滙豐控股 (HSBC) 2005 Q1 法說會逐字稿

Welcome to the HSBC conference call on the 16th of May, 2005.

Throughout today's presentation, all participants will be in a listen-only mode.

After the presentation, there will be an opportunity to ask questions. (OPERATOR INSTRUCTIONS).

I will now hand the conference over to Mr. Douglas Flint.

Thank you, sir.

Please go ahead.

Thank you very much and welcome to those of you who are on the call in Europe, North America and in Asia, very different times of day.

With me on the call today are Bobby Mehta, who is the Chief Executive Officer of our businesses in the United States, and Chairman and Chief Executive of HSBC Finance Corporation, Martin Glynn, who is the Chief Executive of our bank based in New York, and Simon Penney, who is the Chief Financial Officer of our North American businesses based in Chicago.

The next slide on the webcast is one you are all familiar with in terms of the risk of forward-looking statements.

I will not spend any more time on that other than just drawing it to your attention.

The next slide really illustrates one of the challenges that we've sought to overcome by having this webcast and presentation.

It's becoming increasingly difficult to look at legacy regal entity businesses, and we've tried to draw together the information in a way that is helpful to you by showing both the managed basis for HSBC Finance Corporation, which is putting back onto Finance Corporation's balance sheet the securitized receivables as if they were still held and owned.

Then we presented what we call the management basis, which is then adding back, on top of that figure, the mortgages and private label credit card receivables that were transferred to HSBC Bank USA and adjusting for the inter-company profits from amortizations that arose consequent to those transfers together with related fees, so effectively, on a consolidated eliminated basis for those two entities.

When we talk about the bank in the U.S., we will be looking at the bank on a U.S.

GAAP basis.

Turning the slides, we thought very carefully about how to present the numbers to you.

The presentation today is all in U.S.

GAAP, the reason for that being twofold.

One, we want to present a complete picture of IFRS for the first time when we do it, which we will do with our interim results, and also, given that IAS 39 has only recently been amended to the extent that there's been a reinstatement to the fair value option, we are still considering across the group how and where we might take advantage of that in order to get economic hedge accounting.

Therefore, we will show that for the first time when we do the interim results for the group as a whole.

What we've done, though, in this slide is just remind you that there are some significant differences between U.S.

GAAP and historically UK GAAP and prospectively IFRS, but they are made in relation to securitizations and intangibles (ph) are directionally the same in both.

Therefore, I think that is helpful in terms of considering these results and the group as a whole.

At this point, I want to hand over to Bobby Mehta, who is going to take us forward.

Bobby?

Thank you, Douglas, and thank you also to all of the participants on the call.

I'd just like to echo Douglas' thanks to all of you and for your interest.

Let us turn onto page 5, which is the next slide, which essentially shows the U.S.

GAAP reported figures for the finance Corporation and HSBC USA Inc., which is the Bank.

If you look at the line in the middle of the page, I think the key point that I want to draw people's attention to is that, combined with the Finance Corporation and Bank, we in the first quarter of 2005 earned over $1 billion in the USA.

That's about a 27% increase relative to first quarter of '05.

If you then adjust for the income from derivatives -- and I'd just like to remind people on the call that, as a result of and I think as part of the restatement at the end of 2004, we had a number of hedges that failed or swaps that failed hedge accounting and as we marked those to market, that resulted in, in essence, income as represented in the first quarter, fourth quarter and first quarter '05, as represented on this chart.

To the extent that these were really not extraordinary gains or one-time gains, if you like, we have adjusted our combined net income for those numbers.

Once we've done that, you basically again see the adjusted figure for combined net income normalized at 856 for both the Finance Corporation and the Bank.

That shows and 11% gain on a first-quarter '04 versus first-quarter '05 basis, and that's, as I said, an 11% gain.

I will cover the results of the Finance Corporation and my colleague, Martin Glynn, will cover the points with respect to the Bank.

If you can turn to page 6, with respect to Finance Corporation, I know this has been a topic of a fairly significant interest for our investors around the world, and I really have several objectives with respect to this discussion, first obviously to give you all an overview of our first-quarter results, as part of that to summarize and discuss key trends with respect to net interest margin, risk-adjusted revenue, credit and importantly, return on managed assets as well; thirdly, to really explain some of the underlying causes and strategic rationale for the mix shift in assets that has been evident over the last several quarters, particularly near-prime mortgage and near-prime auto.

I also want to comment on the impact of the mortgages originated through the correspondent and wholesale channel and some of the impact that the accounting P&L or the geography of the P&L with respect to that channel has on net interest margin and risk-adjusted revenue.

Before delving in, I'd just like to preface these remarks by saying that I'm pleased with the quarter.

I see encouraging underlying trends in the face of a challenging competitive and interest-rate environment, in particular the performance of our U.S. and Canadian businesses, which collectively, as you'll see from the Q, have enabled us to overcome some of the drag we are experiencing -- (technical difficulty) -- business, the UK Consumer Finance business, to be specific.

If you can turn to page 7 -- once again, to remind people, we are doing this on the management basis that Douglas described.

Net income is up 90 on a U.S.

GAAP management basis, 47% year-over-year -- (technical difficulty) -- first quarter '04 to first quarter '05 and is up 21% after we eliminate the extraordinary gains from the derivative issue.

I would also remind people that the first quarter has substantially all of the revenue and profits for the tax business, so seasonally it tends to be our strongest quarter.

Receivables growth has been strong year-over-year.

Real estate-secured growth has grown 31%.

Cars and unsecured are growing and by our estimation growing faster than the market, and unsecured growth has resumed as compared to a contraction for the comparable period '04 over '03.

Risk-adjusted revenue has recovered substantially to Q1 '04 levels.

The main drivers of this improvement are really improvements in collections, underwriting, growth in fees and, as I will talk about in a moment, exceptionally strong credit performance.

We've seen the RER growth despite a declining risk-adjusted revenue, again in our UK business.

