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Presented to Todd Hamilton, Director Risk Management Prabhu Ramamoorthy Apr 24, 2010

HSBC Presentation Credit Risk in Banking with credit card (retail exposures) perspective and Industry trends. Presented to Todd Hamilton, Director Risk Management Prabhu Ramamoorthy Apr 24, 2010. Credit Risk – Current Review. Macro - Rising Unemployment, Falling Home Equity values, GDP

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Presented to Todd Hamilton, Director Risk Management Prabhu Ramamoorthy Apr 24, 2010

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  1. HSBC PresentationCredit Risk in Banking with credit card (retail exposures) perspective and Industry trends Presented to Todd Hamilton, Director Risk Management Prabhu Ramamoorthy Apr 24, 2010

  2. Credit Risk – Current Review • Macro - Rising Unemployment, Falling Home Equity values, GDP • Reduced consumer spending and loan balances – driving down revenues • Increased Losses, Impairments and loan loss provisions - Impact on Balance Sheet & Income Statement • Slowdown or Absence of Securitization market in funding & transferring Credit Risk Ex – Credit card receivables backed ABS • Thawed Credit (Reluctance to lend to Risky customers) Source: BASEL II http://www.bis.org/publ/bcbs107.pdf?noframes=1 Source: HSBC Finance SEC Annual Report http://www.sec.gov/Archives/edgar/data/354964/000095012310018653/0000950123-10-018653-index.htm Source: http://www.hsbc.com/1/content/assets/investor_relations/hsbc2009ara0.pdf Increased Credit Risk Losses, Write downs BS & IS Pressure

  3. Credit Risk in Banks • Retail Exposure - Credit Cards, SMEs, Mortgage Loans • Wholesale – Corporate and Sovereign • Counterparty credit risk - OTC, Derivatives, swaps • Exposure has to be calculated • Also can be analyzed from Balance Sheet and Trading book perspective • Investment Portfolio (Evaluate Credit Risk of Investments) • BS – Available for Sale, Held and Trading • BS – Assets and Loan exposures mentioned above • Off-Balance Sheet items Source: BASEL II http://www.bis.org/publ/bcbs107.pdf?noframes=1 Source:  HSBC Finance SEC Annual Report http://www.sec.gov/Archives/edgar/data/354964/000095012310018653/0000950123-10-018653-index.htm Source: HSBC PLC Annual Report 2009 http://www.hsbc.com/1/content/assets/investor_relations/hsbc2009ara0.pdf

  4. HSBC North America • HSBC North America – HSBC USA, HSBC Finance, HSBC Canada • Focusing on HSBC Finance • Card, Retail Services and Consumer Finance • Composition • Run off Portfolio (Exit Strategy Planned) • Core Portfolio (Credit Card & Retail Services) • Loan Modifications in 2009 increased the duration of Run-off Portfolio and the reduced rates due to modifications may reduce the NIM • Retain Credit card business for maintaining Credit Quality data Source:  HSBC Holdings PLC JP Morgan Asia Pacific Equity Research 22 April 2010 Source: HSBC Finance SEC Annual Report http://www.sec.gov/Archives/edgar/data/354964/000095012310018653/0000950123-10-018653-index.htm

  5. Delinquency Rate 2+months HSBC Finance – Credit Card in Triangles Credit Card, Real Estate and Auto Delinquencies. Reflects today’s serious conditions. • Source: HSBC Finance SEC Annual Report http://www.sec.gov/Archives/edgar/data/354964/000095012310018653/0000950123-10-018653-index.htm • Source:  HSBC Finance SEC Annual Report

  6. Delinquency Rate 30+Credit Card Master Trusts Comparison Credit Card Delinquencies of Leading Trusts. Shows High Delinquency rates. Are expected to remain flat or head lower for trusts. Source: US Credit Card – Credit Card Trusts Credit Suisse Specialty Finance March 15 2010 Source:  American Express Report The Buckingham Research Group March 15, 2010

  7. Delinquency Rate (in %)Comparison FDIC statistics – Credit Card in Blue FDIC Statistics over a longer period shows a spike in delinquency in the last 2 years. Credit card delinquency in blue for Top 100 Commercial Banks. • Source: http://www.federalreserve.gov/releases/chargeoff/ • Source: http://www.federalreserve.gov/econresdata/releases/statisticsdata.htm

  8. Net Charge off rateHSBC Finance –Credit Card in Triangles Charge Off Rates high for Credit Cards, Real Estate secured when compared to Trusts, FDIC Note: An accounting change policy took place in 2009 (related to charge-off period). • Source: HSBC Finance SEC Annual Report http://www.sec.gov/Archives/edgar/data/354964/000095012310018653/0000950123-10-018653-index.htm

