FORM 6-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Report of Foreign Private Issuer
Pursuant to Rule 13a - 16 or 15d - 16 of
the Securities Exchange Act of 1934
For the month of March, 2007
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- ..............)
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: 5 March 2007
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 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
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
8.40% Debentures Maturing at Holder's Option Annually on New York Stock Exchange
December 15, Commencing in 1986 and Due May 15, 2008
Floating Rate Notes due May 21, 2008 New York Stock Exchange
Floating Rate Notes, due September 15, 2008 New York Stock Exchange
Floating Rate Notes due October 21, 2009 New York Stock Exchange
Floating Rate Notes due October 21, 2009 New York Stock Exchange
4.625% Notes, due September 15, 2010 New York Stock Exchange
5.25% Notes, due January 14, 2011 New York Stock Exchange
6 3/4% Notes, due May 15, 2011 New York Stock Exchange
5.7% Notes due June 1, 2011 New York Stock Exchange
Floating Rate Notes, due July 19, 2012 New York Stock Exchange
Floating Rate Notes, due September 14, 2012 New York Stock Exchange
Floating Rate Notes due January 15, 2014 New York Stock Exchange
5.25% Notes due January 15, 2014 New York Stock Exchange
5.0% Notes, due June 30, 2015 New York Stock Exchange
5.5% Notes due January 19, 2016 New York Stock Exchange
Floating Rate Notes due June 1, 2016 New York Stock Exchange
6.875% Notes, due January 30, 2033 New York Stock Exchange
6% Notes, due November 30, 2033 New York Stock Exchange
Depositary Shares (each representing one-fortieth share of New York Stock Exchange
6.36% Non-Cumulative Preferred Stock, Series B, no par,
$1,000 stated maturity)
Guarantee of Preferred Securities of HSBC Capital Trust IX New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes (X) No ( )
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes ( ) No (X)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes (X) No ( )
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (X)
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 (X)
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act). Yes ( ) No (X)
As of March 2, 2007, there were 55 shares of the registrant's common stock
outstanding, all of which are owned by HSBC Investments (North America) Inc.
DOCUMENTS INCORPORATED BY REFERENCE
None.
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TABLE OF CONTENTS
PART/ITEM NO PAGE
------------ ----
PART I
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Item 1. Business
Organization History and Acquisition by HSBC.............. 4
HSBC North America Operations............................. 4
HSBC Finance Corporation - General........................ 5
Operations................................................ 7
Funding................................................... 12
Regulation and Competition................................ 13
Corporate Governance and Controls......................... 16
Cautionary Statement on Forward-Looking Statements........ 16
Item 1A. Risk Factors................................................ 17
Item 1B. Unresolved Staff Comments................................... 19
Item 2. Properties.................................................. 20
Item 3. Legal Proceedings........................................... 20
Item 4. Submission of Matters to a Vote of Security Holders......... 22
PART II
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Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 22
Item 6. Selected Financial Data..................................... 23
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Executive Overview........................................ 26
Basis of Reporting........................................ 32
Critical Accounting Policies.............................. 40
Receivables Review........................................ 44
Results of Operations..................................... 48
Segment Results - IFRS Management Basis................... 55
Credit Quality............................................ 64
Liquidity and Capital Resources........................... 79
Off Balance Sheet Arrangements and Secured Financings..... 88
Risk Management........................................... 91
Glossary of Terms......................................... 98
Credit Quality Statistics................................. 101
Analysis of Credit Loss Reserves Activity................. 103
Net Interest Margin....................................... 104
Reconciliations to U.S. GAAP Financial Measures........... 106
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 109
Item 8. Financial Statements and Supplementary Data................. 109
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 176
Item 9A. Controls and Procedures..................................... 176
Item 9B. Other Information........................................... 176
2
PART/ITEM NO PAGE
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PART III
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Item 10. Directors and Executive Officers of the Registrant.......... 176
Item 11. Executive Compensation...................................... 184
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters................ 216
Item 13. Certain Relationships and Related Transactions.............. 217
Item 14. Principal Accountant Fees and Services...................... 218
PART IV
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Item 15. Exhibits and Financial Statement Schedules
Financial Statements...................................... 219
Exhibits.................................................. 219
Signatures................................................................. 222
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PART I
ITEM 1. BUSINESS.
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ORGANIZATION HISTORY AND ACQUISITION BY HSBC
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HSBC Finance Corporation traces its origin to 1878 and operated as a consumer
finance company under the name Household Finance Corporation ("HFC") for most of
its history. In 1981, HFC shareholders approved a restructuring that resulted in
the formation of Household International, Inc. ("Household") as a publicly held
holding company and HFC became a wholly-owned subsidiary of Household. For a
period, Household diversified its operations outside the financial services
industry, but returned solely to consumer finance operations through a series of
divestitures in the 1980's and 1990's.
On March 28, 2003, Household was acquired by HSBC Holdings plc ("HSBC") by way
of merger with H2 Acquisition Corporation ("H2"), a wholly owned subsidiary of
HSBC, in a purchase business combination. Following the merger, H2 was renamed
"Household International, Inc." Subsequently, HSBC transferred its ownership
interest in Household to a wholly owned subsidiary, HSBC North America Holdings
Inc. ("HSBC North America"), which subsequently contributed Household to its
wholly-owned subsidiary, HSBC Investments (North America) Inc.
On December 15, 2004, Household merged with its wholly owned subsidiary, HFC. By
operation of law, following the merger, all obligations of HFC became direct
obligations of Household. Following the merger, Household changed its name to
HSBC Finance Corporation. The name change was a continuation of the rebranding
of the Household businesses to the HSBC brand. These actions were taken to
establish a single brand in North America to create a stronger platform to
advance growth across all HSBC business lines.
For all reporting periods up to and including the year ended December 31, 2004,
HSBC prepared its consolidated financial statements in accordance with U.K.
Generally Accepted Accounting Principles ("U.K. GAAP"). From January 1, 2005,
HSBC has prepared its consolidated financial statements in accordance with
International Financial Reporting Standards ("IFRSs") as endorsed by the
European Union and effective for HSBC's reporting for the year ended December
31, 2005. HSBC Finance Corporation reports to HSBC under IFRSs and, as a result,
corporate goals and the individual goals of executives are calculated in
accordance with IFRSs rather than U.K. GAAP, which has been the practice
subsequent to our acquisition by HSBC.
HSBC NORTH AMERICA OPERATIONS
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HSBC North America is the holding company for HSBC's operations in the United
States and Canada. The principal subsidiaries of HSBC North America are HSBC
Finance Corporation, HSBC Bank Canada, a Federal bank chartered under the laws
of Canada, HSBC USA Inc. ("HUSI"), a U.S. bank holding company, HSBC Markets
(USA) Inc., a holding company for investment banking and markets subsidiaries,
and HSBC Technology Services (USA) Inc., a provider of information technology
services. HUSI's principal U.S. banking subsidiary is HSBC Bank USA, National
Association ("HSBC Bank USA"), a national bank with more than 385 banking
offices in New York State located in 44 counties, sixteen branches each in
Florida and California, fifteen branches in New Jersey, two branches in
Pennsylvania and one branch each in Oregon, Washington State, Delaware and
Washington D.C. Under the oversight of HSBC North America, HSBC Finance
Corporation works with its affiliates to maximize opportunities and efficiencies
in HSBC's operations in Canada and the United States. These affiliates do so by
providing each other with, among other things, alternative sources of liquidity
to fund operations and expertise in specialized corporate functions and
services. This has been demonstrated by purchases and sales of receivables
between HSBC Bank USA and HSBC Finance Corporation, a pooling of resources to
create a new unit that provides technology services to all HSBC North America
subsidiaries and shared, but allocated, support among the affiliates for tax,
legal, risk, compliance, accounting, insurance, strategy and internal audit
functions. In addition, clients of HSBC Bank USA and other affiliates are
investors in our debt and preferred securities, providing significant sources of
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liquidity and capital to HSBC Finance Corporation. HSBC Securities (USA) Inc., a
Delaware corporation, registered broker dealer and a subsidiary of HSBC Markets
(USA) Inc., leads or participates as underwriter of all domestic issuances of
our term corporate and asset backed securities. While HSBC Finance Corporation
does not receive advantaged pricing, the underwriting fees and commissions
payable to HSBC Securities (USA) Inc. benefit HSBC as a whole.
HSBC FINANCE CORPORATION - GENERAL
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HSBC Finance Corporation's subsidiaries provide middle-market consumers in the
United States, the United Kingdom, Canada and the Republic of Ireland with
several types of loan products. Prior to November 2006, when we sold our
interests to an affiliate, we also offered consumer loans in Slovakia, the Czech
Republic and Hungary. HSBC Finance Corporation is the principal fund raising
vehicle for the operations of its subsidiaries. In this Form 10-K, HSBC Finance
Corporation and its subsidiaries are referred to as "we," "us" or "our."
Our lending products include real estate secured loans, auto finance loans,
MasterCard(1), Visa(1), American Express(1) and Discover(1) credit card loans,
private label credit card loans, including retail sales contracts and personal
non-credit card loans. We also initiate tax refund anticipation loans and other
related products in the United States and offer specialty insurance products in
the United States, United Kingdom and Canada. We generate cash to fund our
businesses primarily by collecting receivable balances; issuing commercial
paper, medium and long term debt; borrowing from HSBC subsidiaries and
customers; selling consumer receivables; and borrowing under secured financing
facilities. We use the cash generated by these financing activities to invest in
and support receivable growth, to service our debt obligations and to pay
dividends to our parent and preferred stockholders. At December 31, 2006, we had
approximately 36,000 employees and over 66 million customers. Consumers residing
in the state of California accounted for 13% of our domestic consumer
receivables. We also have significant concentrations of domestic consumer
receivables in Florida (7%), New York (6%), Texas (5%), Ohio (5%) and
Pennsylvania (5%).
SIGNIFICANT DEVELOPMENTS SINCE 2001
Since 2001, HSBC Finance Corporation:
- Developed additional distribution channels for our products, including
through the Internet and co-branding opportunities with retail merchants
and service providers.
- Since our acquisition by HSBC we have actively worked with our North
American affiliates to expand HSBC's brand recognition and to leverage
growth opportunities with merchants, suppliers and customers. Our name
was changed to HSBC Finance Corporation and several businesses now
operate under the HSBC name, including our Canadian branch offices, our
domestic and Canadian auto finance business and our credit card banking
subsidiary.
- Recorded a pre-tax charge of $525 million in the third quarter of 2002 in
settlement of alleged violations of Federal and state consumer
protection, consumer financing and banking laws and regulations with
respect to our real estate secured lending from retail branch offices.
- Without admitting or denying wrongdoing, in March 2003 consented to entry
of order by the Securities and Exchange Commission ("SEC") that contained
findings relating to the sufficiency of certain disclosures filed with
the SEC in 2002 regarding loan restructuring practices.
- Announced in the third quarter of 2004 our intention to structure all new
collateralized funding transactions as secured financings. Because prior
public MasterCard and Visa credit card transactions as well as certain
personal non-credit card transactions were structured as sales to
revolving trusts that require replenishment of receivables to support
previously issued securities, receivables continue to be sold to the
related credit card trusts until the revolving periods end, the last of
which is expected to
---------------
(1) MasterCard is a registered trademark of MasterCard International,
Incorporated; Visa is a registered trademark of Visa USA, Inc.; American
Express is a registered trademark of American Express Company and Discover
is a registered trademark of Novus Credit Services, Inc.
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occur in the fourth quarter of 2007. Termination of sale treatment for new
collateralized funding activity reduced our reported net income under U.S.
GAAP in 2006, 2005 and 2004 and will continue to in future periods. However,
there was no impact on cash received from operations.
- Adopted charge-off and account management policies in accordance with the
Uniform Retail Credit Classification and Account Management Policy issued
by the Federal Financial Institutions Examination Council ("FFIEC
Policies") for our domestic credit card and private label portfolios
(excluding consumer lending retail sales contracts) in the fourth quarter
of 2004. Because we sold our domestic private label portfolio (excluding
retail sales contracts at our Consumer Lending business) to HSBC Bank USA
in December 2004, the ongoing impact of the adoption of these policies
only impact our domestic credit card portfolio. As expected, the adoption
of FFIEC Policies for our domestic credit card portfolio did not have a
significant impact on results of operations or cash flows in 2006.
- Since our acquisition by HSBC, our debt ratings as assigned by Fitch
Investor's Service ("Fitch"), Moody's Investors Service ("Moody's") and
Standard and Poor's Corporation ("S&P") have improved to AA-, Aa3 and
AA-, respectively for our senior debt, while our Commercial Paper ratings
have improved to F-1+, P-1, and A-1+, respectively. See Exhibit 99.1 to
this Form 10-K for a complete listing of debt ratings of HSBC Finance
Corporation and our subsidiaries.
- Sold $12.2 billion of domestic private label receivables and the retained
interests associated with securitized private label receivables to HSBC
Bank USA in December 2004. We also entered into an agreement under which
all domestic private label receivables (excluding retail sales contracts
at our Consumer Lending business) originated under private label accounts
are sold to HSBC Bank USA daily, on a servicing retained basis. HSBC Bank
USA also purchased higher quality nonconforming domestic real estate
secured loans from us in December 2003 and in March 2004.
- Deepened the non-prime expertise of our domestic MasterCard/Visa credit
card business through acquisition of Metris Companies, Inc. ("Metris") in
2005.
- Recorded an incremental pre-tax provision for credit losses of $185
million in 2005, reflecting our best estimate of the impact of Hurricane
Katrina on our loan portfolio. As a result of continuing assessments, we
reduced our estimate of credit loss exposure related to Katrina by $90
million in 2006.
- Experienced higher bankruptcy filings in 2005, in particular during the
period leading up to the October 17, 2005 effective date of new
legislation in the United States. As expected, the number of bankruptcy
filings subsequent to the enactment of this new legislation decreased
dramatically, but beginning in the second quarter began to rise from the
low levels following enactment. We believe that a portion of the increase
in net charge-offs resulting from the higher bankruptcy filings in 2005
was an acceleration of net charge-offs that would otherwise have been
experienced in future periods.
- Sold our U.K. credit card business including $2.5 billion of receivables,
the associated cardholder relationships as well as the related retained
interests in securitized credit card receivables and certain assets
relating to the credit card operations to HSBC Bank plc ("HBEU") in
December 2005. The premium received in excess of book value of the assets
transferred, including the goodwill assigned to this business, was
recorded as an increase to additional paid in capital. Our U.K.
subsidiary, HFC Bank Limited, continues to provide collection and other
support services to HBEU for a fee. As a result, in 2006, net interest
income, fee income and provision for credit losses related to this
portfolio were reduced while other revenues increased from servicing
revenues on the portfolio. The net effect of the sale did not result in a
material reduction of our consolidated net income in 2006. We continue to
evaluate the scope of our other U.K. operations.
- Experienced tightened credit spreads relative to Treasury Bonds compared
to those we experienced during the months leading up to the announcement
of our acquisition by HSBC. Primarily as a result of these tightened
credit spreads, we recognized cash funding expense savings of
approximately $940 million in 2006, $600 million in 2005 and $350 million
in 2004 compared to the funding costs we would have incurred using
average spreads from the first half of 2002.
- Prior to the acquisition by HSBC, the majority of our fair value and cash
flow hedges were effective hedges which qualified for the shortcut method
of accounting. Under the Financial Accounting Standards Board's
interpretations of SFAS No. 133, the shortcut method of accounting was no
longer
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allowed for interest rate swaps which were outstanding at the time of the
acquisition by HSBC. As a result of the acquisition, we were required to
reestablish and formally document the hedging relationship associated
with all of our fair value and cash flow hedging instruments and assess
the effectiveness of each hedging relationship, both at inception of the
acquisition and on an ongoing basis. As a result of deficiencies in our
contemporaneous hedge documentation at the time of acquisition, we lost
the ability to apply hedge accounting to our entire cash flow and fair
value hedging portfolio that existed at the time of acquisition by HSBC.
During 2005, we reestablished hedge treatment under the long haul method
of accounting for a significant number of the derivatives in this
portfolio. In addition, all of the hedge relationships which qualified
under the shortcut method provisions of SFAS No. 133 have now been
redesignated, substantially all of which are hedges under the long-haul
method of 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. 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 year ended December 31,
2006 should not be considered indicative of the results for any future
periods.
- In November 2006, sold our entire interest in Kanbay International, an
information technology services firm headquartered in greater Chicago
with offices worldwide, to Capgemini S.A., resulting in a pre-tax gain of
$123 million.