Turning onto NIM and net interest margin, net interest margin has compressed although we believe that that is consistent with the current market environment, where short-term rates have risen and the five and ten-year rates have not, which is where the bulk of our receivables, particularly real estate receivables, are priced off of.

Yield has stabilized at about 10.7%, which is consistent with fourth quarter '04 and down 20 basis points from first quarter '04.

We will discuss this more at length but I wanted to make a number of points at this stage with respect to MIM.

First, both the net interest margin and RER bases exclude the total impact of the derivative gain.

This we believe is conservative in that this change resulted for us in a higher cost of funds.

When we discuss NIM in more detail, Simon will elaborate on this point.

Second, for our correspondent originated loans, we capitalize the purchase premium and amortize this premium through yield.

Concurrently, we have lower operating expenses for this business, so this is simply a matter of P&L geography.

Therefore, we believe this has the effect of lowering NIM and RER, given the disproportionate growth of the loans coming through this channel.

For both of these reasons, particularly the second, you should look at the Roma trends as well as RER and NIM as you evaluate our performance.

Secondly, we've had significant improved credit results year-over-year, driven by stronger analytics, improved collections, the mix of our portfolio and of course a favorable economy.

You see, on the chart, that charge-offs are down 119 basis points; it is also down in raw dollars.

It's down $176 million from first quarter '04, two-plus delinquencies are down 123 basis points and in raw dollars down $674 million from a first quarter '04 perspective.

As you all know, charge-offs are really almost a historical view of credit quality.

What I'm most pleased about is the continued downward trend in delinquencies, because that is in effect a prospective view of credit quality.

Expenses year-over-year are flat to slightly better.

The efficiency ratio is flat to the prior-year quarter, and expenses to receivables are down 29 basis points to 4%, and all of this in a period where we had significantly increased our investments in sales and marketing expense.

If you turn to page 9, this simply shows the income statement at HSBC Finance Corporation on a management basis.

I would like to draw your attention to the box on the bottom third of the chart, which says net income management basis.

It's on this row that we depict our first-quarter '05 net income of $706 million compared to $480 million for first quarter '04.

That is a 47% growth represented on the first chart that I described.

If you strip out the benefits of the derivative income, that adjusted net income is 540 million versus 447 million in first quarter '04, and that represents a 21% increase relative to the first quarter of last year.

If you turn to page 2, look at the key ratios once again on a management basis.

This chart depicts the quarterly progression of net interest margin, risk-adjusted revenue and return on managed assets.

I've made a lot of the points but I would like to reiterate a number of them.

First, net interest margin, risk-adjusted revenue and Roma have the full impact of the derivatives excluded.

Let me repeat that.

NIM, RER and Roma have the full impact of the derivatives excluded and as I said earlier, we believe this is conservative.

Additionally, as I said earlier, net interest margin and RER have been reduced optically because of the higher proportion of correspondent mortgages.

There are obviously other mix-related factors driving the NIM and Roma, which is more near-prime retail mortgages and near-prime auto.

We will address this but overall, these are strategic and deliberate moves on our part with a view to optimize risk and return.

We believe these are Roma-accretive, i.e., accretive on their return on managed assets basis.

You see that coming through on a return on managed assets when you see the sharpest uptick of all of the three lines over the (indiscernible).

Yield has stabilized and gross income therefore has grown proportionately with receivables.

NIM compression has therefore been driven primarily by the rising cost of fund and a flattened yield curve.

As I said earlier, Simon will cover that in a few charts.

Unsecured (indiscernible) receivables have been repriced and as you will see from the Q for our credit card segment, net interest margin in our credit card segment is actually up from first quarter last year to first quarter of this year.

If you turn to page 11, once again, we have the same topline, which is the risk-adjusted revenue as you had on the previous chart, and then you have the two downward-sloping lines for charge-offs and two-plus delinquency.

I think this just pictorially depicts the strong quarterly trends we have seen in this respect.

It's fairly appropriate, at this point, to talk a little bit about bankruptcy filings.

As many of you know, new bankruptcy legislation has been enacted.

There is a six-month window between the date at which the bill was signed and the date it had become defective.

Historically, when this has happened, we have seen an uptick with respect to bankruptcy filings.

We have seen some of that in the first quarter of this year, but the strong credit performance overall has more than compensated for the increased bankruptcy filings.

You can see that coming through in our reported results.

If you turn now to page 12, this chart looks at net interest income and the components thereof.

The upper part of the chart depicts the dollars and the ratios are depicted on the bottom half.

As I said earlier, yields have stabilized despite the mix shift.

The cost of funds has increased 50 basis points from fourth quarter last year to first quarter this year.

Obviously, the key drivers of that are the increases in the short-term cost of funds.

But let me turn it over briefly to Simon to describe some of the underlying factors here.

Simon?

Thank you, Bobby.

As you can see from the lower part of that chart and as Bobby mentioned earlier, the yields on our receivables has stabilized this quarter at about 10.7%, flat on the previous quarter and some 20 basis points down on the first quarter of last year.

What has really been the main driver of net interest margin has been the increase in the cost of funds, which has gone up from around 2.7% in the first quarter of '04 to 3.6% under the quarter under review.

The underlying increase there is about 87 basis points.

I'm sure you all know this but just to remind you, over that same period, average one month LIBOR has gone up something like 154 basis points.

If you look at the 87 basis points increase in the cost of funds which we have experienced, about half of that 43 basis points is due to the impact of higher interest rates.

The loss of hedge accounting -- and you've fully heard this so many times but perhaps to explain -- when we lost hedge accounting on part of our hedging, not any due marked the hedges to market (ph) but the related interest receivable on those swaps is taken out of interest income and treated as part of the mark-to-market on the derivatives.

The effect of that has been to increase our cost of funds by 20 basis points compared with the first quarter of last year.

The remainder of that increase in the cost of funds is largely due to the purchase accounting effects, and there are two elements within this.

