HSBC 2006 Annual Report Download - page 122

HSBC HOLDINGS PLC
Report of the Directors: Financial Review (continued)
Summary income statement
120
14.9 per cent. Revenue growth was 13 per cent and
the cost efficiency ratio was broadly unchanged at
51.3 per cent; the Group’s Tier 1 ratio strengthened
to 9.4 per cent.
HSBC’s results in 2006 reflected the benefits of
diversification of earnings. There were a number of
outstanding achievements, for example, exceeding
US$1 billion pre-tax profits for the first time in
Mexico and the Middle East, and in each of the
Group Private Banking and Commercial Banking
businesses in the Rest of Asia-Pacific. HSBC added
approximately US$1 billion in extra pre-tax profits
in the Rest of Asia-Pacific and globally in the
Commercial Banking businesses.
However, results in 2006 also reflected a decline
in pre-tax profits of around US$725 million in the
Group’s personal businesses in the US as a portfolio
of sub-prime mortgages purchased by a subsidiary of
HSBC Finance (‘mortgage services’) suffered much
higher delinquency than had been built into pricing
these products.
Earnings continued to be well diversified, both
geographically and by customer group. Regionally,
Asia including Hong Kong, had record results as did
the Group’s newly designated Latin America region,
which combines Mexico and Central America with
HSBC’s South American businesses. Within the
Customer Groups, Commercial Banking again
delivered a record performance, as did Private
Banking and Corporate, Investment Banking and
Markets, which made strong progress in the areas in
which the Group has been investing in recent years.
Personal Financial Services declined as growth in
Asia and Latin America was masked by the
problems in the US mortgage services business.
The economic backdrop in 2006 was favourable.
Global equity markets enjoyed strong gains for much
of the year, encouraging expanded investment flows
and creating a receptive marketplace for the high
level of mergers and acquisitions and IPO activity
which followed. However, in these favourable
conditions, the cumulative effect of rising short-term
rates, benign credit conditions and strong liquidity
put pressure on interest margins.
The credit environment for corporate and
commercial lending continued to be exceptionally
good. However, on the back of slowing housing
markets and rising interest rates, a marked
deterioration was experienced in the sub-prime
mortgage market in the US. This more than
outweighed the non-recurrence in 2006 of loan
impairment costs associated with a surge in
bankruptcy filings in the US in the fourth quarter
of 2005, and the effect of hurricane Katrina.
Net operating income before loan impairment
charges and other credit risk provisions of
US$65,366 million was US$7,729 million or 13 per
cent higher than in 2005, 11 per cent higher on an
underlying basis. Commercial Banking, Corporate,
Investment Banking and Markets and Private
Banking operations all achieved strong double-digit
growth. Operating income performance was well
spread geographically, with the strongest growth in
HSBC’s operations in Asia and in Latin America.
Loan impairment and other credit risk
provisions, expressed as a percentage of gross
average advances to customers, at 1.4 per cent, were
20 basis points higher in 2006 than the 1.2 per cent
recorded in 2005. There was also a 20 basis point
rise in the ratio of new loan impairment charges to
gross average advances to customers, from 1.4 per
cent in 2005 to 1.6 per cent in 2006. The charge of
US$10,573 million was US$2,772 million, or 36 per
cent, higher than in 2005, 30 per cent higher on an
underlying basis. Of this increase, approximately
60 per cent arose in the Group’s Personal Financial
Services businesses in North America, with the
major increase being in the US sub-prime mortgage
portfolio acquired through mortgage services.
Impairment charges in the UK were broadly stable as
a percentage of lending to customers despite a rising
trend of consumer recourse to debt mitigation
arrangements. There was also some credit
deterioration in a few emerging market countries,
notably in the first half of 2006, as a consequence of
regulatory changes.
Total operating expenses of US$33,553 million
were US$4,039 million or 14 per cent higher than in
2005, 11 per cent higher on an underlying basis.
Much of the growth reflected investment to expand
the Group’s geographic presence and add product
expertise and sales support. This expansion was most
marked in Personal Financial Services in North
America, and in Corporate, Investment Banking and
Markets, where the cost efficiency ratio improved
slightly as strong revenue growth offset the first full
year effect of investment expenditure in previous
years.
HSBC’s share of profit in associates and joint
ventures increased by US$202 million, with
improved contributions from The Saudi British
Bank, Bank of Communications and Industrial Bank,
supplemented by a first full year contribution from
Ping An Insurance. HSBC’s share of profits from
investments in associates in the Rest of Asia-Pacific
accounted for nearly a quarter of the profits from
that region. For further detailed discussion and
analysis of the Group’s results by geographical