FORM 6-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Report of Foreign Private Issuer
Pursuant to Rule 13a - 16 or 15d - 16 of
the Securities Exchange Act of 1934
For the month of March, 2006
HSBC Holdings plc
42nd Floor, 8 Canada
Square, London E14 5HQ, England
(Indicate by check mark whether the registrant files or will file annual
reports under cover of Form 20-F or Form 40-F).
Form 20-F X Form 40-F ......
(Indicate by check mark whether the registrant by furnishing the information
contained in this Form is also thereby furnishing the information to the
Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of
1934).
Yes....... No X
(If "Yes" is marked, indicate below the file number assigned to the registrant
in connection with Rule 12g3-2(b): 82- ..............)
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UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
OR
( ) 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 1-8198
HSBC FINANCE CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 86-1052062
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
2700 SANDERS ROAD PROSPECT HEIGHTS, ILLINOIS 60070
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(847) 564-5000
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
Floating Rate Notes, due September 15, 2008 New York Stock Exchange
4.625% Notes, due September 15, 2010 New York Stock Exchange
5.25% Notes, due January 14, 2011 New York Stock Exchange
6 3/4% Notes, due May 15, 2011 New York Stock Exchange
Floating Rate Notes, due July 19, 2012 New York Stock Exchange
Floating Rate Notes, due September 14, 2012 New York Stock Exchange
5.0% Notes, due June 30, 2015 New York Stock Exchange
6.875% Notes, due January 30, 2033 New York Stock Exchange
6% Notes, due November 30, 2033 New York Stock Exchange
Depositary Shares (each representing one-fortieth share of New York Stock Exchange
6.36% Non-Cumulative Preferred Stock, Series B, no par,
$1,000 stated maturity)
Guarantee of Preferred Securities of Household Capital Trust New York Stock Exchange
VI
Guarantee of Preferred Securities of Household Capital Trust New York Stock Exchange
VII
Guarantee of Preferred Securities of HSBC Capital Trust IX New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes No ( )
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes ( ) No
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 No ( )
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer ( ) Accelerated filer ( ) Non-accelerated
filer
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes ( ) No
As of March 3, 2006, there were 55 shares of the registrant's common stock
outstanding, all of which are owned by HSBC Investments (North America) Inc.
DOCUMENTS INCORPORATED BY REFERENCE
None.
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TABLE OF CONTENTS
PART/ITEM NO PAGE
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PART I
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Item 1. Business
Organization History and Acquisition by HSBC.............. 4
HSBC North America Operations............................. 4
HSBC Finance Corporation - General........................ 5
Operations................................................ 7
Funding................................................... 11
Regulation and Competition................................ 13
Corporate Governance and Controls......................... 15
Cautionary Statement on Forward-Looking Statements........ 16
Item 1A. Risk Factors................................................ 16
Item 1B. Unresolved Staff Comments................................... 17
Item 2. Properties.................................................. 17
Item 3. Legal Proceedings........................................... 18
Item 4. Submission of Matters to a Vote of Security Holders......... 20
PART II
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Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 20
Item 6. Selected Financial Data..................................... 21
Item 7. Management's Discussion and Analysis of Financial Condition
and Results
of Operations
Executive Overview........................................ 24
Basis of Reporting........................................ 30
Critical Accounting Policies.............................. 37
Receivables Review........................................ 43
Results of Operations..................................... 45
Segment Results - Managed Basis........................... 53
Credit Quality............................................ 60
Liquidity and Capital Resources........................... 74
Off Balance Sheet Arrangements and Secured Financings..... 83
Risk Management........................................... 87
Glossary of Terms......................................... 92
Credit Quality Statistics................................. 95
Analysis of Credit Loss Reserves Activity................. 97
Net Interest Margin....................................... 99
Reconciliations to GAAP Financial Measures................ 102
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 119
Item 8. Financial Statements and Supplementary Data................. 119
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 189
Item 9A. Controls and Procedures..................................... 189
Item 9B. Other Information........................................... 189
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PART/ITEM NO PAGE
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PART III
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Item 10. Directors and Executive Officers of the Registrant.......... 189
Item 11. Executive Compensation...................................... 196
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters................ 203
Item 13. Certain Relationships and Related Transactions.............. 205
Item 14. Principal Accountant Fees and Services...................... 205
PART IV
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Item 15. Exhibits and Financial Statement Schedules
Financial Statements...................................... 205
Exhibits.................................................. 206
Signatures .................................................................. 207
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PART I
ITEM 1. BUSINESS.
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ORGANIZATION HISTORY AND ACQUISITION BY HSBC
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HSBC Finance Corporation traces its origin to 1878 and operated as a consumer
finance company under the name Household Finance Corporation ("HFC") for most of
its history. In 1981, HFC shareholders approved a restructuring that resulted in
the formation of Household International, Inc. ("Household") as a publicly held
holding company and HFC became a wholly-owned subsidiary of Household. For a
period, Household diversified its operations outside the financial services
industry, but returned solely to consumer finance operations through a series of
divestitures in the 1980's and 1990's.
On March 28, 2003, Household was acquired by HSBC Holdings plc ("HSBC") by way
of merger with H2 Acquisition Corporation ("H2"), a wholly owned subsidiary of
HSBC, in a purchase business combination. Following the merger, H2 was renamed
"Household International, Inc." Subsequently, HSBC transferred its ownership
interest in Household to a wholly owned subsidiary, HSBC North America Holdings
Inc. ("HSBC North America"), which subsequently contributed Household to its
wholly-owned subsidiary, HSBC Investments (North America) Inc.
On December 15, 2004, Household merged with its wholly owned subsidiary, HFC. By
operation of law, following the merger, all obligations of HFC became direct
obligations of Household. Following the merger, Household changed its name to
HSBC Finance Corporation. The name change was a continuation of the rebranding
of the Household businesses to the HSBC brand. These actions were taken to
establish a single brand in North America to create a stronger platform to
advance growth across all HSBC business lines.
For all reporting periods up to and including the year ended December 31, 2004,
HSBC prepared its consolidated financial statements in accordance with U.K.
Generally Accepted Accounting Principles ("U.K. GAAP"). From January 1, 2005,
HSBC has prepared its consolidated financial statements in accordance with
International Financial Reporting Standards ("IFRS") as endorsed by the European
Union and effective for HSBC's reporting for the year ended December 31, 2005.
HSBC Finance Corporation now reports to HSBC under IFRS and, as a result,
corporate goals and the individual goals of executives are based upon IFRS
rather than U.K. GAAP, which had been the practice subsequent to our acquisition
by HSBC.
HSBC NORTH AMERICA OPERATIONS
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HSBC North America is the holding company for HSBC's operations in the United
States and Canada. The principal subsidiaries of HSBC North America are HSBC
Finance Corporation, HSBC Bank Canada, a Federal bank chartered under the laws
of Canada, HSBC USA Inc. ("HUSI"), a U.S. bank holding company, HSBC Markets
(USA) Inc., a holding company for investment banking and markets subsidiaries,
and HSBC Technology Services (USA) Inc., a provider of information technology
services. HUSI's principal U.S. banking subsidiary is HSBC Bank USA, National
Association ("HSBC Bank USA"), a national bank with 422 branches in 9 states.
Under the oversight of HSBC North America, HSBC Finance Corporation works with
its affiliates to maximize opportunities and efficiencies in HSBC's operations
in Canada and the United States. These affiliates do so by providing each other
with, among other things, alternative sources of liquidity to fund operations
and expertise in specialized corporate functions and services. This has been
demonstrated by purchases and sales of receivables between HSBC Bank USA and
HSBC Finance Corporation, a pooling of resources to create a new unit that
provides technology services to all HSBC North America subsidiaries and shared,
but allocated, support among the affiliates for tax, legal, risk, compliance,
accounting, insurance, strategy and internal audit functions. In addition,
clients of HSBC Bank USA and other affiliates are investors in our debt and
preferred securities, providing significant sources of liquidity and capital to
HSBC Finance Corporation. HSBC Securities (USA) Inc., a Delaware corporation,
registered broker dealer and a subsidiary of HSBC Markets (USA) Inc., leads or
participates as underwriter of all domestic issuances of our term corporate and
asset backed securities. While HSBC Finance Corporation does
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not receive advantaged pricing, the underwriting fees and commissions payable to
HSBC Securities (USA) Inc. benefit HSBC as a whole.
HSBC FINANCE CORPORATION - GENERAL
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HSBC Finance Corporation's subsidiaries provide middle-market consumers in the
United States, the United Kingdom, Canada, the Republic of Ireland, Slovakia,
the Czech Republic and Hungary with several types of loan products. HSBC Finance
Corporation is the principal fund raising vehicle for the operations of its
subsidiaries. In this Form 10-K, HSBC Finance Corporation and its subsidiaries
are referred to as "we," "us" or "our."
We offer real estate secured loans, auto finance loans, MasterCard(1) and
Visa(1) credit card loans, private label credit card loans including retail
sales contracts and personal non-credit card loans. We also initiate tax refund
anticipation loans in the United States and offer specialty insurance products
in the United States, United Kingdom and Canada. We generate cash to fund our
businesses primarily by collecting receivable balances; issuing commercial
paper, medium and long term debt; borrowing from HSBC subsidiaries and
customers; selling and securitizing consumer receivables; and borrowing under
secured financing facilities. We use the cash generated to invest in and support
receivable growth, to service our debt obligations and to pay dividends to our
parent. At December 31, 2005, we had approximately 35,000 employees and over 60
million customers. Consumers residing in the state of California accounted for
12% of our managed(2) domestic consumer receivables. We also have significant
concentrations of domestic consumer receivables in Florida (6%), New York (6%),
Texas (5%), Ohio (5%), North Carolina (5%) and Pennsylvania (5%).
SIGNIFICANT DEVELOPMENTS SINCE 2000
Since 2000, HSBC Finance Corporation:
- Developed additional distribution channels for our products, including
through the Internet and co-branding opportunities with retail merchants
and service providers.
- Created our Mortgage Services business to acquire nonconforming mortgage
loans originated by unaffiliated third party lenders and invested in
Decision One Mortgage Company LLC ("Decision One"), which was acquired in
1999 to originate nonconforming mortgage loans through third party
brokers.
- Recorded a pre-tax charge of $525 million in the third quarter of 2002 in
settlement of alleged violations of Federal and state consumer
protection, consumer financing and banking laws and regulations with
respect to our real estate secured lending from retail branch offices.
- Without admitting or denying wrongdoing, in March 2003 consented to entry
of order by the Securities and Exchange Commission ("SEC") that contained
findings relating to the sufficiency of certain disclosures filed with
the SEC in 2002 regarding loan restructuring practices.
- Announced in the third quarter of 2004 our intention to structure all new
collateralized funding transactions as secured financings. Because prior
public MasterCard and Visa credit card transactions as well as certain
personal non-credit card transactions were structured as sales to
revolving trusts that require replenishment of receivables to support
previously issued securities, receivables continue to be sold to the
related credit card trusts until the revolving periods end, the last of
which is expected to occur in 2008. Termination of sale treatment for new
collateralized funding activity reduced our
---------------
(1) MasterCard is a registered trademark of MasterCard International,
Incorporated and Visa is a registered trademark of Visa USA, Inc.
(2) We have historically monitored our operations and evaluated trends on both
an owned basis, as shown in our financial statements, and on a managed
basis. Managed basis reporting (a non-GAAP financial measure) assumes that
securitized receivables have not been sold and are still on our balance
sheet. Managed basis information is intended to supplement, and should not
be considered a substitute for, owned basis reporting and should be read in
conjunction with reported owned basis results. See "Basis of Reporting" and
"Reconciliations to GAAP Financial Measures" for additional discussion and
quantitative reconciliations to the equivalent GAAP basis financial measure.
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reported net income under U.S. GAAP in both 2004 and 2005 and will continue
to in future periods. In both periods, there was no impact on cash received
from operations.
- Adopted charge-off and account management policies in accordance with the
Uniform Retail Credit Classification and Account Management Policy issued
by the Federal Financial Institutions Examination Council ("FFIEC
Policies") for our domestic MasterCard/Visa and private label portfolios
(excluding consumer lending retail sales contracts) in the fourth quarter
of 2004. The adoption of FFIEC Policies resulted in a reduction to net
income of approximately $121 million in that quarter. Because we sold our
domestic private label portfolio (excluding retail sales contracts at our
consumer lending business) to HSBC Bank USA in December 2004, the ongoing
impact of the adoption of these policies only impact our domestic
MasterCard and Visa credit card portfolio. As we expected, the adoption
of FFIEC Policies for our MasterCard and Visa portfolio have not had a
significant impact on results of operations or cash flows in 2005.
- Sold $12.2 billion of domestic private label receivables ($15.6 billion
on a managed basis) and the retained interests associated with
securitized private label receivables to HSBC Bank USA in December 2004.
We also entered into an agreement under which all domestic private label
receivables (excluding retail sales contracts at our consumer lending
business) originated under private label accounts are sold to HSBC Bank
USA daily, on a servicing retained basis. HSBC Bank USA also purchased a
portfolio of higher quality nonconforming domestic real estate secured
loans from us in late 2003 and in early 2004.
- In December 2004, received upgraded ratings from Fitch Investors Service
on our senior debt and commercial paper to AA- and F1+, respectively. In
January 2006, Moody's Investors Service raised our Senior Debt Rating to
Aa3 with positive outlook. Moody's also affirmed our P-1 short term
rating in December 2005. Standard and Poor's Corporation's A long-term
rating for HSBC Finance Corporation is rated as stable, as is our A-1
short-term rating.
- Deepened the non-prime expertise of our domestic MasterCard/Visa credit
card business through acquisitions of Renaissance Holdings, Inc. in 2000
and Metris Companies, Inc. ("Metris") in 2005.
- Recorded an incremental pre-tax provision for credit losses of $185
million in 2005, reflecting our best estimate of the impact of Hurricane
Katrina on our loan portfolio. During the fourth quarter of 2005, $11
million of outstanding loans to affected customers was charged-off in
accordance with our charge-off policies.
- Experienced higher bankruptcy filings in 2005, in particular during the
period leading up to the October 17, 2005 effective date of new
legislation in the United States. We had been maintaining credit loss
reserves in anticipation of the impact this new legislation would have on
net charge-offs. However, the magnitude of the spike in bankruptcies
experienced immediately before the new legislation became effective was
larger than anticipated which resulted in an additional $100 million
credit loss provision being recorded during the third quarter of 2005.
Our fourth quarter of 2005 results include an estimated $125 million in
incremental charge-offs of principal, interest and fees and $113 million
in provision expense attributable to bankruptcy reform. The incremental
charge-off in the fourth quarter of 2005 is primarily related to our
MasterCard/Visa portfolio where bankrupt accounts charge-off sooner than
in our secured and personal non-credit card portfolios in accordance with
our charge-off policies for these products. This provision expense
included in our fourth quarter results relating to bankruptcies in our
secured and personal non-credit card portfolios will not begin to migrate
to charge-off until 2006 in accordance with their respective charge-off
policies. As expected, the number of bankruptcy filings subsequent to the
enactment of this new legislation has decreased dramatically. We believe
that a portion of the increase in net charge-offs resulting from the
higher bankruptcy filings is an acceleration of net charge-offs that
would otherwise have been experienced in future periods.
- Sold our U.K. credit card business including $2.5 billion of receivables
($3.1 billion on a managed basis), the associated cardholder
relationships as well as the related retained interests in securitized
credit card receivables and certain assets relating to the credit card
operations to HSBC Bank plc ("HBEU") in December 2005. The premium
received in excess of book value of the assets
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transferred, including the goodwill assigned to this business, has been
recorded as an increase to additional paid in capital and has not been
included in earnings. Our U.K. subsidiary, HFC Bank Limited, will
continue to provide collection and other support services to HBEU for a
fee. As a result, in future periods, net interest income, fee income and
provision for credit losses will be reduced, while other revenues will
increase from servicing revenues on the portfolio. We do not anticipate
the net effect of the sale will result in a material reduction of our
consolidated net income in future periods. We continue to evaluate
strategic alternatives with respect to our other U.K. and European
operations.
- Experienced tightened credit spreads relative to Treasuries compared to
those we experienced during the months leading up to the announcement of
our acquisition by HSBC. Primarily as a result of these tightened credit
spreads, we recognized cash funding expense savings of approximately $600
million in 2005, $350 million in 2004 and $125 million in 2003 compared
to the funding costs we would have incurred using average spreads from
the first half of 2002.
- Prior to the acquisition by HSBC, the majority of our fair value and cash
flow hedges were effective hedges which qualified for the shortcut method
of accounting. Under the Financial Accounting Standards Board's
interpretations of SFAS No. 133, the shortcut method of accounting was no
longer allowed for interest rate swaps which were outstanding at the time
of the acquisition by HSBC. As a result of the acquisition, we were
required to reestablish and formally document the hedging relationship
associated with all of our fair value and cash flow hedging instruments
and assess the effectiveness of each hedging relationship, both at
inception of the acquisition and on an ongoing basis. As a result of
deficiencies in our contemporaneous hedge documentation at the time of
acquisition, we lost the ability to apply hedge accounting to our entire
cash flow and fair value hedging portfolio that existed at the time of
acquisition by HSBC. During 2005, we reestablished hedge treatment under
the long haul method of accounting for a significant number of the
derivatives in this portfolio. This will significantly reduce the
volatility of the mark-to-market on the previously non-qualified
derivatives which have been designated as effective hedges going forward,
but will result in the recording of ineffectiveness under the long-haul
method of accounting. For certain new hedging relationships, however, we
continue to experience income volatility during the period before hedging
documentation is put in place. This net income volatility, whether based
on changes in interest rates for swaps which do not qualify for hedge
accounting or ineffectiveness recorded on our qualifying hedges under the
long-haul method of accounting, impacts the comparability of our reported
results between periods. Accordingly, derivative income for the year
ended December 31, 2005 should not be considered indicative of the
results for any future periods.
- Since our acquisition by HSBC we have actively worked with our North
American affiliates to expand HSBC's brand recognition and to leverage
growth opportunities with merchants, suppliers and customers. Our name
was changed to HSBC Finance Corporation and several businesses now
operate under the HSBC name, including our Canadian branch offices, our
domestic and Canadian auto finance business and our credit card banking
subsidiary.
OPERATIONS
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Our operations are divided into three reportable segments: Consumer, Credit Card
Services and International. Our Consumer segment includes our consumer lending,
mortgage services, retail services, and auto finance businesses. Our Credit Card
Services segment includes our domestic MasterCard and Visa credit card business.
Our International segment includes our foreign operations in the United Kingdom,
Canada, the Republic of Ireland, Slovakia, the Czech Republic and Hungary.
Information about businesses or functions that fall below the segment reporting
quantitative threshold tests such as our insurance services, taxpayer financial
services and commercial operations, as well as our treasury and corporate
activities, which include fair value adjustments related to purchase accounting
and related amortization, are included under the "All Other" caption within our
segment disclosure.
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We have historically monitored our operations and evaluated trends on a managed
basis (a non-GAAP financial measure), which assumes that securitized receivables
have not been sold and are still on our balance sheet. This is because the
receivables that we securitize are subjected to underwriting standards
comparable to our owned portfolio, are serviced by operating personnel without
regard to ownership and result in a similar credit loss exposure for us. In
addition, we have funded our operations and made decisions about allocating
resources, such as capital, on a managed basis. We have begun reporting
"Management Basis" results (a non-GAAP financial measure) in Reports on Form 8-K
with our quarterly results. Management Basis reporting, in addition to managed
basis adjustments, assumes the private label and real estate receivables
transferred to HSBC Bank USA have not been sold and remain on balance sheet. As
we continue to manage and service receivables sold to HSBC Bank USA, we make
decisions about allocating certain resources, such as employees, on a Management
Basis. As referenced above, corporate and individual executive goals, including
those that impact incentive compensation, are established based upon IFRS as it
applies to our parent, HSBC. As a result, management also considers IFRS in
managing our operations.
GENERAL
We generally serve non-conforming and non-prime consumers. Such customers are
individuals who have limited credit histories, modest incomes, high
debt-to-income ratios, high loan-to-value ratios (for auto and real estate
secured products) or have experienced credit problems caused by occasional
delinquencies, prior charge-offs, bankruptcy or other credit related actions.
These customers generally have higher delinquency and credit loss probabilities
and are charged a higher interest rate to compensate for the additional risk of
loss (where the loan is not adequately collateralized to mitigate such
additional risk of loss) and the anticipated additional collection initiatives
that may have to be undertaken over the life of the loan. We also originate
and/or purchase near-prime real estate secured, MasterCard/Visa and auto loans.
In our MasterCard and Visa, retail services and international businesses, we
also serve prime consumers either through co-branding, merchant relationships or
direct mailings.
We are responsive to the needs of our customers in the products we offer and
periodically test new loan products in our different business units. In
particular, consumer demand for alternative mortgage products has increased
significantly in recent years, including requests for interest-only payment
loans, adjustable-rate loans with alternative payment options ("option ARMs")
and negatively amortizing loans. HSBC Finance Corporation does not and does not
anticipate offering option ARMs or other negative amortization products. We do
offer loans under which the borrower makes fixed rate interest-only payments for
some period of time prior to interest rate adjustments and/or higher payments
that include a principal component. Due to customer demand, this segment of our
real estate secured portfolio experienced rapid growth in the third and fourth
quarters of 2005. At December 31, 2005, the outstanding balance of our
interest-only loans was $4.7 billion, or 3.3% of managed receivables. As with
all other products, we underwrite to criteria that consider the particular terms
of the loan and price the interest-only loans in a manner that compensates for
the higher risk that, during the period higher payments are required, customers
may be unable to repay their loans. Additional information concerning
interest-only loans is contained in Note 26, "Concentrations of Credit Risk" to
our consolidated financial statements.
We use our centralized underwriting, collection and processing functions to
adapt our credit standards and collection efforts to national or regional market
conditions. Our underwriting, loan administration and collection functions are
supported by highly automated systems and processing facilities. Our centralized
collection systems are augmented by personalized early collection efforts.
Analytics drive our decisions in marketing, risk pricing, operations and
collections.
We service each customer with a view to understanding that customer's personal
financial needs. We recognize that individuals may not be able to timely meet
all of their financial obligations. Our goal is to assist consumers in
transitioning through financially difficult times which may lead to their doing
more business with our lending subsidiaries or other HSBC affiliates. As a
result, our policies and practices are designed to be flexible to maximize the
collectibility of our loans while not incurring excessive collection expenses on
loans
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that have a high probability of being ultimately uncollectible. Proactive credit
management, "hands-on" customer care and targeted product marketing are means we
use to retain customers and grow our business.
CONSUMER
Our Consumer Lending business is one of the largest subprime home equity
originators in the United States as ranked by Inside B&C Lending. This business
has 1,397 branches located in 45 states, and approximately 2.9 million active
customer accounts, $55.5 billion in managed receivables and 12,800 employees. It
is marketed under both the HFC and Beneficial brand names, each of which caters
to a slightly different type of customer in the middle-market population. Both
brands offer secured and unsecured loan products, such as first and second lien
position closed-end mortgage loans, open-end home equity loans, personal
non-credit card loans, including personal homeowner loans (a secured high
loan-to-value product that we underwrite and treat like an unsecured loan), auto
finance and sales finance contracts. These products are marketed through our
retail branch network, direct mail, telemarketing, strategic alliances and
Internet sourced applications and leads. We also acquire portfolios on an
opportunistic basis. As of December 31, 2005, approximately 94% of our consumer
loans bore fixed rates and 60% were first liens.
Our Mortgage Services business purchases non-conforming first and second lien
position residential mortgage loans, including open-end home equity loans, from
a network of over 280 unaffiliated third-party lenders (i.e., correspondents).
This business has approximately $41.6 billion in managed receivables, 409,000
active customer accounts and 3,100 employees. Purchases are primarily "bulk"
acquisitions (i.e., pools of loans) but also include "flow" acquisitions (i.e.,
loan by loan), and are made based on our specific underwriting guidelines. As of
December 31, 2005, Mortgage Services serviced approximately $4.6 billion of
receivables for other parties, including HSBC Bank USA. We have committed to
purchase real estate secured receivables from select correspondent lenders to
strengthen our relationship with these lenders and to create a sustainable
growth channel for this business. Decision One, a subsidiary of HSBC Finance
Corporation, was purchased in 1999 to assist us in understanding the product
needs of mortgage brokers and trends in the mortgage lending industry. Through
more than 22 branch locations, Decision One directly originates mortgage loans
sourced by mortgage brokers and sells all loans to secondary market purchasers,
including to our Mortgage Services business. As of December 31, 2005,
approximately 45% of the Mortgage Services portfolio were fixed rate loans, 81%
were in first lien position.
On December 29, 2004, our domestic private label receivable portfolio (excluding
retail sales contracts at our consumer lending business) of approximately $15.6
billion of managed receivables was sold to HSBC Bank USA, and agreements were
entered into to sell all future receivables to HSBC Bank USA on a daily basis
and to service the portfolio for HSBC Bank USA for a fee. As a result, we now
sell all domestic private label receivables (excluding retail sales contracts)
upon origination but service the entire portfolio on behalf of HSBC Bank USA.
According to The Nilson Report, the private label servicing portfolio is the
third largest portfolio in the U.S. Our Retail Services business has over 65
active merchant relationships and we service approximately 16.1 million active
customer accounts and have over 2,100 employees. At December 31, 2005, the
serviced private label portfolio consisted of approximately 13 percent of
receivables in the furniture industry, 32 percent in the consumer electronics
industry, 29 percent in the power sport vehicle (snowmobiles, personal
watercraft, ATV's and motorcycles) industry and approximately 15 percent in the
department store industry. Private label financing products are generated
through merchant retail locations, merchant catalog and telephone sales, and
direct mail and Internet applications.
Our Auto Finance business purchases, from a network of approximately 10,000
active dealer relationships, retail installment contracts of consumers who may
not have access to traditional, prime-based lending sources. We also originate
and refinance auto loans through direct mail solicitations, alliance partners,
consumer lending customers and the Internet. At December 31, 2005, this business
had approximately $11.2 billion in managed receivables, approximately 790,000
active customer accounts and 1,900 employees. Approximately 37% of auto finance
receivables are secured by new vehicles. Based upon CNW Research and JD Power,
the
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dealer financing market in the U.S. is highly fragmented with originations in
excess of $580 billion, of which approximately $275 billion are considered
non-prime loans.
CREDIT CARD SERVICES
Our Credit Card Services business includes our MasterCard and Visa receivables
in the United States, including The GM Card(R), the AFL-CIO Union Plus(R) ("UP")
credit card, Household Bank, Orchard Bank and HSBC branded cards, and as of our
December 1, 2005 acquisition of Metris, the Direct Merchants Bank MasterCard.
This business has approximately $26.2 billion in managed receivables, over 17
million active customer accounts and 6,475 employees. According to The Nilson
Report, this business is the fifth largest issuer of MasterCard or Visa credit
cards in the United States (based on receivables). The GM Card(R), a co-branded
credit card issued as part of our alliance with General Motors Corporation
("GM"), enables customers to earn discounts on the purchase or lease of a new GM
vehicle. The UP card program with the AFL-CIO provides benefits and services to
members of various national and international labor unions. The Household Bank,
Orchard Bank and HSBC branded credit cards offer specialized credit card
products to consumers underserved by traditional providers or are marketed in
conjunction with merchant relationships established through our retail services
business. The Direct Merchants Bank branded MasterCard/Visa is a general purpose
card marketed to near-prime customers through direct mail and strategic
partnerships. HSBC branded cards are targeted through direct mail at the prime
market. In addition, Credit Card Services services $1.2 billion of receivables
held by an affiliate, HSBC Bank USA. New receivables and accounts related to the
HSBC Bank USA portfolio are originated by HSBC Bank Nevada, N.A., and
receivables are sold daily to HSBC Bank USA.
Our MasterCard and Visa business is generated primarily through direct mail,
telemarketing, Internet applications, application displays, promotional activity
associated with our affinity and co-branding relationships, mass-media
advertisement (The GM Card(R)) and merchant relationships sourced through our
retail services business. We also cross-sell our credit cards to our existing
consumer lending and retail services customers as well as our taxpayer financial
services customers.
Although our relationships with GM and the AFL-CIO enable us to access a
proprietary customer base, in accordance with our agreements with these
institutions, we own all receivables originated under the programs and are
responsible for all credit and collection decisions as well as the funding for
the programs. These programs are not dependent upon any payments, guarantees or
credit support from these institutions. As a result, we are not directly
dependent upon GM or the AFL-CIO for any specific earnings stream associated
with these programs. We believe we have a strong working relationship with GM
and the AFL-CIO and in 2005 and 2004, we jointly agreed with GM and the AFL-CIO,
respectively, to extend the term of these successful cobranded and Affinity Card
Programs. These agreements do not expire in the near term.
INTERNATIONAL
Our United Kingdom subsidiary is a mid-market consumer lender focusing on
customer service through its branch locations, and consumer electronics through
its retail finance operations and telemarketing. This business offers secured
and unsecured lines of credit, secured and unsecured closed-end loans, retail
finance products and insurance products. We operate in England, Scotland, Wales,
Northern Ireland and the Republic of Ireland. In December 2005 we sold our U.K.
credit card business to HSBC Bank plc. Under agreement with HSBC Bank plc, we
will continue to provide collection services and other support services,
including components of the compliance, financial reporting and human resource
functions, for this credit card portfolio.
Loans held in the United Kingdom and the Republic of Ireland are originated
through a branch network consisting of 187 HFC Bank Limited and Beneficial
Finance branches, merchants, direct mail, broker referrals, the Internet and
outbound telemarketing. Following the sale of the U.K. credit card business,
which included $3.1 billion of managed credit card receivables, we had
approximately $5.9 billion in managed
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receivables, 2.0 million customer accounts and 3,600 employees in our operations
in the United Kingdom and the Republic of Ireland.
We opened offices in Hungary, Czech Republic and Slovakia in 2001, 2002 and
2005, respectively, to facilitate the expansion plans of one of our U.K.
merchant alliances. These offices have approximately $147 million in managed
receivables and 340 employees.
Our Canadian business offers real estate secured and unsecured lines of credit,
secured and unsecured closed-end loans, insurance products, private label credit
cards, MasterCard credit card loans, retail finance products and auto loans to
Canadian consumers. These products are marketed through 124 branch offices in 10
provinces, through direct mail, 80 merchant relationships, 1,000 auto dealer
relationships and the Internet. At December 31, 2005, this business had
approximately $3.2 billion in managed receivables, 1.0 million customer accounts
and 1,500 employees.
ALL OTHER
Our insurance services operation distributes credit life, disability and
unemployment, accidental death and disability, term life, whole life, annuities,
disability, long term care and a variety of other specialty insurance products
to our customers and the customers of HSBC Bank USA. Such products currently are
offered throughout the United States and Canada and are offered to customers
based upon their particular needs. Insurance is directly written by or reinsured
with one or more of our subsidiaries.
The taxpayer financial services business is the leading U.S. provider of
tax-related financial products to consumers through nearly 25,000 unaffiliated
professional tax preparer locations and tax preparation software providers.
Serving more than 9 million customers annually, this business leverages the
annual U.S. income tax filing process to provide products that offer consumers
quick and convenient access to funds in the amount of their anticipated tax
refund. Our taxpayer financial services business processes and collects on
refund anticipation loans that are originated by HSBC Bank USA. In 2005, this
business generated a loan volume of approximately $15.1 billion and employed 125
full-time employees.
To help ensure high standards of responsible lending, we provide
industry-leading compliance programs for our tax preparer business partners. Key
elements of our compliance efforts include mandatory online compliance and
sales-practice training, expanded tax preparer due diligence processes, and
on-going sales practice monitoring to help ensure that our customers are treated
fairly and that they understand their financial choices. Additionally, access to
free consumer financial education resources and a 48-hour satisfaction guarantee
are offered to customers, which further enhances our compliance and customer
service efforts.
Our commercial operations are very limited in scope and are expected to continue
to decline. We have less than $200 million in commercial receivables.
FUNDING
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We fund our operations globally and domestically, using a combination of capital
market and affiliate debt, preferred equity, securitizations, sales of consumer
receivables and borrowings under secured financing facilities. We will continue
to fund a large part of our operations in the global capital markets, primarily
through the use of secured financings, commercial paper, medium-term notes and
long-term debt. We will also continue to sell certain receivables, including our
domestic private label originations (excluding retail sales contracts) to HSBC
Bank USA. Our sale of the entire domestic private label portfolio (excluding
retail sales contracts at our consumer lending business) to HSBC Bank USA
occurred in December 2004 and was a significant source of our funding in 2005.
Our continued success and prospects for growth are largely dependent upon access
to the global capital markets. Numerous factors, internal and external, may
impact our access to, and the costs associated with,
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these markets. These factors may include our debt ratings, overall economic
conditions, overall capital markets volatility and the effectiveness of our
management of credit risks inherent in our customer base.
The merger with HSBC has improved our access to the capital markets and lowered
our funding costs. In addition to providing several important sources of direct
funding, our affiliation with HSBC has also expanded our access to a worldwide
pool of potential investors. While these new funding synergies have somewhat
reduced our reliance on traditional sources to fund our growth, we are focused
on balancing our use of affiliate and third-party funding sources to minimize
funding expense while maximizing liquidity. Because we are now a subsidiary of
HSBC and our credit ratings have improved, our credit spreads relative to
Treasuries have tightened relative to those we experienced during the months
leading up to the announcement of our acquisition by HSBC. Primarily as a result
of these tightened credit spreads, we recognized cash funding expense savings of
approximately $600 million in 2005, $350 million in 2004 and $125 million in
2003 compared to the funding costs we would have incurred using average spreads
and funding mix from the first half of 2002. We anticipate that these tightened
credit spreads in combination with the issuance of new HSBC Finance Corporation
debt and other funding synergies including asset transfers and external fee
savings will enable HSBC to realize annual cash funding expense savings in
excess of $1 billion per year which is anticipated to be achieved in 2006. In
2005, cash funding expense savings realized by HSBC totaled approximately $865
million.
Our long-term debt, preferred stock and commercial paper ratings, as well as the
long-term debt and commercial paper ratings of our Canadian subsidiary, have
been assigned investment grade ratings by all nationally recognized statistical
rating organizations. For a detailed listing of the ratings that have been
assigned to HSBC Finance Corporation and our significant subsidiaries as of
December 31, 2005, see Exhibit 99.1 to this Form 10-K.
Our affiliates provided funding sources for our operations through draws on a
bank line in the U.K., investing in our debt, acquiring credit card, private
label and real estate secured receivables, providing additional common equity
and underwriting sales of our debt securities and Series B preferred stock to
HSBC clients and customers. In 2005, total HSBC related funding aggregated $44.1
billion. A detailed listing of the sources of such funding can be found in
"Liquidity and Capital Resources" in our 2005 MD&A. We expect to continue to
obtain significant funding from HSBC related sources in the future.
Historically, securitization of consumer receivables has been a source of
funding and liquidity for HSBC Finance Corporation. In order to align our
accounting treatment with that of HSBC, in the third quarter of 2004 we began to
structure all new collateralized funding transactions as secured financings. A
gain on sale of receivables is recorded in a securitization. Secured financings
are recorded as debt and no gain on sale is recognized. The termination of sale
treatment for new collateralized funding activity reduces reported net income
under U.S. GAAP, but does not impact cash received from operations. Existing
MasterCard and Visa credit card and personal non-credit card transactions were
structured as sales to revolving trusts that require the addition of new
receivables to support required cash distributions on outstanding securities
until the contractual obligation terminates, the last of which is currently
projected to occur in 2008. Until that time, replenishment gains on sale of
receivables for these securitizations will continue to be reflected in our
financial statements.
Generally, for each securitization and secured financing we utilize credit
enhancement to obtain investment grade ratings on the securities issued by the
trust. To ensure that adequate funds are available to pay investors their
contractual return, we may retain various forms of interests in assets securing
a funding transaction, whether structured as a securitization or a secured
financing, such as over-collateralization, subordinated series, residual
interests (in the case of securitizations) in the receivables or we may fund
cash accounts. Over-collateralization is created by transferring receivables to
the trust issuing the securities that exceed the balance of the securities to be
issued. Subordinated interests provide additional assurance of payment to
investors holding senior securities. Residual interests are also referred to as
interest-only strip receivables and represent rights to future cash flows from
receivables in a securitization trust after investors receive their contractual
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return. Cash accounts can be funded by an initial deposit at the time the
transaction is established and/or from interest payments on the receivables that
exceed the investor's contractual return.
Additional information on our sources and availability of funding are set forth
in the "Liquidity and Capital Resources" and "Off Balance Sheet Arrangements"
sections of our 2005 MD&A.
We will continue to use derivative financial instruments to hedge our currency
and interest rate risk exposure. A description of our use of derivative
financial instruments, including interest rate swaps and foreign exchange
contracts, and other quantitative and qualitative information about our market
risk is set forth in Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations" ("2005 MD&A") under the caption "Risk
Management" and Note 15, "Derivative Financial Instruments," of our consolidated
financial statements ("2005 Financial Statements").
REGULATION AND COMPETITION
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REGULATION
CONSUMER
Our consumer finance businesses operate in a highly regulated environment. These
businesses are subject to laws relating to consumer protection, discrimination
in extending credit, use of credit reports, privacy matters, and disclosure of
credit terms and correction of billing errors. They also are subject to certain
regulations and legislation that limit operations in certain jurisdictions. For
example, limitations may be placed on the amount of interest or fees that a loan
may bear, the amount that may be borrowed, the types of actions that may be
taken to collect or foreclose upon delinquent loans or the information about a
customer that may be shared. Our consumer branch lending offices are generally
licensed in those jurisdictions in which they operate. Such licenses have
limited terms but are renewable, and are revocable for cause. Failure to comply
with these laws and regulations may limit the ability of our licensed lenders to
collect or enforce loan agreements made with consumers and may cause our lending
subsidiaries to be liable for damages and penalties.
There also continues to be a significant amount of legislative activity,
nationally, locally and at the state level, aimed at curbing lending practices
deemed to be "predatory", particularly when such practices are believed to
discriminate against certain groups. In addition, states have sought to alter
lending practices through consumer protection actions brought by state attorneys
general and other state regulators. Legislative activity in this area is
expected to continue targeting certain abusive practices such as loan "flipping"
(making a loan to refinance another loan where there is no tangible benefit to
the borrower), fee "packing" (addition of unnecessary, unwanted and unknown fees
to a borrower), "equity stripping" (lending without regard to the borrower's
ability to repay or making it impossible for the borrower to refinance with
another lender), and outright fraud. HSBC Finance Corporation does not condone,
endorse or engage in any of these practices. We continue to work with regulators
and consumer groups to create appropriate safeguards to avoid these abusive
practices while allowing our borrowers to continue to have access to credit for
personal purposes, such as the purchase of homes, automobiles and consumer
goods. As part of this effort we have adopted a set of lending best practice
initiatives. Increased legislative and regulatory focus is also expected on tax
refund anticipation loans. We anticipate increased legislation seeking to limit
the amount of interest rates and fees that may be charged for refund
anticipation loans as well as efforts to limit permissible interchange fees
charged to merchants and suppliers of services. It is possible that new
legislative or regulatory initiatives will impose additional costs and rules on
our businesses. Although we have the ability to react quickly to new laws and
regulations, it is too early to estimate the effect, if any, these activities
will have on us in a particular locality or nationally.
The Federal Financial Institutions Examination Counsel ("FFIEC") published
guidance in 2005 that mandates changes to the required minimum monthly payment
amount and limits certain fees that may be charged on non-prime credit card
accounts. The requirements were effective on January 1, 2006. It is anticipated
that the changes will result in decreased non-prime credit card fee income and
fluctuations in the provision for credit losses as credit loss provisions for
prime accounts will increase as a result of higher required
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monthly payments while the non-prime provision decreases due to lower levels of
fees incurred by customers. We do not expect the changes will have a material
impact on our consolidated results, but the impact is expected to have a
material impact on the earnings of our Credit Card Services segment. Because the
potential impact can only be estimated based upon numerous assumptions and a
number of factors that are difficult to predict, such as changes in customer
behavior, the ultimate impact will not be fully known or understood for some
time.
BANKING INSTITUTIONS
Our credit card banking subsidiary, HSBC Bank Nevada, N.A. ("HSBC Bank Nevada"),
is a Federally chartered 'credit card bank' which is also a member of the
Federal Reserve System. HSBC Bank Nevada is subject to regulation, supervision
and examination by the Office of the Comptroller of the Currency ("OCC"). The
deposits of HSBC Bank Nevada are insured by the FDIC, which renders it subject
to relevant FDIC regulation.
As a result of our acquisition by HSBC, HSBC Finance Corporation and its
subsidiaries became subject to supervision, regulation and examination by the
Board of Governors of the Federal Reserve System (the "Federal Reserve Board").
HSBC is a bank holding company under the U.S. Bank Holding Company Act of 1956,
as amended (the "BHCA") as a result of its ownership of HSBC Bank USA. On
January 1, 2004, HSBC formed a new company to hold all of its North America
operations, including HSBC Finance Corporation and its subsidiaries. This
company, HSBC North America Holdings Inc. ("HNAH") is also a bank holding
company under the BHCA, by virtue of its ownership and control of HSBC Bank USA.
HSBC and HNAH are registered as financial holding companies under the
Gramm-Leach-Bliley Act amendments to the BHCA, enabling them to offer a broad
range of financial products and services.
The United States is a party to the 1988 Basel Capital Accord (the "Accord") and
U.S. bank regulatory agencies have adopted risk-based capital requirements for
United States banks and bank holding companies that are generally consistent
with the Accord. In addition, U.S. bank regulatory agencies have adopted
'leverage' capital requirements that generally require United States banks and
bank holding companies to maintain a minimum amount of capital in relation to
their balance sheet assets (measured on a non-risk-weighted basis). HSBC Bank
Nevada is subject to these capital requirements.
In June 2004, the Basel Committee on Banking Supervision ("Basel") published a
revised capital adequacy framework for complex and internationally active banks.
Banking regulators in individual countries are expected to adopt implementing
rules and standards for local banking institutions under their jurisdiction.
This framework ("Basel II") is now being considered by U.S. bank regulatory
agencies, including the Federal Reserve Board and the OCC. In 2005, the U.S.
bank regulatory agencies delayed issuing final rules pending further analysis of
capital impact studies. The U.S. bank regulatory agencies are now expected to
publish proposed capital adequacy regulations implementing Basel II by mid-year
2006, followed by the final rules sometime on or around the end of 2006. The
earliest that U.S. banking organizations may adopt the new rules is January 1,
2009.
In 2004, HSBC was advised by the U.S. bank regulatory agencies that HSBC North
America and its subsidiaries, including HSBC Finance Corporation, are considered
to be mandatory participants in the new capital framework. HSBC North America
has established comprehensive Basel II implementation project teams comprised of
risk management specialists representing all risk disciplines. At this time, we
are unable to fully quantify the potential impact of the Basel II standards on
HSBC Finance Corporation.
HSBC Bank Nevada, like other FDIC-insured banks, may be required to pay
assessments to the FDIC for deposit insurance under the FDIC's Bank Insurance
Fund. Under the FDIC's risk-based system for setting deposit insurance
assessments, an institution's assessments vary according to the level of capital
an institution holds, its deposit levels and other factors.
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The Federal Deposit Insurance Corporation Improvement Act of 1991 provides for
extensive regulation of insured depository institutions such as HSBC Bank
Nevada, including requiring Federal banking regulators to take 'prompt
corrective action' with respect to FDIC-insured banks that do not meet minimum
capital requirements. At December 31, 2005, HSBC Bank Nevada was
well-capitalized under applicable OCC and FDIC regulations.
Our principal United Kingdom subsidiary (HFC Bank Limited., formerly known as
HFC Bank plc) is subject to oversight and regulation by the U.K. Financial
Services Authority ("FSA") and the Irish Financial Services Regulatory Authority
of the Republic of Ireland. We have indicated our intent to the FSA to maintain
the regulatory capital of this institution at specified levels. We do not
anticipate that any capital contribution will be required for our United Kingdom
bank in the near term. In May 2005, new consumer protection laws were effective
in the U.K. that will impact ongoing profitability and operations. These changes
did not have a material impact on our results.
We also maintain a trust company in Canada, which is subject to regulatory
supervision by the Office of the Superintendent of Financial Institutions.
INSURANCE
Our credit insurance business is subject to regulatory supervision under the
laws of the states and provinces in which it operates. Regulations vary from
state to state, and province to province, but generally cover licensing of
insurance companies, premium and loss rates, dividend restrictions, types of
insurance that may be sold, permissible investments, policy reserve
requirements, and insurance marketing practices.
Our insurance operations in the United Kingdom are subject to regulatory
supervision by the FSA.
COMPETITION
The consumer financial services industry in which we operate is highly
fragmented and intensely competitive. We generally compete with banks, thrifts,
insurance companies, credit unions, mortgage lenders and brokers, finance
companies, investment banks, and other domestic and foreign financial
institutions in the United States, Canada and the United Kingdom. We compete by
expanding our customer base through portfolio acquisitions or alliance and
co-branding opportunities, offering a variety of consumer loan products and
maintaining a strong service orientation. Customers are generally attracted to
consumer finance products based upon price, available credit limits and other
product features. As a result, customer loyalty is often limited. We believe our
focus on the specific needs of our customers, proprietary credit scoring models
and strong analytics in all aspects of our business allow us to compete
effectively for middle market customers.
CORPORATE GOVERNANCE AND CONTROLS
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HSBC Finance Corporation maintains a website at www.hsbcusa.com/hsbc
-finance on which we make available, as soon as reasonably practicable after
filing with or furnishing to the SEC, our annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, and any amendments to these
reports. Our website also contains our Corporate Governance Standards and
committee charters for the Audit, Compensation, Executive and Nominating and
Governance Committees of our Board of Directors. We have a Statement of Business
Principles and Code of Ethics that expresses the principles upon which we
operate our businesses. Integrity is the foundation of all our business
endeavors and is the result of continued dedication and commitment to the
highest ethical standards in our relationships with each other, with other
organizations and individuals who are our customers. You can find our Statement
of Business Principles and Code of Ethics on our corporate website. We also have
a Code of Ethics for Senior Financial Officers that applies to our finance and
accounting professionals that supplements the Statement of Business Principles.
That Code of Ethics is incorporated by reference in Exhibit 14 to this Annual
Report on Form 10-K. You can request
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printed copies of this information at no charge. Requests should be made to HSBC
Finance Corporation, 2700 Sanders Road, Prospect Heights, Illinois 60070,
Attention: Corporate Secretary.
HSBC Finance Corporation has a Disclosure Committee that is responsible for
maintenance and evaluation of our disclosure controls and procedures and for
assessing the materiality of information required to be disclosed in periodic
reports filed with the SEC. Among its responsibilities is the review of
quarterly certifications of business and financial officers throughout HSBC
Finance Corporation as to the integrity of our financial reporting process, the
adequacy of our internal and disclosure control practices and the accuracy of
our financial statements.
CERTIFICATIONS
In addition to certifications from our Chief Executive Officer and Chief
Financial Officer pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act of
2002 (attached to this report on Form 10-K as Exhibits 31 and 32), we have also
filed a certification with the New York Stock Exchange (the "NYSE") from our
Chief Executive Officer certifying that he is not aware of any violation by HSBC
Finance Corporation of the applicable NYSE corporate governance listing
standards in effect as of March 6, 2006.
CAUTIONARY STATEMENT ON FORWARD-LOOKING STATEMENTS
--------------------------------------------------------------------------------
Certain matters discussed throughout this Form 10-K constitute 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 SEC, in press releases, or oral or written presentations by
representatives of HSBC Finance Corporation that are not statements of
historical fact and may also constitute forward-looking statements. Words such
as "may", "will", "should", "would", "could", "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, 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. Forward-looking
statements are based on our current views and assumptions and speak only as of
the date they are made. HSBC Finance Corporation undertakes no obligation to
update any forward-looking statement to reflect subsequent circumstances or
events.
ITEM 1A. RISK FACTORS
--------------------------------------------------------------------------------
Many important factors, many of which are out of our control, could affect our
actual results and could cause our results to vary materially from those
expressed in public statements or documents. These include:
- changes in laws and regulations, including attempts by local, state and
national regulatory agencies or offices or legislative bodies to control
alleged "predatory" or discriminatory lending practices through broad or
targeted initiatives aimed at lenders operating in consumer lending
markets, including with respect to non-traditional mortgage products and
tax refund anticipation loans;
- increased competition from well-capitalized companies or lenders with
access to government sponsored organizations for our consumer segment
which may impact the terms, rates, costs or profits historically included
in the loan products we offer or purchase;
- changes in accounting or credit policies, practices or standards, as they
may be internally modified from time to time or changes as may be
required by regulatory agencies or the Financial Accounting Standards
Board;
- changes to operational practices from time to time, such as
determinations to sell receivables from our private label portfolio,
structuring more collateralized funding as secured financings, or changes
to our customer account management policies and practices and risk
management/collection practices;
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- changes in overall economic conditions, including the interest rate
environment in which we operate, the capital markets in which we fund our
operations, the market values of consumer owned real estate throughout
the United States, recession, employment and currency fluctuations;
- consumer perception of the availability of credit, including price
competition in the market segments we target and the ramifications or
ease of filing for personal bankruptcy;
- the effectiveness of models or programs to predict loan delinquency or
loss and initiatives to improve collections in all business areas, and
changes we may make from time to time in these models, programs and
initiatives;
- changes in management's estimates of probable losses inherent in our loan
portfolio;
- continued consumer acceptance of our distribution systems and demand for
our loan or insurance products;
- changes associated with, as well as the difficulty in, integrating
systems, operational functions and cultures, as applicable, of any
organization or portfolio acquired by HSBC Finance Corporation, such as
Metris;
- a reduction of our debt ratings by any of the nationally recognized
statistical rating organizations that rate our debt instruments to a
level that is below our current rating;
- amendments to, and interpretations of risk-based capital guidelines and
reporting instructions, including changes in response to the Basel II
Capital Accords;
- the impact of raising the required minimum payments on our credit card
accounts which was effective January 2006;
- the costs, effects and outcome of regulatory reviews or litigation
relating to our nonprime loan receivables or the business practices or
policies of any of our business units, including, but not limited to,
additional compliance requirements;
- increased funding costs resulting from instability in the capital markets
and risk tolerance of fixed income investors;
- the costs, effects and outcomes of any litigation matter that is
determined or otherwise resolved adversely to HSBC Finance Corporation or
its subsidiaries;
- the ability to attract and retain qualified personnel to support the
credit risk analysis, underwriting, servicing, collection and sales
functions of our businesses;
- failure to obtain expected funding from HSBC subsidiaries and clients;
- the impact of natural and other catastrophic disasters and the ability to
collect on our receivables in affected areas; and
- the inability of HSBC Finance Corporation to manage any or all of the
foregoing risks as well as anticipated.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
--------------------------------------------------------------------------------
We have no unresolved written comments from the Securities and Exchange
Commission Staff that have been outstanding for more than 180 days at December
31, 2005.
ITEM 2. PROPERTIES.
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Our operations are located throughout the United States, in 10 provinces in
Canada and in the United Kingdom, with principal facilities located in
Lewisville, Texas; New Castle, Delaware; Brandon, Florida; Jacksonville,
Florida; Tampa, Florida; Chesapeake, Virginia; Virginia Beach, Virginia;
Hanover, Maryland; Minnetonka, Minnesota; Bridgewater, New Jersey; Rockaway, New
Jersey; Las Vegas, Nevada; Charlotte, North Carolina; Portland, Oregon; Pomona,
California; Chicago, Illinois; Elmhurst, Illinois; Franklin Park, Illinois;
Mount Prospect, Illinois; Prospect Heights, Illinois; Schaumburg, Illinois;
Vernon Hills, Illinois; Wood Dale, Illinois; Carmel, Indiana; Salinas,
California; San Diego, California; London, Kentucky; Sioux Falls, South Dakota;
Toronto, Ontario and Montreal, Quebec, Canada; Windsor, Berkshire, United
Kingdom and Birmingham, United Kingdom.
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Substantially all branch offices, divisional offices, corporate offices,
regional processing and regional servicing center spaces are operated under
lease with the exception of the headquarters building for our United Kingdom
operations, a credit card processing facility in Las Vegas, Nevada; a processing
center in Vernon Hills, Illinois; servicing facilities in London, Kentucky, Mt.
Prospect, Illinois, Orlando, Florida and Chesapeake, Virginia; offices in
Birmingham, United Kingdom and an airplane hanger in Wheeling, Illinois. We
believe that such properties are in good condition and meet our current and
reasonably anticipated needs.
ITEM 3. LEGAL PROCEEDINGS.
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GENERAL
We are parties to various legal proceedings resulting from ordinary business
activities relating to our current and/or former operations. Certain of these
actions are or purport to be class actions seeking damages in very large
amounts. These actions assert violations of laws and/or unfair treatment of
consumers. Due to the uncertainties in litigation and other factors, we cannot
be certain that we will ultimately prevail in each instance. We believe that our
defenses to these actions have merit and any adverse decision should not
materially affect our consolidated financial condition.
CONSUMER LITIGATION
During the past several years, the press has widely reported certain industry
related concerns that may impact us. Some of these involve the amount of
litigation instituted against finance and insurance companies operating in
certain states and the large awards obtained from juries in those states. Like
other companies in this industry, some of our subsidiaries are involved in a
number of lawsuits pending against them in these states. The cases, in
particular, generally allege inadequate disclosure or misrepresentation of
financing terms. In some suits, other parties are also named as defendants.
Unspecified compensatory and punitive damages are sought. Several of these suits
purport to be class actions or have multiple plaintiffs. The judicial climate in
these states is such that the outcome of all of these cases is unpredictable.
Although our subsidiaries believe they have substantive legal defenses to these
claims and are prepared to defend each case vigorously, a number of such cases
have been settled or otherwise resolved for amounts that in the aggregate are
not material to our operations. Appropriate insurance carriers have been
notified of each claim, and a number of reservations of rights letters have been
received. Certain of the financing of merchandise claims have been partially
covered by insurance.
CREDIT CARD SERVICES LITIGATION
On November 15, 2004, a matter entitled American Express Travel Related Services
Company, Inc. v. Visa U.S.A. Inc., et al. was filed in the U.S. District Court
for the Southern District of New York. This case alleged that HSBC Finance
Corporation, Household Bank (SB), N.A. (the "HSBC defendants") and others
violated Sections 1 and 2 of the Sherman Act by conspiring to monopolize and
unreasonably restrain trade by allegedly implementing and enforcing an agreement
requiring any United States bank that issues Visa or MasterCard general cards to
refuse to issue such cards from competitors, such as American Express and
Discover. Plaintiff sought a declaration that defendants (including Visa,
MasterCard and other banks belonging to those associations), violated the
antitrust laws, and requested an injunction restraining the defendants, their
directors, officers, employees, agents, successors, owners and members from
"continuing or maintaining in any manner, directly or indirectly, the rules,
policies, and agreements at issue," and sought "full compensation for damages it
has sustained, from each Defendant, jointly, severally," for each of plaintiff's
claims, in an amount "to be trebled according to law, plus interest, attorneys'
fees and costs of suit". On December 27, 2005, plaintiff and the HSBC defendants
filed a stipulation of dismissal with the Court that dismissed all claims
against the HSBC defendants.
Since June 2005, HSBC Finance Corporation, HSBC North America Holdings Inc., and
HSBC Holdings plc., as well as other banks and the Visa and Master Card
associations, were named as defendants in four class
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actions filed in Connecticut and the Eastern District of New York; Photos Etc.
Corp. et al. v. Visa U.S.A., Inc., et al. (D. Conn. No. 3:05-CV-01007 (WWE)):
National Association of Convenience Stores, et al. v. Visa U.S.A., Inc., et
al.(E.D.N.Y. No. 05-CV 4520 (JG)); Jethro Holdings, Inc., et al. v. Visa U.S.A.,
Inc. et al. (E.D.N.Y. No. 05-CV-4521 (JG)); and American Booksellers Ass'n v.
Visa U.S.A., Inc. et al. (E.D.N.Y. No. 05-CV-5391 (JG)). Numerous other
complaints containing similar allegations (in which no HSBC entity is named)
have been filed across the country against Visa, MasterCard and other banks.
These actions principally allege that the imposition of a no-surcharge rule by
the associations and/or the establishment of the interchange fee charged for
credit card transactions causes the merchant discount fee paid by retailers to
be set at supracompetitive levels in violation of the Federal antitrust laws.
The plaintiffs filed motions with the Judicial Panel on Multidistrict Litigation
(the "MDL Panel") to consolidate these actions, and on October 19, 2005, the MDL
Panel issued an order transferring all of the cases to the Eastern District of
New York. At this time, we are unable to quantify the potential impact from this
action, if any.
SECURITIES LITIGATION
In August 2002, we restated previously reported consolidated financial
statements. The restatement related to certain MasterCard and Visa co-branding
and affinity credit card relationships and a third party marketing agreement,
which were entered into between 1992 and 1999. All were part of our Credit Card
Services segment. In consultation with our prior auditors, Arthur Andersen LLP,
we treated payments made in connection with these agreements as prepaid assets
and amortized them in accordance with the underlying economics of the
agreements. Our current auditor, KPMG LLP, advised us that, in its view, these
payments should have either been charged against earnings at the time they were
made or amortized over a shorter period of time. The restatement resulted in a
$155.8 million, after-tax, retroactive reduction to retained earnings at
December 31, 1998. As a result of the restatement, and other corporate events,
including, e.g., the 2002 settlement with 50 states and the District of Columbia
relating to real estate lending practices, HSBC Finance Corporation, and its
directors, certain officers and former auditors, have been involved in various
legal proceedings, some of which purport to be class actions. A number of these
actions allege violations of Federal securities laws, were filed between August
and October 2002, and seek to recover damages in respect of allegedly false and
misleading statements about our common stock. These legal actions have been
consolidated into a single purported class action, Jaffe v. Household
International, Inc., et al., No. 02 C 5893 (N.D. Ill., filed August 19, 2002),
and a consolidated and amended complaint was filed on March 7, 2003. On December
3, 2004, the court signed the parties' stipulation to certify a class with
respect to the claims brought under sec.10 and sec.20 of the Securities Exchange
Act of 1934. The parties stipulated that plaintiffs will not seek to certify a
class with respect to the claims brought under sec.11 and sec.15 of the
Securities Act of 1933 in this action or otherwise.
The amended complaint purports to assert claims under the Federal securities
laws, on behalf of all persons who purchased or otherwise acquired our
securities between October 23, 1997 and October 11, 2002, arising out of alleged
false and misleading statements in connection with our sales and lending
practices, the 2002 state settlement agreement referred to above, the
restatement and the HSBC merger. The amended complaint, which also names as
defendants Arthur Andersen LLP, Goldman, Sachs & Co., and Merrill Lynch, Pierce,
Fenner & Smith, Inc., fails to specify the amount of damages sought. In May
2003, we, and other defendants, filed a motion to dismiss the complaint. On
March 19, 2004, the Court granted in part, and denied in part the defendants'
motion to dismiss the complaint. The Court dismissed all claims against Merrill
Lynch, Pierce, Fenner & Smith, Inc. and Goldman Sachs & Co. The Court also
dismissed certain claims alleging strict liability for alleged misrepresentation
of material facts based on statute of limitations grounds. The claims that
remain against some or all of the defendants essentially allege the defendants
knowingly made a false statement of a material fact in conjunction with the
purchase or sale of securities, that the plaintiffs justifiably relied on such
statement, the false statement(s) caused the plaintiffs' damages, and that some
or all of the defendants should be liable for those alleged statements. All
factual discovery must be completed by May 12, 2006 and expert witness discovery
must be completed by July 24, 2006. At this time, we are unable to quantify the
potential impact from this action, if any.
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On June 27, 2003, a case entitled, West Virginia Laborers Pension Trust Fund v.
Caspersen, et al., was filed in the Chancery Division of the Circuit Court of
Cook County, Illinois as case number 03CH10808. This purported class action
named as defendants the directors of Beneficial Corporation at the time of the
1998 merger of Beneficial Corporation into a subsidiary of HSBC Finance
Corporation, and claimed that those directors' due diligence of HSBC Finance
Corporation at the time they considered the merger was inadequate. The Complaint
claimed that as a result of some of the securities law and other violations
alleged in the Jaffe case, HSBC Finance Corporation common shares lost value.
Pursuant to the merger agreement with Beneficial Corporation, we assumed the
defense of this litigation. In September of 2003, the defendants filed a motion
to dismiss which was granted on June 15, 2004 based upon a lack of personal
jurisdiction over the defendants. The plaintiffs appealed that decision. On May
11, 2005, the appellate court affirmed the trial court's ruling. The time for
any further appeals has expired. In addition, on June 30, 2004, a case entitled,
Employer-Teamsters Local Nos. 175 & 505 Pension Trust Fund v. Caspersen, et al.,
was filed in the Superior Court of New Jersey, Law Division, Somerset County as
Case Number L9479-04. Other than the change in plaintiff, the suit is
substantially identical to the foregoing West Virginia Laborer's Pension Trust
Fund case, and is brought by the same principal law firm that brought that suit.
The defendants' motion to dismiss was granted on February 10, 2005. After
briefing and oral argument, on February 24, 2006 the appellate court affirmed
the trial court's ruling dismissing the complaint. The plaintiffs have 30 days
to appeal this ruling.
With respect to these securities litigation matters, we believe that we have
not, and our officers and directors have not, committed any wrongdoing and in
each instance there will be no finding of improper activities that may result in
a material liability to us or any of our officers or directors.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
--------------------------------------------------------------------------------
Not applicable
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
--------------------------------------------------------------------------------
Not applicable
20
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ITEM 6. SELECTED FINANCIAL DATA.
--------------------------------------------------------------------------------
On March 28, 2003, HSBC Holdings plc ("HSBC") acquired HSBC Finance Corporation
(formerly Household International, Inc.). This resulted in a new basis of
accounting reflecting the fair market value of our assets and liabilities for
the "successor" periods beginning March 29, 2003. Information for all
"predecessor" periods prior to the merger is presented using our historical
basis of accounting, which impacts comparability to our "successor" periods. To
assist in the comparability of our financial results, the "predecessor period"
(January 1 to March 28, 2003) has been combined with the "successor period"
(March 29 to December 31, 2003) to present "combined" results for the year ended
December 31, 2003.
MAR. 29 JAN. 1
YEAR ENDED YEAR ENDED YEAR ENDED THROUGH THROUGH YEAR ENDED DECEMBER 31,
DEC. 31, DEC. 31, DEC. 31, DEC. 31 MAR. 28, -----------------------
2005 2004 2003 2003 2003 2002 2001
------------------------------------------------------------------------------------------------------------------------
(SUCCESSOR) (SUCCESSOR) (COMBINED) (SUCCESSOR)(PREDECESSOR)(PREDECESSOR)(PREDECESSOR)
(IN MILLIONS)
OWNED BASIS STATEMENT OF
INCOME DATA
Net interest income and
other
revenues-operating
basis(1).............. $13,215 $12,364 $11,633 $8,849 $2,784 $11,178 $9,606
Gain on bulk sale of
private label
receivables(3)........ - 663 - - - - -
Loss on disposition of
Thrift assets and
deposits.............. - - - - - 378 -
Provision for credit
losses on owned
receivables-operating
basis(1).............. 4,543 4,296 3,967 2,991 976 3,732 2,913
Total costs and
expenses, excluding
nonrecurring expense
items(1).............. 6,009 5,601 4,993 3,811 1,182 4,290 3,875
HSBC acquisition related
costs incurred by HSBC
Finance Corporation... - - 198 - 198 - -
Settlement charge and
related expenses...... - - - - - 525 -
Adoption of FFIEC
charge-off policies
for domestic private
label and
MasterCard/Visa
portfolios(1),(8)..... - 190 - - - - -
Income taxes............ 891 1,000 872 690 182 695 970
------- ------- ------- ------ ------ ------- ------
Net income(1)........... $ 1,772 $ 1,940 $ 1,603 $1,357 $ 246 $ 1,558 $1,848
======= ======= ======= ====== ====== ======= ======
YEAR ENDED DECEMBER 31, 2005 2004 2003 2002 2001
---------------------------------------------------------------------------------------------------------------------
(SUCCESSOR) (SUCCESSOR) (COMBINED) (PREDECESSOR) (PREDECESSOR)
OWNED BASIS SELECTED FINANCIAL RATIOS
Return on average owned assets(1)............ 1.27 1.57% 1.46% 1.62% 2.26%
Return on average common shareholder's(s')
equity(1).................................. 9.97 10.99 10.89 17.30 24.14
Net interest margin.......................... 6.73 7.33 7.75 7.57 7.85
Efficiency ratio(1).......................... 43.52 41.64 42.77 42.63 38.40
Consumer net charge-off ratio(1)............. 3.03 4.00 4.06 3.81 3.32
Reserves as a percent of net
charge-offs(9)............................. 123.8 89.9 105.7 106.5 110.5
MANAGED BASIS SELECTED FINANCIAL RATIOS(2)
Return on average managed assets(1).......... 1.19 1.33% 1.19% 1.31% 1.82%
Net interest margin.......................... 6.94 7.97 8.60 8.47 8.44
Efficiency ratio(1).......................... 43.16 41.02 35.58 35.99 34.33
Consumer net charge-off ratio(1)............. 3.36 4.61 4.67 4.28 3.73
Reserves as a percent of net
charge-offs(9)............................. 108.6 79.6 117.4 113.8 110.7
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AT DECEMBER 31, 2005 2004 2003 2002 2001
------------------------------------------------------------------------------------------------------------------------
(SUCCESSOR) (SUCCESSOR) (COMBINED) (PREDECESSOR) (PREDECESSOR)
(DOLLARS ARE IN MILLIONS)
OWNED BASIS BALANCE SHEET DATA
Total assets......................................... $156,669 $130,190 $119,052 $ 97,860 $ 88,911
Receivables:(3)
Domestic:
Real estate secured.............................. $ 79,792 $ 61,946 $ 49,026 $ 44,140 $ 42,474
Auto finance..................................... 10,434 7,490 4,138 2,024 2,369
MasterCard/Visa.................................. 23,963 12,371 9,577 7,628 6,967
Private label.................................... 356 341 9,732 9,365 9,853
Personal non-credit card......................... 15,900 12,049 9,624 11,685 11,737
Commercial and other............................. 208 315 399 461 505
-------- -------- -------- -------- --------
Total domestic..................................... $130,653 $ 94,512 $ 82,496 $ 75,303 $ 73,905
-------- -------- -------- -------- --------
Foreign:
Real estate secured.............................. $ 3,034 $ 2,874 $ 2,195 $ 1,679 $ 1,383
Auto finance..................................... 270 54 - - -
MasterCard/Visa.................................. 147 2,264 1,605 1,319 1,174
Private label.................................... 2,164 3,070 2,872 1,974 1,811
Personal non-credit card......................... 3,645 4,079 3,208 2,285 1,600
Commercial and other............................. - 2 2 2 2
-------- -------- -------- -------- --------
Total foreign...................................... $ 9,260 $ 12,343 $ 9,882 $ 7,259 $ 5,970
-------- -------- -------- -------- --------
Total owned receivables:
Real estate secured.............................. $ 82,826 $ 64,820 $ 51,221 $ 45,819 $ 43,857
Auto finance..................................... 10,704 7,544 4,138 2,024 2,369
MasterCard/Visa.................................. 24,110 14,635 11,182 8,947 8,141
Private label.................................... 2,520 3,411 12,604 11,339 11,664
Personal non-credit card......................... 19,545 16,128 12,832 13,970 13,337
Commercial and other............................. 208 317 401 463 507
-------- -------- -------- -------- --------
Total owned receivables............................ $139,913 $106,855 $ 92,378 $ 82,562 $ 79,875
======== ======== ======== ======== ========
Deposits............................................. $ 37 $ 47 $ 232 $ 821 $ 6,562
Commercial paper, bank and other borrowings.......... 11,417 9,013 9,122 6,128 12,024
Due to affiliates(4)................................. 15,534 13,789 7,589 - -
Long term debt....................................... 105,163 85,378 79,632 75,751 57,799
Preferred stock(5)................................... 575 1,100 1,100 1,193 456
Common shareholder's(s') equity(5),(6)............... 18,904 15,841 16,391 9,222 7,843
-------- -------- -------- -------- --------
OWNED BASIS SELECTED FINANCIAL RATIOS
Common and preferred equity to owned assets.......... 12.43% 13.01% 14.69% 10.64% 9.33%
Consumer two-month-and-over contractual
delinquency........................................ 3.84 4.07 5.36 5.34 4.43
Reserves as a percent of receivables................. 3.23 3.39 4.11 4.04 3.33
Reserves as a percent of nonperforming loans......... 108.8 103.0 93.7 94.5 92.7
-------- -------- -------- -------- --------
MANAGED BASIS BALANCE SHEET DATA AND SELECTED
FINANCIAL RATIOS(2)
Total assets......................................... $160,743 $144,415 $145,253 $122,794 $109,859
Managed receivables:(3)
Real estate secured................................ $ 82,826 $ 64,901 $ 51,415 $ 46,275 $ 44,719
Auto finance....................................... 11,896 10,223 8,813 7,442 6,395
MasterCard/Visa.................................... 25,985 22,218 21,149 18,953 17,395
Private label...................................... 2,520 3,411 17,865 14,917 13,814
Personal non-credit card........................... 20,552 20,010 18,936 19,446 17,993
Commercial and other............................... 208 317 401 463 507
-------- -------- -------- -------- --------
Total managed receivables............................ $143,987 $121,080 $118,579 $107,496 $100,823
======== ======== ======== ======== ========
Tangible shareholder's(s') equity to tangible managed
assets ("TETMA")(7)................................ 7.56% 6.27% 6.64% 9.08% 7.57%
Tangible shareholder's(s') equity plus owned loss
reserves to tangible managed assets ("TETMA + Owned
Reserves")(7)...................................... 10.55 9.04 9.50 11.87 10.03
Tangible common equity to tangible managed
assets(7).......................................... 6.07 4.67 5.04 6.83 6.24
Excluding HSBC acquisition purchase accounting
adjustments:
TETMA.............................................. 8.52 7.97 8.55 9.08 7.57
TETMA + Owned Reserves............................. 11.51 10.75 11.42 11.87 10.03
Tangible common equity to tangible managed
assets........................................... 7.02 6.38 6.98 6.83 6.24
Risk adjusted revenue................................ 7.18 6.96 6.98 7.18 7.64
Consumer two-month-and-over contractual
delinquency........................................ 3.89 4.24 5.39 5.24 4.46
Reserves as a percent of receivables................. 3.29 3.73 5.20 4.74 3.78
Reserves as a percent of nonperforming loans......... 108.8 108.4 118.0 112.6 105.0
-------- -------- -------- -------- --------
---------------
(1) The following table, which contains non-GAAP financial information is
provided for comparison of our operating trends only and should be read in
conjunction with our owned basis GAAP financial information. For 2004, the
operating trends, percentages and
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ratios presented below exclude the $121 million decrease in net income
relating to the adoption of Federal Financial Institutions Examination
Council ("FFIEC") charge-off policies for our domestic private label
(excluding retail sales contracts at our consumer lending business) and
MasterCard/Visa receivables and the $423 million (after-tax) gain on the
bulk sale of domestic private label receivables (excluding retail sales
contracts at our consumer lending business) to an affiliate, HSBC Bank USA,
National Association ("HSBC Bank USA"). For 2003, the operating results,
percentages and ratios exclude $167 million (after-tax) of HSBC acquisition
related costs and other merger related items and for 2002, exclude a $333
million (after-tax) settlement charge and related expenses and a $240
million (after-tax) loss on disposition of Thrift assets and deposits. See
"Basis of Reporting" and "Reconciliations to GAAP Financial Measures" in
Management's Discussion and Analysis for additional discussion and
quantitative reconciliations to the equivalent GAAP basis financial measure.
YEAR ENDED DECEMBER 31, 2005 2004 2003 2002 2001
--------------------------------------------------------------------------------------------------------------------
(SUCCESSOR) (SUCCESSOR) (COMBINED)(PREDECESSOR) (PREDECESSOR)
(DOLLARS ARE IN MILLIONS)
Operating net income.............................. $1,772 $1,638 $1,770 $2,131 $1,848
Return on average owned assets.................... 1.27% 1.32% 1.61% 2.21% 2.26%
Return on average common shareholder's(s')
equity.......................................... 9.97 9.21 12.08 23.94 24.14
Owned basis consumer net charge-off ratio......... 3.03 3.84 4.06 3.81 3.32
Managed basis consumer net charge-off ratio....... 3.36 4.44 4.67 4.28 3.73
Owned basis efficiency ratio...................... 43.52 43.42 41.01 36.28 38.40
Return on average managed assets.................. 1.19 1.12 1.32 1.80 1.82
Managed basis efficiency ratio.................... 43.16 42.90 34.11 30.80 34.33
(2) We have historically monitored our operations and evaluated trends on both
an owned basis as shown in our financial statements and on a managed basis.
Managed basis reporting (a non-GAAP financial measure) assumes that
securitized receivables have not been sold and are still on our balance
sheet. Managed basis information is intended to supplement, and should not
be considered a substitute for, owned basis reporting and should be read in
conjunction with reported owned basis results. See "Basis of Reporting" and
"Reconciliations to GAAP Financial Measures" for additional discussion and
quantitative reconciliations to the equivalent GAAP basis financial measure.
(3) In 2005, we sold our U.K. credit card business, which included receivables
of $2.5 billion ($3.1 billion on a managed basis), to HSBC Bank plc. and
acquired $5.3 billion in MasterCard/Visa receivables in conjunction with our
acquisition of Metris Companies, Inc. ("Metris"). In 2004, we sold $.9
billion of higher quality non-conforming real estate secured receivables and
sold our domestic private label receivable portfolio (excluding retail sales
contracts at our consumer lending business) of $12.2 billion ($15.6 billion
on a managed basis) to HSBC Bank USA. In 2003, we sold $2.8 billion of
higher quality non-conforming real estate secured receivables to HSBC Bank
USA and acquired owned basis private label portfolios totaling $1.2 billion
($1.6 billion on a managed basis) and MasterCard and Visa portfolios
totaling $.9 billion. In 2002, we sold $6.3 billion of real estate secured
whole loans from our consumer lending and mortgage services businesses and
purchased a $.5 billion private label portfolio. In 2001, we sold
approximately $1 billion of MasterCard and Visa receivables as a result of
discontinuing our participation in the Goldfish credit card program and
purchased a $.7 billion private label portfolio.
(4) We had received $44.1 billion, $35.7 billion and $14.7 billion in HSBC
related funding as of December 31, 2005, 2004 and 2003, respectively. See
Liquidity and Capital Resources for the components of this funding.
(5) In conjunction with the acquisition by HSBC, our 7.625%, 7.60%, 7.50% and
8.25% preferred stock was converted into the right to receive cash which
totaled approximately $1.1 billion. In consideration of HSBC transferring
sufficient funds to make these payments, we issued $1.1 billion Series A
preferred stock to HSBC on March 28, 2003. Also on March 28, 2003, we called
for redemption of our $4.30, $4.50 and 5.00% preferred stock. In September
2004, HSBC North America Holdings Inc. ("HNAH") issued a new series of
preferred stock to HSBC in exchange for our Series A preferred stock. In
October 2004, HSBC Investments (North America) Inc. ("HINO") issued a new
series of preferred stock to HNAH in exchange for our Series A preferred
stock. Our Series A preferred stock was exchanged by HINO for $1.1 billion
of additional common equity in December 2005.
(6) In 2005, we received a capital contribution of $1.2 billion from HINO to
fund a portion of the purchase in conjunction with our acquisition of
Metris. Common shareholder's equity at December 31, 2005, 2004 and 2003
reflects push-down accounting adjustments resulting from the HSBC merger.
(7) TETMA, TETMA + Owned Reserves and tangible common equity to tangible managed
assets are non-GAAP financial ratios that are used by HSBC Finance
Corporation management or certain rating agencies as a measure to evaluate
capital adequacy and may differ from similarly named measures presented by
other companies. See "Basis of Reporting" for additional discussion on the
use of non-GAAP financial measures and "Reconciliations to GAAP Financial
Measures" for quantitative reconciliations to the equivalent GAAP basis
financial measure.
(8) In December 2004, we adopted charge-off and account management policies in
accordance with the Uniform Retail Credit Classification and Account
Management Policy issued by the FFIEC for our domestic private label
(excluding retail sales contracts at our consumer lending business) and
MasterCard and Visa portfolios. The adoption of the FFIEC charge-off
policies resulted in a reduction to net income of $121 million in the fourth
quarter of 2004. See "Credit Quality" in Management's Discussion and
Analysis and Note 4, "Sale of Domestic Private Label Receivable Portfolio
and Adoption of FFIEC Policies," in the accompanying consolidated financial
statements for further discussion of these policy changes.
(9) The acquisition of Metris in December 2005 has positively impacted this
ratio. Reserves as a percentage of net charge-offs excluding Metris at
December 31, 2005 was 118.2 percent on an owned basis and 103.9 percent on a
managed basis. Additionally, the adoption of FFIEC charge-off policies for
our domestic private label (excluding retail sales contracts at our consumer
lending business) and MasterCard and Visa portfolios and subsequent sale of
the domestic private label portfolio (excluding retail sales contracts at
our consumer lending business) in December 2004 have negatively impacted
these ratios. Reserves as a percentage of net charge-offs excluding net
charge-offs associated with the domestic private label portfolio sold in
2004 and the impact of adopting FFIEC charge-off policies for these
portfolios was 109.2 percent on an owned basis and 96.0 percent on a managed
basis.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
--------------------------------------------------------------------------------
EXECUTIVE OVERVIEW
--------------------------------------------------------------------------------
ORGANIZATION AND BASIS OF REPORTING
HSBC Finance Corporation (formerly Household International, Inc.) and
subsidiaries is an indirect wholly owned subsidiary of HSBC North America
Holdings Inc. ("HNAH") which is a wholly owned subsidiary of HSBC Holdings plc
("HSBC"). HSBC Finance Corporation 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".
HSBC Finance Corporation provides middle-market consumers with real estate
secured loans, auto finance loans, MasterCard* and Visa* credit card loans,
private label credit card loans, including retail sales contracts, and personal
non-credit card loans in the United States, the United Kingdom, Canada, the
Republic of Ireland, Slovakia, the Czech Republic and Hungary. We also initiate
tax refund anticipation loans in the United States and offer credit and
specialty insurance products in the United States, the United Kingdom and
Canada. We generate cash to fund our businesses primarily by collecting
receivable balances; issuing commercial paper, medium and long term debt;
borrowing from HSBC subsidiaries and customers; securitizing and selling
consumer receivables and borrowing under secured financing facilities. We use
the cash generated to invest in and support receivable growth, to service our
debt obligations and to pay dividends to our parent.
The acquisition by HSBC on March 28, 2003 resulted in a new basis of accounting
reflecting the fair market value of our assets and liabilities for the
"successor" periods beginning March 29, 2003. Information for all "predecessor"
periods prior to the merger is presented using our historical basis of
accounting, which impacts comparability to our "successor" periods beginning
March 29, 2003. During 2003, the "predecessor" period contributed $246 million
of net income and the "successor" period contributed $1.4 billion of net income.
To assist in the comparability of our financial results and to make it easier to
discuss and understand our results of operations, Management's Discussion and
Analysis combines the "predecessor period" (January 1 to March 28, 2003) with
the "successor period" (March 29 to December 31, 2003) to present "combined"
results for the year ended December 31, 2003.
In addition to owned basis reporting, we have historically monitored our
operations and evaluated trends on a managed basis (a non-GAAP financial
measure), which assumes that securitized receivables have not been sold and are
still on our balance sheet. See "Basis of Reporting" for further discussion of
the reasons we use this non-GAAP financial measure.
PERFORMANCE, DEVELOPMENTS AND TRENDS
Our net income was $1.8 billion in 2005, $1.9 billion in 2004 and $1.6 billion
in 2003. In measuring our results, management's primary focus is on receivable
growth and operating net income (a non-GAAP financial measure which excludes
certain nonrecurring items). See "Basis of Reporting" for further discussion of
operating net income. Operating net income was $1.8 billion in 2005 compared to
$1.6 billion in 2004 and $1.8 billion in 2003. Operating net income increased in
2005 primarily due to higher other revenues and higher net interest income,
partially offset by a higher provision for credit losses as well as higher costs
and expenses. Other revenues on an operating basis increased primarily due to
higher fee and other income as well as higher gains on affiliate receivable
sales and higher affiliate servicing fees, partially offset by lower derivative
income and lower securitization related revenue. The higher gains on affiliate
receivable sales and higher affiliate servicing revenue were largely driven by
the gains on daily sales of domestic private label receivable originations and
fees earned for servicing the domestic private label receivable portfolio sold
to HSBC Bank USA, National Association ("HSBC Bank USA") in December 2004. Fee
income was higher as a result of higher credit card fees due to higher volume in
our MasterCard/Visa portfolios. Other income was higher
---------------
* MasterCard is a registered trademark of MasterCard International, Incorporated
and Visa is a registered trademark of Visa USA, Inc.
24
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primarily due to higher ancillary credit card revenue and higher gains on asset
sales, including the partial sale of a real estate investment. The increases
were partially offset by lower securitization related revenue due to reduced
securitization activity and lower derivative income. The decrease in derivative
income was primarily due to an upward shift in the forward yield curve which
decreased the value of our pay variable interest rate swaps which do not qualify
for hedge accounting under SFAS No. 133 and to the reduction in the portfolio of
receive variable interest rate swaps which do not qualify for hedge accounting.
The increase in net interest income was due to growth in average receivables and
an improvement in the overall yield on the portfolio, partly offset by a higher
cost of funds. As discussed in more detail below, the higher provision for
credit losses reflects receivable growth, increased credit loss exposure from
Hurricane Katrina and higher charge-off due to significantly higher bankruptcy
filings as a result of new bankruptcy legislation in the United States,
partially offset by otherwise improved credit quality. Costs and expenses
increased to support receivables growth as well as due to increases in marketing
expenses, partially offset by lower other servicing and administrative expenses.
Amortization of purchase accounting fair value adjustments increased net income
by $102 million in 2005, which included $1 million relating to Metris, compared
to $152 million in 2004.
Operating net income declined in 2004 compared to 2003 primarily due to higher
costs and expenses and higher provision for credit losses due to receivables
growth, partially offset by higher net interest income and higher other
revenues. Costs and expenses increased due to receivables growth, increases in
marketing expenses and higher amortization of intangibles which were established
in connection with our acquisition by HSBC. Other revenues increased due to
higher derivative income and higher fee and other income, partially offset by
lower securitization related revenue due to reduced securitization activity. The
increase in net interest income was due to higher average receivable balances,
partially offset by lower yields on our receivables, particularly in real estate
secured, auto finance and personal non-credit card receivables and by higher
interest expense. Interest expense was higher in 2004 resulting from a larger
balance sheet, partially offset by a lower cost of funds. Amortization of
purchase accounting fair value adjustments increased net income by $152 million
in 2004 compared to $91 million in 2003.
Our owned net interest margin was 6.73 percent in 2005 compared to 7.33 percent
in 2004 and 7.75 percent in 2003. The decrease in 2005 was due to higher funding
costs, partially offset by improvements in the overall yield on the portfolio.
The higher yields in 2005 are due to increases in our rates on variable rate
products which were in line with market movements and various other repricing
initiatives. In addition, there was a net increase in yields due to a change in
receivables mix in the owned balance sheet. Increased levels of higher yielding
MasterCard/Visa and personal non-credit card receivables were held on the
balance sheet due to lower securitization activity, but the effect of this on
yields was partially offset by growth in lower yielding real estate secured and
auto finance receivables as well as higher levels of near-prime receivables and
a significant decline in the level of private label receivables as discussed
above. The decrease in net interest margin in 2004 was due to lower overall
yields on our receivables, partially offset by lower funding costs. The lower
yields in 2004 reflect a change in mix with higher levels of near-prime
receivables, competitive pressure on pricing and the run-off of higher yielding
real estate secured receivables, including second lien loans, largely due to
refinancing activity.
In August 2005, Hurricane Katrina ("Katrina") caused destruction and loss to
individuals, businesses and public infrastructure. As of December 31, 2005, we
had $1.3 billion, or 1.0 percent ($1.3 billion or 1.0 percent on a managed
basis) of consumer receivables outstanding with customers living in the Katrina
Federal Emergency Management Agency ("FEMA") designated Individual Assistance
disaster areas(1) with approximately $835 million of these receivables secured
by real estate. Assessment of the impact of Katrina on the collectibility of
these receivables has been complicated by the number of customers that were
displaced from their primary residence. Estimates of loss take into account a
number of factors, such as:
- how the current and long-term financial impact of the disaster on our
customers will affect future loan payments;
---------------
(1) Customers in the Individual Assistance Counties, as defined by FEMA on the
list last updated and published on September 9, 2005.
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- the condition and value of any collateral supporting the amounts
outstanding; and
- the availability of insurance to cover losses on the underlying
collateral.
In an effort to assist our customers affected by the disaster, we initiated
various programs including extended payment arrangements and interest and fee
waivers for up to 90 days or more for certain products depending on customer
circumstances. These interest and fee waivers totaled $14 million during 2005.
We recorded an incremental provision for credit losses for Katrina of $185
million in 2005, which represents our best estimate of Katrina's impact on our
loan portfolio. Because our estimate is influenced by factors outside of our
control, there is uncertainty inherent in the estimate, making it reasonably
possible that it could change. As additional information becomes available
relating to the financial condition of our affected customers, the physical
condition of the collateral for loans which are secured by real estate and the
resultant impact on customer payment patterns, we will continue to review our
estimate of credit loss exposure relating to Katrina and any adjustments will be
reported in earnings when they become known. During the fourth quarter of 2005,
$11 million of loan accounts outstanding to affected customers was charged-off
in accordance with our charge-off policies.
During 2005, we experienced higher bankruptcy filings, in particular during the
period leading up to the October 17, 2005 effective date of new bankruptcy
legislation in the United States. We had been maintaining credit loss reserves
in anticipation of the impact this new legislation would have on net
charge-offs. However, the magnitude of the spike in bankruptcies experienced
immediately before the new legislation became effective was larger than
anticipated which resulted in an additional $100 million credit loss provision
being recorded during the third quarter of 2005. Our fourth quarter results
include an estimated $125 million in incremental charge-offs of principal,
interest and fees and $113 million in provision expense attributable to
bankruptcy reform. The incremental charge-offs in the fourth quarter of 2005 are
primarily related to our MasterCard/Visa portfolio where bankrupt accounts
charge-off sooner than in our secured and personal non-credit card portfolios in
accordance with our charge-off policies for these products. This provision
expense included in our fourth quarter results relating to bankruptcies in our
secured and personal non-credit card portfolios will not begin to migrate to
charge-off until 2006 in accordance with their respective charge-off policies.
As expected, the number of bankruptcy filings subsequent to the enactment of
this new legislation have decreased dramatically. We believe that a portion of
the increase in net charge-offs resulting from the higher bankruptcy filings is
an acceleration of net charge-offs that would otherwise have been experienced in
future periods.
Owned receivables increased to $139.9 billion at December 31, 2005, a 30.9
percent increase from December 31, 2004. With the exception of our private label
portfolio, we experienced growth in all our receivable products with real estate
secured receivables being the primary contributor of the growth. Real estate
secured receivable levels reflect sales to HSBC Bank USA in 2004 and 2003 and
purchases of correspondent receivables directly by HSBC Bank USA of $1.5 billion
and $2.8 billion during 2005 and 2004, a portion of which we otherwise would
have purchased. Purchases of real estate secured receivables from our
correspondents by HSBC Bank USA were discontinued effective September 1, 2005.
Additionally, as discussed in more detail below, our owned receivable balances
increased in 2005 by $5.3 billion as a result of our acquisition of Metris
Companies, Inc. and decreased by $2.5 billion as a result of the sale of our
U.K. credit card business. Lower securitization levels also contributed to the
increase in owned receivables in 2005.
We previously reported that as part of ongoing integration efforts with HSBC we
have been working with HSBC to determine if management efficiencies could be
achieved by transferring all or a portion of our U.K. and other European
operations to HSBC Bank plc ("HBEU"), a U.K. based subsidiary of HSBC, and/or
one or more unrelated third parties. In December 2005, we sold our U.K. credit
card business, including $2.5 billion of receivables ($3.1 billion on a managed
basis), the associated cardholder relationships and the related retained
interests in securitized credit card receivables to HBEU for an aggregate
purchase price of $3.0 billion. The purchase price, which was determined based
on a comparative analysis of sales of other credit card portfolios, was paid in
a combination of cash and $261 million of preferred stock issued by a subsidiary
of HBEU with a rate of one-year Sterling LIBOR, plus 1.30 percent. In addition
to the assets referred to above,
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the sale also included the account origination platform, including the marketing
and credit employees associated with this function, as well as the lease
associated with the credit card call center and the related leaseholds and call
center employees to provide customer continuity after the transfer, as well as
to allow HBEU direct ownership and control of origination and customer service.
We have retained the collection operations related to the credit card operations
and have entered into a service level agreement for a period of not less than
two years to provide collection services and other support services, including
components of the compliance, financial reporting and human resource functions,
for the sold credit card operations to HBEU for a fee. Additionally, the
management teams of HBEU and our remaining U.K. operations will be jointly
involved in decision making involving card marketing to ensure that growth
objectives are met for both businesses. Because the sale of this business is
between affiliates under common control, the premium received in excess of the
book value of the assets transferred of $182 million, including the goodwill
assigned to this business, has been recorded as an increase to additional paid
in capital and has not been included in earnings. In future periods, the net
interest income, fee income and provision for credit losses related to the U.K.
credit card business will be reduced, while other income will be increased by
the receipt of servicing and support services revenue from HBEU. We do not
anticipate that the net effect of this sale will result in a material reduction
of our consolidated net income. We continue to evaluate strategic alternatives
with respect to our other U.K. and European operations.
