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 November, 2005
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- ..............)
--------------------------------------------------------------------------------
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
---------------------
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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
---------------------
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 (X) No ( )
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes ( ) No (X)
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes ( ) No (X)
At October 31, 2005, there were 50 shares of the registrant's common stock
outstanding, all of which were owned indirectly by HSBC Holdings plc.
--------------------------------------------------------------------------------
HSBC FINANCE CORPORATION
FORM 10-Q
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
-----------------------------------------------------------------------------------
Item 1. Consolidated Financial Statements
Statement of Income......................................... 3
Balance Sheet............................................... 4
Statement of Changes in Shareholders' Equity................ 5
Statement of Cash Flows..................................... 6
Notes to Consolidated Financial Statements.................. 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Forward-Looking Statements.................................. 20
Executive Overview.......................................... 20
Basis of Reporting.......................................... 25
Receivables Review.......................................... 31
Results of Operations....................................... 32
Segment Results - Managed Basis............................. 39
Credit Quality.............................................. 46
Liquidity and Capital Resources............................. 52
Risk Management............................................. 57
Reconciliations to GAAP Financial Measures.................. 59
Item 4. Controls and Procedures..................................... 63
PART II. OTHER INFORMATION
-----------------------------------------------------------------------------------
Item 1. Legal Proceedings........................................... 63
Item 6. Exhibits.................................................... 65
Signature.................................................................... 66
2
PART I. FINANCIAL INFORMATION
--------------------------------------------------------------------------------
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
HSBC Finance Corporation
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF INCOME
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------
2005 2004 2005 2004
----------------------------------------------------------------------------------------------------
(IN MILLIONS)
Finance and other interest income.......................... $3.402 $2,779 $9,491 $7,944
Interest expense:
HSBC affiliates.......................................... 222 95 507 213
Non-affiliates........................................... 1,017 715 2,898 2,012
------ ------ ------ ------
NET INTEREST INCOME........................................ 2,163 1,969 6,086 5,719
Provision for credit losses................................ 1,361 1,123 3,233 3,048
------ ------ ------ ------
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES...... 802 846 2,853 2,671
------ ------ ------ ------
Other revenues:
Securitization related revenue........................... 41 267 180 881
Insurance revenue........................................ 229 203 679 618
Investment income........................................ 33 36 99 107
Derivative income (expense).............................. (53) 72 283 248
Fee income............................................... 439 302 1,099 809
Taxpayer financial services revenue (expense)............ (1) (3) 260 209
Gain on receivable sales to HSBC affiliates.............. 99 10 308 25
Servicing fees from HSBC affiliates...................... 102 6 303 11
Other income............................................. 213 147 477 407
------ ------ ------ ------
TOTAL OTHER REVENUES....................................... 1,102 1,040 3,688 3,315
------ ------ ------ ------
Costs and expenses:
Salaries and employee benefits........................... 513 472 1,536 1,414
Sales incentives......................................... 117 91 289 259
Occupancy and equipment expenses......................... 83 77 252 237
Other marketing expenses................................. 196 174 561 437
Other servicing and administrative expenses.............. 149 235 550 659
Support services from HSBC affiliates.................... 226 183 652 556
Amortization of intangibles.............................. 90 83 280 278
Policyholders' benefits.................................. 109 93 347 299
------ ------ ------ ------
TOTAL COSTS AND EXPENSES................................... 1,483 1,408 4,467 4,139
------ ------ ------ ------
Income before income tax expense........................... 421 478 2,074 1,847
Income tax expense......................................... 140 153 695 619
------ ------ ------ ------
NET INCOME................................................. $ 281 $ 325 $1,379 $1,228
====== ====== ====== ======
The accompanying notes are an integral part of the consolidated financial
statements.
3
HSBC Finance Corporation
--------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, DECEMBER 31,
2005 2004
----------------------------------------------------------------------------------------------
(IN MILLIONS, EXCEPT SHARE DATA)
ASSETS
Cash........................................................ $ 744 $ 392
Interest bearing deposits with banks........................ 398 603
Securities purchased under agreements to resell............. 181 2,651
Securities.................................................. 3,946 3,645
Receivables, net............................................ 126,025 104,815
Intangible assets, net...................................... 2,394 2,705
Goodwill.................................................... 6,799 6,856
Properties and equipment, net............................... 457 487
Real estate owned........................................... 462 587
Derivative financial assets................................. 662 4,049
Other assets................................................ 4,506 3,400
-------- --------
TOTAL ASSETS................................................ $146,574 $130,190
======== ========
LIABILITIES
Debt:
Deposits.................................................. $ 36 $ 47
Commercial paper, bank and other borrowings............... 11,623 9,013
Due to affiliates......................................... 17,907 13,789
Long term debt (with original maturities over one year)... 93,181 85,378
-------- --------
Total debt.................................................. 122,747 108,227
Insurance policy and claim reserves......................... 1,298 1,303
Derivative related liabilities.............................. 408 432
Other liabilities........................................... 3,309 3,287
-------- --------
TOTAL LIABILITIES......................................... 127,762 113,249
SHAREHOLDERS' EQUITY
Redeemable preferred stock, 1,501,100 shares authorized:
Series A, $0.01 par value, 1,100 shares issued, held by
HSBC Investments (North America) Inc. ................ 1,100 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,
50 shares issued...................................... - -
Additional paid-in capital............................. 14,661 14,627
Retained earnings...................................... 1,888 571
Accumulated other comprehensive income................. 588 643
-------- --------
TOTAL COMMON SHAREHOLDER'S EQUITY........................... 17,137 15,841
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................. $146,574 $130,190
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
4
HSBC Finance Corporation
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2005 2004
-------------------------------------------------------------------------------
(IN MILLIONS)
PREFERRED STOCK
Balance at beginning of period............................ $ 1,100 $ 1,100
Issuance of Series B preferred stock...................... 575 -
------- -------
Balance at end of period.................................. $ 1,675 $ 1,100
======= =======
COMMON SHAREHOLDER'S EQUITY
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of period......................... $14,627 $14,645
Issuance costs of Series B preferred stock............. (16) -
Return of capital...................................... (16) (31)
Employee benefit plans, including transfers and
other................................................. 66 21
------- -------
Balance at end of period............................... $14,661 $14,635
------- -------
RETAINED EARNINGS
Balance at beginning of period......................... $ 571 $ 1,303
Net income............................................. 1,379 1,228
Dividends:
Preferred stock...................................... (62) (54)
Common stock......................................... - (850)
------- -------
Balance at end of period............................... $ 1,888 $ 1,627
------- -------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance at beginning of period......................... $ 643 $ 443
Net change in unrealized gains (losses) on:
Derivatives classified as cash flow hedges........... 164 44
Securities available for sale and interest-only strip
receivables......................................... (29) (38)
Foreign currency translation adjustments............... (190) 16
------- -------
Other comprehensive (loss) income, net of tax.......... (55) 22
------- -------
Balance at end of period............................... $ 588 $ 465
------- -------
TOTAL COMMON SHAREHOLDER'S EQUITY........................... $17,137 $16,727
------- -------
COMPREHENSIVE INCOME
Net income................................................ $ 1,379 $ 1,228
Other comprehensive (loss) income......................... (55) 22
------- -------
COMPREHENSIVE INCOME........................................ $ 1,324 $ 1,250
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
5
HSBC Finance Corporation
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2005 2004
--------------------------------------------------------------------------------
(IN MILLIONS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income.................................................. $ 1,379 $ 1,228
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Provision for credit losses............................... 3,233 3,048
Insurance policy and claim reserves....................... (146) (138)
Depreciation and amortization............................. 369 367
Net change in interest-only strip receivables............. 217 410
Net change in other assets................................ (1,147) 47
Net change in other liabilities........................... 73 182
Other, net................................................ (261) (520)
-------- --------
Net cash provided by (used in) operating activities......... 3,717 4,624
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Securities:
Purchased................................................. (656) (1,152)
Matured................................................... 480 1,179
Sold...................................................... 154 790
Net change in interest bearing deposits with banks.......... 179 666
Net change in short-term securities available for sale...... (335) 3,009
Net change in securities purchased under agreements to
resell.................................................... 2,470 (350)
Receivables:
Originations, net of collections.......................... (48,566) (42,123)
Purchases and related premiums............................ (959) (597)
Initial and fill-up securitizations....................... 7,388 24,250
Sales to affiliates....................................... 16,286 1,371
Properties and equipment:
Purchases................................................. (60) (55)
Sales..................................................... 2 2
-------- --------
Net cash provided by (used in) investing activities......... (23,617) (13,010)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Debt:
Net change in short-term debt and deposits................ 2,596 5,343
Net change in time certificates........................... (2) (155)
Net change in due to affiliates........................... 4,763 3,760
Long term debt issued..................................... 28,199 12,603
Long term debt retired.................................... (15,624) (12,581)
Redemption of company obligated mandatorily redeemable
preferred securities of subsidiary trusts................. (309) -
Insurance:
Policyholders' benefits paid.............................. (196) (124)
Cash received from policyholders.......................... 288 194
Shareholder's dividends..................................... (8) (850)
Issuance of Series B preferred stock........................ 559 -
-------- --------
Net cash provided by (used in) financing activities......... 20,266 8,190
-------- --------
Effect of exchange rate changes on cash..................... (14) 7
-------- --------
Net change in cash.......................................... 352 (189)
Cash at beginning of period................................. 392 463
-------- --------
CASH AT END OF PERIOD....................................... $ 744 $ 274
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BASIS OF PRESENTATION
--------------------------------------------------------------------------------
HSBC Finance Corporation is an indirect wholly owned subsidiary of HSBC North
America Holdings Inc. ("HNAH"), which is a wholly owned subsidiary of HSBC
Holdings plc ("HSBC"). The accompanying unaudited interim consolidated financial
statements of HSBC Finance Corporation and its subsidiaries have been prepared
in accordance with accounting principles generally accepted in the United States
of America ("U.S. GAAP") for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all normal and recurring adjustments considered necessary for a fair
presentation of financial position, results of operations and cash flows for the
interim periods have been made. HSBC Finance Corporation may also be referred to
in this Form 10-Q as "we," "us" or "our." These unaudited interim consolidated
financial statements should be read in conjunction with our Annual Report on
Form 10-K for the year ended December 31, 2004 (the "2004 Form 10-K"). Certain
reclassifications have been made to prior period amounts to conform to the
current period presentation. Our accounting and reporting policies are
consistent, in all material respects, with those used to prepare the 2004 Form
10-K.
The preparation of financial statements in conformity with U.S. GAAP requires
the use of estimates and assumptions that affect reported amounts and
disclosures. Actual results could differ from those estimates. Interim results
should not be considered indicative of results in future periods.
Interim financial statement disclosures required by U.S. GAAP regarding segments
are included in the Management's Discussion and Analysis of Financial Condition
and Results of Operations ("MD&A") section of this Form 10-Q.
2. ACQUISITION
--------------------------------------------------------------------------------
On August 4, 2005, we entered into a definitive agreement and plan of merger
with Metris Companies Inc. ("Metris") to acquire Metris in an all-cash
transaction which values Metris at approximately $1.6 billion. We currently
intend to issue approximately $1.2 billion in additional common equity to HSBC
Investments (North America) Inc. ("HINO") 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 acquisition is subject to certain conditions including
resolution of the potential civil enforcement action of the Securities and
Exchange Commission against Metris, approval by the stockholders of Metris and
various regulatory consents and is anticipated to close in the fourth quarter of
2005.
7
3. SECURITIES
--------------------------------------------------------------------------------
Securities consisted of the following available-for-sale investments:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
SEPTEMBER 30, 2005 COST GAINS LOSSES VALUE
---------------------------------------------------------------------------------------------------
(IN MILLIONS)
Corporate debt securities............................ $2,511 $25 $(33) $2,503
Money market funds................................... 296 - - 296
U.S. government sponsored enterprises(1)............. 62 - (2) 60
U.S. government and federal agency debt securities... 602 - (3) 599
Non-government mortgage backed securities............ 130 - - 130
Other................................................ 328 2 (5) 325
------ --- ---- ------
Subtotal............................................. 3,929 27 (43) 3,913
Accrued investment income............................ 33 - - 33
------ --- ---- ------
Total securities available for sale.................. $3,962 $27 $(43) $3,946
====== === ==== ======
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)............. 49 - - 49
U.S. government and federal agency debt securities... 344 - (3) 341
Non-government mortgage backed securities............ 74 - (1) 73
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.
A summary of gross unrealized losses and related fair values as of September 30,
2005 and December 31, 2004, classified as to the length of time the losses have
existed follows:
LESS THAN ONE YEAR GREATER THAN ONE YEAR
--------------------------------------- ---------------------------------------
NUMBER GROSS AGGREGATE NUMBER GROSS AGGREGATE
OF UNREALIZED FAIR VALUE OF OF UNREALIZED FAIR VALUE OF
SEPTEMBER 30, 2005 SECURITIES LOSSES INVESTMENTS SECURITIES LOSSES INVESTMENTS
---------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Corporate debt securities... 372 $(17) $873 244 $(16) $612
U.S. government sponsored
enterprises............... 14 (1) 40 28 (1) 60
U.S. government and federal
agency debt securities.... 13 (2) 72 27 (1) 51
Other....................... 21 (3) 158 34 (2) 93
8
LESS THAN ONE YEAR GREATER THAN ONE YEAR
--------------------------------------- ---------------------------------------
NUMBER GROSS AGGREGATE NUMBER GROSS AGGREGATE
OF UNREALIZED FAIR VALUE OF OF UNREALIZED FAIR VALUE OF
DECEMBER 31, 2004 SECURITIES LOSSES INVESTMENTS SECURITIES LOSSES INVESTMENTS
---------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Corporate debt securities... 254 $(6) $636 218 $(8) $647
U.S. government and federal
agency debt securities.... - - - 61 (3) 278
Non-government mortgage
backed securities......... - - - 3 (1) 6
Other....................... 21 (2) 114 42 (1) 130
The gross unrealized losses on our securities available for sale have increased
due to a general increase in short- and medium-term interest rates during the
nine months ended September 30, 2005. 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.
4. RECEIVABLES
--------------------------------------------------------------------------------
Receivables consisted of the following:
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured......................................... $ 78,130 $ 64,820
Auto finance................................................ 10,137 7,544
MasterCard(1)/Visa(1)....................................... 18,974 14,635
Private label............................................... 2,777 3,411
Personal non-credit card.................................... 18,484 16,128
Commercial and other........................................ 220 317
-------- --------
Total owned receivables..................................... 128,722 106,855
Purchase accounting fair value adjustments.................. 98 201
Accrued finance charges..................................... 1,665 1,394
Credit loss reserve for owned receivables................... (4,220) (3,625)
Unearned credit insurance premiums and claims reserves...... (546) (631)
Interest-only strip receivables............................. 87 323
Amounts due and deferred from receivable sales.............. 219 298
-------- --------
Total owned receivables, net................................ 126,025 104,815
Receivables serviced with limited recourse.................. 6,759 14,225
-------- --------
Total managed receivables, net.............................. $132,784 $119,040
======== ========
---------------
(1) MasterCard is a registered trademark of MasterCard International,
Incorporated and Visa is a registered trademark of VISA USA, Inc.
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 as a
result of our acquisition by HSBC and premiums or discounts on purchased loans.
Receivables are further reduced by credit loss reserves and unearned credit
insurance premiums and claims reserves applied to credit risks on consumer
receivables.
9
Interest-only strip receivables are reported net of our estimate of probable
losses under the recourse provisions for receivables serviced with limited
recourse. Our estimate of the recourse obligation totaled $351 million at
September 30, 2005 and $890 million at December 31, 2004. Interest-only strip
receivables also included fair value mark-to-market adjustments, which increased
the balance by $57 million at September 30, 2005 and $76 million at December 31,
2004.
Receivables serviced with limited recourse consisted of the following:
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured......................................... $ - $ 81
Auto finance................................................ 1,474 2,679
MasterCard/Visa............................................. 3,615 7,583
Personal non-credit card.................................... 1,670 3,882
------ -------
Total....................................................... $6,759 $14,225
====== =======
The combination of receivables owned and receivables serviced with limited
recourse, which comprises our managed portfolio, is shown below:
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured......................................... $ 78,130 $ 64,901
Auto finance................................................ 11,611 10,223
MasterCard/Visa............................................. 22,589 22,218
Private label............................................... 2,777 3,411
Personal non-credit card.................................... 20,154 20,010
Commercial and other........................................ 220 317
-------- --------
Total....................................................... $135,481 $121,080
======== ========
10
5. CREDIT LOSS RESERVES
--------------------------------------------------------------------------------
An analysis of credit loss reserves was as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------
2005 2004 2005 2004
------------------------------------------------------------------------------------------------
(IN MILLIONS)
Owned receivables:
Credit loss reserves at beginning of period.......... $ 3,756 $ 3,795 $ 3,625 $ 3,793
Provision for credit losses.......................... 1,361 1,123 3,233 3,048
Charge-offs.......................................... (1,020) (1,068) (2,934) (3,176)
Recoveries........................................... 118 99 325 271
Other, net........................................... 5 4 (29) 17
------- ------- ------- -------
Credit loss reserves for owned receivables........... 4,220 3,953 4,220 3,953
------- ------- ------- -------
Receivables serviced with limited recourse:
Credit loss reserves at beginning of period.......... 525 1,904 890 2,374
Provision for credit losses.......................... (23) (232) 59 169
Charge-offs.......................................... (165) (418) (637) (1,343)
Recoveries........................................... 15 24 48 76
Other, net........................................... (1) (32) (9) (30)
------- ------- ------- -------
Credit loss reserves for receivables serviced with
limited recourse.................................. 351 1,246 351 1,246
------- ------- ------- -------
Credit loss reserves for managed receivables........... $ 4,571 $ 5,199 $ 4,571 $ 5,199
======= ======= ======= =======
The provision for credit losses on owned receivables and overall reserve levels
in 2005 reflect the impact of the bulk sale of our domestic private label
receivables to HSBC Bank USA, National Association ("HSBC Bank USA") in December
2004 as well as the impact of receivable growth and higher bankruptcy filings in
the period leading up to the effective date of the new bankruptcy law in the
United States. The provision for credit losses and overall reserve levels at
September 30, 2005 includes an incremental provision of $180 million recorded in
the third quarter relating to Hurricane Katrina and an additional $100 million
provision due to the spike in bankruptcies experienced in the period leading up
to the October 17, 2005 effective date of new bankruptcy legislation in the
United States.
