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 May, 2006
HSBC Holdings plc
42nd Floor, 8 Canada
Square, London E14 5HQ, England
(Indicate by check mark whether the registrant files or will file annual
reports under cover of Form 20-F or Form 40-F).
Form 20-F X Form 40-F ......
(Indicate by check mark whether the registrant by furnishing the information
contained in this Form is also thereby furnishing the information to the
Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of
1934).
Yes....... No X
(If "Yes" is marked, indicate below the file number assigned to the registrant
in connection with Rule 12g3-2(b): 82- ..............)
--------------------------------------------------------------------------------
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
---------------------
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006
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 No ( )
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer ( ) Accelerated filer ( ) Non-accelerated
filer
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes ( ) No
As of April 30, 2006, there were 55 shares of the registrant's common stock
outstanding, all of which are owned by HSBC Investments (North America) Inc.
--------------------------------------------------------------------------------
HSBC FINANCE CORPORATION
FORM 10-Q
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
--------------------------------------------------------------------------------
Item 1. Consolidated Financial Statements
3
Statement of Income.........................................
4
Balance Sheet...............................................
5
Statement of Changes in Shareholders'('s) Equity............
6
Statement of Cash Flows.....................................
7
Notes to Consolidated Financial Statements..................
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
20
Forward-Looking Statements..................................
20
Executive Overview..........................................
23
Basis of Reporting..........................................
29
Receivables Review..........................................
30
Results of Operations.......................................
35
Segment Results - Managed Basis.............................
40
Credit Quality..............................................
46
Liquidity and Capital Resources.............................
49
Risk Management.............................................
52
Reconciliations to GAAP Financial Measures..................
Item 4. Controls and Procedures..................................... 56
PART II. OTHER INFORMATION
--------------------------------------------------------------------------------
Item 1. Legal Proceedings........................................... 56
Item 1A. Risk Factors................................................ 58
Item 6. Exhibits.................................................... 62
Signature... ............................................................ 63
2
PART I. FINANCIAL INFORMATION
--------------------------------------------------------------------------------
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
HSBC Finance Corporation
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF INCOME
THREE MONTHS ENDED MARCH 31, 2006 2005
-----------------------------------------------------------------------------
(IN MILLIONS)
Finance and other interest income........................... $4,087 $2,950
Interest expense:
HSBC affiliates........................................... 153 151
Non-affiliates............................................ 1,470 911
------ ------
NET INTEREST INCOME......................................... 2,464 1,888
Provision for credit losses................................. 866 841
------ ------
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES....... 1,598 1,047
------ ------
Other revenues:
Securitization related revenue............................ 71 85
Insurance revenue......................................... 230 221
Investment income......................................... 34 33
Derivative income......................................... 57 260
Fee income................................................ 392 306
Taxpayer financial services revenue....................... 234 243
Gain on receivable sales to HSBC affiliates............... 85 100
Servicing fees from HSBC affiliates....................... 108 101
Other income.............................................. 196 113
------ ------
TOTAL OTHER REVENUES........................................ 1,407 1,462
------ ------
Costs and expenses:
Salaries and employee benefits............................ 581 497
Sales incentives.......................................... 80 82
Occupancy and equipment expenses.......................... 83 87
Other marketing expenses.................................. 173 180
Other servicing and administrative expenses............... 239 258
Support services from HSBC affiliates..................... 252 209
Amortization of intangibles............................... 80 107
Policyholders' benefits................................... 118 122
------ ------
TOTAL COSTS AND EXPENSES.................................... 1,606 1,542
------ ------
Income before income tax expense............................ 1,399 967
Income tax expense.......................................... 511 341
------ ------
NET INCOME.................................................. $ 888 $ 626
====== ======
The accompanying notes are an integral part of the consolidated financial
statements.
3
HSBC Finance Corporation
--------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET
MARCH 31, DECEMBER 31,
2006 2005
--------------------------------------------------------------------------------------
(IN MILLIONS,
EXCEPT SHARE DATA)
ASSETS
Cash........................................................ $ 476 $ 903
Interest bearing deposits with banks........................ 599 384
Securities purchased under agreements to resell............. 91 78
Securities.................................................. 4,143 4,051
Receivables, net............................................ 143,890 136,989
Intangible assets, net...................................... 2,400 2,480
Goodwill.................................................... 7,009 7,003
Properties and equipment, net............................... 425 458
Real estate owned........................................... 563 510
Derivative financial assets................................. 282 234
Other assets................................................ 3,802 3,579
-------- --------
TOTAL ASSETS................................................ $163,680 $156,669
======== ========
LIABILITIES
Debt:
Commercial paper, bank and other borrowings............... $ 14,252 $ 11,454
Due to affiliates......................................... 15,520 15,534
Long term debt (with original maturities over one year)... 107,794 105,163
-------- --------
Total debt.................................................. 137,566 132,151
-------- --------
Insurance policy and claim reserves......................... 1,298 1,291
Derivative related liabilities.............................. 640 383
Other liabilities........................................... 3,795 3,365
-------- --------
TOTAL LIABILITIES......................................... 143,299 137,190
SHAREHOLDERS' EQUITY
Redeemable preferred stock, 1,501,100 shares authorized,
Series B, $0.01 par value, 575,000 shares issued.......... 575 575
Common shareholder's equity:
Common stock, $0.01 par value, 100 shares authorized,
55 shares issued...................................... - -
Additional paid-in capital............................. 17,132 17,145
Retained earnings...................................... 2,159 1,280
Accumulated other comprehensive income................. 515 479
-------- --------
TOTAL COMMON SHAREHOLDER'S EQUITY........................... 19,806 18,904
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................. $163,680 $156,669
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
4
HSBC Finance Corporation
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS'('S) EQUITY
THREE MONTHS ENDED MARCH 31, 2006 2005
-------------------------------------------------------------------------------
(IN MILLIONS)
PREFERRED STOCK
Balance at beginning and end of period.................... $ 575 $ 1,100
======= =======
COMMON SHAREHOLDER'S EQUITY
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of period......................... $17,145 $14,627
Employee benefit plans, including transfers and
other................................................. (13) 46
------- -------
Balance at end of period............................... $17,132 $14,673
------- -------
RETAINED EARNINGS
Balance at beginning of period......................... $ 1,280 $ 571
Net income............................................. 888 626
Dividends:
Preferred stock...................................... (9) (18)
------- -------
Balance at end of period............................... $ 2,159 $ 1,179
------- -------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance at beginning of period......................... $ 479 $ 643
Net change in unrealized gains (losses), net of tax,
on:
Derivatives classified as cash flow hedges........... 54 134
Securities available for sale and interest-only strip
receivables......................................... (33) (16)
Foreign currency translation adjustments............... 15 (60)
------- -------
Other comprehensive income, net of tax................. 36 58
------- -------
Balance at end of period............................... $ 515 $ 701
------- -------
TOTAL COMMON SHAREHOLDER'S EQUITY........................... $19,806 $16,553
------- -------
COMPREHENSIVE INCOME
Net income................................................ $ 888 $ 626
Other comprehensive income................................ 36 58
------- -------
COMPREHENSIVE INCOME........................................ $ 924 $ 684
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
5
HSBC Finance Corporation
--------------------------------------------------------------------------------
STATEMENT OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2006 2005
---------------------------------------------------------------------------------
(IN MILLIONS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income.................................................. $ 888 $ 626
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Gain on receivable sales to HSBC affiliates............... (85) (100)
Provision for credit losses............................... 866 841
Insurance policy and claim reserves....................... (49) (29)
Depreciation and amortization............................. 109 142
Net change in other assets................................ (312) (235)
Net change in other liabilities........................... 412 382
Excess tax benefits from share-based compensation
arrangements............................................ (4) -
Other, net................................................ 229 290
-------- --------
Net cash provided by (used in) operating activities......... 2,054 1,917
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Securities:
Purchased................................................. (224) (178)
Matured................................................... 183 95
Sold...................................................... 120 34
Net change in short-term securities available for sale...... (208) 51
Net change in securities purchased under agreements to
resell.................................................... (13) 2,369
Net change in interest bearing deposits with banks.......... (216) 284
Receivables:
Originations, net of collections.......................... (12,994) (11,772)
Purchases and related premiums............................ (9) (8)
Sales to affiliates....................................... 4,909 4,720
Net change in interest-only strip receivables............. (1) 89
Cash received in sale of U.K. credit card business.......... 90 -
Properties and equipment:
Purchases................................................. (8) (17)
Sales..................................................... 8 1
-------- --------
Net cash provided by (used in) investing activities......... (8,363) (4,332)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Debt:
Net change in short-term debt and deposits................ 2,800 1,593
Net change in time certificates........................... - (2)
Net change in due to affiliates........................... (52) 1,430
Long term debt issued..................................... 8,278 3,984
Long term debt retired.................................... (4,961) (4,386)
Redemption of company obligated mandatorily redeemable
preferred securities of subsidiary trusts................. (206) -
Insurance:
Policyholders' benefits paid.............................. (58) (56)
Cash received from policyholders.......................... 88 84
Shareholders' dividends..................................... (9) -
Excess tax benefits from share-based compensation
arrangements.............................................. 4 -
-------- --------
Net cash provided by (used in) financing activities......... 5,884 2,647
-------- --------
Effect of exchange rate changes on cash..................... (2) (2)
-------- --------
Net change in cash.......................................... (427) 230
Cash at beginning of period................................. 903 392
-------- --------
CASH AT END OF PERIOD....................................... $ 476 $ 622
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
6
HSBC Finance Corporation
--------------------------------------------------------------------------------
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 an indirect 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,
2005 (the "2005 Form 10-K"). Certain reclassifications have been made to prior
period amounts to conform to the current period presentation.
The preparation of financial statements in conformity with U.S. GAAP requires
the use of estimates and assumptions that affect reported amounts and
disclosures. Actual results could differ from those estimates. Interim results
should not be considered indicative of results in future periods.
2. SECURITIES
--------------------------------------------------------------------------------
Securities consisted of the following available-for-sale investments:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
MARCH 31, 2006 COST GAINS LOSSES VALUE
---------------------------------------------------------------------------------------------------
(IN MILLIONS)
Corporate debt securities............................ $2,327 $6 $(65) $2,268
Money market funds................................... 435 - - 435
U.S. government sponsored enterprises(1)............. 56 - (3) 53
U.S. government and Federal agency debt securities... 819 - (4) 815
Non-government mortgage backed securities............ 111 - (1) 110
Other................................................ 434 1 (6) 429
------ -- ---- ------
Subtotal............................................. 4,182 7 (79) 4,110
Accrued investment income............................ 33 - - 33
------ -- ---- ------
Total securities available for sale.................. $4,215 $7 $(79) $4,143
====== == ==== ======
7
HSBC Finance Corporation
--------------------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 2005 COST GAINS LOSSES VALUE
---------------------------------------------------------------------------------------------------
(IN MILLIONS)
Corporate debt securities............................ $2,337 $23 $(38) $2,322
Money market funds................................... 315 - - 315
U.S. government sponsored enterprises(1)............. 96 - (2) 94
U.S. government and Federal agency debt securities... 744 - (4) 740
Non-government mortgage backed securities............ 88 - (1) 87
Other................................................ 463 1 (5) 459
------ --- ---- ------
Subtotal............................................. 4,043 24 (50) 4,017
Accrued investment income............................ 34 - - 34
------ --- ---- ------
Total securities available for sale.................. $4,077 $24 $(50) $4,051
====== === ==== ======
---------------
(1) Includes primarily mortgage-backed securities issued by the Federal National
Mortgage Association and the Federal Home Loan Mortgage Corporation.
Money market funds at March 31, 2006 include $250 million which is restricted
for the sole purpose of paying down certain secured financings at the
established payment date. There were no such balances at December 31, 2005.
A summary of gross unrealized losses and related fair values as of March 31,
2006 and December 31, 2005, 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
MARCH 31, 2006 SECURITIES LOSSES INVESTMENTS SECURITIES LOSSES INVESTMENTS
---------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Corporate debt securities... 200 $(17) $514 517 $(48) $1,262
U.S. government sponsored
enterprises............... 12 (1) 31 36 (2) 76
U.S. government and Federal
agency debt securities.... 9 (1) 19 36 (3) 120
Non-government mortgage..... 3 -(1) 4 16 (1) 21
Other....................... 15 -(1) 45 46 (6) 233
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, 2005 SECURITIES LOSSES INVESTMENTS SECURITIES LOSSES INVESTMENTS
---------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Corporate debt securities... 243 $(12) $527 392 $(26) $996
U.S. government sponsored
enterprises............... 32 -(1) 26 25 (2) 64
U.S. government and Federal
agency debt securities.... 15 (1) 49 43 (3) 139
Non-government mortgage..... 3 -(1) 4 16 (1) 22
Other....................... 14 (1) 78 46 (4) 181
---------------
(1) Less than $500 thousand.
8
HSBC Finance Corporation
--------------------------------------------------------------------------------
The gross unrealized losses on our securities available for sale have increased
during the first quarter of 2006 due to a general increase in interest rates.
The contractual terms of these securities do not permit the issuer to settle the
securities at a price less than the par value of the investment. Since
substantially all of these securities are rated A- or better, and because we
have the ability and intent to hold these investments until maturity or a market
price recovery, these securities are not considered other-than-temporarily
impaired.
3. RECEIVABLES
--------------------------------------------------------------------------------
Receivables consisted of the following:
MARCH 31, DECEMBER 31,
2006 2005
--------------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured......................................... $ 89,492 $ 82,826
Auto finance................................................ 11,186 10,704
MasterCard(1)/Visa(1)....................................... 23,449 24,110
Private label............................................... 2,428 2,520
Personal non-credit card.................................... 20,006 19,545
Commercial and other........................................ 206 208
--------- ---------
Total owned receivables..................................... 146,767 139,913
HSBC acquisition purchase accounting fair value
adjustments............................................... 28 63
Accrued finance charges..................................... 1,871 1,831
Credit loss reserve for owned receivables................... (4,468) (4,521)
Unearned credit insurance premiums and claims reserves...... (480) (505)
Interest-only strip receivables............................. 20 23
Amounts due and deferred from receivable sales.............. 152 185
--------- ---------
Total owned receivables, net................................ 143,890 136,989
Receivables serviced with limited recourse.................. 3,109 4,074
--------- ---------
Total managed receivables, net.............................. $ 146,999 $ 141,063
========= =========
---------------
(1) MasterCard is a registered trademark of MasterCard International,
Incorporated and Visa is a registered trademark of VISA USA, Inc.
HSBC acquisition purchase accounting fair value adjustments represent
adjustments which have been "pushed down" to record our receivables at fair
value on March 28, 2003, the date we were acquired by HSBC.
We have a subsidiary, Decision One Mortgage Company, LLC, which directly
originates mortgage loans sourced by mortgage brokers and sells all loans to
secondary market purchasers, including our Mortgage Services business. Loans
held for sale to external parties by this subsidiary totaled $1.2 billion at
March 31, 2006 and $1.7 billion at December 31, 2005 and are included in real
estate secured receivables.
As part of our acquisition of Metris on December 1, 2005, we acquired $5.3
billion of receivables. The receivables acquired were subject to the
requirements of SOP 03-3 to the extent there was evidence of deterioration of
credit quality since origination and for which it was probable, at acquisition,
that all contractually required payments would not be collected and that the
associated line of credit had been closed. The carrying amount of these
receivables was $347 million at March 31, 2006 and $414 million at December 31,
2005 and is included in the MasterCard/Visa receivables in the table above. At
March 31, 2006, no credit loss reserve for these acquired receivables has been
established as there has been no decrease
9
HSBC Finance Corporation
--------------------------------------------------------------------------------
to the expected future cash flows since the acquisition. The outstanding
contractual balance of these receivables was $571 million at March 31, 2006 and
$804 million at December 31, 2005.
At the time of the Metris acquisition, the anticipated cash flows from these
acquired receivables exceeded the amount paid for the receivables. There were no
additions to accretable yield or reclassifications from non-accretable yield
during the quarter ended March 31, 2006. The following summarizes the accretable
yield on these receivables at March 31, 2006:
(IN MILLIONS)
---------------------------------------------------------------------------
Accretable yield at December 31, 2005....................... $(122)
Accretable yield amortized to interest income during the
period.................................................... 30
-----
Accretable yield at March 31, 2006.......................... $ (92)
=====
Interest-only strip receivables are reported net of our estimate of probable
losses under the recourse provisions for receivables serviced with limited
recourse.
Receivables serviced with limited recourse consisted of the following:
MARCH 31, DECEMBER 31,
2006 2005
--------------------------------------------------------------------------------------
(IN MILLIONS)
Auto finance................................................ $ 920 $1,192
MasterCard/Visa............................................. 1,528 1,875
Personal non-credit card.................................... 661 1,007
------ ------
Total....................................................... $3,109 $4,074
====== ======
The combination of receivables owned and receivables serviced with limited
recourse, which comprises our managed portfolio, is shown below:
MARCH 31, DECEMBER 31,
2006 2005
--------------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured......................................... $ 89,492 $ 82,826
Auto finance................................................ 12,106 11,896
MasterCard/Visa............................................. 24,977 25,985
Private label............................................... 2,428 2,520
Personal non-credit card.................................... 20,667 20,552
Commercial and other........................................ 206 208
-------- --------
Total....................................................... $149,876 $143,987
======== ========
We generally serve non-conforming and non-prime consumers. Such customers are
individuals who have limited credit histories, modest incomes, high
debt-to-income ratios or have experienced credit problems caused by occasional
delinquencies, prior charge-offs, bankruptcy or other credit related actions. As
a result, the majority of our secured receivables have a high loan-to-value
ratio. Due to customer demand we offer interest-only loans and expect to
continue to do so. These interest-only loans allow customers to pay only the
accruing interest for a period of time which results in lower payments during
the initial loan period. Depending on a customer's financial situation, the
subsequent increase in the required payment to begin making payment towards the
loan principal could affect our customer's ability to repay the loan at some
future date when the interest rate resets and/or principal payments are
required. As with all our other non-conforming and nonprime loan products, we
underwrite and price interest only loans in a manner that is appropriate to
compensate for their higher risk. At March 31, 2006, the outstanding balance of
our interest-only loans was
10
HSBC Finance Corporation
--------------------------------------------------------------------------------
$6.5 billion, or 4.3% of managed receivables. At December 31, 2005, the
outstanding balance of our interest-only loans was $4.7 billion, or 3.3% of
managed receivables.
4. CREDIT LOSS RESERVES
--------------------------------------------------------------------------------
An analysis of credit loss reserves was as follows:
THREE MONTHS ENDED MARCH 31, 2006 2005
-----------------------------------------------------------------------------
(IN MILLIONS)
Owned receivables:
Credit loss reserves at beginning of period............... $4,521 $3,625
Provision for credit losses............................... 866 841
Charge-offs............................................... (1,054) (953)
Recoveries................................................ 126 90
Other, net................................................ 9 (22)
------ ------
Credit loss reserves for owned receivables................ 4,468 3,581
------ ------
Receivables serviced with limited recourse:
Credit loss reserves at beginning of period............... 215 890
Provision for credit losses............................... 8 30
Charge-offs............................................... (71) (271)
Recoveries................................................ 9 16
Other, net................................................ - (4)
------ ------
Credit loss reserves for receivables serviced with limited
recourse............................................... 161 661
------ ------
Credit loss reserves for managed receivables................ $4,629 $4,242
====== ======
The increase in the provision for credit losses reflects higher receivable
levels, partially offset by lower bankruptcy losses due to reduced bankruptcy
filings resulting from the enactment of new bankruptcy legislation in the United
States in October 2005 and a reduction in the estimated loss exposure resulting
from Hurricane Katrina.