Additionally, in a separate transaction in December 2005, we transferred our
information technology services employees in the U.K. to a subsidiary of HBEU.
Subsequent to the transfer, operating expenses relating to information
technology, which have previously been reported as salaries and fringe benefits
or other servicing and administrative expenses, are now billed to us by HBEU and
reported as support services from HSBC affiliates. During the first quarter of
2006, we anticipate that the information technology equipment in the U.K. will
be sold to HBEU for a purchase price equal to the book value of these assets.
Our return on average common shareholder's(s') equity ("ROE") was 9.97 percent
in 2005 compared to 10.99 percent in 2004, and 10.89 percent in 2003. Our return
on average owned assets ("ROA") was 1.27 percent in 2005 compared to 1.57
percent in 2004 and 1.46 percent in 2003. On an operating basis, ROE was 9.97
percent in 2005 compared to 9.21 percent in 2004 and 12.08 percent in 2003, and
ROA was 1.27 percent in 2005 compared to 1.32 percent in 2004 and 1.61 percent
in 2003. The increase in our operating basis ROE in 2005 reflects higher net
income, as discussed above, while average common shareholder's equity remained
flat. Operating basis ROA decreased during 2005 and 2004 as average owned assets
increase at a faster pace than operating net income primarily due to lower net
interest margin, lower securitization revenue and, in 2005, lower derivative
income.
Our owned basis efficiency ratio was 43.52 percent in 2005 compared to 41.64
percent in 2004 and 42.77 percent in 2003. Our owned basis efficiency ratio on
an operating basis was 43.52 percent in 2005 compared to 43.42 percent in 2004
and 41.01 percent in 2003. These ratios have been significantly impacted by the
results of the domestic private label portfolio which was sold in December 2004.
Excluding the results of this domestic private label portfolio from both
periods, our 2005 efficiency ratio improved 259 basis points as compared to
2004. This improvement is primarily a result of higher net interest income and
other revenues due to higher levels of owned receivables as discussed above,
partially offset by the increase in total costs and expenses to support
receivable growth. In 2004, the deterioration in the efficiency ratio on an
operating basis reflects higher operating expenses including higher intangible
amortization, lower securitization related revenue and lower overall yields on
our receivables, partially offset by higher derivative income.
On December 1, 2005, we acquired Metris Companies Inc. ("Metris") for $1.6
billion in cash. In order to support this acquisition, we received a $1.2
billion capital contribution from our parent, HSBC Investments (North America)
Inc. ("HINO"). This acquisition will expand our presence in the near-prime
credit card market and will strengthen our capabilities to serve the full
spectrum of credit card customers This acquisition resulted in an increase in
our MasterCard/Visa credit card receivable portfolio of $5.3 billion. See Note
3, "Acquisitions," to our accompanying consolidated financial statements for
additional information on the acquisition of Metris.
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CREDIT QUALITY
Our owned basis two-months-and-over contractual delinquency ratio decreased to
3.84 percent at December 31, 2005 from 4.07 percent at December 31, 2004. The
decrease is consistent with the improvements in the delinquency trends we
experienced beginning in 2004 as a result of portfolio growth including higher
levels of real estate secured receivables, improvements in the economy, better
underwriting standards and improved credit quality of originations. These
decreases were partially offset by higher bankruptcy delinquency in our secured
and personal non-credit card receivable portfolios resulting from the spike in
bankruptcy filings in the United States discussed above, which will not begin to
migrate to charge-off until 2006. In addition, our delinquency ratio was
positively impacted by the charge-off in the fourth quarter of 2005 of a
significant number of accounts in our domestic MasterCard/Visa portfolio as a
result of the spike in bankruptcy filings in the United States discussed above.
Dollars of delinquency at December 31, 2005 increased compared to December 31,
2004 due to higher levels of owned receivables in 2005 resulting from a decline
in securitized levels and receivable growth as well as the higher delinquency
levels from higher bankruptcy filings in our real estate secured, auto finance
and personal non-credit card receivable portfolios discussed above.
Net charge-offs as a percentage of average consumer receivables for 2005
decreased 97 basis points from 2004 (or 81 basis points excluding the impact of
the adoption of FFIEC charge-off policies in December 2004 for our domestic
private label (excluding retail sales contracts at our consumer lending
business) and MasterCard/Visa portfolios) primarily as a result of portfolio
growth, the positive impact from the lower delinquency levels we experienced
throughout 2005 as a result of a strong economy as well as improved credit
quality of originations. This was partially offset by an increase in charge-offs
in the fourth quarter of 2005 for our MasterCard/Visa receivable portfolio
resulting from the spike in bankruptcy filings prior to the effective date of
new bankruptcy legislation in the United States. While our real estate secured,
auto finance and personal non-credit card receivables also experienced a spike
in bankruptcy filings prior to the effective date of the new legislation, these
accounts have not yet migrated to charge-off in accordance with our charge-off
policies for these receivable products. Also contributing to the decrease in
2005 was a shift in mix to higher levels of higher credit quality receivables,
particularly real estate secured and auto finance receivables, partially as a
result of the sale of our domestic private label receivable portfolio in
December 2004 as discuss above.
During 2005, our credit loss reserves increased as a result of higher levels of
owned receivables, including lower securitization levels which results in an
increase in our interest in the receivables of certain securitization trusts,
additional reserves resulting from the Metris acquisition, higher dollars of
delinquency driven by growth, increases in bankruptcy filings in both our
domestic and foreign operations and higher credit loss exposure resulting from
Katrina and changes in the required minimum monthly payment for credit card
accounts. These increases were partially offset by the impact of improved credit
quality, and a shift in mix to higher levels of secured receivables and the
release of credit loss reserves of $104 million from the sale of our U.K. credit
card business in December 2005.
FUNDING AND CAPITAL
During 2005, we supplemented unsecured debt issuances with proceeds from the
continuing sale of newly originated domestic private label receivables to HSBC
Bank USA following the bulk sale of this portfolio in December 2004, debt issued
to affiliates, increased levels of secured financings and higher levels of
commercial paper compared to December 31, 2004. Because we are now a subsidiary
of HSBC, our credit ratings have improved and our credit spreads relative to
Treasuries have tightened compared to those we experienced during the months
leading up to the announcement of our acquisition by HSBC. Primarily as a result
of tightened credit spreads, we recognized cash funding expense savings in
excess of approximately $600 million during 2005, $350 million in 2004 and $125
million in 2003 compared to the funding costs we would have incurred using
average spreads and funding mix from the first half of 2002. It is anticipated
that these tightened credit spreads in combination with the issuance of HSBC
Finance Corporation debt and other funding synergies including asset transfers
and external fee savings will enable HSBC to realize annual cash
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funding expense savings in excess of $1 billion per year which is anticipated to
be achieved in 2006. In 2005, the cash funding expense savings realized by HSBC
totaled approximately $865 million.
Securitization of consumer receivables has been a source of funding and
liquidity for us. In order to align our accounting treatment with that of HSBC
initially under U.K. GAAP and now under International Financial Reporting
Standards ("IFRS"), starting in the third quarter of 2004 we began to structure
all new collateralized funding transactions as secured financings. However,
because existing public MasterCard and Visa credit card transactions were
structured as sales to revolving trusts that require replenishments of
receivables to support previously issued securities, receivables will continue
to be sold to these trusts until the revolving periods end, the last of which is
currently projected to occur in 2008. Private label trusts that publicly issued
securities are now replenished by HSBC Bank USA as a result of the daily sale of
new domestic private label credit card originations to HSBC Bank USA. We will
continue to replenish at reduced levels certain non-public personal non-credit
card securities issued to conduits and record the resulting replenishment gains
for a period of time in order to manage liquidity. Since our securitized
receivables have varying lives, it will take time for these receivables to
pay-off and the related interest-only strip receivables to be reduced to zero.
The termination of sale treatment on new collateralized funding activity reduced
our reported net income under U.S. GAAP. There is no impact, however, on cash
received from operations. In 2005, our net interest-only strip receivables,
excluding the mark-to-market adjustment recorded in accumulated other
comprehensive income and the U.K. credit card portion purchased by HBEU,
decreased $253 million. In 2004, our net interest-only strip receivables,
excluding both the mark-to-market adjustment recorded in accumulated other
comprehensive income and the private label portion purchased by HSBC Bank USA,
decreased $466 million.
Tangible shareholder's(s') equity to tangible managed assets ("TETMA") was 7.56
percent at December 31, 2005, and 6.27 percent at December 31, 2004. TETMA +
Owned Reserves was 10.55 percent at December 31, 2005 and 9.04 percent at
December 31, 2004. Tangible common equity to tangible managed assets was 6.07
percent at December 31, 2005 and 4.67 percent at December 31, 2004. Beginning in
the third quarter of 2005, and with the agreement of applicable rating agencies,
we have refined our definition of TETMA and TETMA + Owned Reserves to exclude
the Adjustable Conversion-Rate Equity Security Units for all periods subsequent
to our acquisition by HSBC as this more accurately reflects the impact of these
items on our equity. All periods subsequent to our acquisition by HSBC have been
revised to reflect the current period presentation. Our capital levels at
December 31, 2005 reflect a capital contribution of $1.2 billion from HINO.
Capital levels also reflect common stock dividends of $980 million and $2.6
billion paid to our parent in 2005 and 2004, respectively. Tangible common
equity at December 31, 2005 reflects the exchange of our Series A Preferred
Stock of $1.1 billion plus accrued and unpaid interest for common equity in
December 2005. These ratios represent non-GAAP financial ratios that are used by
HSBC Finance Corporation management and certain rating agencies to evaluate
capital adequacy and may be different from similarly named measures presented by
other companies. See "Reconciliations to GAAP Financial Measures" for additional
discussion and quantitative reconciliation to the equivalent GAAP basis
financial measure.
FUTURE PROSPECTS
Our continued success and prospects for growth are dependent upon access to the
global capital markets. Numerous factors, both internal and external, may impact
our access to, and the costs associated with, these markets. These factors may
include our debt ratings, overall economic conditions, overall capital markets
volatility, the counterparty credit limits of investors to the HSBC Group and
the effectiveness of our management of credit risks inherent in our customer
base. Our acquisition by HSBC has improved our access to the capital markets. It
also has given us the ability to use HSBC's liquidity to partially fund our
operations and reduce our overall reliance on the debt markets. Our affiliation
with HSBC has also expanded our access to a worldwide pool of potential
investors.
Our results are also impacted by general economic conditions, primarily
unemployment, underemployment and interest rates, which are largely out of our
control. Because we generally lend to customers who have limited credit
histories, modest incomes and high debt-to-income ratios or who have experienced
prior credit
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problems, our customers are generally more susceptible to economic slowdowns
than other consumers. When unemployment and underemployment increase, a higher
percentage of our customers default on their loans and our charge-offs increase.
Changes in interest rates generally affect both the rates that we charge to our
customers and the rates that we must pay on our borrowings. In 2005, the
interest rates that we paid on our debt increased. While our receivable
portfolio in 2005 consisted of a higher mix of near-prime receivables and real
estate secured receivables which in general carry lower yields than other types
of receivables we offer, we have experienced higher yields on our receivables in
2005 as a result of increased pricing on variable rate products in line with
market movements as well as other repricing initiatives. Our ability to adjust
our pricing on some of our products reduces our exposure to an increase in
interest rates. The primary risks and opportunities to achieving our business
goals in 2006, which are largely dependent upon economic conditions, could
result in changes to loan volume, charge-offs and net interest income.
BASIS OF REPORTING
--------------------------------------------------------------------------------
Our consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States ("U.S. GAAP"). Unless noted,
the discussion of our financial condition and results of operations included in
MD&A are presented on an owned basis of reporting.
HSBC Finance Corporation's acquisition by HSBC on March 28, 2003 resulted in a
new basis of accounting reflecting the fair value of our assets and liabilities
for the "successor" periods beginning March 29, 2003. Information for all
"predecessor" periods prior to the merger are presented using our historical
basis of accounting, which impacts comparability with the "successor" period
beginning March 29, 2003. To assist in the comparability of our financial
results and to make it easier to discuss and understand our results of
operations, MD&A combines the "predecessor" period (January 1 through March 28,
2003) with the "successor" period (March 29 through December 31, 2003) to
present "combined" results for the year ended December 31, 2003.
In addition to the GAAP financial results reported in our consolidated financial
statements, MD&A includes reference to the following information which is
presented on a non-GAAP basis:
OPERATING RESULTS, PERCENTAGES AND RATIOS Certain percentages and ratios have
been presented on an operating basis and have been calculated using "operating
net income," a non-GAAP financial measure. "Operating net income" is net income
excluding certain nonrecurring items shown in the following table:
2005 2004 2003
--------------------------------------------------------------------------------------
(IN MILLIONS)
Net income.................................................. $1,772 $1,940 $1,603
Gain on bulk sale of private label receivables, after tax... - (423) -
Adoption of FFIEC charge-off policies for domestic private
label and MasterCard and Visa portfolios, after tax....... - 121 -
HSBC acquisition related costs and other merger related
items, after tax.......................................... - - 167
------ ------ ------
Operating net income........................................ $1,772 $1,638 $1,770
====== ====== ======
We believe that excluding these nonrecurring items helps readers of our
financial statements to better understand the results and trends of our
underlying business. While we continue to make daily sales of new private label
receivable originations to HSBC Bank USA, we consider the initial gain on bulk
sale of the receivable portfolio including the retained interests associated
with securitized private label receivables as nonrecurring because our results
of operations for 2004 also include the net interest income, fee income, credit
losses and securitization related revenue generated by the portfolio and the
related retained securitization interests through the date of sale on December
29, 2004. As a result of this transaction, our net interest income, fee income,
provision for credit losses and securitization related revenue from this
portfolio has been substantially reduced while other revenues has substantially
increased as reduced securitization related
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revenue associated with private label receivables has been more than offset by
gains from daily sales of newly originated private label receivables and
servicing revenue on the portfolio received from HSBC Bank USA.
MANAGED BASIS REPORTING We have historically monitored our operations and
evaluated trends on a managed basis (a non-GAAP financial measure), which
assumes that securitized receivables have not been sold and remain on our
balance sheet. This is because the receivables that we securitize are subjected
to underwriting standards comparable to our owned portfolio, are serviced by
operating personnel without regard to ownership and result in a similar credit
loss exposure for us. In addition, we fund our operations and make decisions
about allocating resources such as capital on a managed basis.
When reporting on a managed basis, net interest income, provision for credit
losses and fee income related to receivables securitized are reclassified from
securitization related revenue in our owned statement of income into the
appropriate caption. Additionally, charge-off and delinquency associated with
these receivables are included in our managed basis credit quality statistics.
Debt analysts, rating agencies and fixed income investors have also historically
evaluated our operations on a managed basis for the reasons discussed above and
have historically requested managed basis information from us. We believe that
managed basis information enables such investors and other interested parties to
better understand the performance and quality of our entire loan portfolio and
is important to understanding the quality of originations and the related credit
risk inherent in our owned and securitized portfolios. As the level of our
securitized receivables falls over time, managed basis and owned basis results
will eventually converge. We have begun reporting "Management Basis" results (a
non-GAAP financial measure) in Reports on Form 8-K with our quarterly results.
Management Basis reporting, in addition to managed basis adjustments, assumes
the private label and real estate secured receivables transferred to HSBC Bank
USA have not been sold and remain on balance sheet. We have begun reporting
"Management Basis" results (a non-GAAP financial measure) in Reports on Form 8-K
with our quarterly results. Management Basis reporting, in addition to managed
basis adjustments, assumes the private label and real estate receivables
transferred to HSBC Bank USA have not been sold and remain on balance sheet. As
we continue to manage and service receivables sold to HSBC Bank USA, we make
decisions about allocating certain resources, such as employees, on a Management
Basis.
EQUITY RATIOS Tangible shareholder's equity to tangible managed assets
("TETMA"), tangible shareholder's equity plus owned loss reserves to tangible
managed assets ("TETMA + Owned Reserves") and tangible common equity to tangible
managed assets are non-GAAP financial measures that are used by HSBC Finance
Corporation management and certain rating agencies to evaluate capital adequacy.
These ratios may differ from similarly named measures presented by other
companies. The most directly comparable GAAP financial measure is common and
preferred equity to owned assets.
We and certain rating agencies also monitor our equity ratios excluding the
impact of the HSBC acquisition purchase accounting adjustments. We do so because
we believe that the HSBC acquisition purchase accounting adjustments represent
non-cash transactions which do not affect our business operations, cash flows or
ability to meet our debt obligations.
Preferred securities issued by certain non-consolidated trusts are considered
equity in the TETMA and TETMA + Owned Reserves calculations because of their
long-term subordinated nature and the ability to defer dividends. Previously,
our Adjustable Conversion-Rate Equity Security Units, adjusted for HSBC
acquisition purchase accounting adjustments, were also considered equity in
these calculations. Beginning in the third quarter of 2005, and with the
agreement of applicable rating agencies, we have refined our definition of TETMA
and TETMA + Owned Reserves to exclude the Adjustable Conversion-Rate Equity
Security Units for all periods subsequent to our acquisition by HSBC as this
more accurately reflects the impact of these items on our equity. All periods
subsequent to our acquisition by HSBC have been revised to reflect the current
period presentation.
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INTERNATIONAL FINANCIAL REPORTING STANDARDS Because HSBC reports results in
accordance with IFRS and IFRS results are used in measuring and rewarding
performance of employees, our management also separately monitors net income
under IFRS (a non-U.S. GAAP financial measure). The following table reconciles
our net income on a U.S. GAAP basis to net income on an IFRS basis:
YEAR ENDED
2005
---------------------------------------------------------------------------
(IN MILLIONS)
Net income - U.S. GAAP basis................................ $1,772
Adjustments, net of tax:
Securitizations........................................... 155
Derivatives and hedge accounting (including fair value
adjustments)........................................... (83)
Intangible assets......................................... 174
HSBC acquisition purchase accounting adjustments.......... 292
Loan origination.......................................... (39)
Changes in tax estimates and exposures.................... 66
Gain on sale of U.K. credit card business to HBEU......... 176
Other..................................................... 47
------
Net income - IFRS basis..................................... $2,560
======
Differences between U.S. GAAP and IFRS are as follows:
SECURITIZATIONS
IFRS
- The recognition of securitized assets is governed by a three-step
process. The process may be applied to the whole asset, or a part of an
asset:
- If the rights to the cash flows arising from securitized assets have
been transferred to a third party, the assets concerned are
derecognized.
- If the rights to the cash flows are retained by HSBC but there is a
contractual obligation to pay them to another party, the securitized
assets concerned are derecognized if certain conditions are met such as,
for example, when there is no obligation to pay amounts to the eventual
recipient unless an equivalent amount is collected from the original
asset.
- If some significant risks and rewards of ownership have been
transferred, but some have also been retained, it must be determined
whether or not control has been retained. If control has been retained,
HSBC continues to recognize the asset to the extent of its continuing
involvement; if not, the asset is derecognized.
- The impact from securitizations resulting in higher net income under
IFRS is due to the recognition of income on securitized receivables
under US GAAP in prior periods.
US GAAP
- SFAS 140 "Accounting for Transfers and Servicing of Finance Assets and
Extinguishments of Liabilities" requires that receivables that are sold
to a special purpose entity and securitized can only be derecognized and
a gain or loss on sale recognized if the originator has surrendered
control over the securitized assets.
- Control is surrendered over transferred assets if, and only if, all of
the following conditions are met:
- The transferred assets are put presumptively beyond the reach of the
transferor and its creditors, even in bankruptcy or other receivership.
- Each holder of interests in the transferee (i.e. holder of issued notes)
has the right to pledge or exchange their beneficial interests, and no
condition constrains this right and provides more than a trivial benefit
to the transferor.
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- The transferor does not maintain effective control over the assets
through either an agreement that obligates the transferor to repurchase
or to redeem them before their maturity or through the ability to
unilaterally cause the holder to return specific assets, other than
through a clean-up call.
- If these conditions are not met the securitized assets should continue to
be consolidated.
- When HSBC retains an interest in the securitized assets, such as a
servicing right or the right to residual cash flows from the special
purpose entity ("SPE"), HSBC recognizes this interest at fair value on
sale of the assets to the SPE.
DERIVATIVES AND HEDGE ACCOUNTING
IFRS
- Derivatives are recognized initially, and are subsequently remeasured, at
fair value. Fair values of exchange-traded derivatives are obtained from
quoted market prices. Fair values of over-the-counter ("OTC") derivatives
are obtained using valuation techniques, including discounted cash flow
models and option pricing models.
- In the normal course of business, the fair value of a derivative on
initial recognition is considered to be the transaction price (i.e. the
fair value of the consideration given or received). However, in certain
circumstances the fair value of an instrument will be evidenced by
comparison with other observable current market transactions in the same
instrument (i.e. without modification or repackaging) or will be based on
a valuation technique whose variables include only data from observable
markets, including interest rate yield curves, option volatilities and
currency rates. When such evidence exists, HSBC recognizes a trading
profit or loss on inception of the derivative. When unobservable market
data have a significant impact on the valuation of derivatives, the
entire initial change in fair value indicated by the valuation model is
not recognized immediately in the income statement but is recognized over
the life of the transaction on an appropriate basis or recognized in the
income statement when the inputs become observable, or when the
transaction matures or is closed out.
- Derivatives may be embedded in other financial instruments; for example,
a convertible bond has an embedded conversion option. An embedded
derivative is treated as a separate derivative when its economic
characteristics and risks are not clearly and closely related to those of
the host contract, its terms are the same as those of a stand-alone
derivative, and the combined contract is not held for trading or
designated at fair value through profit and loss. These embedded
derivatives are measured at fair value with changes in fair value
recognized in the income statement.
- Derivatives are classified as assets when their fair value is positive,
or as liabilities when their fair value is negative. Derivative assets
and liabilities arising from different transactions are only netted if
the transactions are with the same counterparty, a legal right of offset
exists, and the cash flows are intended to be settled on a net basis.
- The method of recognizing the resulting fair value gains or losses
depends on whether the derivative is held for trading, or is designated
as a hedging instrument and, if so, the nature of the risk being hedged.
All gains and losses from changes in the fair value of derivatives held
for trading are recognized in the income statement. When derivatives are
designated as hedges, HSBC classifies them as either: (i) hedges of the
change in fair value of recognized assets or liabilities or firm
commitments ("fair value hedge"); (ii) hedges of the variability in
highly probable future cash flows attributable to a recognized asset or
liability, or a forecast transaction ("cash flow hedge"); or (iii) hedges
of net investments in a foreign operation ("net investment hedge"). Hedge
accounting is applied to derivatives designated as hedging instruments in
a fair value, cash flow or net investment hedge provided certain criteria
are met.
Hedge Accounting:
- It is HSBC's policy to document, at the inception of a hedge, the
relationship between the hedging instruments and hedged items, as well
as the risk management objective and strategy for undertaking the hedge.
The policy also requires documentation of the assessment, both at hedge
inception and on an ongoing basis, of whether the derivatives that are
used in hedging transactions are highly effective
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in offsetting changes in fair values or cash flows of hedged items
attributable to the hedged risks. Interest on designated qualifying
hedges is included in "Net interest income".
Fair value hedge:
- Changes in the fair value of derivatives that are designated and qualify
as fair value hedging instruments are recorded in the income statement,
together with changes in the fair values of the assets or liabilities or
groups thereof that are attributable to the hedged risks.
- If the hedging relationship no longer meets the criteria for hedge
accounting, the cumulative adjustment to the carrying amount of a hedged
item is amortized to the income statement based on a recalculated
effective interest rate over the residual period to maturity, unless the
hedged item has been derecognized whereby it is released to the income
statement immediately.
Cash flow hedge:
- The effective portion of changes in the fair value of derivatives that
are designated and qualify as cash flow hedges are recognized in equity.
Any gain or loss relating to an ineffective portion is recognized
immediately in the income statement.
- Amounts accumulated in equity are recycled to the income statement in
the periods in which the hedged item will affect profit or loss.
However, when the forecast transaction that is hedged results in the
recognition of a non-financial asset or a non-financial liability, the
gains and losses previously deferred in equity are transferred from
equity and included in the initial measurement of the cost of the asset
or liability.
- When a hedging instrument expires or is sold, or when a hedge no longer
meets the criteria for hedge accounting, any cumulative gain or loss
existing in equity at that time remains in equity until the forecast
transaction is ultimately recognized in the income statement. When a
forecast transaction is no longer expected to occur, the cumulative gain
or loss that was reported in equity is immediately transferred to the
income statement.
Net investment hedge:
- Hedges of net investments in foreign operations are accounted for in a
similar manner to cash flow hedges. Any gain or loss on the hedging
instrument relating to the effective portion of the hedge is recognized
in equity; the gain or loss relating to the ineffective portion is
recognized immediately in the income statement. Gains and losses
accumulated in equity are included in the income statement on the
disposal of the foreign operation.
Hedge effectiveness testing:
- IAS 39 requires that at inception and throughout its life, each hedge
must be expected to be highly effective (prospective effectiveness) to
qualify for hedge accounting. Actual effectiveness (retrospective
effectiveness) must also be demonstrated on an ongoing basis.
- The documentation of each hedging relationship sets out how the
effectiveness of the hedge is assessed.
- For prospective effectiveness, the hedging instrument must be expected
to be highly effective in achieving offsetting changes in fair value or
cash flows attributable to the hedged risk during the period for which
the hedge is designated. For retrospective effectiveness, the changes in
fair value or cash flows must offset each other in the range of 80 per
cent to 125 per cent for the hedge to be deemed effective.
Derivatives that do not qualify for hedge accounting:
- All gains and losses from changes in the fair value of any derivatives
that do not qualify for hedge accounting are recognized immediately in
the income statement. These gains and losses are reported in "Trading
income", except where derivatives are managed in conjunction with
financial instruments designated at fair value, in which case gains and
losses are reported in "Net income from financial instruments designated
at fair value," other than interest settlements or derivatives used to
hedge issues of our debt which are reported in "Interest payable."
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US GAAP
- The accounting under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities" is generally consistent with that under IAS 39,
which HSBC has followed in its IFRS reporting from January 1, 2005, as
described above. However, specific assumptions regarding hedge
effectiveness under US GAAP are not permitted by IAS 39.
- The requirements of SFAS No. 133 have been effective from January 1,
2001.
- The US GAAP 'shortcut method' permits an assumption of zero
ineffectiveness in hedges of interest rate risk with an interest rate
swap provided specific criteria have been met. IAS 39 does not permit
such an assumption, requiring a measurement of actual ineffectiveness at
each designated effectiveness testing date.
- In addition, IFRS allows greater flexibility in the designation of the
hedged item. Under US GAAP, all contractual cash flows must form part of
the designated relationship, whereas IAS 39 permits the designation of
identifiable benchmark interest cash flows only.
- Certain issued structured notes are classified as trading liabilities
under IFRS, but not under US GAAP. Under IFRS, these notes will be held
at fair value, with changes in fair value reflected in the profit and
loss account. Under US GAAP, if the embedded derivative is not "clearly
and closely related" to the host contract, the embedded derivative will
be bifurcated and held at fair value, the host contract will be marked at
amortized cost, and changes in both will be reflected in the profit and
loss account. If the embedded derivative is "clearly and closely related"
to the host contract, the issued note will be held at amortized cost in
its entirety, with changes in the amortized cost reflected in the profit
and loss account.
- Under US GAAP, derivatives receivable and payable with the same
counterparty may be reported net on the balance sheet when there is an
executed ISDA Master Netting Arrangement covering enforceable
jurisdictions. These contracts do not meet the requirements for set off
under IAS 32 and hence are presented gross on the balance sheet for IFRS.
DESIGNATION OF FINANCIAL ASSETS AND LIABILITIES AT FAIR VALUE THROUGH PROFIT AND
LOSS
IFRS
- Under IAS 39, a financial instrument, other than one held for trading, is
classified in this category if it meets the criteria set out below, and
is so designated by management. An entity may designate financial
instruments at fair value where the designation:
- eliminates or significantly reduces a measurement or recognition
inconsistency that would otherwise arise from measuring financial assets
or financial liabilities or recognizing the gains and losses on them on
different bases; or
- applies to a group of financial assets, financial liabilities or both
that is managed and its performance evaluated on a fair value basis, in
accordance with a documented risk management or investment strategy, and
where information about that group of financial instruments is provided
internally on that basis to key management personnel; or
- relates to financial instruments containing one or more embedded
derivatives that significantly modify the cash flows resulting from
those financial instruments.
- Financial assets and financial liabilities so designated are recognized
initially at fair value, with transaction costs taken directly to the
income statement, and are subsequently remeasured at fair value. This
designation, once made, is irrevocable in respect of the financial
instruments to which it is made. Financial assets and financial
liabilities are recognized using trade date accounting.
- Gains and losses from changes in the fair value of such assets and
liabilities are recognized in the income statement as they arise,
together with related interest income and expense and dividends, within
"Net income from financial instruments designated at fair value".
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US GAAP
- There are no provisions in US GAAP to make an election similar to that in
IAS 39.
- Generally, for financial assets to be measured at fair value with gains
and losses recognized immediately in the income statement, they must
meet the definition of trading securities in SFAS 115, "Accounting for
Certain Investments in Debt and Equity Securities". Financial
liabilities are generally reported at amortized cost under US GAAP.
GOODWILL, PURCHASE ACCOUNTING AND INTANGIBLES
IFRS
- Prior to 1998, goodwill under UK GAAP was written off against equity.
HSBC did not elect to reinstate this goodwill on its balance sheet upon
transition to IFRS. From January 1, 1998 to December 31, 2003 goodwill
was capitalized and amortized over its useful life. The book value of
goodwill existing at December 31, 2003 under UK GAAP was carried forward
under IFRS from January 1, 2004, subject to certain adjustments.
- IFRS 3 "Business Combinations" requires that goodwill should not be
amortized but should be tested for impairment at least annually at the
reporting unit level by applying a test based on recoverable amounts.
- Quoted securities issued as part of the purchase consideration are fair
valued for the purpose of determining the cost of acquisition at their
market price on the date the transaction is completed.
US GAAP
- Up to June 30, 2001, goodwill acquired was capitalized and amortized over
its useful life which could not exceed 25 years. The amortization of
previously acquired goodwill ceased with effect from December 31, 2001.
- Quoted securities issued as part of the purchase consideration are fair
valued for the purpose of determining the cost of acquisition at their
average market price over a reasonable period before and after the date
on which the terms of the acquisition are agreed and announced.
- Changes in tax estimates of the basis in assets and liabilities or other
tax estimates recorded at the date of acquisition by HSBC are adjusted
against goodwill.
LOAN ORIGINATION
IFRS
- Certain loan fee income and incremental directly attributable loan
origination costs are amortized to the income statement over the life of
the loan as part of the effective interest calculation under IAS 39.
US GAAP
- Certain loan fee income and direct but not necessarily incremental loan
origination costs, including an apportionment of overheads, are amortized
to the profit and loss account over the life of the loan as an adjustment
to interest income (SFAS No. 91 "Accounting for Nonrefundable Fees and
Costs Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases".)
LOAN IMPAIRMENT
IFRS
- When statistical models, using historic loss rates adjusted for economic
conditions, provide evidence of impairment in portfolios of loans, their
values are written down to their net recoverable amount. The net
recoverable amount is the present value of the estimated future
recoveries discounted at the portfolio's original effective interest
rate. The calculations include a reasonable estimate of recoveries on
loans individually identified for write-off pursuant to HSBC's credit
guidelines.
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US GAAP
- Where the delinquency status of loans in a portfolio is such that there
is no realistic prospect of recovery, the loans are written off in full,
or to recoverable value where collateral exists. Delinquency depends on
the number of days payment is overdue. The delinquency status is applied
consistently across similar loan products in accordance with HSBC's
credit guidelines. When local regulators mandate the delinquency status
at which write-off must occur for different retail loan products and
these regulations reasonably reflect estimable recoveries on individual
loans, this basis of measuring loan impairment is reflected in US GAAP
accounting. Cash recoveries relating to pools of such written-off loans,
if any, are reported as loan recoveries upon collection.
GAIN ON SALE OF U.K. CREDIT CARD BUSINESS TO HBEU
IFRS
- IFRS requires that all items of income and expense recognized in a period
to be included in profit and loss unless another standard or an
interpretation requires otherwise.
US GAAP
- US GAAP requires that transfers of assets including non-financial assets
between affiliates under common control be treated as capital
transactions.
QUANTITATIVE RECONCILIATIONS OF NON-GAAP FINANCIAL MEASURES TO GAAP FINANCIAL
MEASURES For a reconciliation of managed basis net interest income, fee income
and provision for credit losses to the comparable owned basis amounts, see Note
22, "Business Segments," to the accompanying consolidated financial statements.
For a reconciliation of our owned loan portfolio by product to our managed loan
portfolio, see Note 6, "Receivables," to the accompanying consolidated financial
statements. For additional quantitative reconciliations of non-GAAP financial
measures presented herein to the equivalent GAAP basis financial measures, see
"Reconciliations to GAAP Financial Measures."
CRITICAL ACCOUNTING POLICIES
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Our consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States. We believe our policies are
appropriate and fairly present the financial position of HSBC Finance
Corporation.
The significant accounting policies used in the preparation of our financial
statements are more fully described in Note 2, "Summary of Significant
Accounting Policies," to the accompanying consolidated financial statements.
Certain critical accounting policies, which affect the reported amounts of
assets, liabilities, revenues and expenses, are complex and involve significant
judgment by our management, including the use of estimates and assumptions. We
recognize the different inherent loss characteristics in each of our loan
products as well as the impact of operational policies such as customer account
management policies and practices and risk management/collection practices. As a
result, changes in estimates, assumptions or operational policies could
significantly affect our financial position or our results of operations. We
base and establish our accounting estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities. Actual results may differ from
these estimates under different assumptions, customer account management
policies and practices, risk management/collection practices, or other
conditions as discussed below.
We believe that of the significant accounting policies used in the preparation
of our consolidated financial statements, the items discussed below involve
critical accounting estimates and a high degree of judgment and complexity. Our
management has discussed the development and selection of these critical
accounting policies with our external auditors and the audit committee of our
Board of Directors, including the underlying
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estimates and assumptions, and the audit committee has reviewed our disclosure
relating to these accounting policies and practices in this MD&A.
CREDIT LOSS RESERVES Because we lend money to others, we are exposed to the risk
that borrowers may not repay amounts owed to us when they become contractually
due. Consequently, we maintain credit loss reserves at a level that we consider
adequate, but not excessive, to cover our estimate of probable losses of
principal, interest and fees, including late, overlimit and annual fees, in the
existing portfolio. Loss reserve estimates are reviewed periodically, and
adjustments are reflected through the provision for credit losses in the period
when they become known. We believe the accounting estimate relating to the
reserve for credit losses is a "critical accounting estimate" for the following
reasons:
- The provision for credit losses totaled $4.5 billion in 2005, $4.3
billion in 2004 and $4.0 billion in 2003 and changes in the provision can
materially affect net income. As a percentage of average owned
receivables, the provision was 3.76 percent in 2005 compared to 4.28
percent in 2004 and 4.45 percent in 2003.
- Estimates related to the reserve for credit losses require us to consider
future delinquency and charge-off trends which are uncertain and require
a high degree of judgment.
- The reserve for credit losses is influenced by factors outside of our
control such as customer payment patterns, economic conditions,
bankruptcy trends and changes in laws and regulations.
Because our loss reserve estimate involves judgment and is influenced by factors
outside of our control, it is reasonably possible such estimates could change.
Our estimate of probable net credit losses is inherently uncertain because it is
highly sensitive to changes in economic conditions which influence growth,
portfolio seasoning, bankruptcy trends, delinquency rates and the flow of loans
through the various stages of delinquency, or buckets, the realizable value of
any collateral and actual loss exposure. Changes in such estimates could
significantly impact our credit loss reserves and our provision for credit
losses. For example, a 10% change in our projection of probable net credit
losses on owned receivables could have resulted in a change of approximately
$454 million in our credit loss reserve for owned receivables at December 31,
2005. The reserve for credit losses is a critical accounting estimate for all
three of our reportable segments.
Credit loss reserves are based on a range of estimates and are intended to be
adequate but not excessive. We estimate probable losses for consumer receivables
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. This analysis considers delinquency status, loss
experience and severity and takes into account whether loans are in bankruptcy,
have been restructured or rewritten, or are subject to forbearance, an external
debt management plan, hardship, modification, extension or deferment. In
addition, our loss reserves on consumer receivables are maintained to reflect
our judgment of portfolio risk factors that may not be fully reflected in the
statistical roll rate calculation. Risk factors considered in establishing loss
reserves on consumer receivables include recent growth, product mix, bankruptcy
trends, geographic concentrations, economic conditions, portfolio seasoning,
account management policies and practices, current levels of charge-offs and
delinquencies and other items which can affect consumer payment patters on
outstanding receivables, such as the impact of Katrina.
While our credit loss reserves are available to absorb losses in the entire
portfolio, we specifically consider the credit quality and other risk factors
for each of our products. We recognize the different inherent loss
characteristics in each of our products as well as customer account management
policies and practices and risk management/collection practices. Charge-off
policies are also considered when establishing loss reserve requirements to
ensure the appropriate reserves exist for products with longer charge-off
periods. We also consider key ratios such as reserves to nonperforming loans and
reserves as a percentage of net charge-offs in developing our loss reserve
estimate. In addition to the above procedures for the establishment of our
credit loss reserves, our Retail Credit Risk Management Department independently
evaluates the adequacy of our loss reserve levels.
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We periodically re-evaluate our estimate of probable losses for consumer
receivables. Changes in our estimate are recognized in our statement of income
as provision for credit losses in the period that the estimate is changed. Our
credit loss reserves for owned receivables increased $896 million from December
31, 2004 to $4.5 billion at December 31, 2005 as a direct result of growth in
our loan portfolio, including lower securitization levels, additional reserves
resulting from the Metris acquisition and higher delinquency levels driven by
growth, increases in the level of bankruptcy filings in both our domestic and
foreign operations, higher credit loss exposure resulting from Katrina and
changes in the required minimum monthly payment for credit card accounts. These
increases were partially offset by the impact of improved credit quality, a
shift in mix to higher levels of secured receivables and the release of $104
million of credit loss reserves associated with the sale of our UK credit card
operations. Our reserves as a percentage of receivables were 3.23 percent at
December 31, 2005, 3.39 percent at December 31, 2004 and 4.11 percent at
December 31, 2003. The decrease in reserves as a percentage of receivables for
these periods was primarily due to a continuing trend of improved credit quality
as well as a shift in mix to higher levels of higher credit quality receivables,
particularly real estate secured and auto finance receivables, partially as a
result of the bulk sale of domestic private label receivables in December 2004.
For more information about our charge-off and customer account management
policies and practices, see "Credit Quality - Delinquency and Charge-offs" and
"Credit Quality - Customer Account Management Policies and Practices."
RECEIVABLES SOLD AND SERVICED WITH LIMITED RECOURSE AND SECURITIZATION RELATED
REVENUE We have historically used a variety of sources to fund our operations.
These sources include the use of collateralized funding transactions which are
either structured as securitizations, which receive sale treatment, or as
secured financings, which do not receive sale treatment. For securitizations,
the receivables are removed from the balance sheet and a gain on sale and
interest-only strip receivable are recognized. Determination of both the gain on
sale and the interest-only strip receivable include estimates of future cash
flows to be received over the lives of the sold receivables. We believe the
accounting estimates relating to gains on sale and the value of the
interest-only strip receivable are "critical accounting estimates" for the
following reasons:
- Changes in the estimates of future cash flows used to determine gains on
sale and the value of interest-only strip receivables may materially
affect net income.
- The value of our interest-only strip receivable totaled $23 million at
December 31, 2005 and $323 million at December 31, 2004. This value may
be influenced by factors outside of our control such as consumer payment
patterns and economic conditions which impact charge-off and delinquency.
- Estimates relating to the gain on sale and the value of our interest-only
strip receivable require us to forecast cash flows which are uncertain
and require a high degree of judgment.
The lives of our securitized receivables are relatively short. Recording gains
on sales for receivables with shorter lives reduces the period of time for which
cash flows must be forecasted and, therefore, reduces the potential volatility
of these projections. Because our securitization accounting involves judgment
and is influenced by factors outside of our control, it is reasonably possible
such forecasts and estimates could change. Changes in such estimates or in the
level or mix of receivables securitized could significantly impact the gains on
sale we record and the value of our interest-only strip receivables.
Determination of both the gain on sale and the interest-only strip receivable
are critical accounting estimates for our Consumer and Credit Card Services
segment. Prior to the sale of the U.K. credit card business in December 2005,
determination of both the gain on sale and the interest-only strip receivable
was also a critical accounting estimate for our International segment.
We have not structured any real estate secured receivable collateralized funding
transactions to receive sale treatment since 1997. As a result, the real estate
secured receivables, which generally have longer lives than our other
receivables, and related debt remain on our balance sheet. In the third quarter
of 2004, we decided to structure all new collateralized funding transactions as
secured financings. However, because existing public MasterCard/Visa
transactions were structured as sales to revolving trusts that require
replenishments of
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receivables to support previously issued securities, receivables will continue
to be sold to these trusts until the revolving periods end, the last of which is
currently projected to occur in 2008. Private label trusts that publicly issued
securities will now be replenished by HSBC Bank USA as a result of the daily
sale of new domestic private label credit card originations to HSBC Bank USA. We
will continue to replenish, at reduced levels, certain non-public personal
non-credit card securities issued to conduits and record the resulting
replenishment gains for a period of time in order to manage liquidity. See "Off
Balance Sheet Arrangements and Secured Financings" for further discussion of our
decision to fund all new collateralized funding transactions as secured
financings.
For securitizations, a gain on sale is recognized for the difference between the
carrying value of the receivables securitized and the adjusted sales proceeds.
The adjusted sales proceeds include cash received and the present value estimate
of future cash flows to be received over the lives of the sold receivables.
Future cash flows are based on estimates of prepayments, the impact of interest
rate movements on yields of receivables and securities issued, delinquency of
receivables sold, servicing fees and estimated probable losses under the
recourse provisions based on historical experience and estimates of expected
future performance. Gains on sale net of recourse provisions, servicing income
and excess spread relating to securitized receivables are reported as
securitization related revenue in our consolidated statements of income.
Securitizations also involve the recording of an interest-only strip receivable
which represents our contractual right to receive interest and other cash flows
from the securitization trust. Our interest-only strip receivables are reported
at fair value using discounted cash flow estimates as a separate component of
receivables, net of our estimate of probable losses under the recourse
provisions. Cash flow estimates include estimates of prepayments, the impact of
interest rate movements on yields of receivables and securities issued,
delinquency of receivables sold, servicing fees and estimated probable losses
under the recourse provisions. Unrealized gains and losses are recorded as
adjustments to common shareholder's(s') equity in accumulated other
comprehensive income, net of income taxes. Our interest-only strip receivables
are reviewed for impairment quarterly or earlier if events indicate that the
carrying value may not be recovered. Any decline in the value of our
interest-only strip receivable which is deemed to be other than temporary is
charged against current earnings.
Assumptions used in estimating gains on sales of receivables are evaluated with
each securitization transaction. Assumptions used in valuing interest-only strip
receivables are re-evaluated each quarter based on experience and expectations
of future performances. During 2005, we experienced higher interest rates on
most of the receivables sold and the securities issued and generally experienced
lower delinquency and charge-offs on the underlying receivables sold. During
2004, we experienced lower interest rates on both the receivables sold and
securities issued and generally experienced lower delinquency and charge-offs on
the underlying receivables sold. These factors impact both the gains recorded
and the values of our interest-only strip receivables. Securitization gains are
dependent upon the level and mix of receivables securitized in any particular
year. We have not had any initial securitization of receivables since the second
quarter of 2004 as a result of the decision to structure all new collateralized
funding transactions as secured financings as discussed above. The sensitivity
of our interest-only strip receivable to various adverse changes in assumptions
and the amount of gain recorded and initial receivables securitized in each
period is disclosed in Note 8, "Asset Securitizations," to the accompanying
consolidated financial statements.
Due to our decision to structure all new collateralized funding as secured
financings, we do not anticipate any new initial securitization transactions in
2006.
GOODWILL AND INTANGIBLE ASSETS Goodwill and intangible assets with indefinite
lives are not subject to amortization. Intangible assets with finite lives are
amortized over their estimated useful lives. Goodwill and intangible assets are
reviewed annually on July 1 for impairment using discounted cash flows, but
impairment is reviewed earlier if circumstances indicate that the carrying
amount may not be recoverable. We consider significant and long-term changes in
industry and economic conditions to be our primary indicator of potential
impairment.
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We believe the impairment testing of our goodwill and intangibles is a critical
accounting estimate due to the level of goodwill ($7.0 billion) and intangible
assets ($2.5 billion) recorded at December 31, 2005 and the significant judgment
required in the use of discounted cash flow models to determine fair value.
Discounted cash flow models include such variables as revenue growth rates,
expense trends, interest rates and terminal values. Based on an evaluation of
key data and market factors, management's judgment is required to select the
specific variables to be incorporated into the models. Additionally, the
estimated fair value can be significantly impacted by the cost of capital used
to discount future cash flows. The cost of capital percentage is generally
derived from an appropriate capital asset pricing model, which itself depends on
a number of financial and economic variables which are established on the basis
of management's judgment. When management's judgment is that the anticipated
cash flows have decreased and/or the cost of capital has increased, the effect
will be a lower estimate of fair value. If the fair value is determined to be
lower than the carrying value, an impairment charge will be recorded and net
income will be negatively impacted.
Impairment testing of goodwill requires that the fair value of each reporting
unit be compared to its carrying amount. A reporting unit is defined as any
distinct, separately identifiable component of an operating segment for which
complete, discrete financial information is available that management regularly
reviews. For purposes of the annual goodwill impairment test, we assigned our
goodwill to our reporting units. At July 1, 2005, the estimated fair value of
each reporting unit exceeded its carrying value, resulting in none of our
goodwill being impaired.
Impairment testing of intangible assets requires that the fair value of the
asset be compared to its carrying amount. As a result of our impairment testing
at July 1, 2005, we recorded an impairment charge related to a tradename in the
U.K. For all other intangible assets, we determined that the estimated fair
value of each intangible asset exceeded its carrying value and, as such, none of
our remaining intangible assets were impaired.
As a result of the sale of our U.K. credit card business in December 2005, we
wrote off $218 million of goodwill attributable to this business. Subsequent to
the sale, we performed an interim goodwill impairment test for our remaining
U.K. and European operations as required by SFAS No. 142, "Goodwill and Other
Intangible Assets". As the estimated fair value of our remaining U.K. and
European operations exceeded our carrying value subsequent to the sale, we
concluded that the remaining goodwill assigned to this reporting unit was not
impaired.
VALUATION OF DERIVATIVE INSTRUMENTS AND DERIVATIVE INCOME We regularly use
derivative instruments as part of our risk management strategy to protect the
value of certain assets and liabilities and future cash flows against adverse
interest rate and foreign exchange rate movements. All derivatives are
recognized on the balance sheet at fair value. As of December 31, 2005, the
recorded fair values of derivative assets and liabilities were $234 million and
$383 million, respectively. We believe the valuation of derivative instruments
is a critical accounting estimate because certain instruments are valued using
discounted cash flow modeling techniques in lieu of market value quotes. These
flow modeling techniques require the use of estimates regarding the amount and
timing of future cash flows, which are susceptible to significant change in
future periods based on changes in market rates. The assumptions used in the
cash flow projection models are based on forward yield curves which are
susceptible to changes as market conditions change. We utilize HSBC Bank USA to
determine the fair value of substantially all of our derivatives using these
modeling techniques. We regularly review the results of these valuations for
reasonableness by comparing to an internal determination of fair value or third
party quotes. Significant changes in the fair value can result in equity and
earnings volatility as follows:
- Changes in the fair value of a derivative that has been designated and
qualifies as a fair value hedge, along with the changes in the fair value
of the hedged asset or liability (including losses or gains on firm
commitments), are recorded in current period earnings.
- Changes in the fair value of a derivative that has been designated and
qualifies as a cash flow hedge are recorded in other comprehensive income
to the extent of its effectiveness, until earnings are impacted by the
variability of cash flows from the hedged item.
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- Changes in the fair value of a derivative that has not been designated as
an effective hedge is reported in current period earnings.
This volatility may be mitigated to the extent such derivatives are designated
as effective hedges. If a derivative designated as an effective hedge will be
tested for effectiveness under the long-haul method (which at December 31, 2005
comprises 91 percent of our hedge portfolio based on notional amounts eligible
for hedge accounting), we formally assess, both at the inception of the hedge
and on a quarterly basis, whether the derivative used in a hedging transaction
has been and is expected to continue to be highly effective in offsetting
changes in fair values or cash flows of the hedged item. This assessment is
conducted using statistical regression analysis.
If it is determined as result of this assessment that a derivative is not
expected to be a highly effective hedge or that it has ceased to be a highly
effective hedge, we discontinue hedge accounting as of the beginning of the
quarter in which such determination was made. We also believe the assessment of
the effectiveness of the derivatives used in hedging transactions is a critical
accounting estimate due to the use of statistical regression analysis in making
this determination. Similar to discounted cash flow modeling techniques,
statistical regression analysis also requires the use of estimates regarding the
amount and timing of future cash flows, which are susceptible to significant
change in future periods based on changes in market rates. However, statistical
regression analysis also involves the use of additional assumptions including
the determination of the period over which the analysis should occur as well as
selecting a convention for the treatment of credit spreads in the analysis. The
statistical regression analysis for our derivative instruments is performed by
either HSBC Bank USA or an independent third party.
The outcome of the statistical regression analysis serves as the foundation for
determining whether or not the derivative is highly effective as a hedging
instrument. This can result in earnings volatility as the mark-to-market on
derivatives which do not qualify as effective hedges and the ineffectiveness
associated with qualifying hedges are recorded in current period earnings. The
mark-to market on derivatives which do not qualify as effective hedges was $156
million in 2005, $442 million in 2004 and $230 million in 2003. The
ineffectiveness associated with qualifying hedges was $41 million in 2005, $1
million in 2004 and $2 million in 2003. See "Results of Operations" in
Management's Discussion and Analysis of Financial Condition and Results of
Operations for a discussion of the yearly trends.
For more information about our policies regarding the use of derivative
instruments, see Note 2, "Summary of Significant Accounting Policies," and Note
15, "Derivative Financial Instruments," to the accompanying consolidated
financial statements.
CONTINGENT LIABILITIES Both we and certain of our subsidiaries are parties to
various legal proceedings resulting from ordinary business activities relating
to our current and/or former operations which affect all three of our reportable
segments. Certain of these activities are or purport to be class actions seeking
damages in significant amounts. These actions include assertions concerning
violations of laws and/or unfair treatment of consumers.
Due to the uncertainties in litigation and other factors, we cannot be certain
that we will ultimately prevail in each instance. Also, as the ultimate
resolution of these proceedings is influenced by factors that are outside of our
control, it is reasonably possible our estimated liability under these
proceedings may change. However, based upon our current knowledge, our defenses
to these actions have merit and any adverse decision should not materially
affect our consolidated financial condition, results of operations or cash
flows.
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RECEIVABLES REVIEW
--------------------------------------------------------------------------------
The following table summarizes owned receivables at December 31, 2005 and
increases (decreases) over prior periods:
INCREASES (DECREASES) FROM
-----------------------------------
DECEMBER 31, DECEMBER 31,
2004 2003
DECEMBER 31, ---------------- ----------------
2005 $ % $ %
----------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Real estate secured.......................... $ 82,826 $18,006 27.8% $ 31,605 61.7%
Auto finance................................. 10,704 3,160 41.9 6,566 100+
MasterCard/Visa.............................. 24,110 9,475 64.7 12,928 100+
Private label................................ 2,520 (891) (26.1) (10,084) (80.0)
Personal non-credit card..................... 19,545 3,417 21.2 6,713 52.3
Commercial and other......................... 208 (109) (34.4) (193) (48.1)
-------- ------- ----- -------- -----
Total owned receivables...................... $139,913 $33,058 30.9% $ 47,535 51.5%
======== ======= ===== ======== =====
REAL ESTATE SECURED RECEIVABLES Driven by growth in our correspondent and branch
businesses, real estate secured receivables increased significantly over the
year-ago period. Growth in real estate secured receivables was also supplemented
by purchases from a single correspondent relationship which totaled $1.1 billion
in 2005 and $2.6 billion in 2004. Real estate secured receivable levels in our
branch-based consumer lending business improved because of higher sales volumes
than in the prior year as we continue to emphasize real estate secured loans,
including a near-prime mortgage product we first introduced in 2003. Also
contributing to the increase in our domestic branch operations was $1.7 billion
in 2005 and $900 million in 2004 of acquisitions from a portfolio acquisition
program. We have continued to focus on junior lien loans through portfolio
acquisitions and have expanded our sources for purchasing newly originated loans
from flow correspondents. Additionally, we have expanded our Canadian branch
operations in 2005 which has also resulted in strong real estate secured
receivable growth. The increases in the real estate secured receivable levels
have been partially offset by run-off of higher yielding real estate secured
receivables largely due to refinance activity. Real estate secured receivable
levels reflect sales to HSBC Bank USA of $.9 billion on March 31, 2004 and $2.8
billion on December 31, 2003, as well as HSBC Bank USA's purchase of receivables
directly from correspondents totaling $1.5 billion and $2.8 billion in 2005 and
2004, a portion of which we otherwise would have purchased. Purchases of real
estate secured receivables from our correspondents by HSBC Bank USA were
discontinued effective September 1, 2005.
AUTO FINANCE RECEIVABLES Auto finance receivables increased over the year-ago
period due to organic growth principally in the near-prime portfolio. This came
from newly originated loans acquired from our dealer network, growth in the
consumer direct loan program, expanded distribution through alliance channels
and lower securitization levels. Additionally in 2005, we experienced continued
growth from the expansion of an auto finance program introduced in Canada in the
second quarter of 2004 which at December 31, 2005, has grown to a network of
over 1,000 active dealer relationships.
MASTERCARD AND VISA RECEIVABLES MasterCard and Visa receivables reflect the $5.3
billion of receivables acquired as part of our acquisition of Metris in December
2005 as well as strong domestic organic growth especially in our HSBC branded
prime, Union Privilege and non-prime portfolios. Also contributing to the growth
was the successful launch of a MasterCard/Visa credit card program in Canada.
These increases were offset by the sale of our U.K. credit card business which
included $2.2 billion of MasterCard/Visa receivables. Lower securitization
levels also contributed to the increase at December 31, 2005.
PRIVATE LABEL RECEIVABLES Private label receivables decreased in 2005 as a
result of lower retail sales volumes in the U.K., the sale of our U.K. credit
card business in December 2005, which included $300 million of private
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label receivables and changes in the foreign exchange rates since December 31,
2004. The decrease in 2004 reflects the sale of $12.2 billion of domestic
private label receivables to HSBC Bank USA in December 2004 and our continuing
sale of all new domestic private label receivables (excluding retail sales
contracts) to HSBC Bank USA.
PERSONAL NON-CREDIT CARD RECEIVABLES Personal non-credit card receivables are
comprised of the following:
INCREASES (DECREASES) FROM
-------------------------------
DECEMBER 31, DECEMBER 31,
2004 2003
DECEMBER 31, -------------- --------------
2005 $ % $ %
------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Domestic personal non-credit card............... $11,394 $3,513 44.6% $5,786 100+%
Union Plus personal non-credit card............. 333 (141) (29.7) (381) (53.4)
Personal homeowner loans........................ 4,173 480 13.0 871 26.4
Foreign personal non-credit card................ 3,645 (435) (10.7) 437 13.6
------- ------ ----- ------ -----
Total personal non-credit card receivables...... $19,545 $3,417 21.2% $6,713 52.3%
======= ====== ===== ====== =====
Personal non-credit card receivables increased during 2005 as a result of lower
securitization levels and increased marketing, including several large direct
mail campaigns. In the second half of 2004, we began to increase the
availability of this product as a result of the improving U.S. economy.
Domestic and foreign personal non-credit card loans (cash loans with no
security) are made to customers who may not qualify for either a real estate
secured or personal homeowner loan ("PHL"). The average personal non-credit card
loan is approximately $7,300 and 52 percent of the personal non-credit card
portfolio is closed-end with terms ranging from 12 to 60 months. The Union Plus
personal non-credit card loans are part of our affinity relationship with the
AFL-CIO and are underwritten similar to other personal non-credit card loans.
PHL's typically have terms of 120 to 240 months and are subordinate lien, home
equity loans with high (100 percent or more) combined loan-to-value ratios which
we underwrite, price and manage like unsecured loans. The average PHL is
approximately $19,000. Because recovery upon foreclosure is unlikely after
satisfying senior liens and paying the expenses of foreclosure, we do not
consider the collateral as a source for repayment in our underwriting.
Historically, these loans have performed better from a credit loss perspective
than traditional unsecured loans as consumers are more likely to pay secured
loans than unsecured loans in times of financial distress.
DISTRIBUTION AND SALES We reach our customers through many different
distribution channels and our growth strategies vary across product lines. The
consumer lending business originates real estate and personal non-credit card
products through its retail branch network, direct mail, telemarketing,
strategic alliances and Internet applications and purchases loans as part of a
portfolio acquisition program. The mortgage services business originates real
estate secured receivables through brokers and purchases real estate secured
receivables primarily through correspondents. Private label receivables are
generated through merchant promotions, application displays, Internet
applications, direct mail and telemarketing. Auto finance receivables are
generated primarily through dealer relationships from which installment
contracts are purchased. Additional auto finance receivables are generated
through direct lending which includes alliance partner referrals, Internet
applications and direct mail as well as in our consumer lending branches.
MasterCard and Visa receivables are generated primarily through direct mail,
telemarketing, Internet applications, application displays including in our
consumer lending retail branch network, promotional activity associated with our
co-branding and affinity relationships, mass media advertisements and merchant
relationships sourced through our retail services business. We also supplement
internally-generated receivable growth with portfolio acquisitions.
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Our acquisition by HSBC has allowed us to enlarge our customer base through
cross-selling products to HSBC customers as well as generating new business with
various major corporations. The rebranding of the majority of our U.S. and
Canadian businesses to the HSBC brand has positively impacted these efforts. A
Consumer Finance team, which was established in 2004, has worked throughout 2005
on a consultative basis to extend consumer finance offerings in select emerging
markets across the HSBC Group.
Based on certain criteria, we offer personal non-credit card customers who meet
our current underwriting standards the opportunity to convert their loans into
real estate secured loans. This enables our customers to have access to
additional credit at lower interest rates. This also reduces our potential loss
exposure and improves our portfolio performance as previously unsecured loans
become secured. We converted approximately $652 million of personal non-credit
card loans into real estate secured loans in 2005 and $520 million in 2004. It
is not our practice to rewrite or reclassify delinquent secured loans (real
estate or auto) into personal non-credit card loans.
RESULTS OF OPERATIONS
--------------------------------------------------------------------------------
Unless noted otherwise, the following discusses amounts reported in our owned
basis statement of income.
NET INTEREST INCOME The following table summarizes net interest income:
YEAR ENDED DECEMBER 31, 2005 (1) 2004 (1) 2003 (1)
-----------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Finance and other interest income......... $13,216 10.61% $10,945 10.28% $10,242 10.85%
Interest expense.......................... 4,832 3.88 3,143 2.95 2,928 3.10
------- ----- ------- ----- ------- -----
Net interest income....................... $ 8,384 6.73% $ 7,802 7.33% $ 7,314 7.75%
======= ===== ======= ===== ======= =====
---------------
(1) % Columns: comparison to average owned interest-earning assets.
The increase in net interest income during 2005 was due to higher average
receivables and a higher overall yield, partially offset by higher interest
expense. Overall yields increased as our rates on variable rate products
increased in line with market movements and other repricing initiatives more
than offset a decline in real estate secured and auto finance yields. Changes in
receivable mix also contributed to the increase in yield as the impact of
increased levels of higher yielding MasterCard/Visa and personal non-credit card
receivables due to lower securitization levels was partially offset by growth in
lower yielding real estate secured receivables. Receivable mix was also
significantly impacted by lower levels of private label receivables as a result
of the sale of our domestic private label portfolio (excluding retail sales
contracts at our consumer lending business) in December 2004. The lower real
estate and auto finance yields during 2005 reflect strong receivable and
refinancing growth on receivables originated during an economic cycle with
historically low market rates, high liquidation of older, higher yielding loans,
product expansion into near-prime customer segments and competitive pricing
pressures due to excess market capacity. Yields also benefited from reduced
levels of lower yielding investment securities in 2005. The higher interest
expense, which contributed to lower net interest margin, was due to a larger
balance sheet and a significantly higher cost of funds due to a rising interest
rate environment. In addition, as part of our overall liquidity management
strategy, we continue to extend the maturity of our liability profile which
results in higher interest expense. Our purchase accounting fair value
adjustments include both amortization of fair value adjustments to our external
debt obligations and receivables. Amortization of purchase accounting fair value
adjustments increased net interest income by $520 million in 2005, which
included $4 million relating to Metris, and $743 million in 2004.
The increase in net interest income during 2004 was due to higher average
receivables partially offset by lower yields on our receivables, particularly
real estate secured, auto finance and personal non-credit card receivables and
higher interest expense. The lower yields in 2004 reflect strong receivable and
refinancing growth which has occurred in an economic cycle with historically low
market rates, high liquidation of older, higher yielding loans, product
expansion into near-prime customer segments and competitive pricing pressures
due to excess
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HSBC Finance Corporation
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market capacity. All of these factors contributed to a decrease in overall loan
yields. The higher interest expense experienced in 2004 was due to a larger
balance sheet partially offset by a lower cost of funds. Amortization of
purchase accounting fair value adjustments increased net interest income by $743
million in 2004 and $598 million in 2003.
Net interest margin was 6.73 percent in 2005, 7.33 percent in 2004 and 7.75
percent in 2003. Net interest margin decreased in 2005 as the improvement in the
overall yield on our receivable portfolio, as discussed above, was more than
offset by the higher funding costs. The decrease in 2004 was driven by lower
yields on certain products, partially offset by lower funding costs on our debt.
The following table shows the impact of these items on owned basis net interest
margin:
2005 2004
-------------------------------------------------------------------------
Net interest margin - December 31, 2004 and 2003,
respectively.............................................. 7.33% 7.75%
Impact to net interest margin resulting from:
Bulk sale of domestic private label portfolio in December
2004................................................... (.24) -
Receivable pricing........................................ .11 (.34)
Receivable mix............................................ .12 (.31)
Metris acquisition in December 2005....................... .03 -
Cost of funds change...................................... (.79) .18
Investment securities mix................................. .06 .03
Sale of real estate secured receivables in December
2003................................................... - .11
Other..................................................... .11 (.09)
---- ----
Net interest margin - December 31, 2005 and 2004,
respectively.............................................. 6.73% 7.33%
==== ====
Our net interest income on a managed basis includes finance income earned on our
owned receivables as well as on our securitized receivables. This finance income
is offset by interest expense on the debt recorded on our balance sheet as well
as the contractual rate of return on the instruments issued to investors when
the receivables were securitized. Managed basis net interest income was $9.3
billion in 2005, $10.3 billion in 2004 and $10.2 billion in 2003. Managed basis
net interest margin was 6.94 percent in 2005 compared to 7.97 percent in 2004
and 8.60 percent in 2003. The decrease in 2005 was primarily due to higher
funding costs. The decrease in net interest margin in 2004 was due to lower
yields on our receivables, partially offset by lower funding costs on our debt
as discussed above. Net interest margin is greater than on an owned basis
because the managed basis portfolio includes more unsecured loans which have
higher yields. The following table shows the impact of these items on managed
basis net interest margin:
2005 2004
-------------------------------------------------------------------------
Net interest margin - December 31, 2004 and 2003,
respectively.............................................. 7.97% 8.60%
Impact to net interest margin resulting from:
Bulk sale of domestic private label portfolio in December
2004................................................... (.16) -
Receivable pricing........................................ .10 (.46)
Receivable mix............................................ (.24) (.36)
Metris acquisition in December 2005....................... .03 -
Cost of funds change...................................... (.92) .12
Investment securities mix................................. .06 .02
Sale of real estate secured receivables in December
2003................................................... - .11
Other..................................................... .10 (.06)
---- ----
Net interest margin - December 31, 2005 and 2004,
respectively.............................................. 6.94% 7.97%
==== ====
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Our interest earning assets expose us to interest rate risk. We try to manage
this risk by borrowing money with similar interest rate and maturity profiles;
however, there are instances when this cannot be achieved. When the various
risks inherent in both the asset and the debt to do not meet our desired risk
profile, we use derivative financial instruments to manage these risks to
acceptable interest rate risk levels. See "Risk Management" for additional
information regarding interest rate risk and derivative financial instruments.
See the "Net Interest Margin" tables and "Reconciliation to GAAP Financial
Measures" for additional information regarding our owned basis and managed basis
net interest income.
PROVISION FOR CREDIT LOSSES The provision for credit losses includes current
period net credit losses and an amount which we believe is sufficient to
maintain reserves for losses of principal, interest and fees, including late,
overlimit and annual fees, at a level that reflects known and inherent losses in
the portfolio. Growth in receivables and portfolio seasoning ultimately result
in higher provision for credit losses. The provision for credit losses may also
vary from year to year depending on a variety of additional factors including
product mix and the credit quality of the loans in our portfolio including,
historical delinquency roll rates, customer account management policies and
practices, risk management/collection policies and practices related to our loan
products, economic conditions, changes in laws and regulations and our product
vintage analysis.
The following table summarizes provision for owned credit losses:
YEAR ENDED DECEMBER 31, 2005 2004 2003
--------------------------------------------------------------------------------------
(IN MILLIONS)
Provision for credit losses................................. $4,543 $4,334 $3,967
Our provision for credit losses increased during 2005 primarily due to increased
credit loss exposure as a result of Katrina and higher bankruptcy losses due to
higher bankruptcy filings resulting from new bankruptcy legislation in the
United States. Excluding the increased credit loss provision related to Katrina
and the impact from the increased bankruptcy filings in 2005, our provision for
credit losses declined in 2005 as improved credit quality and a shift in
portfolio mix to higher levels of secured receivables, primarily as a result of
the sale of our domestic private label portfolio (excluding retail sales
contracts at our consumer lending business) in December 2004, were partially
offset by increased requirements due to receivable growth, including lower
securitization levels and higher credit loss exposure in the U.K. Net charge-off
dollars for 2005 decreased $380 million compared to 2004 ($538 million excluding
FFIEC in 2004) primarily due to the lower delinquency levels we have experienced
as a result of the strong economy as well as improved credit quality of
originations. These improvements were partially offset by receivable growth as
well as higher bankruptcy related charge-offs in the fourth quarter of 2005
resulting from the new bankruptcy legislation in the United States. We had been
maintaining credit loss reserves in anticipation of the impact this new
legislation would have on net charge-offs. However, the magnitude of the spike
in bankruptcies experienced immediately before the new legislation became
effective was larger than anticipated which resulted in an additional $100
million credit loss provision being recorded during the third quarter of 2005.
Our fourth quarter results include an estimated $125 million in incremental
charge-offs of principal, interest and fees and $113 million in provision
expense attributable to bankruptcy reform. The incremental charge-off is
primarily related to our MasterCard/Visa portfolio where bankrupt accounts
charge-off sooner in accordance with FFIEC policies than in our secured and
personal non-credit card portfolios. This provision expense included in our
fourth quarter results relating to bankruptcies in our secured and personal
non-credit card portfolios will not begin to migrate to charge-off until 2006 in
accordance with their respective charge-off policies. As expected, the number of
bankruptcy filings subsequent to the enactment of this new legislation have
decreased dramatically. We believe that a portion of the increase in charge-offs
resulting from the higher bankruptcy filings is an acceleration of charge-offs
that would otherwise have been experience in future periods.
Our provision for credit losses increased in 2004 compared to 2003 partially as
a result of the adoption of FFIEC charge-off policies for our domestic private
label (excluding retail sales contracts at our consumer lending business) and
MasterCard/Visa portfolios. The adoption of the FFIEC charge-off policies
resulted in a $38 million increase to loss provision in the fourth quarter of
2004 as the incremental charge-off of
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$158 million associated with these products was partially offset by the release
of $120 million in existing credit loss reserves. Excluding the impact of the
adoption of FFIEC charge-off policies in 2004, our credit loss provision
increased in 2004 compared to 2003 due to receivable growth, including lower
securitization levels, partially offset by improving asset quality. Net
charge-off dollars for 2004 increased $446 million ($288 million excluding
FFIEC) compared to 2003 as higher delinquencies due to adverse economic
conditions which existed in 2003 migrated to charge-off in 2004, partially
offset by an overall improvement in asset quality during 2004.
We increased our credit loss reserves in both 2005 and 2004 as the provision for
owned credit losses was $890 million greater than net charge-offs in 2005 and
$301 million in 2004. The provision as a percent of average owned receivables
was 3.76 percent in 2005, 4.28 percent in 2004 and 4.45 percent in 2003. The
decrease in 2005 reflects receivable growth, better underwriting standards and a
shift in portfolio mix to higher levels of secured receivables, partially offset
by the impact of Katrina and the higher provision resulting from the increased
bankruptcy filings resulting from the new bankruptcy legislation in the United
States. The decrease in 2004 reflects receivable growth and better underwriting
standards.
See "Critical Accounting Policies," "Credit Quality," "Analysis of Credit Loss
Reserves Activity" and "Reconciliations to GAAP Financial Measures" for
additional information regarding our owned basis and managed basis loss reserves
and the adoption of FFIEC policies. See Note 7, "Credit Loss Reserves" in the
accompanying consolidated financial statements for additional analysis of the
owned basis and managed basis loss reserves.
OTHER REVENUES The following table summarizes other revenues:
YEAR ENDED DECEMBER 31, 2005 2004 2003
--------------------------------------------------------------------------------------
(IN MILLIONS)
Securitization related revenue.............................. $ 211 $1,008 $1,461
Insurance revenue........................................... 918 839 746
Investment income........................................... 134 137 196
Derivative income........................................... 249 511 286
Fee income.................................................. 1,568 1,091 1,064
Taxpayer financial services revenue......................... 277 217 185
Gain on bulk sale of private label receivables.............. - 663 -
Gain on receivable sales to HSBC affiliates................. 413 39 16
Servicing fees from HSBC affiliates......................... 409 24 -
Other income................................................ 652 544 365
------ ------ ------
Total other revenues........................................ $4,831 $5,073 $4,319
====== ====== ======
Securitization related revenue is the result of the securitization of our
receivables and includes the following:
YEAR ENDED DECEMBER 31, 2005 2004 2003
------------------------------------------------------------------------------------
(IN MILLIONS)
Net initial gains(1)........................................ $ - $ 25 $ 176
Net replenishment gains(2).................................. 154 414 548
Servicing revenue and excess spread......................... 57 569 737
---- ------ ------
Total....................................................... $211 $1,008 $1,461
==== ====== ======
---------------
(1) Net initial gains reflect inherent recourse provisions of $47 million in
2004 and $963 million in 2003.
(2) Net replenishment gains reflect inherent recourse provisions of $252 million
in 2005, $850 million in 2004 and $849 million in 2003.
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The decline in securitization related revenue in 2005 and 2004 was due to
decreases in the level and product mix of securitized receivables and higher run
off due to shorter expected lives of securitization trusts as a result of our
decision in the third quarter of 2004 to structure all new collateralized
funding transactions as secured financings. Excess spread in 2004 and 2003 was
also negatively impacted by higher recourse estimates at auto finance as a
result of certain vintages performing worse than expected which reduced excess
spread by $91 million in 2004 and $200 million in 2003. Because existing public
MasterCard and Visa credit card transactions were structured as sales to
revolving trusts that require replenishments of receivables to support
previously issued securities, receivables will continue to be sold to these
trusts until the revolving periods end, the last of which is currently projected
to occur in 2008. Private label trusts that publicly issued securities will now
be replenished by HSBC Bank USA as a result of the daily sales of new domestic
private label originations (excluding retail sales contracts) to HSBC Bank USA.
We will continue to replenish at reduced levels, certain non-public personal
non-credit card securities issued to conduits and record the resulting
replenishment gains for a period of time in order to manage liquidity. Since our
securitized receivables have varying lives, it will take time for these
receivables to pay-off and the related interest-only strip receivables to be
reduced to zero. While the termination of sale treatment on new collateralized
funding activity and the reduction of sales under replenishment agreements
reduced our reported net income under U.S. GAAP, there is no impact on cash
received from operations.
In 2005, our net interest-only strip receivables, excluding the mark-to-market
adjustment recorded in accumulated other comprehensive income and the U.K.
credit card portion purchased by HBEU, decreased $253 million. In 2004, our net
interest-only strip receivables, excluding both the mark-to-market adjustment
recorded in accumulated other comprehensive income and the private label portion
purchased by HSBC Bank USA, decreased $466 million as securitized receivables
continue to decline.
See Note 2, "Summary of Significant Accounting Policies," and Note 8, "Asset
Securitizations," to the accompanying consolidated financial statements, and
"Critical Accounting Policies" and "Off Balance Sheet Arrangements and Secured
Financings" for further information on asset securitizations.
Insurance revenue increased in 2005 as we have experienced higher sales volumes
for many of our insurance products in both our U.K. and domestic operations. The
increase in 2004 was due to increased sales in our U.K. business partially
offset by slightly lower revenue from our domestic operations due to the
continued run off of insurance products discontinued in prior years.
Investment income, which includes income on securities available for sale in our
insurance business and realized gains and losses from the sale of securities,
was essentially flat in 2005 as the lower average investment balances and lower
gains from security sales were largely offset by higher yields on our
investments. The decrease in 2004 was a result of decreases in income due to
lower yields on lower average balances, lower gains from security sales and
reduced amortization of purchase accounting fair value adjustments.
Derivative income, which includes realized and unrealized gains and losses on
derivatives which do not qualify as effective hedges under SFAS No. 133 as well
as the ineffectiveness on derivatives associated with our qualifying hedges is
summarized in the table below:
2005 2004 2003
--------------------------------------------------------------------------------
(IN MILLIONS)
Net realized gains (losses)................................. $ 52 $ 68 $ 54
Mark-to-market on derivatives which do not qualify as
effective hedges.......................................... 156 442 230
Ineffectiveness............................................. 41 1 2
---- ---- ----
Total....................................................... $249 $511 $286
==== ==== ====
Derivative income decreased in 2005 primarily due to an upward shift in the
forward yield curve which decreased the value of our pay variable interest rate
swaps which do not qualify for hedge accounting under
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SFAS No. 133 and to the reduction in the portfolio of non-qualifying receive
variable interest rate swaps. The income from ineffectiveness in 2005 resulted
from this designation of a significant number of our non-hedging derivative
portfolio, which had previously not qualified for hedge accounting under SFAS
No. 133, as effective hedges under the long-haul method of accounting during
2005. Redesignation of swaps as effective hedges reduces the overall volatility
of reported income. For certain new hedging relationships, however, we continued
to experience income volatility during the period before hedging documentation
was put in place. We are working to improve this process and reduce the delay
between executing the swap and establishing hedge accounting. Additionally, we
continue to evaluate the steps required to regain hedge accounting treatment
under SFAS No. 133 for the remaining swaps which do not currently qualify for
hedge accounting. Derivative income increased in 2004 due to an increasing
interest rate environment which caused our pay fixed interest rate swaps, which
do not qualify for hedge accounting under SFAS No. 133, to increase in value.
These derivatives were economic hedges of the underlying debt instruments.
Net income volatility, whether based on changes in interest rates for swaps
which do not qualify for hedge accounting or ineffectiveness recorded on our
qualifying hedges under the long haul method of accounting, impacts the
comparability of our reported results between periods. Accordingly, derivative
income for the year ended December 31, 2005 should not be considered indicative
of the results for any future periods.
Fee income, which includes revenues from fee-based products such as credit
cards, increased in 2005 and 2004 due to higher credit card fees, particularly
relating to our non-prime credit card portfolio, due to higher levels of
MasterCard/Visa credit card receivables and, in 2005, improved interchange
rates. In 2005, these increases were partially offset by lower private label
credit card fees and higher rewards program expenses. The lower private label
credit card fees were the result of the bulk sale of domestic private label
receivables to HSBC Bank USA in December 2004. For 2004, the higher credit card
fees were partially offset by higher payments to merchant partners as a result
of portfolio acquisitions in our retail services business. See Note 22,
"Business Segments," to the accompanying consolidated financial statements for
additional information on fee income on a managed basis.
Taxpayer financial services ("TFS") revenue increased in 2005 due to increased
loan volume during the 2005 tax season and revenue on the sale of certain bad
debt recovery rights to third parties in 2005. The increase in 2004 was
primarily due to lower funding costs as a result of our acquisition by HSBC.
Gain on bulk sale of private label receivables resulted from the sale of $12.2
billion of domestic private label receivables ($15.6 billion on a managed basis)
including the retained interests associated with securitized private label
receivables to HSBC Bank USA in December 2004. See Note 4, "Sale of Domestic
Private Label Receivable Portfolio and Adoption of FFIEC Policies," to the
accompanying consolidated financial statements for further information.
Gains on receivable sales to HSBC affiliates in 2005 includes the daily sales of
domestic private label receivable originations (excluding retail sales
contracts) and certain MasterCard/Visa account originations to HSBC Bank USA. In
2004, gains on receivable sales to HSBC affiliates includes the bulk sale of
real estate secured receivables in March 2004 as well as certain MasterCard/Visa
account originations to HSBC Bank USA. See Note 4, "Sale of Domestic Private
Label Receivable Portfolio and Adoption of FFIEC Policies," to the accompanying
consolidated financial statements for further information.
Servicing fees from HSBC affiliates represents revenue received under service
level agreements under which we service MasterCard/Visa credit card and domestic
private label receivables as well as real estate secured and auto finance
receivables for HSBC affiliates. The increases primarily relate to the servicing
fees we receive from HSBC Bank USA for servicing the domestic private label
receivables beginning in December 2004.
Other income increased in 2005 and 2004. The increase in 2005 and 2004 was
primarily due to higher ancillary credit card revenue and higher gains on
miscellaneous asset sales, including the partial sale of a real estate
investment.
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COSTS AND EXPENSES Effective January 1, 2004, our domestic technology services
employees were transferred to HSBC Technology and Services (USA) Inc. ("HTSU").
As a result, operating expenses relating to information technology as well as
certain item processing and statement processing activities, which have
previously been reported as salaries and fringe benefits, occupancy and
equipment expenses, or other servicing and administrative expenses, are now
billed to us by HTSU and reported as support services from HSBC affiliates.
Support services from HSBC affiliates also include banking services and other
miscellaneous services provided by HSBC Bank USA and other subsidiaries of HSBC.
The following table summarizes total costs and expenses:
YEAR ENDED DECEMBER 31, 2005 2004 2003
--------------------------------------------------------------------------------------
(IN MILLIONS)
Salaries and employee benefits.............................. $2,072 $1,886 $1,998
Sales incentives............................................ 397 363 263
Occupancy and equipment expenses............................ 334 323 400
Other marketing expenses.................................... 731 636 548
Other servicing and administrative expenses................. 785 868 1,149
Support services from HSBC affiliates....................... 889 750 -
Amortization of intangibles................................. 345 363 258
Policyholders' benefits..................................... 456 412 377
HSBC acquisition related costs incurred by HSBC Finance
Corporation............................................... - - 198
------ ------ ------
Total costs and expenses.................................... $6,009 $5,601 $5,191
====== ====== ======
Salaries and employee benefits increased in 2005 as a result of additional
staffing, primarily in our consumer lending, mortgage services and Canadian
operations as well as in our corporate functions to support growth. Salaries and
employee benefits decreased in 2004 primarily due to the transfer of our
technology personnel to HTSU. Excluding this change, salaries and fringe
benefits increased $126 million in 2004 as a result of additional staffing to
support growth, primarily in our consumer lending, mortgage services and
international business units and in our compliance functions.
Sales incentives increased in 2005 and 2004 due to higher volumes in our
consumer lending branches and mortgage services business.
Occupancy and equipment expenses increased in 2005 as higher occupancy expense
and higher repairs and maintenance costs were partially offset by lower
depreciation. The decrease in 2004 was primarily due to the formation of HTSU as
discussed above.
Other marketing expenses includes payments for advertising, direct mail programs
and other marketing expenditures. The increase in 2005 was primarily due to
increased domestic credit card marketing expenses due to higher non-prime
marketing expense and investments in new marketing initiatives. Changes in
contractual marketing responsibilities in July 2004 associated with the General
Motors ("GM") co-branded credit card also resulted in increased expenses in both
2005 and 2004.
Other servicing and administrative expenses decreased in 2005 due to lower REO
expenses and a lower estimate of exposure relating to accrued finance charges
associated with certain loan restructures which were partially offset by higher
systems costs. The decrease in 2004 was primarily due to the transfer of certain
item processing and statement processing services to HTSU. This decrease was
partially offset by higher systems and credit bureau costs due to growth, higher
insurance commissions and costs associated with the rebranding.
Effective December 20, 2005, our U.K. based technology services employees were
transferred to HBEU. As a result, operating expenses relating to information
technology, which have previously been reported as salaries and fringe benefits,
are now billed to us by HBEU and reported as support services from HSBC
affiliates.
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Support services from HSBC affiliates, which includes technology and other
services charged to us by HTSU since January 1, 2004 and by HBEU since December
20, 2005, increased in 2005 primarily due to growth.
Amortization of intangibles decreased in 2005 as lower intangible amortization
related to our purchased credit card relationships due to a contract
renegotiation with one of our co-branded credit card partners and lower
amortization associated with an individual contractual relationship was
partially offset by amortization associated with the Metris cardholder
relationships and a write-off related to a trade name in the U.K. The increase
in 2004 was due to the higher amortization of intangibles established in
conjunction with the HSBC acquisition on March 28, 2003. Due to the timing of
the merger, there were nine months of amortization expense in 2003 compared with
a full year of amortization expense in 2004.
Policyholders' benefits increased in 2005 due to a continuing increase in
insurance sales volumes in both our U.K. and domestic operations, partially
offset by lower amortization of fair value adjustments relating to our insurance
business. The increase in 2004 was due to higher sales in our U.K. business and
higher amortization of fair value adjustments relating to our insurance
business, partially offset by lower expenses in our domestic business.
HSBC acquisition related costs incurred by HSBC Finance Corporation in the first
quarter of 2003 include payments to executives under existing employment
contracts and investment banking, legal and other costs relating to our
acquisition by HSBC.
The following table summarizes our owned basis efficiency ratio:
YEAR ENDED DECEMBER 31, 2005 2004 2003
-----------------------------------------------------------------------------------
GAAP basis efficiency ratio................................. 43.52% 41.64% 42.77%
Operating basis efficiency ratio(1)......................... 43.52 43.42 41.01
---------------
(1) Represents a non-GAAP financial measure. See "Basis of Reporting" for
additional discussion on the use of this non-GAAP financial measure and
"Reconciliations to GAAP Financial Measures" for quantitative
reconciliations of our operating efficiency ratio to our owned basis GAAP
efficiency ratio.
Our owned basis efficiency ratio has been significantly impacted by the results
of the domestic private label receivable portfolio which was sold in December
2004. Excluding the results of this domestic private label portfolio from both
periods, our 2005 efficiency ratio improved 259 basis points as compared to
2004. This improvement is primarily a result of higher net interest income and
other revenues due to higher levels of owned receivables, partially offset by
the increase in total costs and expenses to support receivable growth. The
deterioration in the efficiency ratio on an operating basis for 2004 was
primarily attributable to an increase in operating expenses, including higher
intangible amortization and lower securitization related revenue partially
offset by higher net interest income and derivative income.
INCOME TAXES Our effective tax rates were as follows:
Year ended December 31, 2005 (successor).................... 33.5%
Year ended December 31, 2004 (successor).................... 34.0
March 29 through December 31, 2003 (successor).............. 33.7
January 1 through March 28, 2003 (predecessor).............. 42.5
The decrease in the effective tax rate in 2005 is attributable to lower state
tax rates and lower pretax income with low income housing tax credits remaining
constant. The effective tax rate for January 1 through March 28, 2003 was
adversely impacted by the non-deductibility of certain HSBC acquisition related
costs. The effective tax rate differs from the statutory Federal income tax rate
primarily because of the effects of state and local taxes and tax credits.
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SEGMENT RESULTS - MANAGED BASIS
--------------------------------------------------------------------------------
We have three reportable segments: Consumer, Credit Card Services and
International. Our Consumer segment consists of our consumer lending, mortgage
services, retail services and auto finance businesses. Our Credit Card Services
segment consists of our domestic MasterCard and Visa credit card business. Our
International segment consists of our foreign operations in the United Kingdom,
Canada, the Republic of Ireland Slovakia, the Czech Republic and Hungary. There
have been no changes in the basis of our segmentation or any changes in the
measurement of segment profit as compared with the presentation in our 2004 Form
10-K.
The accounting policies of the reportable segments are described in Note 2,
"Summary of Significant Accounting Policies," to the accompanying financial
statements. For segment reporting purposes, intersegment transactions have not
been eliminated. We generally account for transactions between segments as if
they were with third parties.
We have historically monitored our operations and evaluated trends on a managed
basis (a non-GAAP financial measure), which assumes that securitized receivables
have not been sold and are still on our balance sheet. This is because the
receivables that we securitize are subjected to underwriting standards
comparable to our owned portfolio, are serviced by operating personnel without
regard to ownership and result in a similar credit loss exposure for us. In
addition, we fund our operations and make decisions about allocating resources
such as capital on a managed basis.
When reporting on a managed basis, net interest income, provision for credit
losses and fee income related to receivables securitized are reclassified from
securitization related revenue in our owned statement of income into the
appropriate caption.
CONSUMER SEGMENT The following table summarizes the managed basis results for
our Consumer segment:
YEAR ENDED DECEMBER 31, 2005 2004 2003
------------------------------------------------------------------------------------------
(IN MILLIONS)
Net income.................................................. $ 1,498 $ 1,563 $ 1,061
Operating net income........................................ 1,498 1,247 1,061
Net interest income......................................... 6,887 7,699 7,333
Securitization related revenue.............................. (622) (1,433) 337
Fee and other income, excluding gain on the bulk sale of the
domestic private label receivable portfolio............... 1,194 638 664
Gain on bulk sale of private label receivable portfolio..... - 683 -
Intersegment revenues....................................... 108 101 107
Provision for credit losses................................. 2,461 2,575 4,275
Total costs and expenses, excluding settlement charge and
related expenses.......................................... 2,638 2,528 2,358
Receivables................................................. 108,345 87,839 87,104
Assets...................................................... 109,214 89,809 89,791
Net interest margin......................................... 7.09% 8.20% 8.59%
Return on average managed assets............................ 1.53 1.64 1.22
Our Consumer Segment reported higher operating net income in 2005 and 2004.
Operating net income is a non-GAAP financial measure of net income which
excludes the gain on the bulk sale of the domestic private label portfolio
(excluding retail sales contracts at our consumer lending business) and the
impact of adoption of FFIEC charge-off policies for this domestic private label
portfolio in 2004. In 2005, the increase in operating net income was primarily
due to higher fee and other income, higher securitization related revenue and a
lower provision for credit losses, partially offset by lower net interest income
and higher costs and
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expenses. The increase in fee and other income is due to gains on the daily
sales of domestic private label receivable originations to HSBC Bank USA and
receipt of servicing revenue for servicing this portfolio, partially offset by
lower fee income related to the sold receivables. Securitization related revenue
was higher due to lower amortization of prior period gains as a result of
reduced securitization levels. Costs and expenses were higher due to higher
salary expense and higher support services from affiliates, partially offset by
lower REO expenses as well as a lower estimate of exposure relating to accrued
finance charges associated with certain loan restructures.
Net interest income and net interest margin decreased in 2005 primarily due to a
shift in mix to lower yielding real estate secured receivables resulting from
significantly lower levels of private label receivables resulting from the
private label portfolio sale in December 2004 as well as organic growth of real
estate secured receivables. Also contributing to the decrease were lower yields
on real estate secured and auto finance receivables as a result of competitive
pressure on pricing and product expansion into near-prime consumer segments, as
well as the run-off of higher yielding real estate secured receivables,
including second lien loans, largely due to refinance activity. Our auto finance
business experienced lower yields as we have targeted higher credit quality
customers. Although higher credit quality receivables generate lower yields,
such receivables are expected to result in lower operating costs, delinquency
ratios and charge-off. The decreases in yield for our consumer segment
receivable portfolio discussed above were partially offset by higher pricing on
our variable rate products. A higher cost of funds due to a rising interest rate
environment also contributed to the decrease in net interest income and margin.
Our managed basis provision for credit losses, which includes both provision for
owned basis receivables and over-the-life provision for receivables serviced
with limited recourse, decreased during 2005 due to lower net charge-off levels
as a result of improved credit quality and the impact of the sale of the
domestic private label receivable portfolio in December 2004, as well as lower
securitization levels. We have experienced lower dollars of net charge-offs in
our owned portfolio during 2005 due to the sale of $12.2 billion of owned
domestic private label receivables in December 2004 and as a result of improved
credit quality. These factors more than offset the increased provision
requirements associated with receivable growth, the impact from Katrina and the
new bankruptcy legislation in the United States which, as discussed more fully
below, have resulted in a decrease to our owned provision for credit losses.