Part of it is just a lower dollar amortization figure flowing through, but the other has to do with duration.

At the time we marked our liabilities and swaps to market on the (indiscernible) of a change of control in March 2003, if we had a five-year debt with two years outstanding, we essentially marked it to market as a piece of paper with a two-year residual maturity.

At that time, two-year treasuries was around 1.5%.

As that debt matured in the first quarter of 2005, we would replace it with, as an example, a further tranche of five-year debt, and (indiscernible) five-year treasuries in the first quarter this year was around 3.9%.

So to repeat, roughly half that increase in the cost of funds we've experienced over the last 12 months is due to higher market interest rates, around 20 basis points is due to the loss of hedge accounting, and some 24 basis points is due to the purchase accounting and duration impact.

Bobby, nothing further (indiscernible) we turn to page 13.

Thank you, Simon.

Turning to operating expenses, you can see efficiency ratio, as I said earlier, flat from first quarter last year to first quarter of this year, down from the fourth quarter of last year.

Here we've broken out operating expenses and sales and marketing expenses as a proportion of receivables.

Once again, we see positive trends for the first quarter of last year versus the first quarter of this year.

I think, overall, raw dollars of expenses are up 9.4% compared to first quarter of last year and receivables I would point out are up 18% compared to first quarter of last year.

So overall, we believe costs are controlled and they are making prudent investments with respect to sales and marketing expenses and expenses in respect of growing our receivable book and servicing our receivable book.

If you could turn to page 14, which then brings us onto the receivable mix, once again, on a management basis, as we've said earlier, we've 18% growth overall, real-estate secured is broken out between real-estate secured branch versus real-estate secured correspondent.

For the comparable period, the proportion of real estate goes up from 46 -- (technical difficulty) -- 51%, the real estate component includes second lien business, which we're growing, and I'll talk about that momentarily.

The branch business, which is a real estate branch, has grown 25% over this period.

The correspondent business has grown 45%.

What is the rationale for that?

Roughly 66 to 67% of all subprime mortgages, which is our market, growth is originated through the broker general; about 33% is originated through the retail channel.

In our bid to be an important player in both parts of the market, we've chosen to grow both our branch and our correspondent business.

The branch business is our way of participating in the retail channel, and the correspondent business is our mode of participation in the broker channel.

Secondly, I would like to add that while the overall mortgage business went through a fairly sharp contraction from '03 to '04 and some of those contractions trends are continuing through the first quarter of '05, the subprime mortgage business grew substantially between '03' and '04 in both dollar terms and also obviously as a proportion of the total market.

That is the market where we compete, and that is the market in which we participate.

As a result, we've been able to grow our book substantially over this period.

In terms of the mix of mortgages, adjustable-rate mortgages represent less than 25% of our total book and interest-only mortgages represent less than 5% of our book.

The second liens represent a growing portion of our portfolio.

In fact, they grew at faster than the overall rate of growth of the mortgage book overall.

Unsecured portfolio is back in the growth trajectory from a shrinkage in 2004.

Although as a percentage of the portfolio it has shrunk, given the slower growth overall in the unsecured segment, auto has shown solid growth of 14 percent and cards are growing faster in the market, but as you know, market growth for cards has slowed markedly as consumers have moved to home equity and cash-out refinance to consolidate their debt.

If you turn to page 14, this is a chart in which I would like -- I'm sorry, page 15 -- I would like to address some of the questions with respect to the shift in terms of more near-prime component of the book.

First of all, with the retail channel, we in 2004 and the first quarter of 2005 have had record growth in our core subprime mortgage book in terms of gross dollars of sales.

Net of run-off, that has grown 10% versus the first quarter of '04.

The near-prime production has been very successful.

It's been successful, however, off a small base.

What's the rationale for that?

The rationale for that is we typically take about 70,000 real estate applications in our branches.

We write around 10,000 mortgages.

A substantial portion of the 60,000 applications that we take that don't convert into loans are customers who essentially don't take our product because we don't have the appropriate price for them.

In essence, these are customers in a space very adjacent to our four subprime customers.

So in essence, our ability to have a near-prom product which gives a slightly better price to this customer base leverages our fixed cost infrastructure.

In essence, you've already sunk all of the cost of marketing to that customer base, taking the application, and as a result having a slightly better price, which enables us to book these customers -- is a very accretive incremental opportunity for us on the return on managed assets basis, albeit dilutive with respect to net interest margin and Roma.

So strategically, we think this opportunity is incremental, it doesn't dilute the core focus of our subprime mortgage business because all of the pricing is really done centrally and not at the discretion of the branches, and in essence makes us a more robust and stronger business.

In the correspondent and wholesale channel, it's through this channel and it's really in the management results of this channel is what is represented by $5.2 billion of A- business purchased on behalf of HSBC USA, Inc.

It's accretive to net interest margin for the Bank but dilutive to both net interest margin and RER for the Finance Corporation.

It is, however, accretive to our net interest margin and profitability from a North America perspective.

As a result, what we are seeing is some dilution of NIM coming through the Finance Corporation's numbers but once again strategically, this makes a whole lot of sense for us to do from a North American perspective.

The bottom point in that column, which is a purchase premium point, I've made that earlier so I won't reiterate.

With respect to the auto business, our current origination mix is as represented there, so we're moving substantially into the near-prime space.

Why is that?

It is because, from our experience, there are components of the subprime space where losses are very difficult to predict.

In our card business, we are a big player in the subprime card market and we are very successful players in that market because losses there are very predictable, therefore you can price for it.

If loss is not predictable, it's very difficult, in fact impossible, to price for those losses.

As a consequence, we've chosen to exit certain segments of subprime auto where we don't believe we have the predictability and have deliberately decided to say in segments of subprime auto where we believe that predictability exists.

Second, subprime auto tends to be a more expensive segment to service.

They're about 30 to 35% more expensive than near-prom, given the high incidence of charge-offs, repossessions and therefore the cost of remarketing the automobiles as we repossess.

