Interim Report - 11 of 26

Economic background 

The process of reducing debt levels following the credit boom of the past decade continued to restrain growth in the US as households saved more and the rise in consumer spending was subdued. High oil prices made the process of reducing debt more difficult. In the first quarter, the growth of real consumer spending was only 2.2% higher than the level a year ago, compared with a long-run average annual growth rate of 3.3%. This depressed overall growth in GDP to a 2.8% annual rate since the recession ended in mid-2009. Reductions in spending among state and local governments also constrained economic activity. Slow GDP growth kept the unemployment rate high, at 9.2% in June, down only slightly from the peak of 10.1% in 2010. In response to slow growth and low inflation, the Federal Reserve maintained the Fed funds rate in the range of zero to 0.25% and undertook large-scale purchases of fixed-income securities.

Canadian GDP rose by 2.9% in the year ended 31 March 2011, up from 2.1% the year before. Labour market conditions improved with the unemployment rate dropping to 7.4% in June from 7.9% in June 2010. Steep increases in crude oil and gasoline prices drove the headline rate of inflation up to 3.7% in May 2011 from 1.4% a year earlier. However, the core rate of inflation followed by the Bank of Canada ('BoC') was steady at 1.8%. In response to these conditions, the BoC maintained its overnight lending rate at 1.0% throughout the period.

Review of performance

In North America, we reported a profit before tax of US$606m in the first half of 2011, compared with a profit before tax of US$492m in the first half of 2010. Our results included movements on our own debt designated at fair value resulting from changes in credit spreads, while 2010 also included a US$66m gain from the sale of our stake in the Wells Fargo HSBC Trade Bank. On an underlying basis, which excludes these items, the pre-tax profit was US$672m in the first half of 2011, compared with a pre-tax loss of US$51m. This improvement in performance resulted from a significant decline in loan impairment charges, partly offset by a reduction in revenue, both reflecting lower lending balances in HSBC Finance.

During the first half of 2011, we continued to evaluate the strategic options for elements within our US operations and remained focused on managing down our run-off assets sensitively and effectively. In addition, we continued to work closely with our regulators to ensure full compliance with new and existing frameworks and policies.

Profit/(loss) before tax by country within customer groups and global businesses

For footnotes, see page 81.

The North American economies continue to represent a significant share of international trade, and in our CMB and GB&M businesses we remain focused on expanding our business further into areas with strong international connectivity. In CMB, we expanded our operations in the West Coast of the US and in Texas and Florida as well as in eastern Canada to attract the growing number of businesses that trade internationally. Successful cross-border referrals from North America to other HSBC sites increased by 11% from the first half of 2010.

In GB&M, profit before tax fell in the first half of 2011 due to lower releases of collective loan impairment allowances, an increase in compliance costs and a change in the expense recognition of bonus awards. We successfully utilised our established platform in New York to interconnect more closely our GB&M businesses across the Americas and, in the first half of 2011, we syndicated several significant financing transactions for customers in Latin America.

The region represents a significant wealth management market and we continued to direct resources towards the expansion of wealth services and Premier, and remain focused on providing differentiated premium services to internationally minded, upwardly mobile customers.

Net interest income decreased by 9% to US$5.8bn, primarily due to lower lending balances in our Consumer Lending and Mortgage Services portfolios due to continued run-off, and in our Card and Retail Services portfolio as customers continued to pay down outstanding debt. In addition, balances declined following the sale of the vehicle finance portfolio in 2010. This was partly offset by wider asset spreads in our Consumer Lending and Mortgage Services portfolios as the cost of funds fell.

Average customer deposit balances increased in CMB in both the US and Canada as we continued to expand on the West Coast, Texas, Florida and Eastern Canada, and in RBWM due to growth in branch-based deposit products driven by our Premier strategy. In GB&M, increased deposit balances reflected a rise in repurchase transactions.