Reductions to the provision for credit losses and overall reserve levels on
receivables serviced with limited recourse in 2005 also reflect the impact of
the bulk sale discussed above, as well as 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 and our credit loss
reserve methodology are presented in Item 2, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" of this Form 10-Q
under the caption "Credit Quality."
11
6. INTANGIBLE ASSETS
--------------------------------------------------------------------------------
Intangible assets consisted of the following:
ACCUMULATED CARRYING
GROSS AMORTIZATION VALUE
----------------------------------------------------------------------------------------------
(IN MILLIONS)
SEPTEMBER 30, 2005
Purchased credit card relationships and related programs.... $1,686 $507 $1,179
Retail services merchant relationships...................... 270 136 134
Other loan related relationships............................ 326 95 231
Trade names................................................. 717 13 704
Technology, customer lists and other contracts.............. 282 136 146
------ ---- ------
Total....................................................... $3,281 $887 $2,394
====== ==== ======
DECEMBER 31, 2004
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
====== ==== ======
Estimated amortization expense associated with our intangible assets for each of
the following years is as follows:
YEAR ENDING DECEMBER 31,
----------------------------------------------------------------------------
(IN MILLIONS)
2005........................................................ $327
2006........................................................ 265
2007........................................................ 247
2008........................................................ 184
2009........................................................ 167
Thereafter.................................................. 583
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 tradename in the U.K. For all other intangible assets, we
determined that the fair value of each intangible asset exceeded its carrying
value. Therefore, we have concluded that none of our remaining intangible assets
are impaired.
7. 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 our goodwill balance 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 Number 109, "Accounting for Income Taxes," and
for the movements in foreign exchange rates discussed above. We have increased
our goodwill balance by approximately $2 million for the three months ended
September 30, 2005 and reduced the goodwill balance by $11 million for the nine
month period as a result of such changes in tax estimates.
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
12
Intangible Assets"). The fair value of each of the reporting units to which
goodwill was assigned exceeded its carrying value including goodwill. Therefore,
we have concluded that none of our goodwill is impaired.
8. INCOME TAXES
--------------------------------------------------------------------------------
Our effective tax rates were as follows:
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2005 2004 2005 2004
-------------------------------------------------------------------------------------------
Effective tax rate.......................................... 33.3% 32.0% 33.5% 33.5%
The increase in the effective tax rate in the third quarter of 2005 is primarily
due to the acceleration of tax from sales of leveraged leases, partially offset
by lower state tax rates. The year-to-date period reflects the leveraged lease
tax increase, offset by the lower state tax. 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.
9. REDEEMABLE PREFERRED STOCK
--------------------------------------------------------------------------------
We have 1,501,100 shares of preferred stock authorized for issuance. 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 August 2005, we declared an $8 million dividend on the Series B Preferred
Stock which was paid on September 15, 2005.
In March 2003, we issued 1,100 shares of Series A Cumulative Preferred Stock to
HSBC, which are now held by HINO. We currently intend to issue additional common
equity to HINO in exchange for the Series A Cumulative Preferred Stock on or
before December 31, 2005.
10. 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
13
following tables present related party balances and the income and (expense)
generated by related party transactions:
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------------------------------------------------------------------------------------
(IN MILLIONS)
ASSETS, (LIABILITIES) AND EQUITY:
Derivative financial assets, net............................ $ 371 $ 3,297
Other assets................................................ 1,927 604
Due to affiliates........................................... (17,907) (13,789)
Other liabilities........................................... (288) (168)
Series A preferred stock.................................... 1,100 1,100
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------- -------------
2005 2004 2005 2004
--------------------------------------------------------------------------------------------
(IN MILLIONS)
INCOME/(EXPENSE):
Interest expense on borrowings from HSBC and subsidiaries... $(222) $(95) $(507) $(213)
Interest income on advances to HSBC affiliates.............. 15 - 26 -
HSBC Bank USA:
Real estate secured servicing revenues.................... 4 4 12 9
Real estate secured sourcing, underwriting and pricing
revenues............................................... 1 1 3 3
Gain on daily sale of domestic private label receivable
originations........................................... 91 - 283 -
Gain on daily sale of MasterCard/Visa receivables......... 8 10 25 10
Gain on bulk sale of real estate secured receivables...... - - - 15
Taxpayer financial services loan origination fees......... - - (15) -
Domestic private label receivable servicing fees.......... 92 - 273 -
MasterCard/Visa receivable servicing fees................. 3 - 9 -
Other processing, origination and support revenues........ 4 3 12 8
Support services from HSBC affiliates, primarily HSBC
Technology and Services (USA) Inc. ("HTSU")............... (226) (183) (652) (556)
HTSU:
Rental revenue............................................ 13 8 31 24
Administrative services revenue........................... 2 5 11 13
Servicing revenue......................................... 1 - 4 -
Other income from HSBC affiliates........................... - 2 - 2
Other servicing fees from HSBC affiliates................... 2 2 5 2
Stock based compensation expense with HSBC.................. (14) (12) (50) (37)
The notional value of derivative contracts outstanding with HSBC subsidiaries
totaled $64.3 billion at September 30, 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 September 30, 2005,
the fair value of our agreements with affiliate counterparties was below the
level requiring payment of collateral. As such, at September, 30, 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.
The balance outstanding under this line was $1.0 billion at September 30, 2005
and $.6 billion at December 31, 2004 and is included in other assets. Interest
income
14
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 September 30, 2005 and is included in other assets. Interest income
associated with this line of credit is recorded in interest income and reflected
as other income from 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 extended an additional promissory note of $.5 billion to HSI on
September 29, 2005. This promissory note, which is included in other assets at
September 30, 2005, was repaid during October 2005. Interest income associated
with this line of credit is recorded in interest income and reflected as other
income from HSBC affiliates in the table above.
We extended a line of credit of $.4 billion to HSBC Investments (North America)
Inc. on March 31, 2005 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. Interest income associated with this line of
credit is recorded in interest income and reflected as other income from 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 September 30, 2005, we had revolving credit facilities of $2.5 billion from
HSBC domestically and $10.0 billion from HSBC in the U.K., of which $6.6 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 under the
U.K. lines and no balances were outstanding on the domestic lines. Annual
commitment fee requirements to support availability of these lines are paid on a
quarterly basis. Expense recognized for commitment fees totaled $.4 million for
the three months ended September 30, 2005 and 2004, and $1.2 million for the
nine months ended September 30, 2005 and 2004. Commitment fee expense is
included as a component of interest expense -- 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 September 30, 2005, we were servicing $5.0 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 $.4 billion of real estate secured receivables purchased
by HSBC Bank USA during the three months ended September 30, 2005 and $.7
billion during the three months ended September 30, 2004. We sourced, underwrote
and priced $1.5 billion of real estate secured receivables purchased by HSBC
Bank USA during the nine months ended September 30, 2005 and $2.2 billion during
the nine months ended September 30, 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 given HSBC Bank USA's
increasing ability to originate similar product. We continue to service the
receivables HSBC Bank USA previously purchased from these correspondents.
In December 2004, we sold our domestic private label receivable portfolio,
including the retained interests associated with our securitized domestic
private label receivables, to HSBC Bank USA. We continue to service the sold
private label receivables and receive servicing fee income from HSBC Bank USA
for these services. As of September 30, 2005, we were servicing $15.9 billion of
domestic private label receivables for HSBC Bank USA. Servicing fee income from
HSBC Bank USA received for the three month period ended
15
September 30, 2005 of $92 million and $273 million for the nine months ended
September 30, 2005 is included in the table. We continue to maintain the related
customer account relationships and, therefore, sell new domestic private label
receivable originations to HSBC Bank USA on a daily basis. We sold $5,887
million of private label receivables to HSBC Bank USA during the three months
ended September 30, 2005 and $14,825 million in the year-to-date period. 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.
Under several service level agreements, we also provide other 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. Interest expense recorded on the
underlying junior subordinated notes totaled $4 million during both three month
periods ended September 30, 2005 and 2004 and $12 million for both nine month
periods ended September 30, 2005 and 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 interest expense on
borrowings from HSBC and subsidiaries in the table above.
During the third quarter of 2004, our Canadian business began to originate and
service auto loans for an HSBC affiliate in Canada. Fees received for these
services of $2 million for the three months ended September 30, 2005 and $5
million for the nine months ended September 30, 2005 are included in servicing
fees from affiliates and are reflected in other servicing fees 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
during the nine months ended September 30, 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 ("HOBN"), 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 intangible assets. The
receivables continue to be owned by HSBC Bank USA. Originations of new accounts
and receivables are made by HOBN and new receivables are sold daily to HSBC Bank
USA. We sold $514 million of credit card receivables to HSBC Bank USA during the
three months ended September 30, 2005 and $1,461 million in the year-to-date
period. 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.
In addition, we utilize a related HSBC entity to lead manage substantially all
ongoing debt issuances. Fees paid to HSBC and its subsidiaries for such services
totaled approximately $19 million for the three months ended September 30, 2005
and $45 million for the nine months ended September 30, 2005. Fees paid for such
services totaled approximately $2 million for the three months ended September
30, 2004 and $8 million for
16
the nine months ended September 30, 2004. These fees are amortized over the life
of the related debt as a component of interest expense in the table above.
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 $14 million for the three months ended September 30, 2005 and $12 million
for the prior year quarter. Our share of the expense of these plans was $50
million for the nine months ended September 30, 2005 and $37 million for the
year-ago period. These expenses are recorded in salary and employee benefits and
are reflected in the above table.
11. PENSION AND OTHER POSTRETIREMENT BENEFITS
--------------------------------------------------------------------------------
In November 2004, sponsorship of the U.S. defined benefit pension plan of HSBC
Finance Corporation and the U.S. defined benefit pension plan of HSBC Bank USA
was transferred to HNAH. Effective January 1, 2005, the two separate plans were
merged into a single defined benefit pension plan which facilitates the
development of a unified employee benefit policy and unified employee benefit
plan administration for HSBC affiliates operating in the U.S. As a result, the
pension liability relating to our U.S. defined benefit plan of $49 million, net
of tax, was transferred to HNAH as a capital transaction in the first quarter of
2005.
Components of net periodic benefit cost related to our defined benefit pension
plans and our postretirement benefits other than pensions were as follows:
OTHER
POSTRETIREMENT
PENSION BENEFITS BENEFITS
---------------- --------------
THREE MONTHS ENDED SEPTEMBER 30, 2005 2004 2005 2004
------------------------------------------------------------------------------------------------
(IN MILLIONS)
Service cost - benefits earned during the period............ $ 5 $ 14 $ 1 $ 1
Interest cost............................................... 11 13 4 3
Expected return on assets................................... (14) (23) - -
Recognized (gains) losses................................... 1 (1) - -
---- ---- --- ---
Net periodic benefit cost................................... $ 3 $ 3 $ 5 $ 4
==== ==== === ===
OTHER
POSTRETIREMENT
PENSION BENEFITS BENEFITS
---------------- --------------
NINE MONTHS ENDED SEPTEMBER 30, 2005 2004 2005 2004
------------------------------------------------------------------------------------------------
(IN MILLIONS)
Service cost - benefits earned during the period............ $ 37 $ 41 $ 4 $ 3
Interest cost............................................... 47 40 12 10
Expected return on assets................................... (65) (67) - -
Recognized (gains) losses................................... 3 (4) - -
---- ---- --- ---
Net periodic benefit cost................................... $ 22 $ 10 $16 $13
==== ==== === ===
12. BUSINESS SEGMENTS
--------------------------------------------------------------------------------
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, Ireland and the remainder of Europe. 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.
17
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.
Fair value adjustments related to purchase accounting and related amortization
have been allocated to Corporate, which is included in the "All Other" caption
within our segment disclosure. Reconciliations of our managed basis segment
results to managed basis and owned basis consolidated totals are as follows:
MANAGED
CREDIT ADJUSTMENTS/ BASIS OWNED BASIS
CARD RECONCILING CONSOLIDATED SECURITIZATION CONSOLIDATED
CONSUMER SERVICES INTERNATIONAL ALL OTHER ITEMS TOTALS ADJUSTMENTS TOTALS
------------------------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
THREE MONTHS ENDED SEPTEMBER 30, 2005
Net interest
income............. $ 1,733 $ 531 $ 228 $ (152) $ - $ 2,340 $ (177)(3) $ 2,163
Securitization
related revenue.... (171) (42) 2 (6) - (217) 258(3) 41
Fee and other
income............. 307 554 141 152 (35)(1) 1,119 (58)(3) 1,061
Intersegment
revenues........... 27 5 4 (1) (35)(1) - - -
Provision for credit
losses............. 735 465 137 - 1(5) 1,338 23(3) 1,361
Total costs and
expenses........... 647 360 216 260 - 1,483 - 1,483
Net income........... 308 138 12 (154) (23) 281 - 281
Receivables.......... 102,733 19,971 12,564 213 - 135,481 (6,759)(4) 128,722
Assets............... 103,424 19,710 13,574 25,180 (8,555)(2) 153,333 (6,759)(4) 146,574
-------- -------- ------- ------- ------- -------- -------- --------
THREE MONTHS ENDED SEPTEMBER 30, 2004
Net interest
income............. $ 1,956 $ 519 $ 185 $ (110) $ - $ 2,550 $ (581)(3) $ 1,969
Securitization
related revenue.... (547) (77) (87) (31) - (742) 1,009(3) 267
Fee and other
income............. 187 460 130 227 (35)(1) 969 (196)(3) 773
Intersegment
revenues........... 26 6 4 (1) (35)(1) - - -
Provision for credit
losses............. 506 364 19 1 1(5) 891 232(3) 1,123
Total costs and
expenses........... 619 328 181 280 - 1,408 - 1,408
Net income........... 294 134 18 (98) (23) 325 - 325
Receivables.......... 95,946 18,509 11,833 324 - 126,612 (20,175)(4) 106,437
Assets............... 98,099 20,620 12,770 25,030 (8,616)(2) 147,903 (20,175)(4) 127,728
-------- -------- ------- ------- ------- -------- -------- --------
NINE MONTHS ENDED SEPTEMBER 30, 2005
Net interest
income............. $ 5,125 $ 1,545 $ 680 $ (506) $ - $ 6,844 $ (758)(3) $ 6,086
Securitization
related revenue.... (557) (161) 17 (41) - (742) 922(3) 180
Fee and other
income............. 884 1,465 412 1,073 (103)(1) 3,731 (223)(3) 3,508
Intersegment
revenues........... 80 16 11 (4) (103)(1) - - -
Provision for credit
losses............. 1,698 1,120 468 - 6(5) 3,292 (59)(3) 3,233
Total costs and
expenses........... 1,893 1,018 649 907 - 4,467 - 4,467
Net income........... 1,182 452 (11) (173) (71) 1,379 - 1,379
-------- -------- ------- ------- ------- -------- -------- --------
18
MANAGED
CREDIT ADJUSTMENTS/ BASIS OWNED BASIS
CARD RECONCILING CONSOLIDATED SECURITIZATION CONSOLIDATED
CONSUMER SERVICES INTERNATIONAL ALL OTHER ITEMS TOTALS ADJUSTMENTS TOTALS
------------------------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
NINE MONTHS ENDED SEPTEMBER 30, 2004
Net interest
income............. $ 5,735 $ 1,561 $ 583 $ (173) $ - $ 7,706 $ (1,987)(3) $ 5,719
Securitization
related revenue.... (1,089) (222) (92) (124) - (1,527) 2,408(3) 881
Fee and other
income............. 516 1,271 369 969 (101)(1) 3,024 (590)(3) 2,434
Intersegment
revenues........... 74 20 10 (3) (101)(1) - - -
Provision for credit
losses............. 1,905 1,105 207 (1) 1(5) 3,217 (169)(3) 3,048
Total costs and
expenses........... 1,892 890 527 830 - 4,139 - 4,139
Net income........... 855 391 80 (32) (66) 1,228 - 1,228
-------- -------- ------- ------- ------- -------- -------- --------
---------------
(1) Eliminates intersegment revenues.
(2) Eliminates investments in subsidiaries and intercompany borrowings.