In fact, about 35% of our total costs in our auto segment relate to the cost of collection, repossessions and remarketing of automobiles.

So, we have moved fairly aggressively into the near-prime space, because we believe this is the most profitable segment on a return-on-managed-assets basis while being dilutive on a net interest margin and return on our -- on an RER basis.

All of these factors, in addition obviously to the credit benefits we've seen from this mix shift, are contributing to the higher return on managed assets for the consumer segment of our business and by and large presented entirely on a comparable basis.

You'll see, if you look at our 10-Q, there has been a significant increase in the return on average managed assets in that segment of our business, so we believe this is a specific deliberate action to optimize risk and return.

If you can move to page 16, the next two charts -- and I won't go through all of these points except to, at a high level, describe the actions we are taking to continue to maximize and optimize net interest margin with risk-adjusted revenue and receivable mix.

The key points for both our mortgage businesses are to expand (indiscernible) lien production in the unsecured side, increase lines selectively, increase usage of risk space pricing, which should enable us to grow that business at a greater pace than we have historically, more granular pricing for real estate-secured products.

We have certain risk and pricing tools that we believe will enable us to get and has enabled us to get incremental net interest margin RER, of all of which are basically underpinned by deployment of proprietary analytics for pricing and Risk Management.

If you move on then to page 17, I'd like to make a set of similar points with respect to both cards and auto.

In the cards business, we continue to focus on nonprime card sectors.

While this in a way will depress receivable growth, it does lead us to an increase in fee revenues and other revenues, and also enables us to manage and increase our net interest margin.

You see that coming through in the figures.

We focus on incremental fee opportunities, including fee-based and fee-focused product.

In the subprime sector, I would just parenthetically point out, when you have better delinquency performance, there's a strong statistically proven relationship between better delinquency performance and lower fee income.

As a result, we would see some of the impacts of that in our results in first quarter '04 -- and obviously to continue focused on risk-based pricing.

With respect to auto, increase our Direct-to-Consumer originations, originate a more stable and predictable near-prime mix and really optimize collections and portfolio management, which are all actions we've been focused on for the past six months and will continue to do so.

Overall, therefore, with respect to the Finance Corporation, I have to say I'm pleased with the quarter.

We saw stabilization in yields, risk-adjusted revenue, increase in Roma despite compressed net interest margin.

I think I've talked through the strategic rationale for the shift to near-prime and also some of the key reasons why we believe the net interest margin figures we show are conservative, both optically and as a result of some of the accounting changes that we've seen.

I feel we are on course in the tough competitive environment, but we are well-positioned to be competitively successful.

With that, I'd like to turn it over to Martin to give us an overview of the results of the Bank.

Martin?

Martin?

Thank you very much, Bobby.

I'm going to refer to page 19 in the pack and essentially describe the Bank, which is portrayed on page 19 or an legal-entity basis and an U.S.

GAAP basis.

We had a very, very good first quarter.

We've had quite a bit of discussion about managed basis versus legal entity and excluding the recent store card purchase at year-end from HSBC Finance to the Bank, we were up approximately 10% in both revenues and net income.

We also reflect, as Bobby has described, a positive economy.

We have very good credit performance and also we've seen some good activity in the segments that reflect economic activity, particularly in small-business, so we're pleased with the favorable environment, at least in the first quarter, in the economy.

So turning to page 20 and looking at our various customer segments, personal financial services had an excellent quarter and really tracked well against first quarter of '04.

A number of things have changed in that area; in fact, we've essentially reengineered and revitalized the retail front end from pricing, product, promotion, and we are engaged in an active branch expansion plan, particularly outside of footprint.

While we only opened three branches in the first quarter, we have plans for approximately 30 through the year.

In terms of deposit growth, we've seen very good new account growth and it reflected 44% growth year-over-year in terms of new accounts, which was very pleasing.

Also, the mortgage results had an excellent first quarter.

Mortgages both grew year-over-year in volume and we had very favorable trends in terms of mortgage servicing rights issues.

Finally, we are developing new deposit products and we are in fact looking and -- in a soft launch on an online savings account, which will enhance our deposit-gathering abilities significantly.

From a commercial banking point of view, it was a good quarter, although we had a very big investment spend, so the pretax income was essentially flat, down 3%, revenues up on a pre-provision basis, it was up and we are in fact expanding very rapidly beyond New York State and have set up new commercial banking offices in L.A., San Francisco, Boston and Miami.

The highlight of the quarter was our small-business program, where we are the number one SBA lender in New York State and we have had very high growth rates in that segment and credit quality -- in the commercial banking generally it was excellent.

So turning to page 21, our corporate investment banking and markets business, while it was down year-over-year and did suffer from a flatter yield curve, there were a number of investments made, some very good programs in terms of structured credit products.

We are part of the overall group CIBM investment spend and it is certainly very relevant within the U.S. bank.

We also took into the bank during the quarter the onshore business of Bank of Bermuda.

A number of new initiatives are underway there both -- and we highlight two of them, MBS and ABS.

Businesses are coming onstream this year, and so we will be looking forward to contributions in those businesses in the coming quarters.

Private banking had a very good start to the year.

We did sell our small Trust business in order to streamline our activity, and it had very good business quarter-over-quarter.

So that's just a quick highlight of results from the Bank.

I'd like to turn it back over to Bobby.

Thank you, Martin.

I think, just to summarize, I think we've good performance across all of our business lines in North America and Douglas, on over to you for the Q&A.

Bobby, Martin, Simon, thank you very much.

At this point, we would be very pleased to answer questions that any of you have.

If you can identify yourself so that we know where to follow-up if we need to, thank you very much.

Thank you, sir. (OPERATOR INSTRUCTIONS).

Ian Smillie.

It's Ian Smillie from ABN.

