10-Q 1 husi9301810-q.htm 10-Q Document


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q

(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number 001-07436
HSBC USA Inc.
(Exact name of registrant as specified in its charter) 
Maryland
 
13-2764867
(State of incorporation)
 
(I.R.S. Employer Identification No.)
452 Fifth Avenue, New York, New York
 
10018
(Address of principal executive offices)
 
(Zip Code)
Registrant's telephone number, including area code (212) 525-5000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý  No  o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ý  No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
o
Accelerated filer
o
Non-accelerated filer
ý
Smaller reporting company
o
Emerging growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o  No  ý
As of October 26, 2018, there were 714 shares of the registrant's common stock outstanding, all of which are owned by HSBC North America Holdings Inc.
 


HSBC USA Inc.

TABLE OF CONTENTS
Part/Item No.
 
 
Part I
 
Page
Item 1.
Financial Statements (Unaudited):
 
 
 
 
 
 
 
Item 2
Management's Discussion and Analysis of Financial Condition and Results of Operations:
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 3
Item 4
Part II
 
 
Item 1.
Item 5.
Item 6.
 

2

HSBC USA Inc.

PART I
Item 1. Financial Statements
 
CONSOLIDATED STATEMENT OF INCOME (UNAUDITED)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,

2018
 
2017
 
2018
 
2017
 
(in millions)
Interest income:
 
 
 
 
 
 
 
Loans
$
659

 
$
552

 
$
1,894

 
$
1,673

Securities
292

 
231

 
823

 
715

Trading securities
54

 
47

 
156

 
163

Short-term investments
164

 
203

 
479

 
515

Other
19

 
14

 
57

 
38

Total interest income
1,188

 
1,047

 
3,409

 
3,104

Interest expense:
 
 
 
 
 
 
 
Deposits
283

 
188

 
763

 
507

Short-term borrowings
45

 
39

 
121

 
94

Long-term debt
291

 
256

 
831

 
749

Other
10

 
4

 
28

 
15

Total interest expense
629

 
487

 
1,743

 
1,365

Net interest income
559

 
560

 
1,666

 
1,739

Provision for credit losses
20

 
(22
)
 
(96
)
 
(120
)
Net interest income after provision for credit losses
539

 
582

 
1,762

 
1,859

Other revenues:
 
 
 
 
 
 
 
Credit card fees, net
12

 
12

 
38

 
37

Trust and investment management fees
31

 
39

 
103

 
116

Other fees and commissions
171

 
167

 
515

 
492

Trading revenue
154

 
81

 
509

 
222

Other securities gains (losses), net
(5
)
 
5

 
10

 
29

Servicing and other fees from HSBC affiliates
103

 
77

 
289

 
272

Residential mortgage banking expense
(2
)
 
(4
)
 
(4
)
 
(8
)
Gain on instruments designated at fair value and related derivatives
29

 
7

 
63

 
40

Other income (loss)
(7
)
 
9

 
13

 
344

Total other revenues
486

 
393

 
1,536

 
1,544

Operating expenses:
 
 
 
 
 
 
 
Salaries and employee benefits
208

 
268

 
627

 
789

Support services from HSBC affiliates
399

 
378

 
1,215

 
1,161

Occupancy expense, net
49

 
50

 
137

 
152

Other expenses
134

 
124

 
879

 
386

Total operating expenses
790

 
820

 
2,858

 
2,488

Income before income tax
235

 
155

 
440

 
915

Income tax expense
58

 
61

 
232

 
321

Net income
$
177

 
$
94

 
$
208

 
$
594


The accompanying notes are an integral part of the consolidated financial statements.

3

HSBC USA Inc.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,

2018
 
2017
 
2018
 
2017
 
(in millions)
Net income
$
177

 
$
94

 
$
208

 
$
594

Net change in unrealized gains (losses), net of tax:
 
 
 
 
 
 
 
Investment securities
(137
)
 
22

 
(408
)
 
239

Fair value option liabilities attributable to our own credit spread
(47
)
 
(45
)
 
94

 
(133
)
Derivatives designated as cash flow hedges
22

 
2

 
34

 
—

Total other comprehensive income (loss)
(162
)
 
(21
)
 
(280
)
 
106

Comprehensive income (loss)
$
15

 
$
73

 
$
(72
)
 
$
700


The accompanying notes are an integral part of the consolidated financial statements.


4

HSBC USA Inc.

CONSOLIDATED BALANCE SHEET (UNAUDITED)

September 30, 2018
 
December 31, 2017
 
(in millions, except share data)
Assets(1)
 
 
 
Cash and due from banks
$
1,336

 
$
1,115

Interest bearing deposits with banks
20,306

 
11,157

Federal funds sold and securities purchased under agreements to resell (includes $117 million and $80 million designated under fair value option at September 30, 2018 and December 31, 2017, respectively)
4,679

 
32,618

Trading assets
26,556

 
16,150

Securities available-for-sale
31,329

 
30,700

Securities held-to-maturity (fair value of $14.4 billion and $13.9 billion at September 30, 2018 and December 31, 2017, respectively)
14,889

 
13,977

Loans
66,756

 
72,563

Less – allowance for credit losses
535

 
681

Loans, net
66,221

 
71,882

Loans held for sale (includes $242 million and $471 million designated under fair value option at September 30, 2018 and December 31, 2017, respectively)
392

 
715

Properties and equipment, net
159

 
185

Goodwill
1,607

 
1,607

Other assets
6,528

 
7,129

Total assets
$
174,002

 
$
187,235

Liabilities(1)
 
 
 
Debt:
 
 
 
Domestic deposits:
 
 
 
Noninterest bearing
$
25,831

 
$
28,153

Interest bearing (includes $8.0 billion and $7.7 billion designated under fair value option at September 30, 2018 and December 31, 2017, respectively)
76,921

 
84,223

Foreign deposits:
 
 
 
Noninterest bearing
254

 
322

Interest bearing
9,036

 
5,331

Deposits held for sale
48

 
673

Total deposits
112,090

 
118,702

Short-term borrowings (includes $0.9 billion and $2.0 billion designated under fair value option at September 30, 2018 and December 31, 2017, respectively)
4,793

 
4,650

Long-term debt (includes $12.3 billion and $12.9 billion designated under fair value option at September 30, 2018 and December 31, 2017, respectively)
29,516

 
34,966

Total debt
146,399

 
158,318

Trading liabilities
3,948

 
4,879

Interest, taxes and other liabilities
3,655

 
3,944

Total liabilities
154,002

 
167,141

Equity
 
 
 
Preferred stock (no par value; 40,999,000 shares authorized; 1,265 shares issued and outstanding at both September 30, 2018 and December 31, 2017)
1,265

 
1,265

Common equity:
 
 
 
Common stock ($5 par; 150,000,000 shares authorized; 714 shares issued and outstanding at both September 30, 2018 and December 31, 2017)
—

 
—

Additional paid-in capital
18,136

 
18,130

Retained earnings
1,397

 
1,130

Accumulated other comprehensive loss
(798
)
 
(431
)
Total common equity
18,735

 
18,829

Total equity
20,000

 
20,094

Total liabilities and equity
$
174,002

 
$
187,235

 
(1) 
The following table summarizes assets and liabilities related to our consolidated variable interest entities ("VIEs") at September 30, 2018 and December 31, 2017 which are consolidated on our balance sheet. Assets and liabilities exclude intercompany balances that eliminate in consolidation. See Note 17, "Variable Interest Entities," for additional information.

5

HSBC USA Inc.


September 30, 2018
 
December 31, 2017
 
(in millions)
Assets
 
 
 
Other assets
$
121

 
$
154

Total assets
$
121

 
$
154

Liabilities
 
 
 
Long-term debt
$
73

 
$
73

Interest, taxes and other liabilities
61

 
59

Total liabilities
$
134

 
$
132


The accompanying notes are an integral part of the consolidated financial statements.


6

HSBC USA Inc.

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (UNAUDITED)
Nine Months Ended September 30,
2018
 
2017
 
(in millions)
Preferred stock
 
 
 
Balance at beginning and end of period
$
1,265

 
$
1,265

Common stock
 
 
 
Balance at beginning and end of period
—

 
—

Additional paid-in capital
 
 
 
Balance at beginning of period
18,130

 
18,148

Employee benefit plans
6

 
(19
)
Balance at end of period
18,136

 
18,129

Retained earnings
 
 
 
Balance at beginning of period
1,130

 
1,560

Reclassification from accumulated other comprehensive loss of cumulative effect adjustment to initially apply new accounting guidance for equity investments which were previously classified as available-for-sale, net of tax
(4
)
 
—

Cumulative effect adjustment to initially apply new accounting guidance for equity investments which were previously measured at cost, net of tax
10

 
—

Reclassification from accumulated other comprehensive loss of cumulative effective adjustment to initially apply new accounting guidance for stranded tax effects resulting from the Tax Cuts and Jobs Act (“Tax Legislation”)
91

 
—

Reclassification to accumulated other comprehensive loss of cumulative effect adjustment to initially apply new accounting guidance for financial liabilities measured under the fair value option, net of tax
—

 
(174
)
Balance at beginning of period, adjusted
1,227

 
1,386

Net income
208

 
594

Cash dividends declared on preferred stock
(38
)
 
(38
)
Balance at end of period
1,397

 
1,942

Accumulated other comprehensive loss
 
 
 
Balance at beginning of period
(431
)
 
(618
)
Reclassification to retained earnings of cumulative effect adjustment to initially apply new accounting guidance for equity investments which were previously classified as available-for-sale, net of tax
4

 
—

Reclassification to retained earnings of cumulative effective adjustment to initially apply new accounting guidance for stranded tax effects resulting from Tax Legislation
(91
)
 
—

Reclassification from retained earnings of cumulative effect adjustment to initially apply new accounting guidance for financial liabilities measured under the fair value option, net of tax
—

 
174

Balance at beginning of period, adjusted
(518
)
 
(444
)
Other comprehensive income (loss), net of tax
(280
)
 
106

Balance at end of period
(798
)
 
(338
)
Total common equity
18,735

 
19,733

Total equity
$
20,000

 
$
20,998


The accompanying notes are an integral part of the consolidated financial statements.


7

HSBC USA Inc.

CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
Nine Months Ended September 30,
2018
 
2017
 
(in millions)
Cash flows from operating activities
 
 
 
Net income
$
208

 
$
594

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
(63
)
 
(75
)
Provision for credit losses
(96
)
 
(120
)
Net realized gains on securities available-for-sale
(10
)
 
(29
)
Net change in other assets and liabilities
618

 
496

Net change in loans held for sale:
 
 
 
Originations and purchases of loans held for sale
(1,909
)
 
(1,664
)
Sales and collections of loans held for sale
2,205

 
2,025

Net change in trading assets and liabilities
(11,349
)
 
(17,494
)
Lower of amortized cost or fair value adjustments on loans held for sale
(5
)
 
(17
)
Gain on instruments designated at fair value and related derivatives
(63
)
 
(40
)
Net cash used in operating activities
(10,464
)
 
(16,324
)
Cash flows from investing activities
 
 
 
Net change in interest bearing deposits with banks
(9,993
)
 
(2,971
)
Net change in federal funds sold and securities purchased under agreements to resell
27,939

 
12,893

Securities available-for-sale:
 
 
 
Purchases of securities available-for-sale
(7,980
)
 
(7,973
)
Proceeds from sales of securities available-for-sale
3,346

 
12,620

Proceeds from maturities of securities available-for-sale
2,836

 
1,168

Securities held-to-maturity:
 
 
 
Purchases of securities held-to-maturity
(2,673
)
 
(3,455
)
Proceeds from maturities of securities held-to-maturity
1,734

 
1,872

Change in loans:
 
 
 
Collections, net of originations
5,317

 
5,125

Loans sold to third parties
486

 
2,088

Net cash used for acquisitions of properties and equipment
(8
)
 
(14
)
Net outflows related to the sale of a portion of our Private Banking business
(490
)
 
—

Other, net
7

 
466

Net cash provided by investing activities
20,521

 
21,819

Cash flows from financing activities
 
 
 
Net change in deposits
(5,887
)
 
(7,461
)
Debt:
 
 
 
Net change in short-term borrowings
144

 
2,875

Issuance of long-term debt
3,729

 
3,886

Repayment of long-term debt
(8,634
)
 
(5,093
)
Other increases (decreases) in capital surplus
6

 
(19
)
Dividends paid
(38
)
 
(38
)
Net cash used in financing activities
(10,680
)
 
(5,850
)
Net change in cash, due from banks and restricted cash
(623
)
 
(355
)
Cash, due from banks and restricted cash at beginning of period
4,044

 
4,374

Cash, due from banks and restricted cash at end of period(1)
$
3,421

 
$
4,019

 

8

HSBC USA Inc.

(1) 
The following table provides a reconciliation of the total amount of cash, cash equivalents and restricted cash disaggregated by the line items in which they appear within the consolidated balance sheet:
At September 30,
2018
 
2017
 
(in millions)
Cash and due from banks
$
1,336

 
$
986

Restricted cash included in interest bearing deposits with banks
2,085

 
3,033

Total cash, due from banks and restricted cash
$
3,421

 
$
4,019


The accompanying notes are an integral part of the consolidated financial statements.

9

HSBC USA Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. Organization and Presentation
 
HSBC USA Inc. ("HSBC USA"), incorporated under the laws of Maryland, is a New York State based bank holding company and a wholly-owned subsidiary of HSBC North America Holdings Inc. ("HSBC North America"), which is an indirect wholly-owned subsidiary of HSBC Holdings plc ("HSBC" and, together with its subsidiaries, "HSBC Group"). The accompanying unaudited interim consolidated financial statements of HSBC USA and its subsidiaries (collectively "HUSI") have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X, as well as in accordance with predominant practices within the banking industry. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all normal and recurring adjustments considered necessary for a fair presentation of financial position, results of operations and cash flows for the interim periods have been made. HUSI may also be referred to in these notes to the consolidated financial statements as "we," "us" or "our." These unaudited interim consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2017 (the "2017 Form 10-K"). Certain reclassifications have been made to prior period amounts to conform to the current period presentation.
The preparation of financial statements in conformity with U.S. GAAP requires the use of estimates and assumptions that affect reported amounts and disclosures. Actual results could differ from those estimates. Interim results should not be considered indicative of results in future periods.


10

HSBC USA Inc.

2.    Trading Assets and Liabilities
 
 
Trading assets and liabilities consisted of the following:

September 30, 2018
 
December 31, 2017
 
(in millions)
Trading assets:
 
 
 
U.S. Treasury
$
4,037

 
$
3,391

U.S. Government agency issued or guaranteed
111

 
122

U.S. Government sponsored enterprises
22

 
210

Asset-backed securities
220

 
236

Corporate and foreign bonds
8,325

 
6,180

Equity securities
752

 
12

Precious metals
9,945

 
2,274

Derivatives, net
3,144

 
3,725

Total trading assets
$
26,556

 
$
16,150

Trading liabilities:
 
 
 
Securities sold, not yet purchased
$
1,605

 
$
1,722

Payables for precious metals
—

 
524

Derivatives, net
2,343

 
2,633

Total trading liabilities
$
3,948

 
$
4,879

At September 30, 2018 and December 31, 2017, the fair value of derivatives included in trading assets is net of $2,563 million and $3,423 million, respectively, relating to amounts recognized for the obligation to return cash collateral received under master netting agreements with derivative counterparties.
At September 30, 2018 and December 31, 2017, the fair value of derivatives included in trading liabilities is net of $3,405 million and $3,680 million, respectively, relating to amounts recognized for the right to reclaim cash collateral paid under master netting agreements with derivative counterparties.
See Note 9, "Derivative Financial Instruments," for further information on our trading derivatives and related collateral.


11

HSBC USA Inc.

3. Securities
 
 
Our securities available-for-sale and securities held-to-maturity portfolios consisted of the following:
September 30, 2018
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
(in millions)
Securities available-for-sale:
 
 
 
 
 
 
 
U.S. Treasury
$
14,265

 
$
127

 
$
(472
)
 
$
13,920

U.S. Government sponsored enterprises:
 
 
 
 
 
 
 
Mortgage-backed securities
5,605

 
(1
)
 
(243
)
 
5,361

Collateralized mortgage obligations
688

 
—

 
(47
)
 
641

Direct agency obligations
3,004

 
41

 
(3
)
 
3,042

U.S. Government agency issued or guaranteed:
 
 
 
 
 
 
 
Mortgage-backed securities
4,559

 
—

 
(208
)
 
4,351

Collateralized mortgage obligations
1,102

 
—

 
(37
)
 
1,065

Direct agency obligations
335

 
14

 
—

 
349

Asset-backed securities collateralized by:
 
 
 
 
 
 
 
Home equity
46

 
—

 
(2
)
 
44

Other
99

 
6

 
—

 
105

Foreign debt securities(1)
2,451

 
1

 
(1
)
 
2,451

Total available-for-sale securities
$
32,154

 
$
188

 
$
(1,013
)
 
$
31,329

Securities held-to-maturity:
 
 
 
 
 
 
 
U.S. Government sponsored enterprises:
 
 
 
 
 
 
 
Mortgage-backed securities
$
1,865

 
$
1

 
$
(59
)
 
$
1,807

Collateralized mortgage obligations
1,952

 
26

 
(42
)
 
1,936

U.S. Government agency issued or guaranteed:
 
 
 
 
 
 
 
Mortgage-backed securities
2,181

 
2

 
(93
)
 
2,090

Collateralized mortgage obligations
8,878

 
10

 
(289
)
 
8,599

Obligations of U.S. states and political subdivisions
11

 
—

 
—

 
11

Asset-backed securities collateralized by residential mortgages
2

 
—

 
—

 
2

Total held-to-maturity securities
$
14,889

 
$
39

 
$
(483
)
 
$
14,445


12

HSBC USA Inc.

December 31, 2017
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
(in millions)
Securities available-for-sale:
 
 
 
 
 
 
 
U.S. Treasury
$
15,340

 
$
153

 
$
(329
)
 
$
15,164

U.S. Government sponsored enterprises:
 
 
 
 
 
 
 
Mortgage-backed securities
3,616

 
—

 
(77
)
 
3,539

Collateralized mortgage obligations
648

 
—

 
(24
)
 
624

Direct agency obligations
3,369

 
85

 
—

 
3,454

U.S. Government agency issued or guaranteed:
 
 
 
 
 
 
 
Mortgage-backed securities
5,152

 
1

 
(87
)
 
5,066

Collateralized mortgage obligations
792

 
1

 
(18
)
 
775

Direct agency obligations
419

 
19

 
—

 
438

Asset-backed securities collateralized by:
 
 
 
 
 
 
 
Home equity
54

 
—

 
(3
)
 
51

Other
506

 
4

 
—

 
510

Foreign debt securities(1)
902

 
—

 
—

 
902

Equity securities
183

 
—

 
(6
)
 
177

Total available-for-sale securities
$
30,981

 
$
263

 
$
(544
)
 
$
30,700

Securities held-to-maturity:
 
 
 
 
 
 
 
U.S. Government sponsored enterprises:
 
 
 
 
 
 
 
Mortgage-backed securities
$
2,113

 
$
10

 
$
(12
)
 
$
2,111

Collateralized mortgage obligations
1,281

 
41

 
(18
)
 
1,304

U.S. Government agency issued or guaranteed:
 
 
 
 
 
 
 
Mortgage-backed securities
2,485

 
4

 
(13
)
 
2,476

Collateralized mortgage obligations
8,083

 
18

 
(106
)
 
7,995

Obligations of U.S. states and political subdivisions
12

 
1

 
—

 
13

Asset-backed securities collateralized by residential mortgages
3

 
—

 
—

 
3

Total held-to-maturity securities
$
13,977

 
$
74

 
$
(149
)
 
$
13,902

 
(1) 
Foreign debt securities represent public sector entity, bank or corporate debt.
Net unrealized losses were higher within the available-for-sale portfolio as compared with December 31, 2017 due primarily to increasing yields on U.S. Government sponsored mortgage-backed, U.S. Treasury and U.S. Government agency mortgage-backed securities.

13

HSBC USA Inc.

The following table summarizes gross unrealized losses and related fair values at September 30, 2018 and December 31, 2017 classified as to the length of time the losses have existed:
 
One Year or Less
 
Greater Than One Year
September 30, 2018
Number
of
Securities
 
Gross
Unrealized
Losses
 
Aggregate
Fair Value
of Investment
 
Number
of
Securities
 
Gross
Unrealized
Losses
 
Aggregate
Fair Value
of Investment
 
(dollars are in millions)
Securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
11

 
$
(26
)
 
$
1,967

 
39

 
$
(446
)
 
$
8,738

U.S. Government sponsored enterprises
246

 
(65
)
 
3,039

 
94

 
(228
)
 
3,036

U.S. Government agency issued or guaranteed
43

 
(162
)
 
4,058

 
43

 
(83
)
 
1,264

Asset-backed securities
1

 
—

 
—

 
4

 
(2
)
 
44

Foreign debt securities
13

 
(1
)
 
1,045

 
1

 
—

 
44

Securities available-for-sale
314

 
$
(254
)
 
$
10,109

 
181

 
$
(759
)
 
$
13,126

Securities held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
U.S. Government sponsored enterprises
339

 
$
(52
)
 
$
2,488

 
279

 
$
(49
)
 
$
920

U.S. Government agency issued or guaranteed
175

 
(151
)
 
5,161

 
459

 
(231
)
 
4,565

Obligations of U.S. states and political subdivisions
1

 
—

 
—

 
1

 
—

 
—

Securities held-to-maturity
515

 
$
(203
)
 
$
7,649

 
739

 
$
(280
)

$
5,485

 
One Year or Less
 
Greater Than One Year
December 31, 2017
Number
of
Securities
 
Gross
Unrealized
Losses
 
Aggregate
Fair Value
of Investment
 
Number
of
Securities
 
Gross
Unrealized
Losses
 
Aggregate
Fair Value
of Investment
 
(dollars are in millions)
Securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
3

 
$
(3
)
 
$
463

 
48

 
$
(326
)
 
$
10,285

U.S. Government sponsored enterprises
83

 
(7
)
 
883

 
77

 
(94
)
 
3,109

U.S. Government agency issued or guaranteed
52

 
(85
)
 
5,161

 
23

 
(20
)
 
573

Asset-backed securities
—

 
—

 
—

 
4

 
(3
)
 
51

Foreign debt securities
10

 
—

 
733

 
1

 
—

 
44

Equity securities
—

 
—

 
—

 
1

 
(6
)
 
177

Securities available-for-sale
148

 
$
(95
)
 
$
7,240

 
154

 
$
(449
)

$
14,239

Securities held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
U.S. Government sponsored enterprises
264

 
$
(5
)
 
$
1,126

 
284

 
$
(25
)
 
$
1,020

U.S. Government agency issued or guaranteed
116

 
(48
)
 
5,973

 
506

 
(71
)
 
2,962

Obligations of U.S. states and political subdivisions
1

 
—

 
—

 
2

 
—

 
—

Securities held-to-maturity
381

 
$
(53
)
 
$
7,099

 
792

 
$
(96
)
 
$
3,982

Although the fair value of a particular security may be below its amortized cost, it does not necessarily result in a credit loss and hence an other-than-temporary impairment. The decline in fair value may be caused by, among other things, the illiquidity of the market. We have reviewed the securities for which there is an unrealized loss for other-than-temporary impairment in accordance with our accounting policies, discussed further below. At September 30, 2018 and December 31, 2017, we do not consider any of our debt securities to be other-than-temporarily impaired as we expect to recover their amortized cost basis and we neither intend nor expect to be required to sell these securities prior to recovery, even if that equates to holding securities until their individual maturities. However, other-than-temporary impairments may occur in future periods if the credit quality of the securities deteriorates.

14

HSBC USA Inc.

Other-Than-Temporary Impairment  On a quarterly basis, we perform an assessment to determine whether there have been any events or economic circumstances to indicate that a security with an unrealized loss has suffered other-than-temporary impairment. A debt security is considered impaired if its fair value is less than its amortized cost basis at the reporting date. If impaired, we assess whether the impairment is other-than-temporary.
If we intend to sell the debt security or if it is more-likely-than-not that we will be required to sell the debt security before the recovery of its amortized cost basis, the impairment is considered other-than-temporary and the unrealized loss is recorded in earnings. An impairment is also considered other-than-temporary if a credit loss exists (i.e., the present value of the expected future cash flows is less than the amortized cost basis of the debt security). In the event a credit loss exists, the credit loss component of an other-than-temporary impairment is recorded in earnings while the remaining portion of the impairment loss attributable to factors other than credit loss is recognized, net of tax, in other comprehensive income (loss).
For all securities held in the available-for-sale or held-to-maturity portfolios for which unrealized losses attributed to factors other than credit existed, we do not have the intention to sell and believe we will not be required to sell the securities for contractual, regulatory or liquidity reasons as of the reporting date. For a complete description of the factors considered when analyzing debt
securities for impairments, see Note 4, "Securities," in our 2017 Form 10-K. There have been no material changes in our process for assessing impairment during 2018.
During the three and nine months ended September 30, 2018 and 2017, none of our debt securities were determined to have other-than-temporary impairment, as such, there were no other-than-temporary impairment losses recognized related to credit loss.
Other securities gains (losses), net  The following table summarizes realized gains and losses on investment securities transactions attributable to available-for-sale securities:

Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
(in millions)
Gross realized gains
$
1

 
$
9

 
$
31

 
$
42

Gross realized losses
(6
)
 
(4
)
 
(21
)
 
(13
)
Net realized gains (losses)
$
(5
)
 
$
5

 
$
10

 
$
29


15

HSBC USA Inc.

Contractual Maturities and Yields  The following table summarizes the amortized cost and fair values of securities available-for-sale and securities held-to-maturity at September 30, 2018 by contractual maturity. Expected maturities differ from contractual maturities because borrowers have the right to prepay obligations without prepayment penalties in certain cases. The table below also reflects the distribution of maturities of debt securities held at September 30, 2018, together with the approximate taxable equivalent yield of the portfolio. The yields shown are calculated by dividing annualized interest income, including the accretion of discounts and the amortization of premiums, by the amortized cost of securities outstanding at September 30, 2018. Yields on tax-exempt obligations have been computed on a taxable equivalent basis using applicable statutory tax rates.
 
Within
One Year
 
After One
But Within
Five Years
 
After Five
But Within
Ten Years
 
After Ten
Years
Taxable Equivalent Basis
Amount
 
Yield
 
Amount
 
Yield
 
Amount
 
Yield
 
Amount
 
Yield
 
(dollars are in millions)
Available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
—

 
—
%
 
$
4,783

 
2.17
%
 
$
6,968

 
2.18
%
 
$
2,514

 
3.24
%
U.S. Government sponsored enterprises
547

 
3.88

 
2,273

 
2.81

 
2,235

 
2.79

 
4,242

 
3.15

U.S. Government agency issued or guaranteed
50

 
1.85

 
71

 
2.22

 
11

 
3.64

 
5,864

 
2.71

Asset-backed securities
—

 
—

 
—

 
—

 
55

 
5.52

 
90

 
3.95

Foreign debt securities
1,493

 
.01

 
958

 
2.19

 
—

 
—

 
—

 
—

Total amortized cost
$
2,090

 
1.07
%
 
$
8,085

 
2.35
%
 
$
9,269

 
2.35
%
 
$
12,710

 
2.97
%
Total fair value
$
2,095

 
 
 
$
8,006

 
 
 
$
8,869

 
 
 
$
12,359

 
 
Held-to-maturity:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government sponsored enterprises
$
50

 
2.21
%
 
$
391

 
2.71
%
 
$
155

 
2.66
%
 
$
3,221

 
2.95
%
U.S. Government agency issued or guaranteed
—

 
—

 
19

 
3.79

 
27

 
3.65

 
11,013

 
2.61

Obligations of U.S. states and political subdivisions
1

 
4.63

 
5

 
3.27

 
5

 
4.36

 
—

 
—

Asset-backed securities
—

 
—

 
—

 
—

 
—

 
—

 
2

 
8.84

Total amortized cost
$
51

 
2.26
%
 
$
415

 
2.77
%
 
$
187

 
2.85
%
 
$
14,236

 
2.69
%
Total fair value
$
51

 
 
 
$
407

 
 
 
$
181

 
 
 
$
13,806

 
 
Equity Securities As discussed more fully in Note 21, “New Accounting Pronouncements,” beginning January 1, 2018, equity securities (except those accounted for under the equity method or those that result in consolidation) are measured at fair value with changes in fair value recognized in net income.
Included in other assets at September 30, 2018 were $270 million of equity securities which were carried at fair value and $7 million of equity securities without readily determinable fair values which were carried at amortized cost less impairment adjusted for observable price changes.
On a quarterly basis, we perform an assessment to determine whether any equity securities without readily determinable fair values are impaired. In the event an equity security is deemed impaired, the security is written down to fair value with impairment recorded in earnings. At September 30, 2018, none of our equity securities without readily determinable fair values were determined to be impaired.
Also included in other assets were investments in Federal Home Loan Bank ("FHLB") stock and Federal Reserve Bank stock of $201 million and $631 million, respectively, at both September 30, 2018 and December 31, 2017.

16

HSBC USA Inc.

4. Loans
 
 
Loans consisted of the following:

September 30, 2018
 
December 31, 2017
 
(in millions)
Commercial loans:
 
 
 
Real estate, including construction
$
11,882

 
$
10,533

Business and corporate banking
12,731

 
12,504

Global banking(1)
18,672

 
20,088

Other commercial(2)
3,898

 
9,910

Total commercial
47,183

 
53,035

Consumer loans:
 
 
 
Residential mortgages
17,376

 
17,273

Home equity mortgages
1,027

 
1,191

Credit cards
907

 
721

Other consumer
263

 
343

Total consumer
19,573

 
19,528

Total loans
$
66,756

 
$
72,563

 
(1) 
Represents large multinational firms including globally focused U.S. corporate and financial institutions, U.S. dollar lending to multinational banking clients managed by HSBC on a global basis and complex large business clients supported by Global Banking and Markets relationship managers.
(2) 
Includes loans to HSBC affiliates which totaled $1,557 million and $6,750 million at September 30, 2018 and December 31, 2017, respectively. See Note 14, "Related Party Transactions," for additional information regarding loans to HSBC affiliates.
Net deferred origination costs totaled $81 million at both September 30, 2018 and December 31, 2017, respectively. At September 30, 2018 and December 31, 2017, we had a net unamortized premium on our loans of $10 million and $8 million, respectively.

17

HSBC USA Inc.

Aging Analysis of Past Due Loans  The following table summarizes the past due status of our loans, excluding loans held for sale, at September 30, 2018 and December 31, 2017. The aging of past due amounts is determined based on the contractual delinquency status of payments under the loan. An account is generally considered to be contractually delinquent when payments have not been made in accordance with the loan terms. Delinquency status is affected by customer account management policies and practices such as re-age, which results in the re-setting of the contractual delinquency status to current.
 
Past Due
 
Total Past Due 30 Days or More
 
 
 
 
At September 30, 2018
30 - 89 Days
 
90+ Days
 
 
Current(1)
 
Total Loans
 
(in millions)
Commercial loans:
 
 
 
 
 
 
 
 
 
Real estate, including construction
$
13

 
$
1

 
$
14

 
$
11,868

 
$
11,882

Business and corporate banking
137

 
45

 
182

 
12,549

 
12,731

Global banking
—

 
—

 
—

 
18,672

 
18,672

Other commercial
7

 
—

 
7

 
3,891

 
3,898

Total commercial
157

 
46

 
203

 
46,980

 
47,183

Consumer loans:
 
 
 
 
 
 
 
 
 
Residential mortgages
379

 
264

 
643

 
16,733

 
17,376

Home equity mortgages
12

 
29

 
41

 
986

 
1,027

Credit cards
12

 
13

 
25

 
882

 
907

Other consumer
5

 
5

 
10

 
253

 
263

Total consumer
408

 
311

 
719

 
18,854

 
19,573

Total loans
$
565

 
$
357

 
$
922

 
$
65,834

 
$
66,756

 
Past Due
 
Total Past Due 30 Days or More
 
 
 
 
At December 31, 2017
30 - 89 Days
 
90+ Days
 
 
Current(1)
 
Total Loans
 
(in millions)
Commercial loans:
 
 
 
 
 
 
 
 
 
Real estate, including construction
$
27

 
$
9

 
$
36

 
$
10,497

 
$
10,533

Business and corporate banking
25

 
5

 
30

 
12,474

 
12,504

Global banking
—

 
25

 
25

 
20,063

 
20,088

Other commercial
43

 
—

 
43

 
9,867

 
9,910

Total commercial
95

 
39

 
134

 
52,901

 
53,035

Consumer loans:
 
 
 
 
 
 
 
 
 
Residential mortgages
369

 
344

 
713

 
16,560

 
17,273

Home equity mortgages
11

 
36

 
47

 
1,144

 
1,191

Credit cards
8

 
9

 
17

 
704

 
721

Other consumer
5

 
7

 
12

 
331

 
343

Total consumer
393

 
396

 
789

 
18,739

 
19,528

Total loans
$
488

 
$
435

 
$
923

 
$
71,640

 
$
72,563

 
(1) 
Loans less than 30 days past due are presented as current.


18

HSBC USA Inc.

Nonaccrual Loans  Nonaccrual loans, including nonaccrual loans held for sale, and accruing loans 90 days or more delinquent consisted of the following:

September 30, 2018
 
December 31, 2017
 
(in millions)
Nonaccrual loans:
 
 
 
Commercial:
 
 
 
Real estate, including construction
$
6

 
$
12

Business and corporate banking
75

 
215

Global banking
80

 
385

Other commercial
1

 
1

Commercial nonaccrual loans held for sale
—

 
—

Total commercial
162

 
613

Consumer:
 
 
 
Residential mortgages(1)(2)(3)
406

 
414

Home equity mortgages(1)(2)
62

 
67

Consumer nonaccrual loans held for sale
1

 
1

Total consumer
469

 
482

Total nonaccruing loans
631

 
1,095

Accruing loans contractually past due 90 days or more:
 
 
 
Commercial:
 
 
 
Business and corporate banking
1

 
1

Total commercial
1

 
1

Consumer:
 
 
 
Credit cards
13

 
9

Other consumer
6

 
8

Total consumer
19

 
17

Total accruing loans contractually past due 90 days or more
20

 
18

Total nonperforming loans
$
651

 
$
1,113

 
(1) 
At September 30, 2018 and December 31, 2017, nonaccrual consumer mortgage loans held for investment include $334 million and $360 million, respectively, of loans that are carried at the lower of amortized cost or fair value of the collateral less cost to sell.
(2) 
Nonaccrual consumer mortgage loans held for investment include all loans which are 90 or more days contractually delinquent as well as loans discharged under Chapter 7 bankruptcy and not re-affirmed and second lien loans where the first lien loan that we own or service is 90 or more days contractually delinquent.
(3) 
Nonaccrual consumer mortgage loans for all periods does not include guaranteed loans purchased from the Government National Mortgage Association. Repayment of these loans is predominantly insured by the Federal Housing Administration and as such, these loans have different risk characteristics from the rest of our consumer loan portfolio.
The following table provides additional information on our nonaccrual loans:    
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
(in millions)
Interest income that would have been recorded if the nonaccrual loans had been current in accordance with contractual terms during the period
$
10

 
$
15

 
$
37

 
$
53

Interest income that was recorded on nonaccrual loans and included in interest income during the period
12

 
3

 
27

 
16


19

HSBC USA Inc.

Impaired Loans  A loan is considered to be impaired when it is deemed probable that not all principal and interest amounts due according to the contractual terms of the loan agreement will be collected. Probable losses from impaired loans are quantified and recorded as a component of the overall allowance for credit losses. Commercial and consumer loans for which we have modified the loan terms as part of a troubled debt restructuring are considered to be impaired loans. Additionally, commercial loans in nonaccrual status, or that have been partially charged-off or assigned a specific allowance for credit losses are also considered impaired loans.
Troubled debt restructurings  TDR Loans represent loans for which the original contractual terms have been modified to provide for terms that are less than what we would be willing to accept for new loans with comparable risk because of deterioration in the borrower's financial condition.
Modifications for consumer or commercial loans may include changes to one or more terms of the loan, including, but not limited to, a change in interest rate, extension of the amortization period, reduction in payment amount and partial forgiveness or deferment of principal, accrued interest or other loan covenants. A substantial amount of our modifications involve interest rate reductions on consumer loans, which lower the amount of interest income we are contractually entitled to receive in future periods. Through lowering the interest rate and other loan term changes, we believe we are able to increase the amount of cash flow that will ultimately be collected from the loan, given the borrower's financial condition. TDR Loans are reserved for based on the present value of expected future cash flows discounted at the loans' original effective interest rates, which generally results in a higher reserve requirement for these loans, the loan's observable market price or, in the case of certain secured loans, the estimated fair value of the underlying collateral. Once a consumer loan is classified as a TDR Loan, it continues to be reported as such until it is paid off or charged-off. For commercial loans, if subsequent performance is in accordance with the new terms and such terms reflect current market rates at the time of restructure, they will no longer be reported as a TDR Loan beginning in the year after restructuring. During the three and nine months ended September 30, 2018 and 2017 there were no commercial loans that met this criteria and were removed from TDR Loan classification.
The following table presents information about loans which were modified during the three and nine months ended September 30, 2018 and 2017 and as a result of this action became classified as TDR Loans:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
(in millions)
Commercial loans:
 
 
 
 
 
 
 
Business and corporate banking
$
—

 
$
—

 
$
—

 
$
24

Global banking
—

 
—

 
—

 
86

Total commercial
—

 
—

 
—

 
110

Consumer loans:
 
 
 
 
 
 
 
Residential mortgages
5

 
11

 
22

 
27

Home equity mortgages
1

 
2

 
4

 
6

Credit cards
1

 
1

 
3

 
3

Total consumer
7

 
14

 
29

 
36

Total
$
7

 
$
14

 
$
29

 
$
146

The weighted-average contractual rate reduction for consumer loans which became classified as TDR Loans during the three and nine months ended September 30, 2018 was 1.88 percent and 1.98 percent, respectively, compared with 2.41 percent and 1.98 percent during the three and nine months ended September 30, 2017, respectively. The weighted-average contractual rate reduction for commercial loans was not significant in either the number of loans or rate.

20

HSBC USA Inc.

The following table presents information about our TDR Loans and the related allowance for credit losses for TDR Loans:
 
September 30, 2018
 
December 31, 2017
 
Carrying Value
 
Unpaid Principal Balance
 
Carrying Value
 
Unpaid Principal Balance
 
(in millions)
TDR Loans:(1)(2)
 
 
 
 
 
 
 
Commercial loans:
 
 
 
 
 
 
 
Business and corporate banking
$
76

 
$
95

 
$
194

 
$
266

Global banking
110

 
116

 
175

 
180

Total commercial(3)
186

 
211

 
369

 
446

Consumer loans:
 
 
 
 
 
 
 
Residential mortgages(4)
649

 
740

 
683

 
779

Home equity mortgages(4)
35

 
67

 
33

 
66

Credit cards
4

 
4

 
4

 
4

Total consumer
688

 
811

 
720

 
849

Total TDR Loans(5)
$
874

 
$
1,022

 
$
1,089

 
$
1,295

Allowance for credit losses for TDR Loans:(6)
 
 
 
 
 
 
 
Commercial loans:
 
 
 
 
 
 
 
Business and corporate banking
$
6

 
 
 
$
12

 
 
Global banking
—

 
 
 
19

 
 
Total commercial
6

 
 
 
31

 
 
Consumer loans:
 
 
 
 
 
 
 
Residential mortgages
3

 
 
 
7

 
 
Home equity mortgages
1

 
 
 
1

 
 
Credit cards
1

 
 
 
1

 
 
Total consumer
5

 
 
 
9

 
 
Total allowance for credit losses for TDR Loans
$
11

 
 
 
$
40

 
 
 
(1) 
TDR Loans are considered to be impaired loans. For commercial loans, impaired loans include other loans in addition to TDR Loans which totaled $64 million and $329 million at September 30, 2018 and December 31, 2017, respectively.
(2) 
The carrying value of TDR Loans includes basis adjustments on the loans, such as partial charge-offs, unamortized deferred fees and costs on originated loans and premiums or discounts on purchased loans.
(3) 
Additional commitments to lend to commercial borrowers whose loans have been modified in TDR Loans totaled $105 million and $245 million at September 30, 2018 and December 31, 2017, respectively.
(4) 
At September 30, 2018 and December 31, 2017, the carrying value of consumer mortgage TDR Loans held for investment includes $623 million and $655 million, respectively, of loans that are recorded at the lower of amortized cost or fair value of the collateral less cost to sell.
(5) 
At September 30, 2018 and December 31, 2017, the carrying value of TDR Loans includes $340 million and $559 million, respectively, of loans which are classified as nonaccrual.
(6) 
Included in the allowance for credit losses.

21

HSBC USA Inc.

The following table presents information about average TDR Loans and interest income recognized on TDR Loans:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
(in millions)
Average balance of TDR Loans:
 
 
 
 
 
 
 
Commercial loans:
 
 
 
 
 
 
 
Real estate, including construction
$
—

 
$
15

 
$
—

 
$
23

Business and corporate banking
97

 
248

 
136

 
259

Global banking
117

 
164

 
126

 
149

Total commercial
214

 
427

 
262

 
431

Consumer loans:
 
 
 
 
 
 
 
Residential mortgages
657

 
705

 
666

 
709

Home equity mortgages
35

 
31

 
35

 
30

Credit cards
4

 
4

 
4

 
4

Total consumer
696

 
740

 
705

 
743

Total average balance of TDR Loans
$
910

 
$
1,167

 
$
967

 
$
1,174

Interest income recognized on TDR Loans:
 
 
 
 
 
 
 
Commercial loans:
 
 
 
 
 
 
 
Business and corporate banking
$
5

 
$
1

 
$
9

 
$
5

Global banking
1

 
1

 
3

 
2

Total commercial
6

 
2

 
12

 
7

Consumer loans:
 
 
 
 
 
 
 
Residential mortgages
6

 
7

 
20

 
21

Home equity mortgages
—

 
—

 
1

 
1

Total consumer
6

 
7

 
21

 
22

Total interest income recognized on TDR Loans
$
12

 
$
9

 
$
33

 
$
29

The following table presents consumer loans which were classified as TDR Loans during the previous 12 months which subsequently became 60 days or greater contractually delinquent during the three and nine months ended September 30, 2018 and 2017:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
(in millions)
Consumer loans:
 
 
 
 
 
 
 
Residential mortgages
$
4

 
$
2

 
$
6

 
$
7

Home equity mortgages
—

 
1

 
2

 
1

Total consumer
$
4

 
$
3

 
$
8

 
$
8

During the three and nine months ended September 30, 2018 and 2017, there were no commercial TDR Loans which were classified as TDR Loans during the previous 12 months which subsequently became 90 days or greater contractually delinquent.


22

HSBC USA Inc.

Impaired commercial loans  The following table presents information about impaired commercial loans and the related impairment reserve:
 
Amount 
with
Impairment
Reserves(1)
 
Amount
without
Impairment
Reserves(1)
 
Total Impaired
Commercial
Loans(1)(2)
 
Impairment
Reserve
 
Unpaid Principal Balance
 
(in millions)
At September 30, 2018
 
 
 
 
 
 
 
 
 
Real estate, including construction
$
3

 
$
2

 
$
5

 
$
1

 
$
5

Business and corporate banking
61

 
52

 
113

 
24

 
126

Global banking
—

 
131

 
131

 
—

 
138

Other commercial
—

 
1

 
1

 
—

 
1

Total commercial
$
64

 
$
186

 
$
250

 
$
25

 
$
270

At December 31, 2017
 
 
 
 
 
 
 
 
 
Real estate, including construction
$
—

 
$
11

 
$
11

 
$
—

 
$
11

Business and corporate banking
121

 
129

 
250

 
45

 
311

Global banking
262

 
175

 
437

 
82

 
520

Total commercial
$
383

 
$
315

 
$
698

 
$
127

 
$
842

 
(1) 
Reflects the carrying value of impaired commercial loans and includes basis adjustments on the loans, such as partial charge-offs, unamortized deferred fees and costs on originated loans and premiums or discounts on purchased loans.
(2) 
Includes impaired commercial loans that are also considered TDR Loans which totaled $186 million and $369 million at September 30, 2018 and December 31, 2017, respectively.
The following table presents information about average impaired commercial loans and interest income recognized on impaired commercial loans:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
(in millions)
Average balance of impaired commercial loans:
 
 
 
 
 
 
 
Real estate, including construction
$
8

 
$
30

 
$
10

 
$
37

Business and corporate banking
185

 
302

 
227

 
318

Global banking
152

 
559

 
266

 
583

Other commercial
1

 
3

 
—

 
5

Total average balance of impaired commercial loans
$
346

 
$
894

 
$
503

 
$
943

Interest income recognized on impaired commercial loans:
 
 
 
 
 
 
 
Business and corporate banking
$
6

 
$
1

 
$
12

 
$
6

Global banking
1

 
1

 
3

 
2

Total interest income recognized on impaired commercial loans
$
7

 
$
2

 
$
15

 
$
8


23

HSBC USA Inc.

Commercial Loan Credit Quality Indicators  The following credit quality indicators are monitored for our commercial loan portfolio:
Criticized loans  Criticized loan classifications presented in the table below are determined by the assignment of various criticized facility grades based on the risk rating standards of our regulator. The following table summarizes criticized commercial loans:
 
Special Mention
 
Substandard
 
Doubtful
 
Total
 
(in millions)
At September 30, 2018
 
 
 
 
 
 
 
Real estate, including construction
$
504

 
$
72

 
$
4

 
$
580

Business and corporate banking
247

 
285

 
19

 
551

Global banking
258

 
775

 
—

 
1,033

Other commercial
—

 
1

 
—

 
1

Total commercial
$
1,009

 
$
1,133

 
$
23

 
$
2,165

At December 31, 2017
 
 
 
 
 
 
 
Real estate, including construction
$
467

 
$
117

 
$
1

 
$
585

Business and corporate banking
477

 
519

 
44

 
1,040

Global banking
452

 
1,612

 
82

 
2,146

Other commercial
11

 
—

 
—

 
11

Total commercial
$
1,407

 
$
2,248

 
$
127

 
$
3,782

Nonperforming  The following table summarizes the status of our commercial loan portfolio, excluding loans held for sale:
 
Performing
Loans
 
Nonaccrual
Loans
 
Accruing Loans
Contractually Past
Due 90 days or More
 
Total
 
(in millions)
At September 30, 2018
 
 
 
 
 
 
 
Real estate, including construction
$
11,876

 
$
6

 
$
—

 
$
11,882

Business and corporate banking
12,655

 
75

 
1

 
12,731

Global banking
18,592

 
80

 
—

 
18,672

Other commercial
3,897

 
1

 
—

 
3,898

Total commercial
$
47,020

 
$
162

 
$
1

 
$
47,183

At December 31, 2017
 
 
 
 
 
 
 
Real estate, including construction
$
10,521

 
$
12

 
$
—

 
$
10,533

Business and corporate banking
12,288

 
215

 
1

 
12,504

Global banking
19,703

 
385

 
—

 
20,088

Other commercial
9,909

 
1

 
—

 
9,910

Total commercial
$
52,421

 
$
613

 
$
1

 
$
53,035


24

HSBC USA Inc.

Credit risk profile  The following table shows the credit risk profile of our commercial loan portfolio:
 
Investment
Grade(1)
 
Non-Investment
Grade
 
Total
 
(in millions)
At September 30, 2018
 
 
 
 
 
Real estate, including construction
$
7,439

 
$
4,443

 
$
11,882

Business and corporate banking
5,507

 
7,224

 
12,731

Global banking
13,189

 
5,483

 
18,672

Other commercial
3,016

 
882

 
3,898

Total commercial
$
29,151

 
$
18,032

 
$
47,183

At December 31, 2017
 
 
 
 
 
Real estate, including construction
$
7,456

 
$
3,077

 
$
10,533

Business and corporate banking
5,752

 
6,752

 
12,504

Global banking
13,218

 
6,870

 
20,088

Other commercial
8,341

 
1,569

 
9,910

Total commercial
$
34,767

 
$
18,268

 
$
53,035

 
(1) 
Investment grade includes commercial loans with credit ratings of at least BBB- or above or the equivalent based on our internal credit rating system.
Consumer Loan Credit Quality Indicators  The following credit quality indicators are utilized for our consumer loan portfolio:
Delinquency  The following table summarizes dollars of two-months-and-over contractual delinquency and as a percent of total loans and loans held for sale ("delinquency ratio") for our consumer loan portfolio:
 
September 30, 2018
 
December 31, 2017
  
Delinquent Loans
 
Delinquency
Ratio
 
Delinquent Loans
 
Delinquency
Ratio
 
(dollars are in millions)
Residential mortgages(1)(2)
$
329

 
1.89
%
 
$
425

 
2.46
%
Home equity mortgages(1)(2)
31

 
3.02

 
39

 
3.27

Credit cards
18

 
1.98

 
12

 
1.66

Other consumer
7

 
2.20

 
10

 
2.48

Total consumer
$
385

 
1.96
%
 
$
486

 
2.48
%
 
(1) 
At September 30, 2018 and December 31, 2017, consumer mortgage loan delinquency includes $263 million and $342 million, respectively, of loans that are carried at the lower of amortized cost or fair value of the collateral less cost to sell, including $1 million and $1 million, respectively, relating to loans held for sale.
(2) 
At September 30, 2018 and December 31, 2017, consumer mortgage loans and loans held for sale include $157 million and $159 million, respectively, of loans that were in the process of foreclosure.

25

HSBC USA Inc.

Nonperforming  The following table summarizes the status of our consumer loan portfolio, excluding loans held for sale:
 
Performing
Loans
 
Nonaccrual
Loans
 
Accruing Loans
Contractually Past
Due 90 days or More
 
Total
 
(in millions)
At September 30, 2018
 
 
 
 
 
 
 
Residential mortgages
$
16,970

 
$
406

 
$
—

 
$
17,376

Home equity mortgages
965

 
62

 
—

 
1,027

Credit cards
894

 
—

 
13

 
907

Other consumer
257

 
—

 
6

 
263

Total consumer
$
19,086

 
$
468

 
$
19

 
$
19,573

At December 31, 2017
 
 
 
 
 
 
 
Residential mortgages
$
16,859

 
$
414

 
$
—

 
$
17,273

Home equity mortgages
1,124

 
67

 
—

 
1,191

Credit cards
712

 
—

 
9

 
721

Other consumer
335

 
—

 
8

 
343

Total consumer
$
19,030

 
$
481

 
$
17

 
$
19,528

Troubled debt restructurings  See discussion of impaired loans above for further details on this credit quality indicator.
Concentration of Credit Risk  At September 30, 2018 and December 31, 2017, our loan portfolios included interest-only residential mortgage and home equity mortgage loans totaling $3,209 million and $3,424 million, respectively. An interest-only residential mortgage loan allows a customer to pay the interest-only portion of the monthly payment for a period of time which results in lower payments during the initial loan period. However, subsequent events affecting a customer's financial position could affect the ability of customers to repay the loan in the future when the principal payments are required which increases the credit risk of this loan type.


26

HSBC USA Inc.

5.    Allowance for Credit Losses
 
The following table summarizes the changes in the allowance for credit losses by product and the related loan balance by product during the three and nine months ended September 30, 2018 and 2017:
 
Commercial
 
Consumer
 
 
 
Real Estate, including Construction
 
Business
and Corporate Banking
 
Global
Banking
 
Other
Comm'l
 
Residential
Mortgages
 
Home
Equity
Mortgages
 
Credit
Cards
 
Other
Consumer
 
Total
 
(in millions)
Three Months Ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for credit losses – beginning of period
$
88

 
$
196

 
$
154

 
$
19

 
$
15

 
$
9

 
$
45

 
$
5

 
$
531

Provision charged (credited) to income
24

 
9

 
(16
)
 
(4
)
 
(5
)
 
(1
)
 
14

 
(1
)
 
20

Charge-offs
—

 
(3
)
 
(11
)
 
—

 
(2
)
 
(2
)
 
(10
)
 
—

 
(28
)
Recoveries
—

 
2

 
—

 
—

 
5

 
2

 
2

 
1

 
12

Net (charge-offs) recoveries
—

 
(1
)
 
(11
)
 
—

 
3

 
—

 
(8
)
 
1

 
(16
)
Allowance for credit losses – end of period
$
112

 
$
204

 
$
127

 
$
15

 
$
13

 
$
8

 
$
51

 
$
5

 
$
535

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for credit losses – beginning of period
$
81

 
$
261

 
$
425

 
$
14

 
$
20

 
$
12

 
$
30

 
$
5

 
$
848

Provision charged (credited) to income
(1
)
 
(9
)
 
(21
)
 
(1
)
 
4

 
(2
)
 
8

 
—

 
(22
)
Charge-offs
(4
)
 
(7
)
 
(14
)
 
—

 
—

 
(1
)
 
(8
)
 
(1
)
 
(35
)
Recoveries
—

 
2

 
—

 
—

 
2

 
1

 
2

 
1

 
8

Net (charge-offs) recoveries
(4
)
 
(5
)
 
(14
)
 
—

 
2

 
—

 
(6
)
 
—

 
(27
)
Allowance for credit losses – end of period
$
76

 
$
247

 
$
390

 
$
13

 
$
26

 
$
10

 
$
32

 
$
5

 
$
799

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for credit losses – beginning of period
$
82

 
$
244

 
$
264

 
$
18

 
$
25

 
$
11

 
$
32

 
$
5

 
$
681

Provision charged (credited) to income
30

 
(52
)
 
(90
)
 
(3
)
 
(19
)
 
(2
)
 
39

 
1

 
(96
)
Charge-offs
—

 
(34
)
 
(48
)
 
—

 
(3
)
 
(6
)
 
(25
)
 
(3
)
 
(119
)
Recoveries
—

 
46

 
1

 
—

 
10

 
5

 
5

 
2

 
69

Net (charge-offs) recoveries
—

 
12

 
(47
)
 
—

 
7

 
(1
)
 
(20
)
 
(1
)
 
(50
)
Allowance for credit losses – end of period
$
112

 
$
204

 
$
127

 
$
15

 
$
13

 
$
8

 
$
51

 
$
5

 
$
535

Ending balance: collectively evaluated for impairment
$
111

 
$
180

 
$
127

 
$
15

 
$
10

 
$
7

 
$
50

 
$
5

 
$
505

Ending balance: individually evaluated for impairment
1

 
24

 
—

 
—

 
3

 
1

 
1

 
—

 
30

Total allowance for credit losses
$
112

 
$
204

 
$
127

 
$
15

 
$
13

 
$
8

 
$
51

 
$
5

 
$
535

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment(1)
$
11,877

 
$
12,618

 
$
18,541

 
$
3,897

 
$
16,460

 
$
962

 
$
903

 
$
263

 
$
65,521

Individually evaluated for impairment(2)
5

 
113

 
131

 
1

 
57

 
4

 
4

 
—

 
315

Loans carried at lower of amortized cost or fair value less cost to sell
—

 
—

 
—

 
—

 
859

 
61

 
—

 
—

 
920

Total loans
$
11,882

 
$
12,731

 
$
18,672

 
$
3,898

 
$
17,376

 
$
1,027

 
$
907

 
$
263

 
$
66,756

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

27

HSBC USA Inc.