- Due to the slowing of the real estate market, we experienced higher
delinquency and losses in our Mortgage Services real estate portfolio in
2006. In the third quarter of 2006, we tightened our underwriting
standards on loans purchased from correspondents resulting in lower
purchases of second lien and selected higher risk loans. These activities
reduced and will continue to reduce the volume of correspondent purchases
in the future which will have the effect of slowing growth in the real
estate secured portfolio.
- Established common management over our Consumer Lending and Mortgage
Services businesses including Decision One Mortgage Company, LLC
("Decision One") to enhance our combined organizational effectiveness,
drive operational efficiency and improve overall balance sheet management
capabilities. As part of this effort, we are currently evaluating the
most effective structure for our Mortgage Services operations which,
depending upon the outcome, may change the scope and size of this
business going forward.
- Our Consumer Lending business purchased Solstice Capital Group Inc. with
assets of approximately $49 million in the fourth quarter of 2006.
- In November 2006, sold all of the capital stock of our operations in the
Czech Republic, Hungary and Slovakia to a wholly owned subsidiary of HSBC
Bank plc.
- In November 2006, acquired the $2.5 billion mortgage loan portfolio of
KeyBank, N.A.'s division operated as Champion Mortgage, a retail mortgage
lending company.
OPERATIONS
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Our operations are divided into three reportable segments: Consumer, Credit Card
Services and International. Our Consumer segment includes our Consumer Lending,
Mortgage Services, Retail Services, and Auto Finance businesses. Our Credit Card
Services segment includes our domestic MasterCard, Visa and Discover credit card
business. Our International segment includes our foreign operations in the
United Kingdom, Canada and the Republic of Ireland and prior to November 9,
2006, operations in Slovakia, the Czech Republic and Hungary. Information about
businesses or functions that fall below the segment reporting quantitative
threshold tests such as our Insurance Services, Taxpayer Financial Services and
Commercial operations, as well as our Treasury and Corporate activities, which
include fair value adjustments related to
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purchase accounting and related amortization, are included under the "All Other"
caption within our segment disclosure.
Corporate goals and individual goals of executives are currently calculated in
accordance with IFRSs under which HSBC prepares its consolidated financial
statements. In 2006 we initiated a project to refine the monthly internal
management reporting process to place a greater emphasis on IFRS management
basis reporting (a non-U.S. GAAP financial measure) ("IFRS Management Basis").
As a result, operating results are now being monitored and reviewed, trends are
being evaluated and decisions about allocating resources, such as employees, are
being made almost exclusively on an IFRS Management Basis. IFRS Management Basis
results are IFRSs results which assume that the private label and real estate
secured receivables transferred to HSBC Bank USA have not been sold and remain
on our balance sheet. Operations are monitored and trends are evaluated on an
IFRS Management Basis because the customer loan sales to HSBC Bank USA were
conducted primarily to appropriately fund prime customer loans within HSBC and
such customer loans continue to be managed and serviced by us without regard to
ownership. Therefore, we have changed the measurement of segment profit to IFRS
Management Basis in order to align with our revised internal reporting
structure. However, we continue to monitor capital adequacy, establish dividend
policy and report to regulatory agencies on an U.S. GAAP basis. For
comparability purposes, we have restated segment results for the year ended
December 31, 2005 to the IFRS Management Basis. When HSBC began reporting IFRS
results in 2005, it elected to take advantage of certain options available
during the year of transition from U.K. GAAP to IFRSs which provided, among
other things, an exemption from applying certain IFRSs retrospectively.
Therefore, the segment results reported for the year ended December 31, 2004 are
presented on an IFRS Management Basis excluding the retrospective application of
IAS 32, "Financial Instruments: Presentation" and IAS 39, "Financial
Instruments: Recognition and Measurement" which took effect on January 1, 2005
and, as a result, the accounting for credit loss impairment provisioning,
deferred loan origination costs and premiums and derivative income for the year
ended December 31, 2004 remain in accordance with U.K. GAAP, HSBC's previous
basis of reporting. Credit loss provisioning under U.K. GAAP differs from IFRSs
in that IFRSs require a discounted cash flow methodology for estimating
impairment as well as accruing for future recoveries of charged-off loans on a
discounted basis. Under U.K. GAAP only sales incentives were treated as deferred
loan origination costs which results in lower deferrals than those reported
under IFRSs. Additionally, deferred costs and fees could be amortized over the
contractual life of the underlying receivables rather than the expected life as
required under IFRSs. Derivative and hedge accounting under U.K. GAAP differs
from IFRSs in many respects, including the determination of when a hedge exists
as well as the reporting of gains and losses. For a more detailed discussion of
the differences between IFRSs and U.K. GAAP, see Exhibit 99.2 to this Form 10-K.
Also, see "Basis of Reporting" for a more detailed discussion of the differences
between IFRSs and U.S. GAAP.
GENERAL
We generally serve non-conforming and non-prime consumers. Such customers are
individuals who have limited credit histories, modest incomes, high
debt-to-income ratios, high loan-to-value ratios (for auto and real estate
secured products) or have experienced credit problems caused by occasional
delinquencies, prior charge-offs, bankruptcy or other credit related actions.
These customers generally have higher delinquency and credit loss probabilities
and are charged a higher interest rate to compensate for the additional risk of
loss (where the loan is not adequately collateralized to mitigate such
additional risk of loss) and the anticipated additional collection initiatives
that may have to be undertaken over the life of the loan. We also originate
and/or purchase near-prime real estate secured,
MasterCard/Visa/Discover/American Express and auto loans. In our credit card,
retail services and international businesses, we also serve prime consumers
either through co-branding, merchant relationships or direct mailings.
We are responsive to the needs of our customers in the products we offer and
periodically test new loan products in our different business units. In
particular, consumer demand for alternative mortgage products has increased
significantly in recent years, including requests for interest-only payment
loans, adjustable-rate loans
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with alternative payment options ("option ARMs") and negatively amortizing
loans. HSBC Finance Corporation does not and does not anticipate offering option
ARMs or other negative amortization products. We do offer loans under which the
borrower makes fixed rate interest-only payments for some period of time prior
to interest rate adjustments and/or higher payments that include a principal
component. Due to customer demand, this segment of our real estate secured
portfolio experienced rapid growth in the third and fourth quarters of 2005 and
continued into 2006. At December 31, 2006, the outstanding balance of our
interest-only loans was $6.2 billion, or 4 percent of receivables. As with all
other products, we underwrite to criteria that consider the particular terms of
the loan and price the interest-only loans in a manner that compensates for the
higher risk that, during the period higher payments are required, customers may
be unable to repay their loans. Additional information concerning interest-only
loans is contained in Note 24, "Concentrations of Credit Risk" to our
consolidated financial statements.
We use our centralized underwriting, collection and processing functions to
adapt our credit standards and collection efforts to national or regional market
conditions. Our underwriting, loan administration and collection functions are
supported by highly automated systems and processing facilities. Our centralized
collection systems are augmented by personalized early collection efforts.
Analytics drive our decisions in marketing, risk pricing, operations and
collections.
We service each customer with a view to understanding that customer's personal
financial needs. We recognize that individuals may not be able to meet all of
their financial obligations on a timely basis. Our goal is to assist consumers
in transitioning through financially difficult times which may lead to their
doing more business with our lending subsidiaries or other HSBC affiliates. As a
result, our policies and practices are designed to be flexible to maximize the
collectibility of our loans while not incurring excessive collection expenses on
loans that have a high probability of being ultimately uncollectible. Proactive
credit management, "hands-on" customer care and targeted product marketing are
means we use to retain customers and grow our business.
CONSUMER
Our Consumer Lending business is one of the largest subprime home equity
originators in the United States as ranked by Inside B&C Lending. This business
has 1,382 branches located in 46 states, and approximately 3.0 million active
customer accounts, $65.2 billion in receivables and 13,300 employees. It is
marketed under both the HFC and Beneficial brand names, each of which caters to
a slightly different type of customer in the middle-market population. Both
brands offer secured and unsecured loan products, such as first and second lien
position closed-end mortgage loans, open-end home equity loans, personal
non-credit card loans, including personal homeowner loans (a secured high
loan-to-value product that we underwrite and treat like an unsecured loan) and
auto finance receivables. These products are marketed through our retail branch
network, direct mail, telemarketing, strategic alliances and internet sourced
applications and leads. We also acquire portfolios on an opportunistic basis. As
of December 31, 2006, approximately 92% of our consumer loans bore fixed rates,
71% were secured products and 86% of the secured products were first liens.
Our Mortgage Services business purchases non-conforming first and second lien
position residential mortgage loans, including open-end home equity loans, from
a network of over 220 unaffiliated third-party lenders (i.e., correspondents).
This business has approximately $48.0 billion in receivables, 457,000 active
customer accounts and 3,400 employees. Purchases are primarily "bulk"
acquisitions (i.e., pools of loans) but also include "flow" acquisitions (i.e.,
loan by loan), and are made based on our specific underwriting guidelines. As of
December 31, 2006, Mortgage Services serviced approximately $3.3 billion of
receivables for other parties, including HSBC Bank USA. We have committed to
purchase real estate secured receivables from select correspondent lenders to
strengthen our relationship with these lenders and to create a sustainable
growth channel for this business. Decision One, a subsidiary of HSBC Finance
Corporation, was purchased in 1999 to assist us in understanding the product
needs of mortgage brokers and trends in the mortgage lending industry. Through
10 branch locations, Decision One directly originates mortgage loans sourced by
mortgage brokers and sells all loans to secondary market purchasers, including
to our Mortgage Services business.
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During January 2007, Mortgage Services announced a reduction in Decision One
branches from seventeen to ten branches. This reduction is designed to make
Decision One more cost efficient and provide more centralized structure for
credit approval. As of December 31, 2006, approximately 46% of the Mortgage
Services portfolio were fixed rate loans, 79% were in first lien position.
On December 29, 2004, our domestic private label receivable portfolio (excluding
retail sales contracts at our Consumer Lending business) of approximately $12.2
billion of receivables was sold to HSBC Bank USA, and agreements were entered
into to sell all future receivables to HSBC Bank USA on a daily basis and to
service the portfolio for HSBC Bank USA for a fee. As a result, we now sell all
domestic private label receivables, (excluding retail sales contracts) upon
origination but service the entire portfolio on behalf of HSBC Bank USA.
According to The Nilson Report, the private label servicing portfolio is the
third largest portfolio in the U.S. Our Retail Services business has over 65
active merchant relationships and we service approximately 16.6 million active
customer accounts and have over 2,400 employees. At December 31, 2006, the
serviced private label portfolio consisted of approximately 11% of receivables
in the furniture industry, 33% in the consumer electronics industry, 31% in the
power sport vehicle (snowmobiles, personal watercraft, all terrain vehicles and
motorcycles) industry and approximately 13% in the department store industry.
Private label financing products are generated through merchant retail
locations, merchant catalog and telephone sales, and direct mail and Internet
applications.
Our Auto Finance business purchases, from a network of approximately 9,300
active dealer relationships, retail installment contracts of consumers who may
not have access to traditional, prime-based lending sources. We also originate
and refinance auto loans through direct mail solicitations, alliance partners,
consumer lending customers and the Internet. At December 31, 2006, this business
had approximately $11.6 billion in receivables, approximately 820,000 active
customer accounts and 2,500 employees. Approximately 34% of auto finance
receivables are secured by new vehicles.
CREDIT CARD SERVICES
Our Credit Card Services business includes our MasterCard, Visa and Discover
receivables in the United States, including The GM Card(R), the AFL-CIO Union
Plus(R) ("UP") credit card, Household Bank, Orchard Bank and HSBC branded cards,
and as of our December 1, 2005 acquisition of Metris, the Direct Merchants Bank.
This business has approximately $27.7 billion in receivables, over 21 million
active customer accounts and 6,100 employees. According to The Nilson Report,
this business is the fifth largest issuer of MasterCard or Visa credit cards in
the United States (based on receivables). The GM Card(R), a co-branded credit
card issued as part of our alliance with General Motors Corporation ("GM"),
enables customers to earn discounts on the purchase or lease of a new GM
vehicle. The UP card program with the AFL-CIO provides benefits and services to
members of various national and international labor unions. The Household Bank,
Orchard Bank and HSBC branded credit cards offer specialized credit card
products to consumers underserved by traditional providers or are marketed in
conjunction with merchant relationships established through our Retail Services
business. The Direct Merchants Bank branded MasterCard/Visa/Discover is a
general purpose card marketed to non-prime customers through direct mail and
strategic partnerships. HSBC branded cards are targeted through direct mail at
the prime market. In addition, Credit Card Services services $1.2 billion of
receivables held by an affiliate, HSBC Bank USA. New receivables and accounts
related to the HSBC Bank USA portfolio are originated by HSBC Bank Nevada, N.A.,
and receivables are sold daily to HSBC Bank USA.
Our Credit Card Services business is generated primarily through direct mail,
telemarketing, Internet applications, application displays, promotional activity
associated with our affinity and co-branding relationships, mass-media
advertisement (The GM Card(R)) and merchant relationships sourced through our
Retail Services business. We also cross-sell our credit cards to our existing
Consumer Lending and Retail Services customers as well as our Taxpayer Financial
Services and Auto Finance customers.
Although our relationships with GM and the AFL-CIO enable us to access a
proprietary customer base, in accordance with our agreements with these
institutions, we own all receivables originated under the programs
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and are responsible for all credit and collection decisions as well as the
funding for the programs. These programs are not dependent upon any payments,
guarantees or credit support from these institutions. As a result, we are not
directly dependent upon GM or the AFL-CIO for any specific earnings stream
associated with these programs. We believe we have a strong working relationship
with GM and the AFL-CIO and in 2005 and 2004, we jointly agreed with GM and the
AFL-CIO, respectively, to extend the term of these successful co-branded and
Affinity Card Programs. These agreements do not expire in the near term.
INTERNATIONAL
Our United Kingdom subsidiary is a mid-market consumer lender focusing on
customer service through its branch locations, and consumer electronics through
its retail finance operations and telemarketing. This business offers secured
and unsecured lines of credit, secured and unsecured closed-end loans, retail
finance products and insurance products. We operate in England, Scotland, Wales,
Northern Ireland and the Republic of Ireland. In December 2005 we sold our U.K.
credit card business to HSBC Bank plc. Under agreement with HSBC Bank plc, we
will continue to provide collection services and other support services,
including components of the compliance, financial reporting and human resource
functions, for this credit card portfolio.
Loans held in the United Kingdom and the Republic of Ireland are originated
through a branch network consisting of 148 Beneficial Finance branches,
merchants, direct mail, broker referrals, the Internet and outbound
telemarketing. At December 31, 2006 we had approximately $5.5 billion in
receivables, 1.5 million customer accounts and 3,800 employees in our operations
in the United Kingdom and the Republic of Ireland.
In order to consolidate our European operations, we sold all of the capital
stock of our consumer finance operations in the Czech Republic, Hungary and
Slovakia to a wholly owned subsidiary of HSBC Bank plc in November 2006 for a
purchase price of approximately $46 million.
Our Canadian business offers real estate secured and unsecured lines of credit,
real estate secured and unsecured closed-end loans, insurance products, private
label credit cards, MasterCard credit card loans, retail finance products and
auto loans to Canadian consumers. These products are marketed through 134 branch
offices in 10 provinces, through direct mail, 70 merchant relationships, 2,000
auto dealer relationships and the Internet. At December 31, 2006, this business
had approximately $3.9 billion in receivables, 1.0 million customer accounts and
1,600 employees.
ALL OTHER
Our Insurance Services operation distributes credit life, disability and
unemployment, accidental death and disability, term life, whole life, annuities,
disability, long term care and a variety of other specialty insurance products
to our customers and the customers of HSBC Bank USA and HSBC Trust Company
(Delaware), N.A. Such products currently are offered throughout the United
States and Canada and are offered to customers based upon their particular
needs. Insurance distributed to our customers is directly written by or
reinsured with one or more of our subsidiaries. Insurance sold to customers of
HSBC Bank USA is written by unaffiliated insurance companies.
The Taxpayer Financial Services business is the leading U.S. provider of
tax-related financial products to consumers through nearly 28,000 unaffiliated
professional tax preparer locations and tax preparation software providers.
Serving more than 10.6 million customers, this business leverages the annual
U.S. income tax filing process to provide products that offer consumers quick
and convenient access to funds in the amount of their anticipated tax refund.
