HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Consolidated Financial Statements
December 31, 2004 and 2003
(With Independent Auditors’ Report Thereon)
(Free Translation from Spanish Language Original)
Independent Auditors’ Report
(Free translation from Spanish language original)
The Board of Directors and Stockholders HSBC México, S. A., Institución de Banca Múltiple, Grupo Financiero HSBC:
We have examined the accompanying consolidated balance sheets of HSBC México, S. A., Institución de Banca Múltiple, Grupo Financiero HSBC and Subsidiaries (“the Bank”) as of December 31, 2004 and 2003, and the related consolidated statements of operations, stockholders’ equity and changes in financial position for the years then ended. These consolidated financial statements are the responsibility of the Bank’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in Mexico. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement and are prepared in accordance with the accounting criteria for financial institutions in Mexico. An audit consists of examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As explained in note 2 to the consolidated financial statements, the Bank is required to prepare and present its financial statements in accordance with the accounting criteria for credit institutions in Mexico established by the National Banking and Securities Commission (“the Banking Commission”), which in general conform to accounting principles generally accepted in Mexico, issued by the Mexican Institute of Public Accountants. These accounting criteria include particular rules, which in certain respects depart from such principles.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HSBC México, S. A., Institución de Banca Múltiple, Grupo Financiero HSBC and Subsidiaries as of December 31, 2004 and 2003 and the results of their operations, the changes in their stockholders’ equity and the changes in their financial position for the years then ended, in conformity with the accounting criteria established by the Banking Commission for credit institutions in Mexico, as described in note 2 to the consolidated financial statements.
KPMG CARDENAS DOSAL, S. C
Carlos Rivera Nava
February 18, 2005. HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2004 and 2003
(Thousands of Mexican pesos of constant purchasing power as of December 31, 2004)
Assets 2004 2003 Liabilities and Stockholders' Equity 2004 2003
Cash and equivalents (note 5) $ 43,366,702 37,932,990 Deposit funding (note 14): Demand deposits $ 106,996,271 99,534,597 Investment securities (note 6): Time deposits: Trading 2,651,444 9,497,381 General public 61,653,198 53,931,098 Available-for-sale 37,561,387 7,465,898 Money market 814,566 920,595 Held-to-maturity 4,030,275 6,969,516 169,464,035 154,386,290 44,243,106 23,932,795 Bank and other loans (notes 10d and 15): Securities and derivative transactions: Short-term 6,431,576 5,982,933 Debit balances of repurchase/resell Long-term 2,550,966 3,211,057 agreements (note 7) 57,798 68,151 Derivative financial instruments 8,982,542 9,193,990 (note 8) 42,067 2,552 Unassigned securities pending settlement (note 9) - 1,771 Securities and derivative transactions: Credit balances of repurchase/resell 99,865 72,474 agreements (note 7) 31,349 53,417 Derivative financial instruments (note 8) - 115,627 Current loan portfolio (note 10): Commercial loans 27,369,408 21,405,951 31,349 169,044 Financial institutions 4,014,170 2,192,681 Consumer loans 14,713,795 15,623,597 Other accounts payable: Residential mortgages 12,005,788 11,847,656 Income tax and employee statutory Government entities 6,295,301 6,119,489 profit sharing 663,824 410 IPAB 41,803,829 58,726,457 Sundry creditors and other accounts payable 8,184,780 8,558,461
Total current loan portfolio 106,202,291 115,915,831 8,848,604 8,558,871
Past due loan portfolio (note 10): Subordinated debentures outstanding (note 17) 2,206,681 2,324,164 Commercial loans 1,887,639 4,321,394 Financial institutions 302 665 Deferred credits 13,720 12,815 Consumer loans 524,654 431,209 Residential mortgages 826,544 690,761 Total liabilities 189,546,931 174,645,174 Other past due debts 40,988 98,581 Stockholders' equity (note 19): Total past due loan portfolio 3,280,127 5,542,610 Paid-in capital : Capital stock 3,398,658 3,398,658 Total loan portfolio 109,482,418 121,458,441 Additional paid-in capital 6,626,349 6,626,349
Less: 10,025,007 10,025,007 Allowance for loan losses (note 10e) 6,401,626 8,465,683 Earned (lost) capital: Loan portfolio, net 103,080,792 112,992,758 Statutory reserves 1,899,295 2,624,272 Unrealized gain (loss) from valuation of Other accounts receivable, net 3,938,638 3,230,848 available-for-sale securities 15,556 25,509 Cumulative translation adjustment 11,061 11,061 Foreclosed assets (note 11) 495,932 878,922 Cumulative results from updating stockholders' equity (3,146,713) (3,118,650) Premises, furniture and equipment, net (note 12) 3,999,580 3,205,498 Results from holding nonmonetary assets: From valuation of fixed assets 1,210,027 1,210,027 Permanent investments in shares (note 13) 390,067 390,708 From valuation of permanent investments in shares (147,551) (139,762) Deferred income tax (note 18) 2,137,202 3,503,363 Net income 3,099,921 1,637,261
Other assets: 2,941,596 2,249,718 Other assets, deferred charges and intangibles 763,322 781,211 Minority interest 1,672 1,668
Total stockholders' equity 12,968,275 12,276,393
Commitments and contingent liabilities (note 23)
Total assets $ 202,515,206 186,921,567 Total liabilities and stockholders' equity$ 202,515,206 186,921,567
(Continued) HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Consolidated Balance Sheets, Continued
December 31, 2004 and 2003
(Thousands of Mexican pesos of constant purchasing power as of December 31, 2004)
Memorandum accounts
2004 2003
Guarantees issued (note 21a) $ 217,820 72,252 Other contingent liabilities 9,381,329 10,162,906 Irrevocable lines of credit (note 21a) 2,192,775 674,635 Assets in trust or under mandate (note 21b) 61,807,629 45,783,551
$ 73,599,553 56,693,344
Assets in custody or under management (note 21d) $ 49,137,240 112,942,181 Investments on behalf of customers (note 21c) 24,899,913 14,631,642 Amounts committed under agreements with the IPAB 954,839 7,814,126 Amounts contracted in derivative instruments 91,972,264 23,891,834 Investments in SAR funds 2,873,954 2,389,560 Loan portfolio rated 111,893,013 122,205,337 Other memorandum accounts 313,235,771 323,829,737
$ 594,966,994 607,704,417
Securities receivable under repurchase agreements (note 7) $ 36,090,417 62,649,474 Less - Creditors under agreements to repurchase (note 7) 36,061,652 62,634,938
28,765 14,536
Debtors under securities resell agreements (note 7) 6,022,026 29,111,757 Less - Securities deliverable under resell agreements (note 7) 6,024,342 29,111,559
(2,316) 198 Net repurchase/resell agreements $ 26,449 14,734
The accompanying notes are an integral part of these consolidated financial statements.
"These consolidated balance sheets were prepared in accordance with the accounting criteria for credit institutions issued by the NationalBanking and Securities Commission based on Articles 99, 101 and 102 of the Law for Credit Institutions, which are of a general and mandatory nature and have been applied on a consistent basis. Accordingly, they reflect the transactions carried out by the Institution through the datesnoted above. Furthermore, these transactions were carried out and valued in accordance with sound banking practices and the applicable legal and administrative provisions.
These consolidated balance sheets were approved by the Board of Directors under the responsibility of the following officers.
At December 31, 2004, the historical capital stock amounts to $2,003,430,000 (nominal pesos)".
Rubrica Rubrica Alexander A. Flockhart John J. McKenna President and Chief Executive Officer Chief Financial Officer
Rubrica Rubrica W. Graham Thomson Sergio Armando Torres López Director of Internal Audit Chief Accountant HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 2004 and 2003
(Thousands of Mexican pesos of constant purchasing power as of December 31, 2004)
2004 2003
Interest income (note 22) $ 18,505,417 18,136,715 Interest expense (note 22) (6,910,423) (8,198,690) Monetary position result, net (264,561) (177,255)
Financial margin 11,330,433 9,760,770
Provision for loan losses (note 10e) (1,324,083) (3,105,072)
Financial margin after provision for loan losses 10,006,350 6,655,698
Commission and fee income 6,978,138 6,464,584 Commission and fee expense (751,980) (600,733) Financial intermediation income (note 22) 880,567 1,147,693
Total operating income 17,113,075 13,667,242
Administrative and promotional expenses (11,885,888) (11,128,729)
Net operating income (loss) 5,227,187 2,538,513
Other income (note 22) 1,289,147 641,150 Other expense (note 22) (1,031,536) (744,761)
Income before income tax, employee statutory profit sharing (ESPS) and equity in the results of unconsolidated subsidiaries, associated and affiliated companies 5,484,798 2,434,902
Current income tax (IT) (note 18) (1,162,387) (20,976) Deferred IT and ESPS (note 18) (1,228,761) (787,289)
(2,391,148) (808,265)
Income before equity in the results of unconsolidated subsidiaries, associated and affiliated companies 3,093,650 1,626,637
Equity in the results of unconsolidated subsidiaries, associated and affiliated companies, net 13,120 10,524
Income from continuing operations 3,106,770 1,637,161
Discontinued operations, extraordinary items and accounting policy changes, net (note 22) (6,873) -
Net income before minority interest 3,099,897 1,637,161
Minority interest 24 100
Net income $ 3,099,921 1,637,261
The accompanying notes are an integral part of these consolidated financial statements.
"These consolidated statements of operations were prepared in accordance with the accounting criteria for credit institutions issued by the National Banking and SecuritiesCommission based on Articles99, 101 and 102 of the Law for Credit Institutions, which are of a general and mandatory nature and have been applied on a consistent bassis. Accordingly, they reflect the revenues and disbursements relating to the transactions carried out by the Institution through the dates noted above. Furthermore, these transactions were carried out and valued in accordance with sound banking practices and the applicable legal and administrative provisions.
These consolidated statements of operations were approved by the Board of Directors under the responsibility of the following officers".
Rubrica Rubrica Alexander A. Flockhart John J. McKenna President and Chief Executive Officer Chief Financial Officer
Rubrica Rubrica W. Graham Thomson Sergio Armando Torres López Director of Internal Audit Chief Accountant HSBC MEXICO, S. A., Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
Years ended December 31, 2004 and 2003
(Thousands of Mexican pesos of constant purchasing power as of December 31, 2004)
Paid-in capital Earned capital Unrealized gain Increase from Results from holding (loss) from restatement nonmonetary assets Increase from Increase from Increase from valuation of Deficit in of deficit in From From valuation restatement Additional restatement restatement available-for- Cumulative restatement restatement valuation of permanent Total Capital Unpaid of paid-in paid-in of additional Statutory of statutory sale translation of stockholders' of stockholders' of investments Net income Minority stockholders' stock capital stock capital stock capital paid-in capital reserves reserves securities adjustment equity equity fixed assets in shares (loss) interest equity
Balances at December 31, 2002 $ 1,822,590 (2,534) 1,380,688 11,110,363 2,083,839 379,013 2,353,045 (7,706) 10,823 (2,183,307) (916,600) 1,210,027 (119,732) (7,343,476) 2,008 9,779,041
Changes resulting from stockholder resolution: (note 19a): Resolution passed at the Ordinary and Extraordinary General Stockholders' Meeting on April 28, 2003 Appropriation of the net loss for 2002 – – – (6,701,647) (641,829) – – – – – – – – 7,343,476 – –
Resolution passed at the Extraordinary General Stockholders' Meeting on April 2, 2003: Cancellation of Treasury Series "O" shares (2,534) 2,534 – – – – – – – – – – – – – – Merger with HSBC Bank México, S. A. 183,374 – 14,540 718,632 56,991 – – – – 2,923 232 – – – – 976,692
Resolution passed at the Board of Directors' Meeting on April 24, 2003 - payment of dividends – – – – – (100,000) (7,786) – – – – – – – – (107,786)
Resolution passed at the Extraordinary General Stockholders' Meeting on November 4, 2003: Reduction of capital stock (183,374) – (9,996) (818,362) (44,608) – – – – – – – – – – (1,056,340) Capital stock increase 183,374 – 9,996 818,362 44,608 – – – – – – – – – – 1,056,340
Total items related to stockholders' decisions 180,840 2,534 14,540 (5,983,015) (584,838) (100,000) (7,786) – – 2,923 232 – – 7,343,476 – 868,906
Changes related to the recognition of comprehensive income (note 19b): Net income – – – – – – – – – – – – – 1,637,261 100 1,637,361
Valuation effect of unconsolidated subsidiaries, associated and affiliated companies – – – – – – – – – – – – -20,030 – – -20,030
Valuation effect of available-for-sale securities – – – – – – – 33,215 – – – – – – – 33,215
Currency translation adjustment – – – – – – – – 238 – – – – – – 238
Minority interest – – – – – – – – – – – – – – (440) (440)
Recognition of the year's effects of inflation – – – – – – – – – – (21,898) – – – – -21,898
Total comprehensive income – – – – – – – 33,215 238 – (21,898) – (20,030) 1,637,261 (340) 1,628,446
Balances at December 31, 2003 $ 2,003,430 – 1,395,228 5,127,348 1,499,001 279,013 2,345,259 25,509 11,061 (2,180,384) (938,266) 1,210,027 (139,762) 1,637,261 1,668 12,276,393
(Continued) 2
HSBC MEXICO, S. A., Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity, continued
Years ended December 31, 2004 and 2003
(Thousands of Mexican pesos of constant purchasing power as of December 31, 2004)
Paid-in capital Earned capital Unrealized gain Increase from Results from holding (loss) from restatement nonmonetary assets Increase from Increase from Increase from valuation of Deficit in of deficit in From From valuation restatement Additional restatement restatement available-for- Cumulative restatement restatement valuation of permanent Total Capital of paid-in paid-in of additional Statutory of statutory sale translation of stockholders' of stockholders' of investments Net income Minority stockholders' stock capital stock capital paid-in capital reserves reserves securities adjustment equity equity fixed assets in shares (loss) interest equity
Balances at December 31, 2003 $ 2,003,430 1,395,228 5,127,348 1,499,001 279,013 2,345,259 25,509 11,061 (2,180,384) (938,266) 1,210,027 (139,762) 1,637,261 1,668 12,276,393
Changes resulting from stockholder resolution: (note 19a): Resolution passed at the Ordinary and Extraordinary General Stockholders' Meeting on April 27, 2004 Appropriation of the net income for 2003 – – – – 1,637,261 – – – – – – – (1,637,261) – –
Payment of dividends on June 22, 2004 – – – – (581,087) (1,206,152) – – – – – – – – (1,787,239)
Payment of dividends on December 13, 2004 – – – – (545,277) (29,722) – – – – – – – – (574,999)
Total items related to stockholders' decisions – – – – (510,897) (1,235,874) – – – – – – (1,637,261) – (2,362,238)
Changes related to the recognition of comprehensive income (note 19b): Net income – – – – – – – – – – – – 3,099,921 – 3,099,921
Valuation effect of unconsolidated subsidiaries, associated and – affiliated companies – – – – – – – – – – – (7,789) – – (7,789)
Valuation effect of available-for-sale securities – – – – – – (9,953) – – – – – – – (9,953)
Minority interest – – – – – – – – – – – – – 4 4
Recognition of the year's effects of inflation – – – – – – – – – (28,063) – – – – (28,063)
Total comprehensive income – – – – – – (9,953) – – (28,063) – (7,789) 3,099,921 4 3,054,120
Balances at December 31, 2004 $ 2,003,430 1,395,228 5,127,348 1,499,001 789,910 1,109,385 15,556 11,061 (2,180,384) (966,329) 1,210,027 (147,551) 3,099,921 1,672 12,968,275
The accompanying notes are an integral part of these consolidated financial statements.