(3) Reclassifies net interest income, fee income and provision for credit losses
relating to securitized receivables to other revenues.
(4) Represents receivables serviced with limited recourse.
(5) Eliminates bad debt recovery sales between operating segments.
13. 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.
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 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.
19
HSBC Finance Corporation
--------------------------------------------------------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
--------------------------------------------------------------------------------
FORWARD-LOOKING STATEMENTS
--------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") should be read in conjunction with the consolidated
financial statements, notes and tables included elsewhere in this report and
with our Annual Report on Form 10-K for the year ended December 31, 2004 (the
"2004 Form 10-K"). MD&A may contain certain statements that may be
forward-looking in nature within the meaning of the Private Securities
Litigation Reform Act of 1995. Our results may differ materially from those
noted in the forward-looking statements. Words such as "believe", "expects",
"estimates", "targeted", "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. Statements that are
not historical facts, including statements about management's beliefs and
expectations, are forward-looking statements which involve inherent risks and
uncertainties and are based on current views and assumptions. A number of
factors could cause actual results to differ materially from those contained in
any forward-looking statements, such as the impact of natural disasters on the
collectibility of our receivables in the affected areas. For a list of
additional important factors that may affect our actual results, see Cautionary
Statement on Forward Looking Statements in Part I, Item 1 of our 2004 Form 10-K.
EXECUTIVE OVERVIEW
--------------------------------------------------------------------------------
HSBC Finance Corporation is an indirect wholly owned subsidiary of HSBC Holdings
plc ("HSBC"). HSBC Finance Corporation may also be referred to in MD&A as "we",
"us", or "our". In addition to owned basis reporting, we also monitor 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. See "Basis of Reporting" for further discussion of
the reasons we use this non-GAAP financial measure.
Net income was $281 million for the quarter ended September 30, 2005, a decrease
of 14 percent, compared to net income of $325 million in the prior year quarter.
The decrease was driven by an increase in the provision for credit losses due to
Hurricane Katrina and higher bankruptcy filings in the period leading up to the
effective date of new bankruptcy legislation in the United States. The increase
in the provision for credit losses as well as higher costs and expenses was
partially offset by higher other revenues and higher net interest income. Net
income was $1,379 million for the first nine months of 2005, an increase of 12
percent, compared to net income of $1,228 million for the first nine months of
2004. The increase was due to higher other revenues and higher net interest
income, partially offset by higher costs and expenses and a higher provision for
credit losses as discussed above. The increase in other revenues during the
current quarter was primarily due to higher fee and other income, higher gains
on receivable sales to affiliates and higher affiliate servicing fees, partially
offset by lower securitization related revenue and lower derivative income. The
increase in other revenues during the nine month period was primarily due to
higher fee and other income, higher derivative income as well as higher gains on
affiliate receivable sales and higher affiliate servicing fees, partially offset
by 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.
Derivative income decreased in the current quarter due to increases in interest
rates. The upward shift in the forward yield curve decreased the value of our
portfolio of interest rate swaps which do not currently qualify for hedge
accounting under SFAS No. 133. The increase in year-to-date derivative income
reflects the combined impact of increases in interest rates and changes in the
portfolio mix of interest rate swaps which do not currently qualify for hedge
accounting under SFAS No. 133 and ineffectiveness recorded as a result of the
designation of a significant number of our non-hedging derivative portfolio as
effective hedges under the long-haul method of accounting beginning in the
second quarter of 2005. Fee income was higher in both periods as a result of
higher credit
20
HSBC Finance Corporation
--------------------------------------------------------------------------------
card fees due to higher volume in our MasterCard((1)) and Visa(1) portfolios.
Other income was higher in both periods primarily due to higher ancillary credit
card revenue and, for the three month period, higher gains on assets sales,
including the partial sale of a real estate investment. The increases in other
revenues were partially offset by lower securitization related revenue in both
periods due to reduced securitization activity.
The increases in net interest income were due to growth in average receivables
and an improvement in the overall yield on the portfolio, partly offset by a
higher cost of funds. Yields on variable rate products increased in line with
market movements, and also reflect various 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
auto finance receivables were held on the balance sheet due to lower
securitization activity, but the effect of this on yields was largely offset by
growth in lower yielding real estate secured receivables and a significant
decline in the level of private label receivables as discussed above. Interest
expense increased due to a combination of growth in the loan book and a
significantly higher cost of funds. Our net interest margin was 6.81 percent for
the three months ended September 30, 2005 and 6.77 percent for the nine months
ended September 30, 2005 compared to 7.29 percent for the three months ended
September 30, 2004 and 7.41 percent in the nine months ended September 30, 2004.
Net interest margin decreased in both periods as the improvement in overall
yields on our receivables discussed above, was more than offset by the higher
funding costs.
In August 2005, Hurricane Katrina ("Katrina") caused destruction and loss to
individuals, businesses and public infrastructure. As of September 30, 2005, we
had $1.4 billion, or 1.1 percent ($1.5 billion or 1.1 percent on a managed
basis) of consumer receivables outstanding with customers living in the Federal
Emergency Management Agency ("FEMA") designated Individual Assistance disaster
areas(2) with approximately $1 billion of these receivables secured by real
estate. Assessment of the impact of Katrina on the collectibility of these
receivables is continuing, but is complicated by the number of customers that
have been displaced from their primary residence. Preliminary estimates of the
potential impact to our businesses take into account a number of factors on
which we are still gathering information, such as:
- how the current and long-term financial impact of the disaster on our
customers will affect future payment patterns;
- the condition and value of any collateral supporting the amounts
outstanding; and
- the availability of insurance to cover losses on the underlying collateral.
Based on the information currently available, we have recorded an incremental
provision for credit losses of $180 million at September 30, 2005, representing
our best estimate of Katrina's impact on our loan portfolio. As these estimates
are influenced by factors outside of our control, there is uncertainty inherent
in these estimates, making it reasonably probable that they will change. As more
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 have initiated
various programs including extended payment arrangements and interest and fee
waivers for up to 90 days for certain products depending upon customer
circumstances. These interest and fee waivers totaled $7 million during the
quarter. We currently anticipate additional interest and fee waivers of
approximately $14 million during the fourth quarter of 2005.
The increase in provision for credit losses in both periods was driven by
increased loss exposure caused by Hurricane Katrina as well as increased loss
provision resulting from higher bankruptcy filings in the period
---------------
(1) MasterCard is a registered trademark of MasterCard International,
Incorporated and Visa is a registered trademark of VISA USA, Inc.
(2) 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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leading up to the October 17, 2005 effective date of the new bankruptcy
legislation in the United States. We have 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. As a result, we recorded an additional credit loss provision of
$100 million during the third quarter. We currently expect that the higher
levels of personal bankruptcy filings we have been experiencing will result in
significantly higher levels of net charge-offs, predominantly in our domestic
MasterCard/Visa portfolio, during the fourth quarter of 2005 in the region of
$200 million. We believe that a portion of this increase is an acceleration of
net charge-offs that would otherwise have been experienced in future periods. We
will continue to evaluate the impact of the spike in bankruptcy filings on our
credit loss reserves and currently believe that this could result in a reduction
in the allowance in the fourth quarter as charge-offs occur. Excluding in the
third quarter of 2005, the $180 million credit loss provision recorded relating
to Katrina as well as the additional $100 million credit loss provision related
to increased bankruptcy filings, our provision for credit losses declined in
both periods as improved credit quality and a shift in mix to higher levels of
secured receivables, primarily as a result of the sale of our domestic private
label receivable portfolio to HSBC Bank USA in December 2004, was partially
offset by receivable growth.
Total costs and expenses increased due to receivables growth and increases in
marketing expenses, partially offset by lower other servicing and administrative
expenses.
Amortization of purchase accounting fair value adjustments increased net income
by $38 million for the quarter ended September 30, 2005 and $59 million for the
nine months ended September 30, 2005 compared to $43 million for the quarter
ended September 30, 2004 and $103 million for the nine months ended September
30, 2004.
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, a U.K.
based subsidiary of HSBC, and/or one or more unrelated third parties. As of the
date of this filing, a decision has not been made regarding the transfer of all
or a portion of the U.K. and other European operations. We anticipate that a
decision regarding this potential transfer will be reached in the fourth quarter
of 2005; however, any transfer is subject to approval by regulatory authorities
and boards of directors of the affected entities.
Return on average owned assets ("ROA") was .79 percent for the three months
ended September 30, 2005 and 1.35 percent for the nine months ended September
30, 2005 compared to 1.04 percent for the three months ended September 30, 2004
and 1.36 percent for the nine months ended September 30, 2004. ROA remained flat
during the year-to-date period as the higher net income discussed above kept
pace with average owned basis asset growth during the period. The decrease in
the three month period ended September 30, 2005 reflects the impact of higher
provision for credit losses during the quarter due to the impact of Katrina and
increased bankruptcy filings. Return on averaged managed assets ("ROMA") (a
non-GAAP financial measure which assumes that securitized receivables have not
been sold and are still on our balance sheet) was .75 percent for the three
months ended September 30, 2005 and 1.26 percent for the nine months ended
September 30, 2005 compared to .89 percent for the three months ended September
30, 2004 and 1.14 percent for the nine months ended September 30, 2004. ROMA
increased during the year-to-date period as the higher net income discussed
above outpaced average managed basis asset growth during the period. The
decrease in the current quarter reflects the impact of higher provision for
credit losses as discussed above. See "Basis of Reporting" for additional
discussion on the use of non-GAAP financial matters and "Reconciliations to GAAP
Financial Measures" for quantitative reconciliations to the equivalent GAAP
basis financial measures.
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The financial information set forth below summarizes selected financial
highlights of HSBC Finance Corporation as of September 30, 2005 and 2004 and for
the three and nine month periods ended September 30, 2005 and 2004.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------
2005 2004 2005 2004
----------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
NET INCOME:................................................ $ 281 $ 325 $1,379 $1,228
OWNED BASIS RATIOS:
Return on average owned assets........................... .79% 1.04% 1.35% 1.36%
Return on average common shareholder's equity ("ROE").... 6.03 7.07 10.58 9.18
Net interest margin...................................... 6.81 7.29 6.77 7.41
Consumer net charge-off ratio, annualized................ 2.93 3.77 3.00 3.98
Efficiency ratio(1)...................................... 43.54 45.10 43.70 43.96
MANAGED BASIS RATIOS:(2)
Return on average managed assets ("ROMA")................ .75% .89% 1.26% 1.14%
Net interest margin...................................... 6.94 7.88 7.01 8.13
Risk adjusted revenue.................................... 7.34 6.50 7.32 6.69
Consumer net charge-off ratio, annualized................ 3.21 4.38 3.37 4.61
Efficiency ratio(1)...................................... 43.86 48.99 43.43 43.13
AS OF SEPTEMBER 30, 2005 2004
---------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
RECEIVABLES:
Owned basis............................................... $128,722 $106,437
Managed basis(2).......................................... 135,481 126,612
TWO-MONTH-AND-OVER CONTRACTUAL DELINQUENCY RATIOS:
Owned basis............................................... 3.78% 4.43%
Managed basis(2).......................................... 3.87 4.59
---------------
(1) Ratio of total costs and expenses less policyholders' benefits to net
interest income and other revenues less policyholders' benefits.
(2) Managed basis reporting is 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 to the equivalent GAAP basis financial measure.
Owned receivables were $128.7 billion at September 30, 2005, $118.8 billion at
June 30, 2005, and $106.4 billion at September 30, 2004. With the exception of
private label, we experienced growth in all our receivable products compared to
June 30, 2005 and September 30, 2004, with real estate secured receivables being
the primary contributor to the growth. Real estate secured receivables do not
include purchases of correspondent receivables directly by HSBC Bank USA of $1.5
billion in the first eight months of 2005 and $2.1 billion since September 30,
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 given HSBC Bank USA's increasing
ability to originate similar product. Lower securitization levels also
contributed to the increase in owned receivables over both periods.
Our owned basis two-months-and-over-contractual delinquency ratio increased
slightly compared to the prior quarter but decreased compared to the prior year
quarter. The decrease as compared to the prior year quarter is consistent with
improvements in the delinquency trends we experienced beginning in 2004 as a
result of improvements in the economy and better underwriting, improved credit
quality of originations as well as higher levels of real estate secured
receivables. The sale of our domestic private label portfolio in December
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2004 also contributed to the decrease in the delinquency ratio compared with the
prior year quarter. The increase compared to the prior quarter is primarily due
to a seasonal increase in delinquency during the third quarter. Dollars of
delinquency increased compared to the prior quarter due to the higher levels of
owned receivables including lower securitizations, maturation of the portfolio
as well as a seasonal increase in delinquency in the third quarter.
Owned net charge-offs as a percentage of average consumer receivables for the
quarter decreased from the prior year quarter as the lower delinquency levels we
have been experiencing continue to have a positive impact on charge-offs. Also
contributing to the decrease in net charge-offs as a percentage of average
consumer receivables compared to the prior year quarter were improved
collections and the sale of our domestic private label receivable portfolio in
December 2004, partially offset by an increase in bankruptcy filings due to new
bankruptcy legislation in the United States which became effective in October
2005.
Our owned basis efficiency ratio improved compared to the prior year periods
primarily as a result of higher net interest income and other revenues due to
higher levels of owned receivables. This was partially offset by higher costs
and expenses and the impact of the bulk sale of our domestic private label
portfolio in December 2004. Excluding the results of our domestic private label
portfolio from all periods, the improvement in our owned basis efficiency ratio
was 473 basis points for the three month period ended September 30, 2005 and 285
basis points for the year to date period. Excluding the results of our domestic
private label portfolio from all periods, our managed basis efficiency ratio
also showed significant improvement compared to the prior year quarter for the
reasons discussed above.
During 2005, we supplemented unsecured debt issuances with proceeds from the
sale of our domestic private label receivable portfolio to HSBC Bank USA 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 $407 million during the nine months
ended September 30, 2005 ($155 million during the three months ended September
30, 2005) and approximately $235 million during the nine months ended September
30, 2004 ($95 million during the three months ended September 30, 2004) 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 and other funding synergies including asset transfers will eventually
enable HSBC to realize annual cash funding expense savings, including external
fee savings, in excess of $1 billion per year as our existing term debt matures
over the course of the next few years.
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 and MasterCard and 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 several years
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. In the nine
month period ended September 30, 2005, our net interest-only strip receivables,
excluding the mark-to-market adjustment recorded in accumu-
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lated other comprehensive income decreased $217 million, compared to a decrease
of $410 million during the nine month period ended September 30, 2004. There is
no impact, however, on cash received from operations.
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 is presented on an owned basis of reporting.
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 also evaluate 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 and securitized portfolios. As the
level of our securitized receivables falls over time, managed basis and owned
basis results will eventually converge.
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's 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 purchase accounting adjustments. We do so because we believe that the
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 purchase
accounting adjustments, were also considered equity in these calculations.
Beginning in the third quarter of 2005, and with the agreement of certain 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.
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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:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2005 SEPTEMBER 30, 2005
----------------------------------------------------------------------------------------------------
(IN MILLIONS)
Net income - U.S. GAAP basis............................... $281 $1,379
Adjustments, net of tax:
Securitizations.......................................... 65 233
Derivatives and hedge accounting (including fair value
adjustments).......................................... 38 48
Intangible assets........................................ 47 145
Purchase accounting adjustments.......................... (20) 27
Loan origination......................................... (12) (45)
Loan impairment.......................................... (8) (1)
Pension costs............................................ 2 5
Other.................................................... (5) 3
---- ------
Net income - IFRS basis.................................... $388 $1,794
==== ======
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 have been transferred to a third party,
those securitized assets should be derecognized.
- If the rights to the cash flows are retained but there is a contractual
obligation to pay the cash flows to another party, the securitized
assets should be derecognized if certain conditions are met, for
example, where there is no obligation to pay amounts to the eventual
recipient unless an equivalent amount is collected from the original
asset.
- If it is determined that some significant risks and rewards of ownership
have been transferred, but some significant risks and rewards have also
been retained, it must be determined whether or not control has been
retained. If it has not been retained, the asset should be derecognized.
If control has been retained, an entity shall continue to recognize the
asset to the extent of its continuing involvement.
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 those securitized assets.
- Control has been surrendered over transferred assets if and only if all
of the following conditions are met:
- The transferred assets have been 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.
- Where 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, HSBC recognizes this interest at fair value on sale of
the assets.
DERIVATIVES AND HEDGE ACCOUNTING
IFRS
- Derivatives are recognized initially, and are subsequently remeasured, at
fair value. Fair values are obtained from quoted market prices in active
markets, or by using valuation techniques, including recent market
transactions, where an active market does not exist. Valuation techniques
include discounted cash flow models and option pricing models as
appropriate. All derivatives are classified as assets when their fair
value is positive, or as liabilities when their fair value is negative.
- Certain derivatives embedded in other financial instruments, such as the
conversion option in a convertible bond, are treated as separate
derivatives when their economic characteristics and risks are not clearly
and closely related to those of the host contract, the terms of the
embedded derivative are the same as those of a stand-alone derivative,
and the combined contract is not 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.
- Derivative assets and liabilities on different transactions are only
netted if the transactions are with the same counterparty, a legal right
of set-off 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. Where 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 hedging
relationship, the relationship between the hedging instruments and
hedged items, as well as its risk management objective and strategy for
undertaking the hedge. Such policies also require 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 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 value of the asset or liability or
group thereof that are attributable to the hedged risk.