Over-the-life provision for credit losses for securitized receivables recorded
in any given period reflects the level and product mix of securitizations in
that period. Subsequent charge-offs of securitized receivables result in a
decrease in the over-the-life reserves without any corresponding increase to
managed loss provision. In 2005, we increased managed loss reserves as net
charge-offs were less than the provision for credit losses by $57 million. For
2004, we decreased managed loss reserves as net charge-offs were greater than
the provision for credit losses by $1,229 million.
Our managed basis provision for credit losses also reflects an estimate of
incremental credit loss exposure relating to Katrina. The incremental provision
for credit losses for Katrina in the Consumer Segment in 2005 was $130 million
and represents our best estimate of Katrina's impact on our loan portfolio. As
additional information becomes available relating to the financial condition of
our affected customers, the physical condition of the collateral for loans which
are secured by real estate and the resultant impact on customer payment
patterns, we will continue to review our estimate of credit loss exposure
relating to Katrina and any adjustments will be reported in earnings when they
become known. In an effort to assist our customers affected by the disaster, we
initiated various programs including extended payment arrangements for up to 90
days or more depending upon customer circumstances. These interest and fee
waivers were not material to the Consumer Segment's 2005 results.
As previously discussed, the United States enacted new bankruptcy legislation
which resulted in a spike in bankruptcy filings prior to the October 2005
effective date. We had been maintaining credit loss reserves in anticipation of
the impact this new legislation would have on net charge-offs. However, the
magnitude of the spike in bankruptcies experienced immediately before the new
legislation became effective was larger than anticipated. Our fourth quarter
results include an increase of approximately $113 million in our owned provision
for credit losses due to the spike in bankruptcy filings prior to the effective
date. While the
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Consumer Segment experienced an increase in the bankruptcy filings related to
this new legislation, the associated accounts have not yet migrated to
charge-off in accordance with our charge-off policy for real estate secured and
personal non-credit card receivables. This provision expense included in our
fourth quarter results relating to bankruptcies in our secured and personal
non-credit card portfolios will not begin to migrate to charge-off until 2006.
As expected, the number of bankruptcy filings subsequent to the enactment of
this new legislation has decreased dramatically. We believe that a portion of
this increase is an acceleration of charge-offs that would have otherwise been
experienced in future periods.
Compared to net income in 2003, the increase in operating net income in 2004 was
due to increases in net interest income and decreases in provision for credit
losses which were partially offset by higher operating expenses and
substantially lower securitization related revenue. Net interest income
increased primarily due to higher receivable levels. Net interest margin,
however, decreased primarily due to faster growth in lower yielding real estate
secured lending, lower yields on real estate secured, auto finance and personal
non-credit card receivables as a result of competitive pressure on pricing, as
well as the run off of higher yielding real estate secured receivables,
including second lien loans largely due to refinance activity. Our auto finance
business experienced lower yields as we have targeted lower yielding but higher
credit quality customers. These decreases were partially offset by lower cost of
funds. Securitization related revenue decreased in 2004 as a result of a
significant decline in receivables securitized, including the impact of higher
run-off due to shorter expected lives as a result of our decision to structure
all new collateralized funding transactions as secured financings beginning in
the third quarter of 2004. Securitization levels were also lower in 2004 as we
used funding from HSBC, including proceeds from sales of receivables, to assist
in the funding of our operations. Operating expenses increased in 2004 as the
result of additional operating costs to support the increased receivable levels,
including higher salaries and sales incentives. In December 2004, we adopted
FFIEC charge-off policies for our domestic private label credit card portfolio
(excluding retail sales contracts at our consumer lending business) which
resulted in a reduction to net income of $120 million and subsequently sold the
portfolio to HSBC Bank USA. We recorded a pre-tax gain of $663 million on the
sale. See "Credit Quality" and Note 4, "Sale of Domestic Private Label
Receivable Portfolio and Adoption of FFIEC Policies," to the accompanying
consolidated financial statements for further discussion of the adoption of
FFIEC charge-off policies and the portfolio sale.
Managed receivables increased 23 percent to $108.3 billion at December 31, 2005
as compared to $87.8 billion at December 31, 2004. We experienced strong growth
in 2005 in our real estate secured portfolio in both our correspondent and
branch-based consumer lending businesses. We have continued to focus on junior
lien loans through portfolio acquisitions and have expanded our sources for
purchasing newly originated loans from flow correspondents. Real estate secured
receivable levels at December 31, 2005 do not include $1.5 billion of
correspondent receivables purchased directly by HSBC Bank USA, a portion of
which we otherwise would have purchased. Growth in real estate secured
receivables was also supplemented by purchases from a single correspondent
relationship which totaled $1.1 billion in 2005. Also contributing to the
increase were purchases of $1.7 billion in 2005 from a portfolio acquisition
program. Our auto finance portfolio also reported growth due to strong organic
growth, principally in the near-prime portfolios. This came from newly
originated loans acquired from our dealer network, growth in the consumer direct
loan program and expanded distribution through alliance channels. Personal
non-credit card receivables increased from the prior year as we began to
increase the availability of this product in the second half of 2004 as a result
of an improving U.S. economy as well as the success of several large direct mail
campaigns that occurred in 2005.
Managed receivables increased 1 percent to $87.8 billion at December 31, 2004
compared to $87.1 billion at December 31, 2003. The rate of increase in managed
receivables was impacted by the sale of $15.6 billion in domestic private label
receivables to HSBC Bank USA in December of 2004. Had this sale not taken place,
managed receivables would have increased by $16.3 billion or 19 percent in 2004.
We experienced strong growth in 2004 in our real estate secured receivables in
both our correspondent and branch-based consumer lending businesses, which was
partially offset by $2.8 billion of correspondent receivables purchased directly
by HSBC Bank USA, a portion of which we otherwise would have purchased. Growth
in our correspondent
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business was supplemented by purchases from a single correspondent relationship
which totaled $2.6 billion in 2004. We also experienced growth in auto finance
receivables though our dealer network and increased direct mail solicitations.
Personal non-credit card receivables also experienced growth in 2004 as we began
to increase availability of this product in the second half of the year as a
result of an improving economy. Prior to the sale of the domestic portfolio in
December 2004, our private label receivables increased due to organic growth
through existing merchants and a $.5 billion portfolio acquisition.
Return on average managed assets ("ROMA") was 1.53 percent in 2005, 1.64 percent
in 2004 and 1.22 percent in 2003. On an operating basis, ROMA was 1.53 percent
in 2005, 1.32 percent in 2004 and 1.22 percent in 2003. The increase in the
operating ratio in 2005 and 2004 is due to the increase in net income discussed
above which grew faster than average managed assets.
In accordance with Federal Financial Institutions Examination Council ("FFIEC")
guidance, the required minimum monthly payment amounts for domestic private
label credit card accounts has changed. The implementation of these new
requirements began in the fourth quarter of 2005 and will be completed in the
first quarter of 2006. As previously discussed, we sell new domestic private
label receivable originations (excluding retail sales contracts) to HSBC Bank
USA on a daily basis. Estimates of the potential impact to the business are
based on numerous assumptions and take into account a number of factors which
are difficult to predict, such as changes in customer behavior, which will not
be fully known or understood until the changes are implemented. Based on current
estimates, we anticipate that these changes will reduce the premium associated
with these daily sales in 2006. It is not expected this reduction will have a
material impact on either the results of the Consumer Segment or our
consolidated results.
CREDIT CARD SERVICES SEGMENT The following table summarizes the managed basis
results for our Credit Card Services segment.
YEAR ENDED DECEMBER 31, 2005 2004 2003
-----------------------------------------------------------------------------------------
(IN MILLIONS)
Net income.................................................. $ 661 $ 380 $ 500
Operating net income........................................ 661 381 500
Net interest income......................................... 2,150 2,070 1,954
Securitization related revenue.............................. (192) (338) (6)
Fee and other income........................................ 2,016 1,731 1,537
Intersegment revenues....................................... 21 25 30
Provision for credit losses................................. 1,564 1,625 1,598
Total costs and expenses.................................... 1,370 1,238 1,099
Receivables................................................. 26,181 19,670 19,552
Assets...................................................... 27,109 20,049 22,505
Net interest margin......................................... 10.38% 10.00% 9.87%
Return on average managed assets............................ 3.34 1.82 2.44
In December 2005, our Credit Card Services Segment acquired Metris in an
all-cash transaction for $1.6 billion. This acquisition will expand our presence
in the near-prime credit card market and will strengthen our capabilities to
serve the full spectrum of credit card customers. This acquisition increased our
MasterCard/Visa receivables by $5.3 billion. Net income for the Credit Card
Services Segment includes the results of Metris from December 1, 2005 forward
and did not have a significant impact to the results of the Credit Card Services
segment in 2005.
Our Credit Card Services Segment reported higher net income in 2005. The
increase in net income was primarily due to higher fee and other income, higher
net interest income, higher securitization related revenue and lower provision
for credit losses partially offset by higher costs and expenses. Increases in
fee and other income resulted from portfolio growth and improved interchange
rates, as well as increased gains from the
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daily sales of new volume related to the MasterCard/Visa account relationships
purchased from HSBC Bank USA in July 2004. Net interest income increased as a
result of higher average receivables and growth in non-prime receivables. The
increase in net interest income from our receivables reflects increased pricing
on variable yield products and higher receivable balances. Net interest margin
increased in 2005 primarily due to increases in non-prime receivable levels,
higher pricing on variable rate products as well as other repricing initiatives.
Lower average interest earning assets due to lower levels of low yielding
investment securities and the impact of lower amortization from receivable
origination costs resulting from changes in the contractual marketing
responsibilities in July 2004 associated with the GM co-branded credit card also
contributed to the increase. These increases were partially offset by higher
interest expense. Although our non-prime receivables tend to have smaller
balances, they generate higher returns both in terms of net interest margin and
fee income. Higher costs and expenses were to support receivable growth and
increases in marketing expenses. The increase in marketing expenses was due to
higher non-prime marketing expense, investments in new marketing initiatives and
changes in contractual marketing responsibilities in July 2004 associated with
the domestic GM co-branded credit card.
The managed basis provision for credit losses decreased in 2005 due to improved
credit quality, partially offset by receivable growth as well as the increased
credit loss provision relating to the impact of Katrina and the increased
bankruptcy filings resulting from the new bankruptcy legislation in the United
States. Excluding the impact of Katrina and the increased bankruptcy filings,
provision for credit losses on an owned basis also decreased in 2005. We have
experienced higher dollars of net charge-offs in our owned portfolio due to
higher receivable levels as well as the increased credit card charge-offs in the
fourth quarter of 2005 which resulted from the spike in bankruptcy filings prior
to the October 2005 effective date of the new bankruptcy legislation. We had
been maintaining credit loss reserves in anticipation of the impact this new
legislation would have on net charge-offs. However, the magnitude of the spike
in bankruptcies experienced immediately before the new legislation became
effective was larger than anticipated which resulted in an additional $100
million credit loss provision being recorded during the third quarter of 2005.
Our fourth quarter results include an estimated $125 million in incremental
charge-offs of principal, interest and fees attributable to bankruptcy reform
which was offset by a release of our owned credit loss reserves of $125 million.
As expected, the number of bankruptcy filings subsequent to the enactment of
this new legislation has decreased dramatically. We believe that a portion of
the increase in charge-offs resulting from the higher bankruptcy filings is an
acceleration of charge-offs that would otherwise have been experienced in future
periods. For the year, we have increased our managed loss reserves by recording
loss provision greater than net charge-offs of $120 million in 2005.
Our managed basis provision for credit losses also reflects an estimate of
incremental credit loss exposure relating to Katrina. The incremental provision
for credit losses for Katrina in the Credit Card Services Segment in 2005 was
$55 million and represents our best estimate of Katrina's impact on our loan
portfolio. As additional information becomes available relating to the financial
condition of our affected customers and the resultant impact on customer payment
patterns, we will continue to review our estimate of credit loss exposure
relating to Katrina and any adjustments will be reported in earnings when they
become known. In an effort to assist our customers affected by the disaster, we
initiated various programs including extended payment arrangements and interest
and fee waivers for up to 90 days or more depending upon customer circumstances.
These interest and fee waivers were not material to the Credit Card Services
Segment's 2005 results.
Our Credit Card Services Segment reported lower net income and operating net
income in 2004. The decrease in net income was due to lower securitization
levels and higher operating expenses, particularly marketing expenses, partially
offset by increases in net interest income as well as fee and other income.
Increases in net interest income as well as fee and other income in 2004
resulted from higher non-prime receivable levels. Net interest margin increased
compared to 2003 due to higher non-prime receivable levels and lower funding
costs. Securitization related revenue declined as a result of a decline in
receivables securitized, including higher run-off due to higher principal
repayment rates. Our provision for credit losses was essentially flat in 2004 as
reductions due to improving credit quality and changes in securitization levels
were offset by higher levels of
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non-prime receivables which carry a higher reserve requirement and a corporate
adjustment to increase owned reserve levels. We increased managed loss reserves
by recording loss provision greater than net charge-offs of $123 million in
2004. As previously discussed, in December 2004, we adopted FFIEC charge-off
policies for the remainder of our domestic MasterCard and Visa portfolio, which
resulted in an immaterial reduction to net income. See "Credit Quality" for
further discussion of the FFIEC policies and the impact of their adoption.
Managed basis receivables increased 33 percent to $26.2 billion at December 31,
2005 compared to $19.7 billion at December 31, 2004. As discussed above, the
increase was primarily due to the acquisition of Metris in December 2005 which
increased our managed basis receivables by $5.3 billion. Organic growth in our
HSBC branded prime, Union Privilege and non-prime portfolios, partially offset
by the continued decline in certain older acquired portfolios, also contributed
to the increase. Managed basis receivables at December 31, 2004 were flat
compared to $19.6 billion at December 31, 2003. In 2004, increases in our AFL-
CIO Union Plus portfolios, non-prime and prime portfolios were substantially
offset by the continued decline in certain older acquired portfolios.
The increase in ROMA in 2005 is primarily due to the higher net income discussed
above as well as the impact of lower average managed assets. The decrease in
average managed assets is due to lower investment securities during 2005 as a
result of the elimination of investments dedicated to our credit card bank in
2003 resulting from our acquisition by HSBC. ROMA decreased in 2004 compared to
2003 reflecting the lower net income as discussed above.
In accordance with FFIEC guidance, our credit card services business adopted a
plan to phase in changes to the required minimum monthly payment amount and
limit certain fee billings for non-prime credit card accounts. The
implementation of these new requirements began in July 2005 with the
requirements fully phased in by December 31, 2005. Estimates of the potential
impact to the business are based on numerous assumptions and take into account a
number of factors which are difficult to predict, such as changes in customer
behavior and impact of other issuers implementing requirements, which will not
be fully known or understood until the changes have been in place for a period
of time. It is anticipated that the changes will result in decreased non-prime
credit card fee income and fluctuations in the provision for credit losses as
credit loss provisions for prime accounts will increase as a result of higher
required monthly payments while the non-prime provision decreases due to lower
levels of fees incurred by customers. Although we do not expect this will have a
material impact on our consolidated results, the impact to the Credit Card
Services Segment in 2006 will be material.
INTERNATIONAL SEGMENT The following table summarizes the managed basis results
for our International segment:
YEAR ENDED DECEMBER 31, 2005 2004 2003
-----------------------------------------------------------------------------------------
(IN MILLIONS)
Net (loss) income........................................... $ (5) $ 95 $ 170
Net interest income......................................... 907 797 753
Securitization related revenue.............................. 20 (88) 17
Fee and other income........................................ 563 503 380
Intersegment revenues....................................... 17 15 12
Provision for credit losses................................. 642 336 359
Total costs and expenses.................................... 847 726 530
Receivables................................................. 9,260 13,263 11,003
Assets...................................................... 10,109 14,236 11,923
Net interest margin......................................... 7.16% 6.83% 7.44%
Return on average managed assets............................ (.04) .76 1.57
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Our International Segment reported lower net income in 2005 and 2004 driven by a
significant decline in earnings at our U.K. subsidiary. Overall, the decrease in
net income reflects higher operating expenses, and in 2005, higher provision for
credit losses, partially offset by increased fee and other income, and higher
net interest income. Applying constant currency rates, which uses the average
rate of exchange for the 2004 period to translate current period net income, net
loss would have been higher by $4 million in 2005. Applying constant currency
rates for the 2003 period to translate 2004 income, net income for 2004 would
have been lower by $6 million.
Net interest income increased in 2005 and 2004 primarily due to higher average
interest earning assets. Net interest margin increased in 2005 due to increased
yields on credit cards due to repricing initiatives and interest-free balances
not being promoted as strongly in 2005 as in the past, partially offset by
run-off of higher yielding receivables, competitive pricing pressures holding
down yields on our personal loans in the U.K. and increased cost of funds. Net
interest margin decreased in 2004 as the run-off of higher yielding receivables,
competitive pricing pressures and higher cost of funds discussed above were
partially offset by increased yields on credit cards due to less promotion of
interest-free balances. Securitization related revenue increased in 2005 due to
lower amortization of prior period gains as a result of reduced securitization
levels, higher levels of receivable replenishments to support previously issued
securities in the U.K. as well as the recognition of residual balances
associated with certain expired securitization transactions. Securitization
related revenue declined in 2004 as a result of lower levels of securitized
receivables. Fee and other income increased in both years primarily due to
higher insurance revenues.
Provision for credit losses increased in 2005 primarily due to higher
delinquency and charge-off levels in the U.K. due to a general increase in
consumer bad debts in the U.K. market, including increased bankruptcies.
Provision for credit losses decreased in 2004 due to changes in securitization
levels, partially offset by a higher provision for credit losses on owned
receivables due to receivable growth and the higher delinquency and charge-off
levels in the U.K. discussed above. We increased managed loss reserves in 2005
by recording loss provision greater than net charge-offs of $145 million. In
2004, we decreased managed loss reserves by recording loss provision less than
net charge-offs of $29 million. Total costs and expenses increased in 2005 and
2004 due to higher expenses to support receivable growth and collection
activities, increased costs associated with branch expansions in Canada and
higher policyholder benefits because of increased insurance sales volumes. Total
costs and expenses in 2004 were also higher due to the full year impact of
operating costs associated with a 2003 private label portfolio acquisition.
We previously reported that as part of ongoing integration efforts with HSBC we
have been working with HSBC to determine if management efficiencies could be
achieved by transferring all or a portion of our U.K. and other European
operations to HBEU, a U.K. based subsidiary of HSBC, and/or one or more
unrelated third parties. In December 2005, we sold our U.K. credit card
business, including $2.5 billion of receivables ($3.1 billion on a managed
basis), the associated cardholder relationships and the related retained
interests in securitized credit card receivables to HBEU for an aggregate
purchase price of $3.0 billion. The purchase price, which was determined based
on a comparative analysis of sales of other credit card portfolios, was paid in
a combination of cash and $261 million of preferred stock issued by a subsidiary
of HBEU with a rate of one-year Sterling LIBOR, plus 1.30 percent. In addition
to the assets referred to above, the sale also included the account origination
platform, including the marketing and credit employees associated with this
function, as well as the lease associated with the credit card call center and
the related leaseholds and call center employees to provide customer continuity
after the transfer as well as to allow HBEU direct ownership and control of
origination and customer service. We have retained the collection operations
related to the credit card operations and have entered into a service level
agreement for a period of not less than two years to provide collection services
and other support services, including components of the compliance, financial
reporting and human resource functions, for the sold credit card operations to
HBEU for a fee. Additionally, the management teams of HBEU and our remaining
U.K. operations will be jointly involved in decision making involving card
marketing to ensure that growth objectives are met for both businesses. Because
the sale of this business is between affiliates under common control, the
premium received in excess of the book
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value of the assets transferred of $182 million, including the goodwill assigned
to this business, has been recorded as an increase to additional paid in capital
and has not been included in earnings. In future periods, the net interest
income, fee income and provision for credit losses related to the U.K. credit
card business will be reduced, while other income will be increased by the
receipt of servicing and support services revenue from HBEU. While we do not
anticipate that the net effect of this sale will result in a material reduction
of net income of our consolidated results, the impact will likely be material to
our International segment. We continue to evaluate strategic alternatives with
respect to our other U.K. and European operations.
Additionally, in a separate transaction in December 2005, we transferred our
information technology services employees in the U.K. to a subsidiary of HBEU.
As a result, subsequent to the transfer operating expenses relating to
information technology, which have previously been reported as salaries and
fringe benefits or other servicing and administrative expenses, are now billed
to us by HBEU and reported as support services from HSBC affiliates. During the
first quarter of 2006, we anticipate that the information technology equipment
in the U.K. will be sold to HBEU for book value.
Managed receivables of $9.3 billion at December 31, 2005 decreased 30 percent
compared to $13.3 billion at December 31, 2004. The decrease was primarily due
to the sale of the U.K. credit card business to HBEU in December 2005, which
included managed receivables of $3.1 billion. In addition to the sale of our
credit card operations in the U.K., our U.K. based unsecured receivable products
decreased in 2005 due to lower retail sales volume following a slow down in
retail consumer spending in the U.K. These decreases were partially offset by
growth in the receivable portfolio in our Canadian operations. Branch expansions
in Canada in 2005 resulted in strong secured and unsecured receivable growth.
Additionally, the Canadian auto finance program, which was introduced in the
second quarter of 2004, grew to a network of over 1,000 active dealer
relationships at December 31, 2005. Also contributing to the receivable growth
in Canada was the successful launch of a MasterCard/Visa credit card program.
Receivable growth at December 31, 2005 reflects negative foreign exchange
translation impacts of $.6 million compared to December 31, 2004 foreign
exchange rates. Receivable growth at December 31, 2004 reflects positive foreign
exchange translation impacts of $1 billion compared to December 31, 2003 foreign
exchange rates.
The decrease in ROMA for 2005 and 2004 reflects the lower net income as
discussed above as well as higher average managed assets primarily due to
receivable growth.
RECONCILIATION OF MANAGED BASIS SEGMENT RESULTS As discussed above, we have
historically monitored our operations on a managed basis. Therefore, an
adjustment is required to reconcile the managed financial information to our
reported financial information in our consolidated financial statements. This
adjustment reclassifies net interest income, fee income and loss provision into
securitization related revenue. See Note 22, "Business Segments," in the
accompanying consolidated financial statements for a reconciliation of our
managed basis segment results to managed basis and owned basis consolidated
totals.
CREDIT QUALITY
--------------------------------------------------------------------------------
DELINQUENCY AND CHARGE-OFF POLICIES AND PRACTICES Our delinquency and net
charge-off ratios reflect, among other factors, changes in the mix of loans in
our portfolio, the quality of our receivables, the average age of our loans, the
success of our collection and customer account management efforts, bankruptcy
trends, general economic conditions and significant catastrophic events such as
Katrina. The levels of personal bankruptcies also have a direct effect on the
asset quality of our overall portfolio and others in our industry.
Our credit and portfolio management procedures focus on risk-based pricing and
effective collection and customer account management efforts for each loan. We
believe our credit and portfolio management process gives us a reasonable basis
for predicting the credit quality of new accounts. This process is based on our
experience with numerous marketing, credit and risk management tests. We also
believe that our frequent and early contact with delinquent customers, as well
as restructuring and other customer account management techniques which are
designed to optimize account relationships, are helpful in maximizing customer
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collections. See Note 2, "Summary of Significant Accounting Policies," in the
accompanying consolidated financial statements for a description of our
charge-off and nonaccrual policies by product.
Our charge-off policies focus on maximizing the amount of cash collected from a
customer while not incurring excessive collection expenses on a customer who
will likely be ultimately uncollectible. We believe our policies are responsive
to the specific needs of the customer segment we serve. Our real estate and auto
finance charge-off policies consider customer behavior in that initiation of
foreclosure or repossession activities often prompts repayment of delinquent
balances. Our collection procedures and charge-off periods, however, are
designed to avoid ultimate foreclosure or repossession whenever it is reasonably
economically possible. Our MasterCard/Visa charge-off policy is consistent with
industry practice. Charge-off periods for our personal non-credit card product
and, prior to December 2004, our domestic private label credit card product were
designed to be responsive to our customer needs and may therefore be longer than
bank competitors who serve a different market. Our policies have generally been
consistently applied in all material respects. Our loss reserve estimates
consider our charge-off policies to ensure appropriate reserves exist for
products with longer charge-off lives. We believe our current charge-off
policies are appropriate and result in proper loss recognition.
DELINQUENCY - OWNED BASIS
Our policies and practices for the collection of consumer receivables, including
our customer account management policies and practices, permit us to reset the
contractual delinquency status of an account to current, based on indicia or
criteria which, in our judgment, evidence continued payment probability. When we
use a customer account management technique, we may treat the account as being
contractually current and will not reflect it as a delinquent account in our
delinquency statistics. However, if the account subsequently experiences payment
defaults and becomes at least two months contractually delinquent, it will be
reported in our delinquency ratios. See "Customer Account Management Policies
and Practices" for further detail of our practices.
The following table summarizes two-months-and-over contractual delinquency (as a
percent of consumer receivables):
2005 2004
--------------------------------------- ---------------------------------------
DEC. 31 SEPT. 30 JUNE 30 MARCH 31 DEC. 31 SEPT. 30 JUNE 30 MARCH 31
----------------------------------------------------------------------------------------------------------
Real estate secured.... 2.72% 2.51% 2.56% 2.62% 2.96% 3.27% 3.39% 3.87%
Auto finance........... 2.34 2.09 2.08 1.65 2.07 1.81 2.12 1.68
MasterCard/Visa(1)..... 3.66 4.46 4.14 4.60 4.88 5.84 5.83 5.90
Private label.......... 5.43 5.22 4.91 4.71 4.13 4.72 5.00 5.38
Personal non-credit
card................. 9.40 9.18 8.84 8.63 8.69 8.83 8.92 9.64
---- ---- ---- ---- ---- ---- ---- ----
Total consumer(1)...... 3.84% 3.78% 3.73% 3.78% 4.07% 4.43% 4.57% 5.01%
==== ==== ==== ==== ==== ==== ==== ====
---------------
(1) In December 2005, we completed the acquisition of Metris which included
receivables of $5.3 billion. This event had a significant impact on this
ratio. Excluding the receivables from the Metris acquisition from this
calculation, our consumer delinquency ratio for our MasterCard/Visa
portfolio was 4.01% and total consumer delinquency was 3.89%.
Compared to September 30, 2005, our total consumer delinquency increased 6 basis
points at December 31, 2005. The increase was due to higher delinquency levels
at December 31, 2005 for our real estate secured and personal non-credit card
receivable portfolios resulting from portfolio seasoning. The spike in
bankruptcy filings in the period leading up to the effective date of new
bankruptcy legislation in the United States, which will not begin to migrate to
charge-off until 2006 in accordance with our charge-off policies also has led to
increased delinquency. These increases were partially offset by the continuing
strong economy in the United States, better underwriting and improved quality of
originations. The increase in delinquency in our real estate secured portfolio
reflects maturation of recent receivable growth and, as discussed above, the
impact of the spike in bankruptcy filings, partially offset by the strong level
of recent originations, the recent trend of better
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quality new originations and a continuing strong economy. The increase in auto
finance delinquency is due to seasonal increases in delinquency during the
fourth quarter. Excluding the impact of the receivables acquired from Metris and
the sale of our U.K. credit card business in December 2005, our MasterCard/Visa
receivable delinquency ratio decreased 49 basis points as compared to the
September 2005 delinquency ratio. This decrease is a result of lower migration
to two-months-and over contractual delinquency as a result of the spike in
bankruptcy filings experienced in the period leading up to the effective date of
the new bankruptcy legislation as well as changes in receivable mix resulting
from lower securitization levels and the benefit of seasonal receivable growth.
The increase in private label delinquency (which primarily consists of our
foreign private label portfolio that was not sold to HSBC Bank USA in December
2004) reflects increased bankruptcy filings in the U.K. Personal non-credit card
delinquencies increased as a result of higher bankruptcy filings in both the
United States and the U.K., partially offset by improved collection efforts and
strong economic conditions in the U.S.
Compared to December 31, 2004, our total consumer delinquency ratio decreased 23
basis points generally as a result of better underwriting standards, improved
credit quality of originations and improvements in the economy in addition to
the impact of the factors discussed above.
See "Credit Quality Statistics - Managed Basis" for additional information
regarding our managed basis credit quality. See "Customer Account Management
Policies and Practices" regarding the treatment of restructured accounts and
accounts subject to forbearance and other customer account management tools. See
Note 2, "Summary of Significant Accounting Policies," for a detail of our
charge-off policy by product.
NET CHARGE-OFFS OF CONSUMER RECEIVABLES - OWNED BASIS
The following table summarizes net charge-off of consumer receivables as a
percent of average consumer receivables:
2005 2004
--------------------------------------------- ---------------------------------------------
QUARTER ENDED (ANNUALIZED) QUARTER ENDED (ANNUALIZED) 2003(1)
FULL -------------------------------------- FULL --------------------------------- FULL
YEAR DEC. 31 SEPT. 30 JUNE 30 MAR. 31 YEAR DEC. 31 SEPT. 30 JUNE 30 MAR. 31 YEAR
------------------------------------------------------------------------------------------------------------------------
Real estate secured....... .76% .66% .75% .78% .87% 1.10% 1.04% 1.19% 1.04% 1.15% .99%
Auto finance.............. 3.27 3.42 3.25 2.61 3.80 3.43 2.73 3.66 3.05 4.65 4.91
MasterCard/Visa(2)........ 7.12 7.99 6.24 6.93 7.17 8.85 8.44 8.50 9.91 8.66 9.18
Private label(2).......... 4.83 5.60 5.35 4.36 4.18 6.17 9.16 4.79 5.06 5.29 5.75
Personal non-credit
card.................... 7.88 7.59 8.01 7.77 8.18 9.75 8.06 9.50 10.59 11.17 9.89
---- ---- ---- ---- ---- ---- ---- ---- ----- ----- ----
Total consumer............ 3.03% 3.10% 2.93% 2.93% 3.15% 4.00% 4.04% 3.77% 4.02% 4.17% 4.06%
==== ==== ==== ==== ==== ==== ==== ==== ===== ===== ====
Real estate charge-offs
and REO expense as a
percent of average real
estate secured
receivables............. .87% .78% .88% .84% 1.01% 1.38% 1.17% 1.31% 1.47% 1.63% 1.42%
==== ==== ==== ==== ==== ==== ==== ==== ===== ===== ====
---------------
(1) We adopted FSP 144-1 in November 2003. The adoption increased real estate
charge-offs by $9.1 million and auto finance charge-offs by $1.2 million for
the quarter ended December 31, 2003. The adoption increased real estate
charge-offs by 7 basis points for the quarter ended December 31, 2003 and 1
basis point for the full year 2003, auto finance charge-offs by 12 basis
points for the quarter ended December 31, 2003 and 4 basis points for the
full year 2003, and total consumer charge-offs by 4 basis points for the
quarter ended December 31, 2003 and 1 basis point for the full year 2003.
The impact on prior periods was not material.
(2) The adoption of FFIEC charge-off policies for our domestic private label
(excluding retail sales contracts at our consumer lending business) and
MasterCard/Visa portfolios in December 2004 increased private label net
charge-offs by $155 million (432 basis points), MasterCard/Visa net
charge-offs by $3 million (9 basis points) and total consumer net charge-off
by $158 million (57 basis points) for the quarter ended December 31, 2004.
Full year, the adoption increased private label net charge-offs by 119 basis
points, MasterCard/Visa net charge-offs by 2 basis points and total consumer
net charge-offs by 16 basis points.
Net charge-offs as a percentage of average consumer receivables decreased 97
basis points for the full year of 2005 as compared to the full year of 2004. The
net charge-off ratio for full year 2004 was impacted by the adoption of FFIEC
charge-off policies for our domestic private label (excluding retail sales
contracts at our consumer lending business) and MasterCard/Visa portfolios.
Excluding the additional charge-offs in 2004
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resulting from the adoption of these FFIEC policies, net charge-offs for the
full year 2005 decreased 81 basis points compared to 2004 as a result of
receivable growth, the positive impact from the lower delinquency levels we have
experienced as a result of a strong economy as well as improved credit quality
of originations. This was partially offset by the increased charge-offs in the
fourth quarter of 2005 for our MasterCard/Visa receivable portfolio resulting
from the spike in bankruptcy filings prior to the effective date of new
bankruptcy legislation in the United States. Our real estate secured portfolio
experienced a decrease in net charge-offs for full year 2005 reflecting
receivables growth, the recent trend of better quality in new originations and
continuing strong economic conditions. The decrease in the auto finance ratio
for the full year 2005 reflects receivable growth with improved credit quality
of originations, improved collections and better underwriting standards. The
decrease in the MasterCard/Visa and personal non-credit card receivable net
charge-off ratios reflects the positive impact of changes in receivable mix
resulting from lower securitization levels and continued improved credit
quality. As discussed above, the decrease in the MasterCard/Visa ratio was
partially offset by increased net charge-offs resulting from higher
bankruptcies. The net charge-off ratio for the private label portfolio for the
full year 2004 includes the domestic private label portfolio sold to HSBC Bank
USA which contributed 242 basis points to the ratio. The net charge-off ratio
for our private label receivables for the full year 2005 consists primarily of
our foreign private label portfolio which deteriorated in 2005 as a result of a
general increase in consumer bad debts in the U.K. markets, including increased
bankruptcies.
We experienced a decrease in overall net charge-off dollars in 2005. This was
primarily due to lower delinquency levels we have experienced as a result of the
strong economy as well as improved credit quality of originations. These
improvements were partially offset by higher receivable levels in 2005 as well
as higher net charge-offs in the fourth quarter of 2005 of an estimated $125
million for our MasterCard/Visa receivable portfolio resulting from the
increased bankruptcy filings as discussed above. While our real estate secured,
auto finance and personal non-credit card receivable portfolios also experienced
higher bankruptcy filings in the period leading up to the effective date of the
new bankruptcy legislation in the United States, these accounts will not begin
to migrate to charge-off until 2006 in accordance with our charge-off policy for
these receivable products. As expected, the number of bankruptcy filings
subsequent to the enactment of this new legislation have decreased dramatically.
We believe that a portion of the increase in charge-offs resulting from the
higher bankruptcy filings is an acceleration of charge-offs that would otherwise
have been experienced in future periods.
The decrease in real estate charge-offs and REO expense as a percent of average
real estate secured receivables in 2005 from the 2004 ratio was primarily due to
strong receivable growth which will not season for a period of time, the
continuing strong economy and better credit quality of recent originations. As
discussed above, the 2005 ratio was not negatively impacted by the increased
filings associated with the new bankruptcy legislation in the United States due
to the timing of the bankruptcy filings and our charge-off policy for real
estate secured receivables.
Net charge-offs as a percentage of average consumer receivables decreased for
the full year of 2004 as compared to full year 2003 as the lower delinquency
levels we experienced due to an improving economy had an impact on charge-offs.
Average receivable growth also positively impacted the ratios. The decrease in
our net charge-off percentage was reduced by the adoption of FFIEC charge-off
policies for our domestic private label (excluding consumer lending retail sales
contracts) and MasterCard/Visa portfolios. Excluding the additional charge-offs
resulting from the adoption of these FFIEC policies, net charge-offs for the
full year 2004 decreased 22 basis points compared to 2003. Our real estate
secured portfolio experienced increases in net charge-offs reflecting lower
estimates of net realizable value as a result of process changes in 2004 to
better estimate property values at the time of foreclosure. The decrease in the
auto finance ratio reflects receivable growth with improved credit quality of
originations, improved collections and better underwriting standards. The
decrease in the MasterCard/Visa ratio reflects changes in receivable mix and
improved credit quality of originations. The decrease in net charge-offs in the
personal non-credit card portfolio is a result of improved credit quality and
receivable growth as well as improved economic conditions.
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While net consumer charge-offs as a percentage of average receivables decreased
during 2004, we experienced an increase in overall net charge-off dollars in
2004. This is due to higher delinquencies due to adverse economic conditions
which existed in 2003 migrating to charge-off in 2004 as well as to higher
receivable levels in 2004.
The decrease in real estate charge-offs and REO expense as a percent of average
real estate secured receivables in 2004 over the 2003 ratio was the result of
the improved economy, better credit quality of recent originations and fewer
bankruptcy filings in 2004.
See "Credit Quality Statistics - Managed Basis" for additional information
regarding our managed basis credit quality.
OWNED NONPERFORMING ASSETS
AT DECEMBER 31, 2005 2004 2003
--------------------------------------------------------------------------------------
(IN MILLIONS)
Nonaccrual receivables...................................... $3,533 $3,012 $3,144
Accruing consumer receivables 90 or more days delinquent.... 621 507 904
Renegotiated commercial loans............................... - 2 2
------ ------ ------
Total nonperforming receivables............................. 4,154 3,521 4,050
Real estate owned........................................... 510 587 631
------ ------ ------
Total nonperforming assets.................................. $4,664 $4,108 $4,681
====== ====== ======
The increase in total nonperforming assets is primarily due to the receivable
growth we have experienced in 2005 as well as the impact of the increased
bankruptcy filings on our secured and personal non-credit card receivable
portfolios. Total nonperforming assets at December 31, 2004 decreased due to
improved credit quality and collection efforts as well as the bulk sale of
domestic private label receivables to HSBC Bank USA in December 2004, partially
offset by growth. Consistent with industry practice, accruing consumer
receivables 90 or more days delinquent includes domestic MasterCard/Visa
receivables and, for December 31, 2003, our domestic private label credit card
receivables.
CREDIT LOSS RESERVES We maintain credit loss reserves to cover probable losses
of principal, interest and fees, including late, overlimit and annual fees.
Credit loss reserves are based on a range of estimates and are intended to be
adequate but not excessive. We estimate probable losses for owned consumer
receivables 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. This analysis considers delinquency status, loss
experience and severity and takes into account whether loans are in bankruptcy,
have been restructured or rewritten, or are subject to forbearance, an external
debt management plan, hardship, modification, extension or deferment. Our credit
loss reserves also take into consideration the loss severity expected based on
the underlying collateral, if any, for the loan in the event of default.
Delinquency status may be affected by customer account management policies and
practices, such as the restructure of accounts, forbearance agreements, extended
payment plans, modification arrangements, external debt management programs,
loan rewrites and deferments. If customer account management policies, or
changes thereto, shift loans from a "higher" delinquency bucket to a "lower"
delinquency bucket, this will be reflected in our roll rate statistics. To the
extent that restructured accounts have a greater propensity to roll to higher
delinquency buckets, this will be captured in the roll rates. Since the loss
reserve is computed based on the composite of all of these calculations, this
increase in roll rate will be applied to receivables in all respective
delinquency buckets, which will increase the overall reserve level. In addition,
loss reserves on consumer receivables are maintained to reflect our judgment of
portfolio risk factors that may not be fully reflected in the statistical roll
rate calculation. Risk factors considered in establishing loss reserves on
consumer receivables include recent growth, product mix, bankruptcy trends,
geographic concentrations, economic conditions, portfolio seasoning, account
management policies and practices, current levels of charge-offs and
delinquencies, changes in laws
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and regulations and other items which can affect consumer payment patterns on
outstanding receivables, such as the impact of Katrina.
While our credit loss reserves are available to absorb losses in the entire
portfolio, we specifically consider the credit quality and other risk factors
for each of our products. We recognize the different inherent loss
characteristics in each of our products as well as customer account management
policies and practices and risk management/collection practices. Charge-off
policies are also considered when establishing loss reserve requirements to
ensure the appropriate reserves exist for products with longer charge-off
periods. We also consider key ratios such as reserves to nonperforming loans and
reserves as a percentage of net charge-offs in developing our loss reserve
estimate. Loss reserve estimates are reviewed periodically and adjustments are
reported in earnings when they become known. As these estimates are influenced
by factors outside of our control, such as consumer payment patterns and
economic conditions, there is uncertainty inherent in these estimates, making it
reasonably possible that they could change.
The following table sets forth owned basis credit loss reserves for the periods
indicated:
AT DECEMBER 31,
------------------------------------------
2005 2004 2003 2002 2001
----------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Owned credit loss reserves........................ $4,521 $3,625 $3,793 $3,333 $2,663
Reserves as a percent of receivables.............. 3.23% 3.39% 4.11% 4.04% 3.33%
Reserves as a percent of net charge-offs.......... 123.8(2) 89.9(1) 105.7 106.5 110.5
Reserves as a percent of nonperforming loans...... 108.8 103.0 93.7 94.5 92.7
---------------
(1) In December 2004, we adopted FFIEC charge-off policies for our domestic
private label (excluding retail sales contracts at our consumer lending
business) and MasterCard/Visa portfolios and subsequently sold this domestic
private label receivable portfolio. These events had a significant impact on
this ratio. Reserves as a percentage of net charge-offs excluding net
charge-offs associated with the sold domestic private label portfolio and
charge-off relating to the adoption of FFIEC was 109.2% at December 31,
2004.
(2) The acquisition of Metris in December 2005 has positively impacted this
ratio. Reserves as a percentage of net charge-offs excluding Metris was
118.2 percent.
Owned credit loss reserve levels at December 31, 2005, reflect the additional
reserve requirements resulting from higher levels of owned receivables,
including lower securitization levels, higher delinquency levels in our
portfolios driven by growth, the impact of Katrina and minimum monthly payment
changes, additional reserves resulting from the Metris acquisition and the
higher levels of personal bankruptcy filings in both the United States and the
U.K., partially offset by improved asset quality. Credit loss reserves at
December 31, 2005 also reflect the sale of our U.K. credit card business in
December 2005 which decreased credit loss reserves by $104 million. In 2005, we
recorded owned loss provision greater than net charge-offs of $890 million.
Owned credit loss reserve levels at December 31, 2004 reflect the sale of our
domestic private label portfolio (excluding retail sales contracts at our
consumer lending business) which had decreased credit loss reserves by $505
million. Excluding this sale, owned credit loss reserves would have increased
during 2004 reflecting growth in our loan portfolio partially offset by improved
asset quality. In 2004, we recorded owned loss provision greater than net
charge-offs of $301 million. Excluding the impact of adopting FFIEC charge-off
policies for owned domestic private label (excluding retail sales contracts at
our consumer lending business) and MasterCard/Visa portfolios, we recorded owned
loss provision $421 million greater than net charge-offs in 2004.
Beginning in 2004 and continuing in 2005, we have experienced a shift in our
loan portfolio to higher credit quality and lower yielding receivables,
particularly real estate secured and auto finance receivables. Reserves as a
percentage of receivables at December 31, 2005 and 2004 were lower than at
December 31, 2003 as a result of portfolio growth and improved credit quality,
partially offset in 2005 by the impact of additional credit loss reserves
resulting from the impact of Katrina, minimum monthly payment changes and
increased bankruptcy filings. Reserves as a percentage of receivables at
December 31, 2003 were higher than at December 31, 2002 as a result of the sale
of $2.8 billion of higher quality real estate secured loans to HSBC
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Bank USA in December 2003. Had this sale not occurred, reserves as a percentage
of receivables at December 2003 would have been lower than 2002 as a result of
improving credit quality in the latter half of 2003 as delinquency rates
stabilized and charge-off levels began to improve. The trends in the reserve
ratios for 2003 and 2002 reflect the impact of the weak economy, higher
delinquency levels, and uncertainty as to the ultimate impact the weakened
economy would have on delinquency and charge-off levels.
Reserves as a percentage of nonperforming loans increased in 2005. While
nonperforming loans increased in 2005 as discussed above, reserve levels in 2005
increased at a more rapid pace due to receivable growth, the additional reserve
requirements related to Katrina and impact of increased bankruptcy filings on
our secured receivable and personal non-credit card receivable portfolios, which
will not begin to migrate to charge-off until 2006. Reserves as a percentage of
nonperforming loans increased in 2004 as nonperforming loans declined due to
improved credit quality and the private label receivable sale while loss reserve
levels declined at a slower pace due to receivable growth.
Reserves as a percentage of net charge-offs also increased in 2005. As discussed
above, the 2005 ratio was significantly impacted by the acquisition of Metris
and the 2004 ratio was significantly impacted by both the sale of our domestic
private label receivable portfolio (excluding retail sales contracts) in
December 2004 as well as the adoption of FFEIC charge-off policies for our
domestic private label (excluding retail sales contracts) and MasterCard/Visa
portfolios. Excluding these items, reserves as a percentage of net charge-offs
increased 900 basis points. While both our reserve levels at December 31, 2005
and net charge-offs in 2005 were higher than 2004, our reserve levels grew for
the reasons discussed above more rapidly than our net charge-offs.
For securitized receivables, we also record a provision for estimated probable
losses that we expect to incur under the recourse provisions. The following
table sets forth managed credit loss reserves for the periods indicated:
AT DECEMBER 31, 2005 2004 2003 2002 2001
----------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS
Managed credit loss reserves......................
$4,736 $4,515 $6,167 $5,092 $3,811
Reserves as a percent of receivables..............
3.29% 3.73% 5.20% 4.74% 3.78%
Reserves as a percent of net charge-offs..........
108.6(2) 79.6(1) 117.4 113.8 110.7
Reserves as a percent of nonperforming loans......
108.8 108.4 118.0 112.6 105.0
---------------
(1) In December 2004 we adopted FFIEC charge-off policies for our domestic
private label (excluding retail sales contracts at our consumer lending
business) and MasterCard/Visa portfolios and subsequently sold this domestic
private label receivable portfolio. These events had a significant impact on
this ratio. Reserves as a percentage of net charge-offs excluding net
charge-offs associated with the sold domestic private label portfolio and
charge-off relating to the adoption of FFIEC policies was 96.0% on a managed
basis at December 31, 2004.
(2) The acquisition of Metris in December 2005 has positively impacted this
ratio. Reserves as a percentage of net charge-offs excluding Metris was
103.9 percent.
Managed credit loss reserves at December 31, 2005 also increased as the
increases in our owned credit loss reserves as discussed above were offset by
lower reserves on securitized receivables due to run-off and the decision in the
third quarter of 2004 to structure new collateralized funding transactions as
secured financings and the December 2004 domestic private label receivable sale.
Securitized receivables of $4.1 billion at December 31, 2005 decreased $10.1
billion from December 31, 2004.
See the "Analysis of Credit Loss Reserves Activity," "Reconciliations to GAAP
Financial Measures" and Note 7, "Credit Loss Reserves," to the accompanying
consolidated financial statements for additional information regarding our owned
basis and managed basis loss reserves.
CUSTOMER ACCOUNT MANAGEMENT POLICIES AND PRACTICES Our policies and practices
for the collection of consumer receivables, including our customer account
management policies and practices, permit us to reset the contractual
delinquency status of an account to current, based on indicia or criteria which,
in our
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judgment, evidence continued payment probability. Such policies and practices
vary by product and are designed to manage customer relationships, maximize
collection opportunities and avoid foreclosure or repossession if reasonably
possible. If the account subsequently experiences payment defaults, it will
again become contractually delinquent.
In the third quarter of 2003, we implemented certain changes to our
restructuring policies. These changes were intended to eliminate and/or
streamline exception provisions to our existing policies and were generally
effective for receivables originated or acquired after January 1, 2003.
Receivables originated or acquired prior to January 1, 2003 generally are not
subject to the revised restructure and customer account management policies.
However, for ease of administration, in the third quarter of 2003, our Mortgage
Services business elected to adopt uniform policies for all products regardless
of the date an account was originated or acquired. Implementation of the uniform
policy by Mortgage Services had the effect of only counting restructures
occurring on or after January 1, 2003 in assessing restructure eligibility for
purposes of the limitation that no account may be restructured more than four
times in a rolling sixty-month period. Other business units may also elect to
adopt uniform policies. The changes adopted in the third quarter of 2003 have
not had a significant impact on our business model or on our results of
operations as these changes have generally been phased in as new receivables
were originated or acquired. As discussed in more detail below, we also revised
certain policies for our domestic private label credit card and MasterCard and
Visa portfolios in December 2004.
As discussed previously and described more fully in the table below, we adopted
FFIEC account management policies regarding restructuring of past due accounts
for our domestic private label credit card and MasterCard/Visa portfolios in
December 2004. These changes have not had a significant impact on our business
model or on our results of operations.
Approximately two-thirds of all restructured receivables are secured products,
which in general have less loss severity exposure because of the underlying
collateral. Credit loss reserves take into account whether loans have been
restructured, rewritten or are subject to forbearance, an external debt
management plan, modification, extension or deferment. Our credit loss reserves
also take into consideration the loss severity expected based on the underlying
collateral, if any, for the loan.
Our restructuring policies and practices vary by product and are described in
the table that follows and reflect the revisions from the adoption of FFIEC
charge-off and account management policies for our domestic private label
(excluding retail sales contracts at our consumer lending business) and
MasterCard/Visa receivables in December 2004. The fact that the restructuring
criteria may be met for a particular account does not require us to restructure
that account, and the extent to which we restructure accounts that are eligible
under the criteria will vary depending upon our view of prevailing economic
conditions and other factors which may change from period to period. In
addition, for some products, accounts may be restructured without receipt of a
payment in certain special circumstances (e.g. upon reaffirmation of a debt
owed to us in connection with a Chapter 7 bankruptcy proceeding). We use account
restructuring as an account and customer management tool in an effort to
increase the value of our account relationships, and accordingly, the
application of this tool is subject to complexities, variations and changes from
time to time. These policies and practices are continually under review and
assessment to assure that they meet the goals outlined above, and accordingly,
we modify or permit exceptions to these general policies and practices from time
to time. In addition, exceptions to these policies and practices may be made in
specific situations in response to legal or regulatory agreements or orders.
In the policies summarized below, "hardship restructures" and "workout
restructures" refer to situations in which the payment and/or interest rate may
be modified on a temporary or permanent basis. In each case, the contractual
delinquency status is reset to current. "External debt management plans" refers
to situations in which consumers receive assistance in negotiating or scheduling
debt repayment through public or private agencies.
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RESTRUCTURING POLICIES AND PRACTICES
HISTORICAL RESTRUCTURING POLICIES FOLLOWING CHANGES IMPLEMENTED
AND PRACTICES(1),(2),(3) IN THE THIRD QUARTER 2003 AND IN DECEMBER 2004(1),(2),(3)
---------------------------------------------------------------------------------------------------------
REAL ESTATE SECURED REAL ESTATE SECURED
Real Estate - Overall Real Estate - Overall
- An account may be restructured if we - Accounts may be restructured upon receipt of two
receive two qualifying payments within qualifying payments within the 60 days preceding the
the 60 days preceding the restructure; restructure
we may restructure accounts in hardship, - Accounts generally are not eligible for restructure
disaster or strike situations with one until nine months after origination
qualifying payment or no payments - Accounts will be limited to four collection
- Accounts that have filed for Chapter 7 restructures in a rolling sixty-month period
bankruptcy protection may be - Accounts whose borrowers have filed for Chapter 7
restructured upon receipt of a signed bankruptcy protection may be restructured upon
reaffirmation agreement receipt of a signed reaffirmation agreement
- Accounts subject to a Chapter 13 plan - Accounts whose borrowers are subject to a Chapter 13
filed with a bankruptcy court generally plan filed with a bankruptcy court generally may be
require one qualifying payment to be restructured upon receipt of one qualifying payment
restructured - Except for bankruptcy reaffirmation and filed Chapter
- Except for bankruptcy reaffirmation and 13 plans, accounts will generally not be
filed Chapter 13 plans, agreed automatic restructured more than once in a twelve-month period
payment withdrawal or - Accounts whose borrowers agree to pay by automatic
hardship/disaster/strike, accounts are withdrawal are generally restructured upon receipt
generally limited to one restructure of one qualifying payment after initial
every twelve-months authorization for automatic withdrawal(4)
- Accounts generally are not eligible for
restructure until they are on the books
for at least six months
Real Estate - Consumer Lending Real Estate - Mortgage Services(5)
- Accounts whose borrowers agree to pay by - Accounts will generally not be eligible for
automatic withdrawal are generally restructure until nine months after origination and
restructured upon receipt of one six months after acquisition
qualifying payment after initial
authorization for automatic withdrawal
AUTO FINANCE AUTO FINANCE
- Accounts may be extended if we receive - Accounts may generally be extended upon receipt of
one qualifying payment within the 60 two qualifying payments within the 60 days preceding
days preceding the extension the extension
- Accounts may be extended no more than - Accounts may be extended by no more than three months
three months at a time and by no more at a time
than three months in any twelve-month - Accounts will be limited to four extensions in a
period rolling sixty-month period, but in no case will an
- Extensions are limited to six months over account be extended more than a total of six months
the contractual life over the life of the account
- Accounts that have filed for Chapter 7 - Accounts will be limited to one extension every six
bankruptcy protection may be months
restructured upon receipt of a signed - Accounts will not be eligible for extension until
reaffirmation agreement
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RESTRUCTURING POLICIES AND PRACTICES
HISTORICAL RESTRUCTURING POLICIES FOLLOWING CHANGES IMPLEMENTED
AND PRACTICES(1),(2),(3) IN THE THIRD QUARTER 2003 AND IN DECEMBER 2004(1),(2),(3)
---------------------------------------------------------------------------------------------------------
- Accounts whose borrowers are subject to a they are on the books for at least six months
Chapter 13 plan may be restructured upon - Accounts whose borrowers have filed for Chapter 7
filing of the plan with a bankruptcy bankruptcy protection may be restructured upon
court receipt of a signed reaffirmation agreement
- Accounts whose borrowers are subject to a Chapter 13
plan may be restructured upon filing of the plan
with the bankruptcy court.
MASTERCARD AND VISA MASTERCARD AND VISA
- Typically, accounts qualify for Accounts originated between January 2003 - December
restructuring if we receive two or three 2004
qualifying payments prior to the - Accounts typically qualified for restructuring if we
restructure, but accounts in approved received two or three qualifying payments prior to
external debt management programs may the restructure, but accounts in approved external
generally be restructured upon receipt debt management programs could generally be
of one qualifying payment restructured upon receipt of one qualifying payment.
- Generally, accounts may be restructured - Generally, accounts could have been restructured once
once every six months every six months.
Beginning in December 2004, all accounts regardless of
origination date
- Domestic accounts qualify for restructuring if we
receive three consecutive minimum monthly payments
or a lump sum equivalent.
- Domestic accounts qualify for restructuring if the
account has been in existence for a minimum of nine
months and the account has not been restructured in
the prior twelve months and not more than once in
the prior five years.
- Domestic accounts entering third party debt
counseling programs are limited to one restructure
in a five-year period in addition to the general
limits of one restructure in a twelve-month period
and two restructures in a five-year period.
PRIVATE LABEL(6) PRIVATE LABEL(6)
Private Label - Overall Private Label - Overall
- An account may generally be restructured Prior to December 2004 for accounts originated after
if we receive one or more qualifying October 2002
payments, depending upon the merchant. - For certain merchants, receipt of two or three
- Restructuring is limited to once every qualifying payments was required, except accounts in
six months (or longer, depending upon an approved external debt management program could
the merchant) for revolving accounts and be restructured upon receipt of one qualifying
once every twelve-months for closed-end payment.
accounts
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RESTRUCTURING POLICIES AND PRACTICES
HISTORICAL RESTRUCTURING POLICIES FOLLOWING CHANGES IMPLEMENTED
AND PRACTICES(1),(2),(3) IN THE THIRD QUARTER 2003 AND IN DECEMBER 2004(1),(2),(3)
---------------------------------------------------------------------------------------------------------
- Accounts must have been on the books for at least
nine months to be restructured and a minimum of two
qualifying payments were received within the 60 days
preceding the restructure.
- Accounts were not eligible for subsequent restructure
until twelve months after a prior restructure and
upon receipt of three qualifying payments within the
90 days preceding the restructure.
Beginning in December 2004, all accounts regardless of
origination date
- Domestic accounts qualify for restructuring if we
receive three consecutive minimum monthly payments
or a lump sum equivalent.
- Domestic accounts qualify for restructuring if the
account has been in existence for a minimum of nine
months and the account has not been restructured in
the prior twelve months and not more than once in
the prior five years.
- Domestic accounts entering a workout program,
including internal and third party debt counseling
programs, are limited to one restructure in a
five-year period in addition to the general limits
of one restructure in a twelve-month period and two
restructures in a five-year period.
Private Label - Consumer Lending Retail
Sales
Contracts Private Label - Consumer Lending Retail Sales Contracts
- Accounts may be restructured if we - Accounts may be restructured upon receipt of two
receive one qualifying payment within qualifying payments within the 60 days preceding the
the 60 days preceding the restructure; restructure
may restructure accounts in a - Accounts will be limited to one restructure every six
hardship/disaster/strike situation with months
one qualifying payment or no payments - Accounts will be limited to four collection
- If an account is never more than 90 days restructures in a rolling sixty-month period
delinquent, it may generally be - Accounts will not be eligible for restructure until
restructured up to three times per year six months after origination
- If an account is ever more than 90 days
delinquent, generally it may be
restructured with one qualifying payment
no more than four times over its life;
however, generally the account may
thereafter be restructured if two
qualifying payments are received
- Accounts subject to programs for hardship
or strike may require only the receipt
of reduced
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RESTRUCTURING POLICIES AND PRACTICES
HISTORICAL RESTRUCTURING POLICIES FOLLOWING CHANGES IMPLEMENTED
AND PRACTICES(1),(2),(3) IN THE THIRD QUARTER 2003 AND IN DECEMBER 2004(1),(2),(3)
---------------------------------------------------------------------------------------------------------
payments in order to be restructured;
disaster may be restructured with no
payments
PERSONAL NON-CREDIT CARD PERSONAL NON-CREDIT CARD
- Accounts may be restructured if we - Accounts may be restructured upon receipt of two
receive one qualifying payment within qualifying payments within the 60 days preceding the
the 60 days preceding the restructure; restructure
may restructure accounts in a - Accounts will be limited to one restructure every six
hardship/disaster/strike situation with months
one qualifying payment or no payments - Accounts will be limited to four collection
- If an account is never more than 90 days restructures in a rolling sixty-month period
delinquent, it may generally be - Accounts will not be eligible for restructure until
restructured up to three times per year six months after origination
- If an account is ever more than 90 days
delinquent, generally it may be
restructured with one qualifying payment
no more than four times over its life;
however, generally the account may
thereafter be restructured if two
qualifying payments are received
- Accounts subject to programs for hardship
or strike may require only the receipt
of reduced payments in order to be
restructured; disaster may be
restructured with no payments
---------------
(1) We employ account restructuring and other customer account management
policies and practices as flexible customer account management tools as
criteria may vary by product line. In addition to variances in criteria by
product, criteria may also vary within a product line. Also, we continually
review our product lines and assess restructuring criteria and they are
subject to modification or exceptions from time to time. Accordingly, the
description of our account restructuring policies or practices provided in
this table should be taken only as general guidance to the restructuring
approach taken within each product line, and not as assurance that accounts
not meeting these criteria will never be restructured, that every account
meeting these criteria will in fact be restructured or that these criteria
will not change or that exceptions will not be made in individual cases. In
addition, in an effort to determine optimal customer account management
strategies, management may run more conservative tests on some or all
accounts in a product line for fixed periods of time in order to evaluate
the impact of alternative policies and practices.
(2) For our United Kingdom business, all portfolios have a consistent account
restructure policy. An account may be restructured if we receive two or more
qualifying payments within two calendar months, limited to one restructure
every 12 months, with a lifetime limit of three times. In hardship
situations an account may be restructured if a customer makes three
consecutive qualifying monthly payments within the last three calendar
months. Only one hardship restructure is permitted in the life of a loan.
There were no changes to the restructure policies of our United Kingdom
business in 2005 or 2004.
(3) Historically, policy changes are not applied to the entire portfolio on the
date of implementation but are applied to new, or recently originated or
acquired accounts. However, the policies adopted in the third quarter of
2003 for the mortgage services business and the fourth quarter of 2004 for
the domestic private label (excluding retail sales contracts) and
MasterCard/Visa credit card portfolios were applied more broadly. The policy
changes for the mortgage services business which occurred in the third
quarter of 2003, unless otherwise noted, were generally applied to accounts
originated or acquired after January 1, 2003 and the historical
restructuring policies and practices are effective for all accounts
originated or acquired prior to January 1, 2003. Implementation of this
uniform policy had the effect of only counting restructures occurring on or
after January 1, 2003 in assessing restructure eligibility for the purpose
of the limitation that no account may be restructured more than four times
in a rolling 60 month period. These policy changes adopted in the third
quarter of 2003 did not have a significant impact on our business model or
results of operations as the changes are, in effect, phased in as
receivables were originated or acquired. For the adoption of FFIEC policies
which occurred in the fourth quarter of 2004, the policies were effective
immediately for all receivables in the domestic private label credit card
and the MasterCard and Visa portfolios. Other business units may also elect
to adopt uniform policies in future periods.
(4) Our mortgage services business implemented this policy for all accounts
effective March 1, 2004.
(5) Prior to January 1, 2003, accounts that had made at least six qualifying
payments during the life of the loan and that agreed to pay by automatic
withdrawal were generally restructured with one qualifying payment.
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(6) For our Canadian business, private label accounts are limited to one
restructure every four months and if originated or acquired after January 1,
2003, two qualifying payments must be received, the account must be on the
books for at least six months, at least six months must have elapsed since
the last restructure, and there may be no more than four restructures in a
rolling 60 month period.
In addition to our restructuring policies and practices, we employ other
customer account management techniques, which we typically use on a more limited
basis, that are similarly designed to manage customer relationships, maximize
collection opportunities and avoid foreclosure or repossession if reasonably
possible. These additional customer account management techniques include, at
our discretion, actions such as extended payment arrangements, approved external
debt management plans, forbearance, modifications, loan rewrites and/or
deferment pending a change in circumstances. We typically use these customer
account management techniques with individual borrowers in transitional
situations, usually involving borrower hardship circumstances or temporary
setbacks that are expected to affect the borrower's ability to pay the
contractually specified amount for some period of time. For example, under a
forbearance agreement, we may agree not to take certain collection or credit
agency reporting actions with respect to missed payments, often in return for
the borrower's agreeing to pay us an additional amount with future required
payments. In some cases, these additional customer account management techniques
may involve us agreeing to lower the contractual payment amount and/or reduce
the periodic interest rate. In most cases, the delinquency status of an account
is considered to be current if the borrower immediately begins payment under the
new account terms. When we use a customer account management technique, we may
treat the account as being contractually current and will not reflect it as a
delinquent account in our delinquency statistics. However, if the account
subsequently experiences payment defaults, it will again become contractually
delinquent. We generally consider loan rewrites to involve an extension of a new
loan, and such new loans are not reflected in our delinquency or restructuring
statistics. Our account management actions vary by product and are under
continual review and assessment to determine that they meet the goals outlined
above.
The tables below summarize approximate restructuring statistics in our managed
basis domestic portfolio. We report our restructuring statistics on a managed
basis only because the receivables that we securitize are subject to
underwriting standards comparable to our owned portfolio, are generally serviced
and collected without regard to ownership and result in a similar credit loss
exposure for us. As previously reported, in prior periods we used certain
assumptions and estimates to compile our restructure statistics. The systemic
counters used to compile the information presented below exclude from the
reported statistics loans that have been reported as contractually delinquent
but have been reset to a current status because we have determined that the
loans should not have been considered delinquent (e.g., payment application
processing errors). We continue to enhance our ability to capture and segment
restructure data across all business units. When comparing restructuring
statistics from different periods, the fact that our restructure policies and
practices will change over time, that exceptions are made to those policies and
practices, and that our data capture methodologies have been enhanced, should be
taken into account.
TOTAL RESTRUCTURED BY RESTRUCTURE PERIOD - DOMESTIC PORTFOLIO(1)
(MANAGED BASIS)
AT DECEMBER 31, 2005 2004
---------------------------------------------------------------------------
Never restructured.......................................... 89.5% 86.7%
Restructured:
Restructured in the last 6 months......................... 4.0 5.1
Restructured in the last 7-12 months...................... 2.4 3.2
Previously restructured beyond 12 months.................. 4.1 5.0
----- -----
Total ever restructured(2)................................ 10.5 13.3
----- -----
Total....................................................... 100.0% 100.0%
===== =====
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TOTAL RESTRUCTURED BY PRODUCT - DOMESTIC PORTFOLIO(1)
(MANAGED BASIS)
AT DECEMBER 31, 2005 2004
---------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS
Real estate secured......................................... $ 8,334 10.4% $ 8,572 13.8%
Auto finance................................................ 1,688 14.5 1,545 15.2
MasterCard/Visa............................................. 774 3.0 619 3.2
Private label(3)............................................ 26 7.3 21 6.1
Personal non-credit card.................................... 3,369 19.9 3,541 22.4
------- ---- ------- ----
Total(2).................................................... $14,191 10.5% $14,298 13.3%
======= ==== ======= ====
---------------
(1) Excludes foreign businesses, commercial and other.
(2) Total including foreign businesses was 10.3 percent at December 31, 2005 and
12.3 percent at December 31, 2004.
(3) Only reflects consumer lending retail sales contracts which have
historically been classified as private label. All other domestic private
label receivables were sold to HSBC Bank USA in December 2004.
See "Credit Quality Statistics" for further information regarding owned basis
and managed basis delinquency, charge-offs and nonperforming loans.
The amount of domestic and foreign managed receivables in forbearance,
modification, credit card services approved consumer credit counseling
accommodations, rewrites or other customer account management techniques for
which we have reset delinquency and that is not included in the restructured or
delinquency statistics was approximately $.4 billion or .3 percent of managed
receivables at December 31, 2005 compared with $.4 billion or .4 percent of
managed receivables at December 31, 2004
In addition to the above, we granted an initial 30 or 60 day payment deferral
(based on product) to customers living in the Katrina FEMA designated Individual
Assistance disaster areas. This deferral was extended for a period of up to 90
days or longer in certain cases based on a customer's specific circumstances,
consistent with our natural disaster policies. In certain cases these
arrangements have resulted in a customer's delinquency status being reset by 30
days. These extended payment arrangements totaled $1.1 billion or .8 percent of
managed receivables at December 31, 2005 and are not reflected as restructures
in the table above or included in the other customer account management
techniques described in the paragraph above.
ADOPTION OF FFIEC CHARGE-OFF AND ACCOUNT MANAGEMENT POLICIES Upon receipt of
regulatory approval for the sale of our domestic private label portfolio
(excluding retail sales contracts at our consumer lending business) to HSBC Bank
USA in December 2004, we adopted charge-off and account management guidelines in
accordance with the Uniform Retail Credit Classification and Account Management
Policy issued by the Federal Financial Institutions Examination Council for our
domestic private label (excluding retail sales contracts at our consumer lending
business) and our MasterCard and Visa portfolios. The adoption of FFIEC
charge-off policies for our domestic private label and MasterCard/Visa
receivables resulted in a reduction to our net income in December 2004 of
approximately $121 million.
GEOGRAPHIC CONCENTRATIONS The state of California accounts for 12 percent of
both our domestic owned and managed portfolios. No other state accounts for more
than 10 percent of either our domestic owned or managed portfolio. Because of
our centralized underwriting, collections and processing functions, we can
quickly change our credit standards and intensify collection efforts in specific
locations. We believe this lowers risks resulting from such geographic
concentrations.
Our foreign consumer operations located in the United Kingdom and the rest of
Europe accounted for 4 percent of owned consumer receivables and Canada
accounted for 2 percent of owned consumer receivables at December 31, 2005.
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LIQUIDITY AND CAPITAL RESOURCES
--------------------------------------------------------------------------------
While the funding synergies resulting from our acquisition by HSBC have allowed
us to reduce our reliance on traditional sources to fund our growth, our
continued success and prospects for growth are dependent upon access to the
global capital markets. Numerous factors, internal and external, may impact our
access to and the costs associated with issuing debt in these markets. These
factors may include our debt ratings, overall capital markets volatility and the
impact of overall economic conditions on our business. We continue to focus on
balancing our use of affiliate and third-party funding sources to minimize
funding expense while maximizing liquidity. As discussed below, we supplemented
unsecured debt issuance during 2005 with proceeds from the continuing sale of
newly originated domestic private label receivables (excluding retail sales
contracts) to HSBC Bank USA following the bulk sale of this portfolio in
December 2004, debt issued to affiliates, the issuance of Series B preferred
stock, the issuance of additional common equity to HINO and the sale of our U.K.
credit card business to HBEU in December 2005.
Because we are now a subsidiary of HSBC, our credit spreads relative to
Treasuries have tightened compared to those we experienced during the months
leading up to the announcement of our acquisition by HSBC. Primarily as a result
of these tightened credit spreads, we recognized cash funding expense savings of
approximately $600 million in 2005, $350 million in 2004 and $125 million in
2003 compared to the funding costs we would have incurred using average spreads
from the first half of 2002. It is anticipated that these tightened credit
spreads in combination with the issuance of new HSBC Finance Corporation debt
and other funding synergies including asset transfers and external fee savings
will enable HSBC to realize annual cash funding expense savings in excess of $1
billion per year as our existing term debt matures which is anticipated to be
achieved in 2006. In 2005, the cash funding expense savings realized by HSBC
totaled approximately $865 million. The portion of these savings to be realized
by HSBC Finance Corporation will depend in large part upon the amount and timing
of various initiatives between HSBC Finance Corporation and other HSBC
subsidiaries. Amortization of purchase accounting fair value adjustments to our
external debt obligations, reduced interest expense by $656 million in 2005,
including $1 million relating to Metris, $946 million in 2004 and $773 million
in 2003.
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Debt due to affiliates and other HSBC related funding are summarized in the
following table:
DECEMBER 31, 2005 2004
---------------------------------------------------------------------------
(IN BILLIONS)
Debt outstanding to HSBC subsidiaries:
Drawings on bank lines in the U.K. and Europe............. $ 4.2 $ 7.5
Term debt................................................. 11.0 6.0
Preferred securities issued by Household Capital Trust
VIII to HSBC........................................... .3 .3
----- -----
Total debt outstanding to HSBC subsidiaries............... 15.5 13.8
----- -----
Debt outstanding to HSBC clients:
Euro commercial paper..................................... 3.2 2.6
Term debt................................................. 1.3 .8
----- -----
Total debt outstanding to HSBC clients.................... 4.5 3.4
Series A preferred stock issued to HINO..................... - 1.1(1)
Cash received on bulk and subsequent sale of domestic
private label credit card receivables to HSBC Bank USA,
net (cumulative).......................................... 15.7 12.4
Real estate secured receivable activity with HSBC Bank USA:
Cash received on sales (cumulative)....................... 3.7 3.7
Direct purchases from correspondents (cumulative)......... 4.2 2.8
Reductions in real estate secured receivables sold to HSBC
Bank USA............................................... (3.3) (1.5)
----- -----
Total real estate secured receivable activity with HSBC Bank
USA....................................................... 4.6 5.0
Cash received from sale of U.K. credit card business to
HBEU...................................................... 2.6 -
Capital contribution by HINO................................ 1.2(2) -
----- -----
Total HSBC related funding.................................. $44.1 $35.7
===== =====
---------------
(1) In December 2005, the $1.1 billion Series A preferred stock plus all accrued
and unpaid dividends was exchanged for a like amount of common equity and
the Series A preferred stock was retired. We issued 4 shares of common
equity to HINO as part of the exchange.
(2) This capital contribution was made in connection with our acquisition of
Metris.
At December 31, 2005, funding from HSBC, including debt issuances to HSBC
subsidiaries and clients, represented 15 percent of our total managed debt and
preferred stock funding. At December 31, 2004, funding from HSBC, including debt
issuances to HSBC subsidiaries and clients and preferred stock held by HINO,
represented 15 percent of our total managed debt and preferred stock funding.
Cash proceeds from the December 2005 sale of our managed basis U.K. credit card
receivables to HBEU of $2.6 billion in cash were used to partially pay down
drawings on bank lines from HBEU for the U.K. and fund operations. Proceeds from
the December 2004 domestic private label receivable sale to HSBC Bank USA of
$12.4 billion were used to pay down short-term domestic borrowings, including
outstanding commercial paper balances, and to fund operations. Excess liquidity
from the sale was used to temporarily fund available for sale investments.
Proceeds from the March 2004 real estate secured receivable sale were used to
pay-down commercial paper balances which had been used as temporary funding in
the first quarter of 2004 and to fund various debt maturities.
At December 31, 2005, we had commercial paper back stop credit facility of $2.5
billion from HSBC domestically and a revolving credit facility of $5.3 billion
from HSBC in the U.K. At December 31, 2004, we had commercial paper back stop
credit facility of $2.5 billion from HSBC domestically and a revolving credit
facility of $7.5 billion from HSBC in the U.K. At December 31, 2005, $4.2
billion was outstanding under the HBEU lines for the U.K. and no balances were
outstanding under the domestic lines. At December 31, 2004, $7.5 billion was
outstanding under HBEU lines for the U.K. and no balances were outstanding under
the
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domestic lines. A $4.0 billion revolving credit facility with HSBC Private Bank
(Suisse) SA, which was in place during a portion of 2004 to allow temporary
increases in commercial paper issuances in anticipation of the sale of the
private label receivables to HSBC Bank USA, expired on December 30, 2004. We had
derivative contracts with a notional value of $72.2 billion, or approximately 95
percent of total derivative contracts, outstanding with HSBC affiliates at
December 31, 2005. At December 31, 2004, we had derivative contracts with a
notional value of $62.6 billion, or approximately 87 percent of total derivative
contracts, outstanding with HSBC affiliates.
SECURITIES AND OTHER SHORT-TERM INVESTMENTS Securities totaled $4.1 billion at
December 31, 2005 and $3.6 billion at December 31, 2004. Securities purchased
under agreements to resell totaled $78 million at December 31, 2005 and $2.7
billion at December 31, 2004. Interest bearing deposits with banks totaled $384
million at December 31, 2005 and $603 million at December 31, 2004.
COMMERCIAL PAPER, BANK AND OTHER BORROWINGS totaled $11.4 billion at December
31, 2005 and $9.0 billion at December 31, 2004. The increase at December 31,
2005 was primarily a result of a plan to increase our commercial paper issuances
as a result of lowering the coverage ratio of bank credit facilities to
outstanding commercial paper from 100% to 80%. This plan also requires that the
combination of bank credit facilities and undrawn committed conduit facilities
will, at all times, exceed 115% of outstanding commercial paper. This plan,
which was reviewed with the relevant rating agencies, resulted in an increase in
our maximum outstanding commercial paper balance to in excess of $12.0 billion.
At December 31, 2004, we were carrying lower levels of commercial paper as the
proceeds from the bulk sale of domestic private label receivables to HSBC Bank
USA were used to reduce the outstanding balances. Included in this total was
outstanding Euro commercial paper sold to customers of HSBC of $3.2 billion at
December 31, 2005 and $2.6 billion at December 31, 2004.
LONG TERM DEBT (with original maturities over one year) increased to $105.2
billion at December 31, 2005 from $85.4 billion at December 31, 2004. As part of
our overall liquidity management strategy, we continue to extend the maturity of
our liability profile. Significant issuances during 2005 included the following:
- $10.5 billion of domestic and foreign medium-term notes
- $6.0 billion of foreign currency-denominated bonds (including $227
million which was issued to customers of HSBC)
- $1.8 billion of InterNotes(SM) (retail-oriented medium-term notes)
- $11.2 billion of global debt
- $1.0 billion of junior subordinated notes issued to Household Capital
Trust IX.
- $9.7 billion of securities backed by real estate secured, auto finance
and MasterCard/Visa receivables. For accounting purposes, these
transactions were structured as secured financings.
Additionally, as part of the Metris acquisition we assumed $4.6 billion of
securities backed by MasterCard/ Visa receivables which we restructured to fail
sale treatment and are now accounted for as secured financings.
In January 2006, we redeemed the junior subordinated notes issued to Household
Capital Trust VI with an outstanding principal balance of $206 million. In
November 2005, we issued $1.0 billion of preferred securities of Household
Capital Trust IX. The interest rate on these securities is 5.911% from the date
of issuance through November 30, 2015 and is payable semiannually beginning May
30, 2006. After November 30, 2015, the rate changes to the three-month LIBOR
rate, plus 1.926% and is payable quarterly beginning on February 28, 2016. In
June 2005, we redeemed the junior subordinated notes issued to Household Capital
Trust V with an outstanding principal balance of $309 million.
PREFERRED SHARES In June 2005, we issued 575,000 shares of Series B Preferred
Stock for $575 million. Dividends on the Series B Preferred Stock are
non-cumulative and payable quarterly at a rate of 6.36 percent commencing
September 15, 2005. The Series B Preferred Stock may be redeemed at our option
after June 23, 2010. In 2005, we paid dividends totaling $17 million on the
Series B Preferred Stock.
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COMMON EQUITY We issued four shares of common equity to HINO in December 2005 in
exchange for the $1.1 billion Series A Preferred Stock plus all accrued and
unpaid dividends. Additionally, in connection with our acquisition of Metris,
HINO made a capital contribution of $1.2 billion in exchange for one share of
common stock.
SELECTED CAPITAL RATIOS In managing capital, we develop targets for tangible
shareholder's(s') equity to tangible managed assets ("TETMA"), tangible
shareholder's(s') equity plus owned loss reserves to tangible managed assets
("TETMA + Owned Reserves") and tangible common equity to tangible managed
assets. These ratio targets are based on discussions with HSBC and rating
agencies, risks inherent in the portfolio, the projected operating environment
and related risks, and any acquisition objectives. Our targets may change from
time to time to accommodate changes in the operating environment or other
considerations such as those listed above. We are committed to maintaining at
least a mid-single "A" rating and as part of that effort will continue to review
appropriate capital levels with our rating agencies.
On January 30, 2006, Moody's Investor Service raised the Senior Debt Rating for
HSBC Finance Corporation from A1 to Aa3 with positive outlook. Our short-term
rating was also affirmed at Prime-1.
Selected capital ratios are summarized in the following table:
DECEMBER 31, 2005 2004
---------------------------------------------------------------------------
TETMA(1),(2)................................................ 7.56% 6.27%
TETMA + Owned Reserves(1),(2)............................... 10.55 9.04
Tangible common equity to tangible managed assets(1)........ 6.07 4.67
Common and preferred equity to owned assets................. 12.43 13.01
Excluding HSBC acquisition purchase accounting adjustments:
TETMA(1),(2).............................................. 8.52% 7.97%
TETMA + Owned Reserves(1),(2)............................. 11.51 10.75
Tangible common equity to tangible managed assets(1)...... 7.02 6.38
---------------
(1) TETMA, TETMA + Owned Reserves and tangible common equity to tangible managed
assets represent non-GAAP financial ratios that are used by HSBC Finance
Corporation management and applicable rating agencies to evaluate capital
adequacy and may differ from similarly named measures presented by other
companies. See "Basis of Reporting" for additional discussion on the use of
non-GAAP financial measures and "Reconciliations to GAAP Financial Measures"
for quantitative reconciliations to the equivalent GAAP basis financial
measure.
(2) Beginning in the third quarter of 2005, and with the agreement of applicable
rating agencies, we have refined our definition of TETMA and TETMA + Owned
Reserves to exclude the Adjustable Conversion-Rate Equity Security Units for
all periods subsequent to our acquisition by HSBC as this more accurately
reflects the impact of these items on our equity. Prior period amounts have
been revised to reflect the current period presentation.
HSBC FINANCE CORPORATION. HSBC Finance Corporation is an indirect wholly owned
subsidiary of HSBC Holdings plc. On March 28, 2003, HSBC acquired Household
International, Inc. by way of merger in a purchase business combination.
Effective January 1, 2004, HSBC transferred its ownership interest in Household
to a wholly owned subsidiary, HSBC North America Holdings Inc., which
subsequently contributed Household to its wholly owned subsidiary, HSBC
Investments (North America) Inc. ("HINO"). On December 15, 2004, Household
merged with its wholly owned subsidiary, Household Finance Corporation, with
Household as the surviving entity. At the time of the merger, Household changed
its name to "HSBC Finance Corporation."
HSBC Finance Corporation is the parent company that owns the outstanding common
stock of its subsidiaries. Our main source of funds is cash received from
operations and subsidiaries in the form of dividends. In addition, we receive
cash from third parties or affiliates by issuing preferred stock and debt.
HSBC Finance Corporation received cash dividends from its subsidiaries of $514
million in 2005 and $120 million in 2004.
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In conjunction with the acquisition by HSBC, we issued a series of 6.50 percent
cumulative preferred stock in the amount of $1.1 billion ("Series A Preferred
Stock") to HSBC on March 28, 2003. In September 2004, HNAH issued a new series
of preferred stock totaling $1.1 billion to HSBC in exchange for our Series A
Preferred Stock. In October 2004, our immediate parent, HINO, issued a new
series of preferred stock to HNAH in exchange for our Series A Preferred Stock.
We paid dividends on our Series A Preferred Stock of $66 million in October 2005
and $108 million in October 2004. On December 15, 2005, we issued 4 shares of
common stock to HINO in exchange for the $1.1 billion Series A Preferred Stock
plus the accrued and unpaid dividends and the Series A Preferred Stock was
retired.
In November 2005, we issued $1.0 billion of preferred securities of Household
Capital Trust IX. The interest rate on these securities is 5.911% from the date
of issuance through November 30, 2015 and is payable semiannually beginning May
30, 2006. After November 30, 2015, the rate changes to the three-month LIBOR
rate, plus 1.926% and is payable quarterly beginning on February 28, 2016. In
June 2005, we redeemed the junior subordinated notes issued to the Household
Capital Trust V with an outstanding principal balance of $309 million.
In June 2005, we issued 575,000 shares of Series B Preferred Stock for $575
million. Dividends on the Series B Preferred Stock are non-cumulative and
payable quarterly at a rate of 6.36 percent commencing September 15, 2005. The
Series B Preferred Stock may be redeemed at our option after June 23, 2010. In
2005, we paid dividends totaling $17 million on the Series B Preferred Stock.
HSBC Finance Corporation has a number of obligations to meet with its available
cash. It must be able to service its debt and meet the capital needs of its
subsidiaries. It also must pay dividends on its preferred stock and may pay
dividends on its common stock. Dividends of $980 million were paid to HINO, our
immediate parent company, on our common stock in 2005 and $2.6 billion were paid
in 2004. We anticipate paying future dividends to HINO, but will maintain our
capital at levels necessary to maintain at least a mid-single "A" rating either
by limiting the dividends to or through capital contributions from our parent.
At various times, we will make capital contributions to our subsidiaries to
comply with regulatory guidance, support receivable growth, maintain acceptable
investment grade ratings at the subsidiary level, or provide funding for
long-term facilities and technology improvements. HSBC Finance Corporation made
capital contributions to certain subsidiaries of $2.2 billion in 2005 and $1.1
billion in 2004.
SUBSIDIARIES At December 31, 2005, HSBC Finance Corporation had one major
subsidiary, Household Global Funding ("Global"), and manages all domestic
operations. Prior to December 15, 2004, we had two major subsidiaries: Household
Finance Corporation ("HFC"), which managed all domestic operations, and Global.
On December 15, 2004, HFC merged with and into Household International which
changed its name to HSBC Finance Corporation.
DOMESTIC OPERATIONS HSBC Finance Corporation's domestic operations are funded
through the collection of receivable balances; issuing commercial paper,
medium-term debt and long-term debt; securitizing and borrowing under secured
financing facilities and selling consumer receivables. Domestically, HSBC
Finance Corporation markets its commercial paper primarily through an in-house
sales force. The vast majority of our domestic medium-term notes and long-term
debt is now marketed through subsidiaries of HSBC. Domestic medium-term notes
may also be marketed through our in-house sales force and investment banks.
Long-term debt may also be marketed through unaffiliated investment banks.
At December 31, 2005, advances from subsidiaries of HSBC for our domestic
operations totaled $11.0 billion. At December 31, 2004, advances from
subsidiaries of HSBC for our domestic operations totaled $6.0 billion. The
interest rates on funding from HSBC subsidiaries are market-based and comparable
to those available from unaffiliated parties.
Outstanding commercial paper related to our domestic operations totaled $10.9
billion at December 31, 2005 and $8.7 billion at December 31, 2004. As discussed
above, the outstanding domestic commercial paper balance increased significantly
in 2005 as a result of the plan to increase our commercial paper issuances as a
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result of lowering the coverage ratio of bank credit facilities to outstanding
commercial paper from 100% to 80%. This plan also requires that the combination
of bank credit facilities and undrawn committed conduit facilities will, at all
times, exceed 115% of outstanding commercial paper.
Following our acquisition by HSBC, we established a new Euro commercial paper
program, largely targeted towards HSBC clients, which expanded our European
investor base. Under the Euro commercial paper program, commercial paper
denominated in Euros, British pounds and U.S. dollars is sold to foreign
investors. Outstanding Euro commercial paper sold to customers of HSBC totaled
$3.2 billion at December 31, 2005 and $2.6 billion at December 31, 2004. We
actively manage the level of commercial paper outstanding to ensure availability
to core investors while maintaining excess capacity within our
internally-established targets as communicated with the rating agencies.
The following table shows various debt issuances by HSBC Finance Corporation and
its domestic subsidiaries during 2005 and 2004.
2005 2004
----------------------------------------------------------------------------
(IN BILLIONS)
Medium term notes, excluding issuances to HSBC customers and
subsidiaries of HSBC...................................... $ 9.5 $6.4
Medium term notes issued to HSBC customers.................. .2 .3
Medium term notes issued to subsidiaries of HSBC............ 5.0 4.6
Foreign currency-denominated bonds, excluding issuances to
HSBC customers and subsidiaries of HSBC................... 5.8 1.0
Junior subordinated notes issued to the Household Capital
Trust IX.................................................. 1.0 -
Foreign currency-denominated bonds issued to HSBC
customers................................................. .2 .2
Foreign currency-denominated bonds issued to subsidiaries of
HSBC...................................................... - .6
Global debt................................................. 11.2 4.5
InterNotes(SM) (retail-oriented medium-term notes).......... 1.8 1.4
Securities backed by home equity, auto finance and
MasterCard/Visa receivables structured as secured
financings................................................ 9.7 5.1
Additionally, as part of the Metris acquisition we assumed $4.6 billion of
securities backed by MasterCard/ Visa receivables which we restructured to fail
sale treatment and are now accounted for as secured financings.
In order to eliminate future foreign exchange risk, currency swaps were used at
the time of issuance to fix in U.S. dollars substantially all
foreign-denominated notes in 2005 and 2004.
HSBC Finance Corporation issued securities backed by dedicated receivables of
$9.7 billion in 2005 and $5.1 billion in 2004. For accounting purposes, these
transactions were structured as secured financings, therefore, the receivables
and the related debt remain on our balance sheet. At December 31, 2005,
closed-end real estate secured, auto finance and MasterCard/Visa receivables
totaling $21.8 billion secured $15.1 billion of outstanding debt. At December
31, 2004, closed-end real estate secured and auto finance receivables totaling
$10.3 billion secured $7.3 billion of outstanding debt.
HSBC Finance Corporation had committed back-up lines of credit totaling $10.6
billion at December 31, 2005 for its domestic operations. Included in the
December 31, 2005 total are $2.5 billion of revolving credit facilities with
HSBC. None of these back-up lines were drawn upon in 2005. The back-up lines
expire on various dates through 2008. The most restrictive financial covenant
contained in the back-up line agreements that could restrict availability is an
obligation to maintain minimum shareholder's equity of $10.0 billion which is
substantially below our December 31, 2005 common and preferred shareholder's
equity balance of $19.5 billion.
At December 31, 2005, we had facilities with commercial and investment banks
under which our domestic operations may issue securities backed with receivables
up to $15 billion of receivables, including up to
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$12.7 billion of auto finance, MasterCard, Visa, and personal non-credit card
and $2.3 billion of real estate secured receivables. We have increased our total
conduit capacity by $2.2 billion in 2005. Conduit capacity for real estate
secured receivables was decreased $.2 billion and capacity for other products
was increased $2.4 billion. The facilities are renewable at the banks' option.
At December 31, 2005, $5.6 billion of auto finance, MasterCard/Visa, personal
non-credit card and real estate secured receivables were used in collateralized
funding transactions structured either as securitizations or secured financings
under these funding programs and unsecured debt funding. In addition, we have
available a $4 billion single seller mortgage facility (none of which was
outstanding at December 31, 2005). The amount available under the facilities
will vary based on the timing and volume of public securitization transactions.
Through existing term bank financing and new debt issuances, we believe we will
continue to have adequate sources of funds.
GLOBAL Global includes our foreign subsidiaries in the United Kingdom, the rest
of Europe and Canada. Global's assets were $10.7 billion at December 31, 2005
and $14.3 billion at December 31, 2004. Consolidated shareholder's(s') equity
includes the effect of translating our foreign subsidiaries' assets, liabilities
and operating results from their local currency into U.S. dollars.
Each foreign subsidiary conducts its operations using its local currency. While
each foreign subsidiary usually borrows funds in its local currency, both our
United Kingdom and Canadian subsidiaries have historically borrowed funds in
foreign currencies. This allowed the subsidiaries to achieve a lower cost of
funds than that available at that time in their local markets. These borrowings
were converted from foreign currencies to their local currencies using currency
swaps at the time of issuance.
UNITED KINGDOM Our United Kingdom operation is funded with HBEU debt and
previously issued long-term debt. Prior to 2004, at various times we have also
utilized securitizations of receivables, wholesale deposits, commercial paper
and short-term and intermediate term bank lines of credit to fund our U.K.
operations. The following table summarizes the funding of our United Kingdom
operation:
2005 2004
---------------------------------------------------------------------------
(IN BILLIONS)
Due to HSBC affiliates...................................... $4.2 $7.5
Long term debt.............................................. .9 1.0
At December 31, 2005, $.9 billion of long term debt was guaranteed by HSBC
Finance Corporation. HSBC Finance Corporation receives a fee for providing the
guarantee. In 2005 and 2004, our United Kingdom subsidiary primarily received
its funding directly from HSBC.