"These consolidated statements of stockholders' equity were prepared in conformity with the accounting criteria for credit institutions established by the National Banking and Securities Commission based on Articles 99, 101 and 102 of the Law for Credit Institutions, which are of a general and mandatory nature and were applied on a consistent basis. Accordingly, they reflect all the stockholders' equity account entries relating to the transactions carried out by the Bank through the dates noted above. Furthermore, these transactions were carried out and valued in accordance with sound banking practices and the applicable legal and administrative provisions.
These consolidated statements of stockholders' equity were approved by the Board of Directors under the responsibility of the following officers".
Rubrica Rubrica Rubrica Rubrica Alexander A. Flockhart John J. McKenna W. Graham Thomson Sergio Armando Torres López President and Chief Executive Officer Chief Financial Officer Director of Internal Audit Chief Accountant
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Consolidated Statements of Changes in Financial Position
Years ended December 31, 2004 and 2003
(Thousands of Mexican pesos of constant purchasing power as of December 31, 2004)
2004 2003
Operating activities: Net income $ 3,099,921 1,637,261 Items included in operations not requiring (providing) funds: Net unrealized (loss) gain from valuation of securities under repurchase/resell agreements, forwards and financial instruments (57,730) (30,445) Provision for loan losses 1,324,083 3,105,072 Equity in the results of unconsolidated subsidiaries, associated and affiliated companies (13,120) (10,524) Depreciation and amortization 615,852 542,039 Deferred income tax and employee statutory profit sharing 1,228,761 787,290 Provision for foreclosed assets 208,006 28,730 Minority interest (24) (100)
6,405,749 6,059,323
Changes in items related to operations: Increase in operating liabilities: Deposit funding 15,077,745 11,100,834 Accounts payable 289,733 1,321,369 (Increase) decrease in operating assets: Loan portfolio 8,587,883 (844,859) Investment securities (20,319,622) (14,597,628) Securities and derivative transactions, net (107,998) 54,980 Other accounts receivable (707,790) 1,678,628
Funds provided by operating activities 9,225,700 4,772,647
Financing activities: Redemption of outstanding subordinated debentures (117,483) (59,362) Decrease in bank and other loans (211,448) (2,542,814) Dividends paid (2,362,238) (107,785) Increase in capital stock and additional paid-in capital on merger of HSBC Bank (note 19a) - 976,693
Funds used in financing activities (2,691,169) (1,733,268)
Investing activities:
Acquisition of property, premises and equipment, net (1,269,177) (217,293) Permanent investments in shares, net 5,972 37,750 Increase in deferred charges, net (12,598) (587,562) Currency translation adjustment - 238 Decrease (increase) in foreclosed assets 174,984 (140,198)
Funds used in investing activities (1,100,819) (907,065)
Increase in cash and equivalents, includes $277,545 (nominal) from the merger of HSBC Bank México, S. A. 5,433,712 2,132,314
Cash and equivalents: At beginning of year 37,932,990 35,800,676
At end of year $ 43,366,702 37,932,990
The accompanying notes are an integral part of these consolidated financial statements.
"These consolidated statements of changes in financial position have been prepared in conformity with the accounting criteria for credit institutions established by the National Banking and Securities Commission pursuant to Articles 99, 101 and 102 of the Law for Credit Institutions, which are of a general and mandatory nature and have been applied on a consistent basis. Accordingly, they reflect all sources and applications of funds derived from the Bank's operations through the dates noted above. Furthermore, these transactions were carried out and valued in accordance with sound banking practices and the applicable legal and administrative provisions.
These consolidated statements of changes in financial position were approved by the Board of Directors under the responsibility of the following officers".
Rubrica Rubrica Alexander A. Flockhart John J. McKenna President and Chief Excecutive Officer Chief Financial Officer
Rubrica Rubrica W. Graham Thomson Sergio Armando Torres López Director of Internal Audit Chief Accountant HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(Thousands of Mexican pesos of constant purchasing power as of December 31, 2004, unless where otherwise noted)
These financial statements have been translated from the Spanish language original solely for the convenience of foreign/English-speaking readers.
(1) Description of business and significant transactions-
Description of business-
HSBC México, S. A. (“HSBC or the Bank”) is a subsidiary of Grupo Financiero HSBC, S. A. de C. V. (“the Group”) and currently holds 99.99% of its capital stock. In 2002 HSBC Holding plc acquired the Group and currently holds 99.76% of its capital stock. Based on the Law for Credit Institutions (LCI), the Bank is authorized to carry out commercial banking activities, which include but are not limited to: accepting deposits from the general public, granting and receiving loans, engaging in securities transactions and providing trust services. The Bank’s subsidiaries are engaged principally in financial activities.
At the Extraordinary and Ordinary General Stockholders’ Meeting held on September 18, 2003 the stockholders agreed to change the Bank’s name from Banco Internacional, S. A. to HSBC México, S. A., Institución de Banca Múltiple, Grupo Financiero HSBC.
Significant transactions-
Replace of trustee-
On June 4, 2004, Banco del Atlántico, S. A. (in liquidation since May 1, 2004, Atlántico), represented by the Instituto para la Protección al Ahorro Bancario (IPAB) as settlor, and HSBC undersigned an agreement to replace the trustee in accordance with the article 29 fraction III of the LCI. Such agreement designates to HSBC as new trustee in all outstanding contracts of trust and mandates previously managed by Atlántico.
Merger of HSBC Bank México, S. A.-
At the Extraordinary General Stockholders’ Meeting held on April 2, 2003, it was resolved to merge HSBC Bank México, S. A., Institución de Banca Múltiple Filial (merged entity) with the Bank (surviving entity) with figures as of May 31, 2003. The merger increased the Bank’s assets by $1,304,238 ($1,208,405 nominal), liabilities by $327,546 ($303,476 nominal) and stockholders’ equity by $976,692 ($904,929 nominal).
(Continued) 2
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
(2) Summary of significant accounting policies-
(a) Financial statement presentation-
The consolidated financial statements have been prepared based on the banking legislation and in conformity with the accounting criteria for credit institutions in Mexico established by the National Banking and Securities Commission (the Banking Commission). The Banking Commission is responsible for the inspection and supervision of credit institutions and for reviewing their financial information.
The accompanying consolidated financial statements include the financial statements of the Bank and of its subsidiaries in the financial sector subject to consolidation as well as the restructured loan portfolio in UDI Trusts. These Trusts were created to manage the restructured loan portfolio based on various support programs established by the Federal Government (see note 10, section c), where the Bank acts as trustor and trustee and the Federal Government as beneficiary. The trusts have been valued and presented in accordance with the accounting rules established by the Banking Commission. Significant intercompany transactions and balances have been eliminated in consolidation.
In general, the accounting criteria established by the Banking Commission conform to accounting principles generally accepted in Mexico (“Mexican GAAP”), issued by the Mexican Institute of Public Accountants (IMCP) and include particular rules relating to accounting, valuation, presentation and disclosure, which in certain respects, differ from such principles in that they do not limit the consolidation to financial subsidiaries (also see paragraphs c, d and m of this note).
For cases not contemplated therein, the accounting criteria include a process which provides for the supplementary use of other accounting principles and standards, in the following order: Mexican GAAP; International Accounting Standards issued by the International Accounting Standards Committee; accounting principles generally accepted in the United States (“US GAAP”); or in cases not covered by these principles and standards, any other formal and recognized accounting standard that does not contravene the general criteria of the Banking Commission.
The accompanying consolidated financial statements are expressed in Mexican pesos of constant purchasing power, using the Investment Unit (UDI) value. The UDI is a unit of measurement whose value is determined by the Banco de México (Central Bank) based on inflation. UDI values at December 31 are as follows:
Annual Year UDI inflation
2004 $ 3.5347 5.45% 2003 3.3520 3.91% 2002 3.2258 5.58% =====
For purposes of disclosure in the notes to the consolidated financial statements, pesos or “$” refers to Mexican pesos, and when reference is made to dollars, it means dollars of the United States of America.
(Continued) 3
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Assets and liabilities related to purchase and sale of foreign currencies, investments in securities, securities repurchase and resell agreements, and derivative financial instruments are recognized in the consolidated financial statements on the day the transactions are entered into, regardless of the settlement date.
The consolidated financial statements for the year ended December 31, 2003 include certain reclassifications to conform to the classifications used in 2004.
(b) Cash and equivalents-
Cash and equivalents consist of cash, precious metals (coins), bank account balances, 24 and 48- hour foreign currency purchase and sale transactions, bank loans with original maturities of up to three days (“Call Money”) and deposits with the Central Bank.
The receivables associated with 24 and 48-hour foreign currency sales are recorded in “Other accounts receivable” while the obligations arising from such foreign currency purchases are recorded in “Sundry creditors and other accounts payable”.
This category includes the deposits relation to monetary regulation, in compliance with the Law of the Banco de México (Central Bank), whose purpose is regulating the liquidity of the money market. These deposits do not have maturity and bear interest at the average funding rate of the banks.
(c) Investment securities-
Investment securities consist of equities, government securities and bank notes, listed and unlisted, classified into three categories depending on management’s investment intentions. These categories are described as follows.
Trading securities-
Trading securities are bought and held principally to be sold in the near term. Debt and equity securities are initially recorded at cost and subsequently marked to market at the price provided by an independent price vendor. When a fair and representative market value cannot be determined, they are recorded at the latest fair value or otherwise the security is reported at cost plus accrued interest. Equity securities are reported at the lower of market value provided by an independent price vendor, by applying the equity method, acquisition cost restated using UDI factors, or their estimated net realizable value. Valuation effects are recognized in results of operations.
Available-for-sale securities-
Securities not classified as trading or held-to-maturity portfolios are classified as “Available-for- sale”. “Available-for-sale” securities are recorded at cost and valued in the same way as trading securities; however, the mark-to-market adjustment is reported in stockholders’ equity under “Unrealized gain or loss from valuation of “Available-for-sale” securities. Unrealized gains and losses are cancelled when the respective securities are sold, reporting the difference between net realizable value and acquisition cost in results of operations. Where there is persuasive evidence that a security represents a high credit risk and/or the estimated value has decreased, the book value is written down through a charge to results of operations. According to Mexican GAAP, the valuation effect of “Available-for-sale” securities is recognized in the year’s results of operations.
(Continued) 4
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Held-to-maturity securities-
Held-to-maturity securities are those securities that the Bank has the ability and intent to hold until maturity, have defined payments and maturities of more than 90 days. Held-to-maturity securities are recorded at acquisition cost and interest is recognized in income as earned.
Transfers between categories-
Transfers of securities between categories, except transfers to the trading securities category, require express authorization from the Banking Commission. The cumulative effect of the “Unrealized gain or loss from valuation of “Available-for-sale” securities is cancelled and recognized in income upon transferring “Available-for-sale” securities to the trading securities category. For transfers of “Available-for-sale” securities to the held-to-maturity securities category, the “Unrealized gain or loss from valuation of “Available-for-sale” securities is amortized to income based on the remaining term of the securities.
(d) Securities under repurchase/resell agreements-
Securities under repurchase/resell agreements are stated at market value provided by an independent price vendor and the obligations or rights from the commitments to repurchase or resell the securities are stated at the net present value at maturity. Contrary to Mexican GAAP requirements, the consolidated balance sheet reflects the net balance between these two restated values, instead of presenting them separately as assets and liabilities and only offsetting similar transactions with the same party. Transactions where the Bank is both repurchaser and repurchasee with the same entity are not offset. Interest, premiums, gains or losses and valuation adjustments from these transactions are reported in the results of operations under “Interest income”, “Interest expense”, and “Financial intermediation income, net”, respectively”.
In accordance with the Circular 1/2003 of the Central Bank, any repurchase transactions, signed after September 3, 2004, with a maturity period over 3 days; must include an obligation to guarantee such transaction, when the fluctuations in the value of the titles under the repurchase agreement represents a net exposure which exceeds the maximum amount agreed by the parts. The guarantee granted is recorded under the category of investment in securities as guaranteed trading securities or in the category of cash and equivalents as restricted funds. The guarantees received, which does not represent a transfer of property, are recorded in memorandum accounts as assets in custody or under management. Such guarantees are valuedin accordance to current gridelines for investment securities, cash equivalents and assets in custody or under management, respectively.
Securities under repurchase/resell agreements that cannot be renegotiated with a third party are reported as secured borrowing or lending transactions. Premiums are recognized in income as earned over the term of the transaction.
(Continued) 5
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
(e) Derivative transactions-
Transactions with derivative financial instruments comprise those carried out for trading or hedging purposes, the accounting treatment of which is described below:
Futures and forward contracts – The consolidated balance sheet shows the net fluctuation in the market value of the contracts’ future price, which effects are recognized in income, except in the case of hedging transactions where the related gains or losses are recorded as deferred credits or debits, amortized using the straight-line method over the term of the underlying instruments and shown together with the primary position they cover.
Swaps – Rights or obligations arising from the exchange of cash flows or asset yields (swaps) are recorded as assets or liabilities. The assets and liabilities derived from swaps are marked to market, reporting the net value of the swap on the consolidated balance sheet while the related gains or losses are recognized in income, except in the case of transactions designated as hedges where gains or losses are recorded as deferred credits or debits, amortized using the straight-line method over the term of the underlying instruments and shown together with the primary position they cover.
Options – Put and call option obligations (premiums collected) or rights (premiums paid) are recorded at contract value and marked to market, recording all gains or losses in income. Premiums collected or paid are recognized in “Financial intermediation income, net” when the option expires.
(f) Unassigned securities pending settlement-
Securities pending settlement represent commitments for purchasing or selling widely traded securities, whose characteristics or issues are undefined; also known as 24 to 96 hour range transactions. The Bank recognizes an asset or a liability, which represents the securities receivable or deliverable or else the agreed-upon settlement right or obligation. The assets and liabilities derived from securities are marked to market, affecting the year’s results of operations. The assets or liabilities representing the agreed-upon settlement right or obligation are recorded at nominal values. Debit and credit balances of each transaction are offset individually. The debit or credit balance resulting from individually offset transactions is shown in the consolidated balance sheet asset or liability category “Unassigned Securities pending settlement”. Valuation adjustments are recognized in “Financial intermediation income, net” in the consolidated statement of operations.
