segment. As a result, total average loans and deposit balances were13% and 20% higher, respectively, for the first half of 2007, compared with thesame 2006 period. Operating Results The following table summarizes results for the PB segment. ----------------------------------------------------------------------------- 2007 Compared to 2006 Increase (Decrease) ---------------------- 2007 2006 Amount %----------------------------------------------------------------------------- ($ in millions)Three months ended June 30:Net interest income ................... $ 50 $ 48 $ 2 4Other revenues ........................ 71 60 11 18 ---- ---- ---- ---Total revenues ........................ 121 108 13 12Provision for credit losses ........... 5 30 (25) (83) ---- ---- ---- --- 116 78 38 49Operating expenses .................... 86 72 14 19 ---- ---- ---- ---Income before income tax expense ...... $ 30 $ 6 $ 24 400 ==== ==== ==== === Six months ended June 30:Net interest income ................... $100 $ 96 $ 4 4Other revenues ........................ 144 137 7 5 ---- ---- ---- ---Total revenues ........................ 244 233 11 5Provision for credit losses ........... 12 30 (18) (60) ---- ---- ---- --- 232 203 29 14Operating expenses .................... 168 149 19 13 ---- ---- ---- ---Income before income tax expense ...... $ 64 $ 54 $ 10 19 ==== ==== ==== === Higher net interest income for the second quarter and first six months of 2007resulted from the mix of higher average loans and deposit balances. The PB business segment includes an equity investment in a non-consolidatedforeign HSBC affiliate (the foreign equity investment). During the third quarterof 2006, the foreign equity investment sold a portion of its investment in aforeign equity fund to another HSBC affiliate. During the second quarter of2007, the foreign equity investment sold its remaining investment in the foreignequity fund, resulting in a gain from which HUSI recorded additional equityearnings of $7 million. Excluding the impact of this transaction, the decreasein equity investment holdings resulted in lower equity earnings included inother revenues for the first six months of 2007, which was offset by highercommission and fee revenues from managed products, derivatives and annuityproducts. Increased operating expenses for the second quarter and first six months of 2007mainly resulted from higher staff costs related to business expansioninitiatives. The provision for credit losses for the first six months of 2007 includes theimpact of an $8 million charge off related to a specific commercial customerrelationship, for which no allowance was previously recorded. For 2006, theprovision includes a $29 million charge for a combination of charge offs andhigher allowances related to a specific commercial real estate investment loanrelationship for which no allowance was previously recorded. 53 Other Overview The Other segment primarily includes an equity investment in HSBC Republic Bank(Suisse) S.A., and adjustments made at the corporate level for fair value optionaccounting related to certain debt issued. Operating Results The following table summarizes results for the Other segment. -------------------------------------------------------------------------------------- 2007 Compared to 2006 Increase (Decrease) --------------------- 2007 2006 Amount %-------------------------------------------------------------------------------------- ($in millions)Three months ended June 30:Net interest income (expense) ............ $ (3) $ (7) $ 4 *Other revenues ........................... (66) 22 (88) * ---- ---- ---- -----Total revenues ........................... (69) 15 (84) *Provision for credit losses .............. -- -- -- -- ---- ---- ---- ----- (69) 15 (84) *Operating expenses ....................... 1 4 (3) * ---- ---- ---- -----(Loss) income before income tax expense .. $(70) $ 11 $(81) * ==== ==== ==== ===== Six months ended June 30:Net interest income (expense) ............ $ (4) $(10) $ 6 *Other revenues ........................... (61) (3) (58) * ---- ---- ---- -----Total revenues ........................... (65) (13) (52) *Provision for credit losses .............. -- -- -- -- ---- ---- ---- ----- (65) (13) (52) *Operating expenses ....................... 2 4 (2) * ---- ---- ---- -----(Loss) income before income tax expense .. $(67) $(17) $(50) * ==== ==== ==== ===== * Not meaningful. The decrease in other revenues for the second quarter and the first half of 2007primarily resulted from decreases in the fair value of certain debt instruments,as compared with the same 2006 periods. CREDIT QUALITY-------------------------------------------------------------------------------- HUSI enters into a variety of transactions in the normal course of business thatinvolve both on and off-balance sheet credit risk. Principal among theseactivities is lending to various commercial, institutional, governmental andindividual customers. HUSI participates in lending activity throughout the U.S.and, on a limited basis, internationally. HUSI's allowance for credit losses methodology and its accounting policiesrelated to the allowance for credit losses are presented in Critical AccountingPolicies beginning on page 25 of its 2006 Form 10-K and in Note 2 of theconsolidated financial statements beginning on page 99 of its 2006 Form 10-K. HUSI's approach toward credit risk management is summarized on pages 72-74 ofits 2006 Form 10-K. There have been no material revisions to policies ormethodologies during the first half of 2007. 54 Overview The allowance for credit losses increased $40 million (5%) and increased $5million (less than 1%) during the three month and six month periods ended June30, 2007, respectively. Higher allowances associated with the growing privatelabel and MasterCard/Visa credit card receivable portfolios were the primarydrivers for the overall increase. Allowance for credit losses balances andactivity, by loan portfolio, are summarized on page 57 of this Form 10-Q. The provision for credit losses increased $42 million (19%) for the secondquarter of 2007, and increased $90 million (24%) for the first six months of2007 as compared with the same 2006 periods, primarily due to higher provisionsassociated with credit card receivable portfolios, which were partially offsetby lower commercial loan provisions. The provision for credit losses associatedwith various loan portfolios is summarized on page 36 of this Form 10-Q. Problem Loan Management Nonaccruing loans by portfolio and impaired loans are summarized in Note 4 ofthe consolidated financial statements beginning on page 10 of this Form 10-Q. HUSI's policies and practices for placing loans on nonaccruing status aresummarized in Note 2 of the consolidated financial statements, beginning on page99 of its 2006 Form 10-K. Criticized Assets Criticized asset classifications are based on the risk rating standards ofHUSI's primary regulator. Problem credit facilities, which include loans andother credit arrangements such as letters of credit, are assigned variouscriticized facility grades under HUSI's allowance for credit losses methodology. Criticized credit facilities are summarized in the following table. -------------------------------------------------------------------------------- Increase (Decrease) from --------------------------------- December 31, 2006 June 30, 2006 June 30, ----------------- -------------Balance at 2007 Amount % Amount % -------------------------------------------- ($ in millions)Special mention (1): Commercial loans ............ $1,437 $ 186 15 $ 659 85 ------ ----- --- ------ ---Substandard (2): Commercial loans ............ 503 (178) (26) 252 100 Consumer loans .............. 628 27 4 120 24 ------ ----- --- ------ --- 1,131 (151) (12) 372 49 ------ ----- --- ------ --- Doubtful (3): Commercial loans ............ 26 (6) (19) (14) (35) ------ ----- --- ------ ---Total .......................... $2,594 $ 29 1 $1,017 64 ====== ===== === ====== === (1) Generally includes credit facilities that are protected by collateral and/or the credit worthiness of the customer, but are potentially weak based upon economic or market circumstances which, if not checked or corrected, could weaken HUSI's credit position at some future date. (2) Includes credit facilities that are inadequately protected by the underlying collateral and/or general credit worthiness of the customer. These credit facilities present a distinct possibility that HUSI will sustain some loss if the deficiencies are not corrected. (3) Includes credit facilities that have all the weaknesses exhibited by substandard credit facilities, with the added characteristic that the weaknesses make collection or liquidation in full of the recorded loan highly improbable. However, although the possibility of loss is extremely high, certain factors exist which may strengthen the credit at some future date, and therefore the decision to charge off the loan is deferred. Loans graded as doubtful are required to be placed in nonaccruing status. 