Our Taxpayer Financial Services business processes and collects on refund
anticipation products that are originated by HSBC Bank USA. In 2006, this
business generated a loan volume of approximately $16.1 billion and employed 130
full-time employees.
To help ensure high standards of responsible lending, we provide
industry-leading compliance programs for our tax preparer business partners. Key
elements of our compliance efforts include mandatory online compliance and
sales-practice training, expanded tax preparer due diligence processes, and
on-going sales
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practice monitoring to help ensure that our customers are treated fairly and
that they understand their financial choices. Additionally, access to free
consumer financial education resources and a 48-hour satisfaction guarantee are
offered to customers, which further enhances our compliance and customer service
efforts. We are currently undergoing a strategic review of the Taxpayer
Financial Services business to refine our product offering to focus on and
develop products that provide sustained profitability.
Our commercial operations are very limited in scope and are expected to continue
to decline. We have less than $175 million in commercial receivables.
FUNDING
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We fund our operations globally and domestically, using a combination of capital
market and affiliate debt, preferred equity, sales of consumer receivables and
borrowings under secured financing facilities. We will continue to fund a large
part of our operations in the global capital markets, primarily through the use
of secured financings, commercial paper, medium-term notes and long-term debt.
We will also continue to sell certain receivables, including our domestic
private label originations (excluding retail sales contracts) to HSBC Bank USA.
Our sale of the entire domestic private label portfolio (excluding retail sales
contracts at our Consumer Lending business) to HSBC Bank USA occurred in
December 2004. We now originate and sell all newly originated private label
receivables to HSBC Bank USA on a daily basis. In 2006, these sales were a
significant source of funding as we sold $21.6 billion in receivables to HSBC
Bank USA.
Our continued success and prospects for growth are largely dependent upon access
to the global capital markets. Numerous factors, internal and external, may
impact our access to, and the costs associated with, these markets. These
factors may include our debt ratings, overall economic conditions, overall
capital markets volatility and the effectiveness of our management of credit
risks inherent in our customer base.
The merger with HSBC has improved our access to the capital markets and lowered
our funding costs. In addition to providing several important sources of direct
funding, our affiliation with HSBC has also expanded our access to a worldwide
pool of potential investors. While these new funding synergies have somewhat
reduced our reliance on traditional sources to fund our growth, we balance our
use of affiliate and third-party funding sources to minimize funding expense
while maximizing liquidity. Because we are a subsidiary of HSBC our credit
ratings have improved and our credit spreads relative to Treasury Bonds 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 and improved funding availability, we recognized cash funding
expense savings of approximately $940 million in 2006, $600 million in 2005 and
$350 million in 2004 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 pre-tax cash funding
expense savings in excess of $1 billion for the year ended December 31, 2006.
Our long-term debt, preferred stock and commercial paper ratings, as well as the
long-term debt and commercial paper ratings of our Canadian subsidiary, have
been assigned investment grade ratings by all nationally recognized statistical
rating organizations. For a detailed listing of the ratings that have been
assigned to HSBC Finance Corporation and our significant subsidiaries as of
December 31, 2006, see Exhibit 99.1 to this Form 10-K.
Our affiliates provided funding sources for our operations through draws on a
bank line in the U.K., investing in our debt, acquiring credit card, private
label and real estate secured receivables, providing additional common equity
and underwriting sales of our debt securities to HSBC clients and customers. In
2006, total HSBC related funding aggregated $44.6 billion. A detailed listing of
the sources of such funding can be found in "Liquidity and Capital Resources" in
our 2006 MD&A. We expect to continue to obtain significant funding from HSBC
related sources in the future.
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Historically, securitization of consumer receivables has been a source of
funding and liquidity for HSBC Finance Corporation. In order to align our
accounting treatment with that of HSBC, in the third quarter of 2004 we began to
structure all new collateralized funding transactions as secured financings. A
gain on sale of receivables is recorded in a securitization. Secured financings
are recorded as debt and no gain on sale is recognized. The termination of sale
treatment for new collateralized funding activity reduces reported net income
under U.S. GAAP, but does not impact cash received from operations. Existing
credit card and personal non-credit card transactions that were structured as
sales to revolving trusts require the addition of new receivables to support
required cash distributions on outstanding securities until the contractual
obligation terminates, the last of which is currently projected to occur in the
fourth quarter of 2007. Until that time, replenishment gains on sales of
receivables for these securitizations will continue to be reflected in our
financial statements.
Generally, for each securitization and secured financing we utilize credit
enhancement to obtain investment grade ratings on the securities issued by the
trust. To ensure that adequate funds are available to pay investors their
contractual return, we may retain various forms of interests in assets securing
a funding transaction, whether structured as a securitization or a secured
financing, such as over-collateralization, subordinated series, residual
interests (in the case of securitizations) in the receivables or we may fund
cash accounts. Over-collateralization is created by transferring receivables to
the trust issuing the securities that exceed the balance of the securities to be
issued. Subordinated interests provide additional assurance of payment to
investors holding senior securities. Residual interests are also referred to as
interest-only strip receivables and represent rights to future cash flows from
receivables in a securitization trust after investors receive their contractual
return. Cash accounts can be funded by an initial deposit at the time the
transaction is established and/or from interest payments on the receivables that
exceed the investor's contractual return.
Additional information on our sources and availability of funding are set forth
in the "Liquidity and Capital Resources" and "Off Balance Sheet Arrangements"
sections of our 2006 MD&A.
We will continue to use derivative financial instruments to hedge our currency
and interest rate risk exposure. A description of our use of derivative
financial instruments, including interest rate swaps and foreign exchange
contracts and other quantitative and qualitative information about our market
risk is set forth in Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations" ("2006 MD&A") under the caption "Risk
Management" and Note 14, "Derivative Financial Instruments," of our consolidated
financial statements ("2006 Financial Statements").
REGULATION AND COMPETITION
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REGULATION
CONSUMER
Our consumer finance businesses operate in a highly regulated environment. These
businesses are subject to laws relating to consumer protection, discrimination
in extending credit, use of credit reports, privacy matters, and disclosure of
credit terms and correction of billing errors. They also are subject to certain
regulations and legislation that limit operations in certain jurisdictions. For
example, limitations may be placed on the amount of interest or fees that a loan
may bear, the amount that may be borrowed, the types of actions that may be
taken to collect or foreclose upon delinquent loans or the information about a
customer that may be shared. Our consumer branch lending offices are generally
licensed in those jurisdictions in which they operate. Such licenses have
limited terms but are renewable, and are revocable for cause. Failure to comply
with these laws and regulations may limit the ability of our licensed lenders to
collect or enforce loan agreements made with consumers and may cause our lending
subsidiaries to be liable for damages and penalties.
There also continues to be a significant amount of legislative activity,
nationally, locally and at the state level, aimed at curbing lending practices
deemed to be "predatory", particularly when such practices are believed to
discriminate against certain groups. In addition, states have sought to alter
lending practices through consumer
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protection actions brought by state attorneys general and other state
regulators. Legislative activity in this area has targeted certain abusive
practices such as loan "flipping" (making a loan to refinance another loan where
there is no tangible benefit to the borrower), "steering" (making loans that are
more costly than the borrowers qualifications require), fee "packing" (addition
of unnecessary, unwanted and unknown fees to a borrower), "equity stripping"
(lending without regard to the borrower's ability to repay or making it
impossible for the borrower to refinance with another lender), and outright
fraud. It is likely that state and Federal legislators and regulatory
authorities will continue to address perceived lending abuses by considering
action to require additional loan disclosures, limit permissible interchange
fees charged to merchants and suppliers, require lenders to consider the maximum
payments potentially due when reviewing loan applications and limiting rates and
fees charged on tax refund anticipation loans. HSBC Finance Corporation does not
condone, endorse or engage in any abusive lending practice. We continue to work
with regulators and consumer groups to create appropriate safeguards to avoid
abusive practices while allowing our borrowers to continue to have access to
credit for personal purposes, such as the purchase of homes, automobiles and
consumer goods. As part of this effort we have adopted a set of lending best
practice initiatives. It is possible that new legislative or regulatory
initiatives will impose additional costs and rules on our businesses. Although
we have the ability to react quickly to new laws and regulations, it is not
possible to estimate the effect, if any, these initiatives will have on us in a
particular locality or nationally.
The Federal Financial Institutions Examination Counsel ("FFIEC") published
guidance in 2005 that mandates changes to the required minimum monthly payment
amount and limits certain fees that may be charged on non-prime credit card
accounts. The requirements were effective on January 1, 2006. In 2006, the
changes resulted in decreased non-prime credit card fee income and fluctuations
in the provision for credit losses as credit loss provisions for prime accounts
increased as a result of higher required monthly payments while the non-prime
provision decreased due to lower levels of fees incurred by customers. The
changes did not have a material impact on our consolidated results, but the
impact was material to the earnings of our Credit Card Services segment.
BANKING INSTITUTIONS
Our credit card banking subsidiary, HSBC Bank Nevada, N.A. ("HSBC Bank Nevada"),
is a Federally chartered 'credit card bank' which is also a member of the
Federal Reserve System. HSBC Bank Nevada is subject to regulation, supervision
and examination by the Office of the Comptroller of the Currency ("OCC"). The
deposits of HSBC Bank Nevada are insured by the Federal Deposit Insurance
Corporation ("FDIC"), which renders it subject to relevant FDIC regulation.
As a result of our acquisition by HSBC, HSBC Finance Corporation and its
subsidiaries became subject to supervision, regulation and examination by the
Board of Governors of the Federal Reserve System (the "Federal Reserve Board").
HSBC is a bank holding company under the U.S. Bank Holding Company Act of 1956,
as amended (the "BHCA") as a result of its ownership of HSBC Bank USA. On
January 1, 2004, HSBC formed a new company to hold all of its North America
operations, including HSBC Finance Corporation and its subsidiaries. This
company, HSBC North America is also a bank holding company under the BHCA, by
virtue of its ownership of HSBC Bank USA. HSBC and HSBC North America are
registered as financial holding companies under the Gramm-Leach-Bliley Act
amendments to the BHCA, enabling them to offer a broad range of financial
products and services.
The United States is a party to the 1988 Basel Capital Accord (the "Accord") and
U.S. bank regulatory agencies have adopted risk-based capital requirements for
United States banks and bank holding companies that are generally consistent
with the Accord. In addition, U.S. bank regulatory agencies have adopted
'leverage' regulatory capital requirements that generally require United States
banks and bank holding companies to maintain a minimum amount of capital in
relation to their balance sheet assets (measured on a non-risk-weighted basis).
HSBC Bank Nevada is subject to these capital requirements.
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In June 2004, the Basel Committee on Banking Supervision ("Basel") published a
revised capital adequacy framework for complex and internationally active banks.
Banking regulators in individual countries are expected to adopt implementing
rules and standards for local banking institutions under their jurisdiction.
This framework ("Basel II") is now being considered by U.S. bank regulatory
agencies, including the Federal Reserve Board and the OCC. In 2005, the U.S.
bank regulatory agencies delayed issuing final rules pending further analysis of
capital impact studies. The U.S. bank regulatory agencies are now expected to
publish final capital adequacy regulations implementing Basel II in the second
quarter of 2007. The earliest that U.S. banking organizations may adopt the new
rules is January 1, 2009.
In 2004, HSBC was advised by the U.S. bank regulatory agencies that HSBC North
America and its subsidiaries, including HSBC Finance Corporation, are considered
to be mandatory participants in the new capital framework. HSBC North America
has established comprehensive Basel II implementation project teams comprised of
risk management specialists representing all risk disciplines. We anticipate
that the implementation of Basel II could impact the funding mix of HSBC Finance
Corporation but not necessarily require an increase to its equity capital
levels.
HSBC Bank Nevada, like other FDIC-insured banks, may be required to pay
assessments to the FDIC for deposit insurance under the FDIC's Bank Insurance
Fund. Under the FDIC's risk-based system for setting deposit insurance
assessments, an institution's assessments vary according to its deposit levels
and other factors.
The Federal Deposit Insurance Corporation Improvement Act of 1991 provides for
extensive regulation of insured depository institutions such as HSBC Bank
Nevada, including requiring Federal banking regulators to take 'prompt
corrective action' with respect to FDIC-insured banks that do not meet minimum
capital requirements. At December 31, 2006, HSBC Bank Nevada was
well-capitalized under applicable OCC and FDIC regulations.
Our principal United Kingdom subsidiary (HFC Bank Limited, formerly known as HFC
Bank plc) is subject to oversight and regulation by the U.K. Financial Services
Authority ("FSA") and the Irish Financial Services Regulatory Authority of the
Republic of Ireland. We have indicated our intent to the FSA to maintain the
regulatory capital of this institution at specified levels. We do not anticipate
that any capital contribution will be required for our United Kingdom bank in
the near term.
We also maintain a trust company in Canada, which is subject to regulatory
supervision by the Office of the Superintendent of Financial Institutions.
INSURANCE
Our credit insurance business is subject to regulatory supervision under the
laws of the states and provinces in which it operates. Regulations vary from
state to state, and province to province, but generally cover licensing of
insurance companies, premium and loss rates, dividend restrictions, types of
insurance that may be sold, permissible investments, policy reserve
requirements, and insurance marketing practices.
Our insurance operations in the United Kingdom are subject to regulatory
supervision by the FSA.
COMPETITION
The consumer financial services industry in which we operate is highly
fragmented and intensely competitive. We generally compete with banks, thrifts,
insurance companies, credit unions, mortgage lenders and brokers, finance
companies, investment banks, and other domestic and foreign financial
institutions in the United States, Canada and the United Kingdom. We compete by
expanding our customer base through portfolio acquisitions or alliance and
co-branding opportunities, offering a variety of consumer loan products and
maintaining a strong service orientation. Customers are generally attracted to
consumer finance products based upon price, available credit limits and other
product features. As a result, customer loyalty is often
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limited. We believe our focus on the specific needs of our customers,
proprietary credit scoring models and strong analytics in all aspects of our
business allow us to compete effectively for middle market customers.
CORPORATE GOVERNANCE AND CONTROLS
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HSBC Finance Corporation maintains a website at www.hsbcusa.com/hsbc_finance on
which we make available, as soon as reasonably practicable after filing with or
furnishing to the SEC, our annual report on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K, and any amendments to these reports. Our
website also contains our Corporate Governance Standards and committee charters
for the Audit, Compensation, Executive and Nominating and Governance Committees
of our Board of Directors. We have a Statement of Business Principles and Code
of Ethics that expresses the principles upon which we operate our businesses.
Integrity is the foundation of all our business endeavors and is the result of
continued dedication and commitment to the highest ethical standards in our
relationships with each other, with other organizations and individuals who are
our customers. You can find our Statement of Business Principles and Code of
Ethics on our corporate website. We also have a Code of Ethics for Senior
Financial Officers that applies to our finance and accounting professionals that
supplements the Statement of Business Principles. That Code of Ethics is
incorporated by reference in Exhibit 14 to this Annual Report on Form 10-K. You
can request printed copies of this information at no charge. Requests should be
made to HSBC Finance Corporation, 2700 Sanders Road, Prospect Heights, Illinois
60070, Attention: Corporate Secretary.
HSBC Finance Corporation has a Disclosure Committee that is responsible for
maintenance and evaluation of our disclosure controls and procedures and for
assessing the materiality of information required to be disclosed in periodic
reports filed with the SEC. Among its responsibilities is the review of
quarterly certifications of business and financial officers throughout HSBC
Finance Corporation as to the integrity of our financial reporting process, the
adequacy of our internal and disclosure control practices and the accuracy of
our financial statements.
CERTIFICATIONS
In addition to certifications from our Chief Executive Officer and Chief
Financial Officer pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act of
2002 (attached to this report on Form 10-K as Exhibits 31 and 32), we have also
filed a certification with the New York Stock Exchange (the "NYSE") from our
Chief Executive Officer certifying that he is not aware of any violation by HSBC
Finance Corporation of the applicable NYSE corporate governance listing
standards in effect as of March 5, 2007.
CAUTIONARY STATEMENT ON FORWARD-LOOKING STATEMENTS
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Certain matters discussed throughout this Form 10-K constitute forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. In addition, we may make or approve certain statements in future filings
with the SEC, in press releases, or oral or written presentations by
representatives of HSBC Finance Corporation that are not statements of
historical fact and may also constitute forward-looking statements. Words such
as "may", "will", "should", "would", "could", "appears", "believe", "intends",
"expects", "estimates", "targeted", "plans", "anticipates", "goal" and similar
expressions are intended to identify forward-looking statements but should not
be considered as the only means through which these statements may be made.