(Continued) 6
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
(g) Clearing accounts-
Amounts receivable or payable arising from investment securities, securities under repurchase/resell agreements, securities lending and/or derivative financial instruments which have expired but have not been settled at the balance sheet date, as well as amounts receivable or payable resulting from the purchase or sale of foreign currencies which are not for immediate settlement or those with a same day value date, are recorded in clearing accounts.
Debit and credit balances of clearing accounts resulting from foreign currency purchase/sell transactions are offset provided the contractual right exists for offsetting the amounts recorded and there is the intention of settling them on a net basis, or else realizing the asset and liability simultaneously. Assets and liabilities are also offset in transactions of the same nature or that arise from the same contract, provided they have the same maturities and are settled concurrently.
(h) Past due loans and interest-
Outstanding loan and interest balances are classified as past due according to the following criteria:
Loans with principal and interest payable upon maturity – 30 days after due date.
Loans with one principal amortization and periodic interest payments – When interest and principal have not been collected 90 and 30 days after their due date, respectively.
Revolving credits, credit cards and others - When unpaid for two normal billing cycles or when 60 or more days past due.
Mortgage loans – 90 days after the due date of the first unpaid installment.
Installment loans – 90 days after the first unpaid amortization of principal and interest.
Overdrafts from checking accounts without lines of credit - When the overdraft arises.
In addition, a loan is classified as past due when the debtor files for bankrupty protection.
(i) Allowance for loan losses-
An allowance for loan losses is maintained which, in management’s opinion, is sufficient to cover credit risks associated with the loan portfolio, guarantees issued and irrevocable loan commitments. The allowance is established as follows.
Rated loans – Based on studies which classify the loan portfolio, using an internally developed methodology for commercial loans. The Banking Commission in the official letter 601-II- DGSIFC-9867 dated March 16, 2004, authorized HSBC to continue using its internally developed methodology, which complies with the rules and regulations of the Ministry of Finance and Public Credit (SHCP) and the dispositions of the Banking Commission for credit qualification.
(Continued) 7
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
HSBC’s internally developed methodology links the attributes used with the attributes established in the Banking Comission included in the “General Dispositions relating to the Rating Methodology for Loan Portfolios of Credit Institutions” (“the Dispositions”) and published in the Official Gazette on August 20, 2004, which took effect starting December 1, 2004. Such dispositions excluded loans granted to Government states or municipalities, investment projects with own source of payment and trustees of the trusts or structured credit schemes with own net worth. Such disposition also allow individual assessment of the associated risk, are individually evaluated in accordance with the methodology prescribed by the Dispositions, including residential mortgages and other consumer loans (see note 24). The allowance percentages are established considering risk levels according to the following table:
Range of Risk level allowance percentages
A - Minimum 0.5 – 0.9 B - Low 1 – 19.9 C – Medium 20 – 59.9 D – High 60 – 89.9 E – Loss 90 – 100.0
General reserves – In accordance with the Dispositions are considered general reserves with risk grade A (A, B and C-1 in 2003).
Specific reserves – Considered with risk grade B, C, D and E (C-2, D and E in 2003).
Exempt portfolio – consists mainly of loans to government entities, including the IPAB, that are not rated.
Trouble loan – For disclosure purposes in the financial statements, HSBC considers as trouble loans its credits with risk grade D and E.
Additional reserves – are established for those loans, which in management’s opinion, may give rise to concern in the future given the particular situation of the customer, the industry or the economy. They also include items such as uncollected interest and others, the ultimate collection of which may, in management’s opinion, result in a loss for HSBC.
Loans considered irrecoverable are written off against the allowance when their collection is determined to be impractical. Recoveries on loans previously written off are credited to the allowance.
(j) Other accounts receivable-
Reserves are established, based on an evaluation of the levels of risk, for accounts receivable arising from unidentified and identified non-credit transactions that are not recovered within 60 and 90 days, respectively.
(Continued) 8
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
(k) Foreclosed assets and assets received in lieu of payment-
Assets acquired through foreclosure are stated as the lower value between of the adjudicated value or net realizable value. Assets received in lieu of payment are stated at the lower of the appraisal value or the price agreed upon by the parties. Any shortfall between the appraisal value and the balance due is written off against the allowance for loan losses. Assets are written down to reflect any subsequent impairment in their value through a charge against the results of the operations. The assets with commitment of sale are shown at the sale price, recognizing the gain or loss in deferred credit or in the income, respectively. The amount of the collected rents derived from foreclosed assets is deducted against the value of the assets.
Up to November 30, 2003, the write-downs and reserves are deducted from the carrying value of the assets and charged to results of operations. Effective December 1, 2004, the Bank creates additional reserves on a quarterly basis to recognize potential losses for the deterioration in asset value due to the passing of time. These reserves are created in accordance with the Dispositions described in note 2(i) and provisions are established as follows:
Percentage of the allowance Elapsed months since the date of Sundry Foreclosed or lieu of payment Premises assets
More than: 6 0 10 12 10 20 18 10 45 24 15 60 30 25 100 36 30 100 42 35 100 48 40 100 54 50 100 60 100 100
(l) Premises, furniture and equipment-
Premises, furniture and equipment are initially recorded at acquisition cost, and adjusted for inflation by applying UDI factors.
Depreciation and amortization are calculated on the restated asset values using the straight-line method over the estimated useful lives of the assets.
(m) Permanent investments in shares-
The investments in subsidiary companies not subject to consolidation are accounted for under the equity method. The Bank’s equity in the results of subsidiary companies is recognized in the year’s income and its equity in the increase or decrease of other stockholders’ equity accounts is recognized in the Bank’s stockholders’ equity under “Gain or loss on holding non-monetary assets from valuation of permanent investments in shares”.
(Continued) 9
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
This category also includes permanent investments in shares of issuing companies where the Bank exerts no significant influence, which are valued using the cost method and differs from PCGA, adjusted for inflation by applying the UDI value. Valuation adjustments are recognized in the Bank’s stockholders’ equity under “Gain or loss on holding non-monetary assets from valuation of permanent investments in shares”. When the valuation of the investment is consistently below the adjusted cost, the investment is written down to realizable value through a charge to results of operations
(n) Deferred income tax (IT) and employee statutory profit sharing (ESPS)-
Deferred income tax is accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in results of operations for the period enacted.
Deferred ESPS is recognized for timing differences arising from the reconciliation between book and taxable for profit sharing purposes, on which it may reasonably be estimated that a future liability will arise and there is no indication that the liabilities will not materialize.
(o) Deposit funding-
Deposit funding comprise demand and time deposits of the general public, as well as money market funding. Interest is charged to expense on the accrual basis. For instruments sold at a price other than face value, a deferred charge or credit is recognized and the difference is amortized on the straight-line basis over the term of the respective instrument.
(p) Bank and other loans-
Bank and other loans comprise short and long-term bank loans from domestic and foreign banks, loans obtained through credit auctions with Banco de México and development fund financing. In addition, this category includes loans rediscounted with agencies specializing in financing economic, productive or development activities. Interest is recognized on the accrual basis.
(q) Pensions, seniority premiums and post-retirement benefits-
The net periodic cost and accrued pension and seniority premium benefits to which all employees are entitled by law, are recognized based on actuarial calculations of the present value of these obligations using the projected unit credit method and real interest rates as required by Bulletin D- 3 issued by the IMCP. Other compensation to which employees may be entitled, mainly severance or disability, is charged to expense as it is incurred.
In addition, based on the calculations performed by an independent actuary, a liability is recorded, recognizing the cost of the period in the income. HSBC funds the post retirement medical benefits as of 2002. Amortization of unrecognized past service costs is based on an estimated service life of employees of 25 years.
(Continued) 10
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
(r) Restatement of capital stock, statutory reserves and retained earnings (deficit)-
This restatement is determined by multiplying stockholder contributions, statutory reserves and retained earnings (deficit) by UDI values, which measure accumulated inflation from the dates contributed or generated through the most recent year end. The resulting amounts represent the constant value of stockholders’ equity.
(s) Result from holding non-monetary assets-
The result from holding non-monetary assets represents the difference between the specific valuations of these assets and their cost restated based on the value of the UDI.
(t) Monetary position gains and losses-
HSBC recognizes in income the effect (gain or loss) in the purchasing power of its monetary position, which it determines by multiplying the difference between monetary assets and liabilities at the beginning of each month by inflation through year end. The aggregate of these results represents the monetary gain or loss for the year arising from inflation, which is reported in results of operations for the year.
The gain or loss from interest-bearing monetary assets and liabilities is included in the consolidated statement of operations as part of the “Financial margin”, while the gain or loss from all other monetary items and the acquisition cost of “Available-for-sale” securities is presented in “Other income” or “Other expense”, respectively”.
The monetary position gain or loss from the valuation of “Available-for-sale” securities is recognized in the Bank’s stockholders’ equity under “Unrealized gain or loss from valuation of “Available-for-sale” securities.
(u) Revenue recognition-
Interest on loans granted is recorded in income as earned. Interest on past due loans is not recognized in income until collected.
Fees and interest collected in advance are recorded as deferred income under “Deferred credits”, and recognized in results of operations as earned.
Fees related to the issuance of credit cards and services rendered, and those corresponding to commercial, personal and mortgage loans are recorded in income upon collection. In the case of loans subject to fees and conditioned to the occurrence of a particular event, fees are deferred and recognized in income over the term of the loan.
Premiums collected on securities repurchase transactions are recognized in income based on the present value of the price at maturity.
(Continued) 11
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
(v) Foreign currency transactions-
The accounting records are maintained in both pesos and foreign currencies. For financial statement presentation purposes, currencies other than dollars are translated into dollars at the exchange rates established by the Central Bank, and the dollar equivalent, together with dollar balances, is than translated into pesos using the exchange rates determined by the Banking Commission. Foreign exchange gains and losses are recognized in the results of operations.
(w) UDI Trusts-
Asset and liability accounts of the loan portfolios restructured in UDI Trusts are expressed in pesos by applying the UDI value determined by the Central Bank at the end of each month. Income and expense accounts are expressed in pesos by applying the average UDI value.
(x) Contributions to the Bank Savings Protection Institute (IPAB)-
Among other provisions, the Bank Savings Protection Law created the IPAB, which purpose is to establish a system to protect the savings of the public and regulate the financial support granted to banking institutions in order to comply with this objective. During 2004, the IPAB guarantees 100% of bank deposits. Beginning in January 1, 2005, the IPAB will guarantee a maximum of 400,000 UDIS per depositor per institution, in conformity with the decree published in the Official Gazette on December 14, 2000. The Bank recognizes in results of operations the mandatory contributions to the IPAB.
(y) Contingencies-
Liabilities for loss contingencies are recorded when it is probable that a liability has been incurred and the amount of the assessment and/or remediation can be reasonably estimated. When a reasonable estimation cannot be made, qualitative disclosure is provided in the notes to the consolidated financial statements. Contingent revenues, earnings and assets are not recognized until their realization is virtually assured.
(z) Use of estimates-
The preparation of consolidated financial statements requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions.
(3) Update of accounting policy-
General dispositions relating to the Rating Methodology for Loan Portfolios of credit Institutions-
The new Dispositions supersedes the circulars 1449, 1460, 1480, 1493 and 1514 of the Banking Commission. These Dispositions establish new rules to record credit provisions for potential losses of the credits loans (see note 2i) and recognized potential losses due to time in the value of the foreclosed assets or received in lieu of payment (see note 2k). The inception effect did not have any impact in the credit provision, because the new Dispositions are very similar to the internal developed methodology of HSBC. In the case of foreclosed assets o received in lieu of payment, an increase of the provision was recorded for $110,686 charged against the year’s results (see note 11).
(Continued) 12
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
(4) Foreign currency exposure-
Central Bank regulations require that banks maintain balanced positions in foreign currencies within certain limits. The short or long position permitted by the Central Bank is equal to a maximum of 15% of the basic capital. At December 31, 2004 and 2003 the foreign currency position, the consolidated foreign currency position in thousands of dollars is analyzed as follows:
(Thousands of dollars) 2004 2003
Assets 10,363,842 3,317,428 Liabilities 10,164,988 3,119,957
Net long position 198,854 197,471 ======
The exchange rate of the peso to the dollar as of December 31, 2004 and 2003 was $11.1495 and $11.2372, respectively.
(5) Cash and equivalents-
At December 31, 2004 and 2003, cash equivalents are analyzed as follows:
2004 2003
Cash on hand $ 8,154,831 7,113,292 Deposits with domestic and foreign banks 10,412,315 9,807,566 Deposits with Banco de Mexico 22,416,993 18,538,310 Bank loans - 160,681 Other funds available 220,409 172,271 Restricted funds: 24 and 48-hour foreign currency purchases 3,785,918 3,719,605 24 and 48-hour foreign currency sales (1,623,764) (1,578,735)
$ 43,366,702 37,932,990 ======
At December 31, 2004 and 2003 there are precious metals for $23,503 and $23,843, respectively, which are included in other funds available.
According to the Central Bank’s monetary policy, the Bank is required to maintain a monetary regulation deposit which at December 31, 2004 and 2003 amounted to $22,376,981 and $15,530,548, respectively, in compliance with the requirements of the Central Bank, designed to control market liquidity. These deposits loan interest at the average rate of the banking deposits.
(Continued) 13
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
(6) Investment securities-
At December 31, 2004 and 2003 the Bank’s investments in securities were as follows:
2004 2003
Trading: Bank promissory notes $ 1,982,550 8,164,694 Government securities (see note 7) - 314,740 Bonds 668,894 346,170 Government paper (UMS Global) - 660,697 Equities - 11,080
Trading securities 2,651,444 9,497,381
Available-for-sale: Equities 10,857 22,486 Debt securities (*) 37,550,530 7,443,412
37,561,387 7,465,898
Held-to-maturity: Special CETES of the UDI Trusts: Productive plant 166,487 665,428 States and municipalities 364,208 379,308 Residential mortages 2,510,225 3,874,879 Agricultural and fishing - 27,941
3,040,920 4,947,556 Other 989,355 2,021,960
4,030,275 6,969,516
Total investment securities $ 44,243,106 23,932,795 ======
(*) Transactions of the Electronic Payments System (SPEUA)-
Effective August 1, 2003, using government securities (Cetes, Bondes or Udibonos) institutions participating in SPEUA transactions must guarantee their largest risk exposure limits so as to ensure compliance with any additional settlement obligations that may arise in the future. Such guarantees must be for an amount equal to 5% of such limits, which should be increased by a similar amount beginning on the first business day of the following month and subsequently until such guarantees represent 125 percent of the largest of such risk exposure limits.
At December 31, 2004, the Bank maintains a guarantee of $876,367 ($304,796 in 2003) with Banco de Mexico, which covers the 85% required at such date (25% in 2003).