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
HSBC Finance Corporation
--------------------------------------------------------------------------------
5. INTANGIBLE ASSETS
--------------------------------------------------------------------------------
Intangible assets consisted of the following:
ACCUMULATED CARRYING
GROSS AMORTIZATION VALUE
----------------------------------------------------------------------------------------------
(IN MILLIONS)
MARCH 31, 2006
Purchased credit card relationships and related programs.... $1,736 $476 $1,260
Retail services merchant relationships...................... 270 163 107
Other loan related relationships............................ 326 112 214
Trade names................................................. 717 13 704
Technology, customer lists and other contracts.............. 282 167 115
------ ---- ------
Total....................................................... $3,331 $931 $2,400
====== ==== ======
DECEMBER 31, 2005
Purchased credit card relationships and related programs.... $1,736 $442 $1,294
Retail services merchant relationships...................... 270 149 121
Other loan related relationships............................ 326 104 222
Trade names................................................. 717 13 704
Technology, customer lists and other contracts.............. 282 143 139
------ ---- ------
Total....................................................... $3,331 $851 $2,480
====== ==== ======
Estimated amortization expense associated with our intangible assets for each of
the following years is as follows:
YEAR ENDING DECEMBER 31,
---------------------------------------------------------------------------
(IN MILLIONS)
2006........................................................ $269
2007........................................................ 252
2008........................................................ 210
2009........................................................ 197
2010........................................................ 168
Thereafter.................................................. 520
6. GOODWILL
--------------------------------------------------------------------------------
Goodwill balances associated with our foreign businesses will change from period
to period due to movements in foreign exchange. Changes in estimates of the tax
basis in our assets and liabilities or other tax estimates recorded pursuant to
Statement of Financial Accounting Standards Number 109, "Accounting for Income
Taxes," may result in changes to our goodwill balances. During the first quarter
of 2006, we increased our goodwill balance by approximately $2 million as a
result of such changes in tax estimates.
7. INCOME TAXES
--------------------------------------------------------------------------------
Our effective tax rates were as follows:
Three months ended March 31, 2006........................... 36.5%
Three months ended March 31, 2005........................... 35.3
12
HSBC Finance Corporation
--------------------------------------------------------------------------------
The increase in the effective tax rate for the first quarter of 2006 is due to
higher state income taxes and an increase in pretax income with slightly lower
tax credits. The increase in state income taxes is primarily due to an increase
in the blended statutory tax rate of our operating companies. The effective tax
rate differs from the statutory federal income tax rate primarily because of the
effects of state and local income taxes and tax credits.
8. RELATED PARTY TRANSACTIONS
--------------------------------------------------------------------------------
In the normal course of business, we conduct transactions with HSBC and its
subsidiaries. These transactions include funding arrangements, derivative
execution, purchases and sales of receivables, servicing arrangements,
information technology services, item and statement processing services, banking
and other miscellaneous services. The following tables present related party
balances and the income and (expense) generated by related party transactions:
MARCH 31, DECEMBER 31,
2006 2005
--------------------------------------------------------------------------------------
(IN MILLIONS)
ASSETS, (LIABILITIES) AND EQUITY:
Derivative financial assets (liability), net................ $ (479) $ (260)
Affiliate preferred stock received in sale of U.K. credit
card business............................................. 261 261
Other assets................................................ 443 518
Due to affiliates........................................... (15,520) (15,534)
Other liabilities........................................... (329) (445)
THREE MONTHS ENDED MARCH 31, 2006 2005
---------------------------------------------------------------------------
(IN MILLIONS)
INCOME/(EXPENSE):
Interest expense on borrowings from HSBC and subsidiaries... $(153) $(151)
Interest income on advances to HSBC affiliates.............. 5 4
HSBC Bank USA:
Real estate secured servicing revenues.................... 1 4
Real estate secured sourcing, underwriting and pricing
revenues............................................... 2 1
Gain on daily sale of domestic private label receivable
originations........................................... 77 92
Gain on daily sale of MasterCard/Visa receivables......... 8 8
Taxpayer financial services loan origination fees......... (16) (14)
Domestic private label receivable servicing fees.......... 98 92
MasterCard/Visa receivable servicing fees................. 3 3
Other processing, origination and support revenues........ 7 5
Support services from HSBC affiliates....................... (252) (209)
HSBC Technology and Services (USA) Inc ("HTSU"):
Rental revenue............................................ 11 10
Administrative services revenue........................... 3 5
Other servicing fees from HSBC affiliates................... 4 2
Stock based compensation expense with HSBC.................. (17) (11)
The notional value of derivative contracts outstanding with HSBC subsidiaries
totaled $85.6 billion at March 31, 2006 and $72.2 billion at December 31, 2005.
When the fair value of our agreements with affiliate counterparties requires the
posting of collateral by the affiliate, it is provided in the form of
securities, which are not recorded on our balance sheet. Alternately, when the
fair value of our agreements with affiliate
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counterparties requires us to post collateral, it is provided in the form of
cash which is recorded on our balance sheet in other assets. At March 31, 2006,
the fair value of our agreements with affiliate counterparties was above the
level requiring us to post collateral. As such at March 31, 2006, we had posted
cash collateral with affiliates totaling $352 million. At December 31, 2005, the
fair value of our agreements with affiliate counterparties was below the level
requiring the posting of collateral by the affiliate. As such, at December 31,
2005, we were not holding any swap collateral from HSBC affiliates in the form
of securities.
We have extended a line of credit of $2 billion to HSBC USA Inc. No balances
were outstanding under this line at March 31, 2006 or December 31, 2005. Annual
commitment fees associated with this line of credit are 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.
The balance outstanding under this line of credit was $.4 billion at March 31,
2006 and December 31, 2005 and is included in other assets. Interest income
associated with this line of credit is recorded in interest income and reflected
as interest income on advances to HSBC affiliates in the table above.
We extended a promissory note of $.5 billion to HSBC Securities (USA) Inc.
("HSI") on June 27, 2005. This promissory note was repaid during July 2005. We
also extended a promissory note of $.5 billion to HSI on September 29, 2005.
This promissory note was repaid during October 2005. We extended an additional
promissory note of $150 million to HSI on December 28, 2005. This note was
repaid during January 2006. At each reporting date these promissory notes were
included in other assets. Interest income associated with this line of credit is
recorded in interest income and reflected as interest income on advances to HSBC
affiliates in the table above.
On March 31, 2005, we extended a line of credit of $.4 billion to HSBC
Investments (North America) Inc. ("HINO") which was repaid during the second
quarter of 2005. Interest income associated with this line of credit is recorded
in interest income and reflected as interest income on advances to HSBC
affiliates in the table above.
Due to affiliates includes amounts owed to subsidiaries of HSBC (other than
preferred stock).
At March 31, 2006 and December 31, 2005, we had a commercial paper back stop
credit facility of $2.5 billion from HSBC supporting domestic issuances and a
revolving credit facility of $5.3 billion from HSBC Bank plc ("HBEU") to fund
our operations in the U.K. As of March 31, 2006, $4.0 billion was outstanding
under the U.K. lines and no balances were outstanding on the domestic lines. As
of December 31, 2005, $4.2 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 included as a component
of Interest expense -- HSBC affiliates.
In December 2005, we sold our U.K. credit card business, including $2.5 billion
of receivables ($3.1 billion on a managed basis), the associated cardholder
relationships and the related retained interests in securitized credit card
receivables to HBEU, a U.K. based subsidiary of HSBC, for an aggregate purchase
price of $3.0 billion. The purchase price, which was determined based on a
comparative analysis of sales of other credit card portfolios, was paid in a
combination of cash and $261 million of preferred stock issued by a subsidiary
of HBEU with a rate of one-year Sterling LIBOR, plus 1.30 percent. In addition
to the assets referred to above, the sale also included the account origination
platform, including the marketing and credit employees associated with this
function, as well as the lease associated with the credit card call center and
related leaseholds and call center employees to provide customer continuity
after the transfer as well as to allow HBEU direct ownership and control of
origination and customer service. We have retained the collection operations
related to the credit card operations and have entered into a service level
agreement for a period of not less than two years to provide collection services
and other support services, including components of the compliance, financial
reporting and human resource functions, for the sold credit card operations, to
HBEU for a fee. Additionally, the management teams of HBEU and our remaining
U.K. operations will be jointly involved in decision making involving card
marketing to ensure that growth objectives are met for both businesses. Because
the sale of this business is between affiliates under common control, the
premium of
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$182 million received in excess of the book value of the assets transferred,
including the goodwill assigned to this business, was recorded as an increase to
additional paid in capital and was not included in earnings.
In December 2004, we sold our domestic private label receivable portfolio
(excluding retail sales contracts at our consumer lending business), including
the retained interests associated with our securitized domestic private label
receivables to HSBC Bank USA. We continue to service the sold private label
receivables and receive servicing fee income from HSBC Bank USA. As of March 31,
2006, we were servicing $15.9 billion of domestic private label receivables for
HSBC Bank USA. We received servicing fee income from HSBC Bank USA of $98
million during the three month period ended March 31, 2006 and $92 million
during the three month period ended March 31, 2005. We continue to maintain the
related customer account relationships and, therefore, sell new domestic private
label receivable originations (excluding retail sales contracts) to HSBC Bank
USA on a daily basis. We sold $4,396 million of private label receivables to
HSBC Bank USA in the first quarter of 2006 and $4,253 million during the first
quarter of 2005. The gains associated with the sale of these receivables are
reflected in the table above and are recorded in Gain on receivable sales to
HSBC affiliates.
In 2003 and 2004, we sold approximately $3.7 billion of real estate secured
receivables from our mortgage services business to HSBC Bank USA. Under a
separate servicing agreement, we have agreed to service all real estate secured
receivables sold to HSBC Bank USA including all business it purchased from our
correspondents. As of March 31, 2006, we were servicing $4.2 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 $.6 billion of real estate secured receivables purchased
by HSBC Bank USA during the three months ended March 31, 2005. The servicing fee
revenue associated with these receivables is recorded in Servicing fees from
HSBC affiliates and is 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 in the above table.
Purchases of real estate secured receivables from our correspondents by HSBC
Bank USA were discontinued effective September 1, 2005. We continue to service
the receivables HSBC Bank USA previously purchased from these correspondents.
Under various service level agreements, we also provide various services to HSBC
Bank USA. These services include credit card servicing and processing activities
through our credit card services business, loan origination and servicing
through our auto finance business and other operational and administrative
support. Fees received for these services are reported as servicing fees from
HSBC affiliates and are included in the table above.
During 2003, Household Capital Trust VIII issued $275 million in mandatorily
redeemable preferred securities to HSBC. Interest expense recorded on the
underlying junior subordinated notes totaled $4 million during both three month
periods ended March 31, 2006 and 2005 and is included in 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 $3 million for the three months ended March 31, 2006 and $2 million
for the three months ended March 31, 2005 are included in other income and are
reflected in the above table as other servicing fees from HSBC affiliates.
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 $16 million
during the three months ended March 31, 2006 and $14 million during the three
months ended March 31, 2005 and 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 ("HBNV"), formerly known
as Household Bank (SB), N.A., purchased the account relationships associated
with $970 million of MasterCard and Visa credit
15
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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 HBNV and new
receivables are sold daily to HSBC Bank USA. We sold $513 million of credit card
receivables to HSBC Bank USA during the three months ended March 31, 2006 and
$467 million of credit card receivables to HSBC Bank USA during the three months
ended March 31, 2005. The gains associated with the sale of these receivables
are reflected in the table above and are recorded in Gain on receivables 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 December 2005, we transferred our information technology services employees
in the U.K. to a subsidiary of HBEU. Subsequent to the transfer, operating
expenses relating to information technology, which have previously been reported
as salaries and fringe benefits or other servicing and administrative expenses,
are now billed to us by HBEU and reported as support services from HSBC
affiliates. Additionally, during the first quarter of 2006, the information
technology equipment in the U.K. was sold to HBEU for a purchase price equal to
the book value of these assets of $8 million.
In addition, we utilize HSBC Markets (USA) Inc., a related HSBC entity, to lead
manage the underwriting of a majority of our ongoing debt issuances. Fees paid
for such services totaled approximately $15 million for the three months ended
March 31, 2006 and approximately $3 million for the three months ended March 31,
2005. These fees are amortized over the life of the related debt as a component
of interest expense in the table above.
Domestic employees of HSBC Finance Corporation participate in a defined benefit
pension plan sponsored by HNAH. See Note 9, "Pension and Other Postretirement
Benefits," for additional information on this pension plan.
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 $17 million for the three months ended March 31, 2006 and $11 million for
the prior year quarter. These expenses are recorded in salary and employee
benefits and are reflected in the above table. As of March 31, 2006, the total
compensation cost related to non-vested stock based compensation awards was
approximately $205 million and will be recognized into compensation expense over
a weighted-average period of 3.26 years. A more complete description of these
plans is included in the 2005 Form 10-K.
9. PENSION AND OTHER POSTRETIREMENT BENEFITS
--------------------------------------------------------------------------------
Effective January 1, 2005, the two previously separate domestic defined benefit
pension plans of HSBC Finance Corporation and HSBC Bank USA were combined into a
single HNAH defined benefit pension plan which facilitated the development of a
unified employee benefit policy and unified employee benefit plan for HSBC
companies operating in the United States.
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The components of pension expense for the domestic defined benefit pension plan
reflected in our consolidated statement of income are shown in the table below
and reflect the portion of the pension expense of the combined HNAH pension plan
which has been allocated to HSBC Finance Corporation:
THREE MONTHS ENDED MARCH 31, 2006 2005
----------------------------------------------------------------------------
(IN MILLIONS)
Service cost - benefits earned during the period............ $ 13 $ 12
Interest cost............................................... 15 13
Expected return on assets................................... (20) (19)
Recognized (gains) losses................................... 3 -
---- ----
Net periodic benefit cost................................... $ 11 $ 6
==== ====
Components of the net periodic benefit cost for our postretirement benefits
other than pensions are as follows:
THREE MONTHS ENDED MARCH 31, 2006 2005
----------------------------------------------------------------------------
(IN MILLIONS)
Service cost - benefits earned during the period............ $1 $1
Interest cost............................................... 4 4
Expected return on assets................................... - -
Recognized (gains) losses................................... - -
-- --
Net periodic benefit cost................................... $5 $5
== ==
10. 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. The All Other caption includes our
insurance and taxpayer financial services and commercial businesses, as well as
our corporate and treasury activities, each of which falls below the
quantitative threshold test under SFAS No. 131 for determining reportable
segments. There have been no changes in the basis of our segmentation or any
changes in the measurement of segment profit as compared with the presentation
in our 2005 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 similar credit loss exposure for us.
In addition, we fund our operations, and make decisions about allocating certain
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.
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Fair value adjustments related to purchase accounting resulting from our
acquisition by HSBC and related amortization have been allocated to Corporate,
which is included in the "All Other" caption within our segment disclosure.
Reconciliations of our managed basis segment results to managed basis and owned
basis consolidated totals are as follows:
MANAGED
CREDIT ADJUSTMENTS/ BASIS
CARD RECONCILING CONSOLIDATED
CONSUMER SERVICES INTERNATIONAL ALL OTHER ITEMS TOTALS
------------------------------------------------------------------------------------------------------
(IN MILLIONS)
THREE MONTHS ENDED MARCH 31, 2006
Net interest income.... $ 1,822 $ 769 $ 182 $ (206) $ - $ 2,567
Securitization related
revenue.............. (49) (3) - (2) - (54)
Fee and other income... 299 517 113 505 (68)(1) 1,366
Intersegment
revenues............. 57 5 7 (1) (68)(1) -
Provision for credit
losses............... 403 365 106 (2) 2(5) 874
Total costs and
expenses............. 699 433 175 299 - 1,606
Net income............. 609 305 7 11 (44) 888
Receivables............ 115,435 25,146 9,096 199 - 149,876
Assets................. 116,218 25,488 10,091 23,515 (8,523)(2) 166,789
-------- ------- ------- ------- ------- --------
THREE MONTHS ENDED MARCH 31, 2005
Net interest income.... $ 1,693 $ 506 $ 229 $ (208) $ - $ 2,220
Securitization related
revenue.............. (235) (64) 10 (19) - (308)
Fee and other income... 285 436 131 650 (34)(1) 1,468
Intersegment
revenues............. 26 5 4 (1) (34)(1) -
Provision for credit
losses............... 383 321 165 - 2(5) 871
Total costs and
expenses............. 668 324 216 334 - 1,542
Net income............. 433 148 (9) 77 (23) 626
Receivables............ 91,226 19,114 13,041 266 - 123,647
Assets................. 92,368 18,970 13,939 26,804 (8,592)(2) 143,489
-------- ------- ------- ------- ------- --------
OWNED BASIS
SECURITIZATION CONSOLIDATED
ADJUSTMENTS TOTALS
----------------------- -----------------------------
(IN MILLIONS)
THREE MONTHS ENDED MARC
Net interest income.... $ (103)(3) $ 2,464
Securitization related
revenue.............. 125(3) 71
Fee and other income... (30)(3) 1,336
Intersegment
revenues............. - -
Provision for credit
losses............... (8)(3) 866
Total costs and
expenses............. - 1,606
Net income............. - 888
Receivables............ (3,109)(4) 146,767
Assets................. (3,109)(4) 163,680
-------- --------
THREE MONTHS ENDED MARC
Net interest income.... $ (332)(3) $ 1,888
Securitization related
revenue.............. 393(3) 85
Fee and other income... (91)(3) 1,377
Intersegment
revenues............. - -
Provision for credit
losses............... (30)(3) 841
Total costs and
expenses............. - 1,542
Net income............. - 626
Receivables............ (11,486)(4) 112,161
Assets................. (11,486)(4) 132,003
-------- --------
---------------
(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.
11. NEW ACCOUNTING PRONOUNCEMENTS
--------------------------------------------------------------------------------
Effective January 1, 2006, we adopted FASB Statement No. 123 (Revised),
"Share-Based Payment," ("SFAS No. 123R"). Because we had previously adopted the
fair value method of accounting for all equity based awards, the adoption of
SFAS No. 123R did not have a significant impact on our operations or cash flow.
Substantially all of the disclosure requirements of SFAS No. 123R were included
in our 2005 Form 10-K. In addition to changes in the Statement of Cash Flows as
required by SFAS No. 123R, other disclosure requirements which were not included
in our 2005 Form 10-K are included in Note 8, "Related Party Transactions."
Effective January 1, 2006, we adopted FASB Statement No. 154, "Accounting
Changes and Error Corrections: a replacement of APB Opinion No. 20 and FASB
Statement No. 3" ("SFAS No. 154"). The adoption of SFAS No 154 did not have any
impact on our financial position or results of operations.
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Effective January 1, 2006, we adopted FASB 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." The adoption of the impairment guidance
contained in FSP 115-1 and FSP 124-1 did not have a material impact on our
financial position or results of operations.
In February 2006, the FASB issued FASB Statement No. 155, "Accounting for
Certain Hybrid Financial Instruments" ("SFAS No. 155"). SFAS No. 155 permits
companies to elect to measure at fair value entire financial instruments
containing embedded derivatives that would otherwise have to be bifurcated and
accounted for separately. SFAS No. 155 also requires companies to identify
interests in securitized financial assets that are free standing derivatives or
contain embedded derivatives that would have to be accounted for separately,
clarifies which interest - and principal - only strips are subject to SFAS No.