 
Commercial
 
Consumer
 
 
 
Real Estate, including Construction
 
Business
and Corporate Banking
 
Global
Banking
 
Other
Comm'l
 
Residential
Mortgages
 
Home
Equity
Mortgages
 
Credit
Cards
 
Other
Consumer
 
Total
 
(in millions)
Nine Months Ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for credit losses – beginning of period
$
92

 
$
317

 
$
508

 
$
13

 
$
26

 
$
20

 
$
34

 
$
7

 
$
1,017

Provision charged (credited) to income
(9
)
 
(56
)
 
(60
)
 
1

 
(4
)
 
(8
)
 
17

 
(1
)
 
(120
)
Charge-offs
(7
)
 
(30
)
 
(59
)
 
(1
)
 
(3
)
 
(5
)
 
(24
)
 
(3
)
 
(132
)
Recoveries
—

 
16

 
1

 
—

 
7

 
3

 
5

 
2

 
34

Net (charge-offs) recoveries
(7
)
 
(14
)
 
(58
)
 
(1
)
 
4

 
(2
)
 
(19
)
 
(1
)
 
(98
)
Allowance for credit losses – end of period
$
76

 
$
247

 
$
390

 
$
13

 
$
26

 
$
10

 
$
32

 
$
5

 
$
799

Ending balance: collectively evaluated for impairment
$
75

 
$
196

 
$
228

 
$
13

 
$
19

 
$
9

 
$
31

 
$
5

 
$
576

Ending balance: individually evaluated for impairment
1

 
51

 
162

 
—

 
7

 
1

 
1

 
—

 
223

Total allowance for credit losses
$
76

 
$
247

 
$
390

 
$
13

 
$
26

 
$
10

 
$
32

 
$
5

 
$
799

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment(1)
$
10,425

 
$
13,008

 
$
19,434

 
$
4,408

 
$
16,207

 
$
1,164

 
$
652

 
$
379

 
$
65,677

Individually evaluated for impairment(2)
17

 
320

 
516

 
—

 
59

 
3

 
4

 
—

 
919

Loans carried at lower of amortized cost or fair value less cost to sell
—

 
—

 
—

 
—

 
930

 
67

 
—

 
—

 
997

Total loans
$
10,442

 
$
13,328

 
$
19,950

 
$
4,408

 
$
17,196

 
$
1,234

 
$
656

 
$
379

 
$
67,593

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1) 
Other commercial includes loans to HSBC affiliates totaling $1,557 million and $1,820 million at September 30, 2018 and 2017, respectively, for which we do not carry an associated allowance for credit losses.
(2) 
For consumer loans and certain small business loans, these amounts represent TDR Loans for which we evaluate reserves using a discounted cash flow methodology. Each loan is individually identified as a TDR Loan and then grouped together with other TDR Loans with similar characteristics. The discounted cash flow analysis is then applied to these groups of TDR Loans. Loans individually evaluated for impairment exclude TDR Loans that are carried at the lower of amortized cost or fair value of the collateral less cost to sell which totaled $623 million and $662 million at September 30, 2018 and 2017, respectively.


28

HSBC USA Inc.

6. Loans Held for Sale
 
Loans held for sale consisted of the following:

September 30, 2018
 
December 31, 2017
 
(in millions)
Commercial loans:
 
 
 
Real estate, including construction
$
24

 
$
115

Global banking
253

 
533

Total commercial
277

 
648

Consumer loans:
 
 
 
Residential mortgages
60

 
6

Other consumer
55

 
61

Total consumer
115

 
67

Total loans held for sale
$
392

 
$
715

Commercial Loans Commercial loans held for sale primarily consists of certain loans that we have elected to designate under the fair value option which include loans that we originate in connection with our participation in a number of syndicated credit facilities with the intent of selling them to unaffiliated third parties as well as loans that we purchase from the secondary market and hold as hedges against our exposure to certain total return swaps. The fair value of these loans totaled $242 million and $471 million at September 30, 2018 and December 31, 2017, respectively. See Note 10, "Fair Value Option," for additional information.
Commercial loans held for sale also includes certain loans that we no longer intend to hold for investment and transferred to held for sale which totaled $35 million and $62 million at September 30, 2018 and December 31, 2017, respectively. During the three and nine months ended September 30, 2018, we reversed $2 million and $5 million, respectively, of the lower of amortized cost or fair value adjustment previously recorded on commercial loans held for sale as a component of other income (loss) in the consolidated statement of income as a result of an increase in fair value due to improved pricing compared with reversing $4 million and $5 million during the three and nine months ended September 30, 2017, respectively.
Consumer Loans Prior to 2018 applications, we sold agency-eligible residential mortgage loan originations on a servicing released basis directly to PHH Mortgage Corporation ("PHH Mortgage"). Beginning with 2018 applications, PHH Mortgage is no longer obligated to purchase these loans from us directly upon origination and instead we currently intend to market these loans for sale to other third parties on a servicing retained basis. Gains and losses from the sale of these residential mortgage loans are reflected as a component of residential mortgage banking expense in the accompanying consolidated statement of income.
Other consumer loans held for sale reflects student loans which we no longer originate.
Loans held for sale are subject to market risk, liquidity risk and interest rate risk, in that their value will fluctuate as a result of changes in market conditions, as well as the credit environment. As discussed above, prior to 2018 applications, PHH Mortgage was obligated to purchase agency-eligible loans from us directly upon origination and, as such, we retained none of the risk of market changes in mortgage rates for these loans purchased by PHH Mortgage. Beginning with 2018 applications, we now market these loans for sale to other third parties. As a result, in 2018, we have reinstated an economic hedging program to offset changes in the fair value of these mortgage loans held for sale, from the time of commitment to sale, attributable to changes in market interest rates, partially mitigating the interest rate risk for these mortgage loans. Revenue associated with this economic hedging program, which is included in residential mortgage banking expense in the consolidated statement of income, was less than $1 million during both the three and nine months ended September 30, 2018.
Valuation Allowances Excluding the commercial loans designated under the fair value option discussed above, loans held for sale are recorded at the lower of amortized cost or fair value, with adjustments to fair value being recorded as a valuation allowance through other revenues. The valuation allowance on consumer loans held for sale was $4 million and $5 million at September 30, 2018 and December 31, 2017, respectively. The valuation allowance on commercial loans held for sale was $4 million and $10 million at September 30, 2018 and December 31, 2017, respectively.


29

HSBC USA Inc.

7. Goodwill
 
Goodwill was $1,607 million at both September 30, 2018 and December 31, 2017. Goodwill for these periods reflects accumulated impairment losses of $670 million, which were recognized in prior periods.
During the third quarter of 2018, we completed our annual impairment test of goodwill and determined that the fair value of all of our reporting units exceeded their respective carrying amounts.

8. Sale of Certain Private Banking Client Relationships
 
In August 2017, our Private Banking business entered into an agreement to refer parts of its Latin America portfolio, consisting primarily of clients based in areas where we do not have a corporate presence, including Central America and the Andean Pact, to UBS Wealth Management Americas (“UBS”). Under the terms of the agreement, we facilitate the referral of these client relationships to UBS, including the transfer of their client assets as well as the transfer of the relationship managers and client service employees that support these clients. At the time the agreement was signed, total client assets associated with these relationships consisted of approximately $3.5 billion in client investments (which were not reported on our balance sheet) and $1.7 billion in client deposits (which were reported on our balance sheet). Loans associated with these client relationships were not included in the agreement. UBS will pay us a fee of 0.5 percent of the aggregate client assets transferred during the first two years after the agreement was signed. Therefore, the consideration we expect to receive is contingent upon the clients’ decisions to transfer their accounts to UBS, the timing and amounts of client assets transferred and the acceptance of the client assets by UBS. As a result of entering into the agreement, we recorded the contingent consideration expected to be received of $15 million as a receivable at estimated fair value within other assets and recognized a pre-tax gain on sale, net of allocated goodwill and transaction costs, of $8 million in other income (loss) during the third quarter of 2017. The fair value of the contingent consideration is estimated using a discounted cash flow methodology with changes in fair value recognized in other income (loss). During the second quarter of 2018, we reduced the contingent consideration receivable to $12 million and recognized a $3 million loss in other income (loss) as a result of a decline in estimated fair value based on the amount of client assets transferred to date and a revised estimate of the amount of remaining client assets that we expect will be transferred.
Through September 30, 2018, we have completed the transfers of approximately $1.5 billion of client investments and $0.8 billion of client deposits to UBS. We have estimated the amount of remaining client deposits that we expect will be transferred to UBS, which was approximately $48 million at September 30, 2018 compared with $673 million at December 31, 2017, and have classified them as held for sale in our consolidated balance sheet. No lower of cost or fair value adjustment was required as a result of the transfer of deposits to held for sale. An additional $48 million of deposits at September 30, 2018 could be transferred in the event all remaining client deposits associated with these client relationships were to be transferred.

9. Derivative Financial Instruments
 
In the normal course of business, the derivative instruments we enter into are for trading, market making and risk management purposes. For financial reporting purposes, derivative instruments are designated in one of the following categories: (a) hedging instruments designated as qualifying hedges under derivative and hedge accounting principles, (b) financial instruments held for trading or (c) non-qualifying economic hedges. The derivative instruments held are predominantly swaps, futures, options and forward contracts. All derivatives are stated at fair value. Where we enter into enforceable master netting agreements with counterparties, the master netting agreements permit us to net those derivative asset and liability positions and to offset cash collateral held and posted with the same counterparty.
The following table presents the fair value of derivative contracts by major product type on a gross basis. Gross fair values exclude the effects of both counterparty netting as well as collateral, and therefore are not representative of our exposure. The table below also presents the amounts of counterparty netting and cash collateral that have been offset in the consolidated balance sheet, as well as cash and securities collateral posted and received under enforceable master netting agreements that do not meet the criteria for netting. Derivative assets and liabilities which are not subject to an enforceable master netting agreement, or are subject to a netting agreement where an appropriate legal opinion to determine such agreements are enforceable has not been either sought or obtained, have not been netted in the table below. Where we have received or posted collateral under netting agreements where an appropriate legal opinion to determine such agreements are enforceable has not been either sought or obtained, the related collateral also has not been netted in the table below.

30

HSBC USA Inc.

 
September 30, 2018
 
December 31, 2017
 
Derivative Assets
 
Derivative Liabilities
 
Derivative Assets
 
Derivative Liabilities
 
(in millions)
Derivatives accounted for as fair value hedges(1)
 
 
 
 
 
 
 
OTC-cleared(2)
$
—

 
$
—

 
$
84

 
$
390

Bilateral OTC(2)
—

 
73

 
—

 
134

Interest rate contracts
—

 
73

 
84

 
524

Derivatives accounted for as cash flow hedges(1)
 
 
 
 
 
 
 
Foreign exchange contracts - bilateral OTC(2)
37

 
—

 
10

 
—

OTC-cleared(2)
—

 
—

 
4

 
86

Bilateral OTC(2)
4

 
7

 
—

 
22

Interest rate contracts
4

 
7

 
4

 
108

Total derivatives accounted for as hedges
41

 
80

 
98

 
632

Trading derivatives not accounted for as hedges(3)
 
 
 
 
 
 
 
Exchange-traded(2)
3

 
145

 
6

 
59

OTC-cleared(2)
61

 
17

 
11,905

 
10,526

Bilateral OTC(2)
9,586

 
10,098

 
11,549

 
12,997

Interest rate contracts
9,650

 
10,260

 
23,460

 
23,582

Exchange-traded(2)
—

 
21

 
4

 
—

OTC-cleared (2)
—

 
6

 
—

 
—

Bilateral OTC(2)
15,433

 
14,563

 
15,746

 
14,666

Foreign exchange contracts
15,433

 
14,590

 
15,750

 
14,666

Equity contracts - bilateral OTC(2)
3,124

 
3,091

 
2,820

 
2,806

Exchange-traded(2)
64

 
51

 
52

 
108

Bilateral OTC(2)
774

 
800

 
502

 
613

Precious metals contracts
838

 
851

 
554

 
721

OTC-cleared(2)
230

 
242

 
67

 
75

Bilateral OTC(2)
709

 
663

 
589

 
485

Credit contracts
939

 
905

 
656

 
560

Other non-qualifying derivatives not accounted for as hedges(1)
 
 
 
 
 
 
 
OTC-cleared(2)
—

 
—

 
519

 
60

Bilateral OTC(2)
111

 
308

 
170

 
164

Interest rate contracts
111

 
308

 
689

 
224

Foreign exchange contracts - bilateral OTC(2)
5

 
5

 
—

 
—

Equity contracts - bilateral OTC(2)
1,122

 
286

 
1,264

 
145

Precious metals contracts - bilateral OTC(2)
—

 
—

 
—

 
1

Credit contracts - bilateral OTC(2)
10

 
11

 
—

 
24

Other contracts - bilateral OTC(2)(4)
6

 
51

 
6

 
52

Total derivatives
31,279

 
30,438

 
45,297

 
43,413

Less: Gross amounts of receivable / payable subject to enforceable master netting agreements(5)(7)
24,613

 
24,613

 
36,394

 
36,394

Less: Gross amounts of cash collateral received / posted subject to enforceable master netting agreements(6)(7)
3,433

 
3,517

 
4,480

 
3,823

Net amounts of derivative assets / liabilities presented in the balance sheet
3,233

 
2,308

 
4,423

 
3,196

Less: Gross amounts of financial instrument collateral received / posted subject to enforceable master netting agreements but not offset in the consolidated balance sheet
722

 
462

 
742

 
370

Net amounts of derivative assets / liabilities
$
2,511

 
$
1,846

 
$
3,681

 
$
2,826

 
(1) 
Derivative assets / liabilities related to cash flow hedges, fair value hedges and derivative instruments held for purposes other than for trading are recorded in other assets / interest, taxes and other liabilities on the consolidated balance sheet.
(2) 
Over-the-counter ("OTC") derivatives include derivatives executed and settled bilaterally with counterparties without the use of an organized exchange or central clearing house. The credit risk associated with bilateral OTC derivatives is managed through obtaining collateral and enforceable master netting agreements. OTC-cleared derivatives are executed bilaterally in the OTC market but then novated to a central clearing counterparty, whereby the central clearing counterparty becomes the counterparty to each of the original counterparties. Exchange traded derivatives are executed directly on an organized exchange. Credit risk is minimized for OTC-cleared derivatives and exchange traded derivatives through daily margining requirements. During the first

31

HSBC USA Inc.

quarter of 2018, a central clearing counterparty amended its rules for OTC-cleared interest rate derivatives to legally re-characterize daily variation margin payments to be settlement payments as opposed to cash collateral posted. The impact of reflecting the rule change for this central clearing counterparty as of December 31, 2017 would have been a reduction in gross derivative assets and liabilities of approximately $11.5 billion and $10.3 billion, respectively, with corresponding decreases in the related counterparty and cash collateral netting.
(3) 
Trading related derivative assets / liabilities are recorded in trading assets / trading liabilities on the consolidated balance sheet.
(4) 
Consists of swap agreements entered into in conjunction with the sales of Visa Inc. ("Visa") Class B common shares ("Class B Shares").
(5) 
Represents the netting of derivative receivable and payable balances for the same counterparty under enforceable netting agreements.
(6) 
Represents the netting of cash collateral posted and received by counterparty under enforceable netting agreements.
(7) 
Netting is performed at a counterparty level in cases where enforceable master netting agreements are in place, regardless of the type of derivative instrument. Therefore, we have not allocated netting to the different types of derivative instruments shown in the table above.
See Note 18, "Guarantee Arrangements, Pledged Assets and Repurchase Agreements," for further information on offsetting related to resale and repurchase agreements and securities borrowing and lending arrangements.
Derivatives Held for Risk Management Purposes  Our risk management policy requires us to identify, analyze and manage risks arising from the activities conducted during the normal course of business. We use derivative instruments as an asset and liability management tool to manage our exposures in interest rate, foreign currency and credit risks in existing assets and liabilities, commitments and forecasted transactions. The accounting for changes in fair value of a derivative instrument will depend on whether the derivative has been designated and qualifies for hedge accounting.
We designate derivative instruments to offset the fair value risk and cash flow risk arising from fixed-rate and floating-rate assets and liabilities as well as forecasted transactions. We assess the hedging relationships, both at the inception of the hedge and on an ongoing basis, using a regression approach to determine whether the designated hedging instrument is highly effective in offsetting changes in the fair value or the cash flows attributable to the hedged risk. Accounting principles for qualifying hedges require us to prepare detailed documentation describing the relationship between the hedging instrument and the hedged item, including, but not limited to, the risk management objective, the hedging strategy and the methods to assess and measure the ineffectiveness of the hedging relationship. We discontinue hedge accounting when we determine that the hedge is no longer highly effective, the hedging instrument is terminated, sold or expired, the designated forecasted transaction is not probable of occurring, or when the designation is removed by us.
Fair Value Hedges  In the normal course of business, we hold fixed-rate loans and securities and issue fixed-rate senior and subordinated debt obligations. The fair value of fixed-rate (U.S. dollar and non-U.S. dollar denominated) assets and liabilities fluctuates in response to changes in interest rates or foreign currency exchange rates. We utilize interest rate swaps, forward and futures contracts and foreign currency swaps to minimize our exposure to changes in fair value caused by interest rate and foreign currency volatility. The changes in the fair value of the hedged item designated in a qualifying hedge are captured as an adjustment to the carrying amount of the hedged item (basis adjustment). If the hedging relationship is terminated and the hedged item continues to exist, the basis adjustment is amortized over the remaining life of the hedged item.
We recorded basis adjustments for active fair value hedges which decreased the carrying amount of our debt by $179 million and $132 million at September 30, 2018 and December 31, 2017, respectively. During the three and nine months ended September 30, 2018, respectively, we amortized nil and $1 million of basis adjustments related to terminated and/or re-designated fair value hedges of our debt compared with $1 million and $4 million during the three and nine months ended September 30, 2017, respectively. The total accumulated unamortized basis adjustments related to terminated and/or re-designated fair value hedges amounted to a decrease in the carrying amount of our debt of $7 million at September 30, 2018 and an increase of $7 million at December 31, 2017.
We recorded basis adjustments for active fair value hedges of available-for-sale ("AFS") securities which decreased the carrying amount of the securities by $227 million at September 30, 2018 and increased the carrying amount of the securities by $279 million at December 31, 2017.

32

HSBC USA Inc.

The following table presents information on gains and losses on derivative instruments designated and qualifying as hedging instruments in fair value hedges and the hedged items in fair value hedges and their locations on the consolidated statement of income:
 
Gain (Loss) on Derivative
 
Gain (Loss) on Hedged Items
 
Net Ineffective Gain (Loss) Recognized
  
Net Interest Income
 
Other Income (Loss)
 
Net Interest Income
 
Other Income (Loss)
 
Other Income (Loss)
 
(in millions)
Three Months Ended September 30, 2018
 
 
 
 
 
 
 
 
 
Interest rate contracts / AFS Securities
$
(9
)
 
$
147

 
$
92

 
$
(142
)
 
$
5

Interest rate contracts / long-term debt
(18
)
 
5

 
(53
)
 
(5
)
 
—

Total
$
(27
)
 
$
152

 
$
39

 
$
(147
)
 
$
5

 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2017
 
 
 
 
 
 
 
 
 
Interest rate contracts / AFS Securities
$
(28
)
 
$
2

 
$
88

 
$
(2
)
 
$
—

Interest rate contracts / long-term debt
2

 
(5
)
 
(63
)
 
3

 
(2
)
Total
$
(26
)
 
$
(3
)
 
$
25

 
$
1

 
$
(2
)
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2018
 
 
 
 
 
 
 
 
 
Interest rate contracts / AFS Securities
$
(42
)
 
$
634

 
$
268

 
$
(616
)
 
$
18

Interest rate contracts / long-term debt
(38
)
 
(62
)
 
(163
)
 
60

 
(2
)
Total
$
(80
)
 
$
572

 
$
105

 
$
(556
)
 
$
16

 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2017
 
 
 
 
 
 
 
 
 
Interest rate contracts / AFS Securities
$
(95
)
 
$
(59
)
 
$
268

 
$
62

 
$
3

Interest rate contracts / long-term debt
14

 
14

 
(197
)
 
(13
)
 
1

Total
$
(81
)
 
$
(45
)
 
$
71

 
$
49

 
$
4

Cash Flow Hedges  We own or issue floating rate financial instruments and enter into forecasted transactions that give rise to variability in future cash flows. As a part of our risk management strategy, we use interest rate swaps, currency swaps and futures contracts to mitigate risk associated with variability in the cash flows. Changes in fair value of a derivative instrument associated with the effective portion of a qualifying cash flow hedge are recognized in other comprehensive income (loss). When the cash flows being hedged materialize and are recorded in income or expense, the associated gain or loss from the hedging derivative previously recorded in accumulated other comprehensive loss ("AOCI") is reclassified into earnings in the same accounting period in which the designated forecasted transaction or hedged item affects earnings. If a cash flow hedge of a forecasted transaction is de-designated because it is no longer highly effective, or if the hedge relationship is terminated, the cumulative gain or loss on the hedging derivative to that date will continue to be reported in AOCI unless it is probable that the hedged forecasted transaction will not occur by the end of the originally specified time period as documented at the inception of the hedge, at which time the cumulative gain or loss is released into earnings.
At September 30, 2018 and December 31, 2017, active cash flow hedge relationships extend or mature through July 2036. During the three and nine months ended September 30, 2018, respectively, $6 million and $15 million of losses related to terminated and/or re-designated cash flow hedge relationships were amortized to earnings from AOCI compared with losses of $5 million and $11 million during the three and nine months ended September 30, 2017, respectively. During the next twelve months, we expect to amortize $24 million of remaining losses to earnings resulting from these terminated and/or re-designated cash flow hedges. The interest accrual related to the hedging instruments is recognized in interest income.

33

HSBC USA Inc.

The following table presents information on gains and losses on derivative instruments designated and qualifying as hedging instruments in cash flow hedges (including amounts recognized in AOCI from all terminated cash flow hedges) and their locations on the consolidated statement of income:
 
Gain (Loss) Recognized
in AOCI on Derivative
(Effective Portion)
 
Location of 
Gain (Loss) 
Reclassified
from AOCI into Income 
(Effective Portion)
 
Gain (Loss)
Reclassed From
AOCI into Income
(Effective Portion)
 
Location of Gain (Loss) Recognized
in Income on the 
Derivative (Ineffective Portion 
and Amount Excluded from Effectiveness Testing)
 
Gain (Loss)
Recognized in Income on the
Derivative (Ineffective Portion)
 
2018
 
2017
 
 
2018
 
2017
 
 
2018
 
2017
 
(in millions)
Three Months Ended September 30,
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
$
2

 
$
—

 
Net interest income
 
$
—

 
$
—

 
Other income (loss)
 
$
—

 
$
—

Interest rate contracts
$
21

 
$
(3
)
 
Net interest income
 
$
(6
)
 
$
(5
)
 
Other income (loss)
 
$
(1
)
 
$
—

Total
$
23

 
$
(3
)
 
 
 
$
(6
)
 
$
(5
)
 
 
 
$
(1
)
 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
$
(4
)
 
$
—

 
Net interest income
 
$
—

 
$
—

 
Other income (loss)
 
$
—

 
$
—

Interest rate contracts
33

 
(14
)
 
Net interest income
 
(15
)
 
(11
)
 
Other income (loss)
 
(1
)
 
—

Total
$
29

 
$
(14
)
 
 
 
$
(15
)
 
$
(11
)
 
 
 
$
(1
)
 
$
—

Trading Derivatives and Non-Qualifying Hedging Activities  In addition to risk management, we also enter into derivative contracts, including buy- and sell-protection credit derivatives, for the purposes of trading and market making, or repackaging risks to form structured trades to meet clients' risk taking objectives. Additionally, we buy or sell securities and use derivatives to mitigate the market risks arising from our trading activities with our clients that exceed our risk appetite. We also use buy-protection credit derivatives to manage our counterparty credit risk exposure. Where we enter into derivatives for trading purposes, realized and unrealized gains and losses are recognized in trading revenue. Counterparty credit risk associated with OTC derivatives, including risk-mitigating buy-protection credit derivatives, are recognized as an adjustment to the fair value of the derivatives and are recorded in trading revenue.
Our non-qualifying hedging and other activities include:
•
Derivative contracts related to the fixed-rate long-term debt issuances and hybrid instruments, including all structured notes and deposits, for which we have elected fair value option accounting. These derivative contracts are non-qualifying hedges but are considered economic hedges.
•
Credit default swaps which are designated as economic hedges against the credit risks within our loan portfolio. In the event of an impairment loss occurring in a loan that is economically hedged, the impairment loss is recognized as provision for credit losses while the gain on the credit default swap is recorded as other income (loss).
•
Swap agreements entered into in conjunction with the sales of Visa Class B Shares to a third party to retain the litigation risk associated with the Class B Shares sold until the related litigation is settled and the Class B Shares can be converted into Class A common shares ("Class A Shares"). See Note 18, "Guarantee Arrangements, Pledged Assets and Repurchase Agreements," for additional information.
Derivative instruments designated as economic hedges that do not qualify for hedge accounting are recorded at fair value through profit and loss. Realized and unrealized gains and losses on economic hedges are recognized in gain on instruments designated at fair value and related derivatives or other income (loss) while the derivative asset or liability positions are reflected as other assets or other liabilities.

34

HSBC USA Inc.

The following table presents information on gains and losses on derivative instruments held for trading purposes and their locations on the consolidated statement of income:
 
Location of Gain (Loss)
Recognized in Income on Derivatives
Amount of Gain (Loss) Recognized in Income on Derivatives
Three Months Ended September 30,
 
Nine Months Ended September 30,
2018
 
2017
 
2018
 
2017
 
 
(in millions)
Interest rate contracts
Trading revenue
$
65

 
$
(52
)
 
$
394

 
$
(249
)
Foreign exchange contracts
Trading revenue
105

 
116

 
33

 
185

Equity contracts
Trading revenue
11

 
1

 
10

 
—

Precious metals contracts
Trading revenue
44

 
50

 
259

 
161

Credit contracts
Trading revenue
10

 
(41
)
 
6

 
(87
)
Total
 
$
235

 
$
74

 
$
702

 
$
10

The following table presents information on gains and losses on derivative instruments held for non-qualifying hedging and other activities and their locations on the consolidated statement of income:
 
Location of Gain (Loss)
Recognized in Income on Derivatives
Amount of Gain (Loss) Recognized in Income on Derivatives
Three Months Ended September 30,
 
Nine Months Ended September 30,
2018
 
2017
 
2018
 
2017
 
 
(in millions)
Interest rate contracts
Gain on instruments designated at fair value and related derivatives
$
(68
)
 
$
14

 
$
(284
)
 
$
89

Foreign exchange contracts
Gain on instruments designated at fair value and related derivatives
(1
)
 
8

 
(11
)
 
11

Equity contracts
Gain on instruments designated at fair value and related derivatives
276

 
342

 
104

 
863

Credit contracts
Other income (loss)
(9
)
 
(9
)
 
1

 
(39
)
Other contracts(1)
Other income (loss)
(5
)
 
(5
)
 
(19
)
 
(7
)
Total
 
$
193

 
$
350

 
$
(209
)
 
$
917

 
(1) 
Consists of swap agreements entered into in conjunction with the sales of Visa Class B Shares.
Credit-Risk Related Contingent Features  The majority of our derivative contracts contain provisions that require us to maintain a specific credit rating from each of the major credit rating agencies. Sometimes the derivative instrument transactions are a part of broader structured product transactions. If our credit ratings were to fall below the current ratings, the counterparties to our derivative instruments could demand us to post additional collateral. The amount of additional collateral required to be posted will depend on whether we are downgraded by one or more notches. The aggregate fair value of all derivative instruments with credit-risk related contingent features that were in a liability position at September 30, 2018 was $1,073 million, for which we had posted collateral of $666 million. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a liability position at December 31, 2017 was $1,063 million, for which we had posted collateral of $758 million. Substantially all of the collateral posted is in the form of cash or securities available-for-sale. See Note 18, "Guarantee Arrangements, Pledged Assets and Repurchase Agreements," for further details.

35

HSBC USA Inc.

The following table presents the amount of additional collateral that we would be required to post (from the current collateral level) related to derivative instruments with credit-risk related contingent features if our long-term ratings were downgraded by one or two notches. A downgrade by a single rating agency that does not result in a rating lower than a preexisting corresponding rating provided by another rating agency will generally not result in additional collateral.
 
One-notch downgrade
 
Two-notch downgrade
 
(in millions)
Amount of additional collateral to be posted upon downgrade
$
34

 
$
53

Notional Value of Derivative Contracts  The following table summarizes the notional values of derivative contracts:

September 30, 2018
 
December 31, 2017
 
(in millions)
Interest rate:
 
 
 
Futures and forwards
$
783,526

 
$
735,757

Swaps
3,088,381

 
2,687,273

Options written
102,741

 
77,144

Options purchased
118,183

 
93,042

 
4,092,831

 
3,593,216

Foreign exchange:
 
 
 
Swaps, futures and forwards
1,006,804

 
924,163

Options written
28,800

 
25,911

Options purchased
29,183

 
26,617

Spot
49,821

 
19,401

 
1,114,608

 
996,092

Commodities, equities and precious metals:
 
 
 
Swaps, futures and forwards
49,408

 
38,709

Options written
31,982

 
31,631

Options purchased
43,710

 
43,202

 
125,100

 
113,542

Credit derivatives
101,098

 
90,290

Other contracts(1)
838

 
644

Total
$
5,434,475

 
$
4,793,784

 
(1) 
Consists of swap agreements entered into in conjunction with the sales of Visa Class B Shares.


36

HSBC USA Inc.

10. Fair Value Option
 
We report our results to HSBC in accordance with HSBC Group accounting and reporting policies ("Group Reporting Basis"), which apply International Financial Reporting Standards ("IFRSs") as issued by the International Accounting Standards Board ("IASB") and endorsed by the European Union ("EU"). We typically have elected to apply fair value option ("FVO") accounting to selected financial instruments to align the measurement attributes of those instruments under U.S. GAAP and the Group Reporting Basis and to simplify the accounting model applied to those financial instruments. We elected to apply FVO accounting to certain commercial loans held for sale, certain securities purchased and sold under resale and repurchase agreements, certain fixed-rate long-term debt issuances and all of our hybrid instruments, including structured notes and deposits. Excluding the fair value movement on fair value option liabilities attributable to our own credit spread, which is recorded in other comprehensive income (loss), changes in the fair value of fair value option assets and liabilities related to interest rate, credit and other risks as well as the mark-to-market adjustment on the related derivatives and the net realized gains or losses on these derivatives are reported in gain on instruments designated at fair value and related derivatives in the consolidated statement of income.
Loans  We elected to apply FVO accounting to certain commercial syndicated loans which are originated with the intent to sell and certain commercial loans that we purchased from the secondary market and hold as hedges against our exposure to certain total return swaps and include these loans as loans held for sale in the consolidated balance sheet. The election allows us to account for these loans at fair value which is consistent with the manner in which the instruments are managed. Where available, fair value is based on observable market consensus pricing obtained from independent sources, relevant broker quotes or observed market prices of instruments with similar characteristics. Where observable market parameters are not available, fair value is determined based on contractual cash flows adjusted for estimates of prepayment rates, expected default rates and loss severity discounted at management's estimate of the expected rate of return required by market participants. We also consider loan-specific risk mitigating factors such as collateral arrangements in determining the fair value estimate. Interest from these loans is recorded as interest income in the consolidated statement of income. Because a substantial majority of the loans elected for the fair value option are floating rate assets, changes in their fair value are primarily attributable to changes in loan-specific credit risk factors. The components of gain (loss) related to loans designated at fair value are summarized in the table below. At September 30, 2018 and December 31, 2017, no loans for which the fair value option has been elected were 90 days or more past due or in nonaccrual status.
Resale and Repurchase Agreements We elected to apply FVO accounting to certain securities purchased and sold under resale and repurchase agreements which are trading in nature. The election allows us to account for these resale and repurchase agreements at fair value which is consistent with the manner in which the instruments are managed. The fair value of the resale and repurchase agreements is determined using market rates currently offered on comparable transactions with similar underlying collateral and maturities. Interest on these resale and repurchase agreements is recorded as interest income or expense in the consolidated statement of income. The components of gain (loss) related to these resale and repurchase agreements designated at fair value are summarized in the table below.
Long-Term Debt (Own Debt Issuances)  We elected to apply FVO accounting for certain fixed-rate long-term debt for which we had applied or otherwise would elect to apply fair value hedge accounting. The election allows us to achieve a similar accounting effect to hedge accounting without having to meet the hedge accounting requirements. The own debt issuances elected under FVO are traded in secondary markets and, as such, the fair value is determined based on observed prices for the specific instruments. The observed market price of these instruments reflects the effect of changes to our own credit spreads and interest rates. Interest on the fixed-rate debt accounted for under FVO is recorded as interest expense in the consolidated statement of income. The components of gain (loss) in the consolidated statement of income related to long-term debt designated at fair value are summarized in the table below.
Hybrid Instruments  We elected to apply FVO accounting to all of our hybrid instruments issued, including structured notes and deposits. The valuation of the hybrid instruments is predominantly driven by the derivative features embedded within the instruments and our own credit risk. Cash flows of the hybrid instruments in their entirety, including the embedded derivatives, are discounted at an appropriate rate for the applicable duration of the instrument adjusted for our own credit spreads. The credit spreads applied to structured notes are determined with reference to our own debt issuance rates observed in the primary and secondary markets, internal funding rates, and structured note rates in recent executions while the credit spreads applied to structured deposits are determined using market rates currently offered on comparable deposits with similar characteristics and maturities. Interest on this debt is recorded as interest expense in the consolidated statement of income. The components of gain (loss) in the consolidated statement of income related to hybrid instruments designated at fair value are summarized in the table below.

37

HSBC USA Inc.

The following table summarizes the fair value and unpaid principal balance for items we account for under FVO:
 
Fair Value
 
Unpaid Principal Balance
 
Fair Value Over (Under) Unpaid Principal Balance
 
(in millions)
At September 30, 2018
 
 
 
 
 
Commercial loans held for sale
$
242

 
$
247

 
$
(5
)
Securities purchased under resale agreements
117

 
117

 
—

Securities sold under repurchase agreements
916

 
915

 
1

Fixed rate long-term debt
1,962

 
1,750

 
212

Hybrid instruments:
 
 
 
 
 
Structured deposits
7,980

 
8,301

 
(321
)
Structured notes
10,300

 
9,410

 
890

At December 31, 2017
 
 
 
 
 
Commercial loans held for sale
$
471

 
$
483

 
$
(12
)
Securities purchased under resale agreements
80

 
80

 
—

Securities sold under repurchase agreements
2,032

 
2,031

 
1

Fixed rate long-term debt
2,230

 
1,750

 
480

Hybrid instruments:
 
 
 
 
 
Structured deposits
7,693

 
7,685

 
8

Structured notes
10,656

 
9,530

 
1,126


38

HSBC USA Inc.

Components of Gain on Instruments Designated at Fair Value and Related Derivatives  The following table summarizes the components of gain on instruments designated at fair value and related derivatives reflected in the consolidated statement of income for the three and nine months ended September 30, 2018 and 2017:
 
Loans
 
Securities Purchased Under Resale Agreements
 
Securities Sold Under Repurchase Agreements
 
Long-Term
Debt
 
Hybrid
Instruments
 
Total
 
(in millions)
Three Months Ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
Interest rate and other components(1)
$
—

 
$
—

 
$
—

 
$
51

 
$
(229
)
 
$
(178
)
Credit risk component(2)
—

 
—

 
—

 
—

 
—

 
—

Total mark-to-market on financial instruments designated at fair value
—

 
—

 
—

 
51

 
(229
)
 
(178
)
Mark-to-market on related derivatives
—

 
—

 
—

 
(44
)
 
241

 
197

Net realized gain on related long-term debt derivatives
—

 
—

 
—

 
10

 
—

 
10

Gain (loss) on instruments designated at fair value and related derivatives
$
—

 
$
—

 
$
—

 
$
17

 
$
12

 
$
29

 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
Interest rate and other components(1)
$
—

 
$
(1
)
 
$
—

 
$
—

 
$
(355
)
 
$
(356
)
Credit risk component(2)
(1
)
 
—

 
—

 
—

 
—

 
(1
)
Total mark-to-market on financial instruments designated at fair value
(1
)
 
(1
)
 
—

 
—

 
(355
)
 
(357
)
Mark-to-market on related derivatives
—

 
—

 
—

 
(6
)
 
354

 
348

Net realized gain on related long-term debt derivatives
—

 
—

 
—

 
16

 
—

 
16

Gain (loss) on instruments designated at fair value and related derivatives
$
(1
)
 
$
(1
)
 
$
—

 
$
10

 
$
(1
)
 
$
7

 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
Interest rate and other components(1)
$
—

 
$
—

 
$
—

 
$
173

 
$
78

 
$
251

Credit risk component(2)
3

 
—

 
—

 
—

 
—

 
3

Total mark-to-market on financial instruments designated at fair value
3

 
—

 
—

 
173

 
78

 
254

Mark-to-market on related derivatives
—

 
—

 
—

 
(154
)
 
(71
)
 
(225
)
Net realized gain on related long-term debt derivatives
—

 
—

 
—

 
34

 
—

 
34

Gain (loss) on instruments designated at fair value and related derivatives
$
3

 
$
—

 
$
—

 
$
53

 
$
7

 
$
63

 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
Interest rate and other components(1)
$
—

 
$
6

 
$
3

 
$
(7
)
 
$
(922
)
 
$
(920
)
Credit risk component(2)
(3
)
 
—

 
—

 
—

 
—

 
(3
)
Total mark-to-market on financial instruments designated at fair value
(3
)
 
6

 
3

 
(7
)
 
(922
)
 
(923
)
Mark-to-market on related derivatives
—

 
—

 
—

 
(13
)
 
931

 
918

Net realized gain on related long-term debt derivatives
—

 
—

 
—

 
45

 
—

 
45

Gain (loss) on instruments designated at fair value and related derivatives
$
(3
)
 
$
6

 
$
3

 
$
25

 
$
9

 
$
40

 
(1) 
As it relates to hybrid instruments, interest rate and other components primarily includes interest rate, foreign exchange and equity contract risks.
(2) 
The fair value movement on fair value option liabilities attributable to our own credit spread is recorded in common equity as a component of other comprehensive income (loss).

39

HSBC USA Inc.

11. Accumulated Other Comprehensive Loss
 
Accumulated other comprehensive loss includes certain items that are reported directly within a separate component of equity. The following table presents changes in accumulated other comprehensive loss balances:
Three Months Ended September 30,
2018
 
2017
 
(in millions)
Unrealized gains (losses) on investment securities:
 
 
 
Balance at beginning of period
$
(570
)
 
$
(244
)
Other comprehensive income (loss) for period:
 
 
 
Net unrealized gains (losses) arising during period, net of tax of $(46) million and $13 million, respectively
(143
)
 
20

Reclassification adjustment for gains (losses) realized in net income, net of tax of $2 million and $(2) million, respectively(1)
3

 
(3
)
Amortization of net unrealized losses on securities transferred from available-for-sale to held-to-maturity realized in net income, net of tax of $1 million and $3 million, respectively(2)
3

 
5

Total other comprehensive income (loss) for period
(137
)
 
22

Balance at end of period
(707
)
 
(222
)
Unrealized gains (losses) on fair value option liabilities attributable to our own credit spread:
 
 
 
Balance at beginning of period
118

 
86

Other comprehensive income (loss) for period:
 
 
 
Net unrealized losses arising during the period, net of tax of $(15) million and $(26) million, respectively
(47
)
 
(45
)
Total other comprehensive loss for period
(47
)
 
(45
)
Balance at end of period
71

 
41

Unrealized gains (losses) on derivatives designated as cash flow hedges:
 
 
 
Balance at beginning of period
(187
)
 
(159
)
Other comprehensive income (loss) for period:
 
 
 
Net unrealized gains (losses) arising during period, net of tax of $5 million and $(2) million, respectively
18

 
(2
)
Reclassification adjustment for losses realized in net income, net of tax of $2 million and $2 million, respectively(3)
4

 
4

Total other comprehensive income for period
22

 
2

Balance at end of period
(165
)
 
(157
)
Pension and postretirement benefit liability:
 
 
 
Balance at beginning and end of period
3

 
—

Total accumulated other comprehensive loss at end of period
$
(798
)
 
$
(338
)
 
 
 
 

40

HSBC USA Inc.

Nine Months Ended September 30,
2018
 
2017
 
(in millions)
Unrealized gains (losses) on investment securities:
 
 
 
Balance at beginning of period
$
(250
)
 
$
(461
)
Cumulative effective adjustment to initially apply new accounting guidance for equity investments which were previously classified as available-for-sale, net of tax of $2 million(4)
4

 
—

Cumulative effective adjustment to initially apply new accounting guidance for stranded tax effects resulting from Tax Legislation(4)
(53
)
 
—

Balance at beginning of period, adjusted
(299
)
 
(461
)
Other comprehensive income (loss) for period:
 
 
 
Net unrealized gains (losses) arising during period, net of tax of $(131) million and $147 million, respectively
(409
)
 
244

Reclassification adjustment for gains realized in net income, net of tax of $(2) million and $(11) million, respectively(1)
(8
)
 
(18
)
Amortization of net unrealized losses on securities transferred from available-for-sale to held-to-maturity realized in net income, net of tax of $3 million and $8 million, respectively(2)
9

 
13

Total other comprehensive income (loss) for period
(408
)
 
239

Balance at end of period
(707
)
 
(222
)
Unrealized gains (losses) on fair value option liabilities attributable to our own credit spread:
 
 
 
Balance at beginning of period
(19
)
 
—

Cumulative effective adjustment to initially apply new accounting guidance for stranded tax effects resulting from Tax Legislation(4)
(4
)
 
—

Cumulative effect adjustment to initially apply new accounting guidance for financial liabilities measured under the fair value option, net of tax of $103 million(5)
—

 
174

Balance at beginning of period, adjusted
(23
)
 
174

Other comprehensive income (loss) for period:
 
 
 
Net unrealized gains (losses) arising during period, net of tax of $31 million and $(78) million, respectively
94

 
(133
)
Total other comprehensive income (loss) for period
94

 
(133
)
Balance at end of period
71

 
41

Unrealized gains (losses) on derivatives designated as cash flow hedges:
 
 
 
Balance at beginning of period
(164
)
 
(157
)
Cumulative effective adjustment to initially apply new accounting guidance for stranded tax effects resulting from Tax Legislation(4)
(35
)
 
—

Balance at beginning of period, adjusted
(199
)
 
(157
)
Other comprehensive income (loss) for period:
 
 
 
Net unrealized gains (losses) arising during period, net of tax of $7 million and $(6) million, respectively
23

 
(7
)
Reclassification adjustment for losses realized in net income, net of tax of $4 million and $4 million, respectively(3)
11

 
7

Total other comprehensive income for period
34

 
—

Balance at end of period
(165
)
 
(157
)
Pension and postretirement benefit liability:
 
 
 
Balance at beginning of period
2

 
—

Cumulative effective adjustment to initially apply new accounting guidance for stranded tax effects resulting from Tax Legislation(4)
1

 
—

Balance at beginning of period, adjusted
3

 
—

Other comprehensive income (loss) for period:
 
 
 
Change in unfunded pension and postretirement liability, net of tax of less than $1 million and less than $1 million, respectively
—

 
—

Total other comprehensive income for period
—

 
—

Balance at end of period
3

 
—

Total accumulated other comprehensive loss at end of period
$
(798
)
 
$
(338
)
 
(1) 
Amount reclassified to net income is included in other securities gains (losses), net in our consolidated statement of income.
(2) 
Amount amortized to net income is included in interest income in our consolidated statement of income. During 2014, we transferred securities from available-for-sale to held-to-maturity. At the date of transfer, AOCI included net pretax unrealized losses of $234 million related to the transferred securities which are being amortized over the remaining contractual life of each security as an adjustment of yield in a manner consistent with the amortization of any premium or discount.
(3)
Amount reclassified to net income is included in interest income (expense) in our consolidated statement of income.
(4)
See Note 21, "New Accounting Pronouncements," for additional discussion.
(5) 
See Note 2, "Summary of Significant Accounting Polices and New Accounting Pronouncements," in our 2017 Form 10-K for additional discussion.

41

HSBC USA Inc.

12. Pension and Other Postretirement Benefits
 
Defined Benefit Pension Plan The table below reflects the portion of pension expense and its related components of the combined
HSBC North America Pension Plan (either the "HSBC North America Pension Plan" or the "Plan") which has been allocated to us and is recorded in our consolidated statement of income. We have not been allocated any portion of the Plan's net pension liability.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,

2018
 
2017
 
2018
 
2017
 
(in millions)
Interest cost on projected benefit obligation
$
16

 
$
18

 
$
46

 
$
54

Expected return on plan assets
(20
)
 
(22
)
 
(60
)
 
(65
)
Amortization of net actuarial loss
5

 
7

 
15

 
25

Administrative costs
1

 
1

 
3

 
3

Pension expense
$
2

 
$
4

 
$
4

 
$
17

Postretirement Plans Other Than Pensions  Our employees also participate in plans which provide medical and life insurance benefits to retirees and eligible dependents. These plans cover substantially all employees who meet certain age and vested service requirements. We have instituted dollar limits on payments under the plans to control the cost of future medical benefits. The following table reflects the components of the net periodic postretirement benefit cost:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,

2018
 
2017
 
2018
 
2017
 
(in millions)
Interest cost on accumulated benefit obligation
$
—

 
$
—

 
$
1

 
$
1

Net periodic postretirement benefit cost
$
—

 
$
—

 
$
1

 
$
1



42

HSBC USA Inc.

13. Fee Income from Contracts with Customers
 
The following table summarizes fee income from contracts with customers disaggregated by type of activity, as well as a reconciliation to total other revenues, during the three and nine months ended September 30, 2018 and 2017. Following the table is a description of the various types of fee-based activities and how revenue associated with these activities is recognized.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
(in millions)
Credit card fees, net
$
12

 
$
12

 
$
38

 
$
37

Trust and investment management fees
31

 
39

 
103

 
116

Other fees and commissions:
 
 
 
 
 
 
 
Account services
68

 
68

 
206

 
205

Credit facilities
90

 
81

 
254

 
224

Custodial fees
3

 
5

 
8

 
16

Other fees
10

 
13

 
47

 
47

Total other fees and commissions
171

 
167

 
515

 
492

Servicing and other fees from HSBC affiliates
103

 
77

 
289

 
272

Insurance(1)
3

 
4

 
9

 
11

Total fee income from contracts with customers
320

 
299

 
954

 
928

Other non-fee revenues
166

 
94

 
582

 
616

Total other revenues(2)
$
486

 
$
393

 
$
1,536

 
$
1,544

 
(1) 
Included within other income (loss) in the consolidated statement of income.
(2) 
See Note 15, "Business Segments," for a reconciliation of total other revenues on a U.S. GAAP basis to other operating income for each business segment under the Group Reporting Basis.
Credit card fees, net Credit card fees, net includes interchange fees earned from merchants who accept our cards in connection with the purchase of their goods and/or services. These fees are recognized when we satisfy the performance obligation by simultaneously approving a card holder's purchase at the point of sale and remitting payment to the merchant. We recognized interchange fees of $22 million and $65 million during the three and nine months ended September 30, 2018, respectively, compared with $20 million and $59 million during the three and nine months ended September 30, 2017, respectively. Annual fees on credit cards, net of direct lending costs, are billed upfront and recognized on a straight-line basis over one year. Other credit card fees such as cash advance and over-limit fees are transaction based and are recognized and billed at the point in time the transaction occurs which is when the performance obligation is met. Costs related to our credit card rewards program vary based on multiple factors including card holder activity, card holder reward redemption rates and card holder reward selections. These costs are recorded when the rewards are earned by the customer and are presented as a reduction to credit card fees. Credit card rewards program costs totaled $11 million and $32 million during the three and nine months ended September 30, 2018, respectively, compared with $10 million and $26 million during the three and nine months ended September 30, 2017, respectively.
Trust and investment management fees Trust and investment management fees include investment management and administration fees which are typically billed as a percentage of the average value of a customer's assets during an agreed payment period or for some contracts, the value of a customer's assets at the end of an agreed payment period and therefore represent variable consideration. The fee percentage and payment period are agreed with the customer upfront. Generally, payment periods are monthly or quarterly and coincide with our reporting periods, thereby resolving the uncertainty of the variable consideration by the reporting date. For payment periods that do not coincide with our reporting periods, judgment is required to estimate the fee and determine the amount to include in an accrual. An accrual is only recorded to the extent it is highly probable that a significant reversal of revenue will not occur. In most cases, a significant reversal of revenue is not highly probable. Other trust and investment management fees are transaction based and are recognized and billed at the point in time the transaction occurs which is when the performance obligation is met. From time to time, we may also receive performance fees from some funds, though these fees are typically only recognized when the performance fee is determinable and the uncertainty of the variable consideration is resolved.
Account services We provide services for commercial and consumer customer accounts that generate fees from various activities including: accounts statements, ATM transactions, cash withdrawals, wire transfers, check cashing, debit cards and internet and phone banking. The fees for these services are established in the customer account agreement and are either billed individually at the time the service is performed or on a monthly basis for a package or bundle of services as the services are performed. The performance obligation for these services is met when the services are performed. Customer account agreements typically include

43

HSBC USA Inc.

a package of services with multiple performance obligations or a bundle of services making up a single performance obligation. In the case of a package of services, the pattern of transfer to the customer is usually the same for all services, and therefore the package of services is treated as a single performance obligation. In some cases, a package or bundle of services is billed upfront as an annual fee and recognized on a straight-line basis over one year as the services are performed and the performance obligation is met.
Credit facilities Credit facilities fees include fees generated from lending activities that are not included in the direct loan origination fees which are recognized in interest income as an adjustment to yield. This includes fees associated with loan commitments, revolving credit facilities, standby letters of credit, loan syndication and other transaction based fees. These fees are either billed as a fixed price or as a percentage of the approved lending limit or transaction value. The fee percentage is agreed with the customer upfront. Although the percentage-based fees represent variable consideration, the uncertainty of the variable consideration is resolved by the time the revenue is recognized as the lending limit or transaction value is known on the contract or transaction date. Loan syndication fees received for managing a syndication and other transaction based fees are recognized and billed at the point in time the transaction occurs, which is when the performance obligation is met. Fees associated with loan commitments, revolving credit facilities and standby letters of credit are billed upfront and recognized on a straight-line basis over the period the service is performed which is when the performance obligation is met (e.g., the commitment period). In the event a loan commitment or standby letter of credit is exercised, the remaining unamortized fee is recognized as an adjustment to yield over the loan term.
Custodial fees We earn fees from providing customers with custody services, including the safekeeping of financial assets and the processing and servicing of those assets. These fees are typically recognized and billed on a monthly basis over the period the service is performed which is when the performance obligation is met, as a percentage of the value of the customer's assets held in custody (calculated daily or monthly). The fee percentage is agreed with the customer upfront.
Other fees and commissions Other fees and commissions include fees received associated with various other activities such as remittances, imports/exports, clearing and other miscellaneous services. These fees are typically transaction based and are recognized and billed at the point in time the transaction occurs which is when the performance obligation is met.
Servicing and other fees from HSBC affiliates We receive fees from other HSBC affiliates for providing them with various banking, wealth management and other miscellaneous services as well as support for certain administrative and global business activities. These fees are reported in servicing and other fees from HSBC affiliates and are typically recognized and billed on a monthly basis over the period the service is performed or for some fees that are transaction based, at the point in time the transaction occurs, which is when the performance obligation is met. See Note 14, "Related Party Transactions," for additional information regarding the various services provided and other transactions with HSBC affiliates.
Insurance We earn commissions from the sale of third-party insurance policies which are typically recognized on a weekly or monthly basis, when the policy goes into effect which is when the performance obligation is met.
Deferred Fee Income
Information related to deferred fee income on loan commitments, revolving credit facilities and standby letters of credit is included in Note 18, "Guarantee Arrangements, Pledged Assets and Repurchase Agreements," and Note 19, "Fair Value Measurements." Excluding these items, we had deferred fee income related to certain account service fees that are paid upfront and recognized over the service period and annual fees on credit cards which collectively totaled $2 million and $1 million at September 30, 2018 and December 31, 2017, respectively. We expect to recognize this revenue over a remaining period of one year or less.
Other than as described above under trust and investment management fees, we do not use significant judgments in the determination of the amount and timing of fee income from contracts with customers. Additionally, costs to obtain or fulfill contracts with customers were immaterial.


