Interim Report - 7 of 21

Summary

In the analysis of profit and loss by geographical region that follows, operating income and operating expenses include intra‑HSBC items of US$1,467 million (first half of 2009: US$1,347 million; second half of 2009: US$1,409 million).

Profit/(loss) before tax

Total assets23

Risk-weighted assets24

For footnotes, see page 95.

Europe

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

Loans and advances to customers (net) by country

Customer accounts by country

For footnote, see page 95.

Profit before tax

For footnotes, see page 95.

The commentary on Europe is on an underlying basis unless stated otherwise.

Economic briefing

The UK economy experienced a modest recovery during the first half of 2010 as economic conditions stabilised following the severe weakness experienced in 2009. Having fallen 6.4 per cent during the recession, by the end of the second quarter the level of gross domestic product ('GDP') had risen by 1.9 per cent from the low in activity seen in the third quarter of 2009. Labour market conditions also showed signs of stabilisation as the headline rate of unemployment remained around 8 per cent during the half-year. Housing market activity proved subdued and, after appreciating during the early months of 2010, house prices displayed signs of softening during the second quarter. The Bank of England left interest rates unchanged at 0.5 per cent during the first half of the year, while the Asset Purchase Facility also remained steady at £200 billion (US$300 billion). Consumer Price Index ('CPI') inflation remained relatively high throughout the period, falling only marginally from 3.5 per cent in January 2010 to 3.2 per cent in June, well above the Bank of England's 2 per cent target.

The pace of economic recovery also proved lacklustre within the eurozone. In the first quarter the level of GDP rose by just 0.2 per cent on the previous quarter. There was evidence of an acceleration of growth during the second quarter, although economic performance proved increasingly disparate as concerns mounted over the health of the public finances of some member states and a number of austerity programmes were implemented. Tensions within government bond markets across the region prompted the creation of a €750 billion stabilisation fund to be used to provide loans to eurozone governments in need of financial assistance. CPI inflation rose from 0.9 per cent in December 2009 to 1.4 per cent in June 2010, while the unemployment rate increased to an 11-year high of 10 per cent in June 2010. The European Central Bank held the refi rate at 1 per cent throughout the period and, from early May, started to purchase small amounts of the government debt of several eurozone nations in the secondary market.

Review of business performance

Reconciliation of reported and underlying profit before tax

For footnotes, see page 95.

HSBC's European operations reported a pre-tax profit of US$3.5 billion, 18 per cent higher than in the comparable period in 2009 and more than trebled the second half of 2009, mainly due to favourable movements in the Group's own debt held at fair value.

Included within these results was a US$107 million gain on the disposal of the HSBC Insurance Brokers business to Marsh Inc. in April 2010. The first half of 2009 included a US$280 million gain on the sale of the remaining stake in the UK card merchant acquiring business to Global Payments Inc. There was a gain of US$0.6 billion from the widening of credit spreads on the Group's own debt held at fair value; losses of US$0.8 billion and US$2.0 billion were recorded in the first and second halves of 2009, respectively, due to the tightening of credit spreads. Management does not regard the resulting movement of US$1.4 billion compared with the first half of 2009 as part of operating performance. On an underlying basis, which excludes this movement and the gains noted above, profit before tax decreased by 19 per cent compared with the first half of 2009, due to lower income from Global Banking and Markets, where record results in the first half of 2009 were not repeated, partly offset by an overall improvement in credit experience.

In the UK personal sector, Premier customers increased by 9 per cent in the first half of 2010, while Advance attracted 23,000 new customers to HSBC, as the business focused on building sustainable long-term relationships and wealth management revenues in these target segments. Funds under management totalled US$22.0 billion at 30 June 2010, with the World Selection Fund rising by 59 per cent to US$2.3 billion in the first half of the year. Higher revenues were primarily driven by mortgage lending growth. HSBC took an 8 per cent share of new residential mortgage lending in the UK in the first quarter of 2010, with an average new loan to value ratio of 53 per cent.

In Continental Europe, the personal sector increased investment in Premier, growing its customer base to 444,000 in the first half of 2010, particularly in France and Turkey. Advance was launched in Turkey and Poland during the period with a phased roll-out across the region planned in the second half of 2010.

In the UK commercial sector, further progress was made in achieving HSBC's strategy of becoming the leading bank for international business with the number of its UK-based customers managed through the international proposition increasing by 9 per cent during the first half of 2010. Trade and supply chain income increased by 18 per cent on the comparable period. HSBC lent US$2.0 billion to small and medium-sized enterprises ('SME's), and opened accounts for over 65,000 customers starting new businesses. 

The commercial sector in Continental Europe continued to focus on expanding relationships with international businesses. Early signs of business revival were seen in a number of markets, most notably in Germany, Turkey and Poland.

Net interest income fell by 5 per cent compared with the exceptional results reported in the first half of 2009, reflecting a decreasing trend, as forecast, in Balance Sheet Management revenues, as interest rates remained low and major yield curves flattened. In Global Banking and Markets, tighter spreads and a reduction in overall lending balances resulted in lower income in the Credit and lending businesses as corporates repaid debt in order to strengthen their balance sheets.

This reduction was partly offset by mortgage lending growth in the personal sector and wider asset spreads in the UK. This was partly offset by a reduction in deposit spreads which remained narrow in the low interest rate environment and the effects on Personal Financial Services of interest rate cap reductions on credit cards set by the central bank in Turkey.

UK Personal Financial Services maintained its strong deposit base despite fierce competition. Within this, Premier and Advance customer account balances increased by 3 per cent.