I just wanted to clarify a few things to make sure that we've gotten straight (indiscernible) and that what you're telling us here is that risk-adjusted revenue margins at risk-adjusted revenue, sorry, for USA of broadly flat year-on-year, which would imply that the revenues went backward -- and I read in the text that your bad debt charge is likely to rise through the rest of 2005, which is Q1 '05, or sort of the last of the good part of the cycle.

If you put that together with an 18% growth in the balance sheet year-on-year, are you telling us that profit growth for the full year for this business could easily be low single digits?

I will give Bobby time to answer what you said at the front end, and you know we're not going to be caught into making predictions for the year as a whole.

But I'm not sure that I read the trend in risk-adjusted margin or the trend in receivables growth or the interaction between the first quarter and your ability to translate that to the full year in quite the same way that you do, but since Bobby spoke the words, why don't I give him a chance to respond to the way you have interpreted the remarks that have been made about the projection of risk-adjusted margin, which from my perspective and I think from his we felt was an encouraging improvement.

Bobby?

Douglas, thank you.

Let me echo what you said, which is I think the increase in risk-adjusted margin from fourth quarter of last year to first quarter of this year is, from my perspective, an encouraging trend, number one.

Number to, as I said, charge-offs, you know, which are down in broad dollars 174 million from first quarter last year to first quarter this year, is a retrospective view.

But what I'm encouraged by is the fact that delinquencies are down $674 million in broad dollars, despite the 18% growth in the balance sheet.

So you know, again I'm not going to make forward-looking statements, but delinquencies really are a predictor of future charge-offs.

So I think -- so I see those trends as all positive and, you know, would hope that they would be reflected as such.

Douglas?

Yes, I think the other thing to say is there is a correlation, at least in our underwriting models between net interest margin and the risk-adjusted revenues -- sorry, revenues and charge-offs.

I mean, we have, I think, in the last year, successfully underwritten product that we anticipated would have a credit experience that would begin to give us recovery in our risk-adjusted margin.

That is now being borne out in these results.

It's not as if the economy helps but it's really the success of our analytics in identifying where delinquency will go and pricing to that to improve margin.

I think the analytics in the underwriting experience that's now coming through it is very encouraging.

Alaister Ryan (ph).

Thanks.

It's Alaister Ryan at UBS.

A few things -- one, a point of probably stupidity on my part -- the derivatives numbers that you're excluding from your analysis, are (indiscernible) portion of that is actually relating to the higher interest expense you're actually passing through the P&L.

If you could just give us a little bit of color.

I realize it's accruals versus net present values going on but to what extent the directive gains are actually offsetting higher interest expenses.

Second, probably slightly more meaningful, the markets worried that excess capacity in the U.S. is leading to unreasonably high pricing in real estate secured in the broker market.

I assume that's not your concern, given that you put on some quite strong volume growth there in the first quarter.

Let me do the first of it while Bobby prepares to answer the second, but you're absolutely right.

It's not a stupid question; it's actually a perceptive observation, that the work that was done in terms of looking at hedging, which is absolutely economically or substantial economically effective but lost some of the accounting for hedge accounting during the first quarter and therefore that's why there's still (indiscernible) in the first quarter, you're absolutely right.

It is in a PB basis and therefore, if one was doing it as we had done it last year under UK GAAP where the hedges still worked, you would be taking some of those derivatives, some portion of the derivative gains and be offsetting that against interest expense, because essentially the swaps involved are case-based (ph) swaps and therefore, in a rising interest rate market, they have value and they were put in place to hedge the cost of funds and have done so economically.

But in an accounting sense, for reasons that are far too complex to go into, it didn't work and we are in the process of re-establishing the accounting to match the economics of them.

But you're absolutely right.

If one was doing it on an accruals basis, on an old-fashioned effectiveness basis, then you would be taking -- you would be taking a portion of what's in directive gains and offsetting it into interest expense.

Bobby, in terms of the broker market for mortgages and the state of the market?

Thank you, Douglas.

I think Simon can just add a bit more color on the derivatives issue, so I'd like him to do that then I will talk about the broker market.

Just to repeat the comment I made earlier Alaister, and that is that had we maintained sort of hedge accounting, then all of that derivative income reported as such would have flowed through cost of funds, and that would have had a cost of funds some 20 basis points lower in the first quarter than we are reporting.

On the broker market, Alaister, I think your point is a good one in that, as margins in the prime market have compressed, there's been a -- some of the competitive pressures have flowed into the subprime sector, particularly in markets like California, which represent about 40% of the subprime market overall.

Some of the underwriting -- some of the products that have been historically underwritten primarily for the prime market are now coming into the subprime market, products like interest-only and negative-amortization loans, where the monthly payment doesn't even cover principal -- I'm sorry, doesn't cover interest or just covers interest and covers no principal and some that actually don't even cover interest.

In a rising rate environment, you can imagine some of the impacts that that could have with respect to credit quality.

As I said in my comments, less than 25% of our loans are interest-only, and less than -- I'm sorry, less than 25% of our loans are adjustable-rate mortgages and less than 5% of the loans in our portfolio are interest-only.

Our interest-only loans are underwritten to a very conservative standard.

So once again, I would just like to reiterate Douglas' point that where we have entered into some of these segments, we've done them conservatively based on analytics and based on our ability to earn a good return for the risks that we undertake.

Overall, we have a conservative posture with respect to, one, these products.

Two, we tend to be also under-represented in markets that have had the fastest real estate appreciation.

Therefore, there are many predictions that real estate appreciation will slow prospectively, and therefore, there's a variety of predictions as to what that could be, but our view is we are under-represented in those markets.

Our home (indiscernible) loans all tend to be owner-occupied, so they are second or third homes.

As a result, we believe we are actually very well-positioned in the market today, from an underwriting standpoint and some of these competitive pressures that you outlined.

Douglas?

Thanks, Bobby.

John-Paul Crutchley.

John-Paul Crutchley from Merrill Lynch.

I actually have a question about the international segment and the international business, which may be a question for both Douglas and Bobby.