55 Allowance for Credit Losses Changes in the allowance for credit losses by general loan categories aresummarized in the following table. ---------------------------------------------------------------------------------------------------------- June 30, March 31, December 31, September 30, June 30,Quarter ended 2007 2007 2006 2006 2006---------------------------------------------------------------------------------------------------------- ($ in millions) Total loans at quarter end .............. $87,409 $88,893 $90,237 $90,020 $91,205Average total loans ..................... 88,477 88,092 89,343 88,739 88,699 Allowance balance at beginning of quarter .............................. $ 862 $ 897 $ 886 $ 869 $ 837Allowance related to disposal of certain credit card receivables ...... -- -- (2) -- -- Charge offs: Commercial ......................... 34 36 43 29 44 Consumer: Residential mortgages ............ 12 14 10 9 7 Credit card receivables .......... 221 224 205 188 165 Other consumer loans ............. 26 31 32 27 23 ------- ------- ------- ------- ------- Total consumer loans ............. 259 269 247 224 195 ------- ------- ------- ------- ------- Total charge offs .................. 293 305 290 253 239 ------- ------- ------- ------- ------- Recoveries on loans charged off: Commercial ......................... 8 6 9 8 6 Consumer: Residential mortgages ............ 1 -- 1 1 -- Credit card receivables .......... 50 49 47 49 28 Other consumer loans ............. 10 10 9 5 15 ------- ------- ------- ------- ------- Total consumer loans ............. 61 59 57 55 43 ------- ------- ------- ------- ------- Total recoveries ................... 69 65 66 63 49 ------- ------- ------- ------- ------- Total net charge offs ................ 224 240 224 190 190 ------- ------- ------- ------- ------- Provision charged to income .......... 264 205 237 207 222 ------- ------- ------- ------- ------- Allowance balance at end of quarter ............................ $ 902 $ 862 $ 897 $ 886 $ 869 ======= ======= ======= ======= ======= Allowance ratios: Annualized net charge offs to average loans: Commercial ......................... .35% .43% .47% .29% .54% Consumer: Residential mortgages ............ .11 .15 .09 .08 .07 Credit card receivables .......... 3.91 4.01 3.62 3.39 3.61 Other consumer loans ............. 2.58 3.20 3.27 2.95 1.06 ------- ------- ------- ------- ------- Total consumer ................... 1.35 1.43 1.25 1.12 1.00 ------- ------- ------- ------- ------- Total loans ........................ 1.01% 1.11% 1.00% .85% .86% ======= ======= ======= ======= ======= Quarter-end allowance to: Quarter-end total loans .......... 1.03% .97% .99% .98% .95% Quarter-end total nonaccruing loans ......................... 277.54% 280.78% 314.74% 331.84% 354.69% 56 Changes in the allowance for credit losses by general loan categories aresummarized in the following tables. --------------------------------------------------------------------------------------------------------- Residential Credit OtherThree months ended June 30 Commercial Mortgage Card Consumer Unallocated Total--------------------------------------------------------------------------------------------------------- (in millions) 2007Balance at beginning of period ..... $206 $31 $591 $23 $11 $862 ---- --- ---- --- --- ----Charge offs ........................ 34 12 221 26 -- 293Recoveries ......................... 8 1 50 10 -- 69 ---- --- ---- --- --- ---- Net charge offs ................. 26 11 171 16 -- 224 ---- --- ---- --- --- ----Provision charged to income ........ 32 10 204 18 -- 264 ---- --- ---- --- --- ----Balance at end of period ........... $212 $30 $624 $25 $11 $902 ==== === ==== === === ==== 2006Balance at beginning of period ..... $171 $30 $589 $32 $15 $837 ---- --- ---- --- --- ----Allowance related to disposals ..... -- -- -- -- -- --Charge offs ........................ 44 7 165 23 -- 239Recoveries ......................... 6 -- 28 15 -- 49 ---- --- ---- --- --- ---- Net charge offs ................. 38 7 137 8 -- 190 ---- --- ---- --- --- ----Provision charged to income ........ 59 8 148 5 2 222 ---- --- ---- --- --- ----Balance at end of period ........... $192 $31 $600 $29 $17 $869 ==== === ==== === === ==== --------------------------------------------------------------------------------------------------------- Residential Credit OtherSix months ended June 30 Commercial Mortgage Card Consumer Unallocated Total--------------------------------------------------------------------------------------------------------- (in millions) 2007Balance at beginning of period .......................... $203 $31 $626 $26 $11 $897 ---- --- ---- --- --- ----Charge offs ........................ 70 26 445 57 -- 598Recoveries ......................... 14 1 99 20 -- 134 ---- --- ---- --- --- ---- Net charge offs ................. 56 25 346 37 -- 464 ---- --- ---- --- --- ----Provision charged to income ........ 65 24 344 36 -- 469 ---- --- ---- --- --- ----Balance at end of period ........... $212 $30 $624 $25 $11 $902 ==== === ==== === === ==== 2006Balance at beginning of period ..... $162 $34 $600 $36 $14 $846 ---- --- ---- --- --- ----Allowance related to disposals ..... -- -- (6) -- -- (6)Charge offs ........................ 64 18 335 52 -- 469Recoveries ......................... 21 -- 74 24 -- 119 ---- --- ---- --- --- ---- Net charge offs ................. 43 18 261 28 -- 350 ---- --- ---- --- --- ----Provision charged to income ........ 73 15 267 21 3 379 ---- --- ---- --- --- ----Balance at end of period ........... $192 $31 $600 $29 $17 $869 ==== === ==== === === ==== Commercial Loan Credit Quality Components of the commercial allowance for credit losses, as well as movementsin comparison with prior periods, are summarized in the following table. --------------------------------------------------------------------------------------- Increase (Decrease) from --------------------------------- December 31, 2006 June 30, 2006 June 30, ----------------- ------------- 2007 Amount % Amount %--------------------------------------------------------------------------------------- ($ in millions) On-balance sheet allowance: Specific ............................ $ 21 $ 7 50 $ 5 31 Collective .......................... 191 2 1 15 9 ---- --- ---- --- --- 212 9 4 20 10 Unallocated ......................... 11 -- -- (6) (35) ---- --- ---- --- --- Total on-balance sheet allowance .... 223 9 4 14 7 ---- --- ---- --- ---Off-balance sheet allowance ............ 90 (8) (8) 5 6 ---- --- ---- --- ---Total commercial allowances ............ $313 $ 1 -- $19 6 ==== === ==== === === 57 Despite an increase in average commercial loans for the first half of 2007, ascompared with the same 2006 period, total criticized commercial loans wererelatively unchanged from December 31, 2006 to June 30, 2007 (refer to page 55of this Form 10-Q). Overall, commercial loan credit quality remains stable andwell-controlled. Higher criticized loan balances from June 30, 2006 to June 30,2007 (refer to page 55 of this Form 10-Q) resulted mainly from downgrades inreal estate and middle market exposures. The downgrades resulted in part fromchanges in the credit metrics for specific credits within these portfolios.Total nonaccruing commercial loans remain low as a percentage of totalcommercial loans. Based upon evaluation of the repayment capacity of theobligors, including support from adequately margined collateral, performance onguarantees, and other mitigating factors, impairment is modestly higher in 2007as compared with prior reporting periods, and is adequately reflected in theallowances for specific and collective impairment. HUSI management continues to monitor the following factors that could affectportfolio risk: o recent growth initiatives which have resulted in growth in the size and complexity of the commercial loan portfolio; o HUSI's continued geographic expansion; o borrower concentrations; o increased number and complexity of products offered; and o continuing signs of stress within certain segments of the economy. HUSI management continues to monitor and reduce exposures to those industriesconsidered to be higher risk. During 2006, HUSI management began to make moreextensive use of available tools to more actively manage net exposure within itscorporate loan portfolios with an increased syndication capacity as well asincreased use of credit default swaps to economically hedge and reduce certainexposures. Any sudden and/or unexpected adverse economic events or trends couldsignificantly affect credit quality and increase provisions for credit losses.For example, HUSI management is monitoring the U.S. housing market, risinginterest rates and high energy prices, which could potentially lead to adeceleration of U.S. economic activity. Credit Card Receivable Credit Quality Credit card receivables are primarily private label receivables, includingclosed and open ended contracts, acquired from HSBC Finance Corporation.Receivables included in the private label credit card portfolio are generallymaintained in accruing status until being charged off six months afterdelinquency. Selected credit quality data for credit card receivables issummarized in the following table. -------------------------------------------------------------------------------------------------------- June 30, December 31, June 30, 2007 2006 2006-------------------------------------------------------------------------------------------------------- ($ in millions) Accruing balances contractually past due 90 days or more: Balance at end of quarter ....................................... $ 315 $ 339 $ 283 As a percent of total credit card receivables ................... 