HSBC 2003 Annual Report Download - page 102

HSBC HOLDINGS PLC
Financial Review (continued)
100
year. On an underlying basis, pre-tax profit, before
goodwill amortisation, was 13 per cent lower than in
2002 mainly due to lower earnings from mortgage
servicing and higher staff costs.
Net interest income increased by 53 per cent to
US$2,116 million mainly as a result of the inclusion
of HSBC Mexico. The first full year’s result for
HSBC Mexico was strong and ahead of expectations.
Growth in Mexico from a relatively weak
performance in 2002 reflected an improvement in net
interest income driven by a greater level of low cost
deposits and an expanding consumer loan portfolio.
Interest spreads benefited from a change in asset
mix, with over 25 per cent growth in higher yielding
assets, including motor vehicle finance, credit cards
and payroll loans.
On an underlying basis, growth in net interest
income of 7 per cent was mainly driven by growth of
US$2.5 billion in residential mortgage balances in
the US and Canada. In both countries, the low
interest rate environment proved attractive to new
homebuyers and encouraged existing homeowners to
refinance their mortgages. In the US, net interest
income further benefited from improved spreads on
mortgages and an improved mix of loans and savings
deposits.
Other operating income of US$825 million was
62 per cent higher than in 2002. Operations in
Mexico contributed US$461 million to other
operating income in the year. Transaction volumes
on core banking related products, such as credit
cards, deposit-related services and ATMs, grew
significantly. HSBC Mexico led the market with a
34 per cent share in domestic interbank ATM
transactions across Mexico, delivering fee revenue of
US$92 million. In addition, a growing level of fee
income was generated from bancassurance sales and
international remittances.
On an underlying basis, other operating income
fell by 23 per cent. This was primarily caused by a
fall in mortgage banking-related income in the US.
Total servicing-related income decreased by
US$210 million compared with 2002. This decrease
was driven by accelerated amortisation and large
write-downs of mortgage servicing rights (‘MSRs’ )
as many customers refinanced mortgages in order to
take advantage of the low interest rate environment.
MSR income also declined as a result of significant
losses on derivative instruments used to protect the
economic value of MSRs.
In addition, the June/July time period was one of
the more difficult periods related to derivative
activity. Specifically, in June, positions were taken in
derivative instruments to further reduce HSBC’s
exposure to these losses as mortgage rates continued
to fall. However, in July extreme interest rate
volatility ensued and there was a significant rise in
interest rates resulting in a substantial loss in the
value of the derivative instruments. These losses
were only partly offset by subsequent falls in interest
rates, and gains from the sale of certain mortgage-
backed securities available-for-sale that were used as
on-balance sheet economic hedges of the MSRs.
While the value of MSRs generally declines in a
falling interest rate environment as mortgages are
repaid, the effect of this decline is often mitigated by
income from refinancing mortgage loans and
subsequent sales to mortgage agencies. Total loan
volumes sold in 2003 were US$20.1 billion
compared with US$12.4 billion in 2002. Market
conditions during 2003 permitted favourable pricing
which allowed HSBC to earn higher gains on loans
sold as well as a higher spread on refinanced loans.
As a result, sales-related income for 2003 increased
by US$82 million compared with 2002.
Overall, the US mortgage banking business
contributed US$210 million to pre-tax profit in 2003,
compared with US$251 million in 2002. In the US,
HSBC generated increases in deposit-related service
charges and in card fees, though sales of investment
products fell reflecting a lack of confidence in the
equity markets. Increased fees in Canada reflected
higher insurance sales and increased commissions
from retail broking activities as the equity markets
rebounded in 2003.
Growth in operating expenses, excluding
goodwill amortisation, of 65 per cent to US$1,965
million was substantially attributable to the addition
of HSBC Mexico, which contributed US$758 million
to the overall cost base in 2003. In Mexico, savings
in operating expenses were achieved from merging
HSBC Mexico with HSBC’s existing operations in
the country. These savings funded investment to
improve technology support for HSBC Mexico’s
branch network.
On an underlying basis, operating expenses,
excluding goodwill amortisation, increased by 7 per
cent. Pension costs rose due to falls in the long-term
rates of return on assets, and higher profitability
drove increased staff incentive payments. Following