  9. Net Charge off rate Comparison Credit Card Master Trusts Shows Charge-Offs in Major Credit Trusts tracking the pattern shown earlier Charge-Offs continue to be high. Source: US Credit Card – Credit Card Trusts Credit Suisse Specialty Finance March 15 2010 Source:  American Express Report The Buckingham Research Group March 15, 2010

  10. Net Charge off rate (in %)Comparison – FDIC Statistics Credit Card in Blue FDIC Statistics over a longer period shows a spike in charge-off in the last 2 years. Credit card Charge-Offs in blue for Top 100 Commercial Banks and charge off rates are extremely high & hit a peak over the historic time period. • Source: http://www.federalreserve.gov/releases/chargeoff/ • Source: http://www.federalreserve.gov/econresdata/releases/statisticsdata.htm

  11. Loan Loss ProvisionHSBC North America High Loan Loss Provisions for North America. Predicted to decline in future for HSBC North America with recovery. Expected to stay high for HSBC Finance. Source:  HSBC Holdings PLC JP Morgan Asia Pacific Equity Research 22 April 2010 Source:  HSBC PLC Annual Report 2009 http http://www.hsbc.com/1/content/assets/investor_relations/hsbc2009ara0.pdf

  12. Loan Impairments and GrowthHSBC North America On LHS, Impairments and loan losses continue to be high. On RHS, Shrinking Loan Growth in North America. Source:  HSBC Holdings PLC Barclays Capital Report Financial Services European Banks 29 March 2010 Source:  HSBC PLC Annual Report 2009 http http://www.hsbc.com/1/content/assets/investor_relations/hsbc2009ara0.pdf

  13. Data From FDIC WebsiteConsumer Credit Revolving Outstanding changes On LHS, Consumer Revolving Credit declined substantially by 9.6% in 2009. On RHS, CS Revolving changes (annualized) over last 3 months beginning Dec declined. Since June 2008 Credit Lines (Including unused) have come down by 1.4 trillion. In entire 2009, Available credit line decreased by 850 billion (Credit Suisse Estimates). Source: http://www.federalreserve.gov/releases/g19/current/ Source: http://www.federalreserve.gov/releases/g19/current/ Source : US Credit Card – Competitive Trends Credit Suisse Specialty Finance March 23 2010

  14. Competitive trends Mail volume Card Direct Mailings to acquire customers and competition has increased. Willingness to lend and increase credit card outstanding balances which have been pressurized of late. Source:  US Credit Card – Competitive Trends Credit Suisse Specialty Finance March 23 2010 Source : Mintel CooperMedia

  15. CompetitionTop Card Issuers Mail Volume As on March, 2010 Shows Significant increase in Mailings YoY . Conditions have improved over the same period in last year 2009. HSBC in 6th place. Source:  US Credit Card – Competitive Trends Credit Suisse Specialty Finance March 23 2010 Source : Mintel CooperMedia

  16. Product offerings Mail offerings of Credit Card by product characteristic Shows product offerings over the last quarters as a percentage of type. On another note, Annual fees also increased (also as a passage of CARD Act). Source:  US Credit Card – Competitive Trends Credit Suisse Specialty Finance March 23 2010 Source : Mintel CooperMedia

  17. HSBC FinanceRun-off Portfolio and Estimates Declining balances for HSBC Run Off Portfolio and expected Run off. As mentioned earlier, Loan modifications may have prolonged life and reduced NIM. Source: HSBC Holdings PLC JP Morgan Asia Pacific Equity Research 22 April 2010 Source: HSBC PLC Annual Report 2009 http://www.hsbc.com/1/content/assets/investor_relations/hsbc2009ara0.pdf

  18. HSBC FinanceCore Portfolio and Estimates HSBC Core Portfolio composed of Card and Private Labels. Key to maintaining Credit Quality Data for management purposes. Source: HSBC Holdings PLC JP Morgan Asia Pacific Equity Research 22 April 2010 Source: HSBC PLC Annual Report 2009 http://www.hsbc.com/1/content/assets/investor_relations/hsbc2009ara0.pdf

  19. Yield CurveSteepening over 09 Low funding costs. But Prolonged low rates combined with high losses & shrinking assets make it difficult to earn a spread . Source: http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield_historical_2009.shtml

  20. Net Interest MarginHSBC North America – Previous and Estimates On LHS, NIM Actual and Projections for North America. On RHS, You can see that High NIM of HSBC Finance is under pressure and declining. Source: HSBC Holdings PLC JP Morgan Asia Pacific Equity Research 22 April 2010 Source: HSBC PLC Annual Report 2009 http://www.hsbc.com/1/content/assets/investor_relations/hsbc2009ara0.pdf