1.79% 1.86% 1.85% Allowance for credit losses associated with credit card receivables: Balance at end of quarter ....................................... $ 624 $ 626 $ 600 As a percent of total credit card receivables ................... 3.54% 3.43% 3.92% Net charge offs of credit card receivables: Total for the quarter ended ..................................... $ 171 $ 158 $ 137 Annualized net charge offs as a percent of average credit card receivables ........................................ 3.91% 3.62% 3.61% The allowance for credit losses associated with credit card receivablesincreased $33 million (6%) during the second quarter and was relativelyunchanged for the first half of 2007. Net charge off and provision activity washigher during the second quarter and the first half of 2007 due to increasedprivate label and MasterCard/Visa credit card receivable balances and to higherdelinquencies within these portfolios, which have resulted in a highercollective allowance balance. 58 Residential Mortgage Loan Credit Quality The allowance for credit losses related to residential mortgage loans wasrelatively unchanged during the second quarter and the first six months of 2007.HUSI's residential mortgage portfolio is primarily comprised of prime mortgageloans, for which credit quality has remained strong during 2007. Additional disclosures regarding certain risk concentrations inherent within theresidential mortgage loan portfolio are provided beginning on page 63 of thisForm 10-Q. Reserve for Off-Balance Sheet Exposures HUSI maintains a separate reserve for credit risk associated with certainoff-balance sheet exposures including letters of credit, unused commitments toextend credit and financial guarantees. This reserve, included in otherliabilities, was $90 million, $98 million and $85 million at June 30, 2007,December 31, 2006 and June 30, 2006, respectively. Off-balance sheet exposuresare summarized on page 61 of this Form 10-Q. Credit and Market Risks Associated with Derivative Contracts Credit (or repayment) risk in derivative instruments is minimized by enteringinto transactions with high quality counterparties, including other HSBCentities. Counterparties include financial institutions, government agencies,both foreign and domestic, corporations, funds (mutual funds, hedge funds,etc.), insurance companies and private clients. These counterparties are subjectto regular credit review by the credit risk management department. Mostderivative contracts are governed by an International Swaps and DerivativesAssociation Master Agreement. Depending on the type of counterparty and thelevel of expected activity, bilateral collateral arrangements may also berequired. The total risk in a derivative contract is a function of a number of variables,such as: o the existence of a master netting agreement among the counterparties; o volatility of interest rates, currencies, equity or corporate reference entity used as the basis for determining contract payments; o maturity and liquidity of contracts; o credit worthiness of the counterparties in the transaction; and o existence and value of collateral received from counterparties to secure exposures. The following table presents credit risk exposure and net fair value associatedwith derivative contracts. In the table, current credit risk exposure is therecorded fair value of derivative receivables, which represents revaluationgains from the marking to market of derivative contracts held for tradingpurposes, for all counterparties with an International Swaps and DerivativesAssociation Master Agreement in place. Future credit risk exposure in the following table is measured using rulescontained in the risk-based capital guidelines published by U.S. bankingregulatory agencies. The risk exposure calculated in accordance with therisk-based capital guidelines potentially overstates actual credit exposure,because: o the risk-based capital guidelines ignore collateral that may have been received from counterparties to secure exposures; and o the risk-based capital guidelines compute exposures over the life of derivative contracts. However, many contracts contain provisions that allow a bank to close out the transaction if the counterparty fails to post required collateral. As a result, these contracts have potential future exposures that are often much smaller than the future exposures derived from the risk-based capital guidelines. 59 The net credit risk exposure amount in the following table does not reflect theimpact of bilateral netting (i.e., netting with a single counterparty when abilateral netting agreement is in place). However, the risk-based capitalguidelines recognize that bilateral netting agreements reduce credit risk andtherefore allow for reductions of risk-weighted assets when netting requirementshave been met. Therefore, risk-weighted amounts for regulatory capital purposesare a fraction of the original gross exposures. ----------------------------------------------------------------------- June 30, December 31, 2007 2006----------------------------------------------------------------------- (in millions)Risk associated with derivative contracts:Current credit risk exposure ................ $ 9,279 $11,398Future credit risk exposure ................. 76,377 72,447 ------- -------Total risk exposure ......................... 85,656 83,845Less: collateral held against exposure ...... (4,674) (3,989) ------- -------Net credit risk exposure .................... $80,982 $79,856 ======= ======= Market risk is the adverse effect that a change in interest rates, currency, orimplied volatility rates has on the value of a financial instrument. HUSImanages the market risk associated with interest rate and foreign exchangecontracts by establishing and monitoring limits as to the types and degree ofrisk that may be undertaken. HUSI also manages the market risk associated withthe trading derivatives through hedging strategies that correlate the rates,price and spread movements. HUSI measures this risk daily by using Value at Risk(VAR) and other methodologies (refer to pages 66-67 of this Form 10-Q). HUSI's Asset and Liability Policy Committee is responsible for monitoring anddefining the scope and nature of various strategies utilized to manage interestrate risk that are developed through its analysis of data from financialsimulation models and other internal and industry sources. The resulting hedgestrategies are then incorporated into HUSI's overall interest rate riskmanagement and trading strategies. Notional values of derivative contracts are summarized in the following table. ------------------------------------------------------------------------------ June 30, December 31, 2007 2006------------------------------------------------------------------------------ (in millions)Interest rate: Futures and forwards .......................... $ 145,042 $ 94,204 Swaps ......................................... 1,977,492 1,906,688 Options written ............................... 235,099 510,023 Options purchased ............................. 244,758 544,026 ---------- ---------- 2,602,391 3,054,941 ---------- ----------Foreign exchange: Swaps, futures and forwards ................... 486,198 394,621 Options written ............................... 104,366 61,406 Options purchased ............................. 105,163 63,795 Spot .......................................... 49,161 32,654 ---------- ---------- 744,888 552,476 ---------- ----------Commodities, equities and precious metals: Swaps, futures and forwards ................... 43,326 43,620 Options written ............................... 21,699 12,263 Options purchased ............................. 21,669 16,115 ---------- ---------- 86,694 71,998 ---------- ---------- Credit derivatives ............................... 1,022,232 816,422 ---------- ---------- Total ............................................ $4,456,205 $4,495,837 ========== ========== The total notional amounts in the table above relate primarily to HUSI's tradingactivities. Notional amounts included in the table related to non-trading fairvalue, cash flow and economic hedging activities were $23 billion and $27billion at June 30, 2007 and December 31, 2006, respectively. 