44

HSBC USA Inc.

14. Related Party Transactions
 
In the normal course of business, we conduct transactions with HSBC and its subsidiaries. HSBC policy requires that these transactions occur at prevailing market rates and terms and include funding arrangements, derivative transactions, servicing arrangements, information technology support, centralized support services, banking and other miscellaneous services and where applicable, these transactions are compliant with United States banking regulations. All extensions of credit by (and certain credit exposures of) HSBC Bank USA, National Association ("HSBC Bank USA") to other HSBC affiliates (other than Federal Deposit Insurance Corporation ("FDIC") insured banks) are legally required to be secured by eligible collateral. The following tables and discussions below present the more significant related party balances and the income (expense) generated by related party transactions:
 
September 30, 2018
 
December 31, 2017
 
(in millions)
Assets:
 
 
 
Cash and due from banks
$
284

 
$
191

Interest bearing deposits with banks
309

 
473

Securities purchased under agreements to resell(1)
—

 
1,115

Trading assets
94

 
63

Loans
1,557

 
6,750

Other(2)
330

 
134

Total assets
$
2,574

 
$
8,726

Liabilities:
 
 
 
Deposits
$
14,189

 
$
10,521

Trading liabilities
174

 
737

Short-term borrowings
710

 
1,595

Long-term debt
4,844

 
4,841

Other(2)
271

 
387

Total liabilities
$
20,188

 
$
18,081

 
(1) 
Reflects purchases of securities which other HSBC affiliates have agreed to repurchase.
(2) 
Other assets and other liabilities primarily consist of derivative balances associated with hedging activities and other miscellaneous account receivables and payables.

45

HSBC USA Inc.

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
(in millions)
Income (Expense):
 
 
 
 
 
 
 
Interest income
$
26

 
$
16

 
$
72

 
$
51

Interest expense
(96
)
 
(72
)
 
(264
)
 
(208
)
Net interest expense
(70
)
 
(56
)
 
(192
)
 
(157
)
Trading revenue (expense)
(504
)
 
—

 
27

 
(806
)
Servicing and other fees from HSBC affiliates:(1)
 
 
 
 
 
 
 
HSBC Bank plc
48

 
35

 
132

 
110

HSBC Markets (USA) Inc. ("HMUS")
31

 
18

 
92

 
53

HSBC Finance Corporation ("HSBC Finance")
2

 
3

 
4

 
40

Other HSBC affiliates
22

 
21

 
61

 
69

Total servicing and other fees from HSBC affiliates
103

 
77

 
289

 
272

Gain (loss) on instruments designated at fair value and related derivatives
241

 
347

 
(62
)
 
871

Support services from HSBC affiliates:(1)
 
 
 
 
 
 
 
HSBC Technology & Services (USA) ("HTSU")
(301
)
 
(277
)
 
(909
)
 
(872
)
HMUS
(22
)
 
(30
)
 
(78
)
 
(90
)
Other HSBC affiliates
(76
)
 
(71
)
 
(228
)
 
(199
)
Total support services from HSBC affiliates
(399
)
 
(378
)
 
(1,215
)
 
(1,161
)
Rental income from HSBC affiliates, net(1)(2)
10

 
13

 
36

 
41

Stock based compensation expense(3)
(6
)
 
(8
)
 
(21
)
 
(26
)
 
(1) 
During the fourth quarter of 2017, we changed our presentation for certain cost reimbursements that were previously netted as an offset to affiliate expense and began presenting these reimbursements gross in affiliate income for consistency in presentation across similar transactions. Separately, we also concluded that rental revenue we receive from our affiliates for rent on certain office space would be better presented as a reduction to occupancy expense as opposed to a reduction to affiliate expense. As a result, we have reclassified prior period amounts in order to conform to the current year presentation, which increased servicing and other fees from HSBC affiliates by $25 million and $86 million, respectively, increased support services from HSBC affiliates by $38 million and $127 million, respectively, and increased rental income from HSBC affiliates, net by $13 million and $41 million, respectively, during the three and nine months ended September 30, 2017. Reported net income for the three and nine months ended September 30, 2017 remained unaffected.
(2) 
We receive rental revenue from our affiliates, and in some cases pay rental expense to our affiliates, for rent on certain office space. Net rental income from our affiliates is recorded as a component of occupancy expense, net in our consolidated statement of income.
(3) 
Employees may participate in one or more stock compensation plans sponsored by HSBC. These expenses are included in salaries and employee benefits in our consolidated statement of income. Certain employees are also eligible to participate in a defined benefit pension plan and other postretirement plans sponsored by HSBC North America which are discussed in Note 12, "Pension and Other Postretirement Benefits."
During the nine months ended September 30, 2018, our results were impacted by an immaterial out of period adjustment which increased servicing and other fees from HSBC affiliates by approximately $10 million in connection with costs reimbursements related to prior years.
Funding Arrangements with HSBC Affiliates:
We use HSBC affiliates to fund a portion of our borrowing and liquidity needs. At both September 30, 2018 and December 31, 2017, long-term debt with affiliates reflected $4.9 billion of floating rate borrowings from HSBC North America. The outstanding balances include $2.0 billion of senior debt which matures in August 2021, $0.9 billion of subordinated debt which matures in May 2025 and $2.0 billion of senior debt which matures in August 2026.
We have a $150 million uncommitted line of credit with HSBC North America. There was no outstanding balance under this credit facility at either September 30, 2018 or December 31, 2017.
We have also incurred short-term borrowings with certain affiliates, largely securities sold under repurchase agreements with HSBC Securities (USA) Inc. ("HSI"). In addition, certain affiliates have also placed deposits with us.

46

HSBC USA Inc.

Lending and Derivative Related Arrangements Extended to HSBC Affiliates:
At September 30, 2018 and December 31, 2017, we have the following loan balances outstanding with HSBC affiliates:
 
September 30, 2018
 
December 31, 2017
 
(in millions)
HMUS and subsidiaries
$
1,000

 
$
6,690

HSBC Bank Canada
450

 
—

Other short-term affiliate lending
107

 
60

Total loans
$
1,557

 
$
6,750

HMUS and subsidiaries We have extended loans and lines, some of them uncommitted, to HMUS and its subsidiaries in the amount of $7.9 billion at both September 30, 2018 and December 31, 2017 of which $1.0 billion and $6.7 billion, respectively, was outstanding. The maturities of the outstanding balances range from overnight to three months. Each borrowing is re-evaluated prior to its maturity date and either extended or allowed to mature. Included in the outstanding borrowings at December 31, 2017 was a $5.0 billion overnight loan to HSI that was repaid in early January as the wire process from HSI to settle daily activity failed.
HSBC Bank Canada During 2018, we extended an uncommitted line of credit to HSBC Bank Canada in the amount of $500 million, of which $450 million was outstanding at September 30, 2018. The outstanding balance matures in November 2018.
We have extended lines of credit to various other HSBC affiliates totaling $3.2 billion which did not have any outstanding balances at either September 30, 2018 and December 31, 2017.
Other short-term affiliate lending In addition to loans and lines extended to affiliates discussed above, from time to time we may extend loans to affiliates which are generally short term in nature. At September 30, 2018 and December 31, 2017, there were $107 million and $60 million, respectively, of these loans outstanding.
HSBC Finance During the first quarter of 2017, we received $28 million of loan prepayment fees from HSBC Finance associated with the payoff of their loan, which were included in servicing and other fees from HSBC affiliates.
As part of a global HSBC strategy to offset interest rate or other market risks associated with certain securities, debt issues and derivative contracts with unaffiliated third parties, we routinely enter into derivative transactions with HSBC Bank plc and other HSBC affiliates. The notional value of derivative contracts related to these transactions was approximately $801.0 billion and $768.4 billion at September 30, 2018 and December 31, 2017, respectively. The net credit exposure (defined as the net fair value of derivative assets and liabilities, including any collateral received) related to the contracts was approximately $81 million and $64 million at September 30, 2018 and December 31, 2017, respectively. Our Global Banking and Markets business accounts for these transactions on a mark to market basis, with the change in value of contracts with HSBC affiliates substantially offset by the change in value of related contracts entered into with unaffiliated third parties.
Services Provided Between HSBC Affiliates:
Under multiple service level agreements, we provide services to and receive services from various HSBC affiliates. The following summarizes these activities:
•
HSBC North America's technology and support services, including risk management, compliance, operations, finance, tax, legal, human resources, corporate affairs and other shared services, are centralized within HTSU. HTSU also provides certain item processing and statement processing activities to us. The fees we pay HTSU for the centralized support services and processing activities are included in support services from HSBC affiliates. We also receive fees from HTSU for providing certain administrative services to them. The fees we receive from HTSU are included in servicing and other fees from HSBC affiliates. In certain cases, for facilities used by HTSU, we may guarantee their performance under the lease agreements.
•
We use other subsidiaries of HSBC, including HSBC Global Services Limited an HSBC subsidiary located outside of the United States, to provide various support services to our operations, including among other areas, information technology, software development, customer service, collection, risk management and accounting. The expenses related to these services are included in support services from HSBC affiliates.
•
We utilize HSI, a subsidiary of HMUS, for broker dealer, debt underwriting, customer referrals, loan syndication and other treasury and traded markets related services, pursuant to service level agreements. Debt underwriting fees charged by HSI are deferred as a reduction of long-term debt and amortized to interest expense over the life of the related debt. Fees charged by HSI for the other services are included in support services from HSBC affiliates. We also receive fees from HSI for providing certain wealth management services to them. The fees we receive from HSI are included in servicing and other fees from HSBC affiliates.

47

HSBC USA Inc.

•
We receive fees from other subsidiaries of HSBC, including HSBC Bank plc, for providing them with banking and other miscellaneous services as well as support for certain administrative and global business activities. These fees are reported in servicing and other fees from HSBC affiliates.
•
Prior to 2018, we received residential mortgage loan servicing fees from HSBC Finance for services performed on their behalf and paid residential mortgage loan servicing fees to HSBC Finance for services performed on our behalf. The fees we received from HSBC Finance were reported in servicing and other fees from HSBC affiliates. During 2017, HSBC Finance completed the execution of their receivable sales program and, as a result, we are no longer servicing residential mortgage loans for HSBC Finance. Fees we paid to HSBC Finance were reported in support services from HSBC affiliates. This included fees paid for the servicing of residential mortgage loans that we previously purchased from HSBC Finance. During 2017, we sold these residential mortgage loans to third parties.
Other Transactions with HSBC Affiliates
At both September 30, 2018 and December 31, 2017, we had $1,265 million of non-cumulative preferred stock issued and outstanding to HSBC North America. See Note 17, "Preferred Stock," in our 2017 Form 10-K for additional details.

15. Business Segments
 
We have five distinct business segments that we utilize for management reporting and analysis purposes, which are aligned with HSBC's global business strategy: Retail Banking and Wealth Management ("RBWM"), Commercial Banking ("CMB"), Global Banking and Markets ("GB&M"), Private Banking ("PB") and a Corporate Center ("CC"). There have been no changes in the basis of our segmentation as compared with the presentation in our 2017 Form 10-K.
Our segment results are presented in accordance with HSBC Group accounting and reporting policies, which apply IFRSs as issued by the IASB and endorsed by the EU, and, as a result, our segment results are prepared and presented using financial information prepared on the Group Reporting Basis as operating results are monitored and reviewed, trends are evaluated and decisions about allocating resources, such as employees, are primarily made on this basis. We continue, however, to monitor capital adequacy and report to regulatory agencies on a U.S. GAAP basis.
As discussed more fully below, during the first quarter of 2018, we adopted new accounting guidance under the Group Reporting Basis for the requirements of IFRS 9, "Financial Instruments" ("IFRS 9"), and we also implemented a change in accounting policy under the Group Reporting Basis to classify structured notes and deposits as liabilities designated under the fair value option. There have been no additional changes in the measurement of segment profit as compared with the presentation in our 2017 Form 10-K.
A summary of differences between U.S. GAAP and the Group Reporting Basis as they impact our results are presented in Note 22, "Business Segments," in our 2017 Form 10-K. Other than the changes discussed below, there have been no other significant changes since December 31, 2017 in the differences between U.S. GAAP and the Group Reporting Basis impacting our results.
Expected credit losses / loan impairment - In January 2018, we adopted new accounting guidance under the Group Reporting Basis in conjunction with HSBC’s adoption of the requirements of IFRS 9 on January 1, 2018 with the exception of the provisions relating to the presentation of gains and losses on financial instruments designated at fair value which were previously adopted in 2017.
Under IFRS 9, expected credit losses ("ECL") are recognized for a) financial assets measured at amortized cost, including loans, securities purchased under agreements to resell and certain debt securities; b) financial assets measured at fair value with changes in fair value recorded through other comprehensive income (loss), primarily debt securities; and c) certain loan commitments and financial guarantee contracts. Financial assets which have not experienced a significant increase in credit risk since initial recognition are considered to be in ‘stage 1’; financial assets which are considered to have experienced a significant increase in credit risk are in ‘stage 2’; and financial assets for which there is objective evidence of impairment so are considered to be in default or otherwise credit-impaired are in ‘stage 3’. At initial recognition and for financial assets that remain in stage 1, an allowance (or provision in the case of some loan commitments and financial guarantees) is required for ECL resulting from default events that are possible within the next 12 months ('12-month ECL'). In the event of a significant increase in credit risk, an allowance (or provision) is required for ECL resulting from all possible default events over the expected life of the financial instrument ('lifetime ECL') and financial assets are moved to stage 2 or stage 3.
The adoption of the new accounting guidance on January 1, 2018 on our customer loan portfolio resulted in an increase to our customer loan allowance for ECL of approximately $60 million with a corresponding charge to equity under the Group Reporting Basis. The impact of adoption on the allowance for other financial assets was not significant.
Structured notes and deposits - Structured notes and deposits have historically been classified as trading liabilities under the Group Reporting Basis and carried at fair value with changes in fair value recorded in earnings. Beginning January 1, 2018, HSBC

48

HSBC USA Inc.

concluded that a change in accounting policy and presentation from trading liabilities to liabilities designated under the fair value option for structured notes and deposits under the Group Reporting Basis would be appropriate since it would better align with the presentation of similar financial instruments by peers under IFRSs and therefore provide more relevant information about the effect of these financial liabilities on reported financial position and performance. As a result, the fair value movement on structured notes and deposits attributable to our own credit spread is now being recorded in other comprehensive income (loss) under the Group Reporting Basis, consistent with U.S. GAAP. During the three and nine months ended September 30, 2017, total other revenues under the Group Reporting Basis in GB&M included losses of $46 million and $69 million, respectively, from the fair value movement on structured notes and deposits attributable to our own credit spread.
The following table summarizes the results for each segment on a Group Reporting Basis, as well as provides a reconciliation of total results under the Group Reporting Basis to U.S. GAAP consolidated totals:
 
Group Reporting Basis Consolidated Amounts
 
 
 
 
 
 
 
RBWM
 
CMB
 
GB&M
 
PB
 
CC
 
Adjustments/
Reconciling
Items
 
Total
 
Group Reporting Basis
Adjustments(5)
 
Group Reporting Basis
Reclassi-
fications(6)
 
U.S. GAAP
Consolidated
Totals
 
(in millions)
Three Months Ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income(1)
$
223

 
$
206

 
$
157

 
$
42

 
$
17

 
$
—

 
$
645

 
$
(2
)
 
$
(84
)
 
$
559

Other operating income
75

 
56

 
195

 
17

 
70

 
—

 
413

 
(15
)
 
88

 
486

Total operating income
298

 
262

 
352

 
59

 
87

 
—

 
1,058

 
(17
)
 
4

 
1,045

Expected credit losses / provision for credit losses
10

 
(4
)
 
(30
)
 
(1
)
 
(1
)
 
—

 
(26
)
 
47

 
(1
)
 
20

 
288

 
266

 
382

 
60

 
88

 
—

 
1,084

 
(64
)
 
5

 
1,025

Operating expenses(2)
317

 
150

 
203

 
59

 
55

 
—

 
784

 
1

 
5

 
790

Profit (loss) before income tax expense
$
(29
)
 
$
116

 
$
179

 
$
1

 
$
33

 
$
—

 
$
300

 
$
(65
)
 
$
—

 
$
235

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income(1)
$
231

 
$
187

 
$
131

 
$
56

 
$
(10
)
 
$
—

 
$
595

 
$
(9
)
 
$
(26
)
 
$
560

Other operating income(3)
65

 
55

 
125

 
31

 
33

 
—

 
309

 
61

 
23

 
393

Total operating income
296

 
242

 
256

 
87

 
23

 
—

 
904

 
52

 
(3
)
 
953

Loan impairment charges / provision for credit losses
11

 
(8
)
 
(18
)
 
(2
)
 
1

 
—

 
(16
)
 
1

 
(7
)
 
(22
)
 
285

 
250

 
274

 
89

 
22

 
—

 
920

 
51

 
4

 
975

Operating expenses(2)(3)
292

 
142

 
214

 
67

 
103

 
—

 
818

 
(2
)
 
4

 
820

Profit (loss) before income tax expense
$
(7
)
 
$
108

 
$
60

 
$
22

 
$
(81
)
 
$
—

 
$
102

 
$
53

 
$
—

 
$
155

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income(1)
$
664

 
$
587

 
$
457

 
$
132

 
$
50

 
$
—

 
$
1,890

 
$
12

 
$
(236
)
 
$
1,666

Other operating income
239

 
169

 
644

 
53

 
225

 
—

 
1,330

 
(35
)
 
241

 
1,536

Total operating income
903

 
756

 
1,101

 
185

 
275

 
—

 
3,220

 
(23
)
 
5

 
3,202

Expected credit losses / provision for credit losses
16

 
(50
)
 
(187
)
 
(4
)
 
3

 
—

 
(222
)
 
114

 
12

 
(96
)
 
887

 
806

 
1,288

 
189

 
272

 
—

 
3,442

 
(137
)
 
(7
)
 
3,298

Operating expenses(2)
983

 
440

 
628

 
181

 
641

 
—

 
2,873

 
(8
)
 
(7
)
 
2,858

Profit (loss) before income tax expense
$
(96
)
 
$
366

 
$
660

 
$
8

 
$
(369
)
 
$
—

 
$
569

 
$
(129
)
 
$
—

 
$
440

Balances at end of period:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
$
18,977

 
$
25,289

 
$
76,194

 
$
6,742

 
$
78,421

 
$
—

 
$
205,623

 
$
(31,621
)
 
$
—

 
$
174,002

Total loans, net(4)
16,814

 
24,126

 
17,464

 
5,656

 
1,306

 
—

 
65,366

 
(829
)
 
1,684

 
66,221

Goodwill
581

 
358

 
—

 
321

 
—

 
—

 
1,260

 
347

 
—

 
1,607

Total deposits(4)
32,051

 
22,440

 
29,777

 
8,167

 
5,211

 
—

 
97,646

 
(3,441
)
 
17,885

 
112,090


49

HSBC USA Inc.

 
Group Reporting Basis Consolidated Amounts
 
 
 
 
 
 
 
RBWM
 
CMB
 
GB&M
 
PB
 
CC
 
Adjustments/
Reconciling
Items
 
Total
 
Group Reporting Basis
Adjustments(5)
 
Group Reporting Basis
Reclassi-
fications(6)
 
U.S. GAAP
Consolidated
Totals
 
(in millions)
Nine Months Ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income(1)
$
665

 
$
548

 
$
439

 
$
165

 
$
(9
)
 
$
—

 
$
1,808

 
$
(38
)
 
$
(31
)
 
$
1,739

Other operating income(3)
451

 
159

 
436

 
73

 
205

 
—

 
1,324

 
190

 
30

 
1,544

Total operating income
1,116

 
707

 
875

 
238

 
196

 
—

 
3,132

 
152

 
(1
)
 
3,283

Loan impairment charges / provision for credit losses
17

 
(49
)
 
(55
)
 
1

 
—

 
—

 
(86
)
 
(47
)
 
13

 
(120
)
 
1,099

 
756

 
930

 
237

 
196

 
—

 
3,218

 
199

 
(14
)
 
3,403

Operating expenses(2)(3)
865

 
422

 
686

 
191

 
338

 
—

 
2,502

 
—

 
(14
)
 
2,488

Profit (loss) before income tax expense
$
234

 
$
334

 
$
244

 
$
46

 
$
(142
)
 
$
—

 
$
716

 
$
199

 
$
—

 
$
915

Balances at end of period:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
$
18,968

 
$
24,154

 
$
90,779

 
$
7,684

 
$
90,262

 
$
—

 
$
231,847

 
$
(33,961
)
 
$
—

 
$
197,886

Total loans, net
16,781

 
22,959

 
18,843

 
5,900

 
3,751

 
—

 
68,234

 
(1,039
)
 
(401
)
 
66,794

Goodwill
581

 
358

 
—

 
321

 
—

 
—

 
1,260

 
347

 
—

 
1,607

Total deposits
34,275

 
23,919

 
21,628

 
9,737

 
8,394

 
—

 
97,953

 
(3,874
)
 
27,761

 
121,840

 
(1)
Net interest income of each segment represents the difference between actual interest earned on assets and interest incurred on liabilities of the segment adjusted for a funding charge or credit. Segments are charged a cost to fund assets (e.g., customer loans) and receive a funding credit for funds provided (e.g., customer deposits) based on equivalent market rates. The objective of these charges/credits is to transfer interest rate risk from the segments to one centralized unit in Balance Sheet Management and more appropriately reflect the profitability of the segments.
(2)
Expenses for the segments include fully apportioned corporate overhead expenses.
(3) 
During the fourth quarter of 2017, we changed our presentation for certain cost reimbursements that were previously netted as an offset to affiliate expense and began presenting these reimbursements gross in affiliate income. As a result, we have reclassified prior period amounts in order to conform to the current year presentation, which increased both RBWM other operating income and RBWM operating expenses $11 million and $35 million and also increased both GB&M other operating income and GB&M operating expenses $14 million and $51 million during the three and nine months ended September 30, 2017, respectively. See Note 14, "Related Party Transactions," for additional information.
(4) 
In addition to the changes discussed above, in conjunction with HSBC's adoption of the requirements of IFRS 9 we also adopted changes in presentation under the Group Reporting Basis related to affiliate loans and deposits as well as cash collateral posted and received. Beginning January 1, 2018, affiliate loans have been reclassified from other assets to loans, affiliate deposits have been reclassified from other liabilities to deposits, cash collateral posted has been reclassified from loans to other assets and cash collateral received has been reclassified from deposits to other liabilities. As a result of these changes, total loans, net and total deposits in the GB&M segment increased $0.2 billion and $8.6 billion, respectively, and total loans, net and total deposits in the CC segment decreased $2.0 billion and $1.5 billion, respectively, at September 30, 2018.
(5) 
Represents adjustments associated with differences between U.S. GAAP and the Group Reporting Basis.
(6) 
Represents differences in financial statement presentation between U.S. GAAP and the Group Reporting Basis.

16. Retained Earnings and Regulatory Capital Requirements
 
Bank dividends are one of the sources of funds used for payment of shareholder dividends and other HSBC USA cash needs. Approval from the Office of the Comptroller of the Currency ("the OCC") is required if the total of all dividends HSBC Bank USA declares in any year exceeds the cumulative net income for that year, combined with the net income for the two preceding years reduced by dividends attributable to those years, or if the dividend resulted in a reduction of permanent capital. Under a separate restriction, payment of dividends is prohibited in amounts greater than undivided profits then on hand, after deducting actual losses and bad debts. Bad debts are debts due and unpaid for a period of six months unless well secured, as defined, and in the process of collection.
HSBC Bank USA is also required to maintain reserve balances either in the form of vault cash or on deposit with the Federal Reserve Bank, based on a percentage of deposits. At September 30, 2018 and December 31, 2017, HSBC Bank USA was required to maintain $2,085 million and $2,929 million, respectively, of reserve balances with the Federal Reserve Bank which are reported within interest bearing deposits with banks on the consolidated balance sheet.

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HSBC USA Inc.

The following table summarizes the capital amounts and ratios of HSBC USA and HSBC Bank USA, calculated in accordance with banking regulations in effect at September 30, 2018 and December 31, 2017:
 
September 30, 2018
 
December 31, 2017
  
Capital
Amount
 
Well-Capitalized 
Ratio(1)
 
Actual
Ratio
 
Capital
Amount
 
Well-Capitalized
Ratio(1)
 
Actual
Ratio
 
(dollars are in millions)
Common equity Tier 1 ratio:
 
 
 
 
 
 
 
 
 
 
 
HSBC USA
$
17,180

 
4.5
%
(2) 
13.8
%
 
$
17,428

 
4.5
%
(2) 
14.2
%
HSBC Bank USA
19,106

 
6.5

 
15.6

 
19,294

 
6.5

 
16.7

Tier 1 capital ratio:
 
 
 
 
 
 
 
 
 
 
 
HSBC USA
18,445

 
6.0

 
14.8

 
18,696

 
6.0

 
15.3

HSBC Bank USA
21,606

 
8.0

 
17.7

 
21,786

 
8.0

 
18.8

Total capital ratio:
 
 
 
 
 
 
 
 
 
 
 
HSBC USA
21,686

 
10.0

 
17.4

 
22,565

 
10.0

 
18.4

HSBC Bank USA
24,936

 
10.0

 
20.4

 
25,522

 
10.0

 
22.1

Tier 1 leverage ratio:
 
 
 
 
 
 
 
 
 
 
 
HSBC USA
18,445

 
4.0

(2) 
10.7

 
18,696

 
4.0

(2) 
9.9

HSBC Bank USA
21,606

 
5.0

 
12.7

 
21,786

 
5.0

 
11.7

Supplementary leverage ratio ("SLR"):
 
 
 
 
 
 
 
 
 
 
 
HSBC USA
18,445

 
3.0

(3) 
7.5

 
 
 
 
 
N/A

HSBC Bank USA
21,606

 
3.0

(3) 
8.9

 
 
 
 
 
N/A

Risk-weighted assets:
 
 
 
 
 
 
 
 
 
 
 
HSBC USA
124,671

 
 
 
 
 
122,584

 
 
 
 
HSBC Bank USA
122,357

 
 
 
 
 
115,667

 
 
 
 
Adjusted quarterly average assets:(4)
 
 
 
 
 
 
 
 
 
 
 
HSBC USA
171,890

 
 
 
 
 
188,774

 
 
 
 
HSBC Bank USA
170,132

 
 
 
 
 
186,551

 
 
 
 
Total leverage exposure:(5)
 
 
 
 
 
 
 
 
 
 
 
HSBC USA
245,987

 
 
 
 
 
N/A

 
 
 
 
HSBC Bank USA
242,992

 
 
 
 
 
N/A

 
 
 
 
 
(1) 
HSBC USA and HSBC Bank USA are categorized as "well-capitalized," as defined by their principal regulators. To be categorized as well-capitalized under regulatory guidelines, a banking institution must have the ratios reflected in the above table, and must not be subject to a directive, order, or written agreement to meet and maintain specific capital levels.
(2) 
There are no common equity Tier 1 or Tier 1 leverage ratio components in the definition of a well-capitalized bank holding company. The ratios shown are the regulatory minimum ratios.
(3) 
Beginning January 1, 2018, HSBC USA and HSBC Bank USA are required to maintain the regulatory minimum SLR of 3 percent. There is no SLR component in the definition of a well-capitalized banking institution.
(4) 
Represents the Tier 1 leverage ratio denominator which reflects quarterly average assets adjusted for amounts permitted to be deducted from Tier 1 capital.
(5) 
Represents the SLR denominator which includes adjusted quarterly average assets plus certain off-balance sheet exposures.
N/A Not Applicable
In 2013, U.S. banking regulators issued a final rule implementing the Basel III capital framework in the United States ("the Basel III rule") which, for banking organizations such as HSBC North America and HSBC Bank USA, became effective in 2014 with certain provisions being phased in over time through the beginning of 2019. As a result, the capital ratios in the table above are reported in accordance with the fully phased-in Basel III rule for September 30, 2018 and in accordance with the transition rules within the Basel III rule for December 31, 2017. In addition, risk-weighted assets in the table above are calculated using the general risk-based capital rules of the Basel III Standardized Approach.


51

HSBC USA Inc.

17. Variable Interest Entities
 
In the ordinary course of business, we have organized special purpose entities ("SPEs") primarily to structure financial products to meet our clients' investment needs, to facilitate clients to access and raise financing from capital markets and to securitize financial assets held to meet our own funding needs. For disclosure purposes, we aggregate SPEs based on the purpose, risk characteristics and business activities of the SPEs. An SPE is a VIE if it lacks sufficient equity investment at risk to finance its activities without additional subordinated financial support or, as a group, the holders of the equity investment at risk lack either a) the power through voting or similar rights to direct the activities of the entity that most significantly impacts the entity's economic performance; or b) the obligation to absorb the entity's expected losses, the right to receive the expected residual returns, or both.
Variable Interest Entities  We consolidate VIEs in which we hold a controlling financial interest as evidenced by the power to direct the activities of a VIE that most significantly impact its economic performance and the obligation to absorb losses of, or the right to receive benefits from, the VIE that could potentially be significant to the VIE and therefore are deemed to be the primary beneficiary. We take into account our entire involvement in a VIE (explicit or implicit) in identifying variable interests that individually or in the aggregate could be significant enough to warrant our designation as the primary beneficiary and hence require us to consolidate the VIE or otherwise require us to make appropriate disclosures. We consider our involvement to be potentially significant where we, among other things, (i) enter into derivative contracts to absorb the risks and benefits from the VIE or from the assets held by the VIE; (ii) provide a financial guarantee that covers assets held or liabilities issued by a VIE; (iii) sponsor the VIE in that we design, organize and structure the transaction; and (iv) retain a financial or servicing interest in the VIE.
We are required to evaluate whether to consolidate a VIE when we first become involved and on an ongoing basis. In almost all cases, a qualitative analysis of our involvement in the entity provides sufficient evidence to determine whether we are the primary beneficiary. In rare cases, a more detailed analysis to quantify the extent of variability to be absorbed by each variable interest holder is required to determine the primary beneficiary.
Consolidated VIEs  The following table summarizes assets and liabilities related to our consolidated VIEs at September 30, 2018 and December 31, 2017 which are consolidated on our balance sheet. Assets and liabilities exclude intercompany balances that eliminate in consolidation.
 
September 30, 2018
 
December 31, 2017
  
Consolidated
Assets
 
Consolidated
Liabilities
 
Consolidated
Assets
 
Consolidated
Liabilities
 
(in millions)
Low income housing limited liability partnership:
 
 
 
 
 
 
 
Other assets
$
121

 
$
—

 
$
154

 
$
—

Long-term debt
—

 
73

 
—

 
73

Interest, taxes and other liabilities
—

 
61

 
—

 
59

Total
$
121

 
$
134

 
$
154

 
$
132

Low income housing limited liability partnership  In 2009, all low income housing investments held by us at the time were transferred to a Limited Liability Partnership ("LLP") in exchange for debt and equity while a third party invested cash for an equity interest that is mandatorily redeemable at a future date. The LLP was created in order to ensure the utilization of future tax benefits from these low income housing tax projects. The LLP was deemed to be a VIE as it does not have sufficient equity investment at risk to finance its activities. Upon entering into this transaction, we concluded that we are the primary beneficiary of the LLP due to the nature of our continuing involvement and, as a result, consolidate the LLP and report the equity interest issued to the third party investor in other liabilities and the assets of the LLP in other assets on our consolidated balance sheet. The investments held by the LLP represent equity investments in the underlying low income housing partnerships. The LLP does not consolidate the underlying partnerships because it does not have the power to direct the activities of the partnerships that most significantly impact the economic performance of the partnerships.
As a practical expedient, we amortize our low income housing investments in proportion to the allocated tax benefits under the proportional amortization method and present the associated tax benefits net of investment amortization in income tax expense.

52

HSBC USA Inc.

Unconsolidated VIEs  We also have variable interests in other VIEs that are not consolidated because we are not the primary beneficiary. The following table provides additional information on these unconsolidated VIEs, including the variable interests held by us and our maximum exposure to loss arising from our involvements in these VIEs, at September 30, 2018 and December 31, 2017:
 
Total Assets Held by Unconsolidated VIEs
 
Carrying Value of Variable Interests Held Reported as
 
Maximum
Exposure
to Loss
 
 
Assets
 
Liabilities
 
 
(in millions)
At September 30, 2018
 
 
 
 
 
 
 
Structured note vehicles
$
3,023

 
$
1,803

 
$
10

 
$
3,013

Limited partnership investments
1,582

 
460

 
286

 
460

Total
$
4,605

 
$
2,263

 
$
296

 
$
3,473

At December 31, 2017
 
 
 
 
 
 
 
Structured note vehicles
$
3,019

 
$
1,803

 
$
6

 
$
3,013

Limited partnership investments
1,566

 
412

 
262

 
412

Refinancing SPE
412

 
116

 
—

 
116

Total
$
4,997

 
$
2,331

 
$
268

 
$
3,541

Information on the types of variable interest entities with which we are involved, the nature of our involvement and the variable interests held in those entities is presented below.
Structured note vehicles  We provide derivatives, such as interest rate and currency swaps, to structured note vehicles and, in certain instances, invest in the vehicles' debt instruments. We hold variable interests in these structured note vehicles in the form of total return swaps under which we take on the risks and benefits of the structured notes they issue. The same risks and benefits are passed on to third party entities through back-end total return swaps. We earn a spread for facilitating the transaction. Since we do not have the power to direct the activities of the VIE and are not the primary beneficiary, we do not consolidate them. Our maximum exposure to loss is the notional amount of the derivatives wrapping the structured notes. The maximum exposure to loss of $3,013 million at September 30, 2018 will occur in the unlikely scenario where the value of the structured notes is reduced to zero and, at the same time, the counterparty of the back-end swap defaults with zero recovery. In certain instances, we hold credit default swaps with the structured note vehicles under which we receive credit protection on specified reference assets in exchange for the payment of a premium. Through these derivatives, the vehicles assume the credit risk associated with the reference assets which are then passed on to the holders of the debt instruments they issue. Because they create rather than absorb variability, the credit default swaps we hold are not considered variable interests. We record all investments in, and derivative contracts with, unconsolidated structured note vehicles at fair value on our consolidated balance sheet.
Limited partnership investments We invest as a limited partner in partnerships that operate qualified affordable housing, renewable energy and community development projects. The returns of these investments are generated primarily from the tax benefits, including Federal tax credits and tax deductions from operating losses in the project companies. In addition, some of the investments also help us comply with the Community Reinvestment Act. Certain limited partnership structures are considered to be VIEs because either (a) they do not have sufficient equity investment at risk or (b) the limited partners with equity at risk do not have substantive kick-out rights through voting rights or substantive participating rights over the general partner. As a limited partner, we are not the primary beneficiary of the VIEs and do not consolidate them. Our investments in these partnerships are recorded in other assets on the consolidated balance sheet. The maximum exposure to loss shown in the table above represents our recorded investments.
Refinancing SPE Prior to the second quarter of 2018, we organized and provided loans to a SPE to purchase a senior secured financing facility from the originator designed to finance a third party borrower's acquisition of a portfolio of commercial real estate loans in Mexico. During the second quarter of 2018, the loans we provided to the SPE were repaid in full and the SPE was terminated.
Third-party sponsored securitization entities  We invest in asset-backed securities issued by third party sponsored securitization entities which may be considered VIEs. The investments are transacted at arm's-length and decisions to invest are based on a credit analysis of the underlying collateral assets or the issuer. We are a passive investor in these issuers and do not have the power to direct the activities of these issuers. As such, we do not consolidate these securitization entities. Additionally, we do not have other involvements in servicing or managing the collateral assets or provide financial or liquidity support to these issuers which potentially give rise to risk of loss exposure. These investments are an integral part of the disclosure in Note 2, "Trading Assets and Liabilities," Note 3, "Securities," and Note 19, "Fair Value Measurements," and, therefore, are not disclosed in this note to avoid redundancy.

53

HSBC USA Inc.

18. Guarantee Arrangements, Pledged Assets and Repurchase Agreements
 
Guarantee Arrangements As part of our normal operations, we enter into credit derivatives and various off-balance sheet guarantee arrangements with affiliates and third parties. These arrangements arise principally in connection with our lending and client intermediation activities and include standby letters of credit and certain credit derivative transactions. The contractual amounts of these arrangements represent our maximum possible credit exposure in the event that we are required to fulfill the maximum obligation under the contractual terms of the guarantee.
The following table presents total carrying value and contractual amounts of our sell protection credit derivatives and major off-balance sheet guarantee arrangements at September 30, 2018 and December 31, 2017. Following the table is a description of the various arrangements.
 
September 30, 2018
 
December 31, 2017
  
Carrying
Value
 
Notional / Maximum
Exposure to Loss
 
Carrying
Value
 
Notional / Maximum
Exposure to Loss
 
(in millions)
Credit derivatives(1)(2)
$
(74
)
 
$
47,729

 
$
303

 
$
42,328

Financial standby letters of credit, net of participations(3)(4)
—

 
5,216

 
—

 
5,128

Performance standby letters of credit, net of participations(3)(4)
—

 
3,640

 
—

 
3,580

Total
$
(74
)
 
$
56,585

 
$
303

 
$
51,036

 
(1) 
Includes $24,051 million and $25,639 million of notional issued for the benefit of HSBC affiliates at September 30, 2018 and December 31, 2017, respectively.
(2) 
For credit derivatives, the maximum loss is represented by the notional amounts without consideration of mitigating effects from collateral or recourse arrangements.
(3) 
Includes $1,245 million and $1,264 million of both financial and performance standby letters of credit issued for the benefit of HSBC affiliates at September 30, 2018 and December 31, 2017, respectively.
(4) 
For standby letters of credit, maximum loss represents losses to be recognized assuming the letters of credit have been fully drawn and the obligors have defaulted with zero recovery.
Credit-Risk Related Guarantees
Credit derivatives  Credit derivatives are financial instruments that transfer the credit risk of a reference obligation from the credit protection buyer to the credit protection seller who is exposed to the credit risk without buying the reference obligation. We sell credit protection on underlying reference obligations (such as loans or securities) by entering into credit derivatives, primarily in the form of credit default swaps, with various institutions. We account for all credit derivatives at fair value. Where we sell credit protection to a counterparty that holds the reference obligation, the arrangement is effectively a financial guarantee on the reference obligation. Under a credit derivative contract, the credit protection seller will reimburse the credit protection buyer upon occurrence of a credit event (such as bankruptcy, insolvency, restructuring or failure to meet payment obligations when due) as defined in the derivative contract, in return for a periodic premium. Upon occurrence of a credit event, we will pay the counterparty the stated notional amount of the derivative contract and receive the underlying reference obligation. The recovery value of the reference obligation received could be significantly lower than its notional principal amount when a credit event occurs.
Certain derivative contracts are subject to master netting arrangements and related collateral agreements. A party to a derivative contract may demand that the counterparty post additional collateral in the event its net exposure exceeds certain predetermined limits and when the credit rating falls below a certain grade. We set the collateral requirements by counterparty such that the collateral covers various transactions and products, and is not allocated to specific individual contracts.

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HSBC USA Inc.

We manage our exposure to credit derivatives using a variety of risk mitigation strategies where we enter into offsetting hedge positions or transfer the economic risks, in part or in entirety, to investors through the issuance of structured credit products. We actively manage the credit and market risk exposure in the credit derivative portfolios on a net basis and, as such, retain no or a limited net position at any time. The following table summarizes our net credit derivative positions at September 30, 2018 and December 31, 2017:
 
September 30, 2018
 
December 31, 2017
  
Carrying / Fair
Value
 
Notional
 
Carrying / Fair
Value
 
Notional
 
(in millions)
Sell-protection credit derivative positions
$
(74
)
 
$
47,729

 
$
303

 
$
42,328

Buy-protection credit derivative positions
127

 
53,369

 
(188
)
 
47,962

Net position(1)
$
53

 
$
5,640

 
$
115

 
$
5,634

 
(1) 
Positions are presented net in the table above to provide a complete analysis of our risk exposure and depict the way we manage our credit derivative portfolio. The offset of the sell-protection credit derivatives against the buy-protection credit derivatives may not be legally binding in the absence of master netting agreements with the same counterparty. Furthermore, the credit loss triggering events for individual sell protection credit derivatives may not be the same or occur in the same period as those of the buy protection credit derivatives thereby not providing an exact offset.
Standby letters of credit  A standby letter of credit is issued to a third party for the benefit of a client and is a guarantee that the client will perform or satisfy certain obligations under a contract. It irrevocably obligates us to pay a specified amount to the third party beneficiary if the client fails to perform the contractual obligation. We issue two types of standby letters of credit: performance and financial. A performance standby letter of credit is issued where the client is required to perform some non-financial contractual obligation, such as the performance of a specific act, whereas a financial standby letter of credit is issued where the client's contractual obligation is of a financial nature, such as the repayment of a loan or debt instrument. At September 30, 2018, the total amount of outstanding financial standby letters of credit (net of participations) and performance guarantees (net of participations) were $5,216 million and $3,640 million, respectively. At December 31, 2017, the total amount of outstanding financial standby letters of credit (net of participations) and performance guarantees (net of participations) were $5,128 million and $3,580 million, respectively.
The issuance of a standby letter of credit is subject to our credit approval process and collateral requirements. We charge fees for issuing letters of credit commensurate with the client's credit evaluation and the nature of any collateral. Included in other liabilities are deferred fees on standby letters of credit amounting to $44 million and $48 million at September 30, 2018 and December 31, 2017, respectively. Also included in other liabilities is an allowance for credit losses on unfunded standby letters of credit of $19 million and $26 million at September 30, 2018 and December 31, 2017, respectively.
The following table summarizes the credit ratings related to guarantees including the ratings of counterparties against which we sold credit protection and financial standby letters of credit at September 30, 2018 as an indicative proxy of payment risk:
 
Average
Life
(in years)
 
Credit Ratings of the Obligors or the Transactions
Notional/Contractual Amounts
Investment
Grade
 
Non-Investment
Grade
 
Total
 
 
 
(dollars are in millions)
Sell-protection Credit Derivatives(1)
 
 
 
 
 
 
 
Single name credit default swaps ("CDS")
3.1
 
$
26,016

 
$
8,384

 
$
34,400

Index credit derivatives
4.4
 
7,224

 
4,540

 
11,764

Total return swaps
2.7
 
1,291

 
274

 
1,565

Subtotal
 
 
34,531

 
13,198

 
47,729

Standby Letters of Credit(2)
1.2
 
7,490

 
1,366

 
8,856

Total
 
 
$
42,021

 
$
14,564

 
$
56,585

 
(1) 
The credit ratings in the table represent external credit ratings for classification as investment grade and non-investment grade.
(2) 
External ratings for most of the obligors are not available. Presented above are the internal credit ratings which are developed using similar methodologies and rating scale equivalent to external credit ratings for purposes of classification as investment grade and non-investment grade.
Our internal credit ratings are determined based on HSBC's risk rating systems and processes which assign a credit grade based on a scale which ranks the risk of default of a client. The credit grades are assigned and used for managing risk and determining level of credit exposure appetite based on the client's operating performance, liquidity, capital structure and debt service ability.

55

HSBC USA Inc.

In addition, we also incorporate subjective judgments into the risk rating process concerning such things as industry trends, comparison of performance to industry peers and perceived quality of management. We compare our internal risk ratings to outside external rating agency benchmarks, where possible, at the time of formal review and regularly monitor whether our risk ratings are comparable to the external ratings benchmark data.
A non-investment grade rating of a referenced obligor has a negative impact to the fair value of the credit derivative and increases the likelihood that we will be required to perform under the credit derivative contract. We employ market-based parameters and, where possible, use the observable credit spreads of the referenced obligors as measurement inputs in determining the fair value of the credit derivatives. We believe that such market parameters are more indicative of the current status of payment/performance risk than external ratings by the rating agencies which may not be forward-looking in nature and, as a result, lag behind those market-based indicators.
Non Credit-Risk Related Guarantees and Other Arrangements
Visa covered litigation  In 2008, we received Class B Shares as part of Visa's initial public offering ("IPO"). Pursuant to the IPO, we, along with all the other Class B shareholders, agreed to indemnify Visa for the claims and obligations arising from certain specific covered litigation. The Class B Shares are not eligible to be converted into publicly traded Class A Shares until settlement of the covered litigation described in Note 27, "Litigation and Regulatory Matters," in our 2017 Form 10-K and in Note 20, "Litigation and Regulatory Matters," in our Form 10-Q for the six month period ended June 30, 2018. Accordingly, the Class B Shares are considered restricted and are only transferable under limited circumstances, which include transfers to other Class B shareholders.
Beginning in late 2016 and into 2017, we sold substantially all of our remaining Visa Class B Shares to a third party. The net pre-tax gains associated with these sales (which included net pre-tax gains of approximately $312 million during the nine months ended September 30, 2017) were recorded as a component of other income (loss) in the consolidated statement of income. Under the terms of the sale agreements, we entered into swap agreements with the purchaser to retain the litigation risk associated with the Class B Shares sold until the related litigation is settled and the Class B Shares can be converted into Class A Shares. These swaps had a carrying value of $51 million and $52 million at September 30, 2018 and December 31, 2017, respectively. The swap agreements we entered into with the purchaser requires us to (a) make periodic payments, calculated by reference to the market price of Class A Shares and (b) make or receive payments based on subsequent changes in the conversion rate of Class B Shares into Class A Shares. In the third quarter of 2017, we entered into a total return swap position to economically hedge the periodic payments made under these swap agreements. The payments under the derivative will continue until the Class B Shares are able to be converted into Class A Shares. During the second quarter of 2018, we recorded a loss of $7 million related to a change in the Visa Class B Share conversion rate announced by Visa as a result of the outstanding litigation. The fair value of the swap agreements is estimated using a discounted cash flow methodology and is dependent upon the final resolution of the related litigation. Changes in fair value between periods are recognized in other income (loss). See Note 9, "Derivative Financial Instruments," for further information.
Clearing houses and exchanges  We are a member of various exchanges and clearing houses that trade and clear securities and/or derivatives contracts. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, members of a clearing house may be required to contribute to a guaranty fund to backstop members' obligations to the clearing house. As a member, we may be required to pay a proportionate share of the financial obligations of another member who defaults on its obligations to the exchange or the clearing house. Our guarantee obligations would arise only if the exchange or clearing house had exhausted its resources. Any potential contingent liability under these membership agreements cannot be estimated.
Mortgage Loan Repurchase Obligations  We have provided various representations and warranties related to the origination and sale of mortgage loans including, among other things, the ownership of the loans, the validity of the liens, the loan selection and origination process, and the compliance to the origination criteria established by the government agencies. In the event of a breach of our representations and warranties, we may be obligated to repurchase the loans with identified defects or to indemnify the buyers. Our contractual obligation arises only when the breach of representations and warranties are discovered and repurchase is demanded. From 2013 to 2017, agency-eligible mortgage loan originations were sold directly to PHH Mortgage and PHH Mortgage is responsible for origination representations and warranties for all loans purchased. With the insourcing of our mortgage fulfillment operations, effective with applications starting January 2, 2018, we are now responsible for origination representations and warranties for all new agency-eligible mortgage loan originations sold to third parties.
In estimating our repurchase liability arising from breaches of representations and warranties, we consider historical losses on residual risks not covered by settlement agreements adjusted for any risk factors not captured in the historical losses as well as the level of outstanding repurchase demands received. Outstanding repurchase demands received totaled $2 million and $3 million at September 30, 2018 and December 31, 2017, respectively.

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HSBC USA Inc.

The following table summarizes the change in our estimated repurchase liability during the three and nine months ended September 30, 2018 and 2017 for obligations arising from the breach of representations and warranties associated with mortgage loans sold:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
(in millions)
Balance at beginning of period
$
9

 
$
11

 
$
10

 
$
12

Decrease in liability recorded through earnings
—

 
—

 
(1
)
 
(1
)
Realized losses
(1
)
 
(1
)
 
(1
)
 
(1
)
Balance at end of period
$
8

 
$
10

 
$
8

 
$
10

Our repurchase liability of $8 million at September 30, 2018 represents our best estimate of the loss that has been incurred, including interest, arising from breaches of representations and warranties associated with mortgage loans sold. Because the level of mortgage loan repurchase losses is dependent upon economic factors, investor demand strategies and other external risk factors such as housing market trends that may change, the level of the liability for mortgage loan repurchase losses requires significant judgment. We continue to evaluate our methods of determining the best estimate of loss based on recent trends. As these estimates are influenced by factors outside our control, there is uncertainty inherent in these estimates making it reasonably possible that they could change. The range of reasonably possible losses in excess of our recorded repurchase liability is between zero and $25 million at September 30, 2018. This estimated range of reasonably possible losses was determined based upon modifying the assumptions utilized in our best estimate of probable losses to reflect what we believe to be reasonably possible adverse assumptions.
Securitization Activity  In addition to the repurchase risk described above, we have also been involved as a sponsor/seller of loans used to facilitate whole loan securitizations underwritten by our affiliate, HSI. In this regard, we began acquiring residential mortgage loans in 2005 which were warehoused on our balance sheet with the intent of selling them to HSI to facilitate HSI's whole loan securitization program which was discontinued in 2007. During 2005-2007, we purchased and sold $24 billion of such loans to HSI which were subsequently securitized and sold by HSI to third parties. See "Mortgage Securitization Matters" in Note 27, "Litigation and Regulatory Matters," in our 2017 Form 10-K and in Note 20, "Litigation and Regulatory Matters," in this Form 10-Q for additional discussion of related exposure. The outstanding principal balance on these loans was approximately $3.8 billion and $4.1 billion at September 30, 2018 and December 31, 2017, respectively.
Pledged Assets
Pledged assets included in the consolidated balance sheet consisted of the following:
 
September 30, 2018
 
December 31, 2017
 
(in millions)
Interest bearing deposits with banks
$
2,485

 
$
2,952

Trading assets(1)
2,664

 
3,185

Securities available-for-sale(2)
8,110

 
7,210

Securities held-to-maturity(2)
1,797

 
2,131

Loans(3) 
17,348

 
17,404

Other assets(4)
2,091

 
2,253

Total
$
34,495

 
$
35,135

 
(1) 
Trading assets are primarily pledged against liabilities associated with repurchase agreements.
(2) 
Securities are primarily pledged against derivatives, public fund deposits, trust deposits and various short-term and long term borrowings, as well as providing capacity for potential secured borrowings from the FHLB and the Federal Reserve Bank of New York.
(3) 
Loans are primarily residential mortgage loans pledged against current and potential borrowings from the FHLB and the Federal Reserve Bank of New York.
(4) 
Other assets represent cash on deposit with non-banks related to derivative collateral support agreements.
Debt securities pledged as collateral under repurchase agreements that can be sold or repledged by the secured party continue to be reported on the consolidated balance sheet. The fair value of securities available-for-sale that could be sold or repledged was $1,990 million and $524 million at September 30, 2018 and December 31, 2017, respectively. The fair value of trading assets that could be sold or repledged was $2,664 million and $3,185 million at September 30, 2018 and December 31, 2017, respectively.

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HSBC USA Inc.

The fair value of collateral we accepted under security resale agreements but was not reported on the consolidated balance sheet was $8,468 million and $34,759 million at September 30, 2018 and December 31, 2017, respectively, discussed further below. Of this collateral, $7,368 million and $32,459 million could be sold or repledged at September 30, 2018 and December 31, 2017, respectively, of which $910 million and $1,231 million, respectively, had been sold or repledged as collateral under repurchase agreements or to cover short sales.
Repurchase Agreements
We enter into purchases of securities under agreements to resell (resale agreements) and sales of securities under agreements to repurchase (repurchase agreements) identical or substantially the same securities. Resale and repurchase agreements are accounted for as secured lending and secured borrowing transactions, respectively.
Repurchase agreements may require us to deposit cash or other collateral with the lender. In connection with resale agreements, it is our policy to obtain possession of collateral, which may include the securities purchased, with market value in excess of the principal amount loaned. The market value of the collateral subject to the resale and repurchase agreements is regularly monitored, and additional collateral is obtained or provided when appropriate, to ensure appropriate collateral coverage of these secured financing transactions.
The following table provides information about resale and repurchase agreements that are subject to offset at September 30, 2018 and December 31, 2017:
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Balance Sheet
 
 
 
Gross Amounts Recognized
 
Gross Amounts Offset in the Balance Sheet(1)
 
Net Amounts Presented in the Balance Sheet
 
Financial Instruments(2)
 
Cash Collateral Received / Pledged
 
Net Amount(3)
 
(in millions)
At September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
Securities purchased under resale agreements
$
7,639

 
$
2,960

 
$
4,679

 
$
4,675

 
$
—

 
$
4

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Securities sold under repurchase agreements
$
5,432

 
$
2,960

 
$
2,472

 
$
2,449

 
$
—

 
$
23

 
 
 
 
 
 
 
 
 
 
 
 
At December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
Securities purchased under resale agreements
$
33,974

 
$
1,356

 
$
32,618

 
$
32,616

 
$
—

 
$
2

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Securities sold under repurchase agreements
$
4,721

 
$
1,356

 
$
3,365

 
$
3,364

 
$
—

 
$
1

 
(1) 
Represents recognized amount of resale and repurchase agreements with counterparties subject to legally enforceable netting agreements that meet the applicable netting criteria as permitted by generally accepted accounting principles.
(2) 
Represents securities received or pledged to cover financing transaction exposures.
(3) 
Represents the amount of our exposure that is not collateralized / covered by pledged collateral.

58

HSBC USA Inc.