- If the hedging relationship no longer meets the criteria for hedge
accounting, the cumulative adjustment to the carrying amount of a hedged
item for which the effective interest method is used is amortized to the
income statement over the residual period to maturity.
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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
similarly 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:
- To qualify for hedge accounting, IAS 39 requires that at the inception
of the hedge and throughout its life, each hedge must be expected to be
highly effective (prospective effectiveness). 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. The method an HSBC entity adopts
for assessing hedge effectiveness will depend on its risk management
strategy.
- For fair value hedge relationships, HSBC entities utilize the cumulative
dollar offset method or regression analysis as effectiveness testing
methodologies. For cash flow hedge relationships, HSBC entities utilize
the change in variable cash flow method or the cumulative dollar offset
method using the hypothetical derivative approach.
- 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 actual 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'.
US GAAP
- The accounting under SFAS No. 133 'Accounting for Derivative Instruments
and Hedging Activities' is generally consistent with that under IAS 39 as
described above (from January 1, 2005); however see below for discussion
of the designation of financial assets and liabilities at fair value.
- SFAS No. 133 permits the 'shortcut method' of hedge effectiveness testing
for certain transactions. Under this method, it may be assumed, at
inception of the hedge, there is no ineffectiveness in the hedging of
interest rate risk with an interest rate swap provided specific criteria
are met.
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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'.
US GAAP
- There are no provisions to make such an election in US GAAP 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 under US GAAP,
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
- 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 amount.
- The book value of goodwill existing at December 31, 2003 under UK GAAP is
carried forward under IFRS from January 1, 2004, subject to limited
adjustments.
- 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.
- After 1998, goodwill was capitalized and amortized over its useful life.
- Where quoted securities are issued as part of the purchase consideration
in an acquisition, the fair value of those securities for the purpose of
determining the cost of acquisition is the market price of the securities
at the date of acquisition.
US GAAP
- Goodwill acquired up to June 30, 2001 was capitalized and amortized over
its useful life but not more than 25 years. The amortization of
previously acquired goodwill ceased from December 31, 2001.
- Where quoted securities are issued as part of the purchase consideration
in an acquisition, the fair value of those securities for the purpose of
determining the cost of acquisition is the average market price of the
securities for a reasonable period before and after the date that the
terms of the acquisition are agreed and announced.
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LOAN ORIGINATION
IFRS
- Certain loan fee income and incremental directly attributable loan
origination costs are amortized to the profit and loss account 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 91 'Accounting for Nonrefundable Fees and Costs
Associated with Originating or Acquiring Loans and Initial Direct Costs
of Leases'.)
LOAN IMPAIRMENT
IFRS
- Where there is evidence of impairment, based on statistical models using
historic loss rates adjusted for economic conditions, portfolios of loans
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 and includes
reasonably estimable recoveries on loans individually identified for
write-off pursuant to HSBC's credit guidelines.
US GAAP
- Where the delinquency status of loans in a portfolio is such that there
is no realistic prospect of recovery of these amounts, the loans are
written off in full, or to recoverable value where collateral exists. The
delinquency status, for example, the number of days payment is overdue,
where write-off occurs is applied consistently across similar loan
products as described in HSBC's credit guidelines. Where local regulators
mandate the delinquency status at which write-off must occur for
different retail products and these reasonably reflect estimable
recoveries on individual loans, this basis of measuring 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.
PENSION COSTS
IFRS
- IAS 19, "Employee Benefits" requires pension liabilities to be assessed
based on current actuarial assumptions and methods and pension assets to
be measured at fair value. The net pension surplus or deficit,
representing the difference between plan assets and liabilities, is
recognized on the balance sheet.
- As permitted by IAS 19 (revised 2004), HSBC elects to record all
actuarial gains and losses on the pension surplus or deficit in the year
they occur within the Statement of Recognized Income and Expense.
US GAAP
- SFAS 87 'Employers' Accounting for Pensions' prescribes a similar method
of actuarial valuation for pension liabilities and measurement of plan
assets at fair value as IAS 39.
- Where the accumulated benefit obligation (the value of benefits accrued
based on employee service up to the balance sheet date) exceeds the value
of plan assets, HSBC recognizes an additional minimum pension liability
equal to this excess, as long as the excess is greater than any accrual
already established for unfunded pension costs.
- SFAS 87 does not permit recognition of all actuarial gains and losses in
a performance statement other than the primary income statement. Under US
GAAP, HSBC elects to use the 'corridor method', whereby actuarial gains
and losses outside a certain range are recognized in the income
statement, in equal amounts over the remaining service lives of current
employees. That range is equal to 10% of the
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HSBC Finance Corporation
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greater of plan assets and plan liabilities. The remaining additional
minimum pension liability is recognized directly in Other Comprehensive
Income.
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
12, "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 4, "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."
RECEIVABLES REVIEW
--------------------------------------------------------------------------------
The following table summarizes owned receivables at September 30, 2005 and
increases (decreases) over prior periods:
INCREASES (DECREASES) FROM
-----------------------------------
JUNE 30, SEPTEMBER 30,
2005 2004
SEPTEMBER 30, ---------------- ----------------
2005 $ % $ %
---------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Real estate secured........................... $ 78,130 $6,200 8.6% $19,404 33.0%
Auto finance.................................. 10,137 1,140 12.7 3,314 48.6
MasterCard/Visa............................... 18,974 1,553 8.9 7,308 62.6
Private label................................. 2,777 (128) (4.4) (11,223) (80.2)
Personal non-credit card(1)................... 18,484 1,229 7.1 3,596 24.2
Commercial and other.......................... 220 (33) (13.0) (114) (34.1)
-------- ------ ----- ------- -----
Total owned receivables....................... $128,722 $9,961 8.4% $22,285 20.9%
======== ====== ===== ======= =====
---------------
(1) Personal non-credit card receivables are comprised of the following:
INCREASES (DECREASES) FROM
----------------------------------
JUNE 30, SEPTEMBER 30,
2005 2004
SEPTEMBER 30, --------------- ----------------
2005 $ % $ %
----------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Domestic personal non-credit card............... $10,323 $1,175 12.8% $3,182 44.6%
Union Plus personal non-credit card............. 374 (13) (3.4) (136) (26.7)
Personal homeowner loans........................ 3,996 142 3.7 461 13.0
Foreign personal non-credit card................ 3,791 (75) (1.9) 89 2.4
------- ------ ---- ------ -----
Total personal non-credit card.................. $18,484 $1,229 7.1% $3,596 24.2%
======= ====== ==== ====== =====
RECEIVABLE INCREASES (DECREASES) SINCE SEPTEMBER 30, 2004 Driven by growth in
our correspondent and branch businesses, real estate secured receivables
increased over the year-ago period. Real estate secured receivable levels do not
include HSBC Bank USA's purchase of receivables directly from correspondents
totaling $1.5 billion in the first eight months of 2005 and $2.1 billion since
September 30, 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 given HSBC Bank USA's
increasing ability to originate similar product. Growth in real estate secured
receivables was also supplemented by purchases from a single correspondent
relationship which totaled $1.9 billion since September 30, 2004. Real estate
secured receivable levels in our branch-based consumer lending business continue
to increase, as sales volumes remain high. Also contributing to the increase
were purchases of $2.0 billion from a portfolio
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HSBC Finance Corporation
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acquisition program since the prior year quarter. The increases in the real
estate secured receivable levels have been partially offset by run-off of the
higher yielding real estate secured receivables, including second lien loans,
largely due to refinancing activity. Auto finance receivables increased over the
year-ago period due to newly originated loans acquired from our dealer network,
growth in the consumer direct loan program, lower securitization levels and the
introduction of an auto finance program in Canada in the second quarter of 2004.
MasterCard and Visa receivables reflect domestic organic growth especially in
our HSBC branded prime, Union Privilege and non-prime portfolios, growth in the
U.K. over the year ago period, as well as lower securitization levels. The
decrease in private label receivables largely reflects the sale of our domestic
private label receivable portfolio to HSBC Bank USA in December 2004. Personal
non-credit card receivables increased from the year-ago period as we began to
increase the availability of this product domestically in the second half of
2004 as a result of the improving U.S. economy and continued improvements in our
underwriting standards. Personal non-credit card receivables also increased due
to lower securitization levels. The rate of increase in owned receivables was
impacted by the sale of $12.2 billion in domestic private label receivables to
HSBC Bank USA in December 2004. Had this sale not taken place, owned receivables
would have increased by $34.5 billion or 32 percent since September 30, 2004.
RECEIVABLE INCREASES (DECREASES) SINCE JUNE 30, 2005 Both our correspondent and
branch businesses reported growth in their real estate secured portfolios as
discussed above. Real estate secured receivable levels do not include purchases
of correspondent receivables directly by HSBC Bank USA of $.4 billion in July
and August of 2005, a portion of which we otherwise would have purchased. Growth
in our auto finance, MasterCard and Visa and personal non-credit card portfolios
reflect lower levels of securitizations. Growth in our MasterCard and Visa
portfolio also reflects organic growth in our HSBC branded prime, Union
Privilege and non-prime portfolios. Our foreign private label portfolio
decreased due to lower retail sales volumes in the U.K. as well as the impact of
changes in the foreign exchange rates since June 30, 2005. Personal non-credit
card receivables increased from the prior quarter resulting from the success of
several large direct mail campaigns that occurred during the current quarter.
RESULTS OF OPERATIONS
--------------------------------------------------------------------------------
Unless noted otherwise, the following discusses amounts reported in our owned
basis statement of income and dollars represent pre-tax amounts.
NET INTEREST INCOME The following table summarizes net interest income:
INCREASE (DECREASE)
-------------------
THREE MONTHS ENDED SEPTEMBER 30, 2005 (1) 2004 (1) AMOUNT %
---------------------------------------------------------------------------------------------------
Finance and other interest income........... $3,402 10.71% $2,779 10.30% $623 22.4%
Interest expense............................ 1,239 3.90 810 3.01 429 53.0
------ ----- ------ ----- ---- -----
Net interest income......................... $2,163 6.81% $1,969 7.29% $194 9.9%
====== ===== ====== ===== ==== =====
INCREASE (DECREASE)
-------------------
NINE MONTHS ENDED SEPTEMBER 30, 2005 (1) 2004 (1) AMOUNT %
---------------------------------------------------------------------------------------------------
Finance and other interest income........... $9,491 10.56% $7,944 10.29% $1,547 19.5%
Interest expense............................ 3,405 3.79 2,225 2.88 1,180 53.0
------ ----- ------ ----- ------ -----
Net interest income......................... $6,086 6.77% $5,719 7.41% $ 367 6.4%
====== ===== ====== ===== ====== =====
---------------
(1) % Columns: comparison to average owned interest-earning assets, annualized.
The increases in net interest income during the quarter and year-to-date periods
were due to higher average receivables and a higher overall yield, partially
offset by higher interest expense. Overall yields increased as increased yields
on variable rate products in line with market movements and other repricing
initiatives more
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HSBC Finance Corporation
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than offset a decline in real estate secured and auto finance yields. Changes in
receivable mix also contributed to the increase as the impact of increased
levels of higher yielding MasterCard/Visa and auto finance 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 in December 2004. The lower real estate and
auto finance yields during 2005 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
market capacity. 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 adjustments include amortization of fair value adjustments to both
our external debt obligations and receivables. Amortization of purchase
accounting fair value adjustments increased net interest income by $132 million
for the three months ended September 30, 2005 and $392 million for the nine
months ended September 30, 2005 compared to $174 million for the three months
ended September 30, 2004 and $549 million for the nine months ended September
30, 2004.
Net interest margin, annualized, decreased during the three and nine months
ended September 30, 2005 as compared to the year-ago period as the improvement
in the overall yield on our receivable portfolio, as discussed above, was more
than offset by the higher funding costs. The following table shows the impact of
these items on owned basis net interest margin at September 30, 2005:
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2005
-------------------------------------------------------------------------------------------
Net interest margin - September 30, 2004.................... 7.29% 7.41%
Impact to net interest margin resulting from:
Bulk sale of domestic private label portfolio in December
2004................................................... (.29) (.27)
Receivable pricing........................................ .25 .13
Receivable mix............................................ .21 .14
Cost of funds............................................. (.78) (.78)
Investment securities mix................................. .05 .07
Other..................................................... .08 .07
---- ----
Net interest margin - September 30, 2005.................... 6.81% 6.77%
==== ====
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 $2.3
billion in the three months ended September 30, 2005, a decrease of 12 percent
from $2.6 billion in the three months ended September 30, 2004. For the nine
months ended September 30, 2005, managed basis net interest income was $6.8
billion, down 12 percent from $7.7 billion in the nine months ended September
30, 2004. Managed basis net interest margin, annualized, was 6.94 percent in the
current quarter and 7.01 percent in the year-to-date period, compared to 7.88
percent and 8.13 percent in the year-ago periods. The decrease in the current
quarter was due to a higher mix of real estate secured receivables due to
significantly lower levels of private label receivables and higher funding costs
due to a larger balance sheet and a rising interest rate environment, partially
offset by higher yields on our receivables due to pricing increases for variable
rate products and other repricing initiatives. For the year-to-date period, the
decrease reflects lower yields on our receivables, particularly in real estate
secured and auto finance receivables, and a higher mix of real estate secured
receivables due to significantly lower levels of private label receivables,
partially offset by the pricing increases
33
HSBC Finance Corporation
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discussed above. As discussed above, the lower real estate and auto finance
yields during 2005 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 market
capacity. The following table shows the impact of these items on our net
interest margin on a managed basis at September 30, 2005:
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2005
-------------------------------------------------------------------------------------------
Net interest margin - September 30, 2004.................... 7.88% 8.13%
Impact to net interest margin resulting from:
Bulk sale of domestic private label portfolio in December
2004................................................... (.22) (.21)
Receivable pricing........................................ .32 .11
Receivable mix............................................ (.22) (.23)
Cost of funds............................................. (.92) (.91)
Investment securities mix................................. .05 .07
Other..................................................... .05 .05
---- ----
Net interest margin - September 30, 2005.................... 6.94% 7.01%
==== ====
Net interest margin on a managed basis is greater than on an owned basis because
the managed basis portfolio includes relatively more unsecured loans, which have
higher yields.
Managed basis 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) increased to 7.34 percent in the current quarter from 6.50
percent in the year-ago quarter. Managed basis risk adjusted revenue increased
to 7.32 percent in the year-to-date period from 6.69 percent in the year-ago
period. Managed basis risk adjusted revenue increased due to higher other
revenues as well as the result of the positive credit and delinquency trends due
to the improving U.S. economy. Ongoing improvements in underwriting, risk
management and collections as well as product expansion into near-prime customer
segments led to lower charge-offs which more than compensated for the decline in
net interest margin discussed above. See "Basis of Reporting" for additional
discussion on the use of non-GAAP financial measures.
PROVISION FOR CREDIT LOSSES The following table summarizes provision for credit
losses:
INCREASE (DECREASE)
-------------------
2005 2004 AMOUNT %
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Three months ended September 30,........................... $1,361 $1,123 $238 21.2%
Nine months ended September 30,............................ 3,233 3,048 185 6.1
Our provision for credit losses increased during the third quarter of 2005
primarily due to increased credit loss exposure as a result of Katrina and
higher bankruptcy filings in the period leading up to the October 17, 2005
effective date of new bankruptcy legislation in the United States. We have 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. As a result, we recorded an additional
credit loss provision of $100 million during the third quarter. We currently
expect that the higher levels of personal bankruptcy filings we have been
experiencing will result in significantly higher levels of net charge-offs,
predominantly in our domestic MasterCard/Visa portfolio, during the fourth
quarter of 2005 in the region of $200 million. We believe that a portion of this
increase is an acceleration of net charge-offs that would otherwise have been
experienced in future periods. We will continue to evaluate the impact of the
spike in bankruptcy filings on our credit loss reserves and currently believe
that this could result in a reduction in the allowance in the fourth quarter as
charge-offs occur.
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HSBC Finance Corporation
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Excluding the $180 million credit loss provision recorded in the third quarter
related to Katrina as well as the additional $100 million of credit loss
provision related to increased bankruptcy filings, our provision for credit
losses declined in both periods as improved credit quality and a shift in mix to
higher levels of secured receivables primarily as a result of the sale of our
domestic private label portfolio in December 2004 was partially offset by
increased requirements due to receivable growth, including lower securitization
levels. The provision as a percent of average owned receivables, annualized, was
4.41 percent in the current quarter and 3.71 percent year-to-date, compared to
4.36 percent and 4.16 percent in the year-ago periods. In 2005, credit loss
reserves increased as the provision for owned credit losses was $459 million
greater than net charge-offs in the third quarter of 2005 and $624 million in
the year-to-date period. In 2004, provision for owned credit losses was $154
million greater than net charge-offs in the third quarter of 2004 and $143
million in the year-to-date period. The provision for credit losses may vary
from quarter to quarter depending on the product mix and credit quality of loans
in our portfolio. See "Credit Quality" included in this MD&A for further
discussion of factors affecting the provision for credit losses.