133, and amends SFAS No 140 to revise the conditions of a qualifying special
purpose entity. SFAS No. 155 is effective for all financial instruments acquired
or issued after the beginning of a company's first fiscal year that begins after
September 15, 2006. Early adoption is permitted as of the beginning of a
company's fiscal year, provided the company has not yet issued financial
statements for that fiscal year. We elected to early adopt SFAS No. 155
effective January 1, 2006. The adoption of SFAS No. 155 did not have a
significant impact on our financial position or results of operations.
In March 2006, the FASB issued FASB Statement No. 156, "Accounting for Servicing
of Financial Assets," ("SFAS No. 156"). SFAS No. 156, which is an amendment to
SFAS No. 140, addresses the recognition and measurement of separately recognized
servicing assets and liabilities and provides an approach to simplify the
efforts to obtain hedge-like (offset) accounting. SFAS No. 156 is effective for
financial years beginning after September 15, 2006, with early adoption
permitted. As we do not currently have servicing assets recorded on our balance
sheet, SFAS No. 156 will not have any impact on our financial position or
results of operations.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
--------------------------------------------------------------------------------
FORWARD-LOOKING STATEMENTS
--------------------------------------------------------------------------------
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, 2005 (the
"2005 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. In addition, we may make or approve certain
statements in future filings with the SEC, in press releases, or oral or written
presentations by representatives of HSBC Finance Corporation that are not
statements of historical fact and may also constitute forward-looking
statements. Words such as "may", "will", "should", "would", "could", "intends",
"believe", "expects", "estimates", "targeted", "plans", "anticipates", "goal"
and similar expressions are intended to identify forward-looking statements but
should not be considered as the only means through which these statements may be
made. These matters or statements will relate to our future financial condition,
results of operations, plans, objectives, performance or business developments
and will involve known and unknown risks, uncertainties and other factors that
may cause our actual results, performance or achievements to be materially
different from that which was expressed or implied by such forward-looking
statements. Forward-looking statements are based on our current views and
assumptions and speak only as of the date they are made. HSBC Finance
Corporation undertakes no obligation to update any forward-looking statement to
reflect subsequent circumstances or events. Unless noted, the discussion of our
financial condition and results of operations included in MD&A are presented on
an owned basis of reporting.
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 $888 million for the quarter ended March 31, 2006, an increase of
42 percent, compared to $626 million in the prior year quarter. The increase in
net income was due to higher net interest income partially offset by lower other
revenues, a higher provision for credit losses and higher costs and expenses.
The increase in net interest income was due to growth in average receivables and
an improvement in the overall yield on the portfolio, partially offset by a
higher interest expense. Overall yields increased due to increases in our rates
on variable rate products which were in line with market movements and various
other repricing initiatives, such as reduced levels of promotional rate balances
in 2006. Changes in receivable mix also contributed to the increase in yield due
to the impact of increased levels of higher yielding MasterCard/Visa due to
lower securitization levels and our acquisition of Metris Companies, Inc.
("Metris") in December 2005. Interest expense increased due to a larger balance
sheet and a significantly higher cost of funds in line with market movements.
Our net interest margin was 6.69 percent for the three months ended March 31,
2006 compared to 6.68 percent for the three months ended March 31, 2005. Net
interest margin was flat as the improvement in overall yields on our receivables
discussed above was offset by the higher funding costs.
The increase in provision for credit losses resulted from receivable growth,
partially offset by lower bankruptcy losses as a result of reduced filings and,
as discussed more fully below, a reduction in the estimated loss exposure
resulting from Hurricane Katrina ("Katrina"). The decrease in other revenues is
primarily due to lower derivative income partially offset by higher fee and
other income. The decrease in derivative income was primarily due to a
significant reduction during 2005 in the population of interest rate swaps which
do not qualify for hedge accounting under SFAS No. 133, which reduces income
volatility. Fee income was higher as a result of higher credit card fees due to
higher volume in our MasterCard/Visa portfolios, primarily resulting from our
acquisition of Metris in December 2005, and improvements in interchange rates,
partially offset by
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the impact of new FFIEC guidance which limits certain fee billings for non-prime
credit card accounts. Other income was higher primarily due to higher ancillary
credit card revenue. Costs and expenses increased primarily to support
receivables growth including our acquisition of Metris in December 2005.
Amortization of purchase accounting fair value adjustments increased net income
by $22 million for the quarter ended March 31, 2006, which included $5 million
related to our acquisition of Metris in December 2005, compared to a decrease in
net income of $9 million for the quarter ended March 31, 2005.
During the first quarter of 2006, we continued to assess the financial impact of
Katrina on our customers living in the Katrina FEMA designated Individual
Assistance disaster areas, including the related payment patterns of these
customers. As a result of these continuing assessments, including customer
contact and the collection of more information associated with the properties
located in the FEMA designated area, as applicable, we have reduced our estimate
of credit loss exposure by approximately $30 million. 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.
Our return on average owned assets ("ROA") was 2.18 percent for the quarter
ended March 31, 2006 compared to 1.90 percent for the quarter ended March 31,
2005. 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 2.14 percent for the quarter ended March 31, 2006
compared to 1.73 percent in the year-ago period. ROA and ROMA increased during
the quarter ended March 31, 2006 as net income growth, primarily due to higher
net interest income, outpaced the growth in average owned and managed assets
during the period.
The financial information set forth below summarizes selected financial
highlights of HSBC Finance Corporation as of March 31, 2006 and 2005 and for the
three month periods ended March 31, 2006 and 2005.
THREE MONTHS ENDED MARCH 31, 2006 2005
----------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
NET INCOME:................................................. $ 888 $ 626
OWNED BASIS RATIOS:
Return on average owned assets ("ROA").................... 2.18% 1.90%
Return on average common shareholder's(s') equity
("ROE")................................................. 18.14 15.04
Net interest margin....................................... 6.69 6.68
Consumer net charge-off ratio, annualized................. 2.58 3.15
Efficiency ratio(1)....................................... 39.65 43.99
MANAGED BASIS RATIOS:(2)
Return on average managed assets ("ROMA")................. 2.14% 1.73%
Net interest margin....................................... 6.81 7.06
Risk adjusted revenue..................................... 7.67 7.39
Consumer net charge-off ratio, annualized................. 2.69 3.65
Efficiency ratio(1)....................................... 39.56 43.59
AS OF MARCH 31, 2006 2005
---------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
RECEIVABLES:
Owned basis............................................... $146,767 $112,161
Managed basis(2).......................................... 149,876 123,647
TWO-MONTH-AND-OVER CONTRACTUAL DELINQUENCY RATIOS:
OWNED BASIS............................................... 3.62% 3.78%
MANAGED BASIS(2).......................................... 3.65 3.93
---------------
(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.
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Owned receivables were $146.8 billion at March 31, 2006, $139.9 billion at
December 31, 2005, and $112.2 billion at March 31, 2005. With the exception of
private label, we experienced growth in all our receivable products compared to
March 31, 2005, 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 $.9 billion
since March 31, 2005, 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. Lower securitization
levels as well as the acquisition of Metris in December 2005 also contributed to
the increase in owned receivables. Real estate secured receivables were also the
primary contributor to growth as compared to December 31, 2005, which was
partially offset by normal seasonal run-off in our MasterCard/Visa.
Our owned basis two-months-and-over-contractual delinquency ratio decreased
compared to both the prior quarter and the prior year quarter. The decrease is a
result of lower bankruptcy levels following the spike in bankruptcy filings that
occurred after the enactment of new bankruptcy legislation in the United States
in October 2005, receivable growth and the continuing strong economy in the
United States. The decrease compared to the prior quarter also reflects seasonal
improvements in collections as customers use their tax refunds to reduce their
outstanding balances. Dollars of delinquency also decreased compared to the
prior quarter.
Net charge-offs as a percentage of average consumer receivables for the quarter
decreased from the prior year quarter largely as a result of lower bankruptcy
filings in our MasterCard/Visa portfolio due to the new bankruptcy legislation
in the United States which we believe resulted in an acceleration of net
charge-offs in the fourth quarter of 2005, a portion of which would have
otherwise been experienced in 2006. Also contributing to the decrease was
portfolio growth and the positive impact from the lower delinquency levels we
experienced throughout 2005 as a result of a strong economy.
Our owned basis efficiency ratio improved compared to the prior year quarter due
to higher net interest income due to higher levels of receivables, partially
offset by an increase in total costs and expenses to support receivable growth
as well as lower other revenues, primarily due to lower derivative income.
During the first quarter of 2006, we supplemented unsecured debt issuances with
proceeds from the continuing sale of newly originated domestic private label
receivables to HSBC Bank USA, debt issued to affiliates, increased levels of
secured financings and higher levels of commercial paper as a result of the
seasonal activity of our TFS business. Because we are 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 of approximately $214
million during the quarter ended March 31, 2006 and approximately $120 million
during the quarter ended March 31, 2005 compared to the funding costs we would
have incurred using average spreads and funding mix from the first half of 2002.
These tightened credit spreads in combination with the issuance of HSBC Finance
Corporation debt and other funding synergies including asset transfers and debt
underwriting fees paid to HSBC affiliates have enabled HSBC to realize a run
rate for annual cash funding expense savings in excess of $1 billion per year.
In the first quarter of 2006, the cash funding expense savings realized by HSBC
totaled approximately $280 million.
Securitization of consumer receivables has been a source of funding and
liquidity for us. In order to align our accounting treatment with that of HSBC
initially under U.K. GAAP and now under International Financial Reporting
Standards ("IFRSs"), 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
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receivables to support previously issued securities, receivables will continue
to be sold to these trusts until the revolving periods end, the last of which is
currently projected to occur in 2008. We will continue to replenish at reduced
levels certain non-public personal non-credit card securities issued to conduits
and record the resulting replenishment gains for a period of time in order to
manage liquidity. Since our securitized receivables have varying lives, it will
take time for all securitized 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 transactions reduced our reported
net income under U.S. GAAP, there is no impact on cash received.
BASIS OF REPORTING
--------------------------------------------------------------------------------
Our consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States ("U.S. GAAP"). Unless noted,
the discussion of our financial condition and results of operations included in
MD&A are presented on an owned basis of reporting.
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 certain
decisions about allocating resources such as capital on a managed basis.
When reporting on a managed basis, net interest income, provision for credit
losses and fee income related to receivables securitized are reclassified from
securitization related revenue in our owned statement of income into the
appropriate caption. Additionally, charge-off and delinquency associated with
these receivables are included in our managed basis credit quality statistics.
Debt analysts, rating agencies and fixed income investors have also historically
evaluated our operations on a managed basis for the reasons discussed above and
have historically requested managed basis information from us. We believe that
managed basis information enables such investors and other interested parties to
better understand the performance and quality of our entire loan portfolio and
is important to understanding the quality of originations and the related credit
risk inherent in our owned and securitized portfolios. As the level of our
securitized receivables falls over time, managed basis and owned basis results
will eventually converge. We also now report "Management Basis" results (a
non-GAAP financial measure) in Reports on Form 8-K with our quarterly results.
Management Basis reporting, in addition to managed basis adjustments, assumes
the private label and real estate secured receivables transferred to HSBC Bank
USA have not been sold and remain on balance sheet. As we continue to manage and
service receivables sold to HSBC Bank USA, we make decisions about allocating
certain resources, such as employees, on a Management Basis.
EQUITY RATIOS Tangible shareholder's(s') equity to tangible managed assets
("TETMA"), tangible shareholder's(s') equity plus owned loss reserves to
tangible managed assets ("TETMA + Owned Reserves") and tangible common equity to
tangible managed assets are non-GAAP financial measures that are used by HSBC
Finance Corporation management and certain rating agencies to evaluate capital
adequacy. These ratios may differ from similarly named measures presented by
other companies. The most directly comparable GAAP financial measure is common
and preferred equity to owned assets.
We and certain rating agencies also monitor our equity ratios excluding the
impact of the HSBC acquisition purchase accounting adjustments. We do so because
we believe that the HSBC acquisition purchase accounting adjustments represent
non-cash transactions which do not affect our business operations, cash flows or
ability to meet our debt obligations.
Preferred securities issued by certain non-consolidated trusts are considered
equity in the TETMA and TETMA + Owned Reserves calculations because of their
long-term subordinated nature and the ability to defer dividends. Prior to our
acquisition by HSBC, our Adjustable Conversion-Rate Equity Security Units
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were also considered equity in these calculations. TETMA and TETMA + Owned
Reserves exclude the Adjustable Conversion-Rate Equity Security Units for all
periods subsequent to our acquisition by HSBC as this more accurately reflects
the impact of these items on our equity post acquisition.
INTERNATIONAL FINANCIAL REPORTING STANDARDS Because HSBC reports results in
accordance with IFRSs and IFRSs results are used in measuring and rewarding
performance of employees, our management also separately monitors net income
under IFRSs (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 IFRSs basis:
THREE MONTHS ENDED
MARCH 31, 2006
--------------------------------------------------------------------------------
(IN MILLIONS)
Net income - U.S. GAAP basis................................ $888
Adjustments, net of tax:
Securitizations........................................... 21
Derivatives and hedge accounting (including fair value
adjustments)........................................... (71)
Intangible assets......................................... 36
Purchase accounting adjustments........................... 56
Loan origination.......................................... (20)
Loan impairment........................................... 9
Other..................................................... 11
----
Net income - IFRSs basis.................................... $930
====
Significant differences between U.S. GAAP and IFRSs are as follows:
SECURITIZATIONS
IFRSs
- The recognition of securitized assets is governed by a three-step
process, which may be applied to the whole asset, or a part of an asset:
- If the rights to the cash flows arising from securitized assets have
been transferred to a third party, and all the risks and rewards of the
assets have been transferred, the assets concerned are derecognized.
- If the rights to the cash flows are retained by HSBC but there is a
contractual obligation to pay them to another party, the securitized
assets concerned are derecognized if certain conditions are met such as,
for example, when there is no obligation to pay amounts to the eventual
recipient unless an equivalent amount is collected from the original
asset.
- If some significant risks and rewards of ownership have been
transferred, but some have also been retained, it must be determined
whether or not control has been retained. If control has been retained,
HSBC continues to recognize the asset to the extent of its continuing
involvement; if not, the asset is derecognized.
- The impact from securitizations resulting in higher net income under
IFRSs is due to the recognition of income on securitized receivables
under U.S. GAAP in prior periods.
US GAAP
- SFAS 140 "Accounting for Transfers and Servicing of Finance Assets and
Extinguishments of Liabilities" requires that receivables that are sold
to a special purpose entity ("SPE") and securitized can only be
derecognized and a gain or loss on sale recognized if the originator has
surrendered control over the securitized assets.
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- Control is surrendered over transferred assets if, and only if, all of
the following conditions are met:
- The transferred assets are put presumptively beyond the reach of the
transferor and its creditors, even in bankruptcy or other receivership.
- Each holder of interests in the transferee (i.e. holder of issued notes)
has the right to pledge or exchange their beneficial interests, and no
condition constrains this right and provides more than a trivial benefit
to the transferor.
- The transferor does not maintain effective control over the assets
through either an agreement that obligates the transferor to repurchase
or to redeem them before their maturity or through the ability to
unilaterally cause the holder to return specific assets, other than
through a clean-up call.
- If these conditions are not met the securitized assets should continue to
be consolidated.
- When HSBC retains an interest in the securitized assets, such as a
servicing right or the right to residual cash flows from the special
purpose entity, HSBC recognizes this interest at fair value on sale of
the assets to the SPE.
DERIVATIVES AND HEDGE ACCOUNTING
IFRSs
- Derivatives are recognized initially, and are subsequently remeasured, at
fair value. Fair values of exchange-traded derivatives are obtained from
quoted market prices. Fair values of over-the-counter ("OTC") derivatives
are obtained using valuation techniques, including discounted cash flow
models and option pricing models.
- In the normal course of business, the fair value of a derivative on
initial recognition is considered to be the transaction price (that is
the fair value of the consideration given or received). However, in
certain circumstances the fair value of an instrument will be evidenced
by comparison with other observable current market transactions in the
same instrument (without modification or repackaging) or will be based on
a valuation technique whose variables include only data from observable
markets, including interest rate yield curves, option volatilities and
currency rates. When such evidence exists, HSBC recognizes a trading
profit or loss on inception of the derivative. When unobservable market
data have a significant impact on the valuation of derivatives, the
entire initial change in fair value indicated by the valuation model is
not recognized immediately in the income statement but is recognized over
the life of the transaction on an appropriate basis or recognized in the
income statement when the inputs become observable, or when the
transaction matures or is closed out.
- Derivatives may be embedded in other financial instruments; for example,
a convertible bond has an embedded conversion option. An embedded
derivative is treated as a separate derivative when its economic
characteristics and risks are not clearly and closely related to those of
the host contract, its terms are the same as those of a stand-alone
derivative, and the combined contract is not held for trading or
designated at fair value through profit and loss. These embedded
derivatives are measured at fair value with changes in fair value
recognized in the income statement.
- Derivatives are classified as assets when their fair value is positive,
or as liabilities when their fair value is negative. Derivative assets
and liabilities arising from different transactions are only netted if
the transactions are with the same counterparty, a legal right of offset
exists, and the cash flows are intended to be settled on a net basis.
- The method of recognizing the resulting fair value gains or losses
depends on whether the derivative is held for trading, or is designated
as a hedging instrument and, if so, the nature of the risk being hedged.
All gains and losses from changes in the fair value of derivatives held
for trading are recognized in the income statement. When derivatives are
designated as hedges, HSBC classifies them as either: (i) hedges of the
change in fair value of recognized assets or liabilities or firm
commitments ("fair value hedge"); (ii) hedges of the variability in
highly probable future cash flows attributable to a recognized asset or
liability, or a forecast transaction ("cash flow hedge"); or (iii) hedges
of net investments in a foreign operation ("net investment hedge"). Hedge
accounting is applied to derivatives designated as hedging instruments in
a fair value, cash flow or net investment hedge provided certain criteria
are met.
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Hedge Accounting:
- It is HSBC's policy to document, at the inception of a hedge, the
relationship between the hedging instruments and hedged items, as well
as the risk management objective and strategy for undertaking the hedge.
The policy also requires documentation of the assessment, both at hedge
inception and on an ongoing basis, of whether the derivatives that are
used in hedging transactions are highly effective in offsetting changes
in fair values or cash flows of hedged items attributable to the hedged
risks.
Fair value hedge:
- Changes in the fair value of derivatives that are designated and qualify
as fair value hedging instruments are recorded in the income statement,
together with changes in the fair values of the assets or liabilities or
groups thereof that are attributable to the hedged risks.
- If the hedging relationship no longer meets the criteria for hedge
accounting, the cumulative adjustment to the carrying amount of a hedged
item is amortized to the income statement based on a recalculated
effective interest rate over the residual period to maturity, unless the
hedged item has been derecognized whereby it is released to the income
statement immediately.
Cash flow hedge:
- The effective portion of changes in the fair value of derivatives that
are designated and qualify as cash flow hedges are recognized in equity.
Any gain or loss relating to an ineffective portion is recognized
immediately in the income statement.
- Amounts accumulated in equity are recycled to the income statement in
the periods in which the hedged item will affect the income statement.
However, when the forecast transaction that is hedged results in the
recognition of a non-financial asset or a non-financial liability, the
gains and losses previously deferred in equity are transferred from
equity and included in the initial measurement of the cost of the asset
or liability.