As previously discussed, in December 2005, our U.K. operations sold its credit
card operations to HBEU for total consideration of $3.0 billion, including $261
million in preferred stock of a subsidiary of HBEU, and used the proceeds to
partially pay down amounts due to HBEU on bank lines in the U.K. and to pay a
cash dividend of $489 million to HSBC Finance Corporation. Our U.K. operations
also provided a dividend to HSBC Finance Corporation of $41 million of the
preferred stock received in the transaction.
CANADA Our Canadian operation is funded with commercial paper, intermediate debt
and long-term debt. Outstanding commercial paper totaled $442 million at
December 31, 2005 compared to $248 million at December 31, 2004. Intermediate
and long-term debt totaled $2.5 billion at December 31, 2005 compared to $1.9
billion at December 31, 2004. At December 31, 2005, $2.9 billion of the Canadian
subsidiary's debt was guaranteed by HSBC Finance Corporation for which it
receives a fee for providing the guarantee. Committed back-up lines of credit
for Canada were approximately $86 million at December 31, 2005. All of these
back-up lines are guaranteed by HSBC Finance Corporation and none were used in
2005. In 2005, our Canadian operations paid a dividend of $25 million to HSBC
Finance Corporation.
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2006 FUNDING STRATEGY As discussed previously, the acquisition by HSBC has
improved our access to the capital markets as well as expanded our access to a
worldwide pool of potential investors. Our current estimated domestic funding
needs and sources for 2006 are summarized in the table that follows.
(IN BILLIONS)
----------------------------------------------------------------------------
FUNDING NEEDS:
Net asset growth.......................................... $15 - 25
Commercial paper, term debt and securitization
maturities............................................. 30 - 36
Other..................................................... 1 - 3
--------
Total funding needs......................................... $46 - 64
========
FUNDING SOURCES:
External funding, including commercial paper.............. $45 - 59
HSBC and HSBC subsidiaries................................ 1 - 5
--------
Total funding sources....................................... $46 - 64
========
Commercial paper outstanding in 2006 is expected to be in line with the December
31, 2005 balances, except during the first three months of 2006 when commercial
paper balances will be temporarily high due to the seasonal activity of our TFS
business. Approximately two-thirds of outstanding commercial paper is expected
to be domestic commercial paper sold both directly and through dealer programs.
Euro commercial paper is expected to account for approximately one-third of
outstanding commercial paper and will be marketed predominately to HSBC clients.
Term debt issuances are expected to utilize several ongoing programs to achieve
the desired funding. Approximately 70 percent of term debt funding is expected
to be achieved through transactions including U.S. dollar global and Euro
transactions and large medium-term note ("MTN") offerings. Domestic and foreign
retail note programs are expected to account for approximately 20 percent of
term debt issuances. The remaining term debt issuances are expected to consist
of smaller domestic and foreign currency MTN offerings.
As a result of our decision in 2004 to fund all new collateralized funding
transactions as secured financings, we anticipate securitization levels will
continue to decline in 2006. Because existing public MasterCard and Visa credit
card transactions were structured as sales to revolving trusts that require
replenishments of receivables to support previously issued securities,
receivables will continue to be sold to these trusts until the revolving periods
end, the last of which is currently projected to occur in 2008. In addition, we
will continue to replenish at reduced levels, certain non-public personal
non-credit card securities issued to conduits for a period of time in order to
manage liquidity. Since our securitized receivables have varying lives, it will
take time for these receivables to pay-off and the related interest-only strip
receivables to be reduced to zero. The termination of sale treatment on new
collateralized funding activity reduced our reported net income under U.S. GAAP.
There was no impact, however, on cash received from operations or on IFRS
reported results. Because we believe the market for securities backed by
receivables is a reliable, efficient and cost-effective source of funds, we will
continue to use secured financings of consumer receivables as a source of our
funding and liquidity. We anticipate that secured financings in 2006 should
increase significantly over the 2005 levels.
HSBC received regulatory approval in 2003 to provide the direct funding required
by our United Kingdom operations. Accordingly, in 2004 we eliminated all back-up
lines of credit which had previously supported our United Kingdom subsidiary.
All new funding for our United Kingdom subsidiary is now provided directly by
HSBC. Our Canadian operation will continue to fund itself independently through
traditional third-party funding sources such as commercial paper and medium
term-notes. Funding needs in 2006 are not expected to be significant for Canada.
CAPITAL EXPENDITURES We made capital expenditures of $78 million in 2005 and $96
million in 2004.
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COMMITMENTS We also enter into commitments to meet the financing needs of our
customers. In most cases, we have the ability to reduce or eliminate these open
lines of credit. As a result, the amounts below do not necessarily represent
future cash requirements at December 31, 2005:
(IN BILLIONS)
----------------------------------------------------------------------------
Private label, MasterCard and Visa credit cards............. $176.2
Other consumer lines of credit.............................. 15.0
------
Open lines of credit(1)..................................... $191.2
======
---------------
(1) Includes an estimate for acceptance of credit offers mailed to potential
customers prior to December 31, 2005.
At December 31, 2005, our mortgage services business had commitments with
numerous correspondents to purchase up to $1.6 billion of real estate secured
receivables at fair market value, subject to availability based on underwriting
guidelines specified by our mortgage services business and at prices indexed to
general market rates. These commitments have terms of up to one year and can be
renewed upon mutual agreement.
CONTRACTUAL CASH OBLIGATIONS The following table summarizes our long-term
contractual cash obligations at December 31, 2005 by period due:
2006 2007 2008 2009 2010 THEREAFTER TOTAL
-----------------------------------------------------------------------------------------------------------
(IN MILLIONS)
PRINCIPAL BALANCE OF DEBT:
Time certificates of deposit.... $ - $ 9 $ - $ - $ - $ - $ 9
Due to affiliates............... 5,466 624 - 1,831 1,505 6,108 15,534
Long term debt (including
secured financings)........... 19,291 18,805 14,937 11,390 11,357 28,291 104,071
------- ------- ------- ------- ------- ------- --------
Total debt...................... 24,757 19,438 14,937 13,221 12,862 34,399 119,614
------- ------- ------- ------- ------- ------- --------
OPERATING LEASES:
Minimum rental payments......... 197 136 118 96 61 123 731
Minimum sublease income......... 76 28 28 27 16 1 176
------- ------- ------- ------- ------- ------- --------
Total operating leases.......... 121 108 90 69 45 122 555
------- ------- ------- ------- ------- ------- --------
OBLIGATIONS UNDER MERCHANT AND
AFFINITY PROGRAMS............... 127 128 124 124 116 480 1,099
NON-QUALIFIED PENSION AND
POSTRETIREMENT BENEFIT
LIABILITIES(1).................. 24 25 30 27 31 1,102 1,239
------- ------- ------- ------- ------- ------- --------
TOTAL CONTRACTUAL CASH
OBLIGATIONS..................... $25,029 $19,699 $15,181 $13,441 $13,054 $36,103 $122,507
======= ======= ======= ======= ======= ======= ========
---------------
(1) Expected benefit payments calculated include future service component.
These cash obligations could be funded primarily through cash collections on
receivables, from the issuance of new unsecured debt or through secured
financings of receivables. Our receivables and other liquid assets generally
have shorter lives than the liabilities used to fund them.
In January 2006 we entered into a lease for a building in the Village of
Mettawa, Illinois. The new facility will consolidate our Prospect Heights, Mount
Prospect and Deerfield offices. Construction of the building will begin in the
spring of 2006 with the move planned for first and second quarter 2008. An
estimate of the contractual cash obligation associated with this lease will not
be finalized until later in 2006.
Our purchase obligations for goods and services at December 31, 2005 were not
significant.
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OFF BALANCE SHEET ARRANGEMENTS AND SECURED FINANCINGS
--------------------------------------------------------------------------------
SECURITIZATIONS AND SECURED FINANCINGS Securitizations (collateralized funding
transactions structured to receive sale treatment under Statement of Financial
Accounting Standards No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, a Replacement of FASB
Statement No. 125," ("SFAS No. 140")) and secured financings (collateralized
funding transactions which do not receive sale treatment under SFAS No. 140) of
consumer receivables have been a source of funding and liquidity for us.
Securitizations and secured financings have been used to limit our reliance on
the unsecured debt markets and often are more cost-effective than alternative
funding sources.
In a securitization, a designated pool of non-real estate consumer receivables
is removed from the balance sheet and transferred through a limited purpose
financing subsidiary to an unaffiliated trust. This unaffiliated trust is a
qualifying special purpose entity ("QSPE") as defined by SFAS No. 140 and,
therefore, is not consolidated. The QSPE funds its receivable purchase through
the issuance of securities to investors, entitling them to receive specified
cash flows during the life of the securities. The receivables transferred to the
QSPE serve as collateral for the securities. At the time of sale, an
interest-only strip receivable is recorded, representing the present value of
the cash flows we expect to receive over the life of the securitized
receivables, net of estimated credit losses and debt service. Under the terms of
the securitizations, we receive annual servicing fees on the outstanding balance
of the securitized receivables and the rights to future residual cash flows on
the sold receivables after the investors receive their contractual return. Cash
flows related to the interest-only strip receivables and servicing the
receivables are collected over the life of the underlying securitized
receivables.
Certain securitization trusts, such as credit cards, are established at fixed
levels and, due to the revolving nature of the underlying receivables, require
the sale of new receivables into the trust to replace runoff so that the
principal dollar amount of the investors' interest remains unchanged. We refer
to such activity as replenishments. Once the revolving period ends, the
amortization period begins and the trust distributes principal payments to the
investors.
When loans are securitized in transactions structured as sales, we receive cash
proceeds from investors, net of transaction costs and expenses. These proceeds
are generally used to re-pay other debt and corporate obligations and to fund
new loans. The investors' shares of finance charges and fees received from the
securitized loans are collected each month and are primarily used to pay
investors for interest and credit losses and to pay us for servicing fees. We
retain any excess cash flow remaining after such payments are made to investors.
Generally, for each securitization and secured financing we utilize credit
enhancement to obtain investment grade ratings on the securities issued by the
trust. To ensure that adequate funds are available to pay investors their
contractual return, we may retain various forms of interests in assets securing
a funding transaction, whether structured as a securitization or a secured
financing, such as over-collateralization, subordinated series, residual
interests (in the case of securitizations) in the receivables or we may fund
cash accounts. Over-collateralization is created by transferring receivables to
the trust issuing the securities that exceed the balance of the securities to be
issued. Subordinated interests provide additional assurance of payment to
investors holding senior securities. Residual interests are also referred to as
interest-only strip receivables and represent rights to future cash flows from
receivables in a securitization trust after investors receive their contractual
return. Cash accounts can be funded by an initial deposit at the time the
transaction is established and/or from interest payments on the receivables that
exceed the investor's contractual return.
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Our retained securitization interests are not in the form of securities and are
included in receivables on our consolidated balance sheets. These retained
interests were comprised of the following at December 31, 2005 and 2004:
AT DECEMBER 31,
---------------
2005 2004
-----------------------------------------------------------------------------
(IN MILLIONS)
Overcollateralization....................................... $ 295 $ 826
Interest-only strip receivables............................. 23 323
Cash spread accounts........................................ 150 225
Other subordinated interests................................ 2,190 2,809
------ ------
Total retained securitization interests..................... $2,658 $4,183
====== ======
In a secured financing, a designated pool of receivables are conveyed to a
wholly owned limited purpose subsidiary which in turn transfers the receivables
to a trust which sells interests to investors. Repayment of the debt issued by
the trust is secured by the receivables transferred. The transactions are
structured as secured financings under SFAS No. 140. Therefore, the receivables
and the underlying debt of the trust remain on our balance sheet. We do not
recognize a gain in a secured financing transaction. Because the receivables and
the debt remain on our balance sheet, revenues and expenses are reported
consistently with our owned balance sheet portfolio. Using this source of
funding results in similar cash flows as issuing debt through alternative
funding sources.
Securitizations are treated as secured financings under both IFRS and U.K. GAAP.
In order to align our accounting treatment with that of HSBC initially under
U.K. GAAP and now under IFRS, we began to structure all new collateralized
funding transactions as secured financings in the third quarter of 2004.
However, because existing public MasterCard and Visa credit card transactions
were structured as sales to revolving trusts that require replenishments of
receivables to support previously issued securities, receivables will continue
to be sold to these trusts and the resulting replenishment gains recorded until
the revolving periods end, the last of which is currently projected to occur in
early 2008. Private label trusts that publicly issue securities will now be
replenished by HSBC Bank USA as a result of the daily sale of new domestic
private label credit card originations to HSBC Bank USA. We will continue to
replenish at reduced levels, certain non-public personal non-credit card and
MasterCard/ Visa securities issued to conduits and record the resulting
replenishment gains for a period of time in order to manage liquidity. Since our
securitized receivables have varying lives, it will take time for these
receivables to pay-off and the related interest-only strip receivables to be
reduced to zero. The termination of sale treatment on new collateralized funding
activity reduced our reported net income under U.S. GAAP. There was no impact,
however, on cash received from operations.
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Securitizations and secured financings were as follows:
YEAR ENDED DECEMBER 31,
---------------------------
2005 2004 2003
-----------------------------------------------------------------------------------------
(IN MILLIONS)
INITIAL SECURITIZATIONS:
Auto finance................................................ $ - $ - $ 1,523
MasterCard/Visa............................................. - 550 670
Private label............................................... - 190 1,250
Personal non-credit card.................................... - - 3,320
------- ------- -------
Total....................................................... $ - $ 740 $ 6,763
======= ======= =======
REPLENISHMENT SECURITIZATIONS:
MasterCard/Visa............................................. $ 8,620 $20,378 $23,433
Private label............................................... - 9,104 6,767
Personal non-credit card.................................... 211 828 675
------- ------- -------
Total....................................................... $ 8,831 $30,310 $30,875
======= ======= =======
SECURED FINANCINGS:
Real estate secured......................................... $ 4,516 $ 3,299 $ 3,260
Auto finance................................................ 3,418 1,790 -
MasterCard/Visa............................................. 1,785 - -
------- ------- -------
Total....................................................... $ 9,719 $ 5,089 $ 3,260
======= ======= =======
Additionally, as part of the Metris acquisition we assumed $4.6 billion of
securities backed by MasterCard/Visa receivables which we restructured to fail
sale treatment and are now accounted for as secured financings.
Our securitization levels in 2005 were lower while secured financings were
higher in 2005 reflecting the decision in the third quarter of 2004 to structure
all new collateralized funding transactions as secured financings and the use of
additional sources of liquidity provided by HSBC and its subsidiaries.
Outstanding securitized receivables consisted of the following:
AT DECEMBER 31,
----------------
2005 2004
------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured......................................... $ - $ 81
Auto finance................................................ 1,192 2,679
MasterCard/Visa............................................. 1,875 7,583
Personal non-credit card.................................... 1,007 3,882
------ -------
Total....................................................... $4,074 $14,225
====== =======
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The following table summarizes the expected amortization of our securitized
receivables at December 31, 2005:
2006 2007 2008 2009 TOTAL
--------------------------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured......................................... $ - $ - $ - $- $ -
Auto finance................................................ 931 261 - - 1,192
MasterCard/Visa............................................. 1,375 167 333 - 1,875
Personal non-credit card.................................... 885 122 - - 1,007
------ ---- ---- -- ------
Total....................................................... $3,191 $550 $333 $- $4,074
====== ==== ==== == ======
At December 31, 2005, the expected weighted-average remaining life of these
transactions was .76 years.
The securities issued in connection with collateralized funding transactions may
pay off sooner than originally scheduled if certain events occur. For certain
auto transactions, early payoff of securities may occur if established
delinquency or loss levels are exceeded or if certain other events occur. For
all other transactions, early payoff of the securities begins if the annualized
portfolio yield drops below a base rate or if certain other events occur. We do
not presently believe that any early payoff will take place. If early payoff
occurred, our funding requirements would increase. These additional requirements
could be met through issuance of various types of debt or borrowings under
existing back-up lines of credit. We believe we would continue to have adequate
sources of funds if an early payoff event occurred.
At December 31, 2005, securitizations structured as sales represented 3 percent
and secured financings represented 11 percent of the funding associated with our
managed funding portfolio. At December 31, 2004, securitizations structured as
sales represented 12 percent and secured financings represented 6 percent of the
funding associated with our managed funding portfolio.
We continue to believe the market for securities backed by receivables is a
reliable, efficient and cost-effective source of funds, and we will continue to
use secured financings of consumer receivables as a source of our funding and
liquidity. However, if the market for securities backed by receivables were to
change, we may be unable to enter into new secured financings or to do so at
favorable pricing levels. Factors affecting our ability to structure
collateralized funding transactions as secured financings or to do so at
cost-effective rates include the overall credit quality of our securitized
loans, the stability of the securitization markets, the securitization market's
view of our desirability as an investment, and the legal, regulatory, accounting
and tax environments governing collateralized funding transactions.
At December 31, 2005, we had domestic facilities with commercial and investment
banks under which we may use up to $15 billion of our receivables in
collateralized funding transactions structured either as securitizations or
secured financings. The facilities are renewable at the banks' option. At
December 31, 2005, $5.6 billion of auto finance, MasterCard/Visa, personal
non-credit card and real estate secured receivables were used in collateralized
funding transactions structured either as securitizations or secured financings
under these funding programs. In addition, we have available a $4 billion single
seller mortgage facility (none of which was outstanding at December 31, 2005)
structured as a secured financing. As a result of the sale of the managed basis
U.K. credit card receivables to HBEU as previously discussed, we no longer have
any securitized receivables or conduit lines in the U.K. As previously
discussed, beginning in the third quarter of 2004, we decided to fund all new
collateralized funding transactions as secured financings to align our
accounting treatment with that of HSBC initially under U.K. GAAP and now under
IFRS. The amount available under the facilities will vary based on the timing
and volume of collateralized funding transactions. Through existing term bank
financing and new debt issuances, we believe we should continue to have adequate
sources of funds, which could be impacted from time to time by volatility in the
financial markets or if one or more of these facilities were unable to be
renewed.
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For additional information related to our securitization activities, including
the amount of revenues and cash flows resulting from these arrangements, see
Note 8, "Asset Securitizations," to our accompanying consolidated financial
statements.
RISK MANAGEMENT
--------------------------------------------------------------------------------
Our activities involve analysis, evaluation, acceptance and management of some
degree of risk or combination of risks. Accordingly, we have comprehensive risk
management policies to address potential financial risks, which include credit
risk, liquidity risk, market risk (which includes interest rate and foreign
currency exchange risks), reputational risk and operational risk. Our risk
management policies are designed to identify and analyze these risks, to set
appropriate limits and controls, and to monitor the risks and limits continually
by means of reliable and up-to-date administrative and information systems. We
continually modify and enhance our risk management policies and systems to
reflect changes in markets and products and in best practice risk management
processes. Training, individual responsibility and accountability, together with
a disciplined, conservative and constructive culture of control, lie at the
heart of our management of risk. Our risk management policies are primarily
carried out in accordance with practice and limits set by the HSBC Group
Management Board. The HSBC Finance Corporation Asset Liability Committee
("ALCO") meets regularly to review risks and approve appropriate risk management
strategies within the limits established by the HSBC Group Management Board.
Additionally, our Audit Committee receives regular reports on our liquidity
positions in relation to the established limits.
CREDIT RISK MANAGEMENT Credit risk is the risk that financial loss arises from
the failure of a customer or counterparty to meet its obligations under a
contract. Our credit risk arises primarily from lending and treasury activities.
We have established detailed policies to address the credit risk that arises
from our lending activities. Our credit and portfolio management procedures
focus on risk-based pricing and effective collection and customer account
management efforts for each loan. Our lending guidelines, which delineate the
credit risk we are willing to take and the related terms, are specific not only
for each product, but also take into consideration various other factors
including borrower characteristics. We also have specific policies to ensure the
establishment of appropriate credit loss reserves on a timely basis to cover
probable losses of principal, interest and fees. See "Credit Quality" for a
detailed description of our policies regarding the establishment of credit loss
reserves, our delinquency and charge-off policies and practices and our customer
account management policies and practices. While we develop our own policies and
procedures for all of our lending activities, they are based on standards
established by HSBC and are regularly reviewed and updated both on an HSBC
Finance Corporation and HSBC level.
Counterparty credit risk is our primary exposure on our interest rate swap
portfolio. Counterparty credit risk is the risk that the counterparty to a
transaction fails to perform according to the terms of the contract. We control
counterparty credit risk in derivative instruments through established credit
approvals, risk control limits, collateral, and ongoing monitoring procedures.
Counterparty limits have been set and are closely monitored as part of the
overall risk management process and control structure. During the third quarter
of 2003 and continuing through 2005, we utilize an affiliate, HSBC Bank USA, as
the primary provider of new domestic derivative products. We have never suffered
a loss due to counterparty failure.
Currently the majority of our existing derivative contracts are with HSBC
subsidiaries, making them our primary counterparty in derivative transactions.
Most swap agreements, both with unaffiliated and affiliated third parties,
require that payments be made to, or received from, the counterparty when the
fair value of the agreement reaches a certain level. Generally, third-party swap
counterparties provide collateral in the form of cash which is recorded in our
balance sheet as other assets or derivative related liabilities and totaled $91
million at December 31, 2005 and $.4 billion at December 31, 2004. Affiliate
swap counterparties provide collateral in the form of securities as required,
which are not recorded on our balance sheet. At December 31, 2005, the fair
value of our agreements with affiliate counterparties was below the $1.2 billion
level requiring posting of collateral. As such, at December 31, 2005, we were
not holding any swap collateral from HSBC
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affiliates in the form of securities. At December 31, 2004, affiliate swap
counterparties had provided collateral in the form of securities, which were not
recorded on our balance sheet, totaling $2.2 billion. At December 31, 2005, we
had derivative contracts with a notional value of approximately $75.9 billion,
including $71.3 billion outstanding with HSBC Bank USA. At December 31, 2004, we
had derivative contracts with a notional value of approximately $71.6 billion,
including $61.3 billion outstanding with HSBC Bank USA.
See Note 15 to the accompanying consolidated financial statements, "Derivative
Financial Instruments," for additional information related to interest rate risk
management and Note 24, "Fair Value of Financial Instruments," for information
regarding the fair value of certain financial instruments.
LIQUIDITY RISK The management of liquidity risk is addressed in HSBC Finance
Corporation's funding management policies and practices. HSBC Finance
Corporation funds itself principally through unsecured term funding in the
markets, through secured financings and securitization transactions and through
borrowings from HSBC and HSBC clients. Generally, the lives of our assets are
shorter than the lives of the liabilities used to fund them. This initially
reduces liquidity risk by ensuring that funds are received prior to liabilities
becoming due.
Our ability to ensure continuous access to the capital markets and maintain a
diversified funding base is important in meeting our funding needs. To manage
this liquidity risk, we offer a broad line of debt products designed to meet the
needs of both institutional and retail investors. We maintain investor diversity
by placing debt directly with customers, through selected dealer programs and by
targeted issuance of large liquid transactions. Through collateralized funding
transactions, we are able to access an alternative investor base and further
diversify our funding strategies. We also maintain a comprehensive, direct
marketing program to ensure our investors receive consistent and timely
information regarding our financial performance.
The measurement and management of liquidity risk is a primary focus. Three
standard analyses are utilized to accomplish this goal. First, a rolling 60 day
funding plan is updated daily to quantify near-term needs and develop the
appropriate strategies to fund those needs. As part of this process, debt
maturity profiles (daily, monthly, annually) are generated to assist in planning
and limiting any potential rollover risk (which is the risk that we will be
unable to pay our debt or borrow additional funds as it becomes due). Second,
comprehensive plans identifying monthly funding requirements for the next twelve
months are updated at least weekly and monthly funding plans for the next two
years are maintained. These plans focus on funding projected asset growth and
drive both the timing and size of debt issuances. These plans are shared on a
regular basis with HSBC. And third, a Maximum Cumulative Outflow (MCO) analysis
is updated regularly to measure liquidity risk. Cumulative comprehensive cash
inflows are subtracted from outflows to generate a net exposure that is tracked
both monthly over the next 12 month period and annually for 5 years. Net outflow
limits are reviewed by HSBC Finance Corporation's ALCO and HSBC.
We recognize the importance of being prepared for constrained funding
environments. While the potential scenarios driving this analysis have changed
due to our affiliation with HSBC, contingency funding plans are still maintained
as part of the liquidity management process. Alternative funding strategies are
updated regularly for a rolling 12 months and assume limited access to unsecured
funding and continued access to the collateralized funding markets. These
alternative strategies are designed to enable us to achieve monthly funding
goals through controlled growth, sales of receivables and access to committed
sources of contingent liquidity including bank lines and undrawn securitization
conduits. Although our overall liquidity situation has improved significantly
since our acquisition by HSBC, the strategies and analyses utilized in the past
to successfully manage liquidity remain in place today. The combination of this
process with the funding provided by HSBC subsidiaries and clients should ensure
our access to diverse markets, investor bases and adequate funding for the
foreseeable future.
See "Liquidity and Capital Resources" for further discussion of our liquidity
position.
MARKET RISK The objective of our market risk management process is to manage and
control market risk exposures in order to optimize return on risk while
maintaining a market profile as a provider of financial products and services.
Market risk is the risk that movements in market risk factors, including
interest rates and foreign currency exchange rates, will reduce our income or
the value of our portfolios.
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Future net interest income is affected by movements in interest rates. Although
our main operations are in the U.S., we also have operations in Canada and the
U.K. which prepare their financial statements in their local currency.
Accordingly, our financial statements are affected by movements in exchange
rates between the functional currencies of these subsidiaries and the U.S.
dollar. We maintain an overall risk management strategy that uses a variety of
interest rate and currency derivative financial instruments to mitigate our
exposure to fluctuations caused by changes in interest rates and currency
exchange rates. We manage our exposure to interest rate risk primarily through
the use of interest rate swaps, but also use forwards, futures, options, and
other risk management instruments. We manage our exposure to foreign currency
exchange risk primarily through the use of currency swaps, options and forwards.
We do not use leveraged derivative financial instruments for interest rate risk
management. Since our acquisition by HSBC, we have not entered into foreign
exchange contracts to hedge our investment in foreign subsidiaries.
Prior to the acquisition by HSBC, the majority of our fair value and cash flow
hedges were effective hedges which qualified for the shortcut method of
accounting. Under the Financial Accounting Standards Board's interpretations of
SFAS No. 133, the shortcut method of accounting was no longer allowed for
interest rate swaps which were outstanding at the time of our acquisition by
HSBC. As a result of the acquisition, we were required to reestablish and
formally document the hedging relationship associated with all of our fair value
and cash flow hedging instruments and assess the effectiveness of each hedging
relationship, both at the date of the acquisition and on an ongoing basis. As a
result of deficiencies in our contemporaneous hedge documentation at the time of
acquisition, we lost the ability to apply hedge accounting to our entire cash
flow and fair value hedging portfolio that existed at the time of acquisition by
HSBC. Substantially all derivative financial instruments entered into subsequent
to the acquisition qualify as effective hedges under SFAS No. 133 and beginning
in 2005 are being accounted for under the long-haul method of accounting.
Interest rate risk is defined as the impact of changes in market interest rates
on our earnings. We use simulation models to measure the impact of changes in
interest rates on net interest income. The key assumptions used in these models
include expected loan payoff rates, loan volumes and pricing, cash flows from
derivative financial instruments and changes in market conditions. These
assumptions are based on our best estimates of actual conditions. The models
cannot precisely predict the actual impact of changes in interest rates on our
earnings because these assumptions are highly uncertain. At December 31, 2005,
our interest rate risk levels were below those allowed by our existing policy.
We generally fund our assets with liabilities that have similar interest rate
features, or are combined at issuance with derivatives to produce liabilities
with repricing features similar to the assets. This initially reduces interest
rate risk. Over time, however, customer demand for our receivable products
shifts between fixed rate and floating rate products, based on market conditions
and preferences. These shifts in loan products produce different interest rate
risk exposures. We use derivative financial instruments, principally interest
rate swaps, to manage these exposures. Interest rate futures, interest rate
forwards and purchased options are also used on a limited basis to reduce
interest rate risk.
We monitor the impact that an immediate hypothetical increase or decrease in
interest rates of 25 basis points applied at the beginning of each quarter over
a 12 month period would have on our net interest income assuming a growing
balance sheet and the current interest rate risk profile. The following table
summarizes such estimated impact:
AT
DECEMBER 31,
-------------
2005 2004
---------------------------------------------------------------------------
(IN MILLIONS)
Decrease in net interest income following a hypothetical 25
basis points rise in interest rates applied at the
beginning of each quarter over the next 12 months......... $213 $176
Increase in net interest income following a hypothetical 25
basis points fall in interest rates applied at the
beginning of each quarter over the next 12 months......... $120 $169
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These estimates include both the net interest income impact of the derivative
positions we have entered into which are considered to be effective hedges under
SFAS No. 133 and the impact of economic hedges of certain underlying debt
instruments which do not qualify for hedge accounting as previously discussed,
as if they were effective hedges under SFAS No. 133. These estimates also assume
we would not take any corrective actions in response to interest rate movements
and, therefore, exceed what most likely would occur if rates were to change by
the amount indicated.
As part of our overall risk management strategy to reduce earnings volatility,
in 2005 a significant number of our pay fixed/receive variable interest rate
swaps which had not previously qualified for hedge accounting under SFAS No.
133, have been designated as effective hedges using the long-haul method of
accounting, and certain other interest rate swaps were terminated. This will
significantly reduce the volatility of the mark-to-market on the previously
non-qualifying derivatives which have been designated as effective hedges going
forward, but will result in the recording of ineffectiveness under the long-haul
method of accounting under SFAS No. 133. In order to further reduce earnings
volatility that would otherwise result from changes in interest rates, we
continue to evaluate the steps required to regain hedge accounting treatment
under SFAS No. 133 for the remaining swaps which do not currently qualify for
hedge accounting. These derivatives remain economic hedges of the underlying
debt instruments. We will continue to manage our total interest rate risk on a
basis consistent with the risk management process employed since the
acquisition.
HSBC Group also has certain limits and benchmarks that serve as guidelines in
determining the appropriate levels of interest rate risk. One such limit is
expressed in terms of the Present Value of a Basis Point ("PVBP"), which
reflects the change in value of the balance sheet for a one basis point movement
in all interest rates. Our PVBP limit as of December 31, 2005 was $2 million,
which includes the risk associated with hedging instruments. Thus, for a one
basis point change in interest rates, the policy dictates that the value of the
balance sheet shall not increase or decrease by more than $2 million. As of
December 31, 2005, we had a PVBP position of less than $1 million reflecting the
impact of a one basis point increase in interest rates. While the total PVBP
position will not change as a result of the loss of hedge accounting following
our acquisition by HSBC, the following table shows the components of PVBP:
2005 2004
---------------------------------------------------------------------------
(IN MILLIONS)
Risk related to our portfolio of ineffective hedges......... $(1.4) $(2.7)
Risk for all other remaining assets and liabilities......... 2.3 1.9
----- -----
Total PVBP risk............................................. $ .9 $ .8
===== =====
Foreign currency exchange risk refers to the potential changes in current and
future earnings or capital arising from movements in foreign exchange rates. We
enter into foreign exchange rate forward contracts and currency swaps to
minimize currency risk associated with changes in the value of
foreign-denominated liabilities. Currency swaps convert principal and interest
payments on debt issued from one currency to another. For example, we may issue
Euro-denominated debt and then execute a currency swap to convert the obligation
to U.S. dollars. Prior to the acquisition, we had periodically entered into
foreign exchange contracts to hedge portions of our investments in our United
Kingdom and Canada subsidiaries. We estimate that a 10 percent adverse change in
the British pound/U.S. dollar and Canadian dollar/U.S. dollar exchange rate
would result in a decrease in common shareholder's(s') equity of $162 million at
December 31, 2005 and $188 million at December 31, 2004 and would not have a
material impact on net income.
We have issued debt in a variety of currencies and simultaneously executed
currency swaps to hedge the future interest and principal payments. As a result
of the loss of hedge accounting on currency swaps outstanding at the time of our
acquisition, the recognition of the change in the currency risk on these swaps
is recorded differently than the corresponding risk on the underlying foreign
denominated debt. Currency risk on the swap is now recognized immediately on the
net present value of all future swap payments. On the corresponding debt,
currency risk is recognized on the principal outstanding which is converted at
the period
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end spot translation rate and on the interest accrual which is converted at the
average spot rate for the reporting period.
OPERATIONAL RISK Operational risk is the risk of loss arising through fraud,
unauthorized activities, error, omission, inefficiency, systems failure or from
external events. It is inherent in every business organization and covers a wide
spectrum of issues. We manage this risk through a controls-based environment in
which processes are documented, authorization is independent and transactions
are reconciled and monitored. This is supported by an independent program of
periodic reviews undertaken by Internal Audit. We also monitor external
operations risk events which take place to ensure that we remain in line with
best practice and take account of lessons learned from publicized operational
failures within the financial services industry. We also maintain and test
emergency policies and procedures to support operations and our personnel in the
event of disasters.
REPUTATIONAL RISK The safeguarding of our reputation is of paramount importance
to our continued prosperity and is the responsibility of every member of our
staff. Reputational risk can arise from social, ethical or environmental issues,
or as a consequence of operations risk events. Our good reputation depends upon
the way in which we conduct our business, but can also be affected by the way in
which customers, to whom we provide financial services, conduct themselves.
Reputational risk is considered and assessed by the HSBC Group Management Board,
our Board of Directors and senior management during the establishment of
standards for all major aspects of business and the formulation of policy. These
policies, which are an integral part of the internal control systems, are
communicated through manuals and statements of policy, internal communication
and training. The policies set out operational procedures in all areas of
reputational risk, including money laundering deterrence, environmental impact,
anti-corruption measures and employee relations.
We have established a strong internal control structure to minimize the risk of
operational and financial failure and to ensure that a full appraisal of
reputational risk is made before strategic decisions are taken. The HSBC
internal audit function monitors compliance with our policies and standards.
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GLOSSARY OF TERMS
Affinity Credit Card - A MasterCard or Visa account jointly sponsored by the
issuer of the card and an organization whose members share a common interest
(e.g., the AFL-CIO Union Plus(R) credit card program).
Auto Finance Loans - Closed-end loans secured by a first or second lien on a
vehicle.
Co-Branded Credit Card - A MasterCard or Visa account that is jointly sponsored
by the issuer of the card and another corporation (e.g., the GM Card(R)). The
account holder typically receives some form of added benefit for using the card.
Consumer Net Charge-off Ratio - Net charge-offs of consumer receivables divided
by average consumer receivables outstanding.
Contractual Delinquency - A method of determining aging of past due accounts
based on the status of payments under the loan. Delinquency status may be
affected by customer account management policies and practices such as the
restructure of accounts, forbearance agreements, extended payment plans,
modification arrangements, external debt management plans, loan rewrites and
deferments.
Efficiency Ratio - Ratio of total costs and expenses less policyholders'
benefits to net interest income and other revenues less policyholders' benefits.
Fee Income - Income associated with interchange on credit cards and late and
other fees from the origination or acquisition of loans.
Foreign Exchange Contract - A contract used to minimize our exposure to changes
in foreign currency exchange rates.
Futures Contract - An exchange-traded contract to buy or sell a stated amount of
a financial instrument or index at a specified future date and price.
HBEU - HSBC Bank plc, a U.K. based subsidiary of HSBC Holdings plc.
HINO - HSBC Investments (North America) Inc., which is the immediate parent of
HSBC Finance Corporation.
HNAH - HSBC North America Holdings Inc. and the immediate parent of HINO.
HSBC - HSBC Holdings plc.
HSBC Bank USA - HSBC Bank USA, National Association
HTSU - HSBC Technology and Services (USA) Inc., which provides information
technology services to all subsidiaries of HNAH and other subsidiaries of HSBC.
Goodwill - Represents the purchase price over the fair value of identifiable
assets acquired less liabilities assumed from business combinations.
Intangible Assets - Assets (not including financial assets) that lack physical
substance. Our acquired intangibles include purchased credit card relationships
and related programs, merchant relationships in our retail services business,
other loan related relationships, trade names, technology, customer lists and
other contracts.
Interchange Fees - Fees received for processing a credit card transaction
through the MasterCard or Visa network.
Interest-only Strip Receivables - Represent our contractual right to receive
interest and other cash flows from our securitization trusts after the investors
receive their contractual return.
92
HSBC Finance Corporation
--------------------------------------------------------------------------------
Interest Rate Swap - Contract between two parties to exchange interest payments
on a stated principal amount (notional principal) for a specified period.
Typically, one party makes fixed rate payments, while the other party makes
payments using a variable rate.
LIBOR - London Interbank Offered Rate. A widely quoted market rate which is
frequently the index used to determine the rate at which we borrow funds.
Liquidity - A measure of how quickly we can convert assets to cash or raise
additional cash by issuing debt.
Managed Basis - A non-GAAP method of reporting whereby net interest income,
other revenues and credit losses on securitized receivables structured as sales
are reported as if those receivables were still held on our balance sheet.
Managed Receivables - The sum of receivables on our balance sheet and those that
we service for investors as part of our asset securitization program.
MasterCard and Visa Receivables - Receivables generated through customer usage
of MasterCard and Visa credit cards.
Near-prime receivables - A portion of our non-prime receivable portfolio which
is comprised of customers with somewhat stronger credit scores than our other
customers that are priced at rates generally below the rates offered on our
non-prime products.
Net Interest Income - Interest income from receivables and noninsurance
investment securities reduced by interest expense.
Net Interest Margin - Net interest income as a percentage of average
interest-earning assets.
Nonaccrual Loans - Loans on which we no longer accrue interest because ultimate
collection is unlikely.
Non-prime receivables - Receivables which have been priced above the standard
interest rates charged to prime customers due to a higher than average risk for
default as a result of the customer's credit history and the value of
collateral, if applicable.
Options - A contract giving the owner the right, but not the obligation, to buy
or sell a specified item at a fixed price for a specified period.
Owned Receivables - Receivables held on our balance sheet.
Personal Homeowner Loan ("PHL") - A high loan-to-value real estate loan that has
been underwritten and priced as an unsecured loan. These loans are reported as
personal non-credit card receivables.
Personal Non-Credit Card Receivables - Unsecured lines of credit or closed-end
loans made to individuals.
Portfolio Seasoning - Relates to the aging of origination vintages. Loss
patterns emerge slowly over time as new accounts are booked.
Private Label Credit Card - A line of credit made available to customers of
retail merchants evidenced by a credit card bearing the merchant's name.
Product Vintage Analysis - Refers to loss curves on specific product origination
pools by date of origination.
Real Estate Secured Loan - Closed-end loans and revolving lines of credit
secured by first or subordinate liens on residential real estate.
Receivables Serviced with Limited Recourse - Receivables we have securitized in
transactions structured as sales and for which we have some level of potential
loss if defaults occur.
Return on Average Common Shareholder's(s') Equity - Net income less dividends on
preferred stock divided by average common shareholder's(s') equity.
93
HSBC Finance Corporation
--------------------------------------------------------------------------------
Return on Average Managed Assets - Net income divided by average managed assets.
Return on Average Owned Assets - Net income divided by average owned assets.
Risk Adjusted Revenue - A non-GAAP financial measure which represents net
interest income, plus other revenues, excluding securitization related revenue
and the mark-to-market and ineffectiveness related to our derivative
instruments, less net charge-offs as a percentage of average interest earning
assets.
Secured Financing - The process where interests in a dedicated pool of financial
assets are sold to investors. Generally, the receivables are transferred through
a limited purpose financing subsidiary to a trust that issues interests that are
sold to investors. These transactions do not receive sale treatment under SFAS
No. 140. The receivables and related debt remain on our balance sheet.
Securitization - The process where interests in a dedicated pool of financial
assets, typically credit card, auto or personal non-credit card receivables, are
sold to investors. Generally, the receivables are sold to a trust that issues
interests that are sold to investors. These transactions are structured to
receive sale treatment under SFAS No. 140. The receivables are then removed from
our balance sheet.
Securitization Related Revenue - Includes income associated with current and
prior period securitizations structured as sales of receivables with limited
recourse. Such income includes gains on sales, net of our estimate of probable
credit losses under the recourse provisions, servicing income and excess spread
relating to those receivables.
Tangible Common Equity - Common shareholder's(s') equity (excluding unrealized
gains and losses on investments and cash flow hedging instruments and any
minimum pension liability) less acquired intangibles and goodwill.
Tangible Shareholder's(s') Equity - Tangible common equity, preferred stock, and
company obligated mandatorily redeemable preferred securities of subsidiary
trusts (including amounts due to affiliates) adjusted for HSBC acquisition
purchase accounting adjustments.
Tangible Managed Assets - Total managed assets less acquired intangibles,
goodwill and derivative financial assets.
Taxpayer Financial Services ("TFS") Revenue - Our taxpayer financial services
business provides consumer tax refund lending in the United States. This income
primarily consists of fees received from the consumer for origination of a short
term loan which will be repaid from their Federal income tax return refund.
Whole Loan Sales - Sales of loans to third parties without recourse. Typically,
these sales are made pursuant to our liquidity or capital management plans.
94
HSBC FINANCE CORPORATION AND SUBSIDIARIES
CREDIT QUALITY STATISTICS - OWNED BASIS
2005 2004 2003 2002 2001
---------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
OWNED TWO-MONTH-AND-OVER CONTRACTUAL DELINQUENCY RATIOS
Real estate secured.................................... 2.72% 2.96% 4.33% 3.91% 2.63%
Auto finance........................................... 2.34 2.07 2.51 3.96 2.92
MasterCard/Visa(2)..................................... 3.66 4.88 5.76 5.97 5.67
Private label.......................................... 5.43 4.13 5.42 6.36 5.99
Personal non-credit card............................... 9.40 8.69 10.01 8.95 8.44
------ ------ ------ ------ ------
Total consumer(2)...................................... 3.84% 4.07% 5.36% 5.34% 4.43%
====== ====== ====== ====== ======
RATIO OF OWNED NET CHARGE-OFFS TO AVERAGE OWNED
RECEIVABLES FOR THE YEAR
Real estate secured.................................... .76% 1.10% .99% .91% .52%
Auto finance........................................... 3.27 3.43 4.91 6.00 4.00
MasterCard/Visa(1)..................................... 7.12 8.85 9.18 9.46 8.17
Private label(1)....................................... 4.83 6.17 5.75 6.28 5.59
Personal non-credit card............................... 7.88 9.75 9.89 8.26 6.81
------ ------ ------ ------ ------
Total consumer(1)...................................... 3.03 4.00 4.06 3.81 3.32
Commercial............................................. 2.60 - .46 (.40) 2.10
------ ------ ------ ------ ------
Total.................................................. 3.03% 3.98% 4.05% 3.79% 3.31%
====== ====== ====== ====== ======
REAL ESTATE CHARGE-OFFS AND REO EXPENSE AS A PERCENT OF
AVERAGE REAL ESTATE SECURED RECEIVABLES.............. .87% 1.38% 1.42% 1.29% .84%
------ ------ ------ ------ ------
NONACCRUAL OWNED RECEIVABLES
Domestic:
Real estate secured.................................. $1,601 $1,489 $1,777 $1,367 $ 907
Auto finance......................................... 245 155 104 80 69
Private label........................................ 31 24 43 38 39
Personal non-credit card............................. 1,190 908 898 902 782
Foreign................................................ 463 432 316 264 215
------ ------ ------ ------ ------
Total consumer......................................... 3,530 3,008 3,138 2,651 2,012
Commercial and other................................... 3 4 6 15 15
------ ------ ------ ------ ------
Total.................................................. $3,533 $3,012 $3,144 $2,666 $2,027
====== ====== ====== ====== ======
ACCRUING CONSUMER OWNED RECEIVABLES 90 OR MORE DAYS
DELINQUENT
Domestic:
MasterCard/Visa...................................... $ 583 $ 469 $ 443 $ 343 $ 352
Private label........................................ - - 429 491 462
Foreign................................................ 38 38 32 27 30
------ ------ ------ ------ ------
Total.................................................. $ 621 $ 507 $ 904 $ 861 $ 844
====== ====== ====== ====== ======
REAL ESTATE OWNED
Domestic............................................... $ 506 $ 583 $ 627 $ 424 $ 395
Foreign................................................ 4 4 4 3 4
------ ------ ------ ------ ------
Total.................................................. $ 510 $ 587 $ 631 $ 427 $ 399
====== ====== ====== ====== ======
RENEGOTIATED COMMERCIAL LOANS.......................... $ - $ 2 $ 2 $ 1 $ 2
====== ====== ====== ====== ======
---------------
(1) The adoption of FFIEC charge-off policies for our domestic private label
(excluding retail sales contracts at our consumer lending business) and
MasterCard/Visa portfolios in December 2004 increased private label net
charge-offs by $155 million (119 basis points) and MasterCard/Visa net
charge-offs by $3 million (2 basis points) and total consumer net
charge-offs by $158 million (16 basis points) for the year ended December
31, 2004.
(2) In December 2005, we completed the acquisition of Metris which included
receivables of $5.3 billion. This event had a significant impact on this
ratio. Excluding the receivables from the Metris acquisition from this
calculation, our consumer delinquency ratio for our MasterCard/Visa
portfolio was 4.01% and total consumer delinquency was 3.89%.
95
HSBC FINANCE CORPORATION AND SUBSIDIARIES
CREDIT QUALITY STATISTICS - MANAGED BASIS(1)
2005 2004 2003 2002 2001
----------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
MANAGED TWO-MONTH-AND-OVER CONTRACTUAL DELINQUENCY
RATIOS
Real estate secured............................... 2.72% 2.97% 4.35% 3.94% 2.68%
Auto finance...................................... 2.76 2.96 3.84 3.65 3.16
MasterCard/Visa(3)................................ 3.52 3.98 4.16 4.12 4.10
Private label..................................... 5.43 4.13 4.94 6.03 5.48
Personal non-credit card.......................... 9.54 9.30 10.69 9.41 8.87
------ ------ ------ ------ ------
Total consumer(3)................................. 3.89% 4.24% 5.39% 5.24% 4.46%
====== ====== ====== ====== ======
RATIO OF MANAGED NET CHARGE-OFFS TO AVERAGE
MANAGED RECEIVABLES FOR THE YEAR
Real estate secured............................... .76% 1.10% 1.00% .92% .53%
Auto finance...................................... 4.56 5.80 7.00 6.63 5.31
MasterCard/Visa(2)................................ 6.78 7.29 7.26 7.12 6.63
Private label(2).................................. 4.83 6.03 5.62 5.75 5.18
Personal non-credit card.......................... 8.11 10.20 9.97 8.32 6.79
------ ------ ------ ------ ------
Total consumer(2)................................. 3.36 4.61 4.67 4.28 3.73
Commercial........................................ 2.60 - .46 (.40) 2.10
------ ------ ------ ------ ------
Total............................................. 3.36% 4.59% 4.66% 4.26% 3.72%
====== ====== ====== ====== ======
REAL ESTATE CHARGE-OFFS AND REO EXPENSE AS A
PERCENT OF AVERAGE REAL ESTATE SECURED
RECEIVABLES..................................... .87% 1.38% 1.42% 1.29% .83%
------ ------ ------ ------ ------
NONACCRUAL MANAGED RECEIVABLES
Domestic:
Real estate secured............................. $1,601 $1,496 $1,791 $1,391 $ 941
Auto finance.................................... 324 302 338 272 202
Private label................................... 31 24 43 38 39
Personal non-credit card........................ 1,287 1,263 1,464 1,320 1,106
Foreign........................................... 463 469 367 311 263
------ ------ ------ ------ ------
Total consumer.................................... 3,706 3,554 4,003 3,332 2,551
Commercial and other.............................. 3 4 6 15 15
------ ------ ------ ------ ------
Total............................................. $3,709 $3,558 $4,009 $3,347 $2,566
====== ====== ====== ====== ======
ACCRUING CONSUMER MANAGED RECEIVABLES 90 OR MORE
DAYS DELINQUENT
Domestic:
MasterCard/Visa................................. $ 604 $ 570 $ 601 $ 513 $ 527
Private label................................... - - 582 633 503
Foreign........................................... 38 38 32 27 30
------ ------ ------ ------ ------
Total............................................. $ 642 $ 608 $1,215 $1,173 $1,060
====== ====== ====== ====== ======
---------------
(1) These non-GAAP financial measures are provided for comparison of our
operating trends and should be read in conjunction with our owned basis GAAP
financial information. Refer to "Reconciliations to GAAP Financial Measures"
for a discussion of non-GAAP financial information and for quantitative
reconciliations to the equivalent GAAP basis financial measure.
(2) The adoption of FFIEC charge-off policies for our domestic private label
(excluding retail sales contracts at our consumer lending business) and
MasterCard/Visa portfolios in December 2004 increased private label net
charge-offs by $197 million (112 basis points) and MasterCard/Visa net
charge-offs by $5 million (2 basis points) and total consumer net
charge-offs by $202 million (17 basis points) for the year ended December
31, 2004.
(3) In December 2005, we completed the acquisition of Metris which included
receivables of $5.3 billion. This event had a significant impact on this
ratio. Excluding the receivables from the Metris acquisition from this
calculation, our consumer delinquency ratio for our MasterCard/Visa
portfolio was 3.79% and total consumer delinquency was 3.95%.
96
HSBC FINANCE CORPORATION AND SUBSIDIARIES
ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY - OWNED RECEIVABLES
2005 2004 2003 2002 2001
-----------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS
TOTAL OWNED CREDIT LOSS RESERVES AT JANUARY 1...............
$ 3,625 $ 3,793 $ 3,333 $ 2,663 $ 2,112
------- ------- ------- ------- -------
PROVISION FOR CREDIT LOSSES................................. 4,543 4,334 3,967 3,732 2,913
------- ------- ------- ------- -------
CHARGE-OFFS
Domestic:
Real estate secured....................................... (569) (629) (496) (430) (194)
Auto finance.............................................. (311) (204) (148) (159) (94)
MasterCard/Visa(1)........................................ (1,339) (1,082) (936) (736) (646)
Private label(1).......................................... (33) (788) (684) (650) (591)
Personal non-credit card.................................. (1,333) (1,350) (1,354) (1,193) (893)
Foreign..................................................... (509) (355) (257) (223) (237)
------- ------- ------- ------- -------
Total consumer.............................................. (4,094) (4,408) (3,875) (3,391) (2,655)
Commercial and other........................................ (6) (1) (3) (2) (12)
------- ------- ------- ------- -------
Total owned receivables charged off......................... (4,100) (4,409) (3,878) (3,393) (2,667)
------- ------- ------- ------- -------
RECOVERIES
Domestic:
Real estate secured....................................... 27 18 10 7 5
Auto finance.............................................. 18 6 5 7 1
MasterCard/Visa........................................... 157 103 87 59 52
Private label............................................. 6 79 72 48 61
Personal non-credit card.................................. 171 120 82 92 76
Foreign..................................................... 68 50 34 49 62
------- ------- ------- ------- -------
Total consumer.............................................. 447 376 290 262 257
Commercial and other........................................ - - 1 2 -
------- ------- ------- ------- -------
Total recoveries on owned receivables....................... 447 376 291 264 257
OTHER, NET.................................................. 6 (469) 80 67 48
------- ------- ------- ------- -------
OWNED CREDIT LOSS RESERVES
Domestic:
Real estate secured....................................... 718 645 670 551 284
Auto finance.............................................. 222 181 172 126 77
MasterCard/Visa........................................... 1,576 1,205 806 649 594
Private label............................................. 36 28 519 527 499
Personal non-credit card.................................. 1,652 1,237 1,348 1,275 1,032
Foreign..................................................... 312 316 247 172 137
------- ------- ------- ------- -------
Total consumer.............................................. 4,516 3,612 3,762 3,300 2,623
Commercial and other........................................ 5 13 31 33 40
------- ------- ------- ------- -------
TOTAL OWNED CREDIT LOSS RESERVES AT DECEMBER 31............. $ 4,521 $ 3,625 $ 3,793 $ 3,333 $ 2,663
======= ======= ======= ======= =======
RATIO OF OWNED CREDIT LOSS RESERVES TO:
Net charge-offs............................................. 123.8%(3) 89.9%(2) 105.7% 106.5% 110.5%
Receivables:
Consumer.................................................. 3.23 3.39 4.09 4.02 3.31
Commercial................................................ 2.67 8.90 6.80 6.64 7.12
------- ------- ------- ------- -------
Total..................................................... 3.23% 3.39% 4.11% 4.04% 3.33%
======= ======= ======= ======= =======
Nonperforming loans:
Consumer.................................................. 108.8% 102.7% 93.2% 94.0% 91.9%
Commercial................................................ 166.7 535.9 469.8 229.7 278.7
------- ------- ------- ------- -------
Total..................................................... 108.8% 103.0% 93.7% 94.5% 92.7%
======= ======= ======= ======= =======
---------------
(1) Includes $3 million of MasterCard and Visa and $155 million of private label
charge-off relating to the adoption of FFIEC charge-off policies in December
2004.
(2) In December 2004 we adopted FFIEC charge-off policies for our domestic
private label (excluding retail sales contracts at our consumer lending
business) and MasterCard/Visa portfolios and subsequently sold this domestic
private label receivable portfolio. These events had a significant impact on
this ratio. Reserves as a percentage of net charge-offs excluding net
charge-offs associated with the sold domestic private label portfolio and
charge-off relating to the adoption of FFIEC was 109.2% at December 31,
2004.
(3) The acquisition of Metris in December 2005 has positively impacted this
ratio. Reserves as a percentage of net charge-offs excluding Metris was
118.2 percent.
97
HSBC FINANCE CORPORATION AND SUBSIDIARIES
ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY - MANAGED RECEIVABLES(1)
2005 2004 2003 2002 2001
-----------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
TOTAL MANAGED CREDIT LOSS RESERVES AT JANUARY 1............. $ 4,515 $ 6,167 $ 5,092 $ 3,811 $ 3,194
------- ------- ------- ------- -------
PROVISION FOR CREDIT LOSSES................................. 4,650 4,522 6,242 5,655 4,018
------- ------- ------- ------- -------
CHARGE-OFFS
Domestic:
Real estate secured....................................... (569) (631) (500) (437) (203)
Auto finance.............................................. (528) (561) (567) (478) (287)
MasterCard/Visa(2)........................................ (1,573) (1,551) (1,462) (1,274) (1,148)
Private label(2).......................................... (33) (1,066) (918) (764) (640)
Personal non-credit card.................................. (1,585) (1,919) (1,862) (1,600) (1,196)
Foreign..................................................... (574) (423) (330) (280) (282)
------- ------- ------- ------- -------
Total consumer.............................................. (4,862) (6,151) (5,639) (4,833) (3,756)
Commercial and other........................................ (6) (1) (3) (2) (12)
------- ------- ------- ------- -------
Total managed receivables charged off....................... (4,868) (6,152) (5,642) (4,835) (3,768)
------- ------- ------- ------- -------
RECOVERIES
Domestic:
Real estate secured....................................... 27 18 10 7 5
Auto finance.............................................. 32 15 12 17 4
MasterCard/Visa........................................... 174 132 127 96 81
Private label............................................. 6 101 92 56 62
Personal non-credit card.................................. 192 154 106 122 101
Foreign..................................................... 76 58 40 59 72
------- ------- ------- ------- -------
Total consumer.............................................. 507 478 387 357 325
Commercial and other........................................ - - 1 2 -
------- ------- ------- ------- -------
Total recoveries on managed receivables..................... 507 478 388 359 325
OTHER, NET.................................................. (68) (500) 87 102 42
------- ------- ------- ------- -------
MANAGED CREDIT LOSS RESERVES
Domestic:
Real estate secured....................................... 718 646 671 561 304
Auto finance.............................................. 348 516 846 759 449
MasterCard/Visa........................................... 1,592 1,306 1,114 957 975
Private label............................................. 36 28 886 791 603
Personal non-credit card.................................. 1,725 1,635 2,244 1,697 1,217
Foreign..................................................... 312 371 375 294 223
------- ------- ------- ------- -------
Total consumer.............................................. 4,731 4,502 6,136 5,059 3,771
Commercial and other........................................ 5 13 31 33 40
------- ------- ------- ------- -------
TOTAL MANAGED CREDIT LOSS RESERVES AT DECEMBER 31........... $ 4,736 $ 4,515 $ 6,167 $ 5,092 $ 3,811
======= ======= ======= ======= =======
RATIO OF MANAGED CREDIT LOSS RESERVES TO:
Net charge-offs............................................. 108.6%(4) 79.6%(3) 117.4% 113.8% 110.7%
Receivables:
Consumer.................................................. 3.29 3.73 5.19 4.73 3.77
Commercial................................................ 2.67 8.90 6.80 6.64 7.12
------- ------- ------- ------- -------
Total..................................................... 3.29% 3.73% 5.20% 4.74% 3.78%
======= ======= ======= ======= =======
Nonperforming loans:
Consumer.................................................. 108.8% 108.2% 117.6% 112.3% 104.5%
Commercial................................................ 166.7 535.9 469.8 229.7 278.7
------- ------- ------- ------- -------
Total..................................................... 108.8% 108.4% 118.0% 112.6% 105.0%
======= ======= ======= ======= =======
---------------
(1) These non-GAAP financial measures are provided for comparison of our
operating trends and should be read in conjunction with our owned basis GAAP
financial information. Refer to "Reconciliations to GAAP Financial Measures"
for a discussion of non-GAAP financial information and for quantitative
reconciliations to the equivalent GAAP basis financial measure.
(2) Includes $5 million of MasterCard and Visa and $197 million of private label
charge-off relating to the adoption of FFIEC charge-off policies in December
2004.
(3) As previously discussed, the adoption of FFIEC charge-off policies for our
domestic private label (excluding retail sales contracts at our consumer
lending business) and MasterCard/Visa portfolios and subsequent sale of this
domestic private label receivable portfolio in December 2004 had a
significant impact on this ratio. Reserves as a percentage of net
charge-offs excluding net charge-offs associated with the sold domestic
private label portfolio and charge-off relating to the adoption of FFIEC was
96.0% at December 31, 2004.
(4) The acquisition of Metris in December 2005 has positively impacted this
ratio. Reserves as a percentage of net charge-offs excluding Metris was
103.9 percent.
98
HSBC FINANCE CORPORATION AND SUBSIDIARIES
NET INTEREST MARGIN - 2005 COMPARED TO 2004 (OWNED BASIS)
FINANCE AND
INTEREST
AVERAGE AVERAGE INCOME/ INTEREST INCREASE/ (DECREASE) DUE TO:
OUTSTANDING(1) RATE EXPENSE ------------------------------------
------------------- ----------- ------------------- VOLUME RATE
2005 2004 2005 2004 2005 2004 VARIANCE VARIANCE(2) VARIANCE(2)
------------------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Receivables:
Real estate secured... $ 73,097 $ 56,303 8.4% 8.8% $ 6,155 $ 4,974 $ 1,181 $1,424 $ (243)
Auto finance.......... 9,074 5,785 11.8 12.2 1,067 706 361 388 (27)
MasterCard/Visa....... 17,823 11,575 13.9 13.6 2,479 1,572 907 868 39
Private label......... 2,948 13,029 9.4 10.8 278 1,407 (1,129) (970) (159)
Personal non-credit
card................ 17,558 14,194 18.4 16.7 3,226 2,374 852 602 250
Commercial and
other............... 255 354 2.4 2.5 6 9 (3) (2) (1)
HSBC acquisition
purchase accounting
adjustments......... 134 319 - - (139) (201) 62 62 -
-------- -------- ---- ---- ------- ------- ------- ------ ------
Total receivables....... 120,889 101,559 10.8 10.7 13,072 10,841 2,231 2,089 142
Noninsurance
investments........... 3,694 4,853 3.9 2.1 144 104 40 (29) 69
-------- -------- ---- ---- ------- ------- ------- ------ ------
Total interest-earning
assets (excluding
insurance
investments).......... $124,583 $106,412 10.6% 10.3% $13,216 $10,945 $ 2,271 $1,940 $ 331
Insurance investments... 3,159 3,165
Other assets............ 12,058 14,344
-------- --------
TOTAL ASSETS............ $139,800 $123,921
======== ========
Debt:
Deposits.............. $ 40 $ 88 2.3%(6) 1.9% $ 1 $ 2 $ (1) $ (1) $ -
Commercial paper...... 11,877 11,403 3.4 1.8 399 210 189 9 180
Bank and other
borrowings.......... 71 38 2.7(6) 1.9(6) 2 1 1 1 -
Due to affiliates..... 16,654 8,752 4.3 3.9 713 343 370 336 34
Long term debt (with
original maturities
over one year)...... 86,207 79,834 4.3 3.3 3,717 2,587 1,130 222 908
-------- -------- ---- ---- ------- ------- ------- ------ ------
Total debt.............. $114,849 $100,115 4.2% 3.1% $ 4,832 $ 3,143 $ 1,689 $ 495 $1,194
Other liabilities....... 6,649 5,703
-------- --------
Total liabilities....... 121,498 105,818
Preferred securities.... 1,366 1,100
Common shareholder's(s')
equity................ 16,936 17,003
-------- --------
TOTAL LIABILITIES AND
SHAREHOLDER'S(S')
EQUITY................ $139,800 $123,921
======== ========
NET INTEREST MARGIN -
OWNED BASIS(3)(5)..... 6.7% 7.3% $ 8,384 $ 7,802 $ 582 $1,445 $ (863)
==== ==== ======= ======= ======= ====== ======
INTEREST SPREAD - OWNED
BASIS(4).............. 6.4% 7.2%
==== ====
---------------
(1) Nonaccrual loans are included in average outstanding balances.
(2) Rate/volume variance is allocated based on the percentage relationship of
changes in volume and changes in rate to the total interest variance. For
total receivables, total interest-earning assets and total debt, the rate
and volume variances are calculated based on the relative weighting of the
individual components comprising these totals. These totals do not represent
an arithmetic sum of the individual components.
(3) Represents net interest income as a percent of average interest-earning
assets
(4) Represents the difference between the yield earned on interest-earning
assets and the cost of the debt used to fund the assets
(5) The net interest margin analysis includes the following for foreign
businesses:
2005 2004
-------------------------------------------------------------------------------
Average interest-earning assets............................. $12,098 $10,728
Average interest-bearing liabilities........................ 10,231 9,127
Net interest income......................................... 754 712
Net interest margin......................................... 6.2% 6.8%
(6) Average rate does not recompute from the dollar figures presented due to
rounding.
99
HSBC FINANCE CORPORATION AND SUBSIDIARIES
NET INTEREST MARGIN - 2004 COMPARED TO 2003 (OWNED BASIS)
FINANCE AND
INTEREST
AVERAGE AVERAGE INCOME/ INTEREST INCREASE/ (DECREASE) DUE TO:
OUTSTANDING(1) RATE EXPENSE ------------------------------------
------------------- ----------- ------------------- VOLUME RATE
2004 2003 2004 2003 2004 2003 VARIANCE VARIANCE(2) VARIANCE(2)
------------------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Receivables:
Real estate secured... $ 56,303 $ 49,852 8.8% 9.7% $ 4,974 $ 4,852 $122 $ 594 $(472)
Auto finance.......... 5,785 2,920 12.2 12.9 706 378 328 351 (23)
MasterCard/Visa....... 11,575 9,517 13.6 13.3 1,572 1,266 306 279 27
Private label......... 13,029 11,942 10.8 11.6 1,407 1,379 28 125 (97)
Personal non-credit
card................ 14,194 14,009 16.7 17.5 2,374 2,454 (80) 32 (112)
Commercial and
other............... 354 430 2.5 2.2(6) 9 10 (1) (2) 1
HSBC acquisition
purchase accounting
adjustments......... 319 397 - - (201) (200) (1) (1) -
-------- -------- ---- ---- ------- ------- ---- ------ -----
Total receivables....... 101,559 89,067 10.7 11.4 10,841 10,139 702 1,361 (659)
Noninsurance
investments........... 4,853 5,280 2.1 2.0 104 103 1 (9) 10
-------- -------- ---- ---- ------- ------- ---- ------ -----
Total interest-earning
assets (excluding
insurance
investments).......... $106,412 $ 94,347 10.3% 10.9% $10,945 $10,242 $703 $1,251 $(548)
Insurance investments... 3,165 3,160
Other assets............ 14,344 12,590
-------- --------
TOTAL ASSETS............ $123,921 $110,097
======== ========
Debt:
Deposits.............. $ 88 $ 992 1.9% 3.6% $ 2 $ 36 $(34) $ (24) $ (10)
Commercial paper...... 11,403 6,357 1.8 1.6 210 103 107 91 16
Bank and other
borrowings.......... 38 1,187 1.9(6) 3.9 1 46 (45) (29) (16)
Due to affiliates..... 8,752 3,014 3.9 2.4 343 73 270 204 66
Long term debt (with
original maturities
over one year)...... 79,834 73,383 3.3 3.6 2,587 2,670 (83) 223 (306)
-------- -------- ---- ---- ------- ------- ---- ------ -----
Total debt.............. $100,115 $ 84,933 3.1% 3.4% $ 3,143 $ 2,928 $215 $ 492 $(277)
Other liabilities....... 5,703 9,836
-------- --------
Total liabilities....... 105,818 94,769
Preferred securities.... 1,100 1,119
Common shareholder's(s')
equity................ 17,003 14,209
-------- --------
TOTAL LIABILITIES AND
SHAREHOLDER'S(S')
EQUITY................ $123,921 $110,097
======== ========
NET INTEREST MARGIN -
OWNED BASIS(3)(5)..... 7.3% 7.8% $ 7,802 $ 7,314 $488 $ 759 $(271)
==== ==== ======= ======= ==== ====== =====
INTEREST SPREAD - OWNED
BASIS(4).............. 7.2% 7.5%
==== ====
---------------
(1) Nonaccrual loans are included in average outstanding balances.
(2) Rate/volume variance is allocated based on the percentage relationship of
changes in volume and changes in rate to the total interest variance. For
total receivables, total interest-earning assets and total debt, the rate
and volume variances are calculated based on the relative weighting of the
individual components comprising these totals. These totals do not represent
an arithmetic sum of the individual components.
(3) Represents net interest income as a percent of average interest-earning
assets
(4) Represents the difference between the yield earned on interest-earning
assets and the cost of the debt used to fund the assets
(5) The net interest margin analysis includes the following for foreign
businesses:
2004 2003
------------------------------------------------------------------------------
Average interest-earning assets............................. $10,728 $8,779
Average interest-bearing liabilities........................ 9,127 7,957
Net interest income......................................... 712 660
Net interest margin......................................... 6.8% 7.5%
---------------
(6) Average rate does not recompute from the dollar figures presented due to
rounding.
100
HSBC FINANCE CORPORATION AND SUBSIDIARIES
NET INTEREST MARGIN - 2005 COMPARED TO 2004 AND 2003 (MANAGED BASIS)
Net Interest Margin on a Managed Basis As receivables are securitized rather
than held in our portfolio, net interest margin is reclassified to
securitization related revenue. We retain a substantial portion of the profit
inherent in the receivables while increasing liquidity. The comparability of net
interest margin between periods may be impacted by the level and type of
receivables securitized. Net interest margin on a managed basis includes finance
income earned on our owned receivables as well on our securitized receivables.
This finance income is offset by interest expense on the debt recorded on our
balance sheet as well as the contractual rate of return on the instruments
issued to investors when the receivables were securitized.
FINANCE AND INTEREST
AVERAGE OUTSTANDING(1) AVERAGE RATE INCOME/INTEREST EXPENSE
------------------------------ ----------------- ----------------------
2005 2004 2003 2005 2004 2003 2005 2004 2003
------------------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Receivables:
Real estate secured....................... $ 73,120 $ 56,462 $ 50,124 8.4% 8.8% 9.7% $ 6,157 $ 4,984 $ 4,874
Auto finance.............................. 10,937 9,432 7,918 12.3 13.3 14.9 1,342 1,250 1,180
MasterCard/Visa........................... 22,694 20,674 19,272 13.4 12.7 12.9 3,045 2,627 2,484
Private label............................. 2,948 17,579 16,016 9.4 10.8 11.5 278 1,895 1,843
Personal non-credit card.................. 19,956 18,986 19,041 18.3 17.2 17.8 3,650 3,260 3,388
Commercial and other...................... 255 354 430 2.4 2.5 2.2(5) 6 9 10
HSBC acquisition purchase accounting
adjustment.............................. 134 319 397 - - - (139) (201) (200)
-------- -------- -------- ---- ---- ---- ------- ------- -------
Total receivables.......................... 130,044 123,806 113,198 11.0 11.2 12.0 14,339 13,824 13,579
Noninsurance investments................... 3,694 4,853 5,280 3.9 2.1 2.0 144 104 103
-------- -------- -------- ---- ---- ---- ------- ------- -------
Total interest-earning assets (excluding
insurance investments).................... $133,738 $128,659 $118,478 10.8% 10.8% 11.5% $14,483 $13,928 $13,682
-------- -------- -------- ---- ---- ---- ------- ------- -------
Total debt................................. $124,004 $122,362 $109,064 4.2% 3.0% 3.2% $ 5,207 $ 3,671 $ 3,494
-------- -------- -------- ---- ---- ---- ------- ------- -------
NET INTEREST MARGIN - MANAGED BASIS(3)..... 6.9% 8.0% 8.6% $ 9,276 $10,257 $10,188
==== ==== ==== ======= ======= =======
INTEREST SPREAD - MANAGED BASIS(4)......... 6.6% 7.8% 8.3%
==== ==== ====
INCREASE/(DECREASE) DUE TO:
---------------------------------------------------------------------------
2005 COMPARED TO 2004 2004 COMPARED TO 2003
------------------------------------ ------------------------------------
VOLUME RATE VOLUME RATE
VARIANCE VARIANCE(2) VARIANCE(2) VARIANCE VARIANCE(2) VARIANCE(2)
------------------------------------------- ---------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Receivables:
Real estate secured....................... $ 1,173 $1,412 $ (239) $ 110 $ 583 $(473)
Auto finance.............................. 92 189 (97) 70 210 (140)
MasterCard/Visa........................... 418 266 152 143 179 (36)
Private label............................. (1,617) (1,406) (211) 52 173 (121)
Personal non-credit card.................. 390 171 219 (128) (10) (118)
Commercial and other...................... (3) (2) (1) (1) (2) 1
HSBC acquisition purchase accounting
adjustment.............................. 62 62 - (1) (1) -
------- ------ ------- ------- ------ -----
Total receivables.......................... 515 690 (175) 245 1,222 (977)
Noninsurance investments................... 40 (29) 69 1 (9) 10
------- ------ ------- ------- ------ -----
Total interest-earning assets (excluding
insurance investments).................... $ 555 $ 555 $ - $ 246 $1,115 $(869)
------- ------ ------- ------- ------ -----
Total debt................................. $ 1,536 $ 50 $ 1,486 $ 177 $ 405 $(228)
------- ------ ------- ------- ------ -----
NET INTEREST MARGIN - MANAGED BASIS(3)..... $ (981) $ 505 $(1,486) $ 69 $ 710 $(641)
======= ====== ======= ======= ====== =====
INTEREST SPREAD - MANAGED BASIS(4).........
---------------
(1) Nonaccrual loans are included in average outstanding balances.
(2) Rate/volume variance is allocated based on the percentage relationship of
changes in volume and changes in rate to the total interest variance. For
total receivables, total interest-earning assets and total debt, the rate
and volume variances are calculated based on the relative weighting of the
individual components comprising these totals. These totals do not represent
an arithmetic sum of the individual components
(3) Represents net interest income as a percent of average interest-earning
assets
(4) Represents the difference between the yield earned on interest-earning
assets and cost of the debt used to fund the assets.
(5) Average rate does not recompute from dollar figures presented due to
rounding.
101
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
Our consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States ("GAAP"). In addition to the
GAAP financial results reported in our consolidated financial statements, MD&A
includes reference to the following information which is presented on a non-GAAP
basis:
OPERATING RESULTS, PERCENTAGES AND RATIOS Certain percentages and ratios have
been presented on an operating basis and have been calculated using "operating
net income", a non-GAAP financial measure. "Operating net income" is net income
excluding certain nonrecurring items. These nonrecurring items are also excluded
in calculating our operating basis efficiency ratios. We believe that excluding
these items helps readers of our financial statements to understand better the
results and trends of our underlying business.
MANAGED BASIS REPORTING We have historically monitored our operations and
evaluate trends on a managed basis (a non-GAAP financial measure), which assumes
that securitized receivables have not been sold and are still on our balance
sheet. This is because the receivables that we securitize are subjected to
underwriting standards comparable to our owned portfolio, are serviced by
operating personnel without regard to ownership and result in a similar credit
loss exposure for us. In addition, we fund our operations and make decisions
about allocating resources such as capital on a managed basis.
When reporting on a managed basis, net interest margin, provision for credit
losses and fee income related to receivables securitized are reclassified from
securitization related revenue in our owned statements of income into the
appropriate caption. Additionally, charge-off and delinquency associated with
these receivables are included in our managed basis credit quality statistics.
Debt analysts, rating agencies and fixed income investors have also historically
evaluated our operations on a managed basis for the reasons discussed above and
have historically requested managed basis information from us. We believe that
managed basis information enables such investors and other interested parties to
better understand the performance and quality of our entire managed loan
portfolio and is important to understanding the quality of originations and the
related credit risk inherent in our owned portfolio.
EQUITY RATIOS Tangible shareholder's(s') equity to tangible managed assets
("TETMA"), tangible shareholder's(s') equity plus owned loss reserves to
tangible managed assets ("TETMA + Owned Reserves") and tangible common equity to
tangible managed assets are non-GAAP financial measures that are used by HSBC
Finance Corporation management or applicable rating agencies to evaluate capital
adequacy. These ratios may differ from similarly named measures presented by
other companies. The most directly comparable GAAP financial measure is common
and preferred equity to owned assets.
We and certain rating agencies also monitor our equity ratios excluding the
impact of HSBC acquisition purchase accounting adjustments. We do so because we
believe that the HSBC acquisition purchase accounting adjustments represent
non-cash transactions which do not affect our business operations, cash flows or
ability to meet our debt obligations.
Preferred securities issued by certain non-consolidated trusts are considered
equity in the TETMA and TETMA + Owned Reserves calculations because of their
long-term subordinated nature and the ability to defer dividends. Previously,
our Adjustable Conversion-Rate Equity Security Units, adjusted for HSBC
acquisition purchase accounting adjustments, were also considered equity in
these calculations. Beginning in the third quarter of 2005, and with the
agreement of applicable rating agencies, we have refined our definition of TETMA
and TETMA + Owned Reserves to exclude the Adjustable Conversion-Rate Equity
Security Units as this more accurately reflects the impact of these items on our
equity. Prior period amounts have been revised to reflect the current period
presentation.
102
HSBC FINANCE CORPORATION AND SUBSIDIARIES
QUANTITATIVE RECONCILIATIONS OF NON-GAAP FINANCIAL MEASURES TO GAAP FINANCIAL
MEASURES For a reconciliation of managed basis net interest income, fee income
and provision for credit losses to the comparable owned basis amounts, see Note
22, "Business Segments," to the accompanying consolidated financial statements.
For a reconciliation of our owned loan portfolio by product to our managed loan
portfolio, see Note 6, "Receivables," to the accompanying consolidated financial
statements. Reconciliations of our owned basis and managed basis credit quality,
loss reserves, net interest income, selected financial ratios, including
operating ratios, and our equity ratios follow.
103
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
CREDIT QUALITY STATISTICS - 2005
TWO-MONTHS-AND-OVER CONTRACTUAL DELINQUENCY
--------------------------------------------- YEAR-TO-DATE CHARGE-OFFS,
TWO-MONTHS- TWO-MONTHS- NET OF RECOVERIES
AND-OVER AND-OVER --------------------------------------------
CONTRACTUAL RECEIVABLES CONTRACTUAL NET AVERAGE NET
DELINQUENCY OUTSTANDING DELINQUENCY(1) CHARGE-OFFS RECEIVABLES CHARGE-OFFS(1)
-----------------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
OWNED:
First mortgage(2)...... $ 2 $ 21 8.41% $ - $ 24 .90%
Real estate secured.... 2,257 82,826 2.72 556 73,097 .76
Auto finance........... 250 10,704 2.34 296 9,074 3.27
MasterCard/Visa........ 884 24,110 3.66 1,269 17,823 7.12
Private label.......... 137 2,520 5.43 143 2,948 4.83
Personal non-credit
card................. 1,836 19,545 9.40 1,383 17,558 7.88
------ -------- ----- ------ -------- -----
Total consumer......... 5,366 139,726 3.84 3,647 120,524 3.03
Commercial............. - 187 - 6 231 2.60
------ -------- ----- ------ -------- -----
Total.................. $5,366 $139,913 3.84% $3,653 $120,755 3.03%
------ -------- ----- ------ -------- -----
SERVICED WITH LIMITED
RECOURSE:
Real estate secured.... $ - $ - -% $ - $ 23 -%
Auto finance........... 79 1,192 6.63 203 1,863 10.90
MasterCard/Visa........ 30 1,875 1.60 269 4,871 5.52
Private label.......... - - - - - -
Personal non-credit
card................. 125 1,007 12.41 236 2,398 9.84
------ -------- ----- ------ -------- -----
Total.................. $ 234 $ 4,074 5.74% $ 708 $ 9,155 7.73%
------ -------- ----- ------ -------- -----
MANAGED:
First mortgage(2)...... $ 2 $ 21 8.41% $ - $ 24 .90%
Real estate secured.... 2,257 82,826 2.72 556 73,120 .76
Auto finance........... 329 11,896 2.76 499 10,937 4.56
MasterCard/Visa........ 914 25,985 3.52 1,538 22,694 6.78
Private label.......... 137 2,520 5.43 143 2,948 4.83
Personal non-credit
card................. 1,961 20,552 9.54 1,619 19,956 8.11
------ -------- ----- ------ -------- -----
Total consumer......... 5,600 143,800 3.89 4,355 129,679 3.36
Commercial............. - 187 - 6 231 2.60
------ -------- ----- ------ -------- -----
Total.................. $5,600 $143,987 3.89% $4,361 $129,910 3.36%
====== ======== ===== ====== ======== =====
---------------
(1) Certain percentages may not recompute from the dollar figures presented due
to rounding.
(2) Includes our liquidating legacy first and reverse mortgage portfolios.
SERVICED WITH
OWNED LIMITED RECOURSE MANAGED
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
NONACCRUAL RECEIVABLES
Domestic:
Real estate secured....................................... $ 1,601 $ - $ 1,601
Auto finance.............................................. 245 79 324
Private label............................................. 31 - 31
Personal non-credit card.................................. 1,190 97 1,287
Foreign..................................................... 463 - 463
------- ---- -------
Total consumer.............................................. 3,530 176 3,706
Commercial and other........................................ 3 - 3
------- ---- -------
Total....................................................... $ 3,533 $176 $ 3,709
======= ==== =======
ACCRUING CONSUMER RECEIVABLES 90 OR MORE DAYS DELINQUENT
Domestic:
MasterCard/Visa........................................... $ 583 $ 21 $ 604
Private label............................................. - - -
Foreign..................................................... 38 - 38
------- ---- -------
Total....................................................... $ 621 $ 21 $ 642
======= ==== =======
REAL ESTATE CHARGE-OFFS AND REO EXPENSE AS A PERCENT OF
AVERAGE REAL ESTATE SECURED RECEIVABLES
Real estate charge-offs and REO expense..................... $ 636 $ - $ 636
Average real estate secured receivables..................... 73,097 23 73,120
------- ---- -------
Real estate charge-offs and REO expense as a percent of
average real estate secured receivables(1)................ .87% -% .87%
======= ==== =======
---------------
(1) Certain percentages may not recompute from the dollar figures presented due
to rounding.
104
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
CREDIT QUALITY STATISTICS - 2004
TWO-MONTHS-AND-OVER CONTRACTUAL DELINQUENCY
-------------------------------------------- YEAR-TO-DATE CHARGE-OFFS,
TWO-MONTHS- TWO-MONTHS- NET OF RECOVERIES
AND-OVER AND-OVER --------------------------------------------
CONTRACTUAL RECEIVABLES CONTRACTUAL NET AVERAGE NET
DELINQUENCY OUTSTANDING DELINQUENCY(1) CHARGE-OFFS RECEIVABLES CHARGE-OFFS(1)
-----------------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
OWNED:
First mortgage(2)....... $ 1 $ 26 5.04% $ 1 $ 32 2.39%
Real estate secured..... 1,920 64,820 2.96 620 56,303 1.10
Auto finance............ 156 7,544 2.07 198 5,785 3.43
MasterCard/Visa......... 714 14,635 4.88 1,025 11,575 8.85
Private label........... 141 3,411 4.13 804 13,029 6.17
Personal non-credit
card.................. 1,401 16,128 8.69 1,384 14,194 9.75
------ -------- ----- ------ -------- -----
Total consumer.......... 4,333 106,564 4.07 4,032 100,918 4.00
Commercial.............. - 291 - - 322 -
------ -------- ----- ------ -------- -----
Total................... $4,333 $106,855 4.06% $4,032 $101,240 3.98%
------ -------- ----- ------ -------- -----
SERVICED WITH LIMITED
RECOURSE:
Real estate secured..... $ 10 $ 81 12.35% $ 2 $ 159 1.26%
Auto finance............ 147 2,679 5.49 349 3,647 9.57
MasterCard/Visa......... 170 7,583 2.24 482 9,099 5.30
Private label........... - - - 256 4,550 5.63
Personal non-credit
card.................. 461 3,882 11.88 553 4,792 11.54
------ -------- ----- ------ -------- -----
Total................... $ 788 $ 14,225 5.54% $1,642 $ 22,247 7.38%
------ -------- ----- ------ -------- -----
MANAGED:
First mortgage(2)....... $ 1 $ 26 5.04% $ 1 $ 32 2.39%
Real estate secured..... 1,930 64,901 2.97 622 56,462 1.10
Auto finance............ 303 10,223 2.96 547 9,432 5.80
MasterCard/Visa......... 884 22,218 3.98 1,507 20,674 7.29
Private label........... 141 3,411 4.13 1,060 17,579 6.03
Personal non-credit
card.................. 1,862 20,010 9.30 1,937 18,986 10.20
------ -------- ----- ------ -------- -----
Total consumer.......... 5,121 120,789 4.24 5,674 123,165 4.61
Commercial.............. - 291 - - 322 -
------ -------- ----- ------ -------- -----
Total................... $5,121 $121,080 4.23% $5,674 $123,487 4.59%
====== ======== ===== ====== ======== =====
---------------
(1) Certain percentages may not recompute from the dollar figures presented due
to rounding.
(2) Includes our liquidating legacy first and reverse mortgage portfolios.
SERVICED WITH
OWNED LIMITED RECOURSE MANAGED
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
NONACCRUAL RECEIVABLES
Domestic:
Real estate secured....................................... $ 1,489 $ 7 $ 1,496
Auto finance.............................................. 155 147 302
Private label............................................. 24 - 24
Personal non-credit card.................................. 908 355 1,263
Foreign..................................................... 432 37 469
------- ---- -------
Total consumer.............................................. 3,008 546 3,554
Commercial and other........................................ 4 - 4
------- ---- -------
Total....................................................... $ 3,012 $546 $ 3,558
======= ==== =======
ACCRUING CONSUMER RECEIVABLES 90 OR MORE DAYS DELINQUENT
Domestic:
MasterCard/Visa........................................... $ 469 $101 $ 570
Private label............................................. - - -
Foreign..................................................... 38 - 38
------- ---- -------
Total....................................................... $ 507 $101 $ 608
======= ==== =======
REAL ESTATE CHARGE-OFFS AND REO EXPENSE AS A PERCENT OF
AVERAGE REAL ESTATE SECURED RECEIVABLES
Real estate charge-offs and REO expense..................... $ 779 $ 2 $ 781
Average real estate secured receivables..................... 56,303 159 56,462
------- ---- -------
Real estate charge-offs and REO expense as a percent of
average real estate secured receivables(1)................ 1.38% 1.26% 1.38%
======= ==== =======
---------------
(1) Certain percentages may not recompute from the dollar figures presented due
to rounding.
105
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
CREDIT QUALITY STATISTICS - 2003
TWO-MONTHS-AND-OVER CONTRACTUAL DELINQUENCY
--------------------------------------------
TWO-MONTHS- TWO-MONTHS- YEAR-TO-DATE CHARGE-OFFS, NET OF RECOVERIES
AND-OVER AND-OVER --------------------------------------------
CONTRACTUAL RECEIVABLES CONTRACTUAL NET AVERAGE NET
DELINQUENCY OUTSTANDING DELINQUENCY(1) CHARGE-OFFS RECEIVABLES CHARGE-OFFS(1)
------------------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
OWNED:
First mortgage(2)........ $ 3 $ 35 9.14% $ - $ 39 .77%
Real estate secured...... 2,217 51,221 4.33 496 49,852 .99
Auto finance............. 104 4,138 2.51 143 2,920 4.91
MasterCard/Visa.......... 644 11,182 5.76 874 9,517 9.18
Private label............ 683 12,604 5.42 687 11,942 5.75
Personal non-credit
card................... 1,285 12,832 10.01 1,385 14,009 9.89
------ -------- ----- ------ -------- -----
Total consumer........... 4,936 92,012 5.36 3,585 88,279 4.06
Commercial............... - 366 - 2 391 .46
------ -------- ----- ------ -------- -----
Total.................... $4,936 $ 92,378 5.34% $3,587 $ 88,670 4.05%
------ -------- ----- ------ -------- -----
SERVICED WITH LIMITED
RECOURSE:
Real estate secured...... $ 21 $ 194 11.05% $ 5 $ 272 1.69%
Auto finance............. 234 4,675 5.01 411 4,998 8.22
MasterCard/Visa.......... 237 9,967 2.38 525 9,755 5.38
Private label............ 200 5,261 3.79 214 4,074 5.25
Personal non-credit
card................... 740 6,104 12.12 512 5,032 10.17
------ -------- ----- ------ -------- -----
Total.................... $1,432 $ 26,201 5.47% $1,667 $ 24,131 6.91%
------ -------- ----- ------ -------- -----
MANAGED:
First mortgage(2)........ $ 3 $ 35 9.14% $ - $ 39 .77%
Real estate secured...... 2,238 51,415 4.35 501 50,124 1.00
Auto finance............. 338 8,813 3.84 554 7,918 7.00
MasterCard/Visa.......... 881 21,149 4.16 1,399 19,272 7.26
Private label............ 883 17,865 4.94 901 16,016 5.62
Personal non-credit
card................... 2,025 18,936 10.69 1,897 19,041 9.97
------ -------- ----- ------ -------- -----
Total consumer........... 6,368 118,213 5.39 5,252 112,410 4.67
Commercial............... - 366 - 2 391 .46
------ -------- ----- ------ -------- -----
Total.................... $6,368 $118,579 5.37% $5,254 $112,801 4.66%
====== ======== ===== ====== ======== =====
---------------
(1) Certain percentages may not recompute from the dollar figures presented due
to rounding.
(2) Includes our liquidating legacy first and reverse mortgage portfolios.
SERVICED WITH
OWNED LIMITED RECOURSE MANAGED
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
NONACCRUAL RECEIVABLES
Domestic:
Real estate secured....................................... $ 1,777 $ 14 $ 1,791
Auto finance.............................................. 104 234 338
Private label............................................. 43 - 43
Personal non-credit card.................................. 898 566 1,464
Foreign..................................................... 316 51 367
------- ---- -------
Total consumer.............................................. 3,138 865 4,003
Commercial and other........................................ 6 - 6
------- ---- -------
Total....................................................... $ 3,144 $865 $ 4,009
======= ==== =======
ACCRUING CONSUMER RECEIVABLES 90 OR MORE DAYS DELINQUENT
Domestic:
MasterCard/Visa........................................... $ 443 $158 $ 601
Private label............................................. 429 153 582
Foreign..................................................... 32 - 32
------- ---- -------
Total....................................................... $ 904 $311 $ 1,215
======= ==== =======
REAL ESTATE CHARGE-OFFS AND REO EXPENSE AS A PERCENT OF
AVERAGE REAL ESTATE SECURED RECEIVABLES
Real estate charge-offs and REO expense..................... $ 708 $ 5 $ 713
Average real estate secured receivables..................... 49,852 272 50,124
------- ---- -------
Real estate charge-offs and REO expense as a percent of
average real estate secured receivables(1)................ 1.42% 1.69% 1.42%
======= ==== =======
---------------
(1) Certain percentages may not recompute from the dollar figures presented due
to rounding.