The following table provides the class of collateral pledged and remaining contractual maturity of repurchase agreements accounted for as secured borrowings at September 30, 2018 and December 31, 2017:
 
Overnight and Continuous
 
Up to 30 Days
 
31 to 90 Days
 
91 Days to One Year
 
Greater Than One Year
 
Total
 
(in millions)
At September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury, U.S. Government sponsored and U.S. Government agency securities
$
3,621

 
$
149

 
$
73

 
$
466

 
$
1,000

 
$
5,309

Foreign debt securities
—

 
123

 
—

 
—

 
—

 
123

Total repurchase agreements accounted for as secured borrowings
$
3,621

 
$
272

 
$
73

 
$
466

 
$
1,000

 
$
5,432

 
 
 
 
 
 
 
 
 
 
 
 
At December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury, U.S. Government sponsored and U.S. Government agency securities
$
1,166

 
$
838

 
$
888

 
$
284

 
$
1,464

 
$
4,640

Foreign debt securities
—

 
81

 
—

 
—

 
—

 
81

Total repurchase agreements accounted for as secured borrowings
$
1,166

 
$
919

 
$
888

 
$
284

 
$
1,464

 
$
4,721



59

HSBC USA Inc.

19. Fair Value Measurements
 
Accounting principles related to fair value measurements provide a framework for measuring fair value that focuses on the exit price that would be received to sell an asset or paid to transfer a liability in the principal market (or in the absence of the principal market, the most advantageous market) accessible in an orderly transaction between willing market participants (the "Fair Value Framework"). Where required by the applicable accounting standards, assets and liabilities are measured at fair value using the "highest and best use" valuation premise. Fair value measurement guidance clarifies that financial instruments do not have alternative use and, as such, the fair value of financial instruments should be determined using an "in-exchange" valuation premise. However, the fair value measurement literature provides a valuation exception and permits an entity to measure the fair value of a group of financial assets and financial liabilities with offsetting credit risks and/or market risks based on the exit price it would receive or pay to transfer the net risk exposure of a group of assets or liabilities if certain conditions are met. We elected to apply the measurement exception to a group of derivative instruments with offsetting credit risks and market risks, which primarily relate to interest rate, foreign currency, debt and equity price risk, and commodity price risk as of the reporting date.
Fair Value Adjustments  The best evidence of fair value is quoted market price in an actively traded market, where available. In the event listed price or market quotes are not available, valuation techniques that incorporate relevant transaction data and market parameters reflecting the attributes of the asset or liability under consideration are applied. Where applicable, fair value adjustments are made to ensure the financial instruments are appropriately recorded at fair value. The fair value adjustments reflect the risks associated with the products, contractual terms of the transactions, and the liquidity of the markets in which the transactions occur. The fair value adjustments are broadly categorized by the following major types:
Credit risk adjustment - The credit risk adjustment is an adjustment to a group of financial assets and financial liabilities, predominantly derivative assets and derivative liabilities, to reflect the credit quality of the parties to the transaction in arriving at fair value. A credit valuation adjustment to a financial asset is required to reflect the default risk of the counterparty. A debit valuation adjustment to a financial liability is recorded to reflect the default risk of HUSI. See "Valuation Techniques - Derivatives" below for additional details.
Liquidity risk adjustment - The liquidity risk adjustment (primarily in the form of bid-offer adjustment) reflects the cost that would be incurred to close out the market risks by hedging, disposing or unwinding the position. Valuation models generally produce mid-market values. The bid-offer adjustment is made in such a way that results in a measure that reflects the exit price that most represents the fair value of the financial asset or financial liability under consideration or, where applicable, the fair value of the net market risk exposure of a group of financial assets or financial liabilities. These adjustments relate primarily to Level 2 assets.
Model valuation adjustment - Where fair value measurements are determined using an internal valuation model based on observable and unobservable inputs, certain valuation inputs may be less readily determinable. There may be a range of possible valuation inputs that market participants may assume in determining the fair value measurement. The resultant fair value measurement has inherent measurement risk if one or more parameters are unobservable and must be estimated. An input valuation adjustment is necessary to reflect the likelihood that market participants may use different input parameters, and to mitigate the possibility of measurement error. In addition, the values derived from valuation techniques are affected by the choice of valuation model and model limitation. When different valuation techniques are available, the choice of valuation model can be subjective. Furthermore, the valuation model applied may have measurement limitations. In those cases, an additional valuation adjustment is also applied to mitigate the measurement risk. Model valuation adjustments are not material and relate primarily to Level 2 instruments.
We apply stress scenarios in determining appropriate liquidity risk and model risk adjustments for Level 3 fair values by reviewing the historical data for unobservable inputs (e.g., correlation, volatility). Some stress scenarios involve at least a 95 percent confidence interval (i.e., two standard deviations). We also utilize unobservable parameter adjustments when instruments are valued using internally developed models which reflects the uncertainty in the value estimates provided by the model.
Funding Fair Value Adjustment ("FFVA") - The FFVA reflects the estimated present value of the future market funding cost or benefit associated with funding uncollateralized derivative exposure at rates other than the Overnight Indexed Swap ("OIS") rate. See "Valuation Techniques - Derivatives" below for additional details.
Fair Value Hierarchy  The Fair Value Framework establishes a three-tiered fair value hierarchy as follows:
Level 1 quoted market price - Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2 valuation technique using observable inputs - Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are inactive, and measurements determined using valuation models where all significant inputs are observable, such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3 valuation technique with significant unobservable inputs - Level 3 inputs are unobservable inputs for the asset or liability and include situations where fair values are measured using valuation techniques based on one or more significant unobservable inputs.

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HSBC USA Inc.

Classification within the fair value hierarchy is based on whether the lowest hierarchical level input that is significant to the fair value measurement is observable. As such, the classification within the fair value hierarchy is dynamic and can be transferred to other hierarchy levels in each reporting period. Transfers between leveling categories are assessed, determined and recognized at the end of each reporting period.
Valuation Control Framework We have established a control framework which is designed to ensure that fair values are either determined or validated by a function independent of the risk-taker. To that end, the ultimate responsibility for the determination of fair values rests with Finance. Finance has established an independent price validation process to ensure that the assets and liabilities measured at fair value are properly stated.
A valuation committee, chaired by the Head of Product Control, meets monthly to review, monitor and discuss significant valuation matters arising from credit and market risks. The committee is responsible for reviewing and approving valuation policies and procedures including any valuation adjustments pertaining to, among other things, independent price verification, market liquidity, unobservable inputs, model uncertainty and counterparty credit risk. All valuation models are reviewed by the valuation committee in terms of model development, enhancements and performance. All models are independently reviewed by the Markets Independent Model Review function and applicable valuation model recommendations are reported to and discussed with the valuation committee. Significant valuation risks identified in business activities are corroborated and addressed by the committee members and, where applicable, are escalated to the Chief Financial Officer of HUSI and the Audit Committee of the Board of Directors.
Where fair value measurements are determined based on information obtained from independent pricing services or brokers, Finance applies appropriate validation procedures to substantiate fair value. For price validation purposes, quotations from at least two independent pricing sources are obtained for each financial instrument, where possible.
The following factors are considered in determining fair values:
•
similarities between the asset or the liability under consideration and the asset or liability for which quotation is received;
•
collaboration of pricing by referencing to other independent market data such as market transactions and relevant benchmark indices;
•
consistency among different pricing sources;
•
the valuation approach and the methodologies used by the independent pricing sources in determining fair value;
•
the elapsed time between the date to which the market data relates and the measurement date;
•
the source of the fair value information; and
•
whether the security is traded in an active or inactive market.
Greater weight is given to quotations of instruments with recent market transactions, pricing quotes from dealers who stand ready to transact, quotations provided by market-makers who structured such instrument and market consensus pricing based on inputs from a large number of survey participants. Any significant discrepancies among the external quotations are reviewed and adjustments to fair values are recorded where appropriate. Where the transaction volume of a specific instrument has been reduced and the fair value measurement becomes less transparent, Finance will apply more detailed procedures to understand and challenge the appropriateness of the unobservable inputs and the valuation techniques used by the independent pricing service. Where applicable, Finance will develop a fair value estimate using its own pricing model inputs to test reasonableness. Where fair value measurements are determined using internal valuation models, Finance will validate the fair value measurement by either developing unobservable inputs based on the industry consensus pricing surveys in which we participate or back testing by observing the actual settlements occurring soon after the measurement date. Any significant valuation adjustments are reported to and discussed with the valuation committee.

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HSBC USA Inc.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis  The following table presents information about our assets and liabilities measured at fair value on a recurring basis at September 30, 2018 and December 31, 2017, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value. Unless otherwise noted below, assets and liabilities in the following table are recorded at fair value through net income.
 
Fair Value Measurements on a Recurring Basis
September 30, 2018
Level 1
 
Level 2
 
Level 3
 
Gross
Balance
 
Netting(8)
 
Net
Balance
 
(in millions)
Assets:
 
 
 
 
 
 
 
 
 
 
 
Securities purchased under agreements to resell(1)
$
—

 
$
117

 
$
—

 
$
117

 
$
—

 
$
117

Trading assets, excluding derivatives:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury, U.S. Government agencies and sponsored enterprises
4,037

 
133

 
—

 
4,170

 
—

 
4,170

Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Collateralized debt obligations
—

 
—

 
112

 
112

 
—

 
112

Residential mortgages
—

 
—

 
16

 
16

 
—

 
16

Student loans
—

 
—

 
92

 
92

 
—

 
92

Corporate and other domestic debt securities
—

 
—

 
1,803

 
1,803

 
—

 
1,803

Debt securities issued by foreign entities
6,370

 
152

 
—

 
6,522

 
—

 
6,522

Equity securities
752

 
—

 
—

 
752

 
—

 
752

Precious metals trading
—

 
9,945

 
—

 
9,945

 
—

 
9,945

Derivatives:(2)
 
 
 
 
 
 
 
 
 
 
 
Interest rate contracts
3

 
9,762

 
—

 
9,765

 
—

 
9,765

Foreign exchange contracts
—

 
15,474

 
1

 
15,475

 
—

 
15,475

Equity contracts
—

 
4,172

 
74

 
4,246

 
—

 
4,246

Precious metals contracts
64

 
774

 
—

 
838

 
—

 
838

Credit contracts
—

 
874

 
75

 
949

 
—

 
949

Other contracts(3)
—

 
—

 
6

 
6

 
—

 
6

Derivatives netting
—

 
—

 
—

 
—

 
(28,046
)
 
(28,046
)
Total derivatives
67

 
31,056

 
156

 
31,279

 
(28,046
)
 
3,233

Securities available-for-sale:(4)
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury, U.S. Government agencies and sponsored enterprises
17,311

 
11,418

 
—

 
28,729

 
—

 
28,729

Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Home equity
—

 
44

 
—

 
44

 
—

 
44

Other
—

 
—

 
105

 
105

 
—

 
105

Debt securities issued by foreign entities
2,252

 
199

 
—

 
2,451

 
—

 
2,451

Loans(1)
—

 
242

 
—

 
242

 
—

 
242

Other assets:
 
 
 
 
 
 
 
 
 
 
 
Equity securities(5)
—

 
189

 
—

 
189

 
—

 
189

Equity Securities measured at net asset value(5)(6)
—

 
—

 
—

 
81

 
—

 
81

Other(7)
—

 
—

 
4

 
4

 
—

 
4

Total assets
$
30,789

 
$
53,495

 
$
2,288

 
$
86,653

 
$
(28,046
)
 
$
58,607

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Domestic deposits(1)
$
—

 
$
7,037

 
$
943

 
$
7,980

 
$
—

 
$
7,980

Trading liabilities, excluding derivatives
1,605

 
—

 
—

 
1,605

 
—

 
1,605

Derivatives:(2)
 
 
 
 
 
 
 
 
 
 
 
Interest rate contracts
145

 
10,503

 
—

 
10,648

 
—

 
10,648

Foreign exchange contracts
22

 
14,571

 
2

 
14,595

 
—

 
14,595

Equity contracts
—

 
3,313

 
64

 
3,377

 
—

 
3,377

Precious metals contracts
51

 
800

 
—

 
851

 
—

 
851

Credit contracts
—

 
905

 
11

 
916

 
—

 
916

Other contracts(3)
—

 
—

 
51

 
51

 
—

 
51

Derivatives netting
—

 
—

 
—

 
—

 
(28,130
)
 
(28,130
)
Total derivatives
218

 
30,092

 
128

 
30,438

 
(28,130
)
 
2,308

Short-term borrowings(1)
—

 
916

 
—

 
916

 
—

 
916

Long-term debt(1)
—

 
11,730

 
532

 
12,262

 
—

 
12,262

Total liabilities
$
1,823

 
$
49,775

 
$
1,603

 
$
53,201

 
$
(28,130
)
 
$
25,071


62

HSBC USA Inc.

 
Fair Value Measurements on a Recurring Basis
December 31, 2017
Level 1
 
Level 2
 
Level 3
 
Gross
Balance
 
Netting(8)
 
Net
Balance
 
(in millions)
Assets:
 
 
 
 
 
 
 
 
 
 
 
Securities purchased under agreements to resell(1)
$
—

 
$
80

 
$
—

 
$
80

 
$
—

 
$
80

Trading assets, excluding derivatives:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury, U.S. Government agencies and sponsored enterprises
3,391

 
332

 
—

 
3,723

 
—

 
3,723

Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Collateralized debt obligations
—

 
—

 
129

 
129

 
—

 
129

Residential mortgages
—

 
16

 
—

 
16

 
—

 
16

Student loans
—

 
91

 
—

 
91

 
—

 
91

Corporate and other domestic debt securities
—

 
—

 
1,803

 
1,803

 
—

 
1,803

Debt securities issued by foreign entities
4,167

 
210

 
—

 
4,377

 
—

 
4,377

Equity securities(5)
—

 
12

 
—

 
12

 
—

 
12

Precious metals trading
—

 
2,274

 
—

 
2,274

 
—

 
2,274

Derivatives:(2)
 
 
 
 
 
 
 
 
 
 
 
Interest rate contracts
6

 
24,231

 
—

 
24,237

 
—

 
24,237

Foreign exchange contracts
4

 
15,754

 
2

 
15,760

 
—

 
15,760

Equity contracts
—

 
3,911

 
173

 
4,084

 
—

 
4,084

Precious metals contracts
52

 
502

 
—

 
554

 
—

 
554

Credit contracts
—

 
536

 
120

 
656

 
—

 
656

Other contracts(3)
—

 
—

 
6

 
6

 
—

 
6

Derivatives netting
—

 
—

 
—

 
—

 
(40,874
)
 
(40,874
)
Total derivatives
62

 
44,934

 
301

 
45,297

 
(40,874
)
 
4,423

Securities available-for-sale:(4)
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury, U.S. Government agencies and sponsored enterprises
19,056

 
10,004

 
—

 
29,060

 
—

 
29,060

Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Home equity
—

 
51

 
—

 
51

 
—

 
51

Other
—

 
399

 
111

 
510

 
—

 
510

Debt securities issued by foreign entities
850

 
52

 
—

 
902

 
—

 
902

Equity securities(5)
—

 
177

 
—

 
177

 
—

 
177

Loans(1)
—

 
471

 
—

 
471

 
—

 
471

Other assets(7)
—

 
—

 
15

 
15

 
—

 
15

Total assets
$
27,526

 
$
59,103

 
$
2,359

 
$
88,988

 
$
(40,874
)
 
$
48,114

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Domestic deposits(1)
$
—

 
$
6,796

 
$
897

 
$
7,693

 
$
—

 
$
7,693

Trading liabilities, excluding derivatives
1,722

 
524

 
—

 
2,246

 
—

 
2,246

Derivatives:(2)
 
 
 
 
 
 
 
 
 
 
 
Interest rate contracts
59

 
24,379

 
—

 
24,438

 
—

 
24,438

Foreign exchange contracts
—

 
14,664

 
2

 
14,666

 
—

 
14,666

Equity contracts
—

 
2,859

 
92

 
2,951

 
—

 
2,951

Precious metals contracts
108

 
614

 
—

 
722

 
—

 
722

Credit contracts
—

 
578

 
6

 
584

 
—

 
584

Other contracts(3)
—

 
—

 
52

 
52

 
—

 
52

Derivatives netting
—

 
—

 
—

 
—

 
(40,217
)
 
(40,217
)
Total derivatives
167

 
43,094

 
152

 
43,413

 
(40,217
)
 
3,196

Short-term borrowings(1)
—

 
2,032

 
—

 
2,032

 
—

 
2,032

Long-term debt(1)
—

 
12,245

 
641

 
12,886

 
—

 
12,886

Total liabilities
$
1,889

 
$
64,691

 
$
1,690

 
$
68,270

 
$
(40,217
)
 
$
28,053

 
(1) 
See Note 10, "Fair Value Option," for additional information. Excluding the fair value movement on fair value option liabilities attributable to our own credit spread, which is recorded in other comprehensive income (loss), fair value option assets and liabilities are recorded at fair value through net income.
(2) 
Includes trading derivative assets of $3,144 million and $3,725 million and trading derivative liabilities of $2,343 million and $2,633 million at September 30, 2018 and December 31, 2017, respectively, as well as derivatives held for hedging and commitments accounted for as derivatives. See Note 9, "Derivatives," for additional information. Excluding changes in fair value of a derivative instrument associated with the effective portion of a qualifying cash flow hedge, which is recognized initially in other comprehensive income (loss), derivative assets and liabilities are recorded at fair value through net income.
(3) 
Consists of swap agreements entered into in conjunction with the sales of Visa Class B Shares.
(4) 
Securities available-for-sale are recorded at fair value through other comprehensive income (loss).

63

HSBC USA Inc.

(5) 
See Note 3, "Securities," and Note 21, "New Accounting Pronouncements," for additional information. The adoption of new accounting guidance resulted in a reclassification of certain equity investments to other assets as of January 1, 2018.
(6) 
Investments that are measured at fair value using the net asset value per share practical expedient have not been classified in the fair value hierarchy.
(7) 
Represents contingent consideration receivable associated with the sale of a portion of our Private Banking business.
(8) 
Represents counterparty and cash collateral netting which allow the offsetting of amounts relating to certain contracts if certain conditions are met.
Transfers between levels of the fair value hierarchy are recognized at the end of each reporting period.
Transfers between Level 1 and Level 2 measurements  There were no transfers between Levels 1 and 2 during the three and nine months ended September 30, 2018 and 2017.
Information on Level 3 assets and liabilities  The following table summarizes additional information about changes in the fair value of Level 3 assets and liabilities during the three and nine months ended September 30, 2018 and 2017. As a risk management practice, we may risk manage the Level 3 assets and liabilities, in whole or in part, using securities and derivative positions that are classified as Level 1 or Level 2 measurements within the fair value hierarchy. Since those Level 1 and Level 2 risk management positions are not included in the table below, the information provided does not reflect the effect of such risk management activities related to the Level 3 assets and liabilities.
 
Jul. 1,
2018
 
Total Realized / Unrealized Gains
(Losses) Included in
 
Purch-
ases
 
Issu-
ances
 
Settle-
ments
 
Transfers
Into
Level 3
 
Transfers
Out of
Level 3
 
Sep. 30,
2018
 
Current
Period
Unrealized
Gains
(Losses)
 
Earnings
 
Other Compre-hensive Income (Loss)
 
 
(in millions)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading assets, excluding derivatives:(1)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Collateralized debt obligations
$
131

 
$
4

 
$
—

 
$
—

 
$
—

 
$
(23
)
 
$
—

 
$
—

 
$
112

 
$
2

Residential mortgage asset-backed securities
—

 
—

 
—

 
—

 
—

 
—

 
16

 
—

 
16

 
—

Student loan asset-backed securities
—

 
—

 
—

 
—

 
—

 
—

 
92

 
—

 
92

 
—

Corporate and other domestic debt securities
1,803

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
1,803

 
—

Derivatives, net:(2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
(1
)
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(1
)
 
—

Equity contracts
2

 
8

 
—

 
—

 
—

 
1

 
—

 
(1
)
 
10

 
9

Credit contracts
110

 
1

 
—

 
—

 
—

 
(47
)
 
—

 
—

 
64

 
(5
)
Other contracts(3)
(51
)
 
(5
)
 
—

 
—

 
—

 
11

 
—

 
—

 
(45
)
 
—

Other asset-backed securities available-for-sale(4)
107

 
—

 
(2
)
 
—

 
—

 
—

 
—

 
—

 
105

 
(2
)
Other assets(5)
12

 
—

 
—

 
—

 
—

 
(8
)
 
—

 
—

 
4

 
—

Total assets
$
2,113

 
$
8

 
$
(2
)
 
$
—

 
$
—

 
$
(66
)
 
$
108

 
$
(1
)
 
$
2,160

 
$
4

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Domestic deposits(6)
$
(876
)
 
$
(8
)
 
$
(1
)
 
$
—

 
$
(106
)
 
$
25

 
$
(7
)
 
$
30

 
$
(943
)
 
$
(7
)
Long-term debt(6)
(557
)
 
(10
)
 
—

 
—

 
(37
)
 
29

 
—

 
43

 
(532
)
 
(7
)
Total liabilities
$
(1,433
)
 
$
(18
)
 
$
(1
)
 
$
—

 
$
(143
)
 
$
54

 
$
(7
)
 
$
73

 
$
(1,475
)
 
$
(14
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

64

HSBC USA Inc.

 
Jan. 1,
2018
 
Total Realized / Unrealized Gains
(Losses) Included in
 
Purch-
ases
 
Issu-
ances
 
Settle-
ments
 
Transfers
Into
Level 3
 
Transfers
Out of
Level 3
 
Sep. 30,
2018
 
Current
Period
Unrealized
Gains
(Losses)
 
Earnings
 
Other Compre-hensive Income (Loss)
 
 
(in millions)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading assets, excluding derivatives:(1)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Collateralized debt obligations
$
129

 
$
12

 
$
—

 
$
—

 
$
—

 
$
(29
)
 
$
—

 
$
—

 
$
112

 
$
10

Residential mortgage asset-backed securities
—

 
—

 
—

 
—

 
—

 
—

 
16

 
—

 
16

 
—

Student loan asset-backed securities
—

 
—

 
—

 
—

 
—

 
—

 
92

 
—

 
92

 
—

Corporate and other domestic debt securities
1,803

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
1,803

 
—

Derivatives, net:(2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
—

 
(1
)
 
—

 
—

 
—

 
—

 
—

 
—

 
(1
)
 
(1
)
Equity contracts
81

 
(42
)
 
—

 
—

 
—

 
(29
)
 
(1
)
 
1

 
10

 
(34
)
Credit contracts
114

 
3

 
—

 
—

 
—

 
(53
)
 
—

 
—

 
64

 
(35
)
Other contracts(3)
(46
)
 
(19
)
 
—

 
—

 
—

 
20

 
—

 
—

 
(45
)
 
—

Other asset-backed securities available-for-sale(4)
111

 
—

 
(6
)
 
—

 
—

 
—

 
—

 
—

 
105

 
(5
)
Other assets(5)
15

 
(3
)
 
—

 
—

 
—

 
(8
)
 
—

 
—

 
4

 
—

Total assets
$
2,207

 
$
(50
)
 
$
(6
)
 
$
—

 
$
—

 
$
(99
)
 
$
107

 
$
1

 
$
2,160

 
$
(65
)
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Domestic deposits(6)
$
(897
)
 
$
15

 
$
2

 
$
—

 
$
(285
)
 
$
85

 
$
(20
)
 
$
157

 
$
(943
)
 
$
16

Long-term debt(6)
(641
)
 
(4
)
 
5

 
—

 
(180
)
 
170

 
—

 
118

 
(532
)
 
10

Total liabilities
$
(1,538
)
 
$
11

 
$
7

 
$
—

 
$
(465
)
 
$
255

 
$
(20
)
 
$
275

 
$
(1,475
)
 
$
26


65

HSBC USA Inc.

 
Jul. 1,
2017
 
Total Realized / Unrealized Gains
(Losses) Included in
 
Purch-
ases
 
Issu-
ances
 
Settle-
ments
 
Transfers
Into
Level 3
 
Transfers
Out of
Level 3
 
Sep. 30,
2017
 
Current
Period
Unrealized
Gains
(Losses)
 
Earnings
 
Other Compre-hensive Income (Loss)
 
 
(in millions)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading assets, excluding derivatives:(1)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Collateralized debt obligations
$
131

 
$
2

 
$
—

 
$
—

 
$
—

 
$
(8
)
 
$
—

 
$
—

 
$
125

 
$
1

Corporate and other domestic debt securities
1,803

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
1,803

 
—

Derivatives, net:(2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate contracts
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Foreign exchange contracts
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Equity contracts
32

 
33

 
—

 
—

 
—

 
(7
)
 
—

 
(2
)
 
56

 
26

Credit contracts
143

 
(5
)
 
—

 
—

 
—

 
(23
)
 
—

 
—

 
115

 
(2
)
Other contracts(3)
(44
)
 
(5
)
 
—

 
—

 
—

 
3

 
—

 
—

 
(46
)
 
—

Other asset-backed securities available-for-sale(4)
107

 
3

 
—

 
—

 
—

 
—

 
—

 
—

 
110

 
2

Other assets(5)
—

 
15

 
—

 
—

 
—

 
—

 
—

 
—

 
15

 
15

Total assets
$
2,172

 
$
43

 
$
—

 
$
—

 
$
—

 
$
(35
)
 
$
—

 
$
(2
)
 
$
2,178

 
$
42

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Domestic deposits(6)
$
(1,142
)
 
$
(19
)
 
$
(3
)
 
$
—

 
$
(50
)
 
$
191

 
$
(4
)
 
$
82

 
$
(945
)
 
$
(17
)
Long-term debt(6)
(541
)
 
(22
)
 
(1
)
 
—

 
(44
)
 
28

 
—

 
27

 
(553
)
 
(21
)
Total liabilities
$
(1,683
)
 
$
(41
)
 
$
(4
)
 
$
—

 
$
(94
)
 
$
219

 
$
(4
)
 
$
109

 
$
(1,498
)
 
$
(38
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

66

HSBC USA Inc.

 
Jan. 1,
2017
 
Total Realized / Unrealized Gains
(Losses) Included in
 
Purch-
ases
 
Issu-
ances
 
Settle-
ments
 
Transfers
Into
Level 3
 
Transfers
Out of
Level 3
 
Sep. 30,
2017
 
Current
Period
Unrealized
Gains
(Losses)
 
Earnings
 
Other Compre-hensive Income (Loss)
 
 
(in millions)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading assets, excluding derivatives:(1)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Collateralized debt obligations
$
184

 
$
20

 
$
—

 
$
—

 
$
—

 
$
(79
)
 
$
—

 
$
—

 
$
125

 
$
6

Corporate and other domestic debt securities
2,884

 
—

 
—

 
—

 
—

 
(1,081
)
 
—

 
—

 
1,803

 
—

Derivatives, net:(2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate contracts
1

 
(1
)
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(1
)
Foreign exchange contracts
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Equity contracts
(2
)
 
72

 
—

 
—

 
—

 
(15
)
 
—

 
1

 
56

 
52

Credit contracts
193

 
(9
)
 
—

 
—

 
—

 
(69
)
 
—

 
—

 
115

 
(18
)
Other contracts(3)
(9
)
 
(7
)
 
—

 
—

 
(35
)
 
5

 
—

 
—

 
(46
)
 
—

Other asset-backed securities available-for-sale(4)
105

 
5

 
—

 
—

 
—

 
—

 
—

 
—

 
110

 
5

Other assets(5)
—

 
15

 
—

 
—

 
—

 
—

 
—

 
—

 
15

 
15

Total assets
$
3,356

 
$
95

 
$
—

 
$
—

 
$
(35
)
 
$
(1,239
)
 
$
—

 
$
1

 
$
2,178

 
$
59

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Domestic deposits(6)
$
(1,407
)
 
$
(33
)
 
$
9

 
$
—

 
$
(141
)
 
$
468

 
$
(25
)
 
$
184

 
$
(945
)
 
$
(18
)
Long-term debt(6)
(499
)
 
(62
)
 
(7
)
 
—

 
(166
)
 
106

 
(2
)
 
77

 
(553
)
 
(56
)
Total liabilities
$
(1,906
)
 
$
(95
)
 
$
2

 
$
—

 
$
(307
)
 
$
574

 
$
(27
)
 
$
261

 
$
(1,498
)
 
$
(74
)
 
(1) 
Gains (losses) on trading assets, excluding derivatives are included in trading revenue in the consolidated statement of income.
(2) 
Level 3 net derivatives included derivative assets of $156 million and derivative liabilities of $128 million at September 30, 2018 and derivative assets of $294 million and derivative liabilities of $169 million at September 30, 2017. Gains (losses) on derivatives, net are predominantly included in trading revenue in the consolidated statement of income.
(3) 
Consists of swap agreements entered into in conjunction with the sales of Visa Class B Shares.
(4) 
Realized gains (losses) on securities available-for-sale are included in other securities gains (losses), net in the consolidated statement of income. Unrealized gains (losses) on securities available-for-sale are included in other comprehensive income (loss).
(5) 
Represents contingent consideration receivable associated with the sale of a portion of our Private Banking business. Gains (losses) associated with this transaction are included in other income (loss) in the consolidated statement of income.
(6) 
Excluding unrealized gains (losses) on fair value option liabilities attributable to our own credit spread, which are recorded in other comprehensive income (loss), gains (losses) on fair value option liabilities are included in gain on instruments designated at fair value and related derivatives in the consolidated statement of income.

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The following table presents quantitative information about the unobservable inputs used to determine the recurring fair value measurement of assets and liabilities classified as Level 3 fair value measurements at September 30, 2018 and December 31, 2017:
September 30, 2018
Financial Instrument Type
 
Fair Value (in millions)
 
Valuation Technique(s)
 
Significant Unobservable Inputs
 
Range of Inputs
Collateralized debt obligations
 
$
112

 
Broker quotes or consensus pricing and, where applicable, discounted cash flows
 
Prepayment rates
 
0% - 1%
 
 
 
 
 
 
Conditional default rates
 
0% - 1%
 
 
 
 
 
 
Loss severity rates
 
90% - 95%
Residential mortgage asset-backed securities
 
$
16

 
Broker quotes or consensus pricing and, where applicable, discounted cash flows
 
Prepayment rates
 
0% - 5%
 
 
 
 
 
 
Conditional default rates
 
1% - 4%
 
 
 
 
 
 
Loss severity rates
 
80% - 85%
 
 
 
 
 
 
Discount margin
 
100bps - 250bps
Student loan asset-backed securities
 
$
92

 
Broker quotes or consensus pricing and, where applicable, discounted cash flows
 
Prepayment rates
 
7% - 10%
 
 
 
 
 
 
Conditional default rates
 
1% - 2%
 
 
 
 
 
 
Loss severity rates
 
25% - 40%
 
 
 
 
 
 
Discount margin
 
87bps -120bps
Corporate and other domestic debt securities
 
$
1,803

 
Discounted cash flows
 
Spread volatility on collateral assets
 
1% - 4%
 
 
 
 
 
 
Correlation between insurance claim shortfall and collateral value
 
80%
Foreign exchange derivative contracts(1)
 
$
(1
)
 
Option pricing model
 
Implied volatility of currency pairs
 
8% - 10%
Equity derivative contracts(1)
 
$
10

 
Option pricing model
 
Equity / Equity Index volatility
 
7% - 37%
 
 
 
 
 
 
Equity / Equity and Equity / Index correlation
 
43% - 79%
 
 
 
 
 
 
Equity dividend yields
 
0% - 7%
Credit derivative contracts
 
$
64

 
Option pricing model and, where applicable, discounted cash flows
 
Credit default swap spreads
 
67bps - 87bps
Other derivative contracts
 
$
(45
)
 
Discounted cash flows
 
Conversion rate
 
1.6 times
 
 
 
 
 
 
Expected duration
 
2 - 4 years
Other asset-backed securities available-for-sale
 
$
105

 
Discounted cash flows
 
Market assumptions related to yields for comparable instruments
 
1% - 3%
Other assets
 
$
4

 
Discounted cash flows
 
Client transfer rates based on rating
 
50% - 95%
Domestic deposits
(structured deposits)(1)(2)
 
$
(943
)
 
Option adjusted discounted cash flows
 
Implied volatility of currency pairs
 
8% - 10%
 
 
 
 
 
 
Equity / Equity Index volatility
 
7% - 35%
 
 
 
 
 
 
Equity / Equity and Equity / Index correlation
 
43% - 51%
Long-term debt (structured notes)(1)(2)
 
$
(532
)
 
Option adjusted discounted cash flows
 
Implied volatility of currency pairs
 
8% - 10%
 
 
 
 
 
 
Equity / Equity Index volatility
 
7% - 37%
 
 
 
 
 
 
Equity / Equity and Equity / Index correlation
 
44% - 79%

 

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December 31, 2017
Financial Instrument Type
 
Fair Value (in millions)
 
Valuation Technique(s)
 
Significant Unobservable Inputs
 
Range of Inputs
Collateralized debt obligations
 
$
129

 
Broker quotes or consensus pricing and, where applicable, discounted cash flows
 
Prepayment rates
 
0% - 6%
 
 
 
 
 
 
Conditional default rates
 
4% - 6%
 
 
 
 
 
 
Loss severity rates
 
55% - 60%
Corporate and other domestic debt securities
 
$
1,803

 
Discounted cash flows
 
Spread volatility on collateral assets
 
2% - 4%
 
 
 
 
 
 
Correlation between insurance claim shortfall and collateral value
 
80%
Interest rate derivative contracts
 
$
—

 
Market comparable adjusted for probability to fund
 
Probability to fund for rate lock commitments
 
41% - 100%
Foreign exchange derivative contracts(1)
 
$
—

 
Option pricing model
 
Implied volatility of currency pairs
 
6% - 9%
Equity derivative contracts(1)
 
$
81

 
Option pricing model
 
Equity / Equity Index volatility
 
7% - 42%
 
 
 
 
 
 
Equity / Equity and Equity / Index correlation
 
42% - 80%
 
 
 
 
 
 
Equity dividend yields
 
0% - 8%
Credit derivative contracts
 
$
114

 
Option pricing model and, where applicable, discounted cash flows
 
Issuer by issuer correlation of defaults
 
82% - 83%
 
 
 
 
 
 
Credit default swap spreads
 
154bps - 174bps
Other derivative contracts
 
$
(46
)
 
Discounted cash flows
 
Conversion rate
 
1.6 times
 
 
 
 
 
 
Expected duration
 
2 - 4 years
Other asset-backed securities available-for-sale
 
$
111

 
Discounted cash flows
 
Market assumptions related to yields for comparable instruments
 
1% - 3%
Other assets
 
$
15

 
Discounted cash flows
 
Client transfer rates based on rating
 
50% - 95%
Domestic deposits
(structured deposits)(1)(2)
 
$
(897
)
 
Option adjusted discounted cash flows
 
Implied volatility of currency pairs
 
6% - 9%
 
 
 
 
 
 
Equity / Equity Index volatility
 
7% - 42%
 
 
 
 
 
 
Equity / Equity and Equity / Index correlation
 
42% - 80%
Long-term debt (structured notes)(1)(2)
 
$
(641
)
 
Option adjusted discounted cash flows
 
Implied volatility of currency pairs
 
6% - 9%
 
 
 
 
 
 
Equity / Equity Index volatility
 
7% - 42%
 
 
 
 
 
 
Equity / Equity and Equity / Index correlation
 
42% - 80%
 
(1) 
We are the client-facing entity and we enter into identical but opposite derivatives to transfer the resultant risks to our affiliates. With the exception of counterparty credit risks, we are market neutral. The corresponding intra-group derivatives are presented as equity derivatives and foreign exchange derivatives in the table.
(2) 
Structured deposits and structured notes contain embedded derivative features whose fair value measurements contain significant Level 3 inputs.
Significant Unobservable Inputs for Recurring Fair Value Measurements
Collateralized Debt Obligations ("CDOs")
•
Prepayment rate - The rate at which borrowers pay off the mortgage loans early. The prepayment rate is affected by a number of factors including the location of the mortgage collateral, the interest rate type of the mortgage loans, borrowers' credit and sensitivity to interest rate movement. The prepayment rate of our portfolio is close to the mid-point of the range.
•
Default rate - Annualized percentage of default rate over a group of collateral such as residential or commercial mortgage loans. The default rate and loss severity rate are positively correlated. The default rate of our portfolio is tilted towards the higher end of the range.
•
Loss severity rate - Included in our Level 3 CDOs portfolio are trust preferred securities. The loss severity rate of the trust preferred securities is close to the mid-point of the range.
Derivatives
•
Implied volatility - The implied volatility is a significant pricing input for freestanding or embedded options including equity, foreign currency and interest rate options. The level of volatility is a function of the nature of the underlying risk, the level of strike price and the years to maturity of the option. Depending on the underlying risk and tenure, we determine the implied volatility based on observable input where information is available. However, substantially all of the implied

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volatilities are derived based on historical information. The implied volatility for different foreign currency pairs is between 8 percent and 10 percent while the implied volatility for equity/equity or equity/equity index is between 7 percent and 37 percent, respectively, at September 30, 2018. Although implied foreign currency volatility and equity volatility appear to be widely distributed at the portfolio level, the deviation of implied volatility on a trade-by-trade basis is narrower. The average deviation of implied volatility for the foreign currency pair and at-the-money equity option are 3 percent and 7 percent, respectively, at September 30, 2018.
•
Correlations of a group of foreign currency or equity - Correlation measures the relative change in values among two or more variables (i.e., equity or foreign currency pair). Variables can be positively or negatively correlated. Correlation is a key input in determining the fair value of a derivative referenced to a basket of variables such as equities or foreign currencies. A majority of the correlations are not observable, but are derived based on historical data. The correlation between equity/equity and equity/equity index was between 43 percent and 79 percent at September 30, 2018.
Sensitivity of Level 3 Inputs to Fair Value Measurements
Collateralized debt obligations - Probability of default, prepayment speed and loss severity rate are significant unobservable inputs. Significant increase (decrease) in these inputs will result in a lower (higher) fair value measurement of a collateralized debt obligation. A change in assumption for default probability is often accompanied by a directionally similar change in loss severity, and a directionally opposite change in prepayment speed.
Residential mortgage and student loan asset-backed securities - Probability of default, prepayment speed, loss severity rate and discount margin are significant unobservable inputs. Significant increase (decrease) in these inputs will result in a lower (higher) fair value measurement of the securities. A change in assumption for default probability is often accompanied by a directionally similar change in loss severity, and a directionally opposite change in prepayment speed.
Corporate and domestic debt securities - The fair value measurement of certain corporate debt securities is affected by the fair value of the underlying portfolios of investments used as collateral and the make-whole guarantee provided by third party guarantors. The probability that the collateral fair value declines below the collateral call threshold concurrent with the guarantors' failure to perform its make whole obligation is unobservable. The increase (decrease) in the probability the collateral value falls below the collateral call threshold is often accompanied by a directionally similar change in default probability of the guarantor.
Credit derivatives - Correlation of default among a basket of reference credit names is a significant unobservable input if the credit attributes of the portfolio are not within the parameters of relevant standardized CDS indices. Significant increase (decrease) in the default correlation will result in a lower (higher) fair value measurement of the credit derivative. A change in assumption for default correlation is often accompanied by a directionally similar change in default probability and loss rates of other credit names in the basket. For certain credit derivatives, the credit spreads of credit default swap contracts insuring asset backed securities is a significant unobservable input. Significant increase (decrease) in the credit spreads will result in a lower (higher) fair value measurement of the credit derivative.
Equity and foreign exchange derivatives - The fair value measurement of a structured equity or foreign exchange derivative is primarily affected by the implied volatility of the underlying equity price or exchange rate of the paired foreign currencies. The implied volatility is not observable. Significant increase (decrease) in the implied volatility will result in a higher (lower) fair value of a long position in the derivative contract.
Other derivatives - The fair value of the swap agreements we entered into in conjunction with the sales of Visa Class B Shares is dependent upon the final resolution of the related litigation. Significant unobservable inputs used in the fair value measurement include estimated changes in the conversion rate of Visa Class B Shares into Visa Class A Shares and the expected timing of the final resolution. An increase (decrease) in the loss estimate or in the timing of the resolution of the related litigation would result in a higher (lower) fair value measurement of the derivative.
Other asset-backed securities available-for-sale - The fair value measurement of certain asset-backed securities is primarily affected by estimated yields which are determined based on current market yields of comparable instruments adjusted for market liquidity. An increase (decrease) in the yields would result in a decrease (increase) in the fair value measurement of the securities.
Other assets - The fair value of the contingent consideration receivable associated with the sale of a portion of our Private Banking business is dependent upon the clients’ decisions to transfer their accounts to UBS, the timing and amounts of client assets transferred and the acceptance of the client assets by UBS which are significant unobservable inputs. An increase (decrease) in the client transfer rate would result in a higher (lower) fair value measurement of the receivable.
Significant Transfers Into and Out of Level 3 Measurements During the three and nine months ended September 30, 2018, we transferred $30 million and $157 million, respectively, of domestic deposits and $43 million and $118 million, respectively, of long-term debt, which we have elected to carry at fair value, from Level 3 to Level 2 as a result of the embedded derivative no longer being unobservable as the derivative option is closer to maturity and there is more observability in short term volatility. During the three and nine months ended September 30, 2018, we transferred $7 million and $20 million, respectively, of domestic deposits, which we have elected to carry at fair value, from Level 2 to Level 3 as a result of a change in the observability of

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underlying instruments that resulted in the embedded derivative being unobservable. Additionally, during the third quarter of 2018, we transferred $16 million of residential mortgage asset-backed securities and $92 million of student loan asset-backed securities from Level 2 to Level 3 as the inputs used to value these securities have become less observable.
During the three and nine months ended September 30, 2017, we transferred $82 million and $184 million, respectively, of domestic deposits and $27 million and $77 million, respectively, of long-term debt, which we have elected to carry at fair value, from Level 3 to Level 2 as a result of the embedded derivative no longer being unobservable as the derivative option is closer in maturity and there is more observability in short term volatility. Additionally, during the three and nine months ended September 30, 2017, we transferred $4 million and $25 million, respectively, of domestic deposits, which we have elected to carry at fair value, from Level 2 to Level 3 as a result of a change in the observability of underlying instruments that resulted in the embedded derivative being unobservable.
Assets and Liabilities Recorded at Fair Value on a Non-recurring Basis  Certain financial and non-financial assets are measured at fair value on a non-recurring basis and therefore, are not included in the tables above. These assets include (a) mortgage and commercial loans classified as held for sale reported at the lower of amortized cost or fair value and (b) impaired loans or assets that are written down to fair value based on the valuation of underlying collateral during the period. These instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustment in certain circumstances (e.g., impairment). The following table presents the fair value hierarchy level within which the fair value of the financial and non-financial assets has been recorded at September 30, 2018 and December 31, 2017. The gains (losses) during the three and nine months ended September 30, 2018 and 2017 are also included.
 
Non-Recurring Fair Value Measurements
at September 30, 2018
 
Total Gains (Losses)
For the Three Months Ended September 30, 2018
 
Total Gains (Losses)
For the Nine Months Ended
September 30, 2018
  
Level 1
 
Level 2
 
Level 3
 
Total
 
(in millions)
Residential mortgage loans held for sale(1)
$
—

 
$
—

 
$
2

 
$
2

 
$
—

 
$
—

Consumer loans(2)
—

 
13

 
—

 
13

 
(2
)
 
(4
)
Commercial loans held for sale(3)
—

 
36

 
—

 
36

 
2

 
5

Impaired commercial loans(4)
—

 
—

 
36

 
36

 
8

 
109

Real estate owned(5)
—

 
7

 
—

 
7

 
1

 
3

Total assets at fair value on a non-recurring basis
$
—

 
$
56

 
$
38

 
$
94

 
$
9

 
$
113

 
Non-Recurring Fair Value Measurements
at December 31, 2017
 
Total Gains (Losses)
For the Three Months Ended September 30, 2017
 
Total Gains (Losses)
For the Nine Months Ended
September 30, 2017
  
Level 1
 
Level 2
 
Level 3
 
Total
 
(in millions)
Residential mortgage loans held for sale(1)
$
—

 
$
—

 
$
2

 
$
2

 
$
—

 
$
7

Consumer loans(2)
—

 
21

 
—

 
21

 
(2
)
 
(10
)
Commercial loans held for sale(3)
—

 
62

 
—

 
62

 
4

 
4

Impaired commercial loans(4)
—

 
—

 
289

 
289

 
38

 
87

Real estate owned(5)
—

 
6

 
—

 
6

 
2

 
6

Total assets at fair value on a non-recurring basis
$
—

 
$
89

 
$
291

 
$
380

 
$
42

 
$
94

 
(1) 
At September 30, 2018 and December 31, 2017, the fair value of the loans held for sale was below cost. Certain residential mortgage loans held for sale have been classified as Level 3 fair value measurements within the fair value hierarchy as the underlying real estate properties used to determine fair value are illiquid assets as a result of market conditions. Additionally, the fair value of these properties is affected by, among other things, the location, the payment history and the completeness of the loan documentation.
(2) 
Represents residential mortgage loans held for investment whose carrying amount was reduced during the periods presented based on the fair value of the underlying collateral.
(3) 
At September 30, 2018 and December 31, 2017, the fair value of the loans held for sale was below cost.
(4) 
Certain commercial loans have undergone troubled debt restructurings and are considered impaired. As a matter of practical expedient, we measure the credit impairment of a collateral-dependent loan based on the fair value of the collateral asset. The collateral often involves real estate properties that are illiquid due to market conditions. As a result, these loans are classified as a Level 3 fair value measurement within the fair value hierarchy.
(5) 
Real estate owned is required to be reported on the balance sheet net of transactions costs. The real estate owned amounts in the table above reflect the fair value unadjusted for transaction costs.

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The following tables present quantitative information about non-recurring fair value measurements of assets and liabilities classified with Level 3 of the fair value hierarchy at September 30, 2018 and December 31, 2017:
At September 30, 2018
 
 
 
 
 
 
 
 
Financial Instrument Type
 
Fair Value (in millions)
 
Valuation Technique(s)
 
Significant Unobservable Inputs
 
Range of Inputs
Residential mortgage loans held for sale
 
$
2

 
Third party appraisal valuation based on estimated loss severities, including collateral values
 
Loss severity rates
 
30% - 100%
Impaired commercial loans
 
36

 
Valuation of third party appraisal
on underlying collateral
 
Loss severity rates
 
13% - 100%
At December 31, 2017
Financial Instrument Type
 
Fair Value (in millions)
 
Valuation Technique(s)
 
Significant Unobservable Inputs
 
Range of Inputs
Residential mortgage loans held for sale
 
$
2

 
Third party appraisal valuation based on estimated loss severities, including collateral values
 
Loss severity rates
 
30% - 100%
Impaired commercial loans
 
289

 
Valuation of third party appraisal
on underlying collateral
 
Loss severity rates
 
9% - 61%
Significant Unobservable Inputs for Non-Recurring Fair Value Measurements
Residential mortgage loans held for sale includes subprime residential mortgage loans which were previously acquired with the intent of securitizing or selling them to third parties. The weighted average loss severity rate for these was approximately 70 percent at September 30, 2018. These severity rates are primarily impacted by the value of the underlying collateral securing the loans.
The weighted average severity rate for impaired commercial loans was approximately 41 percent at September 30, 2018. These severity rates are primarily impacted by the value of the underlying collateral securing the loans.
Valuation Techniques  Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.
Securities purchased and sold under resale and repurchase agreements designated under FVO - We elected to apply FVO accounting to certain securities purchased and sold under resale and repurchase agreements at fair value. The fair value of these resale and repurchase agreements is determined using market rates currently offered on comparable transactions with similar underlying collateral and maturities.
Consumer loans held for sale – Consumer loans held for sale are recorded at the lower of amortized cost or fair value. The fair value estimates of consumer loans held for sale are determined primarily using observed market prices of instruments with similar characteristics. Adjustments are made to reflect differences in collateral location, loan-to-value ratio, FICO scores, vintage year, default rates, the completeness of the loan documentation and other risk characteristics. Where observable market parameters are not available, fair value is determined using the discounted cash flow method using assumptions consistent with those which would be used by market participants in valuing such loans, including estimates of prepayment rates, default rates, loss severities and market rates of return. We also may hold discussions on value directly with potential investors.
Commercial loans held for sale - Commercial loans held for sale (that are not designated under FVO as discussed below) are recorded at the lower of amortized cost or fair value. The fair value estimates of commercial loans held for sale are determined primarily using observable market consensus pricing obtained from independent sources, relevant broker quotes or observed market prices of instruments with similar characteristics. We also may hold discussions on value directly with potential investors.
Commercial loans held for sale designated under FVO – We elected to apply FVO accounting to certain commercial loans held for sale at fair value. Where available, fair value is based on observable market consensus pricing obtained from independent sources, relevant broker quotes or observed market prices of instruments with similar characteristics. Where observable market parameters are not available, fair value is determined based on contractual cash flows adjusted for estimates of prepayment rates, expected default rates and loss severity discounted at management's estimate of the expected rate of return required by market participants. We also consider loan-specific risk mitigating factors such as collateral arrangements in determining the fair value estimate.
Commercial impaired loans – Generally represents collateral dependent commercial loans with fair value determined based on pricing quotes obtained from an independent third party appraisal.
Precious metals trading - Precious metals trading primarily includes physical inventory which is valued using spot prices.

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 Securities - Where available, debt and equity securities are valued based on quoted market prices. If a quoted market price for the identical security is not available, the security is valued based on quotes from similar securities, where possible. For certain securities, internally developed valuation models are used to determine fair values or validate quotes obtained from pricing services. The following summarizes the valuation methodology used for our major security classes:
•
U.S. Treasury, U.S. Government agency issued or guaranteed and obligations of U.S. state and political subdivisions – As these securities transact in an active market, fair value measurements are based on quoted prices for the identical security or quoted prices for similar securities with adjustments as necessary made using observable inputs which are market corroborated.
•
U.S. Government sponsored enterprises – For government sponsored mortgage-backed securities which transact in an active market, fair value measurements are based on quoted prices for the identical security or quoted prices for similar securities with adjustments as necessary made using observable inputs which are market corroborated. For government sponsored mortgage-backed securities which do not transact in an active market, fair value is determined primarily based on pricing information obtained from pricing services and is verified by internal review processes.
•
Asset-backed securities, including collateralized debt obligations – Fair value is primarily determined based on pricing information obtained from independent pricing services adjusted for the characteristics and the performance of the underlying collateral.
•
Other domestic debt and foreign debt securities (corporate and government) - For non-callable corporate securities, a credit spread scale is created for each issuer. These spreads are then added to the equivalent maturity U.S. Treasury yield to determine current pricing. Credit spreads are obtained from the new market, secondary trading levels and dealer quotes. For securities with early redemption features, an option adjusted spread model is incorporated to adjust the spreads determined above. Additionally, we survey the broker/dealer community to obtain relevant trade data including benchmark quotes and updated spreads.
•
Equity securities – Fair value measurements are determined based on quoted prices for the identical security. Certain equity securities represent investments in private equity funds that help us comply with the Community Reinvestment Act. The fair value of these investments are estimated using the net asset value per share as calculated by the fund managers. Distributions will be received from the funds as the underlying assets are liquidated. While the funds do not allow us to redeem our investments, we are permitted to sell or transfer our investments subject to the approval of the fund manager. Unfunded commitments associated with these investments totaled $39 million and $43 million at September 30, 2018 and December 31, 2017, respectively.
The following tables provide additional information relating to asset-backed securities as well as certain collateralized debt obligations held at September 30, 2018:
Trading asset-backed securities:
Rating of Securities:(1)
Collateral Type:
Level 3
 
Total
 
 
(in millions)
AAA - A
Student loans
$
92

 
$
92

BBB - B
Collateralized debt obligations
112

 
112

CCC - Unrated
Residential mortgages - Subprime
16

 
16

 
 
$
220

 
$
220

Available-for-sale securities backed by collateral:
Rating of Securities:(1)
Collateral Type:
Level 2
 
Level 3
 
Total
 
 
(in millions)
AAA - A
Home equity - Alt A
$
44

 
$
—

 
$
44

 
Other
—

 
48

 
48

 
Total AAA -A
$
44

 
$
48

 
$
92

BBB -B
Other
—

 
57

 
57

 
 
$
44

 
$
105

 
$
149

 
(1)  
We utilize Standard and Poor's ("S&P") as the primary source of credit ratings in the tables above. If S&P ratings are not available, ratings by Moody's and Fitch are used in that order. Ratings for collateralized debt obligations represent the ratings associated with the underlying collateral.