(Continued) 14
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Transfer between investment categories-
As of December 31, 2004, the Banking Commission authorized the transfer from “Trading securities” to “Available-for-sale” is analized as follows:
Number Issuer of shares
UMS 08 @ 8.625 25,000 PEMEX 09 @ 7.875 25,000 UMS 08 @ 4.625 25,000
Total 75,000 =====
Up to Decembre 31, 2004, the gains and losses associated with the aforementioned investments were recognized in the statement of income. The valuation of such securities that recorded in the “Available- for-sale” category amounted $897,165.
In 2003, the Banking Commission authorized the Bank to transfer “Trading” securities to the “Available- for-sale” category effective July 31, 2003, is analyzed as follows:
Number Issuer of shares
Edoardo B 16,500,743 Simec B 117,500 Cmr B 2,250,000 Other issuers 20,051,924
Total 38,920,167 ======
Up to July 31, 2003, the gains and losses associated with the aforementioned investments were recognized in the statement of income. At December 31, 2004 the valuation of such securities recorded in the “Available-for-sale” category amounted $127,109 (nominal).
As of December 31, 2004 and 2003, the investment in debt securities of the same issues, greater than $743 and $656 millions (5% of the net capital of HSBC), classified as trading and “Available-for-sale”, are analized as follows:
Thousands Partial Issue of titles amount Total
2004 :
Trading
IBANOBRAS 05011 1,983,994 $ 1,982,557 $ 1,982,557 ======
(Continued) 15
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Thousands Partial Issue of titles amount Total
2003 :
Trading: IBACMEXT04014 1,004,418 $ 1,057,732 IBACMEXT04024 120,204 126,434 1,184,166
IBANOBRAS04044 973,055 1,021,072 IBANOBRAS04033 174,927 183,807 1,204,879
IBANSAN04035 788,711 828,474 828,474
INAFIN04012 905,544 953,933 INAFIN04013 1,015,985 1,070,094 INAFIN04015 717,361 755,310 INAFIN04033 1,214,324 1,275,975 INAFIN04041 849,490 891,864 4,947,176 ======$ 8,164,695 ======
Available-for-sale: IBANOBRAS04024 1,004,612 $ 1,056,685 IBANOBRAS04033 502,625 528,143 $ 1,584,828 ======
Classification of investment securities-
At December 31, 2004 and 2003 the investment securities are classified according to their term as follows:
2004 2003 Securities Short Long Short Long
Trading $ 2,602,256 49,188 8,512,744 984,637 Available-for-sale 353,172 37,208,215 4,727,004 2,738,894 Held-to-maturity 65,605 3,964,670 70,278 6,899,238
$ 3,021,033 41,222,073 13,310,026 10,622,769 ======
$ 44,243,106 23,932,795 ======
(Continued) 16
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
(7) Securities under repurchase/resell agreements-
At December 31, 2004 and 2003 securities under repurchase/resell agreements are analyzed as follows:
2004 2003 Net balance Net balance Debit Credit Total Debit Credit Total
Securities receivable $ 31,900,425 4,189,992 36,090,417 41,617,771 21,031,703 62,649,474 Creditors under agreements to repurchase (31,861,129) (4,200,523) (36,061,652) (41,557,063) (21,077,875) (62,634,938)
Securities sold under agreements to repurchase, carried forward 39,296 (10,531) 28,765 60,708 (46,172) 14,536 ======
Securities deliverable (1,999,624) (4,024,718) (6,024,342) (10,959,508) (18,152,051) (29,111,559) Debtors under agreements to resell 2,018,126 4,003,900 6,022,026 10,966,951 18,144,806 29,111,757
Securities purchased under agreements to resell 18,502 (20,818) $ (2,316) 7,443 (7,245) $ 198 ======
Debit (credit) balances under repurchase/resell agreements $ 57,798 (31,349) 68,151 (53,417) ======
At December 31, 2004 and 2003, the Bank had executed repurchase/resell agreements and had net positions by type of security and average term in days as follows:
2004 2003 Average Average Average Average selling purchase selling purchase Sale Purchase term term Purchase Sale term term
Securities receivable (deliverable)
Government BONDE182 $ 7,111,643 (3,018,272) 28 32 323,611 - 77 - BONDEST 638,392 (502,782) 20 28 8,726,757 (8,406,989) 35 15 BONOS 2,726,468 - 3 - 4,176,519 (1,054,679) 3 2 BPAT 6,239,295 (1,999,624) 21 3 6,053,123 (2,906,744) 20 20 BREMS 10,528,592 - 9 - 7,418,349 (2,640,803) 42 2 CETES 1,212,644 (216,770) 6 28 9,595,657 (241,975) 15 2 IPAB 4,799,928 (286,894) 32 28 11,817,396 (1,838,913) 32 18
Carried forward $ 33,256,962 (6,024,342) 48,111,412 (17,090,103)
17
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
2004 2003 Average Average Average Average selling purchase selling purchase Sale Purchase term term Purchase Sale term term
Securities receivable (deliverable)
Brought forward $ 33,256,962 (6,024,342) 48,111,412 (17,090,103)
Bank Promissory notes 2,363,859 - 7 - 14,048,526 (12,021,456) 9 2 Bonds 469,596 - 77 - 489,536 - 114 -
36,090,417 (6,024,342) 62,649,474 (29,111,559)
(Creditors) debtors under agreements to repurchase /resell (36,061,652) 6,022,026 (62,634,938) 29,111,757
28,765 (2,316) 14,536 198
Reclassifications 29,033 (29,033) 53,615 (53,615)
Debit (credit) balances under repurchase/resell agreements $ 57,798 (31,349) 68,151 (53,417) ======
(8) Derivative instruments-
Trading:
At December 31, 2004 and 2003, derivative financial instruments for trading purposes are analyzed as follows:
2004 2003 2003 Assets Assets Liabilities
Contracts: Foreign exchange forwards (mainly pesos and dollars) $ 20,190 2,168 - Interest rate futures 335 384 - Foreign exchange swaps - - 113,058 Interest rate swaps 21,542 - 2,569
$ 42,067 2,552 115,627 ======
(Continued) 18
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
As of December 31, 2004, as explained in note 6; the Banking Commission authorized a transfer from Trading Securities to “Available-for-sale”. As result of this transfer, the foreign currency swaps were reclassified from trading to hedging purposes.
Hedge transactions:
Derivative transactions for hedging purposes are presented in the consolidated balance sheet together with the primary position they cover. At December 31, 2004 and 2003, derivative financial instruments for hedging purposes are analyzed as follows:
Primary Valuation position 2004 2003
Currency swaps Investment securities (note 6) $ (90,215) - Interest rate swaps Loans to the IPAB (note 10b) (1,671) 1,421 ======
Notional amounts:
Notional amounts of contracts represent the derivatives volume outstanding and not the potential gain or loss associated with the market risk or credit risk of such instruments. The notional amounts represent the amount to which a rate or price is applied for determining the amount of cash flows to be exchanged. Notional amounts of the derivative financial instruments at December 31, 2004 and 2003 are as follows:
2004 2003 Purchase Sale Net Purchase Sale Net
Hedging purposes
Interest rate contracts: Swaps $ 4,376,000 (3,000,000) 1,376,000 - (2,720,000) (2,720,000)
Foreign currency: Swaps 826,175 - 826,175 - - -
$ 5,202,175 (3,000,000) 2,202,175 - (2,720,000) (2,720,000) ======
(Continued) 19
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
2004 2003 Purchase Sale Net Purchase Sale Net Trading purposes
Interest rate contracts: Futures $ 8,500,000 - 8,500,000 5,219,100 - 5,219,100 Swaps 14,680,000 (13,435,000) 1,245,000 250,000 (450,000) (200,000)
$ 23,180,000 (13,435,000) 9,745,000 5,469,100 (450,000) 5,019,100 ======
Foreign currency: Forwards 21,798,566 (25,356,523) (3,557,957) 5,980,397 (7,997,357) (2,016,960) Swaps - - - 826,175 (921,710) (95,535)
$ 21,798,566 (25,356,523) (3,557,957) 6,806,572 (8,919,067) (2,112,495) ======
(9) Unassigned securities pending settlement-
At December 31, 2003 securities (Cetes and government bonds) unassigned pending settlement are analyzed as follows:
Bought Sold Settlement term Term Amount in days Amount in days
Government bonds $ 495,242 2 to 5 190,306 2 to 5 Cetes 529,164 2 to 5 312,567 2
$ 1,024,406 502,873 ======
At December 31, 2003 the valuation of these transactions resulted in a gain of $1,771 ($1,651 bought and $120 sold).
(10) Loan portfolio-
At December 31, 2004 and 2003 the Bank’s credit risk is disclosed in the consolidated balance sheet as follows:
2004 2003
Total loan portfolio, shown in the balance sheet, carried forward $ 109,482,418 121,458,441
20
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
2004 2003
Total loan portfolio, shown in the balance sheet, brought forward $ 109,482,418 121,458,441
Recorded in memorandum accounts (note 21a): Guarantees 217,820 72,252 Irrevocable lines of credit 2,192,775 674,635
2,410,595 746,887
$ 111,893,013 122,205,328 ======
(a) Classification of loan portfolio into current and past due by currency, rated portfolio, economic sector and by aging of past due loans-
At December 31, 2004 and 2003, the classification of loans into current and past due by currency, which includes the restructured portfolio of UDI Trusts, and by economic sector, rated portfolio and aging of past due loans is shown on the two following pages.
The rated commercial loan includes the guarantees and irrevocable lines of credit garanted by HSBC, which are recorded in memorandum accounts.
(Continued) 21
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Figures as of December 31, 2004
(Thousands of constant Mexican pesos as of December 31, 2004)
At December 31, 2004 the loan portfolio is analyzed as follows:
Commercial Financial entities Consumer Residential mortgages Government entities IPAB Past due indebtedness Total Current:
Pesos $ 19,074,534 3,520,915 14,713,247 5,698,110 5,169,236 41,803,829 - 89,979,871 Foreign currency 7,558,236 493,255 541 3,836 732,749 - - 8,788,617 UDIS 736,638 - 7 6,303,842 393,316 - - 7,433,803
Total 27,369,408 4,014,170 14,713,795 12,005,788 6,295,301 41,803,829 - 106,202,291
Past due:
Pesos 964,616 302 524,319 250,910 - - 39,664 1,779,811 Foreign currency 599,268 - 56 - - - 1,324 600,648 UDIS 323,755 - 279 575,634 - - - 899,668
Total 1,887,639 302 524,654 826,544 - - 40,988 3,280,127
Total
Pesos 20,039,150 3,521,217 15,237,566 5,949,020 5,169,236 41,803,829 39,664 91,759,682 Foreign currency 8,157,504 493,255 597 3,836 732,749 - 1,324 9,389,265 UDIS 1,060,393 - 286 6,879,476 393,316 - - 8,333,471
Total $ 29,257,047 4,014,472 15,238,449 12,832,332 6,295,301 41,803,829 40,988 109,482,418 ======
Classification by activity
Manufacturing $ 12,016,380 Financial 3,096,678 Car loans 8,019,715 Construction 12,832,332 Municipalities 670,682 Simple loans 24,063,193 Past due 40,988 services and housing indebtedness
Agriculture, forestry and Credit Credit fishing 6,645,575 Unions 504,319 cards 3,770,301 - States 1,535,051 Loans swap 17,740,636 Loan to the Leasing Multiple Federal Trade and companies 227,781 loans 2,817,407 Government tourism 6,121,297 - (support programs) 414,059 Fixed Services 4,473,795 Other 185,694 installments 631,026 ______Other 3,675,509 ______
$ 29,257,047 4,014,472 15,238,449 12,832,332 6,295,301 41,803,829 40,988 109,482,418 ======
Portfolio rating risk % Rated Allowance for Related Allowance for Rated Allowance for Rated Allowance for Rated Allowance for Rated Allowance for Rated Allowance for Rated Allowance for loans loan losses loans loan losses loans loan losses loans loan losses loans loan losses loans loan losses loans loan losses loans loan losses
0.5 to 09 A-Minimum $ 27,067,673 164,026 3,909,152 22,969 11,977,931 90,750 8,917,693 75,487 4,911,902 31,191 - - - - 56,784,351 384,423 1 to 19.9 B-Low 1,825,333 295,485 105,018 20,992 2,092,283 184,352 3,103,855 153,237 860,632 26,313 - - - - 7,987,121 680,379 20 to 59.9 C-Medium 887,795 285,630 - - 469,853 207,296 149,500 54,654 108,708 21,742 - - - - 1,615,856 569,322 60 to 89.9 D-High 729,005 455,506 - - 622,820 459,146 535,441 380,364 ------1,887,266 1,295,016 90 to 100 E-Irrecoverable 1,157,836 1,146,453 302 302 75,562 75,561 125,843 117,963 - - - - 40,988 40,988 1,400,531 1,381,267
$ 31,667,642 2,347,100 4,014,472 44,263 15,238,449 1,017,105 12,832,332 781,705 5,881,242 79,246 - - 40,988 40,988 69,675,125 4,310,407 ======
Additional reserves - - - 2,091,219 - - - 2,091,219
$ 2,347,100 44,263 1,017,105 2,872,924 79,246 - 40,988 6,401,626 ======
Past due loans by aging
1 to 180 days past due $ 292,610 3 369,397 160,149 - - 34,158 856,317 181 to 365 days past due 126,327 - 66,117 214,632 - - 713 407,789 1 to 2 years past due 267,991 - 8,143 284,359 - - 1,720 562,213 Over 2 years past due 1,200,711 299 80,997 167,404 - - 4,397 1,453,808
$ 1,887,639 302 524,654 826,544 - - 40,988 3,280,127 ======
(Continued)
22
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Figures as of December 31, 2004
(Thousands of constant Mexican pesos as of December 31, 2004)
At December 31, 2003 the loan portfolio is analyzed as follows:
Commercial Financial entities Consumer Residential mortgages Government entities IPAB Past due indebtedness Total Current:
Pesos $ 13,752,277 2,137,040 15,620,541 4,540,672 3,871,562 58,726,457 - 98,648,549 Foreign currency 6,782,112 55,641 3,049 4,078 831,103 - - 7,675,983 UDIS 871,562 - 7 7,302,906 1,416,824 - - 9,591,299
Total 21,405,951 2,192,681 15,623,597 11,847,656 6,119,489 58,726,457 - 115,915,831
Past due:
Pesos 1,539,316 665 429,809 215,324 - - 53,149 2,238,263 Foreign currency 1,308,501 - 310 - - - 45,432 1,354,243 UDIS 1,473,577 - 1,090 475,437 - - - 1,950,104
Total 4,321,394 665 431,209 690,761 - - 98,581 5,542,610
Total
Pesos 15,291,593 2,137,705 16,050,350 4,755,996 3,871,562 58,726,457 53,149 100,886,812 Foreign currency 8,090,613 55,641 3,359 4,078 831,103 - 45,432 9,030,226 UDIS 2,345,139 - 1,097 7,778,343 1,416,824 - - 11,541,403
Total $ 25,727,345 2,193,346 16,054,806 12,538,417 6,119,489 58,726,457 98,581 121,458,441 ======
Classification by activity Manufacturing $ 8,412,995 Financial Car loans 10,771,840 Construction 12,538,417 Municipalities 217,941 Simple loans 40,915,161 Past due services 1,271,581 and housing indebtedness 98,581 States 2,314,805 Agriculture, forestry and Credit Credit Loan to the fishing 8,061,360 Unions 480,716 cards 2,983,204 Federal Government (support programs) 485,146 Loan swap 17,811,296 Leasing Multiple Trade and companies 230,900 loans 2,208,423 tourism 4,873,833 Other 3,101,597 Fixed Services 4,379,157 Other 210,149 installments 91,339 ______$ 25,727,345 2,193,346 16,054,806 12,538,417 6,119,489 58,726,457 98,581 121,458,441 ======Portfolio rating risk % Rated Allowance for Related Allowance for Rated Allowance for Rated Allowance for Rated Allowance for Rated Allowance for Rated Allowance for Rated Allowance for loans loan losses loans loan losses loans loan losses loans loan losses loans loan losses loans loan losses loans loan losses loans loan losses
De 0.5 a .99 A- Minimum $ 17,803,787 123,620 1,904,989 11,619 12,443,890 62,219 4,049,575 31,697 5,504,768 31,809 - - - - 41,707,009 260,964 De 1 a 19.9 B- Low 2,854,014 438,407 159,229 31,783 2,352,092 235,209 6,527,135 273,009 129,575 25,649 - - - - 12,022,045 1,004,057 De 20 a 59.9 C- Medium 1,571,482 537,953 - - 570,781 256,852 1,594,255 416,221 ------3,736,518 1,211,026 De 60 a 89.9 D- High 1,432,350 886,687 95,743 57,445 619,109 456,288 321,315 223,387 ------2,468,517 1,623,807 De 90 a 100 E- Irrecoverable 2,812,610 2,811,943 33,385 33,382 68,934 68,934 46,137 31,181 - - - - 98,581 98,581 3,059,647 3,044,021
$ 26,474,243 4,798,610 2,193,346 134,229 16,054,806 1,079,502 12,538,417 975,495 5,634,343 57,458 - - 98,581 98,581 62,993,736 7,143,875 ======
Additional reserves 59,785 - - 1,262,023 - - - 1,321,808
4,858,395 134,229 1,079,502 2,237,518 57,458 - 98,581 8,465,683 ======
Past due loans by aging
1-180 days past due $ 435,264 - 293,523 233,775 - - 88,331 1,050,893 181-365 days past due 403,855 12 87,316 117,473 - - 1,724 610,380 1-2 years past due 402,406 399 6,864 34,758 - - 6,537 450,964 Over 2 years past due 3,079,869 254 43,506 304,755 - - 1,989 3,430,373
$ 4,321,394 665 431,209 690,761 - - 98,581 5,542,610 ======
(Continued) 23
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
(b) Loans to the IPAB-
At December 31, 2004 and 2003 the Bank had entered into the following transactions with the IPAB:
2004 2003
Unsecured loan $ 24,063,193 40,915,161 Loan swap 17,740,636 17,811,296
$ 41,803,829 58,726,457 ======
Unsecured loan:
On December 7, 2001 the IPAB, Atlántico and the Bank entered into an agreement (the Agreement) with the purpose of setting forth the terms and conditions for completing the financial reorganization of Atlántico in line with the provisions of transitory article nine of the Bank Savings Protection Law.