Net fee income increased by 13 per cent. Fee income was received for management services provided by HSBC to Structured Investment Conduits and management fees rose in Global Asset Management and the wealth management segment of the personal sector, driven by an increase in the average value of funds under management. Net inflows into Global Asset Management funds were US$8.1 billion in the first half of 2010. The Equity Capital Markets business, however, was affected by a reduction in client activity as the exceptional volumes seen in the first half of 2009 were not repeated.

Net trading income fell by 54 per cent to US$1.6 billion as increased economic uncertainty and subdued market conditions following the concerns over European sovereign debt in the second quarter of 2010 resulted in lower client activity and demand for foreign exchange, Credit and Rates products.

In credit trading, a net release of US$230 million of previous write-downs on legacy positions and monoline exposures reflected an overall improvement in asset prices; the first half of 2009 included a reported net charge of US$252 million. However, this benefit was more than offset by the non-recurrence of gains in other parts of the business that arose in the first half of 2009. Performance in the foreign exchange business remained strong but suffered from a reduction in market volatility and customer-driven volumes compared with the unprecedented levels experienced in late 2008 and early 2009, and Rates income decreased following a slowdown in client activity.

Included within 'Net trading income' was a fair value gain of US$177 million resulting from widening credit spreads on structured liabilities; a loss of US$120 million was reported in the first half of 2009. In addition, foreign exchange gains were reported on trading assets held as economic hedges of foreign currency debt designated at fair value, with the offset reported in 'Net income from financial instruments designated at fair value'. Foreign exchange losses were reported on these instruments in the first half of 2009.

Trading income also included fair value losses on non-qualifying hedges, mainly cross-currency swaps used to economically hedge fixed rate long-term debt issued by HSBC Holdings. The fair value losses, which were driven by a decline in long-term US dollar interest rates relative to sterling and euro interest rates, compared with fair value gains on these instruments in the first half of 2009. This was partly offset by the non-recurrence of a loss on a forward foreign exchange contract associated with the Group's rights issue.

Net income from financial instruments designated at fair value reduced by US$208 million. Losses on the fair value of assets held to meet liabilities under insurance and investment contracts were recognised as equity markets fell, compared with gains reported in the first half of 2009. To the extent that these losses accrued to policyholders holding unit-linked insurance policies and insurance or investment contracts with DPF, there was a corresponding decrease in net insurance claims incurred and movement in liabilities to policyholders.

In addition, foreign exchange losses on debt designated at fair value were reported in the period, with the offset reported in 'Net trading income'. This was partly offset by fair value gains from interest and exchange rate ineffectiveness in the economic hedging of long-term debt designated at fair value compared with fair value losses in the first half of 2009.

Gains less losses from financial investments increased to US$237 million as improved market conditions resulted in lower impairment charges and afforded opportunities to realise private equity investments at a profit. Gains were also realised on available-for-sale assets.

Net earned insurance premiums were broadly in line with the first half of 2009, with an increase in France driven by successful sales campaigns offset by lower premiums in the UK as the motor insurance underwriting business was placed into run-off during the second half of 2009 with no new customer business written in 2010.

Other operating income increased by 51 per cent, primarily due to the gain on the sale and leaseback of HSBC's Paris headquarters.

Net insurance claims incurred and movement in liabilities to policyholders decreased by 16 per cent. This was in line with the movement in liabilities to policyholders reported above in 'Financial instruments designated at fair value', coupled with significantly lower claims provisioning related to the now closed UK motor insurance book. An increase in reserves was recorded in the first half of 2009 to reflect the rising incidence and severity of claims at that time. No further deterioration in claims was observed in the UK motor insurance book in the first half of 2010 and, accordingly, no equivalent reserve strengthening was required.

Loan impairment charges and other credit risk provisions decreased by 48 per cent to US$1.5 billion, reflecting an overall improvement in the credit environment in the region and the Group's success in mitigating risk. In Global Banking and Markets, loan impairment charges fell compared with both halves of 2009, reflecting the improved credit quality of the portfolio. The significant impairments taken in relation to a small number of clients in both halves of 2009 did not recur. Credit risk provisions on certain ABSs held on the available-for-sale portfolio decreased as asset prices rose and default rates declined.

Lower loan impairment charges in the personal sector were driven by an improvement in delinquencies across both the secured and unsecured lending portfolios, in part due to enhanced credit risk management practices and improved collections, falling by US$239 million in the UK and US$61 million in Turkey. In the commercial sector, loan impairment charges reduced by US$205 million. The commercial property sector in the UK experienced the most significant improvement with impairments. Continuation of the positive loan impairment trend experienced in the first half of 2010 in the commercial and personal sectors remains highly sensitive to general economic activity, employment, interest rates and house prices. 

Operating expenses, excluding the impact of two unusual items, were marginally higher in the first half of 2009: Global Banking and Markets' costs included one-off payroll taxes on certain bonuses paid in the second quarter of 2010 in respect of 2009 of US$308 million in the UK and US$42 million in France; and a US$480 million pension accounting gain (US$499 million as reported) in the first half of 2009 related to a change in the delivery of certain staff benefits in the main UK pension scheme which did not recur.

Employee compensation and benefits increased by 19 per cent to US$4.1 billion as a result of these unusual items, partly offset by the Group's continued efforts to leverage global scale and technology platforms to re-engineer the business and make sustainable reductions in its cost base. General and administrative expenses increased by 13 per cent to US$3.1 billion, driven by higher services contracted out and IT costs along with increased rental expenses following the sale and leaseback of 8 Canada Square in London.

Reconciliation of reported and underlying profit before tax

For footnotes, see page 95.

Analysis by customer group and global business

Profit/(loss) before tax