Net fee income declined by 6% to US$1.7bn, as a result of lower late and overlimit fees in our Card and Retail Services business, reflecting lower volumes and delinquency rates, customers actively seeking to reduce their credit card debt and changes required by the CARD Act.

In December 2010, we exited the Taxpayer Financial Services business, further reducing our fee income compared with the first half of 2010.

Net trading income increased by US$511m to US$448m, driven by fair value movements on non-qualifying hedges which reflected fluctuations in long‑term US interest rates. In the first half of 2011, these rates declined, but to a lesser extent than in the corresponding period in 2010, resulting in lower adverse fair value movements in non‑qualifying hedges.

In addition, in the first half of 2011 loss provisions for loan repurchase obligations relating to loans previously sold were lower while, in our GB&M business, trading income remained broadly flat. This reflected higher deal volumes in foreign exchange, metals and interest rate and emerging markets derivatives, and improved revenue on structured credit products which was broadly offset by the non-recurrence of a gain in the first half of 2010 associated with a settlement relating to certain loans previously purchased for re-sale from a third party.

Net expense from financial instruments designated at fair value of US$53m was 42% less than in the first half of 2010. This was due to lower adverse fair value movements from interest rate ineffectiveness in the economic hedging of our long-term debt designated at fair value, reflecting the decrease in long-term US interest rates.

Gains less losses from financial investmentsdeclined by 7% to US$110m, mainly due to lower gains on the disposal of private equity investments.

Other operating income declined by 29% to US$168m due to higher losses on foreclosed properties, reflecting an increase in the number of such properties sold and declines in house prices in the first half of 2011 and the non-recurrence of a US$56m gain on the sale of our New York headquarters. This was partly offset by the non-recurrence of a US$77m loss on the sale of the vehicle finance loan portfolio and servicing operation in the first half of 2010.

Loan impairment charges and other credit risk provisions decreased by 33% to US$3.0bn, primarily due to lower lending balances in our run‑off Consumer Lending and Mortgage Services portfolios and in our Card and Retail Services portfolio. The decline also reflected an overall improvement in credit quality resulting in lower delinquency levels and reduced write-offs. In our Consumer Lending and Mortgage Servicesbusiness, the improvement was partly offset by an incremental charge resulting from adverse changes to economic assumptions on the pace of recovery in home prices and delays in the timing of expected cash flows, mainly as a result of the suspension of foreclosure activity that began in late 2010.

Loan impairment charges and other credit risk provisions in CMB declined by 58% to US$45m, driven by lower impairment allowances relating to commercial real estate and middle market exposures and lower write-offs in business banking, reflecting improved credit quality and lower delinquency. This was partially offset by a specific loan impairment charge associated with the downgrade of an individual commercial real estate loan.

In GB&M, net recoveries of loan impairment charges and other credit risk provisions were 85% lower than in the first half of 2010 as a reduction in higher‑risk balances and a stabilisation of credit quality resulted in a reduced release of collective loan impairment allowances in the first half of 2011.

Further commentary on delinquency trends in the US RBWM portfolios is provided in 'Areas of special interest - US personal lending' on page 107.

Operating expenses increased by 15%. This included a charge of US$144m relating to the impairment of certain previously capitalised software development costs in the first half of 2011 and the non-recurrence of a pension curtailment gain in the first half of 2010. Excluding these items, operating expenses grew by 8%, mainly due to an increase in litigation provisions and, in GB&M, an increase in amortisation charges for previous years' performance shares and accelerated expense recognition for future deferred bonus awards. In addition, legal and compliance costs were higher and marketing expenses in Card and Retail Services rose, driven by an increase in direct mail volumes, albeit at lower than historical levels. Also notable in the first half of 2011 were severance costs of US$46m resulting from a planned reduction in staff numbers. Partly offsetting these increases were lower costs following the sale of the vehicle finance servicing operation and closure of the Taxpayer Financial Services business.

Profit/(loss) before tax and balance sheet data - North America

Profit/(loss) before tax and balance sheet data - North America (continued)

For footnotes, see page 81.