In the terms of the Agreement, Atlántico was obliged to invest in a instrument of payment issued by the IPAB, all resources received with the purpose to conclude the financial reorganization, as well as the prommisory notes and credit rights Atlántico maintained and that were due by the IPAB.
On September 27, 2002, the Bank granted a $47,356,995 (nominal) loan to the IPAB. The loan is documented by a promissory note that may only be endorsed to Banco de Mexico as a guarantee for the note amount. The loan matures on December 30, 2009 but with the right of prepayment, and bears interest at a rate equal to the arithmetic average of the annual yield rates of 91-day Cetes sold during the interest accrual period plus one percentage point. Interest accrued on the loan is payable by the IPAB on the last day of each calendar quarter.
In November and December 2004, the IPAB prepaid principal $12,122,153 and $2,610,702 (nominal), respectively.
Loan swap:
The Bank and the Mexican financial authorities executed agreements to exchange portfolio flows for promissory notes due by the FOBAPROA (currently the IPAB). The exchange agreements consider the delivery of cash flows from commercial loans in exchange for the cash flows of a promissory note, less a percentage of loan losses to be borne by the Bank.
At December 31, 2004 and 2003, the loan swap is analyzed as follows:
2004 2003
Promissory notes $ 25,208,765 31,444,123 Loan collections, pending delivery to the IPAB (292,082) (6,273,880) Allowance for uncollectible amounts (7,176,047) (7,358,947)
$ 17,740,636 17,811,296 ======
(Continued) 24
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Federal Government support programs:
As a result of the economic crisis in 1995, the Federal Government and the Asociación de Banqueros de México, A.C. (the Mexican Bankers’ Association) established loan support programs and agreements, so that debtors of credit institutions could comply with their obligations. The programs and agreements currently in effect are as follows:
· Financial Support and Promotion for Micro, Small and Medium-sized Companies (FOPYME). · Financial Support to the Agricultural, Cattle-raising and Fishery Sector (FINAPE). · Additional Benefits to Housing Loan Debtors (BADCV). · Additional Benefits to FOVI Housing Loan Debtors (BADCF).
The financial support programs and agreements consist of discounts granted to debtors, which are generally absorbed proportionately by the Federal Government and the Bank, in accordance with the terms of each program. Certain discounts are conditional subject to the net cash flows contributed by the Bank to the specific economic sector. As of December 31, 2004 and 2003, receivables from the Federal Government in connection with discounts granted are as follows:
2004 2003
Unconditioned receivables: Related to BADCV and BADCVF $ 408,499 476,743 Related to FOPYME 1,361 2,334 Related to FINAPE 1,112 1,286
410,972 480,363
Conditioned receivables: Related to FOPYME 1,956 3,316 Related to FINAPE 1,131 1,467
3,087 4,783
$ 414,059 485,146 ======
The Bank’s cost associated with the various debtor support programs and agreements for the years ended December 31, 2004 and 2003 is analyzed as follows:
2004 2003
FOPYME $ 2,955 5,722 FINAPE 1,912 1,753 Residential mortgages and FOVI type housing 292,893 354,533
$ 297,760 362,008 ======
(Continued) 25
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
(c) UDI Trust restructured loans-
The Bank participated in several loan-restructuring programs established between the Federal Government and the Mexican banks. The Bank underwrote restructuring programs that consisted mainly of changing the peso-denominated loans to UDIs through trusts created with funding provided by the Central Bank. At December 31, 2004 and 2003, the balances of restructured loans are analyzed as follows:
2004 2003 Average Average annual annual Loan portfolio interest Loan portfolio interest Current Past due rate Current Past due rate
Domestic productive plant $ 1,243 - 7.11% 12,226 743,900 9.95% States and muni- cipalities 383,393 - 7.58% 1,405,980 - 7.12% Residential mortgages 5,398,604 468,694 8.72% 6,244,582 287,658 7.17%
$ 5,783,240 468,694 7,662,788 1,031,558 ======
(d) Additional loan portfolio information-
Annual weighted lending rates:
During 2004 and 2003, the annual weighted lending rates (unaudited) were as follows:
2004 2003
Commercial loans 9.56% 12.11% Financial entities 10.85% 8.91% Personal loans 32.76% 35.96% Residential mortgages 14.33% 13.34% Government entities 11.60% 13.90%
Loans rediscounted with recourse:
The Mexican Government has established certain funds to promote the development of specific areas of the agriculture, cattle-raising, industrial and tourism sectors, which are managed mainly by the Central Bank, Nacional Financiera, Banco Nacional de Comercio Exterior and Fondo de Garantía y Fomento para la Agricultura by rediscounting loans with recourse. At December 31, 2004 and 2003, the amount of loans granted under these programs aggregated $8,909,446 and $9,737,809, respectively, and the related liability is included in “Bank and other loans”.
(Continued) 26
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Restructured loans:
At December 31, 2004 and 2003, restructured loans are analyzed as follows:
2004 2003 Loan portfolio Loan portfolio Current Past due Total Current Past due Total
Agriculture Portfolio Restructure Program System (SIRECA) $ 5,651 62,183 67,834 6,846 68,998 75,844 With Bank funds 1,650,564 430,974 2,081,538 1,928,511 918,547 2,847,058
$ 1,656,215 493,157 2,149,372 1,935,357 987,545 2,922,902 ======
The amount of interest income recognized from the restructuring of past due loans aggregated $451,172 and $1,235,570 for the years ended December 31, 2004 and 2003, respectively. The Bank obtained additional guarantees when carrying out loan restructures.
Below is an analysis of the annual movement of past due loans for the years ended December 31, 2004 and 2003:
2004 2003
Balance at beginning of year $ 5,542,610 14,853,783 Collections (2,600,756) (4,494,753) Write-offs (1,942,308) (7,729,280) Transfers to current loan portfolio (1,355,494) (862,465) Transfers from current loan portfolio 4,365,046 5,114,766 Exchange rate fluctuations 85,819 251,968 Residential mortgage loan sales (423,544) (1,507,884) Other minor items (391,246) (83,525)
Balance at end of year $ 3,280,127 5,542,610 ======
The estimate of nominal interest that would have accrued in 2004 from the past due loan portfolio is $387,731 ($940,825 in 2003).
Impaired loans:
At December 31, 2004 and 2003, the balance of impaired commercial loans is $1,928,131 and $4,472,670, respectively, of which $346,918 and $571,591 are recorded as current loans and $1,581,213 and $3,901,079 as past due loans, respectively.
(Continued) 27
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Risk concentration:
At December 31, 2004, HSBC’s accounting records includes three loans which individually exceeds the 10% of the basic capital, in addition to being the three largest loans. The sum of these three credits at December 31, 2004, amounted to $5,466,549 (46.21% of the basic capital).
(e) Allowance for loan losses-
As explained in notes 2i and 24c, an allowance is established to provide for credit risks associated with the collection of the Bank’s loan portfolio.
At December 31, 2004 and 2003 the allowance for loan losses, analyzed in section (a) above is comprised as follows:
2004 2003
Rated loan estimate $ 4,310,407 6,774,603 Additional reserves, including past due interest 2,091,219 1,241,005 Reserves for the Single Payment Equivalent to Rent Scheme - 12,480
6,401,626 8,028,088 Inflation effect - 437,595
Total allowance for loan losses $ 6,401,626 8,465,683 ======
At December 31, 2004, the balance of the allowance for loan losses, general A (A, B and C-1 in 2003) and specific B-1 to E (C-2, D and E in 2003) amounts to $2,475,642 and $3,925,984, respectively ($3,710,078 and $4,755,605, respectively in 2003).
The movement of the allowance for loan losses for the years ended December 31, 2004 and 2003 (in nominal pesos) is summarized below:
2004 2003
Balance at beginning of year $ 8,028,088 15,696,480 Provisions charged to income 1,122,610 2,864,426 Reinstatement of reserves 873,789 641,263 Exchange rate valuation effects 120,962 170,495 Applications: Write-offs (3,023,621) (7,409,347) Debt forgiveness (720,202) (3,935,229)
6,401,626 8,028,088 Restatement for inflation - 437,595
Balance at end of year $ 6,401,626 8,465,683 ======
(Continued) 28
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Additionally, the provision for loan loss in the 2004 and 2003 consolidated statements of operations includes $201,473 and $84,512, respectively, for the loss sharing under the IPAB loan swap (see note 10b).
(11) Foreclosed assets or received in lieu of payment-
As of December 31, 2004 and 2003, foreclosed assets or assets received in lieu of payment are analyzed as follows:
2004 2003 Amount Provision Amount Provision
Securities and sundry assets: Securities $ 620,114 (594,738) 636,029 (625,632) Sundry assets 111,144 (81,994) 94,415 (80,221)
731,258 (676,732) 730,444 (705,853) Premises: Land 350,481 (323,879) 569,379 (380,759) Buildings 1,304,678 (889,874) 1,939,770 (1,274,059)
1,655,159 (1,213,753) 2,509,149 (1,654,818)
$ 2,386,417 (1,890,485) 3,239,593 (2,360,671) ======
$ 495,932 878,922 ======
The provision in 2004 amounted to $208,006 ($28,730, in 2003), which includes $110,686 of the inception effect of the new dispositions $110,686.
(12) Premises, furniture and equipment-
Premises, furniture and equipment at December 31, 2004 and 2003 are analyzed as follows:
Annual 2004 2003 depreciation rate
Premises $ 2,050,668 1,760,659 5% Office furniture and equipment 2,342,222 2,220,169 10% Computer equipment 1,728,212 1,260,533 various Transportation equipment 117,843 112,604 25% Installation expenses 1,761,499 1,609,423 10% and 5% Other equipment 665,923 605,020 various
Carried forward $ 8,666,367 7,568,408
29
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
2004 2003
Brought forward $ 8,666,367 7,568,408
Accumulated depreciation and amortization (5,584,899) (5,140,748)
3,081,468 2,427,660 Land 918,112 777,838
$ 3,999,580 3,205,498 ======
Depreciation and amortization charged to income in 2004 and 2003 amounted to $615,852 and $542,039, respectively.
(13) Permanent investments in shares-
At December 31, 2004 and 2003, permanent investments in shares of unconsolidated subsidiaries, associated and affiliated companies, classified by activity, are analyzed as follows:
2004 2003
Unconsolidated subsidiaries: Real estate companies $ 28,585 32,851 Other 20,172 6,830 Associated and affiliated companies: Supplementary banking services 316,286 326,441 Mutual funds 13,440 21,161 Security and protection 9,852 1,677 Other activities 1,732 1,748
$ 390,067 390,708 ======
(14) Deposits-
The weighted average deposit rates (unaudited) during the years ended December 31, 2004 and 2003 are analyzed as follows:
2004 rates 2003 rates Pesos Dollars UDIS Pesos Dollars UDIS
Demand deposits 1.05 0.41 - 1.12 0.58 - Savings deposits 1.28 0.76 - 1.27 0.76 - Time deposits 5.74 0.89 1.09 5.72 0.81 1.18 Money market 8.47 3.08 - 8.14 3.06 -
(Continued) 30
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
The money market is comprised primarily of promissory notes denominated in pesos with interest payable at maturity and terms ranging from 1 to 365 days.
(15) Bank and other loans-
At December 31, 2004 and 2003, bank and other loans are analyzed as follows:
2004 2003 Term Term Short Long Short Long
Pesos: Banco de México $ 262,533 - - - Development banks* 1,820,067 256,641 648,500 332,458 Multiple bank 192,467 - - - Promotion funds* 3,235,323 1,878,803 3,225,966 2,336,579
5,510,390 2,135,444 3,874,466 2,669,037 Foreign currencies: Development banks* 191,919 51,534 237,269 110,780 Promotion funds* 604,080 139,828 1,725,021 346,874 Foreign banks 125,187 224,160 146,177 84,366
921,186 415,522 2,108,467 542,020
Total by term 6,431,576 2,550,966 5,982,933 3,211,057
Total bank and other loans $ 8,982,542 9,193,990 ======
* Secured by the loans granted under the respective schemes (see note 10d).