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Derivatives – Derivatives are recorded at fair value. Asset and liability positions in individual derivatives that are covered by legally enforceable master netting agreements, including receivables (payables) for cash collateral posted (received), are offset and presented net in accordance with accounting principles which allow the offsetting of amounts.
Derivatives traded on an exchange are valued using quoted prices. OTC derivatives, which comprise a majority of derivative contract positions, are valued using valuation techniques. The fair value for the majority of our derivative instruments are determined based on internally developed models that utilize independently corroborated market parameters, including interest rate yield curves, option volatilities, and currency rates. For complex or long-dated derivative products where market data is not available, fair value may be affected by the underlying assumptions about, among other things, the timing of cash flows, expected exposure, probability of default and recovery rates. The fair values of certain structured derivative products are sensitive to unobservable inputs such as default correlations of the referenced credit and volatilities of embedded options. These estimates are susceptible to significant change in future periods as market conditions change.
We use the OIS curves as the base discounting curve for measuring the fair value of all derivatives, both collateralized and uncollateralized, and apply a FFVA to reflect the estimated present value of the future market funding cost or benefit associated with funding uncollateralized derivative exposure at rates other than the OIS rate. The FFVA is calculated by applying future market funding spreads to the expected future funding exposure of any uncollateralized component of the OTC derivative portfolio. The expected future funding exposure is calculated by a simulation methodology, where available, and is adjusted for events that may terminate the exposure, such as the default of HUSI or the counterparty.
Significant inputs related to derivative classes are broken down as follows:
•
Credit Derivatives – Use credit default curves and recovery rates which are generally provided by broker quotes and various pricing services. Certain credit derivatives may also use correlation inputs in their model valuation.
•
Interest Rate Derivatives – Swaps use interest rate curves based on currency that are actively quoted by brokers and other pricing services. Options will also use volatility inputs which are also quoted in the broker market.
•
Foreign Exchange ("FX") Derivatives – FX transactions, to the extent possible, use spot and forward FX rates which are quoted in the broker market. Where applicable, we also use implied volatility of currency pairs as inputs.
•
Equity Derivatives – Use listed equity security pricing and implied volatilities from equity traded options position.
•
Precious Metal Derivatives – Use spot and forward metal rates which are quoted in the broker market.
As discussed earlier, we make fair value adjustments to model valuations in order to ensure that those values represent appropriate estimates of fair value. These adjustments, which are applied consistently over time, are generally required to reflect factors such as bid-ask spreads and counterparty credit risk that can affect prices in arms-length transactions with unrelated third parties. Such adjustments are based on management judgment and may not be observable.
We estimate the counterparty credit risk for financial assets and our own credit standing for financial liabilities (the "credit risk adjustments") in determining the fair value measurement. For derivative instruments, we calculate the credit risk adjustment by applying the probability of default of the counterparty to the expected exposure, and multiplying the result by the expected loss given default. We also take into consideration the risk mitigating factors including collateral agreements and master netting agreements in determining credit risk adjustments. We estimate the implied probability of default based on the credit spread of the specific counterparty observed in the credit default swap market. Where credit default spread of the counterparty is not available, we use the credit default spread of a specific proxy (e.g., the credit default swap spread of the counterparty's parent) or a proxy based on credit default swaps referencing to credit names of similar credit standing.
Real estate owned - Fair value is determined based on third party appraisals obtained at the time we take title to the property and, if less than the carrying amount of the loan, the carrying amount of the loan is adjusted to the fair value. The carrying amount of the property is further reduced, if necessary, at least every 90 days to reflect observable local market data, including local area sales data.
Structured notes and deposits designated under FVO – Structured notes and deposits are hybrid instruments containing embedded derivatives and are elected to be measured at fair value in their entirety under FVO accounting principles. The valuation of hybrid instruments is predominantly driven by the derivative features embedded within the instruments and our own credit risk. The valuation of embedded derivatives may include significant unobservable inputs such as correlation of the referenced credit names or volatility of the embedded option. Cash flows of the funded notes and deposits in their entirety, including the embedded derivatives, are discounted at the relevant interest rates for the duration of the instrument adjusted for our own credit spreads. The credit spreads so applied are determined with reference to our own debt issuance rates observed in primary and secondary markets, internal funding rates, and the structured note rates in recent executions.
Long-term debt designated under FVO – We elected to apply FVO accounting to certain of our own debt issuances for which fair value hedge accounting otherwise would have been applied. These own debt issuances elected under FVO are traded in secondary markets and, as such, the fair value is determined based on observed prices for the specific instrument. The observed market price

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of these instruments reflects the effect of our own credit spreads. The credit spreads applied to these instruments were derived from the spreads at the measurement date.
Additional Disclosures About the Fair Value of Financial Instruments that are Not Carried at Fair Value on the Consolidated Balance Sheet The fair value estimates set forth below are made solely to comply with disclosures required by generally accepted accounting principles in the United States and should be read in conjunction with the financial statements and notes included in this report.
The carrying amount of certain financial instruments recorded at cost on the consolidated balance sheet is considered to approximate fair value because they are short-term in nature, bear interest rates that approximate market rates, and generally have negligible credit risk. These items include cash and due from banks, interest bearing deposits with banks, customer acceptance assets and liabilities, federal funds sold and purchased, certain securities purchased and sold under resale and repurchase agreements, deposits with no stated maturity (e.g., demand, savings and certain money market deposits), short-term borrowings and dividends payable.
The following table summarizes the carrying value and estimated fair value of our financial instruments, excluding financial instruments that are carried at fair value on a recurring basis, at September 30, 2018 and December 31, 2017 and their classification within the fair value hierarchy:
September 30, 2018
Carrying
Value
 
Fair
Value
 
Level 1
 
Level 2
 
Level 3
 
(in millions)
Financial assets:
 
 
 
 
 
 
 
 
 
Short-term financial assets
$
21,662

 
$
21,662

 
$
1,336

 
$
20,306

 
$
20

Federal funds sold and securities purchased under agreements to resell
4,562

 
4,562

 
—

 
4,562

 
—

Securities held-to-maturity
14,889

 
14,445

 
—

 
14,445

 
—

Commercial loans, net of allowance for credit losses
46,725

 
48,698

 
—

 
—

 
48,698

Commercial loans held for sale
35

 
35

 
—

 
35

 
—

Consumer loans, net of allowance for credit losses
19,496

 
18,734

 
—

 
—

 
18,734

Consumer loans held for sale:
 
 
 
 
 
 
 
 
 
Residential mortgages
60

 
60

 
—

 
59

 
1

Other consumer
55

 
55

 
—

 
—

 
55

Financial liabilities:
 
 
 
 
 
 
 
 
 
Short-term financial liabilities
$
3,897

 
$
3,896

 
$
—

 
$
3,876

 
$
20

Deposits:
 
 
 
 
 
 
 
 
 
Without fixed maturities
91,937

 
91,937

 
—

 
91,937

 
—

Fixed maturities
12,125

 
12,064

 
—

 
12,064

 
—

Deposits held for sale
48

 
48

 
—

 
48

 
—

Long-term debt
17,254

 
17,524

 
—

 
17,524

 
—


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December 31, 2017
Carrying
Value
 
Fair
Value
 
Level 1
 
Level 2
 
Level 3
 
(in millions)
Financial assets:
 
 
 
 
 
 
 
 
 
Short-term financial assets
$
12,304

 
$
12,304

 
$
1,115

 
$
11,157

 
$
32

Federal funds sold and securities purchased under agreements to resell
32,538

 
32,538

 
—

 
32,538

 
—

Securities held-to-maturity
13,977

 
13,902

 
—

 
13,902

 
—

Commercial loans, net of allowance for credit losses
52,427

 
54,210

 
—

 
—

 
54,210

Commercial loans held for sale
177

 
177

 
—

 
177

 
—

Consumer loans, net of allowance for credit losses
19,455

 
18,598

 
—

 
—

 
18,598

Consumer loans held for sale:
 
 
 
 
 
 
 
 
 
Residential mortgages
6

 
6

 
—

 
5

 
1

Other consumer
61

 
61

 
—

 
—

 
61

Financial liabilities:
 
 
 
 
 
 
 
 
 
Short-term financial liabilities
$
2,650

 
$
2,667

 
$
—

 
$
2,635

 
$
32

Deposits:
 
 
 
 
 
 
 
 
 
Without fixed maturities
100,502

 
100,502

 
—

 
100,502

 
—

Fixed maturities
9,834

 
9,782

 
—

 
9,782

 
—

Deposits held for sale
673

 
673

 
—

 
673

 
—

Long-term debt
22,080

 
22,717

 
—

 
22,717

 
—

Lending-related commitments - The fair value of loan commitments, revolving credit facilities and standby letters of credit are not included in the table. The majority of the lending-related commitments are not carried at fair value on a recurring basis nor are they actively traded. These instruments generate fees, which approximate those currently charged to originate similar commitments, which are recognized over the term of the commitment period. Deferred fees on loan commitments, revolving credit facilities and standby letters of credit totaled $166 million and $158 million at September 30, 2018 and December 31, 2017, respectively.

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20. Litigation and Regulatory Matters
 
The following supplements, and should be read together with, the disclosure in Note 27, "Litigation and Regulatory Matters," in our 2017 Form 10-K and in Note 20, "Litigation and Regulatory Matters," in our Form 10-Q for the three month period ended March 31, 2018 (the "2018 First Quarter Form 10-Q") and the six month period ended June 30, 2018 (the "2018 Second Quarter
Form 10-Q"). Only those matters with significant updates and new matters since our disclosure in our 2017 Form 10-K, our 2018 First Quarter Form 10-Q and our 2018 Second Quarter Form 10-Q are reported herein.
In addition to the matters described below and in our 2017 Form 10-K, our 2018 First Quarter Form 10-Q and our 2018 Second
Quarter Form 10-Q, in the ordinary course of business, we are routinely named as defendants in, or as parties to, various legal actions and proceedings relating to activities of our current and/or former operations. These legal actions and proceedings may include claims for substantial or indeterminate compensatory or punitive damages, or for injunctive relief. In the ordinary course of business, we also are subject to governmental and regulatory examinations, information-gathering requests, investigations and proceedings (both formal and informal), certain of which may result in adverse judgments, settlements, fines, penalties, injunctions or other relief. In connection with formal and informal inquiries by these regulators, we receive numerous requests, subpoenas and orders seeking documents, testimony and other information in connection with various aspects of our regulated activities.
Due to the inherent unpredictability of legal matters, including litigation, governmental and regulatory matters, particularly where the damages sought are substantial or indeterminate or when the proceedings or investigations are in the early stages, we cannot determine with any degree of certainty the timing or ultimate resolution of such matters or the eventual loss, fines, penalties or business impact, if any, that may result. We establish reserves for litigation, governmental and regulatory matters when those matters present loss contingencies that are both probable and can be reasonably estimated. Once established, reserves are adjusted from time to time, as appropriate, in light of additional information. The actual costs of resolving litigation and regulatory matters, however, may be substantially higher than the amounts reserved for those matters. During the three and nine months ended September 30, 2018, we recorded expenses of $3 million and $513 million, respectively, related to various legal matters.
For the legal matters disclosed below, including litigation and governmental and regulatory matters, as well as for the legal matters disclosed in Note 27, "Litigation and Regulatory Matters," in our 2017 Form 10-K and in Note 20, "Litigation and Regulatory Matters," in our 2018 First Quarter Form 10-Q and our 2018 Second Quarter Form 10-Q, as to which a loss in excess of accrued liability is reasonably possible in future periods and for which there is sufficient currently available information on the basis of which management believes it can make a reliable estimate, we believe a reasonable estimate could be as much as $325 million for HUSI. The legal matters underlying this estimate of possible loss will change from time to time and actual results may differ significantly from this current estimate.
In addition, based on the facts currently known for each of the ongoing investigations disclosed in Note 27, "Litigation and Regulatory Matters," in our 2017 Form 10-K and in Note 20, "Litigation and Regulatory Matters," in our 2018 First Quarter Form 10-Q and our 2018 Second Quarter Form 10-Q, it is not practicable at this time for us to determine the terms on which these ongoing investigations will be resolved or the timing of such resolution. As matters progress, it is possible that any fines and/or penalties could be significant.
Given the substantial or indeterminate amounts sought in certain of these matters, and the inherent unpredictability of such matters, an adverse outcome in certain of these matters could have a material adverse effect on our consolidated financial statements in any particular quarterly or annual period.
Madoff Litigation
In 2008, Bernard L. Madoff ("Madoff") was arrested and ultimately pleaded guilty to running a Ponzi scheme and a trustee was appointed for the liquidation of his firm, Bernard L. Madoff Investment Securities LLC ("Madoff Securities"), an SEC-registered broker-dealer and investment adviser. Various non-U.S. HSBC companies provided custodial, administration and similar services to a number of funds incorporated outside the United States whose assets were invested with Madoff Securities. Plaintiffs (including funds, funds investors and the Madoff Securities trustee ("Trustee"), as described below) have commenced Madoff-related proceedings against numerous defendants arising out of Madoff Securities' fraud.
In the SPV OSUS Ltd. v. HSBC Bank plc, HSBC Bank USA N.A., et al. action, defendants filed a motion to dismiss plaintiffs’ amended complaint in September 2018.
The U.S. Bankruptcy Court for the Southern District of New York issued a partial decision in August 2018 in the actions brought by the liquidators of the Fairfield Sentry Limited, Fairfield Sigma Limited and Fairfield Lambda Limited (together, “Fairfield”) funds against the defendants, including HSBC Bank USA. That decision denied defendants’ motion to dismiss for lack of subject matter jurisdiction and adopted defendants’ position that certain subscription agreements, allegedly signed by defendants when placing investments in the Fairfield funds, do not confer personal jurisdiction in this action. The remaining arguments raised in the parties’ motions remain pending. In September 2018, the court so-ordered a stipulation among the parties pursuant to which

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the court will resolve the remaining issues on defendants’ motion to dismiss and the liquidators’ motion to amend the complaints in any order the court deems appropriate. The motions thus remain pending in substantial part.
Mexican Government Bond Litigation In July 2018, plaintiffs filed an amended consolidated complaint on behalf of the putative class.  Defendants filed motions to dismiss in September 2018.
Benchmark Rate Litigation
In October 2018, the court granted in part and denied in part the defendants’ motion to dismiss the second amended complaint and dismissed the non-SIBOR panel banks in Frontpoint Asian Event Driven Fund, L.P., et al. v. Citibank, N.A., et al. (Case No. 15-cv-05263). The Hongkong and Shanghai Banking Corporation Limited is the only remaining HSBC defendant in the action. Accordingly, this matter will no longer be reported.
Mortgage Securitization Matters 
In October 2018, HSBC North America reached a definitive agreement to resolve the U.S. Department of Justice’s (“DOJ”) investigation of its legacy securitization, issuance and underwriting of residential mortgage-backed securities ("RMBS") issued between 2005 and 2007. Under the terms of the agreement, HSBC North America, without admitting liability or wrongdoing under the Financial Industry Reform, Recovery and Enforcement Act ("FIRREA"), paid to the DOJ in October a $765 million civil monetary penalty, of which $492 million was paid by HUSI. As previously disclosed, HSBC North America and HUSI were fully reserved for these amounts as of June 30, 2018. The settlement releases HSBC North America and its subsidiaries and affiliates, including HSBC Bank USA, from potential civil claims by the DOJ related to its legacy securitization, issuance and underwriting of RMBS from 2005 to 2007, and requires no additional remedial action.
Deutsche Bank National Trust Company, as trustee of HASCO 2007-NC1, filed a motion for leave to appeal the dismissal of the action with the New York Court of Appeals, which was granted in September 2018.
Anti-Money Laundering, Bank Secrecy Act and Office of Foreign Assets Control Matters
As previously disclosed, in June 2018, the Office of the Comptroller of the Currency ("OCC") terminated the 2010 consent cease and desist order and the 2012 enterprise-wide compliance consent order after determining that HSBC Bank USA had satisfied the requirements of the respective orders. In August 2018, the Federal Reserve Board terminated the 2010 consent cease and desist order entered into by our parent, HSBC North America. In September 2018, the OCC terminated the second OCC consent order entered into in 2012 by HSBC Bank USA which, among other things, required the bank to correct the circumstances noted in the OCC’s report and imposed certain restrictions on HSBC Bank USA.
Charlotte Freeman, et al. v. HSBC Holdings plc, et al. In August 2018, defendants submitted objections to the magistrate judge’s report and recommendation to deny defendants’ motion to dismiss, and plaintiffs submitted a response in October 2018. We await a decision from the district court.
Jeffrey Siegel, et al. v. HSBC Holdings plc, et al. In August 2018, ‎plaintiffs appealed the district court’s decision granting HSBC North America’s and HSBC Bank USA’s motion to dismiss.
Ramiro Giron, et al. v. Hong Kong and Shanghai Bank Corporation, Ltd., HSBC Bank USA, N.A., et al.  The court granted plaintiffs’ motion to withdraw the appeal and the matter is now concluded. 
Rigoberto Vasquez and Eva Garcia et al v. Hong Kong and Shanghai Banking Corporation Ltd., HSBC Bank USA, N.A., et al.
In August 2018, the HSBC defendants filed a motion to dismiss. In response, plaintiffs filed a motion for leave to amend the complaint, which the court granted. Plaintiffs filed an amended complaint in October 2018.



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21. New Accounting Pronouncements
 
The following new accounting pronouncements were adopted effective January 1, 2018:
•
Recognition of Revenue from Contracts with Customers In May 2014, the Financial Accounting Standards Board ("FASB") issued an Accounting Standards Update ("ASU") which provides a principles-based framework for revenue recognition. Additionally, the ASU requires improved disclosures to help users of financial statements better understand the nature, amount, timing, and uncertainty of revenue that is recognized. The core principle of the five-step revenue recognition framework is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The scope of the new guidance is limited to certain revenues classified as fee based income. We did not identify any changes to our revenue recognition policies necessary in order to comply with the ASU. Therefore, the adoption of this guidance did not have any impact on our financial position or results of operations. See Note 13, "Fee Income from Contracts with Customers," for the new disclosure required by this standard.
•
Financial Instruments - Classification and Measurement (Excluding Financial Liabilities Measured Under the Fair Value Option) In January 2016, the FASB issued an ASU which changed aspects of its guidance on classification and measurement of financial instruments. The ASU requires equity investments (except those accounted for under the equity method or those that result in consolidation) to be measured at fair value with changes in fair value recognized in net income. Under a practicability exception, entities may measure equity investments that do not have readily determinable fair values at cost less impairment adjusted for observable price changes. Under this exception, a qualitative assessment for impairment will be required and, if impairment exists, the carrying amount of the investments must be adjusted to their fair value and an impairment loss recognized in net income. Additionally, the ASU requires new disclosure related to equity investments and modifies certain disclosure requirements related to the fair value of financial instruments. The adoption of this guidance required a cumulative effect adjustment to the consolidated balance sheet as of January 1, 2018, resulting in an increase in retained earnings of $10 million, after tax, to reflect the impact of recording certain equity investments at fair value which were previously measured at cost, as well as a reclassification from accumulated other comprehensive loss to retained earnings of an after tax loss of $4 million related to equity investments which were previously classified as available-for-sale. The adoption of this guidance also resulted in a reclassification of $12 million and $177 million of equity investments which were previously classified as trading securities and available-for-sale securities, respectively, to other assets as of January 1, 2018. See Note 3, "Securities," for the new disclosure required by this standard.
•
Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments In August 2016, the FASB issued an ASU that provides targeted amendments to clarify how certain cash receipts and cash payments should be classified in the statement of cash flows. Under the ASU, the portion of the cash payments attributable to accreted interest for the settlement of zero-coupon bonds should be classified as cash outflows for operating activities rather than financing activities and cash proceeds from the settlement of bank-owned life insurance policies should be classified as cash inflows from investing activities rather than operating activities. While the adoption of this guidance resulted in a change in classification in the statement of cash flows, it did not have a material impact on the statement of cash flows, and it did not have any impact on our financial position or results of operations. The adoption of this guidance required prior periods to be revised and resulted in an increase in cash used in operating activities of $8 million, an increase in cash provided by investing activities of $3 million and a decrease in cash used in financing activities of $5 million during the nine months ended September 30, 2017.
•
Statement of Cash Flows - Restricted Cash In November 2016, the FASB issued an ASU that clarifies how restricted cash and restricted cash equivalents should be presented in the statement of cash flows. The ASU requires entities to show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. While the adoption of this guidance resulted in a change in classification in the statement of cash flows to include our required reserve balance with the Federal Reserve Bank within a new line item called cash, due from banks and restricted cash, it did not have any impact on our financial position or results of operations. The adoption of this guidance on January 1, 2018 required prior periods to be revised and resulted in a decrease in cash provided by investing activities of $106 million during the nine months ended September 30, 2017.
•
Business Combinations - Clarifying the Definition of a Business In January 2017, the FASB issued an ASU which provides clarification on the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in the ASU provide a screen to determine when an integrated set of activities and assets (a "set") is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. The amendments also provide a framework to assist entities in evaluating whether both an input and a substantive process are present. The adoption of this guidance did not have any impact on our financial position or results of operations.

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•
Compensation - Retirement Benefits In March 2017, the FASB issued an ASU that requires only the service cost component of net periodic pension and postretirement benefit costs to be reported in salaries and employee benefits in the statement of income while the other components of net periodic pension and postretirement benefit costs are required to be reported separately from the service cost component. The guidance is not applicable, however, to multiemployer plans. The adoption of this guidance did not have a material impact on our financial statement presentation.
•
Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Loss  In February 2018, the FASB issued an ASU that allows for the reclassification of tax effects within accumulated other comprehensive loss (referred to as stranded tax effects) to retained earnings resulting from the change in the federal corporate income tax rate in the Tax Legislation which was signed into law on December 22, 2017. We elected to early adopt this guidance in the first quarter of 2018 and recorded a cumulative effect adjustment to the consolidated balance sheet, resulting in a reclass of approximately $91 million of tax benefits from accumulated other comprehensive loss to retained earnings as of January 1, 2018.
The following are accounting pronouncements which will be adopted in future periods:
•
Leases In February 2016, the FASB issued an ASU which requires a lessee to recognize a lease liability and a right-of-use asset on its balance sheet for all leases, including operating leases, with a term greater than 12 months. Lease classification is still performed, with any lease classified as a finance lease reported as a financing transaction. The ASU does not substantially change lessor accounting. Additionally, the ASU makes several other targeted amendments including a) revising the definition of lease payments to include fixed payments by the lessee to cover lessor costs related to ownership of the underlying asset such as for property taxes or insurance; b) requiring seller-lessees in a sale-leaseback transaction to recognize the entire gain from the sale of the underlying asset at the time of sale rather than over the leaseback term; and c) expanding disclosures to provide additional quantitative and qualitative information about lease transactions. The ASU is effective for all annual and interim periods beginning January 1, 2019. We plan to apply the guidance by recording a cumulative effect adjustment to the consolidated balance sheet as of the beginning of the first reporting period in which the guidance is effective. We have conducted a review of our existing lease contracts and service contracts which may contain embedded leases and currently expect a gross-up of our balance sheet in the range of approximately $650 million to $700 million as a result of recognizing lease liabilities and corresponding right of use assets for operating leases upon adoption as of January 1, 2019. The adoption of this guidance will also require a cumulative effect adjustment to recognize the previously deferred gain on the sale and leaseback of our 452 Fifth Avenue property, which is expected to result in an increase in retained earnings of approximately $27 million, after tax, as of January 1, 2019. The adoption of this guidance is not expected to result in material changes to the recognition of operating lease expense.
•
Financial Instruments - Credit Impairment In June 2016, the FASB issued an ASU that significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The ASU requires entities to estimate and recognize an allowance for lifetime expected credit losses for loans (including TDR Loans), held-to-maturity debt securities, off-balance sheet credit exposures and certain other financial assets measured at amortized cost. The ASU also requires entities to recognize an allowance for credit losses on AFS debt securities and revises the accounting model for purchased credit impaired loans and debt securities. Additionally, existing disclosures will also be revised under the ASU. The ASU is effective for all annual and interim periods beginning January 1, 2020 and is required to be applied by recording a cumulative effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. While early adoption is permitted beginning in the first quarter of 2019, we currently do not expect to elect early adoption. We have begun our implementation efforts, leveraging our participation in support of HSBC's implementation of IFRS 9 where feasible, to identify key interpretive issues and are assessing existing credit loss forecasting models and processes against the new guidance to determine what modifications may be required. While we continue to evaluate the impact the new guidance will have on our financial position and results of operations, we currently expect the new guidance will result in an increase to our allowance for credit losses given the change to estimated losses over the contractual life of the loan portfolio as well as the adoption of an allowance for debt securities. The amount of the increase to our allowance is still under review and will depend, in part, upon the composition of our loan and held-to-maturity securities portfolios at the adoption date as well as economic conditions and loss forecasts at that date.
•
Goodwill Impairment Testing In January 2017, the FASB issued an ASU that simplifies the accounting for goodwill impairment by removing step two of the goodwill impairment test. Under step two, an entity was required to determine the fair value of individual assets and liabilities of a reporting unit (including unrecognized assets and liabilities) using the procedure for determining fair values in a business combination. Under the new guidance, goodwill impairment will now be measured at the amount by which a reporting unit’s carrying amount, including those with a zero or negative carrying amount, exceeds its fair value. Any resulting impairment is limited to the carrying amount of goodwill. An entity must also disclose the amount of goodwill allocated to each reporting unit with a zero or negative carrying amount. The ASU is effective for all annual and interim periods beginning January 1, 2020 and is required to be applied prospectively with early adoption permitted. The adoption of this guidance is not expected to have a material impact on the results of our goodwill impairment testing, our financial position or results of operations.

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•
Premium Amortization on Purchased Callable Debt Securities In March 2017, the FASB issued an ASU that shortens the premium amortization period for purchased non-contingently callable debt securities by requiring the premium to be amortized to the earliest call date, rather than the contractual maturity date. After the earliest call date, if the call option is not exercised, the effective yield will be reset using the payment terms of the debt security. The new guidance does not change the discount amortization period for purchased debt securities. The discount continues to be amortized to the contractual maturity date. The ASU is effective for all annual and interim periods beginning January 1, 2019 and is required to be applied by recording a cumulative effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. While early adoption is permitted, we currently do not expect to elect early adoption. The adoption of this guidance is not expected to have a material impact on our financial position or results of operations.
•
Derivatives and Hedging - Targeted Improvements to Accounting for Hedging Activities In August 2017, the FASB issued an ASU amending its hedge accounting guidance to expand an entity’s ability to hedge nonfinancial and financial risk components, reduce complexity in fair value hedges of interest rate risk and ease the requirements for effectiveness testing and hedge documentation. The new guidance also eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item. Existing disclosures will also be revised. The ASU is effective for all annual and interim periods beginning January 1, 2019 and is required to be applied by recording a cumulative effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. While early adoption is permitted, we currently do not expect to elect early adoption. The adoption of this guidance is not expected to have a material impact on our financial position or results of operations.
•
Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement In August 2018, the FASB issued an ASU that eliminates, amends and adds certain disclosure requirements for fair value measurements. The ASU is effective for all annual and interim periods beginning January 1, 2020, with early adoption permitted. We are currently evaluating the impact of adopting this ASU. While adoption of this guidance will result in changes to our existing disclosures, it will not have any impact on our financial position or results of operations.
There have been no additional accounting pronouncements issued that are expected to have or could have a material impact on our financial position or results of operations.


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Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Forward-Looking Statements
 
Certain matters discussed throughout this Form 10-Q are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make or approve certain statements in future filings with the United States Securities and Exchange Commission ("SEC"), in press releases, or oral or written presentations by representatives of HSBC USA Inc. ("HSBC USA" and, together with its subsidiaries, "HUSI") that are not statements of historical fact and may also constitute forward-looking statements. Words such as "may," "will," "should," "would," "could," "appears," "believe," "intends," "expects," "estimates," "targeted," "plans," "anticipates," "goal," and similar expressions are intended to identify forward-looking statements but should not be considered as the only means through which these statements may be made. These matters or statements will relate to our future financial condition, economic forecast, results of operations, plans, objectives, performance or business developments and will involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from that which was expressed or implied by such forward-looking statements.
All forward-looking statements are, by their nature, subject to risks and uncertainties, many of which are beyond our control. Our actual future results may differ materially from those set forth in our forward-looking statements. While there is no assurance that any list of risks and uncertainties or risk factors is complete, below are certain factors which could cause actual results to differ materially from those in the forward-looking statements:
•
uncertain market and economic conditions in the United States and abroad, including but not limited to, changes in interest rates, energy prices and unemployment levels, a decline in housing prices, the availability of credit and liquidity, changes in consumer confidence and consumer spending and behavior, consumer perception as to the continuing availability of credit and price competition in the market segments we serve and the consequences of unexpected geopolitical events, such as the outbreak of hostilities between countries and the decision by the United Kingdom ("U.K.") to exit the European Union ("EU");
•
changes in laws and regulatory requirements;
•
the potential impact of any legal, regulatory or policy changes affecting financial institutions and the global economy as a result of the current Administration in the U.S.;
•
the ability to deliver on our regulatory priorities;
•
capital and liquidity requirements under Basel guidance, the Federal Reserve Board's ("FRB") Comprehensive Capital Analysis and Review ("CCAR") program, and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ("Dodd-Frank Act") stress testing ("DFAST"), including the U.S. FRB requirements for U.S. global systemically important banks ("G-SIBs") and U.S. intermediate holding companies ("IHCs") owned by non-U.S. G-SIBs to issue total loss-absorbing capacity ("TLAC") instruments;
•
regulatory requirements in the U.S. and in non-U.S. jurisdictions to facilitate the future orderly resolution of large financial institutions;
•
changes in central banks' policies with respect to the provision or removal of liquidity support to financial markets;
•
the ability of HSBC Holdings plc ("HSBC" and, together with its subsidiaries, "HSBC Group") and HSBC Bank USA, National Association ("HSBC Bank USA") to fulfill the requirements imposed by our consent orders as well as guidance from regulators generally;
•
the use of us as a conduit for illegal activities without our knowledge by third parties;
•
the ability to successfully manage our risks;
•
the possibility of the inadequacy of our data management and policies and processes;
•
the financial condition of our clients and counterparties and our ability to manage counterparty risk;
•
concentrations of credit and market risk, including exposure to Latin American corporate clients and the oil and gas markets;
•
increases in our allowance for credit losses and changes in our assessment of our loan portfolios;
•
the ability to implement our business strategies;
•
the ability to successfully implement changes to our operational practices as needed and/or required from time to time;
•
damage to our reputation;
•
the ability to attract and retain customers and to attract and retain key employees;

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•
the effects of competition in the markets where we operate including increased competition from non-bank financial services companies, including securities firms;
•
the effects of operational risks that are inherent in banking operations, including fraudulent and other criminal activities, breakdowns in processes or procedures and systems failure or non-availability;
•
disruption in our operations from the external environment arising from events such as natural disasters, global pandemics, acts of war, terrorist attacks, or essential utility outages;
•
a failure in or a breach of our operation or security systems or infrastructure, or those of third party servicers or vendors, including as a result of cyberattacks;
•
the ability of third party suppliers, outsourcing vendors, off-shored functions and our affiliates to provide adequate services;
•
losses suffered due to the negligence, fraud or misconduct of our employees or the negligence, fraud or misconduct on the part of third parties;
•
a failure in our internal controls;
•
our ability to meet our funding requirements;
•
adverse changes to our credit ratings;
•
financial difficulties or credit downgrades of mortgage bond insurers;
•
our ability to cross-sell our products to existing customers;
•
changes in Financial Accounting Standards Board ("FASB") and International Accounting Standards Board ("IASB") accounting standards and their interpretation;
•
heightened regulatory and government enforcement scrutiny of financial institutions, including in connection with product governance and sales practices, account opening and closing procedures, customer and employee complaints and sales compensation structures related to such practices;
•
continued heightened regulatory scrutiny with respect to existing and future residential mortgage servicing and foreclosure practices, with particular focus on loss mitigation, foreclosure prevention and outsourcing;
•
possible negative impact of regulatory investigations and legal proceedings related to alleged foreign exchange manipulation;
•
changes in the methodology for determining benchmark rates;
•
heightened regulatory and government enforcement scrutiny of financial markets, with a particular focus on traded asset classes, including foreign exchange;
•
the possibility of incorrect assumptions or estimates in our financial statements, including reserves related to litigation, deferred tax assets and the fair value of certain assets and liabilities;
•
model limitations or failure;
•
the possibility of incorrect interpretations, application of or changes in tax laws to which we and our clients are subject;
•
additional financial contribution requirements to the HSBC North America Holdings Inc. ("HSBC North America") pension plan;
•
unexpected and/or increased expenses relating to, among other things, litigation and regulatory matters, remediation efforts, penalties and fines; and
•
the other risk factors and uncertainties described under Item 1A, "Risk Factors," in our Annual Report on Form 10-K for the year ended December 31, 2017 ("2017 Form 10-K").
Forward-looking statements are based on our current views and assumptions and speak only as of the date they are made. We undertake no obligation to update any forward-looking statement to reflect subsequent circumstances or events. You should, however, consider any additional disclosures of a forward-looking nature that arise after the date hereof as may be discussed in any of our subsequent Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q or Current Reports on Form 8-K.


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Executive Overview
 
HSBC USA is a wholly-owned subsidiary of HSBC North America, which is an indirect wholly-owned subsidiary of HSBC. HUSI may also be referred to in Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") as "we," "us" or "our."
Economic Environment  The U.S. economy continued to grow during the first nine months of 2018. U.S. Gross Domestic Product ("GDP") grew at an estimated annual rate of 3.5 percent in the third quarter of 2018, higher than 2017's GDP annual growth rate, while inflation in the third quarter of 2018 averaged near the FRB's target inflation rate. In September 2018, the FRB increased short-term interest rates by 25 basis points, the third such rate increase this year, and has indicated that it will likely increase short-term interest rates once more during the fourth quarter of 2018. During the first nine months of 2018, the FRB also continued reducing its holdings of U.S. Treasury bonds and mortgage-backed securities. These actions by the FRB could cause longer term interest rates to continue to rise over time. The U.S. economy added over 1.8 million jobs during the first nine months of 2018 and the total unemployment rate fell to 3.7 percent at September 2018 as compared with 4.1 percent at December 2017.
Although the U.S. economy continued to grow, uncertainty concerning the future economic environment exists despite continued improvements in many segments of the global economy. The sustainability of the economic recovery will be determined by numerous other variables including consumer sentiment, energy prices, credit market volatility, employment levels and housing market conditions which will impact corporate earnings and the capital markets. Concerns over higher interest rates, inflation, U.S. trade policy and geopolitical events as well as the implications of those events on the markets in general further add to global uncertainty. Higher interest rates, in combination with global economic conditions, fiscal and monetary policy and the level of regulatory and government scrutiny of financial institutions will continue to impact our results in 2018 and beyond.
Performance, Developments and Trends The following table sets forth selected financial highlights for HUSI for the three and nine months ended September 30, 2018 and 2017 and at September 30, 2018 and December 31, 2017:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,

2018
 
2017
 
2018
 
2017
 
(dollars are in millions)
Net income
$
177

 
$
94

 
$
208

 
$
594

Rate of return on average:
 
 
 
 
 
 
 
Total assets
.4
%
 
.2
%
 
.2
%
 
.4
%
Total risk-weighted assets
.6

 
.3

 
.2

 
.7

Total common equity
3.7

 
1.9

 
1.2

 
3.8

Total equity
3.5

 
1.8

 
1.4

 
3.8

Net interest margin
1.43

 
1.26

 
1.40

 
1.28

Efficiency ratio
75.6

 
86.0

 
89.3

 
75.8

Commercial net charge-off ratio(1)
.10

 
.19

 
.10

 
.21

Consumer net charge-off ratio(1)
.08

 
.08

 
.10

 
.12

 
(1) 
Excludes loans held for sale.


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HSBC USA Inc.

 
September 30, 2018
 
December 31, 2017
 
(dollars are in millions)
Additional Select Ratios:
 
 
 
Allowance as a percent of loans(1)
.80
%
 
.94
%
Commercial allowance as a percent of loans(1)
.97

 
1.15

Consumer allowance as a percent of loans(1)
.39

 
.37

Consumer two-months-and-over contractual delinquency
1.96

 
2.48

Loans to deposits ratios(2)
74.60

 
73.70

Common equity Tier 1 capital to risk-weighted assets
13.8

 
14.2

Tier 1 capital to risk-weighted assets
14.8

 
15.3

Total capital to risk-weighted assets
17.4

 
18.4

Tier 1 leverage ratio
10.7

 
9.9

Supplementary leverage ratio
7.5

 
7.3

Total equity to total assets
11.5

 
10.7

 
 
 
 
Select Balance Sheet Data:
 
 
 
Cash and interest bearing deposits with banks
$
21,642

 
$
12,272

Trading assets
26,556

 
16,150

Securities available-for-sale
31,329

 
30,700

Loans:
 
 
 
   Commercial loans
47,183

 
53,035

   Consumer loans
19,573

 
19,528

Total loans
66,756

 
72,563

Deposits
112,090

 
118,702

 
(1) 
Excludes loans held for sale.
(2) 
Represents period end loans, net of allowance for loan losses, as a percentage of core deposits as calculated in accordance with Federal Financial Institutions Examination Council guidelines which generally include all domestic demand, money market and other savings accounts, as well as time deposits with balances not exceeding $250,000.
Net income was $177 million and $208 million during the three and nine months ended September 30, 2018, respectively, compared with $94 million and $594 million during the three and nine months ended September 30, 2017, respectively. Income before income tax was $235 million and $440 million during the three and nine months ended September 30, 2018, respectively, compared with $155 million and $915 million during the three and nine months ended September 30, 2017, respectively. Income before income tax increased during the three months ended September 30, 2018 due to higher other revenues and lower operating expenses, partially offset by a higher provision for credit losses. In the year-to-date period, income before income tax decreased due to higher operating expenses driven primarily by expense recorded in the current year related to the settlement of a mortgage securitization legal matter as discussed further below, lower net interest income, lower releases in the provision for credit losses and lower other revenues which reflect the non-recurrence of gains recorded in the prior year on the sales of Visa Inc. ("Visa") Class B common shares ("Class B Shares").
In October 2018, HSBC North America and certain subsidiaries reached an agreement with the U.S. Department of Justice ("DOJ'") to resolve the DOJ's investigation of their legacy securitization, issuance and underwriting of residential mortgage-backed securities issued between 2005 and 2007. Under the terms of the agreement, HSBC North America, without admitting liability or wrongdoing under the Financial Industry Reform, Recovery and Enforcement Act ("FIRREA"), paid to the DOJ in October a $765 million civil monetary penalty, of which $492 million was paid by HUSI and was recorded as a charge to other expenses during the first half of 2018. For additional discussion, see Note 20, "Litigation and Regulatory Matters," in the accompanying consolidated financial statements.


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HSBC USA Inc.

Our reported results in all periods were impacted by certain items management believes to be significant, which distort comparability between periods. Significant items are excluded to arrive at adjusted performance because management would ordinarily identify and consider them separately to better understand underlying business trends. The following table summarizes the impact of these significant items for all periods presented:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,

2018
 
2017
 
2018
 
2017
 
(in millions)
Income before income tax, as reported
$
235

 
$
155

 
$
440

 
$
915

Expense related to the settlement of certain mortgage loan legal matters
—

 
—

 
507

 
—

Costs to achieve(1)
—

 
51

 
—

 
159

Gains on sales of Visa Inc. Class B common shares to a third party(2)
—

 
—

 
7

 
(312
)
Adjusted performance(3)
$
235

 
$
206

 
$
954

 
$
762

 
(1) 
Reflects transformation costs incurred through 2017 to deliver the cost reduction and productivity outcomes outlined in the HSBC Investor Update in June 2015. See "Results of Operations" for a more detailed discussion of these costs.
(2) 
In 2018, includes a loss of $7 million recorded during the second quarter related to a change in the Visa Class B Share conversion rate announced by Visa as a result of the outstanding litigation for which we retained the associated risk. See Note 18, "Guarantee Arrangements, Pledged Assets and Repurchase Agreements," in the accompanying consolidated financial statements for additional information.
(3) 
Represents a non-U.S. GAAP financial measure.
Excluding the collective impact of the items in the table above, our adjusted performance during the three and nine months ended September 30, 2018 increased $29 million and $192 million, respectively, compared with prior year periods due to higher other revenues driven by higher trading revenue, partially offset by a higher provision for credit losses, higher operating expenses and, in the year-to-date period, lower net interest income.
See "Results of Operations" for a more detailed discussion of our operating trends. In addition, see "Balance Sheet Review" for further discussion on our asset and liability trends, "Liquidity and Capital Resources" for further discussion on funding and capital and "Credit Quality" for additional discussion on our credit trends.


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HSBC USA Inc.

Basis of Reporting
 
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP").
Group Reporting Basis We report financial information to HSBC in accordance with HSBC Group accounting and reporting policies, which apply International Financial Reporting Standards ("IFRSs") as issued by the IASB and endorsed by the EU and, as a result, our segment results are prepared and presented using financial information prepared on the basis of HSBC Group's accounting and reporting policies ("Group Reporting Basis"). Because operating results on the Group Reporting Basis are used in managing our businesses and rewarding performance of employees, our management also separately monitors profit before tax under this basis of reporting. The following table reconciles our U.S. GAAP versus Group Reporting Basis profit before tax:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,

2018
 
2017
 
2018
 
2017
 
(in millions)
Profit before tax – U.S. GAAP basis
$
235

 
$
155

 
$
440

 
$
915

Adjustments:
 
 
 
 
 
 
 
Expected credit losses / loan impairment
51

 
5

 
122

 
(18
)
Loan origination
11

 
2

 
13

 
6

Loans held for sale
(6
)
 
(20
)
 
(15
)
 
(141
)
Property
(2
)
 
(2
)
 
(6
)
 
(9
)
Litigation expense
1

 
3

 
(3
)
 
11

Pension and other postretirement benefit costs
—

 
1

 
(2
)
 
8

Structured notes and deposits
—

 
(46
)
 
—

 
(69
)
Low income housing tax credit investments
1

 
2

 
3

 
5

Other
9

 
2

 
17

 
8

Profit before tax – Group Reporting Basis
$
300

 
$
102

 
$
569

 
$
716

The significant differences between U.S. GAAP and the Group Reporting Basis impacting our results presented in the table above are discussed in more detail within "Basis of Reporting" in our 2017 Form 10-K. Other than the changes discussed below, there have been no other significant changes since December 31, 2017 in the differences between U.S. GAAP and the Group Reporting Basis impacting our results.
Expected credit losses / loan impairment - In January 2018, we adopted new accounting guidance under the Group Reporting Basis in conjunction with HSBC’s adoption of the requirements of IFRS 9, "Financial Instruments" ("IFRS 9"), on January 1, 2018 with the exception of the provisions relating to the presentation of gains and losses on financial instruments designated at fair value which were previously adopted in 2017.
Under IFRS 9, expected credit losses ("ECL") are recognized for a) financial assets measured at amortized cost, including loans, securities purchased under agreements to resell and certain debt securities; b) financial assets measured at fair value with changes in fair value recorded through other comprehensive income (loss), primarily debt securities; and c) certain loan commitments and financial guarantee contracts. Financial assets which have not experienced a significant increase in credit risk since initial recognition are considered to be in ‘stage 1’; financial assets which are considered to have experienced a significant increase in credit risk are in ‘stage 2’; and financial assets for which there is objective evidence of impairment so are considered to be in default or otherwise credit-impaired are in ‘stage 3’. At initial recognition and for financial assets that remain in stage 1, an allowance (or provision in the case of some loan commitments and financial guarantees) is required for ECL resulting from default events that are possible within the next 12 months ('12-month ECL'). In the event of a significant increase in credit risk, an allowance (or provision) is required for ECL resulting from all possible default events over the expected life of the financial instrument ('lifetime ECL') and financial assets are moved to stage 2 or stage 3.
The adoption of the new accounting guidance on January 1, 2018 on our customer loan portfolio resulted in an increase to our customer loan allowance for ECL of approximately $60 million with a corresponding charge to equity under the Group Reporting Basis. The impact of adoption on the allowance for other financial assets was not significant. The amounts shown in the table above represents the difference in credit loss provision for the periods presented. During the three months ended September 30, 2018, reserve releases were recorded under the Group Reporting Basis due primarily to a reduction of ECL associated with oil and gas clients while a provision for credit losses was recorded under U.S. GAAP as reserve releases driven by paydowns, sales and maturities were more than offset by the impact of downgrades, which was more pronounced under U.S. GAAP due to the

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HSBC USA Inc.

longer loss emergence period, as well as a provision under U.S. GAAP for risk factors associated with geopolitical risks and market volatility inherent in certain segments of the portfolio. In the year-to-date period, reserve releases were recorded under both the Group Reporting Basis and U.S. GAAP, though the releases were higher under the Group Reporting Basis. The higher reserve releases under the Group Reporting Basis were primarily due to releases associated with a single client relationship driven by improvements in credit conditions which resulted in reclassification from 'stage 2' (which requires a lifetime ECL estimate) to 'stage 1' (which requires a 12-month ECL estimate) and other modeling factors as well as a reduction of ECL associated with oil and gas clients. In addition, reserve releases driven by paydowns, sales and maturities were partially offset by the impact of downgrades, which was more pronounced under U.S. GAAP due to the longer loss emergence period, as well as a provision under U.S. GAAP for risk factors associated with geopolitical risks and market volatility inherent in certain segments of the portfolio.
Structured notes and deposits - Structured notes and deposits have historically been classified as trading liabilities under the Group Reporting Basis and carried at fair value with changes in fair value recorded in earnings. Beginning January 1, 2018, HSBC concluded that a change in accounting policy and presentation from trading liabilities to liabilities designated under the fair value option for structured notes and deposits under the Group Reporting Basis would be appropriate since it would better align with the presentation of similar financial instruments by peers under IFRSs and therefore provide more relevant information about the effect of these financial liabilities on reported financial position and performance. As a result, the fair value movement on structured notes and deposits attributable to our own credit spread is now being recorded in other comprehensive income (loss) under the Group Reporting Basis, consistent with U.S. GAAP.

Balance Sheet Review
 
We utilize deposits and borrowings from various sources to provide liquidity, fund our balance sheet, meet cash and capital needs, and fund investments in subsidiaries. The following table provides balance sheet totals at September 30, 2018 and increases (decreases) since December 31, 2017:
 
 
 
Increase (Decrease) From
 
 
 
December 31, 2017
  
September 30, 2018
 
Amount
 
%
 
(dollars are in millions)
Period end assets:
 
 
 
 
 
Short-term investments
$
26,321

 
$
(18,569
)
 
(41.4
)%
Loans, net
66,221

 
(5,661
)
 
(7.9
)
Loans held for sale
392

 
(323
)
 
(45.2
)
Trading assets
26,556

 
10,406

 
64.4

Securities
46,218

 
1,541

 
3.4

All other assets
8,294

 
(627
)
 
(7.0
)
 
$
174,002

 
$
(13,233
)
 
(7.1
)%
Period end liabilities and equity:
 
 
 
 
 
Total deposits
$
112,090

 
$
(6,612
)
 
(5.6
)%
Trading liabilities
3,948

 
(931
)
 
(19.1
)
Short-term borrowings
4,793

 
143

 
3.1

Long-term debt
29,516

 
(5,450
)
 
(15.6
)
Interest, taxes and other liabilities
3,655

 
(289
)
 
(7.3
)
Total equity
20,000

 
(94
)
 
(.5
)
 
$
174,002

 
$
(13,233
)
 
(7.1
)%
Short-Term Investments  Short-term investments include cash and due from banks, interest bearing deposits with banks and federal funds sold and securities purchased under agreements to resell. Balances may fluctuate from period to period depending upon our liquidity position at the time and our strategy for deploying liquidity. Short-term investments decreased compared with December 31, 2017 due to a redeployment of surplus liquidity in the short term to precious metal inventory positions which are included in trading assets, a decline in client deposits and the repayment of long-term debt that matured during the first nine months of 2018. These decreases were partially offset by the impact of a $5.0 billion overnight loan to an affiliate that was outstanding at year-end, as the wire process from the affiliate to settle daily activity failed. This loan was repaid in early January.

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HSBC USA Inc.

Loans, Net  The following table summarizes our loan balances at September 30, 2018 and increases (decreases) since December 31, 2017:
 
 
 
Increase (Decrease) From
 
 
 
December 31, 2017
  
September 30, 2018
 
Amount
 
%
 
(dollars are in millions)
Commercial loans:
 
 
 
 
 
Real estate, including construction
$
11,882

 
$
1,349

 
12.8
 %
Business and corporate banking
12,731

 
227

 
1.8

Global banking(1)
18,672

 
(1,416
)
 
(7.0
)
Other commercial(2)
3,898

 
(6,012
)
 
(60.7
)
Total commercial
47,183

 
(5,852
)
 
(11.0
)
Consumer loans:
 
 
 
 
 
Residential mortgages
17,376

 
103

 
.6

Home equity mortgages
1,027

 
(164
)
 
(13.8
)
Credit cards
907

 
186

 
25.8

Other consumer
263

 
(80
)
 
(23.3
)
Total consumer
19,573

 
45

 
.2

Total loans
66,756

 
(5,807
)
 
(8.0
)
Allowance for credit losses
535

 
(146
)
 
(21.4
)
Loans, net
$
66,221

 
$
(5,661
)
 
(7.9
)%
 
 
(1) 
Represents large multinational firms including globally focused U.S. corporate and financial institutions, U.S. dollar lending to multinational banking clients managed by HSBC on a global basis and complex large business clients supported by GB&M relationship managers.
(2) 
Includes loans to HSBC affiliates which totaled $1,557 million and $6,750 million at September 30, 2018 and December 31, 2017, respectively.
Commercial loans decreased as compared with December 31, 2017 largely reflecting the impact of a $5.0 billion overnight loan to an affiliate that was outstanding at year-end and was repaid in early January as discussed above and, to a lesser extent, paydowns, sales and maturities exceeding loan growth due to new business activity. The trend in commercial non-affiliate loans primarily reflects decreases in the diversified financial, energy and pharmaceutical industries, partially offset by growth in the real estate and telecommunication industries.
Consumer loans were flat compared with December 31, 2017 as an increase in credit card receivables reflecting growth in customer activity driven by new product promotions which are targeted beyond our current customer base and higher residential mortgage loans which we continue to target towards our Premier and Advance customer relationships were largely offset by a continued decline in home equity mortgages due to net paydowns as our focus continues to shift towards residential mortgage loans and lower other consumer loans.
The following table presents loan-to-value ("LTV") ratios for our residential mortgage loan portfolio, excluding mortgage loans held for sale:
 
LTV Ratios(1)(2)
 
September 30, 2018
 
December 31, 2017
  
First Lien
 
Second Lien
 
First Lien
 
Second Lien
LTV < 80%
98.4
%
 
93.2
%
 
97.6
%
 
89.8
%
80% < LTV < 90%
1.1

 
4.9

 
1.6

 
6.6

90% < LTV < 100%
.3

 
1.4

 
.5

 
2.6

LTV > 100%
.2

 
.5

 
.3

 
1.0

Average LTV for portfolio
49.3

 
49.6

 
51.0

 
52.4

 
 
(1) 
LTVs for first liens are calculated using the loan balance as of the reporting date. LTVs for second liens are calculated using the loan balance as of the reporting date plus the senior lien amount at origination. Current estimated property values are derived from the property's appraised value at the time of loan origination updated by the change in the Federal Housing Finance Agency's house pricing index ("HPI") at either a Core Based Statistical Area or state level. The estimated value of the homes could differ from actual fair values due to changes in condition of the underlying property, variations in housing

89

HSBC USA Inc.

price changes within metropolitan statistical areas and other factors. As a result, actual property values associated with loans that end in foreclosure may be significantly lower than the estimates used for purposes of this disclosure.
(2) 
Current estimated property values are calculated using the most current HPIs available and applied on an individual loan basis, which results in an approximate three month delay in the production of reportable statistics. Therefore, the information in the table above reflects current estimated property values using HPIs at June 30, 2018 and September 30, 2017, respectively.
Loans Held for Sale  The following table summarizes loans held for sale at September 30, 2018 and increases (decreases) since December 31, 2017:
 
 
 
Increase (Decrease) From
 
 
 
December 31, 2017
  
September 30, 2018
 
Amount
 
%
 
(dollars are in millions)
Commercial loans:
 
 
 
 
 
Real estate, including construction
$
24

 
$
(91
)
 
(79.1
)%
Global banking
253

 
(280
)
 
(52.5
)
Total commercial
277

 
(371
)
 
(57.3
)
Consumer loans:
 
 
 
 
 
Residential mortgages
60

 
54

 
*

Other consumer
55

 
(6
)
 
(9.8
)
Total consumer
115

 
48

 
71.6

Total loans held for sale
$
392

 
$
(323
)
 
(45.2
)%
 
*
Percentage change is greater than 100 percent.
Commercial loans held for sale decreased compared with December 31, 2017. Commercial loans held for sale primarily consists of certain loans that we have elected to designate under the fair value option which include loans that we originate in connection with our participation in a number of syndicated credit facilities with the intent of selling them to unaffiliated third parties as well as loans that we purchase from the secondary market and hold as hedges against our exposure to certain total return swaps. The fair value of these loans totaled $242 million and $471 million at September 30, 2018 and December 31, 2017, respectively. Balances will fluctuate from period to period depending on the volume and level of activity.
Commercial loans held for sale also includes certain loans that we no longer intend to hold for investment and transferred to held for sale which totaled $35 million and $62 million at September 30, 2018 and December 31, 2017, respectively.
Consumer loans held for sale increased compared with December 31, 2017. Prior to 2018 applications, we sold agency-eligible residential mortgage loan originations on a servicing released basis directly to PHH Mortgage Corporation ("PHH Mortgage"). Beginning with 2018 applications, PHH Mortgage is no longer obligated to purchase these loans from us directly upon origination and instead we currently intend to market these loans for sale to other third parties on a servicing retained basis. Gains and losses from the sale of these residential mortgage loans are reflected as a component of residential mortgage banking expense in the accompanying consolidated statement of income.
Other consumer loans held for sale reflects student loans which we no longer originate.
Excluding the commercial loans designated under fair value option discussed above, loans held for sale are recorded at the lower of amortized cost or fair value, with adjustments to fair value being recorded as a valuation allowance through other revenues. The valuation allowance on consumer loans held for sale was $4 million and $5 million at September 30, 2018 and December 31, 2017, respectively. The valuation allowance on commercial loans held for sale was $4 million and $10 million at September 30, 2018 and December 31, 2017, respectively.

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HSBC USA Inc.