These matters or statements will relate to our future financial condition,
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.
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ITEM 1A. RISK FACTORS
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The following discussion provides a 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. In 2006, certain markets experienced a significant slow
down in the appreciation of property values and in other markets, property
values depreciated. While there have been some indications that lead us to
believe the slow down may be moderating, continued or expanded slowing of
appreciation or increased depreciation could be expected to result in higher
delinquency and losses in our real estate portfolio. In addition, certain
changes to the conditions described above 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
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 substantial and unpredictable ways, including limiting the types of
consumer loan products we can offer. With a changing political climate in
Washington, D.C., we anticipate increased consumer protection activity at the
Federal level. In addition, new risk-based capital guidelines and reporting
instructions, including changes in response to Basel II Capital Accords could
require a significant increase in our capital requirements or changes in our
funding mix, resulting in lower net income. 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
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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 a 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 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.
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
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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, could potentially increase borrowing costs, and
depending on its severity, 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
acquisitions of Metris Companies, Inc. ("Metris") in 2005 and Solstice Capital
Group Inc. and the mortgage portfolio of Champion Mortgage in 2006. There can be
no assurance that our acquisitions will have the anticipated positive results,
including results relating to: the total cost of integration; anticipated
cross-sell opportunities; 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 application are complex and 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 conduct
business transactions with our counterparties could be adversely affected to the
extent our reputation, or the reputation of affiliates operating under the HSBC
brand 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. Reputational issues include, but are not limited to,
appropriately addressing potential conflicts of interest, legal and regulatory
requirements, ethical issues, adequacy of anti-money laundering processes,
privacy issues, record-keeping, sales and trading practices, the proper
identification of the legal, reputational, credit, liquidity and market risks
inherent in products offered and general company performance. The failure to
address these issues appropriately could make our customers unwilling to do
business with us, which could adversely affect our results of operations.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
--------------------------------------------------------------------------------
We have no unresolved written comments from the Securities and Exchange
Commission Staff that have been outstanding for more than 180 days at December
31, 2006.
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ITEM 2. PROPERTIES.
--------------------------------------------------------------------------------
Our operations are located throughout the United States, in 10 provinces in
Canada and in the United Kingdom, with principal facilities located in
Lewisville, Texas; New Castle, Delaware; Brandon, Florida; Jacksonville,
Florida; Tampa, Florida; Orlando, Florida; Chesapeake, Virginia; Virginia Beach,
Virginia; Whitemarsh, Maryland; Hanover, Maryland; Minnetonka, Minnesota;
Bridgewater, New Jersey; Rockaway, New Jersey; Las Vegas, Nevada; Charlotte,
North Carolina; Portland, Oregon; Tulsa, Oklahoma; Chicago, Illinois; Deerfield,
Illinois; Elmhurst, Illinois; Franklin Park, Illinois; Mount Prospect, Illinois;
Prospect Heights, Illinois; Schaumburg, Illinois; Vernon Hills, Illinois; Wood
Dale, Illinois; Carmel, Indiana; Irvine, California; Pomona, California;
Salinas, California; San Diego, California; London, Kentucky; Sioux Falls, South
Dakota; Phoenix, Arizona; Toronto, Ontario and Montreal, Quebec, Canada;
Windsor, Sheffield and Birmingham, United Kingdom. In January 2006 we entered
into a lease for a building in the Village of Mettawa, Illinois. The new
facility will consolidate our Prospect Heights, Mount Prospect and Deerfield
offices. Construction of the building began in the spring of 2006 with the move
planned for first and second quarters of 2008.
Substantially all branch offices, divisional offices, corporate offices,
regional processing and regional servicing center spaces are operated under
lease with the exception of the headquarters building for our United Kingdom
operations, a credit card processing facility in Las Vegas, Nevada; a processing
center in Vernon Hills, Illinois; servicing facilities in London, Kentucky, Mt.
Prospect, Illinois, Orlando, Florida and Chesapeake, Virginia and offices in
Birmingham, United Kingdom. We believe that such properties are in good
condition and meet our current and reasonably anticipated needs.
ITEM 3. 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
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. Insurance carriers have been notified as
appropriate, and from time to time reservations of rights letters have been
received.
CREDIT CARD SERVICES LITIGATION
Since June 2005, HSBC Finance Corporation, HSBC North America, and HSBC, as well
as other banks and the Visa and Master Card associations, were named as
defendants in four class actions filed in Connecticut
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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. Discovery has begun. 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 collection, sales and
lending practices, the 2002 state settlement agreement referred to above, the
restatement and the HSBC merger. The amended complaint, which also names as
defendants Arthur Andersen LLP, Goldman, Sachs & Co., and Merrill Lynch, Pierce,
Fenner & Smith, Inc., fails to specify the amount of damages sought. In May
2003, we, and other defendants, filed a motion to dismiss the complaint. On
March 19, 2004, the Court granted in part, and denied in part the defendants'
motion to dismiss the complaint. The Court dismissed all claims against Merrill
Lynch, Pierce, Fenner & Smith, Inc. and Goldman Sachs & Co. The Court also
dismissed certain claims alleging strict liability for alleged misrepresentation
of material facts based on statute of limitations grounds. The claims that
remain against some or all of the defendants essentially allege the defendants
knowingly made a false statement of a material fact in conjunction with the
purchase or sale of securities, that the plaintiffs justifiably relied on such
statement, the false statement(s) caused the plaintiffs' damages, and that some
or all of the defendants should be liable for those alleged statements. On
February 28, 2006, the Court also
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dismissed all alleged sec.10 claims that arose prior to July 30, 1999,
shortening the class period by 22 months. The bulk of fact discovery concluded
on January 31, 2007. Expert discovery is expected to conclude on September 14,
2007. Separately, one of the defendants, Arthur Andersen LLP, entered into a
settlement of the claims against Arthur Andersen. This settlement received Court
approval in April 2006. 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
--------------------------------------------------------------------------------
Not applicable
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
--------------------------------------------------------------------------------
Not applicable
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ITEM 6. SELECTED FINANCIAL DATA.
--------------------------------------------------------------------------------
On March 28, 2003, HSBC Holdings plc ("HSBC") acquired HSBC Finance Corporation
(formerly Household International, Inc.). This resulted in a new basis of
accounting reflecting the fair market value of our assets and liabilities for
the "successor" periods beginning March 29, 2003. Information for all
"predecessor" periods prior to the merger is presented using our historical
basis of accounting, which impacts comparability to our "successor" periods. To
assist in the comparability of our financial results, the "predecessor period"
(January 1 to March 28, 2003) has been combined with the "successor period"
(March 29 to December 31, 2003) to present "combined" results for the year ended
December 31, 2003.
MAR. 29 JAN. 1
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED THROUGH THROUGH YEAR ENDED
DEC. 31, DEC. 31, DEC. 31, DEC. 31, DEC. 31 MAR. 28, DEC. 31,
2006 2005 2004 2003 2003 2003 2002
---------------------------------------------------------------------------------------------------------------------------------
(SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (COMBINED) (SUCCESSOR) (PREDECESSOR) (PREDECESSOR)
(IN MILLIONS)
STATEMENT OF INCOME DATA
Net interest income and other
revenues-operating
basis(1)................... $15,488 $13,347 $12,454 $11,672 $8,888 $2,784 $11,178
Gain on sale of investment in
Kanbay..................... 123
Gain on bulk sale of private
label receivables(2)()..... - - 663 - - - -
Loss on disposition of Thrift
assets and deposits........ - - - - - - 378
Provision for credit losses
on owned
receivables-operating
basis(1)................... 6,564 4,543 4,296 3,967 2,991 976 3,732
Total costs and expenses,
excluding nonrecurring
expense items(1)........... 6,760 6,141 5,691 5,032 3,850 1,182 4,290
HSBC acquisition related
costs incurred by HSBC
Finance Corporation........ - - - 198 - 198 -
Settlement charge and related
expenses................... - - - - - - 525
Adoption of FFIEC charge-off
policies for domestic
private label and credit
card portfolios(1),(7)..... - - 190 - - - -
Income taxes................. 844 891 1,000 872 690 182 695
------- ------- ------- ------- ------ ------ -------
Net income(1)................ $ 1,443 $ 1,772 $ 1,940 $ 1,603 $1,357 $ 246 $ 1,558
======= ======= ======= ======= ====== ====== =======
YEAR ENDED DECEMBER 31, 2006 2005 2004 2003 2002
---------------------------------------------------------------------------------------------------------------------
(SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (COMBINED) (PREDECESSOR)
(IN MILLIONS)
BALANCE SHEET DATA
Total assets................................... $179,459 $156,669 $130,190 $119,052 $97,860
Receivables:(2)()
Domestic:
Real estate secured........................ $ 94,209 $ 79,792 $ 61,946 $ 49,026 $44,140
Auto finance............................... 12,193 10,434 7,490 4,138 2,024
Credit card................................ 27,499 23,963 12,371 9,577 7,628
Private label.............................. 289 356 341 9,732 9,365
Personal non-credit card................... 18,245 15,900 12,049 9,624 11,685
Commercial and other....................... 181 208 315 399 461
-------- -------- -------- -------- -------
Total domestic............................... $152,616 $130,653 $ 94,512 $ 82,496 $75,303
-------- -------- -------- -------- -------
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YEAR ENDED DECEMBER 31, 2006 2005 2004 2003 2002
---------------------------------------------------------------------------------------------------------------------
(SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (COMBINED) (PREDECESSOR)
(IN MILLIONS)
Foreign:
Real estate secured........................ $ 3,552 $ 3,034 $ 2,874 $ 2,195 $ 1,679
Auto finance............................... 311 270 54 - -
Credit card................................ 215 147 2,264 1,605 1,319
Private label.............................. 2,220 2,164 3,070 2,872 1,974
Personal non-credit card................... 3,122 3,645 4,079 3,208 2,285
Commercial and other....................... - - 2 2 2
-------- -------- -------- -------- -------
Total foreign................................ $ 9,420 $ 9,260 $ 12,343 $ 9,882 $ 7,259
-------- -------- -------- -------- -------
Total receivables:
Real estate secured........................ $ 97,761 $ 82,826 $ 64,820 $ 51,221 $45,819
Auto finance............................... 12,504 10,704 7,544 4,138 2,024
Credit card................................ 27,714 24,110 14,635 11,182 8,947
Private label.............................. 2,509 2,520 3,411 12,604 11,339
Personal non-credit card................... 21,367 19,545 16,128 12,832 13,970
Commercial and other....................... 181 208 317 401 463
-------- -------- -------- -------- -------
Total owned receivables...................... $162,036 $139,913 $106,855 $ 92,378 $82,562
======== ======== ======== ======== =======
Commercial paper, bank and other borrowings.... $ 11,055 $ 11,454 $ 9,060 $ 9,354 $ 6,949
Due to affiliates(3)........................... 15,172 15,534 13,789 7,589 -
Long term debt................................. 127,590 105,163 85,378 79,632 75,751
Preferred stock(4)............................. 575 575 1,100 1,100 1,193
Common shareholder's(s') equity(4),(5)......... 19,515 18,904 15,841 16,391 9,222
-------- -------- -------- -------- -------
YEAR ENDED DECEMBER 31, 2006 2005 2004 2003 2002
---------------------------------------------------------------------------------------------------------------------
(SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (COMBINED) (PREDECESSOR)
SELECTED FINANCIAL RATIOS
Return on average assets(1).................... .85% 1.27% 1.57% 1.46% 1.62%
Return on average common shareholder's(s')
equity(1).................................... 7.07 9.97 10.99 10.89 17.30
Net interest margin............................ 6.56 6.73 7.33 7.75 7.57
Efficiency ratio(1)............................ 41.55 44.10 42.05 42.97 42.77
Consumer net charge-off ratio(1)............... 2.97 3.03 4.00 4.06 3.81
Consumer two-month-and-over contractual
delinquency.................................. 4.59 3.89 4.13 5.40 5.37
Reserves as a percent of net charge-offs(8).... 145.8 123.8 89.9 105.7 106.5
Reserves as a percent of receivables........... 4.07 3.23 3.39 4.11 4.04
Reserves as a percent of nonperforming loans... 114.8 106.9 100.9 92.8 93.7
Common and preferred equity to owned assets.... 11.19% 12.43% 13.01% 14.69% 10.64%
Tangible shareholder's(s') equity to tangible
managed assets ("TETMA")(6).................. 7.20 7.56 6.27 6.64 9.08
Tangible shareholder's(s') equity plus owned
loss reserves to tangible managed assets
("TETMA + Owned Reserves")(6)(9)............. 11.08 10.55 9.04 9.50 11.87
Tangible common equity to tangible managed
assets(6).................................... 6.11 6.07 4.67 5.04 6.83
Excluding HSBC acquisition purchase accounting
adjustments:
TETMA........................................ 7.85 8.52 7.97 8.55 9.08
TETMA + Owned Reserves....................... 11.73 11.51 10.75 11.42 11.87
Tangible common equity to tangible managed
assets..................................... 6.76 7.02 6.38 6.98 6.83
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---------------
(1)The following table, which contains non-U.S. GAAP financial information is
provided for comparison of our operating trends only and should be read in
conjunction with our U.S. GAAP financial information. For 2006, the operating
trends, percentages and ratios presented below exclude the $78 million
increase in net income relating to the sale of our interest in Kanbay
International, Inc ("Kanbay"), an information technology services firm
headquartered in greater Chicago with offices worldwide. For 2004, the
operating trends, percentages and ratios presented below exclude the $121
million decrease in net income relating to the adoption of Federal Financial
Institutions Examination Council ("FFIEC") charge-off policies for our
domestic private label (excluding retail sales contracts at our Consumer
Lending business) and credit card receivables and the $423 million
(after-tax) gain on the bulk sale of domestic private label receivables
(excluding retail sales contracts at our Consumer Lending business) to an
affiliate, HSBC Bank USA, National Association ("HSBC Bank USA"). For 2003,
the operating results, percentages and ratios exclude $167 million
(after-tax) of HSBC acquisition related costs and other merger related items
and for 2002, exclude a $333 million (after-tax) settlement charge and
related expenses and a $240 million (after-tax) loss on disposition of Thrift
assets and deposits. See "Basis of Reporting" and "Reconciliations to U.S.
GAAP Financial Measures" in Management's Discussion and Analysis for
additional discussion and quantitative reconciliations to the equivalent U.S.
GAAP basis financial measure.
YEAR ENDED DECEMBER 31, 2006 2005 2004 2003 2002
------------------------------------------------------------------------------------------------------------------
(SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (COMBINED) (PREDECESSOR)
(DOLLARS ARE IN MILLIONS)
Operating net income........................ $1,365 $1,772 $1,638 $1,770 $2,131
Return on average assets.................... .80% 1.27% 1.32% 1.61% 2.21%
Return on average common shareholder's(s')
equity.................................... 6.68 9.97 9.21 12.08 23.94
Consumer net charge-off ratio............... 2.97 3.03 3.84 4.06 3.81
Efficiency ratio............................ 41.89 44.10 43.84 41.21 36.43
(2) In November 2006, we purchased $2.5 billion of real estate secured
receivables from Champion Mortgage ("Champion") and we sold the capital
stock of our operations in the Czech Republic, Hungary and Slovakia (the
"European Operations") to a wholly owned subsidiary of HSBC Bank plc
("HBEU"), which included $199 million of private label and personal
non-credit card receivables. In the fourth quarter of 2006 we purchased
Solstice Capital Group Inc. ("Solstice") which included $32 million of real
estate secured receivables. In 2005, we sold our U.K. credit card business,
which included receivables of $2.5 billion, to HBEU and acquired $5.3
billion in credit card receivables in conjunction with our acquisition of
Metris Companies, Inc. ("Metris"). In 2004, we sold $.9 billion of higher
quality non-conforming real estate secured receivables and sold our domestic
private label receivable portfolio (excluding retail sales contracts at our
Consumer Lending business) of $12.2 billion to HSBC Bank USA. In 2003, we
sold $2.8 billion of higher quality non-conforming real estate secured
receivables to HSBC Bank USA and acquired owned basis private label
portfolios totaling $1.2 billion and credit card portfolios totaling $.9
billion. In 2002, we sold $6.3 billion of real estate secured whole loans
from our Consumer Lending and Mortgage Services businesses and purchased a
$.5 billion private label portfolio.