At December 31, 2004, the average annual rates are analyzed as follows:
Pesos Dollars
Banco de México 7.06% - Development banks 7.46% 2.40% Promotion funds 5.88% 2.60% Foreign banks - 1.59% ======
(16) Pensions, seniority premiums and post-retirement benefits-
Starting April 2004, the defined benefit pensions plan incorporates a defined contribution component, consequently the employees, inaccordance with their age and the services years, elected the option more convenient for them. The defined benefit pension plan (DBPP) includes all the union employees and employees whose retirement date of jubilation is near; the rest of them employees elected the defined contribution pension plan (DCPP).
(Continued) 31
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
As provided for by the collective bargaining agreement, all employees who reach 60 years old with 5 years of service or 55 years old with 35 years of service are eligible under the established non- contributory pension plan. The plan also covers seniority premium benefits to which employees are entitled in accordance with the Federal Labor Law. Contributions in 2004 and 2003 amounted to $95,876 (nominal) and $752,282 (nominal), respectively.
The cost, obligations and assets of the pension, seniority premiums and post-retirement medical benefits plans mentioned in note 2q were determined based on the calculations performed by an independent actuary dated November 30, 2004.
Effect of reduction or extinction of the DBPP, due to the employees which take the option of the DCPP, reduce the next periods cost of DBPP, in a similar amount of the annual contribution of the DCPP.
The components of the net periodic cost for the years ended December 31, 2004 and 2003 are as follows (nominal pesos):
2004 2003 Pensions Pensions and seniority Medical and seniority Medical premiums benefits premiums benefits
Service cost $ 37,293 45,690 67,618 33,808 Interest cost 68,276 78,659 75,725 40,693 Return on plan assets (87,081) (48,234) (69,127) (3,431) Amortization of prior service cost and plan modifications (1,066) 26,097 5,896 51,465 Variances in assumptions and plan adjustments 5,504 54,039 (66) - Amortization of transition liability 4,570 15,128 4,830 14,408 Effect of reductions/ extrintions (56,159) - - - Inflationary effect 963 5,998 - -
Net periodic cost $ (27,700) 177,377 84,876 136,943 ======
2004 2003
Net periodic (income) cost: Pension and seniority premium (DBPP) $ (27,700) 84,876 Medical Benefits 177,377 136,943
Period Contribution: Pensions (DCPP) 40,000 -
$ 189,677 221,819 ======
(Continued) 32
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
At December 31, 2004 and 2003, benefit obligations are analyzed as follows:
2004 2003 Pensions Pensions and seniority Medical and seniority Medical premiums benefits premiums benefits
Projected benefit obligation (PBO) $ 1,378,036 1,692,109 1,432,738 1,522,625 Unamortized items 21,611 (1,144,038) (18,101) (1,204,885)
Required assets 1,399,647 548,071 1,414,637 317,740
Loss: Plan assets 1,457,734 881,671 1,414,637 766,429
Fund assets $ 58,087 333,600 - 448,689 ======
Interest rates used in the actuarial projections are:
2004 2003
Rate of return on plan assets 6.50% 6.50% Discount rate 5.25% 5.25% Salary increase rate 1.50% 1.50% Estimated inflation rate 3.50% 3.50%
(17) Outstanding subordinated debentures-
At December 31, 2004 and 2003, the Bank had issued subordinated debentures, not convertible into shares of its capital stock and accrued interest thereon are analyzed as follows:
2004 2003 Debentures placed:
In 2003, maturing in 2013 $ 2,200,000 2,319,918 Accrued interest 6,681 4,246
Total subordinated debentures $ 2,206,681 2,324,164 ======
Debentures bear interest at a 28-day equivalent Equilibrium Interbank Interest Rate (TIIE). The Bank reserves the right to redeem the debentures beginning in May 2009.
(Continued) 33
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
(18) Income (IT) and asset (AT) taxes and employee statutory profit sharing (ESPS)-
Under current Mexican tax law, corporations must pay the greater of their IT and AT. For determining taxable income for IT purposes there are specific rules relating to the deductibility of expenses and the recognition of the effects of inflation. ESPS is computed practically on the same basis as IT. During the year ended December 31, 2004 ESPS expense recerved was $259,728.
The AT Law provides for a 1.8% tax on restated assets, less certain liabilities. AT payable in excess of IT for the year may be recovered in the ten succeeding years, restated for inflation, provided that IT exceeds AT in any of such years. Due to its uncertain recovery AT is charged to income of the year in which incurred.
At December 31, 2004 and 2003, the IT and AT expense in the consolidated statement of operations is $1,162,387 and $20,976, respectively.
During 2004, HSBC filed amendments to its income tax returns for the years 1999 to 2003. These amendments had the purpose of avoiding differences between the criteria used by HSBC in conformity with the Law and the comments received from the officers of the SHCP, related to the tax treatement of the IPAB swap operation (formerly Fobaproa).
The amendment to the income tax returns considers the exclusion of all effects of the IPAB swap operations, which will be taxable or deductible at the liquidation date of the swap, and hence reduce the tax losses by the amount of 2,567,944. The issue mentioned in this paragraph did not originated any penalty for HSBC.
Following is a reconciliation between the Bank’s accounting income and taxable income for IT and ESPS purposes:
2004 2003
Income (loss) before IT, ESPS and equity in earnings of unconsolidated subsidiaries, associated and affiliated companies $ 5,484,798 2,434,902 (Loss) income before taxes of subsidaries consolidated (18,300) 89,817 Accounting effects of inflation, net 485,785 222,898
Income (loss) in nominal pesos 5,952,283 2,747,617 Add (deduct) reconciling items (in nominal pesos): Difference between accounting and tax depreciation (25,609) (44,944) Net tax effects of inflation 292,031 (254,430) Allowance for loan losses (2,824,810) (488,014) Reserve for FOBAPROA promissory note and loss sharing 197,486 - Write-offs 656,988 395,474 Nondeductible expenses 176,801 123,976 Pension plan - (500,000) Provisions (284,496) (486,193) Trust UDIS Banxico (480,514) - Prepaid expenses (261,431) - Non taxable recoveries (526,613) - Other, net (285,099) (97,645)
Taxable income before tax loss carryforwards, carried forward $ 2,587,017 1,395,841 34
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
2004 2003
Taxable income before tax loss carryforwards, brought forward $ 2,587,017 1,395,841 Utilization of prior years’ tax loss carryforwards (448,032) (1,395,841)
Taxable income $ 2,138,985 - ======
IT expenses at the rate 33% $ 705,865 - ESPS expense at the 10% 248,370 - Excess of the provision 183,126 -
IT and ESPS in the income statement $ 1,137,361 - ======
Deferred IT and ESPS:
The decrease in the deferred taxes during 2004, comprises the amortization of the tax losses, the effect of special cetes Udis-Banxico and the loss sharing (see note 10b). Changes in deferred taxes for the year 2003 include the deferred tax asset arising from the merger of HSBC Bank México, S. A. (see note 1) and the valuation reserve.
The items that give rise to significant portions of the deferred tax assets and liabilities at December 31, 2004 and 2003 are presented below:
2004 2003 Deferred tax assets: Valuation of financial instruments $ - 124,826 Allowance for loan losses 1,496,082 3,325,769 Allowance for foreclosed assets 567,146 - Tax loss carryforwards 31,034 965,112 Fixed assets 19,335 - Loss-Sharing 2,086,424 - Valuation reserve (84,565) (304,000) Other 154,376 114,924
4,269,832 4,226,631 Deferred tax liabilities: Interest from Cetes UDIS-Banxico (1,201,058) - Valuation of financial instruments (28,605) - UDI Trusts (657,463) (664,408) Fixed assets - (29,950) Advanced deductions (140,000) (210,000) Prepaid expenses (79,444) - Other (26,060) -
(2,132,630) (904,358)
Carried forward $ 2,137,202 3,322,273 35
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
2004 2003
Brought forward $ 2,137,202 3,322,273
Restatement for inflation - 181,090
Net deferred tax assets $ 2,137,202 3,503,363 ======
The valuation allowance for deferred tax assets as of December 31, 2004 and 2003 amounted $84,565 and $320,570 ($304,000 nominal). In assessing the realizability of deferred tax assets, the Bank’s management considers the probability that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible, the performance of the loan portfolio and its allowance, and other factors. The Bank’s management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment.
Other considerations:
In accordance with the IT Law, tax losses, restated for inflation, may be carried forward to offset the taxable income of the ten succeeding years. At December 31, 2004, HSBC amortized all tax losses. For the fiscal year 2005, the IT rate changes of 32% to 30% which decreases one percentage point by fiscal period, to rise 28% in 2007.
In accordance with Mexican tax law, the tax authorities are entitled to examine transactions carried out during the five years prior to the most recent income tax return filed.
In accordance with the Income Tax Law, companies carrying out transactions with related parties are subject to certain requirements as to the determination of prices, since such prices must be similar to those that would be used in arm’s-length transactions.
(19) Stockholders’ equity-
The principal characteristics of stockholders’ equity are described below:
(a) Structure of capital stock-
Activity in 2004
On April 27, 2004, the Ordinary General Stockholders’ Meeting agreed to apply the net income of 2003 amounting to $1,637,261 ($1,552,630 nominal) against “statutory reserves” amounting to $163,726 ($155,263 nominal) and the remaining $1,473,535 ($1,397,367 nominal) to “Other reserves”.
The Board of Directors on June 22, and December 13, 2004 paid a dividend of $1,787,239 ($1,725,004 nominal) and $574,999, respectively.
After the aforementioned activity, capital stock at December 31, 2004 is represented by 1,001,715,231 shares with a par value of two pesos per share, of which 909,930,993 are Series “F” and 91,784,238 Series “B” shares.
(Continued) 36
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Activity in 2003
On April 2, 2003, the Extraordinary General Stockholders’ Meeting resolved to cancel 1,266,636 Series “O” treasury shares, which subscription and payment were pending. This resulted in a reduction in the authorized capital stock of $2,534 (nominal). It was also resolved to increase the Bank’s capital stock by $197,914 ($183,374 nominal), through the issue of 91,687,041 Series “O” shares. The increase led to the recognition of $775,622 ($718,632 nominal) of additional paid-in capital. Also, it was resolved to merge HSBC Bank México, S. A., Institución de Banca Múltiple Filial with the Bank (surviving entity).
On April 28, 2003, the Extraordinary and Ordinary General Stockholders’ Meeting resolved to apply the net loss for 2002 of $7,343,476 ($6,701,647 nominal) against the “Additional paid-in capital” account, as well as converting Series “O” shares owned by the Group into Series “F” shares and the remainder, owned by other stockholders, into Series “B” shares.
On April 30, 2002 the Ordinary General Stockholders’ Meeting placed at the disposition of the Board of Directors the balance of the other reserves account (recorded in statutory reserves), corresponding to the net income recorded in 2001. The Board of Directors’ Meeting held on April 24, 2003 declared and paid a dividend of $107,786 ($100,000 nominal).
On November 4, 2003, the Extraordinary General Stockholders’ Meeting resolved to cancel 91,687,041 Series “B” shares by refunding to the stockholders $10.9256 pesos per share, thus reducing capital stock and additional paid-in capital by $193,370 and $862,970, respectively. On December 29, 2003 capital stock and the additional paid-in capital were reduced by $193,369 and $862,970, respectively, and on that same date, the Group increased its capital stock and additional paid-in capital by the same amounts.
After the aforementioned activity, capital stock at December 31, 2003 is represented by 1,001,715,231 shares with a par value of two pesos per share, of which 909,930,993 are Series “F” and 91,784,238 Series “B” shares.
(b) Comprehensive income (loss)-
The comprehensive income (loss) reported in the consolidated statement of stockholders’ equity represents the results of the Bank’s activities during the year and includes the net income (loss), the gain or loss from valuing investments in “Available-for-sale” securities, permanent investment in shares and fixed assets, and the translation effect of the foreign subsidiary and mandatory convertible subordinated debentures, which in accordance with the applicable accounting principles, are reported directly in stockholders’ equity.
(c) Restrictions on stockholders’ equity-
The Credit Institutions Law requires that the Bank segregate 10% of its net income for the year to the statutory reserves up to the amount of its paid-in capital stock.
Stockholder contributions may be reimbursed to the stockholders tax-free, to the extent that the tax basis of such contributions equal or exceed stockholders’ equity. Retained earnings on which no income taxes have been paid, are subject to income taxes in the event of distribution to stockholders.
(Continued) 37
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
The unappropriated retained earnings of subsidiaries may not be distributed to the Bank’s stockholders until these are received by way of dividends. Also, gains from marking to market investment securities and derivative transactions may not be distributed until realized.
(d) Capitalization-
The SHCP requires that credit institutions maintain a minimum capitalization percentage of risk- based assets, which is calculated by applying certain specific percentages according to the level of risk assigned. At December 31, 2004 and 2003 information relating to the Bank’s net capital, risk- based assets and capital requirements (in millions of pesos) is as shown in the next page.
2004 2003 Basic, supplementary and net capital
Stockholders’ equity $ 12,966.6 12,274.7 Reduced by: Deferred taxes - (1,716.3) Intangible assets (1,065.2) (443.1) Investments in shares of financial entities (15.8) (26.4) Investments in shares of other companies (32.6) (34.8) Investment in subordinated debt (25.4) (8.4)
Basic capital (Tier 1) 11,827.6 10,045.7 Add: Subordinated debentures 2,200.0 2,320.8 Excess of the allowance for loan losses over past due loan portfolio 833.2 771.0
Supplementary capital (Tier 2) 3,033.2 3,091.8
Net capital (Tier 1+ Tier 2) $ 14,860.8 13,137.5 ======
Risk-based assets and capital requirements Equivalent risk-weighted Capital assets requirements 2004 2003 2004 2003 Market risk: Transactions or positions: In pesos at nominal rates $ 29,322.1 19,857.2 2,345.8 1,588.6 In pesos at real rates or denominated in UDIS 1,241.5 1,158.2 99.3 92.7 In foreign currency at nominal rates 1,364.5 1,799.7 109.2 144.0 In UDIS or with returns linked to the Consumer Price Index 13.3 10.7 1.1 0.9 Foreign currency positions or with exchange rate indexed returns 3,156.1 2,867.4 252.5 229.4 Equities or with indexed returns 0.2 40.7 - 3.3
Total market risk, carried forward $ 35,097.7 25,733.9 2,807.9 2,058.9 38
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Risk-based assets and capital requirements Equivalent risk-weighted Capital assets requirements 2004 2003 2004 2003 Market risk:
Total market risk, brought forward $ 35,097.7 25,733.9 2,807.9 2,058.9
Credit risk: Group I (weighted at 0%) - - - - Group II (weighted at 10%) 245.9 300.3 19.7 24.0 Group II (weighted at 11.5%) - 1.2 - 0.1 Group II (weighted at 20%) 5,810.7 6,154.0 464.9 492.3 Group II (weighted at 23%) 1,063.9 491.1 85.1 39.3 Group III (weighted at 50%) 14.5 16.5 1.2 1.3 Group III (weighted at 100%) 62,304.9 57,742.3 4,984.4 4,619.4 Group III (weighted at 112%) 1,610.8 1,024.9 128.9 82.0 Group III (weighted at 115%) - 193.3 - 15.5 Group III (weighted at 150%) 2,365.9 1,447.3 189.3 115.8
Total credit risk 73,416.6 67,370.9 5,873.5 5,389.7
Total market and credit risks $ 108,514.3 93,104.8 8,681.4 7,448.6 ======
2004 2003 Capitalization indices: Capital to credit risk assets: Basic capital (Tier 1) 16.11% 14.91% Supplementary capital (Tier 2) 4.13% 4.59%
Net capital (Tier 1 + Tier 2) 20.24% 19.50% ======Capital to market and credit risk assets: Basic capital (Tier 1) 10.90% 10.79% Supplementary capital (Tier 2) 2.80% 3.32%
Net capital (Tier1 + Tier 2) 13.70% 14.11% ======
Beginning in 2002 the Bank ceased using the regulatory facilities referred to by transitory Article three of the rules for capitalization requirements of full-service banks.