60 OFF-BALANCE SHEET ARRANGEMENTS-------------------------------------------------------------------------------- The following table provides maturity information related to off-balance sheetarrangements. Descriptions of these arrangements are found on pages 68-69 ofHUSI's 2006 Form 10-K. ---------------------------------------------------------------------------------------------------- Balance at June 30, 2007 ------------------------------------------ One Over One Over Balance at Year Through Five December 31, or Less Five Years Years Total 2006---------------------------------------------------------------------------------------------------- (in millions) Standby letters of credit, net of participations (1) .................. $ 5,314 $ 2,445 $ 145 $ 7,904 $ 7,259Commercial letters of credit ........... 992 187 -- 1,179 795Loan sales with recourse ............... -- 1 6 7 8Credit derivative contracts (2) ........ 19,796 284,778 228,900 533,474 431,631Commitments to extend credit: Commercial .......................... 17,107 33,445 5,855 56,407 55,862 Consumer ............................ 9,668 -- -- 9,668 9,627 ------- -------- -------- -------- --------Total .................................. $52,877 $320,856 $234,906 $608,639 $505,182 ======= ======== ======== ======== ======== (1) Includes $570 million and $542 million issued for the benefit of HSBC affiliates at June 30, 2007 and December 31, 2006, respectively. (2) Includes $84,952 million and $71,908 million issued for the benefit of HSBC affiliates at June 30, 2007 and December 31, 2006, respectively. Letters of Credit Fees are charged for issuing letters of credit commensurate with the customer'scredit evaluation and the nature of any collateral. Included in otherliabilities are deferred fees on standby letters of credit, representing thefair value of the "stand ready obligation to perform" under these guarantees,amounting to $24 million and $21 million at June 30, 2007 and December 31, 2006,respectively. Also included in other liabilities is an allowance for creditlosses on unfunded standby letters of credit of $25 million at June 30, 2007 andDecember 31, 2006. Credit Derivatives HUSI enters into credit derivative contracts primarily to satisfy the needs ofits customers and, in certain cases, for its own benefit. Credit derivatives arearrangements that provide for one party (the "protection buyer") to transfer thecredit risk of a "reference asset" to another party (the "protection seller").Under this arrangement, the protection seller assumes the credit risk associatedwith the reference asset without directly purchasing it. The protection buyeragrees to pay a specified fee to the protection seller. In return, theprotection seller agrees to pay the protection buyer an agreed upon amount ifthere is a default during the term of the contract. In accordance with its policy, HUSI offsets most of the risk it assumes inselling credit protection through a credit derivative contract with anothercounterparty. Credit derivatives are recorded at fair value. The commitmentamount included in the table is the maximum amount that HUSI could be requiredto pay, without consideration of the approximately equal amount receivable fromthird parties and any associated collateral. Securitizations and Secured Financings On December 29, 2004, HUSI acquired a domestic private label loan portfolio fromHSBC Finance Corporation, without recourse, which included securitized privatelabel credit card receivables, and retained interest assets related to thesesecuritizations. These credit card securitization transactions were structuredto receive sale treatment under Statement of Financial Accounting Standards No.140, Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities, a replacement of FASB Statement No. 125 (SFAS140). 61 In the third quarter of 2006, the last remaining securitization trust agreementrelated to the private label portfolio acquired from HSBC Finance Corporation in2004 was amended. As a result, the securitization trust no longer qualifies forsale treatment in accordance with U.S. GAAP, and the transaction is now recordedas a secured financing transaction. At the agreement amendment date, alloutstanding investments, credit card receivables and liabilities related to thetrust were recorded on HUSI's consolidated balance sheet. Under IFRSs, HUSI's securitizations are treated as secured financings. In orderto align its accounting treatment with that of HSBC, all of HUSI'scollateralized funding transactions have been structured as secured financingsunder U.S. GAAP since the third quarter of 2004. In a secured financing, adesignated pool of receivables is conveyed to a wholly owned limited purposesubsidiary, which in turn transfers the receivables to a trust that sellsinterests to investors. Repayment of the debt issued by the trust is secured bythe receivables transferred. The transactions are structured as securedfinancings under SFAS 140. Therefore, the receivables and the underlying debt ofthe trust remain on HUSI's balance sheet. HUSI does not recognize a gain in asecured financing transaction. Because the receivables and debt remain on thebalance sheet, revenues and expenses are reported consistent with the ownedbalance sheet portfolio. There have been no new secured financing transactionsin the first six months of 2007. HUSI's secured financings and securitized receivables are summarized in thefollowing table. ----------------------------------------------------------------------------------------------------- June 30, December 31, 2007 2006----------------------------------------------------------------------------------------------------- (in millions) Secured financings included in long-term debt ............................. $1,350 $2,134 ====== ======Private label credit card receivables collateralizing secured financings at period end ............................................................. $1,646 $2,439 ====== ====== 62 RISK MANAGEMENT-------------------------------------------------------------------------------- Overview Some degree of risk is inherent in virtually all of HUSI's activities. For theprincipal activities undertaken by HUSI, the most important types of risks areconsidered to be credit, interest rate, market, liquidity, operational,fiduciary and reputational. Market risk broadly refers to price risk inherent inmark to market positions taken on trading and non-trading instruments.Operational risk technically includes legal and compliance risk. However, sincecompliance risk, including anti-money laundering (AML) risk, has such broadscope within HUSI's businesses, it is addressed as a separate functionaldiscipline. During the first six months of 2007, there have been no significantchanges in policies or approach for managing various types of risk. Liquidity Management HUSI's approach to address liquidity risk is summarized on pages 75-76 of HUSI's2006 Form 10-K. There have been no changes in HUSI's approach toward liquidityrisk management during 2007. HUSI's ability to regularly attract wholesale funds at a competitive cost isenhanced by strong ratings from the major credit rating agencies. At June 30,2007, HUSI and HBUS maintained the following debt ratings. --------------------------------------------------------------------------------At June 30, 2007 Moody's S&P Fitch--------------------------------------------------------------------------------HUSI: Short-term borrowings .............................. P-1 A-1+ F1+ Long-term debt ..................................... Aa3 AA- AA HBUS: Short-term borrowings .............................. P-1 A-1+ F1+ Long-term debt ..................................... Aa2 AA AA HUSI periodically issues capital instruments to fund balance sheet growth, tomeet cash and capital needs, or to fund investments in subsidiaries. In December2005, the United States Securities and Exchange Commission (SEC) amended itsrules regarding registration, communications and offerings under the SecuritiesAct of 1933. The amended rules facilitate access to capital markets bywell-established public companies, provide more flexibility regardingrestrictions on corporate communications during a securities offering andfurther integrate disclosures under the Securities Act of 1933 and theSecurities Exchange Act of 1934. The amended rules provide the most flexibilityto "well-known seasoned issuers", including the option of automaticeffectiveness upon filing of shelf registration statements and relief under theliberalized communications rules. HUSI currently satisfies the eligibilityrequirements for designation as a "well-known seasoned issuer", and has aneffective shelf registration statement with the SEC under which it may issuedebt securities, preferred stock, either separately or represented by depositaryshares, warrants, purchase contracts and units. Concentrations of Risk Inherent in Loan Portfolios Certain risk concentrations are inherent within the residential mortgage loanportfolio, including concentrations that result in credit risk. A concentrationof risk is defined as a significant exposure with an individual or group engagedin similar activities or affected similarly by economic conditions. As is truefor all loan portfolios, HUSI utilizes high underwriting standards and pricesloans in a manner that is appropriate to compensate for the higher riskassociated with these concentrations. HUSI originates certain residential mortgage loans that have high loan-to-value(LTV) ratios and no mortgage insurance, which could result in potentialinability to recover the entire investment in loans involving foreclosed ordamaged properties. At June 30, 2007 and December 31, 2006, high LTV loans weremainly loans on primary residences with LTV ratios equal to or exceeding 90%. 