Firstly, I guess there's a number of issues and trends going on there.

You've flagged the higher provisions, etc.

You also (indiscernible) invest in that business and restructuring some of the branches too.

I was wondering if you could give us a bit more feel about, in terms of the cost base, how much of that is investment and how much of it is restructuring.

I also have a question for Douglas.

I mean, clearly there is some (indiscernible) in that part of the portfolio.

I'm wondering if it's specific to the household elements of the portfolio or could you comment on whether those trends you are seeing across the board are HSBC portfolio?

Let me deal with that one.

Bobby is reflecting on the work cost question.

It's absolutely fair to say that the UK unsecured credit markets have been showing some degree of weakness and the HFC business here is certainly not immune from that and indeed, I think we've said at the time we did our full-year results for '04 that indeed one of the areas that we saw continuing pressure was as a result of rising interest rates, slower growth in employment and the moves in bankruptcy that the personal unsecured portfolio was going to probably have a higher credit cost than it had historically but still within its margins.

So yes, I think what you're reflecting is the UK economy today, J.P., so no more really to say than that.

It is a UK issue, of which the HFC business is a part.

Can the repositioning of a business maybe, Bobby, in terms of how much of that cost spend is restructuring and versus investment?

Douglas, do you have any comments on that?

Do you want me to --(multiple speakers)?

No, I mean, I'm not sure we'd be very comfortable giving a split because we have made some fairly broad assumptions as to what we're doing.

I think we are increasingly looking to integrate operationally the consumer finance business with the rest of the operations in the UK to try and improve cost efficiency.

But I think some of the cost growth you're seeing today is actually additional activity in the area of collections because of the credit experience that you pointed to.

I think I would just add that I don't really have a whole lot to add to what Douglas said other than to say the sum of the cost growth is in respect of the full-year impact of some of the new relationships we've taken on, like the John Lewis partnership, and growing that business.

Simon Samuels.

Yes, thanks very much.

Good morning, or good afternoon, I'm not sure where all of you are.

Simon Samuels (indiscernible) Smith Barney.

I actually have two questions.

The first is, say, the lesser important one but I'm slightly confused by this management basis for HSBC Finance Corporation.

If I look at slide 9 and look through the net interest and other income and provisions and costs that you report on a management basis and compare it to your managed basis U.S.

GAAP, it basically looks like the management basis sort of pre-tax profits are about 130 million higher than the managed basis U.S.

GAAP, i.e., (indiscernible) the value of all the various transfers from household to HSBC USA.

So I kind of assumed, if I put that off of the (indiscernible) slide 19, if I took that out of HSBC USA, because that's (indiscernible) the profits kind of been transferred to, that would give me a better sense of how HSBC USA is doing, if you like, freestanding without these various distortions.

The analysis suggests, and I'm sure there is a mistake in it somewhere, but it suggests that HSBC USA's profits are down about 30%.

If I just rip out of that 492 million pre-tax income that HSBC USA made, if I just remove from that the, it's like 130 million boost that's come from household transfers, then profits would be done sharply.

So the first question is has the math gone fuzzy somewhere and maybe you could help me as to quite what is going on there?

Yes, it has gone fuzzy.

I mean, this is getting one of the problems now with all the legal entities, particularly under U.S.

GAAP, Simon, which we try to eliminate -- we did intimate in slide 5 -- because one of the issues of course in the legal entity business for the bank is that you set up all the purchased intangibles on the transfer of the credit card portfolio that was transferred across, which are being amortized against (indiscernible) which of course, from a group perspective, eliminates (indiscernible) consolidation, so it is not as simple as -- you can't do what you've don -- (multiple speakers).

The most substantial question was really one, I guess, of Bobby.

It had to do with the U.S. bankruptcy filing trends that you referred to.

I think the law change was passed I think in the second week of April, obviously as you say with a six-month delay defect to implementation.

Now, if I understood your comments previously, you suggested that the Q1 numbers nevertheless included some increase in bankruptcy filings I guess in anticipation that the law would change.

But if you look at the weaker bankruptcy trends as we do, obviously the big increase in signings has really -- they've exploded from the beginning of April right through to the middle of May so far.

So it's really -- I mean, in the last six weeks, the bankruptcy trends have related deteriorated in the U.S.

So I was wondering if you could just comment maybe a little bit more fully on the extent to which Q1 has already, as you suggest, been damaged by this trend and particularly how the rest of the year is going to be impacted.

Sure, Simon.

As you probably know, we have a very thorough loss (indiscernible) costing methodology within the Finance Corporation.

We forecast our losses on a vintage basis, role-rate basis.

Like you, we track bankruptcy filings daily and suffice it to say, there was obviously some anticipatory increase in bankruptcy filings, particularly in February and March, as the likelihood of the bankruptcy filing -- the new law becoming law increased.

You know, we continue to see that increase but, you know, feel that the overall credit performance is -- continues to be very strong.

At the risk of not wanting to make a forward-looking statement, I would probably want to stop there unless, Douglas, you would like me to say more.

I think Simon is suggesting that the marketplace is seeing significantly higher bankruptcy stats.

I mean, do you recognize those market statistics?

We do, and we see that and from our perspective, we have taken that into account in our forecast for the rest of the year.

Nick Lord.

Good afternoon.

It's Nick Lord from Deutsche Bank.

A couple of questions, really.

Obviously, during the presentation, you were trying to present a story whereby I suppose household is understating various changes in terms of the products it's writing (indiscernible) various improvements in terms of the delinquencies and the collections.

I just wonder if you could give us a couple of comments on two things.

First of all, maybe you could comment on what's happening to individual product pricing.

I notice your yield is flat despite the fact that interest rates were up and clearly you will have changed the product mix in different types of near-time, subprime during the quarter, so are individual like-for-like product margins still coming down in your market?