106
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
CREDIT QUALITY STATISTICS - 2002
TWO-MONTHS-AND-OVER CONTRACTUAL DELINQUENCY
--------------------------------------------
TWO-MONTHS- TWO-MONTHS- YEAR-TO-DATE CHARGE-OFFS, NET OF RECOVERIES
AND-OVER AND-OVER --------------------------------------------
CONTRACTUAL RECEIVABLES CONTRACTUAL NET AVERAGE NET
DELINQUENCY OUTSTANDING DELINQUENCY(1) CHARGE-OFFS RECEIVABLES CHARGE-OFFS(1)
------------------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
OWNED:
First mortgage(2)........ $ 4 $ 44 9.71% $ 2 $ 54 3.70%
Real estate secured...... 1,794 45,819 3.91 431 47,258 .91
Auto finance............. 80 2,024 3.96 152 2,529 6.00
MasterCard/Visa.......... 534 8,947 5.97 716 7,569 9.46
Private label............ 721 11,339 6.36 676 10,775 6.28
Personal non-credit
card................... 1,251 13,970 8.95 1,154 13,968 8.26
------ -------- ----- ------ -------- ----
Total consumer........... 4,384 82,143 5.34 3,131 82,153 3.81
Commercial............... - 419 - (2) 429 (.40)
------ -------- ----- ------ -------- ----
Total.................... $4,384 $ 82,562 5.31% $3,129 $ 82,582 3.79%
------ -------- ----- ------ -------- ----
SERVICED WITH LIMITED
RECOURSE:
Real estate secured...... $ 31 $ 456 6.82% $ 7 $ 572 1.26%
Auto finance............. 192 5,418 3.54 308 4,413 7.00
MasterCard/Visa.......... 247 10,006 2.46 512 9,677 5.28
Private label............ 178 3,578 4.96 107 2,840 3.75
Personal non-credit
card................... 579 5,476 10.60 413 4,869 8.49
------ -------- ----- ------ -------- ----
Total.................... $1,227 $ 24,934 4.92% $1,347 $ 22,371 6.02%
------ -------- ----- ------ -------- ----
MANAGED:
First mortgage(2)........ $ 4 $ 44 9.71% $ 2 $ 54 3.70%
Real estate secured...... 1,825 46,275 3.94 438 47,830 .92
Auto finance............. 272 7,442 3.65 460 6,942 6.63
MasterCard/Visa.......... 781 18,953 4.12 1,228 17,246 7.12
Private label............ 899 14,917 6.03 783 13,615 5.75
Personal non-credit
card................... 1,830 19,446 9.41 1,567 18,837 8.32
------ -------- ----- ------ -------- ----
Total consumer........... 5,611 107,077 5.24 4,478 104,524 4.28
Commercial............... - 419 - (2) 429 (.40)
------ -------- ----- ------ -------- ----
Total.................... $5,611 $107,496 5.22% $4,476 $104,953 4.26%
====== ======== ===== ====== ======== ====
---------------
(1) Certain percentages may not recompute from the dollar figures presented due
to rounding.
(2) Includes our liquidating legacy first and reverse mortgage portfolios.
SERVICED WITH
OWNED LIMITED RECOURSE MANAGED
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
NONACCRUAL RECEIVABLES
Domestic:
Real estate secured....................................... $ 1,367 $ 24 $ 1,391
Auto finance.............................................. 80 192 272
Private label............................................. 38 - 38
Personal non-credit card.................................. 902 418 1,320
Foreign..................................................... 264 47 311
------- ---- -------
Total consumer.............................................. 2,651 681 3,332
Commercial and other........................................ 15 - 15
------- ---- -------
Total....................................................... $ 2,666 $681 $ 3,347
======= ==== =======
ACCRUING CONSUMER RECEIVABLES 90 OR MORE DAYS DELINQUENT
Domestic:
MasterCard/Visa........................................... $ 343 $170 $ 513
Private label............................................. 491 142 633
Foreign..................................................... 27 - 27
------- ---- -------
Total....................................................... $ 861 $312 $ 1,173
======= ==== =======
REAL ESTATE CHARGE-OFFS AND REO EXPENSE AS A PERCENT OF
AVERAGE REAL ESTATE SECURED RECEIVABLES
Real estate charge-offs and REO expense..................... $ 608 $ 7 $ 615
Average real estate secured receivables..................... 47,258 572 47,830
------- ---- -------
Real estate charge-offs and REO expense as a percent of
average real estate secured receivables(1)................ 1.29% 1.28% 1.29%
======= ==== =======
---------------
(1) Certain percentages may not recompute from the dollar figures presented due
to rounding.
107
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
CREDIT QUALITY STATISTICS - 2001
TWO-MONTHS-AND-OVER CONTRACTUAL DELINQUENCY
--------------------------------------------
TWO-MONTHS- TWO-MONTHS- YEAR-TO-DATE CHARGE-OFFS, NET OF RECOVERIES
AND-OVER AND-OVER --------------------------------------------
CONTRACTUAL RECEIVABLES CONTRACTUAL NET AVERAGE NET
DELINQUENCY OUTSTANDING DELINQUENCY(1) CHARGE-OFFS RECEIVABLES CHARGE-OFFS(1)
------------------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
OWNED:
First mortgage(2)........ $ 8 $ 63 12.78% $ 2 $ 75 2.28%
Real estate secured...... 1,154 43,857 2.63 202 38,851 .52
Auto finance............. 69 2,369 2.92 93 2,319 4.00
MasterCard/Visa.......... 462 8,141 5.67 665 8,138 8.17
Private label............ 699 11,664 5.99 587 10,516 5.59
Personal non-credit
card................... 1,126 13,337 8.44 851 12,486 6.81
------ -------- ----- ------ ------- ----
Total consumer........... 3,518 79,431 4.43 2,400 72,385 3.32
Commercial............... - 444 - 10 480 2.10
------ -------- ----- ------ ------- ----
Total.................... $3,518 $ 79,875 4.40% $2,410 $72,865 3.31%
------ -------- ----- ------ ------- ----
SERVICED WITH LIMITED
RECOURSE:
Real estate secured...... $ 43 $ 862 5.00% $ 8 $ 1,198 .70%
Auto finance............. 133 4,026 3.29 189 3,004 6.32
MasterCard/Visa.......... 252 9,254 2.73 482 9,145 5.27
Private label............ 58 2,150 2.69 48 1,745 2.72
Personal non-credit
card................... 469 4,656 10.09 305 4,528 6.74
------ -------- ----- ------ ------- ----
Total.................... $ 955 $ 20,948 4.56% $1,032 $19,620 5.26%
------ -------- ----- ------ ------- ----
MANAGED:
First mortgage(2)........ $ 8 $ 63 12.78% $ 2 $ 75 2.28%
Real estate secured...... 1,197 44,719 2.68 210 40,049 .53
Auto finance............. 202 6,395 3.16 282 5,323 5.31
MasterCard/Visa.......... 714 17,395 4.10 1,147 17,283 6.63
Private label............ 757 13,814 5.48 635 12,261 5.18
Personal non-credit
card................... 1,595 17,993 8.87 1,156 17,014 6.79
------ -------- ----- ------ ------- ----
Total consumer........... 4,473 100,379 4.46 3,432 92,005 3.73
Commercial............... - 444 - 10 480 2.10
------ -------- ----- ------ ------- ----
Total.................... $4,473 $100,823 4.44% $3,442 $92,485 3.72%
====== ======== ===== ====== ======= ====
---------------
(1) Certain percentages may not recompute from the dollar figures presented due
to rounding.
(2) Includes our liquidating legacy first and reverse mortgage portfolios.
SERVICED WITH
OWNED LIMITED RECOURSE MANAGED
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
NONACCRUAL RECEIVABLES
Domestic:
Real estate secured....................................... $ 907 $ 34 $ 941
Auto finance.............................................. 69 133 202
Private label............................................. 39 - 39
Personal non-credit card.................................. 782 324 1,106
Foreign..................................................... 215 48 263
------- ------ -------
Total consumer.............................................. 2,012 539 2,551
Commercial and other........................................ 15 - 15
------- ------ -------
Total....................................................... $ 2,027 $ 539 $ 2,566
======= ====== =======
ACCRUING CONSUMER RECEIVABLES 90 OR MORE DAYS DELINQUENT
Domestic:
MasterCard/Visa........................................... $ 352 $ 175 $ 527
Private label............................................. 462 41 503
Foreign..................................................... 30 - 30
------- ------ -------
Total....................................................... $ 844 $ 216 $ 1,060
======= ====== =======
REAL ESTATE CHARGE-OFFS AND REO EXPENSE AS A PERCENT OF
AVERAGE REAL ESTATE SECURED RECEIVABLES
Real estate charge-offs and REO expense..................... $ 326 $ 8 $ 334
Average real estate secured receivables..................... 38,850 1,199 40,049
------- ------ -------
Real estate charge-offs and REO expense as a percent of
average real estate secured receivables(1)................ .84% .70% .83%
======= ====== =======
---------------
(1) Certain percentages may not recompute from the dollar figures presented due
to rounding.
108
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY - 2005
SERVICED WITH
OWNED LIMITED RECOURSE MANAGED
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
TOTAL CREDIT LOSS RESERVES AT JANUARY 1..................... $ 3,625 $ 890 $ 4,515
------- ----- -------
PROVISION FOR CREDIT LOSSES................................. 4,543 107 4,650
------- ----- -------
CHARGE-OFFS
Domestic:
Real estate secured....................................... (569) - (569)
Auto finance.............................................. (311) (217) (528)
MasterCard/Visa........................................... (1,339) (234) (1,573)
Private label............................................. (33) - (33)
Personal non-credit card.................................. (1,333) (252) (1,585)
Foreign..................................................... (509) (65) (574)
------- ----- -------
Total consumer.............................................. (4,094) (768) (4,862)
Commercial and other........................................ (6) - (6)
------- ----- -------
Total receivables charged off............................... (4,100) (768) (4,868)
------- ----- -------
RECOVERIES
Domestic:
Real estate secured....................................... 27 - 27
Auto finance.............................................. 18 14 32
MasterCard/Visa........................................... 157 17 174
Private label............................................. 6 - 6
Personal non-credit card.................................. 171 21 192
Foreign..................................................... 68 8 76
------- ----- -------
Total consumer.............................................. 447 60 507
Commercial and other........................................ - - -
------- ----- -------
Total recoveries on receivables............................. 447 60 507
OTHER, NET.................................................. 6 (74) (68)
------- ----- -------
CREDIT LOSS RESERVES
Domestic:
Real estate secured....................................... 718 - 718
Auto finance.............................................. 222 126 348
MasterCard/Visa........................................... 1,576 16 1,592
Private label............................................. 36 - 36
Personal non-credit card.................................. 1,652 73 1,725
Foreign..................................................... 312 - 312
------- ----- -------
Total consumer.............................................. 4,516 215 4,731
Commercial and other........................................ 5 - 5
------- ----- -------
TOTAL CREDIT LOSS RESERVES AT DECEMBER 31................... $ 4,521 $ 215 $ 4,736
======= ===== =======
SERVICED WITH
OWNED LIMITED RECOURSE MANAGED
---------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
RESERVES AS A PERCENTAGE OF NET
CHARGE-OFFS:
Net charge-offs........................... $ 3,653 123.8% $ 708 30.4% $ 4,361 108.6%
RESERVES AS A PERCENTAGE OF RECEIVABLES:
Receivables:
Consumer................................ $139,726 3.23 $4,074 5.28% $143,800 3.29%
Commercial.............................. 187 2.67 - - 187 2.67
-------- ----- ------ ----- -------- -----
Total................................... $139,913 3.23% $4,074 5.28% $143,987 3.29%
======== ===== ====== ===== ======== =====
RESERVES AS A PERCENTAGE OF NONPERFORMING
LOANS:
Nonperforming loans:
Consumer................................ $ 4,151 108.8% $ 197 109.1% $ 4,348 108.8%
Commercial.............................. 3 166.7 - - 3 166.7
-------- ----- ------ ----- -------- -----
Total................................... $ 4,154 108.8% $ 197 109.1% $ 4,351 108.8%
======== ===== ====== ===== ======== =====
109
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY - 2004
SERVICED WITH
OWNED LIMITED RECOURSE MANAGED
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
TOTAL CREDIT LOSS RESERVES AT JANUARY 1..................... $ 3,793 $ 2,374 $ 6,167
------- ------- -------
PROVISION FOR CREDIT LOSSES................................. 4,334 188 4,522
------- ------- -------
CHARGE-OFFS
Domestic:
Real estate secured....................................... (629) (2) (631)
Auto finance.............................................. (204) (357) (561)
MasterCard/Visa........................................... (1,082) (469) (1,551)
Private label............................................. (788) (278) (1,066)
Personal non-credit card.................................. (1,350) (569) (1,919)
Foreign..................................................... (355) (68) (423)
------- ------- -------
Total consumer.............................................. (4,408) (1,743) (6,151)
Commercial and other........................................ (1) - (1)
------- ------- -------
Total receivables charged off............................... (4,409) (1,743) (6,152)
------- ------- -------
RECOVERIES
Domestic:
Real estate secured....................................... 18 - 18
Auto finance.............................................. 6 9 15
MasterCard/Visa........................................... 103 29 132
Private label............................................. 79 22 101
Personal non-credit card.................................. 120 34 154
Foreign..................................................... 50 8 58
------- ------- -------
Total consumer.............................................. 376 102 478
Commercial and other........................................ - - -
------- ------- -------
Total recoveries on receivables............................. 376 102 478
OTHER, NET.................................................. (469) (31) (500)
------- ------- -------
CREDIT LOSS RESERVES
Domestic:
Real estate secured....................................... 645 1 646
Auto finance.............................................. 181 335 516
MasterCard/Visa........................................... 1,205 101 1,306
Private label............................................. 28 - 28
Personal non-credit card.................................. 1,237 398 1,635
Foreign..................................................... 316 55 371
------- ------- -------
Total consumer.............................................. 3,612 890 4,502
Commercial and other........................................ 13 - 13
------- ------- -------
TOTAL CREDIT LOSS RESERVES AT DECEMBER 31................... $ 3,625 $ 890 $ 4,515
======= ======= =======
SERVICED WITH
OWNED LIMITED RECOURSE MANAGED
-----------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
RESERVES AS A PERCENTAGE OF NET CHARGE-OFFS:
Net charge-offs................................... $ 4,033 89.9% $ 1,641 54.2% $ 5,674 79.6%
RESERVES AS A PERCENTAGE OF RECEIVABLES:
Receivables:
Consumer........................................ $106,564 3.39 $14,225 6.26% $120,789 3.73%
Commercial...................................... 291 8.90 - - 291 8.90
-------- ----- ------- ----- -------- -----
Total........................................... $106,855 3.39% $14,225 6.26% $121,080 3.73%
======== ===== ======= ===== ======== =====
RESERVES AS A PERCENTAGE OF NONPERFORMING LOANS:
Nonperforming loans:
Consumer........................................ $ 3,516 102.7% $ 646 137.8% $ 4,162 108.2%
Commercial...................................... 5 535.9 - - 5 535.9
-------- ----- ------- ----- -------- -----
Total........................................... $ 3,521 103.0% $ 646 137.8% $ 4,167 108.4%
======== ===== ======= ===== ======== =====
110
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY - 2003
SERVICED WITH
OWNED LIMITED RECOURSE MANAGED
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
TOTAL CREDIT LOSS RESERVES AT JANUARY 1..................... $ 3,333 $ 1,759 $ 5,092
------- ------- -------
PROVISION FOR CREDIT LOSSES................................. 3,967 2,275 6,242
------- ------- -------
CHARGE-OFFS
Domestic:
Real estate secured....................................... (496) (4) (500)
Auto finance.............................................. (148) (419) (567)
MasterCard/Visa........................................... (936) (526) (1,462)
Private label............................................. (684) (234) (918)
Personal non-credit card.................................. (1,354) (508) (1,862)
Foreign..................................................... (257) (73) (330)
------- ------- -------
Total consumer.............................................. (3,875) (1,764) (5,639)
Commercial and other........................................ (3) - (3)
------- ------- -------
Total receivables charged off............................... (3,878) (1,764) (5,642)
------- ------- -------
RECOVERIES
Domestic:
Real estate secured....................................... 10 - 10
Auto finance.............................................. 5 7 12
MasterCard/Visa........................................... 87 40 127
Private label............................................. 72 20 92
Personal non-credit card.................................. 82 24 106
Foreign..................................................... 34 6 40
------- ------- -------
Total consumer.............................................. 290 97 387
Commercial and other........................................ 1 - 1
------- ------- -------
Total recoveries on receivables............................. 291 97 388
OTHER, NET.................................................. 80 7 87
------- ------- -------
CREDIT LOSS RESERVES
Domestic:
Real estate secured....................................... 670 1 671
Auto finance.............................................. 172 674 846
MasterCard/Visa........................................... 806 308 1,114
Private label............................................. 519 367 886
Personal non-credit card.................................. 1,348 896 2,244
Foreign..................................................... 247 128 375
------- ------- -------
Total consumer.............................................. 3,762 2,374 6,136
Commercial and other........................................ 31 - 31
------- ------- -------
TOTAL CREDIT LOSS RESERVES AT DECEMBER 31................... $ 3,793 $ 2,374 $ 6,167
======= ======= =======
SERVICED WITH
OWNED LIMITED RECOURSE MANAGED
---------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
RESERVES AS A PERCENTAGE OF NET
CHARGE-OFFS:
Net charge-offs............................ $ 3,587 105.7% $ 1,667 142.4% $ 5,254 117.4%
RESERVES AS A PERCENTAGE OF RECEIVABLES:
Receivables:
Consumer................................. $92,012 4.09% $26,201 9.06% $118,213 5.19%
Commercial............................... 366 6.80 - - 366 6.80
------- ----- ------- ----- -------- -----
Total.................................... $92,378 4.11% $26,201 9.06% $118,579 5.20%
======= ===== ======= ===== ======== =====
RESERVES AS A PERCENTAGE OF NONPERFORMING
LOANS:
Nonperforming loans:
Consumer................................. $ 4,045 93.2% $ 1,176 201.8% $ 5,221 117.6%
Commercial............................... 5 469.8 - - 5 469.8
------- ----- ------- ----- -------- -----
Total.................................... $ 4,050 93.7% $ 1,176 201.8% $ 5,226 118.0%
======= ===== ======= ===== ======== =====
111
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY - 2002
SERVICED WITH
OWNED LIMITED RECOURSE MANAGED
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
TOTAL CREDIT LOSS RESERVES AT JANUARY 1..................... $ 2,663 $ 1,148 $ 3,811
------- ------- -------
PROVISION FOR CREDIT LOSSES................................. 3,732 1,923 5,655
------- ------- -------
CHARGE-OFFS
Domestic:
Real estate secured....................................... (430) (7) (437)
Auto finance.............................................. (159) (319) (478)
MasterCard/Visa........................................... (736) (538) (1,274)
Private label............................................. (650) (114) (764)
Personal non-credit card.................................. (1,193) (407) (1,600)
Foreign..................................................... (223) (57) (280)
------- ------- -------
Total consumer.............................................. (3,391) (1,442) (4,833)
Commercial and other........................................ (2) - (2)
------- ------- -------
Total receivables charged off............................... (3,393) (1,442) (4,835)
------- ------- -------
RECOVERIES
Domestic:
Real estate secured....................................... 7 - 7
Auto finance.............................................. 7 10 17
MasterCard/Visa........................................... 59 37 96
Private label............................................. 48 8 56
Personal non-credit card.................................. 92 30 122
Foreign..................................................... 49 10 59
------- ------- -------
Total consumer.............................................. 262 95 357
Commercial and other........................................ 2 - 2
------- ------- -------
Total recoveries on receivables............................. 264 95 359
OTHER, NET.................................................. 67 35 102
------- ------- -------
CREDIT LOSS RESERVES
Domestic:
Real estate secured....................................... 551 10 561
Auto finance.............................................. 126 633 759
MasterCard/Visa........................................... 649 308 957
Private label............................................. 527 264 791
Personal non-credit card.................................. 1,275 422 1,697
Foreign..................................................... 172 122 294
------- ------- -------
Total consumer.............................................. 3,300 1,759 5,059
Commercial and other........................................ 33 - 33
------- ------- -------
TOTAL CREDIT LOSS RESERVES AT DECEMBER 31................... $ 3,333 $ 1,759 $ 5,092
======= ======= =======
SERVICED WITH
OWNED LIMITED RECOURSE MANAGED
-----------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
RESERVES AS A PERCENTAGE OF NET CHARGE-OFFS:
Net charge-offs................................ $ 3,129 106.5% $ 1,347 130.6% $ 4,476 113.8%
RESERVES AS A PERCENTAGE OF RECEIVABLES:
Receivables:
Consumer..................................... $82,143 4.02 $24,934 7.06% $107,077 4.73%
Commercial................................... 419 6.64 - - 419 6.64
------- ----- ------- ----- -------- -----
Total........................................ $82,562 4.04% $24,934 7.06% $107,496 4.74%
======= ===== ======= ===== ======== =====
RESERVES AS A PERCENTAGE OF NONPERFORMING
LOANS:
Nonperforming loans:
Consumer..................................... $ 3,516 94.0% $ 994 177.0% $ 4,510 112.3%
Commercial................................... 12 229.7 - - 12 229.7
------- ----- ------- ----- -------- -----
Total........................................ $ 3,528 94.5% $ 994 177.0% $ 4,522 112.6%
======= ===== ======= ===== ======== =====
112
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY - 2001
SERVICED WITH
OWNED LIMITED RECOURSE MANAGED
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
TOTAL CREDIT LOSS RESERVES AT JANUARY 1..................... $ 2,112 $ 1,082 $ 3,194
------- ------- -------
PROVISION FOR CREDIT LOSSES................................. 2,913 1,105 4,018
------- ------- -------
CHARGE-OFFS
Domestic:
Real estate secured....................................... (194) (9) (203)
Auto finance.............................................. (94) (193) (287)
MasterCard/Visa........................................... (646) (502) (1,148)
Private label............................................. (591) (49) (640)
Personal non-credit card.................................. (893) (303) (1,196)
Foreign..................................................... (237) (45) (282)
------- ------- -------
Total consumer.............................................. (2,655) (1,101) (3,756)
Commercial and other........................................ (12) - (12)
------- ------- -------
Total receivables charged off............................... (2,667) (1,101) (3,768)
------- ------- -------
RECOVERIES
Domestic:
Real estate secured....................................... 5 - 5
Auto finance.............................................. 1 3 4
MasterCard/Visa........................................... 52 29 81
Private label............................................. 61 1 62
Personal non-credit card.................................. 76 25 101
Foreign..................................................... 62 10 72
------- ------- -------
Total consumer.............................................. 257 68 325
Commercial and other........................................ - - -
------- ------- -------
Total recoveries on receivables............................. 257 68 325
OTHER, NET.................................................. 48 (6) 42
------- ------- -------
CREDIT LOSS RESERVES
Domestic:
Real estate secured....................................... 284 20 304
Auto finance.............................................. 77 372 449
MasterCard/Visa........................................... 594 381 975
Private label............................................. 499 104 603
Personal non-credit card.................................. 1,032 185 1,217
Foreign..................................................... 137 86 223
------- ------- -------
Total consumer.............................................. 2,623 1,148 3,771
Commercial and other........................................ 40 - 40
------- ------- -------
TOTAL CREDIT LOSS RESERVES AT DECEMBER 31................... $ 2,663 $ 1,148 $ 3,811
======= ======= =======
SERVICED WITH
OWNED LIMITED RECOURSE MANAGED
---------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
RESERVES AS A PERCENTAGE OF NET
CHARGE-OFFS:
Net charge-offs.......................... $ 2,410 110.5% $ 1,033 111.2% $ 3,443 110.7%
RESERVES AS A PERCENTAGE OF RECEIVABLES:
Receivables:
Consumer............................... $79,431 3.31 $20,948 5.48% $100,379 3.77%
Commercial............................. 444 7.12 - - 444 7.12
------- ----- ------- ----- -------- -----
Total.................................. $79,875 3.33% $20,948 5.48% $100,823 3.78%
======= ===== ======= ===== ======== =====
RESERVES AS A PERCENTAGE OF NONPERFORMING
LOANS:
Nonperforming loans:
Consumer............................... $ 2,863 91.9% $ 754 152.2% $ 3,617 104.5%
Commercial............................. 11 278.7 - - 11 278.7
------- ----- ------- ----- -------- -----
Total.................................. $ 2,874 92.7% $ 754 152.2% $ 3,628 105.0%
======= ===== ======= ===== ======== =====
113
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
NET INTEREST MARGIN - 2005 COMPARED TO 2004
FINANCE AND
INTEREST
AVERAGE AVERAGE INCOME/INTEREST INCREASE/(DECREASE) DUE TO:
OUTSTANDING(1) RATE EXPENSE ---------------------------
------------------- ----------- --------------- VOLUME RATE
2005 2004 2005 2004 2005 2004 VARIANCE VARIANCE(2)VARIANCE(2)
------------------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
OWNED:
Receivables:
Real estate secured............... $ 73,097 $ 56,303 8.4% 8.8% $ 6,155 $ 4,974 $ 1,181 $ 1,424 $ (243)
Auto finance...................... 9,074 5,785 11.8 12.2 1,067 706 361 388 (27)
MasterCard/Visa................... 17,823 11,575 13.9 13.6 2,479 1,572 907 868 39
Private label..................... 2,948 13,029 9.4 10.8 278 1,407 (1,129) (970) (159)
Personal non-credit card.......... 17,558 14,194 18.4 16.7 3,226 2,374 852 602 250
Commercial and other.............. 255 354 2.4 2.5 6 9 (3) (2) (1)
HSBC acquisition purchase
accounting adjustments.......... 134 319 - - (139) (201) 62 62 -
-------- -------- ---- ---- ------- ------- ------- ------- -------
Total receivables.................. 120,889 101,559 10.8 10.7 13,072 10,841 2,231 2,089 142
Noninsurance investments........... 3,694 4,853 3.9 2.1 144 104 40 (29) 69
-------- -------- ---- ---- ------- ------- ------- ------- -------
Total interest-earning assets
(excluding insurance
investments)...................... $124,583 $106,412 10.6% 10.3% $13,216 $10,945 $ 2,271 $ 1,940 $ 331
-------- -------- ---- ---- ------- ------- ------- ------- -------
Total debt......................... $114,849 $100,115 4.2% 3.1% $ 4,832 $ 3,143 $ 1,689 $ 495 $ 1,194
-------- -------- ---- ---- ------- ------- ------- ------- -------
Net Interest Margin(3)............. 6.7% 7.3% $ 8,384 $ 7,802 $ 582 $ 1,445 $ (863)
==== ==== ======= ======= ======= ======= =======
Interest Spread(4)................. 6.4% 7.2%
==== ====
SERVICED WITH LIMITED RECOURSE:
Receivables:
Real estate secured............... $ 23 $ 159 8.7% 6.3% $ 2 $ 10 $ (8) $ (12) $ 4
Auto finance...................... 1,863 3,647 14.8 14.9 275 544 (269) (198) (71)
MasterCard/Visa................... 4,871 9,099 11.6 11.6 566 1,055 (489) (602) 113
Private label..................... - 4,550 - 10.7 - 488 (488) (436) (52)
Personal non-credit card.......... 2,398 4,792 17.7 18.5 424 886 (462) (431) (31)
-------- -------- ---- ---- ------- ------- ----- ------- -------
Total receivables.................. 9,155 22,247 13.8 13.4 1,267 2,983 (1,716) (1,399) (317)
-------- -------- ---- ---- ------- ------ ------ ------- -------
Total interest-earning assets
(excluding insurance
investments)...................... $ 9,155 $ 22,247 13.8% 13.4% $ 1,267 $ 2,983 $(1,716) $(1,385) $ (331)
-------- -------- ---- ---- ------- ------- ------- ------- -------
Total debt......................... $ 9,155 $ 22,247 4.1% 2.4% $ 375 $ 528 $ (153) $ (445) $ 292
-------- -------- ---- ---- ------- ------- ------- ------- -------
Net Interest Margin(3)............. 9.7% 11.0% $ 892 $ 2,455 $(1,563) $ (940) $ (623)
==== ==== ======= ======= ======= ======= =======
Interest Spread(4)................. 9.7% 11.0%
==== ====
MANAGED:
Receivables:
Real estate secured............... $ 73,120 $ 56,462 8.4% 8.8% $ 6,157 $ 4,984 $ 1,173 $ 1,412 $ (239)
Auto finance...................... 10,937 9,432 12.3 13.3 1,342 1,250 92 189 (97)
MasterCard/Visa................... 22,694 20,674 13.4 12.7 3,045 2,627 418 266 152
Private label..................... 2,948 17,579 9.4 10.8 278 1,895 (1,617) (1,406) (211)
Personal non-credit card.......... 19,956 18,986 18.3 17.2 3,650 3,260 390 171 219
Commercial and other.............. 255 354 2.4 2.5 6 9 (3) (2) (1)
HSBC acquisition purchase
accounting adjustments.......... 134 319 - - (139) (201) 62 62 -
-------- -------- ---- ---- ------- ------- ------- ------- -------
Total receivables.................. 130,044 123,806 11.0 11.2 14,339 13,824 515 690 (175)
Noninsurance investments........... 3,694 4,853 3.9 2.1 144 104 40 (29) 69
-------- -------- ---- ---- ------- ------- ------- ------ -------
Total interest-earning assets
(excluding insurance
investments)...................... $133,738 $128,659 10.8% 10.8% $14,483 $13,928 $ 555 $ 555 $ -
-------- -------- ---- ---- ------- ------- ----- ------- -------
Total debt......................... $124,004 $122,362 4.2% 3.0% $ 5,207 $ 3,671 $ 1,536 $ 50 $ 1,486
-------- -------- ---- ---- ------- ------- ----- ------- -------
Net Interest Margin(3)............. 6.9% 8.0% $ 9,276 $10,257 $ (981) $ 505 $(1,486)
==== ==== ======= ======= ======= ======= =======
Interest Spread(4)................. 6.6% 7.8%
==== ====
---------------
(1) Nonaccrual loans are included in average outstanding balances.
(2) Rate/volume variance is allocated based on the percentage relationship of
changes in volume and changes in rate to the total interest variance. For
total receivables, total interest-earning assets and total debt, the rate
and volume variances are calculated based on the relative weighting of the
individual components comprising these totals. These totals do not represent
an arithmetic sum of the individual components
(3) Represents net interest income as a percent of average interest-earning
assets
(4) Represents the difference between the yield earned on interest-earning
assets and cost of the debt used to fund the assets.
114
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
NET INTEREST MARGIN - 2004 COMPARED TO 2003
FINANCE AND
INTEREST
AVERAGE AVERAGE INCOME/ INTEREST INCREASE/ (DECREASE) DUE TO:
OUTSTANDING(1) RATE EXPENSE ------------------------------------
------------------- ------------- ----------- VOLUME RATE
2004 2003 2004 2003 2004 2003 VARIANCE VARIANCE(2) VARIANCE(2)
------------------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
OWNED:
Receivables:
Real estate secured.... $ 56,303 $ 49,852 8.8% 9.7% $ 4,974 $ 4,852 $ 122 $ 594 $(472)
Auto finance........... 5,785 2,920 12.2 12.9 706 378 328 351 (23)
MasterCard/Visa........ 11,575 9,517 13.6 13.3 1,572 1,266 306 279 27
Private label.......... 13,029 11,942 10.8 11.6 1,407 1,379 28 125 (97)
Personal non-credit card.. 14,194 14,009 16.7 17.5 2,374 2,454 (80) 32 (112)
Commercial and other...... 354 430 2.5 2.2(5) 9 10 (1) (2) 1
HSBC acquisition purchase
accounting adjustments.. 319 397 - - (201) (200) (1) (1) -
------ -------- ---- ------ ------- ------- ----- ------ -----
Total receivables........ 101,559 89,067 10.7 11.4 10,841 10,139 702 1,361 (659)
Noninsurance investments. 4,853 5,280 2.1 2.0 104 103 1 (9) 10
----- -------- ---- ------ ------- ------- ----- ------ -----
Total interest-earning assets
(excluding insurance
investments)........... $106,412 $ 94,347 10.3% 10.9% $10,945 $10,242 $ 703 $1,251 $(548)
-------- -------- ---- ------ ------- ------- ----- ------ -----
Total debt............. $100,115 $ 84,933 3.1% 3.4% $ 3,143 $ 2,928 $ 215 $ 492 $(277)
-------- -------- ---- ------ ------- ------- ----- ------ -----
Net Interest Margin(3) 7.3% 7.8% $ 7,802 $ 7,314 $ 488 $ 759 $(271)
==== ====== ======= ======= ===== ====== =====
Interest Spread(4)........... 7.2% 7.5%
==== ======
SERVICED WITH LIMITED
RECOURSE:
Receivables:
Real estate secured... $ 159 $ 272 6.3% 8.3%(5) $ 10 $ 22 $ (12) $ (11) $ (1)
Auto finance........... 3,647 4,998 14.9 16.0 544 802 (258) (141) (117)
MasterCard/Visa........ 9,099 9,755 11.6 12.5 1,055 1,218 (163) (100) (63)
Private label.......... 4,550 4,074 10.7 11.4 488 464 24 48 (24)
Personal non-credit card.. 4,792 5,032 18.5 18.6 886 934 (48) (42) (6)
------- -------- ---- ------ ------- ------- ----- ------ -----
Total receivables...... 22,247 24,131 13.4 14.3 2,983 3,440 (457) (139) (318)
------- -------- ---- ------ ------- ------- ----- ------ -----
Total interest-earning assets
(excluding insurance
investments)........... $ 22,247 $ 24,131 13.4% 14.3% $ 2,983 $ 3,440 $(457) $ (136) $(321)
------- -------- ---- ------ ------- ------- ----- ------ -----
Total debt.............. $ 22,247 $ 24,131 2.4% 2.2% $ 528 $ 566 $ (38) $ (87) $ 49
-------- -------- ---- ------ ------- ------- ----- ------ -----
Net Interest Margin(3)..... 11.0% 11.9% $ 2,455 $ 2,874 $(419) $ (49) $(370)
==== ====== ======= ======= ===== ====== =====
Interest Spread(4)........... 11.0% 12.0%
==== ======
MANAGED:
Receivables:
Real estate secured... $ 56,462 $ 50,124 8.8% 9.7% $ 4,984 $ 4,874 $ 110 $ 583 $(473)
Auto finance.......... 9,432 7,918 13.3 14.9 1,250 1,180 70 210 (140)
MasterCard/Visa....... 20,674 19,272 12.7 12.9 2,627 2,484 143 179 (36)
Private label......... 17,579 16,016 10.8 11.5 1,895 1,843 52 173 (121)
Personal non-credit card 18,986 19,041 17.2 17.8 3,260 3,388 (128) (10) (118)
Commercial and other.... 354 430 2.5 2.2(5) 9 10 (1) (2) 1
HSBC acquisition purchase
accounting adjustments. 319 397 - - (201) (200) (1) (1) -
-------- -------- ---- ------ ------- ------- ----- ------ -----
Total receivables...... 123,806 113,198 11.2 12.0 13,824 13,579 245 1,222 (977)
Noninsurance investments 4,853 5,280 2.1 2.0 104 103 1 (9) 10
-------- -------- ---- ------ ------- ------- ----- ------ -----
Total interest-earning assets
(excluding insurance
investments).......... $128,659 $118,478 10.8% 11.5% $13,928 $13,682 $ 246 $1,115 $(869)
-------- -------- ---- ------ ------- ------- ----- ------ -----
Total debt............. $122,362 $109,064 3.0% 3.2% $ 3,671 $ 3,494 $ 177 $ 405 $(228)
-------- -------- ---- ------ ------- ------- ----- ------ -----
Net Interest Margin(3) 8.0% 8.6% $10,257 $10,188 $ 69 $ 710 $(641)
==== ====== ======= ======= ===== ====== =====
Interest Spread(4)...... 7.8% 8.3%
==== ======
---------------
(1) Nonaccrual loans are included in average outstanding balances.
(2) Rate/volume variance is allocated based on the percentage relationship of
changes in volume and changes in rate to the total interest variance. For
total receivables, total interest-earning assets and total debt, the rate
and volume variances are calculated based on the relative weighting of the
individual components comprising these totals. These totals do not represent
an arithmetic sum of the individual components
(3) Represents net interest income as a percent of average interest-earning
assets
(4) Represents the difference between the yield earned on interest-earning
assets and cost of the debt used to fund the assets.
(5) Average rate does not recompute from dollar figures presented due to
rounding.
115
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
SELECTED FINANCIAL DATA AND STATISTICS
2005 2004 2003 2002 2001
------------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
RETURN ON AVERAGE COMMON SHAREHOLDER'S(S') EQUITY:
Net income.................................................. $ 1,772 $ 1,940 $ 1,603 $ 1,558 $ 1,848
Dividends on preferred stock.............................. (83) (72) (76) (63) (16)
-------- -------- -------- -------- --------
Net income available to common shareholders................. $ 1,689 $ 1,868 $ 1,527 $ 1,495 $ 1,832
Gain on bulk sale of private label receivables.............. - (423) - - -
Adoption of FFIEC charge-off policies for domestic private
label (excluding retail sales contracts) and
MasterCard/Visa portfolios................................ - 121 - - -
HSBC acquisition related costs and other merger related
items incurred by HSBC Finance Corporation................ - - 167 - -
Settlement charge and related expenses...................... - - - 333 -
Loss on the disposition of Thrift assets and deposits....... - - - 240 -
-------- -------- -------- -------- --------
Operating net income available to common shareholders....... $ 1,689 $ 1,566 $ 1,694 $ 2,068 $ 1,832
-------- -------- -------- -------- --------
Average common shareholder's(s') equity..................... $ 16,936 $ 17,003 $ 14,022 $ 8,640 $ 7,589
-------- -------- -------- -------- --------
Return on average common shareholder's(s') equity........... 9.97% 10.99% 10.89% 17.30% 24.14%
Return on average common shareholder's(s') equity, operating
basis..................................................... 9.97 9.21 12.08 23.94 24.14
======== ======== ======== ======== ========
RETURN ON AVERAGE ASSETS:
Net income.................................................. $ 1,772 $ 1,940 $ 1,603 $ 1,558 $ 1,848
Operating net income........................................ 1,772 1,638 1,770 2,131 1,848
-------- -------- -------- -------- --------
Average assets:
Owned basis............................................... $139,800 $123,921 $110,097 $ 96,304 $ 81,782
Serviced with limited recourse............................ 9,155 22,247 24,131 22,371 19,620
-------- -------- -------- -------- --------
Managed basis............................................. $148,955 $146,168 $134,228 $118,675 $101,402
-------- -------- -------- -------- --------
Return on average owned assets.............................. 1.27% 1.57% 1.46% 1.62% 2.26%
Return on average owned assets, operating basis............. 1.27 1.32 1.61 2.21 2.26
Return on average managed assets............................ 1.19 1.33 1.19 1.31 1.82
Return on average managed assets, operating basis........... 1.19 1.12 1.32 1.80 1.82
======== ======== ======== ======== ========
EFFICIENCY RATIO:
Total costs and expenses less policyholders' benefits....... $ 5,553 $ 5,189 $ 4,814 $ 4,447 $ 3,573
HSBC acquisition related costs and other merger related
items incurred by HSBC Finance Corporation.............. - - (198) - -
Settlement charge and related expenses.................... - - - (525) -
-------- -------- -------- -------- --------
Total costs and expenses less policyholders' benefits,
excluding nonrecurring items............................ $ 5,553 $ 5,189 $ 4,616 $ 3,922 $ 3,573
-------- -------- -------- -------- --------
Net interest income and other revenues less policyholders'
benefits:
Owned basis............................................... $ 12,759 $ 12,463 $ 11,256 $ 10,432 $ 9,304
Serviced with limited recourse............................ 107 188 2,275 1,923 1,105
-------- -------- -------- -------- --------
Managed basis............................................. $ 12,866 $ 12,651 $ 13,531 $ 12,355 $ 10,409
-------- -------- -------- -------- --------
Nonrecurring items:
Gain on bulk sale of private label receivables............ $ - $ 663 - - -
Adoption of FFIEC charge-off policies for domestic private
label (excluding retail sales contracts) and
MasterCard/Visa portfolios - owned...................... - 151 - - -
Adoption of FFIEC charge-off policies for domestic private
label (excluding retail sales contracts) and
MasterCard/Visa portfolios - managed.................... - 107 - - -
Loss on the disposition of Thrift assets and deposits..... - - - $ 378 -
Net interest income and other revenues less policyholders'
benefits, excluding nonrecurring items:
Owned basis............................................... $ 12,759 $ 11,951 $ 11,256 $ 10,810 $ 9,304
Serviced with limited recourse............................ 107 144 2,275 1,923 1,105
-------- -------- -------- -------- --------
Managed basis............................................. $ 12,866 $ 12,095 $ 13,531 $ 12,733 $ 10,409
-------- -------- -------- -------- --------
Owned basis efficiency ratio................................ 43.52% 41.64% 42.77% 42.63% 38.40%
Owned basis efficiency ratio, operating basis............... 43.52 43.42 41.01 36.28 38.40
Managed basis efficiency ratio.............................. 43.16 41.02 35.58 35.99 34.33
Managed basis efficiency ratio, operating basis............. 43.16 42.90 34.11 30.80 34.33
======== ======== ======== ======== ========
116
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
SELECTED FINANCIAL DATA AND STATISTICS
2005 2004 2003 2002 2001
--------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
NET INTEREST MARGIN:
Net Interest Income:
Owned basis............................................ $ 8,384 $ 7,802 $ 7,314 $ 6,654 $ 5,787
Serviced with limited recourse....................... 892 2,455 2,874 2,683 2,094
-------- -------- -------- -------- -------
Managed basis.......................................... $ 9,276 $ 10,257 $ 10,188 $ 9,337 $ 7,881
-------- -------- -------- -------- -------
Average interest-earning assets:
Owned basis............................................ $124,583 $106,412 $ 94,347 $ 87,884 $73,759
Serviced with limited recourse....................... 9,155 22,247 24,131 22,371 19,620
-------- -------- -------- -------- -------
Managed basis.......................................... $133,738 $128,659 $118,478 $110,255 $93,379
-------- -------- -------- -------- -------
Owned basis net interest margin.......................... 6.73% 7.33% 7.75% 7.57% 7.85%
Managed basis net interest margin........................ 6.94 7.97 8.60 8.47 8.44
======== ======== ======== ======== =======
MANAGED BASIS RISK ADJUSTED REVENUE:
Net interest income...................................... $ 9,276 $ 10,257 $ 10,188 $ 9,337 $ 7,881
Other revenues........................................... 4,046 2,143 3,720 3,386 2,831
Less:
Securitization related revenue......................... 837 2,004 (147) (705) (136)
Mark-to-market on derivatives which do not qualify as
effective hedges and ineffectiveness associated with
qualifying hedges under SFAS No. 133................. (197) (443) (232) (3) (1)
Net charge-offs........................................ (4,361) (5,674) (5,254) (4,476) (3,443)
Gain on bulk sale of private label receivables........... - 663 - - -
Loss on disposition of thrift assets..................... - - - 378 -
-------- -------- -------- -------- -------
Risk adjusted revenue.................................. 9,601 8,950 8,275 7,917 7,132
Risk adjusted revenue, excluding nonrecurring items....
Adoption of FFIEC charge-off policies for domestic
private label (excluding retail sales contracts)
and MasterCard/ Visa portfolios.................... - 309 - - -
Gain on bulk sale of private label receivables..... - (663) - - -
-------- -------- -------- -------- -------
Risk adjusted revenue, excluding nonrecurring
items.......................................... 9,601 8,596 8,275 7,917 7,132
Average interest-earning assets.................. $133,738 $128,659 $118,478 $110,255 $93,379
======== ======== ======== ======== =======
Managed basis risk adjusted revenue.................... 7.18% 6.96% 6.98% 7.18% 7.64%
Managed basis risk adjusted revenue, operating basis... 7.18 6.68 6.98 7.18 7.64
======== ======== ======== ======== =======
RESERVES AS A PERCENT OF NET CHARGE-OFFS:
Loss reserves:
Owned basis............................................ $ 4,521 $ 3,625 $ 3,793 $ 3,333 $ 2,663
Serviced with limited recourse......................... 215 890 2,374 1,759 1,148
-------- -------- -------- -------- -------
Managed basis............................................ 4,736 4,515 6,167 5,092 3,811
-------- -------- -------- -------- -------
Net charge-offs:
Owned basis.............................................. $ 3,653 $ 4,033 $ 3,587 $ 3,129 $ 2,410
Serviced with limited recourse........................... 708 1,641 1,667 1,347 1,033
-------- -------- -------- -------- -------
Managed basis............................................ 4,361 5,674 5,254 4,476 3,443
-------- -------- -------- -------- -------
Nonrecurring items:
Net charge-offs for domestic private label receivables
sold:
Owned basis............................................ $ - $ 709 - - -
Managed basis.......................................... - 965 - - -
Adoption of FFIEC charge-off policies for MasterCard/Visa
portfolio:
Owned basis............................................ - 3 - - -
Managed basis.......................................... - 5 - - -
Net charge-offs, excluding nonrecurring items:
Owned basis.............................................. $ 3,653 $ 3,321 $ 3,587 $ 3,129 $ 2,410
Serviced with limited recourse........................... 708 1,383 1,667 1,347 1,033
-------- -------- -------- -------- -------
Managed basis............................................ 4,361 4,704 5,254 4,476 3,443
-------- -------- -------- -------- -------
Reserves as a percentage of net charge-offs, owned
basis.................................................. 123.8% 89.9% 105.7% 106.5% 110.5%
Reserves as a percentage of net charge-offs, managed
basis.................................................. 108.6 79.6 117.4 113.8 110.7
Reserves as a percentage of net charge-offs, owned
operating basis........................................ 123.8 109.2 105.7 106.5 110.5
Reserves as a percentage of net charge-offs, managed
operating basis........................................ 108.6 96.0 117.4 113.8 110.7
117
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
EQUITY RATIOS
2005 2004 2003 2002 2001
------------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
TANGIBLE COMMON EQUITY:
Common shareholder's(s') equity............................. $ 18,904 $ 15,841 $ 16,391 $ 9,222 $ 7,843
Exclude:
Unrealized (gains) losses on cash flow hedging
instruments............................................. (260) (119) 10 737 699
Minimum pension liability................................. - 4 - 30 -
Unrealized gains on investments and interest-only strip
receivables............................................. 3 (53) (167) (319) (223)
Intangibles assets........................................ (2,480) (2,705) (2,856) (386) (456)
Goodwill.................................................. (7,003) (6,856) (6,697) (1,122) (1,107)
-------- -------- -------- -------- --------
Tangible common equity...................................... 9,164 6,112 6,681 8,162 6,756
Purchase accounting adjustments............................. 1,441 2,227 2,548 - -
-------- -------- -------- -------- --------
Tangible common equity, excluding HSBC acquisition purchase
accounting adjustments.................................... $ 10,605 $ 8,339 $ 9,229 $ 8,162 $ 6,756
======== ======== ======== ======== ========
TANGIBLE SHAREHOLDER'S(S') EQUITY:
Tangible common equity...................................... $ 9,164 $ 6,112 $ 6,681 $ 8,162 $ 6,756
Preferred stock............................................. 575 1,100 1,100 1,193 456
Mandatorily redeemable preferred securities of Household
Capital Trusts............................................ 1,679 994 1,031 975 975
Adjustable Conversion-Rate Equity Security Units............ - - - 511 -
-------- -------- -------- -------- --------
Tangible shareholder's(s') equity........................... 11,418 8,206 8,812 10,841 8,187
HSBC acquisition purchase accounting adjustments............ 1,438 2,208 2,492 - -
-------- -------- -------- -------- --------
Tangible shareholder's(s') equity, excluding purchase
accounting adjustments.................................... $ 12,856 $ 10,414 $ 11,304 $ 10,841 $ 8,187
======== ======== ======== ======== ========
TANGIBLE SHAREHOLDER'S(S') EQUITY PLUS OWNED LOSS RESERVES:
Tangible shareholder's(s') equity........................... $ 11,418 $ 8,206 $ 8,812 $ 10,841 $ 8,187
Owned loss reserves......................................... 4,521 3,625 3,793 3,333 2,663
-------- -------- -------- -------- --------
Tangible shareholder's(s') equity plus owned loss
reserves.................................................. 15,939 11,831 12,605 14,174 10,850
HSBC acquisition purchase accounting adjustments............ 1,438 2,208 2,492 - -
-------- -------- -------- -------- --------
Tangible shareholder's(s') equity plus owned loss reserves,
excluding purchase accounting adjustments................. $ 17,377 $ 14,039 $ 15,097 $ 14,174 $ 10,850
======== ======== ======== ======== ========
TANGIBLE MANAGED ASSETS:
Owned assets................................................ $156,669 $130,190 $119,052 $ 97,860 $ 88,911
Receivables serviced with limited recourse.................. 4,074 14,225 26,201 24,934 20,948
-------- -------- -------- -------- --------
Managed assets.............................................. 160,743 144,415 145,253 122,794 109,859
Exclude:
Intangible assets......................................... (2,480) (2,705) (2,856) (386) (456)
Goodwill.................................................. (7,003) (6,856) (6,697) (1,122) (1,107)
Derivative financial assets............................... (234) (4,049) (3,016) (1,864) (97)
-------- -------- -------- -------- --------
Tangible managed assets..................................... 151,026 130,805 132,684 119,422 108,199
HSBC acquisition purchase accounting adjustments............ (52) (202) (431) - -
-------- -------- -------- -------- --------
Tangible managed assets, excluding purchase accounting
adjustments............................................... $150,974 $130,603 $132,253 $119,422 $108,199
======== ======== ======== ======== ========
EQUITY RATIOS:
Common and preferred equity to owned assets................. 12.43% 13.01% 14.69% 10.64% 9.33%
Tangible common equity to tangible managed assets........... 6.07 4.67 5.04 6.83 6.24
Tangible shareholder's(s') equity to tangible managed
assets.................................................... 7.56 6.27 6.64 9.08 7.57
Tangible shareholder's(s') equity plus owned loss reserves
to tangible managed assets................................ 10.55 9.04 9.50 11.87 10.03
Excluding HSBC acquisition purchase accounting adjustments:
Tangible common equity to tangible managed assets......... 7.02 6.38 6.98 6.83 6.24
Tangible shareholder's(s') equity to tangible managed
assets.................................................. 8.52 7.97 8.55 9.08 7.57
Tangible shareholder's(s') equity plus owned loss reserves
to tangible managed assets.............................. 11.51 10.75 11.42 11.87 10.03
======== ======== ======== ======== ========
118
HSBC Finance Corporation
--------------------------------------------------------------------------------
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
--------------------------------------------------------------------------------
Information required by this Item is included in sections of Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations on the following pages: "Liquidity and Capital Resources", pages
74-82, "Off Balance Sheet Arrangements and Secured Financings", pages 83-87 and
"Risk Management", pages 87-91.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
--------------------------------------------------------------------------------
Our 2005 Financial Statements meet the requirements of Regulation S-X. The 2005
Financial Statements and supplementary financial information specified by Item
302 of Regulation S-K are set forth below.
119
HSBC Finance Corporation
--------------------------------------------------------------------------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholder
HSBC Finance Corporation:
We have audited the accompanying consolidated balance sheets of HSBC Finance
Corporation (a Delaware corporation), an indirect wholly-owned subsidiary of
HSBC Holdings plc, and subsidiaries as of December 31, 2005 (successor basis)
and December 31, 2004 (successor basis) and the related consolidated statements
of income, changes in shareholder's(s') equity, and cash flows for each of the
years in the two-year period ended December 31, 2005 (successor basis), and for
the periods January 1, 2003 through March 28, 2003 (predecessor basis) and March
29, 2003 through December 31, 2003 (successor basis). These consolidated
financial statements are the responsibility of HSBC Finance Corporation's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of HSBC Finance Corporation's
internal control over financial reporting. Accordingly, we express no such
opinion. An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the aforementioned consolidated financial statements present
fairly, in all material respects, the financial position of HSBC Finance
Corporation and subsidiaries as of December 31, 2005 (successor basis) and
December 31, 2004 (successor basis), and the results of their operations and
their cash flows for each of the years in the two-year period ended December 31,
2005 (successor basis) and for the period March 29, 2003 through December 31,
2003 (successor basis), in conformity with U.S. generally accepted accounting
principles. Further, in our opinion, the aforementioned consolidated financial
statements present fairly, in all material respects, the results of operations
and cash flows of HSBC Finance Corporation and subsidiaries for the period
January 1, 2003 through March 28, 2003 (predecessor basis), in conformity with
U.S. generally accepted accounting principles.
As discussed in Note 3 to the consolidated financial statements, effective March
28, 2003, HSBC Holdings plc acquired all of the outstanding stock of Household
International, Inc. (now HSBC Finance Corporation) in a business combination
accounted for as a purchase. As a result of the acquisition, the consolidated
financial information for the period after the acquisition is presented on a
different cost basis than that for the periods before the acquisition and,
therefore, is not comparable.
/s/ KPMG LLP
Chicago, Illinois
March 6, 2006
120
HSBC Finance Corporation
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF INCOME
MARCH 29 JANUARY 1
YEAR ENDED YEAR ENDED THROUGH THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 28,
2005 2004 2003 2003
----------------------------------------------------------------------------------------------------------------
(SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (PREDECESSOR)
(IN MILLIONS)
Finance and other interest income....... $13,216 $10,945 $7,773 $2,469
Interest expense:
HSBC affiliates....................... 713 343 73 -
Non-affiliates........................ 4,119 2,800 1,958 897
------- ------- ------ ------
NET INTEREST INCOME..................... 8,384 7,802 5,742 1,572
Provision for credit losses............. 4,543 4,334 2,991 976
------- ------- ------ ------
NET INTEREST INCOME AFTER PROVISION FOR
CREDIT LOSSES......................... 3,841 3,468 2,751 596
------- ------- ------ ------
Other revenues:
Securitization related revenue........ 211 1,008 1,027 434
Insurance revenue..................... 918 839 575 171
Investment income..................... 134 137 116 80
Derivative income..................... 249 511 284 2
Fee income............................ 1,568 1,091 784 280
Taxpayer financial services revenue... 277 217 4 181
Gain on bulk sale of private label
receivables........................ - 663 - -
Gain on receivable sales to HSBC
affiliates......................... 413 39 16 -
Servicing fees from HSBC affiliates... 409 24 -
Other income.......................... 652 544 301 64
------- ------- ------ ------
TOTAL OTHER REVENUES.................... 4,831 5,073 3,107 1,212
------- ------- ------ ------
Costs and expenses:
Salaries and employee benefits........ 2,072 1,886 1,507 491
Sales incentives...................... 397 363 226 37
Occupancy and equipment expenses...... 334 323 302 98
Other marketing expenses.............. 731 636 409 139
Other servicing and administrative
expenses........................... 785 868 835 314
Support services from HSBC
affiliates......................... 889 750 - -
Amortization of intangibles........... 345 363 246 12
Policyholders' benefits............... 456 412 286 91
HSBC acquisition related costs
incurred by HSBC Finance
Corporation........................ - - - 198
------- ------- ------ ------
TOTAL COSTS AND EXPENSES................ 6,009 5,601 3,811 1,380
------- ------- ------ ------
Income before income tax expense........ 2,663 2,940 2,047 428
Income tax expense...................... 891 1,000 690 182
------- ------- ------ ------
NET INCOME.............................. $ 1,772 $ 1,940 $1,357 $ 246
======= ======= ====== ======
The accompanying notes are an integral part of the consolidated financial
statements.
121
HSBC Finance Corporation
--------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET
YEAR ENDED DECEMBER 31, 2005 2004
---------------------------------------------------------------------------------------
(SUCCESSOR) (SUCCESSOR)
(IN MILLIONS,
EXCEPT SHARE DATA)
ASSETS
Cash........................................................ $ 903 $ 392
Interest bearing deposits with banks........................ 384 603
Securities purchased under agreements to resell............. 78 2,651
Securities.................................................. 4,051 3,645
Receivables, net............................................ 136,989 104,815
Intangible assets, net...................................... 2,480 2,705
Goodwill.................................................... 7,003 6,856
Properties and equipment, net............................... 458 487
Real estate owned........................................... 510 587
Derivative financial assets................................. 234 4,049
Other assets................................................ 3,579 3,400
-------- --------
TOTAL ASSETS................................................ $156,669 $130,190
======== ========
LIABILITIES
Debt:
Deposits.................................................. $ 37 $ 47
Commercial paper, bank and other borrowings............... 11,417 9,013
Due to affiliates......................................... 15,534 13,789
Long term debt (with original maturities over one year)... 105,163 85,378
-------- --------
Total debt.................................................. 132,151 108,227
-------- --------
Insurance policy and claim reserves......................... 1,291 1,303
Derivative related liabilities.............................. 383 432
Other liabilities........................................... 3,365 3,287
-------- --------
TOTAL LIABILITIES........................................... 137,190 113,249
-------- --------
SHAREHOLDER'S(S') EQUITY
Redeemable preferred stock, 1,501,100 shares authorized at
December 31, 2005 and 1,100 shares authorized at December
31, 2004:
Series A, $0.01 par value, 1,100 shares issued at
December 31, 2004, held by HSBC Investments (North
America) Inc. ........................................ - 1,100
Series B, $0.01 par value, 575,000 shares issued....... 575 -
Common shareholder's equity:
Common stock, $0.01 par value, 100 shares authorized;
55 and 50 shares issued at December 31, 2005 and 2004,
respectively.......................................... - -
Additional paid-in capital............................. 17,145 14,627
Retained earnings...................................... 1,280 571
Accumulated other comprehensive income................. 479 643
-------- --------
TOTAL COMMON SHAREHOLDER'S EQUITY........................... 18,904 15,841
-------- --------
TOTAL LIABILITIES AND SHAREHOLDER'S(S') EQUITY.............. $156,669 $130,190
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
122
HSBC Finance Corporation
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDER'S(S') EQUITY
MARCH 29 JANUARY 1
YEAR ENDED YEAR ENDED THROUGH THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 28,
2005 2004 2003 2003
------------------------------------------------------------------------------------------------------------------------
(SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (PREDECESSOR)
(IN MILLIONS)
PREFERRED STOCK
Balance at beginning of period............................. $ 1,100 $ 1,100 $ 1,100 $ 1,193
Reclassification of preferred stock issuance costs......... - - - 21
Issuance of Series B preferred stock....................... 575 - - -
Redemption of preferred stock.............................. - - - (114)
Exchange of Series A preferred stock for common stock...... (1,100) - - -
------- ------- ------- -------
Balance at end of period................................... $ 575 $ 1,100 $ 1,100 $ 1,100
======= ======= ======= =======
COMMON SHAREHOLDER'S(S') EQUITY
COMMON STOCK
Balance at beginning of period........................... $ - $ - $ - $ 552
Issuance of common stock in exchange for Series A
Preferred Stock........................................ - - - -
Effect of push-down accounting of HSBC's purchase price
on net assets.......................................... - - - (552)
------- ------- ------- -------
Balance at end of period................................. $ - $ - $ - $ -
------- ------- ------- -------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of period........................... $14,627 $14,645 $14,661 $ 1,911
Premium on sale of U.K. credit card business to
affiliate.............................................. 182 - - -
Issuance of common stock in exchange for Series A
preferred stock........................................ 1,112 - - -
Capital contribution from parent company................. 1,200 - - -
Return of capital to HSBC................................ (19) (31) (41) -
Employee benefit plans, including transfers and other.... 59 13 25 10
Reclassification of preferred stock issuance costs....... - - - (21)
Issuance costs of Series B preferred stock............... (16) - - -
Effect of push-down accounting of HSBC's purchase price
on net assets.......................................... - - - 12,761
------- ------- ------- -------
Balance at end of period................................. $17,145 $14,627 $14,645 $14,661
------- ------- ------- -------
RETAINED EARNINGS
Balance at beginning of period........................... 571 1,303 $ - $ 9,885
Net income............................................... 1,772 1,940 1,357 246
Dividends:
Preferred stock........................................ (83) (72) (54) (22)
Common stock........................................... (980) (2,600) - (412)
Effect of push-down accounting of HSBC's purchase price
on net assets.......................................... - - - (9,697)
------- ------- ------- -------
Balance at end of period................................. $ 1,280 $ 571 $ 1,303 $ -
------- ------- ------- -------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance at beginning of period........................... $ 643 $ 443 $ - $ (695)
Net change in unrealized gains (losses) on:
Derivatives classified as cash flow hedges........... 141 130 (11) 101
Securities available for sale and interest-only strip
receivables......................................... (56) (114) 168 (25)
Minimum pension liability.............................. 4 (4) - -
Foreign currency translation adjustment................ (253) 188 286 (24)
------- ------- ------- -------
Other comprehensive income, net of tax................... (164) 200 443 52
Effect of push-down accounting of HSBC's purchase price
on net assets.......................................... - - - 643
------- ------- ------- -------
Balance at end of period................................. $ 479 $ 643 $ 443 $ -
------- ------- ------- -------
COMMON STOCK IN TREASURY
Balance at beginning of period........................... - - - $(2,431)
Exercise of stock options................................ - - - 12
Issuance of common stock for employee benefit plans...... - - - 12
Purchase of treasury stock............................... - - - (164)
Effect of push-down accounting of HSBC's purchase price
on net assets.......................................... - - - 2,571
------- ------- ------- -------
Balance at end of period................................. - - - -
TOTAL COMMON SHAREHOLDER'S(S') EQUITY....................... $18,904 $15,841 $16,391 $14,661
======= ======= ======= =======
COMPREHENSIVE INCOME
Net income.................................................. $ 1,772 $ 1,940 $ 1,357 $ 246
Other comprehensive (loss) income........................... (164) 200 443 52
------- ------- ------- -------
COMPREHENSIVE INCOME........................................ $ 1,608 $ 2,140 $ 1,800 $ 298
======= ======= ======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
123
HSBC Finance Corporation
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDER'S(S') EQUITY (CONTINUED)
MARCH 29 JANUARY 1
YEAR ENDED YEAR ENDED THROUGH THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 28,
SHARES OUTSTANDING 2005 2004 2003 2003
-------------------------------------------------------------------------------------------------------------
(SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (PREDECESSOR)
PREFERRED STOCK
Balance at beginning of period................. 1,100 1,100 1,100 2,448,279
Redemption of preferred stock.................. - - (1,348,279)
Conversion of preferred stock to right to
receive cash................................. - - - (1,100,000)
Issuance of preferred stock.................... 575 - - 1,100
Conversion of Series A preferred stock to
common stock................................. (1,100) - - -
------ ----- ----- ------------
Balance at end of period....................... 575 1,100 1,100 1,100
====== ===== ===== ============
COMMON STOCK
ISSUED
Balance at beginning of period............... 50 50 50 551,811,025
Exercise of stock options.................... - - - 3,557
Cancellation of common stock................. - - - (551,814,582)
Issuance of common stock to parent........... 5 - - 50
------ ----- ----- ------------
Balance at end of period..................... 55 50 50 50
------ ----- ----- ------------
IN TREASURY
Balance at beginning of period............... - - - (77,197,686)
Exercise of stock options.................... - - - 435,530
Issuance of common stock for employee benefit
plans...................................... - - - 1,464,984
Purchase of treasury stock................... - - - (2,861,400)
Issuance of common stock for restricted stock
rights which vested upon change in
control.................................... - - - 2,342,890
Cancellation of common stock................. - - - 75,815,682
------ ----- ----- ------------
Balance at end of period..................... - - - -
------ ----- ----- ------------
NET COMMON STOCK OUTSTANDING..................... 55 50 50 50
====== ===== ===== ============
The accompanying notes are an integral part of the consolidated financial
statements.
124
HSBC Finance Corporation
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES
Net income.................................................. $ 1,772 $ 1,940 $ 1,357 $ 246
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Provision for credit losses................................ 4,543 4,334 2,991 976
Gain on bulk sale of private label receivables............. - (663) - -
Gain on receivable sales to HSBC affiliates................ (413) (39) (16) -
Insurance policy and claim reserves........................ (222) (170) (196) 47
Depreciation and amortization.............................. 457 483 344 53
Deferred income tax (benefit) provision.................... (366) 348 (83) 90
Net change in other assets................................. 326 (696) 842 (593)
Net change in other liabilities............................ 393 23 (735) 526
Other, net................................................. (762) 521 (108) 78
-------- -------- -------- -------
Net cash provided by (used in) operating activities......... 5,728 6,081 4,396 1,423
-------- -------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Securities:
Purchased.................................................. (852) (1,363) (4,750) (1,047)
Matured.................................................... 646 1,375 3,403 584
Sold....................................................... 429 854 687 768
Net change in short-term securities available for sale...... (472) 5,372 (1,832) (391)
Net change in securities purchased under agreements to
resell..................................................... 2,573 (2,651) - -
Net change in interest bearing deposits with banks.......... 187 466 (795) 16
Receivables:
Originations, net of collections........................... (56,617) (33,021) (16,630) (2,144)
Purchases and related premiums............................. (1,053) (608) (2,473) (129)
Initial securitizations.................................... - 740 5,568 1,195
Sales to affiliates........................................ 23,106 14,279 2,844 -
Net change in interest-only strip receivables.............. 253 466 400 30
Cash received in sale of U.K. credit card business.......... 2,627 - - -
Net cash paid for acquisition of Metris..................... (1,572) - - -
Properties and equipment:
Purchases.................................................. (78) (96) (94) (21)
Sales...................................................... 7 4 6 -
-------- -------- -------- -------
Net cash provided by (used in) investing activities......... (30,816) (14,183) (13,666) (1,139)
-------- -------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Debt:
Net change in short-term debt and deposits................. 2,383 (180) 3,284 (514)
Net change in time certificates............................ (2) (161) (708) 150
Net change in due to affiliates............................ 2,435 5,716 7,023 -
Long term debt issued...................................... 40,214 19,916 15,559 4,361
Long term debt retired..................................... (20,967) (14,628) (15,789) (4,030)
Issuance of company obligated mandatorily redeemable
preferred securities of subsidiary trusts to HSBC........ 1,031 - 275 -
Redemption of company obligated mandatorily redeemable
preferred securities of subsidiary trusts................ (309) - (275) -
Insurance:
Policyholders' benefits paid............................... (250) (194) (121) (36)
Cash received from policyholders........................... 380 265 127 33
Capital contribution from parent............................ 1,200
Shareholder's(s') dividends................................. (1,063) (2,708) (293) (141)
Issuance of preferred stock................................. 559 - - -
Redemption of preferred stock............................... - - - (114)
Purchase of treasury stock.................................. - - - (164)
Issuance of common stock for employee benefit plans......... - - - 62
-------- -------- -------- -------
Net cash provided by (used in) financing activities......... 25,611 8,026 9,082 (393)
-------- -------- -------- -------
Effect of exchange rate changes on cash..................... (12) 5 (23) (15)
-------- -------- -------- -------
Net change in cash.......................................... 511 (71) (211) (124)
Cash at beginning of period................................. 392 463 674 798
-------- -------- -------- -------
CASH AT END OF PERIOD....................................... $ 903 $ 392 $ 463 $ 674
======== ======== ======== =======
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid............................................... $ 5,233 $ 3,468 $ 2,582 $ 897
Income taxes paid........................................... 1,119 842 600 40
-------- -------- -------- -------
SUPPLEMENTAL NONCASH FINANCING AND CAPITAL ACTIVITIES:
Push-down of purchase price by HSBC......................... $ - $ - $ - $14,661
Affiliate preferred stock received in sale of U.K. credit
card business.............................................. 261 - - -
Exchange of preferred for common stock...................... 1,112 - - 1,100
======== ======== ======== =======
The accompanying notes are an integral part of the consolidated financial
statements.
125
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
--------------------------------------------------------------------------------
HSBC Finance Corporation (formerly Household International, Inc.) and its
subsidiaries were acquired by a wholly owned subsidiary of HSBC Holdings plc
("HSBC") on March 28, 2003 in a purchase business combination recorded under the
"push-down" method of accounting, which resulted in a new basis of accounting
for the "successor" period beginning March 29, 2003. Information relating to all
"predecessor" periods prior to the acquisition is presented using the historical
basis of accounting.
HSBC Finance Corporation and subsidiaries, is an indirect wholly owned
subsidiary of HSBC North America Holdings Inc. ("HNAH"), which is an indirect
wholly-owned subsidiary of HSBC. HSBC Finance Corporation provides middle-market
consumers with several types of loan products in the United States, the United
Kingdom, Canada, the Republic of Ireland, the Czech Republic, Slovakia and
Hungary. HSBC Finance Corporation may also be referred to in these notes to the
consolidated financial statements as "we," "us" or "our." Our lending products
include real estate secured loans, auto finance loans, MasterCard* and Visa*
credit card loans, private label credit card loans, including retail sales
contracts, and personal non-credit card loans. We also initiate tax refund
anticipation loans in the United States and offer credit and specialty insurance
in the United States, the United Kingdom and Canada. We have three reportable
segments: Consumer, Credit Card Services, and International. Our Consumer
segment consists of our branch-based consumer lending, mortgage services, retail
services, and auto finance businesses. Our Credit Card Services segment consists
of our domestic MasterCard and Visa credit card business. Our International
segment consists of our foreign operations in the United Kingdom ("U.K."), the
Republic of Ireland, Slovakia, the Czech Republic, Hungary and Canada.
During 2004, Household International, Inc. ("Household") rebranded the majority
of its U.S. and Canadian businesses to the HSBC brand. Businesses previously
operating under the Household name are now called HSBC. Our consumer lending
business retained the HFC and Beneficial brands in the United States,
accompanied by the HSBC Group's endorsement signature, "Member HSBC Group." The
single brand has allowed HSBC in North America to better align its businesses,
provided a stronger platform to service customers and advanced growth. The HSBC
brand also positions us to expand the products and services offered to our
customers. As part of this initiative, Household changed its name to HSBC
Finance Corporation in December 2004.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
--------------------------------------------------------------------------------
BASIS OF PRESENTATION The consolidated financial statements include the accounts
of HSBC Finance Corporation and all subsidiaries including all variable interest
entities in which we are the primary beneficiary as defined by Financial
Accounting Standards Board Interpretation No. 46 (Revised). Unaffiliated trusts
to which we have transferred securitized receivables which are qualifying
special purpose entities ("QSPEs") as defined by Statement of Financial
Accounting Standards ("SFAS") No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities," are not consolidated.
All significant intercompany accounts and transactions have been eliminated.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates. Certain reclassifications have been made to prior year amounts to
conform to the current period presentation.
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL Securities purchased under
agreements to resell are treated as collateralized financing transactions and
are carried at the amounts at which the securities were acquired plus accrued
interest. Interest income earned on these securities is included in net interest
income.
---------------
* MasterCard is a registered trademark of MasterCard International, Incorporated
and VISA is a registered trademark of VISA USA, Inc.
126
INVESTMENT SECURITIES We maintain investment portfolios (comprised primarily of
debt securities and money market funds) in both our noninsurance and insurance
operations. Our entire investment securities portfolio was classified as
available-for-sale at December 31, 2005 and 2004. Available-for-sale investments
are intended to be invested for an indefinite period but may be sold in response
to events we expect to occur in the foreseeable future. These investments are
carried at fair value. Unrealized holding gains and losses on available-for-sale
investments are recorded as adjustments to common shareholder's equity in
accumulated other comprehensive income, net of income taxes. Any decline in the
fair value of investments which is deemed to be other than temporary is charged
against current earnings.
Cost of investment securities sold is determined using the specific
identification method. Interest income earned on the noninsurance investment
portfolio is classified in the statements of income in net interest income.
Realized gains and losses from the investment portfolio and investment income
from the insurance portfolio are recorded in investment income. Accrued
investment income is classified with investment securities.
RECEIVABLES Finance receivables are carried at amortized cost which represents
the principal amount outstanding, net of any unearned income, charge-offs,
unamortized deferred fees and costs on originated loans, purchase accounting
fair value adjustments and premiums or discounts on purchased loans. Finance
receivables are further reduced by credit loss reserves and unearned credit
insurance premiums and claims reserves applicable to credit risks on our
consumer receivables. Receivables held for sale are carried at the lower of
aggregate cost or market value and remain presented as receivables in the
consolidated balance sheet. Finance income is recognized using the effective
yield method. Premiums and discounts, including purchase accounting adjustments
on receivables, are recognized as adjustments to the yield of the related
receivables. Origination fees, which include points on real estate secured
loans, are deferred and generally amortized to finance income over the estimated
life of the related receivables, except to the extent they offset directly
related lending costs. Net deferred origination costs (fees), excluding
MasterCard and Visa, totaled $26 million at December 31, 2005 and ($43) million
at December 31, 2004. MasterCard and Visa annual fees are netted with direct
lending costs, deferred, and amortized on a straight-line basis over one year.
Deferred MasterCard and Visa annual fees, net of direct lending costs related to
these receivables, totaled $191 million at December 31, 2005 and $107 million at
December 31, 2004.
Beginning in 2005, for loans acquired within the scope of Statement of Position
03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer"
("SOP 03-3"), the difference between the estimated future cash flows on the
loans accrued and the purchase price for the loans is recognized into income
over the life of the acquired loans on a level yield basis. Credit loss reserves
are not recorded at the time of acquisition for these loans in accordance with
SOP 03-3. Credit loss reserves are only recorded if there is a deterioration in
credit quality subsequent to the acquisition date.
Insurance reserves and unearned premiums applicable to credit risks on consumer
receivables are treated as a reduction of receivables in the balance sheet,
since payments on such policies generally are used to reduce outstanding
receivables.
PROVISION AND CREDIT LOSS RESERVES Provision for credit losses on owned
receivables is made in an amount sufficient to maintain credit loss reserves at
a level considered adequate, but not excessive, to cover probable losses of
principal, interest and fees, including late, overlimit and annual fees, in the
existing owned portfolio. We estimate probable losses for owned consumer
receivables 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. This analysis considers delinquency status, loss
experience and severity and takes into account whether loans are in bankruptcy,
have been restructured, rewritten or are subject to forbearance, an external
debt management plan, hardship, modification, extension or deferment. Our credit
loss reserves also take into consideration the loss severity expected based on
the underlying collateral, if any, for the loan in the event of default.
Delinquency status may be affected by customer account management policies and
practices, such as the restructure of accounts, forbearance agreements, extended
payment plans, modification arrangements, loan rewrites and deferments. When
customer account management policies, or changes thereto, shift loans from a
"higher" delinquency bucket to a "lower" delinquency bucket, this will be
reflected in our roll rate
127
statistics. To the extent that restructured accounts have a greater propensity
to roll to higher delinquency buckets, this will be captured in the roll rates.
Since the loss reserve is computed based on the composite of all these
calculations, this increase in roll rate will be applied to receivables in all
respective buckets, which will increase the overall reserve level. In addition,
loss reserves on consumer receivables are maintained to reflect our judgment of
portfolio risk factors which may not be fully reflected in the statistical roll
rate calculation. Risk factors considered in establishing loss reserves on
consumer receivables include recent growth, product mix, bankruptcy trends,
geographic concentrations, economic conditions, portfolio seasoning, account
management policies and practices and current levels of charge-offs and
delinquencies. For commercial loans, probable losses are calculated using
estimates of amounts and timing of future cash flows expected to be received on
loans.
While our credit loss reserves are available to absorb losses in the entire
portfolio, we specifically consider the credit quality and other risk factors
for each of our products. We recognize the different inherent loss
characteristics in each of our products as well as customer account management
policies and practices and risk management/collection practices. Charge-off
policies are also considered when establishing loss reserve requirements to
ensure appropriate allowances exist for products with longer charge-off periods.
We also consider key ratios such as reserves to nonperforming loans and reserves
as a percentage of net charge-offs in developing our loss reserve estimate. Loss
reserve estimates are reviewed periodically and adjustments are reported in
earnings when they become known. As these estimates are influenced by factors
outside our control, such as consumer payment patterns and economic conditions,
there is uncertainty inherent in these estimates, making it reasonably possible
that they could change.
CHARGE-OFF AND NONACCRUAL POLICIES AND PRACTICES Our consumer charge-off and
nonaccrual policies vary by product and are summarized below:
PRODUCT CHARGE-OFF POLICIES AND PRACTICES NONACCRUAL POLICIES AND PRACTICES(1)
-------------------------------------------------------------------------------------------------------
Real estate Secured(2,4) Carrying values in excess of net Interest income accruals are
realizable value are charged-off suspended when principal or interest
at or before the time foreclosure payments are more than three months
is completed or when settlement contractually past due and resumed
is reached with the borrower. If when the receivable becomes less
foreclosure is not pursued, and than three months contractually past
there is no reasonable due.
expectation for recovery
(insurance claim, title claim,
pre-discharge bankrupt account),
generally the account will be
charged-off by the end of the
month in which the account
becomes nine months contractually
delinquent.
Auto finance(4, 6) Carrying values in excess of net Interest income accruals are
realizable value are charged off suspended and the portion of
at the earlier of the following: previously accrued interest expected
- the collateral has been to be uncollectible is written off
repossessed and sold, when principal payments are more
- the collateral has been in our than two months contractually past
possession for more than 90 due and resumed when the receivable
days, or becomes less than two months
- the loan becomes 150 days contractually past due.
contractually delinquent.
128
PRODUCT CHARGE-OFF POLICIES AND PRACTICES NONACCRUAL POLICIES AND PRACTICES(1)
-------------------------------------------------------------------------------------------------------
MasterCard and Visa(5) Generally charged-off by the end Interest generally accrues until
of the month in which the account charge-off.
becomes six months contractually
delinquent.
Private label(3, 5) Subsequent to the adoption of Interest generally accrues until
FFIEC policies in December 2004, charge-off, except for retail sales
domestic receivables (excluding contracts at our consumer lending
retail sales contracts at our business. Interest income accruals
consumer lending business) are for retail sales contracts are
charged-off by the end of the suspended when principal or interest
month in which the account payments are more than three months
becomes six months contractually contractually delinquent. After
delinquent. Our domestic private suspension, interest income is
label receivable portfolio generally recorded as collected.
(excluding retail sales contracts
at our consumer lending business)
was sold to HSBC Bank USA on
December 29, 2004. Prior to
December 2004, receivables were
generally charged-off the month
following the month in which the
account became nine months
contractually delinquent.
Beginning in the fourth quarter
of 2002, receivables originated
through new domestic merchant
relationships were charged-off by
the end of the month in which the
account became six months
contractually delinquent.
Retail sales contracts at our
consumer lending business
generally charge-off the month
following the month in which the
account becomes nine months
contractually delinquent and no
payment received in six months,
but in no event to exceed 12
months contractually delinquent.
129
PRODUCT CHARGE-OFF POLICIES AND PRACTICES NONACCRUAL POLICIES AND PRACTICES(1)
-------------------------------------------------------------------------------------------------------
Personal non-credit card(3) Generally charged-off the month Interest income accruals are
following the month in which the suspended when principal or interest
account becomes nine months payments are more than three months
contractually delinquent and no contractually delinquent. For PHLs,
payment received in six months, interest income accruals resume if
but in no event to exceed 12 the receivable becomes less than
months contractually delinquent three months contractually past due.
(except in our United Kingdom For all other personal non- credit
business which may be longer). card receivables for which income
accruals are suspended, interest
income is generally recorded as
collected.
---------------
(1) For our United Kingdom business, interest income accruals are suspended when
principal or interest payments are more than three months contractually
delinquent.
(2) For our United Kingdom business, real estate secured carrying values in
excess of net realizable value are charged-off at time of sale.
(3) For our Canada business, the private label and personal non-credit card
charge-off policy prior to December 2004 required a charge-off of an account
where no payment was received in six months, but in no event was an account
to exceed 18 months contractually delinquent. In December 2004, the policy
was revised to charge-off accounts when no payment is received in six months
but in no event is an account to exceed 12 months contractually delinquent.
This policy change was not part of the adoption of FFIEC policies discussed
in Note 4 and its impact was not material to our net income.
(4) In November 2003, the FASB issued FASB Staff Position Number 144-1,
"Determination of Cost Basis for Foreclosed Assets under FASB Statement No.
15, and the Measurement of Cumulative Losses Previously Recognized Under
Paragraph 37 of FASB Statement No. 144" ("FSP 144-1"). Under FSP 144-1,
sales commissions related to the sale of foreclosed assets are recognized as
a charge-off through the provision for credit losses. Previously, we had
recognized sales commission expense as a component of other servicing and
administrative expenses in our statements of income. We adopted FSP 144-1 in
November 2003. The adoption had no significant impact on our net income.
(5) For our United Kingdom business, prior to the sale of our U.K. credit card
business in December 2005, delinquent MasterCard/Visa accounts were
charged-off the month following the month in which the account becomes six
months contractually delinquent. Delinquent private label receivables are
charged-off the month following the month in which the account becomes nine
months contractually delinquent.
(6) For our Canada business, the interest income accruals on auto loans are
suspended and the portion of previously accrued interest expected to be
uncollectible is written off when principal payments are more than three
months contractually past due and resumed when the receivables become less
than three months contractually past due.
In December 2004, upon receipt of regulatory approval for the sale of our
domestic private label portfolio (excluding retail sales contracts at our
consumer lending business) to HSBC Bank USA, National Association ("HSBC Bank
USA"), we adopted charge-off and account management policies in accordance with
the Uniform Retail Credit Classification and Account Management Policy issued by
the Federal Financial Institutions Examination Council ("FFIEC") for our
domestic private label (excluding retail sales contracts at our consumer lending
business) and MasterCard/Visa portfolios. See Note 4, "Sale of Domestic Private
Label Receivable Portfolio and Adoption of FFIEC Policies."
Charge-off involving a bankruptcy for our domestic private label (excluding
retail sales contracts at our consumer lending business) and MasterCard and Visa
receivables subsequent to the adoption of FFIEC charge-off policies in December
2004 occurs by the end of the month 60 days after notification or 180 days
delinquent, whichever is sooner. For domestic auto finance receivables, bankrupt
accounts are charged off no later than the end of the month in which the loan
becomes 210 days contractually delinquent. Charge-off involving a bankruptcy for
our real estate secured and personal non-credit card receivables are consistent
with the credit charge-off policy for these products. Prior to December 2004,
charge-offs involving a bankruptcy for our domestic private label (excluding
retail sales contracts at our consumer lending business) receivables occurred by
the end of the month 90 days after notification. Our domestic private label
receivable portfolio (excluding retail sales contracts at our consumer lending
business) was sold to HSBC Bank USA on December 29, 2004.
RECEIVABLES SOLD AND SERVICED WITH LIMITED RECOURSE AND SECURITIZATION RELATED
REVENUE Certain auto finance, MasterCard and Visa, private label and personal
non-credit card receivables have been securitized
130
and sold to investors with limited recourse. We have retained the servicing
rights to these receivables. Recourse is limited to our rights to future cash
flow and any subordinated interest that we may retain. Upon sale, these
receivables are removed from the balance sheet and a gain on sale is recognized
for the difference between the carrying value of the receivables and the
adjusted sales proceeds. The adjusted sales proceeds include cash received and
the present value estimate of future cash flows to be received over the lives of
the sold receivables. Future cash flows are based on estimates of prepayments,
the impact of interest rate movements on yields of receivables and securities
issued, delinquency of receivables sold, servicing fees and other factors. The
resulting gain is also adjusted by a provision for estimated probable losses
under the recourse provisions. This provision and the related reserve for
receivables serviced with limited recourse are established at the time of sale
to cover all probable credit losses over-the-life of the receivables sold based
on historical experience and estimates of expected future performance. The
methodologies vary depending upon the type of receivable sold, using either
historical monthly net charge-off rates applied to the expected balances to be
received over the remaining life of the receivable or a historical static pool
analysis. The reserves are reviewed periodically by evaluating the estimated
future cash flows of each securitized pool to ensure that there is sufficient
remaining cash flow to cover estimated future credit losses. Any changes to the
estimates for the reserve for receivables serviced with limited recourse are
made in the period they become known. Gains on sale net of recourse provisions,
servicing income and excess spread relating to securitized receivables are
reported in the accompanying consolidated statements of income as securitization
revenue.
In connection with these transactions, we record an interest-only strip
receivable, representing our contractual right to receive interest and other
cash flows from our securitization trusts. Our interest-only strip receivables
are reported at fair value using discounted cash flow estimates as a separate
component of receivables net of our estimate of probable losses under the
recourse provisions. Cash flow estimates include estimates of prepayments, the
impact of interest rate movements on yields of receivables and securities
issued, delinquency of receivables sold, servicing fees and estimated probable
losses under the recourse provisions. Unrealized gains and losses are recorded
as adjustments to common shareholder's equity in accumulated other comprehensive
income, net of income taxes. Our interest-only strip receivables are reviewed
for impairment quarterly or earlier if events indicate that the carrying value
may not be recovered. Any decline in the fair value of the interest-only strip
receivable which is deemed to be other than temporary is charged against current
earnings.
We have also, in certain cases, retained other subordinated interests in these
securitizations. Neither the interest-only strip receivables nor the other
subordinated interests are in the form of securities.
In order to align our accounting treatment with that of HSBC initially under
U.K. GAAP and now under International Financial Reporting Standards ("IFRS"),
starting in the third quarter of 2004 we began to structure all new
collateralized funding transactions as secured financings. However, because
existing public MasterCard and Visa credit card transactions were structured as
sales to revolving trusts that require replenishments to support previously
issued securities, receivables will continue to be sold to these trusts until
the revolving periods end, the last of which is currently projected to occur in
2008. Private label trusts that publicly issued securities are now replenished
by HSBC Bank USA as a result of the daily sale of new domestic private label
credit card originations to HSBC Bank USA. We will continue to replenish at
reduced levels certain non-public personal non-credit card securities issued to
conduits and record the resulting replenishment gains for a period of time in
order to manage liquidity. Since our securitized receivables have varying lives,
it will take a period of time for these receivables to pay-off and the related
interest only strip receivables to be reduced to zero.
PROPERTIES AND EQUIPMENT, NET Properties and equipment are recorded at cost, net
of accumulated depreciation and amortization. As a result of our acquisition by
HSBC, the amortized cost of our properties and equipment was adjusted to fair
market value and accumulated depreciation and amortization on a "predecessor"
basis was eliminated at the time of the acquisition. For financial reporting
purposes, depreciation is provided on a straight-line basis over the estimated
useful lives of the assets which generally range from 3 to 40 years. Leasehold
improvements are amortized over the lesser of the economic useful life of the
improvement or the term of the lease. Maintenance and repairs are expensed as
incurred.
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REPOSSESSED COLLATERAL Real estate owned is valued at the lower of cost or fair
value less estimated costs to sell. These values are periodically reviewed and
reduced, if necessary. Costs of holding real estate and related gains and losses
on disposition are credited or charged to operations as incurred as a component
of operating expense. Repossessed vehicles, net of loss reserves when
applicable, are recorded at the lower of the estimated fair market value or the
outstanding receivable balance.
INSURANCE Insurance revenues on monthly premium insurance policies are
recognized when billed. Insurance revenues on the remaining insurance contracts
are recorded as unearned premiums and recognized into income based on the nature
and terms of the underlying contracts. Liabilities for credit insurance policies
are based upon estimated settlement amounts for both reported and incurred but
not yet reported losses. Liabilities for future benefits on annuity contracts
and specialty and corporate owned life insurance products are based on actuarial
assumptions as to investment yields, mortality and withdrawals.
INTANGIBLE ASSETS Intangible assets consist of purchased credit card
relationships and related programs, retail services merchant relationships,
other loan related relationships, trade names, technology, customer lists and
other contracts. The trade names are not subject to amortization, as we believe
they have indefinite lives. The remaining intangible assets are being amortized
over their estimated useful lives either on a straight-line basis or in
proportion to the underlying revenues generated. These useful lives range from 5
years for retail services merchant relationships to approximately 10 years for
certain loan related relationships. Intangible assets are reviewed for
impairment using discounted cash flows annually, or earlier if events indicate
that the carrying amounts may not be recoverable. We consider significant and
long-term changes in industry and economic conditions to be our primary
indicator of potential impairment. Impairment charges, when required, are
calculated using discounted cash flows.
GOODWILL Goodwill represents the purchase price over the fair value of
identifiable assets acquired less liabilities assumed from business
combinations. Goodwill is not amortized, but is reviewed for impairment annually
using discounted cash flows but impairment may be reviewed earlier if
circumstances indicate that the carrying amount may not be recoverable. We
consider significant and long-term changes in industry and economic conditions
to be our primary indicator of potential impairment.
TREASURY STOCK Prior to the acquisition by HSBC, repurchases of treasury stock
were accounted for using the cost method with common stock in treasury
classified in the balance sheet as a reduction of common shareholder's equity.
Treasury stock was reissued at average cost.
DERIVATIVE FINANCIAL INSTRUMENTS All derivatives are recognized on the balance
sheet at their fair value. At the inception of the hedging relationship, we
designate the derivative as a fair value hedge, a cash flow hedge, a hedge of a
net investment in a foreign operation, or a non-hedging derivative. Fair value
hedges include hedges of the fair value of a recognized asset or liability and
certain foreign currency hedges. Cash flow hedges include hedges of the
variability of cash flows to be received or paid related to a recognized asset
or liability and certain foreign currency hedges. Changes in the fair value of
derivatives designated as fair value hedges, along with the change in fair value
on the hedged asset or liability that is attributable to the hedged risk, are
recorded in current period earnings.
Changes in the fair value of derivatives designated as cash flow hedges, to the
extent effective as a hedge, are recorded in accumulated other comprehensive
income and reclassified into earnings in the period during which the hedged item
affects earnings. Changes in the fair value of derivatives used to hedge our net
investment in foreign subsidiaries, to the extent effective as a hedge, are
recorded in common shareholder's(s') equity as a component of the cumulative
translation adjustment account within accumulated other comprehensive income.
Changes in the fair value of derivative instruments not designated as hedging
instruments and ineffective portions of changes in the fair value of hedging
instruments are recognized in other revenue as derivative income in the current
period.
For derivative instruments designated as hedges, we formally document all
relationships between hedging instruments and hedged items. This documentation
includes our risk management objective and strategy for undertaking various
hedge transactions, as well as how hedge effectiveness and ineffectiveness will
be measured. This process includes linking derivatives to specific assets and
liabilities on the balance sheet. We
132
also formally assess, both at the hedge's inception and on a quarterly basis,
whether the derivatives that are used in hedging transactions are highly
effective in offsetting changes in fair values or cash flows of hedged items.