63 HUSI also originates interest-only residential mortgage loans that allowborrowers to pay only the accruing interest for a period of time, which resultsin lower payments during the initial loan period. Depending on a customer'sfinancial situation, the subsequent increase in the required paymentattributable to loan principal could affect a customer's ability to repay theloan at some future date when the interest rate resets and/or principal paymentsare required. Outstanding balances of high LTV and interest-only residential mortgage loansare summarized in the following table. -------------------------------------------------------------------------------- June 30, December 31, 2007 2006-------------------------------------------------------------------------------- (in millions)Residential mortgage loans with high LTV and no mortgage insurance ............................... $2,361 $ 2,717Interest-only residential mortgage loans ............ 6,788 7,537 ------ -------Total ............................................... $9,149 $10,254 ====== ======= Concentrations of first and second liens within the residential mortgage loanportfolio are summarized in the following table. Amounts in the table excludeloans held for sale. -------------------------------------------------------------------------------- June 30, December 31, 2007 2006-------------------------------------------------------------------------------- (in millions)Closed end: First lien ........................................ $29,989 $31,876 Second lien ....................................... 661 474Revolving: Second lien ....................................... 3,058 3,231 ------- -------Total ................................................ $33,708 $35,581 ======= ======= HUSI also offers adjustable rate residential mortgage loans which allow it toadjust pricing on the loan in line with market movements. As interest rates haverisen over the last three years, many adjustable rate loans are expected torequire a significantly higher monthly payment following their first adjustment.A customer's financial situation at the time of the interest rate reset couldaffect their ability to repay the loan after the adjustment, or may cause thecustomer to prepay or refinance the loan. At June 30, 2007, HUSI hadapproximately $19.3 billion in adjustable rate residential mortgage loans. Forthe remainder of 2007, approximately $.9 billion of adjustable rate residentialmortgage loans will experience their first interest rate reset. In 2008,approximately $3.3 billion of adjustable rate residential mortgage loans willexperience their first interest rate reset. Interest Rate Risk Management Various techniques are utilized to quantify and monitor risks associated withthe repricing characteristics of HUSI's assets, liabilities, and derivativecontracts. The approach toward managing interest rate risk is summarized onpages 77-79 of HUSI's 2006 Form 10-K. During the first six months of 2007, therewere no significant changes in policies or approach for managing interest raterisk. Present Value of a Basis Point (PVBP) Analysis PVBP is the change in value of the balance sheet for a one basis point upwardmovement in all interest rates. HUSI's PVBP position is summarized in thefollowing table. --------------------------------------------------------------------------------June 30, 2007 Values-------------------------------------------------------------------------------- (in millions)Institutional PVBP movement limit .............................. $6.5PVBP position at period end .................................... 2.6 64 Economic Value of Equity Economic value of equity is the change in value of the assets and liabilities(excluding capital and goodwill) for either a 200 basis point gradual rateincrease or decrease. HUSI's economic value of equity position is summarized inthe following table. ---------------------------------------------------------------------------------------------------------June 30, 2007 Values (%)--------------------------------------------------------------------------------------------------------- Institutional economic value of equity limit ............................................ +/- 20Projected change in value (reflects projected rate movements on July 1, 2007): Change resulting from a gradual 200 basis point increase in interest rates ........... (7) Change resulting from a gradual 200 basis point decrease in interest rates ........... -- (1) (1) Less than .5% loss in value The loss in value for a 200 basis point increase or decrease in rates is aresult of the negative convexity of the residential whole loan and mortgagebacked securities portfolios. If rates decrease, the projected prepaymentsrelated to these portfolios will accelerate, causing less appreciation than acomparable term, non-convex instrument. If rates increase, projected prepaymentswill slow, which will cause the average lives of these positions to extend andresult in a greater loss in market value. Dynamic Simulation Modeling Various modeling techniques are utilized to monitor a number of interest ratescenarios for their impact on net interest income. These techniques include bothrate shock scenarios which assume immediate market rate movements by as much as200 basis points, as well as scenarios in which rates rise or fall by as much as200 basis points over a twelve month period. The following table reflects theimpact on net interest income of the scenarios utilized by these modelingtechniques. ----------------------------------------------------------------------------------------------------------------- June 30, 2007 Values ----------------------- Amount %----------------------------------------------------------------------------------------------------------------- ($ in millions) Projected change in net interest income for scenarios subject to a formal institutional movement limit (reflects projected rate movements on July 1, 2007): Institutional base earnings movement limit .......................................... (10) Change resulting from a gradual 200 basis point increase in the yield curve ......... $(211) (7) Change resulting from a gradual 200 basis point decrease in the yield curve ......... 245 8 Change resulting from a gradual 100 basis point increase in the yield curve ......... (101) (3) Change resulting from a gradual 100 basis point decrease in the yield curve ......... 125 4 Other significant scenarios monitored for internal purposes, not subject to a formal institutional movement limit (reflects projected rate movements on July 1, 2007): Change resulting from an immediate 100 basis point increase in the yield curve ...... (178) (6) Change resulting from an immediate 100 basis point decrease in the yield curve ...... 200 6 Change resulting from an immediate 200 basis point increase in the yield curve ...... (368) (11) Change resulting from an immediate 200 basis point decrease in the yield curve ...... 341 11 The projections do not take into consideration possible complicating factorssuch as the effect of changes in interest rates on the credit quality, size andcomposition of the balance sheet. Therefore, although this provides a reasonableestimate of interest rate sensitivity, actual results will vary from theseestimates, possibly by significant amounts. 65 Capital Risk/Sensitivity of Other Comprehensive Income Large movements of interest rates could directly affect some reported capitaland capital ratios. The mark to market valuation of available for salesecurities is adjusted on a tax effective basis through other comprehensiveincome in the consolidated statement of changes in shareholders' equity.Although this valuation mark is excluded from Tier 1 and Tier 2 capital ratios,it is included in two important accounting based capital ratios: the tangiblecommon equity to tangible assets and the tangible common equity to risk weightedassets. As of June 30, 2007, HUSI had an available for sale securities portfolioof approximately $20 billion with a net negative mark to market of $644 millionincluded in tangible common equity of $8 billion. An increase of 25 basis pointsin interest rates of all maturities would lower the mark to market byapproximately $180 million to a net loss of $824 million with the followingresults on the tangible capital ratios. ---------------------------------------------------------------------------------------- Proforma - Reflecting 25 Basis PointsJune 30, 2007 Actual Increase in Rates---------------------------------------------------------------------------------------- Tangible common equity to tangible assets ............. 4.77% 4.71%Tangible common equity to risk weighted assets ........ 