(Continued) 39
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
(20) Related party transactions and balances-
During the normal course of business, the Bank carries out transactions with related parties. According to the Bank’s policies, the Board of Directors authorizes all credit transactions with related parties, which are granted at market rates with guarantees and terms in accordance with sound banking practices. At December 31, 2004 and 2003, the Bank had granted loans to related parties totaling $535,305 and $1,310,209, respectively.
In addition to interest and commissions on the above-mentioned loans, the principal transactions carried out with related parties during the years ended December 31, 2004 and 2003, were as follows:
2004 2003 Revenues: Administrative services $ 221,813 246,285 Other 203,414 8,003
$ 425,227 254,288 ======Expenses: Insurance premiums $ 282,502 266,787 Interest and commissions 1,111 870 Premiums on securities repurchase/resell agreements 152,163 149,198 Administrative expenses 2,625 45,688 Rents 4,477 - Others 1,999 -
$ 444,877 462,543 ======
Balances receivable from and payable to related parties as of December 31, 2004 and 2003, were as follows:
2004 2003 Receivable Payable Receivable Payable
Mutual funds $ 11,549 - 17,348 - HSBC Seguros, S. A. de C. V. - 3,565 - 21,498 HSBC Vida, S. A. de C. V. - 2,686 6,090 38,945 HSBC Casa de Bolsa, S. A. de C. V. 3,185 - 7,208 3,026 HSBC Fianzas, S. A. 7,983 11 - 1,683 HSBC Pensiones, S. A. 646 376 - 614 INMX Servicios, S. A. de C. V. - - 1,840 - INMX Comercialización, S. A. de C. V. - - 358 -
$ 23,363 6,638 32,844 65,766 ======
(21) Memorandum accounts-
(a) Irrevocable lines of credit and guarantees-
At December 31, 2004 and 2003, the Bank had irrevocable commitments to grant loans of $2,192,775 and had issued guarantees of $217,820 ($674,635 and $72,252, respectively, in 2003).
(Continued) 40
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
At December 31, 2004 and 2003 the allowance for letters of credits and guarantees issued amounts to $27,801 and $18,707 in 2003, respectively, and is included in the allowance for loan losses.
(b) Assets in trust or under mandate-
The Bank’s trust activity, which is recorded in memorandum accounts, is summarized as follows:
2004 2003
Type of trust: Administrative $ 28,500,279 19,818,696 Guarantee 11,913,218 10,559,577 Investment 12,111,003 7,560,583 Other 8,961,254 7,735,427
61,485,754 45,674,283
Mandates 321,875 109,268
$ 61,807,629 45,783,551 ======
Trust department revenue for the years ended December 31, 2004 and 2003 amounted to $109,674 and $107,824, respectively.
On June 4 2004, Atlántico represented by the IPAB as settlor and HSBC undersigned an agreement to replace the trustee under the provision of article 29 fraction III of the LCI and the terms of the “Debt and Assignment Recognition Agreement” dated October 1, 2002. As a result of the agreement, HSBC has replaced Atlántico as trustee in all outsanding contracts of trust and mandates ($7,908,619 nominal). HSBC is obligated to perform all legal, administrative, operational and accounting activities to comply with the objectives of the trusts and mandates.
(c) Investments on behalf of customers-
The Bank receives funds from the public and invests them in various instruments of the Mexican financial system on behalf of its customers, which it records in memorandum accounts as follows:
2004 2003
Mutual funds: Managed by the Group $ 515,940 544,452 Other 920,174 677,959 Government securities 15,395,593 3,827,230 Equities and other 8,068,206 9,582,001
$ 24,899,913 14,631,642 ======
The amount of funds invested in the Bank’s own instruments forms part of the liabilities included in the consolidated balance sheet.
(Continued) 41
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
(d) Assets in custody or under management-
The Bank records in this account the assets and securities of third parties it receives in custody or for management purposes. At December 31, 2004 and 2003, this account comprises:
2004 2003
Assets in custody $ 8,097,306 32,068,511 Pledged assets 623,911 2,371,207 Assets under management 40,416,023 78,502,463
$ 49,137,240 112,942,181 ======
(22) Additional information on results of operation and segments-
(a) Statement of operations by segment-
The statement of operations by segment includes Personal Financial Services (PFS), Commercial Banking (CMB), Corporate, Investment Banking and Markets (CIBM) and other Corporate Activities (OCA). A brief description of the Bank’s business segments follows.
Personal Financial Services – Business segment focused primarily on individuals that comprises mainly consumer products, which include credit cards, personal and car loans as well as mortgage loans and traditional deposits.
Commercial Banking – Business segment focused primarily on corporations, offering financing in Mexican pesos and other currencies, lines of credit for working capital, term loans, and the financing of exports, in addition to financial services relating to checking and investment accounts and cash management.
Corporate, Investment Banking & Markets – This segment includes lines of products focused primarily on corporations, which comprise: trust, treasury and custody services, corporate finance advisory, as well as risk management and cash flow services. This segment comprises products such as letters of credit, factoring, discounted documents and investments in the money and capital markets.
Other Corporate Activities – This segment includes transactions not conducted directly or indirectly with the customers, it represents structural business operations.
(Continued) 42
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
A condensed statement of operations information (in millions of pesos) by segment at December 31, 2004 and 2003 is as follows:
2004 PFS CMB CIBM OAC Total
Financial margin $ 6,819.2 1,788.4 419.0 2,303.8 11,330.4 Allowance for loan losses (308.6) (80.0) (9.3) (926.2) (1,324.1)
Adjusted financial margin 6,510.6 1,708.4 409.7 1,377.6 10,006.3
Commssions and fees, net 4,373.5 1,146.0 416.9 289.8 6,226.2 Financial intermediation income 330.3 86.6 326.5 137.2 880.6
Total operating income 11,214.4 2,941.0 1,153.1 1,804.6 17,113.1
Administrative and promotion expenses (9,098.9) (1,790.5) (758.7) (237.8) (11,885.9)
Net operating income (loss) 2,115.5 1,150.5 394.4 1,566.8 5,227.2
Other expenses, net 48.6 31.3 10.6 167.1 257.6 Taxes (908.8) (496.4) (170.1) (815.8) (2,391.1)
Income (loss) before equity in results of susidiaries 1,255.3 685.4 234.9 918.1 3,093.7
Equity in results of subsidiaries - - - 13.1 13.1
Income of continues operations 1,255.3 685.4 234.9 931.2 3,106.8 Result of discontinued transactions - - - (6.9) (6.9)
Income (loss) before minority interest 1,255.3 685.4 234.9 924.3 3,099.9
Minority interest - - - - -
Net income (loss) $ 1,255.3 685.4 234.9 924.3 3,099.9 ======
(Continued) 43
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
2003 PFS CMB CIMB OAC Total
Financial margin $ 5,765.7 1,565.5 519.3 1,910.2 9,760.7 Allowance for loan losses (613.2) (414.7) (90.9) (1,986.2) (3,105.0)
Adjusted financial margin 5,152.5 1,150.8 428.4 (76.0) 6,655.7
Commissions and fees, net 4,299.9 1,084.6 282.2 197.2 5,863.9 Financial intermediation income 293.0 110.4 678.4 65.8 1,147.6
Total operating income (loss) 9,745.4 2,345.8 1,389.0 187.0 13,667.2
Administrative and promotion expenses (8,448.4) (1,669.8) (666.0) (344.5) (11,128.7)
Net operating income (loss) 1,297.0 676.0 723.0 (157.5) 2,538.5
Other expenses, net (133.6) (43.6) (20.8) 94.4 (103.6) Taxes (357.9) (194.7) (216.0) (39.7) (808.3)
Income (loss) before equity in results of subsidiaries 805.5 437.7 486.2 (102.8) 1,626.6
Equity in the results of subsidiaries - - - 10.5 10.5
Income (loss) before minority interest 805.5 437.7 486.2 (92.3) 1,637.1
Minority interest - - - 0.1 0.1
Net income (loss) $ 805.5 437.7 486.2 (92.2) 1,637.2 ======
At December 31, 2004 and 2003, the following items comprise the financial margin:
Interest income:
Interest income for the years ended December 31, 2004 and 2003 is comprised as shown on the following page.
(Continued) 44
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
2004 2003
Cash and equivalents $ 1,468,512 1,518,345 Investment securities 2,106,886 1,064,910 Interest and premiums on securities purchased under agreements to resell 3,068,366 4,232,132 Loan portfolio 11,199,592 10,788,523 Other, including restatement for inflation 662,061 532,805
$ 18,505,417 18,136,715 ======
Interest income by type of loan is comprised as follows:
2004 2003 Current Past-due Current Past-due
Commercial loans $ 1,720,763 124,400 1,756,299 174,968 Financial entities 216,451 125 174,193 162 Consumer loans 3,068,018 27,055 2,672,517 21,569 Residential mortgage loans 1,172,290 19,445 1,228,807 58,730 Government entities 382,569 567 210,602 252 IPAB 4,467,909 - 4,490,424 -
$ 11,028,000 171,592 10,532,842 255,681 ======
$ 11,199,592 10,788,523 ======
Interest expense:
Interest expense for the years ended December 31, 2004 and 2003 is comprised as follows:
2004 2003
Demand deposits $ 605,843 373,165 Time deposits 2,371,436 2,434,132 Bank and other loans 482,504 540,498 Interest and premiums on securities sold under agreements to repurchase 3,070,380 4,321,183 Interest on subordinated debentures 157,749 156,059 Other, including restatement for inflation 222,511 373,653
$ 6,910,423 8,198,690 ======
(Continued) 45
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Monetary position gain (loss):
For the years ended December 31, 2004 and 2003, the monetary position from financial margin- related accounts generated a loss and a gain of $264,561 and $177,255, respectively.
The average balances (in nominal pesos) of the principal monetary asset and liability captions used to compute the monetary position result are as follows:
2004 2003
Assets: Cash and equivalents $ 34,797,371 34,511,830 Investment securities 26,224,272 10,619,845 Securities and derivative transactions 62,414 39,373 Loan portfolio 107,009,141 103,227,300
Total assets 168,093,198 148,398,348
Liabilities: Deposit funding 151,504,393 132,593,248 Bank and other loans 10,208,135 9,777,491 Securities and derivative transactions (17,313) 7,869 Subordinated debentures 2,204,834 2,032,964
Total liabilities 163,900,049 144,411,572
$ 4,193,149 3,986,776 ======
(b) Financial intermediation gain (loss)-
For the years ended December 31, 2004 and 2003, the financial intermediation gain (loss) is analyzed as follows:
2004 2003
Valuation gain (loss): Investment securities $ 4,359 (1,510) Securities repurchase/resell agreements (8,141) 33,002 Trading derivatives 65,229 (17,483) Securities pending settlement - (519) Foreign currency exchange and precious metals (3,717) 15,381
Carried forward $ 57,730 28,871 46
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
2004 2003
Brought forward $ 57,730 28,871
Purchase/sale gain (loss): Investment securities 236,284 187,903 Securities repurchase/resell agreements 26,920 333,336 Foreign currency exchange and precious metals 559,633 522,257
822,837 1,043,496
Restatement for inflation - 75,326
$ 880,567 1,147,693 ======
(c) Other income-
For the years ended December 31, 2004 and 2003, other income is analyzed as follows:
2004 2003
Recoveries $ 773,506 150,982 Gain on sale of foreclosed assets or received in lieu of payment 292,005 258,766 Gain on sale of premises, furniture and equipment 33,511 4,601 Other, including restatement for inflation 190,125 226,801
$ 1,289,147 641,150 ======
(d) Other expense-
At December 31, 2004 and 2003, other expense includes:
2004 2003
Write-offs and losses $ 874,059 534,528 Monetary position loss from non-financial margin items 157,477 85,401 Other, including restatement for inflation - 124,832
$ 1,031,536 744,761 ======
(Continued) 47
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
The average balance (in nominal pesos) of the principal monetary asset and liability captions used in determining the net monetary position from non-financial margin items is shown below:
2004 2003
Assets: Investment securities $ 128,928 49,890 Other accounts receivable 10,776,768 5,067,609 Foreclosed assets 691,961 781,820 Deferred income tax 4,205,110 4,319,421 Permanent investments in shares 22,103 20,237 Other 560,726 83,644
Total assets 16,385,596 10,322,621
Liabilities: Other accounts payable 11,375,525 7,647,475 Deferred credits 1,430,535 633,712
Total liabilities 12,806,060 8,281,187
$ 3,579,536 2,041,434 ======
(e) Financial indicators-
The principal financial indicators as of and for the years ended December 31, 2004 and 2003 are analyzed below:
2004 2003
Slowness in paying up index 3.0% 4.5% Allowance for loan losses to past-due loan portfolio 195.2% 152.7% Operating efficiency (administrative and promotional expenses to average total assets) 6.7% 6.6% ROE (net income to average stockholders’equity) 23.9% 12.5% ROA (net income to average total assets) 1.5% 0.8% Liquidity (liquid assets/liquid liabilities)* 73.6% 52.2% Financial marging after provision for ban bases/average earnie assets 5.8% 3.6% Capital to credit risk assets 20.2% 19.5% Capital to market and credit risk 13.7% 14.1%
* Liquid assets – Cash and equivalents, trading and available-for-sale securities. * Liquid liabilities - Demand deposits, demand and short-term bank and other loans.