OTHER REVENUES The following table summarizes other revenues:
INCREASE (DECREASE)
--------------------
THREE MONTHS ENDED SEPTEMBER 30, 2005 2004 AMOUNT %
---------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Securitization related revenue............................. $ 41 $ 267 $(226) (84.6)%
Insurance revenue.......................................... 229 203 26 12.8
Investment income.......................................... 33 36 (3) (8.3)
Derivative income (expense)................................ (53) 72 (125) (100+)
Fee income................................................. 439 302 137 45.4
Taxpayer financial services revenue (expense).............. (1) (3) 2 66.7
Gains on receivable sales to HSBC affiliates............... 99 10 89 100+
Servicing fees from HSBC affiliates........................ 102 6 96 100+
Other income............................................... 213 147 66 44.9
------ ------ ----- -----
Total other revenues....................................... $1,102 $1,040 $ 62 6.0%
====== ====== ===== =====
INCREASE (DECREASE)
--------------------
NINE MONTHS ENDED SEPTEMBER 30, 2005 2004 AMOUNT %
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Securitization related revenue............................ $ 180 $ 881 $(701) (79.6)%
Insurance revenue......................................... 679 618 61 9.9
Investment income......................................... 99 107 (8) (7.5)
Derivative income......................................... 283 248 35 14.1
Fee income................................................ 1,099 809 290 35.8
Taxpayer financial services revenue....................... 260 209 51 24.4
Gains on receivable sales to HSBC affiliates.............. 308 25 283 100+
Servicing fees from HSBC affiliates....................... 303 11 292 100+
Other income.............................................. 477 407 70 17.2
------ ------ ----- -------
Total other revenues...................................... $3,688 $3,315 $ 373 11.3%
====== ====== ===== =======
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HSBC Finance Corporation
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Securitization related revenue is the result of the securitization of our
receivables and includes the following:
INCREASE (DECREASE)
-------------------
THREE MONTHS ENDED SEPTEMBER 30, 2005 2004 AMOUNT %
-----------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net initial gains(1)........................................ $ - $ - $ - -%
Net replenishment gains(1).................................. 38 112 (74) (66.1)
Servicing revenue and excess spread......................... 3 155 (152) (98.1)
--- ---- ----- ------
Total....................................................... $41 $267 $(226) (84.6)%
=== ==== ===== ======
INCREASE (DECREASE)
-------------------
NINE MONTHS ENDED SEPTEMBER 30, 2005 2004 AMOUNT %
-----------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net initial gains(1)........................................ $ - $ 25 $ (25) (100.0)%
Net replenishment gains(1).................................. 135 344 (209) (60.8)
Servicing revenue and excess spread......................... 45 512 (467) (91.2)
---- ---- ----- ------
Total....................................................... $180 $881 $(701) (79.6)%
==== ==== ===== ======
---------------
(1) Net of our estimate of probable credit losses under the recourse provisions.
The decreases in securitization related revenue were due to decreases in the
level and product mix of receivables securitized and higher run-off due to
shorter expected lives. 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 sales of new domestic private label receivable originations
to HSBC Bank USA. We will continue to replenish at reduced levels certain
non-public personal non-credit card and MasterCard and 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. While the termination of sale treatment
on new collateralized funding activity since the third quarter of 2004 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.
Our interest-only strip receivables, net of the related loss reserve and
excluding the mark-to-market adjustment recorded in accumulated other
comprehensive income, decreased $43 million in the current quarter and $217
million year-to-date, compared to a decrease of $122 million and $410 million in
the year-ago periods, as securitized receivables continued to decrease.
Insurance revenue increased in both periods as we have experienced higher sales
volumes for many of our insurance products in both our U.K. and domestic
operations.
Investment income includes income on securities available for sale in our
insurance business and realized gains and losses from the sale of securities.
Investment income decreased in both periods as a result of decreases in income
due to lower average balances and lower gains from security sales, partially
offset by higher yields.
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HSBC Finance Corporation
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Derivative income (expense), 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 tables below:
THREE MONTHS ENDED SEPTEMBER 30, 2005 2004
----------------------------------------------------------------------------
(IN MILLIONS)
Net realized gains.......................................... $ 13 $19
Mark-to-market on derivatives which do not qualify as
effective hedges.......................................... (114) 53
Ineffectiveness associated with qualifying hedges........... 48 -
----- ---
Total....................................................... $ (53) $72
===== ===
NINE MONTHS ENDED SEPTEMBER 30, 2005 2004
---------------------------------------------------------------------------
(IN MILLIONS)
Net realized gains.......................................... $ 46 $ 36
Mark-to-market on derivatives which do not qualify as
effective hedges.......................................... 211 211
Ineffectiveness associated with qualifying hedges........... 26 1
---- ----
Total....................................................... $283 $248
==== ====
Derivative income decreased in the current quarter due to increases in interest
rates. The upward shift in the forward yield curve decreased the value of our
portfolio of interest rate swaps which do not qualify for hedge accounting under
SFAS No. 133. This was largely the result of a significant increase in the
notional value of our pay variable interest rate swaps entered into during the
third quarter in connection with long term debt issuances which gave rise to
income volatility during the period before hedging documentation was put in
place. The increase in year-to-date derivative income reflects the combined
impact of increases in interest rates and changes in the portfolio mix of
interest rate swaps which do not qualify for hedge accounting under SFAS No. 133
and recorded ineffectiveness as a result of the designation of a significant
number of our non-hedging derivative portfolio as effective hedges under the
long-haul method of accounting beginning in the second quarter of 2005. As part
of our overall risk management strategy to reduce earnings volatility, 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.
Additionally, we are working to improve the process at the inception of new
hedging relationships in order to reduce the delay which currently exists
between executing the swap and establishing hedge accounting. These derivatives
remain economic hedges of the underlying debt instruments.
Fee income increased during both periods due to higher credit card fees,
particularly relating to our non-prime credit card portfolio, due to higher
levels of MasterCard and Visa credit card receivables and improved interchange
rates, partially offset by lower private label credit card fees and higher
reward program expenses. The lower private label credit card fees were the
result of the sale of our domestic private label portfolio to HSBC Bank USA in
December 2004. See "Segment Results -- Managed Basis" for additional information
on fee income on a managed basis.
Taxpayer financial services ("TFS") revenue, which was essentially flat during
the current quarter, increased during the year-to-date period due to increased
loan volume during the 2005 tax season and a gain of $24 million on the sale of
certain bad debt recovery rights to a third party in the first quarter of 2005.
37
HSBC Finance Corporation
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Gains on receivable sales to HSBC affiliates relate to the daily sales of
domestic private label receivable originations and certain MasterCard/Visa
account originations and the bulk sales of real estate secured receivables to
HSBC Bank, USA. The increases primarily relate to our agreement with HSBC Bank
USA in December 2004 to sell all new domestic private label receivable
originations on a daily basis.
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 during both the three and nine month periods ended
September 30, 2005 primarily due to higher ancillary credit card revenue and,
for the three month period, higher gains on asset sales, including the partial
sale of a real estate investment.
COSTS AND EXPENSES The following table summarizes total costs and expenses:
INCREASE (DECREASE)
-------------------
THREE MONTHS ENDED SEPTEMBER 30, 2005 2004 AMOUNT %
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Salaries and employee benefits............................. $ 513 $ 472 $41 8.7%
Sales incentives........................................... 117 91 26 28.6
Occupancy and equipment expenses........................... 83 77 6 7.8
Other marketing expenses................................... 196 174 22 12.6
Other servicing and administrative expenses................ 149 235 (86) (36.6)
Support services from HSBC affiliates...................... 226 183 43 23.5
Amortization of intangibles................................ 90 83 7 8.4
Policyholders' benefits.................................... 109 93 16 17.2
------ ------ --- ------
Total costs and expenses................................... $1,483 $1,408 $75 5.3%
====== ====== === ======
INCREASE (DECREASE)
-------------------
NINE MONTHS ENDED SEPTEMBER 30, 2005 2004 AMOUNT %
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Salaries and employee benefits............................. $1,536 $1,414 $ 122 8.6%
Sales incentives........................................... 289 259 30 11.6
Occupancy and equipment expenses........................... 252 237 15 6.3
Other marketing expenses................................... 561 437 124 28.4
Other servicing and administrative expenses................ 550 659 (109) (16.5)
Support services from HSBC affiliates...................... 652 556 96 17.3
Amortization of intangibles................................ 280 278 2 .7
Policyholders' benefits.................................... 347 299 48 16.1
------ ------ ----- ------
Total costs and expenses................................... $4,467 $4,139 $ 328 7.9%
====== ====== ===== ======
Salaries and employee benefits increased during both the three and nine month
periods ended September 30, 2005 as a result of additional staffing, primarily
in our consumer lending, mortgage services and international businesses to
support growth.
Sales incentives increased during both the three and nine month periods ended
September 30, 2005 due to higher sales volumes during the quarter in our
consumer lending and mortgage services businesses.
Occupancy and equipment expenses increased during both periods as higher
occupancy expense and higher repairs and maintenance costs were partially offset
by lower depreciation.
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Other marketing expenses includes payments for advertising, direct mail programs
and other marketing expenditures. The increase in both the three and nine month
periods ended September 30, 2005 was primarily due to increased domestic credit
card marketing expenses due to higher non-prime marketing expense and
investments in new marketing initiatives and for the year-to-date period,
changes in contractual marketing responsibilities in July 2004 associated with
the General Motors ("GM") co-branded credit card.
Other servicing and administrative expenses decreased in both the three and nine
month periods ended September 30, 2005 due to lower legal and other professional
expenses. Additionally, during the year-to-date period we experienced lower REO
expenses as well as a lower estimate of exposure relating to accrued finance
charges associated with certain loan restructures which were partially offset by
higher systems costs.
Support services from HSBC affiliates, which includes technology and other
services charged to us by HSBC Technology and Services (USA) Inc. ("HTSU"),
increased primarily due to growth.
Amortization of intangibles increased during the three month period ended
September 30, 2005 due to the impairment related to a tradename in the U.K.,
partially offset by lower intangible amortization related to our purchased
credit card relationships in the quarter due to a contract renegotiation related
to one of our co-branded credit card partners. Amortization of intangibles was
higher in the year-to-date period as higher intangible amortization related to
our purchased credit card relationships and the write off related to a tradename
in the U.K. were partially offset by lower intangible amortization related to
our TFS business.
Policyholders' benefits increased during both periods due to a continuing
increase in insurance sales volume in both our U.K. and domestic operations,
partially offset by lower amortization of fair value adjustments relating to our
insurance business. The increase over the year-ago periods for our domestic
operations is also attributable to the termination of a reinsurance contract in
the third quarter of 2004.
The following table summarizes our owned basis efficiency ratio:
2005 2004
---------------------------------------------------------------------------
Three months ended September 30............................. 43.54% 45.10%
Nine months ended September 30.............................. 43.70 43.96
Our owned basis efficiency ratio improved during both the three and nine month
periods ended September 30, 2005 primarily as a result of higher net interest
income and other revenues due to higher levels of owned receivables. This was
partially offset by higher costs and expenses and the impact of the bulk sale of
our domestic private label portfolio in December 2004. Excluding the results of
our domestic private label portfolio from all periods, the improvement in our
owned basis efficiency ratio was 473 basis points for the three month period
ended September 30, 2005 and 285 basis points for the year to date period.
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, Ireland and the remainder of Europe.
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.
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
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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 results for our Consumer
segment:
INCREASE (DECREASE)
-------------------
THREE MONTHS ENDED SEPTEMBER 30, 2005 2004 AMOUNT %
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net income.............................................. $ 308 $ 294 $ 14 4.8%
Net interest income..................................... 1,733 1,956 (223) (11.4)
Securitization related revenue.......................... (171) (547) 376 68.7
Fee and other income.................................... 307 187 120 64.2
Intersegment revenues................................... 27 26 1 3.8
Provision for credit losses............................. 735 506 229 45.3
Total costs and expenses................................ 647 619 28 4.5
Receivables............................................. 102,733 95,946 6,787 7.1
Assets.................................................. 103,424 98,099 5,325 5.4
Net interest margin, annualized......................... 7.02% 8.20% - -
Return on average managed assets........................ 1.24 1.22 - -
INCREASE (DECREASE)
-------------------
NINE MONTHS ENDED SEPTEMBER 30, 2005 2004 AMOUNT %
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net income................................................ $1,182 $ 855 $327 38.2%
Net interest income....................................... 5,125 5,735 (610) (10.6)
Securitization related revenue............................ (557) (1,089) 532 48.9
Fee and other income...................................... 884 516 368 71.3
Intersegment revenues..................................... 80 74 6 8.1
Provision for credit losses............................... 1,698 1,905 (207) (10.9)
Total costs and expenses.................................. 1,893 1,892 1 .1
Net interest margin, annualized........................... 7.27% 8.33% - -
Return on average managed assets.......................... 1.66 1.22 - -
Our Consumer segment reported higher net income during both the three and nine
month periods ended September 30, 2005. The increase in net income was primarily
due to higher fee and other income and improved securitization related revenue,
partially offset by lower net interest income and, for the three month period,
higher provision for credit losses and higher costs and 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 improved due to lower
amortization of prior period gains as a result of reduced securitization levels.
Costs and expenses were higher in the quarter due to higher salary expense,
increased REO expense and higher support services from affiliates, partially
offset by a lower estimate of exposure relating to accrued finance charges
associated with certain loan restructures. On a year-to-date basis, costs and
expenses were flat as higher salary expense and higher support services from
affiliates were 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, annualized, decreased during both
the three and nine month periods ended September 30, 2005 compared to the
year-ago periods primarily due to a shift in mix to lower
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yielding real estate secured receivables resulting from significantly lower
levels of private label receivables primarily resulting from the sale of our
private label portfolio 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 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 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 the year-to-date period 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 the three and nine month periods ended
September 30, 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 increased requirements associated with receivable
growth and the impact from Katrina, as discussed more fully below, and has
resulted in a decrease to our owned provision for credit losses in the
year-to-date period and, excluding the increase associated with Katrina, in the
three month period. Over-the-life provision for credit losses for securitized
receivables recorded in any given period reflect 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. The combination of these
factors resulted in a decrease in managed loss reserves and managed loss
provision during the year. Managed loss provision was higher, however, in the
quarter as the prior year quarter's provision for receivables serviced with
limited recourse reflects a higher benefit from the release of over-the-live
reserves due to lower securitization levels which was offset by higher
amortization of prior period gains. In the three months ended September 30,
2005, the provision for credit losses was greater than net charge-offs by $129
million while net charge-offs were greater than the provision for credit losses
by $137 million for the year-to-date period. For 2004, we decreased managed loss
reserves as net charge-offs were greater than the provision for credit losses by
$414 million and $895 million in the year-ago periods.
Our managed basis provision for credit losses also reflects an estimate of
incremental credit loss exposure relating to Katrina. Based on the information
currently available, we have recorded an incremental provision for credit losses
of $125 million at the Consumer Segment. As more 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 have initiated various programs including
extended payment arrangements and interest and fee waivers for up to 90 days
depending upon customer circumstances. These interest and fee waivers were not
material during the quarter for the Consumer Segment.
Managed receivables increased 8 percent to $102.7 billion at September 30, 2005
as compared to $95.3 billion at June 30, 2005. Growth during the quarter was
driven by higher real estate secured receivables in both our correspondent and
branch-based consumer lending businesses. Real estate secured receivable levels
do not include direct purchases of receivables by HSBC Bank USA from
correspondents totaling $.4 billion, a portion of which we otherwise would have
purchased. Also contributing to the increase was $.3 billion from a portfolio
acquisition program during the third quarter of 2005. We also experienced growth
in auto finance receivables as a result of newly originated loans acquired from
our dealer network as well as through the
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consumer direct loan program. Personal non-credit card receivables also
increased resulting from the success of several large direct mail campaigns that
occurred during the quarter.
Compared to September 30, 2004, managed receivables increased 7 percent. 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 2004.
Had this sale not taken place, managed receivables would have increased by $22.4
billion or 23 percent at September 30, 2005. We continued to experience strong
growth in our real estate secured portfolio in the third quarter of 2005. Real
estate secured receivable levels do not include $2.1 billion of correspondent
receivables purchased directly by HSBC Bank USA since September 30, 2004, 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 $1.9 billion since September 30, 2004.
Also contributing to the increase were purchases of $2.0 billion from a
portfolio acquisition program since the prior year quarter. Our auto finance
portfolio also reported strong growth as a result of newly originated loans
acquired from our dealer network as well as increases through the consumer
direct loan program. Personal non-credit card receivables increased from the
year-ago period as we began to increase the availability of this product
domestically in the second half of 2004 as a result of the improving U.S.
economy.
The increase in return on average managed assets reflects the higher net income
discussed above. Additionally, for both the three and nine month periods ended
September 30, 2005, ROMA reflects higher average managed assets.
In accordance with Federal Financial Institutions Examination Council ("FFIEC")
guidance, in the first quarter of 2006, the required minimum monthly payment
amounts for domestic private label credit card accounts will change. As
previously discussed, we sell new domestic private label receivable originations
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 beginning 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 results for our
Credit Card Services segment.