Trading Assets and Liabilities  The following table summarizes trading assets and liabilities at September 30, 2018 and increases (decreases) since December 31, 2017:
 
 
 
 
Increase (Decrease) From
 
 
 
December 31, 2017
  
September 30, 2018
 
Amount
 
%
 
(dollars are in millions)
Trading assets:
 
 
 
 
 
Securities(1)
$
13,467

 
$
3,316

 
32.7
 %
Precious metals
9,945

 
7,671

 
*

Derivatives, net(2)
3,144

 
(581
)
 
(15.6
)
 
$
26,556

 
$
10,406

 
64.4
 %
Trading liabilities:
 
 
 
 
 
Securities sold, not yet purchased
$
1,605

 
$
(117
)
 
(6.8
)%
Payables for precious metals
—

 
(524
)
 
(100.0
)
Derivatives, net(3)
2,343

 
(290
)
 
(11.0
)
 
$
3,948

 
$
(931
)
 
(19.1
)%
 
*
Percentage change is greater than 100 percent.
(1) 
See Note 2, "Trading Assets and Liabilities," in the accompanying consolidated financial statements for a breakout of trading securities by category.
(2) 
At September 30, 2018 and December 31, 2017, the fair value of derivatives included in trading assets has been reduced by $2,563 million and $3,423 million, respectively, relating to amounts recognized for the obligation to return cash collateral received under master netting agreements with derivative counterparties.
(3) 
At September 30, 2018 and December 31, 2017, the fair value of derivatives included in trading liabilities has been reduced by $3,405 million and $3,680 million, respectively, relating to amounts recognized for the right to reclaim cash collateral paid under master netting agreements with derivative counterparties.
Trading securities balances increased compared with December 31, 2017 due to increases in foreign sovereign, U.S. Treasury and equity positions. Trading securities positions are held as economic hedges of interest rate, credit and, beginning in 2018, equity derivative products issued to clients of domestic and emerging markets. Balances of securities sold, not yet purchased were lower compared with December 31, 2017 driven by a decrease in short U.S. Treasury positions related to economic hedges of derivatives in the interest rate trading portfolio.
Precious metals trading assets increased compared with December 31, 2017 due to increases in our own gold and silver inventory positions due primarily to a redeployment of surplus liquidity in the short term which is economically hedged with derivative positions to protect against changes in market pricing and, to a lesser extent, an increase in positions held as hedges for client activity. These increases were partially offset by lower spot prices. Payables for precious metals were lower reflecting a decline in borrowing of gold inventory to support client activity levels. Precious metal positions may not represent our net underlying exposure as we may use derivatives contracts to reduce our risk associated with these positions, the fair value of which would appear in derivatives in the table above.
Derivative asset and liability balances both decreased compared with December 31, 2017 mainly from market movements which resulted in lower valuations of interest rate and foreign exchange derivatives, partially offset by higher valuations of commodity, credit and equity derivatives.
Securities  Securities include securities available-for-sale and securities held-to-maturity. Securities balances were higher compared with December 31, 2017 driven by net purchases of U.S. Government sponsored mortgage-backed and foreign sovereign securities, partially offset by net sales of U.S. Treasury and other asset-backed securities as part of a continuing strategy to maximize returns while balancing the securities portfolio for risk management purposes based on the current interest rate environment and liquidity needs. In addition, as discussed more fully in Note 21, “New Accounting Pronouncements,” the adoption of new accounting guidance resulted in a reclassification of certain equity investments to other assets as of January 1, 2018.
All Other Assets  All other assets includes, among other items, properties and equipment, net and goodwill. All other assets decreased compared with December 31, 2017 due primarily to lower derivative balances associated with economic hedging activities. This decrease was partially offset by the impact of the adoption of new accounting guidance related to equity investments as discussed above as well as higher outstanding settlement balances related to security sales.

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HSBC USA Inc.

During the third quarter of 2018, we completed our annual impairment test of goodwill and determined that the fair value of all of our reporting units exceeded their carrying amounts, with the fair value of each reporting unit being 159 percent or more of book value, including allocated goodwill.
Deposits  The following table summarizes deposit balances by major depositor categories at September 30, 2018 and increases (decreases) since December 31, 2017:
 
 
 
Increase (Decrease) From
 
 
 
December 31, 2017
  
September 30, 2018
 
Amount
 
%
 
(dollars are in millions)
Individuals, partnerships and corporations
$
95,166

 
$
(9,003
)
 
(8.6
)%
Domestic and foreign banks
13,564

 
2,693

 
24.8

U.S. government and states and political subdivisions
586

 
(37
)
 
(5.9
)
Foreign governments and official institutions
2,726

 
360

 
15.2

Deposits held for sale(1)
48

 
(625
)
 
(92.9
)
Total deposits
$
112,090

 
$
(6,612
)
 
(5.6
)%
Total core deposits(2)
$
89,297

 
$
(9,203
)
 
(9.3
)%
 
 
(1) 
Represents deposits associated with the sale of a portion of our Private Banking business. No lower of cost or fair value adjustment was required as a result of the transfer to held for sale.
(2) 
Core deposits, as calculated in accordance with Federal Financial Institutions Examination Council ("FFIEC") guidelines, generally include all domestic demand, money market and other savings accounts, as well as time deposits with balances not exceeding $250,000.
Total deposits decreased compared with December 31, 2017 largely due to lower commercial demand and savings deposits driven by a large deposit outflow associated with a client that was acquired by another company during the third quarter, the impact of seasonality as clients managed their cash needs at year-end and volatility reflecting the impact of competitive pressures in a rising interest rate environment. Also contributing to the decrease in total deposits compared with December 31, 2017 were lower retail savings deposits driven primarily by the attrition of balances associated with previous promotional rate campaigns as well as lower Private Banking deposits reflecting the impact of the client referral agreement with UBS Wealth Management Americas ("UBS"). These decreases were partially offset by higher deposits from affiliates and higher wholesale time deposits. The strategy for our core retail banking business includes building relationship deposits across multiple markets, channels and segments. This strategy involves various initiatives, such as:
•
HSBC Premier, a comprehensive banking and wealth management proposition for the internationally minded mass affluent customer with a dedicated premier relationship manager. Total Premier deposits decreased to $22,691 million at September 30, 2018 compared with $25,726 million at December 31, 2017 as new balance growth was more than offset by the attrition discussed above; and
•
Expanding our existing customer relationships by needs-based sales of wealth, banking and mortgage products.
We continue to actively manage our balance sheet to increase profitability while maintaining adequate liquidity.
Short-Term Borrowings  Short-term borrowings were slightly higher compared with December 31, 2017 as an increase in commercial paper outstanding was largely offset by a decrease in securities sold under repurchase agreements.
Long-Term Debt  Long-term debt decreased compared with December 31, 2017 as the impact of debt issuances were more than offset by debt retirements. Debt issuances during the three and nine months ended September 30, 2018 totaled $1,051 million and $3,729 million, respectively, of which $361 million and $871 million, respectively, was issued by HSBC Bank USA.
Incremental issuances from our shelf registration statement with the SEC totaled $2,858 million of senior structured notes during the nine months ended September 30, 2018. Total long-term debt outstanding under this shelf was $16,271 million and $21,387 million at September 30, 2018 and December 31, 2017, respectively.
Incremental issuances from the HSBC Bank USA Global Bank Note Program totaled $871 million during the nine months ended September 30, 2018. Total debt outstanding under this program was $4,341 million and $4,117 million at September 30, 2018 and December 31, 2017, respectively.
Borrowings from the Federal Home Loan Bank of New York ("FHLB") totaled $3,100 million at both September 30, 2018 and December 31, 2017.

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HSBC USA Inc.

Interest, Taxes and Other Liabilities  Interest, taxes and other liabilities decreased compared with December 31, 2017 due primarily to declines in derivative balances associated with hedging activities, tax liabilities and accrued interest payable. These decreases were partially offset by higher reserves for legal matters and higher outstanding settlement balances related to security purchases.

Results of Operations
 
Net Interest Income  Net interest income is the total interest income on earning assets less the total interest expense on deposits and borrowed funds. An analysis of consolidated average balances and interest rates is presented in this MD&A under the caption "Consolidated Average Balances and Interest Rates."
The significant components of net interest margin are summarized in the following table:
 
 
 
2018 Compared to
2017
Increase (Decrease)
 
 
Three Months Ended September 30,
2018
 
Volume
 
Rate
 
2017
 
(dollars are in millions)
Interest income:
 
 
 
 
 
 
 
Short-term investments
$
164

 
$
(123
)
 
$
84

 
$
203

Trading securities
54

 
16

 
(9
)
 
47

Securities
292

 
2

 
59

 
231

Commercial loans
470

 
(17
)
 
116

 
371

Consumer loans
189

 
1

 
7

 
181

Other
19

 
2

 
3

 
14

Total interest income
1,188

 
(119
)
 
260

 
1,047

Interest expense:
 
 
 
 
 
 
 
Deposits
283

 
(13
)
 
108

 
188

Short-term borrowings
45

 
(33
)
 
39

 
39

Long-term debt
291

 
(50
)
 
85

 
256

Tax liabilities and other
10

 
—

 
6

 
4

Total interest expense
629

 
(96
)
 
238

 
487

Net interest income
$
559

 
$
(23
)
 
$
22

 
$
560

 
 
 
 
 
 
 
 
Yield on total interest earning assets
3.04
%
 
 
 
 
 
2.35
%
Cost of total interest bearing liabilities
2.03

 
 
 
 
 
1.35

Interest rate spread
1.01

 
 
 
 
 
1.00

Benefit from net non-interest paying funds(1)
.42

 
 
 
 
 
.26

Net interest margin on average earning assets
1.43
%
 
 
 
 
 
1.26
%
 
 
 
 
 
 
 
 

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HSBC USA Inc.

 
 
 
2018 Compared to
2017
Increase (Decrease)
 
 
Nine Months Ended September 30,
2018
 
Volume
 
Rate
 
2017
 
(dollars are in millions)
Interest income:
 
 
 
 
 
 
 
Short-term investments
$
479

 
$
(261
)
 
$
225

 
$
515

Trading securities
156

 
39

 
(46
)
 
163

Securities
823

 
(47
)
 
155

 
715

Commercial loans
1,336

 
(81
)
 
292

 
1,125

Consumer loans
558

 
(6
)
 
16

 
548

Other
57

 
14

 
5

 
38

Total interest income
3,409

 
(342
)
 
647

 
3,104

Interest expense:
 
 
 
 
 
 
 
Deposits
763

 
(39
)
 
295

 
507

Short-term borrowings
121

 
(47
)
 
74

 
94

Long-term debt
831

 
(124
)
 
206

 
749

Tax liabilities and other
28

 
6

 
7

 
15

Total interest expense
1,743

 
(204
)
 
582

 
1,365

Net interest income
$
1,666

 
$
(138
)
 
$
65

 
$
1,739

 
 
 
 
 
 
 
 
Yield on total interest earning assets
2.87
%
 
 
 
 
 
2.28
%
Cost of total interest bearing liabilities
1.83

 
 
 
 
 
1.27

Interest rate spread
1.04

 
 
 
 
 
1.01

Benefit from net non-interest paying funds(1)
.36

 
 
 
 
 
.27

Net interest margin on average earning assets
1.40
%
 
 
 
 
 
1.28
%
 
(1) 
Represents the benefit associated with interest earning assets in excess of interest bearing liabilities. Increased percentages reflect growth in this excess, while decreased percentages reflect a reduction in this excess.
Net interest income was relatively flat during the three months ended September 30, 2018 and decreased in the year-to-date period. Higher market rates resulted in higher interest income from short-term investments, securities and loans which was partially offset by higher deposit, short-term borrowings and long-term debt interest expense in both periods. The favorable net impact of higher market rates were offset in the three-month period and more than offset in the year-to-date period by lower interest income from the impact of lower average short-term investment and loan balances, partially offset by lower interest expense from the impact of lower average deposit, short-term borrowings and long-term debt balances.
Short-term investments Interest income decreased during the three and nine months ended September 30, 2018 due to lower average balances, partially offset by higher yields earned on these investments.
Trading securities Interest income was higher during the three months ended September 30, 2018 due primarily to an increase in lower yielding foreign sovereign positions which resulted in higher average balances, partially offset by lower yields. In the year-to-date period, interest income was lower due to a shift in mix driven by a decrease in higher yielding corporate bond positions and an increase in lower yielding foreign sovereign positions which resulted in lower yields, partially offset by higher average balances. Securities in the trading portfolio are managed as economic hedges against the derivative activity of our clients. As a result, interest income associated with trading securities was partially offset within trading revenue by the performance of the associated derivatives as discussed further below.
Securities Interest income increased during the three and nine months ended September 30, 2018 due to higher yields. The increase was partially offset in the year-to-date period by lower average balances driven by net sales of U.S. Treasury and U.S. Government sponsored mortgage-backed securities, partially offset by net purchases of U.S. Government agency mortgage-backed and foreign sovereign securities.
Commercial loans Interest income was higher during the three and nine months ended September 30, 2018 due to higher yields driven by rate increases on variable rate products, partially offset by lower average balances due to paydowns, sales and maturities exceeding loan growth from new business activity.

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HSBC USA Inc.

Consumer loans Interest income increased during the three and nine months ended September 30, 2018 due primarily to higher yields on residential mortgages. The increase was partially offset in the year-to-date period by lower average balances driven by the impact of residential mortgage loan sales in the prior year.
Other Higher interest income during the three and nine months ended September 30, 2018 reflects higher average balances as well as higher yields on cash collateral posted.
Deposits Interest expense increased during the three and nine months ended September 30, 2018 due primarily to higher rates paid reflecting the impact of rate increases on wholesale deposits and promotional rates offered to our retail customers on savings accounts and certificates of deposits. This increase was partially offset by lower average interest-bearing deposit balances driven by lower deposits from affiliates, lower retail savings deposits driven primarily by the attrition of balances associated with previous promotional rate campaigns, lower deposits in Private Banking reflecting the impact of the client referral agreement with UBS as well as a decline in wholesale time deposits.
Short-term borrowings Higher interest expense during the three and nine months ended September 30, 2018 was due to higher rates paid on these borrowings, partially offset by lower average borrowings.
Long-term debt Interest expense was higher during the three and nine months ended September 30, 2018 due to higher rates paid reflecting the impact of rate increases on variable rate borrowings and new issuances, partially offset by lower average borrowings.
Tax liabilities and other Interest expense increased during the three and nine months ended September 30, 2018 driven by higher rates paid on securities sold, not yet repurchased and, in the year-to-date period, higher average balances.
Provision for Credit Losses  The following table summarizes the provision for credit losses associated with our various loan portfolios:
 
 
 
 
 
Increase (Decrease)
Three Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Commercial:
 
 
 
 
 
 
 
Real estate, including construction
$
24

 
$
(1
)
 
$
25

 
*

Business and corporate banking
9

 
(9
)
 
18

 
*

Global banking
(16
)
 
(21
)
 
5

 
23.8
 %
Other commercial
(4
)
 
(1
)
 
(3
)
 
*

Total commercial
13

 
(32
)
 
45

 
*

Consumer:
 
 
 
 
 
 
 
Residential mortgages
(5
)
 
4

 
(9
)
 
*

Home equity mortgages
(1
)
 
(2
)
 
1

 
50.0

Credit cards
14

 
8

 
6

 
75.0

Other consumer
(1
)
 
—

 
(1
)
 
*

Total consumer
7

 
10

 
(3
)
 
(30.0
)
Total provision for credit losses
$
20

 
$
(22
)
 
$
42

 
*

Provision as a percentage of average loans
.1
 %
 
(.1
)%
 
 
 
 
 
 
 
 
 
 
 
 

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HSBC USA Inc.

 
 
 
 
 
Increase (Decrease)
Nine Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Commercial:
 
 
 
 
 
 
 
Real estate, including construction
$
30

 
$
(9
)
 
$
39

 
*

Business and corporate banking
(52
)
 
(56
)
 
4

 
7.1

Global banking
(90
)
 
(60
)
 
(30
)
 
(50.0
)
Other commercial
(3
)
 
1

 
(4
)
 
*

Total commercial
(115
)
 
(124
)
 
9

 
7.3

Consumer:
 
 
 
 
 
 
 
Residential mortgages
(19
)
 
(4
)
 
(15
)
 
*

Home equity mortgages
(2
)
 
(8
)
 
6

 
75.0

Credit cards
39

 
17

 
22

 
*

Other consumer
1

 
(1
)
 
2

 
*

Total consumer
19

 
4

 
15

 
*

Total provision for credit losses
$
(96
)
 
$
(120
)
 
$
24

 
20.0
 %
Provision as a percentage of average loans
(.2
)%
 
(.2
)%
 


 
 
 
*
Percentage change is greater than 100 percent.
Our provision for credit losses increased $42 million during the three months ended September 30, 2018 driven by an increased provision for credit losses in our commercial loan portfolio. In the year-to-date period, our provision for credit losses increased $24 million due to an increased provision for credit losses in our consumer loan portfolio and lower releases in the provision for credit losses in our commercial loan portfolio. During the three months ended September 30, 2018, we increased our allowance for credit losses as the provision for credit losses was higher than net charge-offs by $4 million. In the year-to-date period, we decreased our allowance for credit losses as the provision for credit losses was lower than net charge-offs by $146 million.
The provision for credit losses in our commercial loan portfolio increased $45 million during the three months ended September 30, 2018. While both years reflected releases in credit loss reserves driven by paydowns, sales and maturities, the releases in the current year period were more than offset by higher provisions for downgrades reflecting weakness in the financial condition of certain clients as well as a higher provision for risk factors associated with geopolitical risks and market volatility inherent in certain segments of the portfolio. In the year-to-date period, releases in the commercial provision for credit losses were lower by $9 million. While both years reflected continued improvements in the credit quality of our portfolio driven by paydowns, sales and maturities as we continued to focus efforts on improving returns as well as improvements in credit conditions associated with certain client relationships, the releases in the current year period were partially offset by a higher provision for risk factors associated with geopolitical risks and market volatility inherent in certain segments of the portfolio, an update to the loss emergence period factors and higher provisions for downgrades reflecting weakness in the financial condition of certain clients.
The provision for credit losses on residential mortgages and home equity mortgages decreased $8 million and $9 million during the three and nine months ended September 30, 2018, respectively, driven by continued improvements in economic and credit conditions, including lower dollars of delinquency on accounts less than 180 days contractually delinquent.
The provision for credit losses associated with credit cards and other consumer loans increased $5 million and $24 million during the three and nine months ended September 30, 2018, respectively, due to a higher provision for credit losses in credit cards reflecting growth in customer activity driven by new product promotions as previously discussed and higher dollars of delinquency.
Our methodology and accounting policies related to the allowance for credit losses are presented in our 2017 Form 10-K under the caption "Critical Accounting Policies and Estimates" and in Note 2, "Summary of Significant Accounting Policies and New Accounting Pronouncements." See "Credit Quality" in this MD&A for additional discussion on the allowance for credit losses associated with our various loan portfolios.

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HSBC USA Inc.

Other Revenues  The following table summarizes the components of other revenues:
 
 
 
 
 
Increase (Decrease)
Three Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Credit card fees, net
$
12

 
$
12

 
$
—

 
—

Trust and investment management fees
31

 
39

 
(8
)
 
(20.5
)
Other fees and commissions
171

 
167

 
4

 
2.4

Trading revenue
154

 
81

 
73

 
90.1

Other securities gains (losses), net
(5
)
 
5

 
(10
)
 
*

Servicing and other fees from HSBC affiliates(1)
103

 
77

 
26

 
33.8

Residential mortgage banking expense
(2
)
 
(4
)
 
2

 
50.0

Gain on instruments designated at fair value and related derivatives
29

 
7

 
22

 
*

Other income (loss):
 
 
 
 

 


Valuation of loans held for sale
1

 
3

 
(2
)
 
(66.7
)
Insurance
3

 
4

 
(1
)
 
(25.0
)
Miscellaneous income (loss)
(11
)
 
2

 
(13
)
 
*

Total other income (loss)
(7
)
 
9

 
(16
)
 
*

Total other revenues
$
486

 
$
393

 
$
93

 
23.7
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Increase (Decrease)
Nine Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(in millions)
Credit card fees, net
$
38

 
$
37

 
$
1

 
2.7
 %
Trust and investment management fees
103

 
116

 
(13
)
 
(11.2
)
Other fees and commissions
515

 
492

 
23

 
4.7

Trading revenue
509

 
222

 
287

 
*

Other securities gains (losses), net
10

 
29

 
(19
)
 
(65.5
)
Servicing and other fees from HSBC affiliates(1)
289

 
272

 
17

 
6.3

Residential mortgage banking expense
(4
)
 
(8
)
 
4

 
50.0

Gain on instruments designated at fair value and related derivatives
63

 
40

 
23

 
57.5

Other income (loss):
 
 
 
 

 


Valuation of loans held for sale
5

 
17

 
(12
)
 
(70.6
)
Insurance
9

 
11

 
(2
)
 
(18.2
)
Gains on sales of Visa Class B Shares to a third party
—

 
312

 
(312
)
 
(100.0
)
Miscellaneous income (loss)
(1
)
 
4

 
(5
)
 
*

Total other income (loss)
13

 
344

 
(331
)
 
(96.2
)
Total other revenues
$
1,536

 
$
1,544

 
$
(8
)
 
(.5
)%
 
*
Percentage change is greater than 100 percent.
(1)
During the fourth quarter of 2017, we changed our presentation for certain cost reimbursements that were previously netted as an offset to affiliate expense and began presenting these reimbursements gross in affiliate income. As a result, we have reclassified prior period amounts in order to conform to the current year presentation. See Note 14, "Related Party Transactions," in the accompanying consolidated financial statements for additional information.
Credit card fees, net  Credit card fees, net was flat during the three and nine months ended September 30, 2018 as higher interchange fees were offset by higher cost estimates associated with our credit card rewards program.
Trust and investment management fees  Trust and investment management fees decreased during the three and nine months ended September 30, 2018 due to lower assets under management in Private Banking reflecting the impact of the client referral agreement with UBS as well as a decrease in assets under management in retail fixed income funds.
Other fees and commissions Other fees and commissions increased during the three and nine months ended September 30, 2018 due to higher credit facilities fees driven by increased fees from loan commitments, standby letters of credit and, in the year-to-

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HSBC USA Inc.

date period, loan syndication. These increases were partially offset in both periods by lower custody fees. See Note 13, "Fee Income from Contracts with Customers," in the accompanying consolidated financial statements for additional information including a summary of the components of other fees and commissions.
Trading revenue  Trading revenue is generated by participation in the foreign exchange, rates, credit, equities and precious metals markets. The following table presents trading revenue by business activity. Not included in the table below is the impact of net interest income related to trading securities which is an integral part of trading activities' overall performance. Net interest income related to trading activities is recorded in net interest income in the consolidated statement of income. Trading revenues related to the mortgage banking business are included in residential mortgage banking expense.
 
 
 
 
 
Increase (Decrease)
Three Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Business Activities:
 
 
 
 
 
 
 
Derivatives(1)
$
34

 
$
(28
)
 
$
62

 
*

Foreign Exchange
40

 
51

 
(11
)
 
(21.6
)
Metals
66

 
53

 
13

 
24.5

Balance Sheet Management
7

 
6

 
1

 
16.7

Global Banking
2

 
(1
)
 
3

 
*

Other trading
5

 
—

 
5

 
*

Total trading revenue
$
154

 
$
81

 
$
73

 
90.1
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Increase (Decrease)
Nine Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(in millions)
Business Activities:
 
 
 
 
 
 
 
Derivatives(1)
$
93

 
$
(79
)
 
$
172

 
*

Foreign Exchange
157

 
151

 
6

 
4.0

Metals
232

 
136

 
96

 
70.6

Balance Sheet Management
20

 
16

 
4

 
25.0

Global Banking
(2
)
 
(2
)
 
—

 
—

Other trading
9

 
—

 
9

 
*

Total trading revenue
$
509

 
$
222

 
$
287

 
*

 
*
Percentage change is greater than 100 percent.
(1)
Includes derivative contracts related to the Credit, Rates and Equities business activities within Global Markets as well as our legacy structured credit products. Derivative contracts related to the Foreign Exchange and Metals business activities within Global Markets as well as derivative products related to Balance Sheet Management, Global Banking and other trading are reported separately within those respective business activities.
Trading revenue increased during the three and nine months ended September 30, 2018 largely driven by the improved performance of Derivatives and Metals.
Trading revenue from Derivatives improved during the three and nine months ended September 30, 2018 due primarily to improved performance in Rates driven by emerging markets products, favorable debit valuation adjustments associated with movements in our own credit spreads and favorable valuation adjustments on our legacy structured credit products. These improvements were partially offset by underperformance in Credit and Equities and, in the year-to-date period, the non-recurrence of a gain of approximately $11 million recorded during the second quarter of 2017 related to the unwind of one of our unconsolidated variable interest entities ("VIEs"). Derivatives trading revenue does not reflect associated net interest income as certain derivatives, such as total return swaps, were economically hedged by holding the underlying interest bearing referenced assets.
Foreign Exchange trading revenue decreased during the three months ended September 30, 2018 reflecting the impact of market conditions. In the year-to-date period, Foreign Exchange trading revenue was higher driven by increased client trading activity.
Metals trading revenue was higher during the three and nine months ended September 30, 2018 due to increased client trading activity and, in the year-to-date period, increased activity associated with a redeployment of surplus liquidity in the short term to Metals.

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HSBC USA Inc.

Trading revenue related to Balance Sheet Management activities was flat during the three months ended September 30, 2018 and increased in the year-to-date period due to the improved performance of economic hedge positions used to manage interest rate risk.
Global Banking trading revenue improved during the three months ended September 30, 2018 and was flat in the year-to-date period. The improvement in the three-month period was due primarily to a lower valuation reserve on credit default swap economic hedge positions.
Other trading revenue during the three and nine months ended September 30, 2018 reflects gains from a total return swap position used to economically hedge the periodic payments made under the swap agreements we entered into in conjunction with the sales of Visa Class B Shares. Changes in fair value of the swap agreements between periods are recognized in other income (loss).
Other securities gains (losses), net  We maintain securities portfolios as part of our balance sheet diversification and risk management strategies. During the three and nine months ended September 30, 2018, we sold $736 million and $3,346 million, respectively, of primarily U.S. Treasury, U.S. Government agency mortgage-backed and U.S. Government sponsored mortgage-backed securities compared with sales of $2,286 million and $12,620 million during the prior year periods as part of a continuing strategy to maximize returns while balancing the securities portfolio for risk management purposes based on the current interest rate environment and liquidity needs. Other securities gains (losses), net decreased during the three months ended September 30, 2018 largely due to the sale of U.S. Treasury securities which resulted in losses in the current year period compared with gains in the prior year period. In the year-to-date period, other securities gains (losses), net decreased reflecting the impact of lower sales activity associated with balancing the securities portfolio for risk management purposes. The gross realized gains and losses from sales of securities, which is included as a component of other securities gains (losses), net above, are summarized in Note 3, "Securities," in the accompanying consolidated financial statements.
Servicing and other fees from HSBC affiliates Servicing and other fees from HSBC affiliates increased during the three and nine months ended September 30, 2018 driven by higher cost reimbursements associated with wealth management activities performed on behalf of HSBC Markets (USA) Inc. ("HMUS"), higher cost reimbursements associated with trading activities performed on behalf of HSBC Bank plc, higher fee income associated with trading activity booked on the balance sheets of other HSBC affiliates and, in the year-to-date period, approximately $10 million of cost reimbursements recorded in the current year reflecting the impact of entering into an agreement with HSBC in December 2017 under which they reimburse us for costs associated with enhancing the HSBC Group's digital banking platform. These increases were partially offset by lower fees due to the transfer of certain operational support staff from HSBC Bank USA to HSBC Technology & Services (USA) ("HTSU") support services as discussed below as well as the non-recurrence of fees received from HSBC Finance Corporation ("HSBC Finance") in the prior year, including fees associated with residential mortgage servicing activities performed prior to the completion of its receivable sales program and, in the year-to-date period, $28 million of loan prepayment fees.
Residential mortgage banking expense  Residential mortgage banking expense decreased during the three and nine months ended September 30, 2018 due to lower losses associated with the execution of certain Community Reinvestment Act activities and, in the year-to-date period, an early termination fee received from PHH Mortgage during the first quarter of 2018.
Gain on instruments designated at fair value and related derivatives  We have elected to apply fair value option accounting to certain commercial loans held for sale, certain securities purchased and sold under resale and repurchase agreements, certain of our own fixed-rate debt issuances and all of our hybrid instruments issued, including structured notes and deposits. We also use derivatives to economically hedge the interest rate and other risks associated with certain financial liabilities for which fair value option accounting has been elected. Gain on instruments designated at fair value and related derivatives was higher during the three and nine months ended September 30, 2018 attributable primarily to favorable movements related to the economic hedging of interest rate and other risks within our own debt and structured notes as well as favorable fair value adjustments on loans. These increases were partially offset in the year-to-date period by unfavorable movements related to the economic hedging of interest rate and other risks within our structured deposits and unfavorable fair value adjustments on securities purchased under resale agreements. See Note 10, "Fair Value Option," in the accompanying consolidated financial statements for additional information including a breakout of these amounts by individual component.
Other income (loss)  Beginning in late 2016 and into 2017, we sold substantially all of our remaining Visa Class B Shares to a third party. The portion of these shares sold during the nine months ended September 30, 2017 resulted in net pre-tax gains of approximately $312 million. Excluding this item from the year-to-date period, other income (loss) remained lower during the three and nine months ended September 30, 2018 due primarily to the non-recurrence of gains of $6 million and $48 million recorded from the sale of certain residential mortgages during the three and nine months ended September 30, 2017, respectively, the non-recurrence of an $8 million gain recorded associated with the sale of a portion of our Private Banking business during the third quarter of 2017, lower valuation gains on loans held for sale and, in the year-to-date period, a loss of $7 million recorded during the second quarter of 2018 related to a change in the Visa Class B Share conversion rate announced by Visa as a result of the outstanding litigation for which we retained the associated risk. These decreases were partially offset by higher income associated with fair value hedge ineffectiveness and, in the year-to-date period, lower losses associated with credit default swap protection which largely reflects the hedging of a single client relationship.

99

HSBC USA Inc.

Operating Expenses  The following table summarizes the components of operating expenses:
 
 
 
 
 
Increase (Decrease)
Three Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Salaries and employee benefits
$
208

 
$
268

 
$
(60
)
 
(22.4
)%
Support services from HSBC affiliates:(1)
 
 
 
 
 
 
 
Fees paid to HTSU
301

 
277

 
24

 
8.7

Fees paid to HMUS
22

 
30

 
(8
)
 
(26.7
)
Fees paid to other HSBC affiliates
76

 
71

 
5

 
7.0

Total support services from HSBC affiliates
399

 
378

 
21

 
5.6

Occupancy expense, net(1)
49

 
50

 
(1
)
 
(2.0
)
Other expenses:
 
 
 
 

 


Equipment and software
17

 
13

 
4

 
30.8

Marketing
24

 
16

 
8

 
50.0

Outside services
12

 
21

 
(9
)
 
(42.9
)
Professional fees
25

 
28

 
(3
)
 
(10.7
)
Off-balance sheet credit reserves
3

 
7

 
(4
)
 
(57.1
)
Federal Deposit Insurance Corporation ("FDIC") assessment fees
29

 
26

 
3

 
11.5

Expense related to legal matters
3

 
—

 
3

 
*

Miscellaneous
21

 
13

 
8

 
61.5

Total other expenses
134

 
124

 
10

 
8.1

Total operating expenses
$
790

 
$
820

 
$
(30
)
 
(3.7
)%
Personnel - average number
4,787

 
5,810

 
 
 
 
Efficiency ratio
75.6
%
 
86.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Increase (Decrease)
Nine Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Salaries and employee benefits
$
627

 
$
789

 
$
(162
)
 
(20.5
)%
Support services from HSBC affiliates:(1)
 
 
 
 
 
 
 
Fees paid to HTSU
909

 
872

 
37

 
4.2

Fees paid to HMUS
78

 
90

 
(12
)
 
(13.3
)
Fees paid to other HSBC affiliates
228

 
199

 
29

 
14.6

Total support services from HSBC affiliates
1,215

 
1,161

 
54

 
4.7

Occupancy expense, net(1)
137

 
152

 
(15
)
 
(9.9
)
Other expenses:
 
 
 
 

 


Equipment and software
44

 
37

 
7

 
18.9

Marketing
85

 
45

 
40

 
88.9

Outside services
44

 
63

 
(19
)
 
(30.2
)
Professional fees
70

 
69

 
1

 
1.4

Off-balance sheet credit reserves
(12
)
 
(13
)
 
1

 
7.7

FDIC assessment fees
91

 
106

 
(15
)
 
(14.2
)
Expense related to legal matters
513

 
26

 
487

 
*

Miscellaneous
44

 
53

 
(9
)
 
(17.0
)
Total other expenses
879

 
386

 
493

 
*

Total operating expenses
$
2,858

 
$
2,488

 
$
370

 
14.9
 %
Personnel - average number
4,782

 
5,791

 
 
 
 
Efficiency ratio
89.3
%
 
75.8
%
 
 
 
 

100

HSBC USA Inc.

 
*
Percentage change is greater than 100 percent.
(1)
During the fourth quarter of 2017, we changed our presentation for certain cost reimbursements that were previously netted as an offset to affiliate expense and began presenting these reimbursements gross in affiliate income. Separately, we also concluded that rental revenue we receive from our affiliates for rent on certain office space would be better presented as a reduction to occupancy expense as opposed to a reduction to affiliate expense. As a result, we have reclassified prior period amounts in order to conform to the current year presentation. See Note 14, "Related Party Transactions," in the accompanying consolidated financial statements for additional information.
Prior to 2018, costs to achieve, which reflected transformation costs to deliver the cost reduction and productivity outcomes outlined in the HSBC Investor Update in June 2015, were a significant component of total operating expenses. Costs to achieve primarily consisted of project cost support service charges from HTSU, lease termination and associated expenses, professional fees and severance costs. Excluding costs to achieve, total operating expenses increased $21 million and $529 million during the three and nine months ended September 30, 2018, respectively. The following table presents costs to achieve by financial statement line item:
Three Months Ended September 30,
2017
 
(in millions)
Salaries and employee benefits
$
6

Support services from HSBC affiliates
31

Occupancy expense, net
7

Other expenses
7

Total operating expenses
$
51

 
 
Nine Months Ended September 30,
2017
 
(in millions)
Salaries and employee benefits
$
14

Support services from HSBC affiliates
98

Occupancy expense, net
26

Other expenses
21

Total operating expenses
$
159

Salaries and employee benefits  Salaries and employee benefits decreased during the three and nine months ended September 30, 2018 due primarily to lower expense reflecting the impact of transferring certain operational support staff from HSBC Bank USA to HTSU support services in January 2018 in order to comply with certain banking reforms. The decrease in salaries and employee benefits also reflects lower incentive compensation expense, the non-recurrence of costs to achieve recorded in the prior year periods as discussed above, lower pension expense driven primarily by the impact of the lump-sum settlement offer completed during the fourth quarter of 2017, the non-recurrence of expense recorded in the prior year periods related to staff performing residential mortgage serving activities on behalf of HSBC Finance prior to the completion of its receivable sales program and, in the year-to-date period, lower expense associated with long-term disability medical benefits. These decreases were partially offset by the addition of personnel associated with growth initiatives in certain businesses.
Support services from HSBC affiliates  Support services from HSBC affiliates increased during the three and nine months ended September 30, 2018 due primarily to higher expense associated with certain operational support staff which were transferred from HSBC Bank USA to HTSU support services as discussed above as well as increased costs associated with our investment to improve and modernize our legacy business systems. These increases were partially offset by the favorable impact of cost management efforts in our technology and support service functions and the non-recurrence of costs to achieve recorded in the prior year periods as discussed above. A summary of the activities charged to us from various HSBC affiliates is included in Note 14, "Related Party Transactions," in the accompanying consolidated financial statements.
Occupancy expense, net  Occupancy expense was flat during the three months ended September 30, 2018 and decreased in the year-to-date period as the non-recurrence of costs to achieve recorded in the prior year periods as discussed above was offset in the three-month period and partially offset in the year-to-date period by higher rent expense, increased maintenance costs and the impact of extending the lease of our 452 Fifth Avenue property, including the 1 W. 39th Street building. The sale and leaseback of our 452 Fifth Avenue property in 2010 resulted in a gain which is deferred and was being recognized over the lease term (which was ten years) due to our continuing involvement. During the second quarter of 2017, we extended the lease for an additional five years as well as the amortization of the deferred gain to reflect the new lease term.
Other expenses  Other expenses were higher during the three and nine months ended September 30, 2018 due to higher expense related to legal matters, including expense in the current year-to-date period related to the settlement of a mortgage securitization matter, as well as higher marketing expense, higher operational losses largely associated with certain mortgage servicing advances

101

HSBC USA Inc.

in the current year and higher losses associated with card fraud. These increases were partially offset by higher levels of expense capitalization related to internally developed software, the non-recurrence of costs to achieve recorded in the prior year periods, lower outside services expense and, in the year-to-date period, lower deposit insurance assessment fees. For additional discussion of the mortgage securitization legal matter, see Note 20, "Litigation and Regulatory Matters," in the accompanying consolidated financial statements.
Efficiency ratio  Our efficiency ratio improved during the three months ended September 30, 2018 due to lower operating expenses and higher other revenues as discussed in detail above. In the year-to-date period, our efficiency ratio was higher due to higher operating expenses, lower net interest income and lower other revenues as discussed in detail above.
Income tax expense The following table provides an analysis of the difference between effective rates based on the provision for income taxes attributable to pretax income and the statutory U.S. Federal income tax rate:
Three Months Ended September 30,
2018
 
2017
 
(dollars are in millions)
Tax expense at the U.S. Federal statutory income tax rate
$
49

 
21.0
 %
 
$
54

 
35.0
 %
Increase (decrease) in rate resulting from:
 
 
 
 
 
 
 
State and local taxes, net of Federal benefit
10

 
4.3

 
4

 
2.6

Non-deductible FDIC assessment fees
1

 
.4

 
—

 
—

Other non-deductible / non-taxable items
2

 
.9

 
1

 
.6

Items affecting prior periods(1)
(1
)
 
(.4
)
 
(2
)
 
(1.3
)
Low income housing and other tax credit investments
(2
)
 
(.9
)
 
(4
)
 
(2.6
)
Other
(1
)
 
(.6
)
 
8

 
5.2

Provision for income taxes
$
58

 
24.7
 %
 
$
61

 
39.4
 %
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
2018
 
2017
 
(dollars are in millions)
Tax expense at the U.S. Federal statutory income tax rate
$
92

 
21.0
 %
 
$
320

 
35.0
 %
Increase (decrease) in rate resulting from:
 
 
 
 
 
 
 
State and local taxes, net of Federal benefit
35

 
8.0

 
25

 
2.7

Non-deductible FDIC assessment fees
20

 
4.5

 
—

 
—

Other non-deductible / non-taxable items(2)
107

 
24.3

 
3

 
.3

Items affecting prior periods(1)
(18
)
 
(4.1
)
 
(11
)
 
(1.2
)
Low income housing and other tax credit investments
(4
)
 
(.9
)
 
(16
)
 
(1.7
)
Stock based compensation
(1
)
 
(.2
)
 
(10
)
 
(1.1
)
Other
1

 
.1

 
10

 
1.1

Provision for income taxes
$
232

 
52.7
 %
 
$
321

 
35.1
 %
 
(1) 
For 2018, the amounts primarily relate to revaluation of certain deferred tax assets due to tax return adjustments and the Federal tax rate legislation change. For 2017, the amounts relate to the impact of State tax rate adjustments on deferred tax assets and changes in tax credits as a result of filing the 2016 Federal income tax return.
(2) 
For the nine months ended September 30, 2018, the amount primarily relates to the accrual of non-deductible expense related to legal matters.
In December 2017, the Tax Cuts and Jobs Act ("Tax Legislation") was enacted which reduced the Federal corporate income tax rate from 35 percent to 21 percent effective January 1, 2018. The Tax Legislation also contained other complex provisions, such as the Base Erosion and Anti-Abuse Tax ("BEAT"), which may have a material impact in future periods on income tax expense and taxes payable for the HSBC North America consolidated tax group, of which we are a member. We continue to evaluate the BEAT provisions and their potential impact, which is currently uncertain and will depend on future tax regulatory guidance, actions HSBC North America or its affiliates may take as a result of the Tax Legislation and the future earnings of HUSI and other subsidiaries of HSBC North America. Although our analysis is ongoing and could change depending upon the factors discussed above, we currently do not anticipate a material impact on our financial position or results of operations from the BEAT.


102

HSBC USA Inc.

Segment Results – Group Reporting Basis
 
We have five distinct business segments that are utilized for management reporting and analysis purposes which are aligned with HSBC's global business strategy: Retail Banking and Wealth Management ("RBWM"), Commercial Banking ("CMB"), Global Banking and Markets ("GB&M"), Private Banking ("PB") and a Corporate Center ("CC"). The segments, which are generally based upon customer groupings and global businesses, are described under Item 1, "Business," in our 2017 Form 10-K. There have been no changes in the basis of our segmentation as compared with the presentation in our 2017 Form 10-K.
We report financial information to our parent, HSBC, in accordance with HSBC Group accounting and reporting policies, which apply IFRS issued by the IASB and endorsed by the EU, and, as a result, our segment results are prepared and presented using financial information prepared on the Group Reporting Basis as operating results are monitored and reviewed, trends are evaluated and decisions about allocating resources, such as employees, are primarily made on this basis. We continue, however, to monitor capital adequacy and report to regulatory agencies on a U.S. GAAP basis.
As discussed more fully in "Basis of Reporting" in this MD&A, during the first quarter of 2018, we adopted new accounting guidance under the Group Reporting Basis for the requirements of IFRS 9 and we also implemented a change in accounting policy under the Group Reporting Basis to classify structured notes and deposits as liabilities designated under the fair value option. There have been no additional changes in the measurement of segment profit as compared with the presentation in our 2017 Form 10-K.
The significant differences between U.S. GAAP and the Group Reporting Basis as they impact our results are summarized in our 2017 Form 10-K in Note 22, "Business Segments," and under the caption "Basis of Reporting" in the MD&A section. In addition, see "Basis of Reporting" in this MD&A for a discussion of significant changes since December 31, 2017 in the differences between U.S. GAAP and the Group Reporting Basis impacting our results.
Retail Banking and Wealth Management  RBWM provides a range of banking and wealth products and services to individuals and certain small businesses, focusing on internationally minded customers in large metropolitan centers on the West and East coasts.
During the first nine months of 2018, we continued to direct resources towards the development and delivery of premium service. Particular focus has been placed on HSBC Premier, HSBC's global banking service which offers customers a seamless international service, and HSBC Advance, a proposition directed towards the emerging affluent customer in the initial stages of wealth accumulation. In addition, we have experienced higher credit card receivables reflecting growth in customer activity driven by new product promotions which are targeted beyond our current customer base.

103

HSBC USA Inc.

The following table summarizes the Group Reporting Basis results for our RBWM segment:
 
 
 
 
 
Increase (Decrease)
Three Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Net interest income
$
223

 
$
231

 
$
(8
)
 
(3.5
)%
Other operating income(1)
75

 
65

 
10

 
15.4

Total operating income(2)
298

 
296

 
2

 
.7

Expected credit losses / loan impairment charges
10

 
11

 
(1
)
 
(9.1
)
Net operating income
288

 
285

 
3

 
1.1

Operating expenses(1)
317

 
292

 
25

 
8.6

Profit (loss) before tax
$
(29
)
 
$
(7
)
 
$
(22
)
 
*

 
 
 
 
 
 
 
 
 
 
 
 
 
Increase (Decrease)
Nine Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Net interest income
$
664

 
$
665

 
$
(1
)
 
(.2
)%
Other operating income(1)
239

 
451

 
(212
)
 
(47.0
)
Total operating income(2)
903

 
1,116

 
(213
)
 
(19.1
)
Expected credit losses / loan impairment charges
16

 
17

 
(1
)
 
(5.9
)
Net operating income
887

 
1,099

 
(212
)
 
(19.3
)
Operating expenses(1)
983

 
865

 
118

 
13.6

Profit (loss) before tax
$
(96
)
 
$
234

 
$
(330
)
 
*

 
*
Percentage change is greater than 100 percent.
(1) 
During the fourth quarter of 2017, we changed our presentation for certain cost reimbursements that were previously netted as an offset to affiliate expense and began presenting these reimbursements gross in affiliate income. As a result, we have reclassified prior period amounts in order to conform to the current year presentation, which increased both RBWM other operating income and RBWM operating expenses $11 million and $35 million during the three and nine months ended September 30, 2017, respectively. See Note 14, "Related Party Transactions," for additional information.
(2) 
The following table summarizes the impact of key activities on the total operating income of our RBWM segment:
 
 
 
 
 
Increase (Decrease)
Three Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Current accounts, savings and deposits
$
175

 
$
168

 
$
7

 
4.2
 %
Mortgages, credit cards and other personal lending
56

 
64

 
(8
)
 
(12.5
)
Wealth and asset management products(3)
26

 
42

 
(16
)
 
(38.1
)
Retail business banking and other(3)
41

 
22

 
19

 
86.4

Total operating income
$
298

 
$
296

 
$
2

 
.7
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Increase (Decrease)
Nine Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Current accounts, savings and deposits
$
518

 
$
467

 
$
51

 
10.9
 %
Mortgages, credit cards and other personal lending
172

 
210

 
(38
)
 
(18.1
)
Wealth and asset management products(3)
85

 
130

 
(45
)
 
(34.6
)
Retail business banking and other(3)(4)
128

 
309

 
(181
)
 
(58.6
)
Total operating income
$
903

 
$
1,116

 
$
(213
)
 
(19.1
)%
(3) 
In 2018, we began reporting cost reimbursements associated with activities performed on behalf of other HSBC affiliates in Retail business banking and other. As a result, we reported $24 million and $72 million of cost reimbursements in Retail business banking and other during the three and nine months ended September 30, 2018, respectively, that previously would have been reported in Wealth and asset management products.
(4) 
During the nine months ended September 30, 2017, Retail business banking and other reflects gains on the sales of Visa Class B Shares of approximately $312 million and a loss on the sale of certain partially charged-off residential mortgages as discussed below.
Our RBWM segment reported higher loss before tax during the three months ended September 30, 2018 due primarily to higher operating expenses and lower net interest income, partially offset by higher other operating income. During the nine months ended

104

HSBC USA Inc.

September 30, 2018, our RBWM segment reported a loss before tax compared with a profit before tax during the nine months ended September 30, 2017 primarily due to lower other operating income driven by the non-recurrence of net pre-tax gains of approximately $312 million recorded from the sales of Visa Class B Shares in the prior year as well as higher operating expenses.
Net interest income decreased during the three months ended September 30, 2018 largely due to lower net interest income from lending driven by a continued decline in home equity mortgages and lower spreads, partially offset by higher net interest income from deposits driven by improved spreads. In the year-to-date period, net interest income was relatively flat as lower net interest income from lending reflecting the impact of loan sales in the prior year and a continued decline in home equity mortgages was offset by higher net interest income from deposits driven by improved spreads.
Excluding the gains on the sales of Visa Class B Shares as discussed above, other operating income increased during the three and nine months ended September 30, 2018 due to higher cost reimbursements associated with wealth management activities performed on behalf of HMUS and, in the year-to-date period, the non-recurrence of a loss of $73 million recorded during the first quarter of 2017 on the sale of certain partially charged-off residential mortgages and approximately $10 million of cost reimbursements recorded in the current year reflecting the impact of entering into an agreement with HSBC in December 2017 under which they reimburse us for costs associated with enhancing the HSBC Group's digital banking platform. These increases were partially offset in the year-to-date period by a loss of $7 million recorded during the second quarter of 2018 related to a change in the Visa Class B Share conversion rate announced by Visa as a result of the outstanding litigation for which we retained the associated risk.
Expected credit losses were relatively flat during the three and nine months ended September 30, 2018 as higher loss estimates in credit cards reflecting growth in customer activity driven by new product promotions as discussed above was offset by lower loss estimates in residential mortgages driven by continued improvements in economic and credit conditions. In addition, the current year periods reflect the impact of adopting IFRS 9.
Operating expenses increased during the three and nine months ended September 30, 2018 due to higher marketing expense largely driven by new product promotions in credit cards, higher expense related to the addition of personnel associated with growth initiatives, higher operational losses largely associated with certain mortgage servicing advances in the current year, higher losses associated with card fraud, higher support service cost allocations from affiliates and, in the year-to-date period, higher legal costs.
Commercial Banking  CMB offers a full range of commercial financial services and tailored solutions to enable clients to grow their businesses, focusing on key markets with high concentrations of international connectivity.
Total quarter-to-date average loans outstanding, including loans held for sale, increased 3 percent as compared with the third quarter of 2017 as we focused efforts on improving returns while growing the business. Total quarter-to-date average deposits outstanding were 3 percent higher as compared with the third quarter of 2017.

105

HSBC USA Inc.

The following table summarizes the Group Reporting Basis results for our CMB segment:
 
 
 
 
 
Increase (Decrease)
Three Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Net interest income
$
206

 
$
187

 
$
19

 
10.2
 %
Other operating income
56

 
55

 
1

 
1.8

Total operating income(1)
262

 
242

 
20

 
8.3

Expected credit losses / loan impairment charges
(4
)
 
(8
)
 
4

 
50.0

Net operating income
266

 
250

 
16

 
6.4

Operating expenses
150

 
142

 
8

 
5.6

Profit before tax
$
116

 
$
108

 
$
8

 
7.4
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Increase (Decrease)
Nine Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Net interest income
$
587

 
$
548

 
$
39

 
7.1
 %
Other operating income
169

 
159

 
10

 
6.3

Total operating income(1)
756

 
707

 
49

 
6.9

Expected credit losses / loan impairment charges
(50
)
 
(49
)
 
(1
)
 
(2.0
)
Net operating income
806

 
756

 
50

 
6.6

Operating expenses
440

 
422

 
18

 
4.3

Profit before tax
$
366

 
$
334

 
$
32

 
9.6
 %
 
(1) 
The following table summarizes the impact of key activities on the total operating income of our CMB segment:
 
 
 
 
 
Increase (Decrease)
Three Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Lending and Transaction Management
$
113

 
$
109

 
$
4

 
3.7
 %
Global Liquidity and Cash Management, current accounts and savings deposits
118

 
107

 
11

 
10.3

Global Trade and Receivables Finance
12

 
13

 
(1
)
 
(7.7
)
Investment banking products and other
19

 
13

 
6

 
46.2

Total operating income
$
262

 
$
242

 
$
20

 
8.3
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Increase (Decrease)
Nine Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Lending and Transaction Management
$
330

 
$
326

 
$
4

 
1.2
 %
Global Liquidity and Cash Management, current accounts and savings deposits
343

 
305

 
38

 
12.5

Global Trade and Receivables Finance
36

 
40

 
(4
)
 
(10.0
)
Investment banking products and other
47

 
36

 
11

 
30.6

Total operating income
$
756

 
$
707

 
$
49

 
6.9
 %
Our CMB segment reported higher profit before tax during the three and nine months ended September 30, 2018 due primarily to higher net interest income and, in the year-to-date period, higher other operating income. These increases were partially offset in both periods by higher operating expenses.
Net interest income increased during the three and nine months ended September 30, 2018 due to the favorable impact of higher loan and deposit balances and improved spreads from rate increases.
Other operating income was flat during the three months ended September 30, 2018 and increased in the year-to-date period due to higher credit facility fees and higher GB&M collaboration revenue.
Expected credit losses reflected lower releases during the three months ended September 30, 2018 and was flat in the year-to-date period. While both years reflected releases in credit loss reserves driven by paydowns, sales and maturities as well as improvements

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HSBC USA Inc.

in credit conditions associated with certain client relationships, the releases in the current year three-month period were lower due to higher provisions for downgrades reflecting weakness in the financial condition of certain clients. In addition, the current year periods reflect the impact of adopting IFRS 9.
Operating expenses increased during the three and nine months ended September 30, 2018 due primarily to higher support service cost allocations from affiliates, partially offset by lower staff costs and, in the year-to-date period, lower deposit insurance assessment fees.
Global Banking and Markets  GB&M provides tailored financial solutions to major government, corporate and institutional clients worldwide.
We continue to target U.S. companies with international banking requirements and foreign companies with banking needs in the Americas. Consistent with our global strategy, we are also focused on identifying opportunities to offer our products to CMB, PB and RBWM customers.
The following table summarizes the Group Reporting Basis results for our GB&M segment:
 
 
 
 
 
Increase (Decrease)
Three Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Net interest income
$
157

 
$
131

 
$
26

 
19.8
 %
Other operating income(1)
195

 
125

 
70

 
56.0

Total operating income(2)
352

 
256

 
96

 
37.5

Expected credit losses / loan impairment charges
(30
)
 
(18
)
 
(12
)
 
(66.7
)
Net operating income
382

 
274

 
108

 
39.4

Operating expenses(1)
203

 
214

 
(11
)
 
(5.1
)
Profit before tax
$
179

 
$
60

 
$
119

 
*

 
 
 
 
 
 
 
 
 
 
 
 
 
Increase (Decrease)
Nine Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Net interest income
$
457

 
$
439

 
$
18

 
4.1
 %
Other operating income(1)
644

 
436

 
208

 
47.7

Total operating income(2)
1,101

 
875

 
226

 
25.8

Expected credit losses / loan impairment charges
(187
)
 
(55
)
 
(132
)
 
*

Net operating income
1,288

 
930

 
358

 
38.5

Operating expenses(1)
628

 
686

 
(58
)
 
(8.5
)
Profit before tax
$
660

 
$
244

 
$
416

 
*

 
*
Percentage change is greater than 100 percent.
(1) 
During the fourth quarter of 2017, we changed our presentation for certain cost reimbursements that were previously netted as an offset to affiliate expense and began presenting these reimbursements gross in affiliate income. As a result, we have reclassified prior period amounts in order to conform to the current year presentation, which increased both GB&M other operating income and GB&M operating expenses $14 million and $51 million during the three and nine months ended September 30, 2017, respectively. See Note 14, "Related Party Transactions," for additional information.

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(2) 
The following table summarizes the impact of key activities on the total operating income of our GB&M segment. For purposes of the discussion below the table, total operating income is referred to as revenue.
 
