HSBC 2005 Annual Report Download - page 400

HSBC HOLDINGS PLC
Notes on the Financial Statements (continued)
398
Loans outside the scope of SFAS 114
For smaller-balance homogeneous loans for which future cash flows from written-off balances can reasonably be
estimated on a portfolio basis, an asset equal to the present value of the cash flows is recognised under IFRSs as
it was previously under UK GAAP. This asset is not recognised for US GAAP purposes. This divergence
resulted in higher net income in 2005 of US$20 million under US GAAP compared with IFRSs, and a reduction
in the carrying value of loans and advances to customers and shareholders’ equity at 31 December 2005 of
US$327 million. There was no difference in reported net income or shareholders’ equity for 2004.
(i) Earnings per share
Basic earnings per share under US GAAP, SFAS 128 ‘Earnings per Share’, is calculated by dividing net income
of US$14,703 million (2004: US$12,506 million) by the weighted average number of ordinary shares in issue in
2005 of 11,042 million (2004: 10,916 million).
Diluted earnings per share under US GAAP is calculated by dividing net income, which requires no adjustment
for the effects of dilutive ordinary potential shares, by the weighted average number of shares outstanding plus
the weighted average number of ordinary shares that would be issued on conversion of all the dilutive potential
ordinary shares in 2005 of 11,334 million (2004: 11,063 million).
(j) Variable interest entities (‘VIEs’)
Nature, purpose and activities of VIEs with which HSBC is involved
HSBC uses VIE structures in the normal course of business in a variety of activities (outlined below), but
primarily to facilitate client needs. HSBC’s involvement in VIEs is, therefore, commercially driven. VIEs are
only used after careful consideration is given to the most appropriate structure to achieve HSBC’s objectives
from control, risk allocation, taxation and regulatory perspectives. The main VIEs are discussed below.
(i) Asset-backed conduits (‘ABCs’) and securitisation vehicles
ABCs and securitisation vehicles are structures in which interests in consumer and commercial receivables
are sold to investors. ABCs generally consist of entities which purchase assets from clients to meet their
financing needs, while securitisation vehicles generally acquire assets originated by HSBC itself and thereby
provide HSBC with a cost-effective source of financing. Under both structures, commercial paper, notes, or
equity interests are issued to investors to fund the purchase of receivables, and cash received from the
receivables is used to service the finance provided by the investors. In certain instances, HSBC receives fees
for providing liquidity facility commitments and for acting as administrator of the vehicle.
HSBC’s exposure to loss generally arises from commitments to provide back-up liquidity facilities for the
vehicles; interest-rate swaps in which HSBC is the counterparty; retained or acquired interests in the
receivables sold; or acquired interests in the vehicles themselves. In certain vehicles, the risk of loss to
HSBC is reduced by credit enhancements provided by the originator of the receivables or other parties.
In addition to these securitisation vehicles, HSBC (primarily through its North American subsidiaries)
securitises assets through entities that are not considered VIEs, including government-sponsored financing
vehicles and vehicles considered qualifying special-purpose entities under US GAAP. These entities are not
consolidated under US GAAP although certain of them are consolidated under IFRSs.
(ii) Infrastructure projects and funds
HSBC acts as an arranger for both public and private infrastructure projects and funds. The use of VIE
structures in such projects is common as a method of attracting a wider class of investor by dividing into
tranches the risk associated with such projects. HSBC’s exposure to loss generally arises from the provision
of subordinated or mezzanine debt finance to projects, either directly or through a consolidated investment
fund investing in infrastructure projects.
HSBC is deemed to be the primary beneficiary of an infrastructure project or fund when its investment in a
project’s equity, subordinated debt or mezzanine debt, or its interest in a fund, is at a level at which it
absorbs the majority of the expected losses or residual returns of the project or fund.