INCREASE (DECREASE)
-------------------
THREE MONTHS ENDED SEPTEMBER 30, 2005 2004 AMOUNT %
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net income............................................... $ 138 $ 134 $ 4 3.0%
Net interest income...................................... 531 519 12 2.3
Securitization related revenue........................... (42) (77) 35 45.5
Fee and other income..................................... 554 460 94 20.4
Intersegment revenues.................................... 5 6 (1) (16.7)
Provision for credit losses.............................. 465 364 101 27.7
Total costs and expenses................................. 360 328 32 9.8
Receivables.............................................. 19,971 18,509 1,462 7.9
Assets................................................... 19,710 20,620 (910) (4.4)
Net interest margin, annualized.......................... 10.27% 10.24% - -
Return on average managed assets......................... 2.80 2.60 - -
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INCREASE (DECREASE)
-------------------
NINE MONTHS ENDED SEPTEMBER 30, 2005 2004 AMOUNT %
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net income................................................. $ 452 $ 391 $ 61 15.6%
Net interest income........................................ 1,545 1,561 (16) (1.0)
Securitization related revenue............................. (161) (222) 61 27.5
Fee and other income....................................... 1,465 1,271 194 15.3
Intersegment revenues...................................... 16 20 (4) (20.0)
Provision for credit losses................................ 1,120 1,105 15 1.4
Total costs and expenses................................... 1,018 890 128 14.4
Net interest margin, annualized............................ 10.27% 10.10% - -
Return on average managed assets........................... 3.10 2.50 - -
Our Credit Card Services segment reported higher net income during both the
three and nine month periods ended September 30, 2005. The increase in net
income during both periods was primarily due to higher fee and other income
partially offset by higher provision for credit losses and higher costs and
expenses. Increases in fee and other income resulted from portfolio growth and
higher interchange fees, as well as increased gains from the daily sales of new
volume related to the MasterCard/Visa account relationships purchased from HSBC
Bank USA in July 2004. 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 and investments in new marketing
initiatives and for the year-to-date period, changes in contractual marketing
responsibilities in July 2004 associated with the domestic GM co-branded credit
card.
The managed basis provision for credit losses increased in both periods.
Excluding, in the third quarter of 2005, the credit loss provision recorded
relating to Katrina and the additional provision related to the increased
bankruptcy filings, our provision for credit losses declined in both periods due
to improved credit quality, partially offset by receivable growth. We increased
managed loss reserves by recording loss provision greater than net charge-off of
$154 million in the third quarter of 2005 and $127 million year-to-date,
compared to increasing managed loss reserves by recording loss provision greater
than net charge-off of $15 million in the third quarter of 2004 and decreasing
managed loss reserves year-to-date September 30, 2004 by recording loss
provision less than net charge-off of $6 million. We have been maintaining
credit loss reserves in anticipation of the impact the new bankruptcy
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. As a result, we recorded an additional
$100 million credit loss provision relating to these filings in the third
quarter. We currently expect that the higher levels of personal bankruptcy
filings we have been experiencing will result in significantly higher levels of
net charge-offs in our domestic MasterCard/Visa portfolio during the fourth
quarter of 2005. We believe that a portion of this increase is an acceleration
of net charge-offs that would otherwise have been experienced in future periods.
We will continue to evaluate the impact of the spike in bankruptcy filings on
our credit loss reserves and currently believe that this could result in a
reduction in the allowance in the fourth quarter as charge-offs occur.
Our managed basis provision for credit losses also reflects an estimate of
incremental credit loss exposure relating to Katrina. Based on the information
currently available, we have recorded an incremental provision for credit losses
of $55 million at the Credit Card Services Segment. As more 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 have initiated various programs including
extended payment arrangements and interest and fee waivers for up to 90 days or
longer depending upon customer circumstances. These interest and fee waivers
were not material during the quarter for the Credit Card Services Segment.
Net interest income, which increased during the current quarter, decreased in
the year-to-date period. The decrease reflects higher interest expense as a
result of a rising interest rate environment and lower investment
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income due to lower investment levels, partially offset by higher finance and
other interest income on our receivables. The increase in finance and other
interest income on our receivables during the current quarter reflects increased
pricing on variable yield products and higher receivable balances partially
offset by higher interest expense. Net interest margin increased compared to the
year-ago periods primarily due to increases in subprime 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,
partially offset by higher interest expense. Although our subprime receivables
tend to have smaller balances, they generate higher returns both in terms of net
interest margin and fee income. Net interest margin for both periods was
positively impacted by the disposal of certain low yielding investment
securities as a result of the elimination of investments dedicated to our credit
card bank resulting from our acquisition by HSBC.
Managed receivables of $20.0 billion increased 2 percent compared to $19.6
billion at June 30, 2005. Compared to September 30, 2004, managed receivables
increased 8 percent. The increase during both periods reflects organic growth in
our HSBC branded prime, Union Privilege and non-prime portfolios, which was
partially offset by the continued decline in certain older acquired portfolios.
The increase in ROMA in both periods reflects lower average managed assets as
well as the higher net income discussed above. 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 resulting from our
acquisition by HSBC.
In accordance with FFIEC guidance, our credit card services business has 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 to be 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, 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 fee income and fluctuations in the provision for credit
losses beginning in 2006. Although we do not expect this will have a material
impact on our consolidated results, the impact will be material to the Credit
Card Services Segment in 2006.
As previously disclosed, we sold our domestic private label portfolio to HSBC
Bank USA in December 2004. We and HSBC Bank USA will consider potential
transfers of some of our MasterCard and Visa receivables to HSBC Bank USA in the
future based upon continuing evaluation of capital and liquidity at each entity.
INTERNATIONAL SEGMENT The following table summarizes results for our
International segment:
INCREASE (DECREASE)
-------------------
THREE MONTHS ENDED SEPTEMBER 30, 2005 2004 AMOUNT %
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net income............................................... $ 12 $ 18 $(6) (33.3)%
Net interest income...................................... 228 185 43 23.2
Securitization related revenue........................... 2 (87) 89 100+
Fee and other income..................................... 141 130 11 8.5
Intersegment revenues.................................... 4 4 - -
Provision for credit losses.............................. 137 19 118 100+
Total costs and expenses................................. 216 181 35 19.3
Receivables.............................................. 12,564 11,833 731 6.2
Assets................................................... 13,574 12,770 804 6.3
Net interest margin annualized........................... 7.22% 6.29% - -
Return on average managed assets......................... .36 .57 - -
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INCREASE (DECREASE)
--------------------
NINE MONTHS ENDED SEPTEMBER 30, 2005 2004 AMOUNT %
-------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net (loss) income........................................... $(11) $ 80 $(91) (100+)%
Net interest income......................................... 680 583 97 16.6
Securitization related revenue.............................. 17 (92) 109 100+
Fee and other income........................................ 412 369 43 11.7
Intersegment revenues....................................... 11 10 1 10.0
Provision for credit losses................................. 468 207 261 100+
Total costs and expenses.................................... 649 527 122 23.1
Net interest margin annualized.............................. 7.05% 6.76% - -
Return on average managed assets............................ (.10) .86 - -
Our International segment reported lower net income for the three months ended
September 30, 2005 and a net loss for the year-to-date period. The lower net
income and year-to-date net loss reflect higher provision for credit losses and
higher costs and expenses, partially offset by higher net interest income and
increased fee and other income. Applying constant currency rates, which uses the
average rate of exchange for the three and nine month periods ended September
30, 2004 to translate current period net income, net income as reported for the
current quarter would not have been materially different and the net loss higher
by $2 million year-to-date.
Net interest income increased during both periods due to higher receivable
levels, partially offset by higher cost of funds in the U.K. for the
year-to-date period due to a rising interest rate environment. Net interest
margin, annualized, increased during both the three and nine month periods due
to increased yields on credit cards due to repricing initiatives during the
current quarter and interest-free balances not being promoted as strongly 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, for the year-to-date period, increased cost of funds. Securitization
related revenue increased during the quarter and year-to-date period due to
lower amortization of prior period gains as a result of reduced securitization
levels and, for the year-to-date period, 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. Fee and other income increased primarily due to
higher insurance revenues. Managed basis provision for credit losses increased
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. We increased managed loss reserves by recording loss provision
greater than net charge-offs of $3 million for the current quarter and $111
million year-to-date. We decreased managed loss reserves by recording loss
provision less than net charge-off of $74 million during the third quarter of
2004 and $52 million for that year-to-date period. Total costs and expenses
increased primarily due to higher expenses to support receivable growth and
collection activities, higher policyholder benefits because of increased
insurance sales volumes, and, for the nine month period, costs associated with
branch closures in the U.K.
Compared to June 30, 2005, managed receivables were unchanged due to lower
retail sales volume following a slow down in retail consumer spending in the
U.K. Compared to September 30, 2004, managed receivables increased 6 percent due
to strong growth in our real estate secured, personal non-credit card and
MasterCard/ Visa portfolios as well as growth from the introduction of an auto
finance program in Canada in the third quarter of 2004. Applying constant
currency rates, managed receivables at September 30, 2005 would not have been
materially different using June 30, 2005 or September 30, 2004 exchange rates.
The decrease in ROMA in both the three and nine month periods ended September
30, 2005 reflects higher provision for credit losses due to higher delinquency
and charge-off levels in the U.K. and higher costs and expenses, as well as
higher average managed assets primarily due to receivable growth since September
30, 2004.
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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, a U.K.
based subsidiary of HSBC, and/or one or more unrelated third parties. As of the
date of this filing, a decision has not been made regarding the transfer of all
or a portion of our U.K. and other European operations. We anticipate that a
decision regarding this potential transfer will be reached in the fourth quarter
of 2005; however, any transfer is subject to approval by regulatory authorities
and boards of directors of the affected entities.
Reconciliation of Managed Basis Segment Results As discussed above, we monitor
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 12, "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
--------------------------------------------------------------------------------
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 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 percent of net annualized charge-offs in developing our loss
reserve estimates. 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. See Note 4,
"Receivables," in the
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accompanying consolidated financial statements for receivables by product type
and Note 5, "Credit Loss Reserves," for an analysis of changes in the credit
loss reserves.
The following table summarizes owned basis credit loss reserves:
SEPTEMBER 30, JUNE 30, SEPTEMBER 30,
2005 2005 2004
----------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Owned credit loss reserves................................ $4,220 $3,756 $3,953
Reserves as a percent of:
Receivables............................................. 3.28% 3.16% 3.71%
Net charge-offs(1)...................................... 117.0 111.3 102.0
Nonperforming loans..................................... 110.0 107.6 104.1
---------------
(1) Quarter-to-date, annualized.
Owned credit loss reserves at September 30, 2005 increased as compared to June
30, 2005 and September 30, 2004 as the provision for owned credit losses during
the current quarter was $459 million greater than net charge-offs reflecting
higher levels of owned receivables and, as previously discussed, additional
provision due to increases in bankruptcy filings in both our domestic and
foreign operations, which largely impacts our unsecured consumer products, and
the additional credit loss reserves resulting from Katrina. These increases were
partially offset by the impact of stable credit quality, the release of $505
million of owned credit loss reserves in December 2004 associated with the sold
domestic private label portfolio as well as a shift in mix to higher levels of
secured receivables. During the three months ended September 30, 2004, provision
for owned credit losses was $154 million greater than net charge-offs. Reserve
levels at September 30, 2005 reflect the factors discussed above. The trends in
the reserve ratios reflect the fact that we are experiencing a shift in our loan
portfolio to higher credit quality receivables, particularly real estate secured
and auto finance receivables, partially offset by the impact of additional
credit loss reserves for Katrina and increased bankruptcy filings.
For securitized receivables, we also record a provision for estimated probable
losses that we expect to incur under the recourse provisions. The following
table summarizes managed credit loss reserves:
SEPTEMBER 30, JUNE 30, SEPTEMBER 30,
2005 2005 2004
----------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Managed credit loss reserves.............................. $4,571 $4,281 $5,199
Reserves as a percent of:
Receivables............................................. 3.37% 3.35% 4.11%
Net charge-offs(1)...................................... 108.6 104.1 95.4
Nonperforming loans..................................... 110.3 110.2 111.1
---------------
(1) Quarter-to-date, annualized.
Managed credit loss reserves at September 30, 2005 also increased compared to
June 30, 2005 as the increases in our owned credit loss reserves as discussed
above were offset by lower reserves on securitized receivables due to run-off.
Managed credit loss reserves at September 30, 2005 decreased as compared to
September 30, 2004 as a result of improvements in credit quality, changes in
securitization levels and the sale of our domestic private label receivable
portfolio in December 2004 as previously discussed, partially offset by
additional reserves resulting from receivable growth and Katrina and increased
bankruptcy filings.
See "Basis of Reporting" for additional discussion on the use of non-GAAP
financial measures and "Reconciliations to GAAP Financial Measures" for
quantitative reconciliations of the non-GAAP financial measures to the
comparable GAAP basis financial measure.
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DELINQUENCY - OWNED BASIS
The following table summarizes two-months-and-over contractual delinquency (as a
percent of consumer receivables):
SEPTEMBER 30, JUNE 30, SEPTEMBER 30,
2005 2005 2004
----------------------------------------------------------------------------------------------------
Real estate secured....................................... 2.51% 2.56% 3.27%
Auto finance.............................................. 2.09 2.08 1.81
MasterCard/Visa........................................... 4.46 4.14 5.84
Private label............................................. 5.22 4.91 4.72
Personal non-credit card.................................. 9.18 8.84 8.83
---- ---- ----
Total..................................................... 3.78% 3.73% 4.43%
==== ==== ====
Total owned delinquency as a percentage of consumer receivables increased 5
basis points compared to the prior quarter. The increase in the delinquency
ratio is primarily due to seasonal increases in delinquency in the third
quarter, partially offset by the continuing strong economy, better underwriting
and improved quality of originations. The overall decrease in the delinquency
ratio of our real estate secured portfolio reflects receivable growth, the
recent trend of better quality in new originations and a continuing strong
economy. The increase in the MasterCard/Visa delinquency ratio reflects a
seasonal increase in delinquencies during the third quarter, partially offset by
changes in receivable mix resulting from lower securitization levels. The
increases in the delinquency ratio in our private label receivables (which
includes our foreign private label portfolio that was not sold to HSBC Bank USA
in December 2004) and our personal non-credit card portfolio also reflects the
increased bankruptcy filings in both the United States and the U.K. The increase
in personal non-credit card delinquencies was partially offset by improved
collection efforts and strong economic conditions in the U.S.
Compared to a year ago, total delinquency decreased 65 basis points generally as
a result of improvements in the U.S. economy, better underwriting, improved
credit quality as well as higher levels of real estate secured receivables. As
discussed above, the increase in delinquency in our private label receivables
(which includes our foreign private label portfolio that was not sold to HSBC
Bank USA in December 2004) and our personal non-credit card portfolio reflects
the general increase in consumer bad debts in the U.K. market, including
increased bankruptcies. The increase in the personal non-credit card portfolio
also reflects the increase in bankruptcy filings in the United States due to new
bankruptcy legislation in the United States which became effective in October
2005. Delinquency levels at September 30, 2004 include the domestic private
label portfolio which contributed approximately 5 basis points to total
delinquency.
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NET CHARGE-OFFS OF CONSUMER RECEIVABLES - OWNED BASIS
The following table summarizes net charge-offs of consumer receivables (as a
percent, annualized, of average consumer receivables):
SEPTEMBER 30, JUNE 30, SEPTEMBER 30,
2005 2005 2004
----------------------------------------------------------------------------------------------------
Real estate secured....................................... .75% .78% 1.19%
Auto finance.............................................. 3.25 2.61 3.66
MasterCard/Visa........................................... 6.24 6.93 8.50
Private label............................................. 5.35 4.36 4.79
Personal non-credit card.................................. 8.01 7.77 9.50
---- ---- ----
Total..................................................... 2.93% 2.93% 3.77%
==== ==== ====
Real estate secured net charge-offs and REO expense as a
percent of average real estate secured receivables...... .88% .84% 1.31%
Total net charge-offs as a percent, annualized, of average consumer receivables
has remained flat during the quarter ended September 30, 2005 compared to the
quarter ended June 30, 2005 as the lower delinquency levels we have been
experiencing due to an improving economy and which had a positive impact on
charge-offs, were offset by an increase in bankruptcy filings due to new
bankruptcy legislation in the United States as well as increased bankruptcy
filings in the U.K. Our real estate secured portfolio experienced a decrease in
net charge-offs reflecting the recent trend of better quality in new
originations and continuing strong economic conditions. The increase in auto
finance net charge-offs reflects a seasonal pattern of higher charge-offs in the
third quarter. The decrease in MasterCard/Visa charge-offs reflects changes in
receivable mix resulting from lower securitization levels and continued improved
credit quality. The increase in net charge-offs for the private label portfolio
reflects the general increase in consumer bad debts in the U.K. markets,
including increased bankruptcies. The increase in net charge-offs in the
personal non-credit card portfolio reflects the increase in bankruptcy filings,
as discussed above.
Total net charge-offs as a percentage, annualized, of average consumer
receivables for the current quarter decreased from the September 2004 net
charge-off levels. Principal factors behind the decrease were improved
collections and better underwriting, including both improved modeling and
improved credit quality of new originations, stable economic conditions, as well
as the sale of our domestic private label portfolio in December 2004. These were
partially offset by the increased bankruptcy filings discussed above. The
September 2004 net charge-off ratio includes the domestic private label
portfolio which contributed 14 basis points to the ratio. The decrease in auto
finance net charge-offs also reflects improved used auto prices which resulted
in lower loss severities.