 
 
 
 
Increase (Decrease)
Three Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Credit
$
9

 
$
2

 
$
7

 
*

Rates
3

 
15

 
(12
)
 
(80.0
)
Foreign Exchange and Metals
54

 
59

 
(5
)
 
(8.5
)
Equities
12

 
10

 
2

 
20.0

Total Global Markets
78

 
86

 
(8
)
 
(9.3
)
Global Banking
83

 
63

 
20

 
31.7

Global Liquidity and Cash Management
127

 
121

 
6

 
5.0

Securities Services
13

 
15

 
(2
)
 
(13.3
)
Global Trade and Receivables Finance
14

 
11

 
3

 
27.3

Credit and funding valuation adjustments(3)
13

 
(50
)
 
63

 
*

Other(4)
24

 
10

 
14

 
*

Total operating income
$
352

 
$
256

 
$
96

 
37.5
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Increase (Decrease)
Nine Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Credit
$
31

 
$
12

 
$
19

 
*

Rates
21

 
59

 
(38
)
 
(64.4
)
Foreign Exchange and Metals
226

 
195

 
31

 
15.9

Equities
25

 
24

 
1

 
4.2

Total Global Markets
303

 
290

 
13

 
4.5

Global Banking
264

 
195

 
69

 
35.4

Global Liquidity and Cash Management
386

 
369

 
17

 
4.6

Securities Services
39

 
38

 
1

 
2.6

Global Trade and Receivables Finance
41

 
36

 
5

 
13.9

Credit and funding valuation adjustments(3)
6

 
(86
)
 
92

 
*

Other(4)
62

 
33

 
29

 
87.9

Total operating income
$
1,101

 
$
875

 
$
226

 
25.8
 %
(3) 
During the three and nine months ended September 30, 2017, credit and funding valuation adjustments included losses of $46 million and $69 million, respectively, from the fair value movement on structured notes and deposits attributable to our own credit spread.
(4) 
Other includes cost reimbursements associated with activities performed on behalf of other HSBC affiliates, corporate funding charges and net interest income on capital held in the business and not assigned to products.
Our GB&M segment reported higher profit before tax during the three and nine months ended September 30, 2018 due to higher other operating income, higher releases in expected credit losses, lower operating expenses and higher net interest income.
Credit revenue increased during the three and nine months ended September 30, 2018 due to higher revenue from collateralized financing related activity.
Revenue from Rates decreased during the three and nine months ended September 30, 2018 due to lower revenue from emerging markets products and, in the year-to-date period, lower revenue from interest rate swaps and other rate products.
Foreign Exchange and Metals revenue decreased during the three months ended September 30, 2018 due to lower revenue in Foreign Exchange reflecting the impact of market conditions. In the year-to-date period, Foreign Exchange and Metals revenue was higher due to higher revenue in Metals driven by increased client trading activity.
Equities revenue was relatively flat during the three and nine months ended September 30, 2018.
Global Banking revenue increased during the three and nine months ended September 30, 2018 due to higher income associated with credit default swap protection which largely reflects the hedging of a single client exposure, higher loan commitment and other fees, lower losses from loan sales and, in the year-to-date period, higher loan syndication fees. These increases were partially offset in the year-to-date period by lower net interest income driven by lower loan balances due to paydowns, sales and maturities exceeding loan growth as we focused efforts on improving returns.

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HSBC USA Inc.

Global Liquidity and Cash Management revenue increased during the three and nine months ended September 30, 2018 driven by higher net interest income due to an increase in high quality deposit balances and the favorable impact of higher short-term market rates as well as higher clearing fees. These increases were partially offset by lower compliance fees and the reporting change for cost reimbursements associated with activities performed on behalf of other HSBC affiliates discussed further below.
Securities Services revenue decreased during the three months ended September 30, 2018 due to the reporting change for cost reimbursements associated with activities performed on behalf of other HSBC affiliates discussed further below. This decrease was more than offset in the year-to-date period by higher revenue from new direct custody and clearing client activity as well as higher net interest income due to the favorable impact of higher short-term market rates.
Global Trade and Receivables Finance revenue increased during the three and nine months ended September 30, 2018 due to higher fees on standby letters of credit.
As previously discussed, beginning January 1, 2018, the fair value movement on structured notes and deposits attributable to our own credit spread is now being recorded in other comprehensive income (loss). During the three and nine months ended September 30, 2017 credit and funding valuation adjustments included losses of $46 million and $69 million, respectively, from the fair value movement on structured notes and deposits attributable to our own credit spread. Excluding this item, credit and funding valuation adjustments improved during the three and nine months ended September 30, 2018 attributable primarily to movements in our own credit spreads within our derivative liability balances and funding spreads.
Other revenue increased during the three and nine months ended September 30, 2018 reflecting higher net interest income on capital held in the business and not assigned to products, higher cost reimbursements associated with activities performed on behalf of other HSBC affiliates and, in the year-to-date period, the non-recurrence of an inducement fee paid to a third party in the first quarter of 2017 associated with the sale of a portion of our portfolio of residual interests in real estate mortgage investment conduits. These increases were partially offset by higher corporate funding and excess liquidity charges. In addition, in 2018 we began reporting cost reimbursements associated with activities performed on behalf of other HSBC affiliates in Other. As a result, we reported $9 million and $25 million of cost reimbursements in Other during the three and nine months ended September 30, 2018, respectively, that previously would have been reported in Global Liquidity and Cash Management and Securities Services above.
Expected credit losses reflected higher releases during the three and nine months ended September 30, 2018 due to continued improvements in the credit quality of our portfolio driven by paydowns, sales and maturities as we continued to focus efforts on improving returns as well as improvements in credit conditions associated with certain client relationships, including the upgrade of a large oil and gas client relationship during the second quarter of 2018. In addition, the current year periods reflect the impact of adopting IFRS 9.
Operating expenses were lower during the three and nine months ended September 30, 2018 due primarily to lower staff costs and, in the year-to-date period, lower deposit insurance assessment fees and lower legal costs. While corporate function cost allocations from affiliates were higher, partially offsetting the decrease in the three-month period, they were lower and contributed to the decrease in the year-to-date period.
Private Banking  PB serves high net worth and ultra-high net worth individuals and families with complex needs domestically and abroad.
Total client deposit levels decreased $2,552 million or 24 percent and total loans decreased by $244 million or 4 percent as compared with September 30, 2017. Overall period end client assets were $3,392 million lower than September 30, 2017.
In August 2017, our PB business entered into an agreement to refer parts of its Latin America portfolio, consisting primarily of clients based in areas where we do not have a corporate presence, including Central America and the Andean Pact, to UBS. Under the terms of the agreement, we facilitate the referral of these client relationships to UBS for a fee, including the transfer of client assets, consisting of client investments and deposits, as well as the transfer of the relationship managers and client service employees that support these clients. Loans associated with these client relationships were not included in the agreement. Total operating income associated with these client relationships was approximately $2 million and $14 million during the three and nine months ended September 30, 2018, respectively, and $13 million and $38 million during the three and nine months ended September 30, 2017, respectively.

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HSBC USA Inc.

The following table provides additional information regarding client assets during the nine months ended September 30, 2018 and 2017:
Nine Months Ended September 30,
2018
 
2017
 
(in millions)
Client assets at beginning of period
$
39,089

 
$
40,462

Net new money
1,311

 
205

Client transfers to UBS
(1,464
)
 
—

Value change
144

 
1,805

Client assets at end of period
$
39,080

 
$
42,472

The following table summarizes the Group Reporting Basis results for our PB segment:
 
 
 
 
 
Increase (Decrease)
Three Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Net interest income
$
42

 
$
56

 
$
(14
)
 
(25.0
)%
Other operating income
17

 
31

 
(14
)
 
(45.2
)
Total operating income
59

 
87

 
(28
)
 
(32.2
)
Expected credit losses / loan impairment charges
(1
)
 
(2
)
 
1

 
50.0

Net operating income
60

 
89

 
(29
)
 
(32.6
)
Operating expenses
59

 
67

 
(8
)
 
(11.9
)
Profit (loss) before tax
$
1

 
$
22

 
$
(21
)
 
(95.5
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
Increase (Decrease)
Nine Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Net interest income
$
132

 
$
165

 
$
(33
)
 
(20.0
)%
Other operating income
53

 
73

 
(20
)
 
(27.4
)
Total operating income
185

 
238

 
(53
)
 
(22.3
)
Expected credit losses / loan impairment charges
(4
)
 
1

 
(5
)
 
*

Net operating income
189

 
237

 
(48
)
 
(20.3
)
Operating expenses
181

 
191

 
(10
)
 
(5.2
)
Profit (loss) before tax
$
8

 
$
46

 
$
(38
)
 
(82.6
)%
 
*
Percentage change is greater than 100 percent.
Our PB segment reported lower profit before tax during the three and nine months ended September 30, 2018 due to lower net interest income and lower other operating income, partially offset by lower operating expenses and, in the year-to-date period, improved expected credit losses.
Net interest income decreased during the three and nine months ended September 30, 2018 reflecting the impact of lower deposit balances due primarily to the impact of the client referral agreement with UBS.
During the third quarter of 2017, we recorded a net pre-tax gain of $9 million associated with the sale of a portion of our Private Banking business as discussed above. During the second quarter of 2018, we recorded a $3 million loss as a result of a decline in the estimated fair value of the contingent consideration receivable associated with the sale. Excluding these items, other operating income remained lower during the three and nine months ended September 30, 2018 due to lower fees and commissions reflecting a decline in assets under management.
Expected credit losses were flat during the three months ended September 30, 2018. In the year-to-date period, expected credit losses improved driven by a recovery in the current year reflecting lower loss estimates in the mortgage portfolio. In addition, the current year periods reflect the impact of adopting IFRS 9.
Operating expenses decreased during the three and nine months ended September 30, 2018 reflecting lower staff costs.

110

HSBC USA Inc.

Corporate Center  CC includes Balance Sheet Management, our legacy structured credit products, income and expense associated with certain affiliate transactions, certain corporate function costs, adjustments to the fair value of HSBC shares held for stock plans, interest expense associated with certain tax exposures, income associated with other tax related investments and changes in the fair value of certain debt issued for which fair value option accounting was elected and related derivatives (excluding the fair value movement on our own fair value option debt attributable to our own credit spread which is recorded in other comprehensive income (loss)). For periods prior to 2018, CC also included costs to achieve, which primarily consisted of project cost support service charges from HTSU, lease termination and associated expenses, professional fees and severance costs, as well as certain legacy residential mortgage loan and servicing activities.
The following table summarizes the Group Reporting Basis results for our CC segment:
 
 
 
 
 
Increase (Decrease)
Three Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Net interest income (expense)
$
17

 
$
(10
)
 
$
27

 
*

Other operating income
70

 
33

 
37

 
*

Total operating income(1)
87

 
23

 
64

 
*

Expected credit losses / loan impairment charges
(1
)
 
1

 
(2
)
 
*

Net operating income
88

 
22

 
66

 
*

Operating expenses
55

 
103

 
(48
)
 
(46.6
)
Profit (loss) before tax
$
33

 
$
(81
)
 
$
114

 
*

 
 
 
 
 
 
 
 
 
 
 
 
 
Increase (Decrease)
Nine Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Net interest income (expense)
$
50

 
$
(9
)
 
$
59

 
*

Other operating income
225

 
205

 
20

 
9.8

Total operating income(1)
275

 
196

 
79

 
40.3

Expected credit losses / loan impairment charges
3

 
—

 
3

 
*

Net operating income
272

 
196

 
76

 
38.8

Operating expenses
641

 
338

 
303

 
89.6

Profit (loss) before tax
$
(369
)
 
$
(142
)
 
$
(227
)
 
*

 
*
Percentage change is greater than 100 percent.
(1) 
The following table summarizes the impact of key activities on the total operating income of our CC segment:
 
 
 
 
 
Increase (Decrease)
Three Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Balance Sheet Management(2)
$
52

 
$
56

 
$
(4
)
 
(7.1
)%
Legacy structured credit products
7

 
1

 
6

 
*

Legacy residential mortgage activities(3)
—

 
(23
)
 
23

 
100.0

Other
28

 
(11
)
 
39

 
*

Total operating income
$
87

 
$
23

 
$
64

 
*

 
 
 
 
 
 
 
 
 
 
 
 
 
Increase (Decrease)
Nine Months Ended September 30,
2018
 
2017
 
Amount
 
%
 
(dollars are in millions)
Balance Sheet Management(2)
$
198

 
$
189

 
$
9

 
4.8
 %
Legacy structured credit products
25

 
25

 
—

 
—

Legacy residential mortgage activities(3)
—

 
3

 
(3
)
 
(100.0
)
Other
52

 
(21
)
 
73

 
*

Total operating income
$
275

 
$
196

 
$
79

 
40.3
 %
(2) 
Balance Sheet Management includes gains (losses) on the sale of securities of $(5) million and $10 million in the three and nine months ended September 30, 2018, respectively, compared with $3 million and $24 million in the three and nine months ended September 30, 2017, respectively.

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HSBC USA Inc.

(3) 
Reflected fees associated with residential mortgage servicing activities performed on behalf of HSBC Finance prior to the completion of its receivable sales program and revenue associated with certain residential mortgage loans that we previously purchased from HSBC Finance and sold during 2017.
Our CC segment reported a profit before tax during the three months ended September 30, 2018 compared with a loss before tax in the prior year quarter due to lower operating expenses, higher other operating income and higher net interest income. In the year-to-date period, our CC segment reported higher loss before tax due to higher operating expenses driven primarily by expense recorded in the current year related to the settlement of a mortgage securitization legal matter, partially offset by higher net interest income and higher other operating income.
Net interest income was higher during the three and nine months ended September 30, 2018 due primarily to the impact of the liquidity framework we adopted in preparation for the planned implementation of the Net Stable Funding Ratio ("NSFR") which provides a temporary cap on the net liquidity charge to GB&M until the NSFR becomes effective. The framework, in combination with lower liquidity charges in GB&M, resulted in lower excess liquidity charges being retained in the CC compared with the prior year. See "Risk Management" in this MD&A for additional discussion of the NSFR. The increase in net interest income also reflects higher corporate funding charges to the businesses as the charges in the prior year were reduced due to the loan prepayment fees received from HSBC Finance as discussed below.
Other operating income increased during the three and nine months ended September 30, 2018 driven largely by favorable valuation adjustments on our legacy structured credit products, favorable movements related to the economic hedging of interest rate risk within our own debt and higher income associated with fair value hedge ineffectiveness. These increases were partially offset by lower gains from asset sales in Balance Sheet Management and, in the year-to-date period, the non-recurrence of revenue recorded in the prior year associated with legacy activities, including $28 million of loan prepayment fees received from HSBC Finance during the first quarter of 2017 and a gain of approximately $11 million associated with the unwind of one of our unconsolidated VIEs during the second quarter of 2017. While sales of certain residential mortgages that we previously purchased from HSBC Finance resulted in a loss of $7 million during the third quarter of 2017, which contributed to the increase in the three-month period, they resulted in a net gain of $5 million in the prior year-to-date period which partially offset the increase.
Expected credit losses were lower during the three months ended September 30, 2018 and higher in the year-to-date period reflecting the impact of recording expected credit losses on certain financial assets in the current year periods due to the adoption of IFRS 9.
Operating expenses were lower during the three months ended September 30, 2018 and higher in the year-to-date period as a result of the non-recurrence of costs to achieve as discussed above of approximately $40 million and $129 million during the three and nine months ended September 30, 2017, respectively, as well as higher levels of expense capitalization related to internally developed software and the non-recurrence of expense related to staff performing residential mortgage serving activities on behalf of HSBC Finance which were more than offset in the year-to-date period by higher expense related to legal matters reflecting the settlement of a mortgage securitization matter.
Reconciliation of Segment Results  As previously discussed, segment results are reported on a Group Reporting Basis. For segment reporting purposes, inter-segment transactions have not been eliminated, and we generally account for transactions between segments as if they were with third parties. See Note 15, "Business Segments," in the accompanying consolidated financial statements for a reconciliation of our Group Reporting Basis segment results to U.S. GAAP consolidated totals.

Credit Quality
 
In the normal course of business, we enter into a variety of transactions that involve both on and off-balance sheet credit risk. Principal among these activities is lending to various commercial, institutional, governmental and individual customers. We participate in lending activity throughout the U.S. and, on a limited basis, internationally.
Our reported results under U.S. GAAP reflect the following methodologies for establishing the allowance for credit losses.
Allowance for Credit Losses  Commercial loans are monitored on a continuous basis with a formal assessment completed, at a minimum, annually. As part of this process, a credit grade and loss given default are assigned and an allowance is established for these loans based on a probability of default estimate associated with each credit grade under the allowance for credit losses methodology. Credit Review, a function independent of the business, provides an ongoing assessment of lending activities that includes independently assessing credit grades and loss given default estimates for sampled credits across various portfolios. When it is deemed probable based upon known facts and circumstances that full interest and principal on an individual loan will not be collected in accordance with its contractual terms, the loan is considered impaired. An impairment reserve is then established based on the present value of expected future cash flows, discounted at the loan's original effective interest rate, or as a practical expedient, the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. Updated appraisals for collateral dependent loans are generally obtained only when such loans are considered troubled and the frequency of such updates are generally based on management judgment under the specific circumstances on a case-by-case basis. In addition, loss reserves

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HSBC USA Inc.

on commercial loans are maintained to reflect our judgment of portfolio risk factors which may not be fully reflected in the reserve calculations.
Our probability of default estimates for commercial loans are mapped to our credit grade master scale. These probability of default estimates are validated on an annual basis using back-testing of actual default rates and benchmarking of the internal ratings with external rating agency data like Standard and Poor's ("S&P") ratings and default rates. Substantially all appraisals in connection with commercial real estate loans are ordered by the independent real estate appraisal review unit at HSBC. The appraisal must be reviewed and accepted by this unit. For loans greater than $250,000, an appraisal is generally ordered when the loan is classified as Substandard as defined by the Office of the Comptroller of the Currency ("OCC"). On average, it takes approximately four weeks from the time the appraisal is ordered until it is completed and the values accepted by HSBC's independent appraisal review unit. Subsequent provisions or charge-offs are completed shortly thereafter, generally within the quarter in which the appraisal is received.
In situations where an external appraisal is not used to determine the fair value of the underlying collateral of impaired loans, current information such as rent rolls and operating statements of the subject property are reviewed and presented in a standardized format. Operating results such as net operating income and cash flows before and after debt service are established and reported with relevant ratios. Third-party market data is gathered and reviewed for relevance to the subject collateral. Data is also collected from similar properties within the portfolio. Actual sales levels of properties, operating income and expense figures and rental data on a square foot basis are derived from existing loans and, when appropriate, used as comparables for the subject property. Property specific data, augmented by market data research, is used to project a stabilized year of income and expense to create a 10-year cash flow model to be discounted at appropriate rates to present value. These valuations are then used to determine if any impairment on the underlying loans exists and an appropriate allowance is recorded when warranted.
For loans identified as troubled debt restructurings ("TDR Loans"), an allowance for credit losses is maintained based on the present value of expected future cash flows discounted at the loans' original effective interest rate or in the case of certain loans which are solely dependent on the collateral for repayment, the estimated fair value of the collateral less costs to sell. The circumstances in which we perform a loan modification involving a TDR Loan at a then current market interest rate for a borrower with similar credit risk would include other changes to the terms of the original loan made as part of the restructuring (e.g. principal reductions, collateral changes, etc.) in order for the loan to be classified as a TDR Loan.
For pools of homogeneous consumer loans and certain small business loans which do not qualify as TDR Loans, we estimate probable losses using a roll rate migration analysis that estimates the likelihood that a loan will progress through the various stages of delinquency, or buckets, and ultimately charge-off based upon recent historical performance experience of other loans in our portfolio. This migration analysis incorporates estimates of the period of time between a loss occurring and the confirming event of its charge-off. This analysis considers delinquency status, loss experience and severity and takes into account whether borrowers have filed for bankruptcy or have been subject to account management actions, such as the re-age or modification of accounts. We also take into consideration the loss severity expected based on the underlying collateral, if any, for the loan in the event of default based on historical and recent trends which are updated monthly based on a rolling average of several months' data using the most recently available information.
 The roll rate methodology is a migration analysis based on contractual delinquency and rolling average historical loss experience which captures the increased likelihood of an account migrating to charge-off as the past due status of such account increases. The roll rate models used were developed by tracking the movement of delinquencies by age of delinquency by "bucket" over a specified time period. Each bucket represents a period of delinquency in 30-day increments. The roll from the last delinquency bucket results in charge-off. Contractual delinquency is a method for determining aging of past due accounts based on the status of payments under the loan. Average roll rates are developed to avoid temporary aberrations caused by seasonal trends in delinquency experienced by some product types. We have determined that a 12-month average roll rate balances the desire to avoid temporary aberrations, while at the same time analyzing recent historical data. The roll rate calculations are performed monthly and are done consistently from period to period. We regularly monitor our portfolio to evaluate the period of time utilized in our roll rate migration analysis and perform a formal review on an annual basis. In addition, loss reserves on consumer loans are maintained to reflect our judgment of portfolio risk factors which may not be fully reflected in the statistical roll rate calculation.
Our allowance for credit losses methodology and our accounting policies related to the allowance for credit losses are presented in further detail under the caption "Critical Accounting Policies and Estimates" and in Note 2, "Summary of Significant Accounting Policies and New Accounting Pronouncements," in our 2017 Form 10-K. Our approach toward credit risk management is summarized under the caption "Risk Management" in our 2017 Form 10-K. There have been no significant revisions to our policies or methodologies during the first nine months of 2018.

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HSBC USA Inc.

The following table sets forth the allowance for credit losses for the periods indicated:
 
September 30, 2018
 
June 30, 2018
 
December 31, 2017
 
(dollars are in millions)
Allowance for credit losses
$
535

 
$
531

 
$
681

Ratio of Allowance for credit losses to:
 
 
 
 
 
Loans:(1)
 
 
 
 
 
Commercial:
 
 
 
 
 
Non-affiliates
1.00
%
 
1.02
%
 
1.31
%
Affiliates
—

 
—

 
—

Total commercial
.97

 
.98

 
1.15

Consumer:
 
 
 
 
 
Residential mortgages
.07

 
.09

 
.14

Home equity mortgages
.78

 
.83

 
.92

Credit cards
5.62

 
5.35

 
4.44

Other consumer
1.90

 
1.65

 
1.46

Total consumer
.39

 
.38

 
.37

Total
.80
%
 
.80
%
 
.94
%
Net charge-offs:(2)
 
 
 
 
 
Commercial(3)
974
%
 
993
%
 
405
%
Consumer
385

 
336

 
348

Total
799
%
 
781
%
 
398
%
Nonperforming loans:(1)(4)
 
 
 
 
 
Commercial
281
%
 
131
%
 
99
%
Consumer
16

 
15

 
15

Total
82
%
 
64
%
 
61
%
 
(1) 
Ratios exclude loans held for sale as these loans are carried at the lower of amortized cost or fair value.
(2) 
Ratios at September 30, 2018 and June 30, 2018 reflect year-to-date net charge-offs, annualized. Ratio at December 31, 2017 reflects full year net charge-offs.
(3) 
Our commercial net charge-off coverage ratio for the year-to-date periods ended September 30, 2018 and June 30, 2018 and year ended December 31, 2017 was 117 months, 119 months and 49 months, respectively. The net charge-off coverage ratio represents the commercial allowance for credit losses at period end divided by average monthly commercial net charge-offs during the period.
(4) 
Represents our commercial and consumer allowance for credit losses, as appropriate, divided by the corresponding outstanding balance of total nonperforming loans held for investment. Nonperforming loans include accruing loans contractually past due 90 days or more.
See Note 5, "Allowance for Credit Losses," in the accompanying consolidated financial statements for a rollforward of credit losses by general loan categories for the three and nine months ended September 30, 2018 and 2017.
The allowance for credit losses at September 30, 2018 was relatively flat as compared with June 30, 2018 and decreased $146 million or 21 percent as compared with December 31, 2017 due to lower loss estimates in our commercial loan portfolio.
Our commercial allowance for credit losses was flat as compared with June 30, 2018 as releases of reserves driven by paydowns, sales and maturities were offset by higher provisions for downgrades reflecting weakness in the financial condition of certain clients as well as a higher provision for risk factors associated with geopolitical risks and market volatility inherent in certain segments of the portfolio. As compared with December 31, 2017, our commercial allowance for credit losses decreased $150 million or 25 percent reflecting continued improvements in the credit quality of our portfolio driven by paydowns, sales and maturities as we continued to focus efforts on improving returns as well as improvements in credit conditions associated with certain client relationships. These decreases were partially offset by a higher provision for risk factors associated with geopolitical risks and market volatility inherent in certain segments of the portfolio, an update to the loss emergence period factors and higher provisions for downgrades reflecting weakness in the financial condition of certain clients.
Our consumer allowance for credit losses increased $3 million or 4 percent as compared with June 30, 2018 and increased $4 million or 5 percent as compared with December 31, 2017 due to a higher allowance for credit losses in credit cards reflecting growth in customer activity driven by new product promotions as previously discussed and higher dollars of delinquency, partially

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offset by a lower allowance for credit losses in residential mortgages and home equity mortgages due to continued improvements in economic and credit conditions, including lower dollars of delinquency on accounts less than 180 days contractually delinquent.
Our residential mortgage loan allowance for credit losses in all periods reflects consideration of risk factors relating to trends such as recent portfolio performance as compared with average roll rates as well as housing market trends and second lien exposure.
The allowance for credit losses as a percentage of total loans held for investment at September 30, 2018 was flat as compared with June 30, 2018 and decreased as compared with December 31, 2017 due to a lower commercial allowance for credit losses for the reasons discussed above.
The allowance for credit losses as a percentage of net charge-offs at September 30, 2018 was relatively flat as compared with June 30, 2018 and increased as compared with December 31, 2017 as a decrease in dollars of net charge-offs driven by lower charge-offs in our commercial loan portfolio associated with a single mining client relationship and loan sales outpaced the decrease in our overall allowance for credit losses for the reasons discussed above.
The allowance for credit losses as a percentage of nonperforming loans held for investment at September 30, 2018 increased as compared with both June 30, 2018 and December 31, 2017 driven by a decrease in nonperforming loans due primarily to managed reductions in certain exposures in our commercial loan portfolio which was partially offset as compared with December 31, 2017 by a decrease in our overall allowance for credit losses for the reasons discussed above.
The following table presents the allowance for credit losses by major loan categories, excluding loans held for sale:
 
Amount
 
% of
Loans to
Total
Loans
 
Amount
 
% of
Loans to
Total
Loans
 
Amount
 
% of
Loans to
Total
Loans
 
September 30, 2018
 
June 30, 2018
 
December 31, 2017
 
(dollars are in millions)
Commercial(1)
$
458

 
70.7
%
 
$
457

 
70.5
%
 
$
608

 
73.1
%
Consumer:
 
 
 
 
 
 
 
 
 
 
 
Residential mortgages
13

 
26.0

 
15

 
26.1

 
25

 
23.8

Home equity mortgages
8

 
1.5

 
9

 
1.6

 
11

 
1.6

Credit cards
51

 
1.4

 
45

 
1.3

 
32

 
1.0

Other consumer
5

 
.4

 
5

 
.5

 
5

 
.5

Total consumer
77

 
29.3

 
74

 
29.5

 
73

 
26.9

Total
$
535

 
100.0
%
 
$
531

 
100.0
%
 
$
681

 
100.0
%
 
(1) 
See Note 5, "Allowance for Credit Losses," in the accompanying consolidated financial statements for components of the commercial allowance for credit losses.
Reserves for Off-Balance Sheet Credit Risk  We also maintain a separate reserve for credit risk associated with certain commercial off-balance sheet exposures, including letters of credit, unused commitments to extend credit and financial guarantees. The following table summarizes this reserve, which is included in other liabilities on the consolidated balance sheet. The related provision is recorded as a component of other expense within operating expenses.
 
September 30, 2018
 
June 30, 2018
 
December 31, 2017
 
(in millions)
Off-balance sheet credit risk reserve
$
95

 
$
92

 
$
106

The increase in off-balance sheet reserves at September 30, 2018 as compared with June 30, 2018 largely reflects the downgrade of a single client relationship. As compared with December 31, 2017, off-balance sheet reserves decreased reflecting managed reductions in certain exposures and improvements in credit conditions associated certain client relationships. Off-balance sheet exposures are summarized under the caption "Off-Balance Sheet Arrangements, Credit Derivatives and Other Contractual Obligations" in this MD&A.

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Delinquency  The following table summarizes dollars of two-months-and-over contractual delinquency and two-months-and-over contractual delinquency as a percent of total loans and loans held for sale ("delinquency ratio"):
 
September 30, 2018
 
June 30, 2018
 
December 31, 2017
 
(dollars are in millions)
Delinquent loans:
 
 
 
 
 
Commercial
$
99

 
$
16

 
$
45

Consumer:
 
 
 
 
 
Residential mortgages(1)(2)
329

 
356

 
425

Home equity mortgages(1)(2)
31

 
32

 
39

Credit cards
18

 
15

 
12

Other consumer
7

 
8

 
10

Total consumer
385

 
411

 
486

Total
$
484

 
$
427

 
$
531

Delinquency ratio:
 
 
 
 
 
Commercial
.21
%
 
.03
%
 
.08
%
Consumer:
 
 
 
 
 
Residential mortgages(1)(2)
1.89

 
2.05

 
2.46

Home equity mortgages(1)(2)
3.02

 
2.95

 
3.27

Credit cards
1.98

 
1.78

 
1.66

Other consumer
2.20

 
2.23

 
2.48

Total consumer
1.96

 
2.09

 
2.48

Total
.72
%
 
.64
%
 
.72
%
 
(1) 
At September 30, 2018, June 30, 2018 and December 31, 2017, consumer mortgage loan delinquency includes $263 million, $285 million and $342 million, respectively, of loans that are carried at the lower of amortized cost or fair value of the collateral less costs to sell, including $1 million, $1 million and $1 million, respectively, relating to loans held for sale.
(2)The following table reflects dollars of contractual delinquency and delinquency ratios for interest-only loans and adjustable rate mortgage loans:
 
September 30, 2018
 
June 30, 2018
 
December 31, 2017
 
(dollars are in millions)
Dollars of delinquent loans:
 
 
 
 
 
Interest-only loans
$
9

 
$
12

 
$
10

ARM loans
112

 
133

 
142

Delinquency ratio:
 
 
 
 
 
Interest-only loans
.28
%
 
.37
%
 
.29
%
ARM loans
.94

 
1.11

 
1.19

Compared with June 30, 2018, our two-months-and-over contractual delinquency ratio increased 8 basis points due to higher dollars of delinquency in our commercial loan portfolio, partially offset by lower dollars of delinquency in our consumer loan portfolio. As compared with December 31, 2017, our two-months-and-over contractual delinquency ratio was flat as higher dollars of delinquency in our commercial loan portfolio was offset by lower dollars of delinquency in our consumer loan portfolio as well as lower outstanding loan balances driven by a decrease in the commercial loan portfolio.
Compared with June 30, 2018 and December 31, 2017, our commercial loan two-months-and-over contractual delinquency ratio increased 18 basis point and 13 basis points, respectively, due to higher dollars of delinquency largely driven by several global banking clients which became 60 days delinquent in the third quarter. The increase was partially offset as compared with December 31, 2017 by the collection of a large global banking loan in the first quarter as well as lower outstanding loan balances.
Our consumer loan two-month-and-over contractual delinquency ratio decreased 13 basis points and 52 basis points from June 30, 2018 and December 31, 2017, respectively, due primarily to lower dollars of residential mortgage delinquency driven by continued improvements in economic and credit conditions.

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HSBC USA Inc.

Net Charge-offs of Loans  The following table summarizes net charge-off (recovery) dollars as well as the net charge-off (recovery) of loans for the quarter, annualized, as a percentage of average loans, excluding loans held for sale, ("net charge-off ratio"):
 
September 30, 2018
 
June 30, 2018
 
September 30, 2017
 
(dollars are in millions)
Net Charge-off Dollars:
 
 
 
 
 
Commercial:
 
 
 
 
 
Real estate, including construction
$
—

 
$
—

 
$
4

Business and corporate banking
1

 
(16
)
 
5

Global banking
11

 
32

 
14

Other commercial
—

 
—

 
—

Total commercial
12

 
16

 
23

Consumer:
 
 
 
 
 
Residential mortgages
(3
)
 
(1
)
 
(2
)
Home equity mortgages
—

 
1

 
—

Credit cards
8

 
6

 
6

Other consumer
(1
)
 
1

 
—

Total consumer
4

 
7

 
4

Total
$
16

 
$
23

 
$
27

Net Charge-off Ratio:
 
 
 
 
 
Commercial:
 
 
 
 
 
Real estate, including construction
—
 %
 
—
 %
 
.15
 %
Business and corporate banking
.03

 
(.51
)
 
.15

Global banking
.24

 
.65

 
.28

Other commercial
—

 
—

 
—

Total commercial
.10

 
.13

 
.19

Consumer:
 
 
 
 
 
Residential mortgages
(.07
)
 
(.02
)
 
(.04
)
Home equity mortgages
—

 
.36

 
—

Credit cards
3.66

 
2.97

 
3.68

Other consumer
(1.35
)
 
1.18

 
—

Total consumer
.08

 
.14

 
.08

Total
.10
 %
 
.14
 %
 
.16
 %
   Our net charge-off ratio as a percentage of average loans for the quarter ended September 30, 2018 decreased 4 basis points compared with the quarter ended June 30, 2018 due to lower levels of net charge-offs in our commercial loan portfolio largely driven by a charge-off recorded during the second quarter of 2018 related to the sale of a single mining client relationship as well as lower levels of net charge-offs in our consumer loan portfolio due to continued improvements in economic and credit conditions.
Compared with the quarter ended September 30, 2017, our net charge-off ratio as a percentage of average loans decreased 6 basis points due to lower levels of net charge-offs associated with loan sales in our commercial loan portfolio while levels of net charge-offs in our consumer loan portfolio were flat.


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HSBC USA Inc.

Nonperforming Assets  Nonperforming assets consisted of the following: 
 
September 30, 2018
 
June 30, 2018
 
December 31, 2017
 
(in millions)
Nonaccrual loans:
 
 
 
 
 
Commercial:
 
 
 
 
 
Real estate, including construction
$
6

 
$
13

 
$
12

Business and corporate banking
75

 
218

 
215

Global banking
80

 
117

 
385

Other commercial
1

 
—

 
1

Commercial nonaccrual loans held for sale
—

 
—

 
—

Total commercial
162

 
348

 
613

Consumer:
 
 
 
 
 
Residential mortgages(1)(2)(3)
406

 
405

 
414

Home equity mortgages(1)(2)
62

 
63

 
67

Consumer nonaccrual loans held for sale
1

 
1

 
1

Total consumer
469

 
469

 
482

Total nonaccruing loans
631

 
817

 
1,095

Accruing loans contractually past due 90 days or more:
 
 
 
 
 
Commercial:
 
 
 
 
 
Business and corporate banking
1

 
1

 
1

Total commercial
1

 
1

 
1

Consumer:
 
 
 
 
 
Credit cards
13

 
11

 
9

Other consumer
6

 
5

 
8

Total consumer
19

 
16

 
17

Total accruing loans contractually past due 90 days or more
20

 
17

 
18

Total nonperforming loans
651

 
834

 
1,113

Other real estate owned(4)
10

 
12

 
11

Total nonperforming assets
$
661

 
$
846

 
$
1,124

 
(1) 
At September 30, 2018, June 30, 2018 and December 31, 2017, nonaccrual consumer mortgage loans held for investment include $334 million, $348 million and $360 million, respectively, of loans that are carried at the lower of amortized cost or fair value of the collateral less cost to sell.
(2) 
Nonaccrual consumer mortgage loans held for investment include all loans which are 90 or more days contractually delinquent as well as loans discharged under Chapter 7 bankruptcy and not re-affirmed and second lien loans where the first lien loan that we own or service is 90 or more days contractually delinquent.
(3) 
Nonaccrual consumer mortgage loans for all periods does not include guaranteed loans purchased from the Government National Mortgage Association. Repayment of these loans is predominantly insured by the Federal Housing Administration and as such, these loans have different risk characteristics from the rest of our customer loan portfolio.
(4) 
Includes $1 million or less of commercial other real estate owned at September 30, 2018, June 30, 2018 and December 31, 2017.
Nonaccrual loans at September 30, 2018 decreased as compared with both June 30, 2018 and December 31, 2017 due primarily to lower levels of nonaccrual loans in our commercial loan portfolio driven by managed reductions in certain exposures, including the sale of a single mining client relationship during the second quarter. Nonaccrual loans in our consumer loan portfolio were also lower as compared with December 31, 2017 reflecting continued improvements in economic and credit conditions. Accruing loans past due 90 days or more remained relatively flat as compared with both June 30, 2018 and December 31, 2017.
Our policies and practices for problem loan management and placing loans on nonaccrual status are summarized in Note 2, "Summary of Significant Accounting Policies and New Accounting Pronouncements," in our 2017 Form 10-K.
Impaired Commercial Loans  See Note 4, "Loans," in the accompanying consolidated financial statements for information regarding impaired loans, including TDR Loans as well as certain other commercial credit quality indicators. Commercial impaired loans decreased as compared with both June 30, 2018 and December 31, 2017 largely due to lower nonaccrual loans for the reasons discussed above.

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HSBC USA Inc.

Concentration of Credit Risk  A concentration of credit risk is defined as a significant credit exposure with an individual or group engaged in similar activities or affected similarly by economic conditions. We enter into a variety of transactions in the normal course of business that involve both on and off-balance sheet credit risk. Principal among these activities is lending to various commercial, institutional, governmental and individual customers throughout the United States and internationally. We manage the varying degrees of credit risk associated with on and off-balance sheet transactions through specific credit policies and procedures which provide for a strict approval, monitoring and reporting process. It is our policy to require collateral when it is deemed appropriate. Varying degrees and types of collateral are secured depending upon management's credit evaluation.
Our consumer loan portfolio includes the following types of loans:
•
Interest-only loans – A loan which allows a customer to pay the interest-only portion of the monthly payment for a period of time which results in lower payments during the initial loan period.
•
Adjustable rate mortgage ("ARM") loans – A loan which allows us to adjust pricing on the loan in line with market movements.
The following table summarizes the balances of interest-only and ARM loans in our loan portfolios, including certain loans held for sale, at September 30, 2018 and December 31, 2017. Each category is not mutually exclusive and loans may appear in more than one category below.
 
September 30, 2018
 
December 31, 2017
 
(in millions)
Interest-only residential mortgage and home equity mortgage loans
$
3,209

 
$
3,424

ARM loans(1)
11,930

 
11,976

 
(1) 
During the remainder of 2018 and during 2019, approximately $88 million and $580 million, respectively, of the ARM loans will experience their first interest rate reset.
The following table summarizes the concentrations of first and second liens within the outstanding residential mortgage and home equity mortgage portfolios. Amounts in the table exclude residential mortgage loans held for sale of $60 million and $6 million at September 30, 2018 and December 31, 2017, respectively.
 
September 30, 2018
 
December 31, 2017
 
(in millions)
Closed end:
 
 
 
First lien
$
17,376

 
$
17,273

Second lien
43

 
49

Revolving(1)
984

 
1,142

Total
$
18,403

 
$
18,464

 
(1) 
A majority of revolving are second lien mortgages.

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HSBC USA Inc.

Geographic Concentrations The following table reflects regional exposure at September 30, 2018 and December 31, 2017 for our real estate secured loan portfolios:
 
Commercial
Real Estate, including Construction Loans
 
Residential
Mortgages and
Home Equity
Mortgages
September 30, 2018
 
 
 
New York State
33.4
%
 
32.0
%
California
22.0

 
43.1

North Central United States
3.5

 
2.1

North Eastern United States, excluding New York State
5.7

 
7.9

Southern United States
28.1

 
10.4

Western United States, excluding California
7.3

 
4.5

Total
100.0
%
 
100.0
%
December 31, 2017
 
 
 
New York State
34.0
%
 
31.9
%
California
22.0

 
42.6

North Central United States
3.2

 
2.3

North Eastern United States, excluding New York State
6.8

 
8.1

Southern United States
26.2

 
10.6

Western United States, excluding California
6.7

 
4.5

Mexico
1.1

 
—

Total
100.0
%
 
100.0
%
Credit Risks Associated with Derivative Contracts  Credit risk associated with derivatives is measured as the net replacement cost of derivative contracts in a receivable position in the event the counterparties of such contracts fail to perform under the terms of those contracts. In managing derivative credit risk, both the current exposure, which is the replacement cost of contracts on the measurement date, as well as an estimate of the potential change in value of contracts over their remaining lives are considered. Counterparties to our derivative activities include financial institutions, central clearing parties, foreign and domestic government agencies, corporations, funds (mutual funds, hedge funds, etc.), insurance companies and private clients as well as other HSBC entities. These counterparties are subject to regular credit review by the credit risk management department. To minimize credit risk, we may enter into legally enforceable master netting agreements which reduce risk by permitting the closeout and netting of transactions with the same counterparty upon occurrence of certain events. In addition, we reduce credit risk by obtaining collateral from counterparties. The determination of the need for and the levels of collateral will differ based on an assessment of the credit risk of the counterparty and/or regulatory requirements.
The total risk in a derivative contract is a function of a number of variables, such as:
•
volatility of interest rates, currencies, equity or corporate reference entity used as the basis for determining contract payments;
•
current market events or trends;
•
country risk;
•
maturity and liquidity of contracts;
•
creditworthiness of the counterparties in the transaction;
•
the existence of a master netting agreement among the counterparties; and
•
existence and value of collateral received from counterparties to secure exposures.
The table below presents total credit risk exposure calculated using the general risk-based capital rules of the Basel III Standardized Approach which includes the net positive mark-to-market of the derivative contracts plus any adjusted potential future exposure as measured in reference to the notional amount. The regulatory capital rules recognize that bilateral netting agreements reduce credit risk and, therefore, allow for reductions of risk-weighted assets when netting requirements have been met and collateral exists. As a result, risk-weighted amounts for regulatory capital purposes are a portion of the original gross exposures. Furthermore, many contracts contain provisions that allow us to close out the transaction if the counterparty fails to post required collateral. In addition, many contracts give us the right to break the transactions earlier than the final maturity date. As a result, these contracts have potential future exposures that are often much smaller than the future exposures derived from the regulatory capital rules.

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HSBC USA Inc.

 
September 30, 2018
 
December 31, 2017
 
(in millions)
Risk associated with derivative contracts:
 
 
 
Total credit risk exposure
$
34,989

 
$
30,737

Less: collateral held against exposure
5,524

 
7,213

Net credit risk exposure
$
29,465

 
$
23,524


Liquidity and Capital Resources
 
Effective liquidity management is defined as ensuring we can meet customer loan requests, customer deposit maturities/withdrawals and other cash commitments efficiently under both normal operating conditions and under unpredictable circumstances of industry or market stress. To achieve this objective, we have guidelines that require sufficient liquidity to cover potential funding requirements and to avoid over-dependence on volatile, less reliable funding markets. Guidelines are set for the consolidated balance sheet of HSBC USA to ensure that it is a source of strength for our regulated, deposit-taking banking subsidiary, as well as to address the more limited sources of liquidity available to it as a holding company. Similar guidelines are set for HSBC Bank USA to ensure that it can meet its liquidity needs in various stress scenarios. Cash flow analysis, including stress testing scenarios, forms the basis for liquidity management and contingency funding plans. See "Risk Management" in this MD&A for further discussion of our approach towards liquidity risk management, including information regarding the key measures employed to define, monitor and control our liquidity and funding risk. During the first nine months of 2018, marketplace liquidity continued to remain available for most sources of funding.
Interest Bearing Deposits with Banks totaled $20,306 million and $11,157 million at September 30, 2018 and December 31, 2017, respectively, of which $19,775 million and $10,338 million, respectively, were held with the Federal Reserve Bank. Balances may fluctuate from period to period depending upon our liquidity position at the time and our strategy for deploying liquidity. Surplus interest bearing deposits with the Federal Reserve Bank may be deployed into securities purchased under agreements to resell or other investments depending on market conditions and the opportunity to maximize returns.
Federal Funds Sold and Securities Purchased under Agreements to Resell totaled $4,679 million and $32,618 million at September 30, 2018 and December 31, 2017, respectively. Balances may fluctuate from period to period depending upon our liquidity position at the time and our strategy for deploying liquidity.
Trading Assets includes securities totaling $13,467 million and $10,151 million at September 30, 2018 and December 31, 2017, respectively. See "Balance Sheet Review" in this MD&A for further analysis and discussion on trends.
Securities includes securities available-for-sale and securities held-to-maturity totaling $46,218 million and $44,677 million at September 30, 2018 and December 31, 2017, respectively. See "Balance Sheet Review" in this MD&A for further analysis and discussion on trends.
Short-Term Borrowings totaled $4,793 million and $4,650 million at September 30, 2018 and December 31, 2017, respectively. See "Balance Sheet Review" in this MD&A for further analysis and discussion on short-term borrowing trends.
Deposits totaled $112,090 million and $118,702 million at September 30, 2018 and December 31, 2017, respectively, which included $89,297 million and $98,500 million, respectively, of core deposits as calculated in accordance with FFIEC guidelines. See "Balance Sheet Review" in this MD&A for further analysis and discussion on deposit trends.

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HSBC USA Inc.

Long-Term Debt decreased to $29,516 million at September 30, 2018 from $34,966 million at December 31, 2017. The following table presents the maturities of long-term debt at September 30, 2018:
 
(in millions)
2018
$
1,862

2019
5,492

2020
7,058

2021
4,118

2022
1,546

Thereafter
9,440

Total
$
29,516

The following table summarizes issuances and retirements of long-term debt during the nine months ended September 30, 2018 and 2017:
Nine Months Ended September 30,
2018
 
2017
 
(in millions)
Long-term debt issued
$
3,729

 
$
3,886

Long-term debt repaid
(8,634
)
 
(5,098
)
Net long-term debt repaid
$
(4,905
)
 
$
(1,212
)
See "Balance Sheet Review" in this MD&A for further analysis and discussion on long-term debt trends, including additional information on debt issued and repaid during the nine months ended September 30, 2018.
Under our shelf registration statement on file with the SEC, we may issue certain securities including debt securities and preferred stock. We satisfy the eligibility requirements for designation as a "well-known seasoned issuer," which allows us to file a registration statement that does not have a limit on issuance capacity. The ability to issue under the registration statement is limited by the authority granted by the Board of Directors. At September 30, 2018, we were authorized to issue up to $36 billion, of which $19,729 million was available. HSBC Bank USA has a $40 billion Global Bank Note Program that provides for the issuance of subordinated and senior notes, of which $14,529 million was available at September 30, 2018. We anticipate using the Global Bank Note Program more in the future as part of our efforts designed to minimize overall funding costs while accessing diverse funding channels.
As a member of the FHLB and the Federal Reserve Bank of New York, we have secured borrowing facilities which are collateralized by loans and investment securities. At September 30, 2018, long-term debt included $3,100 million of borrowings from the FHLB facility. Based upon the amounts pledged as collateral under these facilities, we have additional borrowing capacity of up to $14,284 million.
Preferred Equity  See Note 17, "Preferred Stock," in our 2017 Form 10-K for information regarding all outstanding preferred share issues.
Common Equity  During the nine months ended September 30, 2018, HSBC USA did not receive any cash capital contributions from its parent, HSBC North America, and did not make any capital contributions to its subsidiary, HSBC Bank USA.
Capital Ratios  In managing capital, we develop targets for common equity Tier 1 capital to risk-weighted assets, Tier 1 capital to risk-weighted assets, total capital to risk-weighted assets, Tier 1 capital to adjusted quarterly average assets (i.e., the "Tier 1 leverage ratio") and Tier 1 capital to total leverage exposure (i.e., the "supplementary leverage ratio" or "SLR"). Capital targets are reviewed at least semi-annually to ensure they reflect our business mix and risk profile, as well as real-time conditions and circumstances. The following table summarizes HSBC USA's Basel III fully phased-in capital ratios calculated as of September 30, 2018 and December 31, 2017:
 
September 30, 2018
 
December 31, 2017
Common equity Tier 1 capital to risk-weighted assets
13.8
%
 
14.1
%
Tier 1 capital to risk-weighted assets
14.8

 
15.2

Total capital to risk-weighted assets
17.4

 
18.1

Tier 1 leverage ratio(1)
10.7

 
9.9

Supplementary leverage ratio(2)
7.5

 
7.3

 
(1) 
Adjusted quarterly average assets, the Tier 1 leverage ratio denominator, reflects quarterly average assets adjusted for amounts permitted to be deducted from Tier 1 capital.

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HSBC USA Inc.