- When a hedging instrument expires or is sold, or when a hedge no longer
meets the criteria for hedge accounting, any cumulative gain or loss
existing in equity at that time remains in equity until the forecast
transaction is ultimately recognized in the income statement. When a
forecast transaction is no longer expected to occur, the cumulative gain
or loss that was reported in equity is immediately transferred to the
income statement.
Net investment hedge:
- Hedges of net investments in foreign operations are accounted for in a
similar manner to cash flow hedges. Any gain or loss on the hedging
instrument relating to the effective portion of the hedge is recognized
in equity; the gain or loss relating to the ineffective portion is
recognized immediately in the income statement. Gains and losses
accumulated in equity are included in the income statement on the
disposal of the foreign operation.
Hedge effectiveness testing:
- IAS 39 requires that at inception and throughout its life, each hedge
must be expected to be highly effective (prospective effectiveness) to
qualify for hedge accounting. Actual effectiveness (retrospective
effectiveness) must also be demonstrated on an ongoing basis.
- The documentation of each hedging relationship sets out how the
effectiveness of the hedge is assessed.
- For prospective effectiveness, the hedging instrument must be expected
to be highly effective in achieving offsetting changes in fair value or
cash flows attributable to the hedged risk during the period for which
the hedge is designated. For retrospective effectiveness, the changes in
fair value or cash flows must offset each other in the range of 80 per
cent to 125 per cent for the hedge to be deemed effective.
Derivatives that do not qualify for hedge accounting:
- All gains and losses from changes in the fair value of any derivatives
that do not qualify for hedge accounting are recognized immediately in
the income statement.
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US GAAP
- The accounting under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities" is generally consistent with that under IAS 39,
which HSBC has followed in its IFRSs reporting from January 1, 2005, as
described above. However, specific assumptions regarding hedge
effectiveness under US GAAP are not permitted by IAS 39.
- The requirements of SFAS No. 133 have been effective from January 1,
2001.
- The US GAAP 'shortcut method' permits an assumption of zero
ineffectiveness in hedges of interest rate risk with an interest rate
swap provided specific criteria have been met. IAS 39 does not permit
such an assumption, requiring a measurement of actual ineffectiveness at
each designated effectiveness testing date.
- In addition, IFRSs allows greater flexibility in the designation of the
hedged item. Under US GAAP, all contractual cash flows must form part of
the designated relationship, whereas IAS 39 permits the designation of
identifiable benchmark interest cash flows only.
- Under US GAAP, derivatives receivable and payable with the same
counterparty may be reported net on the balance sheet when there is an
executed ISDA Master Netting Arrangement covering enforceable
jurisdictions. These contracts do not meet the requirements for set off
under IAS 32 and hence are presented gross on the balance sheet for
IFRSs.
DESIGNATION OF FINANCIAL ASSETS AND LIABILITIES AT FAIR VALUE THROUGH PROFIT AND
LOSS
IFRSs
- 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 management; 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 relates. 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.
US GAAP
- There are no provisions in US GAAP to make an election similar to that in
IAS 39.
- Generally, for financial assets to be measured at fair value with gains
and losses recognized immediately in the income statement, they must meet
the definition of trading securities in SFAS 115, "Accounting for Certain
Investments in Debt and Equity Securities". Financial liabilities are
generally reported at amortized cost under US GAAP.
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GOODWILL, PURCHASE ACCOUNTING AND INTANGIBLES
IFRSs
- 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 IFRSs. From January 1, 1998 to December 31, 2003 goodwill
was capitalized and amortized over its useful life. The carrying amount
of goodwill existing at December 31, 2003 under UK GAAP was carried
forward under the transition rules of IFRS from January 1, 2004, subject
to certain adjustments.
- IFRS 3 "Business Combinations" requires that goodwill should not be
amortized but should be tested for impairment at least annually at the
reporting unit level by applying a test based on recoverable amounts.
- Quoted securities issued as part of the purchase consideration are fair
valued for the purpose of determining the cost of acquisition at their
market price on the date the transaction is completed.
US GAAP
- Up to June 30, 2001, goodwill acquired was capitalized and amortized over
its useful life which could not exceed 25 years. The amortization of
previously acquired goodwill ceased with effect from December 31, 2001.
- Quoted securities issued as part of the purchase consideration are fair
valued for the purpose of determining the cost of acquisition at their
average market price over a reasonable period before and after the date
on which the terms of the acquisition are agreed and announced.
- Changes in tax estimates of the basis in assets and liabilities or other
tax estimates recorded at the date of acquisition by HSBC are adjusted
against goodwill.
LOAN ORIGINATION
IFRSs
- Certain loan fee income and incremental directly attributable loan
origination costs are amortized to the income statement over the life of
the loan as part of the effective interest calculation under IAS 39.
US GAAP
- Certain loan fee income and direct but not necessarily incremental loan
origination costs, including an apportionment of overheads, are amortized
to the profit and loss account over the life of the loan as an adjustment
to interest income (SFAS No. 91 "Accounting for Nonrefundable Fees and
Costs Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases".)
LOAN IMPAIRMENT
IFRSs
- When statistical models, using historic loss rates adjusted for economic
conditions, provide evidence of impairment in portfolios of loans, their
values are written down to their net recoverable amount. The net
recoverable amount is the present value of the estimated future
recoveries discounted at the portfolio's original effective interest
rate. The calculations include a reasonable estimate of recoveries on
loans individually identified for write-off pursuant to HSBC's credit
guidelines.
US GAAP
- Where the delinquency status of loans in a portfolio is such that there
is no realistic prospect of recovery, the loans are written off in full,
or to recoverable value where collateral exists. Delinquency depends on
the number of days payment is overdue. The delinquency status is applied
consistently across similar loan products in accordance with HSBC's
credit guidelines. When local regulators mandate the delinquency status
at which write-off must occur for different retail loan products and
these regulations reasonably reflect estimable recoveries on individual
loans, this basis of measuring loan impairment is reflected in US GAAP
accounting. Cash recoveries relating to pools of such written-off loans,
if any, are reported as loan recoveries upon collection.
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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
10, "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 3, "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 March 31, 2006 and increases
(decreases) over prior periods:
INCREASES (DECREASES) FROM
-------------------------------
DECEMBER 31, MARCH 31,
2005 2005
MARCH 31, ------------- ---------------
2006 $ % $ %
-----------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Real estate secured............................... $ 89,492 $6,666 8.0% $21,006 30.7%
Auto finance...................................... 11,186 482 4.5 3,079 38.0
MasterCard/Visa................................... 23,449 (661) (2.7) 7,895 50.8
Private label..................................... 2,428 (92) (3.7) (702) (22.4)
Personal non-credit card(1)....................... 20,006 461 2.4 3,398 20.5
Commercial and other.............................. 206 (2) (1.0) (70) (25.4)
-------- ------ ---- ------- -----
Total owned receivables........................... $146,767 $6,854 4.9% $34,606 30.9%
======== ====== ==== ======= =====
---------------
(1) Personal non-credit card receivables are comprised of the following:
INCREASES (DECREASES) FROM
------------------------------
DECEMBER 31, MARCH 31,
2005 2005
MARCH 31, ------------- --------------
2006 $ % $ %
-----------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Domestic personal non-credit card.................. $11,944 $ 550 4.8% $3,510 41.6%
Union Plus personal non-credit card................ 298 (35) (10.5) (128) (30.0)
Personal homeowner loans........................... 4,241 68 1.6 551 14.9
Foreign personal non-credit card................... 3,523 (122) (3.3) (535) (13.2)
------- ----- ----- ------ -----
Total personal non-credit card..................... $20,006 $ 461 2.4% $3,398 20.5%
======= ===== ===== ====== =====
RECEIVABLE INCREASES (DECREASES) SINCE MARCH 31, 2005 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
$.9 billion since March 31, 2005, 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. Real estate
secured receivable levels in our branch-based consumer lending business improved
because of higher sales volumes as we continue to emphasize real estate secured
loans, including near-prime mortgage products. Also contributing to the increase
were purchases of $1.6 billion from portfolio acquisition programs since the
prior year quarter. We have continued to focus on increasing our mix of junior
lien loans through portfolio acquisitions and continue to expand our sources for
purchasing newly originated loans from flow correspondents. Auto finance
receivables increased over the year-ago period due to organic growth principally
in the near-prime portfolio. This came from newly originated loans acquired from
our
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dealer network, growth in the consumer direct loan program and lower
securitization levels. Additionally, we have experienced continued growth from
the expansion of our auto finance program in Canada. MasterCard and Visa
receivables growth reflects the $5.3 billion of receivables acquired as part of
our acquisition of Metris in December 2005, strong domestic organic growth
especially in our HSBC branded prime, Union Privilege and non-prime portfolios,
lower securitization levels and the successful launch of a MasterCard/Visa
program in Canada in 2005. These increases were partially offset by the sale of
our U.K. credit card business in December 2005 which included $2.2 billion of
MasterCard/Visa receivables. Private label receivables decreased from the year
ago period as a result of lower retail sales volumes in the U.K., the sale of
our U.K. credit card business in December 2005, which included $300 million of
private label receivables, and changes in the foreign exchange rate since March
31, 2005. Personal non-credit card receivables increased from the year-ago
period as a result of increased marketing, including several large direct mail
campaigns, lower securitization levels and changes in the foreign exchange rate
since March 31, 2005 for our foreign personal non-credit card receivables.
RECEIVABLE INCREASES (DECREASES) SINCE DECEMBER 31, 2005 Both our correspondent
and branch businesses reported growth in their real estate secured portfolios as
discussed above. Contributing to the increase in real estate secured receivable
levels were purchases of $.5 billion from portfolio acquisition programs since
December 31, 2005. Growth in our auto finance portfolio reflects lower levels of
securitizations, organic growth and increased volume in both the dealer network
and the consumer direct loan program. The decrease in our MasterCard/Visa
portfolio reflects normal seasonal run-off, partially offset by lower
securitization levels. Our foreign private label portfolio decreased due to
decreases in retail sales volume in the U.K. Personal non-credit card
receivables increased as a result of increased marketing and lower
securitization levels.
RESULTS OF OPERATIONS
--------------------------------------------------------------------------------
Unless noted otherwise, the following discusses amounts reported in our owned
basis statement of income.
NET INTEREST INCOME The following table summarizes net interest income:
INCREASE (DECREASE)
-------------------
THREE MONTHS ENDED MARCH 31, 2006 (1) 2005 (1) AMOUNT %
---------------------------------------------------------------------------------------------------
Finance and other interest income........... $4,087 11.10% $2,950 10.44% $1,137 38.5%
Interest expense............................ 1,623 4.41 1,062 3.76 561 52.8
------ ----- ------ ----- ------ ----
Net interest income......................... $2,464 6.69% $1,888 6.68% $ 576 30.5%
====== ===== ====== ===== ====== ====
---------------
(1) % Columns: comparison to average owned interest-earning assets.
The increase in net interest income during the quarter ended March 31, 2006 was
due to higher average receivables and a higher overall yield, partially offset
by higher interest expense. Overall yields increased due to increases in our
rates on variable rate products which were in line with market movements and
various other repricing initiatives, such as reduced levels of promotional rate
balances in 2006. Changes in receivable mix also contributed to the increase in
yield due to the impact of increased levels of higher yielding MasterCard/ Visa
due to lower securitization levels and our acquisition of Metris in December
2005. The higher interest expense was due to a larger balance sheet and a
significantly higher cost of funds due to a rising interest rate environment. In
addition, as part of our overall liquidity management strategy, we continue to
extend the maturity of our liability profile which results in higher interest
expense. Our purchase accounting fair value adjustments include both
amortization of fair value adjustments to our external debt obligations and
receivables. Amortization of purchase accounting fair value adjustments
increased net interest income by $114 million, which included $17 million
relating to Metris, during the quarter ended March 31, 2006 and $113 million
during the quarter ended March 31, 2005.
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Net interest margin, annualized, was primarily flat during the three months
ended March 31, 2006 as compared to the year-ago period as the improvement in
the overall yield on our receivable portfolio, as discussed above, was offset by
the higher funding costs. The following table shows the impact of these items on
net interest margin at March 31, 2006:
Net interest margin for the three months ended March 31,
2005...................................................... 6.68%
Impact to net interest margin resulting from:
Sale of U.K. credit card business in December 2005........ .04
Metris acquisition in December 2005....................... .36
Receivable pricing........................................ .32
Receivable mix............................................ .08
Cost of funds............................................. (.67)
Other..................................................... (.12)
----
Net interest margin for the three months ended March 31,
2006...................................................... 6.69%
====
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 $2.6
billion in the three months ended March 31, 2006, an increase of 16 percent from
$2.2 billion in the three months ended March 31, 2005. Managed basis net
interest margin, annualized, was 6.81 percent in the first quarter of 2006,
compared to 7.06 percent in the year-ago period. The decrease was due to higher
funding costs due to a larger managed basis balance sheet and a rising interest
rate environment, partially offset by the higher yields on our receivables as
discussed above. The following table shows the impact of these items on our net
interest margin on a managed basis at March 31, 2006:
Net interest margin for the three months ended March 31,
2005...................................................... 7.06%
Impact to net interest margin resulting from:
Sale of U.K. credit card business in December 2005........ .03
Metris acquisition in December 2005....................... .35
Receivable pricing........................................ .34
Receivable mix............................................ (.23)
Cost of funds............................................. (.74)
Other..................................................... -
----
Net interest margin for the three months ended March 31,
2006...................................................... 6.81%
====
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. The effect on net interest margin of receivable mix is greater on
a managed basis because on an owned basis, the impact of higher levels of higher
yielding MasterCard/Visa receivables due to lower securitization levels is
offsetting the impact of higher levels of lower yielding correspondent real
estate secured receivables that we see in our managed portfolio.
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 on derivatives which do not qualify as
effective hedges and ineffectiveness associated with qualifying hedges under
SFAS No. 133, less net charge-offs as a percentage of average interest earning
assets) increased to 7.67 percent at March 31, 2006 from 7.39 percent at March
31, 2005. Managed basis risk adjusted revenue increased as the positive credit
and delinquency trends due to the continuing strong economy in the United States
as well as lower bankruptcy losses as a result of reduced filings in the United
States led to lower charge-offs which more than compensated
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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)
-------------------
2006 2005 AMOUNT %
----------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Three months ended March 31,............................... $866 $841 $25 3.0%
Our provision for credit losses increased during the first quarter of 2006. The
increase in the provision for credit losses reflects higher receivable levels,
partially offset by a significant decline in bankruptcy filings, a continued
strong economy in the United States and a reduction in the estimated loss
exposure resulting from Katrina. The provision as a percent of average owned
receivables, annualized, was 2.40 percent in the first quarter of 2006, compared
to 3.08 percent in the year-ago period. During the current quarter, credit loss
reserves decreased as the provision for owned credit losses was $62 million less
than net charge-offs. In the first quarter of 2005, the provision for owned
credit losses was $22 million less than net charge-offs. 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 MARCH 31, 2006 2005 AMOUNT %
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Securitization related revenue............................. $ 71 $ 85 $ (14) (16.5)%
Insurance revenue.......................................... 230 221 9 4.1
Investment income.......................................... 34 33 1 3.0
Derivative income.......................................... 57 260 (203) (78.1)
Fee income................................................. 392 306 86 28.1
Taxpayer financial services revenue........................ 234 243 (9) (3.7)
Gain on receivable sales to HSBC affiliates................ 85 100 (15) (15.0)
Servicing fees from HSBC affiliates........................ 108 101 7 6.9
Other income............................................... 196 113 83 73.5
------ ------ ----- -----
Total other revenues....................................... $1,407 $1,462 $ (55) (3.8)%
====== ====== ===== =====
Securitization related revenue is the result of the securitization of our
receivables and includes the following:
INCREASE (DECREASE)
-------------------
THREE MONTHS ENDED MARCH 31, 2006 2005 AMOUNT %
---------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net initial gains........................................... $ - $ - $ - -
Net replenishment gains(1).................................. 15 53 (38) (71.7)%
Servicing revenue and excess spread......................... 56 32 24 75.0
--- --- ---- -----
Total....................................................... $71 $85 $(14) (16.5)%
=== === ==== =====
---------------
(1) Net replenishment gains reflect inherent recourse provisions of $14 million
in the first quarter of 2006 and $86 million in the first quarter of 2005.
The decline in securitization related revenue in 2006 was due to decreases in
the level of securitized receivables as a result of our decision in the third
quarter of 2004 to structure all new collateralized funding transactions as
secured financings. Because existing public MasterCard and Visa credit card
transactions were
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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. We will continue to replenish at reduced
levels, certain non-public personal non-credit card securities issued to
conduits and record the resulting replenishment gains for a period of time in
order to manage liquidity. Since our securitized receivables have varying lives,
it will take time for all securitized 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 transactions reduced our reported
net income under U.S. GAAP, there is no impact on cash received.
Insurance revenue was relatively flat during the first quarter of 2006 as
increased revenue in our domestic operations resulting from higher volume in our
debt cancellation products and life insurance line were partially offset by a
decrease in sales volumes in our U.K. operations.
Investment income, which includes income on securities available for sale in our
insurance business and realized gains and losses from the sale of securities,
was essentially flat in the first quarter of 2006 as lower average insurance
balances were offset by increases in interest rates.
Derivative income, which includes realized and unrealized gains and losses on
derivatives which do not qualify as effective hedges under SFAS No. 133 as well
as the ineffectiveness on derivatives associated with our qualifying hedges, is
summarized in the table below:
THREE MONTHS ENDED MARCH 31, 2006 2005
---------------------------------------------------------------------------
(IN MILLIONS)
Net realized gains (losses)................................. $ 4 $ 15
Mark-to-market on derivatives which do not qualify as
effective hedges.......................................... (10) 245
Ineffectiveness............................................. 63 -
---- ----
Total....................................................... $ 57 $260
==== ====
Derivative income decreased in 2006 primarily due to a significant reduction
during 2005 in the population of interest rate swaps which do not qualify for
hedge accounting under SFAS No. 133. The income from ineffectiveness in the
first quarter of 2006 resulted from the designation during 2005 of a significant
number of our derivatives, which had previously not qualified for hedge
accounting under SFAS No. 133, as effective hedges under the long-haul method of
accounting. In addition, substantially all of the hedge relationships which
qualified under the shortcut method provisions of SFAS No. 133 have now been
redesignated as hedges under the long-haul method of hedge accounting.
Redesignation of swaps as effective hedges reduces the overall volatility of
reported mark-to-market income, although establishing such swaps as long-haul
hedges creates volatility as a result of hedge ineffectiveness. For certain new
hedging relationships, however, we continued to experience income volatility
during the period before hedging documentation was put in place. We are working
to improve this process and reduce the delay between executing the swap and
establishing hedge accounting. Additionally, we continue to evaluate the steps
required to regain hedge accounting treatment under SFAS No. 133 for a portion
of the remaining swaps which do not currently qualify for hedge accounting. All
derivatives are economic hedges of the underlying debt instruments regardless of
the accounting treatment.
Net income volatility, whether based on changes in interest rates for swaps
which do not qualify for hedge accounting or ineffectiveness recorded on our
qualifying hedges under the long haul method of accounting, impacts the
comparability of our reported results between periods. Accordingly, derivative
income for the three months ended March 31, 2006 should not be considered
indicative of the results for any future periods.
Fee income, which includes revenues from fee-based products such as credit
cards, increased in the first quarter of 2006 due to higher credit card fees,
particularly relating to our non-prime credit card portfolio, due to higher
levels of MasterCard/Visa credit card receivables, primarily as a result of our
acquisition of Metris in December 2005 and in improvements in the interchange
rates after the first quarter of 2005. These increases were partially offset by
the impact of new FFIEC guidance which limits certain fee billings for non-prime
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credit card accounts. See "Segment Results - Managed Basis" for additional
information on fee income on a managed basis.