(Continued) 48
HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
(f) Extraordinary item-
On July 13, 2004, the Bank exchanged the Fobaproa prommisory note for new payment instruments issued by the IPAB. The amount exchanged excluded $6,873 for the updated amount of loans that the IPAB regarded as related loans and formed part of the Capitalization and Portfolio Purchase Program. Consequently, the Bank as trustee recognized a loss for such amount, which it recorded under “Discontinued operations, extraordinary items and changes in accounting policies” in the consolidated statement of income.
(23) Commitments and contingent liabilities-
(a) Leases-
Certain premises and equipment are leased. Lease agreements provide for regular adjustments to rent amounts based on changing economic factors. Total lease expense aggregated $821,247 in 2004 and $811,194 in 2003.
(b) Lawsuits and litigation-
The Bank is involved in a number of lawsuits and claims arising in the normal course of business. It is not expected that the final outcome of these matters will have a significant adverse effect on the Bank’s financial position and results of operations. Certain cases are covered by an indemnity clause of the agreement with the IPAB, the Bank and Atlántico dated December 7, 2001.
(c) Labor obligations-
Those arising from the obligations mentioned in the last paragraph of note 2q.
(d) Trust activities-
The Bank’s management is concluding the process of analyzing and identifying potential contingencies relating to its obligations as trustee. At December 31, 2004, based on the latest management assessment of the associated risks of each trust and mandate and the supporting documentation there are no conditions that require the creation of an allowance.
(24) Risk management-
The purpose of the comprehensive risk management function is to identify and measure risks, follow up on the impact that these risks may have on the operations and control their effects on income and shareholder value by applying the best mitigating strategies available, and the incorporation of a risk culture in daily transactions.
The ultimate purpose of HSBC is to generate shareholder value by maintaining the organization's stability and creditworthiness. Sound financial management increases the profitability of performing assets, helps maintain appropriate liquidity levels and provides control over exposure to losses.
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In compliance with the provisions issued by the Banking Commission and HSBC’s guidelines, the Bank continues to implement a series of initiatives designed to strengthen the comprehensive risk management function and thus identify and measure, monitor, transfer and control the credit, liquidity and market as well as general operational and specific technological and legal risk exposures arising from HSBC’s transactions.
The Board of Directors is responsible for establishing HSBC’s risk management policies as well as the overall risk level to which the Bank is exposed. The Board of Directors is also responsible for approving, at least once a year, related policies and procedures and for establishing the structure of limits for the various types of risks in relation to HSBC’s stockholders' equity. Furthermore, pursuant to the policies in force, the Board of Directors entrusts the implementation of the procedures designed to identify, measure, monitor, control, inform and disclose risks to Senior Management, the Risk Committee, the Comprehensive Risk Management Unit and the Risk Management Area. It also grants the necessary powers to the Risk Committee to authorize any deviations from the specified limits. Such deviations must be subsequently reported to the Board of Directors.
Adhering to the prudential Banking Commission provisions concerning risks, the risk management function comprises the market, credit, liquidity, operational and legal risks, inherent in HSBC’s operations.
(a) Market risk-
Market risk is defined as the potential loss arising from changes in risk factors relating to the valuation or future expected results of assets, liabilities or contingent liabilities transactions such as interest rates, foreign exchange rates and price indexes, among others. The objective of HSBC’s market risk management is to identify, measure, monitor, limit, control, inform and disclose HSBC’s risk exposures.
HSBC uses the “Value at Risk” (VaR) and the “Present Value of a Basis Point” (PVBP) techniques to measure market risk exposure. Both risk measures are monitored on a daily basis in accordance with market risk exposure limits set by management. The VaR is calculated using the MonteCarlo simulation method, which estimates the potential losses resulting from movements in all market risk factors. The confidence level for calculating VaR has been set at 99.5% with a one-day holding period; accordingly, the VaR level represents the maximum loss that the Bank could possibly experience in one day with a 99.5% probability. The PVBP is a technique to measure risk exposure resulting from changes in interest rates. The PVBP is calculated for peso, dollar and other currency rates in which HSBC has interest rate risk exposure. This measure shows the potential loss that results from a one basis point change in interest rates used to determine the price of financial assets and liabilities. It must be mentioned that to calculate VaR and PVBP, all of HSBC’s positions are marked to market.
The VaR and PVBP of HSBC and its “Trading” and “Accrual” portfolio subdivision for the last three quarters of 2004 (in millions of dollars) is as shown on the next page.
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HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
Value at Risk (VaR):
4th quarter 2004 Sept. 30, 2004 Dec. 30, 2004 Limits average
HSBC (6.53) (9.630) 30.000 (6.770) Accrual (6.47) (9.650) 35.000 (6.640) Trading (0.32) (0.599) 6.000 (0.890) Foreign exchange desk (0.01) (0.029) 1.800 (0.068) Money market desk (0.29) (0.604) 5.000 (0.460) Capital market desk - - - -
“Present Value of a Basis Point” (PVBP) for peso interest rates
HSBC 0.206 0.068 0.500 0.170 Accrual 0.225 0.141 0.550 0.200 Trading (0.018) (0.073) 0.200 (0.033) Foreign exchange desk NA NA NA NA Money market desk (0.018) (0.073) 0.200 (0.033) Capital market desk NA NA NA NA
* Absolute value
NA = Not Applicable
NOTE: Most of HSBC’s interest rate risk exposure is explained through the PVBP for peso interest rates. Other currency interest rate risk (also measured through PVBP) is practically insignificant.
HSBC’s average VaR for the fourth quarter of 2004 remained virtually unchanged from the prior quarter. However, VaR at the end of the fourth quarter of 2004 increased 47% versus the prior quarter, mainly due to the increase of financial instruments positions in the “Accrual” portfolio. Notwithstanding such increase, the average VaR for said quarter was significantly below the risk exposure at the end of the quarter; therefore, during most of the days in the quarter, the risk measure was below the level at the quarter-end. During the period, the VaR levels remained below management limits.
The total PVBP for peso interest rates was reduced to one third at the end of the fourth quarter of 2004 versus the prior quarter. The average PVBP for the fourth quarter of 2004 was lower than the PVBP level for the prior quarter. This situation reflects a lower interest rate risk exposure in HSBC’s net position. Consequently, the PVBP remained below the pre-established limits. It must be mentioned that the PVBP only measures risk exposure related to interest rates (increase by one basis point), while VaR measures the potential loss arising from adverse movements in all risk factors (interest rates, foreign exchange rates, etc.); therefore, changes in both measures will not always be in the same direction.
To calibrate the models for calculating VaR and PVBP, the Bank performs performance test (back- testing) on a regular basis, by comparing the historical VaR to the losses that would have resulted from holding the portfolio. As regards the PVBP, it is compared with the portfolio sensitivity to market quotations. The results of these tests confirm the accuracy of the models.
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HSBC MEXICO, S. A. Institución de Banca Múltiple, Grupo Financiero HSBC AND SUBSIDIARIES
(b) Liquidity risk-
Liquidity risk arises from the institution’s asset and liability maturity gaps. The maturities of liability transactions regarding customer demand and time deposits differ from those of asset transactions relating to loan and investment in securities.
HSBC has implemented limits for liquidity ratios, in Mexican pesos and dollars. Such liquidity ratios are calculated on a daily basis and compared with the limits authorized by the Asset and Liability Management Committee and confirmed by the HSBC Group. The Institution also reviews on a daily basis the cash commitments and evaluates the requirements of the main customers to diversify funding.
HSBC is considering to develop for 2005 a methodology to measure liquidity risk based on different-term cash flow projections and the development of liquidity scenarios.
Since 2003, HSBC has developed and implemented a liquidity contingency plan. Such plan defines potential liquidity contingencies, sets forth the individuals who are responsible for the plan, establishes the steps to be followed in case of a contingency and determines the alternative funding that the institution would use in the event of any contingency.
(b) Credit risk-
Transactions with customers originate credit risk exposure. Such exposure is recorded in the balance sheet and memorandum accounts. Exposure to credit risk recorded in the balance sheet includes items representing loans, while that recorded in memorandum accounts represents a contingent risk for HSBC.
HSBC has developed policies and procedures to manage its loan portfolio risk level and composition, with the purpose of quantifying and managing the loan portfolio-related credit risks and reducing the risk of loss resulting from a customer’s failure to comply with the terms of the loan agreement. To this end, HSBC uses models typified as noncompliance models. Under this approach, the credit risk should be understood as the risk of non-payment and irrecoverability of loans granted or to be granted to a certain customer and in transactions with financial instruments where counterparties may default. The risk of non-payment refers to the likelihood that a given customer may default on its commitments to pay both the principal and interest thereon while the risk of irrecoverability refers to the likelihood that in the future HSBC will be unable to recover the funds loaned to a customer plus incidental charges.
Policies and procedures for granting, controlling and collecting loans, as well as evaluating and monitoring credit risk and the methods used to identify current or past due impaired commercial loans.
HSBC’s business areas carry out studies to propose new loans and reassess those that have already been granted. These studies include the support provided by the account executives as well as the rate proposed for the loan application.
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As regards the abovementioned proposals, the Executive Direction for Loan Analysis and Approval analyzes and authorizes or otherwise refers to the appropriate resolution level for ensuring adequate segregation between business origination and authorization activities.
The authorization of all loans is the responsibility of HSBC’s Board of Directors. Such power has been delegated to officers of both, the Institution and the Group. Each officer’s authorization level is assigned depending on his/her level, experience and skills shown at HSBC. Currently, this power has been granted to executives from the Credit and Risks area and to the General Direction.
In order to properly follow up on the general portfolio, it is an Institution’s policy to perform a loan study of all customers at least once a year and of impaired customers once every six months. Also, these studies undergo normal evaluation and authorization processes applied to new and reassessed loans.
The account executive in charge is responsible for the complete relationship with the customer during the whole credit process, from origination through recovery of the entire loan. For such purpose, the account executive has tools and support such as portfolio control systems, authorized lines records and the system to follow up on legal actions, among other things. There are supporting areas for the recovery of special portfolio, which as in the case of impaired portfolio management, follow specific policies in this regard.
Among the loan procedures, there are actions for the early detection of impaired loans. Such actions comprise, among other things: modification in risk levels between one quarter and another, negative signals resulting from inspection visits to customers’ premises, negative reports in the Credit Bureau or adverse changes in the customer’s economic environment. Once the increase in the risk has been detected, monitoring procedures are established, which include the transfer of these accounts to special Recovery or Customer Advisory Service areas. The Customer Advisory Service area is focused on preventive rather than corrective tasks.
Credit risk concentrations – HSBC has policies and procedures in place for maintaining a sound, diversified and risk-controlled and prudent portfolio, which include the establishment of credit risk exposure limits considering business unit, currency, etc.
Through official document number 601-II-DGSIFC-7651/2005 dated February 4, 2005, the Banking Commission renewed the authorization to HSBC to continue using its internal rating models for a 2-year period beginning December 1, 2004. Loans are rated and provided for in accordance with the provisions of the Banking Commission’s Circular 1480.
This model considers the following risk factors: country risk, financial performance, financial hedging, debtor management, overall strength (the customer’s relation to the environment, competitiveness, strengths and weaknesses), account management, industry conditions and repayment history. These factors represent the valuation of the customer’s credit risk profile and are derived from the experience of HSBC in statistical analyses and its adaptation to the Mexican market.
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The internal rating system classifies both current and potential risks in a rating from 1 to 10. The ratings ranging from 1 (low risk) to 5 (medium risk) constitute acceptable risk levels, whereas those ranging from 6 to 9 are considered non-acceptable risk levels and 10 constitutes a total loss. Pursuant to applicable regulatory provisions, the Bank has established equivalencies between its internal credit ratings (1 to 10) and the risk levels provided by the Banking Commission’s Circular (A-1, A-2, B-1, B-2, B-3, C-1, C-2, D and E).
Credit culture-
To create and foster a credit culture, HSBC has permanent training programs for personnel involved in the loan origination and authorization processes. Among such programs advanced training in commercial banking practices is required, which provides support tools for the analysis and evaluation of credit risks, as well as decision-making workshops.
Implementation of prudential credit criteria-
In accordance with the “prudential credit provisions” issued by the Banking Commission, HSBC has established control measures to timely identify, measure and limit the taking of risks derived from the lending activity in its different phases. These measures are documented in the Credit Policies and Procedures Manual, and are reviewed and updated on a regular basis as well as submitted to the Board of Directors for approval every year.
(d) Operational risk-
Operational risk is the risk of loss arising through frauds, unauthorized activities, errors, omissions, inefficiencies, systems failures or from external events. They are all subject to HSBC’s risk management. This definition excludes the strategic or reputational risks, which are part of other risk management agenda of HSBC.
For operational risk management, a specialized central unit has been established. Additionally about a hundred middle-management officers have been designated, who despite pertaining to their own business or support areas, they maintain a functional relationship with the operational risk management unit and deal with the relevant risk management activities.
During the second half of 2004, all of the operational risks throughout the HSBC structure were identified and assessed. During the year, in addition to denominating and classifying all identifiable operational risks, three parameters were evaluated for each identified risk: feasibility, impact and exposure.
Based on the values obtained from those parameters, a risk rating was determined to which one of the first four letters of the alphabet (A, B, C or D) was assigned depending on their higher or lower significance. The proportions of the risks assessed for each of such ratings as a percentage of total number of risks so assessed were as follows: 5%, 20%, 50% and 25%, respectively.
Furthermore, for the second year in a row, in 2004 major events (those entailing a rather significant cost) were recorded and input in a database specifically designed for that purpose. The database will become in the future, as statistical significance is attained, the supporting tool for computing capital allowances for operational risks.
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Both risks identified and assessed and the events occurred in the year have been marked with the appropriate label to classify them within the various risk categories, based on the following taxonomy:
Individuals Employee fraud/malice crime Unauthorized activities/employee misconduct (intentional) Labor Law Labor interruption Key personnel loss or understaffing Processes Procedure risk Valuation/Pricing Internal and external information and legal compliance Project risk management/ changes Sales risks Systems Information technology investment risk Systems development and implementation Systems failures Systems security failures Information capacity External Legal/civil liability Criminal activities Externalization Risk/Vendors Disasters and infrastructure service failures Regulatory risk Political/Government Risks
The operational risk category includes additionally two specific risk classes: technological and legal risks.
The importance of exercising an appropriate control over the technological risk meaning that the information technology processes have been subjected to an ISO 0001certification procedure and, therefore, a stringent methodology is in place for their operation, and plenty of relevant documentation is available. Such documentation is contained in a computer information application designed for that purpose by the ISO certifier, and is available for review the supervising authority.
Furthermore, for legal risk management actions have been taken which include: establishing policies and procedures for proper legal proceedings and execution of judicial acts; allowances for potential losses arising from adverse judicial or administrative resolutions; making employees and officers aware of the judicial and administrative provisions applicable to relevant operations; conducting statutory audits, the latest of which was made in July 2004; as well as implementing a historical database on judicial and administrative resolutions, relevant grounds and costs.”