OWNED NONPERFORMING ASSETS
SEPTEMBER 30, JUNE 30, SEPTEMBER 30,
2005 2005 2004
----------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Nonaccrual receivables.................................... $3,273 $3,008 $2,891
Accruing consumer receivables 90 or more days
delinquent.............................................. 563 482 905
Renegotiated commercial loans............................. -- 1 1
------ ------ ------
Total nonperforming receivables........................... 3,836 3,491 3,797
Real estate owned......................................... 462 459 601
------ ------ ------
Total nonperforming assets................................ $4,298 $3,950 $4,398
====== ====== ======
Credit loss reserves as a percent of nonperforming
receivables............................................. 110.0% 107.6% 104.1%
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Compared to June 30, 2005, the increase in total nonperforming receivables is
primarily attributable to seasonal trends in delinquency as well as increased
bankruptcy filings experienced in both our domestic and foreign operations.
Compared to September 30, 2004, the decrease in total nonperforming assets is
due to improved credit quality, continued improvement in the economy, collection
efforts as well as the impact of the bulk sale of our domestic private label
receivable portfolio in December 2004. Consistent with industry practice,
accruing consumer receivables 90 or more days delinquent includes domestic
MasterCard and Visa and for September 30, 2004, our domestic private label
credit card receivables.
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 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.
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, we use certain assumptions and
estimates to compile our restructure statistics. 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.
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TOTAL RESTRUCTURED BY RESTRUCTURE PERIOD - DOMESTIC PORTFOLIO(1)
(MANAGED BASIS)
SEPTEMBER 30, JUNE 30, SEPTEMBER 30,
2005(3) 2005(3) 2004
----------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Never restructured........................................ 88.9% 88.0% 86.5%
Restructured:
Restructured in the last 6 months....................... 4.0 4.2 4.8
Restructured in the last 7-12 months.................... 2.9 3.3 3.6
Previously restructured beyond 12 months................ 4.2 4.5 5.1
------- ------- -------
Total ever restructured(2).............................. 11.1 12.0 13.5
------- ------- -------
Total..................................................... 100.0% 100.0% 100.0%
======= ======= =======
TOTAL RESTRUCTURED BY PRODUCT - DOMESTIC PORTFOLIO(1)
(MANAGED BASIS)
Real estate secured....................................... $ 8,205 $ 8,277 $ 8,895
Auto finance.............................................. 1,593 1,585 1,420
MasterCard/Visa........................................... 484 526 628
Private label(3).......................................... 24 24 756
Personal non-credit card.................................. 3,353 3,396 3,688
------- ------- -------
Total..................................................... $13,659 $13,808 $15,387
======= ======= =======
(AS A PERCENT OF MANAGED RECEIVABLES)
Real estate secured....................................... 10.9% 12.0% 15.8%
Auto finance.............................................. 14.0 14.9 14.4
MasterCard/Visa........................................... 2.5 2.7 3.5
Private label(3).......................................... 7.0 7.1 5.0
Personal non-credit card.................................. 20.6 21.6 24.3
------- ------- -------
Total(2).................................................. 11.1% 12.0% 13.5%
======= ======= =======
---------------
(1) Excludes foreign businesses, commercial and other.
(2) Total including foreign businesses was 10.5 percent at September 30, 2005,
11.3 percent at June 30, 2005, and 12.6 percent at September 30, 2004.
(3) Reflects consumer lending retail sales contracts which have historically
been classified as private label.
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 September 30, 2005, $.4 billion or .3 percent of managed
receivables at June 30, 2005 and $.5 billion or .4 percent of managed assets at
September 30, 2004.
In addition to the above, we have granted an initial 30 or 60 day payment
deferral (based on product) to customers living in the FEMA designated
Individual Assistance disaster areas. This deferral may be extended for a period
of up to 90 days or longer 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
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HSBC Finance Corporation
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being reset by 30 days. These extended payment arrangements totaled $.7 billion
or .4% of managed receivables at September 30, 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.
LIQUIDITY AND CAPITAL RESOURCES
--------------------------------------------------------------------------------
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 the nine months ended
September 30, 2005 with proceeds from the sale of our domestic private label
receivable portfolio to HSBC Bank USA in December 2004, debt issued to
affiliates, higher levels of commercial paper and the issuance of Series B
preferred stock.
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 $407 million in the nine months ended September 30, 2005 ($155
million in the three months ended September 30, 2005) and approximately $235
million in the nine months ended September 30, 2004 ($95 million in the three
months ended September 30, 2004) 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 and other funding synergies
including asset transfers will eventually enable HSBC to realize annual cash
funding expense savings, including external fee savings, in excess of $1 billion
per year as our existing term debt matures over the course of the next few
years. 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.
Debt due to affiliates and other HSBC related funding are summarized in the
following table:
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------------------------------------------------------------------------------------
(IN BILLIONS)
Debt issued to HSBC subsidiaries:
Drawings on bank lines in the U.K......................... $ 6.6 $ 7.5
Term debt................................................. 11.0 6.0
Preferred securities issued by Household Capital Trust
VIII................................................... .3 .3
----- -----
Total debt issued to HSBC subsidiaries.................... 17.9 13.8
----- -----
Debt issued to HSBC clients:
Euro commercial paper..................................... 3.4 2.6
Term debt................................................. 1.2 .8
----- -----
Total debt issued to HSBC clients......................... 4.6 3.4
Preferred stock held by HSBC Investments (North America)
Inc. ..................................................... 1.1 1.1
Cash received on bulk and subsequent sales of domestic
private label receivables to HSBC Bank USA, net
(cumulative).............................................. 14.5 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
Run-off of real estate secured receivable activity with
HSBC Bank USA.......................................... (2.9) (1.5)
----- -----
Total real estate secured receivable activity with HSBC Bank
USA....................................................... 5.0 5.0
----- -----
Total HSBC related funding.................................. $43.1 $35.7
===== =====
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At September 30, 2005, funding from HSBC, including debt issues to HSBC
subsidiaries and clients and preferred stock held by HSBC Investments (North
America) Inc. ("HINO") but excluding cash received on asset sales to HSBC
subsidiaries, represented 18 percent of our total managed debt and preferred
stock funding. At December 31, 2004, funding from HSBC, including debt issues to
HSBC subsidiaries and clients and preferred stock held by HINO but excluding
cash received on asset sales to HSBC subsidiaries, represented 15 percent of our
total managed debt and preferred stock funding.
In addition to the HSBC related funding received, we have extended lines of
credit and promissory notes to other HSBC subsidiaries at interest rates
comparable to third-party rates for notes with similar terms. At September 30,
2005, $1.9 billion was outstanding under these agreements compared to $.6
billion outstanding at December 31, 2004.
Proceeds from the December 2004 domestic private label bulk 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 at December 31, 2004.
As of September 30, 2005, we had revolving credit facilities of $2.5 billion
from HSBC domestically and $10 billion from HSBC subsidiaries in the U.K. There
have been no draws on the domestic line. At September 30, 2005, $6.6 billion was
outstanding under the U.K. lines. We had derivative contracts with a notional
value of $64.3 billion, or approximately 96 percent of total derivative
contracts, outstanding with HSBC affiliates at September 30, 2005. We had
derivative contracts with a notional value of $62.6 billion, or approximately 87
percent of total derivative contracts, outstanding with HSBC affiliates at
December 31, 2004.
SECURITIES totaled $3.9 billion at September 30, 2005 and $3.6 billion at
December 31, 2004. Securities purchased under agreements to resell totaled $181
million at September 30, 2005 and $2.7 billion at December 31, 2004. Interest
bearing deposits with banks totaled $398 million at September 30, 2005 and $603
million at December 31, 2004. Our total investment balances at December 31, 2004
were high as a result of the timing of the bulk sale of the domestic private
label receivable portfolio to HSBC Bank USA on December 29, 2004.
COMMERCIAL PAPER, BANK AND OTHER BORROWINGS totaled $11.6 billion at September
30, 2005 and $9.0 billion at December 31, 2004. The increase at September 30,
2005 was 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 assumes 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.
Additionally, at December 31, 2004, we were carrying lower levels of commercial
paper as the proceeds from the sale of the domestic private label loan portfolio
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 $3.4
billion at September 30, 2005 and $2.6 billion at December 31, 2004.
LONG TERM DEBT (with original maturities over one year) increased to $93.2
billion at September 30, 2005 from $85.4 billion at December 31, 2004.
Significant third party issuance during the nine months ended September 30, 2005
included the following:
- $7.6 billion of domestic and foreign medium-term notes
- $4.4 billion of foreign currency-denominated bonds
- $1.3 billion of InterNotes(SM) (retail-oriented medium-term notes)
- $9.6 billion of global debt
- $5.4 billion of securities backed by real estate secured, auto finance,
and MasterCard/Visa receivables. For accounting purposes, these
transactions were structured as secured financings.
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In June 2005, we redeemed the junior subordinated notes issued to the 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 August 2005, we declared an $8 million dividend on the
Series B Preferred Stock which was paid on September 15, 2005.
In March 2003, we issued 1,100 shares of Series A Cumulative Preferred Stock to
HSBC, which are now held by HINO.
COMMON EQUITY We currently intend to issue additional common equity to HINO in
exchange for the Series A Cumulative Preferred Stock on or before December 15,
2005. In addition, in connection with our pending purchase of Metris, we
currently intend to issue approximately $1.2 billion in additional common equity
to HINO to fund a portion of the $1.6 billion purchase price. The acquisition of
Metris is subject to certain conditions and is anticipated to close in the
fourth quarter of 2005.
SELECTED CAPITAL RATIOS are summarized in the following table:
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------------------------------------------------------------------------------------
TETMA(1),(2)................................................ 6.97% 6.27%
TETMA + Owned Reserves(1),(2)............................... 9.91 9.04
Tangible common equity to tangible managed assets(1)........ 5.33 4.67
Common and preferred equity to owned assets................. 12.83 13.01
Excluding purchase accounting adjustments:
TETMA(1),(2).............................................. 8.10 7.97
TETMA + Owned Reserves(1),(2)............................. 11.04 10.75
Tangible common equity to tangible managed assets(1)...... 6.46 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 certain 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 certain
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.
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 used to limit our reliance on the unsecured debt
markets.
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
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HSBC Finance Corporation
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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.
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 that 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
consistent with our owned balance sheet portfolio. Using this source of funding
results in similar cash flows as issuing debt through alternative funding
sources.
Under IFRS and prior to 2005 under U.K. GAAP, our securitizations are treated as
secured financings. In order to align our accounting treatment with that of
HSBC, 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 and
MasterCard and 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 is no impact,
however, on cash received from operations. 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.
As previously discussed, securitization levels were much lower in the nine
months ended September 30, 2005 as a result of the use of alternate funding
sources, including funding from HSBC subsidiaries, and our decision to structure
all new collateralized funding transactions as secured financings beginning in
the third quarter of 2004.
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Securitizations (excluding replenishments of certificateholder interests) and
secured financings are summarized in the following table:
THREE MONTHS ENDED SEPTEMBER 30, 2005 2004
-----------------------------------------------------------------------------
(IN MILLIONS)
INITIAL SECURITIZATIONS:
Auto finance................................................ $ - $ -
MasterCard/Visa............................................. - -
Private label............................................... - -
Personal non-credit card.................................... - -
------ ------
Total....................................................... $ - $ -
====== ======
SECURED FINANCINGS:
Real estate secured......................................... $1,321 $1,549
Auto finance................................................ 945 750
MasterCard/Visa............................................. 750 -
------ ------
Total....................................................... $3,016 $2,299
====== ======
NINE MONTHS ENDED SEPTEMBER 30, 2005 2004
-----------------------------------------------------------------------------
(IN MILLIONS)
INITIAL SECURITIZATIONS:
Auto finance................................................ $ - $ -
MasterCard/Visa............................................. - 550
Private label............................................... - 190
Personal non-credit card.................................... - -
------ ------
Total....................................................... $ - $ 740
====== ======
SECURED FINANCINGS:
Real estate secured......................................... $2,240 $3,299
Auto finance................................................ 1,943 750
MasterCard/Visa............................................. 1,250 -
------ ------
Total....................................................... $5,433 $4,049
====== ======
Our securitized receivables totaled $6.8 billion at September 30, 2005 compared
to $14.2 billion at December 31, 2004. As of September 30, 2005, secured
financings of $7.7 billion were secured by $13.0 billion of real estate secured,
auto finance and MasterCard/Visa receivables. Secured financings of $7.3 billion
at December 31, 2004 were secured by $10.3 billion of real estate secured and
auto finance receivables. At September 30, 2005, securitizations structured as
sales represented 5 percent and secured financings represented 6 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.
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2005 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 2005 are summarized in the table that follows:
ACTUAL ESTIMATED
JANUARY 1 OCTOBER 1
THROUGH THROUGH ESTIMATED
SEPTEMBER 30, DECEMBER 31, FULL YEAR
2005 2005 2005
---------------------------------------------------------------------------------------------------
(IN BILLIONS)
FUNDING NEEDS:
Net asset growth....................................... $16 $ 3 - 6(1) $19 - 22
Commercial paper, term debt and securitization
maturities.......................................... 26 2 - 12 28 - 38
Other.................................................. 1 1 - 3(1) 2 - 4
--- ------- --------
Total funding needs, including growth.................. $43 $6 - 21 $49 - 64
=== ======= ========
FUNDING SOURCES:
External funding, including HSBC clients............... $38 $6 - 20 $44 - 58
HSBC and HSBC subsidiaries............................. 5 0 - 1 5 - 6
--- ------- --------
Total funding sources.................................. $43 $6 - 21 $49 - 64
=== ======= ========
---------------
(1) Capital requirements resulting from the acquisition of Metris are included
in Other.
RISK MANAGEMENT
--------------------------------------------------------------------------------
CREDIT RISK There have been no significant changes in our approach to credit
risk management since December 31, 2004.
At September 30, 2005, we had derivative contracts with a notional value of
approximately $67.1 billion, including $64.3 billion outstanding with HSBC
affiliates. 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 $343 million at September 30, 2005. Affiliate swap counterparties
provide collateral in the form of securities as required, which are not recorded
on our balance sheet. At September 30, 2005, the fair value of our agreements
with affiliate counterparties was below the level requiring payment of
collateral. As such at September, 30, 2005, we were not holding any swap
collateral from HSBC affiliates in the form of securities.
LIQUIDITY RISK There have been no significant changes in our approach to
liquidity risk since December 31, 2004.
MARKET RISK HSBC has certain limits and benchmarks that serve as guidelines in
determining 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 total PVBP limit as of September 30, 2005 was $2
million, which includes 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. Our
PVBP position at both September 30, 2005 and December 31, 2004 was less than $1
million.
While the total PVBP position was not impacted by the loss of hedge accounting
for certain derivative financial instruments at the time of our acquisition by
HSBC, the portfolio of ineffective hedges remaining at September 30, 2005
represent PVBP risk of $($1.7) million. The interest rate risk remaining for all
other assets and liabilities, including effective hedges, results in an
offsetting PVBP risk of $2.3 million. Therefore,
57
HSBC Finance Corporation
--------------------------------------------------------------------------------
at September 30, 2005 we had a net PVBP position of less than $1 million, which
is within our PVBP limit of $2 million.
We also monitor the impact that a 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. The following table
summarizes such estimated impact:
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------------------------------------------------------------------------------------
(IN MILLIONS)
Decrease in net interest income following a hypothetical 25
basis points rise in interest rates applied on a quarterly
basis over the next 12 months............................. $179 $176
Increase in net interest income following a hypothetical 25
basis points fall in interest rates applied on a quarterly
basis over the next 12 months............................. $119 $169
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 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.
Net interest income at risk has changed as a result of the loss of hedge
accounting on our portfolio of economic hedges. At September 30, 2005, our net
interest income sensitivity to a hypothetical 25 basis point rise in rates
applied on a quarterly basis over the next 12 months is a decrease of $188
million as opposed to the amount reported above, and the sensitivity to a
hypothetical 25 basis point fall in rates applied on a quarterly basis over the
next 12 months is an increase of $128 million as opposed to the amount reported
above. At December 31, 2004, our net interest income sensitivity to a
hypothetical 25 basis point rise in rates applied on a quarterly basis over the
next 12 months is a decrease of $190 million as opposed to the amount reported
above, and the sensitivity to a hypothetical 25 basis point fall in rates
applied on a quarterly basis over the next 12 months is an increase of $186
million as opposed to the amount reported above. This sensitivity only considers
changes in interest rates and does not consider changes from other variables,
such as exchange rates that may impact margin. The decrease in exposure to
rising interest rates results primarily from the reclassification of the pay
fixed/receive floating interest rate swaps, which do not qualify for hedge
accounting under SFAS No. 133. As part of our overall risk management strategy
to reduce earnings volatility, in the second and third quarters of 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.
OPERATIONAL RISK There has been no significant change in our approach to
operational risk management since December 31, 2004.