(3) We had received $44.6 billion, $44.1 billion, $35.7 billion and $14.7
billion in HSBC related funding as of December 31, 2006, 2005, 2004 and
2003, respectively. See Liquidity and Capital Resources for the components
of this funding.
(4) In conjunction with the acquisition by HSBC, our 7.625%, 7.60%, 7.50% and
8.25% preferred stock was converted into the right to receive cash which
totaled approximately $1.1 billion. In consideration of HSBC transferring
sufficient funds to make these payments, we issued $1.1 billion Series A
preferred stock to HSBC on March 28, 2003. Also on March 28, 2003, we called
for redemption of our $4.30, $4.50 and 5.00% preferred stock. In September
2004, HSBC North America Holdings Inc. ("HSBC North America") issued a new
series of preferred stock to HSBC in exchange for our Series A preferred
stock. In October 2004, HSBC Investments (North America) Inc. ("HINO")
issued a new series of preferred stock to HSBC North America in exchange for
our Series A preferred stock. Our Series A preferred stock was exchanged by
HINO for $1.1 billion of additional common equity in December 2005.
(5) In 2006, we received a capital contribution of $163 million from HINO to
fund a portion of the purchase in conjunction with our acquisition of the
Champion portfolio. In 2005, we received a capital contribution of $1.2
billion from HINO to fund a portion of the purchase in conjunction with our
acquisition of Metris. Common shareholder's equity at December 31, 2006,
2005, 2004 and 2003 reflects push-down accounting adjustments resulting from
the HSBC merger.
(6) TETMA, TETMA + Owned Reserves and tangible common equity to tangible managed
assets are non-U.S. GAAP financial ratios that are used by HSBC Finance
Corporation management or certain rating agencies as a measure to evaluate
capital adequacy and may differ from similarly named measures presented by
other companies. See "Basis of Reporting" for additional discussion on the
use of non-U.S. GAAP financial measures and "Reconciliations to U.S. GAAP
Financial Measures" for quantitative reconciliations to the equivalent U.S.
GAAP basis financial measure.
(7) In December 2004, we adopted charge-off and account management policies in
accordance with the Uniform Retail Credit Classification and Account
Management Policy issued by the FFIEC for our domestic private label
(excluding retail sales contracts at our consumer lending business) and
credit card portfolios. The adoption of the FFIEC charge-off policies
resulted in a reduction to net income of $121 million in the fourth quarter
of 2004. See "Credit Quality" in Management's Discussion and Analysis and
Note 4, "Sale of Domestic Private Label Receivable Portfolio and Adoption of
FFIEC Policies," in the accompanying consolidated financial statements for
further discussion of these policy changes.
(8) This ratio was positively impacted in 2006 by significantly higher loss
estimates at our Mortgage Services business where the related charge-offs
will not occur until future periods. In addition, the acquisition of Metris
in December 2005 has positively impacted this ratio in 2005. Reserves as a
percentage of net charge-offs excluding Metris at December 31, 2005 was
118.2 percent. Additionally, the adoption of FFIEC charge-off policies for
our domestic private label (excluding retail sales contracts at our consumer
lending business) and credit card portfolios and subsequent sale of the
domestic private label portfolio (excluding retail sales contracts at our
consumer lending business) in December 2004 have negatively impacted these
ratios. Reserves as a percentage of net charge-offs excluding net
charge-offs associated with the domestic private label portfolio sold in
2004 and the impact of adopting FFIEC charge-off policies for these
portfolios was 109.2 percent.
(9) This ratio was positively impacted in 2006 by significantly higher credit
loss reserves at our Mortgage Services business.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
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EXECUTIVE OVERVIEW
ORGANIZATION AND BASIS OF REPORTING
HSBC Finance Corporation (formerly Household International, Inc.) and
subsidiaries is an indirect wholly owned subsidiary of HSBC North America
Holdings Inc. ("HSBC North America") which is a wholly owned subsidiary of HSBC
Holdings plc ("HSBC"). HSBC Finance Corporation may also be referred to in
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") as "we", "us", or "our".
HSBC Finance Corporation provides middle-market consumers with several types of
loan products in the United States, the United Kingdom, Canada, the Republic of
Ireland and prior to November 9, 2006, Slovakia, the Czech Republic and Hungary
("European Operations"). Our lending products include real estate secured loans,
auto finance loans, MasterCard(1), Visa(1), American Express(1) and Discover(1)
credit card loans ("Credit Card"), private label credit card loans, including
retail sales contracts and personal non-credit card loans. We also initiate tax
refund anticipation loans and other related products in the United States and
offer specialty insurance products in the United States, United Kingdom and
Canada. We generate cash to fund our businesses primarily by collecting
receivable balances, issuing commercial paper, medium and long term debt;
borrowing from HSBC subsidiaries and customers and borrowing under secured
financing facilities. We use the cash generated to invest in and support
receivable growth, to service our debt obligations and to pay dividends to our
parent.
2006 EVENTS
- We continue to monitor the impact of several trends affecting the
mortgage lending industry. Real estate markets in a large portion of the
United States have been affected by a general slowing in the rate of
appreciation in property values, or an actual decline in some markets,
while the period of time available properties remain on the market has
increased. Additionally, the ability of some borrowers to repay their
adjustable rate mortgage ("ARM") loans have been impacted as the interest
rates on their loans increase as rates adjust under their contracts.
Interest rate adjustments on first mortgages may also have a direct
impact on a borrower's ability to repay any underlying second lien
mortgage loan on a property. Similarly, as interest-only mortgage loans
leave the interest-only payment period, the ability of borrowers to make
the increased payments may be impacted. Numerous studies have been
published indicating that mortgage loan originations throughout the
industry from 2005 and 2006 are performing worse than originations from
prior periods.
In 2005 and continuing into the first six months of 2006, second lien
mortgage loans in our Mortgage Services business increased significantly
as a percentage of total loans acquired when compared to prior periods.
During the second quarter of 2006 we began to witness deterioration in the
performance of mortgage loans acquired in 2005 by our Mortgage Services
business, particularly in the second lien and portions of the first lien
portfolios. The deterioration continued in the third quarter and began to
affect these same components of loans acquired in 2006 by this business.
In the fourth quarter of 2006, deterioration of these components worsened
considerably, largely related to the first lien adjustable rate mortgage
portfolio, as well as loans in the second lien portfolio. We have now been
able to determine that a significant number of our second lien customers
have underlying adjustable rate first mortgages that face repricing in the
near-term which has impacted the probability of repayment on the related
second lien mortgage loan. As the interest rate adjustments will occur in
an environment of substantially higher interest rates, lower home value
appreciation and tightening credit, we expect the
---------------
(1) MasterCard is a registered trademark of MasterCard International,
Incorporated; Visa is a registered trademark of Visa USA, Inc.; American
Express is a registered trademark of American Express Company and Discover
is a registered trademark of Novus Credit Services, Inc.
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probability of default for adjustable rate first mortgages subject to
repricing as well as any second lien mortgage loans that are subordinate
to an adjustable rate first lien will be greater than what we have
historically experienced. As a result, our loss estimates relating to our
Mortgage Services' portfolio have increased.
Accordingly, while overall credit performance, as measured by delinquency
and charge-off is performing as expected across other parts of our
domestic mortgage portfolio, we are reporting higher delinquency and
losses this year in the Mortgage Services business, largely as a result of
the affected 2005 and 2006 originations. Numerous risk mitigation efforts
have been implemented in this business relating to the affected components
of the portfolio. These include enhanced segmentation and analytics to
identify the higher risk portions of the portfolio and increased
collections capacity. As appropriate and in accordance with defined
policies, we will restructure and/or modify loans if we believe the
customer will continue to pay. We are also contacting customers who have
adjustable rate mortgage loans nearing the first reset that we expect will
be the most impacted by a rate adjustment in order to assess their ability
to make the adjusted payment and, as appropriate, refinance or modify the
loans. Further, we have slowed growth in this portion of the portfolio by
implementing repricing initiatives in selected origination segments and
tightening underwriting criteria, especially for second lien, stated
income (low documentation) and lower credit scoring segments. These
actions, combined with normal portfolio attrition resulted in a net
reduction in the principal balance of our Mortgage Services loan portfolio
during the second half of 2006. We expect this portfolio to remain under
pressure as the 2005 and 2006 originations season further. Accordingly, we
expect the increasing trend in overall delinquency and charge-offs in our
Mortgage Services business to continue.
- On October 4, 2006, we purchased Solstice Capital Group Inc. ("Solstice")
with assets of approximately $49 million, in an all cash transaction for
approximately $50 million. Additional consideration may be paid based on
Solstice's 2007 pre-tax income. Solstice markets a range of mortgage and
home equity products to customers through direct mail. This acquisition
will add momentum to our origination growth plan by providing an
additional channel to customers.
- We previously reported that as part of our continuing integration efforts
with HSBC we were evaluating the scope of our U.K. and other European
operations. As a result, in November 2006, we sold all of the capital
stock of our European Operations to a wholly owned subsidiary of HSBC
Bank plc ("HBEU"), a U.K. based subsidiary of HSBC, for an aggregate
purchase price of approximately $46 million. Because the sale of this
business was between affiliates under common control, the premium
received in excess of the book value of the stock transferred of $13
million, including the goodwill assigned to this business, was recorded
as an increase to additional paid-in capital and was not reflected in
earnings.
- On November 21, 2006, we sold our entire interest in Kanbay
International, Inc ("Kanbay"), an information technology services firm
headquartered in greater Chicago with offices worldwide, to Capgemini
S.A. in an all cash transaction for an aggregate purchase price of $145
million and recorded a pre-tax gain of $123 million.
- On November 29, 2006, we purchased the mortgage loan portfolio of
Champion Mortgage ("Champion"), a division of KeyBank, N.A. for a
purchase price of $2.5 billion. The portfolio acquisition consists of
approximately 30,000 first and second lien mortgage and home equity loan
customers, primarily in the non-prime credit spectrum. This acquisition
will expand our presence in the non-prime real estate secured market and
provide additional cross-sell opportunities and resulted in an increase
in our real estate secured portfolio of $2.5 billion.
- In 2006, Standard & Poor's Corporation raised the senior debt rating for
HSBC Finance Corporation from A to AA-, raised the senior subordinated
debt rating from A- to A+, raised the commercial paper rating from A-1 to
A-1+, and raised the Series B preferred stock rating from BBB+ to A.
Also, during the fourth quarter of 2006 Standard and Poor's Corporations
changed our total outlook on our issuer default rating to "positive
outlook". During 2006, Moody's Investors Service raised the rating for
all of our debt with the Senior Debt Rating for HSBC Finance Corporation
raised from A1 to Aa3 and the
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Series B preferred stock rating for HSBC Finance Corporation from A3 to
A2. Our short-term rating was also affirmed at Prime-1. In the third
quarter of 2006, Fitch changed the total outlook on our issuer default
rating to "positive outlook" from "stable outlook."
- In the fourth quarter of 2006 we established common management over our
Consumer Lending and Mortgage Services businesses, including Decision One
Mortgage Company, LLC ("Decision One") to enhance our combined
organizational effectiveness, drive operational efficiency and improve
overall balance sheet management capabilities. As part of this effort, we
are currently evaluating the most effective structure for our Mortgage
Services operations which, depending upon the outcome, may change the
scope and size of this business going forward.
- In August 2005, Hurricane Katrina ("Katrina") caused destruction and loss
to individuals, businesses and public infrastructure. We recorded an
incremental provision for credit losses for Katrina of $185 million in
2005. As a result of our continuing assessments, including customer
contact and the collection of more information associated with the
properties located in the Katrina Federal Emergency Management Agency
("FEMA") designated areas, we reduced our estimate of credit loss
exposure by approximately $90 million in 2006.
PERFORMANCE, DEVELOPMENTS AND TRENDS
Our net income was $1.4 billion in 2006, $1.8 billion in 2005 and $1.9 billion
in 2004. In measuring our results, management's primary focus is on receivable
growth and operating net income (a non-U.S. GAAP financial measure which
excludes certain nonrecurring items). See "Basis of Reporting" for further
discussion of operating net income. Operating net income was $1.4 billion in
2006 compared to $1.8 billion in 2005 and $1.6 billion in 2004. Operating net
income decreased significantly in 2006 primarily due to a substantial increase
in our provision for credit losses and higher costs and expenses, which was
partially offset by higher net interest income and higher other revenues. As
discussed in more detail above, the higher provision for credit losses was
largely driven by higher delinquency and loss estimates at our Mortgage Services
business as loans acquired in 2005 and 2006 in the second lien and portions of
the first lien real estate secured portfolio are experiencing significantly
higher delinquency and for loans acquired in 2005 and early 2006, higher charge-
offs. Also contributing to the increase in loss provision was the impact of
higher receivable levels and portfolio seasoning including the Metris portfolio
acquired in December 2005. These increases were partially offset by lower
bankruptcy losses as a result of reduced filings following the bankruptcy law
changes in October 2005, the benefit of stable unemployment levels in the United
States and as discussed more fully above, a reduction in the estimated loss
exposure resulting from Katrina. Costs and expenses increased to support
receivables growth including the full year impact in 2006 of our acquisition of
Metris in December 2005, as well as increases in REO expenses as a result of
higher volumes and higher losses on sale. These increases were partially offset
by lower expenses at our U.K. business following the sale of the cards business
in December 2005 and lower intangible amortization. The increase in net interest
income was due to growth in average receivables and an improvement in the
overall yield on the portfolio, partly offset by a higher cost of funds. Changes
in receivable mix also contributed to the increase in yield due to the impact of
increased levels of higher yielding credit card receivables due to lower
securitization levels and our acquisition of Metris which contributed $161
million of net income in 2006. Other revenues on an operating basis increased
primarily due to higher fee income and enhancement services revenue, as well as
higher affiliate servicing fees, partially offset by lower other income, lower
derivative income and lower securitization related income. Fee income and
enhancement services revenue were higher in 2006 as a result of higher volumes
in our credit card portfolios, primarily resulting from our acquisition of
Metris. The increase in fee income was partially offset by the impact of FFIEC
guidance which limits certain fee billings for non-prime credit card accounts.
Affiliate servicing fees increased due to higher levels of receivables being
serviced. The decrease in other income was primarily due to lower gains on sales
of real estate secured receivables by our Decision One mortgage operations and
an increase in the liability for estimated losses from indemnification
provisions on Decision One loans previously sold. The decrease in derivative
income was primarily due to a rising interest rate environment and a significant
reduction during 2005 in the population of interest rate swaps which did not
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qualify for hedge accounting under SFAS No. 133. Securitization related revenue
decreased due to reduced securitization activity. Amortization of purchase
accounting fair value adjustments increased net income by $96 million in 2006,
which included $14 million relating to Metris, compared to $102 million in 2005,
which included $1 million relating to Metris.
Operating net income increased in 2005 primarily due to higher other revenues
and higher net interest income, partially offset by a higher provision for
credit losses as well as higher costs and expenses. Other revenues on an
operating basis increased primarily due to higher fee and other income as well
as higher enhancement services revenues and higher gains on affiliate receivable
sales and higher affiliate servicing fees, partially offset by lower derivative
income and lower securitization related revenue. The higher gains on affiliate
receivable sales and higher affiliate servicing revenue were largely driven by
the gains on daily sales of domestic private label receivable originations and
fees earned for servicing the domestic private label receivables sold to HSBC
Bank USA, National Association ("HSBC Bank USA") in December 2004. Fee income
and enhancement services revenues were higher as a result of increased volume in
our credit card portfolios. Other income was higher primarily due to higher
gains on asset sales, including the sale of a real estate investment. These
increases were partially offset by lower securitization related revenue due to
reduced securitization activity and lower derivative income. The decrease in
derivative income was primarily due to an increase in interest rates which
reduced realized gains and to the reduction in the portfolio of receive variable
interest rate swaps which do not qualify for hedge accounting under SFAS No.
133. The increase in net interest income was due to growth in average
receivables and an improvement in the overall yield on the portfolio, partly
offset by a higher cost of funds. As discussed in more detail below, the higher
provision for credit losses was due to receivable growth, increased credit loss
exposure from Katrina and higher charge-off due to significantly higher
bankruptcy filings as a result of new bankruptcy legislation in the United
States. Costs and expenses increased to support receivables growth as well as
due to increases in marketing expenses, partially offset by lower other
servicing and administrative expenses. Amortization of purchase accounting fair
value adjustments increased net income by $102 million in 2005, which included
$1 million relating to Metris, compared to $152 million in 2004.