This assessment is conducted using statistical regression analysis. For interest
rate swaps which meet the shortcut method criteria under SFAS No. 133, no
ongoing assessment is required. When as a result of the quarterly assessment, it
is determined that a derivative has ceased to be a highly effective hedge, we
discontinue hedge accounting as of the beginning of the quarter in which such
determination was made.
When hedge accounting is discontinued because it is determined that the
derivative no longer qualifies as an effective hedge, the derivative will
continue to be carried on the balance sheet at its fair value, with changes in
its fair value recognized in current period earnings. For fair value hedges, the
formerly hedged asset or liability will no longer be adjusted for changes in
fair value and any previously recorded adjustments to the carrying value of the
hedged asset or liability will be amortized in the same manner that the hedged
item affects income. For cash flow hedges, amounts previously recorded in
accumulated other comprehensive income will be reclassified into income in the
same manner that the hedged item affects income.
If the hedging instrument is terminated early, the derivative is removed from
the balance sheet. Accounting for the adjustments to the hedged asset or
liability or adjustments to accumulated other comprehensive income are the same
as described above when a derivative no longer qualifies as an effective hedge.
If the hedged asset or liability is sold or extinguished, the derivative will
continue to be carried on the balance sheet at its fair value, with changes in
its fair value recognized in current period earnings. The hedged item, including
previously recorded mark-to-market adjustments, is derecognized immediately as a
component of the gain or loss upon disposition.
FOREIGN CURRENCY TRANSLATION We have foreign subsidiaries located in the United
Kingdom and Canada. The functional currency for each foreign subsidiary is its
local currency. Assets and liabilities of these subsidiaries are translated at
the rate of exchange in effect on the balance sheet date. Translation
adjustments resulting from this process are accumulated in common
shareholder's(s') equity as a component of accumulated other comprehensive
income. Income and expenses are translated at the average rate of exchange
prevailing during the year.
Prior to our acquisition by HSBC, we periodically entered into forward exchange
contracts and foreign currency options to hedge our investment in foreign
subsidiaries. After-tax gains and losses on contracts to hedge foreign currency
fluctuations are accumulated in common shareholder's equity as a component of
accumulated other comprehensive income. Effects of foreign currency translation
in the statements of cash flows are offset against the cumulative foreign
currency adjustment, except for the impact on cash. Foreign currency transaction
gains and losses are included in income as they occur.
STOCK-BASED COMPENSATION In 2002, we adopted the fair value method of accounting
for our stock option and employee stock purchase plans. We elected to recognize
stock compensation cost prospectively for all new awards granted under those
plans beginning January 1, 2002 as provided under SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure (an amendment of FASB
Statement No. 123") ("SFAS No. 148"). The fair value of these awards granted
beginning in 2002 is recognized as expense over the vesting period, generally
either three or four years. As option expense is recognized over the vesting
period of the awards, compensation expense included in the determination of net
income for the period January 1, 2003 through March 28, 2003 does not reflect
the expense which would have been recognized if the fair value method had been
applied to all awards since the original effective date of SFAS No. 123. Because
options granted prior to November 2002 vested upon completion of our acquisition
by HSBC on March 29, 2003, all of our stock options are now accounted for using
the fair value method. In 2004, we began to consider forfeitures for all stock
awards granted subsequent to March 28, 2003 as part of our estimate of
compensation expense rather than adjust compensation expense as forfeitures
occur. The cumulative impact of the change was not material.
Compensation expense relating to restricted stock rights ("RSRs") is based upon
the market value of the RSRs on the date of grant and is charged to earnings
over the vesting period of the RSRs, generally three or five years.
133
The following table illustrates the effect on net income if the fair value
method had been applied to all outstanding and unvested awards in the period
prior to the acquisition:
JANUARY 1
THROUGH
MARCH 28,
2003
----------------------------------------------------------------------------
(PREDECESSOR)
(IN MILLIONS)
Net income, as reported..................................... $246
Add stock-based employee compensation expense included in
reported net income, net of tax:
Stock option and employee stock purchase plans............ 7
Restricted stock rights................................... 11
Deduct stock-based employee compensation expense
determined under the fair value method, net of tax:
Stock option and employee stock purchase plans............ (53)
Restricted stock rights................................... (45)
----
Pro forma net income........................................ $166
====
INCOME TAXES HSBC Finance Corporation is included in HNAH's consolidated Federal
income tax return and in various state income tax returns. In addition, HSBC
Finance Corporation files some unconsolidated state tax returns. Deferred tax
assets and liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities and are measured using the
enacted tax rates and laws that will be in effect. Investment tax credits
generated by leveraged leases are accounted for using the deferral method.
Changes in estimates of the basis in our assets and liabilities or other
estimates recorded at the date of our acquisition by HSBC are adjusted against
goodwill.
TRANSACTIONS WITH RELATED PARTIES In the normal course of business, we enter
into transactions with HSBC and its subsidiaries. These transactions include
funding arrangements, purchases and sales of receivables, servicing
arrangements, information technology services, item processing and statement
processing services, banking and other miscellaneous services.
NEW ACCOUNTING PRONOUNCEMENTS In December 2004, the FASB issued FASB Statement
No. 123 (Revised), "Share-Based Payment," ("SFAS No. 123R"). SFAS No. 123R
requires public entities to measure the cost of stock-based compensation based
on the grant date fair value of the award as well as other additional disclosure
requirements. On March 28, 2005, the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 107 which amended the compliance date to allow
public companies to comply with the provisions of SFAS No. 123R at the beginning
of their next fiscal year that begins after June 15, 2005, instead of the next
reporting period as originally required by SFAS No. 123R. Because we currently
apply the fair value method of accounting for all equity based awards, the
adoption of SFAS 123R will not have a significant effect on the results of our
operations or cash flows.
In May 2005, the FASB issued FASB Statement No. 154, "Accounting Changes and
Error Corrections: a replacement of APB Opinion No. 20 and FASB Statement No. 3"
("SFAS No. 154") which requires companies to apply voluntary changes in
accounting principles retrospectively whenever it is practicable. The
retrospective application requirement replaces APB 20's requirement to recognize
most voluntary changes in accounting principle by including the cumulative
effect of the change in net income during the period the change occurs.
Retrospective application will be the required transition method for new
accounting pronouncements in the event that a newly-issued pronouncement does
not specify transition guidance. SFAS No. 154 is effective for accounting
changes made in fiscal years beginning after December 15, 2005 and is not
expected to have a material impact on our financial position or results of
operations.
In November 2005, the Financial Accounting Standards Board (FASB) issued Staff
Position Nos. FAS 115-1 and FAS 124-1 ("FSP 115-1 and FSP 124-1"), "The Meaning
of Other-Than-Temporary
134
Impairment and Its Application to Certain Investments," in response to Emerging
Issues Task Force 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments." FSP 115-1 and FSP 124-1 provide guidance
regarding the determination as to when an investment is considered impaired,
whether that impairment is other-than-temporary, and the measurement of an
impairment loss. FSP 115-1 and FSP 124-1 also include accounting considerations
subsequent to the recognition of an other-than-temporary impairment and require
certain disclosures about unrealized losses that have not been recognized as
other-than-temporary impairments. These requirements are effective for annual
reporting periods beginning after December 15, 2005. Adoption of the impairment
guidance contained in FSP 115-1 and FSP 124-1 is not expected to have a material
impact on our financial position or results of operations.
In February 2006, the FASB issued FASB Statement No. 155, "Accounting for
Certain Hybrid Financial Instruments" ("SFAS No. 155"). SFAS No. 155 permits
fair value measurement for any hybrid financial instrument that contains an
embedded derivative that would otherwise require bifurcation. An irrevocable
election may be made to initially and subsequently measure such a hybrid
financial instrument at fair value, with changes in fair value recognized
through income. Such election needs to be supported by concurrent documentation.
SFAS No. 155 is effective for financial years beginning after September 15,
2006, with early adoption permitted. We are currently evaluating the impact that
adoption of SFAS No. 155 will have on our financial position or results of
operations.
3. ACQUISITIONS AND DIVESTITURES
--------------------------------------------------------------------------------
ACQUISITION OF METRIS COMPANIES INC. On December 1, 2005, we acquired the
outstanding capital stock of Metris Companies Inc. ("Metris"), a provider of
financial products and services to middle market consumers throughout the United
States, in an all-cash transaction for $1.6 billion. HSBC Investments (North
America) Inc. ("HINO") made a capital contribution of $1.2 billion to fund a
portion of the purchase price. This acquisition will expand our presence in the
near-prime credit card market and will strengthen our capabilities to serve the
full spectrum of credit card customers. The results of Metris are included in
our consolidated financial statements beginning December 1, 2005.
The purchase price was allocated to the assets and liabilities acquired based on
their estimated fair values at the acquisition date. These preliminary fair
values were estimated, in part, based on third party valuation data. These fair
value adjustments represent current estimates and are subject to further
adjustment as our valuation data is finalized. Goodwill associated with the
Metris acquisition is not tax deductible. The initial purchase price allocations
may be adjusted within one year of the purchase date for changes in estimates of
the
135
fair value of assets acquired and liabilities assumed. The following table
summarizes the estimated fair values of the owned basis assets acquired and
liabilities assumed as a result of the acquisition of Metris:
(IN MILLIONS)
--------------------------------------------------------------------------------------------
ASSETS ACQUIRED:
Cash........................................................ $ 22
Investment securities....................................... 230
Receivables............................................... $5,333
Credit loss reserves...................................... (151)
------
Receivables, net............................................ 5,182
Intangible assets........................................... 271
Goodwill.................................................... 522
Properties and equipment.................................... 20
Other assets................................................ 198
------
Total assets acquired..................................... $6,445
======
LIABILITIES ASSUMED:
Long term debt (with original maturities over one year)..... $4,602
Other liabilities........................................... 249
------
Total liabilities assumed................................. $4,851
======
TOTAL PURCHASE PRICE........................................ $1,594
======
The intangible assets resulting from this acquisition are purchased credit card
relationships. The purchased credit card relationships are being amortized over
their estimated useful life of seven years on a straight-line basis with no
residual value.
The following table summarizes pro forma financial information assuming the
Metris acquisition had occurred on January 1, 2004. The pro forma information
uses Metris data for the periods presented. This pro forma financial information
does not necessarily represent what would have occurred if the transaction had
taken place on the dates presented and should not be taken as representative of
our future consolidated results of operations or financial position.
Additionally, the pro forma financial information shown below does not reflect
any costs associated with the integration of Metris into our operations or any
operating synergies we ultimately expect to realize.
2005 2004
------------------------------- -------------------------------
HSBC FINANCE PRO HSBC FINANCE PRO
CORPORATION METRIS FORMA CORPORATION METRIS FORMA
-------------------------------------------------------------------------------------------------
(IN MILLIONS)
Net interest income and other
revenues.................... $13,215 $1,142 $14,357 $12,875 $1,395 $14,270
Net income.................... 1,772 50 1,822 1,940 19 1,959
SALE OF U.K. CREDIT CARD BUSINESS In December 2005, we sold our U.K. credit card
business, including $2.5 billion of receivables ($3.1 billion on a managed
basis), the associated cardholder relationships and the related retained
interests in securitized credit card receivables to HSBC Bank plc ("HBEU"), a
U.K. based subsidiary of HSBC, for an aggregate purchase price of $3.0 billion.
The purchase price, which was determined based on a comparative analysis of
sales of other credit card portfolios, was paid in a combination of cash and
$261 million of preferred stock issued by a subsidiary of HBEU with a rate of
one-year Sterling LIBOR, plus 1.30 percent. In addition to the assets referred
to above, the sale also included the account origination platform, including the
marketing and credit employees associated with this function, as well as the
lease associated with the credit card call center and the related leaseholds and
call center employees to provide customer continuity after the transfer as well
as to allow HBEU direct ownership and control of origination
136
and customer service. We have retained the collection operations related to the
credit card operations and have entered into a service level agreement for a
period of not less than two years to provide collection services and other
support services, including components of the compliance, financial reporting
and human resource functions, for the sold credit card operations to HBEU for a
fee. Additionally, the management teams of HBEU and our remaining U.K.
operations will be jointly involved in decision making involving card marketing
to ensure that growth objectives are met for both businesses. Because the sale
of this business is between affiliates under common control, the premium
received in excess of the book value of the assets transferred of $182 million,
including the goodwill assigned to this business, has been recorded as an
increase to additional paid in capital and has not been included in earnings. In
future periods, the net interest income, fee income and provision for credit
losses related to the U.K. credit card business will be reduced, while other
income will be increased by the receipt of servicing and support services
revenue from HBEU. We do not anticipate that the net effect of this sale will
result in a material reduction of net income of our consolidated results.
ACQUISITION OF HSBC FINANCE CORPORATION BY HSBC HOLDINGS PLC On March 28, 2003,
we were acquired by HSBC by way of merger in a purchase business combination.
HSBC believes that the acquisition offers significant opportunities to extend
our business model into countries and territories currently served by HSBC and
broadens the product range available to the enlarged customer base. Under the
terms of the acquisition agreement, each share of our approximately 476 million
outstanding common shares at the time of acquisition was converted into the
right to receive, at the holder's election, either 2.675 ordinary shares of
HSBC, of nominal value $0.50 each ("HSBC Ordinary Shares"), or 0.535 American
depositary shares, each representing an interest in five HSBC Ordinary Shares.
Additionally, each of our depositary shares representing, respectively,
one-fortieth of a share of 8 1/4% cumulative preferred stock, Series 1992-A,
one-fortieth of a share of 7.50% cumulative preferred stock, Series 2001-A,
one-fortieth of a share of 7.60% cumulative preferred stock, Series 2002-A and
one-fortieth of a share of 7 5/8% cumulative preferred stock, Series 2002-B, was
converted into the right to receive $25 in cash per depositary share, plus
accrued and unpaid dividends up to but not including the effective date of the
acquisition which was an aggregate amount of approximately $1.1 billion. In
consideration of HSBC transferring sufficient funds to make the payments
described above with respect to our depositary shares, we issued the Series A
Cumulative Preferred Stock ("Series A Preferred Stock") in the amount of $1.1
billion to HSBC on March 28, 2003.
Also on March 28, 2003, we called for redemption all the issued and outstanding
shares of our 5.00% cumulative preferred stock, $4.50 cumulative preferred stock
and $4.30 cumulative preferred stock totaling $114 million. Pursuant to the
terms of these issues of preferred stock, we paid a redemption price of $50.00
per share of 5.00% cumulative preferred stock, $103.00 per share of $4.50
cumulative preferred stock and $100.00 per share of $4.30 cumulative preferred
stock, plus, in each case, all dividends accrued and unpaid, whether or not
earned or declared, to the redemption date. Additionally, on March 28, 2003, we
declared a dividend of $0.8694 per share on our common stock, which was paid on
May 6, 2003 to our holders of record on March 28, 2003.
In conjunction with our acquisition by HSBC, we incurred acquisition related
costs of $198 million. Consistent with the guidelines for accounting for
business combinations, these costs were expensed in our statement of income for
the period January 1 through March 28, 2003.
The purchase price paid by HSBC for our common stock plus related purchase
accounting adjustments was valued at $14.7 billion and is recorded as
"Additional paid-in capital" in the accompanying consolidated balance sheet. The
purchase price was allocated to our assets and liabilities based on their
estimated fair values at the acquisition date based, in part, on third party
valuation data. During the first quarter of 2004, we made final adjustments to
the allocation of purchase price to our assets and liabilities. Since the
one-year anniversary of our acquisition by HSBC was completed during the first
quarter of 2004, no further acquisition-related adjustments to the purchase
price allocation will occur, except for changes in estimates for the tax basis
in our assets and liabilities or other tax estimates recorded at the date of our
acquisition by HSBC pursuant to Statement of Financial Accounting Standards No.
109, "Accounting for Income Taxes."
137
4. SALE OF DOMESTIC PRIVATE LABEL RECEIVABLE PORTFOLIO AND ADOPTION OF FFIEC
POLICIES
--------------------------------------------------------------------------------
On December 29, 2004, we sold our domestic private label receivable portfolio
(excluding retail sales contracts at our consumer lending business), including
the retained interests associated with securitized private label receivables, to
HSBC Bank USA for an aggregate purchase price of $12.4 billion and recorded a
gain of $663 million ($423 million after-tax). Included in this gain was the
release of $505 million in credit loss reserves associated with the portfolio.
The domestic private label receivable portfolio sold consisted of receivables
with a balance of $12.2 billion ($15.6 billion on a managed basis). The purchase
price was determined based upon an independent valuation opinion.
We retained the customer relationships and by agreement will sell additional
domestic private label receivable originations (excluding retail sales
contracts) generated under current and future private label accounts to HSBC
Bank USA on a daily basis at fair market value. We will also service the
receivables for HSBC Bank USA for a fee under a service agreement that was
reviewed by the staff of the Board of Governors of the Federal Reserve Board
(the "Federal Reserve Board".)
Upon receipt of regulatory approval for the sale of this domestic private label
receivable portfolio, we adopted charge-off and account management policies in
accordance with the Uniform Retail Credit Classification and Account Management
Policy issued by the Federal Financial Institutions Examination Council ("FFIEC
Policies") for our domestic private label (excluding retail sales contracts at
our consumer lending business) and MasterCard and Visa portfolios. The adoption
of FFIEC charge-off policies for our domestic private label (excluding retail
sales contracts at our consumer lending business) and MasterCard/Visa
receivables resulted in a reduction to our 2004 net income of $121 million.
5. SECURITIES
--------------------------------------------------------------------------------
Securities consisted of the following available-for-sale investments:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 2005 COST GAINS LOSSES VALUE
---------------------------------------------------------------------------------------------------
(IN MILLIONS)
Corporate debt securities............................ $2,337 $23 $(38) $2,322
Money market funds................................... 315 - - 315
U.S. government sponsored enterprises(1)............. 96 - (2) 94
U.S. government and Federal agency debt securities... 744 - (4) 740
Non-government mortgage backed securities............ 88 - (1) 87
Other................................................ 463 1 (5) 459
------ --- ---- ------
Subtotal............................................. 4,043 24 (50) 4,017
Accrued investment income............................ 34 - - 34
------ --- ---- ------
Total securities available for sale.................. $4,077 $24 $(50) $4,051
====== === ==== ======
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GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 2004 COST GAINS LOSSES VALUE
---------------------------------------------------------------------------------------------------
(IN MILLIONS)
Corporate debt securities............................ $2,520 $27 $(14) $2,533
Money market funds................................... 230 - - 230
U.S. government sponsored enterprises(1)............. 100 - (1) 99
U.S. government and Federal agency debt securities... 323 - (3) 320
Non-government mortgage backed securities............ 44 - - 44
Other................................................ 385 1 (3) 383
------ --- ---- ------
Subtotal............................................. 3,602 28 (21) 3,609
Accrued investment income............................ 36 - - 36
------ --- ---- ------
Total securities available for sale.................. $3,638 $28 $(21) $3,645
====== === ==== ======
---------------
(1) Includes primarily mortgage-backed securities issued by the Federal National
Mortgage Association and the Federal Home Loan Mortgage Corporation.
Proceeds from the sale of available-for-sale investments totaled approximately
$.4 billion in 2005, $.9 billion in 2004, $.7 billion in the period March 29
through December 31, 2003 and $.8 billion in the period January 1 through March
28, 2003. We realized gross gains of $10 million in 2005, $15 million in 2004,
$18 million in the period March 29 through December 31, 2003 and $41 million in
the period January 1 through March 28, 2003. We realized gross losses of $10
million in 2005, $3 million in 2004, $.4 million in the period March 29 through
December 31, 2003 and $3 million in the period January 1 through March 28, 2003
on those sales.
A summary of gross unrealized losses and related fair values as of December 31,
2005, classified as to the length of time the losses have existed is presented
in the following table:
LESS THAN ONE YEAR GREATER THAN ONE YEAR
--------------------------------------- ---------------------------------------
GROSS AGGREGATE GROSS AGGREGATE
NUMBER OF UNREALIZED FAIR VALUE OF NUMBER OF UNREALIZED FAIR VALUE OF
DECEMBER 31, 2005 SECURITIES LOSSES INVESTMENTS SECURITIES LOSSES INVESTMENTS
-------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Corporate debt
securities.............. 243 $(12) $527 392 $(26) $996
U.S. government sponsored
enterprises............. 32 -(1) 26 25 (2) 64
U.S. government and
Federal agency debt
securities.............. 15 (1) 49 43 (3) 139
Non-government mortgage... 3 -(1) 4 16 (1) 22
Other..................... 14 (1) 78 46 (4) 181
---------------
(1) Less than $500 thousand.
The gross unrealized losses on our securities available for sale have increased
during 2005 due to a general increase in interest rates. The contractual terms
of these securities do not permit the issuer to settle the securities at a price
less than the par value of the investment. Since substantially all of these
securities are rated A- or better, and because we have the ability and intent to
hold these investments until maturity or a market price recovery, these
securities are not considered other-than temporarily impaired.
The amortized cost of our securities available for sale was adjusted to fair
market value at the time of the merger with HSBC. See Note 25, "Fair Value of
Financial Instruments," for further discussion of the relationship between the
fair value of our assets and liabilities.
139
Contractual maturities of and yields on investments in debt securities were as
follows:
AT DECEMBER 31, 2005
----------------------------------------------------
DUE AFTER 1 AFTER 5
WITHIN BUT WITHIN BUT WITHIN AFTER
1 YEAR 5 YEARS 10 YEARS 10 YEARS TOTAL
----------------------------------------------------------------------------------------------------
(IN MILLIONS)
Corporate debt securities:
Amortized cost.............................. $418 $989 $317 $613 $2,337
Fair value.................................. 416 963 313 630 2,322
Yield(1).................................... 4.57% 3.96% 5.07% 5.76% 4.69%
U.S. government sponsored enterprises:
Amortized cost.............................. - 9 $ 14 $ 73 $ 96
Fair value.................................. - 9 14 71 94
Yield(1).................................... - 3.34 4.21% 3.97% 3.95%
U.S. government and Federal agency debt
securities:
Amortized cost.............................. $566 $111 $ 7 $ 60 $ 744
Fair value.................................. 565 108 7 60 740
Yield(1).................................... 4.13% 3.67% 4.39% 4.68% 4.11%
---------------
(1) Computed by dividing annualized interest by the amortized cost of respective
investment securities.
6. RECEIVABLES
--------------------------------------------------------------------------------
Receivables consisted of the following:
AT DECEMBER 31,
-------------------
2005 2004
---------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured......................................... $ 82,826 $ 64,820
Auto finance................................................ 10,704 7,544
MasterCard/Visa............................................. 24,110 14,635
Private label............................................... 2,520 3,411
Personal non-credit card.................................... 19,545 16,128
Commercial and other........................................ 208 317
-------- --------
Total owned receivables..................................... 139,913 106,855
HSBC acquisition purchase accounting fair value
adjustments............................................... 63 201
Accrued finance charges..................................... 1,831 1,394
Credit loss reserve for owned receivables................... (4,521) (3,625)
Unearned credit insurance premiums and claims reserves...... (505) (631)
Interest-only strip receivables............................. 23 323
Amounts due and deferred from receivable sales.............. 185 298
-------- --------
Total owned receivables, net................................ 136,989 104,815
Receivables serviced with limited recourse.................. 4,074 14,225
-------- --------
Total managed receivables, net.............................. $141,063 $119,040
======== ========
HSBC acquisition purchase accounting fair value adjustments represent
adjustments which have been "pushed down" to record our receivables at fair
value at the date of acquisition by HSBC.
140
We have a subsidiary, Decision One Mortgage Company, LLC, which directly
originates mortgage loans sourced by mortgage brokers and sells all loans to
secondary market purchasers, including our Mortgage Services businesses. Loans
held for sale to external parties by this subsidiary totaled $1.7 billion at
December 31, 2005 and $1.1 billion at December 31, 2004 and are included in real
estate secured receivables.
In December 2005, we sold our U.K. based credit card operations, including $2.5
billion of receivables ($3.1 billion on a managed basis) and the related
retained interests in securitized credit card receivables to HBEU. See Note 3,
"Acquisitions and Divestitures," for additional information regarding this sale.
As discussed more fully in Note 3, "Acquisitions and Divestitures," as part of
our acquisition of Metris on December 1, 2005, we acquired $5.3 billion of
receivables. The receivables acquired as part of our acquisition of Metris in
2005 were subject to the requirements of SOP 03-3 to the extent there was
evidence of deterioration of credit quality since origination and for which it
was probable, at acquisition, that all contractually required payments would not
be collected and that the associated line of credit had been closed. The
following table summarizes the outstanding receivable balances, the cash flows
expected to be collected and the fair value of the receivables to which SOP 03-3
has been applied:
(IN MILLIONS)
---------------------------------------------------------------------------
Outstanding contractual receivable balance at acquisition... $925
Cash flows expected to be collected at acquisition.......... 563
Basis in acquired receivables at acquisition................ 432
The carrying amount of these receivables at December 31, 2005 of $414 million is
included in the MasterCard/Visa receivables in the table above. At December 31,
2005, no credit loss reserve for these acquired receivables has been established
as there has been no change in anticipated future cash flows since the Metris
acquisition. The outstanding contractual balance of these receivables at
December 31, 2005 is $804 million.
At the time of the Metris acquisition, the anticipated cash flows from these
acquired receivables exceeded the amount paid for the receivables. The following
summarizes the Accretable Yield on these receivables at December 31, 2005:
(IN MILLIONS)
---------------------------------------------------------------------------
Accretable yield established for Metris acquisition......... $(131)
Accretable yield amortized to interest income during 2005... 9
-----
Balance at December 31, 2005................................ $(122)
=====
Foreign receivables included in owned receivables were as follows:
AT DECEMBER 31,
---------------------------------------------------
UNITED KINGDOM AND
THE REST OF EUROPE CANADA
------------------------ ------------------------
2005 2004 2003 2005 2004 2003
-----------------------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured....................... $1,654 $1,832 $1,354 $1,380 $1,042 $ 841
Auto finance.............................. - - - 270 54 -
MasterCard/Visa........................... - 2,264 1,605 147 - -
Private label............................. 1,330 2,249 2,142 834 821 729
Personal non-credit card.................. 3,038 3,562 2,741 607 517 467
Commercial and other...................... - - 1 - 2 2
------ ------ ------ ------ ------ ------
Total..................................... $6,022 $9,907 $7,843 $3,238 $2,436 $2,039
====== ====== ====== ====== ====== ======
Foreign owned receivables represented 7 percent of owned receivables at December
31, 2005 and 12 percent of owned receivables at December 31, 2004.
141
Receivables serviced with limited recourse consisted of the following:
AT DECEMBER 31,
----------------
2005 2004
------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured......................................... $ - $ 81
Auto finance................................................ 1,192 2,679
MasterCard/Visa............................................. 1,875 7,583
Private label............................................... - -
Personal non-credit card.................................... 1,007 3,882
------ -------
Total....................................................... $4,074 $14,225
====== =======
The combination of receivables owned and receivables serviced with limited
recourse, which comprises our managed portfolio, is shown below:
AT DECEMBER 31,
-------------------
2005 2004
---------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured......................................... $ 82,826 $ 64,901
Auto finance................................................ 11,896 10,223
MasterCard/Visa............................................. 25,985 22,218
Private label............................................... 2,520 3,411
Personal non-credit card.................................... 20,552 20,010
Commercial and other........................................ 208 317
-------- --------
Total....................................................... $143,987 $121,080
======== ========
We maintain facilities with third parties which provide for the securitization
or secured financing of receivables on both a revolving and non-revolving basis
totaling $15 billion, of which $5.6 billion were utilized at December 31, 2005.
The amount available under these facilities will vary based on the timing and
volume of public securitization or secured financing transactions and our
general liquidity plans.
Contractual maturities of owned receivables were as follows:
AT DECEMBER 31, 2005
-------------------------------------------------------------------
2006 2007 2008 2009 2010 THEREAFTER TOTAL
--------------------------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured.......... $ 421 $ 341 $ 343 $ 389 $ 493 $80,839 $ 82,826
Auto finance................. 2,539 2,290 2,154 1,831 1,271 619 10,704
MasterCard/Visa.............. 3,415 2,739 2,311 1,961 1,673 12,011 24,110
Private label................ 1,372 454 365 193 64 72 2,520
Personal non-credit card..... 2,369 1,724 1,916 3,007 5,393 5,136 19,545
Commercial and other......... 9 - - - 55 144 208
------- ------ ------ ------ ------ ------- --------
Total........................ $10,125 $7,548 $7,089 $7,381 $8,949 $98,821 $139,913
======= ====== ====== ====== ====== ======= ========
A substantial portion of consumer receivables, based on our experience, will be
renewed or repaid prior to contractual maturity. The above maturity schedule
should not be regarded as a forecast of future cash collections. The ratio of
annual cash collections of principal on owned receivables to average principal
balances, excluding credit card receivables, approximated 33 percent in 2005 and
39 percent in 2004.
142
The following table summarizes contractual maturities of owned receivables due
after one year by repricing characteristic:
AT DECEMBER 31, 2005
--------------------------
OVER 1 BUT
WITHIN OVER
5 YEARS 5 YEARS
----------------------------------------------------------------------------------------
(IN MILLIONS)
Receivables at predetermined interest rates................. $23,089 $81,463
Receivables at floating or adjustable rates................. 7,878 17,358
------- -------
Total....................................................... $30,967 $98,821
======= =======
Nonaccrual owned consumer receivables totaled $3.5 billion (including $463
million relating to foreign operations) at December 31, 2005 and $3.0 billion
(including $432 million relating to foreign operations) at December 31, 2004.
Interest income that would have been recorded if such nonaccrual receivables had
been current and in accordance with contractual terms was approximately $475
million (including $66 million relating to foreign operations) in 2005 and $377
million (including $50 million relating to foreign operations) in 2004. Interest
income that was included in finance and other interest income prior to these
loans being placed on nonaccrual status was approximately $229 million
(including $31 million relating to foreign operations) in 2005 and $197 million
(including $27 million relating to foreign operations) in 2004. For an analysis
of reserves for credit losses on an owned and managed basis, see our "Analysis
of Credit Loss Reserves Activity" in Management's Discussion and Analysis and
Note 7, "Credit Loss Reserves."
Interest-only strip receivables are reported net of our estimate of probable
losses under the recourse provisions for receivables serviced with limited
recourse. Reductions to our interest-only strip receivables in 2005 reflect the
impact of reduced securitization levels, including our decision to structure new
collateralized funding transactions as secured financings.
Amounts due and deferred from receivable sales include assets established for
certain receivable sales, including funds deposited in spread accounts, and net
customer payments due from (to) the securitization trustee.
We issued securities backed by dedicated home equity loan receivables of $4.5
billion in 2005 and $3.3 billion in 2004. We issued securities backed by
dedicated auto finance loan receivables of $3.4 billion in 2005 and $1.8 billion
in 2004. We issued securities backed by dedicated MasterCard/Visa credit card
receivables of $1.8 billion in 2005. For accounting purposes, these transactions
were structured as secured financings, therefore, the receivables and the
related debt remain on our balance sheet. Additionally, as part of the Metris
acquisition we assumed $4.6 billion of securities backed by MasterCard/Visa
receivables which are accounted for as secured financings. Real estate secured
receivables included closed-end real estate secured receivables totaling $8.4
billion at December 31, 2005 and $7.7 billion at December 31, 2004 that secured
the outstanding debt related to these transactions. Auto finance receivables
totaling $4.6 billion at December 31, 2005 and $2.6 billion at December 31, 2004
secured the outstanding debt related to these transactions. MasterCard/ Visa
credit card receivables of $8.8 billion at December 31, 2005 secured the
outstanding debt related to these transactions. There were no transactions
structured as secured financings in 2004 for MasterCard/Visa credit card
receivables.
143
7. CREDIT LOSS RESERVES
--------------------------------------------------------------------------------
An analysis of credit loss reserves was as follows:
AT DECEMBER 31,
---------------------------
2005 2004 2003
-----------------------------------------------------------------------------------------
(IN MILLIONS)
Owned receivables:
Credit loss reserves at beginning of period............... $ 3,625 $ 3,793 $ 3,333
Provision for credit losses............................... 4,543 4,334 3,967
Charge-offs............................................... (4,100) (4,409) (3,878)
Recoveries................................................ 447 376 291
Other, net................................................ 6 (469) 80
------- ------- -------
Credit loss reserves for owned receivables................ 4,521 3,625 3,793
------- ------- -------
Receivables serviced with limited recourse:
Credit loss reserves at beginning of period............... 890 2,374 1,759
Provision for credit losses............................... 107 188 2,275
Charge-offs............................................... (768) (1,743) (1,764)
Recoveries................................................ 60 102 97
Other, net................................................ (74) (31) 7
------- ------- -------
Credit loss reserves for receivables serviced with limited
recourse............................................... 215 890 2,374
------- ------- -------
Credit loss reserves for managed receivables................ $ 4,736 $ 4,515 $ 6,167
======= ======= =======
Reductions to the provision for credit losses and overall reserve levels on
receivables serviced with limited recourse in 2005 and 2004 reflect the impact
of reduced securitization levels, including our decision to structure new
collateralized funding transactions as secured financings.
Further analysis of credit quality and credit loss reserves is presented in Item
7, "Management's Discussion and Analysis of Financial Condition and Results of
Operations" of Form 10-K under the caption "Credit Quality."
8. ASSET SECURITIZATIONS
--------------------------------------------------------------------------------
We have sold auto finance, MasterCard and Visa, private label and personal
non-credit card receivables in various securitization transactions. We continue
to service and receive servicing fees on the outstanding balance of these
securitized receivables. We also retain rights to future cash flows arising from
these receivables after the investors receive their contractual return. We have
also, in certain cases, retained other subordinated interests in these
securitizations. These transactions result in the recording of an interest-only
strip receivable which represents the value of the future residual cash flows
from securitized receivables. The investors and the securitization trusts have
only limited recourse to our assets for failure of debtors to pay. That recourse
is limited to our rights to future cash flow and any subordinated interest we
retain. Servicing assets and liabilities are not recognized in conjunction with
our securitizations since we receive adequate compensation relative to current
market rates to service the receivables sold. See Note 2, "Summary of
Significant Accounting Policies," for further discussion on our accounting for
interest-only strip receivables.
In the third quarter of 2004, we began to structure all new collateralized
funding transactions as secured financings. However, because existing public
MasterCard and Visa credit card transactions were structured as sales to
revolving trusts that require replenishments of receivables to support
previously issued securities, receivables will continue to be sold to these
trusts until the revolving periods end, the last of which is expected to occur
in early 2008 based on current projections. After December 29, 2004, private
label trusts that publicly issued securities are now replenished by HSBC Bank
USA as a result of the daily sales of new domestic
144
private label credit card originations to HSBC Bank USA. In addition, we will
continue to replenish at reduced levels, certain non-public personal non-credit
card securities issued to conduits and record the resulting replenishment gains
for a period of time to manage liquidity. Since our securitized receivables have
varying lives, it will take a period of time for these receivables to pay-off
and the related interest-only strip receivables to be reduced to zero.
Securitization related revenue includes income associated with the current and
prior period securitization of receivables with limited recourse structured as
sales. Such income includes gains on sales, net of our estimate of probable
credit losses under the recourse provisions, servicing income and excess spread
relating to those receivables.
MARCH 29 JANUARY 1
YEAR ENDED YEAR ENDED THROUGH THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 28,
2005 2004 2003 2003
------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Net initial gains(1).......................... $ - $ 25 $ 135 $ 41
Net replenishment gains(2).................... 154 414 411 137
Servicing revenue and excess spread........... 57 569 481 256
---- ------ ------ ----
Total securitization related revenue.......... $211 $1,008 $1,027 $434
==== ====== ====== ====
---------------
(1) Net initial gains reflect inherent recourse provisions of $47 million in
2004, $825 million in the period March 29 to December 31, 2003 and $138
million in the period January 1 to March 28, 2003.
(2) Net replenishment gains reflect inherent recourse provisions of $252 million
in 2005, $850 million in 2004, $656 million in the period March 29 to
December 31, 2003 and $193 million in the period January 1 to March 28,
2003.
Our interest-only strip receivables, net of the inherent recourse provisions and
excluding the mark-to-market adjustment recorded in accumulated other
comprehensive income, in 2005 the U.K. credit card portion purchased by HBEU and
in 2004, the private label portion purchased by HSBC Bank USA decreased $253
million in 2005, $466 million in 2004, $400 million in the period March 29 to
December 31, 2003, and $30 million in the period January 1 to March 28, 2003.
145
Net initial gains, which represent gross initial gains net of our estimate of
probable credit losses under the recourse provisions, and the key economic
assumptions used in measuring the net initial gains from securitizations were as
follows:
PERSONAL
AUTO MASTERCARD/ PRIVATE NON-CREDIT
YEAR ENDED DECEMBER 31, FINANCE VISA LABEL CARD TOTAL
-----------------------------------------------------------------------------------------------------
2005
Net initial gains (in millions)................ $ - $ - $ - $ - $ -
Key economic assumptions:(1)
Weighted-average life (in years)............. - - - -
Payment speed................................ - - - -
Expected credit losses (annual rate)......... - - - -
Discount rate on cash flows.................. - - - -
Cost of funds................................ - - - -
2004
Net initial gains (in millions)................ $ 6(2) $ 14 $ 5 $ - $ 25
Key economic assumptions:(1)
Weighted-average life (in years)............. 2.1 .3 .4 -
Payment speed................................ 35.0% 93.5% 93.5% -
Expected credit losses (annual rate)......... 5.7 4.9 4.8 -
Discount rate on cash flows.................. 10.0 9.0 10.0 -
Cost of funds................................ 3.0 1.5 1.4 -
2003
Net initial gains (in millions)................ $ 56 $ 25 $ 51 $ 44 $176
Key economic assumptions:(1)
Weighted-average life (in years)............. 2.1 .4 .7 1.7
Payment speed................................ 35.4% 93.3% 74.5% 43.3%
Expected credit losses (annual rate)......... 6.1 5.1 5.7 12.0
Discount rate on cash flows.................. 10.0 9.0 10.0 11.0
Cost of funds................................ 2.2 1.8 1.8 2.1
---------------
(1) Weighted-average annual rates for securitizations entered into during the
period for securitizations of loans with similar characteristics.
(2) In 2004, auto finance was involved in a securitization which later was
restructured as a secured financing. The initial gain reflected above was
the gain on the initial transaction that remained after the securitization
was restructured, as required under Emerging Issues Task Force Issue No.
02-9.
Certain securitization trusts, such as credit cards, are established at fixed
levels and require frequent sales of new receivables into the trust to replace
receivable run-off. These replenishments totaled $8.8 billion in 2005, $30.3
billion in 2004 and $30.9 billion in 2003.
146
Cash flows received from securitization trusts were as follows:
PERSONAL
REAL ESTATE AUTO MASTERCARD/ PRIVATE NON-CREDIT
YEAR ENDED DECEMBER 31, SECURED FINANCE VISA LABEL CARD TOTAL
------------------------------------------------------------------------------------------------------
(IN MILLIONS)
2005
Proceeds from initial
securitizations................ $ - $ - $ - $ - $ - $ -
Servicing fees received.......... - 45 97 - 46 188
Other cash flow received on
retained interests(1).......... - 40 243 - 52 335
2004
Proceeds from initial
securitizations................ $ - $ -(2) $550 $ 190 $ - $ 740
Servicing fees received.......... 1 86 185 93 161 526
Other cash flow received on
retained interests(1).......... 4 (1) 696 252 80 1,031
2003
Proceeds from initial
securitizations................ $ - $1,523 $670 $1,250 $3,320 $6,763
Servicing fees received.......... 4 117 202 82 136 541
Other cash flow received on
retained interests(1).......... 10 92 844 249 183 1,378
---------------
(1) Other cash flows include all cash flows from interest-only strip
receivables, excluding servicing fees.
(2) In 2004, auto finance was involved in a securitization which was later
restructured as a secured financing. These transactions are reported net in
the table above.
At December 31, 2005, the sensitivity of the current fair value of the
interest-only strip receivables to an immediate 10 percent and 20 percent
unfavorable change in assumptions are presented in the table below. These
sensitivities are based on assumptions used to value our interest-only strip
receivables at December 31, 2005.
PERSONAL
AUTO MASTERCARD/ NON-CREDIT
FINANCE VISA CARD
------------------------------------------------------------------------------------------------
Carrying value (fair value) of interest-only strip
receivables............................................... $ (13) $ 20 $ 16
Weighted-average life (in years)............................ 1.2 .3 .5
Payment speed assumption (annual rate)...................... 55.8% 96.3% 86.9%
Impact on fair value of 10% adverse change................ $ (5) $ (2) $ (1)
Impact on fair value of 20% adverse change................ (12) (4) (2)
Expected credit losses (annual rate)........................ 10.6% 4.6% 9.4%
Impact on fair value of 10% adverse change................ $ (12) $ (2) $ (4)
Impact on fair value of 20% adverse change................ (25) (3) (8)
Discount rate on residual cash flows (annual rate).......... 10.0% 9.0% 11.0%
Impact on fair value of 10% adverse change................ $ (2) $ - $ -
Impact on fair value of 20% adverse change................ (3) - -
Variable returns to investors (annual rate)................. - 2.9% 5.7%
Impact on fair value of 10% adverse change................ $ - $ (1) $ (2)
Impact on fair value of 20% adverse change................ - (2) (5)
These sensitivities are hypothetical and should not be considered to be
predictive of future performance. As the figures indicate, the change in fair
value based on a 10 percent variation in assumptions cannot necessarily be
extrapolated because the relationship of the change in assumption to the change
in fair value may not be linear. Also, in this table, the effect of a variation
in a particular assumption on the fair value of the residual cash flow is
calculated independently from any change in another assumption. In reality,
changes in one factor
147
may contribute to changes in another (for example, increases in market interest
rates may result in lower prepayments) which might magnify or counteract the
sensitivities. Furthermore, the estimated fair values as disclosed should not be
considered indicative of future earnings on these assets.
Static pool credit losses are calculated by summing actual and projected future
credit losses and dividing them by the original balance of each pool of asset.
Due to the short term revolving nature of MasterCard and Visa receivables, the
weighted-average percentage of static pool credit losses is not considered to be
materially different from the weighted-average charge-off assumptions used in
determining the fair value of our interest-only strip receivables in the table
above. At December 31, 2005, static pool credit losses for auto finance loans
securitized in 2003 were estimated to be 10.6 percent and for auto finance loans
securitized in 2002 were estimated to be 14.8 percent.
Receivables and two-month-and-over contractual delinquency for our managed and
serviced with limited recourse portfolios were as follows:
AT DECEMBER 31,
-----------------------------------------------------
2005 2004
------------------------- -------------------------
RECEIVABLES DELINQUENT RECEIVABLES DELINQUENT
OUTSTANDING RECEIVABLES OUTSTANDING RECEIVABLES
-------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
MANAGED RECEIVABLES:
First mortgage(1)............................. $ 21 8.41% $ 26 5.04%
Real estate secured........................... 82,826 2.72 64,901 2.97
Auto finance.................................. 11,896 2.76 10,223 2.96
MasterCard/Visa............................... 25,985 3.52 22,218 3.98
Private label................................. 2,520 5.43 3,411 4.13
Personal non-credit card...................... 20,552 9.54 20,010 9.30
-------- ----- -------- -----
Total consumer................................ 143,800 3.89 120,789 4.24
Commercial.................................... 187 - 291 -
-------- ----- -------- -----
Total managed receivables....................... $143,987 3.89% $121,080 4.23%
-------- ----- -------- -----
RECEIVABLES SERVICED WITH LIMITED RECOURSE:
Real estate secured........................... $ - -% $ (81) 12.35%
Auto finance.................................. (1,192) 6.63 (2,679) 5.49
MasterCard/Visa............................... (1,875) 1.60 (7,583) 2.24
Personal non-credit card...................... (1,007) 12.41 (3,882) 11.88
-------- ----- -------- -----
Total receivables serviced with limited
recourse...................................... (4,074) 5.74 (14,225) 5.54
-------- ----- -------- -----
OWNED CONSUMER RECEIVABLES...................... $139,726 3.84% $106,564 4.07%
======== ===== ======== =====
---------------
(1) Includes our liquidating legacy first and reverse mortgage portfolios.
148
Average receivables and net charge-offs for our managed and serviced with
limited recourse portfolios were as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
2005 2004
------------------------- -------------------------
AVERAGE NET AVERAGE NET
RECEIVABLES CHARGE-OFFS RECEIVABLES CHARGE-OFFS
--------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
MANAGED RECEIVABLES:
First mortgage(1).............................. $ 24 .90% $ 32 2.39%
Real estate secured............................ 73,120 .76 56,462 1.10
Auto finance................................... 10,937 4.56 9,432 5.80
MasterCard/Visa(2)............................. 22,694 6.78 20,674 7.29
Private label(2)............................... 2,948 4.83 17,579 6.03
Personal non-credit card....................... 19,956 8.11 18,986 10.20
-------- ---- -------- -----
Total consumer.............................. 129,679 3.36 123,165 4.61
Commercial..................................... 231 2.60 322 -
-------- ---- -------- -----
Total managed receivables........................ $129,910 3.36% $123,487 4.59%
-------- ---- -------- -----
RECEIVABLES SERVICED WITH LIMITED RECOURSE:
Real estate secured............................ $ (23) -% $ (159) 1.26%
Auto finance................................... (1,863) 10.90 (3,647) 9.57
MasterCard/Visa(2)............................. (4,871) 5.52 (9,099) 5.30
Private label(2)............................... - - (4,550) 5.63
Personal non-credit card....................... (2,398) 9.84 (4,792) 11.54
-------- ---- -------- -----
Total receivables serviced with limited
recourse....................................... (9,155) 7.73 (22,247) 7.38
-------- ---- -------- -----
OWNED CONSUMER RECEIVABLES(2).................... $120,524 3.03% $100,918 4.00%
======== ==== ======== =====
---------------
(1) Includes our liquidating legacy first and reverse mortgage portfolios.
(2) The adoption of FFIEC charge-off policies for our domestic private label
(excluding retail sales contracts at our consumer lending business) and
MasterCard/Visa portfolios in December 2004 increased managed basis net
charge-off by 2 basis points for MasterCard/Visa and 112 basis points for
private label receivables and increased receivables serviced with limited
recourse net charge-offs by 2 basis points for MasterCard/Visa and 94 basis
points for private label receivables and increased owned consumer net
charge-offs by 16 basis points.
9. PROPERTIES AND EQUIPMENT, NET
--------------------------------------------------------------------------------
AT
DECEMBER 31,
------------- DEPRECIABLE
2005 2004 LIFE
-----------------------------------------------------------------------------------------
(IN MILLIONS
Land........................................................ -
$ 28 $ 27
Buildings and improvements.................................. 10-40 years
288 280
Furniture and equipment..................................... 3 - 10
376 348
---- ----
Total....................................................... 692 655
Accumulated depreciation and amortization................... 234 168
---- ----
Properties and equipment, net............................... $458 $487
==== ====
149
Depreciation and amortization expense totaled $131 million in 2005, $127 million
in 2004, $101 million in the period March 29 through December 31, 2003 and $33
million in the period January 1 through March 28, 2003.
10. INTANGIBLE ASSETS
--------------------------------------------------------------------------------
Intangible assets consisted of the following:
ACCUMULATED CARRYING
DECEMBER 31, 2005 GROSS AMORTIZATION VALUE
----------------------------------------------------------------------------------------------
(IN MILLIONS
Purchased credit card relationships and related programs....
$1,736 $442 $1,294
Retail services merchant relationships......................
270 149 121
Other loan related relationships............................
326 104 222
Trade names.................................................
717 13 704
Technology, customer lists and other contracts..............
282 143 139
------ ---- ------
Total....................................................... $3,331 $851 $2,480
====== ==== ======
ACCUMULATED CARRYING
DECEMBER 31, 2004 GROSS AMORTIZATION VALUE
----------------------------------------------------------------------------------------------
(IN MILLIONS
Purchased credit card relationships and related programs....
$1,723 $355 $1,368
Retail services merchant relationships......................
270 95 175
Other loan related relationships............................
326 71 255
Trade names.................................................
718 - 718
Technology, customer lists and other contracts..............
281 92 189
------ ---- ------
Total....................................................... $3,318 $613 $2,705
====== ==== ======
During the third quarter of 2005, we completed our annual impairment test of
intangible assets. As a result of our testing, we recorded an impairment charge
related to a trade name in the United Kingdom. This charge is included as a
component of amortization of intangibles in our consolidated income statement.
For all other intangible assets, we determined that the fair value of each
intangible asset exceeded its carrying value, resulting in a conclusion that
none of our remaining intangible assets are impaired.
Weighted-average amortization periods for our intangible assets as of December
31, 2005 were as follows:
(IN MONTHS)
-------------------------------------------------------------------------
Purchased credit card relationships and related programs.... 115
Retail services merchant relationships...................... 60
Other loan related relationships............................ 110
Technology, customer lists and other contracts.............. 61
Intangible assets........................................... 90
Intangible amortization expense totaled $345 million in 2005, $363 million in
2004, $246 million in the period March 29 through December 31, 2003 and $12
million in the period January 1 through March 28, 2003.
The trade names are not subject to amortization as we believe they have
indefinite lives. The remaining acquired intangibles are being amortized as
applicable over their estimated useful lives either on a straight-line basis or
in proportion to the underlying revenues generated. These useful lives range
from 5 years for retail services merchant relationships to approximately 10
years for certain loan related relationships. Our purchased credit card
relationships have estimated residual values of $162 million as of December 31,
2005.
150
Estimated amortization expense associated with our intangible assets for each of
the following years is as follows:
YEAR ENDING DECEMBER 31, (IN MILLIONS)
---------------------------------------------------------------------------
2006........................................................ $269
2007........................................................ 252
2008........................................................ 210
2009........................................................ 197
2010........................................................ 168
Thereafter.................................................. 520
11. GOODWILL
--------------------------------------------------------------------------------
Goodwill balances associated with our foreign businesses will change from period
to period due to movements in foreign exchange. Since the one-year anniversary
in the first quarter of 2004 of our acquisition by HSBC, no further
acquisition-related adjustments to the goodwill resulting from our acquisition
by HSBC will occur, except for changes in estimates of the tax basis in our
assets and liabilities or other tax estimates recorded at the date of our
acquisition by HSBC, pursuant to Statement of Financial Accounting Standards No.
109, "Accounting for Income Taxes," and for the movements in foreign exchange
rates discussed above.
Changes in the carrying amount of goodwill are as follows:
2005 2004
-----------------------------------------------------------------------------
(IN MILLIONS)
Balance at beginning of year................................ $6,856 $6,697
2005 acquisitions, primarily Metris....................... 533 -
Write off of goodwill allocated to the U.K. credit card
business sold to HBEU.................................. (218) -
Change in estimate of the tax basis of assets and
liabilities recorded in the HSBC acquisition........... (76) (56)
Final adjustments to HSBC purchase price allocation....... - 141
Impact of foreign currency translation.................... (92) 74
------ ------
Balance at end of year...................................... $7,003 $6,856
====== ======
Goodwill established as a result of our acquisition by HSBC has not been
allocated to or included in the reported results of our reportable segments as
the acquisition by HSBC was outside of the ongoing operational activities of our
reportable segments. This is consistent with management's view of our reportable
segment results. Goodwill of $522 million resulting from our acquisition of
Metris and $11 million related to the acquisition of a small mortgage brokerage
firm by our Canadian operations are included in the reported results of the
Credit Card Services and International Segments, respectively, as these
acquisitions specifically related to the operations of these segments and is
consistent with management's view of the segment results.
During the third quarter of 2005, we completed our annual impairment test of
goodwill. For purposes of this test, we assigned the goodwill to our reporting
units (as defined in SFAS No. 142, "Goodwill and Other Intangible Assets").
The fair value of each of the reporting units to which goodwill was assigned
exceeded its carrying value including goodwill, resulting in a conclusion that
none of our goodwill is impaired.
As required by SFAS No. 142, "Goodwill and Other Intangible Assets," subsequent
to the sale of the U.K. credit card business we performed an interim goodwill
impairment test for our remaining U.K. and European operations. As the estimated
fair value of our remaining U.K. and European operations exceeded its carrying
value subsequent to the sale, we concluded that the remaining goodwill assigned
to this reporting unit was not impaired.
151
12. DEPOSITS
--------------------------------------------------------------------------------
The following table shows domestic and foreign deposits at December 31, 2005.
AT DECEMBER 31,
---------------------------------------
2005(1) 2004(1)
------------------ ------------------
WEIGHTED- WEIGHTED-
AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE
-------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Time certificates....................................... $ 9 5.8% $12 5.3%
Savings accounts........................................ 27 3.1 34 1.5
Demand accounts......................................... 1 - 1 -
--- --- --- ---
Total deposits.......................................... $37 3.7% $47 2.4%
=== === === ===
---------------
(1) Includes $2 million in domestic deposits at December 31, 2005. There were no
domestic deposits at December 31, 2004.
Average deposits and related weighted-average interest rates for our foreign
operations are included in the table below. Average domestic deposits were
immaterial in 2005.
AT DECEMBER 31,
------------------------------------------------------------------
2005 2004 2003
-------------------- -------------------- --------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
DEPOSITS RATE DEPOSITS RATE DEPOSITS RATE
-------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
FOREIGN
Time certificates.................. $ 9 5.6% $40 2.5% $953 3.5%
Savings and demand accounts........ 28 1.5 48 1.4 38 2.8
--- --- --- --- ---- ---
Total foreign deposits............. 37 2.5 88 1.9 991 3.5
--- --- --- --- ---- ---
Total deposits..................... $40 2.3% $88 1.9% $992 3.5%
=== === === === ==== ===
Interest expense on total deposits was $1 million in 2005, $2 million in 2004,
$28 million in the period March 29 through December 31, 2003 and $8 million in
the period January 1 through March 28, 2003. Interest expense on domestic
deposits was zero in 2005 and 2004 and insignificant in 2003.
Maturities of time certificates in amounts of $100,000 or more at December 31,
2005, all of which were foreign, were:
(IN MILLIONS)
---------------------------------------------------------------------------
3 months or less............................................ $-
Over 3 months through 6 months.............................. -
Over 6 months through 12 months............................. -
Over 12 months.............................................. 9
--
Total....................................................... $9
==
Contractual maturities of time certificates within each interest rate range at
December 31, 2005 were as follows:
INTEREST RATE 2006 2007 2008 2009 2010 THEREAFTER TOTAL
----------------------------------------------------------------------------------------------------
4.00% - 5.99%................................ $- $9 $- $- $- $- $9
== == == == == == ==
152
13. COMMERCIAL PAPER, BANK AND OTHER BORROWINGS
--------------------------------------------------------------------------------
COMMERCIAL BANK AND OTHER
PAPER BORROWINGS TOTAL
-------------------------------------------------------------------------------------------------
2005
Balance................................................... $11,360 $ 57 $11,417
Highest aggregate month-end balance....................... 14,864
Average borrowings........................................ 11,877 71 11,948
Weighted-average interest rate:
At year-end............................................. 4.2% 4.0% 4.2%
Paid during year........................................ 3.4 2.7 3.4
2004
Balance................................................... $ 8,969 $ 44 $ 9,013
Highest aggregate month-end balance....................... 16,179
Average borrowings........................................ 11,403 38 11,441
Weighted-average interest rate:
At year-end............................................. 2.2% 2.6% 2.2%
Paid during year........................................ 1.8 1.9 1.8
2003
Balance................................................... $ 8,256 $ 866 $ 9,122
Highest aggregate month-end balance....................... 9,856
Average borrowings........................................ 6,357 1,187 7,544
Weighted-average interest rate:
At year-end............................................. 1.2% 3.6% 1.4%
Paid during year........................................ 1.6 3.9 2.0
Commercial paper included obligations of foreign subsidiaries of $442 million at
December 31, 2005, $248 million at December 31, 2004 and $307 million at
December 31, 2003. Bank and other borrowings included obligations of foreign
subsidiaries of $20 million at December 31, 2005, $44 million at December 31,
2004 and $832 million at December 31, 2003.
Interest expense for commercial paper, bank and other borrowings totaled $401
million in 2005, $211 million in 2004, $130 million in the period March 29
through December 31, 2003 and $19 million in the period January 1 through March
28, 2003.
We maintain various bank credit agreements primarily to support commercial paper
borrowings and also to provide funding in the U.K. We had committed back-up
lines and other bank lines of $16.3 billion at December 31, 2005, including $8.0
billion with HSBC and subsidiaries and $18.0 billion at December 31, 2004,
including $10.1 billion with HSBC and subsidiaries. Our U.K. subsidiary had
drawn $4.2 billion on its bank lines of credit (all with HSBC) at December 31,
2005 and had $7.4 billion drawn on its bank lines of credit (all with HSBC), at
December 31, 2004. A $4.0 billion revolving credit facility with HSBC Private
Bank (Suisse) SA, which was in place during a portion of 2004 to allow temporary
increases in commercial paper issuances in anticipation of the sale of the
private label receivables to HSBC Bank USA, expired on December 30, 2004. Formal
credit lines are reviewed annually and expire at various dates through 2008.
Borrowings under these lines generally are available at a surcharge over LIBOR.
The most restrictive financial covenant contained in the back-up line agreements
that could restrict availability is an obligation to maintain minimum
shareholder's equity of $10.0 billion which is substantially below our December
31, 2005 common and preferred shareholder's(s') equity balance of $19.5 billion.
Because our U.K. subsidiary receives its funding directly from HSBC, we
eliminated all third-party back-up lines at our U.K. subsidiary in 2004. Annual
commitment fee requirements to support availability of these lines at December
31, 2005 totaled
153
$7 million and included $2 million for the HSBC lines. Annual commitment fee
requirements to support availability of these lines at December 31, 2004 totaled
$7 million and included $2 million for the HSBC lines.
14. LONG TERM DEBT (WITH ORIGINAL MATURITIES OVER ONE YEAR)
--------------------------------------------------------------------------------
AT DECEMBER 31,
-------------------
2005 2004
---------------------------------------------------------------------------------
(IN MILLIONS)
SENIOR DEBT
FIXED RATE:
8.875% Adjustable Conversion-Rate Equity Security
Units................................................. $ 541 $ 529
Secured financings:
1.50% to 2.99%; due 2005 to 2007..................... - 239
3.00% to 3.99%; due 2006 to 2008..................... 3,947 346
4.00% to 4.49%; due 2006 to 2009..................... 2,254 -
4.50% to 4.99%; due 2006 to 2010..................... 1,024 -
7.00% to 7.49%; due 2005............................. - 51
7.50% to 7.99%; due 2005............................. - 10
8.00% to 8.99%; due 2005............................. - 11
Other fixed rate senior debt:
2.40% to 3.99%; due 2006 to 2010..................... 2,864 6,310
4.00% to 4.99%; due 2006 to 2023..................... 21,902 10,878
5.00% to 5.49%; due 2006 to 2023..................... 6,188 5,082
5.50% to 5.99%; due 2006 to 2024..................... 7,188 6,922
6.00% to 6.49%; due 2006 to 2033..................... 8,453 8,380
6.50% to 6.99%; due 2006 to 2033..................... 8,076 9,247
7.00% to 7.49%; due 2006 to 2032..................... 4,587 6,333
7.50% to 7.99%; due 2006 to 2032..................... 4,906 7,450
8.00% to 9.00%; due 2006 to 2012..................... 1,244 3,497
VARIABLE INTEREST RATE:
Secured financings - 2.63% to 5.28%; due 2006 to
2010.................................................. 7,893 6,668
Other variable interest rate senior debt - 2.16% to
6.73%; due 2006 to 2018............................... 21,488 10,555
SENIOR SUBORDINATED DEBT - 4.56%, due 2005.................. - 170
JUNIOR SUBORDINATED NOTES ISSUED TO CAPITAL TRUSTS.......... 1,443 722
UNAMORTIZED DISCOUNT........................................ (341) (296)
HSBC ACQUISITION PURCHASE ACCOUNTING FAIR VALUE
ADJUSTMENTS............................................... 1,506 2,274
-------- -------
TOTAL LONG TERM DEBT........................................ $105,163 $85,378
======== =======
HSBC acquisition purchase accounting fair value adjustments represent
adjustments which have been "pushed down" to record our long term debt at fair
value at the date of our acquisition by HSBC.
Secured financings of $15.1 billion at December 31, 2005 are secured by $21.8
billion of real estate secured, auto finance and MasterCard/Visa credit card
receivables. Secured financings of $7.3 billion at December 31, 2004 are secured
by $10.3 billion of real estate secured and auto finance receivables.
At December 31, 2005, long term debt included carrying value adjustments
relating to derivative financial instruments which decreased the debt balance by
$862 million and a foreign currency translation adjustment relating to our
foreign denominated debt which increased the debt balance by $272 million. At
December 31, 2004, long term debt included carrying value adjustments relating
to derivative financial instruments which
154
decreased the debt balance by $121 million and a foreign currency translation
adjustment relating to our foreign denominated debt which increased the debt
balance by $4 billion.
Weighted-average interest rates were 5.3 percent at December 31, 2005 and 5.1
percent at December 31, 2004 (excluding HSBC acquisition purchase accounting
adjustments). Interest expense for long term debt was $3.7 billion in 2005, $2.6
billion in 2004, $1.8 billion in the period March 29 through December 31, 2003
and $870 million in the period January 1 through March 28, 2003. The most
restrictive financial covenants contained in the terms of our debt agreements
are the maintenance of a minimum shareholder's equity of $10.0 billion which is
substantially lower than our common and preferred shareholder's(s') equity
balance of $19.5 billion at December 31, 2005. Debt denominated in a foreign
currency is included in the applicable rate category based on the effective U.S.
dollar equivalent rate as summarized in Note 15, "Derivative Financial
Instruments."
In 2002, we issued $541 million of 8.875 percent Adjustable Conversion-Rate
Equity Security Units. Each Adjustable Conversion-Rate Equity Security Unit
consisted initially of a contract to purchase, for $25, a number of shares of
HSBC Finance Corporation (formerly known as Household International, Inc.)
common stock on February 15, 2006 and a senior note issued by our then wholly
owned subsidiary, Household Finance Corporation, with a principal amount of $25.
Since the time the units were issued, HSBC Finance Corporation was acquired by
HSBC Holdings plc and Household Finance Corporation was merged with and into
HSBC Finance. As a result of these transactions, the stock purchase contracts
now obligate holders to purchase, for $25, between 2.6041 and 3.1249 HSBC
ordinary shares on February 15, 2006, and HSBC Finance Corporation has succeeded
Household Finance Corporation as the obligor on the senior notes. In November
2005 we remarketed the notes and reset the rate. The net proceeds from the sale
of the units were allocated between the purchase contracts and the senior
unsecured notes on our balance sheet based on the fair value of each at the date
of the offering. During 2005, .1 million stock purchase contracts were
exercised. During 2004, .6 million stock purchase contracts were exercised. At
December 31, 2005, unexercised stock purchase contracts totaled 1.3 million. The
remaining stock purchase contracts matured on February 15, 2006 and HSBC issued
ordinary shares for the remaining stock purchase contracts on that date. The
settlement rate for each such purchase contract was 2.6041 HSBC ordinary shares.
The following table summarizes our junior subordinated notes issued to capital
trusts ("Junior Subordinated Notes") and the related company obligated
mandatorily redeemable preferred securities ("Preferred Securities"):
HOUSEHOLD CAPITAL HOUSEHOLD CAPITAL HOUSEHOLD CAPITAL
TRUST IX TRUST VII TRUST VI
("HCT IX") ("HCT VII") ("HCT VI")
-----------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
JUNIOR SUBORDINATED NOTES:
Principal balance....................... $ 1,031 $ 206.2 $ 206.2
Interest rate........................... 5.91% 7.5% 8.25%
Redeemable by issuer.................... November 2015 November 2006 January 2006
Stated maturity......................... November 2035 November 2031 January 2031
PREFERRED SECURITIES:
Rate.................................... 5.91% 7.5% 8.25%
Face value.............................. $ 1,000 $ 200 $ 200
Issue date.............................. November 2005 November 2001 January 2001
The Preferred Securities must be redeemed when the Junior Subordinated Notes are
paid. The Junior Subordinated Notes have a stated maturity date, but are
redeemable by us, in whole or in part, beginning on the dates indicated above at
which time the Preferred Securities are callable at par ($25 per Preferred
Security) plus accrued and unpaid dividends. Dividends on the Preferred
Securities are cumulative, payable quarterly in arrears, and are deferrable at
our option for up to five years. We cannot pay dividends on our preferred and
common stocks during such deferments. The Preferred Securities have a
liquidation value of $25 per preferred security.
155
Our obligations with respect to the Junior Subordinated Notes, when considered
together with certain undertakings of HSBC Finance Corporation with respect to
the Trusts, constitute full and unconditional guarantees by us of the Trusts'
obligations under the respective Preferred Securities.
Maturities of long term debt at December 31, 2005 were as follows:
(IN MILLIONS)
---------------------------------------------------------------------------
2006........................................................ $ 19,580
2007........................................................ 19,046
2008........................................................ 15,050
2009........................................................ 11,472
2010........................................................ 11,402
Thereafter.................................................. 28,613
--------
Total....................................................... $105,163
========
Certain components of our long term debt may be redeemed prior to its stated
maturity.
15. DERIVATIVE FINANCIAL INSTRUMENTS
--------------------------------------------------------------------------------
Our business activities involve analysis, evaluation, acceptance and management
of some degree of risk or combination of risks. Accordingly, we have
comprehensive risk management policies to address potential financial risks,
which include credit risk (which includes counterparty credit risk), liquidity
risk, market risk, and operational risks. Our risk management policy is designed
to identify and analyze these risks, to set appropriate limits and controls, and
to monitor the risks and limits continually by means of reliable and up-to-date
administrative and information systems. Our risk management policies are
primarily carried out in accordance with practice and limits set by the HSBC
Group Management Board. The HSBC Finance Corporation Asset Liability Committee
("ALCO") meets regularly to review risks and approve appropriate risk management
strategies within the limits established by the HSBC Group Management Board.
Additionally, our Audit Committee receives regular reports on our liquidity
positions in relation to the established limits. In accordance with the policies
and strategies established by ALCO, in the normal course of business, we enter
into various transactions involving derivative financial instruments. These
derivative financial instruments primarily are used to manage our market risk.
For further information on our strategies for managing interest rate and foreign
exchange rate risk, see the "Risk Management" section within our Management's
Discussion and Analysis of Financial Condition and Results of Operations.
OBJECTIVES FOR HOLDING DERIVATIVE FINANCIAL INSTRUMENTS Market risk (which
includes interest rate and foreign currency exchange risks) is the possibility
that a change in interest rates or foreign exchange rates will cause a financial
instrument to decrease in value or become more costly to settle. We try to
manage this risk by borrowing money with similar interest rate and maturity
profiles; however, there are instances when this cannot be achieved. Over time,
customer demand for our receivable products shifts between fixed rate and
floating rate products, based on market conditions and preferences. These shifts
in loan products result in different funding strategies and produce different
interest rate risk exposures. We maintain an overall risk management strategy
that uses a variety of interest rate and currency derivative financial
instruments to mitigate our exposure to fluctuations caused by changes in
interest rates and currency exchange rates. We manage our exposure to interest
rate risk primarily through the use of interest rate swaps, but also use
forwards, futures, options, and other risk management instruments. We manage our
exposure to foreign currency exchange risk primarily through the use of currency
swaps, options and forwards. We do not use leveraged derivative financial
instruments for interest rate risk management.
Interest rate swaps are contractual agreements between two counterparties for
the exchange of periodic interest payments generally based on a notional
principal amount and agreed-upon fixed or floating rates. The majority of our
interest rate swaps are used to manage our exposure to changes in interest rates
by converting floating rate assets or debt to fixed rate or by converting fixed
rate assets or debt to floating rate. We have also
156
entered into currency swaps to convert both principal and interest payments on
debt issued from one currency to the appropriate functional currency.
Forwards and futures are agreements between two parties, committing one to sell
and the other to buy a specific quantity of an instrument on some future date.
The parties agree to buy or sell at a specified price in the future, and their
profit or loss is determined by the difference between the arranged price and
the level of the spot price when the contract is settled. We have used both
interest rate and foreign exchange rate forward contracts as well as interest
rate futures contracts. We use foreign exchange rate forward contracts to reduce
our exposure to foreign currency exchange risk. Interest rate forward and
futures contracts are used to hedge resets of interest rates on our floating
rate assets and liabilities. Cash requirements for forward contracts include the
receipt or payment of cash upon the sale or purchase of the instrument.
Purchased options grant the purchaser the right, but not the obligation, to
either purchase or sell a financial instrument at a specified price within a
specified period. The seller of the option has written a contract which creates
an obligation to either sell or purchase the financial instrument at the
agreed-upon price if, and when, the purchaser exercises the option. We use caps
to limit the risk associated with an increase in rates and floors to limit the
risk associated with a decrease in rates.
CREDIT RISK By utilizing derivative financial instruments, we are exposed to
counterparty credit risk. Counterparty credit risk is our primary exposure on
our interest rate swap portfolio. Counterparty credit risk is the risk that the
counterparty to a transaction fails to perform according to the terms of the
contract. We control the counterparty credit (or repayment) risk in derivative
instruments through established credit approvals, risk control limits,
collateral, and ongoing monitoring procedures. Our exposure to credit risk for
futures is limited as these contracts are traded on organized exchanges. Each
day, changes in futures contract values are settled in cash. In contrast, swap
agreements and forward contracts have credit risk relating to the performance of
the counterparty. Beginning in the third quarter of 2003, we began utilizing an
affiliate, HSBC Bank USA, as the primary provider of new domestic derivative
products. We have never suffered a loss due to counterparty failure.
At December 31, 2005, most of our existing derivative contracts are with HSBC
subsidiaries, making them our primary counterparty in derivative transactions.
Most swap agreements require that payments be made to, or received from, the
counterparty when the fair value of the agreement reaches a certain level.
Generally, third-party swap counterparties provide collateral in the form of
cash which are recorded in our balance sheet as derivative related liabilities
and totaled $91 million at December 31, 2005. Affiliate swap counterparties
provide collateral in the form of securities, as required, which are not
recorded on our balance sheet. At December 31, 2005, the fair value of our
agreements with affiliate counterparties was below the $1.2 billion level
requiring posting of collateral. At December 31, 2005, we had derivative
contracts with a notional value of approximately $75.9 billion, including $71.3
billion outstanding with HSBC Bank USA. Derivative financial instruments are
generally expressed in terms of notional principal or contract amounts which are
much larger than the amounts potentially at risk for nonpayment by
counterparties.
FAIR VALUE AND CASH FLOW HEDGES To manage our exposure to changes in interest
rates, we enter into interest rate swap agreements and currency swaps which have
been designated as fair value or cash flow hedges under SFAS No. 133. Prior to
the acquisition by HSBC, the majority of our fair value and cash flow hedges
were effective hedges which qualified for the shortcut method of accounting.
Under the Financial Accounting Standards Board's interpretations of SFAS No.
133, the shortcut method of accounting was no longer allowed for interest rate
swaps which were outstanding at the time of the acquisition by HSBC. As a result
of the acquisition, we were required to reestablish and formally document the
hedging relationship associated with all of our fair value and cash flow hedging
instruments and assess the effectiveness of each hedging relationship, both at
inception of the acquisition and on an ongoing basis. Due to deficiencies in our
contemporaneous hedge documentation at the time of acquisition, we lost the
ability to apply hedge accounting to our entire cash flow and fair value hedging
portfolio that existed at the time of acquisition by HSBC. During 2005, we
reestablished hedge treatment under the long haul method of accounting for a
significant number of the derivatives in this portfolio. We continue to evaluate
the steps required to regain hedge accounting treatment under SFAS No. 133 for
the remaining swaps which do not currently qualify for hedge accounting. The
157
majority of all derivative financial instruments entered into subsequent to the
acquisition qualify as effective hedges under SFAS No. 133.
Fair value hedges include interest rate swaps which convert our fixed rate debt
to variable rate debt and currency swaps which convert debt issued from one
currency into pay variable debt of the appropriate functional currency. Hedge
ineffectiveness associated with fair value hedges is recorded in other revenues
as derivative income (expense) and was a gain of $117 million ($75 million after
tax) in 2005, a gain of $.6 million ($.4 million after tax) in 2004, a gain of
$.8 million ($.5 million after tax) in the period March 29 through December 31,
2003, and a gain of $3 million ($2 million after tax) in the period January 1
through March 28, 2003. All of our fair value hedges were associated with debt
during 2005, 2004 and 2003. We recorded fair value adjustments for unexpired
fair value hedges which decreased the carrying value of our debt by $695 million
at December 31, 2005 and $60 million at December 31, 2004. Fair value
adjustments for unexpired fair value hedges on a "predecessor" basis are
included in the HSBC acquisition purchase accounting fair value adjustment to
debt as a result of push-down accounting effective March 29, 2003 when the
"successor" period began.
Cash flow hedges include interest rate swaps which convert our variable rate
debt or assets to fixed rate debt or assets and currency swaps which convert
debt issued from one currency into pay fixed debt of the appropriate functional
currency. Gains and (losses) on unexpired derivative instruments designated as
cash flow hedges (net of tax) are reported in accumulated other comprehensive
income and totaled a gain of $237 million ($151 million after tax) at December
31, 2005 and $83 million ($53 million after tax) at December 31, 2004. We expect
$110 million ($70 million after tax) of currently unrealized net gains will be
reclassified to earnings within one year, however, these unrealized gains will
be offset by increased interest expense associated with the variable cash flows
of the hedged items and will result in no net economic impact to our earnings.
Hedge ineffectiveness associated with cash flow hedges is recorded in other
revenues as derivative income was a loss of $76 million ($49 million after tax)
in 2005 and was immaterial in 2004 and was a gain of $.5 million ($.3 million
after tax) in the period March 29 through December 31, 2003. Hedge
ineffectiveness associated with cash flow hedges was immaterial for the period
January 1 through March 28, 2003.
At December 31, 2005, $234 million of derivative instruments, at fair value,
were recorded in derivative financial assets and $292 million in derivative
related liabilities. At December 31, 2004, $4.0 billion of derivative
instruments, at fair value, were recorded in derivative financial assets and $70
million in derivative related liabilities.
Information related to deferred gains and losses before taxes on terminated
derivatives was as follows:
2005 2004
-----------------------------------------------------------------------------------------
(IN MILLIONS)
Deferred gains.............................................. $ 173 $ 210
Deferred losses............................................. 215 168
Weighted-average amortization period:
Deferred gains............................................ 4 YEARS 7 years
Deferred losses........................................... 5 YEARS 8 years
Increases (decreases) to carrying values resulting from net
deferred gains and losses:
Long term debt............................................ $ (111) $ (61)
Accumulated other comprehensive income.................... 69 103
158
Information related to deferred gains and losses before taxes on discontinued
hedges was as follows:
2005 2004
----------------------------------------------------------------------------------
(IN MILLIONS)
Deferred gains.............................................. $ 197 $-
Deferred losses............................................. 152 -
Weighted-average amortization period:
Deferred gains............................................ 5 YEARS -
Deferred losses........................................... 6 YEARS -
Increases (decreases) to carrying values resulting from net
deferred gains and losses:
Long term debt............................................ $ (56) -
Accumulated other comprehensive income.................... 101 -
Amortization of net deferred gains (losses) totaled ($12) million in 2005, ($23)
million in 2004, ($7) million in the period March 29 through December 31, 2003
and $80 million in the period January 1 through March 28, 2003.
HEDGES OF NET INVESTMENTS IN FOREIGN OPERATIONS Prior to the acquisition by
HSBC, we used forward-exchange contracts and foreign currency options to hedge
our net investments in foreign operations. We used these hedges to protect
against adverse movements in exchange rates. Net gains and (losses) (net of tax)
related to these derivatives were included in accumulated other comprehensive
income and totaled $.1 million in the period March 29 through December 31, 2003
for the contracts that terminated subsequent to the acquisition by HSBC and
($12) million in the period January 1 through March 28, 2003. We have not
entered into foreign exchange contracts to hedge our investment in foreign
subsidiaries since our acquisition by HSBC.
NON-QUALIFYING HEDGING ACTIVITIES We may also use forward rate agreements,
interest rate caps, exchange traded futures, and interest rate and currency
swaps which are not designated as hedges under SFAS No. 133, either because they
do not qualify as effective hedges or because we lost the ability to apply hedge
accounting following our acquisition by HSBC as discussed above. These financial
instruments are economic hedges but do not qualify for hedge accounting and are
primarily used to minimize our exposure to changes in interest rates and
currency exchange rates. Unrealized and realized gains (losses) on derivatives
which were not designated as hedges are reported in other revenues as derivative
income and totaled $208 million ($133 million after tax) in 2005, $510 million
($324 million after tax) in 2004; $285 million ($181 million after tax) in the
period March 29, 2003 through December 31, 2003 and $(1) million ($(.7) million
after tax) in the period January 1 through March 28, 2003.
DERIVATIVE INCOME Derivative income as discussed above includes realized and
unrealized gains and losses on derivatives which do not qualify as effective
hedges under SFAS No. 133 as well as the ineffectiveness on derivatives
associated with our qualifying hedges and is summarized in the table below:
2005 2004 2003
--------------------------------------------------------------------------------
(IN MILLIONS)
Net realized gains (losses)................................. $ 52 $ 68 $ 54
Mark-to-market on derivatives which do not qualify as
effective hedges.......................................... 156 442 230
Ineffectiveness............................................. 41 1 2
---- ---- ----
Total....................................................... $249 $511 $286
==== ==== ====
159
DERIVATIVE FINANCIAL INSTRUMENTS The following table summarizes derivative
financial instrument activity:
EXCHANGE TRADED NON-EXCHANGE TRADED
--------------------------------- ------------------------------------------
INTEREST RATE FOREIGN EXCHANGE
FUTURES CONTRACTS INTEREST RATE CONTRACTS
--------------------- OPTIONS RATE CURRENCY --------------------
PURCHASED SOLD PURCHASED SWAPS SWAPS PURCHASED SOLD
---------------------------------------------------------------------------------------------------------
2005
Notional amount, 2004.... $ - $ - $ 1,691 $ 45,253 $18,150 $ 1,146 $ 614
New contracts............ - - - 1 - - -
New contracts purchased
from subsidiaries of
HSBC................... - - - 25,373 6,824 1,113 4,860
Matured or expired
contracts.............. - - (1,691) (5,657) (3,225) (482) (4,762)
Terminated contracts..... - - - (15,362) - (142) (247)
In-substance
maturities(1).......... - - - - - - -
Assignment of contracts
to subsidiaries of
HSBC................... - - - - - - -
----- ----- ------- -------- ------- -------- --------
Notional amount, 2005.... $ - $ - $ - $ 49,608 $21,719 $ 1,635 $ 465
===== ===== ======= ======== ======= ======== ========
Fair value, 2005(3):
Fair value hedges...... $ - $ - $ - $ (612) $ (178) $ - $ -
Cash flow hedges....... - - - 103 658 (22) -
Net investment in
foreign operations... - - - - - - -
Non-hedging
derivatives.......... - - - (31) 24 - -
----- ----- ------- -------- ------- -------- --------
Total.................. $ - $ - $ - $ (540) $ 504 $ (22) $ -
===== ===== ======= ======== ======= ======== ========
2004
Notional amount, 2003.... $ - $ - $ 1,900 $ 41,312 $16,538 $ 1,223 $ 594
New contracts............ - - - - - 1,628 1,432
New contracts purchased
from subsidiaries of
HSBC................... - - 3,491 29,607 11,457 17,988 8,778
Matured or expired
contracts.............. - - (3,700) (7,568) (1,407) (14,343) (4,840)
Terminated contracts..... - - - (7,211) (5,333) - -
In-substance
maturities(1).......... - - - - - (5,350) (5,350)
Assignment of contracts
to subsidiaries of
HSBC................... - - - (10,887) (3,105) - -
----- ----- ------- -------- ------- -------- --------
Notional amount, 2004.... $ - $ - $ 1,691 $ 45,253 $18,150 $ 1,146 $ 614
===== ===== ======= ======== ======= ======== ========
Fair value, 2004(3):
Fair value hedges...... $ - $ - $ - $ (46) $ - $ - $ 2
Cash flow hedges....... - - - 12 403 24 -
Net investment in
foreign operations... - - - - - - -
Non-hedging
derivatives.......... - - - (81) 3,670 - -
----- ----- ------- -------- ------- -------- --------
Total.................. $ - $ - $ - $ (115) $ 4,073 $ 24 $ 2
===== ===== ======= ======== ======= ======== ========
2003
Notional amount, 2002.... $ - $ - $ 3,400 $ 44,506 $11,661 $ 376 $ 2,525
New contracts............ 600 (600) - 7,601 1,219 20,102 17,548
New contracts purchased
from subsidiaries of
HSBC................... - - 3,385 25,369 10,399 3,144 642
Matured or expired
contracts.............. - - (4,404) (15,137) (1,401) (3,190) (912)
Terminated contracts..... - - (481) (11,984) (146) - -
In-substance
maturities(1).......... (600) 600 - - - (19,209) (19,209)
Assignment of contracts
to subsidiaries of
HSBC................... - - - (9,043) (5,194) - -
Loss of shortcut
accounting(2):
Terminated contracts... - - - (26,530) - - -
New contracts.......... - - - 26,530 - - -
----- ----- ------- -------- ------- -------- --------
Notional amount, 2003.... $ -- $ - $ 1,900 $ 41,312 $16,538 $ 1,223 $ 594
===== ===== ======= ======== ======= ======== ========
Fair value, 2003(3):
Fair value hedges...... $ - $ - $ - $ 138 $ 101 $ - $ 23
Cash flow hedges....... - - - (147) 419 41 -
Net investment in
foreign operations... - - - - - - -
Non-hedging
derivatives.......... - - - (162) 2,500 - -
----- ----- ------- -------- ------- -------- --------
Total.................. $ - $ - $ - $ (171) $ 3,020 $ 41 $ 23
===== ===== ======= ======== ======= ======== ========
NON-EXCHANGE TRADED
----------------------------
INTEREST RATE
FORWARD CONTRACTS CAPS
------------------ AND
PURCHASED SOLD FLOORS TOTAL
------------------------- ---------------------------------------
2005
Notional amount, 2004.... $ 374 $- $ 4,380 $ 71,608
New contracts............ - - 30 31
New contracts purchased
from subsidiaries of
HSBC................... 1,707 - - 39,877
Matured or expired
contracts.............. - - (1,894) (17,741)
Terminated contracts..... (1,909) - (249) (17,909)
In-substance
maturities(1).......... - - - -
Assignment of contracts
to subsidiaries of
HSBC................... - - - -
------- -- ------- --------
Notional amount, 2005.... $ 172 $- $ 2,267 $ 75,866
======= == ======= ========
Fair value, 2005(3):
Fair value hedges...... $ - $- $ - $ (790)
Cash flow hedges....... - - - 739
Net investment in
foreign operations... - - - -
Non-hedging
derivatives.......... - - - (7)
------- -- ------- --------
Total.................. $ - $- $ - $ (58)
======= == ======= ========
2004
Notional amount, 2003.... $ 174 $- $ 6,627 $ 68,368
New contracts............ - - - 3,060
New contracts purchased
from subsidiaries of
HSBC................... 1,643 - 444 73,408
Matured or expired
contracts.............. (1,443) - (2,691) (35,992)
Terminated contracts..... - - - (12,544)
In-substance
maturities(1).......... - - - (10,700)
Assignment of contracts
to subsidiaries of
HSBC................... - - - (13,992)
------- -- ------- --------
Notional amount, 2004.... $ 374 $- $ 4,380 $ 71,608
======= == ======= ========
Fair value, 2004(3):
Fair value hedges...... $ - $- $ - $ (48)
Cash flow hedges....... - - - 439
Net investment in
foreign operations... - - - -
Non-hedging
derivatives.......... - - - 3,589
------- -- ------- --------
Total.................. $ - $- $ - $ 3,980
======= == ======= ========
2003
Notional amount, 2002.... $ 159 $- $ 7,221 $ 69,848
New contracts............ 906 - - 48,576
New contracts purchased
from subsidiaries of
HSBC................... 174 - 4,333 47,446
Matured or expired
contracts.............. (506) - (4,927) (30,477)
Terminated contracts..... (559) - - (13,170)
In-substance
maturities(1).......... - - - (39,618)
Assignment of contracts
to subsidiaries of
HSBC................... - - - (14,237)
Loss of shortcut
accounting(2):
Terminated contracts... - - - (26,530)
New contracts.......... - - - 26,530
------- -- ------- --------
Notional amount, 2003.... $ 174 $- $ 6,627 $ 68,368
======= == ======= ========
Fair value, 2003(3):
Fair value hedges...... $ - $- $ - $ 216
Cash flow hedges....... - - - 313
Net investment in
foreign operations... - - - -
Non-hedging
derivatives.......... - - - 2,338
------- -- ------- --------
Total.................. $ - $- $ - $ 2,867
======= == ======= ========
160
---------------
(1) Represent contracts terminated as the market execution technique of closing
the transaction either (a) just prior to maturity to avoid delivery of the
underlying instrument or (b) at the maturity of the underlying items being
hedged.
(2) Under the Financial Accounting Standards Board's interpretations of SFAS No.
133, the shortcut method of accounting was no longer allowed for interest
rate swaps which were outstanding at the time of the acquisition by HSBC.
(3) (Bracketed) unbracketed amounts represent amounts to be (paid) received by
us had these positions been closed out at the respective balance sheet date.
Bracketed amounts do not necessarily represent risk of loss as the fair
value of the derivative financial instrument and the items being hedged must
be evaluated together. See Note 24, 'Fair Value of Financial Instruments,'
for further discussion of the relationship between the fair value of our
assets and liabilities.
We operate in three functional currencies, the U.S. dollar, the British pound
and the Canadian dollar. The U.S. dollar is the functional currency for
exchange-traded interest rate futures contracts and options. Non-exchange traded
instruments are restated in U.S. dollars by country as follows:
FOREIGN EXCHANGE INTEREST RATE
RATE CONTRACTS FORWARD OTHER RISK
INTEREST RATE CURRENCY ---------------- CONTRACTS MANAGEMENT
SWAPS SWAPS PURCHASED SOLD PURCHASED INSTRUMENTS
---------------------------------------------------------------------------------------------------------
(IN MILLIONS)
2005
United States................. $47,693 $21,175 $1,622 $465 $ - $2,267
Canada........................ 995 - 13 - 172 -
United Kingdom................ 920 544 - - - -
------- ------- ------ ---- ---- ------
$49,608 $21,719 $1,635 $465 $172 $2,267
======= ======= ====== ==== ==== ======
2004
United States................. $42,365 $17,543 $1,146 $599 $ - $4,345
Canada........................ 582 - - 15 374 -
United Kingdom................ 2,306 607 - - - 35
------- ------- ------ ---- ---- ------
$45,253 $18,150 $1,146 $614 $374 $4,380
======= ======= ====== ==== ==== ======
2003
United States................. $39,653 $14,995 $1,223 $593 $ - $6,595
Canada........................ 405 - - 1 174 -
United Kingdom................ 1,254 1,543 - - - 32
------- ------- ------ ---- ---- ------
$41,312 $16,538 $1,223 $594 $174 $6,627
======= ======= ====== ==== ==== ======
The table below reflects the items hedged using derivative financial instruments
which qualify for hedge accounting at December 31, 2005. The critical terms of
the derivative financial instruments have been designed to match those of the
related asset or liability.
FOREIGN
INTEREST RATE CURRENCY EXCHANGE RATE
SWAPS SWAPS CONTRACTS
----------------------------------------------------------------------------------------------------
(IN MILLIONS)
Investment securities..................................... $ - $ - $ -
Commercial paper, bank and other borrowings............... 920 - 1,622
Long term debt............................................ 45,913 18,689 -
Advances to foreign subsidiaries.......................... - - 465
------- ------- ------
Total items hedged using derivative financial
instruments............................................. $46,833 $18,689 $2,087
======= ======= ======
161
The following table summarizes the maturities and related weighted-average
receive/pay rates of interest rate swaps outstanding at December 31, 2005:
2006 2007 2008 2009 2010 2011 THEREAFTER TOTAL
-----------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
PAY A FIXED RATE/RECEIVE A
FLOATING RATE:
Notional value............... $8,892 $7,471 $3,320 $2,569 $ 232 $ 153 $ 450 $23,087
Weighted-average receive
rate....................... 4.40% 4.36% 4.63% 4.75% 4.66% 5.15% 5.66% 4.49%
Weighted-average pay rate.... 3.54 4.34 4.81 4.88 4.10 4.36 4.97 4.12
------ ------ ------ ------ ------ ------ ------ -------
PAY A FLOATING RATE/RECEIVE A
FIXED RATE:
Notional value............... $ 291 $ 483 $2,608 $4,953 $3,142 $5,550 $9,494 $26,521
Weighted-average receive
rate....................... 3.55 3.12 3.72 4.04 4.27 4.55 4.98 4.46
Weighted-average pay rate.... 4.68 4.44 4.52 4.31 3.85 4.59 4.39 4.37
------ ------ ------ ------ ------ ------ ------ -------
Total notional value........... $9,183 $7,954 $5,928 $7,522 $3,374 $5,703 $9,944 $49,608
====== ====== ====== ====== ====== ====== ====== =======
TOTAL WEIGHTED-AVERAGE RATES ON
SWAPS:
Receive rate................. 4.37% 4.29% 4.23% 4.28% 4.30% 4.56% 5.01% 4.47%
Pay rate..................... 3.58 4.34 4.68 4.50 3.87 4.58 4.42 4.25
The floating rates that we pay or receive are based on spot rates from
independent market sources for the index contained in each interest rate swap
contract, which generally are based on either 1, 3 or 6-month LIBOR. These
current floating rates are different than the floating rates in effect when the
contracts were initiated. Changes in spot rates impact the variable rate
information disclosed above. However, these changes in spot rates also impact
the interest rate on the underlying assets or liabilities. We use derivative
financial instruments as either qualifying hedging instruments under SFAS No.