Taxpayer financial services ("TFS") revenue decreased during the three months
ended March 31, 2006 as TFS revenue during the three months ended March 31, 2005
reflects a gain of $24 million on the sale of certain bad debt recovery rights
to a third party. Excluding the impact of this gain in the prior year quarter,
TFS revenue increased in the first quarter 2006 due to increased loan volume in
the 2006 tax season.
Gain on receivable sales to HSBC affiliates includes the daily sales of domestic
private label receivable originations (excluding retail sales contracts) and
certain MasterCard/Visa account originations to HSBC Bank USA. The decrease in
the gain on receivable sales to HSBC affiliates primarily reflects lower pricing
on the daily sales of domestic private label receivable originations during the
first quarter of 2006. Pricing for the daily sale of domestic private label
receivable originations has been negatively impacted by higher funding costs as
well as lower returns on new merchant relationships.
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 relate to higher levels of
receivables being serviced during the first quarter of 2006.
Other income increased in the first quarter of 2006 primarily due to higher
ancillary credit card revenue as a result of higher levels of MasterCard/Visa
receivables, including the acquisition of Metris in December 2005, and higher
gains on miscellaneous asset sales, including the partial sale of a real estate
investment.
COSTS AND EXPENSES Effective December 20, 2005, our U.K. based technology
services employees were transferred to HSBC Bank plc ("HBEU"). As a result,
operating expenses relating to information technology, which have previously
been reported as salaries and fringe benefits, are now billed to us by HBEU and
reported as support services from HSBC affiliates.
The following table summarizes total costs and expenses:
INCREASE
(DECREASE)
--------------
THREE MONTHS ENDED MARCH 31, 2006 2005 AMOUNT %
----------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Salaries and employee benefits.............................. $ 581 $ 497 $ 84 16.9%
Sales incentives............................................ 80 82 (2) (2.4)
Occupancy and equipment expenses............................ 83 87 (4) (4.6)
Other marketing expenses.................................... 173 180 (7) (3.9)
Other servicing and administrative expenses................. 239 258 (19) (7.4)
Support services from HSBC affiliates....................... 252 209 43 20.6
Amortization of intangibles................................. 80 107 (27) (25.2)
Policyholders' benefits..................................... 118 122 (4) (3.3)
------ ------ ---- -----
Total costs and expenses.................................... $1,606 $1,542 $ 64 4.2%
====== ====== ==== =====
Salaries and employee benefits increased in the first quarter of 2006 as a
result of additional staffing in our consumer lending, mortgage services, retail
services and Canadian operations to support growth as well as additional
staffing in our credit card services operations as a result of the acquisition
of Metris in December 2005. These increases were offset by lower salaries and
employee benefits expense in our U.K. operations as a result of the sale of our
U.K. credit card business and the transfer of our U.K. based technology services
employees to HBEU in December 2005.
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Sales incentives were essentially flat during the first quarter of 2006 as
higher volumes in our consumer lending branches and Canadian business were
offset by a decrease in sales incentives in our mortgage services business as
well as our U.K. operations.
Occupancy and equipment expenses decreased in the first quarter of 2006 as a
result of the sale of our U.K. credit card business in December 2005 which
included the lease associated with the credit card call center. This decrease
was partially offset by higher occupancy and equipment expenses resulting from
our acquisition of Metris in December 2005.
Other marketing expenses includes payments for advertising, direct mail programs
and other marketing expenditures. The decrease in the first quarter of 2006 was
primarily due to decreased marketing expenses in our U.K. operations as a result
of the sale of our U.K. credit card business in December 2005.
Other servicing and administrative expenses decreased during the three months
ended March 31, 2006 as compared to the year-ago period. During the first
quarter of 2006 we incurred lower professional services fees, including lower
legal and consulting expenses and a lower provision for fraud losses which was
partially offset by higher insurance operating expenses and higher REO expenses.
Support services from HSBC affiliates, includes technology and other services
charged to us by HSBC Technology and Services (USA) Inc. ("HTSU"), which
increased in the first quarter of 2006 primarily due to receivable growth.
Additionally, in the first quarter of 2006, support services from HSBC
affiliates also includes certain information technology operating expenses for
our U.K. operations charged to us by HBEU.
Amortization of intangibles decreased in the first quarter of 2006 as a result
of lower intangible amortization for our purchased credit card relationships due
to a contract renegotiation with one of our co-branded credit card partners,
lower amortization related to an individual contractual relationship and lower
amortization associated with our U.K. operations as a result of the sale of our
U.K. credit card business in December 2005. These decreases were partially
offset by increased amortization associated with the Metris cardholder
relationships.
Policyholders' benefits decreased slightly in the first quarter of 2006
primarily due to lower amortization of fair value adjustments relating to our
insurance business.
Efficiency ratio The following table summarizes our owned basis efficiency
ratio:
2006 2005
---------------------------------------------------------------------------
Three months ended March 31................................. 39.65% 43.99%
Our owned basis efficiency ratio improved compared to the prior year quarter due
to higher net interest income due to higher levels of receivables, partially
offset by an increase in total costs and expenses to support receivable growth
as well as lower other revenues, primarily due to lower derivative income.
SEGMENT RESULTS - MANAGED BASIS
--------------------------------------------------------------------------------
We have three reportable segments: Consumer, Credit Card Services and
International. Our Consumer segment consists of our consumer lending, mortgage
services, retail services and auto finance businesses. Our Credit Card Services
segment consists of our domestic MasterCard and Visa credit card business. Our
International segment consists of our foreign operations in the United Kingdom,
Canada, the Republic of Ireland, Slovakia, the Czech Republic and Hungary. The
All Other caption includes our insurance and taxpayer financial services and
commercial businesses, as well as our corporate and treasury activities, each of
which falls below the quantitative threshold test under SFAS No. 131 for
determining reportable segments. There have been no changes in the basis of our
segmentation or any changes in the measurement of segment profit as compared
with the presentation in our 2005 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
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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 certain
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 MARCH 31 2006 2005 AMOUNT %
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net income............................................. $ 609 $ 433 $ 176 40.6%
Net interest income.................................... 1,822 1,693 129 7.6
Securitization related revenue......................... (49) (235) 186 79.1
Fee and other income................................... 299 285 14 4.9
Intersegment revenues.................................. 57 26 31 100+
Provision for credit losses............................ 403 383 20 5.2
Total costs and expenses............................... 699 668 31 4.6
Receivables............................................ 115,435 91,226 24,209 26.5
Assets................................................. 116,218 92,368 23,850 25.8
Net interest margin, annualized........................ 6.46% 7.54% - -
Return on average managed assets....................... 2.16 1.91 - -
Our Consumer Segment reported higher net income in the first quarter of 2006 due
to higher net interest income, higher fee and other income, and higher
securitization related revenue, partially offset by higher provision for credit
losses and higher costs and expenses. Net interest income increased during the
quarter ended March 31, 2006 primarily due to higher average receivables,
partially offset by higher interest expense. Net interest margin decreased from
the year ago period due to a shift in mix due to growth in lower yielding
receivables and product expansion into near-prime consumer segments. Also
contributing to the decrease were lower yields on auto finance receivables 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. These lower yields
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.
The increase in fee and other income in the first quarter of 2006 is due to
higher servicing fees from HSBC Bank USA on the sold domestic private label
receivable portfolio and higher credit insurance commissions, partially offset
by lower gains on receivable sales including sales of domestic private label
receivable originations to HSBC Bank USA. Securitization related revenue was
higher due to lower amortization of prior period gains as a result of reduced
securitization levels. Costs and expenses were higher due to higher salary
expense and higher support services from affiliates.
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, increased during the first quarter of 2006 due to
receivable growth, partially offset by lower levels of bankruptcy filings in the
United States in the first quarter of 2006 and a reduction in the estimated loss
exposure resulting from Katrina of approximately $7 million. We have experienced
higher dollars of net charge-offs in our owned portfolio during the first
quarter of 2006 due to lower securitization levels. These factors have been more
than offset by the impact of the lower delinquency levels we have experienced in
the first quarter of 2006 driven by a significant decline in bankruptcy filings
and a continued strong economy in the United States which resulted in a decrease
to our owned provision for credit losses compared to the prior year quarter.
Over-the-life provision for credit losses
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for securitized receivables recorded in any given period reflects the level and
product mix of securitizations in that period. Subsequent charge-offs of
securitized receivables result in a decrease in the over-the-life reserves
without any corresponding increase to managed loss provision. In the first
quarter of 2006, we decreased managed loss reserves as net charge-offs were
greater than the provision for credit losses by $226 million. Net charge-offs
were greater than the provision for credit losses by $272 million for the three
months ended March 31, 2005.
Managed receivables increased 7 percent to $115.4 billion at March 31, 2006 as
compared to $108.3 billion at December 31, 2005. We continued to experience
strong growth in the first quarter of 2006 in our real estate secured portfolio
in both our correspondent and branch-based consumer lending businesses. We have
continued to focus on increasing our mix of junior lien loans through portfolio
acquisitions and continue to expand our sources for purchasing newly originated
loans from flow correspondents. Contributing to the increase were purchases of
$.5 billion from portfolio acquisition programs since the prior quarter. Our
auto finance portfolio also reported growth due to organic growth and increased
volume in both the dealer network and the consumer direct loan program. Personal
non-credit card receivables increased from the prior year as we have increased
the availability of this product due to the strong U.S. economy. The success of
several large direct mail campaigns also contributed to growth in the portfolio.
Compared to March 31, 2005, managed receivables increased 27 percent. Real
estate growth was also strong compared to the year ago period as a result of
strong growth in both our correspondent and branch-based consumer lending
businesses. We have continued to focus on increasing our mix of junior lien
loans through portfolio acquisitions and continue to expand our sources for
purchasing newly originated loans from flow correspondents. Real estate secured
receivable levels at March 31, 2006 do not include $.9 billion of correspondent
receivables purchased directly by HSBC Bank USA since March 31, 2005, a portion
of which we otherwise would have purchased. Also contributing to the increase
were purchases of $1.6 billion from portfolio acquisition programs since the
prior year quarter. Growth in our auto finance portfolio from the year ago
period is due to organic growth, principally in the near-prime portfolio. This
came from newly originated loans acquired from our dealer network and growth in
the consumer loan program. Growth in our personal non-credit card portfolio was
the result of increased marketing, including several large direct mail
campaigns.
Return on average managed assets ("ROMA") was 2.16 percent for the first quarter
of 2006, compared to 1.91 percent in the year-ago period. The increase in the
ratio in the first quarter of 2006 is due to the increase in net income
discussed above which grew faster than average managed assets.
In accordance with Federal Financial Institutions Examination Council ("FFIEC")
guidance, the required minimum monthly payment amounts for domestic private
label credit card accounts have changed. The implementation of these new
requirements began in the fourth quarter of 2005 and was completed in the first
quarter of 2006. As previously discussed, we sell new domestic private label
receivable originations (excluding retail sales contracts) to HSBC Bank USA on a
daily basis. Estimates of the potential impact to the business are based on
numerous assumptions and take into account a number of factors which are
difficult to predict, such as changes in customer behavior, which will not be
fully known or understood until the changes have been in place for a period of
time. Based on current estimates, we anticipate that these changes will have an
unfavorable impact on the premiums associated with these daily sales in 2007. It
is not expected this reduction will have a material impact on either the results
of the Consumer Segment or our consolidated results.
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CREDIT CARD SERVICES SEGMENT The following table summarizes results for our
Credit Card Services segment.
INCREASE (DECREASE)
--------------------
THREE MONTHS ENDED MARCH 31 2006 2005 AMOUNT %
---------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net income............................................... $ 305 $ 148 $ 157 100+%
Net interest income...................................... 769 506 263 52.0
Securitization related revenue........................... (3) (64) 61 95.3
Fee and other income..................................... 517 436 81 18.6
Intersegment revenues.................................... 5 5 - -
Provision for credit losses.............................. 365 321 44 13.7
Total costs and expenses................................. 433 324 109 33.6
Receivables.............................................. 25,146 19,114 6,032 31.6
Assets................................................... 25,488 18,970 6,518 34.4
Net interest margin, annualized.......................... 11.86% 10.34% - -
Return on average managed assets......................... 4.67 3.06 - -
Our Credit Card Services Segment reported higher net income in the first quarter
of 2006. The increase in net income was primarily due to higher net interest
income, higher fee and other income and higher securitization related revenue
partially offset by higher provision for credit losses and higher costs and
expenses. The acquisition of Metris, which was completed in December 2005,
contributed $23 million of net income during the quarter. Net interest income
increased as a result of the Metris acquisition, which contributed to higher
overall yields due in part to higher levels of near-prime receivables, partially
offset by higher interest expense. Net interest margin increased in the first
quarter of 2006 primarily due to higher overall yields due to increases in
non-prime receivable levels, including the receivables acquired as part of
Metris, higher pricing on variable rate products and other repricing
initiatives, such as reduced levels of promotional rate balances in 2006. These
increases were partially offset by a higher cost of funds. Although our
non-prime receivables tend to have smaller balances, they generate higher
returns both in terms of net interest margin and fee income. Increases in fee
and other income resulted from portfolio growth, including the Metris receivable
portfolios acquired in December 2005, and improvements in interchange rates
since March 2005. This increase in fee income was partially offset by adverse
impacts of limiting certain fee billings on non-prime credit card accounts as
discussed below. Our provision for credit losses was higher in the first quarter
of 2006 as a result of portfolio growth, including additions from the Metris
acquisition, partially offset by a reduction in our estimated loss exposure
related to Katrina of approximately $23 million and the impact of lower levels
of bankruptcy filings in the first quarter of 2006. We increased managed loss
reserves by recording loss provision greater than net charge-off of $104 million
in the first quarter of 2006. The increase in loss provision is related to the
Metris acquisition, partly offset by a decrease in loss provision for the other
portfolios. In the first quarter of 2005, we decreased managed loss reserves by
recording loss provision less than net charge-off of $23 million. Higher costs
and expenses were to support receivable growth.
Managed receivables decreased 4 percent to $25.1 billion at March 31, 2006
compared to $26.2 billion at December 31, 2005. The decrease during the quarter
was due primarily to normal seasonal run-off. Compared to March 31, 2005,
managed receivables increased 32 percent. This increase was due to organic
growth in our HSBC branded prime, Union Privilege and non-prime portfolios, and
also due to the acquisition of Metris in December 2005 which increased
receivables by $5.3 billion.
The increase in ROMA in the first quarter of 2006 is primarily due to higher net
income discussed above which grew faster than average managed assets.
In accordance with FFIEC guidance, our credit card services business adopted a
plan to phase in changes to the required minimum monthly payment amount and
limit certain fee billings for non-prime credit card accounts. The
implementation of these new requirements began in July 2005 with the
requirements fully
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HSBC Finance Corporation
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phased in by December 31, 2005. Estimates of the potential impact to the
business are based on numerous assumptions and take into account a number of
factors which are difficult to predict, such as changes in customer behavior and
impact of other issuers implementing requirements, which will not be fully known
or understood until the changes have been in place for a period of time. These
changes have resulted in lower non-prime credit card fee income in the first
quarter of 2006. It is anticipated that the changes will result in fluctuations
in the provision for credit losses in future periods as credit loss provisions
for prime accounts will increase as a result of higher required monthly payments
while the non-prime provision decreases due to lower levels of fees incurred by
customers. Although we do not expect this will have a material impact on our
consolidated results, the impact to the Credit Card Services Segment in 2006
will be material.
INTERNATIONAL SEGMENT The following table summarizes results for our
International segment:
INCREASE (DECREASE)
--------------------
THREE MONTHS ENDED MARCH 31, 2006 2005 AMOUNT %
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net income (loss)....................................... $ 7 $ (9) $ 16 100+%
Net interest income..................................... 182 229 (47) (20.5)
Securitization related revenue.......................... - 10 (10) (100.0)
Fee and other income.................................... 113 131 (18) (13.7)
Intersegment revenues................................... 7 4 3 75.0
Provision for credit losses............................. 106 165 (59) (35.8)
Total costs and expenses................................ 175 216 (41) (19.0)
Receivables............................................. 9,096 13,041 (3,945) (30.3)
Assets.................................................. 10,091 13,939 (3,848) (27.6)
Net interest margin annualized.......................... 7.78% 7.02% - -
Return on average managed assets........................ .27 (.25) - -
Our International segment reported net income in the first quarter of 2006 after
a loss of $9 million in the prior year quarter. The increase in net income
reflects lower total costs and expenses and lower provision for credit losses,
partially offset by lower fee and other income and lower net interest income as
a result of the December 2005 sale of our U.K. credit card business to HBEU.
Applying constant currency rates, which uses the average rate of exchange for
the 2005 quarter to translate current period net income, the net income would
have been lower by $2 million in 2006.
Net interest income decreased during the quarter primarily as a result of lower
receivable levels in our U.K. subsidiary due to the sale of our U.K. credit card
business including $3.1 billion in managed receivables to HBEU as well as lower
receivable levels resulting from lower retail sales volumes in the U.K. This was
partially offset by higher net interest income in our Canadian operations due to
higher receivable levels. Net interest margin increased in the first quarter of
2006 due to the change in receivable mix resulting from the sale of our U.K
credit card business in December 2005 as well as a decreased cost of funds.
Provision for credit losses decreased in the first quarter of 2006 primarily due
to the lower receivable balance as a result of the sale of our U.K. credit card
business. We increased managed loss reserves by recording loss provision greater
than net charge-offs of $8 million for the first quarter of 2006 and compared
with $55 million in the year-ago period. Fee and other income and total costs
and expenses decreased as a result of the sale of our U.K. credit card business
in December 2005. The decrease in total costs and expenses was partially offset
by increased costs associated with growth in the Canadian business.
Managed receivables of $9.1 billion at March 31, 2006 decreased 2 percent
compared to $9.3 billion at December 31, 2005. In the first quarter of 2006, our
U.K. based unsecured receivable products decreased due to lower retail sales
volume following a slow down in retail consumer spending in the U.K. These
decreases were partially offset by growth in the receivable portfolio in our
Canadian operations. Branch expansions in Canada in 2005 have resulted in growth
in both the secured and unsecured receivable portfolios. Compared to
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March 31, 2005, receivables decreased 30 percent due to the sale of our U.K.
credit card business as well as lower retail sales volumes in the U.K. These
decreases were partially offset by receivable growth in our Canadian operations
as discussed above as well as from the successful launch of a MasterCard/Visa
credit card program in 2005. Applying constant currency rates, managed
receivables at March 31, 2006 would have been $42 million lower using December
31, 2005 exchange rates and $375 million higher using March 31, 2005 exchange
rates.
The increase in ROMA for the first quarter of 2006 reflects the higher net
income as discussed above, and lower average managed assets as a result of the
sale of our U.K. credit card business in December 2005.
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, changes
in laws and regulations and other items which can affect consumer payment
patterns on outstanding receivables, such as the impact of natural disasters,
such as Katrina and global pandemics.