Our net interest margin was 6.56 percent in 2006 compared to 6.73 percent in
2005 and 7.33 percent in 2004. The decrease in both 2006 and 2005 was due to
higher funding costs, partially offset by improvements in the overall yield on
the portfolio. Overall yields increased in both years due to increases in our
rates on fixed and variable rate products which reflected market movements and
various other repricing initiatives which, in 2006, included reduced levels of
promotional rate balances. Yields in 2006 were also favorably impacted by
receivable mix with increased levels of higher yielding products such as credit
cards due in part to the full year benefit from the Metris acquisition and
reduced securitization levels, increased levels of personal non-credit card
receivables due to growth and higher levels of second lien real estate secured
loans. Receivables mix contributed to higher yields in 2005 as increased levels
of higher yielding credit cards and personal non-credit card receivables were
held on the balance sheet due to lower securitization activity, but the effect
of this on yields was partially offset by growth in lower yielding real estate
secured and auto finance receivables as well as higher levels of near-prime
receivables and a significant decline in the level of private label receivables
due to the sale to HSBC Bank USA as discussed above.
Receivables increased to $162.0 billion at December 31, 2006, a 15.8 percent
increase from December 31, 2005. With the exception of our private label
portfolio, we experienced growth in all our receivable products with real estate
secured receivables being the primary contributor of the growth. The increase in
real estate secured receivable levels reflect organic growth as well as the $2.5
billion Champion portfolio purchased in November 2006. Real estate receivable
growth was tempered in the second half of 2006 due to our previously discussed
risk mitigation efforts at our Mortgage Services business which reduced, and
will continue to reduce, the volume of correspondent purchases in the future
which will have the effect of slowing growth in the real estate secured
portfolio. Lower securitization levels at our Credit Card business also
contributed to the increase in receivables in 2006.
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Our return on average common shareholder's(s') equity ("ROE") was 7.07 percent
in 2006 compared to 9.97 percent in 2005, and 10.99 percent in 2004. Our return
on average owned assets ("ROA") was .85 percent in 2006 compared to 1.27 percent
in 2005 and 1.57 percent in 2004. On an operating basis, ROE was 6.68 percent in
2006 compared to 9.97 percent in 2005 and 9.21 percent in 2004, and ROA was .80
percent in 2006 compared to 1.27 percent in 2005 and 1.32 percent in 2004. The
decrease in our operating basis ROE in 2006 reflects lower income and higher
average equity. Operating basis ROA decreased during 2006 and 2005 as average
owned assets increased at a faster pace than operating net income primarily due
to significantly higher provision for credit losses in 2006, lower net interest
margin in both years and in 2005, significantly lower derivative income.
Our efficiency ratio was 41.55 percent in 2006 compared to 44.10 percent in 2005
and 42.05 percent in 2004. Our efficiency ratio on an operating basis was 41.89
percent in 2006 compared to 44.10 percent in 2005 and 43.84 percent in 2004. The
improvement in efficiency ratio in 2006 was primarily a result of higher net
interest income and higher fee income and enhancement services revenues due to
higher levels of receivables, partially offset by an increase in total costs and
expenses to support receivable growth as well as higher losses on REO
properties. The 2005 and 2004 ratios were significantly impacted by the results
of the domestic private label portfolio which was sold in December 2004.
Excluding the results of this domestic private label portfolio from both
periods, our 2005 efficiency ratio improved 259 basis points as compared to
2004. This improvement was primarily a result of higher net interest income and
other revenues due to higher levels of owned receivables partially offset by the
increase in total costs and expenses to support receivable growth.
CREDIT QUALITY
Our two-months-and-over contractual delinquency ratio increased to 4.59 percent
at December 31, 2006 from 3.89 percent at December 31, 2005. The increase in the
total delinquency ratio was largely driven by higher real estate secured
delinquency levels principally at our Mortgage Services business due to the
deteriorating performance of certain loans acquired in 2005 and 2006 as more
fully discussed above. Also contributing to the increase in delinquency ratio
was higher credit card delinquency primarily due to the unusually low level of
delinquency at the end of 2005 as a result of the impact of the changes in
bankruptcy law as well as higher delinquency in the Metris portfolio and
seasoning of the personal non-credit card portfolio. Dollars of delinquency at
December 31, 2006 increased compared to December 31, 2005 due to higher levels
of receivables in 2006, including lower securitization levels as well as higher
delinquency levels in our real estate secured, credit card and personal
non-credit card portfolios as discussed above. Lower bankruptcy filings also
contributed to the increase in delinquency dollars and delinquency ratios as
some customers who previously may have filed bankruptcy under the previous
bankruptcy laws, and therefore charged off earlier, are progressing through the
various stages of delinquency and will become credit charge-off.
Net charge-offs as a percentage of average consumer receivables for 2006
decreased 6 basis points from 2005. Decreases in personal bankruptcy net
charge-offs in our credit card portfolio following the October 2005 bankruptcy
law changes in the United States was substantially offset by higher net
charge-offs in our real estate secured portfolio and in particular at our
Mortgage Services business, as well as higher net charge-offs in our auto
finance portfolio. Our auto finance portfolio also experienced higher net
charge-offs in 2006 due to the seasoning of a growing portfolio and a one-time
acceleration in charge-offs totaling $24 million as a result of a change in
charge-off policy related to repossessed vehicles in December 2006.
During 2006, our credit loss reserve levels increased significantly as a result
of higher loss estimates in our Mortgage Services business as previously
discussed, higher levels of receivables due in part to lower securitization
levels and higher dollars of delinquency driven by growth and portfolio
seasoning. These increases were partially offset by lower personal bankruptcy
levels, a reduction in the estimated loss exposure resulting from Katrina and
the benefits of stable unemployment in the United States. We recorded loss
provision in excess of net charge-offs of $2,045 million during 2006 of which
$1,668 million ($1,411 million in the fourth quarter) related to our Mortgage
Services business.
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FUNDING AND CAPITAL
During 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 and secured financings. Because we are a
subsidiary of HSBC, our credit ratings have improved and our credit spreads
relative to Treasury Bonds have tightened compared to those we experienced
during the months leading up to the announcement of our acquisition by HSBC. In
2006, Standard & Poor's Corporation raised the ratings on HSBC Finance
Corporation's senior debt, commercial paper, and the Series B preferred stock.
Also, during the fourth quarter of 2006 Standard and Poor's Corporations changed
our total outlook on our issuer default rating to "positive outlook". During
2006, Moody's Investors Service raised the rating for all of our debt. Our short
term rating was also affirmed at Prime-1. In the third quarter of 2006, Fitch
changed the total outlook on our issuer default rating to "positive outlook"
from "stable outlook." Primarily as a result of tightened credit spreads and
improved funding availability, we recognized cash funding expense savings of
approximately $940 million during 2006, $600 million in 2005 and $350 million in
2004 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 pre-tax cash funding expense savings
in excess of $1.0 billion for the year ended December 31, 2006.
Securitization of consumer receivables has historically 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 credit card transactions were structured as sales to
revolving trusts that require replenishments of receivables to support
previously issued securities, receivables will continue to be sold to these
trusts until the revolving periods end, the last of which is currently projected
to occur in the fourth quarter of 2007. We will also 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. The termination of sale treatment on new
collateralized funding activity has reduced our reported net income under U.S.
GAAP since the third quarter of 2004. There has been no impact, however, on cash
received from operations.
Tangible shareholders' equity to tangible managed assets ("TETMA") was 7.20
percent at December 31, 2006, and 7.56 percent at December 31, 2005. TETMA +
Owned Reserves was 11.08 percent at December 31, 2006 and 10.55 percent at
December 31, 2005. Tangible common equity to tangible managed assets was 6.11
percent at December 31, 2006 and 6.07 percent at December 31, 2005. Our capital
levels reflect a capital contribution of $163 million in 2006 and $1.2 billion
in 2005 from HSBC Investments (North America) Inc. ("HINO"). Capital levels also
reflect common stock dividends of $809 million and $980 million paid to our
parent in 2006 and 2005, respectively. Tangible common equity at December 31,
2005 reflects the exchange of our Series A Preferred Stock of $1.1 billion plus
accrued and unpaid interest for common equity in December 2005. These ratios
represent non-U.S. GAAP financial ratios that are used by HSBC Finance
Corporation management and certain rating agencies to evaluate capital adequacy
and may be different from similarly named measures presented by other companies.
See "Basis of Reporting" and "Reconciliations to U.S. GAAP Financial Measures"
for additional discussion and quantitative reconciliation to the equivalent U.S.
GAAP basis financial measure.
FUTURE PROSPECTS
Our continued success and prospects for growth are dependent upon access to the
global capital markets. Numerous factors, both internal and external, may impact
our access to, and the costs associated with, these markets. These factors may
include our debt ratings, overall economic conditions, overall capital markets
volatility, the counterparty credit limits of investors to the HSBC Group and
the effectiveness of our management of credit risks inherent in our customer
base. Our acquisition by HSBC has improved our access to the capital markets. It
also has given us the ability to use HSBC's liquidity to partially fund our
operations
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and reduce our overall reliance on the debt markets. Our affiliation with HSBC
has also expanded our access to a worldwide pool of potential investors.
Our results are also impacted by general economic conditions, primarily
unemployment, underemployment and interest rates, which are largely out of our
control. Because we generally lend to customers who have limited credit
histories, modest incomes and high debt-to-income ratios or who have experienced
prior credit problems, our customers are generally more susceptible to economic
slowdowns than other consumers. When unemployment and underemployment increase,
a higher percentage of our customers default on their loans and our charge-offs
increase. Changes in interest rates generally affect both the rates that we
charge to our customers and the rates that we must pay on our borrowings. In
2006, the interest rates that we paid on our debt increased. We have experienced
higher yields on our receivables in 2006 as a result of increased pricing on
variable rate products in line with market movements as well as other repricing
initiatives. Our ability to adjust our pricing on some of our products reduces
our exposure to an increase in interest rates. In 2007 and 2008, approximately
$10.8 billion and $5.1 billion, respectively, of our adjustable rate mortgage
loans will experience their first interest rate reset based on receivable levels
outstanding at December 31, 2006. In addition, our analysis indicates that a
significant portion of the second lien mortgages in our Mortgage Services
portfolio at December 31, 2006 are subordinated to first lien adjustable rate
mortgages that will face a rate reset in the next three years. As interest rates
have risen over the last three years many adjustable rate loans are expected to
require a significantly higher monthly payment following their first adjustment.
As a result, delinquency and charge-offs are increasing. We are proactively
contacting customers who we expect will be most impacted in order to assess
their ability to make adjusted payments. As appropriate and in accordance with
defined policy, some of these customers may be offered the opportunity to
refinance or modify their loans. The primary risks and opportunities to
achieving our business goals in 2007 are largely dependent upon economic
conditions, which includes a weakened housing market, a slowing U.S. economy, a
weakening consumer credit cycle and the impact of ARM resets, all of which could
result in changes to loan volume, charge-offs, net interest income and
ultimately net income.
BASIS OF REPORTING
--------------------------------------------------------------------------------
Our consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States ("U.S. GAAP"). Unless noted,
the discussion of our financial condition and results of operations included in
MD&A are presented on an owned basis of reporting. Certain reclassifications
have been made to prior year amounts to conform to the current year
presentation.
In addition to the U.S. GAAP financial results reported in our consolidated
financial statements, MD&A includes reference to the following information which
is presented on a non-U.S. GAAP basis:
OPERATING RESULTS, PERCENTAGES AND RATIOS Certain percentages and ratios have
been presented on an operating basis and have been calculated using "operating
net income," a non-U.S. GAAP financial measure. "Operating net income" is net
income excluding certain nonrecurring items shown in the following table:
2006 2005 2004
--------------------------------------------------------------------------------------
(IN MILLIONS)
Net income.................................................. $1,443 $1,772 $1,940
Gain on sale of investment in Kanbay, after tax............. (78) - -
Gain on bulk sale of private label receivables, after tax... - - (423)
Adoption of FFIEC charge-off policies for domestic private
label and credit card portfolios, after tax............... - - 121
------ ------ ------
Operating net income........................................ $1,365 $1,772 $1,638
====== ====== ======
We believe that excluding these nonrecurring items helps readers of our
financial statements to better understand the results and trends of our
underlying business. Because our investment in Kanbay was not part of our normal
business activities, we consider the gain on sale of such investment to be a
nonrecurring item.
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Additionally, while we continue to make daily sales of new private label
receivable originations to HSBC Bank USA, we consider the initial gain on bulk
sale of the receivable portfolio including the retained interests associated
with securitized private label receivables as nonrecurring because our results
of operations for 2004 also include the net interest income, fee income, credit
losses and securitization related revenue generated by the portfolio and the
related retained securitization interests through the date of sale on December
29, 2004. As a result of this transaction, our net interest income, fee income,
provision for credit losses and securitization related revenue from this
portfolio has been substantially reduced while other revenues has substantially
increased as reduced securitization related revenue associated with private
label receivables has been more than offset by gains from daily sales of newly
originated private label receivables and servicing revenue on the portfolio
received from HSBC Bank USA.
EQUITY RATIOS Tangible shareholder's equity to tangible managed assets
("TETMA"), tangible shareholder's equity plus owned loss reserves to tangible
managed assets ("TETMA + Owned Reserves") and tangible common equity to tangible
managed assets are non-U.S. GAAP financial measures that are used by HSBC
Finance Corporation management and certain rating agencies to evaluate capital
adequacy. Managed assets include owned assets plus loans which we have sold and
service with limited recourse. These ratios may differ from similarly named
measures presented by other companies. The most directly comparable U.S. 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 our ability to defer dividends. Prior to our
acquisition by HSBC, our Adjustable Conversion Rate Equity Security Units were
considered equity in these calculations.
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:
YEAR ENDED
2006 2005
-----------------------------------------------------------------------------
(IN MILLIONS)
Net income - U.S. GAAP basis................................ $1,443 $1,772
adjustments, net of tax:
Securitizations........................................... 25 155
Derivatives and hedge accounting (including fair value
adjustments)........................................... (171) (83)
Intangible assets......................................... 113 174
Purchase accounting adjustments........................... 42 292
Loan origination.......................................... (27) (39)
Loan impairment........................................... 36 -
Loans held for sale....................................... 28 -
Interest recognition...................................... 33 -
Changes in tax estimates and exposures.................... 94 66
Gain on sale of European Operations to HBEU subsidiary.... 12 -
Gain on sale of U.K. credit card business to HBEU......... - 176
Other..................................................... 56 47
------ ------
Net income - IFRSs basis.................................... $1,684 $2,560
====== ======
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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.
U.S. 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.
- 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 SPE, 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
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interest rate yield curves, option volatilities and currency rates. When
such evidence exists, HSBC recognizes a trading gain 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. These embedded derivatives are measured at fair
value with changes in fair value recognized in the income statement.
- Derivatives are classified as assets when their fair value is positive,
or as liabilities when their fair value is negative. Derivative assets
and liabilities arising from different transactions are only netted if
the transactions are with the same counterparty, a legal right of offset
exists, and the cash flows are intended to be settled on a net basis.
- The method of recognizing the resulting fair value gains or losses
depends on whether the derivative is held for trading, or is designated
as a hedging instrument and, if so, the nature of the risk being hedged.
All gains and losses from changes in the fair value of derivatives held
for trading are recognized in the income statement. When derivatives are
designated as hedges, HSBC classifies them as either: (i) hedges of the
change in fair value of recognized assets or liabilities or firm
commitments ("fair value hedge"); (ii) hedges of the variability in
highly probable future cash flows attributable to a recognized asset or
liability, or a forecast transaction ("cash flow hedge"); or (iii) hedges
of net investments in a foreign operation ("net investment hedge"). Hedge
accounting is applied to derivatives designated as hedging instruments in
a fair value, cash flow or net investment hedge provided certain criteria
are met.
Hedge Accounting:
- It is HSBC's policy to document, at the inception of a hedge, the
relationship between the hedging instruments and hedged items, as well
as the risk management objective and strategy for undertaking the hedge.
The policy also requires documentation of the assessment, both at hedge
inception and on an ongoing basis, of whether the derivatives used in
the 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.
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- 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.
U.S. 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 U.S. GAAP are not permitted by IAS 39.
- The requirements of SFAS No. 133 have been effective from January 1,
2001.
- The U.S. 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 U.S. 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 U.S. 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 offset
under IAS 32 and hence are presented gross on the balance sheet under
IFRSs.