133 or economic hedges to hedge the volatility of earnings resulting from
changes in interest rates on the underlying hedged items. Use of interest rate
swaps which qualify as effective hedges under SFAS No. 133 increased our net
interest income by 24 basis points in 2005, 49 basis points in 2004 and 49 basis
points in 2003.
16. INCOME TAXES
--------------------------------------------------------------------------------
Total income taxes were:
MARCH 29 JANUARY 1
YEAR ENDED YEAR ENDED THROUGH THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 28,
2005 2004 2003 2003
----------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Provision for income taxes related to
operations................................ $891 $1,000 $690 $182
Income taxes related to adjustments included
in common shareholder's(s') equity:
Unrealized gains (losses) on investments
and interest-only strip receivables,
net.................................... (29) (71) 105 (13)
Unrealized gains (losses) on cash flow
hedging instruments.................... 74 61 (9) 57
Minimum pension liability................. 2 (2) - -
Foreign currency translation
adjustments............................ (6) 12 - (7)
Exercise of stock based compensation...... (9) (18) (15) (2)
Tax on sale of U.K. credit card business
to affiliate........................... (21) - - -
---- ------ ---- ----
Total....................................... $902 $ 982 $771 $217
==== ====== ==== ====
162
Provisions for income taxes related to operations were:
MARCH 29 JANUARY 1
YEAR ENDED YEAR ENDED THROUGH THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 28,
2005 2004 2003 2003
------------------------------------------------------------------------------------------------------
(IN MILLIONS)
CURRENT
United States................................. $1,253 $ 593 $688 $ 74
Foreign....................................... 4 59 85 19
------ ------ ---- ----
Total current................................. 1,257 652 773 93
------ ------ ---- ----
DEFERRED
United States................................. (396) 348 (87) 91
Foreign....................................... 30 - 4 (2)
------ ------ ---- ----
Total deferred................................ (366) 348 (83) 89
------ ------ ---- ----
Total income taxes............................ $ 891 $1,000 $690 $182
====== ====== ==== ====
The significant components of deferred provisions attributable to income from
operations were:
MARCH 29 JANUARY 1
YEAR ENDED YEAR ENDED THROUGH THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 28,
2005 2004 2003 2003
------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Deferred income tax (benefit) provision
(excluding the effects of other
components)................................. $(342) $348 $(83) $89
Adjustment of valuation allowance............. (2) - - -
Change in operating loss carryforwards........ (12) - - -
Adjustment to statutory tax rate.............. (10) - - -
----- ---- ---- ---
Deferred income tax provision................. $(366) $348 $(83) $89
===== ==== ==== ===
Income before income taxes were:
MARCH 29 JANUARY 1
YEAR ENDED YEAR ENDED THROUGH THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 28,
2005 2004 2003 2003
------------------------------------------------------------------------------------------------------
(IN MILLIONS)
United States................................. $2,560 $2,786 $1,801 $379
Foreign....................................... 103 154 246 49
------ ------ ------ ----
Total income before income taxes.............. $2,663 $2,940 $2,047 $428
====== ====== ====== ====
163
Effective tax rates are analyzed as follows:
MARCH 29 JANUARY 1
YEAR ENDED YEAR ENDED THROUGH THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 28,
2005 2004 2003 2003
------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Statutory Federal income tax rate............. 35.0% 35.0% 35.0% 35.0%
Increase (decrease) in rate resulting from:
State and local taxes, net of Federal
benefit.................................. .9 1.4 1.4 1.9
Low income housing and other tax credits.... (3.2) (2.9) (3.0) (5.1)
Noncurrent tax requirements................. - - (1.5) (3.0)
Nondeductible acquisition costs............. - - - 11.0
Other....................................... .8 .5 1.8 2.7
---- ---- ---- -----
Effective tax rate............................ 33.5% 34.0% 33.7% 42.5%
==== ==== ==== =====
Temporary differences which gave rise to a significant portion of deferred tax
assets and liabilities were as follows:
AT DECEMBER 31,
---------------
2005 2004
-----------------------------------------------------------------------------
(IN MILLIONS)
DEFERRED TAX ASSETS
Credit loss reserves........................................ $1,438 $1,497
Other reserves.............................................. 129 73
Market value adjustment..................................... 95 214
Debt........................................................ 80 162
Other....................................................... 429 397
------ ------
Total deferred tax assets................................... 2,171 2,343
Valuation allowance......................................... (28) (28)
------ ------
Total deferred tax assets net of valuation allowance........ 2,143 2,315
------ ------
DEFERRED TAX LIABILITIES
Intangibles................................................. 779 934
Fee income.................................................. 545 375
Deferred loan origination costs............................. 239 189
Receivables................................................. 163 231
Leveraged lease transactions, net........................... 78 129
Receivables sold............................................ 22 413
Other....................................................... 162 191
------ ------
Total deferred tax liabilities.............................. 1,988 2,462
------ ------
Net deferred tax asset (liability).......................... $ 155 $ (147)
====== ======
In addition, provision for U.S. income taxes had not been made at December 31,
2004 on $80 million of undistributed, untaxed earnings of Household Life
Insurance Company accumulated in its Policyholders' Surplus Account under tax
laws in effect prior to 1984. This amount would have been subject to taxation in
the event Household Life Insurance Company made distributions in excess of its
Shareholders' Surplus Account (generally undistributed accumulated after-tax
earnings) and certain other events. If Household Life Insurance Company had been
subject to tax on the full amount of its Policyholders' Surplus Account, the
additional income tax payable would have been approximately $28 million.
164
Unlike prior law provisions treating distributions by a life insurance company
as first coming out of its Shareholders' Surplus Account and then out of its
Policyholders' Surplus Account, the American Jobs Creation Act of 2004 (the
"AJCA") contains provisions that would reverse such order and treat
distributions as first coming out of Policyholders' Surplus Account and then out
of a Shareholders' Surplus Account. These new provisions also eliminated the
imposition of the income tax on any distributions from a Policyholders' Surplus
Account. Such provisions apply to distributions made by a life insurance company
after December 31, 2004 and before January 1, 2007.
Household Life Insurance Company paid a dividend in the year ended December 31,
2005 in an amount in excess of the Policyholders' Surplus Account. This dividend
eliminated the balance in that account and the potential for a tax on any future
distributions from the account.
Provision for U.S. income tax had not been made on net undistributed earnings of
foreign subsidiaries of $118 million at December 31, 2005 and $643 million at
December 31, 2004. Determination of the amount of unrecognized deferred tax
liability related to investments in foreign subsidiaries is not practicable.
The AJCA included provisions to allow a deduction of 85% of certain foreign
earnings that are repatriated in 2004 or 2005. We elected to apply this
provision to a $489 million distribution in December 2005 by our U.K.
subsidiary. Tax of $26 million related to this distribution is included as part
of the current 2005 U.S. tax expense shown above.
At December 31, 2005, we had net operating loss carryforwards of $987 million
for state tax purposes which expire as follows: $332 million in 2006-2010; $150
million in 2011-2015; $287 million in 2016-2020 and $218 million in 2021-2025.
17. REDEEMABLE PREFERRED STOCK
--------------------------------------------------------------------------------
In conjunction with our acquisition by HSBC, our 7.625%, 7.60%, 7.50% and 8.25%
preferred stock was converted into the right to receive cash which totaled
approximately $1.1 billion. In consideration of HSBC transferring sufficient
funds to make these payments, we issued the Series A cumulative preferred stock
to HSBC on March 28, 2003. Simultaneous with our acquisition by HSBC, we called
for redemption our $4.30, $4.50 and 5.00% preferred stock. Through a series of
transactions which concluded in October 2004, the Series A Preferred Stock were
transferred from HSBC to HINO. On December 15, 2005, we issued four shares of
common stock to HINO in exchange for the Series A Preferred Stock. See Note 19,
"Related Party Transactions," for further discussion.
In June 2005, we issued 575,000 shares of 6.36 percent Non-Cumulative Preferred
Stock, Series B ("Series B Preferred Stock"). Dividends on the Series B
Preferred Stock are non-cumulative and payable quarterly at a rate of 6.36
percent commencing September 15, 2005. The Series B Preferred Stock may be
redeemed at our option after June 23, 2010 at $1,000 per share, plus accrued
dividends. The redemption and liquidation value is $1,000 per share plus accrued
and unpaid dividends. The holders of Series B Preferred Stock are entitled to
payment before any capital distribution is made to the common shareholder and
have no voting rights except for the right to elect two additional members to
the board of directors in the event that dividends have not been declared and
paid for six quarters, or as otherwise provided by law. Additionally, as long as
any shares of the Series B Preferred Stock are outstanding, the authorization,
creation or issuance of any class or series of stock which would rank prior to
the Series B Preferred Stock with respect to dividends or amounts payable upon
liquidation or dissolution of HSBC Finance Corporation must be approved by the
holders of at least two-thirds of the shares of Series B Preferred Stock
outstanding at that time. Related issuance costs of $16 million have been
recorded as a reduction of additional paid-in capital. In 2005, we declared
dividends totaling $17 million on the Series B Preferred Stock which were paid
prior to December 31, 2005.
165
18. ACCUMULATED OTHER COMPREHENSIVE INCOME
--------------------------------------------------------------------------------
Accumulated other comprehensive income includes certain items that are reported
directly within a separate component of shareholders' equity. The following
table presents changes in accumulated other comprehensive income balances.
MARCH 29 JANUARY 1
YEAR ENDED YEAR ENDED THROUGH THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 28,
2005 2004 2003 2003
----------------------------------------------------------------------------------------------------------
(SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (PREDECESSOR)
(IN MILLIONS)
Unrealized gains (losses) on investments and
interest-only strip receivables:
Balance at beginning of period.............. $ 54 $168 $294 $ 319
Effect of push-down accounting of HSBC's
purchase price on net assets............. - - (294) -
Other comprehensive income for period:
Net unrealized holding gains (losses)
arising during period, net of tax of
$29 million, $67 million, $(111)
million and $0 million, respectively... (56) (106) 179 -
Reclassification adjustment for gains
realized in net income, net of taxes of
$- million, $4 million, $6 million and
$13 million, respectively.............. - (8) (11) (25)
----- ---- ---- -----
Total other comprehensive income for
period................................... (56) (114) 168 (25)
----- ---- ---- -----
Balance at end of period.................... (2) 54 168 294
----- ---- ---- -----
Unrealized gains (losses) on cash flow hedging
instruments:
Balance at beginning of period.............. 119 (11) (636) (737)
Effect of push-down accounting of HSBC's
purchase price on net assets............. - - 636 -
Other comprehensive income for period:
Net gains (losses) arising during period,
net of tax of $(92) million, $(34)
million, $19 million and $(10) million,
respectively........................... 173 72 (22) 19
Reclassification adjustment for losses
realized in net income, net of tax of
$18 million, $(27) million, $(10)
million and $(47) million,
respectively........................... (32) 58 11 82
----- ---- ---- -----
Total other comprehensive income for
period................................... 141 130 (11) 101
----- ---- ---- -----
Balance at end of period.................... 260 119 (11) (636)
----- ---- ---- -----
166
MARCH 29 JANUARY 1
YEAR ENDED YEAR ENDED THROUGH THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 28,
2005 2004 2003 2003
----------------------------------------------------------------------------------------------------------
(SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (PREDECESSOR)
(IN MILLIONS)
Minimum pension liability:
Balance at beginning of period.............. (4) - (30) (30)
Effect of push-down accounting of HSBC's
purchase price on net assets............. - - 30 -
Other comprehensive income for period:
Pension liability settlement adjustment,
net of tax of $(2) million in 2005 and
$2 million in 2004..................... 4 (4) - -
----- ---- ---- -----
Total other comprehensive income for
period................................... 4 (4) - -
----- ---- ---- -----
Balance at end of period.................... - (4) - (30)
----- ---- ---- -----
Foreign currency translation adjustments:
Balance at beginning of period.............. 474 286 (271) (247)
Effect of push-down accounting of HSBC's
purchase price on net assets............. - - 271 -
Other comprehensive income for period:
Translation gains, net of tax of $6
million, $(12) million, $0 million and
$7 million, respectively............... (253) 188 286 (24)
----- ---- ---- -----
Total other comprehensive income for
period................................... (253) 188 286 (24)
----- ---- ---- -----
Balance at end of period.................... 221 474 286 (271)
----- ---- ---- -----
Total accumulated other comprehensive income
(loss) at end of period..................... $ 479 $643 $443 $(643)
===== ==== ==== =====
19. RELATED PARTY TRANSACTIONS
--------------------------------------------------------------------------------
In the normal course of business, we conduct transactions with HSBC and its
subsidiaries. These transactions include funding arrangements, purchases and
sales of receivables, servicing arrangements, information technology services,
item and statement processing services, banking and other miscellaneous
services. The following tables present related party balances and the income and
(expense) generated by related party transactions:
AT DECEMBER 31, 2005 2004
---------------------------------------------------------------------------------
(IN MILLIONS)
ASSETS, (LIABILITIES) AND EQUITY:
Derivative financial assets (liability), net................ $ (260) $ 3,297
Affiliate preferred stock received in sale of U.K. credit
card business............................................. 261 -
Other assets................................................ 518 604
Due to affiliates........................................... (15,534) (13,789)
Other liabilities........................................... (445) (168)
Series A Preferred Stock.................................... - 1,100(1)
Premium on sale of U.K. credit card business to affiliate
recorded as an increase to additional paid in capital..... 182 -
---------------
(1) In December 2005, the $1.1 billion Series A preferred stock plus all accrued
and unpaid dividends was exchanged for a like amount of common equity and
the Series A preferred stock was retired. We issued 4 shares of common
equity to HINO as part of the exchange.
167
FOR THE YEAR ENDED DECEMBER 31, 2005 2004 2003
-----------------------------------------------------------------------------------
INCOME/(EXPENSE):
Interest expense on borrowings from HSBC and subsidiaries... $(713) $(343) $ (73)
Interest income on advances to HSBC affiliates.............. 37 5 -
HSBC Bank USA:
Real estate secured servicing revenues.................... 16 13 -
Real estate secured sourcing, underwriting and pricing
revenues............................................... 3 4 -
Gain on bulk sale of real estate secured receivables...... - 15 16
Gain on bulk sale of domestic private label receivable
portfolio.............................................. - 663 -
Gain on daily sale of domestic private label receivable
originations........................................... 379 3 -
Gain on daily sale of MasterCard/Visa receivables......... 34 21 -
Taxpayer financial services loan origination fees......... (15) - -
Domestic private label receivable servicing fees.......... 368 3 -
MasterCard/Visa receivable servicing fees................. 11 1 -
Other processing, origination and support revenues........ 17 15 -
Support services from HSBC affiliates, primarily HSBC
Technology and Services (USA) Inc. ("HTSU")............... (889) (750) -
HTSU:
Rental revenue............................................ 42 33 -
Administrative services revenue........................... 14 18 -
Servicing revenue......................................... 5 - -
Other servicing fees from HSBC affiliates................... 6 3 -
Stock based compensation expense with HSBC.................. (66) (45) -
The notional value of derivative contracts outstanding with HSBC subsidiaries
totaled $72.2 billion at December 31, 2005 and $62.6 billion at December 31,
2004. Affiliate swap counterparties provide collateral in the form of securities
as required, which are not recorded on our balance sheet. At December 31, 2005,
the fair value of our agreements with affiliate counterparties was below the
$1.2 billion level requiring posting of collateral. As such, at December 31,
2005, we were not holding any swap collateral from HSBC affiliates in the form
of securities. At December 31, 2004, affiliate swap counterparties had provided
collateral in the form of securities, which were not recorded on our balance
sheet, totaling $2.2 billion.
We have extended a line of credit of $2 billion to HSBC USA Inc. at interest
rates comparable to third-party rates for a line of credit with similar terms.
No balances were outstanding under this line at December 31, 2005. The balance
outstanding under this line was $.6 billion at December 31, 2004 and is included
in other assets. Interest income associated with this line of credit is recorded
in interest income and reflected as interest income on advances to HSBC
affiliates in the table above.
We extended a revolving line of credit of $.5 billion to HTSU on June 28, 2005
at interest rates comparable to third-party rates for a line of credit with
similar terms. The balance outstanding under this line of credit was $.4 billion
at December 31, 2005 and is included in other assets. Interest income associated
with this line of credit is recorded in interest income and reflected as
interest income on advances to HSBC affiliates in the table above.
We extended a promissory note of $.5 billion to HSBC Securities (USA) Inc.
("HSI") on June 27, 2005 at interest rates comparable to third-party rates for a
line of credit with similar terms. This promissory note was repaid during July
2005. We also extended a promissory note of $.5 billion to HSI on September 29,
2005. This promissory note was repaid during October 2005. We extended an
additional promissory note of $150 million to HSI on December 28, 2005 and is
included in other assets. This note was repaid during January 2006. Interest
income associated with this line of credit is recorded in interest income and
reflected as interest income on advances to HSBC affiliates in the table above.
168
On March 31, 2005, we extended a line of credit of $.4 billion to HINO which was
repaid during the second quarter of 2005. This line of credit was at interest
rates comparable to third-party rates for a line of credit with similar terms.
During the second quarter of 2004, we made advances to our immediate parent,
HINO, totaling $266 million which were repaid during the third quarter of 2004.
Interest income associated with this line of credit is recorded in interest
income and reflected as interest income on advances to HSBC affiliates in the
table above.
Due to affiliates includes amounts owed to subsidiaries of HSBC (other than
preferred stock). This funding was at interest rates (both the underlying
benchmark rate and credit spreads) comparable to third-party rates for debt with
similar maturities.
At December 31, 2005, we had commercial paper back stop credit facility of $2.5
billion from HSBC domestically and a revolving credit facility of $5.3 billion
from HSBC in the U.K. At December 31, 2004, we had commercial paper back stop
credit facility of $2.5 billion from HSBC domestically and a revolving credit
facility of $7.5 billion from HSBC in the U.K. As of December 31, 2005, $4.2
billion was outstanding under the U.K. lines and no balances were outstanding on
the domestic lines. As of December 31, 2004, $7.4 billion was outstanding on the
U.K. lines and no balances were outstanding on the domestic lines. Annual
commitment fee requirements to support availability of these lines totaled $2
million in 2005 and 2004 and are included as a component of interest
expense - HSBC affiliates.
In December 2005, we sold our U.K. credit card business, including $2.5 billion
of receivables ($3.1 billion on a managed basis), the associated cardholder
relationships and the related retained interests in securitized credit card
receivables to HBEU, a U.K. based subsidiary of HSBC, for an aggregate purchase
price of $3.0 billion. The purchase price, which was determined based on a
comparative analysis of sales of other credit card portfolios, was paid in a
combination of cash and $261 million of preferred stock issued by a subsidiary
of HBEU with a rate of one-year Sterling LIBOR, plus 1.30 percent. In addition
to the assets referred to above, the sale also included the account origination
platform, including the marketing and credit employees associated with this
function, as well as the lease associated with the credit card call center and
related leaseholds and call center employees to provide customer continuity
after the transfer as well as to allow HBEU direct ownership and control of
origination and customer service. We have retained the collection operations
related to the credit card operations and have entered into a service level
agreement for a period of not less than two years to provide collection services
and other support services, including components of the compliance, financial
reporting and human resource functions, for the sold credit card operations to
HBEU for a fee. Additionally, the management teams of HBEU and our remaining
U.K. operations will be jointly involved in decision making involving card
marketing to ensure that growth objectives are met for both businesses. Because
the sale of this business is between affiliates under common control, the
premium received in excess of the book value of the assets transferred of $182
million, including the goodwill assigned to this business, has been recorded as
an increase to additional paid in capital and has not been included in earnings.
In future periods, the net interest income, fee income and provision for credit
losses for the International Segment will be reduced, while other income will be
increased by the receipt of servicing revenue for these credit card receivables
from HBEU. We do not anticipate that the net effect of this sale will result in
a material reduction of net income of our consolidated results.
In December 2004, we sold our domestic private label receivable portfolio
(excluding retail sales contracts at our consumer lending business), including
the retained interests associated with our securitized domestic private label
receivables to HSBC Bank USA for $12.4 billion. We recorded an after-tax gain on
the sale of $423 million in 2004. See Note 4, "Sale of Domestic Private Label
Receivable Portfolio and Adoption of FFIEC Policies." We continue to service the
sold private label receivables and receive servicing fee income from HSBC Bank
USA for these services. As of December 31, 2005, we were servicing $17.1 billion
of domestic private label receivables for HSBC Bank USA. We received servicing
fee income from HSBC Bank USA of $368 million in 2005 and $3 million during
December 2004 subsequent to the initial bulk sale. The servicing fee income is
included in the table above. We continue to maintain the related customer
account relationships and, therefore, sell new domestic private label receivable
originations (excluding retail sales contracts) to HSBC Bank USA on a daily
basis. We sold $21,050 million of private label receivables to HSBC Bank USA in
2005 and $12,394 million during December 2004 including the initial bulk sale
and the
169
subsequent daily sales of new originations. The gains associated with the sale
of these receivables are reflected in the table above and are recorded in gain
on receivable sales to HSBC affiliates.
In the first quarter of 2004, we sold approximately $.9 billion of real estate
secured receivables from our mortgage services business to HSBC Bank USA and
recorded a pre-tax gain of $15 million on the sale. Under a separate servicing
agreement, we have agreed to service all real estate secured receivables sold to
HSBC Bank USA including all future business it purchases from our
correspondents. As of December 31, 2005, we were servicing $4.6 billion of real
estate secured receivables for HSBC Bank USA. We also received fees from HSBC
Bank USA pursuant to a service level agreement under which we sourced,
underwrote and priced $1.5 billion of real estate secured receivables purchased
by HSBC Bank USA during 2005 and $2.8 billion in 2004. The servicing fee revenue
associated with these receivables is recorded in servicing fees from HSBC
affiliates and are reflected as real estate secured servicing revenues in the
above table. Fees received for sourcing, underwriting and pricing the
receivables have been recorded as other income and are reflected as real estate
secured sourcing, underwriting and pricing revenues from HSBC Bank USA in the
above table. Purchases of real estate secured receivables from our
correspondents by HSBC Bank USA were discontinued effective September 1, 2005.
We continue to service the receivables HSBC Bank USA previously purchased from
these correspondents.
Under various service level agreements, we also provide various services to HSBC
Bank USA. These services include credit card servicing and processing activities
through our credit card services business, loan origination and servicing
through our auto finance business and other operational and administrative
support. Fees received for these services are reported as servicing fees from
HSBC affiliates and are included in the table above.
During 2003, Household Capital Trust VIII issued $275 million in mandatorily
redeemable preferred securities to HSBC. The terms of this issuance were as
follows:
(DOLLARS ARE IN MILLIONS)
----------------------------------------------------------------------------------------
Junior Subordinated Notes:
Principal balance......................................... $284
Redeemable by issuer...................................... September 26, 2008
Stated maturity........................................... November 15, 2033
Preferred Securities:
Rate...................................................... 6.375%
Face value................................................ $275
Issue date................................................ September 2003
Interest expense recorded on the underlying junior subordinated notes totaled
$18 million in 2005 and $18 million in 2004. The interest expense for the
Household Capital Trust VIII is included in interest expense - HSBC affiliates
in the consolidated statement of income and is reflected as a component of
interest expense on borrowings from HSBC and subsidiaries in the table above.
During 2004, our Canadian business began to originate and service auto loans for
an HSBC affiliate in Canada. Fees received for these services are included in
other income and are reflected in other income from HSBC affiliates in the above
table.
Effective October 1, 2004, HSBC Bank USA became the originating lender for loans
initiated by our taxpayer financial services business for clients of various
third party tax preparers. We purchase the loans originated by HSBC Bank USA
daily for a fee. Origination fees paid to HSBC Bank USA totaled $15 million in
2005. These origination fees are included as an offset to taxpayer financial
services revenue and are reflected as taxpayer financial services loan
origination fees in the above table.
On July 1, 2004, HSBC Bank Nevada, National Association ("HSBC Bank Nevada"),
formerly known as Household Bank (SB), N.A., purchased the account relationships
associated with $970 million of MasterCard and Visa credit card receivables from
HSBC Bank USA for approximately $99 million, which are included in
170
intangible assets. The receivables continue to be owned by HSBC Bank USA.
Originations of new accounts and receivables are made by HSBC Bank Nevada and
new receivables are sold daily to HSBC Bank USA. We sold $2,055 million of
credit card receivables to HSBC Bank USA in 2005 and $1,029 million in 2004. The
gains associated with the sale of these receivables are reflected in the table
above and are recorded in gain on receivable sales to HSBC affiliates.
Effective January 1, 2004, our technology services employees, as well as
technology services employees from other HSBC entities in North America, were
transferred to HTSU. In addition, technology related assets and software
purchased subsequent to January 1, 2004 are generally purchased and owned by
HTSU. Technology related assets owned by HSBC Finance Corporation prior to
January 1, 2004 currently remain in place and were not transferred to HTSU. In
addition to information technology services, HTSU also provides certain item
processing and statement processing activities to us pursuant to a master
service level agreement. Support services from HSBC affiliates includes services
provided by HTSU as well as banking services and other miscellaneous services
provided by HSBC Bank USA and other subsidiaries of HSBC. We also receive
revenue from HTSU for rent on certain office space, which has been recorded as a
reduction of occupancy and equipment expenses, and for certain administrative
costs, which has been recorded as other income.
Additionally, in a separate transaction in December 2005, we transferred our
information technology services employees in the U.K. to a subsidiary of HBEU.
Subsequent to the transfer, operating expenses relating to information
technology, which have previously been reported as salaries and fringe benefits
or other servicing and administrative expenses, are now billed to us by HBEU and
reported as support services from HSBC affiliates. During the first quarter of
2006, we anticipate that the information technology equipment in the U.K. will
be sold to HBEU for a purchase price equal to the book value of these assets.
In addition, we utilize HSBC Markets (USA) Inc., a related HSBC entity, to lead
manage a majority of our ongoing debt issuances. Fees paid for such services
totaled approximately $59 million in 2005 and $18 million in 2004. These fees
are amortized over the life of the related debt as a component of interest
expense.
In consideration of HSBC transferring sufficient funds to make the payments
described in Note 3, "Acquisitions and Divestitures," with respect to certain
HSBC Finance Corporation preferred stock, we issued the Series A Preferred Stock
in the amount of $1.1 billion to HSBC on March 28, 2003. In September 2004, HNAH
issued a new series of preferred stock totaling $1.1 billion to HSBC in exchange
for our outstanding Series A Preferred Stock. In October 2004, our immediate
parent, HINO, issued a new series of preferred stock to HNAH in exchange for our
Series A Preferred Stock. We paid dividends on our Series A Preferred Stock of
$66 million in October 2005 and $108 million in October 2004. On December 15,
2005, we issued 4 shares of common stock to HINO in exchange for the Series A
Preferred Stock.
Employees of HSBC Finance Corporation participate in one or more stock
compensation plans sponsored by HSBC. Our share of the expense of these plans
was $66 million in 2005 and $45 million in 2004. These expenses are recorded in
salary and employee benefits and are reflected in the above table.
20. STOCK OPTION PLANS
--------------------------------------------------------------------------------
STOCK OPTION PLANS The HSBC Holdings Group Share Option Plan (the "Group Share
Option Plan"), which replaced the former Household stock option plans, was a
long-term incentive compensation plan available to certain employees prior to
2005. Grants were usually made annually. At the 2005 HSBC Annual Meeting of
Stockholders, HSBC adopted and the shareholders' approved the HSBC Share Plan
("Group Share Plan") to replace this plan. During 2005, no further options were
granted to employees although stock option grants from previous years remain in
effect subject to the same conditions as before. In lieu of options, in 2005,
these employees received grants of shares of HSBC stock subject to certain
vesting conditions as discussed further below. Options granted to employees in
2004 vest 100% upon the attainment of certain company performance conditions in
either year 3, 4 or 5 and expire ten years from the date of grant. If the
performance conditions are not met in year 5, the options will be forfeited.
Options granted to employees in 2003 will vest 75 percent in year three with the
remaining 25 percent vesting in year four and expire ten years from the date of
grant. Options are granted at market value. Compensation expense related to the
Group Share Option Plan, which is
171
recognized over the vesting period, totaled $6 million in 2005, $8 million in
2004 and $1 million for the period March 29 through December 31, 2003.
Information with respect to the Group Share Option Plan is as follows:
2005 2004 2003
--------------------- --------------------- ----------------------
WEIGHTED- WEIGHTED- WEIGHTED-
HSBC AVERAGE HSBC AVERAGE HSBC AVERAGE
ORDINARY PRICE PER ORDINARY PRICE PER ORDINARY PRICE PER
SHARES SHARE SHARES SHARE SHARES SHARE
--------------------------------------------------------------------------------------------------------
Outstanding at beginning of
year.......................... 6,245,800 $14.96 4,069,800 $15.31 - $ -
Granted......................... - - 2,638,000 14.37 4,069,800 15.31
Exercised....................... - - - - - -
Transferred..................... (30,000) 15.31 (462,000) 14.69 - -
Expired or canceled............. (40,000) 14.37 - - - -
--------- ------ --------- ------ ---------- ------
Outstanding at end of year...... 6,175,800 14.96 6,245,800 14.96 4,069,800 15.31
========= ====== ========= ====== ========== ======
Exercisable at end of year...... - $ - - $ - - $ -
========= ====== ========= ====== ========== ======
Weighted-average fair value of
options granted............... $ - $ 2.68 $ 4.74
====== ====== ======
The transfers shown above relate to employees who have transferred to other HSBC
entities during each year. The transfers in 2005 primarily relate to certain of
our U.K. employees who were transferred to HBEU as part of the sale of our U.K.
credit card business in December 2005. The transfers in 2004 relate to our
technology services employees who were transferred to HTSU effective January 1,
2004.
The following table summarizes information about stock options outstanding under
the Group Share Option Plan at December 31, 2005.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------- -----------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
RANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE OUTSTANDING PRICE
-------------------------------------------------------------------------------------------------------
$12.51 - $15.00......................... 2,266,000 8.34 $14.37 - $-
$15.01 - $17.50......................... 3,909,800 7.85 15.31 - -
The fair value of each option granted under the Group Share Option Plan in 2004,
measured at the grant date, was calculated using a binomial lattice methodology
that is based on the underlying assumptions of the Black-Scholes option pricing
model. When modeling options with vesting that are dependent on attainment of
certain performance conditions over a period of time, these performance targets
are incorporated into the model using Monte-Carlo simulation. The expected life
of options depends on the behavior of option holders, which is incorporated into
the option model consistent with historic observable data. The fair values are
inherently subjective and uncertain due to the assumptions made and the
limitations of the model used. Prior to 2004, options were valued using a
simpler methodology also based on the Black-Scholes option pricing model. The
significant weighted average assumptions used to estimate the fair value of the
options granted by year are as follows:
2005 2004 2003
----------------------------------------------------------------------------------------
Risk-free interest rate..................................... - 4.9% 5.3%
Expected life............................................... - 6.9 years 5 years
Expected volatility......................................... - 25.0% 30.0%
Prior to our acquisition by HSBC, certain employees were eligible to participate
in the former Household stock option plan. Employee stock options generally
vested equally over four years and expired 10 years from the date of grant. Upon
completion of our acquisition by HSBC, all options granted prior to November
2002
172
vested and became outstanding options to purchase HSBC ordinary shares. Options
granted under the former Household plan subsequent to October 2002 were
converted into options to purchase ordinary shares of HSBC, but did not vest
under the change in control. Compensation expense related to the former
Household plan totaled $6 million in 2005, $8 million in 2004, $5 million in the
period March 29 through December 31, 2003 and $4 million in the period January 1
through March 28, 2003.
Prior to 2003, non-employee directors annually received options to purchase
shares of Household's common stock at the stock's fair market value on the day
the option was granted. Director options had a term of ten years and one day,
fully vested six months from the date granted, and once vested were exercisable
at any time during the option term. In November 2002, non-employee directors
chose not to receive their annual option to purchase 10,000 shares of
Household's common stock in light of the transaction with HSBC. Instead, each
director received a cash payment of $120,000 which was the fair market value of
the options he or she would have otherwise received. None of our non-employee
directors currently receive equity as part of their retainer.
Information with respect to stock options granted under the former Household
plan is as follows:
2005 2004 2003
---------------------- ---------------------- ----------------------
WEIGHTED- WEIGHTED- WEIGHTED-
HSBC AVERAGE HSBC AVERAGE HSBC AVERAGE
ORDINARY PRICE PER ORDINARY PRICE PER ORDINARY PRICE PER
SHARES SHARE SHARES SHARE SHARES SHARE
--------------------------------------------------------------------------------------------------------
Outstanding at beginning of
year........................ 38,865,993 $15.71 45,194,343 $14.76 19,850,371 $36.80
Granted....................... - - - - - -
Exercised..................... (2,609,665) 10.92 (5,780,935) 8.43 (439,087) 11.04
Transferred (142,292) 12.15 (517,321) 14.58 - -
Expired or canceled........... (82,030) 7.97 (30,094) 10.66 (231,557) 53.28
---------- ------ ---------- ------ ---------- ------
Outstanding at March 28,
2003........................ - - - - 19,179,727 37.20
Conversion to HSBC ordinary
shares...................... - - - - 51,305,796 13.90
Exercised..................... - - - - (4,749,726) 5.00
Expired or canceled........... - - - - (1,361,727) 16.49
---------- ------ ---------- ------ ---------- ------
Outstanding at end of year.... 36,032,006 $16.09 38,865,993 $15.71 45,194,343 $14.76
========== ====== ========== ====== ========== ======
Exercisable at end of year.... 34,479,337 $16.21 35,373,778 $16.21 39,743,144 $15.32
========== ====== ========== ====== ========== ======
The transfers shown above primarily relate to employees who have transferred to
HTSU during each year.
The following table summarizes information about stock options outstanding under
the former Household plan, all of which are in HSBC ordinary shares, at December
31, 2005:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------- -----------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
RANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE OUTSTANDING PRICE
-------------------------------------------------------------------------------------------------------
$4.01 - $5.00........................... 8,576 2.64 $ 2.54 8,576 $ 2.54
$5.01 - $10.00.......................... 730,947 1.58 8.98 730,947 8.98
$10.01 - $12.50......................... 7,039,515 6.20 10.77 5,486,846 10.77
$12.51 - $15.00......................... 8,276,901 2.50 14.08 8,276,901 14.08
$15.01 - $17.50......................... 6,140,562 3.64 16.95 6,140,562 16.95
$17.51 - $20.00......................... 6,371,183 4.84 18.41 6,371,183 18.41
$20.01 - $25.00......................... 7,464,322 5.87 21.37 7,464,322 21.37
RESTRICTED SHARE PLANS Subsequent to our acquisition by HSBC, key employees are
also provided awards in the form of restricted shares ("RSRs") under HSBC's
Restricted Share Plan prior to 2005 and under the Group Share Plan beginning in
2005. Annual awards to employees in 2005 are fully vested after three years.
173
Awards to employees in 2004 vest over five years contingent upon the achievement
of certain company performance targets. Additionally, in 2004, we made a small
number of RSR awards subject only to vesting conditions, which conditions can
vary depending on the nature of the award, the longest of which vests over a
five year period. Awards in 2003 generally vested over a three or five year
period and did not require the achievement of company performance targets.
Information with respect to RSRs awarded under HSBC's Restricted Share
Plan/Group Share Plan, all of which are in HSBC ordinary shares, is as follows:
MARCH 29
YEAR ENDED YEAR ENDED THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2005 2004 2003
---------------------------------------------------------------------------------------------------
RSRs awarded........................................... 6,669,152 2,996,878 5,893,889
Weighted-average fair market value per share........... $ 15.86 $ 15.09 $ 12.43
RSRs outstanding at December 31........................ 11,787,706 7,030,688 5,893,889
Compensation cost: (in millions)
Pre-tax.............................................. $ 42 $ 17 $ 9
After-tax............................................ 27 11 6
Prior to the merger, Household's executive compensation plans also provided for
issuance of RSRs which entitled an employee to receive a stated number of shares
of Household common stock if the employee satisfied the conditions set by the
Compensation Committee for the award. Upon completion of the merger with HSBC,
all RSRs granted under the former Household plan prior to November 2002 vested
and became outstanding shares of HSBC. RSRs granted under the former Household
plan subsequent to October 2002 were converted into rights to receive HSBC
ordinary shares. Upon vesting, the employee can elect to receive either HSBC
ordinary shares or American depository shares.
Information with respect to RSRs awarded under the pre-merger Household plan,
all of which are in HSBC ordinary shares, is as follows:
2005 2004 2003
-----------------------------------------------------------------------------------------------
RSRs awarded............................................. - - 134,552
Weighted-average fair market value per share............. $ - $ - $ 27.11
RSRs outstanding at December 31.......................... 1,309,073 2,238,628 2,512,242
Compensation cost: (in millions)
Pre-tax................................................ $ 6 $ 8 $ 23
After-tax.............................................. 4 5 15
The pre-tax compensation cost with respect to the RSR's awarded under the
pre-merger Household plan reflected above includes $5 million for the period
March 29 to December 31, 2003.
EMPLOYEE STOCK PURCHASE PLANS The HSBC Holdings Savings-Related Share Option
Plan (the "HSBC Sharesave Plan"), which replaced the former Household employee
stock purchase plan, allows eligible employees to enter into savings contracts
to save up to approximately $400 per month, with the option to use the savings
to acquire ordinary shares of HSBC at the end of the contract period. There are
currently two types of plans offered which allow the participant to select
saving contracts of either a 3 or 5 year length. The options are exercisable
within six months following the third or fifth year, respectively, of the
commencement
174
of the related savings contract, at a 20 percent discount for options granted in
2005, 2004 and 2003. HSBC ordinary shares granted and the related fair value of
the options for 2005, 2004 and 2003 are presented below:
2005 2004 2003
------------------------ ------------------------ ------------------------
HSBC FAIR VALUE HSBC FAIR VALUE HSBC FAIR VALUE
ORDINARY PER SHARE OF ORDINARY PER SHARE OF ORDINARY PER SHARE OF
SHARES SHARES SHARES SHARES SHARES SHARES
GRANTED GRANTED GRANTED GRANTED GRANTED GRANTED
--------------------------------------------------------------------------------------------------------
3 year vesting period... 1,064,168 3.73 1,124,776 $3.44 2,810,598 $3.19
5 year vesting period... 236,782 3.78 303,981 3.80 903,171 3.28
Compensation expense related to the grants under the HSBC Sharesave Plan totaled
$6 million in 2005, $5 million in 2004 and $2 million for the period March 29
through December 31, 2003.
The fair value of each option granted under the HSBC Sharesave Plan was
estimated as of the date of grant using a third party option pricing model in
2005 and 2004 and the Black-Scholes option pricing model in 2003. The fair value
estimates used the following weighted-average assumptions:
2005 2004 2003
-------------------------------------------------------------------------------------------------
Risk-free interest rate.............................. 4.3% 4.9% 4.1%
Expected life........................................ 3 OR 5 YEARS 3 or 5 years 3 or 5 years
Expected volatility.................................. 20.0% 25.0% 30.0%
Prior to the merger, we also maintained an Employee Stock Purchase Plan (the
"ESPP"). The ESPP provided a means for employees to purchase shares of our
common stock at 85 percent of the lesser of its market price at the beginning or
end of a one-year subscription period. The ESPP was terminated on March 7, 2003
and 775,480 shares of our common stock were purchased on that date. Compensation
expense related to the ESPP totaled $7 million in the period January 1 to March
28, 2003.
21. PENSION AND OTHER POSTRETIREMENT BENEFITS
--------------------------------------------------------------------------------
DEFINED BENEFIT PENSION PLANS In November 2004, sponsorship of the domestic
defined benefit pension plan of HSBC Finance Corporation and the domestic
defined benefit pension plan of HSBC Bank USA were transferred to HNAH.
Effective January 1, 2005, the two separate plans were combined into a single
HNAH defined benefit pension plan which facilitates the development of a unified
employee benefit policy and unified employee benefit plan administration for
HSBC companies operating in the United States. As a result, the pension
liability relating to our domestic defined benefit plan of $49 million, net of
tax, was transferred to HNAH as a capital transaction in the first quarter of
2005.
The components of pension expense for the domestic defined benefit plan
reflected in our consolidated statement of income are shown in the table below.
The pension expense for the year ended December 31, 2005 reflects the portion of
the pension expense of the combined HNAH pension plan which has been allocated
to HSBC Finance Corporation.
MARCH 29 JANUARY 1
YEAR ENDED YEAR ENDED THROUGH THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 28,
2005 2004 2003 2003
------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Service cost - benefits earned during the
period................................... $ 46 $ 52 $ 35 $ 10
Interest cost on projected benefit
obligation............................... 54 46 31 4
Expected return on assets.................. (78) (82) (44) (15)
Amortization of prior service cost......... - - - -
Recognized losses.......................... 4 (5) - 14
---- ---- ---- ----
Pension expense............................ $ 26 $ 11 $ 22 $ 13
==== ==== ==== ====
175
The information and activity presented below as of and for the year ended
December 31, 2005 relates to the post-merger HNAH defined benefit pension plan,
unless noted otherwise. The information and activity presented as of December
31, 2004 and for the year then ended and for the periods March 29 through
December 31, 2005 and January 1 through March 28, 2003 reflect the pre-merger
HSBC Finance Corporation domestic defined benefit pension plan balances and
activity.
The assumptions used in determining pension expense of the domestic defined
benefit plan are as follows:
2005 2004 2003
----------------------------------------------------------------------------------------------------
(POST-MERGER) (PRE-MERGER) (PRE-MERGER)
Discount rate(1)....................................... 6.00% 6.25% 6.50%
Salary increase assumption............................. 3.75 3.75 4.0
Expected long-term rate of return on plan assets....... 8.33 8.75 8.0
---------------
(1) The discount rate used for the period January 1 through March 28, 2003 was
6.75%.
HNAH retains both an unrelated third party as well as an affiliate to provide
investment consulting services. Given the plan's current allocation of equity
and fixed income securities and using investment return assumptions which are
based on long term historical data, the long term expected return for plan
assets is reasonable. The funded status of the domestic defined benefit pension
plan is shown below. The components shown below as of December 31, 2005 reflect
the funded status of the post-merger HNAH pension plan and not the interests of
HSBC Finance Corporation.
AT DECEMBER 31,
----------------------------
2005 2004
------------------------------------------------------------------------------------------
(POST-MERGER) (PRE-MERGER)
(IN MILLIONS)
Funded status............................................... $(146) $(19)
Unrecognized net actuarial loss (gain)...................... 502 (57)
Unamortized prior service cost.............................. 3 -
----- ----
Prepaid pension cost/(Accrued pension liability)............ $ 359 $(76)
===== ====
There were no intangible assets recognized on HSBC Finance Corporation's balance
sheet at December 31, 2004.
A reconciliation of beginning and ending balances of the fair value of plan
assets associated with the domestic defined benefit pension plan is shown below.
The activity shown for the year ended December 31, 2005 reflects the activity of
the merged HNAH plan.
YEAR ENDED
DECEMBER 31,
----------------------------
2005 2004
------------------------------------------------------------------------------------------
(POST-MERGER) (PRE-MERGER)
(IN MILLIONS)
Fair value of plan assets at beginning of year.............. $1,000 $ 969
Transfer in of assets from the former HSBC Bank USA pension
plan...................................................... 1,304 -
Actual return on plan assets................................ 168 92
Employer contributions...................................... - -
Benefits paid............................................... (89) (61)
------ ------
Fair value of plan assets at end of year.................... $2,383 $1,000
====== ======
It is currently not anticipated that employer contributions to the domestic
defined benefit plan will be made in 2006.
176
The allocation of the domestic pension plan assets at December 31, 2005 and 2004
is as follows:
PERCENTAGE OF
PLAN ASSETS AT
DECEMBER 31,
----------------------------
2005 2004
------------------------------------------------------------------------------------------
(POST-MERGER) (PRE-MERGER)
Equity securities........................................... 69% 77%
Debt securities............................................. 31 21
Other....................................................... - 2
--- ---
Total....................................................... 100% 100%
=== ===
There were no investments in HSBC ordinary shares or American depository shares
at December 31, 2005 or 2004.
The primary objective of the defined benefit pension plan is to provide eligible
employees with regular pension benefits. Since the domestic plans are governed
by the Employee Retirement Income Security Act of 1974 ("ERISA"), ERISA
regulations serve as guidance for the management of plan assets. Consistent with
prudent standards of preservation of capital and maintenance of liquidity, the
goals of the plans are to earn the highest possible rate of return consistent
with the tolerance for risk as determined by the investment committee in its
role as a fiduciary. In carrying out these objectives, short-term fluctuations
in the value of plan assets are considered secondary to long-term investment
results. Both a third party and an affiliate are used to provide investment
consulting services such as recommendations on the type of funds to be invested
in and monitoring the performance of fund managers. In order to achieve the
return objectives of the plans, the plans are diversified to ensure that adverse
results from one security or security class will not have an unduly detrimental
effect on the entire investment portfolio. Assets are diversified by type,
characteristic and number of investments as well as by investment style of
management organization. Equity securities are invested in large, mid and small
capitalization domestic stocks as well as international stocks.
A reconciliation of beginning and ending balances of the projected benefit
obligation of the domestic defined benefit pension plan is shown below. The
projected benefit obligation shown for the year ended December 31, 2005 reflects
the projected benefit obligation of the merged HNAH plan.
YEAR ENDED DECEMBER 31,
----------------------------
2005 2004
------------------------------------------------------------------------------------------
(POST-MERGER) (PRE-MERGER)
(IN MILLIONS)
Projected benefit obligation at beginning of year........... $1,019 $ 898
Transfer in from the HSBC Bank USA defined benefit plan..... 1,174 -
Service cost................................................ 94 52
Interest cost............................................... 130 46
Actuarial gains............................................. 202 84
Benefits paid............................................... (89) (61)
------ ------
Projected benefit obligation at end of year................. $2,530 $1,019
====== ======
Our share of the projected benefit obligation at December 31, 2005 is
approximately $1.1 billion. The accumulated benefit obligation for the
post-merger domestic HNAH defined benefit pension plan was $2.2 billion at
December 31, 2005. Our share of the accumulated benefit obligation at December
31, 2005 was approximately $1.0 billion. The accumulated benefit obligation for
the pre-merger domestic defined benefit pension plan was $1.0 billion at
December 31, 2004.
177
Estimated future benefit payments for the HNAH domestic defined benefit plan and
HSBC Finance Corporation's share of those payments are as follows:
HSBC FINANCE
CORPORATION'S
HNAH SHARE
----------------------------------------------------------------------------------
(IN MILLIONS)
2006........................................................ $102 $ 51
2007........................................................ 112 57
2008........................................................ 121 60
2009........................................................ 129 63
2010........................................................ 136 65
2011-2015................................................... 848 389
The assumptions used in determining the projected benefit obligation of the
domestic defined benefit plans at December 31 are as follows:
2005 2004 2003
----------------------------------------------------------------------------------------------------
(POST-MERGER) (PRE-MERGER) (PRE-MERGER)
Discount rate.......................................... 5.70% 6.00% 6.25%
Salary increase assumption............................. 3.75 3.75 3.75
FOREIGN DEFINED BENEFIT PENSION PLANS We sponsor various additional defined
benefit pension plans for our foreign based employees. Pension expense for our
foreign defined benefit pension plans was $2 million in 2005, $2 million in
2004, $2 million in the period March 29 through December 31, 2003 and $1 million
in the period January 1 through March 31, 2003. For our foreign plan, the fair
value of plan assets was $135 million at December 31, 2005 and $122 million at
December 31, 2004. The projected benefit obligation for our foreign defined
benefit pension plans was $164 million at December 31, 2005 and $143 million at
December 31, 2004.
SUPPLEMENTAL RETIREMENT PLAN A non-qualified supplemental retirement plan is
also provided. This plan, which is currently unfunded, provides eligible
employees defined pension benefits outside the qualified retirement plan.
Benefits are based on average earnings, years of service and age at retirement.
The projected benefit obligation was $73 million at December 31, 2005 and $82
million at December 31, 2004. Pension expense related to the supplemental
retirement plan was $11 million in 2005, $19 million in 2004, $9 million in the
period March 29 through December 31, 2003 and $3 million in the period January 1
through March 28, 2003. An additional minimum liability of $6 million related to
this plan was recognized in 2004 and reversed in 2005.
DEFINED CONTRIBUTION PLANS Various 401(k) savings plans and profit sharing plans
exist for employees meeting certain eligibility requirements. Under these plans,
each participant's contribution is matched by the company up to a maximum of 6
percent of the participant's compensation. Prior to the merger with HSBC,
company contributions were in the form of Household common stock. Subsequent to
the merger, company contributions are in the form of cash. Total expense for
these plans for HSBC Finance Corporation was $91 million in 2005, $82 million in
2004, $50 million in the period March 29 through December 31, 2003 and $21
million in the period January 1 through March 28, 2003.
Effective January 1, 2005, HSBC Finance Corporation's 401(k) savings plans
merged with the HSBC Bank USA's 401(k) savings plan under HNAH.
POSTRETIREMENT PLANS OTHER THAN PENSIONS Our employees also participate in plans
which provide medical, dental 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
our payments under the plans to control the cost of future medical benefits.
178
The net postretirement benefit cost included the following:
MARCH 29 JANUARY 1
YEAR ENDED YEAR ENDED THROUGH THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 28,
2005 2004 2003 2003
------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Service cost - benefits earned during the
period...................................... $ 5 $ 4 $ 3 $1
Interest cost................................. 15 13 10 1
Expected return on assets..................... - - - 2
Amortization of prior service cost............ - - - -
Recognized (gains) losses..................... - - - -
--- --- --- --
Net periodic postretirement benefit cost...... $20 $17 $13 $4
=== === === ==
The assumptions used in determining the net periodic postretirement benefit cost
for our domestic postretirement benefit plans are as follows:
2005 2004 2003
--------------------------------------------------------------------------------
Discount rate............................................... 6.00% 6.25% 6.50%
Salary increase assumption.................................. 3.75 3.75 4.0
---------------
(1) The discount rate used for the period January 1 through March 28, 2003 was
6.75%.
A reconciliation of the beginning and ending balances of the accumulated
postretirement benefit obligation is as follows:
YEAR ENDED
DECEMBER 31,
-------------
2005 2004
---------------------------------------------------------------------------
(IN MILLIONS)
Accumulated benefit obligation at beginning of year......... $254 $252
Service cost................................................ 5 4
Interest cost............................................... 15 13
Foreign currency exchange rate changes...................... 1 1
Actuarial gains............................................. (15) (2)
Benefits paid............................................... (18) (14)
---- ----
Accumulated benefit obligation at end of year............... $242 $254
==== ====
Our postretirement benefit plans are funded on a pay-as-you-go basis. We
currently estimate that we will pay benefits of approximately $17 million
relating to our postretirement benefit plans in 2006. The components of the
accrued postretirement benefit obligation are as follows:
AT DECEMBER 31,
---------------
2005 2004
-----------------------------------------------------------------------------
(IN MILLIONS)
Funded status............................................... $(242) $(254)
Unamortized prior service cost.............................. 7 3
Unrecognized net actuarial gain............................. (33) (9)
----- -----
Accrued postretirement benefit obligation................... $(268) $(260)
===== =====
179
Estimated future benefit payments for our domestic plans are as follows:
(IN MILLIONS)
----------------------------------------------------------------------------
2006........................................................ $17
2007........................................................ 17
2008........................................................ 18
2009........................................................ 19
2010........................................................ 19
2011-2015................................................... 97
The assumptions used in determining the benefit obligation of our domestic
postretirement benefit plans at December 31 are as follows:
2005 2004 2003
--------------------------------------------------------------------------------
Discount rate............................................... 5.70% 6.00% 6.25%
Salary increase assumption.................................. 3.75 3.75 3.75
A 10.5 percent annual rate of increase in the gross cost of covered health care
benefits was assumed for 2006. This rate of increase is assumed to decline
gradually to 5.0 percent in 2014.
Assumed health care cost trend rates have an effect on the amounts reported for
health care plans. A one-percentage point change in assumed health care cost
trend rates would increase (decrease) service and interest costs and the
postretirement benefit obligation as follows:
ONE PERCENT ONE PERCENT
INCREASE DECREASE
---------------------------------------------------------------------------------------
(IN MILLIONS)
Effect on total of service and interest cost components..... $.7 $(.6)
Effect on postretirement benefit obligation................. 9 (8)
22. BUSINESS SEGMENTS
--------------------------------------------------------------------------------
We have three reportable segments: Consumer, Credit Card Services, and
International. Our segments are managed separately and are characterized by
different middle-market consumer lending products, origination processes, and
locations. Our Consumer segment consists of our consumer lending, mortgage
services, retail services, and auto finance businesses. Our Credit Card Services
segment consists of our domestic MasterCard and Visa credit card business. Our
International segment consists of our foreign operations in Canada, the United
Kingdom and the rest of Europe. The Consumer segment provides real estate
secured, automobile secured, personal non-credit card and private label loans,
including retail sales contracts. Loans are offered with both revolving and
closed-end terms and with fixed or variable interest rates. Loans are originated
through branch locations, correspondents, mortgage brokers, direct mail,
telemarketing, independent merchants or automobile dealers. The Credit Card
Services segment offers MasterCard and Visa credit card loans throughout the
United States primarily via strategic affinity and co-branding relationships,
direct mail, and our branch network to non-prime customers. The International
segment offers secured and unsecured lines of credit and secured and unsecured
closed-end loans primarily in the United Kingdom, Canada, the Republic of
Ireland, Slovakia, the Czech Republic and Hungary. In addition, the United
Kingdom operation offers credit insurance in connection with all loan products.
We also cross sell our credit cards to existing real estate secured, private
label and tax services customers. All segments offer products and service
customers through the Internet. The All Other caption includes our insurance and
taxpayer financial services and commercial businesses, as well as our corporate
and treasury activities, each of which falls below the quantitative threshold
tests under SFAS No. 131 for determining reportable segments. There have been no
changes in the basis of our segmentation or any changes in the measurement of
segment profit as compared with the prior year presentation.
180
The accounting policies of the reportable segments are described in Note 2,
"Summary of Significant Accounting Policies." For segment reporting purposes,
intersegment transactions have not been eliminated. We generally account for
transactions between segments as if they were with third parties. We evaluate
performance and allocate resources based on income from operations after income
taxes and returns on equity and managed assets.
We have historically monitored our operations and evaluated trends on a managed
basis (a non-GAAP financial measure), which assumes that securitized receivables
have not been sold and are still on our balance sheet. This is because the
receivables that we securitize are subjected to underwriting standards
comparable to our owned portfolio, are generally serviced by operating personnel
without regard to ownership and result in a similar credit loss exposure for us.
In addition, we fund our operations, and make decisions about allocating
resources such as capital on a managed basis. When reporting on a managed basis,
net interest income, provision for credit losses and fee income related to
receivables securitized are reclassified from securitization related revenue in
our owned statement of income into the appropriate caption.
Income statement information included in the table for 2003 combines January 1
through March 28, 2003 (the "predecessor period") and March 29 to December 31,
2003 (the "successor" period) in order to present "combined" financial results
for 2003. As a result, managed and owned basis consolidated totals for 2003
include combined information from both the "successor" and "predecessor" periods
which impacts comparability to the current period.
Fair value adjustments related to purchase accounting resulting from our
acquisition by HSBC and related amortization have been allocated to Corporate,
which is included in the "All Other" caption within our segment disclosure.
Reconciliation of our managed basis segment results to managed basis and owned
basis consolidated totals are as follows:
MANAGED
CREDIT ADJUSTMENTS/ BASIS
CARD INTER- ALL RECONCILING CONSOLIDATED
CONSUMER SERVICES NATIONAL OTHER ITEMS TOTALS
-------------------------------------------------------------------------------------------------------
(IN MILLIONS)
YEAR ENDED DECEMBER 31, 2005
Net interest income............ $ 6,887 $ 2,150 $ 907 $ (668) $ - $ 9,276
Securitization related
revenue...................... (622) (192) 20 (43) - (837)
Fee and other income........... 1,194 2,016 563 1,250 (140)(2) 4,883
Intersegment revenues.......... 108 21 17 (6) (140)(2) -
Provision for credit losses.... 2,461 1,564 642 (27) 10(3) 4,650
Depreciation and
amortization................. 14 23 28 392 - 457
Total costs and expenses....... 2,638 1,370 847 1,154 - 6,009
Income tax expense (benefit)... 853 376 5 (289) (54)(4) 891
Net income..................... 1,498 661 (5) (287) (95) 1,772
Receivables.................... 108,345 26,181 9,260 201 - 143,987
Assets......................... 109,214 27,109 10,109 22,845 (8,534)(5) 160,743
Expenditures for long-lived
assets(7).................... 24 4 21 28 - 77
-------- ------- ------- ------- ------- --------
OWNED BASIS
SECURITIZATION CONSOLIDATED
ADJUSTMENTS TOTALS
------------------------------- -----------------------------
(IN MILLIONS)
YEAR ENDED DECEMBER 31, 2005
Net interest income............ $ (892)(6) $ 8,384
Securitization related
revenue...................... 1,048(6) 211
Fee and other income........... (263)(6) 4,620
Intersegment revenues.......... - -
Provision for credit losses.... (107)(6) 4,543
Depreciation and
amortization................. - 457
Total costs and expenses....... - 6,009
Income tax expense (benefit)... - 891
Net income..................... - 1,772
Receivables.................... (4,074)(8) 139,913
Assets......................... (4,074)(8) 156,669
Expenditures for long-lived
assets(7).................... - 77
-------- --------
181
MANAGED
CREDIT ADJUSTMENTS/ BASIS
CARD INTER- ALL RECONCILING CONSOLIDATED
CONSUMER SERVICES NATIONAL OTHER ITEMS TOTALS
-------------------------------------------------------------------------------------------------------
(IN MILLIONS)
YEAR ENDED DECEMBER 31, 2004
Net interest income............ $ 7,699 $ 2,070 $ 797 $ (309) $ - $ 10,257
Securitization related
revenue...................... (1,433) (338) (88) (145) - (2,004)
Fee and other income, excluding
gain on sale of domestic
private label credit card
receivables.................. 638 1,731 503 1,412 (137)(2) 4,147
Gain on bulk sale of domestic
private label credit card
receivables.................. 683 - - (20) - 663
Intersegment revenues.......... 101 25 15 (4) (137)(2) -
Provision for credit losses.... 2,575 1,625 336 (16) 2(3) 4,522
Depreciation and
amortization................. 13 53 34 383 - 483
Total costs and expenses....... 2,528 1,238 726 1,109 - 5,601
Income tax expense (benefit)... 915 216 53 (133) (51)(4) 1,000
Net income..................... 1,563 380 95 (10) (88) 1,940
Operating net income(1)........ 1,247 381 95 3 (88) 1,638
Receivables.................... 87,839 19,670 13,263 308 - 121,080
Assets......................... 89,809 20,049 14,236 28,921 (8,600)(5) 144,415
Expenditures for long-lived
assets(7).................... 18 4 20 54 - 96
-------- ------- ------- ------- ------- --------
YEAR ENDED DECEMBER 31, 2003
Net interest income............ $ 7,333 $ 1,954 $ 753 $ 148 $ - $ 10,188
Securitization related
revenue...................... 337 (6) 17 (201) - 147
Fee and other income........... 664 1,537 380 1,139 (147)(2) 3,573
Intersegment revenues.......... 107 30 12 (2) (147)(2) -
Provision for credit losses.... 4,275 1,598 359 3 7(3) 6,242
Depreciation and
amortization................. 14 52 30 295 - 391
HSBC acquisition related costs
incurred by HSBC Finance
Corporation.................. - - - 198 - 198
Total costs and expenses....... 2,358 1,099 530 1,204 - 5,191
Income tax expense (benefit)... 631 287 90 (80) (56)(4) 872
Net income..................... 1,061 500 170 (30) (98) 1,603
Operating net income(1)........ 1,061 500 170 137 (98) 1,770
Receivables.................... 87,104 19,552 11,003 920 - 118,579
Assets......................... 89,791 22,505 11,923 29,754 (8,720)(5) 145,253
Expenditures for long-lived
assets(7).................... 30 3 18 83 - 134
-------- ------- ------- ------- ------- --------
OWNED BASIS
SECURITIZATION CONSOLIDATED
ADJUSTMENTS TOTALS
------------------------------- -----------------------------
(IN MILLIONS)
YEAR ENDED DECEMBER 31, 2004
Net interest income............ $ (2,455)(6) $ 7,802
Securitization related
revenue...................... 3,012(6) 1,008
Fee and other income, excluding
gain on sale of domestic
private label credit card
receivables.................. (745)(6) 3,402
Gain on bulk sale of domestic
private label credit card
receivables.................. - 663
Intersegment revenues.......... - -
Provision for credit losses.... (188)(6) 4,334
Depreciation and
amortization................. - 483
Total costs and expenses....... - 5,601
Income tax expense (benefit)... - 1,000
Net income..................... - 1,940
Operating net income(1)........ - 1,638
Receivables.................... (14,225)(8) 106,855
Assets......................... (14,225)(8) 130,190
Expenditures for long-lived
assets(7).................... - 96
-------- --------
YEAR ENDED DECEMBER 31, 2003
Net interest income............ $ (2,874)(6) $ 7,314
Securitization related
revenue...................... 1,314(6) 1,461
Fee and other income........... (715)(6) 2,858
Intersegment revenues.......... - -
Provision for credit losses.... (2,275)(6) 3,967
Depreciation and
amortization................. - 391
HSBC acquisition related costs
incurred by HSBC Finance
Corporation.................. - 198
Total costs and expenses....... - 5,191
Income tax expense (benefit)... - 872
Net income..................... - 1,603
Operating net income(1)........ - 1,770
Receivables.................... (26,201)(8) 92,378
Assets......................... (26,201)(8) 119,052
Expenditures for long-lived
assets(7).................... - 134
-------- --------
---------------
(1) This non-GAAP financial measure is provided for comparison of our operating
trends only and should be read in conjunction with our owned basis GAAP
financial information. Operating net income in 2004 excludes the gain on the
bulk sale of domestic private label credit card receivables of $423 million
(after-tax) and the impact of the adoption of FFIEC charge-off policies for
the domestic private label (excluding retail sales contracts at our consumer
lending business) and MasterCard/Visa credit card portfolios of $121 million
(after-tax). In 2003, operating net income excludes $167 million (after-tax)
of HSBC acquisition related costs and other merger related items incurred by
HSBC Finance Corporation. In 2002, operating net income excludes the $333
million (after-tax) for the settlement charge and related expenses and the
loss of $240 million (after-tax) from the disposition of Thrift assets and
deposits. See "Basis of Reporting" for additional discussion on the use of
non-GAAP financial measures.
(2) Eliminates intersegment revenues.
(3) Eliminates bad debt recovery sales between operating segments.
(4) Tax benefit associated with items comprising adjustments/reconciling items.
(5) Eliminates investments in subsidiaries and intercompany borrowings.
(6) Reclassifies net interest income, fee income and provision for credit losses
relating to securitized receivables to other revenues.
(7) Includes goodwill associated with purchase business combinations other than
the HSBC merger as well as capital expenditures.
(8) Represents receivables serviced with limited recourse.
182
23. COMMITMENTS AND CONTINGENT LIABILITIES
--------------------------------------------------------------------------------
LEASE OBLIGATIONS: We lease certain offices, buildings and equipment for periods
which generally do not exceed 25 years. The leases have various renewal options.
The office space leases generally require us to pay certain operating expenses.
Net rental expense under operating leases was $132 million in 2005, $117 million
in 2004, $112 million in the period March 29 through December 31, 2003 and $36
million in the period January 1 through March 28, 2003.
We have lease obligations on certain office space which has been subleased
through the end of the lease period. Under these agreements, the sublessee has
assumed future rental obligations on the lease.
Future net minimum lease commitments under noncancelable operating lease
arrangements were:
MINIMUM MINIMUM
RENTAL SUBLEASE
YEAR ENDING DECEMBER 31, PAYMENTS INCOME NET
----------------------------------------------------------------------------------------
(IN MILLIONS)
2006........................................................ $197 $ 76 $121
2007........................................................ 136 28 108
2008........................................................ 118 28 90
2009........................................................ 96 27 69
2010........................................................ 61 16 45
Thereafter.................................................. 123 1 122
---- ---- ----
Net minimum lease commitments............................... $731 $176 $555
==== ==== ====
In January 2006 we entered into a lease for a building in the Village of
Mettawa, Illinois. The new facility will consolidate our Prospect Heights, Mount
Prospect and Deerfield offices. Construction of the building will begin in the
spring of 2006 with the move planned for first and second quarter 2008. An
estimate of the future net minimum lease commitment associated with this lease
will not be finalized until later in 2006.
LITIGATION: Both we and certain of our subsidiaries are parties to various legal
proceedings resulting from ordinary business activities relating to our current
and/or former operations which affect all three of our reportable segments.
Certain of these activities are or purport to be class actions seeking damages
in significant amounts. These actions include assertions concerning violations
of laws and/or unfair treatment of consumers.
Due to the uncertainties in litigation and other factors, we cannot be certain
that we will ultimately prevail in each instance. Also, as the ultimate
resolution of these proceedings is influenced by factors that are outside of our
control, it is reasonably possible our estimated liability under these
proceedings may change. However, based upon our current knowledge, our defenses
to these actions have merit and any adverse decision should not materially
affect our consolidated financial condition, results of operations or cash
flows.
OTHER COMMITMENTS: At December 31, 2005, our mortgage services business had
commitments with numerous correspondents to purchase up to $1.6 billion of real
estate secured receivables at fair market value, subject to availability based
on underwriting guidelines specified by our mortgage services business. These
commitments have terms of up to one year and can be renewed upon mutual
agreement.
24. FAIR VALUE OF FINANCIAL INSTRUMENTS
--------------------------------------------------------------------------------
We have estimated the fair value of our financial instruments in accordance with
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments" ("SFAS No.
107"). Fair value estimates, methods and assumptions set forth below for our
financial instruments are made solely to comply with the requirements of SFAS
No. 107 and should be read in conjunction with the financial statements and
notes in this Annual Report.
183
A significant portion of our financial instruments do not have a quoted market
price. For these items, fair values were estimated by discounting estimated
future cash flows at estimated current market discount rates. Assumptions used
to estimate future cash flows are consistent with management's assessments
regarding ultimate collectibility of assets and related interest and with
estimates of product lives and repricing characteristics used in our
asset/liability management process. All assumptions are based on historical
experience adjusted for future expectations. Assumptions used to determine fair
values for financial instruments for which no active market exists are
inherently judgmental and changes in these assumptions could significantly
affect fair value calculations.
As required under generally accepted accounting principles, a number of other
assets recorded on the balance sheets (such as acquired credit card
relationships, the value of consumer lending relationships for originated
receivables and the franchise values of our business units) are not considered
financial instruments and, accordingly, are not valued for purposes of this
disclosure. However, on March 29, 2003, as a result of our acquisition by HSBC,
these other assets were adjusted to their fair market value based, in part, on
third party valuation data, under the "push-down" method of accounting. (See
Note 3, "Acquisitions.") We believe there continues to be substantial value
associated with these assets based on current market conditions and historical
experience. Accordingly, the estimated fair value of financial instruments, as
disclosed, does not fully represent our entire value, nor the changes in our
entire value.
The following is a summary of the carrying value and estimated fair value of our
financial instruments:
AT DECEMBER 31,
-------------------------------------------------------------------------
2005 2004
----------------------------------- -----------------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
VALUE FAIR VALUE DIFFERENCE VALUE FAIR VALUE DIFFERENCE
------------------------------------------------------------------------------------------------------
(IN MILLIONS)
ASSETS:
Cash....................... $ 903 $ 903 $ - $ 392 $ 392 $ -
Interest bearing deposits
with banks............... 384 384 - 603 603 -
Securities purchased under
agreements to resell..... 78 78 - 2,651 2,651 -
Securities................. 4,051 4,051 - 3,645 3,645 -
Receivables................ 136,989 137,591 602 104,815 105,314 499
Due from affiliates........ 518 518 - 604 604 -
Derivative financial
assets................... 234 234 - 4,049 4,049 -
--------- --------- ------- --------- --------- -------
Total assets............... 143,157 143,759 602 116,759 117,258 499
--------- --------- ------- --------- --------- -------
LIABILITIES:
Deposits................... (37) (37) - (47) (47) -
Commercial paper, bank and
other borrowings......... (11,417) (11,417) - (9,013) (9,013) -
Due to affiliates.......... (15,534) (15,568) (34) (13,789) (13,819) (30)
Long term debt............. (105,163) (106,314) (1,151) (85,378) (86,752) (1,374)
Insurance policy and claim
reserves................. (1,291) (1,336) (45) (1,303) (1,370) (67)
Derivative financial
liabilities.............. (292) (292) - (70) (70) -
--------- --------- ------- --------- --------- -------
Total liabilities.......... (133,734) (134,964) (1,230) (109,600) (111,071) (1,471)
--------- --------- ------- --------- --------- -------
Total...................... $ 9,423 $ 8,795 $ (628) $ 7,159 $ 6,187 $ (972)
========= ========= ======= ========= ========= =======
184
CASH: Carrying value approximates fair value due to cash's liquid nature.
INTEREST BEARING DEPOSITS WITH BANKS: Carrying value approximates fair value due
to the asset's liquid nature.
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL: The fair value of securities
purchased under agreements to resell approximates carrying value due to their
short-term maturity.
SECURITIES: Securities are classified as available-for-sale and are carried at
fair value on the balance sheets. Fair values are based on quoted market prices
or dealer quotes. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.
RECEIVABLES: The fair value of adjustable rate receivables generally
approximates carrying value because interest rates on these receivables adjust
with changing market interest rates. The fair value of fixed rate consumer
receivables was estimated by discounting future expected cash flows at interest
rates which approximate the current interest rates that would achieve a similar
return on assets with comparable risk characteristics. Receivables also includes
our interest-only strip receivables. The interest-only strip receivables are
carried at fair value on our balance sheets. Fair value is based on an estimate
of the present value of future cash flows associated with securitizations of
certain real estate secured, auto finance, MasterCard and Visa, private label
and personal non-credit card receivables.
DEPOSITS: The fair value of our savings and demand accounts equaled the carrying
amount as stipulated in SFAS No. 107. The fair value of fixed rate time
certificates was estimated by discounting future expected cash flows at interest
rates that we offer on such products at the respective valuation dates.
COMMERCIAL PAPER, BANK AND OTHER BORROWINGS: The fair value of these instruments
approximates existing carrying value because interest rates on these instruments
adjust with changes in market interest rates due to their short-term maturity or
repricing characteristics.
DUE TO AFFILIATES: The estimated fair value of our debt instruments due to
affiliates was determined by discounting future expected cash flows at interest
rates offered for similar types of debt instruments. Carrying value is typically
used to estimate the fair value of floating rate debt.
LONG TERM DEBT: The estimated fair value of our fixed rate debt instruments was
determined using either quoted market prices or by discounting future expected
cash flows at current interest rates offered for similar types of debt
instruments. Carrying value is typically used to estimate the fair value of
floating rate debt.
INSURANCE POLICY AND CLAIM RESERVES: The fair value of insurance reserves for
periodic payment annuities was estimated by discounting future expected cash
flows at estimated market interest rates at December 31, 2005 and 2004. The fair
value of other insurance reserves is not required to be determined in accordance
with SFAS No. 107.
DERIVATIVE FINANCIAL ASSETS AND LIABILITIES: All derivative financial assets and
liabilities, which exclude amounts receivable from or payable to swap
counterparties, are carried at fair value on the balance sheet. Where practical,
quoted market prices were used to determine fair value of these instruments. For
non-exchange traded contracts, fair value was determined using discounted cash
flow modeling techniques in lieu of market value quotes. We enter into foreign
exchange contracts to hedge our exposure to currency risk on foreign denominated
debt. We also enter into interest rate contracts to hedge our exposure to
interest rate risk on assets and liabilities, including debt. As a result,
decreases/increases in the fair value of derivative financial instruments which
have been designated as effective hedges are offset by a corresponding
increase/decrease in the fair value of the individual asset or liability being
hedged. See Note 15, "Derivative Financial Instruments," for additional
discussion of the nature of these items.
25. ATTORNEY GENERAL SETTLEMENT
--------------------------------------------------------------------------------
In October 2002, we reached agreement with a multi-state working group of state
attorneys general and regulatory agencies to effect a nationwide resolution of
alleged violations of Federal and/or state consumer protection, consumer
financing and banking laws and regulations with respect to secured real estate
lending from Household Finance Corporation and Beneficial Corporation and their
subsidiaries conducting retail
185
branch consumer lending operations. This agreement, and related subsequent
consent decrees and similar documentation entered into with each of the 50
states and the District of Columbia, are referred to collectively as the
"Multi-State Settlement Agreement", which became effective on December 16, 2002.
Pursuant to the Multi-State Settlement Agreement, we funded a $484 million
settlement fund that was divided among the states (and the District of
Columbia), with each state receiving a proportionate share of the funds based
upon the volume of the retail branch originated real estate secured loans we
made in that state during the period of January 1, 1999 to September 30, 2002.
No fines, penalties or punitive damages were assessed by the states pursuant to
the Multi-State Settlement Agreement.
In August 2003, notices of a claims procedure were distributed to holders of
approximately 591,000 accounts identified as having potential claims.
Approximately 82% of customers accepted funds in settlement and had executed a
release of all civil claims against us relating to the specified consumer
lending practices. All checks were mailed. Each state agreed that the settlement
resolves all current civil investigations and proceedings by the attorneys
general and state lending regulators relating to the lending practices at issue.
We recorded a pre-tax charge of $525 million ($333 million after-tax) during the
third quarter of 2002 related to the Multi-State Settlement Agreement. The
charge reflects the costs of this settlement agreement and related matters and
has been reflected in the statement of income in total costs and expenses.
26. 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 having similar economic
characteristics that would cause their ability to meet contractual obligations
to be similarly affected by changes in economic or other conditions.
We generally serve non-conforming and non-prime consumers. Such customers are
individuals who have limited credit histories, modest incomes, high
debt-to-income ratios or have experienced credit problems caused by occasional
delinquencies, prior charge-offs, bankruptcy or other credit related actions. As
a result, the majority of our secured receivables have a high loan-to-value
ratio. Due to customer demand we offer interest-only loans and expect to
continue to do so. These interest-only loans allow customers to pay only the
accruing interest for a period of time which results in lower payments during
the initial loan period. Depending on a customer's financial situation, the
subsequent increase in the required payment to begin making payment towards the
loan principal could affect our customer's ability to repay the loan at some
future date when the interest rate resets and/or principal payments are
required. As with all our other non-conforming and nonprime loan products, we
underwrite and price interest only loans in a manner that is appropriate to
compensate for their higher risk. At December 31, 2005, the outstanding balance
of our interest-only loans was $4.7 billion, or 3.3% of managed receivables.
Because we primarily lend to consumers, we do not have receivables from any
industry group that equal or exceed 10 percent of total owned or managed
receivables at December 31, 2005 and 2004. We lend nationwide and our
receivables on both an owned and managed basis are distributed as follows at
December 31, 2005:
PERCENT OF TOTAL
DOMESTIC
STATE/REGION RECEIVABLES
-------------------------------------------------------------------------------
California.................................................. 12%
Midwest (IL, IN, IA, KS, MI, MN, MO, NE, ND, OH, SD, WI).... 23
Southeast (AL, FL, GA, KY, MS, NC, SC, TN).................. 21
Middle Atlantic (DE, DC, MD, NJ, PA, VA, WV)................ 15
Southwest (AZ, AR, LA, NM, OK, TX).......................... 10
Northeast (CT, ME, MA, NH, NY, RI, VT)...................... 10
West (AK, CO, HI, ID, MT, NV, OR, UT, WA, WY)............... 9
186
27. GEOGRAPHIC DATA
--------------------------------------------------------------------------------
The tables below summarize our owned basis assets, revenues and income before
income taxes by material country. Purchase accounting adjustments are reported
within the appropriate country.
AT DECEMBER 31,
-----------------------------------------------------------
IDENTIFIABLE ASSETS LONG-LIVED ASSETS(1)
------------------------------ --------------------------
2005 2004 2003 2005 2004 2003
-----------------------------------------------------------------------------------------------
(IN MILLIONS)
United States..................... $145,955 $115,938 $107,342 $9,382 $ 8,974 $ 9,132
United Kingdom.................... 7,006 11,468 9,401 403 942 809
Canada............................ 3,479 2,581 2,183 153 129 137
Europe............................ 229 203 126 3 3 2
-------- -------- -------- ------ ------- -------
Total............................. $156,669 $130,190 $119,052 $9,941 $10,048 $10,080
======== ======== ======== ====== ======= =======
---------------
(1) Includes properties and equipment, goodwill and acquired intangibles.
YEAR ENDED DECEMBER 31,
---------------------------------------------------------
REVENUES INCOME BEFORE INCOME TAXES
--------------------------- ---------------------------
2005 2004 2003 2005 2004 2003
--------------------------------------------------------------------------------------------------
(IN MILLIONS)
United States.......................... $16,003 $14,346 $13,146 $2,609 $2,858 $2,235
United Kingdom......................... 1,563 1,316 1,091 (37) 6 147
Canada................................. 450 340 284 96 82 68
Europe................................. 31 16 40 (5) (6) 25
------- ------- ------- ------ ------ ------
Total.................................. $18,047 $16,018 $14,561 $2,663 $2,940 $2,475
======= ======= ======= ====== ====== ======
187
HSBC Finance Corporation
--------------------------------------------------------------------------------
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
THREE THREE THREE THREE THREE THREE THREE THREE
MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED ENDED ENDED ENDED ENDED
DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
2005 2005 2005 2005 2004 2004 2004 2004
------------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Finance and other interest
income........................ $3,725 $3,402 $3,139 $2,950 $3,001 $2,779 $2,637 $2,528
Interest expense................ 1,427 1,239 1,104 1,062 918 810 707 708
------ ------ ------ ------ ------ ------ ------ ------
Net interest income............. 2,298 2,163 2,035 1,888 2,083 1,969 1,930 1,820
Provision for credit losses on
owned receivables............. 1,310 1,361 1,031 841 1,286 1,123 997 928
------ ------ ------ ------ ------ ------ ------ ------
Net interest income after
provision for credit losses... 988 802 1,004 1,047 797 846 933 892
------ ------ ------ ------ ------ ------ ------ ------
Securitization related
revenue....................... 31 41 54 85 127 267 266 348
Insurance revenue............... 239 229 229 221 221 203 204 211
Investment income............... 35 33 33 33 30 36 30 41
Fee income...................... 469 439 354 306 282 302 242 265
Derivative income (expense)..... (34) (53) 76 260 263 72 124 52
Taxpayer financial services
income........................ 17 (1) 18 243 8 (3) 6 206
Other income.................... 386 414 360 314 164 163 180 100
Gain on bulk sale of private
label receivables............. - - - - 663 - - -
------ ------ ------ ------ ------ ------ ------ ------
Total other revenues............ 1,143 1,102 1,124 1,462 1,758 1,040 1,052 1,223
------ ------ ------ ------ ------ ------ ------ ------
Salaries and fringe benefits.... 536 513 526 497 472 472 457 485
Sales incentives................ 108 117 90 82 104 91 90 78
Occupancy and equipment
expense....................... 82 83 82 87 86 77 77 83
Other marketing expenses........ 170 196 185 180 199 174 131 132
Other servicing and
administrative expenses....... 235 149 143 258 209 235 198 226
Support services from HSBC
affiliates.................... 237 226 217 209 194 183 196 177
Amortization of acquired
intangibles................... 65 90 83 107 85 83 79 116
Policyholders' benefits......... 109 109 116 122 113 93 93 113
------ ------ ------ ------ ------ ------ ------ ------
Total costs and expenses........ 1,542 1,483 1,442 1,542 1,462 1,408 1,321 1,410
------ ------ ------ ------ ------ ------ ------ ------
Income before income taxes...... 589 421 686 967 1,093 478 664 705
Income taxes.................... 196 140 214 341 381 153 231 235
------ ------ ------ ------ ------ ------ ------ ------
Net income...................... $ 393 $ 281 $ 472 $ 626 $ 712 $ 325 $ 433 $ 470
====== ====== ====== ====== ====== ====== ====== ======
Operating net income(1)......... $ 393 $ 281 $ 472 $ 626 $ 410 $ 325 $ 433 $ 470
====== ====== ====== ====== ====== ====== ====== ======
---------------
(1)Operating net income is a non-GAAP financial measure and is provided for
comparison of our operating trends only and should be read in conjunction
with our owned basis GAAP financial information. For 2004, operating net
income excludes the $121 million decrease in net income relating to the
adoption of Federal Financial Institutions Examination Council charge-off
policies for our domestic private label (excluding retail sales contracts at
our consumer lending business) and MasterCard/ Visa receivables and the $423
million (after-tax) gain on the bulk sale of domestic private label
receivables to an affiliate.
188
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
--------------------------------------------------------------------------------
There were no disagreements on accounting and financial disclosure matters
between HSBC Finance Corporation and its independent accountants during 2005.
ITEM 9A. 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 Finance Corporation
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 outside 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.
There have been no significant changes in our internal and disclosure controls
or in other factors which could significantly affect internal and disclosure
controls subsequent to the date that we carried out our evaluation.
HSBC Finance Corporation continues the process to complete a thorough review of
its internal controls as part of its preparation for compliance with the
requirements of Section 404 of the Sarbanes-Oxley Act of 2002. Section 404
requires our management to report on, and our external auditors to attest to,
the effectiveness of our internal control structure and procedures for financial
reporting. As a non-accelerated filer under Rule 12b-2 of the Exchange Act, our
first report under Section 404 will be contained in our Form 10-K for the period
ended December 31, 2007.
ITEM 9B. OTHER INFORMATION.
--------------------------------------------------------------------------------
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
--------------------------------------------------------------------------------
DIRECTORS
Set forth below is certain biographical information relating to the members of
HSBC Finance Corporation's Board of Directors. Each director is elected
annually. There are no family relationships among the directors.
WILLIAM R. P. DALTON, age 62, joined HSBC Finance Corporation's Board in April
2003. Mr. Dalton retired in May 2004 as an Executive Director of HSBC Holdings
plc, a position he held from April 1998. He also served HSBC as Global Head of
Personal Financial Services from August 2000 to May 2004. From April 1998 to
January 2004 he was Chief Executive of HSBC Bank plc. Mr. Dalton held positions
with various HSBC entities for 24 years.
Mr. Dalton is a member of the Compensation Committee.
GARY G. DILLON, age 71, joined HSBC Finance Corporation's Board in 1984. Mr.
Dillon retired as Chairman of the Board of Schwitzer Group (a manufacturer of
engine components) on March 1, 1999. He had served as Chairman of Schwitzer from
1991 and Chief Executive Officer of Schwitzer from 1989. From 1989 to 1997 he
also served as President of Schwitzer. Prior to 1989 he was President and Chief
Executive Officer of Household Manufacturing, Inc., the former diversified
manufacturing subsidiary of HSBC Finance Corporation.
189
Mr. Dillon is a member of the Compensation, Executive, Offering and Audit
Committees.
J. DUDLEY FISHBURN, age 59, joined HSBC Finance Corporation's Board in 1995. Mr.
Fishburn became Chairman of the Board of HFC Bank Ltd. (HSBC Finance
Corporation's primary subsidiary in the United Kingdom) in 1998. He previously
served as the Conservative Member of Parliament for Kensington in London from
1988 to 1997. Prior to entering Parliament, Mr. Fishburn was Executive Editor
for The Economist Newspaper Ltd. from 1979 until 1988. He is also a Director of
Altria Inc., First NIS Fund (Luxembourg), Henderson Smaller Companies Investment
Trust plc, The Beazley Group plc, and a Trustee of The Peabody Trust.
Mr. Fishburn is a member of the Nominating & Governance Committee.
CYRUS F. FREIDHEIM, JR., age 70, joined HSBC Finance Corporation's Board in
1992. Mr. Freidheim served as Chairman of the Board and Chief Executive Officer
of Chiquita Brands International, Inc. from March 2002 until January 2004 and
Chairman until May 2004. In March 2002, he retired as Vice Chairman of Booz,
Allen & Hamilton, Inc. (a management consulting firm), with which he had been
affiliated since 1966. He is also a Director of Allegheny Energy, Inc.,
Hollinger International, Inc. and SITEL Corp., Inc. and a Trustee of Thunderbird
Galvin School of Institutional Management and a Trustee of the Brookings
Institution. He was a director until March 2002 of Arasys, Inc. and
Pharmaceutical Industries LLC and until May 2000 of Security Capital Group, Inc.
Mr. Freidheim is the Lead Director and a such is the Chair of the Executive
Committee and an ex-officio member of the Audit, Compensation and Nominating and
Governance Committees.
ROBERT K. HERDMAN, age 57, joined HSBC Finance Corporation's Board in 2004. He
also serves as a member of the Board of Directors of HSBC North America
Holdings, Inc. Mr. Herdman is a Managing Director of Kalorama Partners LLC, a
Washington, D.C. consulting firm. Mr. Herdman was the Chief Accountant of the
U.S. Securities and Exchange Commission from October 2001 to November 2002. The
Chief Accountant serves as the principal advisor to the Commission on accounting
and auditing matters, and is responsible for formulating and administering the
accounting program and policies of the Commission. Prior to joining the SEC, Mr.
Herdman was Ernst & Young's Vice Chairman of Professional Practice for its
Assurance and Advisory Business Services (AABS) practice in the Americas and the
Global Director of AABS Professional Practice for Ernst & Young International.
Mr. Herdman was the senior E&Y partner responsible for the firms' relationships
with the SEC, Financial Accounting Standards Board (FASB) and American Institute
of Certified Public Accountants (AICPA). He was on the AICPA's SEC Practice
Section Executive Committee (1995-2001) and a member of the AICPA's Board of
Directors (2000-2001). Mr. Herdman is a member of the Board of Directors of
Westwood One, Inc. (chair of the Audit Committee and member of the Nominating
and Governance Committee), and a member of the Board of Advisors of EPG, Inc., a
family-owned business in Aurora, Ohio and of Stadia Capital LLC, a New York
hedge fund.
Mr. Herdman is Chair of the Audit Committee.
ALAN W. JEBSON, age 56, joined HSBC Finance Corporation's Board in 2003. He is
an Executive Director and the current Chief Operating Officer of HSBC with
responsibility for HSBC's worldwide operational functions and for managing
certain head office departments. Mr. Jebson has announced his intention to
retire from HSBC effective May 2006. Mr. Jebson joined The Hongkong and Shanghai
Banking Corporation Limited in 1978 as Manager Computer Audit before serving
with The Saudi British Bank in technical services and planning roles. He has
worked in various IT capacities in Hong Kong and London for HSBC from 1978 until
becoming its Chief Operating Officer in June 2003. He served as Group General
Manager, Information Technology in April 1996 and was appointed Group IT
Director and an Executive Director of HSBC Holdings in 2000.
Mr. Jebson is an ex-officio member of the Audit Committee.
GEORGE A. LORCH, age 64, joined HSBC Finance Corporation's Board in 1994. In
August 2000, Mr. Lorch became a Chairman Emeritus of Armstrong Holdings, Inc.
From May until August 2000, Mr. Lorch served as Chairman and President and Chief
Executive Officer of Armstrong Holdings, Inc. (the parent of Armstrong
190
World Industries, Inc.). Mr. Lorch served as Chairman of the Board of Armstrong
World Industries, Inc. (a manufacturer of interior finishes) from 1994 and
President and Chief Executive Officer from 1993 until May 2000. Mr. Lorch is a
Director of The Williams Companies, Inc., Autoliv, Inc. and Pfizer Inc.
Mr. Lorch is Chair of the Compensation Committee and a member of the Nominating
& Governance Committee.
SIDDHARTH N. MEHTA, age 47, is the Chairman and Chief Executive Officer of HSBC
Finance Corporation since May 2005 and Chief Executive Officer of HSBC North
America Holdings Inc. since March 2005. He is also Group Managing Director of
HSBC Holdings plc, with responsibility for the strategic management of consumer
finance and credit cards throughout the HSBC Group. Mr. Mehta joined HSBC
Finance Corporation in 1998 as Group Executive - Credit Card Services. Prior to
joining HSBC Finance Corporation, Mr. Mehta was Senior Vice President at The
Boston Consulting Group in Los Angeles and co-leader of Boston Consulting Group
Financial Services Practice in the United States. Mr. Mehta serves on the board
of directors for MasterCard International, U.S. region, and the board of
international advisors for the Monterey, California, Institute of International
Studies. He is a member of the Financial Services Roundtable and serves on the
board of advisors for the Myelin Repair Foundation, a not-for-profit
organization working to fund research for multiple sclerosis.
Mr. Mehta is a member of the Executive Committee.
LARREE M. RENDA, age 47, joined HSBC Finance Corporation's Board in 2001. Ms.
Renda has been employed by Safeway Inc. since 1974. She became Executive Vice
President, Chief Strategist and Administrative Officer in November, 2005. Prior
to her current position she served as Executive Vice President for Retail
Operations, Human Resources, Public Affairs, Labor and Government Relations
since 1999. Prior to this position, she was a Senior Vice President from 1994 to
1999, and a Vice President from 1991 to 1994. She is also a director and
Chairwoman of the Board of The Safeway Foundation and serves on the board of
directors for Casa Ley, S.A. de C.V. in which Safeway Inc. holds a 49% interest.