6.52 6.43 Market Risk Management Value at Risk (VAR) VAR analysis is used to estimate the potential losses that could occur on riskpositions as a result of movements in market rates and prices over a specifiedtime horizon and to a given level of confidence. VAR calculations are performedfor all material trading activities and as a tool for managing interest raterisk inherent in non-trading activities. HUSI calculates VAR daily for a one-dayholding period to a 99% confidence level. At a 99% confidence level for atwo-year observation period, HUSI is setting as its limit the fifth worst lossperformance in the last 500 business days. VAR - Trading Activities HUSI's management of market risk is based on restricting individual operationsto trading within a list of permissible instruments, and enforcing rigorousapproval procedures for new products. In particular, trading in the more complexderivative products is restricted to offices with appropriate levels of productexpertise and robust control systems. In addition, at both portfolio and position levels, market risk in tradingportfolios is monitored and controlled using a complementary set of techniques,including VAR and various techniques for monitoring interest rate risk(beginning on page 64 of this Form 10-Q). These techniques quantify the impacton capital of defined market movements. Trading portfolios reside primarily within the Markets unit of the CIBM businesssegment, which include warehoused residential mortgage loans purchased forsecuritizations and within the mortgage banking subsidiary included within thePFS business segment. Portfolios include foreign exchange, derivatives, preciousmetals (gold, silver, platinum), equities, money market instruments andsecurities. Trading occurs as a result of customer facilitation, proprietaryposition taking, and economic hedging. In this context, economic hedging mayinclude, for example, forward contracts to sell residential mortgages andderivative contracts which, while economically viable, may not satisfy the hedgerequirements of Statement of Financial Accounting Standards No. 133, Accountingfor Derivative Instruments and Hedging Activities (SFAS 133). The trading portfolios have defined limits pertaining to items such aspermissible investments, risk exposures, loss review, balance sheet size andproduct concentrations. "Loss review" refers to the maximum amount of loss thatmay be incurred before senior management intervention is required. 66 Trading VAR for 2007 is summarized in the following table. -------------------------------------------------------------------------------------------- Six months ended June 30, 2007 June 30, ------------------------------ December 31, 2007 Minimum Maximum Average 2006-------------------------------------------------------------------------------------------- (in millions) Total trading .............. $19 $ 8 $19 $13 $ 9Precious metals ............ -- (1) -- (1) 4 1 2Credit derivatives ......... 6 2 7 4 4Equities ................... 1 -- (1) 4 -- (1) -- (1)Foreign exchange ........... 1 1 3 1 2Interest rate .............. 5 8 20 14 13 (1) Less than $500 thousand. The frequency distribution of daily market risk-related revenues for tradingactivities during 2007 is summarized in the following table. Market risk-relatedtrading revenues include realized and unrealized gains (losses) related totrading activities, but exclude the related net interest income. Analysis of thegain (loss) data for the three months ended June 30, 2007 shows that the largestdaily gain was $25 million and the largest daily loss was $9 million. Analysisof the gain (loss) data for the six months ended June 30, 2007 shows that thelargest daily gain was $25 million and the largest daily loss was $12 million. --------------------------------------------------------------------------------------------------Ranges of daily Treasury trading revenue earned from market risk-related activities Below $(5) to $0 to $5 to Over (in millions) $(5) $0 $5 $10 $10-------------------------------------------------------------------------------------------------- Three months ended June 30, 2007:Number of trading days market risk-related revenue was within the stated range ....................... 3 8 30 16 6 Six months ended June 30, 2007:Number of trading days market risk-related revenue was within the stated range ....................... 14 38 50 17 6 VAR - Non-trading Activities The principal objective of market risk management of non-trading portfolios isto optimize net interest income. Market risk in non-trading portfolios arisesprincipally from mismatches between the future yield on assets and their fundingcost, as a result of interest rate changes. Analysis of this risk is complicatedby having to make assumptions on optionality in certain product areas, forexample, mortgage prepayments, and from behavioral assumptions regarding theeconomic duration of liabilities which are contractually repayable on demand.The prospective change in future net interest income from non-trading portfolioswill be reflected in the current realizable value of these positions, shouldthey be sold or closed prior to maturity. In order to manage this riskoptimally, market risk in non-trading portfolios is transferred to GlobalMarkets or to separate books managed under the supervision of ALCO. Once marketrisk has been consolidated in Global Markets or ALCO-managed books, the netexposure is typically managed through the use of interest rate swaps withinagreed-upon limits. Non-trading VAR for 2007, assuming a 99% confidence level for a two-yearobservation period and a one-day "holding period", is summarized in thefollowing table. ----------------------------------------------------------------------------------------- Six months ended June 30, 2007 June 30, ------------------------------- December 31, 2007 Minimum Maximum Average 2006----------------------------------------------------------------------------------------- (in millions) Interest rate ............. $41 $18 $55 $29 $24 67 Trading Activities - HSBC Mortgage Corporation (USA) HSBC Mortgage Corporation (USA) is HUSI's mortgage banking subsidiary. Tradingoccurs in mortgage banking operations as a result of an economic hedging programintended to offset changes in value of mortgage servicing rights and the salableloan pipeline. Economic hedging may include, for example, forward contracts tosell residential mortgages and derivative contracts used to protect the value ofMSRs. MSRs are assets that represent the present value of net servicing income(servicing fees, ancillary income, escrow and deposit float, net of servicingcosts). MSRs are recognized upon the sale of the underlying loans or at the timethat servicing rights are purchased. MSRs are subject to interest rate risk, inthat their value will fluctuate as a result of a changing interest rateenvironment. Interest rate risk is mitigated through an active hedging program that usestrading securities and derivative instruments to offset changes in value ofMSRs. Since the hedging program involves trading activity, risk is quantifiedand managed using a number of risk assessment techniques. Rate Shock Analysis Modeling techniques are used to monitor certain interest rate scenarios fortheir impact on the economic value of net hedged MSRs, as reflected in thefollowing table. -------------------------------------------------------------------------------------------------------June 30, 2007 Values------------------------------------------------------------------------------------------------------- (in millions) Projected change in net market value of hedged MSRs portfolio (reflects projected rate movements on July 1, 2007): Value of hedged MSRs portfolio ..................................................... $552 Change resulting from an immediate 50 basis point decrease in the yield curve: Change limit (no worse than) .................................................... (16) Calculated change in net market value ........................................... (3) Change resulting from an immediate 50 basis point increase in the yield curve: Change limit (no worse than) .................................................... (8) Calculated change in net market value ........................................... 5 Change resulting from an immediate 100 basis point increase in the yield curve: Change limit (no worse than) .................................................... (12) Calculated change in net market value ........................................... 11 Economic Value of MSRs The economic value of the net, hedged MSRs portfolio is monitored on a dailybasis for interest rate sensitivity. If the economic value declines by more thanestablished limits for one day or one month, various levels of managementreview, intervention and/or corrective actions are required. Hedge Volatility The frequency distribution of the weekly economic value of MSR assets during2007 is summarized in the following table. This includes the change in themarket value of the MSR asset net of changes in the market value of theunderlying hedging positions used to hedge the asset. The changes in economicvalue are adjusted for changes in MSR valuation assumptions that were madeduring the course of the quarter, if applicable. -------------------------------------------------------------------------------------------------Ranges of mortgage economic value from market risk- Below $(2) to $0 to $2 to Over related activities (in millions) $(2) $0 $2 $4 $4------------------------------------------------------------------------------------------------- Three months ended June 30, 2007:Number of trading weeks market risk-related revenue was within the stated range ........................ 