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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 a
combination of 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.
- Derivative income declined in 2006 largely due to tightened credit
spreads on the application of the fair value option to our debt.
U.S. GAAP
- 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
usually reported at amortized cost under U.S. GAAP.
In 2006, a cumulative adjustment was recorded to increase net interest income
under IFRSs by approximately $207 million ($131 million net of tax), largely to
correct the amortization of purchase accounting adjustments on certain debt that
was not included in the fair value option adjustments under IFRSs in 2005. Of
the amount recognized, approximately $45 million, (after-tax), would otherwise
have been recorded as an adjustment to IFRSs net income in 2005.
GOODWILL, PURCHASE ACCOUNTING AND INTANGIBLES
IFRSs
- Prior to 1998, goodwill under U.K. 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 U.K. GAAP was carried
forward under the transition rules of IFRS 1 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.
U.S. 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.
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- 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.
U.S. GAAP
- Certain loan fee income and direct but not necessarily incremental loan
origination costs, including an apportionment of overheads, are amortized
to the income statement 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
- Where 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.
U.S. 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 estimated recoveries on individual
loans, this basis of measuring loan impairment is reflected in U.S. GAAP
accounting. Cash recoveries relating to pools of such written-off loans,
if any, are reported as loan recoveries upon collection.
LOANS HELD FOR RESALE
IFRSs
- Under IAS 39, loans held for resale are treated as trading assets.
- As trading assets, loans held for resale are initially recorded at fair
value, with changes in fair value being recognized in current period
earnings.
- Any gains realized on sales of such loans are recognized in current
period earnings on the trade date.
U.S. GAAP
- Under U.S. GAAP, loans held for resale are designated as loans on the
balance sheet.
- Such loans are recorded at the lower of amortized cost or market value
(LOCOM). Therefore, recorded value cannot exceed amortized cost.
- Subsequent gains on sales of such loans are recognized in current period
earnings on the settlement date.
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INTEREST RECOGNITION
IFRSs
- The calculation and recognition of effective interest rates under IAS 39
requires an estimate of "all fees and points paid or received between
parties to the contract" that are an integral part of the effective
interest rate be included.
U.S. GAAP
- FAS 91 also generally requires all fees and costs associated with
originating a loan to be recognized as interest, but when the interest
rate increases during the term of the loan it prohibits the recognition
of interest income to the extent that the net investment in the loan
would increase to an amount greater than the amount at which the borrower
could settle the obligation.
During the second quarter of 2006, we implemented a methodology for calculating
the effective interest rate for introductory rate credit card receivables and in
the fourth quarter of 2006, we implemented a methodology for calculating the
effective interest rate for real estate secured prepayment penalties over the
expected life of the products which resulted in an increase to interest income
of $154 million ($97 million after-tax) being recognized for introductory rate
credit card receivables and a decrease to interest income of $120 million ($76
million after-tax) being recognized for prepayment penalties on real estate
secured loans. Of the amounts recognized, approximately $58 million (after-tax)
related to introductory rate credit card receivables and approximately $11
million (after-tax) related to prepayment penalties on real estate secured loans
would otherwise have been recorded as an IFRSs opening balance sheet adjustment
as at January 1, 2005.
GAIN ON SALE OF U.K. CREDIT CARD BUSINESS AND EUROPEAN OPERATIONS TO AFFILIATE
IFRSs
- IFRSs requires that all items of income and expense recognized in a
period to be included in profit and loss unless another standard or an
interpretation requires otherwise.
U.S. GAAP
- U.S. GAAP requires that transfers of assets including non-financial
assets between affiliates under common control be treated as capital
transactions.
IFRS MANAGEMENT BASIS REPORTING As previously discussed, corporate goals and
individual goals of executives are currently calculated in accordance with IFRSs
under which HSBC prepares its consolidated financial statements. In 2006 we
initiated a project to refine the monthly internal management reporting process
to place a greater emphasis on IFRS management basis reporting (a non-U.S. GAAP
financial measure). As a result, operating results are now being monitored and
reviewed, trends are being evaluated and decisions about allocating resources,
such as employees, are being made almost exclusively on an IFRS Management
Basis. IFRS Management Basis results are IFRSs results which assume that the
private label and real estate secured receivables transferred to HSBC Bank USA
have not been sold and remain on our balance sheet. Operations are monitored and
trends are evaluated on an IFRS Management Basis because the customer loan sales
to HSBC Bank USA were conducted primarily to appropriately fund prime customer
loans within HSBC and such customer loans continue to be managed and serviced by
us without regard to ownership. Therefore, we have changed the measurement of
segment profit to IFRS Management Basis in order to align with our revised
internal reporting structure. However, we continue to monitor capital adequacy,
establish dividend policy and report to regulatory agencies on an U.S. GAAP
basis. For comparability purposes, we have restated segment results for the year
ended December 31, 2005 to the IFRS Management Basis. When HSBC began reporting
IFRS results in 2005, it elected to take advantage of certain options available
during the year of transition from U.K. GAAP to IFRSs which provided, among
other things, an exemption from applying certain IFRSs retrospectively.
Therefore, the segment results reported for the year ended December 31, 2004 are
presented on an IFRS Management Basis excluding the retrospective application of
IAS 32, "Financial Instruments: Presentation" and IAS 39, "Financial
Instruments: Recognition and Measurement" which took effect on January 1, 2005
and, as a result, the accounting for credit loss
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impairment provisioning, deferred loan origination costs and premiums and
derivative income for the year ended December 31, 2004 remain in accordance with
U.K. GAAP, HSBC's previous basis of reporting. Credit loss provisioning under
U.K. GAAP differs from IFRSs in that IFRSs require a discounted cash flow
methodology for estimating impairment as well as accruing for future recoveries
of charged-off loans on a discounted basis. Under U.K. GAAP only sales
incentives were treated as deferred loan origination costs which results in
lower deferrals than those reported under IFRSs. Additionally, deferred costs
and fees could be amortized over the contractual life of the underlying
receivable rather than the expected life as required under IFRSs. Derivative and
hedge accounting under U.K. GAAP differs from IFRSs in many respects, including
the determination of when a hedge exists as well as the reporting of gains and
losses. For a more detailed discussion of the differences between IFRSs and U.K.
GAAP, see Exhibit 99.2 to this Form 10-K. Also, see "Basis of Reporting" for a
more detailed discussion of the differences between IFRSs and U.S. GAAP.
QUANTITATIVE RECONCILIATIONS OF NON-U.S. GAAP FINANCIAL MEASURES TO U.S. GAAP
FINANCIAL MEASURES For quantitative reconciliations of non-U.S. GAAP financial
measures presented herein to the equivalent GAAP basis financial measures, see
"Reconciliations to U.S. GAAP Financial Measures."
CRITICAL ACCOUNTING POLICIES
--------------------------------------------------------------------------------
Our consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States. We believe our policies are
appropriate and fairly present the financial position of HSBC Finance
Corporation.
The significant accounting policies used in the preparation of our financial
statements are more fully described in Note 2, "Summary of Significant
Accounting Policies," to the accompanying consolidated financial statements.
Certain critical accounting policies, which affect the reported amounts of
assets, liabilities, revenues and expenses, are complex and involve significant
judgment by our management, including the use of estimates and assumptions. We
recognize the different inherent loss characteristics in each of our loan
products as well as the impact of operational policies such as customer account
management policies and practices and risk management/collection practices. As a
result, changes in estimates, assumptions or operational policies could
significantly affect our financial position or our results of operations. We
base and establish our accounting estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities. Actual results may differ from
these estimates under different assumptions, customer account management
policies and practices, risk management/collection practices, or other
conditions as discussed below.
We believe that of the significant accounting policies used in the preparation
of our consolidated financial statements, the items discussed below involve
critical accounting estimates and a high degree of judgment and complexity. Our
management has discussed the development and selection of these critical
accounting policies with our external auditors and the Audit Committee of our
Board of Directors, including the underlying estimates and assumptions, and the
Audit Committee has reviewed our disclosure relating to these accounting
policies and practices in this MD&A.
CREDIT LOSS RESERVES Because we lend money to others, we are exposed to the risk
that borrowers may not repay amounts owed to us when they become contractually
due. Consequently, we maintain credit loss reserves at a level that we consider
adequate, but not excessive, to cover our estimate of probable losses of
principal, interest and fees, including late, overlimit and annual fees, in the
existing portfolio. Loss reserves are set at each business unit in consultation
with Corporate Finance and Credit Risk Management. Loss reserve estimates are
reviewed periodically, and adjustments are reflected through the provision for
credit losses in the
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period when they become known. We believe the accounting estimate relating to
the reserve for credit losses is a "critical accounting estimate" for the
following reasons:
- The provision for credit losses totaled $6.6 billion in 2006, $4.5
billion in 2005 and $4.3 billion in 2004 and changes in the provision can
materially affect net income. As a percentage of average receivables, the
provision was 4.31 percent in 2006 compared to 3.76 percent in 2005 and
4.28 percent in 2004.
- Estimates related to the reserve for credit losses require us to
anticipate future delinquency and charge-off trends which are uncertain
and require a high degree of judgment.
- The reserve for credit losses is influenced by factors outside of our
control such as customer payment patterns, economic conditions such as
national and local trends in housing markets, interest rates, bankruptcy
trends and changes in laws and regulations.
Because our loss reserve estimate involves judgment and is influenced by factors
outside of our control, it is reasonably possible such estimates could change.
Our estimate of probable net credit losses is inherently uncertain because it is
highly sensitive to changes in economic conditions which influence growth,
portfolio seasoning, bankruptcy trends, trends in housing markets, the ability
of customers to refinance their adjustable rate mortgages, delinquency rates and
the flow of loans through the various stages of delinquency, or buckets, the
realizable value of any collateral and actual loss exposure. Changes in such
estimates could significantly impact our credit loss reserves and our provision
for credit losses. For example, a 10% change in our projection of probable net
credit losses on receivables could have resulted in a change of approximately
$656 million in our credit loss reserve for receivables at December 31, 2006.
The reserve for credit losses is a critical accounting estimate for all three of
our reportable segments.
Credit loss reserves are based on estimates and are intended to be adequate but
not excessive. We estimate probable losses for consumer receivables using a roll
rate migration analysis which utilizes recent historical data to estimate the
likelihood that a loan will progress through the various stages of delinquency,
or buckets, and ultimately charge off. This analysis considers delinquency
status, loss experience and severity and takes into account whether loans are in
bankruptcy, have been restructured or rewritten, or are subject to forbearance,
an external debt management plan, hardship, modification, extension or
deferment. In addition, our loss reserves on consumer receivables are maintained
to reflect our judgment of portfolio risk factors that may not be fully
reflected in the statistical roll rate calculation. Risk factors considered in
establishing loss reserves on consumer receivables include recent growth,
product mix, bankruptcy trends, geographic concentrations, loan product features
such as adjustable rate loans, economic conditions such as national and local
trends in housing markets and interest rates, 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 natural disasters
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 as a percentage of
nonperforming loans, reserves as a percentage of net charge-offs and number of
months charge-off coverage in developing our loss reserve estimate. In addition
to the above procedures for the establishment of our credit loss reserves, our
Retail Credit Risk Management department independently evaluates the adequacy of
our loss reserve levels.
We periodically re-evaluate our estimate of probable losses for consumer
receivables. Changes in our estimate are recognized in our statement of income
as provision for credit losses in the period that the estimate is changed. Our
credit loss reserves for receivables increased $2.1 billion from December 31,
2005 to $6.6 billion at December 31, 2006 as a result of higher loss estimates
in our Mortgage Services business due to the deteriorating performance in the
second lien and portions of the first lien real estate secured loans acquired in
2005 and 2006, higher levels of receivables due in part to lower securitization
levels, higher overall delinquency
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levels in our portfolio driven by growth and portfolio seasoning and the impact
of the acquisition of Metris in December 2005. These increases were partially
offset by lower personal bankruptcy levels, a reduction in the estimated loss
exposure resulting from Katrina and the benefits of stable unemployment in the
United States. At December 31, 2006, we recorded loss reserves at our Mortgage
Services business of $2.1 billion that included estimates of losses attributable
to ARM resets on first and second liens, a higher charge-off rate and expected
loss severity on second liens generally and particularly, second liens
subordinate to ARMs held by other lenders that face a rate reset in the next
three years. Our reserves as a percentage of receivables were 4.07 percent at
December 31, 2006, 3.23 percent at December 31, 2005 and 3.39 percent at
December 31, 2004. Reserves as a percentage of receivables increased compared to
December 31, 2005 primarily due to higher real estate loss estimates as
discussed above.
For more information about our charge-off and customer account management
policies and practices, see "Credit Quality - Delinquency and Charge-offs" and
"Credit Quality - Customer Account Management Policies and Practices."
GOODWILL AND INTANGIBLE ASSETS Goodwill and intangible assets with indefinite
lives are not subject to amortization. Intangible assets with finite lives are
amortized over their estimated useful lives. Goodwill and intangible assets are
reviewed annually on July 1 for impairment using discounted cash flows, but
impairment is reviewed earlier if circumstances indicate that the carrying
amount may not be recoverable. We consider significant and long-term changes in
industry and economic conditions to be our primary indicator of potential
impairment.
We believe the impairment testing of our goodwill and intangibles is a critical
accounting estimate due to the level of goodwill ($7.0 billion) and intangible
assets ($2.2 billion) recorded at December 31, 2006 and the significant judgment
required in the use of discounted cash flow models to determine fair value.
Discounted cash flow models include such variables as revenue growth rates,
expense trends, interest rates and terminal values. Based on an evaluation of
key data and market factors, management's judgment is required to select the
specific variables to be incorporated into the models. Additionally, the
estimated fair value can be significantly impacted by the cost of capital used
to discount future cash flows. The cost of capital percentage is generally
derived from an appropriate capital asset pricing model, which itself depends on
a number of financial and economic variables which are established on the basis
of management's judgment. Because our fair value estimate involves judgment and
is influenced by factors outside our control, it is reasonably possible such
estimates could change. When management's judgment is that the anticipated cash
flows have decreased and/or the cost of capital has increased, the effect will
be a lower estimate of fair value. If the fair value is determined to be lower
than the carrying value, an impairment charge will be recorded and net income
will be negatively impacted.
Impairment testing of goodwill requires that the fair value of each reporting
unit be compared to its carrying amount. A reporting unit is defined as any
distinct, separately identifiable component of an operating segment for which
complete, discrete financial information is available that management regularly
reviews. For purposes of the annual goodwill impairment test, we assigned our
goodwill to our reporting units. At July 1, 2006, the estimated fair value of
each reporting unit exceeded its carrying value, resulting in none of our
goodwill being impaired.
Impairment testing of intangible assets requires that the fair value of the
asset be compared to its carrying amount. For all intangible assets, at July 1,
2006, the estimated fair value of each intangible asset exceeded it carrying
value and, as such, none of our intangible assets were impaired.
Included in the sale of our European Operations in November 2006, was $13
million of goodwill attributable to this business. Subsequent to the sale, we
performed an interim goodwill impairment test for our business remaining in the
U.K. and European operations as required by SFAS No. 142, "Goodwill and Other
Intangible Assets" ("SFAS No. 142"). As the estimated fair value of our
remaining U.K. and European operations exceeded our carrying value subsequent to
the sale, we concluded that the remaining goodwill assigned to this reporting
unit was not impaired.
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As a result of the adverse change in the business climate experienced by our
Mortgage Services business in the second half of 2006, we performed an interim
goodwill impairment test for this reporting unit as of December 31, 2006. As the
estimated fair value of our Mortgage Services business exceeded our carrying
value, we concluded that the remaining goodwill assigned to this reporting unit
was not impaired.
VALUATION OF DERIVATIVE INSTRUMENTS AND DERIVATIVE INCOME We regularly use
derivative instruments as part of our risk management strategy to protect the
value of certain assets and liabilities and future cash flows against adverse
interest rate and foreign exchange rate movements. All derivatives are
recognized on the balance sheet at fair value. As of December 31, 2006, the
recorded fair values of derivative assets and liabilities were $1,461 million
and $1,222 million, respectively. We believe the valuation of derivative
instruments is a critical accounting estimate because certain instruments are
valued using discounted cash flow modeling techniques in lieu of market value
quotes. These modeling techniques require the use of estimates regarding the
amount and timing of future cash flows, which are also susceptible to
significant change in future periods based on changes in market rates. The
assumptions used in the cash flow projection models are based on forward yield
curves which are also susceptible to changes as market conditions change.