Ms. Renda is a member of the Retailing Initiative Advisory Board of the Wharton
School of Business and serves as a trustee on the National Joint Labor
Management Committee. Additionally she serves on the board of directors of both
the California and U.S. Chamber of Commerce.
Ms. Renda is Chair of the Nominating & Governance Committee and a member of the
Audit Committee.
191
EXECUTIVE OFFICERS
Information regarding the executive officers of HSBC Finance Corporation as of
March 6, 2006 is presented in the following table.
-----------------------------------------------------------------------------------------------
YEAR
NAME AGE APPOINTED PRESENT POSITION
-----------------------------------------------------------------------------------------------
Siddharth N. Mehta 47 2005 Chairman and Chief Executive Officer
Sandra L. Derickson 52 2000 Vice Chairman
David D. Gibbons 50 2004 Senior Executive Vice President - Chief Risk
Officer
Simon Penney 57 2003 Senior Executive Vice President
Kenneth H. Robin 59 1989 Senior Executive Vice President - General Counsel
& Corporate Secretary
Andrew C. Armishaw 43 2004 Group Executive - Chief Information Officer
James B. Kauffman 58 2002 Executive Vice President - Policy & Compliance
Steven B. Gonabe 54 2005 Executive Vice President - Administration
Lisa M. Sodeika 42 2004 Executive Vice President - Corporate Affairs
Beverley A. Sibblies 44 2004 Senior Vice President - Chief Financial Officer
J. Denis O'Toole 61 2003 Senior Vice President - Government Relations
Faye M. Polayes 54 2004 Senior Vice President - Taxes
Edgar D. Ancona 53 2002 Senior Vice President - Treasurer
Bruce A. Fletcher 45 2005 Senior Vice President - Chief Credit Officer
Patrick A. Cozza 50 2004 Group Executive
Thomas M. Detelich 49 2002 Group Executive
Walter G. Menezes 60 2004 Group Executive
John J. Haines 42 2004 Managing Director - Auto Finance
Joseph W. Hoff 55 2005 Managing Director - Retail Services
Gary R. Esposito 45 2005 Managing Director - Mortgage Services
James E. Binyon 42 2006 Vice President and Chief Accounting Officer
-----------------------------------------------------------------------------------------------
Sandra L. Derickson, Vice Chairman of HSBC Finance Corporation since May 2004
and Group Executive of HSBC North America Holdings Inc. since August 2004. From
May 2001 to August 2002 she served as Managing Director-Retail Services of
Household International, Inc., and from August 2002 to May 2004 she served as
Group Executive with responsibilities for insurance, taxpayer financial services
and auto finance businesses and the HFC Bank - UK operations, as well as the
private label credit card operations. Prior to joining HSBC Finance Corporation
Ms. Derickson was an officer at General Electric Company from 1991 until 1999.
Ms. Derickson is also a member of the Board of Directors of Hexcel Corporation.
David D. Gibbons, Senior Executive Vice President, Chief Risk Officer of HSBC
Finance Corporation and of HSBC North America Holdings Inc. since March 2004.
Prior to that Mr. Gibbons was Deputy Comptroller for Special Supervision from
October 2002 to March 2004, Mr. Gibbons was with the OCC from September 1977 to
March 2004 and Deputy Comptroller of the Currency for Credit Risk from 1997 to
2002.
Simon Penney, Senior Executive Vice President of HSBC Finance Corporation since
May 2003 and Senior Executive Vice President and Chief Financial Officer of HSBC
North America Holdings Inc. since January 2004. From May 2003 until October 2005
Mr. Penney served as Chief Financial Officer of HSBC Finance Corporation. From
1995 to April 2003 he was Chief Financial Officer and a member of the executive
committee of the Hongkong and Shanghai Banking Corporation Limited. In 1999 he
was also appointed a non-executive director and a member of the audit committee
of Hang Seng Bank Ltd., a 62.14% owned subsidiary of HSBC. Mr. Penney has spent
a total of 23 years working for various subsidiaries of the HSBC Group.
192
Kenneth H. Robin, Senior Executive Vice President, General Counsel and Corporate
Secretary of HSBC Finance Corporation since May 2003 and Senior Executive Vice
President, General Counsel and Corporate Secretary of HSBC North America
Holdings Inc. since January 2004. Prior to that Mr. Robin was Senior Vice
President, General Counsel and Corporate Secretary of Household International,
Inc., the predecessor of HSBC Finance Corporation, since 1993.
Andrew C. Armishaw, Group Executive and Chief Information Officer of HSBC
Finance Corporation and Senior Executive Vice President and Chief Information
Officer of HSBC North America Holdings Inc. since January 2004. From January
2001 to December 2003 Mr. Armishaw was Head of Global Resourcing for HSBC and
from 1994 to 1999 was Chief Executive Officer of First Direct (a subsidiary of
HSBC) and Chief Information Officer of First Direct.
James B. Kauffman, Executive Vice President of Policy and Compliance of HSBC
Finance Corporation and of HSBC North America Holdings Inc. since February 2004.
Mr. Kauffman joined HSBC Finance Corporation in June 2002 as Vice President of
Compliance and became Executive Vice President on February 2004. From March 2001
to June 2002 Mr. Kauffman served as Secretary of Banking of the Commonwealth of
Pennsylvania, served as Chairman of the Board of Directors of the Pennsylvania
Housing Finance Agency and sat on several other state economic development
boards. From January 1994 to December 1998, Mr. Kauffman served as Chairman and
Chief Executive Office of Keystone Bank. Mr. Kauffman also served as Chief
Credit Policy Officer for Keystone Financial, Inc. from January 1994 to December
1998.
Steven B. Gonabe, Executive Vice President of Administration of HSBC Finance
Corporation and of HSBC North America Holdings Inc. since July 2005. From June
1997 to July 2005 Mr. Gonabe was Vice President of Human Resources for HSBC
credit card services, auto finance and mortgage services businesses and national
director of human resources for the credit card services group. Mr. Gonabe
serves on the board of directors for the United Way of Monterey County and is a
member of the Junior Achievement of Silicon Valley and Monterey Bay, California.
Lisa M. Sodeika, Executive Vice President of Corporate Affairs of HSBC Finance
Corporation and of HSBC North America Holdings Inc. since June 2005. Ms. Sodeika
directs HSBC North America's public relations, CRA-community development,
consumer affairs, communications, philanthropic services and government
relations activities. From January 2003 to June 2005 Ms. Sodeika was Senior Vice
President - Corporate Affairs and Vice President - Consumer Affairs. From
October 2000 to December 2002 Ms. Sodeika served as Executive Assistant to the
group executive of consumer lending and to the Vice Chairman of Household
International, Inc., and from January 2000 to October 2000 held the position of
Vice President - Underwriting for the consumer lending division.
Beverley A. Sibblies, Senior Vice President and Chief Financial Officer of HSBC
Finance Corporation and Executive Vice President of Finance of HSBC North
America Holdings Inc. since October 2005. Ms. Sibblies joined HSBC Finance
Corporation in December 2004 as the Senior Vice President and Chief Accounting
Officer. Prior to joining HSBC Finance Corporation, she served as Executive Vice
President and Chief Financial Officer for EMC Mortgage from June 2000 to
February 2004. Prior to that, she served as a partner in the financial services
practice of Deloitte & Touche, LLP from July, 1997.
J. Denis O'Toole, Senior Vice President of Government Relations of HSBC Finance
Corporation since January 2003. From September 1992 to December 2002 Mr. O'Toole
was Vice President of Government Relations and in 1992 was hired as Vice
President and Director of HSBC Finance Corporation's Federal government
relations office. From January 1989 to August 2005 Mr. O'Toole was the Executive
Vice President of the Saving and Community Bankers of America, from May 1978 to
December 1988, Director of Legislative Operations and Senior Federal Legislative
Counsel to the American Bankers Association, from April 1973 to April 1978, Vice
President of Government Relations to the National Association of Home Builders,
and from April 1972 to March 1973, a litigation attorney for the Office of
General Counsel of the U.S. Department of Housing.
Faye M. Polayes, Senior Vice President of Tax for HSBC Finance Corporation since
January 2004. She has been Executive Vice President, Tax for HSBC North America
Holdings Inc. since January 2004 and
193
Executive Vice President, Tax for HSBC Bank USA since January 1, 2000. Including
Ms. Polayes 18 years at Republic National Bank of New York as Tax Counsel, she
has been with HSBC for 23 years. Ms. Polayes has served on the Board of
Directors of the Organization for International Investment ("OFII") since June
2005. OFII is a not-for-profit organization whose members are foreign owned U.S.
corporations. It provides information to its members regarding legislative and
regulatory matters of common concern and lobbies on the Federal and state level
in connection with proposed legislation. Ms. Polayes has served on the Board of
Directors of the Jump Rhythm Jazz Project, a Chicago based dance company which
is a not-for-profit corporation, since December, 2005.
Edgar D. Ancona, Senior Vice President and Treasurer of HSBC Finance Corporation
and Executive Vice President - Asset and Liability Management of HSBC North
America Holdings Inc. since February 2004. Mr. Ancona joined HSBC Finance
Corporation in 1994, after having spent 17 years at Citicorp in various treasury
and operational functions. He is a director of HSBC Financial Corporation
Limited in Canada. Mr. Ancona is also a director of the LifeSource Blood
Services and the Central Blood Bank.
Bruce A. Fletcher, Senior Vice President and Chief Credit Officer of HSBC
Finance Corporation since April, 2005. Prior to joining HSBC Finance
Corporation, Mr. Fletcher served as Managing Director and Senior Credit Officer
for Citigroup, where during a period of more than 15 years he held a variety of
line and staff risk management positions.
Patrick A. Cozza, Group Executive of HSBC Finance Corporation since April 2004.
Prior to that Mr. Cozza became President - Refund Lending and Insurance Services
in 2002 and Managing Director and Chief Executive Officer - Refund Lending in
2000. He also serves on the board of directors of Junior Achievement in New
Jersey and Cancer Hope Network.
Thomas M. Detelich, Group Executive of HSBC Finance Corporation since July 2002.
Mr. Detelich also held the positions of Managing Director at Beneficial
Corporation from March 2000 to July 2002 and Managing Director of Household
Finance Corporation from January 1999 to July 2002 and regional general manager
of consumer lending. Mr. Detelich was formerly with Transamerica in several
management positions. He was with Transamerica for 21 years.
Walter G. Menezes, Group Executive of HSBC Finance Corporation since April 2004
and is responsible for HSBC Finance Corporation's credit card and private label
credit card operations. Mr. Menezes held the title of President and Chief
Executive Officer for Auto Finance from 2002 to August 2004 and Managing
Director and Chief Credit Officer of Credit Card Services since from 1998 to
2002. He joined HSBC Finance Corporation in 1996 as National Director
Collections - Credit Card Services.
John J. Haines, Managing Director of Auto Finance of HSBC Finance Corporation
since joining HSBC Finance Corporation in August 2004. From May 1989 to August
2004 Mr. Haines worked for General Electric where he was Senior Vice President -
Products and Services for General Electric Fleet Services and Senior Vice
President - North American Operations for General Electric Fleet Services. Mr.
Haines is a member of the Automotive Finance Committee of the Consumer Bankers
Association.
Joseph W. Hoff, Managing Director of Retail Services of HSBC Finance Corporation
since March 2005. Mr. Hoff served as Chief Financial Officer for the Retail
Services business from April 1995 to March 2005. He has been with HSBC Finance
Corporation since 1976 in various accounting and planning, acquisitions and
corporate finance lending and treasury positions.
Gary R. Esposito, Managing Director of Mortgage Services of HSBC Finance
Corporation since September 2005. Prior to that Mr. Esposito held the position
of Head of Consumer Lending Sales from November 2003 to September 2005 and was
the President, Chief Executive Officer and Chairman for HSBC Canada from
September 2000 to November 2003. He was also National Director, branch and
retail operations from 1998 through 2000. He has been with HSBC Finance
Corporation since 1982.
James E. Binyon, Vice President and Chief Accounting Officer since February
2006, and from September 2004 was Vice President and Controller of Corporate
Finance. From November 2001 to August 2004 he served as Finance Director of
First Direct, and from February 1995 to October 2001 was Senior Area
194
Accounting Manager, and Manager - Balance Sheet Management for HSBC Hong Kong.
Mr. Binyon was Manager-Asset Management & Funding, and Manager - Treasury Audit
Department between 1992 and 1995. Prior to joining HSBC, Mr. Binyon spent five
years at KPMG.
AUDIT COMMITTEE
The primary purpose of the audit committee is to assist the Board of Directors
in fulfilling its oversight responsibilities relating to HSBC Finance
Corporation's accounting, auditing and financial reporting practices. The audit
committee is currently comprised of the following independent Directors (as
defined by HSBC Finance Corporation's Corporate Governance Standards which are
based upon the rules of the New York Stock Exchange): Gary G. Dillon; Robert K.
Herdman and Larree M. Renda. In addition, Cyrus F. Freidheim, Jr., Lead
Director, and Alan W. Jebson, Chief Operating Officer of HSBC, are non-voting
members of the Committee. The Board has determined that each of these
individuals is financially literate. The Board of Directors has determined that
Robert K. Herdman qualifies as an audit committee financial expert.
CODE OF ETHICS
HSBC Finance Corporation's Board of Directors has adopted a Code of Ethics for
Senior Financial Officers. That Code of Ethics is incorporated by reference in
Exhibit 14 to this Annual Report on Form 10-K. HSBC Finance Corporation also has
a general code of ethics applicable to all employees that is referred to as its
Statement of Business Principles and Code of Ethics. That document is available
on our website at www.hsbcusa.com or upon written request made to HSBC Finance
Corporation, 2700 Sanders Road, Prospect Heights, Illinois 60070, Attention:
Corporate Secretary.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act, as amended, requires certain of our
Directors, executive officers and any persons who own more than ten percent of a
registered class of our equity securities to report their initial ownership and
any subsequent change to the SEC and the New York Stock Exchange ("NYSE"). With
respect to the 6.36% Series B Preferred Stock of HSBC Finance Corporation, we
reviewed copies of all reports furnished to us and obtained written
representations from our Directors and executive officers that no other reports
were required. Based solely on a review of copies of such forms furnished to us
and written representations from the applicable Directors and executive
officers, all Section 16(a) filing requirements were complied with for the 2005
fiscal year.
195
ITEM 11. EXECUTIVE COMPENSATION.
--------------------------------------------------------------------------------
EXECUTIVE COMPENSATION
The following tables and narrative text discuss the compensation awarded to,
earned by or paid to (i) Messrs. Aldinger and Mehta, who served as our Chief
Executive Officer during 2005, and (ii) our four other most highly compensated
executive officers who were serving as executive officers as of December 31,
2005.
SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION
-----------------------------------
AWARDS PAYOUTS
------------------------ --------
ANNUAL COMPENSATION NUMBER OF
----------------------------------------- RESTRICTED SHARES
NAME AND OTHER ANNUAL STOCK UNDERLYING LTIP
PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION(1) RIGHTS(2) OPTIONS PAYOUTS
-------------------------------------------------------------------------------------------------------------------
Siddharth N. Mehta(4, 6)... 2005 $ 900,000 $3,000,000 $ 58,831 $10,999,992 - -
Chairman & 2004 650,000 2,500,000 109,063 - 204,000 -
Chief Executive Officer 2003 550,000 2,000,000 53,000 4,999,988 408,000 -
William F. Aldinger III(5,
6)....................... 2005 $1,000,000 $ - $ 68,299 - - -
Former Chairman & 2004 1,000,000 4,000,000 162,076 - - -
Chief Executive Officer 2003 1,000,000 4,000,000 147,958 $ 9,999,986 - -
Sandra L. Derickson(6)..... 2005 $ 700,000 $2,100,000 $ 11,298 $ 8,499,990 - -
Vice Chairman 2004 600,000 1,800,000 14,158 - 102,000 -
2003 500,000 1,200,000 15,184 3,749,988 204,000 -
Thomas M. Detelich......... 2005 $ 650,000 $1,800,000 $ 6,578 $ 5,499,998 - -
Group Executive 2004 550,000 1,500,000 6,074 - 102,000 -
2003 500,000 650,000 2,481 3,749,998 204,000 -
Walter G. Menezes.......... 2005 $ 600,000 $1,300,000 $ 2,444 $ 5,499,998 - -
Group Executive 2004 500,000 1,000,000 3,755 - 150,000 -
2003 350,000 500,501 1,650 - 150,000 -
Kenneth H. Robin(6)........ 2005 $ 600,000 $1,150,000 $ 18,591 $ 3,199,986 - -
Senior EVP - 2004 400,000 1,000,000 23,923 - 102,000 -
General Counsel & 2003 400,000 900,000 22,047 1,499,997 204,000 -
Corporate Secretary
NAME AND ALL OTHER
PRINCIPAL POSITION COMPENSATION(3)
--------------------------- ---------------
Siddharth N. Mehta(4, 6)... $ 204,971
Chairman & 160,568
Chief Executive Officer 11,082,743
William F. Aldinger III(5,
6)....................... $25,603,038
Former Chairman & 310,062
Chief Executive Officer 20,461,842
Sandra L. Derickson(6)..... $ 155,151
Vice Chairman 111,259
3,316,678
Thomas M. Detelich......... $ 132,279
Group Executive 74,340
2,531,871
Walter G. Menezes.......... $ 109,582
Group Executive 63,861
1,484,830
Kenneth H. Robin(6)........ $ 105,601
Senior EVP - 88,062
General Counsel & 4,901,703
Corporate Secretary
---------------
(1) Other Annual Compensation includes items such as financial planning
services, physical exams, club initiation fees, expatriate benefits, and car
allowances. SEC rules require disclosure of the specific type and amount of
compensation when a benefit exceeds 25% of the total Other Annual
Compensation for an individual executive officer. That itemization follows:
Car allowances for Mr. Aldinger were $15,000 in each of years 2003 and 2004
and $5,481 for 2005 and for Messrs. Mehta and Robin were $11,000 for each of
2003, 2004 and 2005 respectively. (Ms. Derickson and Messrs. Detelich and
Menezes are not eligible for a car allowance). Personal use of aircraft for
Mr. Aldinger for 2003, 2004 and 2005 was $110,678, $123,291 and $56,449
respectively. Mr. Aldinger, while Chairman of HSBC Finance Corporation was
expressly directed by corporate policy to use our corporate aircraft to the
fullest extent for business and personal travel; however, the value of
personal aircraft use was reported as income. Club Initiation fees for Mr.
Mehta for 2003 and 2004 were $40,000 and $20,000 respectively. Personal use
of Corporate Apartment for Mr. Mehta in 2005 was $700, for Mr. Aldinger in
2003 was $2,880 and in 2004 was $1,020 and for Mr. Robin in 2003 was $540
and in 2004 was $1,020. Personal use of Corporate Limo for Mr. Mehta was
$8,576 in 2005, for Mr. Aldinger $7,400 in 2003, $7,600 in 2004 and $2,191
in 2005 and for Mr. Robin $335 in 2005. Financial Counseling for Mr. Mehta
was $4,000 in 2004 and $10,000 in 2005, for Mr. Aldinger $10,000 in each of
years 2003 and 2004, for Ms. Derickson $4,000 in 2003 and $3,750 in 2004,
for Mr. Detelich $481 in 2003, and $3,500 in each of 2004 and 2005, and for
Mr. Robin $4,000 in each of 2003 and 2004 and $3,100 in 2005. Executive
Physical expenses for Mr. Mehta was $1,671 in 2004 and $2,131 in 2005, for
Mr. Aldinger $3,105 for 2004 and $2,079 for 2005, for Ms. Derickson $9,184
for 2003, $2,915 for 2004 and $9,198 for 2005, for Mr. Detelich $978 in
2005, for Mr. Menezes $1,650 in 2003, $1,695 in 2004 and $344 in 2005 and
for Mr. Robin $4,507 in 2003, $2,408 in 2004 and $2,056 in 2005. All named
executive officers received Executive Umbrella Liability Coverage in the
amounts of $2,000 for 2003, $2,060 in 2004 and $2,100 in 2005. In 2004 and
2005 Mr. Mehta had $39,994 and $24,324 in relocation and moving expenses,
including a tax gross up for the 2004 payment.
(2) For 2003 this amount represents the dollar value of restricted shares issued
to the named executive officers under the HSBC Holdings Restricted Share
Plan 2000. The dollar value reflected in the table is based on the fair
market value of the underlying HSBC Holdings plc ordinary shares on April
15, 2003 (the date of grant) converted into U.S. dollars using the exchange
rate applied at the time of
196
grant. For Messrs. Aldinger and Robin the shares vest ratably over 3 years
from the date of grant. For Messrs. Mehta and Detelich and Ms. Derickson the
shares vest ratably over 5 years from the date of grant. For 2005, this
amount represents the dollar value of the restricted shares issued to the
named executive officers under the HSBC Share Plan. The named executive
officers were awarded two separate grants in 2005. The dollar value
reflected in the table is based on the fair market value of the underlying
HSBC Holdings plc ordinary shares on March 31, 2005 (the date of grant) and
on May 27, 2005 (the date of grant) and converted into U.S. dollars using
the exchange rates applied at the time of grant. The March 31, 2005 grant is
performance based and the shares will vest in whole or in part 3 years from
the date of grant if all or some of the performance conditions are met as
follows: 50% of the award is subject to a total shareholder return measure
("TRS") against a competitor group, depending on HSBC's ranking against the
group at the end of the performance period, the TRS portion of the grant may
vest on a sliding scale from 100% to 0%. The remaining 50% of the award is
subject to an earning per share measure ("EPS") and the EPS portion of the
grant may vest based on an incremental EPS percentage in accordance with a
defined formula. If the aggregate incremental EPS is less than 24%, the EPS
portion will be forfeited and if it is 52% or more, the EPS component will
vest in full. The May 27, 2005 grant was a special grant made to 6 key
executives to assist in retention and to reward outstanding performance and
vests ratably over 5 years for each of Messrs. Mehta, Detelich and Menezes
and Ms. Derickson and ratably over 2 years for Mr. Robin. These valuations
do not take into account the diminution in value attributable to the
restrictions applicable to the underlying shares. As of December 31, 2005,
the total number of shares and values of the restricted shares held by the
named executive officers were as follows: Mr. Mehta 977,057 shares
($15,683,978), Ms. Derickson 748,632 shares ($12,017,239), Mr. Detelich
559,239 shares ($8,977,053), Mr. Menezes 347,107 shares ($5,571,854) and Mr.
Robin 250,148 shares ($4,015,442). Mr. Aldinger's restricted stock vested in
full on the date of termination. The value of shares was calculated using a
share price of GBP9.33 per share and a currency exchange rate of 1.7205.
Dividend equivalents, in the form of additional shares, are paid on all
underlying shares for restricted stock at the same rate as paid to ordinary
share shareholders.
(3) Includes life insurance premiums paid by HSBC Finance Corporation in 2003,
2004 and 2005 for the benefit of executives as follows: Mr. Mehta, $3,510,
$3,645, $3,510; Mr. Aldinger, $10,062, $10,062, $3,870; Ms. Derickson,
$4,727, $5,336, $5,382; Mr. Detelich, $2,318, $3,379, $3,510; Mr. Menezes,
$6,611, $6,946, $13,813 and Mr. Robin, $10,062, $10,062, $10,062. Also
includes HSBC Finance Corporation's contribution for the named executive
officer's participation in the Tax Reduction Investment Plan and
Supplemental Tax Reduction Investment Plan in 2003, 2004 and 2005 as
follows: Mr. Mehta, $108,000, $156,923, $201,461; Mr. Aldinger, $180,000,
$300,000, $616,923; Ms. Derickson, $90,000, $105,923, $149,769; Mr.
Detelich, $69,000, $70,962, $128,769; Mr. Menezes, $42,000, $56,915, $95,769
and Mr. Robin, $66,000, $78,000, $95,539. For 2003, the remaining amounts
represent parachute payments and accelerated vesting of restricted stock
rights in connection with the change in control provisions contained in the
named executive officers' employment agreements. Mr. Aldinger's 2005
compensation also includes payments made pursuant to his employment
agreement under which he received a separation payment in the amount of
$5,000,000 and accelerated vesting of all outstanding restricted stock.
(4) Mr. Mehta assumed the role of Chairman and Chief Executive Officer of HSBC
Finance Corporation on May 1, 2005.
(5) Mr. Aldinger resigned as Chairman and Chief Executive Officer of HSBC
Finance Corporation April 30, 2005.
(6) Part of the compensation payable to these individuals includes compensation
for services rendered to HSBC North America.
INCENTIVE AND STOCK OPTION PLANS
Pre-Merger
Following HSBC's acquisition of HSBC Finance Corporation in 2003, all
outstanding options and other equity based awards approved under the Household
International 1996 Long-Term Executive Incentive Compensation Plan (the "1996
Plan") and various option plans assumed by HSBC Finance Corporation in
connection with the mergers with Beneficial Corporation in 1998 and Renaissance
Holdings, Inc. in 2000 were converted into rights to receive HSBC Holdings plc
ordinary shares in the same ratio as the share exchange offer for the
acquisition of HSBC Finance Corporation (2.675 HSBC Holdings plc ordinary shares
for each HSBC Finance Corporation common share) and the exercise prices per
share were adjusted accordingly.
All outstanding options granted prior to November 12, 2002 immediately vested on
completion of the acquisition and remain exercisable through their respective
expiration dates. Options granted on or after November 13, 2002 but prior to
March 28, 2003, the date of the completion of the merger, are exercisable on
their original terms, subject to adjustment to reflect the exchange ratio.
As of December 31, 2005, options to buy 35,251,439 shares of HSBC ordinary stock
were outstanding under the 1996 Plan and options to purchase 780,567 ordinary
shares were outstanding under the Beneficial Corporation and Renaissance
Holdings Inc. option plans. At the time of merger, HSBC established employee
benefit trusts to hold shares underlying the options. As of December 31, 2005,
the HSBC (Household) Employee Benefit Trust 2003 held 3,006,623 HSBC ordinary
shares and 2,198,829 American Depository
197
Shares, each of which represents five HSBC ordinary shares, which may be used to
satisfy the exercise of employee stock options.
The average purchase price for all outstanding options held by the 322
participants in the 1996 Plan, Beneficial Corporation and Renaissance Holdings
Inc. plans at December 31, 2005, was $16.09 with expiration dates from 2006 to
2012.
All outstanding restricted stock rights ("RSRs") granted prior to November 12,
2002 immediately vested on completion of the merger. RSRs granted after November
12, 2002 but prior to March 28, 2003 remain exercisable on their original terms,
except that they have been adjusted to reflect the exchange ratio. A holder of
RSRs is not entitled to any of the rights of a holder of ordinary shares until
the shares are issued; however, the Remuneration Committee (the "Remuneration
Committee") of HSBC Holdings plc may direct HSBC Finance Corporation to pay the
holder cash equal to the cash dividends declared on ordinary shares for each
share of stock subject to an RSR. As of December 31, 2005, 1,309,073 shares were
subject to issuance under outstanding RSR awards under the 1996 Plan. The
issuance of any underlying stock pursuant to vesting of RSRs will be newly
issued ordinary shares.
The number of options, RSRs and underlying shares will be proportionately
adjusted for any stock dividends, stock splits, consolidations or
reclassifications. No further options or other equity based awards will be
granted under any of the pre-merger plans.
Post Merger
Beginning March 28, 2003 but prior to May 27, 2005, options and other equity
based awards were made to HSBC Finance Corporation employees under the HSBC
Holdings Group Share Option Plan ("Group Share Option Plan") and the HSBC
Restricted Share Plan 2000 ("Restricted Share Plan"). Under both the Group Share
Option Plan and the Restricted Share Plan, the Remuneration Committee has the
discretion to grant employees awards of stock options or restricted shares with
or without company performance conditions. Generally option and RSR awards
granted in 2003 were granted without any company performance conditions and
options and RSR awards granted in 2004 were granted subject to performance
conditions to better align the HSBC Finance Corporation employees with the
interests of HSBC. Both the Group Share Option Plan and the Restricted Share
Plan terminated in May 2005 and no further awards may be made under either of
these plans. The number of options, RSRs and underlying shares will be
proportionately adjusted for any stock dividends, stock splits, consolidations
or reclassifications.
In May 2005, the HSBC Holdings plc Board of Directors adopted and the
shareholders approved the HSBC Share Plan ("Group Share Plan"). The Remuneration
Committee at its discretion may make awards of restricted shares and
market-price options, each with or without performance conditions. For 2005, as
an incentive and a retention tool, HSBC awarded restricted shares to middle
management and performance shares to executive management. The restricted shares
generally vest in full 3 years after the date of grant and the performance
shares will vest in full or in part 3 years after the date of grant if certain
company performance conditions are met. A holder of restricted shares or
performance shares is not entitled to any of the rights of a holder of ordinary
shares until the shares are issued; however, the Remuneration Committee may
direct the trustee of the employee benefit trusts to record a share based
dividend equivalent to the cash dividends declared on ordinary shares for each
share of stock subject to a restricted share.
As of December 31, 2005, employees of HSBC Finance Corporation held options to
buy 6,175,800 shares of HSBC ordinary stock under the Group Share Option Plan
and RSRs representing 11,787,706 under the Restricted Share Plan and the Group
Share Plan.
The average purchase price for all outstanding options held by the participants
under the Group Share Option Plan at December 31, 2005 was $14.96 with
expiration dates from 2013-2014.
HSBC Finance Corporation did not issue stock options to its named executive
officers in 2005.
198
The following table shows that the named executive officers did not exercise any
stock options in 2005. The table also shows the number of options that have not
been exercised and their potential value using the fair market value on December
31, 2005. The fair market value has been converted from British Pounds Sterling
to U.S. dollars using an exchange rate of 1.7205.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
NUMBER OF SHARES VALUE OF UNEXERCISED
UNDERLYING IN-THE-MONEY
UNEXERCISED OPTIONS AT OPTIONS AT
DECEMBER 31, 2005 DECEMBER 31, 2005(1)
SHARES VALUE --------------------------- ---------------------------
NAME EXERCISED REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
-----------------------------------------------------------------------------------------------------------
Siddharth N. Mehta....... - $- 3,034,150 541,750 $ 1,122,367 $1,088,113
William F. Aldinger
III.................... - - 9,656,750 - 16,409,788 -
Sandra L. Derickson...... - - 543,375 270,875 1,115,029 544,056
Thomas M. Detelich....... - - 576,813 270,875 1,240,219 490,028
Walter G. Menezes........ - - 500,325 251,750 639,786 438,933
Kenneth H. Robin......... - - 1,364,600 270,875 2,323,273 577,716
---------------
(1) Calculated based on the fair market value of HSBC Holdings plc. ordinary
shares on December 31, 2005 (L9.33 per share).
SAVINGS AND PENSION PLANS
HSBC North America maintains the HSBC-North America (U.S.) Tax Reduction
Investment Plan ("TRIP"), which is a deferred profit-sharing and savings plan
for its eligible employees. With certain exceptions, a U.S. employee who has
been employed for 30 days and who is not part of a collective bargaining unit
may contribute into TRIP, on a pre-tax and after-tax basis, up to 40% (15% if
highly compensated) of the participant's cash compensation (subject to a maximum
annual pre-tax contribution by a participant of $15,000, as adjusted for cost of
living increases, and certain other limitations imposed by the Internal Revenue
Code) and invest such contributions in separate equity or income funds.
If the employee has been employed for at least one year, HSBC Finance
Corporation contributes 3% of compensation on behalf of each participant who
contributes 1% and matches any additional participant contributions up to 4% of
compensation. However, matching contributions will not exceed 6% of a
participant's compensation if the participant contributes 4% or more of
compensation. The plan provides for immediate vesting of all contributions. With
certain exceptions, a participant's after-tax contributions which have not been
matched by us can be withdrawn at any time. Both our matching contributions made
prior to 1999 and the participant's after-tax contributions which have been
matched may be withdrawn after five years of participation in the plan. A
participant's pre-tax contributions and our matching contributions after 1998
may not be withdrawn except for an immediate financial hardship, upon
termination of employment, or after attaining age 59 1/2. Participants may
borrow from their TRIP accounts under certain circumstances.
HSBC North America also maintains the Supplemental Tax Reduction Investment Plan
("Supplemental TRIP") which is an unfunded plan for eligible employees of HSBC
Finance Corporation and its participating subsidiaries prior to the merger with
HSBC whose participation in TRIP is limited by the Internal Revenue Code. Only
matching contributions required to be made by us pursuant to the basic TRIP
formula are invested in Supplemental TRIP through a credit to a bookkeeping
account maintained by us which deems such contributions to be invested in equity
or income funds selected by the participant.
The HSBC-North America (U.S.) Retirement Income Plan ("RIP") is a
non-contributory, defined benefit pension plan for employees of HSBC North
America and its U.S. subsidiaries who are at least 21 years of age with one year
of service and not part of a collective bargaining unit. RIP contains plan
formulas for pre-merger Household employees as well as a cash balance formula
for hires after 1999. Under the pre-merger Household
199
formula, annual pension benefits equal a percentage of an employee's "Final
Average Salary" (as defined below) not in excess of "Covered Compensation" (as
defined below) plus a percentage of an employee's Final Average Salary that
exceeds Covered Compensation. "Covered Compensation" is the average of the
Social Security taxable wage base over the 35-year period ending in the year of
retirement or earlier termination of employment. "Final Average Salary" equals
the average of salary plus bonus for the 48 successive highest paid months out
of the employee's last 10 years of service. The percentage applied to Final
Average Salary and Covered Compensation is determined on the basis of years of
employment and age at retirement. This percentage increases as years of
employment and age at retirement increase. Participants become fully vested in
their accrued pension benefits after three years of vesting service. Payment of
vested pension benefits normally begins at age 65, but an early retirement
benefit at reduced levels may be paid if a participant is at least 55 years of
age with 10 years of employment or, if the participant was an employee on
December 31, 1989, is at least 50 years of age with 15 years of employment.
Effective January 1, 2000, RIP was amended to provide a cash balance
account-based formula instead of the traditional defined benefit formula
described above for employees hired after 1999. The account-based formula
provides a benefit based upon a percentage of compensation for each year of
service and an assumed rate of return. The contribution percentage is 2% and the
assumed rate of return is tied to the lesser of the 10-year or 30-year Treasury
rate. Effective January 1, 2005, RIP was amended to reflect the merger of the
HSBC Bank USA Pension Plan into RIP and the continuance of that plan formula for
participants transferred to RIP.
In 1997, HSBC Finance Corporation's Board of Directors adopted a Supplemental
Executive Retirement Plan ("SERP") for Mr. Aldinger because he would not
otherwise qualify for a full benefit under RIP and the Household Supplemental
Retirement Income Plan ("Supplemental RIP") due to his age when he joined HSBC
Finance Corporation. In 2000, the SERP was subsequently amended and restated to
provide for a benefit based upon the RIP 1989 formula but with 20 years of
benefit service being added and with an offset not only for RIP and Supplemental
RIP but also for pension benefits received from Wells Fargo and Citibank. The
benefit under the SERP formula (before offset) will not be increased, however,
except for interest, after Mr. Aldinger attains age 60. Upon the change of
control triggered by the purchase of HSBC Finance Corporation by HSBC, the
pension benefit for Mr. Aldinger was projected out for three years and then
accruals ceased.
TRIP and RIP may be made available to members of a collective bargaining unit if
inclusion results from good faith bargaining.
A portion of the benefits payable under RIP to certain executive officers
(including those named in the Summary Compensation Table) may be paid by us
through the Supplemental RIP. Supplemental RIP was established due to the
limitation imposed on the RIP by Federal laws limiting benefits payable under
tax-qualified plans.
The following table illustrates the amount of RIP (including Supplemental RIP)
total annual pension benefits on a straight-life annuity basis for eligible
employees retiring at age 65 who were employed before 1990. If the employee was
hired after 1989 and does not have at least 30 years of employment at
retirement, his/her benefit will be reduced for each month less than 30 years.
The amounts in this table are not subject to
200
deduction for Social Security or other offset amounts and do not reflect any
limitations on benefits imposed by ERISA or Federal tax laws. Ms. Derickson is
covered under the cash balance account based formula.
The years of employment of Messrs. Detelich, Robin, Aldinger, Menezes, Mehta and
Ms. Derickson for purposes of RIP are, respectively, 30 years, 17 years, 12
years, 10 years, 8 years, and 6 years.
AVERAGE ANNUAL
COMPENSATION
USED AS BASIS FOR 15 TO 30 YEARS OF 35 YEARS OF 40 OR MORE YEARS OF
COMPUTING PENSIONS EMPLOYMENT EMPLOYMENT EMPLOYMENT
-------------------------------------------------------------------------------------------------------
$1,500,000..................................... $ 852,071 $ 889,571 $ 927,071
2,000,000...................................... 1,137,071 1,187,071 1,237,071
2,500,000...................................... 1,422,071 1,484,571 1,547,071
3,000,000...................................... 1,707,071 1,782,071 1,857,071
3,500,000...................................... 1,992,071 2,079,571 2,167,071
4,000,000...................................... 2,277,071 2,377,071 2,477,071
4,500,000...................................... 2,562,071 2,674,571 2,787,071
5,000,000...................................... 2,847,071 2,972,071 3,097,071
5,500,000...................................... 3,132,071 3,269,571 3,407,071
6,000,000...................................... 3,417,071 3,567,071 3,717,071
DIRECTOR COMPENSATION
In 2005, the non-management Directors of HSBC Finance Corporation received an
annual cash retainer of $170,000 (except the Chair of the Executive Committee,
who received a retainer of $182,000). HSBC Finance Corporation does not pay
additional compensation for committee membership, with the exception of the
Audit Committee for which each member received an additional $15,000 (except the
Chair of the Audit Committee, who instead received an additional $25,000), or
meeting attendance fees to its Directors. The Chairs of the Compensation and
Nominating & Governance Committees received an additional $15,000, and the Lead
Director as Chair of the Executive Committee received an additional $50,000.
Directors who are employees of HSBC Finance Corporation or any of its
subsidiaries do not receive any additional compensation related to their Board
service. In February 2006, the Board reviewed its directors compensation
philosophy compared to other same sized financial and professional service
organizations and determined to make no changes to the current compensation
structure.
Directors have the ability to defer up to 100% of their yearly retainers and/or
fees into the HSBC-North America Directors Non-Qualified Deferred Compensation
Plan. Under this plan, Directors have the ability to defer pre-tax dollars with
the choice of a scheduled in-service withdrawal or distribution at termination
with lump sum, quarterly or annual installments.
We provide each Director with $250,000 of accidental death and dismemberment
insurance and a $10,000,000 personal excess liability insurance policy.
Independent Directors also are offered, on terms that are not more favorable
than those available to the general public, a MasterCard/Visa credit card issued
by one of our subsidiaries with a credit limit of $15,000. HSBC Finance
Corporation guarantees the repayment of amounts charged on each card. Directors
may use an apartment we maintain in New York City for their personal use, as
available. Directors are credited with $340 additional compensation for tax
purposes for each night the apartment is used for personal use.
Under HSBC Finance Corporation's Matching Gift Program, we match charitable
gifts to qualified organizations (subject to a maximum of $10,000 per year),
with a double match for the first $500 donated to higher education institutions
(both public and private) and eligible non-profit organizations which promote
neighborhood revitalization or economic development for low and moderate income
populations. Each current independent Director may ask us to contribute up to
$10,000 annually to charities of the Director's choice which qualify under our
philanthropic program.
201
Prior to the merger, independent Directors could elect to receive all or a
portion of their cash compensation in shares of former Household common stock,
defer it under the Deferred Fee Plan for Directors or purchase options to
acquire common stock. Under the Deferred Fee Plan, Directors were permitted to
invest their deferred compensation in either units of phantom shares of the
former Household common stock, with dividends credited toward additional stock
units, or cash, with interest credited at a market rate set under the plan.
Prior to 1995, HSBC Finance Corporation had a Directors' Retirement Income Plan
where the present value of each Director's accrued benefit was deposited into
the Deferred Phantom Stock Plan for Directors. Under the Deferred Phantom Stock
Plan, Directors with less than ten years of service received 750 phantom shares
of former Household common stock annually during the first ten years of service
as a Director. In January 1997, the Board eliminated this and all future
Director retirement benefits. Any payouts to current Directors earned under the
Deferred Phantom Stock Plan will be made only when a Director leaves the Board
due to death, retirement or resignation and were to be paid in shares of
Household common stock either in a lump sum or installments as selected by the
Director.
Following the acquisition, all rights to receive Household common stock under
both plans above were converted into rights to receive HSBC Holdings plc
ordinary shares and in May 2004, those rights were further converted into rights
to receive American Depository Shares, each of which represents five ordinary
shares, when the plans were rolled into a non-qualified deferred compensation
plan for Directors. No new shares may be issued under the plans. As of December
31, 2005, 56,459 American Depository Shares were held in the deferred
compensation plan account for Directors.
EMPLOYMENT AGREEMENTS
Upon completion of the merger with HSBC, Messrs. Detelich, Mehta and Robin and
Ms. Derickson received new employment agreements that, except as noted below
with respect to Mr. Mehta and Ms. Derickson, will end on March 28, 2006. Under
the new employment agreements, each executive will generally serve in the same
position that such executive held as of the date of the merger. During the term,
each executive will be paid an annual base salary of not less than such
executive's annual base salary as of the date of the merger and will receive an
annual bonus in an amount at least equal to 75 percent of the annual average of
such executive's bonuses earned with respect to the three-year period ended
December 31, 2001 (pro rated for any partial year). During the term of the
agreements, each of the executives will be eligible to participate, as approved
by the HSBC Board of Directors, in any equity-based incentive compensation plan
or program of HSBC as in effect from time to time for similarly situated senior
executives of HSBC Finance Corporation. In addition, during the term, each
executive will be eligible to participate in the various retirement, medical,
disability and life insurance plans, programs and arrangements of HSBC Finance
Corporation in accordance with the terms of such plans, programs and
arrangements, provided that they will not receive age and service credit under
the HSBC North America retirement plans that would be duplicative of the age and
service credit that they are entitled to under the prior employment agreements
or employment protection agreements, as applicable.
If during the term of the new employment agreement, an executive's employment is
terminated by HSBC Finance Corporation other than for "cause" or disability or
the executive resigns for "good reason," subject to the executive's execution of
a general release in favor of HSBC Finance Corporation and its affiliates, the
executive will continue to receive the executive's base salary and annual bonus
described above at that time and in the manner such payments would have been
paid had the executive remained employed for the remainder of the term of the
employment agreement and, to the extent permitted under the terms of the
applicable plans, the continuation of welfare benefits, umbrella liability
insurance and automobile and financial counseling allowances from the date of
termination until the earlier of the executive becoming eligible to participate
in similar plans of another employer and the last day of the term of the
employment agreement.
These new employment agreements superseded each executive's prior employment
agreement or employment protection agreement, as applicable, with HSBC Finance
Corporation (except that the excise tax gross-up
202
provision in the pre-merger agreements survived). At the merger with HSBC,
Messrs. Aldinger, Detelich, Mehta and Robin and Ms. Derickson had employment or
employment protection agreements that were deemed to have terminated due to a
"qualifying termination," entitling the executives to cash payments under the
prior agreements. Payments were made to those executives under the formula
described below under "Employment Protection Agreement of Mr. Menezes" except
that for Messrs. Aldinger, Mehta and Robin the protection period was based on 36
months instead of 18 and there was no reduction in payments to avoid an excise
tax.
The contracts for Sandra L. Derickson and Siddharth N. Mehta were extended by
two years and now will expire as of March 28, 2008. Under Mr. Mehta's extended
contract, he will serve as Chairman and Chief Executive Officer of HSBC Finance
Corporation and also Chief Executive Officer of HSBC North America Holdings Inc.
His base salary was increased to $900,000. The annual bonus for Mr. Mehta and
for Ms. Derickson with respect to each fiscal year after 2005 shall be at least
equal to 75 percent of the annual average of the bonuses earned by each of them
with respect to fiscal years 2003, 2004 and 2005 (pro rated for any partial
year). Mr. Mehta and Ms. Derickson were also awarded in 2005 one-time special
retention grants of HSBC restricted shares equal to $8 million and $6 million,
respectively, based on the closing price of HSBC ordinary shares as of the date
of the grant. These shares will vest in five equal installments on each of the
first five anniversaries of March 26, 2005, subject to accelerated vesting upon
termination of employment by HSBC Finance Corporation without cause, or by Mr.
Mehta or Ms. Derickson, in each case, for good reason.
EMPLOYMENT PROTECTION AGREEMENT OF MR. MENEZES
Mr. Menezes, has an employment protection agreement pursuant to which if, during
the 18 month period following a change in control of HSBC Finance Corporation,
Mr. Menezes' employment is terminated due to a "qualifying termination" (which
includes a termination other than for "cause" or disability, or resignation by
Mr. Menezes for "good reason"), he will be entitled to receive a cash payment
consisting of:
- A pro rata annual bonus through the date of termination, based on the
highest of the annual bonuses payable during the three years preceding
the year in which the termination occurs;
- A payment equal to 1.5 times the sum of the applicable base salary and
highest annual bonus; and
- A payment equal to the value of 18 months of additional employer
contributions under HSBC North America's tax-qualified and supplemental
defined contribution plans.
In addition, upon a qualifying termination following a change in control, Mr.
Menezes will be entitled to continued welfare benefit coverage for 18 months
after the date of termination, 18 months of additional age and service credit
under HSBC North America's tax-qualified and supplemental defined benefit
retirement plans, and outplacement services. If any amounts or benefits received
under the employment protection agreements or otherwise are subject to the
excise tax imposed under section 4999 of the Internal Revenue Code, an
additional payment will be made to restore Mr. Menezes to the after-tax position
in which he would have been if the excise tax had not been imposed. However, if
a small reduction in the amount payable would render the excise tax
inapplicable, then this reduction will be made instead.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
--------------------------------------------------------------------------------
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
HSBC Finance Corporation's common stock is 100% owned by HSBC Investments (North
America) Inc. ("HINO"). HINO is an indirect wholly owned subsidiary of HSBC.
203
SECURITY OWNERSHIP BY MANAGEMENT
The following table lists the beneficial ownership, as of January 31, 2006, of
HSBC ordinary shares or interests in ordinary shares and Series B Preferred
Stock of HSBC Finance Corporation by each director and the executive officers
named in the Summary Compensation Table on page 196, individually, and the
directors and executive officers as a group. Each of the individuals listed
below and all directors and executive officers as a group own less than 1% of
the ordinary shares of HSBC and the Series B Preferred Stock of HSBC Finance
Corporation.
NUMBER OF SERIES B SHARES THAT MAY
SHARES PREFERRED OF BE ACQUIRED
BENEFICIALLY HSBC WITHIN 60 DAYS NUMBER OF
OWNED OF HSBC FINANCE BY EXERCISE OF COMMON STOCK
HOLDINGS PLC(1)(2) CORPORATION OPTIONS(3) EQUIVALENTS(4) TOTAL
--------------------------------------------------------------------------------------------------------------------
DIRECTORS
William R. P. Dalton......... 118,508 - - - 118,508
Gary G. Dillon............... 210,587 - 131,076 37,890 379,553
J. Dudley Fishburn........... 15,678 - 90,950 4,050 110,678
Cyrus F. Freidheim, Jr. ..... 15,755 - 151,264 21,347 188,366
Robert K. Herdman............ - - - - -
Alan W. Jebson............... 109,032 - - 180,491 289,523
George A. Lorch.............. 13,605 - 145,789 30,190 189,584
Siddharth N. Mehta........... 277,838 - 3,034,150 61,172 3,373,160
Larree M. Renda.............. 8,250 2,000 40,125 130 50,505
NAMED EXECUTIVE OFFICERS
William F. Aldinger III...... - - 9,656,750 - 9,656,750
Sandra L. Derickson.......... 129,820 - 543,375 27,474 700,669
Thomas M. Detelich........... 4,000 - 576,813 4,134 584,947
Walter G. Menezes............ 109,370 - 522,616 - 631,986
Kenneth H. Robin............. 335,990 - 1,364,000 68,508 1,768,498
ALL DIRECTORS AND EXECUTIVE
OFFICERS AS A GROUP........ 1,348,433 2,000 16,256,908 435,386 18,042,727
---------------
(1) Directors and executive officers have sole voting and investment power over
the shares listed above, except as follows.
The number of ordinary shares held by spouses, children and charitable or
family foundations in which voting and investment power is shared (or
presumed to be shared) is as follows: Mr. Dalton, 56,019 and Mr. Lorch,
13,650; and Directors and executive officers as a group, 69,669.
(2) Some of the shares included in the table above were held in American
Depository Shares, each of which represents five HSBC ordinary shares.
(3) Represents the number of ordinary shares which may be acquired by HSBC
Finance Corporation's Directors and executive officers through April 1,
2006, pursuant to the exercise of stock options.
(4) Represents the number of ordinary share equivalents owned by executive
officers under HSBC Finance Corporation's TRIP and HSBC North America
Employee Non-Qualified Deferred Compensation Plan and by Directors under
HSBC North America Directors Non-Qualified Deferred Compensation Plan. Some
of the shares included in the table above were held in American Depository
Shares, each of which represents five HSBC ordinary shares.
204
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
--------------------------------------------------------------------------------
None.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
--------------------------------------------------------------------------------
AUDIT FEES. The aggregate amount billed by our principal accountant, KPMG LLP,
for audit services performed during the fiscal years ended December 31, 2005 and
2004 was $6,785,000 and $5,565,000, respectively. Audit services include the
auditing of financial statements, quarterly reviews, statutory audits, and the
preparation of comfort letters, consents and review of registration statements.
AUDIT RELATED FEES. The aggregate amount billed by KPMG LLP in connection with
audit related services performed during the fiscal years ended December 31, 2005
and 2004 was $1,272,000 and $691,000, respectively. Audit related services
include employee benefit plan audits, translation services, and audit or
attestation services not required by statute or regulation.
TAX FEES. Total fees billed by KPMG LLP for tax related services for the fiscal
years ended December 31, 2005 and 2004 were $658,000 and $2,656,000,
respectively. These services include tax related research, general tax services
in connection with transactions and legislation and tax services for review of
Federal and state tax accounts for possible overassessment of interest and/or
penalties.
ALL OTHER. Other than those fees described above, there were no other fees
billed for services performed by KPMG LLP during the fiscal years ended December
31, 2005 and December 31, 2004.
All of the fees described above were approved by HSBC Finance Corporation's
audit committee.
AUDIT COMMITTEE PRE-APPROVAL POLICIES AND PROCEDURES. HSBC Finance Corporation's
audit committee pre-approves the audit and non-audit services performed by KPMG
LLP, our principal accountants, in order to assure that the provision of such
services does not impair KPMG LLP's independence. Unless a type of service to be
provided by KPMG LLP has received general pre-approval, it will require specific
pre-approval by the audit committee. In addition, any proposed services
exceeding pre-approval cost levels will require specific pre-approval by the
audit committee.
The term of any pre-approval is 12 months from the date of pre-approval, unless
the audit committee specifically provides for a different period. The audit
committee will periodically revise the list of pre-approved services, based on
subsequent determinations, and has delegated pre-approval authority to the Chair
of the audit committee. In the event the Chair of the audit committee exercises
such delegated authority, he will report such pre-approval decisions to the
audit committee at its next scheduled meeting. The audit committee does not
delegate its responsibilities to pre-approve services performed by the
independent auditor to management.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
--------------------------------------------------------------------------------
(a)(1) Financial Statements.
The consolidated financial statements listed below, together with an opinion of
KPMG LLP dated March 6, 2006 with respect thereto, are included in this Form
10-K pursuant to Item 8. Financial Statements and Supplementary Data of this
Form 10-K.
HSBC FINANCE CORPORATION AND SUBSIDIARIES:
Report of Independent Registered Public Accounting Firm
Consolidated Statement of Income
Consolidated Balance Sheet
Consolidated Statement of Cash Flows
Consolidated Statement of Changes in Shareholder's(s') Equity
Notes to Consolidated Financial Statements
205
Selected Quarterly Financial Data (Unaudited)
(a)(2) Not applicable
(a)(3) Exhibits.
3(i) Amended and Restated Certificate of Incorporation of HSBC
Finance Corporation effective as of December 15, 2004, as
amended (incorporated by reference to Exhibit 3.1 of HSBC
Finance Corporation's Current Report on Form 8-K filed June
22, 2005 and Exhibit 3.1(b) of HSBC Finance Corporation's
Current Report on Form 8-K filed December 19, 2005).
3(ii) Bylaws of HSBC Finance Corporation, as amended December 15,
2004 (incorporated by reference to Exhibit 3(ii) of HSBC
Finance Corporation's Annual Report on Form 10-K for the
year ended December 31, 2004 filed February 28, 2005).
4.1 Amended and Restated Standard Multiple-Series Indenture
Provisions for Senior Debt Securities of HSBC Finance
Corporation dated as of December 15, 2004 (incorporated by
reference to Exhibit 4.1 of Amendment No. 1 to HSBC Finance
Corporation's Registration Statements on Form S-3 Nos.
333-120494, 333-120495 and 333-120496 filed December 16,
2004).
4.2* Amended and Restated Indenture for Senior Debt Securities
dated as of December 15, 2004 between HSBC Finance
Corporation and JPMorgan Chase Bank, N.A., as Trustee
(incorporated by reference to Exhibit 4.2 of Amendment No. 1
to HSBC Finance Corporation's Registration Statements on
Form S-3 Nos. 333-120495 and 333-120496 filed December 16,
2004).
4.3 The principal amount of debt outstanding under each other
instrument defining the rights of Holders of our long-term
senior and senior subordinated debt does not exceed 10
percent of our total assets. HSBC Finance Corporation agrees
to furnish to the Securities and Exchange Commission, upon
request, a copy of each instrument defining the rights of
holders of our long-term senior and senior subordinated
debt.
12 Statement of Computation of Ratio of Earnings to Fixed
Charges and to Combined Fixed Charges and Preferred Stock
Dividends.
14 Code of Ethics for Senior Financial Officers (incorporated
by reference to Exhibit 14 of HSBC Finance Corporation's
Annual Report on Form 10-K for the year ended December 31,
2004 filed February 28, 2005).
21 Subsidiaries of HSBC Finance Corporation.
23 Consent of KPMG LLP, Independent Registered Public
Accounting Firm.
24 Power of Attorney (included on page 207 of this Form 10-K).
31 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
99.1 Ratings of HSBC Finance Corporation and its significant
subsidiaries.
Upon receiving a written request, we will furnish copies of the exhibits
referred to above free of charge. Requests should be made to HSBC Finance
Corporation, 2700 Sanders Road, Prospect Heights, Illinois 60070, Attention:
Corporate Secretary.
---------------
* Substantially identical indentures exist with U.S. Bank National Association,
BNY Midwest Trust Company and JPMorgan Trust Company, National Association.
206
SIGNATURES
--------------------------------------------------------------------------------
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, HSBC Finance Corporation has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized on this, the 6th day
of March, 2006.
HSBC FINANCE CORPORATION
By: /s/ Siddharth N. Mehta
------------------------------------
Siddharth N. Mehta
Chairman and Chief Executive
Officer
Each person whose signature appears below constitutes and appoints P.D. Schwartz
as his/her true and lawful attorney-in-fact and agent, with full power of
substitution and resubstitution, for him/her in his/her name, place and stead,
in any and all capacities, to sign and file, with the Securities and Exchange
Commission, this Form 10-K and any and all amendments and exhibits thereto, and
all documents in connection therewith, granting unto each such attorney-in-fact
and agent full power and authority to do and perform each and every act and
thing requisite and necessary to be done, as fully to all intents and purposes
as he/she might or could do in person, hereby ratifying and confirming all that
such attorney-in-fact and agent or their substitutes may lawfully do or cause to
be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of HSBC Finance
Corporation and in the capacities indicated on the 6th day of March, 2006.
SIGNATURE TITLE
--------------------------------------------------------------------------------------------------------
/s/ S. N. MEHTA Chairman and Chief Executive Officer and
------------------------------------------------------ Director (as Principal Executive Officer)
(S. N. Mehta)
/s/ W. R. P. DALTON Director
------------------------------------------------------
(W. R. P. Dalton)
/s/ G. G. DILLON Director
------------------------------------------------------
(G. G. Dillon)
/s/ J. D. FISHBURN Director
------------------------------------------------------
(J. D. Fishburn)
/s/ C. F. FREIDHEIM, JR. Director
------------------------------------------------------
(C. F. Freidheim, Jr.)
/s/ R. K. HERDMAN Director
------------------------------------------------------
(R. K. Herdman)
/s/ A. W. JEBSON Director
------------------------------------------------------
(A. W. Jebson)
/s/ G. A. LORCH Director
------------------------------------------------------
(G. A. Lorch)
207
SIGNATURE TITLE
--------------------------------------------------------------------------------------------------------
/s/ L. M. RENDA Director
------------------------------------------------------
(L. M. Renda)
/s/ B. A. SIBBLIES Senior Vice President and Chief Financial
------------------------------------------------------ Officer
(B. A. Sibblies)
/s/ J. E. BINYON Vice President and Chief Accounting Officer
------------------------------------------------------
(J. E. Binyon)
208
EXHIBIT INDEX
--------------------------------------------------------------------------------
3(i) Amended and Restated Certificate of Incorporation of HSBC
Finance Corporation effective as of December 15, 2004, as
amended (incorporated by reference to Exhibit 3.1 of HSBC
Finance Corporation's Current Report on Form 8-K filed June
22, 2005 and Exhibit 3.1(b) of HSBC Finance Corporation's
Current Report on Form 8-K filed December 19, 2005).
3(ii) Bylaws of HSBC Finance Corporation, as amended December 15,
2004 (incorporated by reference to Exhibit 3(ii) of HSBC
Finance Corporation's Annual Report on Form 10-K for the
year ended December 31, 2004 filed February 28, 2005).
4.1 Amended and Restated Standard Multiple-Series Indenture
Provisions for Senior Debt Securities of HSBC Finance
Corporation dated as of December 15, 2004 (incorporated by
reference to Exhibit 4.1 of Amendment No. 1 to HSBC Finance
Corporation's Registration Statements on Form S-3 Nos.
333-120494, 333-120495 and 333-120496 filed December 16,
2004).
4.2* Amended and Restated Indenture for Senior Debt Securities
dated as of December 15, 2004 between HSBC Finance
Corporation and JPMorgan Chase Bank, N.A., as Trustee
(incorporated by reference to Exhibit 4.2 of Amendment No. 1
to HSBC Finance Corporation's Registration Statements on
Form S-3 Nos. 333-120495 and 333-120496 filed December 16,
2004).
4.3 The principal amount of debt outstanding under each other
instrument defining the rights of Holders of our long-term
senior and senior subordinated debt does not exceed 10
percent of our total assets. HSBC Finance Corporation agrees
to furnish to the Securities and Exchange Commission, upon
request, a copy of each instrument defining the rights of
holders of our long-term senior and senior subordinated
debt.
12 Statement of Computation of Ratio of Earnings to Fixed
Charges and to Combined Fixed Charges and Preferred Stock
Dividends.
14 Code of Ethics for Senior Financial Officers (incorporated
by reference to Exhibit 14 of HSBC Finance Corporation's
Annual Report on Form 10-K for the year ended December 31,
2004 filed February 28, 2005).
21 Subsidiaries of HSBC Finance Corporation.
23 Consent of KPMG LLP, Independent Registered Public
Accounting Firm.
24 Power of Attorney (included on page 207 of this Form 10-K).
31 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
99.1 Ratings of HSBC Finance Corporation and its significant
subsidiaries.
---------------
* Substantially identical indentures exist with U.S. Bank National Association,
BNY Midwest Trust Company and JPMorgan Trust Company, National Association.
EXHIBIT 12
HSBC FINANCE CORPORATION
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND TO
COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
MARCH 29 JANUARY 1
YEAR ENDED YEAR ENDED THROUGH THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 28,
2005 2004 2003 2003 2002 2001
------------------------------------------------------------------------------------------------------------------------
(SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (PREDECESSOR) (PREDECESSOR) (PREDECESSOR)
(IN MILLIONS)
Net income..................... $1,772 $1,940 $1,357 $ 246 $1,558 $1,848
Income taxes................... 891 1,000 690 182 695 970
------ ------ ------ ------ ------ ------
Income before income taxes..... 2,663 2,940 2,047 428 2,253 2,818
------ ------ ------ ------ ------ ------
Fixed charges:
Interest expense(1).......... 4,832 3,143 2,031 898 3,879 4,197
Interest portion of
rentals(2)................. 61 54 40 18 68 64
------ ------ ------ ------ ------ ------
Total fixed charges............ 4,893 3,197 2,071 916 3,947 4,261
------ ------ ------ ------ ------ ------
Total earnings as defined...... $7,556 $6,137 $4,118 $1,344 $6,200 $7,079
Ratio of earnings to fixed
charges...................... 1.54 1.92(4) 1.99 1.47(5) 1.57(6) 1.66
====== ====== ====== ====== ====== ======
Preferred stock dividends(3)... 125 108 86 32 91 24
====== ====== ====== ====== ====== ======
Ratio of earnings to combined
fixed charges and preferred
stock dividends.............. 1.51 1.86(4) 1.91 1.42(5) 1.54(6) 1.65
====== ====== ====== ====== ====== ======
---------------
(1) For financial statement purposes, these amounts are reduced for income
earned on temporary investment of excess funds, generally resulting from
over-subscriptions of commercial paper issuances.
(2) Represents one-third of rentals, which approximates the portion representing
interest.
(3) Preferred stock dividends are grossed up to their pretax equivalents.
(4) The 2004 ratios have been negatively impacted by $121 million (after-tax)
from the adoption of FFIEC charge-off policies for our domestic private
label (excluding retail sales contracts at our consumer lending business)
and MasterCard and Visa portfolios in December 2004 and positively impacted
by the $423 million (after-tax) gain on the bulk sale of our domestic
private label receivables (excluding retail sales contracts at our consumer
lending business) to HSBC Bank USA in December 2004. Excluding these items,
our ratio of earnings to fixed charges would have been 1.83 percent and our
ratio of earnings to combined fixed charges and preferred stock dividends
would have been 1.77 percent. These non-GAAP financial ratios are provided
for comparison of our operating trends only.
(5) The 2003 ratios have been negatively impacted by the $167 million
(after-tax) of HSBC acquisition related costs and other merger related items
incurred by HSBC Finance Corporation. Excluding these charges, our ratio of
earnings to fixed charges would have been 1.69 percent and our ratio of
earnings to combined fixed charges and preferred stock dividends would have
been 1.63 percent. These non-GAAP financial ratios are provided for
comparison of our operating trends only.
(6) The 2002 ratios have been negatively impacted by the $333 million
(after-tax) settlement charge and related expenses and the $240 million
(after-tax) loss on the disposition of Thrift assets and deposits. Excluding
these charges, our ratio of earnings to fixed charges would have been 1.80
percent and our ratio of earnings to combined fixed charges and preferred
stock dividends would have been 1.76 percent. These non-GAAP financial
ratios are provided for comparison of our operating trends only.
EXHIBIT 21
SUBSIDIARIES OF HSBC FINANCE CORPORATION
US -- STATE
NAMES OF SUBSIDIARIES ORGANIZED
--------------------- --------------
AHLIC Investment Holdings Corporation....................... Delaware
B.I.G. Insurance Agency, Inc. .............................. Ohio
Beaver Valley, Inc. ........................................ Delaware
Bencharge Credit Service Holding Company.................... Delaware
Beneficial Alabama Inc. .................................... Alabama
Beneficial Arizona Inc...................................... Delaware
Beneficial California Inc. ................................. Delaware
Beneficial Colorado Inc. ................................... Delaware
Beneficial Commercial Corporation........................... Delaware
Beneficial Commercial Holding Corporation................... Delaware
Beneficial Company LLC (f/k/a Beneficial Corporation)....... Delaware
Beneficial Connecticut Inc. ................................ Delaware
Beneficial Consumer Discount Company........................ Pennsylvania
dba BMC of PA
Beneficial Credit Services Inc. ............................ Delaware
Beneficial Credit Services of Connecticut Inc. ............. Delaware
Beneficial Credit Services of Mississippi Inc. ............. Delaware
Beneficial Credit Services of South Carolina Inc. .......... Delaware
Beneficial Delaware Inc. ................................... Delaware
Beneficial Direct, Inc. .................................... New Jersey
Beneficial Discount Co. of Virginia......................... Delaware
Beneficial Facilities Corporation........................... New Jersey
Beneficial Finance Co. ..................................... Delaware
Beneficial Finance Co. of West Virginia..................... Delaware
Beneficial Finance Services, Inc. .......................... Kansas
Beneficial Florida Inc. .................................... Delaware
dba Beneficial Credit Services Inc.
Beneficial Franchise Company Inc. .......................... Delaware
Beneficial Georgia Inc. .................................... Delaware
Beneficial Hawaii Inc. ..................................... Delaware
Beneficial Homeowner Service Corporation.................... Delaware
Beneficial Idaho Inc. ...................................... Delaware
Beneficial Illinois Inc. ................................... Delaware
Beneficial Income Tax Service Holding Co., Inc. ............ Delaware
Beneficial Indiana Inc. .................................... Delaware
dba Beneficial Mortgage Co. of Indiana
Beneficial Investment Co. .................................. Delaware
Beneficial Iowa Inc. ....................................... Iowa
Beneficial Kansas Inc. ..................................... Kansas
Beneficial Kentucky Inc. ................................... Delaware
Beneficial Land Company, Inc. .............................. New Jersey
Beneficial Leasing Group, Inc. ............................. Delaware
US -- STATE
NAMES OF SUBSIDIARIES ORGANIZED
--------------------- --------------
Beneficial Loan & Thrift Co. ............................... Minnesota
Beneficial Loan Corporation of Kentucky..................... Kentucky
Beneficial Louisiana Inc. .................................. Delaware
Beneficial Maine Inc. ...................................... Delaware
dba Beneficial Credit Services
Beneficial Management Corporation........................... Delaware
Beneficial Management Corporation of America................ Delaware
Beneficial Management Headquarters, Inc. ................... New Jersey
Beneficial Management Institute, Inc. ...................... New York
Beneficial Mark Holding Inc. ............................... Delaware
Beneficial Maryland Inc. ................................... Delaware
Beneficial Massachusetts Inc. .............................. Delaware
Beneficial Michigan Inc. ................................... Delaware
Beneficial Mississippi Inc. ................................ Delaware
Beneficial Missouri, Inc. .................................. Delaware
Beneficial Montana Inc. .................................... Delaware
Beneficial Mortgage Co. of Arizona.......................... Delaware
Beneficial Mortgage Co. of Colorado......................... Delaware
Beneficial Mortgage Co. of Connecticut...................... Delaware
Beneficial Mortgage Co. of Florida.......................... Delaware
Beneficial Mortgage Co. of Georgia.......................... Delaware
Beneficial Mortgage Co. of Idaho............................ Delaware
Beneficial Mortgage Co. of Indiana.......................... Delaware
Beneficial Mortgage Co. of Kansas, Inc. .................... Delaware
Beneficial Mortgage Co. of Louisiana........................ Delaware
Beneficial Mortgage Co. of Maryland......................... Delaware
Beneficial Mortgage Co. of Massachusetts.................... Delaware
Beneficial Mortgage Co. of Mississippi...................... Delaware
Beneficial Mortgage Co. of Missouri, Inc. .................. Delaware
Beneficial Mortgage Co. of Nevada........................... Delaware
Beneficial Mortgage Co. of New Hampshire.................... Delaware
Beneficial Mortgage Co. of North Carolina................... Delaware
Beneficial Mortgage Co. of Oklahoma......................... Delaware
Beneficial Mortgage Co. of Rhode Island..................... Delaware
Beneficial Mortgage Co. of South Carolina................... Delaware
Beneficial Mortgage Co. of Texas............................ Delaware
Beneficial Mortgage Co. of Utah............................. Delaware
Beneficial Mortgage Co. of Virginia......................... Delaware
Beneficial Mortgage Corporation............................. Delaware
Beneficial Mortgage Holding Company......................... Delaware
Beneficial Nebraska Inc. ................................... Nebraska
Beneficial Nevada Inc. ..................................... Delaware
Beneficial New Hampshire Inc. .............................. Delaware
Beneficial New Jersey Inc. ................................. Delaware
Beneficial New Mexico Inc. ................................. Delaware
US -- STATE
NAMES OF SUBSIDIARIES ORGANIZED
--------------------- --------------
Beneficial New York Inc. ................................... New York
Beneficial North Carolina Inc. ............................. Delaware
Beneficial Ohio Inc. ....................................... Delaware
Beneficial Oklahoma Inc. ................................... Delaware
dba Beneficial Credit Services
Beneficial Oregon Inc. ..................................... Delaware
Beneficial Real Estate Company, Inc. ....................... New Jersey
Beneficial Real Estate Joint Venture, Inc. ................. Delaware
Beneficial Rhode Island Inc. ............................... Delaware
Beneficial Service Corporation.............................. Delaware
Beneficial Service Corporation of Delaware.................. Delaware
Beneficial South Carolina Inc. ............................. Delaware
Beneficial South Dakota Inc. ............................... Delaware
Beneficial Systems Development Corporation.................. Delaware
Beneficial Technology Corporation........................... Delaware
Beneficial Tennessee Inc. .................................. Tennessee
Beneficial Texas Inc. ...................................... Texas
Beneficial Trademark Co. ................................... Delaware
Beneficial Utah Inc. ....................................... Delaware
Beneficial Vermont Inc. .................................... Delaware
Beneficial Virginia Inc. ................................... Delaware
Beneficial Washington Inc. ................................. Delaware
Beneficial West Virginia, Inc. ............................. West Virginia
Beneficial Wisconsin Inc. .................................. Delaware
Beneficial Wyoming Inc. .................................... Wyoming
dba Beneficial Credit Services
Benevest Escrow Company..................................... Delaware
Benevest Group Inc. ........................................ Delaware
Benevest Services, Inc. .................................... Washington
BFC Agency, Inc. ........................................... Delaware
BFC Insurance Agency of Nevada.............................. Nevada
BMC Holding Company......................................... Delaware
Bon Secour Properties Inc. ................................. Alabama
Business Lakeview, Inc. .................................... Delaware
Cal-Pacific Services, Inc. ................................. California
Capital Financial Services Inc. ............................ Nevada
dba Capital Financial Services I Inc.
dba Capital Financial Services No. 1 Inc.
dba CFSI, Inc.
dba HB Financial Services
Central Insurance Administrators, Inc. ..................... Delaware
Chattanooga Valley Associates............................... Tennessee
Com Realty, Inc. ........................................... Delaware
Craig-Hallum Corporation.................................... Delaware
Decision One Loan Company of Minnesota...................... Minnesota
US -- STATE
NAMES OF SUBSIDIARIES ORGANIZED
--------------------- --------------
Decision One Mortgage Company, LLC.......................... North Carolina
Eighth HFC Leasing Corporation.............................. Delaware
Eleventh Avenue Properties Corporation...................... Delaware
Fifteenth HFC Leasing Corporation........................... Delaware
Fifth HFC Leasing Corporation............................... Delaware
Financial Network Alliance, L.L.P. ......................... Illinois
First Central National Life Insurance Company of New York... New York
FNA Consumer Discount Company............................... Pennsylvania
Fourteenth HFC Leasing Corporation.......................... Delaware
Fourth HFC Leasing Corporation.............................. Delaware
H I Venture Four, Inc. ..................................... Florida
H I Venture One, Inc. ...................................... Florida
H I Venture Three, Inc. .................................... Florida
Hamilton Investments, Inc. ................................. Delaware
Harbour Island Inc. ........................................ Florida
HFC Agency of Missouri, Inc. ............................... Missouri
HFC Commercial Realty, Inc. ................................ Delaware
HFC Company LLC (f/k/a Household Group, Inc.)............... Delaware
HFC Leasing, Inc. .......................................... Delaware
HFS Investments, Inc. ...................................... Nevada
HFTA Consumer Discount Co. ................................. Pennsylvania
HFTA Corporation............................................ Delaware
HFTA Eighth Corporation..................................... Ohio
HFTA Fifth Corporation...................................... Nevada
HFTA First Financial Corp. ................................. California
HFTA Fourth Corporation..................................... Minnesota
HFTA Ninth Corporation...................................... West Virginia
HFTA Second Corporation..................................... Alabama
HFTA Seventh Corporation.................................... New Jersey
HFTA Sixth Corporation...................................... Nevada
HFTA Tenth Corporation...................................... Washington
HFTA Third Corporation...................................... Delaware
Household Acquisition Corporation........................... Delaware
Household Affinity Funding Corporation II................... Delaware
Household Affinity Funding Corporation III.................. Delaware
Household Aviation, LLC..................................... Delaware
Household Business Services, Inc. .......................... Delaware
Household Capital Markets LLC............................... Delaware
Household Card Funding Corporation.......................... Delaware
Household Commercial Financial Services, Inc. .............. Delaware
Household Commercial of California, Inc. ................... California
Household Company of Maine.................................. Maine
Household Consumer Loan Corporation......................... Nevada
Household Consumer Loan Corporation II...................... Delaware
Household Corporation....................................... Delaware
US -- STATE
NAMES OF SUBSIDIARIES ORGANIZED
--------------------- --------------
Household Credit Services Overseas, Inc. ................... Delaware
Household Finance Consumer Discount Company................. Pennsylvania
Household Finance Corporation............................... Delaware
Household Finance Corporation II............................ Delaware
dba Household Mortgage Company
dba Household Finance Corporation of Virginia
Household Finance Corporation III........................... Delaware
dba HFC Mortgage of Nebraska
dba Household Mortgage Services
dba HSBC Mortgage
Household Finance Corporation of Alabama.................... Alabama
Household Finance Corporation of California................. Delaware
Household Finance Corporation of Nevada..................... Delaware
Household Finance Corporation of West Virginia.............. West Virginia
Household Finance Industrial Loan Company................... Washington
Household Finance Industrial Loan Company of Iowa........... Iowa
Household Finance Realty Corporation of Nevada.............. Delaware
Household Finance Realty Corporation of New York............ Delaware
Household Financial Center Inc. ............................ Tennessee
Household Financial Services, Inc........................... Delaware
Household Global Funding, Inc. ............................. Delaware
Household Industrial Finance Company........................ Minnesota
Household Industrial Loan Co. of Kentucky................... Kentucky
Household Insurance Agency, Inc. ........................... Michigan
Household Insurance Agency, Inc. Nevada..................... Nevada
Household Insurance Group Holding Company................... Delaware
Household Insurance Group, Inc. ............................ Delaware
Household Investment Funding, Inc. ......................... Delaware
Household Ireland Holdings Inc. ............................ Delaware
Household Life Insurance Co. of Arizona..................... Arizona
Household Life Insurance Company............................ Michigan
Household Life Insurance Company of Delaware................ Delaware
Household N Q Pension Company............................... Delaware
Household OPEB I, Inc. ..................................... Illinois
Household Pooling Corporation............................... Nevada
Household Realty Corporation................................ Delaware
Household Receivables Acquisition Company................... Delaware
Household Receivables Acquisition Company II................ Delaware
Household Receivables Funding, Inc. III..................... Delaware
Household Recovery Services Corporation..................... Delaware
Household REIT Corporation.................................. Nevada
Household Relocation Management, Inc. ...................... Illinois
Household Servicing, Inc. .................................. Delaware
Household Tax Masters Acquisition Corporation............... Delaware
Housekey Financial Corporation.............................. Illinois
US -- STATE
NAMES OF SUBSIDIARIES ORGANIZED
--------------------- --------------
HSBC - GR Corp. (f/k/a Household Financial Group, Ltd.)..... Delaware
HSBC Affinity Corporation I (f/k/a HFC Card Funding
Corporation).............................................. Delaware
HSBC Auto Accounts Inc. (f/k/a OFL-A Receivables Corp.)..... Delaware
HSBC Auto Credit Inc. (f/k/a Household Automotive Credit
Corporation).............................................. Delaware
HSBC Auto Finance Inc. (f/k/a Household Automotive Finance
Corporation).............................................. Delaware
HSBC Auto Receivables Corporation (f/k/a Household Auto
Receivables Corporation).................................. Nevada
HSBC Bank Nevada N. A. (f/k/a Household Bank (SB), N.A.).... United States
HSBC Card Services (III) Inc. (f/k/a Household Card
Services, Inc.)........................................... Nevada
HSBC Card Services (III) Inc. (f/k/a Household Credit
Services, Inc.)........................................... Delaware
HSBC Card Services II Inc. (f/k/a Household Credit Services
II, Inc.)................................................. Oregon
HSBC Credit Center, Inc. ................................... Delaware
HSBC Home Equity Loan Corporation I (f/k/a HFC Revolving
Corporation).............................................. Delaware
HSBC Insurance Company of Delaware (f/k/a Service General
Insurance Company)........................................ Ohio
HSBC Mortgage Funding Corporation I (f/k/a Household
Mortgage Funding Corporation III)......................... Delaware
HSBC Mortgage Services Warehouse Lending Inc.(f/k/a HFC
Funding Corporation)...................................... Delaware
HSBC Pay Services, Inc. (f/k/a Household Payroll Services,
Inc.)..................................................... Delaware
HSBC Retail Services Inc. (f/k/a Household Retail Services,
Inc.)..................................................... Delaware
HSBC Single Seller Depositor (USA) LLC...................... Delaware
HSBC Taxpayer Financial Services Inc.(f/k/a Household Tax
Masters Inc.)............................................. Delaware
HSBC TFS I 2005 LLC......................................... Delaware
HSBC TFS I LLC.............................................. Delaware
HSBC TFS II 2005 LLC........................................ Delaware
HSBC TFS II LLC............................................. Delaware
Hull 752 Corporation........................................ Delaware
Hull 753 Corporation........................................ Delaware
JV Mortgage Capital Consumer Discount Company............... Pennsylvania
JV Mortgage Capital, Inc. .................................. Delaware
JV Mortgage Capital, L.P. .................................. Delaware
KMD Center, Inc. ........................................... Delaware
Leasing at Sixty-First Corporation.......................... Delaware
Macray Corporation.......................................... California
magnUS Services, Inc. ...................................... Delaware
MES Insurance Agency, LLC................................... Delaware
Metris Receivables, Inc. ................................... Delaware
Moore's Realty Inc. ........................................ Delaware
Mortgage One Corporation.................................... Delaware
Mortgage Two Corporation.................................... Delaware
MTX LLC..................................................... Delaware
Neil Corporation............................................ Delaware
Nineteenth HFC Leasing Corporation.......................... Delaware
North Indemnity Insurance Company........................... Delaware
Old K & B Corporation....................................... Michigan
Pacific Agency, Inc. ....................................... Nevada
Pacific Finance Loans....................................... California
Pargen Corporation.......................................... California
US -- STATE
NAMES OF SUBSIDIARIES ORGANIZED
--------------------- --------------
Personal Mortgage Corporation............................... Delaware
Personal Mortgage Holding Company........................... Delaware
PPSG Corporation............................................ Delaware
Properties on Twenty-Second Corporation..................... Delaware
Real Estate Collateral Management Company................... Delaware
Renaissance Bankcard Services of Kentucky................... Kentucky
Second HFC Leasing Corporation.............................. Delaware
Service Administrators, Inc. (USA).......................... Colorado
Service Management Corporation.............................. Ohio
Seven Acres Leasing Corporation............................. Delaware
Seventh HFC Leasing Corporation............................. Delaware
Silliman Corporation........................................ Delaware
Sixth HFC Leasing Corporation............................... Delaware
South Property Corporation.................................. Delaware
Southern Trust Company...................................... Delaware
Southwest Beneficial Finance, Inc. ......................... Illinois
Southwest Texas General Agency, Inc. ....................... Texas
SPE 1 2005 Manager Inc. .................................... Delaware
SPE 1 Manager Inc. ......................................... Delaware
Tampa Island Transit Company, Inc. ......................... Florida
Tenth Leasing Corporation................................... Delaware
Third HFC Leasing Corporation............................... Delaware
Thirteenth HFC Leasing Corporation.......................... Delaware
Twenty-Sixth Place Corporation.............................. Delaware
Valley Properties Corporation............................... Tennessee
Wasco Properties, Inc. ..................................... Delaware
Wesco Insurance Company..................................... Delaware
NON-US AFFILIATES
NAMES OF SUBSIDIARIES COUNTRY ORGANIZED
--------------------- -----------------
Amstelveen FSC, Ltd. ....................................... Bermuda
Beneficial (Hungary) Financial Services Limited............. Hungary
Beneficial Building Company Limited......................... England
Beneficial Data Systems Limited............................. England
Beneficial Finance a.s...................................... Czech Republic
Beneficial Financial Services Limited....................... England
Beneficial Financing Limited................................ England
Beneficial Leasing Limited.................................. England
Beneficial Limited.......................................... England
Beneficial Premium Services Limited......................... England
Beneficial Trust Investments Limited........................ England
Beneficial Trust Nominees Limited........................... England
BFC Insurance (Life) Limited................................ Ireland
BFC Insurance Limited....................................... Ireland
BFC Ireland (Holdings) Limited.............................. Ireland
NAMES OF SUBSIDIARIES COUNTRY ORGANIZED
--------------------- -----------------
BFC Pension Plan (Ireland) Limited.......................... Ireland
BFC Reinsurance Limited..................................... Ireland
D.L.R.S. Limited............................................ England
Endeavour Personal Finance Limited.......................... England
First Finance Brokers Limited............................... England
Hamilton Financial Planning Services Ltd. .................. England
Hamilton Insurance Company Limited.......................... England
Hamilton Life Assurance Company Limited..................... England
HFC Bank Limited............................................ England
HFC Financial Services Holdings (Ireland) Limited........... Ireland
HFC Pension Plan (Ireland) Limited.......................... Ireland
HFC Pension Plan Limited.................................... England
Household (Jersey) Limited.................................. Channel Island
Household Commercial Canada, Inc. .......................... Canada
Household Computer Services Limited......................... England
Household Finance Limited................................... England
Household Funding plc....................................... England
Household Global Holdings, BV............................... Netherlands
Household International Europe Limited...................... England
Household International Netherlands B.V..................... Netherlands
Household Investments Limited............................... England
Household Leasing Limited................................... England
Household Management Corporation Limited.................... England & Wales
Household Overseas Limited.................................. England
Household Realty Corporation Limited........................ Canada
Household Trust Company..................................... Canada
HSBC Finance Corporation Canada (f/k/a Household Finance
Corporation of Canada).................................... Canada
HSBC Financial Corporation Limited (f/k/a Household
Financial Corporation Limited)............................ Canada
HSBC Retail Services Limited (f/k/a Household Financial
Corporation Inc.)......................................... Canada
ICOM Limited................................................ Bermuda
Invis Inc. ................................................. Canada
John Lewis Financial Services Limited....................... England
Night Watch FSC, Ltd. ...................................... Bermuda
Overseas Leasing Five FSC, Ltd. ............................ Bermuda
Overseas Leasing Four FSC, Ltd. ............................ Bermuda
Overseas Leasing One FSC, Ltd. ............................. Bermuda
Overseas Leasing Twp FSC, Ltd. ............................. Bermuda
Security Trust Limited...................................... England
Sterling Credit Limited..................................... England
Sterling Credit Management Limited.......................... England
Sterling Mortgages Limited.................................. England
The Loan Corporation Limited................................ England
EXHIBIT 23
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors of HSBC Finance Corporation:
We consent to the incorporation of our report dated March 6, 2006, included in
this Annual Report on Form 10-K of HSBC Finance Corporation (the Company) as of
December 31, 2005 (successor basis) and December 31, 2004 (successor basis) and
for each of the years in the two-year period ended December 31, 2005 (successor
basis), and for the period January 1, 2003 through March 28, 2003 (predecessor
basis) and March 29, 2003 through December 31, 2003 (successor basis), into the
Company's previously filed Registration Statements No. 2-86383, No. 33-21343,
No. 33-45454, No. 33-45455, No. 33-52211, No. 33-58727, No. 333-00397, No.
33-44066, No. 333-03673, No. 333-39639, No. 333-58287, No. 333-58289, No.
333-58291, No. 333-47073, No. 333-36589, No. 333-30600, No. 333-50000, No.
333-70794, No. 333-71198, No. 333-83474 and No. 333-99107 on Form S-8 and
Registration Statements No. 333-70744, No. 333-60510, No. 333-01025, No.
333-47945, No. 333-59453, No. 333-82119, No. 333-45740, No. 333-56152, No.
333-73746, No. 333-75328, No. 333-85886, No. 333-33240, No. 333-61964, No.
333-111413, No. 333-53862, No. 333-33052, No. 333-72453, No. 333-60543, No.
333-64175, No. 333-120494, No. 333-120495, No. 333-120496 and No. 333-100737 on
Form S-3.
Our report dated March 6, 2006 contains an explanatory paragraph that states
effective March 28, 2003, HSBC Holdings plc acquired all of the outstanding
stock of Household International, Inc. (now HSBC Finance Corporation) in a
business combination accounted for as a purchase. As a result of the
acquisition, the consolidated financial information for the period after the
acquisition is presented on a different cost basis than that for the periods
before the acquisition and, therefore, is not comparable.
/s/ KPMG LLP
Chicago, Illinois
March 6, 2006
EXHIBIT 31
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Siddharth N. Mehta, Chairman and Chief Executive Officer of HSBC Finance
Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of HSBC Finance
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this annual report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) disclosed in this annual report any change in the registrant's
internal control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal control
over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal controls over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: March 6, 2006
/s/ SIDDHARTH N. MEHTA
--------------------------------------
Siddharth N. Mehta
Chairman and Chief Executive Officer
EXHIBIT 31
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Beverley A. Sibblies, Senior Vice President and Chief Financial Officer of
HSBC Finance Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of HSBC Finance
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this annual report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) disclosed in this annual report any change in the registrant's
internal control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal control
over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal controls over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: March 6, 2006
/s/ BEVERLEY A. SIBBLIES
--------------------------------------
Beverley A. Sibblies
Senior Executive Vice President
and Chief Financial Officer
EXHIBIT 32
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The certification set forth below is being submitted in connection with the HSBC
Finance Corporation (the "Company") Annual Report on Form 10-K for the fiscal
year ended December 31, 2005 as filed with the Securities and Exchange
Commission on the date hereof (the "Report") for the purpose of complying with
Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the
"Exchange Act") and Section 1350 of Chapter 63 of Title 18 of the United States
Code.
I, Siddharth N. Mehta, Chairman and Chief Executive Officer of the Company,
certify that:
1. the Report fully complies with the requirements of Section 13(a) or
15(d) of the Exchange Act; and
2. the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of
HSBC Finance Corporation.
March 6, 2006
/s/ SIDDHARTH N. MEHTA
--------------------------------------
Siddharth N. Mehta
Chairman and Chief Executive Officer
This certification accompanies each Report pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the
Sarbanes-Oxley Act of 2002, be deemed filed by HSBC Finance Corporation for
purposes of Section 18 of the Securities Exchange Act of 1934, as amended.
Signed originals of these written statements required by Section 906 of the
Sarbanes-Oxley Act of 2002 have been provided to HSBC Finance Corporation and
will be retained by HSBC Finance Corporation and furnished to the Securities and
Exchange Commission or its staff upon request.
EXHIBIT 32
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The certification set forth below is being submitted in connection with the HSBC
Finance Corporation (the "Company") Annual Report on Form 10-K for the fiscal
year ended December 31, 2005 as filed with the Securities and Exchange
Commission on the date hereof (the "Report") for the purpose of complying with
Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the
"Exchange Act") and Section 1350 of Chapter 63 of Title 18 of the United States
Code.
I, Beverley A. Sibblies, Senior Vice President and Chief Financial Officer of
the Company, certify that:
1. the Report fully complies with the requirements of Section 13(a) or
15(d) of the Exchange Act; and
2. the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of
HSBC Finance Corporation.
March 6, 2006
/s/ BEVERLEY A. SIBBLIES
--------------------------------------
Beverley A. Sibblies
Senior Vice President
and Chief Financial Officer
This certification accompanies each Report pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the
Sarbanes-Oxley Act of 2002, be deemed filed by HSBC Finance Corporation for
purposes of Section 18 of the Securities Exchange Act of 1934, as amended.
Signed originals of these written statements required by Section 906 of the
Sarbanes-Oxley Act of 2002 have been provided to HSBC Finance Corporation and
will be retained by HSBC Finance Corporation and furnished to the Securities and
Exchange Commission or its staff upon request.
EXHIBIT 99.1
HSBC FINANCE CORPORATION AND SUBSIDIARIES
DEBT AND PREFERRED STOCK SECURITIES RATINGS
STANDARD & MOODY'S DOMINION
POOR'S INVESTORS BOARD RATING
CORPORATION SERVICE FITCH, INC. SERVICE
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AS OF MARCH 6, 2006
HSBC Finance Corporation
Senior debt................................... A Aa3 AA- AA (low)
Senior subordinated debt...................... A- A2 A+ *
Commercial paper.............................. A-1 P-1 F-1+ R-1 (middle)
Series B preferred stock...................... BBB+ A3 A+ *
HFC Bank Limited
Senior debt................................... A Aa3 AA- *
Commercial paper.............................. A-1 P-1 F-1+ *
HSBC Bank Nevada, National Association
Senior debt................................... A A1 AA- *
HSBC Financial Corporation Limited
Senior notes and term loans................... * * * AA (low)
Commercial paper.............................. * * * R-1 (middle)
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* Not rated by this agency.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
HSBC Holdings plc
By:
Name: P A Stafford
Title: Assistant Group Secretary
Date: 6 March 2006