58
HSBC FINANCE CORPORATION
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------------- -----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
---------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
RETURN ON AVERAGE ASSETS:
Net income................................ $ 281 $ 325 $ 1,379 $ 1,228
======== ======== ======== ========
Average assets:
Owned basis............................. $141,765 $124,512 $136,185 $120,456
Serviced with limited recourse.......... 7,779 21,542 10,288 23,462
-------- -------- -------- --------
Managed basis........................... $149,544 $146,054 $146,473 $143,918
======== ======== ======== ========
Return on average owned assets............ .79% 1.04% 1.35% 1.36%
Return on average managed assets.......... .75 .89 1.26 1.14
RETURN ON AVERAGE COMMON SHAREHOLDER'S
EQUITY:
Net income................................ $ 281 $ 325 $ 1,379 $ 1,228
Dividends on preferred stock.............. (25) (18) (62) (54)
-------- -------- -------- --------
Net income available to common
shareholders............................ $ 256 $ 307 $ 1,317 $ 1,174
======== ======== ======== ========
Average common shareholder's equity....... $ 16,973 $ 17,367 $ 16,605 $ 17,057
Return on average common shareholder's
equity.................................. 6.03% 7.07% 10.58% 9.18%
NET INTEREST INCOME:
Net interest income:
Owned basis............................. $ 2,163 $ 1,969 $ 6,086 $ 5,719
Serviced with limited recourse.......... 177 581 758 1,987
-------- -------- -------- --------
Managed basis........................... $ 2,340 $ 2,550 $ 6,844 $ 7,706
======== ======== ======== ========
Average interest-earning assets:
Owned basis............................. $127,038 $107,955 $119,848 $102,957
Serviced with limited recourse.......... 7,779 21,542 10,288 23,462
-------- -------- -------- --------
Managed basis........................... $134,817 $129,497 $130,136 $126,419
======== ======== ======== ========
Owned basis net interest margin........... 6.81% 7.29% 6.77% 7.41%
Managed basis net interest margin......... 6.94 7.88 7.01 8.13
MANAGED BASIS RISK ADJUSTED REVENUE:
Net interest income....................... $ 2,340 $ 2,550 $ 6,844 $ 7,706
Other revenues, excluding securitization
related revenue and the mark-to-market
on derivatives which do not qualify as
effective hedges and ineffectiveness
associated with qualifying hedges under
SFAS No. 133............................ 1,185 916 3,494 2,812
Less: Net charge-offs..................... (1,052) (1,363) (3,198) (4,172)
-------- -------- -------- --------
Risk adjusted revenue..................... $ 2,473 $ 2,103 $ 7,140 $ 6,346
======== ======== ======== ========
Average interest-earning assets........... $134,817 $129,497 $130,136 $126,419
Managed basis risk adjusted revenue....... 7.34% 6.50% 7.32% 6.69%
59
HSBC FINANCE CORPORATION
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------------------- -----------------------------
SEPTEMBER 30, JUNE 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2005 2005 2004 2005 2004
---------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
CONSUMER NET CHARGE-OFF RATIO:
Consumer net charge-offs:
Owned basis.................. $ 902 $ 844 $ 969 $ 2,602 $ 2,905
Serviced with limited
recourse.................. 150 184 394 589 1,267
-------- -------- -------- -------- --------
Managed basis................ $ 1,052 $ 1,028 $ 1,363 $ 3,191 $ 4,172
======== ======== ======== ======== ========
Average consumer receivables:
Owned basis.................. $123,163 $115,354 $102,821 $115,815 $ 97,328
Serviced with limited
recourse.................. 7,779 10,203 21,542 10,288 23,462
-------- -------- -------- -------- --------
Managed basis................ $130,942 $125,557 $124,363 $126,103 $120,790
======== ======== ======== ======== ========
Owned basis consumer net
charge-off ratio............. 2.93% 2.93% 3.77% 3.00% 3.98%
Managed basis consumer net
charge-off ratio............. 3.21 3.28 4.38 3.37 4.61
======== ======== ======== ======== ========
RESERVES AS A PERCENT OF NET
CHARGE-OFFS
Loss reserves:
Owned basis.................. $ 4,220 $ 3,756 $ 3,953 $ 4,220 $ 3,953
Serviced with limited
recourse.................. 351 525 1,246 351 1,246
-------- -------- -------- -------- --------
Managed basis................ $ 4,571 $ 4,281 $ 5,199 $ 4,571 $ 5,199
======== ======== ======== ======== ========
Net charge-offs:
Owned basis.................. $ 902 $ 844 $ 969 $ 2,609 $ 2,905
Serviced with limited
recourse.................. 150 184 394 589 1,267
-------- -------- -------- -------- --------
Managed basis................ $ 1,052 $ 1,028 $ 1,363 $ 3,198 $ 4,172
======== ======== ======== ======== ========
Owned basis reserves as a
percent of net charge-offs... 117.0% 111.3% 102.0% 121.3% 102.1%
Managed basis reserves as a
percent of net charge-offs... 108.6 104.1 95.4 107.2 93.5
EFFICIENCY RATIO:
Total costs and expenses less
policyholders' benefits...... $ 1,374 $ 1,326 $ 1,315 $ 4,120 $ 3,840
======== ======== ======== ======== ========
Net interest income and other
revenues less policyholders'
benefits:
Owned basis.................. $ 3,156 $ 3,043 $ 2,916 $ 9,427 $ 8,735
Serviced with limited
recourse.................. (23) 52 (232) 59 169
-------- -------- -------- -------- --------
Managed basis................ $ 3,133 $ 3,095 $ 2,684 $ 9,486 $ 8,904
======== ======== ======== ======== ========
Owned basis efficiency ratio... 43.54% 43.58% 45.10% 43.70% 43.96%
Managed basis efficiency
ratio........................ 43.86 42.84 48.99 43.43 43.13
60
HSBC FINANCE CORPORATION
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
SEPTEMBER 30, JUNE 30, SEPTEMBER 30,
2005 2005 2004
---------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
TWO-MONTHS-AND-OVER-CONTRACTUAL DELINQUENCY:
Consumer two-months-and-over-contractual delinquency:
Owned basis............................................ $ 4,861 $ 4,419 $ 4,702
Serviced with limited recourse......................... 376 484 1,092
-------- -------- --------
Managed basis.......................................... $ 5,237 $ 4,903 $ 5,794
======== ======== ========
Consumer receivables:
Owned basis............................................ $128,524 $118,532 $106,130
Serviced with limited recourse......................... 6,759 8,980 20,175
-------- -------- --------
Managed basis.......................................... $135,283 $127,512 $126,305
======== ======== ========
Consumer two-months-and-over-contractual delinquency:
Owned basis............................................ 3.78% 3.73% 4.43%
Managed basis.......................................... 3.87 3.85 4.59
RESERVES AS A PERCENT OF RECEIVABLES:
Loss reserves:
Owned basis............................................ $ 4,220 $ 3,756 $ 3,953
Serviced with limited recourse......................... 351 525 1,246
-------- -------- --------
Managed basis.......................................... $ 4,571 $ 4,281 $ 5,199
======== ======== ========
Receivables:
Owned basis............................................ $128,722 $118,761 $106,437
Serviced with limited recourse......................... 6,759 8,980 20,175
-------- -------- --------
Managed basis.......................................... $135,481 $127,741 $126,612
======== ======== ========
Reserves as a percent of receivables:
Owned basis............................................ 3.28% 3.16% 3.71%
Managed basis.......................................... 3.37 3.35 4.11
RESERVES AS A PERCENT OF NONPERFORMING LOANS:
Loss reserves:
Owned basis............................................ $ 4,220 $ 3,756 $ 3,953
Serviced with limited recourse......................... 351 525 1,246
-------- -------- --------
Managed basis.......................................... $ 4,571 $ 4,281 $ 5,199
======== ======== ========
Nonperforming loans:
Owned basis............................................ $ 3,836 $ 3,491 $ 3,797
Serviced with limited recourse......................... 309 395 881
-------- -------- --------
Managed basis.......................................... $ 4,145 $ 3,886 $ 4,678
======== ======== ========
Reserves as a percent of nonperforming loans:
Owned basis............................................ 110.0% 107.6% 104.1%
Managed basis.......................................... 110.3 110.2 111.1
61
HSBC FINANCE CORPORATION
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
TANGIBLE COMMON EQUITY:
Common shareholder's equity................................. $ 17,137 $ 15,841
Exclude:
Unrealized (gains) losses on cash flow hedging
instruments............................................ (283) (119)
Minimum pension liability................................. 4 4
Unrealized gains on investments and interest-only strip
receivables............................................ (24) (53)
Intangible assets......................................... (2,394) (2,705)
Goodwill.................................................. (6,799) (6,856)
-------- --------
Tangible common equity...................................... 7,641 6,112
Purchase accounting adjustments............................. 1,617 2,227
-------- --------
Tangible common equity, excluding purchase accounting
adjustments............................................... $ 9,258 $ 8,339
======== ========
TANGIBLE SHAREHOLDERS' EQUITY:
Tangible common equity...................................... $ 7,641 $ 6,112
Preferred stock............................................. 1,675 1,100
Mandatorily redeemable preferred securities of Household
Capital Trusts............................................ 681 994
-------- --------
Tangible shareholder's equity............................... 9,997 8,206
Purchase accounting adjustments............................. 1,611 2,208
-------- --------
Tangible shareholders' equity, excluding purchase accounting
adjustments............................................... $ 11,608 $ 10,414
======== ========
TANGIBLE SHAREHOLDERS' EQUITY PLUS OWNED LOSS RESERVES:
Tangible shareholders' equity............................... $ 9,997 $ 8,206
Owned loss reserves......................................... 4,220 3,625
-------- --------
Tangible shareholders' equity plus owned loss reserves...... 14,217 11,831
Purchase accounting adjustments............................. 1,611 2,208
-------- --------
Tangible shareholders' equity plus owned loss reserves,
excluding purchase accounting adjustments................. $ 15,828 $ 14,039
======== ========
TANGIBLE MANAGED ASSETS:
Owned assets................................................ $146,574 $130,190
Receivables serviced with limited recourse.................. 6,759 14,225
-------- --------
Managed assets.............................................. 153,333 144,415
Exclude:
Intangible assets......................................... (2,394) (2,705)
Goodwill.................................................. (6,799) (6,856)
Derivative financial assets............................... (662) (4,049)
-------- --------
Tangible managed assets..................................... 143,478 130,805
Purchase accounting adjustments............................. (91) (202)
-------- --------
Tangible managed assets, excluding purchase accounting
adjustments............................................... $143,387 $130,603
======== ========
EQUITY RATIOS:
Common and preferred equity to owned assets................. 12.83% 13.01%
Tangible common equity to tangible managed assets........... 5.33 4.67
Tangible shareholders' equity to tangible managed assets
("TETMA")................................................. 6.97 6.27
Tangible shareholders' equity plus owned loss reserves to
tangible managed assets ("TETMA + Owned Reserves")........ 9.91 9.04
Excluding purchase accounting adjustments:
Tangible common equity to tangible managed assets......... 6.46 6.38
TETMA..................................................... 8.10 7.97
TETMA + Owned Reserves.................................... 11.04 10.75
======== ========
62
ITEM 4. CONTROLS AND PROCEDURES
--------------------------------------------------------------------------------
DISCLOSURE CONTROLS 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. Our disclosure controls and procedures are designed to ensure that
information required to be disclosed by HSBC Finance Corporation in the reports
we file under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), is recorded, processed, summarized and reported on a timely basis. 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.
INTERNAL CONTROLS There have not been any changes in our internal control over
financial reporting during the fiscal quarter to which this report relates that
have materially affected, or are reasonably likely to materially affect, our
internal controls over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
--------------------------------------------------------------------------------
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 LENDING 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 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 alleges that HSBC Finance
Corporation, Household Bank (SB), N.A. 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 seeks a
declaration that defendants in this action (including Visa, MasterCard and other
banks belonging to those associations), have violated the antitrust laws, and
requests an injunction restraining the defendants, their directors, officers,
employees, agents, successors, owners and members from "continuing or
maintaining in any
63
manner, directly or indirectly, the rules, policies, and agreements at issue,"
and seeks "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 February
18, 2005, the Defendants filed a motion to dismiss the complaint for failure to
state a cause of action. At this time, we are unable to quantify the potential
impact from this action, if any.
On June 22, 2005, a matter entitled Photos Etc. Corporation, et al. v. VISA
U.S.A. Inc., et al. was filed in the U.S. District Court for the District of
Connecticut as case number 305CV1007. This purported class action named as
defendants VISA, MasterCard and a number of alleged members of those
associations, including HSBC Finance Corporation and two other HSBC entities.
The case seeks certification of a class of retail merchants that operate
commercial businesses throughout the United States and alleges the defendants
engage in an anti-competitive conspiracy to fix the level of "interchange fees"
charged by the associations. This and other similar suits filed in various
federal courts have been consolidated for pre-trial matters in the U.S. District
Court for 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.
64
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 and the
plaintiffs have appealed that 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 6. EXHIBITS
--------------------------------------------------------------------------------
Exhibits included in this Report:
3 Amended and Restated Certificate of Incorporation of HSBC
Finance Corporation and amendments thereto, including
Amended Certificate of Designations of Series A Cumulative
Preferred Stock of HSBC Finance Corporation and Certificate
of Designations of Series B Cumulative Preferred Stock
(previously filed as Exhibit 3.1 to HSBC Finance
Corporation's Current Report on Form 8-K, dated June 16,
2005, filed with the Securities and Exchange Commission on
June 22, 2005).
12 Statement of Computation of Ratio of Earnings to Fixed
Charges and to Combined Fixed Charges and Preferred Stock
Dividends.
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 Debt and Preferred Stock Securities Ratings.
65
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 FINANCE CORPORATION
(Registrant)
/s/ Beverley A. Sibblies
--------------------------------------
Beverley A. Sibblies
Senior Vice President and
Chief Financial Officer
Date: November 14, 2005
66
EXHIBIT INDEX
--------------------------------------------------------------------------------
3 Amended and Restated Certificate of Incorporation of HSBC
Finance Corporation and amendments thereto, including
Amended Certificate of Designations of Series A Cumulative
Preferred Stock of HSBC Finance Corporation and Certificate
of Designations of Series B Cumulative Preferred Stock
(previously filed as Exhibit 3.1 to HSBC Finance
Corporation's Current Report on Form 8-K, dated June 16,
2005, filed with the Securities and Exchange Commission on
June 22, 2005).
12 Statement of Computation of Ratio of Earnings to Fixed
Charges and to Combined Fixed Charges and Preferred Stock
Dividends.
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 Debt and Preferred Stock Securities Ratings.
EXHIBIT 12
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND TO
COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
2005 2004
-------------------------------------------------------------------------------
(DOLLARS ARE IN
MILLIONS)
Net income.................................................. $1,379 $1,228
Income tax expense.......................................... 695 619
------ ------
Income before income tax expense............................ 2,074 1,847
------ ------
Fixed charges:
Interest expense.......................................... 3,405 2,225
Interest portion of rentals(1)............................ 45 39
------ ------
Total fixed charges......................................... 3,450 2,264
------ ------
Total earnings as defined................................... $5,524 $4,111
====== ======
Ratio of earnings to fixed charges.......................... 1.60 1.82
Preferred stock dividends(2)................................ 93 81
Ratio of earnings to combined fixed charges and preferred
stock dividends........................................... 1.56 1.75
---------------
(1) Represents one-third of rentals, which approximates the portion representing
interest.
(2) Preferred stock dividends are grossed up to their pretax equivalents.
EXHIBIT 31
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
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 report on Form 10-Q of HSBC Finance
Corporation;
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other
financial information included in this 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
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
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this 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 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 function):
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: November 14, 2005
/s/ SIDDHARTH N. MEHTA
--------------------------------------
Siddharth N. Mehta
Chairman and Chief Executive Officer
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 report on Form 10-Q of HSBC Finance
Corporation;
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other
financial information included in this 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
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
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this 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 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 function):
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: November 14, 2005
/s/ BEVERLEY A. SIBBLIES
--------------------------------------
Beverley A. Sibblies
Senior Vice President and
Chief Financial Officer
EXHIBIT 32
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of HSBC Finance Corporation on Form 10-Q
for the period ending September 30, 2005 as filed with the Securities and
Exchange Commission on the date hereof (the "Report"), I, Siddharth N. Mehta,
Chairman and Chief Executive Officer of HSBC Finance Corporation, certify,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a)
or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
/s/ SIDDHARTH N. MEHTA
--------------------------------------
Siddharth N. Mehta
Chairman and Chief Executive Officer
November 14, 2005
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.
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of HSBC Finance Corporation on Form 10-Q
for the period ending September 30, 2005 as filed with the Securities and
Exchange Commission on the date hereof (the "Report"), I, Beverley A. Sibblies,
Senior Vice President and Chief Financial Officer of HSBC Finance Corporation,
certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a)
or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
/s/ BEVERLEY A. SIBBLIES
--------------------------------------
Beverley A. Sibblies
Senior Vice President and
Chief Financial Officer
November 14, 2005
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
DEBT AND PREFERRED STOCK SECURITIES RATINGS
STANDARD & MOODY'S
POOR'S INVESTORS DOMINION BOARD
CORPORATION SERVICE FITCH, INC. RATING SERVICE
-------------------------------------------------------------------------------------------------------
AT SEPTEMBER 30, 2005
HSBC Finance Corporation
Senior debt.................................. A A1 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 A1 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)
---------------
* 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:P A Stafford
Name: P A Stafford
Title: Assistant Group Secretary
Date: 14 November 2005