While our credit loss reserves are available to absorb losses in the entire
portfolio, we specifically consider the credit quality and other risk factors
for each of our products. We recognize the different inherent loss
characteristics in each of our products as well as customer account management
policies and practices and risk management/collection practices. Charge-off
policies are also considered when establishing loss reserve requirements to
ensure the appropriate reserves exist for products with longer charge-off
periods. We also consider key ratios such as reserves to nonperforming loans and
reserves as a percentage of net charge-offs in developing our loss reserve
estimate. Loss reserve estimates are reviewed periodically and adjustments are
reported in earnings when they become known. As these estimates are influenced
by factors outside of our control, such as consumer payment patterns and
economic conditions, there is uncertainty inherent in these estimates, making it
reasonably possible that they could change. See Note 3, "Receivables," in the
accompanying consolidated financial statements for receivables by product type
and Note 4, "Credit Loss Reserves," for an analysis of changes in the credit
loss reserves.
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The following table summarizes owned basis credit loss reserves:
MARCH 31, DECEMBER 31, MARCH 31,
2006 2005 2005
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Owned credit loss reserves.................................. $4,468 $4,521 $3,581
Reserves as a percent of:
Receivables............................................... 3.04% 3.23% 3.19%
Net charge-offs(1)........................................ 120.4(2) 108.3(2) 103.7
Nonperforming loans....................................... 104.7 108.8 103.6
---------------
(1) Quarter-to-date, annualized.
(2) The acquisition of Metris in December 2005 has positively impacted this
ratio. Reserves as a percentage of net charge-offs excluding Metris was
112.8 percent at March 31, 2006 and 103.7 percent at December 31, 2005.
Owned credit loss reserves at March 31, 2006 decreased as compared to December
31, 2005 as the provision for owned credit losses was $62 million lower than net
charge-offs reflecting lower delinquency levels as a result of lower bankruptcy
levels following the enactment of the new bankruptcy legislation in 2005, a
reduction in the estimated loss exposure resulting from Katrina and seasonal
improvements in our collection activities. Owned credit loss reserves at March
31, 2006 increased as compared to March 31, 2005 resulting from higher levels of
owned receivables, including lower securitization levels, additional reserves
resulting from the impact of Katrina, anticipated impacts from minimum monthly
payment changes, and the Metris acquisition. These increases were partially
offset by significantly lower personal bankruptcy levels, the benefits of a
strong U.S. economy, including low unemployment levels, and the impact of the
sale of our U.K. credit card business in December 2005 which decreased credit
loss reserves by $104 million.
Beginning in 2004 and continuing in 2005, we have changed the mix in our loan
portfolio to higher credit quality and lower yielding receivables, particularly
real estate secured and auto finance receivables. Reserves as a percentage of
receivables at March 31, 2006 were lower than at December 31, 2005 and March 31,
2005 as a result of recent portfolio growth and lower levels of personal
bankruptcy filings in the United States in the first quarter of 2006.
Reserves as a percentage of net charge-offs increased in 2006. The December 31,
2005 ratio was significantly impacted by the acquisition of Metris in December
2005. Excluding the Metris acquisition in both periods, reserves as a percentage
of net charge-offs increased 910 basis points. While both our reserve levels at
March 31, 2006 and net charge-offs in the first quarter of 2006 decreased as
compared to the fourth quarter of 2005, net charge-offs decreased at a more
rapid pace than our reserve levels. The fourth quarter of 2005 net charge-off
levels were impacted by the spike in MasterCard/Visa charge-offs following the
increase in personal bankruptcy filings prior to the effective date of new
bankruptcy legislation in the U.S., a portion of which was an acceleration of
MasterCard/Visa net charge-offs that would otherwise have been experienced in
future periods. As a result, charge-off levels in the first quarter of 2006
benefited from the acceleration of these charge-offs which occurred in the
fourth quarter of 2005.
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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:
MARCH 31, DECEMBER 31, MARCH 31,
2006 2005 2005
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Managed credit loss reserves................................ $4,629 $4,736 $4,242
Reserves as a percent of:
Receivables............................................... 3.09% 3.29% 3.43%
Net charge-offs(1)........................................ 116.9(2) 101.8(2) 94.9
Nonperforming loans....................................... 105.4 108.8 106.9
---------------
(1) Quarter-to-date, annualized.
(2) The acquisition of Metris in December 2005 has positively impacted this
ratio. Reserves as a percentage of net charge-offs excluding Metris was
109.7 percent at March 31, 2006 and 97.7 percent at December 31, 2005.
Managed credit loss reserves at March 31, 2006 also decreased compared to
December 31, 2005 due to the decreases in owned credit loss reserves discussed
above and the impact of lower reserves on securitized receivables as a result of
run-off. Managed credit loss reserves at March 31, 2006 increased as compared to
the prior year quarter due to the increases in owned credit loss reserves
discussed above, partially offset by lower reserves on securitized receivables
as a result of run-off. Securitized receivables of $3.1 billion at March 31,
2006 decreased from $4.1 billion at December 31, 2005 and $11.5 billion at March
31, 2005.
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.
DELINQUENCY - OWNED BASIS
The following table summarizes two-months-and-over contractual delinquency (as a
percent of consumer receivables):
MARCH 31, DECEMBER 31, MARCH 31,
2006 2005 2005
--------------------------------------------------------------------------------------------------
Real estate secured......................................... 2.46% 2.72% 2.62%
Auto finance................................................ 1.65 2.34 1.65
MasterCard/Visa(1).......................................... 4.35 3.66 4.60
Private label............................................... 5.50 5.43 4.71
Personal non-credit card.................................... 8.86 9.40 8.63
---- ---- ----
Total(1).................................................... 3.62% 3.84% 3.78%
==== ==== ====
---------------
(1) In December 2005, we completed the acquisition of Metris which included
receivables of $5.3 billion. This event had a significant impact on this
ratio. Excluding the receivables from the Metris acquisition from this
calculation, our consumer delinquency ratio for our MasterCard/Visa
portfolio was 4.01% and total consumer delinquency was 3.89% at December 31,
2005.
Total owned delinquency decreased $53 million, or 22 basis points, compared to
the prior quarter. The decrease is a combination of lower bankruptcy levels
following the enactment of new bankruptcy legislation in 2005, receivable growth
and the continuing strong economy in the United States. Delinquency was also
favorably impacted by seasonal improvements in our collection activities in the
first quarter as customers use their tax refunds to reduce their outstanding
balances. The overall decrease in delinquency of our real estate secured and
auto finance portfolios reflects receivable growth, seasonal improvement in
collection results and continued strong economic conditions. The increase in
MasterCard/Visa delinquencies primarily reflects the seasoning of the Metris
portfolio purchased in December 2005 as further described below. The increase in
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delinquency in our private label receivables (which primarily consists of our
foreign private label portfolio that was not sold to HSBC Bank USA in December
2004) reflects declining receivables and the deterioration of the financial
circumstances of our customers across the U.K. The decrease in personal
non-credit card delinquencies reflects the positive impact of receivable growth
as well as seasonal improvements in collection results, lower bankruptcy filings
and the continued strong economic conditions in the U.S.
As noted above, the increase in MasterCard/Visa delinquencies reflects the
seasoning of the Metris portfolio purchased in December 2005. The receivables
acquired as part of our acquisition of Metris were subject to the requirements
of Statement of Position 03-3, "Accounting for Certain Loans or Debt Securities
Acquired in a Transfer" ("SOP 03-3"). In accordance with SOP 03-3, our
investment in any acquired receivables which showed evidence of credit
deterioration at the time of acquisition was based on the net cash flows
expected to be collected. The increase in delinquency reflects the seasoning of
the receivables we acquired which did not show any evidence of credit
deterioration at the time of the acquisition, a portion of which have now become
delinquent.
Compared to the year-ago period, total delinquency decreased 16 basis points as
most products reported lower delinquency levels. The improvements are generally
the result of portfolio growth, the benefit of a strong U.S. economy including
low unemployment levels, and lower bankruptcy levels due to the new bankruptcy
legislation as discussed above.
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):
MARCH 31, DECEMBER 31, MARCH 31,
2006 2005 2005
--------------------------------------------------------------------------------------------------
Real estate secured......................................... .75% .66% .87%
Auto finance................................................ 3.50 3.42 3.80
MasterCard/Visa............................................. 4.00 7.99 7.17
Private label............................................... 5.62 5.60 4.18
Personal non-credit card.................................... 7.94 7.59 8.18
---- ---- ----
Total....................................................... 2.58% 3.10% 3.15%
==== ==== ====
Real estate secured net charge-offs and REO expense as a
percent of average real estate secured receivables........ .89% .78% 1.01%
Net charge-offs as a percent, annualized, of average consumer receivables
decreased compared to both the prior and year ago quarters primarily as a result
of lower levels of personal bankruptcy filings in our MasterCard/Visa portfolio
due to the new bankruptcy legislation in the U.S. which resulted in an
acceleration of net charge-offs in the fourth quarter of 2005, a portion of
which would have otherwise been experienced in 2006. The net charge-off ratio
for our MasterCard/Visa portfolio was also positively impacted by the
receivables acquired in our acquisition of Metris which were subject to the
reporting requirements of SOP 03-3 as discussed above. Our real estate secured
portfolio experienced an increase in net charge-offs during the first quarter
reflecting seasoning of the growing portfolio. The increase in net charge-offs
in the personal non-credit card portfolio is due to portfolio seasoning.
Total net charge-offs for the current quarter decreased from the March 2005
quarter primarily due to a decrease in personal bankruptcy filings in our
MasterCard/Visa portfolio following the October 2005 enactment of new bankruptcy
legislation in the United States. Also contributing to the decrease was
portfolio growth and the positive impact from the lower delinquency levels we
experienced throughout 2005 as a result of a strong economy.
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OWNED NONPERFORMING ASSETS
MARCH 31, DECEMBER 31, MARCH 31,
2006 2005 2005
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Nonaccrual receivables...................................... $3,525 $3,533 $2,956
Accruing consumer receivables 90 or more days delinquent.... 740 621 499
Renegotiated commercial loans............................... 1 - 1
------ ------ ------
Total nonperforming receivables............................. 4,266 4,154 3,456
Real estate owned........................................... 563 510 509
------ ------ ------
Total nonperforming assets.................................. $4,829 $4,664 $3,965
====== ====== ======
Credit loss reserves as a percent of nonperforming
receivables............................................... 104.7% 108.8% 103.6%
Compared to December 31, 2005, the increase in total nonperforming assets is
primarily due to the seasoning of the Metris portfolio as discussed above.
Consistent with industry practice, accruing consumer receivables 90 or more days
delinquent includes domestic MasterCard/Visa 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, in prior periods we used certain
assumptions and estimates to compile our restructure statistics. The systemic
counters used to compile the information presented below exclude from the
reported statistics loans that have been reported as contractually delinquent
but have been reset to a current status because we have determined that the
loans should not have been considered delinquent (e.g., payment application
processing errors). 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)
MARCH 31, DECEMBER 31, MARCH 31,
2006 2005 2005
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Never restructured.......................................... 89.7% 89.5% 87.2%
Restructured:
Restructured in the last 6 months......................... 4.0 4.0 4.8
Restructured in the last 7-12 months...................... 2.4 2.4 3.2
Previously restructured beyond 12 months.................. 3.9 4.1 4.8
------- ------- -------
Total ever restructured(2)................................ 10.3 10.5 12.8
------- ------- -------
Total....................................................... 100.0% 100.0% 100.0%
======= ======= =======
TOTAL RESTRUCTURED BY PRODUCT - DOMESTIC PORTFOLIO(1)
(MANAGED BASIS)
Real estate secured......................................... $ 8,395 $ 8,334 $ 8,470
Auto finance................................................ 1,712 1,688 1,560
MasterCard/Visa............................................. 937 774 567
Private label(3)............................................ 26 26 23
Personal non-credit card.................................... 3,411 3,369 3,466
------- ------- -------
Total....................................................... $14,481 $14,191 $14,086
======= ======= =======
(AS A PERCENT OF MANAGED RECEIVABLES)
Real estate secured......................................... 9.7% 10.4% 12.9%
Auto finance................................................ 14.5 14.5 15.3
MasterCard/Visa............................................. 3.8 3.0 3.0
Private label(3)............................................ 7.3 7.3 7.0
Personal non-credit card.................................... 19.9 19.9 22.3
------- ------- -------
Total(2).................................................... 10.3% 10.5% 12.8%
======= ======= =======
---------------
(1) Excludes foreign businesses, commercial and other.
(2) Total including foreign businesses was 10.1 percent at March 31, 2006, 10.3
percent at December 31, 2005 and 11.9 percent at March 31, 2005.
(3) Only reflects consumer lending retail sales contracts which have
historically been classified as private label. All other domestic private
label receivables were sold to HSBC Bank USA in December 2004.
See "Credit Quality Statistics" for further information regarding owned basis
and managed basis delinquency, charge-offs and nonperforming loans.
The amount of domestic and foreign managed receivables in forbearance,
modification, credit card services approved consumer credit counseling
accommodations, rewrites or other customer account management techniques for
which we have reset delinquency and that is not included in the restructured or
delinquency statistics was approximately $.4 billion or .3 percent of managed
receivables at March 31, 2006 and December 31, 2005.
In addition to the above, we granted an initial 30 or 60 day payment deferral
(based on product) to customers living in the Katrina FEMA designated Individual
Assistance disaster areas. This deferral was extended for a period of up to 90
days or longer in certain cases based on a customer's specific circumstances,
consistent with our natural disaster policies. In certain cases these
arrangements have resulted in a customer's delinquency
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status being reset by 30 days or more. These extended payment arrangements
affected approximately $1.1 billion of managed receivables and are not reflected
as restructures in the table above or included in the other customer account
management techniques described in the paragraph above unless the accounts
subsequently qualify for restructuring under our restructure policies and
procedures as described in the 2005 Form 10-K.
LIQUIDITY AND CAPITAL RESOURCES
--------------------------------------------------------------------------------
We continue to focus on balancing our use of affiliate and third party funding
sources to minimize funding expense while managing liquidity. During the first
quarter of 2006, we supplemented unsecured debt issuances with proceeds from the
continuing sale of newly originated domestic private label receivables to HSBC
Bank USA, debt issued to affiliates, secured financings and higher levels of
commercial paper as a result of the seasonal activity of our TFS business.
Because we are 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 of approximately $214 million during the quarter ended
March 31, 2006 and approximately $120 million during the quarter ended March 31,
2005 compared to the funding costs we would have incurred using average spreads
and funding mix from the first half of 2002. These tightened credit spreads in
combination with the issuance of HSBC Finance Corporation debt and other funding
synergies including asset transfers and debt underwriting fees paid to HSBC
affiliates have enabled HSBC to realize a run rate for annual cash funding
expense savings in excess of $1 billion per year. In the first quarter of 2006,
the cash funding expense savings realized by HSBC totaled approximately $280
million.
Debt due to affiliates and other HSBC related funding are summarized in the
following table:
MARCH 31, DECEMBER 31,
2006 2005
--------------------------------------------------------------------------------------
(IN BILLIONS)
Debt issued to HSBC subsidiaries:
Drawings on bank lines in the U.K and Europe.............. $ 4.0 $ 4.2
Term debt................................................. 11.2 11.0
Preferred securities issued by Household Capital Trust
VIII to HSBC........................................... .3 .3
----- -----
Total debt outstanding to HSBC subsidiaries............... 15.5 15.5
----- -----
Debt outstanding to HSBC clients:
Euro commercial paper..................................... 3.3 3.2
Term debt................................................. 1.3 1.3
----- -----
Total debt outstanding to HSBC clients.................... 4.6 4.5
Cash received on bulk and subsequent sales of domestic
private label credit card receivables to HSBC Bank USA,
net (cumulative).......................................... 14.5 15.7
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 4.2
Reductions in real estate secured receivables sold to HSBC
Bank USA............................................... (3.7) (3.3)
----- -----
Total real estate secured receivable activity with HSBC Bank
USA....................................................... 4.2 4.6
----- -----
Cash received from sale of U.K. credit card business to HBEU
(cumulative).............................................. 2.7 2.6
Capital contribution by HINO (cumulative)................... 1.2 1.2(1)
----- -----
Total HSBC related funding.................................. $42.7 $44.1
===== =====
---------------
(1) This capital contribution was made in connection with the acquisition of
Metris.
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Funding from HSBC, including debt issuances to HSBC subsidiaries and clients,
represented 15 percent of our total managed debt at March 31, 2006 and December
31, 2005.
Cash proceeds from the December 2005 sale of our managed basis U.K. credit card
receivables to HBEU of $2.6 billion were used partially to pay down drawings on
bank lines from HBEU in the U.K. and partially to fund operations.
At March 31, 2006, we had a commercial paper back stop credit facility of $2.5
billion from HSBC supporting domestic issuances and a revolving credit facility
of $5.3 billion from HBEU to fund our operations in the U.K. There have been no
draws on the domestic line. At March 31, 2006, $4.0 billion was outstanding
under the U.K. lines. We had derivative contracts with a notional value of $85.6
billion, or approximately 96 percent of total derivative contracts, outstanding
with HSBC affiliates at March 31, 2006. At December 31, 2005, we had derivative
contracts with a notional value of $72.2 billion, or approximately 95 percent of
total derivative contracts, outstanding with HSBC affiliates.
SECURITIES AND OTHER SHORT-TERM INVESTMENTS Securities totaled $4.1 billion at
March 31, 2006 and December 31, 2005. Securities purchased under agreements to
resell totaled $91 million at March 31, 2006 and $78 million at December 31,
2005. Interest bearing deposits with banks totaled $599 million at March 31,
2006 and $384 million at December 31, 2005.
COMMERCIAL PAPER, BANK AND OTHER BORROWINGS totaled $14.2 billion at March 31,
2006 and $11.4 billion at December 31, 2005. The increase at March 31, 2006 was
a result of the funding of the seasonal activity of our TFS business. Included
in this total was outstanding Euro commercial paper sold to customers of HSBC of
$3.3 billion at March 31, 2006 and $3.2 billion at December 31, 2005.
LONG TERM DEBT (with original maturities over one year) increased to $107.8
billion at March 31, 2006 from $105.2 billion at December 31, 2005. As part of
our overall liquidity management strategy, we continue to extend the maturity of
our liability profile. Significant third party issuances during the first
quarter of 2006 included the following:
- $3.0 billion of domestic medium-term notes
- $.8 billion of foreign currency-denominated bonds
- $.5 billion of InterNotes(SM) (retail-oriented medium-term notes)
- $2.5 billion of global debt
- $1.5 billion of securities backed by real estate secured and
MasterCard/Visa receivables. For accounting purposes, these transactions
were structured as secured financings.
In the first quarter of 2006, we redeemed the junior subordinated notes issued
to Household Capital Trust VI with an outstanding principal balance of $206
million.
SELECTED CAPITAL RATIOS are summarized in the following table:
MARCH 31, DECEMBER 31,
2006 2005
--------------------------------------------------------------------------------------
TETMA(1).................................................... 7.75% 7.56%
TETMA + Owned Reserves(1)................................... 10.59 10.55
Tangible common equity to tangible managed assets(1)........ 6.44 6.07
Common and preferred equity to owned assets................. 12.45 12.43
Excluding purchase accounting adjustments:
TETMA(1).................................................. 8.62 8.52
TETMA + Owned Reserves(1)................................. 11.47 11.51
Tangible common equity to tangible managed assets(1)...... 7.32 7.02
---------------
(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.
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SECURITIZATIONS AND SECURED FINANCINGS Securitizations (collateralized funding
transactions structured to receive sale treatment under Statement of Financial
Accounting Standards No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, a Replacement of FASB
Statement No. 125," ("SFAS No. 140")) and secured financings (collateralized
funding transactions which do not receive sale treatment under SFAS No. 140) of
consumer receivables have been a source of funding and liquidity for us.