2 3 5 2 1 Six months ended June 30, 2007:Number of trading weeks market risk-related revenue was within the stated range ........................ 4 6 10 4 2 68 HSBC USA Inc.Consolidated Average Balances and Interest Rates-------------------------------------------------------------------------------- The following table shows the quarter to date average balances of the principalcomponents of assets, liabilities and shareholders' equity together with theirrespective interest amounts and rates earned or paid, presented on a taxableequivalent basis. Three months ended June 30, --------------------------------------------------------------- 2007 2006 ---------------------------- ----------------------------- Balance Interest Rate* Balance Interest Rate* --------------------------------------------------------------- (in millions) AssetsInterest bearing deposits with banks ............ $ 5,745 $ 81 5.64% $ 4,893 $ 74 6.08%Federal funds sold and securities purchased under resale agreements ............ 12,855 177 5.53 9,722 119 4.88Trading assets .................................. 12,582 168 5.37 10,982 102 3.74Securities ...................................... 21,907 282 5.16 21,925 281 5.13Loans Commercial ................................... 29,538 480 6.52 27,994 431 6.18 Consumer: Residential mortgages .................... 38,904 530 5.46 42,483 560 5.29 Credit cards ............................. 17,555 405 9.26 15,215 324 8.55 Other consumer ........................... 2,480 62 10.08 3,007 67 8.91 -------- ------ ------ -------- ------ ------ Total consumer ............................. 58,939 997 6.79 60,705 951 6.28 -------- ------ ------ -------- ------ ------ Total loans ................................ 88,477 1,477 6.70 88,699 1,382 6.25 -------- ------ ------ -------- ------ ------Other ........................................... 3,035 44 5.74 1,829 24 5.21 -------- ------ ------ -------- ------ ------Total earning assets ............................ 144,601 $2,229 6.18% 138,050 $1,982 5.76% -------- ====== ------ -------- ====== ------Allowance for credit losses ..................... (918) (921)Cash and due from banks ......................... 2,804 3,808Other assets .................................... 21,515 23,944 -------- --------Total assets .................................... $168,002 $164,881 ======== ======== Liabilities and Shareholders' EquityDeposits in domestic offices Savings deposits ............................. $ 43,434 $ 356 3.29% $ 35,195 $ 239 2.72% Other time deposits .......................... 22,236 303 5.47 24,177 281 4.67Deposits in foreign offices Foreign banks deposits ....................... 8,860 112 5.05 7,385 95 5.17 Other time and savings ....................... 15,685 188 4.81 15,245 154 4.04 -------- ------ ------ -------- ------ ------Total interest bearing deposits ................. 90,215 959 4.26 82,002 769 3.76 -------- ------ ------ -------- ------ ------Short-term borrowings ........................... 8,948 105 4.70 10,825 74 2.73Long-term debt .................................. 28,806 350 4.88 28,922 357 4.95 -------- ------ ------ -------- ------ ------Total interest bearing liabilities .............. 127,969 1,414 4.43 121,749 1,200 3.95 -------- ------ ------ -------- ------ ------Net interest income / Interest rate spread ...... $ 815 1.75% $ 782 1.81% ====== ------ ====== ------Noninterest bearing deposits .................... 13,188 11,722Other liabilities ............................... 14,652 19,378Total shareholders' equity ...................... 12,193 12,032 -------- --------Total liabilities and shareholders' equity ...... $168,002 $164,881 ======== ========Net interest margin on average earning assets ... 2.26% 2.27% ------ ------Net interest margin on average total assets ..... 1.94% 1.90% ====== ====== * Rates are calculated on unrounded numbers. Total weighted average rate earned on earning assets is interest and feeearnings divided by daily average amounts of total interest earning assets,including the daily average amount on nonperforming loans. Loan interest for thethree months ended June 30, 2007 and 2006 included fees of $13 million and $17million, respectively. 69 HSBC USA Inc.Consolidated Average Balances and Interest Rates-------------------------------------------------------------------------------- The following table shows the year to date average balances of the principalcomponents of assets, liabilities and shareholders' equity together with theirrespective interest amounts and rates earned or paid, presented on a taxableequivalent basis. Six months ended June 30, --------------------------------------------------------------- 2007 2006 ---------------------------- ----------------------------- Balance Interest Rate* Balance Interest Rate* --------------------------------------------------------------- (in millions) AssetsInterest bearing deposits with banks ............ $ 4,855 $ 137 5.72% $ 4,421 $ 127 5.77%Federal funds sold and securities purchased under resale agreements ............ 12,467 340 5.50 8,210 192 4.72Trading assets .................................. 11,677 309 5.34 10,542 210 4.02Securities ...................................... 22,214 576 5.23 21,621 551 5.13Loans Commercial ................................... 29,104 939 6.51 27,237 816 6.05 Consumer: Residential mortgages .................... 38,994 1,057 5.47 43,180 1,129 5.27 Credit cards ............................. 17,619 797 9.12 15,188 592 7.86 Other consumer ........................... 2,568 126 9.89 3,056 132 8.71 -------- ------ ------ -------- ------ ------ Total consumer ............................. 59,181 1,980 6.75 61,424 1,853 6.08 -------- ------ ------ -------- ------ ------ Total loans ................................ 88,285 2,919 6.67 88,661 2,669 6.07 -------- ------ ------ -------- ------ ------Other ........................................... 2,656 76 5.74 1,256 37 5.98 -------- ------ ------ -------- ------ ------Total earning assets ............................ 142,154 $4,357 6.18% 134,711 $3,786 5.67% -------- ====== ------ -------- ====== ------Allowance for credit losses ..................... (928) (928)Cash and due from banks ......................... 2,989 3,977Other assets .................................... 21,548 22,573 -------- --------Total assets .................................... $165,763 $160,333 ======== ======== Liabilities and Shareholders' EquityDeposits in domestic offices Savings deposits ............................. $ 41,939 $ 677 3.26% $ 32,189 $ 392 2.46% Other time deposits .......................... 22,798 612 5.41 25,449 563 4.46Deposits in foreign offices Foreign banks deposits ....................... 8,958 221 4.97 7,303 172 4.75 Other time and savings ....................... 14,467 338 4.71 15,013 292 3.92 -------- ------ ------ -------- ------ ------Total interest bearing deposits ................. 88,162 1,848 4.23 79,954 1,419 3.58 -------- ------ ------ -------- ------ ------Short-term borrowings ........................... 8,797 176 4.04 10,435 146 2.82Long-term debt .................................. 29,029 723 5.02 28,917 697 4.86 -------- ------ ------ -------- ------ ------Total interest bearing liabilities .............. 125,988 2,747 4.40 119,306 2,262 3.82 -------- ------ ------ -------- ------ ------Net interest income / Interest rate spread ...... $1,610 1.78% $1,524 1.85% ====== ------ ====== ------Noninterest bearing deposits .................... 13,558 12,358Other liabilities ............................... 14,002 16,796Total shareholders' equity ...................... 12,215 11,873 -------- --------Total liabilities and shareholders' equity ...... $165,763 $160,333 ======== ========Net interest margin on average earning assets ... 2.28% 2.28% ------ ------Net interest margin on average total assets ..... 1.96% 1.92% ====== ====== * Rates are calculated on unrounded numbers. Total weighted average rate earned on earning assets is interest and feeearnings divided by daily average amounts of total interest earning assets,including the daily average amount on nonperforming loans. Loan interest for thesix months ended June 30, 2007 and 2006 included fees of $23 million and $29million, respectively. 