  21. Net Interest MarginHSBC North America – PFS (including CF) Reflects exit strategy from CF in HSBC Finance . High LLPs currently. Expected to get better with lower LLP in future. Source: HSBC Holdings PLC JP Morgan Asia Pacific Equity Research 22 April 2010 Source: HSBC PLC Annual Report 2009 http://www.hsbc.com/1/content/assets/investor_relations/hsbc2009ara0.pdf

  22. External Environment & RegulationsCARD Act • Prohibits raising of interest rates within 60 days of a late payment • Prohibits Changes to contracts(hikes) as a result of late payment on another card • Issuers must provide 45 days advance notice before interest rate hike and changes in writing • Prohibits issuance of Credit card to people under 21 in principle • Prior consent required for over limit fees • Promotional APRs must be valid for at least 6 months Consequence Reduced Balances & Revenues Higher fees Source:  http://www.kansascityfed.org/comaffrs/creditcards/Webinar.2010.03.08.pdf Source: http://www.federalreserve.gov/consumerinfo/wyntk_creditcardrules.htm

  23. Regulatory RequirementsBasel II Credit Risk • Credit Risk Capital Calculations • AIRB -Internal estimates of PD, LGD, EAD • Probability of Default Estimates • Retail Exposure – Internal Data • Corporate - Structural Models such as KMV Merton • Significant Data challenges, quality issues • Used in Capital Calculations Source:  BASEL II http://www.bis.org/publ/bcbs107.pdf?noframes=1 Source: http://www.federatedinvestors.com/ffw/funds/fundoverview.do?basketid=1022&fundshareid=1347&link=products&ut=unregistered_webuser PD LGD EAD

  24. Banking Models & Uses • Credit Policies & Credit Risk Management • Credit Scoring Models – Internal, External (A way of expressing Probability of Default) • Bad Rates, Delinquency scores • Segmentation and Individual Scorecards for each segment • Probability of Default Calculations– Logistic Regression, Discriminant Analysis • Consumers • Small Business Credit cards • Ex Z score – A Discriminant analysis for scoring companies based on Financial Ratios • Exposure Calculations • Loss forecasts, Return Analysis by Demographics, Product & Borrower Characteristics • Marketing , Segmentation for exploratory analysis – • CART, CHAID and decision rules • Direct Marketing • Targeted Marketing, Customer selection • Predicting Response Rates for Campaigns Source:  BASEL II http://www.bis.org/publ/bcbs107.pdf?noframes=1 Source: Wiley Credit Risk Scorecards Developing and Implementing Intelligent Credit Scoring – Naeem Siddiqi

  25. Credit Scoring Models • Credit Score for consumer models – FICO score & Credit Bureaus, borrower characteristics and product characteristics • Credit scoring models for SMEs – combination of business + personal credit scores • Experian, D&B data • Industry, No of Employees, Size, Geography, Trades opened, Suppliers • Bankruptcies, Delinquency Rate • Financial Information – BS and IS Ratios Source:  BASEL II http://www.bis.org/publ/bcbs107.pdf?noframes=1 Source: Wiley Credit Risk Scorecards Developing and Implementing Intelligent Credit Scoring – Naeem Siddiqi

  26. BanksCredit Risk Management & Summary Basel II requirements and compliance have also assisted in managing risk and capital requirements. A Deloitte report presents interesting insights (see source below). Source: BASEL II http://www.bis.org/publ/bcbs107.pdf?noframes=1 Source: http://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Assets/Documents/us_fsi_GlobalRskMgmtSrvy_June09.pdf Source:  http://www.sec.gov/Archives/edgar/data/354964/000095012310018653/0000950123-10-018653-index.htm

  27. Important Links, Materials & References • HSBC Finance SEC 10k • http://www.sec.gov/Archives/edgar/data/354964/000095012310018653/0000950123-10-018653-index.htm • HSBC USA SEC 10k • http://www.sec.gov/Archives/edgar/data/83246/000095012310018586/0000950123-10-018586-index.htm • HSBC Plc Annual Report • http://www.hsbc.com/1/content/assets/investor_relations/hsbc2009ara0.pdf • HSBC Holdings Plc JP Morgan Asia Pacific Equity Research 22 April 2010 • HSBC Holdings Plc Barclays Capital Financial Services European Banks 29 March 2010 • US Credit Card – Credit Card Trusts Credit Suisse Specialty Finance March 15 2010 • US Credit Card - Competitive Credit Suisse Specialty Finance March 23 2010 • American Express Report The Buckingham Research Group March 15, 2010 • Federal Reserve Statistics • http://www.federalreserve.gov/econresdata/releases/statisticsdata.htm • http://www.federalreserve.gov/releases/chargeoff/ • Wiley Credit Risk Scorecards Developing and Implementing Intelligent Credit Scoring – Naeem Siddiqi

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