Secondly, just getting back to the question really about consumer bad debts, I wonder if maybe Douglas could give us a comment on where he sees the consumer credit cycles in the UK and the U.S. at the moment.

Does he think that the consumer credit cycle in the U.S. is looking to be considerably better, going forward, than that we see in the UK?

Well, let me give you my tuppins worth on that while is Bobby is answering -- preparing on the product pricing.

I mean, I think that it obviously depends on your view of economics, but my own perception is that the U.S. is likely to be a better picture of credit experience, given the growth in employment, the growth in hours worked and the growth in dollars in the average pay packet.

All of those would be I think positive to credit trends.

I think I answered, in the previous question, there are some aspects of slowdown in consumer spending in the UK that I think means that the exceptional performance we've had is likely to give something back, although we're seeing no carryover between unsecured credit and secured credit, which is clearly encouraging.

So, I think we are seeing some weakening against prior years because of all the things that were mentioned before, but not dramatically so.

We are not crossing over into the mortgage market.

Bobby, in terms of your view of the U.S. and do you want to add anything, and then talk about individual product pricing?

Certainly.

With respect to the overall economy, Douglas, I think your points are spot on, that the recent employment statistics are in fact encouraging; unemployment rates are flat to slightly down; hours worked are increasing; and there is some growth in income, as well.

That is obviously feeding through into the credit environment here in the U.S.

With respect to product pricing, that's one that that is kind of impossible to answer in 100 words or less but generally what I would say is that the mix shift in auto -- we will see lower yields in auto and therefore lower net interest margin.

A combination of the slight mix shift we will continue to see in our retail branch originations between sub-core subprime auto -- sorry, (indiscernible) subprime mortgage and near-time mortgage will have some downward impact on yield.

I think, on the unsecured side, we would be able to maintain -- increase yield and thereby maintain margin, generally speaking.

So I think that is the overall picture.

There is obviously a whole lot of sophistication and analytics that we put into pricing and so -- but generally speaking, I think that's the picture that I see at this point in time.

The pressure on net interest margin, as Simon and Douglas have talked about, will come, I believe, principally from increasing -- the increasing cost of funds, particularly the short-term rates.

If the five and ten-year rates increase, that will give us some incremental pricing power, if you like, on the mortgage side.

So far, that has not come through, but (indiscernible) obviously very vigilant for those kinds of opportunities.

Douglas?

No, that's fine.

I think the other thing you might develop a little bit, because you do it more accurately than me, is the impact of floor rates, which I always find fascinating.

Well, in essence, because of the short-term -- or rather how quickly the short-term rates have increased, basically all of our variable rate card receivables are now repricing pretty much in tandem with short-term rates.

That's really what is driving up, Douglas, the increase in that, combined with continued focus on low-prime and sub-time card in our card business is what's driving up the net interest margin in our cards portfolio.

Whereas we didn't have that pricing tension when the short-term rates were so much lower.

Correct, we did not have that last year and I think that's come through in the first quarter.

Robert Law.

It's Robert Law from Lehman.

I've got three areas I'd like to explore, if I may, please?

Firstly, I suspect I know the answer to this, but I mean, if you add the two pretax profits of the two businesses together, I gather it's something like US$1.459 billion of cap of BPT.

Could I invite you to give us some indication as to what that is?

Can it contribute in the group accounts?

Yes, I mean, you can ask us, obviously.

Robert, I have to say the number of hours that were spent trying to work out how we would do that and because of this problem of -- not problem or just the sheer fact that we're still going through the IFRS transition and in particular on hedging relationships because of the ability to use fair value option, and therefore, we concluded it was better not to give a number that looked as if it could be right to discover that we change it at some point in the future.

What I would say is, if you look at the historic relationship between U.S. numbers and what was included in the Group account size to get back to the UK GAAP, the major areas of difference, the biggest being securitization accounting, doesn't change.

It continues to be the biggest difference, together with amortization of intangibles and purchase accounting adjustments, again which continue to be in the same direction.

So kind of the big differences that you've seen historically would be similar in direction, and the hedge accounting I think is still less clear as to what the answer will be, because we haven't fully evaluated whether and to what extent we use fair value options.

So I think that's all I can say;

I'm sorry.

So in terms of what we ought to do is strip out the derivative impact and try and make those adjustments, is that --?

If I were you, that's what I would do.

I don't know how I would do it, but that is what I would try and do.

Then move onto margin and costs please.

On the margin, obviously you've given us some detail about the squeeze on the funding side.

The effect of higher interest rates that we've seen to date, does that come through already in these numbers, or is there some drag effect still to come through from the rate rises we've seen already?

Simon, do you to do --?

I mean, most of the stuff of the short-terms is coming through in commercial paper, so there's bound to be a modest lag but I think it would reprice fairly quickly, that the extent to which is because of the duration effect as we are repricing our sets that were taken down to residual duration and basic acquisition and are now going onto whatever they were, three, four, five-year liability liabilities.

Then -- that's clearly, -- there is a lag effect as these issues amortize -- but as you say, come to a maturity and a refinance.

But as far as the short-term ones, I would have thought it's relative.

There must be some lag but not a huge one.

Simon?

I think you put it, Douglas, very succinctly.

I mean, the market forecasts are for further rate increases this year but they are largely priced in.

But that will put some, as those things flow through, will put some pressure, as you mentioned, as the old debt runs off and the new debt longer duration comes on.

Yes, theirs will be a continuing effect as we go through the rest of this year.

That was what I was trying to get at.

So, in terms of the impact looking at your margin further forward, we can extrapolate what we've seen here with further interest rate rises and we can extrapolate the effect of the unwind of the mark-to-market of the longer-term fundings, for want of a better phrase, continuing?

Yes, that's right.

Then on the other side, as you are saying, we are beginning to get out of the periods where we had no pricing power in cards because we are getting above floor rate thresholds, and you know, as Bobby said, there are a number of other initiatives in place to identify opportunities to use pricing power within what is obviously still a competitive marketplace.