70 Item 3. Quantitative and Qualitative Disclosures About Market Risk-------------------------------------------------------------------------------- Refer to Item 2, Management's Discussion and Analysis of Financial Condition andResults of Operations, under the captions "Interest Rate Risk Management" and"Trading Activities", beginning on page 63 of this Form 10-Q. Item 4. Controls and Procedures-------------------------------------------------------------------------------- HUSI maintains a system of internal and disclosure controls and proceduresdesigned to ensure that information required to be disclosed in reports filed orsubmitted under the Securities Exchange Act of 1934, as amended, (the ExchangeAct), is recorded, processed, summarized and reported on a timely basis. HUSI'sBoard of Directors, operating through its Audit Committee, which is composedentirely of independent outside directors, provides oversight to the financialreporting process. An evaluation was conducted, with the participation of the Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of HUSI's disclosurecontrols and procedures as of the end of the period covered by this report.Based upon that evaluation, the Chief Executive Officer and Chief FinancialOfficer concluded that HUSI's disclosure controls and procedures were effectiveas of the end of the period covered by this report so as to alert them in atimely fashion to material information required to be disclosed in reports filedunder the Exchange Act. There have been no changes in HUSI's internal controls or in other factors thatcould significantly affect internal and disclosure controls subsequent to thedate that the evaluation was carried out. HUSI continues the process to complete a thorough review of its internalcontrols as part of its preparation for compliance with the requirements ofSection 404 of the Sarbanes-Oxley Act of 2002 (Section 404). Section 404requires management to report on, and external auditors to attest to, theeffectiveness of HUSI's internal control structure and procedures for financialreporting. As a non-accelerated filer under Rule 12b-2 of the Exchange Act,HUSI's first report under Section 404 will be contained in its Form 10-K for theperiod ended December 31, 2007. 71 Part II - OTHER INFORMATION-------------------------------------------------------------------------------- Item 1A. Risk Factors-------------------------------------------------------------------------------- Risk factors were set forth in HUSI's Form 10-K for the period ended December31, 2006. There have been no material changes from the risk factors disclosed inthat Form 10-K. Item 6. Exhibits-------------------------------------------------------------------------------- 12 Computation of Ratio of Earnings to Fixed Charges and Earnings to Combined Fixed Charges and Preferred Stock Dividends. 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.0 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 72 SIGNATURE-------------------------------------------------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized. HSBC USA Inc. ------------- (Registrant) Date: July 30, 2007 /s/ Joseph R. Simpson ------------------------------------------ Joseph R. Simpson Executive Vice President and Controller (On behalf of Registrant) 73 Exhibit 12 HSBC USA Inc. Computation of Ratio of Earnings to Fixed Charges and Earnings to Combined Fixed Charges and Preferred Stock Dividends (in millions, except ratios) --------------------------------------------------------------------------------------------------Six months ended June 30 2007 2006-------------------------------------------------------------------------------------------------- Ratios excluding interest on deposits: Net income ................................................................... $ 564 $ 594 Income tax expense ........................................................... 253 308 Less: Undistributed equity earnings .......................................... -- 25 Fixed charges: Interest on: Borrowed funds ......................................................... 176 146 Long-term debt ......................................................... 723 697 One third of rents, net of income from subleases .......................... 14 12 ------ ------ Total fixed charges, excluding interest on deposits .......................... 913 855 Earnings before taxes and fixed charges, net of undistributed equity earnings .................................................................. $1,730 $1,732 ====== ====== Ratio of earnings to fixed charges ........................................... 1.89 2.03 ====== ====== Total preferred stock dividend factor (1) .................................... $ 72 $ 57 ------ ------ Fixed charges, including the preferred stock dividend factor ................. $ 985 $ 912 ====== ====== Ratio of earnings to combined fixed charges and preferred stock dividends .... 1.76 1.90 ====== ====== Ratios including interest on deposits: Total fixed charges, excluding interest on deposits .......................... $ 913 $ 855 Add: Interest on deposits .................................................... 1,848 1,419 ------ ------ Total fixed charges, including interest on deposits .......................... $2,761 $2,274 ====== ====== Earnings before taxes and fixed charges, net of undistributed equity earnings .................................................................. $1,730 $1,732 Add: Interest on deposits .................................................... 1,848 1,419 ------ ------ Total ........................................................................ $3,578 $3,151 ====== ====== Ratio of earnings to fixed charges ........................................... 1.30 1.39 ====== ====== Fixed charges, including the preferred stock dividend factor ................. $ 985 $ 912 Add: Interest on deposits .................................................... 1,848 1,419 ------ ------ Fixed charges, including the preferred stock dividend factor and interest on deposits ............................................................... $2,833 $2,331 ====== ====== Ratio of earnings to combined fixed charges and preferred stock dividends .... 1.26 1.35 ====== ====== (1) Preferred stock dividends grossed up to their pretax equivalents. 74 Exhibit 31.1 Certification of Chief Executive Officer pursuant to Section 302 of theSarbanes-Oxley Act of 2002.-------------------------------------------------------------------------------- I, Paul J. Lawrence, certify that: 1. I have reviewed this report on Form 10-Q for the quarterly period ended June 30, 2007 of HSBC USA Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal controls over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal controls over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: July 30, 2007 /s/ Paul J. Lawrence --------------------------------------- Paul J. Lawrence President and Chief Executive Officer 75 Exhibit 31.2 Certification of Chief Financial Officer pursuant to Section 302 of theSarbanes-Oxley Act of 2002.-------------------------------------------------------------------------------- I, Gerard Mattia, certify that: 1. I have reviewed this report on Form 10-Q for the quarterly period ended June 30, 2007 of HSBC USA Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal controls over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal controls over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: July 30, 2007 /s/ Gerard Mattia --------------------------------------- Gerard Mattia Senior Executive Vice President and Chief Financial Officer 76 Exhibit 32.0 Certification of Chief Executive Officer and Chief Financial Officer pursuant toSection 906 of the Sarbanes-Oxley Act of 2002.-------------------------------------------------------------------------------- Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and(b) of section 1350, chapter 63 of title 18, United States Code), each of theundersigned officers of HSBC USA Inc., a Maryland corporation (HUSI), doeshereby certify, to such officer's knowledge, that: The Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 (the Form10-Q) of HUSI fully complies with the requirements of section 13(a) or 15(d) ofthe Securities Exchange Act of 1934 and information contained in the Form 10-Qfairly presents, in all material respects, the financial condition and resultsof operations of HUSI. Date: July 30, 2007 /s/ Paul J. Lawrence ---------------------------------------- Paul J. Lawrence President and Chief Executive Officer Date: July 30, 2007 /s/ Gerard Mattia ---------------------------------------- Gerard Mattia Senior Executive Vice President and Chief Financial Officer The foregoing certification is being furnished solely pursuant to Section 906 ofthe Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter63 of title 18, United States Code) and is not being filed as part of the Form10-Q or as a separate disclosure document. A signed original of this written statement required by Section 906, or otherdocument authenticating, acknowledging, or otherwise adopting the signature thatappears in typed form within the electronic version of this written statementrequired by Section 906, has been provided to HSBC USA Inc. and will be retainedby HSBC USA Inc. and furnished to the United States Securities and ExchangeCommission or its staff upon request. 77 This information is provided by RNS The company news service from the London Stock ExchangeRelated Shares:
HSBC Holdings