(2) 
Beginning January 1, 2018, HSBC USA is required to maintain the regulatory minimum SLR of 3 percent. Total leverage exposure, the SLR denominator, includes adjusted quarterly average assets plus certain off-balance sheet exposures.
HSBC USA manages capital in accordance with HSBC Group policy. The HSBC North America Internal Capital Adequacy Assessment Process ("ICAAP") works in conjunction with the HSBC Group's ICAAP. The HSBC North America ICAAP applies to HSBC Bank USA and evaluates regulatory capital adequacy and capital adequacy under various stress scenarios. Our approach is to meet our capital needs for these stress scenarios locally through activities which reduce risk. To the extent that local alternatives are insufficient, as a wholly-owned subsidiary of HSBC, we would seek support from our ultimate parent. Regulatory capital requirements are based on the amount of capital required to be held, plus applicable capital buffers, as defined by regulations, and the amount of risk-weighted assets and leverage exposure, also calculated based on regulatory definitions.
In 2013, U.S. banking regulators issued a final rule implementing the Basel III capital framework in the United States (the "Basel III rule") which, for banking organizations such as HSBC North America and HSBC Bank USA, became effective in 2014 with certain provisions being phased in over time through the beginning of 2019. The Basel III rule established an integrated regulatory capital framework to improve the quality and quantity of regulatory capital, though the latter is still being modified given the recent finalization of revisions in December 2017 as discussed below. In addition to phasing in a complete replacement to the general risk-based capital rules for determining risk-weighted assets (the "Standardized Approach") and the leverage exposure, the Basel III rule builds on the advanced internal ratings approach for credit risk and advanced measurement approach for operational risk (taken together, the "Advanced Approaches"). For additional discussion of the Basel III final rule requirements, including fully phased-in required minimum capital ratios, see Part I, "Regulation and Competition - Regulatory Capital and Liquidity Requirements," in our 2017 Form 10-K. As previously disclosed, in accordance with FRB rules, HSBC North America and HSBC Bank USA received regulatory approval to opt out of the Advanced Approaches and are calculating their risk-based capital requirements solely under the Standardized Approach. HSBC Bank USA submits an annual statement to the OCC to maintain this opt out.
In December 2017, the Basel Committee adopted a package of revisions to the Basel III framework that aim to increase consistency in risk-weighted asset calculations and improve the comparability of bank capital ratios (the "Basel III Revisions"). The Basel III Revisions include changes to the Standardized Approach and internal ratings-based approach to determining credit risk, revisions to the operational risk framework, a leverage ratio surcharge for G-SIBs and an aggregate capital output floor. The Basel III Revisions are not currently applicable to any U.S. banking organization and must first be implemented by the federal banking agencies. The agencies are expected to act before the January 1, 2022 implementation deadline agreed by the Basel Committee, but it is unclear whether they will deviate significantly from the Basel III Revisions in the direction of greater conservatism as they did with respect to the Basel III framework. For further discussion of the requirements of the Basel III Revisions see Part I, "Regulation and Competition - Regulatory Capital and Liquidity Requirements," in our 2017 Form 10-K.
In April 2018, the FRB issued a proposal that would, among other things, replace the current fixed 2.5 percent capital conservation buffer with a dynamic, institution-specific risk-based stress capital buffer ("SCB"). The proposal would also introduce a stress Tier 1 leverage buffer requirement ("SLB") for IHCs and bank holding companies ("BHCs") that are subject to the FRB's CCAR program, including HSBC North America. It is expected that both the SCB and SLB will vary in size throughout the economic cycle depending on a firm's risk exposures and the severity of the stress scenarios. Under the proposal, the SCB and SLB would be recalibrated annually based on the sum of (i) HSBC North America's projected losses under the severely adverse scenario in the FRB's supervisory stress tests and (ii) four quarters of HSBC North America's planned future dividends. If HSBC North America's risk-based capital and Tier 1 leverage ratios were to fall to levels within the SCB or SLB, respectively, it would become subject to increasing restrictions on its capital distributions and discretionary bonus payments. The proposal would also eliminate the quantitative objection component of CCAR, and instead rely on the capital rule's automatic restrictions on capital distributions that are triggered if a firm breaches its buffer requirements. However, the proposal would not change CCAR's qualitative review process or objections based on qualitative deficiencies for large and complex firms, including HSBC North America. Although an initial impact study performed by the FRB anticipates a decrease in required capital for non G-SIBs subject to CCAR, the study did not include all IHCs, hence may not have considered the business model differences between IHCs and BHCs. The proposed rule was subject to a 60-day comment period, with all comments due on June 25, 2018. The proposal would be effective on December 31, 2018, with the first SCB and SLB requirements generally effective on October 1, 2019.
As a result of the adoption of the final rules by the U.S. banking regulators implementing the Basel III regulatory capital and liquidity reforms from the Basel Committee, together with the impact of similar implementation by U.K. banking regulators, the future implementation of the Basel IV Revisions and the FRB's proposal to establish SCB and SLB requirements, we continue to review the composition of our capital structure and capital buffers.
In 2015, the Financial Stability Board ("FSB") issued its final standards for TLAC requirements for G-SIBs. In 2016, the FRB adopted final rules implementing the FSB's TLAC standard in the United States. The rules require, among other things, the U.S. IHCs of non U.S. G-SIBs, including HSBC North America, to maintain minimum amounts of TLAC which would include minimum levels of Tier 1 capital and long-term debt satisfying certain eligibility criteria, and a related TLAC buffer commencing January 1, 2019, without the benefit of a phase-in period. The TLAC rules also include 'clean holding company requirements' that impose

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limitations on the types of financial transactions that HSBC North America could engage in. The FSB's TLAC standard and the FRB's TLAC rules represent a significant expansion of the current regulatory capital framework. To support compliance when the TLAC rules become effective, HSBC North America will be required in future periods to issue additional long-term debt that is TLAC compliant and modify the terms of existing long-term debt in order for that debt to be TLAC compliant.
In April 2018, the FRB issued a proposal to align the calculation of TLAC for U.S. IHCs of non U.S. G-SIBs with the calculation methodology used by G-SIBs beginning on January 1, 2019. The proposal seeks to modify the leverage requirements related to TLAC and could also translate to a marginal benefit in the way total TLAC (inclusive of buffers) is calculated for HSBC North America. The comment period for the proposal closed on June 25, 2018.
Resolution Planning HSBC is required to submit annually a resolution plan to the FRB and the FDIC under the Dodd-Frank Act (the Systemically Important Financial Institution Plan or "SIFI Plan") and HSBC Bank USA is required to submit an annual resolution plan under the Federal Deposit Insurance Act (the Insured Depository Institution Plan or "IDI Plan"). In July 2018, HSBC Bank USA submitted its latest annual IDI Plan. HSBC has been advised that the next submission date for the SIFI Plan is extended to December 31, 2018. Additionally, HBUS has been advised that the next submission date for the IDI Plan is extended to no sooner than July 1, 2020. In each instance, the annual requirements will be fulfilled with the timely submission of the December 2018 and July 2020 or later plans.
Capital Planning and Stress Testing U.S. bank holding companies with $50 billion or more in total consolidated assets, including HSBC North America, are required to comply with the FRB's capital plan rule and CCAR program, as well as the annual supervisory stress tests conducted by the FRB, and the semi-annual company-run stress tests as required under DFAST. As part of the CCAR process, the FRB undertakes a supervisory assessment of bank holding companies on their capital adequacy, internal capital adequacy assessment process and plans for capital distributions. Per current capital plan and stress test rules, the FRB can object to a capital plan for qualitative or quantitative reasons, in which case the company cannot make capital distributions (with the exception of those that may have already received a non-objection in the previous year) without specific FRB approval. HSBC North America participates in the CCAR and DFAST programs of the FRB and submitted its latest CCAR capital plan and annual company-run DFAST results in April 2018 and its latest mid-cycle DFAST results in October 2018. HSBC Bank USA is subject to the OCC's DFAST requirements, which require certain banks to conduct annual company-run stress tests, and submitted its latest annual DFAST results in April 2018. The company-run stress tests are forward looking exercises to assess the impact of hypothetical macroeconomic baseline, adverse and severely adverse scenarios provided by the FRB and the OCC for the annual exercise, and internally developed scenarios for both the annual and mid-cycle exercises, on the financial condition and capital adequacy of a bank-holding company or bank over a nine quarter planning horizon. In January 2017, the FRB announced that so-called "large and noncomplex" firms, which are firms with less than $250 billion in total consolidated assets and less than $75 billion in total nonbanking assets, are exempt from the CCAR qualitative assessment. HSBC North America does not currently fall into the category of "large and noncomplex" and, therefore, remained subject to the qualitative review in the 2018 CCAR cycle. As discussed above, the FRB expects to remove the quantitative objection component of CCAR beginning December 31, 2018.
In June 2018, the FRB publicly disclosed its own DFAST and CCAR results and informed HSBC North America, our parent company, that it did not object to HSBC North America's capital plan or the planned capital distributions included in its 2018 CCAR submission.
HSBC North America and HSBC Bank USA are required to disclose the results of their annual DFAST under the FRB and OCC’s severely adverse stress scenario and HSBC North America is required to disclose the results of its mid-cycle DFAST under its internally developed severely adverse stress scenario. In July 2018, HSBC North America and HSBC Bank USA publicly disclosed their most recent annual DFAST results. In October 2018, HSBC North America publicly disclosed the results of its mid-cycle DFAST results.
Stress testing results are based solely on hypothetical adverse stress scenarios and should not be viewed or interpreted as forecasts of expected outcomes or capital adequacy or of the actual financial condition of HSBC North America or HSBC Bank USA. Capital planning and stress testing for HSBC North America or HSBC Bank USA may impact our future capital and liquidity. See Part I, "Regulation and Competition - Regulatory Capital and Liquidity Requirements," in our 2017 Form 10-K for further discussion on capital planning and stress testing, including additional detail regarding the FRB's supervisory assessment as part of the CCAR process.
While bank holding company regulatory capital compliance is generally performed at the HSBC North America level, and also separately for HSBC Bank USA, as a bank holding company we are required to meet minimum capital requirements imposed by the FRB. We present our capital ratios, together with HSBC Bank USA's in Note 16, "Retained Earnings and Regulatory Capital Requirements," in the accompanying consolidated financial statements.
In December 2017, the FRB finalized changes to the CCAR program that requires certain IHCs of foreign banking organizations, including HSBC North America, to provide information about the effects of a hypothetical global market shock on trading and counterparty exposures as part of their supervisory adverse and severely adverse stress testing scenarios. For the 2018 CCAR

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cycle, HSBC North America was subject to an interim, simplified global market shock designed to assess its potential losses and capital impact associated with market and counterparty credit risk. Beginning with the 2019 CCAR cycle, HSBC North America will be subject to the full global market shock, potentially causing additional projected stress losses under such tests.
In May 2018, Congress passed legislation that, in addition to other changes applicable to smaller, community banks, would remove the requirements for HSBC North America to perform mid-cycle DFAST and run an adverse scenario as part of DFAST. The legislation still needs to be formally adopted into U.S. rule-making by the FRB, but is indicative of greater stress testing relief and more tailored regulations for U.S. BHCs and IHCs of varying size and complexity.
Other Regulatory Developments In May 2018, the five federal agencies responsible for administration of the Volcker Rule (FRB, SEC, FDIC, OCC, and Commodity Futures Trading Commission) jointly issued a proposal to simplify and tailor compliance requirements related to the Volcker Rule, which generally prohibits banking entities from engaging in proprietary trading and from owning or controlling hedge funds or private equity funds. Given that HSBC North America has more than $10 billion in trading assets and liabilities, it would still be subject to the highest expectations under the Volcker Rule.
In June 2018, the FRB finalized a rule, consistent with the Dodd-Frank Act, to limit credit exposures to single counterparties for large BHCs, including HSBC North America. As a result of the rule, HSBC North America, together with its subsidiaries, will be prohibited from having net credit exposure to a single unaffiliated counterparty in excess of 25 percent of HSBC North America's Tier 1 capital beginning July 1, 2020. In addition, HSBC North America, together with its subsidiaries, could become subject to a separate limit on its exposures to certain unaffiliated systemically important counterparties if its parent, HSBC, cannot certify its compliance with a large exposure regime in the U.K. that is consistent with the Basel large exposure framework by January 1, 2020. We continue to evaluate the potential effects of this rule on our operations.
2018 Funding Strategy  Our current estimate for funding needs and sources for 2018 are summarized in the following table:
                                                                                                                                                          
Actual January 1 through September 30, 2018
 
Estimated October 1 through December 31, 2018
 
Estimated Full Year 2018
  
(in billions)
Increase (decrease) in funding needs:
 
 
 
 
 
Net change in loans
$
(6
)
 
$
1

 
$
(5
)
Net change in short-term investments and securities
(17
)
 
8

 
(9
)
Net change in trading and other assets
10

 
(4
)
 
6

Total funding needs
$
(13
)
 
$
5

 
$
(8
)
Increase (decrease) in funding sources:
 
 
 
 
 
Net change in deposits
$
(7
)
 
$
2

 
$
(5
)
Net change in trading and other short-term liabilities
(1
)
 
—

 
(1
)
Net change in long-term debt
(5
)
 
3

 
(2
)
Total funding sources
$
(13
)
 
$
5

 
$
(8
)
The above table reflects a long-term funding strategy. Daily balances fluctuate as we accommodate customer needs, while ensuring that we have liquidity in place to support the balance sheet maturity funding profile. Should market conditions deteriorate, we have contingency plans to generate additional liquidity through the sales of assets or financing transactions. We remain confident in our ability to access the market for long-term debt funding needs in the current market environment. We continue to seek well-priced and stable customer deposits. We also intend to continue to sell new agency-eligible mortgage loan originations to third parties.
HSBC Bank USA is subject to significant restrictions imposed by federal law on extensions of credit to, and certain other "covered transactions" with HSBC USA and other affiliates. Covered transactions include loans and other extensions of credit, investments and asset purchases, and certain other transactions involving the transfer of value from a subsidiary bank to an affiliate or for the benefit of an affiliate. A bank's credit exposure to an affiliate as a result of a derivative, securities lending/borrowing or repurchase transaction is also subject to these restrictions. A bank's transactions with its non-bank affiliates are also required to be on arm's length terms. Certain Edge Act subsidiaries of HSBC Bank USA are limited in the amount of funds they can provide to other affiliates including their parent. Amounts above their level of invested capital have to be secured with U.S. government securities.
For further discussion relating to our sources of liquidity and contingency funding plan, see the caption "Risk Management" in this MD&A.

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Off-Balance Sheet Arrangements, Credit Derivatives and Other Contractual Obligations
 
As part of our normal operations, we enter into credit derivatives and various off-balance sheet arrangements with affiliates and third parties. These arrangements arise principally in connection with our lending and client intermediation activities and involve primarily extensions of credit and, in certain cases, guarantees.
As a financial services provider, we routinely extend credit through loan commitments and lines and letters of credit and provide financial guarantees, including derivative transactions having characteristics of a guarantee. The contractual amounts of these financial instruments represent our maximum possible credit exposure in the event that a counterparty draws down the full commitment amount or we are required to fulfill our maximum obligation under a guarantee.
The following table provides maturity information related to our credit derivatives and off-balance sheet arrangements. Many of these commitments and guarantees expire unused or without default. As a result, we believe that the contractual amount is not representative of the actual future credit exposure or funding requirements.  
 
Balance at September 30, 2018
 
 
  
One Year or less
 
Over One through Five Years
 
Over Five Years
 
Total
 
Balance at
December 31,
2017
 
(in millions)
Standby letters of credit, net of participations(1)
$
6,360

 
$
2,376

 
$
120

 
$
8,856

 
$
8,708

Commercial letters of credit
334

 
2

 
—

 
336

 
234

Credit derivatives(2)
8,007

 
35,688

 
4,034

 
47,729

 
42,328

Other commitments to extend credit:
 
 
 
 
 
 
 
 
 
Commercial(3)
20,860

 
65,451

 
3,800

 
90,111

 
78,787

Consumer
7,824

 
—

 
—

 
7,824

 
7,443

Total
$
43,385

 
$
103,517

 
$
7,954

 
$
154,856

 
$
137,500

 
(1) 
Includes $1,245 million and $1,264 million issued for the benefit of HSBC affiliates at September 30, 2018 and December 31, 2017, respectively.
(2) 
Includes $24,051 million and $25,639 million issued for the benefit of HSBC affiliates at September 30, 2018 and December 31, 2017, respectively.
(3) 
Includes $1,870 million and $400 million issued for the benefit of HSBC affiliates at September 30, 2018 and December 31, 2017, respectively.
Other Commitments to Extend Credit  Other commitments to extend credit include arrangements whereby we are contractually obligated to extend credit in the form of loans, participations in loans, lease financing receivables, or similar transactions. Consumer commitments are comprised of certain unused MasterCard/Visa credit card lines, where we have the right to change terms or conditions upon notification to the customer, and commitments to extend credit secured by residential properties, where we have the right to change terms or conditions, for cause, upon notification to the customer. Commercial commitments comprise primarily those related to secured and unsecured loans and lines of credit.
In addition to the above, we have established and manage a number of constant net asset value ("CNAV") money market funds that invest in shorter-dated highly-rated money market securities to provide investors with a highly liquid and secure investment. These funds price the assets in their portfolio on an amortized cost basis, which enables them to create and liquidate shares at a constant price. The funds, however, are not permitted to price their portfolios at amortized cost if that amount varies by more than 50 basis points from the portfolio's market value. In that case, the fund would be required to price its portfolio at market value and consequently would no longer be able to create or liquidate shares at a constant price. We do not consolidate the CNAV funds because we do not absorb the majority of the expected future risk associated with the fund's assets, including interest rate, liquidity, credit and other relevant risks that are expected to affect the value of the assets.


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Fair Value
 
Control Over Valuation Process and Procedures  We have established a control framework which is designed to ensure that fair values are either determined or validated by a function independent of the risk-taker. See Note 19, "Fair Value Measurements," in the accompanying consolidated financial statements for further details on our valuation control framework.
Fair Value Hierarchy  Fair value measurement accounting principles establish a fair value hierarchy structure that prioritizes the inputs to determine the fair value of an asset or liability (the "Fair Value Framework"). The Fair Value Framework distinguishes between inputs that are based on observed market data and unobservable inputs that reflect market participants' assumptions. It emphasizes the use of valuation methodologies that maximize observable market inputs. For financial instruments carried at fair value, the best evidence of fair value is a quoted price in an actively traded market (Level 1). Where the market for a financial instrument is not active, valuation techniques are used. The majority of our valuation techniques use market inputs that are either observable or indirectly derived from and corroborated by observable market data for substantially the full term of the financial instrument (Level 2). Because Level 1 and Level 2 instruments are determined by observable inputs, less judgment is applied in determining their fair values. In the absence of observable market inputs, the financial instrument is valued based on valuation techniques that feature one or more significant unobservable inputs (Level 3). The determination of the level of fair value hierarchy within which the fair value measurement of an asset or a liability is classified often requires judgment and may change over time as market conditions evolve. We consider the following factors in developing the fair value hierarchy:
•
whether the asset or liability is transacted in an active market with a quoted market price;
•
the level of bid-ask spreads;
•
a lack of pricing transparency due to, among other things, complexity of the product and market liquidity;
•
whether only a few transactions are observed over a significant period of time;
•
whether the pricing quotations differ substantially among independent pricing services;
•
whether inputs to the valuation techniques can be derived from or corroborated with market data; and
•
whether significant adjustments are made to the observed pricing information or model output to determine the fair value.
Level 1 inputs are unadjusted quoted prices in active markets that the reporting entity has the ability to access for identical assets or liabilities. A financial instrument is classified as a Level 1 measurement if it is listed on an exchange or is an instrument actively traded in the over-the-counter ("OTC") market where transactions occur with sufficient frequency and volume. We regard financial instruments such as debt securities, equity securities and derivative contracts listed on the primary exchanges of a country to be actively traded. Non-exchange-traded instruments classified as Level 1 assets include securities issued by the U.S. Treasury, to-be-announced securities, non-callable securities issued by U.S. Government sponsored enterprises and certain foreign government-backed debt.
Level 2 inputs are those that are observable either directly or indirectly but do not qualify as Level 1 inputs. We classify mortgage pass-through securities, agency and certain non-agency mortgage collateralized obligations, certain derivative contracts, asset-backed securities, obligations of U.S. states and political subdivisions, corporate debt, certain foreign government-backed debt, preferred securities, securities purchased and sold under resale and repurchase agreements, precious metals, certain commercial loans held for sale, residential mortgage loans whose carrying amount was reduced based on the fair value of the underlying collateral and real estate owned as Level 2 measurements. Where possible, at least two quotations from independent sources are obtained based on transactions involving comparable assets and liabilities to validate the fair value of these instruments. We have established a process to understand the methodologies and inputs used by the third party pricing services to ensure that pricing information met the fair value objective. Where significant differences arise among the independent pricing quotes and the internally determined fair value, we investigate and reconcile the differences. If the investigation results in a significant adjustment to the fair value, the instrument will be classified as Level 3 within the fair value hierarchy. In general, we have observed that there is a correlation between the credit standing and the market liquidity of a non-derivative instrument.
Level 2 derivative instruments are generally valued based on discounted future cash flows or an option pricing model adjusted for counterparty credit risk and market liquidity. The fair value of certain derivative products is determined using valuation techniques based on inputs derived from observable indices traded in the OTC market. Appropriate control processes and procedures have been applied to ensure that the derived inputs are applied to value only those instruments that share similar risks to the relevant benchmark indices and therefore demonstrate a similar response to market factors.
Level 3 inputs are unobservable estimates that management expects market participants would use to determine the fair value of the asset or liability. That is, Level 3 inputs incorporate market participants' assumptions about risk and the risk premium required by market participants in order to bear that risk. We develop Level 3 inputs based on the best information available in the circumstances. At September 30, 2018 and December 31, 2017, our Level 3 measurements included the following: collateralized debt obligations ("CDOs") for which there is a lack of pricing transparency due to market illiquidity, certain structured deposits and structured notes for which the embedded credit, foreign exchange or equity derivatives have significant unobservable inputs

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(e.g., volatility or default correlations), asset-backed credit default swaps with certain inputs which are unobservable, certain subprime residential mortgage loans held for sale, certain corporate debt securities, certain asset-backed securities, impaired commercial loans, derivatives referenced to illiquid assets of less desirable credit quality, swap agreements entered into in conjunction with the sales of Visa Class B Shares for which the fair value is dependent upon the final resolution of the related litigation and a contingent consideration receivable associated with the sale of a portion of our Private Banking business.
See Note 19, "Fair Value Measurements," in the accompanying consolidated financial statements for additional information on Level 3 inputs as well as a discussion of transfers between Level 1 and Level 2 measurements during the three and nine months ended September 30, 2018 and 2017.
Level 3 Measurements  The following table provides information about Level 3 assets/liabilities in relation to total assets/liabilities measured at fair value at September 30, 2018 and December 31, 2017:
 
September 30, 2018
 
December 31, 2017
 
(dollars are in millions)
Level 3 assets(1)(2)
$
2,326

 
$
2,650

Total assets measured at fair value(1)(3)
86,747

 
89,368

Level 3 liabilities(1)
1,603

 
1,690

Total liabilities measured at fair value(1)
53,201

 
68,270

Level 3 assets as a percent of total assets measured at fair value
2.7
%
 
3.0
%
Level 3 liabilities as a percent of total liabilities measured at fair value
3.0
%
 
2.5
%
 
(1) 
Presented without netting which allows the offsetting of amounts relating to certain contracts if certain conditions are met.
(2) 
Includes $2,288 million of recurring Level 3 assets and $38 million of non-recurring Level 3 assets at September 30, 2018. Includes $2,359 million of recurring Level 3 assets and $291 million of non-recurring Level 3 assets at December 31, 2017.
(3) 
Includes $86,653 million of assets measured on a recurring basis and $94 million of assets measured on a non-recurring basis at September 30, 2018. Includes $88,988 million of assets measured on a recurring basis and $380 million of assets measured on a non-recurring basis at December 31, 2017.
Significant Changes in Fair Value for Level 3 Assets and Liabilities We have entered into credit default swaps with a monoline insurer to hedge our credit exposure in certain asset-backed securities and synthetic CDOs. We made $2 million and $8 million positive credit risk adjustments to the fair value of our credit default swap contracts during the three and nine months ended September 30, 2018, respectively, compared with $2 million negative and $3 million positive adjustments during the three and nine months ended September 30, 2017, respectively. These adjustments to fair value are recorded in trading revenue in the consolidated statement of income. We have recorded a cumulative credit adjustment reserve of $4 million and $12 million against our monoline exposure at September 30, 2018 and December 31, 2017, respectively. The fair value of our monoline exposure net of cumulative credit adjustment reserves equaled $67 million and $105 million at September 30, 2018 and December 31, 2017, respectively.
See Note 19, "Fair Value Measurements," in the accompanying consolidated financial statements for information on additions to and transfers into (out of) Level 3 measurements during the three and nine months ended September 30, 2018 and 2017 as well as for further details including the classification hierarchy associated with assets and liabilities measured at fair value.
Effect of Changes in Significant Unobservable Inputs  The fair value of certain financial instruments is measured using valuation techniques that incorporate pricing assumptions not supported by, derived from or corroborated by observable market data. The resultant fair value measurements are dependent on unobservable input parameters which can be selected from a range of estimates and may be interdependent. Changes in one or more of the significant unobservable input parameters may change the fair value measurements of these financial instruments. For the purpose of preparing the financial statements, the final valuation inputs selected are based on management's best judgment that reflect the assumptions market participants would use in pricing similar assets or liabilities.
The unobservable input parameters selected are subject to the internal valuation control processes and procedures. When we perform a test of all the significant input parameters to the extreme values within the range at the same time, it could result in an increase of the overall fair value measurement of approximately $82 million or a decrease of the overall fair value measurement of approximately $23 million at September 30, 2018. The effect of changes in significant unobservable input parameters are primarily driven by the uncertainty in determining the fair value of credit derivatives executed against certain insurers as well as credit default swaps with a certain monoline insurer and certain asset-backed securities including CDOs.

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Assets Underlying Asset-backed Securities  The following tables summarize the types of assets underlying our asset-backed securities as well as certain collateralized debt obligations held at September 30, 2018:
 
  
Total
 
 
(in millions)
Rating of securities:(1)
Collateral type:
 
A
Residential mortgages - Alt A
2

 
Home equity - Alt A
44

 
Student loans
92

 
Other
48

 
Total A
186

BBB
Collateralized debt obligations
112

 
Other
57

 
Total BBB
169

CCC
Residential mortgages - Subprime
16

 
 
$
371

 
(1)  
We utilize S&P as the primary source of credit ratings in the tables above. If S&P ratings are not available, ratings by Moody's and Fitch are used, in that order. Ratings for collateralized debt obligations represent the ratings associated with the underlying collateral.

Risk Management
 
Overview  Managing risk effectively is fundamental to the delivery of our strategic priorities. We use a comprehensive risk management framework that is applied at all levels of the organization and across all risk types with effective governance and corresponding risk management tools to help ensure it is appropriately implemented. This framework fosters the continuous monitoring of the risk environment and an integrated evaluation of risks and their interactions. It is designed to ensure that we have a robust and consistent approach to risk management across all of our activities. Our risk management framework has been designed to provide robust controls and ongoing monitoring of our principal risks.
Our Board of Directors and its committees, principally the Audit, Risk, and Compliance and Conduct Committees, have oversight responsibility for the effective management of risk and approves our risk appetite. The Risk Committee advises the Board of Directors on risk appetite and its alignment with our strategy, risk governance and internal controls as well as high-level risk related matters.
The principal risks associated with our operations include the following:
•
Credit risk is the potential that a borrower or counterparty will default on a credit obligation, as well as the impact on the value of credit instruments due to changes in the probability of borrower default. Credit risk includes risk associated with cross-border exposures;
•
Liquidity risk is the potential that an institution will be unable to meet its obligations as they become due or fund its customers because of inadequate cash flow or the inability to liquidate assets or obtain funding itself;
•
Interest rate risk is the potential reduction of net interest income due to mismatched pricing between assets and liabilities as well as losses in value due to interest rate movements;
•
Market risk is the risk that movements in market factors, such as foreign exchange rates, interest rates, credit spreads, equity prices and commodity prices, will reduce our income or the value of our portfolios;
•
Operational risk is the risk to achieving our strategy or objectives as a result of inadequate or failed internal processes, people and systems, or from external events;
•
Regulatory compliance risk is the risk that we fail to observe the letter and spirit of all relevant laws, codes, rules, regulations and standards of good market practice causing us to incur fines, penalties and damage to our business and reputation;
•
Financial crime risk is the risk that we knowingly or unknowingly help parties to commit or to further potentially illegal activity through the HSBC Group. It arises from day to day banking operations;
•
Fiduciary risk is the risk of breaching fiduciary duties where we act in a fiduciary capacity as trustee, investment manager or as mandated by law or regulation;

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•
Reputational risk is the risk arising from failure to meet stakeholder expectations as a result of any event, behavior, action or inaction, either by us, our employees, the HSBC Group or those with whom it is associated, that may cause stakeholders to form a negative view of us. This might also result in financial or non-financial impacts, loss of confidence or other consequences;
•
Strategic risk is the risk that the business will fail to identify, execute and react appropriately to opportunities and/or threats arising from changes in the market, some of which may emerge over a number of years such as changing economic and political circumstances, customer requirements, demographic trends, regulatory developments or competitor action;
•
Security risk is the risk to the business from terrorism, information security, incidents/disasters, cyber attacks, insider risk and groups hostile to HSBC interests;
•
Model risk is the potential for adverse consequences from decisions based on incorrect or misused model outputs and reports. This occurs primarily for two reasons: 1) the model may produce inaccurate outputs when compared with the intended business use and design objective; and 2) the model could be used incorrectly;
•
Pension risk is the risk of increased costs from the post-employment benefit plans that we have established for our employees;
•
Sustainability risk is the risk that financial services provided to customers indirectly result in unacceptable impacts on people or on the environment.
Our risk management process involves the use of various simulation models. We believe that the assumptions used in these models are reasonable, but actual events may unfold differently than what is assumed in the models. Consequently, model results may be considered reasonable estimates, with the understanding that actual results may differ significantly from model projections.
See "Risk Management" in MD&A in our 2017 Form 10-K for a more complete discussion of the objectives of our risk management system as well as our risk management policies and practices. There have been no material changes to our approach to risk management since December 31, 2017.
Liquidity Risk Management   Liquidity risk is the risk that an institution will be unable to meet its obligations as they become due or fund its customers because of an inability to liquidate assets or obtain adequate funding. There have been no material changes to our approach towards liquidity risk management since December 31, 2017. See "Risk Management" in MD&A in our 2017 Form 10-K for a more complete discussion of our approach to liquidity risk. Although our overall approach to liquidity risk management has not changed, we continuously monitor the impact of market events on our liquidity positions and will continue to adapt our liquidity framework to reflect market events and the evolving regulatory landscape and view as to best practices.
As part of our approach towards liquidity risk management, we employ the measures discussed below to define, monitor and control our liquidity and funding risk in accordance with HSBC policy.
The Basel Committee based Liquidity Coverage Ratio ("LCR") is designed to be a short-term liquidity measure to ensure banks have sufficient High Quality Liquid Assets ("HQLA") to cover net stressed cash outflows over the next 30 days. At both September 30, 2018 and December 31, 2017, HSBC USA's LCR under the EU LCR rule exceeded 100 percent. A LCR of 100 percent or higher reflects an unencumbered HQLA balance that is equal to or exceeds liquidity needs for a 30 calendar day liquidity stress scenario. HQLA consists of cash or assets that can be converted into cash at little or no loss of value in private markets.
The European calibration of the Basel Committee based NSFR, which is a longer term liquidity measure with a 12-month time horizon to ensure a sustainable maturity structure of assets and liabilities, is still pending. Therefore, our calculation of NSFR is based on our current interpretation and understanding of the Basel Committee NSFR guidance, which may differ in future periods depending on completion of the European calibration and further implementation guidance from regulators. At both September 30, 2018 and December 31, 2017, HSBC USA's estimated NSFR exceeded 100 percent. A NSFR of 100 percent or more reflects an available stable funding balance from liabilities and capital over the next 12 months that is equal to or exceeds the required amount of funding for assets and off-balance sheet exposures.
In 2014, the FRB, the OCC and the FDIC issued final regulations to implement the LCR in the United States, applicable to certain large banking institutions, including HSBC North America and HSBC Bank USA. The U.S. LCR rule is generally consistent with the Basel Committee guidelines, but is more stringent in several areas including the range of assets that qualify as HQLA and the assumed rate of outflows of certain kinds of funding. Under the U.S. rule, U.S. institutions, including HSBC North America and HSBC Bank USA, have been required to maintain a minimum LCR of 100 percent since January 1, 2017, two years ahead of the Basel Committee's timeframe for compliance by January 1, 2019, and report LCR to U.S. regulators on a daily basis. During the nine months ended September 30, 2018 and year ended December 31, 2017, HSBC Bank USA's LCR under the U.S. LCR rule remained above the 100 percent minimum requirement. The U.S. LCR rule does not address the U.S. NSFR requirement, which is currently under review by U.S. banking regulators and the Basel Committee. Based on the results of their review, the Basel Committee and U.S. banking regulators may make further changes to the NSFR. In April 2016, U.S. regulators issued for public comment a proposal to implement the NSFR in the United States, applicable to certain large banking organizations, including HSBC North America and HSBC Bank USA. The U.S. NSFR proposal is generally consistent with the Basel Committee guidelines, but similar to the U.S. LCR rule, is more stringent in several areas including the required stable funding factors applied to certain

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assets such as mortgage-backed securities. At both September 30, 2018 and December 31, 2017, HSBC Bank USA's estimated NSFR, based on our current interpretation and understanding of the proposed U.S. NSFR rule, exceeded 100 percent.
HSBC North America and HSBC Bank USA have adjusted their liquidity profiles to support compliance with these rules. HSBC North America and HSBC Bank USA may need to make further changes to their liquidity profiles to support compliance with any future final rules.
Our liquidity risk management approach includes deposits, supplemented by wholesale borrowing to fund our balance sheet, and using security sales or secured borrowings for liquidity stress situations in our liquidity contingency plans. In addition, current regulatory initiatives require banks to retain a portfolio of HQLA. As such, we are maintaining a large portfolio of high quality sovereign and sovereign guaranteed securities.
Our ability to regularly attract wholesale funds at a competitive cost is enhanced by strong ratings from the major credit ratings agencies. The following table reflects the short and long-term credit ratings of HSBC USA and HSBC Bank USA at September 30, 2018:
  
Moody's
S&P
Fitch
HSBC USA:
 
 
 
Short-term borrowings
P-1
A-1
F1+
Long-term/senior debt
A2
A
AA-
HSBC Bank USA:
 
 
 
Short-term borrowings
P-1
A-1+
F1+
Long-term/senior debt
Aa3(1)
AA-
AA-
 
(1) 
Moody's long-term deposit rating for HSBC Bank USA was Aa2 at September 30, 2018.
Rating agencies continue to evaluate economic and geopolitical trends, regulatory developments, future profitability, risk management practices and legal matters, all of which could lead to adverse ratings actions.
Although we closely monitor and strive to manage factors influencing our credit ratings, there is no assurance that our credit ratings will not change in the future. At September 30, 2018, there were no pending actions in terms of changes to ratings on the debt of HSBC USA or HSBC Bank USA from any of the rating agencies.
Interest Rate Risk Management  Interest rate risk is the potential reduction of net interest income due to mismatched pricing between assets and liabilities as well as losses in value due to interest rate movements. Various techniques are utilized to quantify and monitor risks associated with the repricing characteristics of our assets, liabilities and derivative contracts. There have been no material changes to our approach towards interest rate risk management since December 31, 2017. See "Risk Management" in MD&A in our 2017 Form 10-K for a more complete discussion of our approach to interest rate risk.
Economic value of equity ("EVE") EVE represents the present value of the banking book cash flows that could be provided to our equity holder under a managed run-off scenario. An EVE sensitivity represents the change in EVE due to a defined movement in interest rates. We manage to an immediate parallel upward shock of 200 basis points and an immediate parallel downward shock of 200 basis points to the market implied interest rates. At both September 30, 2018 and December 31, 2017, our economic value of equity remains higher than our book value of equity under the base case, up 200 basis points and down 200 basis points scenarios.

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Net interest income simulation modeling techniques We utilize simulation modeling to monitor a number of interest rate scenarios for their impact on projected net interest income. These techniques simulate the impact on projected net interest income under various scenarios, such as rate shock scenarios, which assume immediate market rate movements by as much as 200 basis points, as well as scenarios in which rates gradually rise by as much as 200 basis point or fall by as much as 100 basis points over a twelve month period. In the gradual scenarios, 25 percent of the interest rate movement occurs at the beginning of each quarter. The following table reflects the impact on our projected net interest income of the scenarios utilized by these modeling techniques:
 
September 30, 2018
 
December 31, 2017
 
Amount
 
%
 
Amount
 
%
 
(dollars are in millions)
Estimated increase (decrease) in projected net interest income (reflects projected rate movements on October 1, 2018 and January 1, 2018, respectively):
 
 
 
 
 
 
 
Resulting from a gradual 100 basis point increase in the yield curve
$
95

 
3
 %
 
$
148

 
6
 %
Resulting from a gradual 100 basis point decrease in the yield curve
(46
)
 
(2
)
 
(138
)
 
(5
)
Resulting from a gradual 200 basis point increase in the yield curve
162

 
5

 
243

 
9

Other significant scenarios monitored (reflects projected rate movements on October 1, 2018 and January 1, 2018, respectively):
 
 
 
 
 
 
 
Resulting from an immediate 50 basis point decrease in the yield curve
(33
)
 
(1
)
 
(116
)
 
(5
)
Resulting from an immediate 100 basis point increase in the yield curve
131

 
4

 
216

 
8

Resulting from an immediate 100 basis point decrease in the yield curve
(139
)
 
(5
)
 
(323
)
 
(13
)
Resulting from an immediate 200 basis point increase in the yield curve
219

 
7

 
350

 
14

The projections do not take into consideration possible complicating factors such as the effect of changes in interest rates on the credit quality, size and composition of the balance sheet. Therefore, although this provides a reasonable estimate of interest rate sensitivity, actual results will differ from these estimates, possibly by significant amounts.
Capital risk/sensitivity of other comprehensive loss  Large movements of interest rates could directly affect some reported capital balances and ratios. The mark-to-market valuation of available-for-sale securities is recorded on a tax effected basis to accumulated other comprehensive loss. This valuation mark is included in two important accounting based capital ratios: common equity Tier 1 capital to risk-weighted assets and total equity to total assets. Under the final rule adopting the Basel III regulatory capital reforms, the valuation mark was being phased into common equity Tier 1 capital over five years beginning in 2014. At September 30, 2018, we had an available-for-sale securities portfolio of approximately $31,329 million with a negative mark-to-market adjustment of $825 million. An increase of 25 basis points in interest rates of all maturities would lower the mark-to-market by approximately $320 million to a net loss of $1,145 million with the following results on our capital ratios:
 
September 30, 2018
 
December 31, 2017
 
Actual
 
Proforma(1)
 
Actual
 
Proforma(1)
Common equity Tier 1 capital to risk-weighted assets
13.8
%
 
13.6
%
 
14.2
%
 
14.1
%
Total equity to total assets
11.5

 
11.4

 
10.7

 
10.7

 
(1) 
Proforma percentages reflect a 25 basis point increase in interest rates.
Market Risk Management  Market risk is the risk that movements in market factors, such as foreign exchange rates, interest rates, credit spreads, equity prices and commodity prices, will reduce our income or the value of our portfolios. Exposure to market risk is separated into two portfolios:
•
Trading portfolios comprise positions arising from market-making and warehousing of client-derived positions.
•
Non-trading portfolios comprise positions that primarily arise from the interest rate management of our retail and commercial banking assets and liabilities and financial investments classified as available-for-sale and held-to-maturity.
There have been no material changes to our approach towards market risk management since December 31, 2017. See "Risk Management" in MD&A in our 2017 Form 10-K for a more complete discussion of our approach to market risk.
Value at Risk ("VaR")  VaR is a technique for estimating potential losses on risk positions as a result of movements in market rates and prices over a specified time horizon and to a given level of confidence. The use of VaR is integrated into market risk management and calculated for all trading positions regardless of how we capitalize them. In addition, we calculate VaR for non-trading portfolios to have a complete picture of risk. VAR measures are calculated at a 99 percent confidence level and use a one-day holding period.

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Trading Portfolios  Trading VaR generates from the Global Markets unit of the GB&M business segment. Portfolios are mainly comprised of foreign exchange products, interest rate swaps and precious metals (i.e., gold, silver, platinum) in both North America and emerging markets.
Daily VaR (trading portfolios), 99 percent 1 day (in millions):
hsbcusatradingvar20180930.jpg
The following table summarizes our trading VaR for the nine months ended September 30, 2018:
 
Foreign exchange and commodity
 
Interest rate
 
Credit Spread
 
Portfolio diversification(1)
 
Total(2)
 
(in millions)
At September 30, 2018
$
2

 
$
6

 
$
2

 
$
(4
)
 
$
6

 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2018
 
 
 
 
 
 
 
 
 
Average
2

 
6

 
1

 
(3
)
 
6

Maximum
5

 
11

 
2

 
 
 
10

Minimum
1

 
3

 
—

 
 
 
4

 
 
 
 
 
 
 
 
 
 
At December 31, 2017
$
2

 
$
5

 
$
1

 
$
(2
)
 
$
6

 
(1) 
Portfolio diversification is the market risk dispersion effect of holding a portfolio containing different risk types. It represents the reduction in unsystematic market risk that occurs when combining a number of different risk types, for example, foreign exchange, interest rate and credit spread, together in one portfolio. It is measured as the difference between the sum of the VaR by individual risk type and the combined total VaR. A negative number represents the benefit of portfolio diversification. As the maximum and minimum occur on different days for different risk types, it is not meaningful to calculate a portfolio diversification benefit for these measures.
(2) 
The total VaR is non-additive across risk types due to diversification effects. For presentation purposes, portfolio diversification of the VaR for trading portfolios includes VaR-based risk-not-in-VaR.
Back-testing We routinely validate the accuracy of our VaR models by back-testing them against hypothetical profit and loss that excludes non-modeled items such as fees, commissions and revenues of intra-day transactions from the actual reported profit and loss. We would expect, on average, to see two or three profits and two or three losses in excess of VaR at the 99 percent confident level over a one-year period. The actual number of profits or losses in excess of VaR over this period can therefore be used to gauge how well the models are performing. To ensure a conservative approach to calculating our risk exposures, it is important to note that profits in excess of VaR are only considered when back-testing the accuracy of models and are not used for capital purposes.
In the nine months ended September 30, 2018, we experienced two back-testing exceptions. The first exception, a loss exception, occurred in May and was driven by an overall sell off in emerging markets, which was exacerbated due to specific macroeconomic conditions in Argentina. The second exception, a profit exception, occurred in August and was driven by a continued sell off in emerging markets largely attributable to Argentina.

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Back-testing of trading VaR against our hypothetical profit and loss (in millions):
hsbcusabacktesting20180930.jpg
Non-trading Portfolios  Non-trading VaR predominantly relates to Balance Sheet Management and represents the potential negative changes in the investment portfolio market value (which includes available-for-sale and held-to-maturity assets) and associated hedges. Our investment portfolio holdings are mainly comprised of U.S. Treasury, U.S. Government agency mortgage-backed and U.S. Government sponsored mortgage-backed securities. Our non-trading VaR exposure is driven by interest rates, mortgage spreads, and asset swap spreads.
The following table summarizes our non-trading VaR for the nine months ended September 30, 2018:
 
Interest rate
 
Credit Spread
 
Portfolio diversification(1)
 
Total(1)
 
(in millions)
At September 30, 2018
$
59

 
$
21

 
$
(20
)
 
$
60

 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2018
 
 
 
 
 
 
 
Average
58

 
20

 
(18
)
 
60

Maximum
80

 
22

 
 
 
79

Minimum
38

 
17

 
 
 
47

 
 
 
 
 
 
 
 
At December 31, 2017
$
39

 
$
18

 
$
(12
)
 
$
45

 
(1) 
Refer to the Trading VaR table above for additional information.
Non-trading VaR also includes the interest rate risk of non-trading financial assets and liabilities held by the global businesses and transfer priced into Balance Sheet Management which has the mandate to centrally manage and hedge it. For a broader discussion on how interest rate risk is managed, please refer to the "Risk Management - Interest Rate Risk Management" section in MD&A in our 2017 Form 10-K.

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CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES
 
The following table summarizes the quarter-to-date and year-to-date average daily balances of the principal components of assets, liabilities and equity together with their respective interest amounts and rates earned or paid. Net interest margin is calculated by dividing net interest income by the average interest earning assets from which interest income is earned. Loan interest for the three and nine months ended September 30, 2018 included fees of $17 million and $53 million, respectively, compared with fees of $15 million and $61 million during the three and nine months ended September 30, 2017, respectively.
Three Months Ended September 30,
2018
 
2017
 
Average Balance
 
Interest
 
Rate
 
Average Balance
 
Interest
 
Rate
 
(dollars are in millions)
Assets
 
 
 
 
 
 
 
 
 
 
 
Interest bearing deposits with banks
$
20,705

 
$
115

 
2.20
%
 
$
44,300

 
$
148

 
1.33
%
Federal funds sold and securities purchased under resale agreements
5,134

 
49

 
3.79

 
5,410

 
55

 
4.03

Trading securities
13,735

 
54

 
1.56

 
9,943

 
47

 
1.88

Securities
45,797

 
292

 
2.53

 
45,474

 
231

 
2.02

Loans:
 
 
 
 
 
 
 
 
 
 
 
Commercial
46,458

 
470

 
4.01

 
48,565

 
371

 
3.03

Consumer:

 

 

 


 


 


Residential mortgages
17,428

 
152

 
3.46

 
17,235

 
143

 
3.29

Home equity mortgages
1,062

 
12

 
4.48

 
1,257

 
13

 
4.10

Credit cards
873

 
18

 
8.18

 
652

 
18

 
10.95

Other consumer
353

 
7

 
7.87

 
465

 
7

 
5.97

Total consumer
19,716

 
189

 
3.80

 
19,609

 
181

 
3.66

Total loans
66,174

 
659

 
3.95

 
68,174

 
552

 
3.21

Other
3,464

 
19

 
2.18

 
3,129

 
14

 
1.78

Total interest earning assets
$
155,009

 
$
1,188

 
3.04
%
 
$
176,430

 
$
1,047

 
2.35
%
Allowance for credit losses
(526
)
 
 
 
 
 
(841
)
 
 
 
 
Cash and due from banks
1,288

 
 
 
 
 
1,088

 
 
 
 
Other assets
17,761

 
 
 
 
 
22,647

 
 
 
 
Total assets
$
173,532

 
 
 
 
 
$
199,324

 
 
 
 
Liabilities and Equity
 
 
 
 
 
 
 
 
 
 
 
Domestic deposits:
 
 
 
 
 
 
 
 
 
 
 
Savings deposits
$
46,480

 
$
78

 
.67
%
 
$
48,829

 
$
66

 
.54
%
Time deposits
22,773

 
153

 
2.67

 
22,412

 
95

 
1.68

Other interest bearing deposits
9,704

 
41

 
1.68

 
10,912

 
14

 
.51

Foreign deposits:
 
 
 
 
 
 
 
 
 
 
 
Foreign banks deposits
3,998

 
4

 
.40

 
5,195

 
8

 
.61

Other interest bearing deposits
1,640

 
7

 
1.69

 
2,807

 
5

 
.71

Deposits held for sale
58

 
—

 
.51

 
237

 
—

 
.58

Total interest bearing deposits
84,653

 
283

 
1.33

 
90,392

 
188

 
.83

Short-term borrowings
5,730

 
45

 
3.12

 
13,904

 
39

 
1.11

Long-term debt
30,872

 
291

 
3.74

 
37,361

 
256

 
2.72

Total interest bearing deposits and debt
121,255

 
619

 
2.03

 
141,657

 
483

 
1.35

Tax liabilities and other
1,394

 
10

 
2.85

 
1,266

 
4

 
1.25

Total interest bearing liabilities
$
122,649

 
$
629

 
2.03
%
 
$
142,923

 
$
487

 
1.35
%
Net interest income/Interest rate spread


 
$
559

 
1.01
%
 


 
$
560

 
1.00
%
Noninterest bearing deposits
24,403

 
 
 
 
 
28,002

 
 
 
 
Other liabilities
6,431

 
 
 
 
 
7,393

 
 
 
 
Total equity
20,049

 
 
 
 
 
21,006

 
 
 
 
Total liabilities and equity
$
173,532

 
 
 
 
 
$
199,324

 
 
 
 
Net interest margin on average earning assets
 
 
 
 
1.43
%
 
 
 
 
 
1.26
%
Net interest income to average total assets
 
 
 
 
1.28
%
 
 
 
 
 
1.11
%
 
 
 
 
 
 
 
 
 
 
 
 

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HSBC USA Inc.

Nine Months Ended September 30,
2018

2017
 
Average Balance
 
Interest
 
Rate
 
Average Balance
 
Interest
 
Rate
 
(dollars are in millions)
Assets
 
 
 
 
 
 
 
 
 
 
 
Interest bearing deposits with banks
$
22,877

 
$
325

 
1.90
%
 
$
42,646

 
$
352

 
1.10
%
Federal funds sold and securities purchased under resale agreements
6,567

 
154

 
3.14

 
7,214

 
163

 
3.02

Trading securities
13,013

 
156

 
1.60

 
10,207

 
163

 
2.14

Securities
45,270

 
823

 
2.43

 
48,310

 
715

 
1.98

Loans:
 
 
 
 
 
 
 
 
 
 
 
Commercial
47,612

 
1,336

 
3.75

 
51,103

 
1,125

 
2.94

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Residential mortgages
17,379

 
449

 
3.45

 
17,465

 
438

 
3.35

Home equity mortgages
1,112

 
37

 
4.45

 
1,316

 
38

 
3.86

Credit cards
806

 
51

 
8.46

 
651

 
52

 
10.68

Other consumer
383

 
21

 
7.33

 
459

 
20

 
5.83

Total consumer
19,680

 
558

 
3.79

 
19,891

 
548

 
3.68

Total loans
67,292

 
1,894

 
3.76

 
70,994

 
1,673

 
3.15

Other
3,934

 
57

 
1.94

 
2,953

 
38

 
1.72

Total interest earning assets
$
158,953

 
$
3,409

 
2.87
%
 
$
182,324

 
$
3,104

 
2.28
%
Allowance for credit losses
(585
)
 
 
 
 
 
(920
)
 
 
 
 
Cash and due from banks
1,076

 
 
 
 
 
1,104

 
 
 
 
Other assets
20,568

 
 
 
 
 
18,866

 
 
 
 
Total assets
$
180,012

 
 
 
 
 
$
201,374

 
 
 
 
Liabilities and Equity
 
 
 
 
 
 
 
 
 
 
 
Domestic deposits:
 
 
 
 
 
 
 
 
 
 
 
Savings deposits
$
48,772

 
$
229

 
.63
%
 
$
49,501

 
$
170

 
.46
%
Time deposits
22,305

 
401

 
2.40

 
22,818

 
257

 
1.51

Other interest bearing deposits
10,313

 
105

 
1.36

 
11,414

 
30

 
.35

Foreign deposits:
 
 
 
 
 
 
 
 
 
 
 
Foreign banks deposits
4,343

 
13

 
.40

 
6,674

 
33

 
.66

Other interest bearing deposits
1,501

 
14

 
1.25

 
3,696

 
17

 
.61

Deposits held for sale
195

 
1

 
.58

 
80

 
—

 
.58

Total interest bearing deposits
87,429

 
763

 
1.17

 
94,183

 
507

 
.72

Short-term borrowings
6,353

 
121

 
2.55

 
10,380

 
94

 
1.21

Long-term debt
32,061

 
831

 
3.47

 
37,730

 
749

 
2.65

Total interest bearing deposits and debt
125,843

 
1,715

 
1.82

 
142,293

 
1,350

 
1.27

Tax liabilities and other
1,440

 
28

 
2.60

 
1,068

 
15

 
1.88

Total interest bearing liabilities
$
127,283

 
$
1,743

 
1.83
%
 
$
143,361

 
$
1,365

 
1.27
%
Net interest income/Interest rate spread
 
 
$
1,666

 
1.04
%
 
 
 
$
1,739

 
1.01
%
Noninterest bearing deposits
25,722

 
 
 
 
 
29,998

 
 
 
 
Other liabilities
7,076

 
 
 
 
 
7,266

 
 
 
 
Total equity
19,931

 
 
 
 
 
20,749

 
 
 
 
Total liabilities and equity
$
180,012

 
 
 
 
 
$
201,374

 
 
 
 
Net interest margin on average earning assets
 
 
 
 
1.40
%
 
 
 
 
 
1.28
%
Net interest income to average total assets
 
 
 
 
1.24
%
 
 
 
 
 
1.15
%


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HSBC USA Inc.

Item 3.    Quantitative and Qualitative Disclosures about Market Risk
 
Information required by this Item is included within Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations in the Risk Management section under the captions "Interest Rate Risk Management" and "Market Risk Management."

Item 4.    Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures We maintain a system of internal and disclosure controls and procedures designed to ensure that information required to be disclosed by HSBC USA in the reports we file or submit under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized and reported on a timely basis. Our Board of Directors, operating through its Audit Committee, which is composed entirely of independent non-executive directors, provides oversight to our financial reporting process.
We conducted an evaluation, with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report so as to alert them in a timely fashion to material information required to be disclosed in reports we file under the Exchange Act.
Changes in Internal Control over Financial Reporting There has been no change in our internal control over financial reporting that occurred during the quarter ended September 30, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II
Item 1. Legal Proceedings
 
See Note 20, "Litigation and Regulatory Matters," in the accompanying consolidated financial statements for our legal proceedings disclosure, which is incorporated herein by reference.

Item 5.    Other Information
 
Disclosures pursuant to Section 13(r) of the Securities Exchange Act Section 13(r) of the Securities Exchange Act requires each issuer registered with the SEC to disclose in its annual or quarterly reports whether it or any of its affiliates have knowingly engaged in specified activities or transactions with persons or entities targeted by U.S. sanctions programs relating to Iran, terrorism, or the proliferation of weapons of mass destruction, even if those activities are not prohibited by U.S. law and are conducted outside the U.S. by non-U.S. affiliates in compliance with local laws and regulations.
To comply with this requirement, HSBC has requested relevant information from its affiliates globally. During the period covered by this Form 10-Q, HUSI did not engage in activities or transactions requiring disclosure pursuant to Section 13(r) other than those activities related to frozen accounts and transactions permitted under relevant U.S. sanction programs described under "Frozen Accounts and Transactions" below. The following activities conducted by our affiliates are disclosed in response to Section 13(r):
Legacy contractual obligations related to guarantees Between 1996 and 2007, the HSBC Group provided guarantees to a number of its non-Iranian customers in Europe and the Middle East for various business activities in Iran. In a number of cases, the HSBC Group issued counter indemnities in support of guarantees issued by Iranian banks as the Iranian beneficiaries of the guarantees required that they be backed directly by Iranian banks. The Iranian banks to which the HSBC Group provided counter indemnities included Bank Tejarat, Bank Melli, and the Bank of Industry and Mine.
There was no measurable gross revenue in the third quarter of 2018 under those guarantees and counter indemnities. The HSBC Group does not allocate direct costs to fees and commissions and, therefore, has not disclosed a separate net profit measure. The HSBC Group is seeking to cancel all relevant guarantees and counter indemnities and does not currently intend to provide any new guarantees or counter indemnities involving Iran. None were cancelled in the third quarter of 2018 and approximately 19 remain outstanding.
Other relationships with Iranian banks Activity related to U.S.-sanctioned Iranian banks not covered elsewhere in this disclosure includes the following:
Ÿ
The HSBC Group maintains an account in the United Kingdom for an Iranian-owned, U.K.-regulated financial institution. This account is generally no longer restricted under U.K. law, though HSBC maintains restrictions on the account as a matter of policy. The HSBC Group is seeking to exit this account. Estimated gross revenue in the third quarter of 2018 on this account, which includes fees and/or commissions, was approximately $31,300.
Ÿ
The HSBC Group acts as the trustee and administrator for a pension scheme involving eight employees of a U.S.-sanctioned Iranian bank in Hong Kong. Under the rules of this scheme, the HSBC Group accepts contributions from the Iranian bank each month and allocates the funds into the pension accounts of the Iranian bank’s employees. The HSBC Group runs and operates this pension scheme in accordance with Hong Kong laws and regulations. Estimated gross revenue, which includes fees and/or commissions, generated by this pension scheme during the third quarter of 2018 was approximately $156.
For the Iranian bank related-activity discussed above, the HSBC Group does not allocate direct costs to fees and commissions and, therefore, has not disclosed a separate net profit measure.
The HSBC Group has been holding a safe custody box for the Central Bank of Iran. For a number of years, the box has not been accessed by the Central Bank of Iran and no fees have been charged to the Central Bank of Iran.
The HSBC Group currently intends to continue to wind down the activity discussed in this section, to the extent legally permissible, and not enter into any new such activity.
Other Activity The HSBC Group has an insurance company customer in the United Arab Emirates that, during the third quarter of 2018, made four payments for the reimbursement of medical treatment to a hospital located in the United Arab Emirates and owned by the Government of Iran. HSBC processed all four payments to the hospital made by its customer.
The HSBC Group maintains an account for a customer in Europe that made a payment to an Iranian-owned airline during the third quarter of 2018.

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For the activity in this section, there was no measurable gross revenue or net profit to the HSBC Group during the third quarter of 2018.
Frozen accounts and transactions The HSBC Group and HSBC Bank USA (a subsidiary of HUSI) maintain several accounts that are frozen as a result of relevant sanctions programs, and safekeeping boxes and other similar custodial relationships, for which no activity, except as licensed or otherwise authorized, took place during the third quarter of 2018. There was no measurable gross revenue or net profit to the HSBC Group during the third quarter of 2018 relating to these frozen accounts.


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Item 6. Exhibits
 
3(i)
 
 
3(ii)
Bylaws of HSBC USA Inc., as Amended and Restated effective July 24, 2018 (incorporated by reference to Exhibit 3.2 to HSBC USA Inc.'s Current Report on Form 8-K filed July 26, 2018).
 
 
12
 
 
31
 
 
32
 
 
101.INS
XBRL Instance Document(1)
 
 
101.SCH
XBRL Taxonomy Extension Schema Document(1)
 
 
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document(1)
 
 
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document(1)
 
 
101.LAB
XBRL Taxonomy Extension Label Linkbase Document(1)
 
 
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document(1)
 
(1) 
Pursuant to Rule 405 of Regulation S-T, includes the following financial information included in our Quarterly Report on Form 10-Q for the quarter ended September 30, 2018, formatted in eXtensible Business Reporting Language ("XBRL") interactive data files: (i) the Consolidated Statement of Income for the three and nine months ended September 30, 2018 and 2017, (ii) the Consolidated Statement of Comprehensive Income (Loss) for the three and nine months ended September 30, 2018 and 2017, (iii) the Consolidated Balance Sheet at September 30, 2018 and December 31, 2017, (iv) the Consolidated Statement of Changes in Equity for the nine months ended September 30, 2018 and 2017, (v) the Consolidated Statement of Cash Flows for the nine months ended September 30, 2018 and 2017, and (vi) the Notes to Consolidated Financial Statements.


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Signatures
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, HSBC USA Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: October 29, 2018

HSBC USA INC.
 
 
 
By:
 
/s/ MARK A. ZAESKE
 
 
Mark A. Zaeske
 
 
Senior Executive Vice President and
 
 
Chief Financial Officer


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