So, there's a lot of moving parts as ever.

The only other point, Douglas, if I may, I would add that the expectation of increasing short-term rates is not disconnected from the economy continuing to be relatively robust and stable.

Therefore, while there may be some pressure on net interest margin for the reasons that you describe, you know, then there should be a countervailing impact on credit.

So, all of that flow-through to risk-adjusted revenue, which is where I think, from our perspective, we focus our attention, that's the (indiscernible) question but we think there's some countervailing their impacts as well.

I would draw back to something we've said ever since we got to know the last (ph) company, that as long as rates are rising because of inflationary and growth concerns, it tends to be positive for the finance company.

Finally, can you give us some feel for how big the tax-based business is in terms of its contribution to PBT in the first quarter?

I think that's in the Q. Yes, go ahead, Simon.

I will let you address that.

It's Simon Penney here.

If you can flip back to slide 5 on the presentation, there's a footnote there that says that the first quarter of '05 and the first quarter of '04 reflects TempCare (ph) financial services revenues of 131 million and 113 million respectively, net of tax.

The post-tax contribution division was 131 in the first quarter of this year, 113 in the first quarter of last year.

Does that answer your question, sir?

Yes, thank you.

The next question comes from Sir James Alexander (ph).

James Alexander from LMG (ph).

I've got three questions.

One is, on slide 5, what is that 80 million in Q1 '05 exactly?

Say you added together higher combined net income?

Then a second question is, you couldn't just say whether you think (indiscernible) in UK GAAP terms and what these numbers might be in UK GAAP (indiscernible) what the progression was, that is the numbers you reported last year?

The kind of third question is, whether you could just sum up what has changed in the last six months in that rather gloomy conference call we had about the third-quarter numbers back in October and November, 2004.

Douglas?

I'm always gloomy, James! (LAUGHTER).

I'm not sure we were as gloomy as some of the people on the call.

I think you've got projections as to what we think are going to happen, and it's difficult to say, in the basis of forward-looking projections, what we think we are or what will happen but there were a lot of things going on which we like to talk about that were there to improve our risk-adjusted margin.

If we had been right about the underwriting analytics, then we should have been seeing -- hoping to see better credit experience against the lower margin, or the lower-yield products, and I think that is what has come through.

I'm sure Simon will improve my technical self, but I think, if you look at that eliminations line, you see a big reduction in the fourth quarter of '04 and then again in the first quarter of '05.

I think among the biggest elements of that is at the end of '04, there was a huge gain on selling the portfolio at market value to the Bank from the finance company.

In the first quarter of '05, you've got the intangible asset represented by the gain being amortized.

So in a part, it's the same-store reversing; there was again a sale inter-company and that which is now the amortized.

We took out the gain obviously and now we're taking out the amortization.

If there's anything else that's -- and Simon, help me and --.

Yes, Doug, I would think there's really three principle elements to that 80 million.

The first, as you say, is that the Bank is amortizing, over a relatively short period, the premium it paid to acquire the private label credit card receivables from the Finance Corporation but also within the Finance Corporation, daily gains are generated as new receivables are sold across to the Bank, and also the Finance Corporation receives servicing fees from the Bank to support the receivables now on the Bank's book.

It's the unwind of those three principle elements that nets the 80 million.

What was your third one?

We talked about being depressed that we should apologize for? (multiple speakers) (LAUGHTER).

It's confusing enough.

We've got U.S.

GAAP, managed basis, management basis, and then by August, we will have IFRS, and it's just -- I mean, UK GAAP doesn't exist any more and it doesn't exist any more.

We tried to be helpful to the extent that the principle elements of reconciliation are the intangibles and securitization, which -- that doesn't change.

To throw in another number is unhelpful, particularly because hedge accounting, which I suspect we're going to talk about every quarter for the rest of my life, but hedge accounting under U.S., UK and IFRS, is different.

Therefore, we give you a number in UK GAAP and it would be different under IFRS, so I don't want to put any more numbers out.

I'm sorry.

I think this is a one-time.

When we get to August, we will have the IFRS number for the half and you'll be able to look at that against history.

Then you will have your series but for this particular point in time, we're just in a hiatus.

Does that answer your question, sir?

Yes, at least it just (indiscernible) 80 million, because items in both HSBC Finance Corp. and HSBC USA that understate the Group revenues, the combined net revenue -- combined net income, that's what you're saying?

Yes, it eliminates the inter-company profits and losses, of which a big part is the amortization of the purchased intangibles.

Okay, thank you.

(OPERATOR INSTRUCTIONS).

Porter Collins (ph).

This is Steve Hiasen (ph) for Porter.

Just quickly, I'm sorry I came on the call very late, so you might have answer this question, but I'm hearing that there is a price war going on in the home equity industry in the U.S.

I'm wondering if you're seeing the same things.

If you are, how you are adjusting.

Bobby, that sounds like one for you.

Okay, you know, obviously pricing is competitive, Steve.

The segments we compete in, which are the subprime segments, tend to be less price-competitive and less interest-rate sensitive, and so our view is that we get -- we compete judiciously; we believe we have some proprietary analytics and models; and you know, we are not purely -- because we are not a gain-on-sale securitizer, we don't have the same drive for volume.

I understand, but I'm hearing from -- that people price their home equity loans generally -- or if it's a two year -- two years up 75 basis points this year, and rate sheets have not changed in the last four months.

It sounds like it's a lot more competitive than it's usually been.

I'm just wondering if you're seeing that.

I think we see that primarily in the prime segment, Steve, not as much in the subprime.

Okay, thank you.

There are no further questions, sir.

Are there any other points you wish to raise?

Just to say again thank you to everyone who has participated in the call.

Particularly if there are any listeners currently in Asia, thank you for staying up so late.

But thank you for your interest and we look forward to talking to again before too long.

Thank you.

Ladies and gentlemen, this concludes the HSBC conference call.

Thank you for participating; you may now disconnect.