Securitizations and secured financings have been used to limit our reliance on
the unsecured debt markets.
In a securitization, a designated pool of non-real estate consumer receivables
is removed from the balance sheet and transferred through a limited purpose
financing subsidiary to an unaffiliated trust. This unaffiliated trust is a
qualifying special purpose entity ("QSPE") as defined by SFAS No. 140 and,
therefore, is not consolidated. The QSPE funds its receivable purchase through
the issuance of securities to investors, entitling them to receive specified
cash flows during the life of the securities. The receivables transferred to the
QSPE serve as collateral for the securities. At the time of sale, an
interest-only strip receivable is recorded, representing the present value of
the cash flows we expect to receive over the life of the securitized
receivables, net of estimated credit losses and debt service. Under the terms of
the securitizations, we receive annual servicing fees on the outstanding balance
of the securitized receivables and the rights to future residual cash flows on
the sold receivables after the investors receive their contractual return. Cash
flows related to the interest-only strip receivables and servicing the
receivables are collected over the life of the underlying securitized
receivables.
In a secured financing, a designated pool of receivables is conveyed to a wholly
owned limited purpose subsidiary which in turn transfers the receivables to a
trust which sells interests to investors. Repayment of the debt issued by the
trust is secured by the receivables transferred. The transactions are structured
as secured financings under SFAS No. 140. Therefore, the receivables and the
underlying debt of the trust remain on our balance sheet. We do not recognize a
gain in a secured financing transaction. Because the receivables and the debt
remain on our balance sheet, revenues and expenses are reported consistently
with our owned balance sheet portfolio. Using this source of funding results in
similar cash flows as issuing debt through alternative funding sources.
Securitizations are treated as secured financings under both IFRSs and U.K.
GAAP. In order to align our accounting treatment with that of HSBC initially
under U.K. GAAP and now under IFRSs, we began to structure all new
collateralized funding transactions as secured financings in the third quarter
of 2004. However, because existing public MasterCard and Visa credit card
transactions were structured as sales to revolving trusts that require
replenishments of receivables to support previously issued securities,
receivables will continue to be sold to these trusts and the resulting
replenishment gains recorded until the revolving periods end, the last of which
is currently projected to occur in early 2008. We will continue to replenish at
reduced levels, certain non-public personal non-credit card and MasterCard/ Visa
securities issued to conduits and record the resulting replenishment gains for a
period of time in order to manage liquidity. Since our securitized receivables
have varying lives, it will take time for these receivables to pay-off and the
related interest-only strip receivables to be reduced to zero. The termination
of sale treatment on new collateralized funding activity reduced our reported
net income under U.S. GAAP. There was no impact, however, on cash received.
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.
48
HSBC Finance Corporation
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There were no securitizations (excluding replenishments of certificateholder
interests) during the first quarter of 2006 or 2005. Secured financings are
summarized in the following table:
THREE MONTHS ENDED MARCH 31 2006 2005
----------------------------------------------------------------------------
(IN MILLIONS)
SECURED FINANCINGS:
Real estate secured......................................... $ 350 $ -
MasterCard/Visa............................................. 1,120 -
Auto finance................................................ - -
------ -----
Total....................................................... $1,470 $ -
====== =====
Our securitized receivables totaled $3.1 billion at March 31, 2006 compared to
$4.1 billion at December 31, 2005. As of March 31, 2006, outstanding secured
financings of $15.1 billion were secured by $21.4 billion of real estate
secured, auto finance and MasterCard/Visa receivables. Secured financings of
$15.1 billion at December 31, 2005 were secured by $21.8 billion of real estate
secured, auto finance and MasterCard/Visa receivables. At March 31, 2006,
securitizations structured as sales represented 2 percent and secured financings
represented 11 percent of the funding associated with our managed funding
portfolio. At December 31, 2005, securitizations structured as sales represented
3 percent and secured financings represented 11 percent of the funding
associated with our managed funding portfolio.
2006 FUNDING STRATEGY As discussed previously, the acquisition by HSBC has
improved our access to the capital markets as well as expanded our access to a
worldwide pool of potential investors. Our current estimated domestic funding
needs and sources for 2006 are summarized in the table that follows:
ACTUAL ESTIMATED
JANUARY 1 APRIL 1
THROUGH THROUGH ESTIMATED
MARCH 31, DECEMBER 31, FULL YEAR
2006 2006 2006
--------------------------------------------------------------------------------------------------
(IN BILLIONS)
FUNDING NEEDS:
Net asset growth.......................................... $ 4 $ 9 - 19 $13 - 23
Commercial paper, term debt and securitization
maturities............................................. 16 14 - 20 30 - 36
Other..................................................... - 1 - 3 1 - 3
--- -------- --------
Total funding needs....................................... $20 $24 - 42 $44 - 62
=== ======== ========
FUNDING SOURCES:
External funding, including commercial paper.............. $20 $23 - 37 $43 - 57
HSBC and HSBC subsidiaries................................ - 1 - 5 1 - 5
--- -------- --------
Total funding sources..................................... $20 $24 - 42 $44 - 62
=== ======== ========
RISK MANAGEMENT
--------------------------------------------------------------------------------
CREDIT RISK There have been no significant changes in our approach to credit
risk management since December 31, 2005.
At March 31, 2006, we had derivative contracts with a notional value of
approximately $89.0 billion, including $85.6 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 $90 million at March 31, 2006 and $91 million at December 31, 2005.
When the fair value of our agreements
49
HSBC Finance Corporation
--------------------------------------------------------------------------------
with affiliate counterparties requires the posting of collateral by the
affiliate, it is provided in the form of securities, which are not recorded on
our balance sheet. Alternately, when the fair value of our agreements with
affiliate counterparties requires us to post collateral, it is provided in the
form of cash which is recorded on our balance sheet in other assets. At March
31, 2006, the fair value of our agreements with affiliate counterparties was
above the level that requires us to post collateral. As such at March 31, 2006,
we had posted cash collateral with affiliates totaling $352 million. At December
31, 2005, the fair value of our agreements with affiliate counterparties was
below the level requiring the posting of collateral by the affiliate. As such,
at December 31, 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, 2005.
MARKET RISK HSBC Group has certain limits and benchmarks that serve as
guidelines in determining the appropriate levels of interest rate risk. One such
limit is expressed in terms of the Present Value of a Basis Point ("PVBP"),
which reflects the change in value of the balance sheet for a one basis point
movement in all interest rates. Our PVBP limit as of March 31, 2006 was $2
million, which includes the risk associated with hedging instruments. Thus, for
a one basis point change in interest rates, the policy dictates that the value
of the balance sheet shall not increase or decrease by more than $2 million. As
of March 31, 2006 and December 31, 2005, we had a PVBP position of less than $1
million reflecting the impact of a one basis point increase in interest rates.
While the total PVBP position will not change as a result of the loss of hedge
accounting following our acquisition by HSBC, the following table shows the
components of PVBP:
MARCH 31, DECEMBER 31,
2006 2005
--------------------------------------------------------------------------------------
(IN MILLIONS)
Risk related to our portfolio of ineffective hedges......... $(1.9) $(1.4)
Risk for all other remaining assets and liabilities......... 1.9 2.3
----- -----
Total PVBP risk............................................. $ - $ .9
===== =====
We also monitor the impact that an immediate hypothetical increase or decrease
in interest rates of 25 basis points applied at the beginning of each quarter
over a 12 month period would have on our net interest income assuming a growing
balance sheet and the current interest rate risk profile. The following table
summarizes such estimated impact:
MARCH 31, DECEMBER 31,
2006 2005
--------------------------------------------------------------------------------------
(IN MILLIONS)
Decrease in net interest income following a hypothetical 25
basis points
rise in interest rates applied at the beginning of each
quarter over the
next 12 months............................................ $ 89 $213
Increase in net interest income following a hypothetical 25
basis points
fall in interest rates applied at the beginning of each
quarter over the
next 12 months............................................ $197 $120
These estimates include both the net interest income impact of the derivative
positions we have entered into which are considered to be effective hedges under
SFAS No. 133 and the impact of economic hedges of certain underlying debt
instruments which do not qualify for hedge accounting as previously discussed,
as if they were effective hedges under SFAS No. 133. These estimates also assume
we would not take any corrective actions in response to interest rate movements
and, therefore, exceed what most likely would occur if rates were to change by
the amount indicated.
50
HSBC Finance Corporation
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As part of our overall risk management strategy to reduce earnings volatility,
in 2005 a significant number of our pay fixed/receive variable interest rate
swaps which had not previously qualified for hedge accounting under SFAS No.
133, have been designated as effective hedges using the long-haul method of
accounting, and certain other interest rate swaps were terminated. This will
significantly reduce the volatility of the mark-to-market on the previously
non-qualifying derivatives which have been designated as effective hedges going
forward, but will result in the recording of ineffectiveness under the long-haul
method of accounting under SFAS No. 133. In order to further reduce earnings
volatility that would otherwise result from changes in interest rates, we
continue to evaluate the steps required to regain hedge accounting treatment
under SFAS No. 133 for the remaining swaps which do not currently qualify for
hedge accounting. These derivatives remain economic hedges of the underlying
debt instruments. We will continue to manage our total interest rate risk on a
basis consistent with the risk management process employed since the
acquisition.
INSURANCE RISK The principal insurance risk we face is that the cost of claims
combined with acquisition and administration costs may exceed the aggregate
amount of premiums received and investment income earned. We manage our
insurance risks through the application of formal pricing, underwriting, and
claims procedures. These procedures are also designed to ensure compliance with
regulations.
OPERATIONAL RISK There has been no significant change in our approach to
operational risk management since December 31, 2005.
51
HSBC FINANCE CORPORATION
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
THREE MONTHS ENDED
-------------------------
MARCH 31, MARCH 31,
2006 2005
---------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
RETURN ON AVERAGE ASSETS:
Net income.................................................. $ 888 $ 626
-------- --------
Average assets:
Owned basis............................................... $162,688 $131,954
Serviced with limited recourse............................ 3,505 12,884
-------- --------
Managed basis............................................. $166,193 $144,838
-------- --------
Return on average owned assets.............................. 2.18% 1.90%
Return on average managed assets............................ 2.14 1.73
======== ========
RETURN ON AVERAGE COMMON SHAREHOLDER'S(S') EQUITY:
Net income.................................................. $ 888 $ 626
Dividends on preferred stock................................ (9) (18)
-------- --------
Net income available to common shareholders................. $ 879 $ 608
-------- --------
Average common shareholder's(s') equity..................... $ 19,379 $ 16,170
-------- --------
Return on average common shareholder's(s') equity........... 18.14% 15.04%
======== ========
NET INTEREST MARGIN:
Net interest income:
Owned basis............................................... $ 2,464 $ 1,888
Serviced with limited recourse............................ 103 332
-------- --------
Managed basis............................................. $ 2,567 $ 2,220
-------- --------
Average interest-earning assets:
Owned basis............................................... $147,266 $112,985
Serviced with limited recourse............................ 3,505 12,884
-------- --------
Managed basis............................................. $150,771 $125,869
-------- --------
Owned basis net interest margin............................. 6.69% 6.68%
Managed basis net interest margin........................... 6.81 7.06
======== ========
MANAGED BASIS RISK ADJUSTED REVENUE:
Net interest income......................................... $ 2,567 $ 2,220
Other revenues.............................................. 1,312 1,160
Excluding:
Securitization related revenue............................ 54 308
Mark-to-market on derivatives which do not qualify as
effective hedges and ineffectiveness associated with
qualifying hedges under SFAS No. 133................... (53) (245)
Net charge-offs........................................... (990) (1,118)
-------- --------
Risk adjusted revenue....................................... 2,890 2,325
Average interest-earning assets............................. $150,771 $125,869
-------- --------
Managed basis risk adjusted revenue......................... 7.67% 7.39%
======== ========
52
HSBC FINANCE CORPORATION
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
THREE MONTHS ENDED
------------------------------------
MARCH 31, MARCH 31, DECEMBER 31,
2006 2005 2005
-------------------------------------------------------------------------------------------------
(DOLLAR AMOUNTS ARE IN MILLIONS)
CONSUMER NET CHARGE-OFF RATIO:
Consumer net charge-offs:
Owned basis.............................................. $ 928 $ 856 $ 1,044
Serviced with limited recourse........................... 62 255 119
-------- -------- --------
Managed basis............................................ $ 990 $ 1,111 $ 1,163
-------- -------- --------
Average consumer receivables:
Owned basis.............................................. $143,893 $108,928 $134,647
Serviced with limited recourse........................... 3,505 12,884 5,757
-------- -------- --------
Managed basis............................................ $147,398 $121,812 $140,404
-------- -------- --------
Owned basis consumer net charge-off ratio.................. 2.58% 3.15% 3.10%
Managed basis consumer net charge-off ratio................ 2.69 3.65 3.31
======== ======== ========
RESERVES AS A PERCENTAGE OF NET CHARGE-OFFS
Loss reserves:
Owned basis.............................................. $ 4,468 $ 3,581 $ 4,521
Serviced with limited recourse........................... 161 661 215
-------- -------- --------
Managed basis............................................ $ 4,629 $ 4,242 $ 4,736
-------- -------- --------
Net charge-offs:
Owned basis.............................................. $ 928 $ 863 $ 1,044
Serviced with limited recourse........................... 62 255 119
-------- -------- --------
Managed basis............................................ $ 990 $ 1,118 $ 1,163
-------- -------- --------
Owned basis reserves as a percentage of net charge-offs.... 120.4% 103.7% 108.3%
Managed basis reserves as a percentage of net
charge-offs.............................................. 116.9 94.9 101.8
======== ======== ========
EFFICIENCY RATIO:
Total costs and expenses less policyholders' benefits...... $ 1,488 $ 1,420 $ 1,433
-------- -------- --------
Net interest income and other revenues less policyholders'
benefits:
Owned basis.............................................. $ 3,753 $ 3,228 $ 3,332
Serviced with limited recourse........................... 8 30 48
-------- -------- --------
Managed basis............................................ $ 3,761 $ 3,258 $ 3,380
-------- -------- --------
Owned basis efficiency ratio............................... 39.65% 43.99% 43.01%
Managed basis efficiency ratio............................. 39.56 43.59 42.40
======== ======== ========
53
HSBC FINANCE CORPORATION
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
MARCH 31, DECEMBER 31, MARCH 31,
2006 2005 2005
----------------------------------------------------------------------------------------------------------
(DOLLAR AMOUNTS ARE IN MILLIONS)
TWO-MONTHS-AND-OVER-CONTRACTUAL DELINQUENCY:
Consumer two-months-and-over-contractual delinquency:
Owned basis.............................................. $ 5,312 $ 5,366 $ 4,229
Serviced with limited recourse........................... 153 234 626
-------- -------- --------
Managed basis............................................ $ 5,465 $ 5,600 $ 4,855
-------- -------- --------
Consumer receivables:
Owned basis.............................................. $146,580 $139,726 $111,911
Serviced with limited recourse........................... 3,109 4,074 11,486
-------- -------- --------
Managed basis............................................ $149,689 $143,800 $123,397
-------- -------- --------
Consumer two-months-and-over-contractual delinquency:
Owned basis.............................................. 3.62% 3.84% 3.78%
Managed basis............................................ 3.65 3.89 3.93
======== ======== ========
RESERVES AS A PERCENTAGE OF RECEIVABLES:
Loss reserves:
Owned basis.............................................. $ 4,468 $ 4,521 $ 3,581
Serviced with limited recourse........................... 161 215 661
-------- -------- --------
Managed basis............................................ $ 4,629 $ 4,736 $ 4,242
-------- -------- --------
Receivables:
Owned basis.............................................. $146,767 $139,913 $112,161
Serviced with limited recourse........................... 3,109 4,074 11,486
-------- -------- --------
Managed basis............................................ $149,876 $143,987 $123,647
-------- -------- --------
Reserves as a percentage of receivables:
Owned basis.............................................. 3.04% 3.23% 3.19%
Managed basis............................................ 3.09 3.29 3.43
======== ======== ========
RESERVES AS A PERCENTAGE OF NONPERFORMING LOANS:
Loss reserves:
Owned basis.............................................. $ 4,468 $ 4,521 $ 3,581
Serviced with limited recourse........................... 161 215 661
-------- -------- --------
Managed basis............................................ $ 4,629 $ 4,736 $ 4,242
-------- -------- --------
Nonperforming loans:
Owned basis.............................................. $ 4,266 $ 4,154 $ 3,456
Serviced with limited recourse........................... 126 197 511
-------- -------- --------
Managed basis............................................ $ 4,392 $ 4,351 $ 3,967
-------- -------- --------
Reserves as a percentage of nonperforming loans:
Owned basis.............................................. 104.7% 108.8% 103.6%
Managed basis............................................ 105.4 108.8 106.9
======== ======== ========
54
HSBC FINANCE CORPORATION
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
MARCH 31, DECEMBER 31,
2006 2005
----------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
TANGIBLE COMMON EQUITY:
Common shareholder's equity................................. $ 19,806 $ 18,904
Exclude:
Unrealized (gains) losses on cash flow hedging
instruments............................................. (313) (260)
Minimum pension liability................................. - -
Unrealized gains on investments and interest-only strip
receivables............................................. 35 3
Intangible assets......................................... (2,400) (2,480)
Goodwill.................................................. (7,009) (7,003)
-------- --------
Tangible common equity...................................... 10,119 9,164
HSBC acquisition purchase accounting adjustments............ 1,379 1,441
-------- --------
Tangible common equity, excluding HSBC acquisition purchase
accounting adjustments.................................... $ 11,498 $ 10,605
======== ========
TANGIBLE SHAREHOLDER'S(S') EQUITY:
Tangible common equity...................................... $ 10,119 $ 9,164
Preferred stock............................................. 575 575
Mandatorily redeemable preferred securities of Household
Capital Trusts............................................ 1,478 1,679
-------- --------
Tangible shareholder's(s') equity........................... 12,172 11,418
HSBC acquisition purchase accounting adjustments............ 1,376 1,438
-------- --------
Tangible shareholder's(s') equity, excluding HSBC
acquisition purchase accounting adjustments............... $ 13,548 $ 12,856
======== ========
TANGIBLE SHAREHOLDER'S(S') EQUITY PLUS OWNED LOSS RESERVES:
Tangible shareholder's(s') equity........................... $ 12,172 $ 11,418
Owned loss reserves......................................... 4,468 4,521
-------- --------
Tangible shareholder's(s') equity plus owned loss
reserves.................................................. 16,640 15,939
HSBC acquisition purchase accounting adjustments............ 1,376 1,438
-------- --------
Tangible shareholder's(s') equity plus owned loss reserves,
excluding HSBC acquisition purchase accounting
adjustments............................................... $ 18,016 $ 17,377
======== ========
TANGIBLE MANAGED ASSETS:
Owned assets................................................ $163,680 $156,669
Receivables serviced with limited recourse.................. 3,109 4,074
-------- --------
Managed assets.............................................. 166,789 160,743
Exclude:
Intangible assets......................................... (2,400) (2,480)
Goodwill.................................................. (7,009) (7,003)
Derivative financial assets............................... (282) (234)
-------- --------
Tangible managed assets..................................... 157,098 151,026
HSBC acquisition purchase accounting adjustments............ (14) (52)
-------- --------
Tangible managed assets, excluding HSBC acquisition purchase
accounting adjustments.................................... $157,084 $150,974
======== ========
EQUITY RATIOS:
Common and preferred equity to owned assets................. 12.45% 12.43%
Tangible common equity to tangible managed assets........... 6.44 6.07
Tangible shareholder's(s') equity to tangible managed assets
("TETMA")................................................. 7.75 7.56
Tangible shareholder's(s') equity plus owned loss reserves
to tangible managed assets ("TETMA + Owned Reserves")..... 10.59 10.55
Excluding HSBC acquisition purchase accounting adjustments:
Tangible common equity to tangible managed assets......... 7.32 7.02
TETMA..................................................... 8.62 8.52
TETMA + Owned Reserves.................................... 11.47 11.51
======== ========
55
HSBC Finance Corporation
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ITEM 4. CONTROLS AND PROCEDURES
--------------------------------------------------------------------------------
We maintain a system of internal and disclosure controls and procedures designed
to ensure that information required to be disclosed by HSBC Finance Corporation
in the reports we file or submit under the Securities Exchange Act of 1934, as
amended, (the "Exchange Act"), is recorded, processed, summarized and reported
on a timely basis. Our Board of Directors, operating through its audit
committee, which is composed entirely of independent outside directors, provides
oversight to our financial reporting process.
We conducted an evaluation, with the participation of the Chief Executive
Officer and Chief Financial Officer, of the effectiveness of our disclosure
controls and procedures as of the end of the period covered by this report.
Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures were effective as
of the end of the period covered by this report so as to alert them in a timely
fashion to material information required to be disclosed in reports we file
under the Exchange Act.
There have been no significant changes in our internal and disclosure controls
or in other factors which could significantly affect internal and disclosure
controls subsequent to the date that we carried out our evaluation.
HSBC Finance Corporation continues the process to complete a thorough review of
its internal controls as part of its preparation for compliance with the
requirements of Section 404 of the Sarbanes-Oxley Act of 2002. Section 404
requires our management to report on, and our external auditors to attest to,
the effectiveness of our internal control structure and procedures for financial
reporting. As a non-accelerated filer under Rule 12b-2 of the Exchange Act, our
first report under Section 404 will be contained in our Form 10-K for the period
ended December 31, 2007.
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 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 lenders 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 as appropriate, and a number of reservations of rights letters have
been received.
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CREDIT CARD SERVICES LITIGATION
Since June 2005, HSBC Finance Corporation, HSBC North America Holdings Inc., and
HSBC Holdings plc., as well as other banks and the Visa and Master Card
associations, were named as defendants in four class actions filed in
Connecticut and the Eastern District of New York; Photos Etc. Corp. et al. v.
Visa U.S.A., Inc., et al. (D. Conn. No. 3:05-CV-01007 (WWE)): National
Association of Convenience Stores, et al. v. Visa U.S.A., Inc., et al.(E.D.N.Y.
No. 05-CV 4520 (JG)); Jethro Holdings, Inc., et al. v. Visa U.S.A., Inc. et
al.(E.D.N.Y. No. 05-CV-4521 (JG)); and American Booksellers Ass'n v. Visa
U.S.A., Inc. et al. (E.D.N.Y. No. 05-CV-5391 (JG)). Numerous other complaints
containing similar allegations (in which no HSBC entity is named) were filed
across the country against Visa, MasterCard and other banks. These actions
principally allege that the imposition of a no-surcharge rule by the
associations and/or the establishment of the interchange fee charged for credit
card transactions causes the merchant discount fee paid by retailers to be set
at supracompetitive levels in violation of the Federal antitrust laws. In
response to motions of the plaintiffs on October 19, 2005, the Judicial Panel on
Multidistrict Litigation (the "MDL Panel") issued an order consolidating these
suits and transferred all of the cases to the Eastern District of New York. The
consolidated case is: In re Payment Card Interchange Fee and Merchant Discount
Antitrust Litigation, MDL 1720, E.D.N.Y. A consolidated, amended complaint was
filed by the plaintiffs on April 24, 2006. 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
57
HSBC Finance Corporation
--------------------------------------------------------------------------------
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. On February 28, 2006,
the Court has also dismissed all alleged sec.10 claims that arose prior to July
30, 1999, shortening the class period by 22 months. The discovery schedule
currently provides that all factual discovery must be completed by May 12, 2006
and expert witness discovery must be completed by July 24, 2006. However, we
expect those deadlines to be extended. Separately, one of the defendants, Arthur
Andersen, entered into a settlement of the claims against Andersen. This
settlement is subject to Court approval. At this time, we are unable to quantify
the potential impact from this action, if any.
With respect to this securities litigation, 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.
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 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 was
substantially identical to the foregoing West Virginia Laborer's Pension Trust
Fund case, and was brought by the same principal law firm that brought that
suit. The defendants' motion to dismiss was granted on February 10, 2005. After
briefing and oral argument, on February 24, 2006 the appellate court affirmed
the trial court's ruling dismissing the complaint. The time for further appeals
has expired.
ITEM 1A. RISK FACTORS
--------------------------------------------------------------------------------
Risk factors were provided in our 2005 Form 10-K; however, the following
discussion provides a more detailed description of some of the important risk
factors that could affect our actual results and could cause our results to vary
materially from those expressed in public statements or documents. However,
other factors besides those discussed below or elsewhere in other of our reports
filed or furnished with the SEC, could affect our business or results. The
reader should not consider any description of such factors to be a complete set
of all potential risks that may face HSBC Finance Corporation.
GENERAL BUSINESS, ECONOMIC, POLITICAL AND MARKET CONDITIONS. Our business and
earnings are affected by general business, economic, market and political
conditions in the United States and abroad. Given the concentration of our
business activities in the United States, we are particularly exposed to
downturns in the United States economy. For example in a poor economic
environment there is greater likelihood that more of our customers or
counterparties could become delinquent on their loans or other obligations to
us, which, in turn, could result in higher level of charge-offs and provision
for credit losses, all of which would adversely affect our earnings. General
business, economic and market conditions that could affect us include short-term
and long-term interest rates, inflation, recession, monetary supply,
fluctuations in both debt and equity capital markets in which we fund our
operations, market value of consumer owned real estate throughout the United
States, consumer perception as to the availability of credit and the ease of
filing of bankruptcy. Certain changes to these conditions could diminish demand
for our products and services, or increase the cost to provide such products or
services. Political conditions also can impact our earnings. Acts or threats of
war or
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terrorism, as well as actions taken by the United States or other governments in
response to such acts or threats, could affect business and economic conditions
in the United States.
FEDERAL AND STATE REGULATION. We operate in a highly regulated environment.
Changes in federal, state and local laws and regulations affecting banking,
consumer credit, bankruptcy, privacy, consumer protection or other matters could
materially impact our performance. Specifically, attempts by local, state and
national regulatory agencies to control alleged "predatory" or discriminatory
lending practices through broad or targeted legislative or regulatory
initiatives aimed at lenders operation in consumer lending markets, including
non-traditional mortgage products or tax refund anticipation loans, could affect
us in a substantial and unpredictable ways, including limiting the types of
consumer loan products we can offer. In addition, there may be amendments to,
and new interpretations of risk-based capital guidelines and reporting
instructions, including changes in response to Basel II Capital Accords. We
cannot determine whether such legislative or regulatory initiatives will be
instituted or predict the impact of such initiatives would have on our results.
CHANGES IN ACCOUNTING STANDARDS. Our accounting policies and methods are
fundamental to how we record and report our financial condition and results of
operations. From time to time the Financial Accounting Standards Board ("FASB"),
the SEC and our bank regulators, including the Office of Comptroller of the
Currency and the Board of Governors of the Federal Reserve System, change the
financial accounting and reporting standards that govern the preparation of
external financial statements. These changes are beyond our control, can be hard
to predict and could materially impact how we report our financial results and
condition. We could be required to apply a new or revised standard
retroactively, resulting in our restating prior period financial statements in
material amounts.
COMPETITION. We operate in a highly competitive environment and we expect
competitive conditions to continue to intensify as continued merger activity in
the financial services industry produces larger, better-capitalized and more
geographically-diverse companies, including lenders with access to government
sponsored organizations for our consumer segment, that are capable of offering a
wider array of consumer financial products and services at competitive prices.
In addition, the traditional segregation of the financial services industry into
prime and non-prime segments has eroded and in the future is expected to
continue to do so, further increasing competition for our core customer base.
Such competition may impact the terms, rates, costs and/or profits historically
included in the loan products we offer or purchase. There can be no assurance
that the significant and increasing competition in the financial services
industry will not materially adversely affect our future results of operations.
MANAGEMENT PROJECTIONS. Pursuant to U.S. GAAP, our management is required to use
certain estimates in preparing our financial statements, including accounting
estimates to determine loan loss reserves, reserves related to future
litigation, and the fair market value of certain assets and liabilities, among
other items. In particular, loan loss reserve estimates are judgmental and are
influenced by factors outside our control. As result, estimates could change as
economic conditions change. If our management's determined values for such items
turn out to be substantially inaccurate, we may experience unexpected losses
which could be material.
LAWSUITS AND REGULATORY INVESTIGATIONS AND PROCEEDINGS. HSBC Finance Corporation
or one of our subsidiaries is named as a defendant in various legal actions,
including class actions and other litigation or disputes with third parties, as
well as investigations or proceedings brought by regulatory agencies. These or
other future actions brought against us may result in judgments, settlements,
fines, penalties or other results, including additional compliance requirements,
adverse to us which could materially adversely affect our business, financial
condition or results of operation, or cause us serious reputational harm.
OPERATIONAL RISKS. Our businesses are dependent on our ability to process a
large number of increasingly complex transactions. If any of our financial,
accounting, or other data processing systems fail or have other significant
shortcomings, we could be materially adversely affected. We are similarly
dependent on our employees. We could be materially adversely affected if an
employee causes a significant operational break-down or failure, either as a
result of human error or where an individual purposefully sabotages or
fraudulently
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manipulates our operations or systems. Third parties with which we do business
could also be sources of operational risk to us, including relating to
break-downs or failures of such parties' own systems or employees. Any of these
occurrences could result in diminished ability by us to operate one or more of
our businesses, potential liability to clients, reputational damage and
regulatory intervention, all of which could materially adversely affect us.
We may also be subject to disruptions of our operating systems arising from
events that are wholly or partially beyond our control, which may include, for
example, computer viruses or electrical or telecommunications outages or natural
disasters, such as Hurricane Katrina, or events arising from local or regional
politics, including terrorist acts. Such disruptions may give rise to losses in
service to customers, inability to collect our receivables in affected areas and
other loss or liability to us.
In a company as large and complex as ours, lapses or deficiencies in internal
control over financial reporting are likely to occur from time to time, and
there is no assurance that significant deficiencies or material weaknesses in
internal controls may not occur in the future.
In addition there is the risk that our controls and procedures as well as
business continuity and data security systems prove to be inadequate. Any such
failure could affect our operations and could materially adversely affect our
results of operations by requiring us to expend significant resources to correct
the defect, as well as by exposing us to litigation or losses not covered by
insurance.
Changes to operational practices from time to time, such as determinations to
sell receivables from our domestic private label portfolio, structuring all new
collateralized funding transactions as secured financings, or changes to our
customer account management and risk management/collection policies and
practices could materially impact our performance and results. For instance, it
is unclear what impact, if any, the raising of the minimum payment on our credit
card accounts which was effective in January 2006 will have.
LIQUIDITY. Our liquidity is critical to our ability to operate our businesses,
grow and be profitable. A compromise to our liquidity could therefore have a
negative effect on us. Potential conditions that could negatively affect our
liquidity include diminished access to capital markets, unforeseen cash or
capital requirements, an inability to sell assets and an inability to obtain
expected funding from HSBC subsidiaries and clients.
Our credit ratings are an important part of maintaining our liquidity, as a
reduction in our credit ratings would also negatively affect our liquidity. A
credit ratings downgrade, depending on its severity, could potentially increase
borrowing costs, limit access to capital markets, require cash payments or
collateral posting, and permit termination of certain contracts material to us.
ACQUISITION INTEGRATION. We have in the past and may in the future seek to grow
our business by acquiring other businesses or loan portfolios, such as our
acquisition of Metris Companies, Inc. ("Metris") in 2005. There can be no
assurance that our acquisitions will have the anticipated positive results,
including results relating to: the total cost of integration; the time required
to complete the integration; the amount of longer-term cost savings; or the
overall performance of the combined entity. Integration of an acquired business
can be complex and costly, sometimes including combining relevant accounting and
data processing systems and management controls, as well as managing relevant
relationships with clients, suppliers and other business partners, as well as
with employees.
There is no assurance that our most recent acquisitions or that any businesses
or portfolios acquired in the future will be successfully integrated and will
result in all of the positive benefits anticipated. If we are not able to
integrate successfully our past and any future acquisitions, there is the risk
our results of operations could be materially and adversely affected.
RISK MANAGEMENT. We seek to monitor and control our risk exposure through a
variety of separate but complementary financial, credit, operational, compliance
and legal reporting systems, including models and programs that predict loan
delinquency and loss. While we employ a broad and diversified set of risk
monitoring and risk mitigation techniques, those techniques and the judgments
that accompany their
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HSBC Finance Corporation
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application cannot anticipate every economic and financial outcome or the
specifics and timing of such outcomes. Accordingly, our ability to successfully
identify and manage risks facing us is an important factor that can
significantly impact our results.
EMPLOYEE RETENTION. Our employees are our most important resource and, in many
areas of the financial services industry, competition for qualified personnel is
intense. If we were unable to continue to retain and attract qualified employees
to support the various functions of our business, including the credit risk
analysis, underwriting, servicing, collection and sales, our performance,
including our competitive position, could be materially adversely affected.
REPUTATIONAL RISK. Our ability to attract and retain customers and transact with
our counterparties could be adversely affected to the extent our reputation is
damaged. Our failure to address, or to appear to fail to address, various issues
that could give rise to reputational risk could cause harm to us and our
business prospects. These issues include, but are not limited to, appropriately
addressing potential conflicts of interest, legal and regulatory requirements,
ethical issues, money-laundering, privacy, record-keeping, sales and trading
practices, and the proper identification of the legal, reputational, credit,
liquidity and market risks inherent in our products. The failure to address
appropriately these issues could make our customers unwilling to do business
with us, which could adversely affect our results.
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HSBC Finance Corporation
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ITEM 6. EXHIBITS
--------------------------------------------------------------------------------
Exhibits included in this Report:
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
62
HSBC Finance Corporation
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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: May 12, 2006
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HSBC Finance Corporation
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EXHIBIT INDEX
--------------------------------------------------------------------------------
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
64
HSBC Finance Corporation
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EXHIBIT 12
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND TO
COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
THREE MONTHS ENDED
MARCH 31,
-------------------
2006 2005
---------------------------------------------------------------------------------
(DOLLARS ARE IN
MILLIONS)
Net income.................................................. $ 888 $ 626
Income tax expense.......................................... 511 341
------ ------
Income before income tax expense............................ 1,399 967
------ ------
Fixed charges:
Interest expense.......................................... 1,623 1,062
Interest portion of rentals(1)............................ 16 15
------ ------
Total fixed charges......................................... 1,639 1,077
------ ------
Total earnings as defined................................... $3,038 $2,044
====== ======
Ratio of earnings to fixed charges.......................... 1.85 1.90
Preferred stock dividends(2)................................ 14 28
Ratio of earnings to combined fixed charges and preferred
stock dividends........................................... 1.84 1.85
---------------
(1) Represents one-third of rentals, which approximates the portion representing
interest.
(2) Preferred stock dividends are grossed up to their pretax equivalents.
HSBC Finance Corporation
--------------------------------------------------------------------------------
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 annual 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 functions):
a) all significant deficiencies and material weaknesses in the
design or operation of internal controls over financial reporting which
are reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: May 12, 2006
/s/ SIDDHARTH N. MEHTA
--------------------------------------
Siddharth N. Mehta
Chairman and Chief Executive Officer
HSBC Finance Corporation
--------------------------------------------------------------------------------
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 annual 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 functions):
a) all significant deficiencies and material weaknesses in the
design or operation of internal controls over financial reporting which
are reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: May 12, 2006
/s/ BEVERLEY A. SIBBLIES
--------------------------------------
Beverley A. Sibblies
Senior Executive Vice President
and Chief Financial Officer
HSBC Finance Corporation
--------------------------------------------------------------------------------
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
The certification set forth below is being submitted in connection with the HSBC
Finance Corporation (the "Company") Quarterly Report on Form 10-Q for the period
ending March 31, 2006 as filed with the Securities and Exchange Commission on
the date hereof (the "Report") for the purpose of complying with Rule 13a-14(b)
or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the "Exchange Act")
and Section 1350 of Chapter 63 of Title 18 of the United States Code.
I, Siddharth N. Mehta, Chairman and Chief Executive Officer of the Company,
certify that:
1. the Report fully complies with the requirements of Section 13(a) or
15(d) of the Exchange Act; and
2. the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of
HSBC Finance Corporation.
May 12, 2006 /s/ SIDDHARTH N. MEHTA
-------------------------------------
Siddharth N. Mehta
Chairman and Chief Executive Officer
HSBC Finance Corporation
--------------------------------------------------------------------------------
CERTIFICATION PURSUANT TO 18 U.S.C.
SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906 OF
THE SARBANES-OXLEY ACT OF 2002
The certification set forth below is being submitted in connection with the HSBC
Finance Corporation (the "Company") Quarterly Report on Form 10-Q for the period
ending March 31, 2006 as filed with the Securities and Exchange Commission on
the date hereof (the "Report") for the purpose of complying with Rule 13a-14(b)
or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the "Exchange Act")
and Section 1350 of Chapter 63 of Title 18 of the United States Code.
I, Beverley A. Sibblies, Senior Vice President and Chief Financial Officer of
the Company, certify that:
1. the Report fully complies with the requirements of Section 13(a) or
15(d) of the Exchange Act; and
2. the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of
HSBC Finance Corporation.
May 12, 2006 /s/ BEVERLEY A. SIBBLIES
-------------------------------------
Beverley A. Sibblies
Senior Vice President
and Chief Financial Officer
This certification accompanies each Report pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the
Sarbanes-Oxley Act of 2002, be deemed filed by HSBC Finance Corporation for
purposes of Section 18 of the Securities Exchange Act of 1934, as amended.
Signed originals of these written statements required by Section 906 of the
Sarbanes-Oxley Act of 2002 have been provided to HSBC Finance Corporation and
will be retained by HSBC Finance Corporation and furnished to the Securities and
Exchange Commission or its staff upon request.
HSBC Finance Corporation
--------------------------------------------------------------------------------
EXHIBIT 99.1
DEBT AND PREFERRED STOCK SECURITIES RATINGS
STANDARD & MOODY'S
POOR'S INVESTORS DOMINION BOARD
CORPORATION SERVICE FITCH, INC. RATING SERVICE
-------------------------------------------------------------------------------------------------------
AS OF MARCH 31, 2006
HSBC Finance Corporation
Senior debt.................................. A Aa3 AA- AA (low)
Senior subordinated debt..................... A- A2 A+ *
Commercial paper............................. A-1 P-1 F-1+ R-1 (middle)
Series B preferred stock..................... BBB+ A3 A+ *
HFC Bank Limited
Senior debt.................................. A Aa3 AA- *
Commercial paper............................. A-1 P-1 F-1+ *
HSBC Bank Nevada, National Association
Senior debt.................................. A A1 AA- *
HSBC Financial Corporation Limited
Senior notes and term loans.................. * * * AA (low)
Commercial paper............................. * * * R-1 (middle)
---------------
* Not rated by this agency.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
HSBC Holdings plc
By:
Name: P A Stafford
Title: Assistant Group Secretary
Date: 15 May 2006