We utilize HSBC Bank USA to determine the fair value of substantially all of our
derivatives using these modeling techniques. We regularly review the results of
these valuations for reasonableness by comparing to an internal determination of
fair value or third party quotes. Significant changes in the fair value can
result in equity and earnings volatility as follows:
- Changes in the fair value of a derivative that has been designated and
qualifies as a fair value hedge, along with the changes in the fair value
of the hedged asset or liability (including losses or gains on firm
commitments), are recorded in current period earnings.
- Changes in the fair value of a derivative that has been designated and
qualifies as a cash flow hedge are recorded in other comprehensive income
to the extent of its effectiveness, until earnings are impacted by the
variability of cash flows from the hedged item.
- Changes in the fair value of a derivative that has not been designated as
an effective hedge is reported in current period earnings.
A derivative designated as an effective hedge will be tested for effectiveness
in virtually all circumstances under the long-haul method (which at December 31,
2006 comprises 100 percent of our hedge portfolio based on notional amounts
eligible for hedge accounting). For these transactions, we formally assess, both
at the inception of the hedge and on a quarterly basis, whether the derivative
used in a hedging transaction has been and is expected to continue to be highly
effective in offsetting changes in fair values or cash flows of the hedged item.
This assessment is conducted using statistical regression analysis.
If it is determined as a result of this assessment that a derivative is not
expected to be a highly effective hedge or that it has ceased to be a highly
effective hedge, we discontinue hedge accounting as of the beginning of the
quarter in which such determination was made. We also believe the assessment of
the effectiveness of the derivatives used in hedging transactions is a critical
accounting estimate due to the use of statistical regression analysis in making
this determination. Similar to discounted cash flow modeling techniques,
statistical regression analysis also requires the use of estimates regarding the
amount and timing of future cash flows, which are susceptible to significant
change in future periods based on changes in market rates. Statistical
regression analysis also involves the use of additional assumptions including
the determination of the period over which the analysis should occur as well as
selecting a convention for the treatment of credit spreads in the analysis. The
statistical regression analysis for our derivative instruments is performed by
either HSBC Bank USA or an independent third party.
The outcome of the statistical regression analysis serves as the foundation for
determining whether or not the derivative is highly effective as a hedging
instrument. This can result in earnings volatility as the mark-to-market on
derivatives which do not qualify as effective hedges and the ineffectiveness
associated with qualifying hedges are recorded in current period earnings. The
mark-to market on derivatives which do not qualify as effective hedges was $28
million in 2006, $156 million in 2005 and $442 million in 2004. The
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ineffectiveness associated with qualifying hedges was $169 million in 2006, $41
million in 2005 and $1 million in 2004. See "Results of Operations" in
Management's Discussion and Analysis of Financial Condition and Results of
Operations for a discussion of the yearly trends.
For more information about our policies regarding the use of derivative
instruments, see Note 2, "Summary of Significant Accounting Policies," and Note
14, "Derivative Financial Instruments," to the accompanying consolidated
financial statements.
CONTINGENT LIABILITIES Both we and certain of our subsidiaries are parties to
various legal proceedings resulting from ordinary business activities relating
to our current and/or former operations which affect all three of our reportable
segments. Certain of these activities are or purport to be class actions seeking
damages in significant amounts. These actions include assertions concerning
violations of laws and/or unfair treatment of consumers.
Due to the uncertainties in litigation and other factors, we cannot be certain
that we will ultimately prevail in each instance. Also, as the ultimate
resolution of these proceedings is influenced by factors that are outside of our
control, it is reasonably possible our estimated liability under these
proceedings may change. However, based upon our current knowledge, our defenses
to these actions have merit and any adverse decision should not materially
affect our consolidated financial condition, results of operations or cash
flows.
RECEIVABLES REVIEW
--------------------------------------------------------------------------------
The following table summarizes receivables at December 31, 2006 and increases
(decreases) over prior periods:
INCREASES (DECREASES) FROM
---------------------------------
DECEMBER 31, DECEMBER 31,
2005 2004
DECEMBER 31, --------------- ---------------
2006 $ % $ %
------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Real estate secured(1)........................ $ 97,761 $14,935 18.0% $32,941 50.8%
Auto finance.................................. 12,504 1,800 16.8 4,960 65.7
Credit card................................... 27,714 3,604 14.9 13,079 89.4
Private label................................. 2,509 (11) (0.4) (902) (26.4)
Personal non-credit card...................... 21,367 1,822 9.3 5,239 32.5
Commercial and other.......................... 181 (27) (13.0) (136) (42.9)
-------- ------- ----- ------- -----
Total receivables............................. $162,036 $22,123 15.8% $55,181 51.6%
======== ======= ===== ======= =====
---------------
(1) Real estate secured receivables are comprised of the following:
INCREASES (DECREASES) FROM
-------------------------------
DECEMBER 31, DECEMBER 31,
2005 2004
DECEMBER 31, -------------- --------------
2006 $ % $ %
------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Mortgage Services........................................... $47,968 $ 6,413 15.4% $19,265 67.1%
Consumer Lending............................................ 46,226 8,004 20.9 13,003 39.1
Foreign and all other....................................... 3,567 518 17.0 673 23.3
------- ------- ---- ------- ----
Total real estate secured................................... $97,761 $14,935 18.0% $32,941 50.8%
======= ======= ==== ======= ====
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REAL ESTATE SECURED RECEIVABLES Real estate secured receivables can be further
analyzed as follows:
INCREASES (DECREASES) FROM
---------------------------------
DECEMBER 31, DECEMBER 31,
2005 2004
DECEMBER 31, --------------- ---------------
2006 $ % $ %
------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Real estate secured:
Closed-end:
First lien............................... $77,901 $11,082 16.6% $23,769 43.9%
Second lien.............................. 15,090 3,275 27.7 7,168 90.5
Revolving:
First lien............................... 556 (70) (11.2) (228) (29.1)
Second lien.............................. 4,214 648 18.2 2,232 112.6
------- ------- ----- ------- -----
Total real estate secured..................... $97,761 $14,935 18.0% $32,941 50.8%
======= ======= ===== ======= =====
Real estate secured receivables increased significantly over the year-ago period
driven by growth in our branch and correspondent businesses. Growth in our
branch-based Consumer Lending business improved because of higher sales volumes
than in the prior year as we continue to emphasize real estate secured loans,
including a near-prime mortgage product we first introduced in 2003. Also
contributing to the increase was the acquisition of the $2.5 billion Champion
portfolio in November 2006, as well as the $.4 billion in 2006 and the $1.7
billion in 2005 of acquisitions from a portfolio acquisition program. Our
Mortgage Services correspondent business experienced growth in the first six
months of 2006 as management continued to focus on junior lien loans through
portfolio acquisitions and expanded our sources for purchasing newly originated
loans from flow correspondents. This growth was partially offset when management
revised its business plan and reduced purchases of second lien and selected
higher risk products in the second half of 2006. These actions combined with
normal portfolio attrition, resulted in a decline in the overall portfolio
balance at our Mortgage Services business since June 2006. In addition, a
decline in loan prepayments in 2006 due to the current rising interest rate
environment resulted in lower run-off rates for our real estate secured
portfolio. In 2005 we expanded our Canadian branch operations which has also
experienced strong real estate secured receivable growth.
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The following table summarizes various real estate secured receivables
information for our Mortgage Services and Consumer Lending businesses:
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
2006 2005 2004
------------------- ------------------- -------------------
MORTGAGE CONSUMER MORTGAGE CONSUMER MORTGAGE CONSUMER
SERVICES LENDING SERVICES LENDING SERVICES LENDING
---------------------------------------------------------------------------------------------------
(IN MILLIONS)
Fixed rate........................ $21,733 $42,675(1) $18,876 $36,415 $12,789 $31,947
Adjustable rate................... 26,235 3,551 22,679 $ 1,807 15,914 1,276
------- ------- ------- ------- ------- -------
Total............................. $47,968 $46,226 $41,555 $38,222 $28,703 $33,223
======= ======= ======= ======= ======= =======
First lien........................ $38,031 $39,684 $33,897 $33,017 $25,225 $29,287
Second lien....................... 9,937 6,542 7,658 5,205 3,478 3,936
------- ------- ------- ------- ------- -------
Total............................. $47,968 $46,226 $41,555 $38,222 $28,703 $33,223
======= ======= ======= ======= ======= =======
Adjustable rate................... $20,108 $ 3,551 $17,826 $ 1,807 $14,859 $ 1,276
Interest only..................... 6,127 - 4,853 - 1,055 -
------- ------- ------- ------- ------- -------
Total adjustable rate............. $26,235 $ 3,551 $22,679 $ 1,807 $15,914 $ 1,276
======= ======= ======= ======= ======= =======
Total stated income (low
documentation).................. $11,772 $ - $ 7,344 $ - $ 3,112 $ -
======= ======= ======= ======= ======= =======
---------------
(1) Includes interest-only loans of $46 million.
At December 31, 2006 real estate secured loans originated and acquired
subsequent to December 31, 2004 by our Mortgage Services business accounted for
approximately 70 percent of total Mortgage Services receivables in a first lien
and approximately 90 percent of total Mortgage Services receivables in a second
lien position.
AUTO FINANCE RECEIVABLES Auto finance receivables increased over the year-ago
period due to organic growth principally in the near-prime portfolio. We
experienced increases in newly originated loans acquired from our dealer network
and growth in the consumer direct loan program. Additionally in 2006, we
experienced continued growth from the expansion of an auto finance program
introduced in Canada in the second quarter of 2004 which at December 31, 2006,
has grown to a network of 2,000 active dealer relationships.
CREDIT CARD RECEIVABLES Credit card receivables reflect strong domestic organic
growth in our Union Privilege and non-prime portfolios including Metris. Also
contributing to the growth was the successful launch of a MasterCard/Visa credit
card program in Canada in 2005. Lower securitization levels also contributed to
the increase at December 31, 2006. Receivable balances at December 31, 2005 were
impacted by the $5.3 billion of receivables acquired as part of our acquisition
of Metris as well as the sale of our U.K. credit card business which included
$2.2 billion of MasterCard/Visa receivables.
PRIVATE LABEL RECEIVABLES Private label receivables decreased in 2006 as a
result of lower retail sales volumes in the U.K. and the termination of new
domestic retail sales contract originations in October 2006, partially offset by
growth in our Canadian business.
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PERSONAL NON-CREDIT CARD RECEIVABLES Personal non-credit card receivables are
comprised of the following:
INCREASES (DECREASES) FROM
----------------------------------
DECEMBER 31, DECEMBER 31,
2005 2004
DECEMBER 31, --------------- ---------------
2006 $ % $ %
-----------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Domestic personal non-credit card........... $13,763 $2,369 20.8% $5,798 72.8%
Union Plus personal non-credit card......... 235 (98) (29.4) (240) (50.5)
Personal homeowner loans.................... 4,247 74 1.8 639 17.7
Foreign personal non-credit card............ 3,122 (523) (14.3) (958) (23.5)
------- ------ ----- ------ -----
Total personal non-credit card
receivables............................... $21,367 $1,822 9.3% $5,239 32.5%
======= ====== ===== ====== =====
Personal non-credit card receivables increased during 2006 as a result of
increased marketing, including several large direct mail campaigns.
Domestic and foreign personal non-credit card loans (cash loans with no
security) are made to customers who may not qualify for either a real estate
secured or personal homeowner loan ("PHL"). The average personal non-credit card
loan is approximately $6,600 and 46 percent of the personal non-credit card
portfolio is closed-end with terms ranging from 12 to 60 months. The Union Plus
personal non-credit card loans are part of our affinity relationship with the
AFL-CIO and are underwritten similar to other personal non-credit card loans.
PHL's typically have terms of 120 to 240 months and are subordinate lien, home
equity loans with high (100 percent or more) combined loan-to-value ratios which
we underwrite, price and manage like unsecured loans. The average PHL is
approximately $14,000. Because recovery upon foreclosure is unlikely after
satisfying senior liens and paying the expenses of foreclosure, we do not
consider the collateral as a source for repayment in our underwriting.
Historically, these loans have performed better from a credit loss perspective
than traditional unsecured loans as consumers are more likely to pay secured
loans than unsecured loans in times of financial distress.
DISTRIBUTION AND SALES We reach our customers through many different
distribution channels and our growth strategies vary across product lines. The
Consumer Lending business originates real estate and personal non-credit card
products through its retail branch network, direct mail, telemarketing,
strategic alliances and Internet applications and purchases loans as part of a
portfolio acquisition program. The Mortgage Services business originates real
estate secured receivables sourced through brokers and purchases real estate
secured receivables primarily through correspondents. Private label receivables
are generated through point of sale, merchant promotions, application displays,
Internet applications, direct mail and telemarketing. Auto finance receivables
are generated primarily through dealer relationships from which installment
contracts are purchased. Additional auto finance receivables are generated
through direct lending which includes alliance partner referrals, Internet
applications and direct mail as well as in our Consumer Lending branches. Credit
card receivables are generated primarily through direct mail, telemarketing,
Internet applications, application displays including in our Consumer Lending
retail branch network, promotional activity associated with our co-branding and
affinity relationships, mass media advertisements and merchant relationships
sourced through our Retail Services business. We also supplement
internally-generated receivable growth with strategic portfolio acquisitions.
Our acquisition by HSBC enabled us to enlarge our customer base through
cross-selling products to HSBC customers as well as generate new business with
various major corporations. The rebranding of the majority of our U.S. and
Canadian businesses to the HSBC brand has positively impacted these efforts. A
Consumer Finance team, which was established in 2004, has worked throughout 2005
and 2006 on a consultative basis to extend consumer finance offerings in select
emerging markets across the HSBC Group.
Based on certain criteria, we offer personal non-credit card customers who meet
our current underwriting standards the opportunity to convert their loans into
real estate secured loans. This enables our customers to
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have access to additional credit at lower interest rates. This also reduces our
potential loss exposure and improves our portfolio performance as previously
unsecured loans become secured. We converted approximately $665 million of
personal non-credit card loans into real estate secured loans in 2006 and $652
million in 2005. It is not our practice to rewrite or reclassify delinquent
secured loans (real estate or auto) into personal non-credit card loans.
RESULTS OF OPERATIONS
--------------------------------------------------------------------------------
Unless noted otherwise, the following discusses amounts reported in our owned
basis statement of income.
NET INTEREST INCOME The following table summarizes net interest income:
YEAR ENDED DECEMBER 31, 2006 (1) 2005 (1) 2004 (1)
-----------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Finance and other interest income......... $17,562 11.31% $13,216 10.61% $10,945 10.28%
Interest expense.......................... 7,374 4.75 4,832 3.88 3,143 2.95
------- ----- ------- ----- ------- -----
Net interest income....................... $10,188 6.56% $ 8,384 6.73% $ 7,802 7.33%
======= ===== ======= ===== ======= =====
---------------
(1) % Columns: comparison to average owned interest-earning assets.
The increase in net interest income during 2006 was due to higher average
receivables and higher overall yields, partially offset by higher interest
expense. Overall yields increased due to increases in our rates on fixed and
variable rate products which reflected market movements and various other
repricing initiatives which in 2006 included reduced levels of promotional rate
balances. Yields in 2006 were also favorably impacted by receivable mix with
increased levels of higher yielding products such as credit cards, due in part
to the full year benefit from the Metris acquisition and reduced securitization
levels; higher levels of personal non-credit card receivables due to growth and
higher levels of second lien real estate secured loans. The higher interest
expense, which contributed to lower net interest margin, was due to a larger
balance sheet and a significantly higher cost of funds due to a rising interest
rate environment. In addition, as part of our overall liquidity management
strategy, we continue to extend the maturity of our liability profile which
results in higher interest expense. Our purchase accounting fair value
adjustments include both amortization of fair value adjustments to our external
debt obligations and receivables. Amortization of purchase accounting fair value
adjustments increased net interest income by $418 million in 2006, which
included $62 million relating to Metris and $520 million in 2005, which included
$4 million relating to Metris.
The increase in net interest income during 2005 was due to higher average
receivables and a higher overall yield, partially offset by higher interest
expense. Overall yields increased as our rates on variable rate products
increased in line with market movements and other repricing initiatives more
than offset a decline in real estate secured and auto finance yields. Changes in
receivable mix also contributed to the increase in yield as the impact of
increased levels of higher yielding credit card and personal non-credit card
receivables due to lower securitization levels was partially offset by growth in
lower yielding real estate secured receivables. Receivable mix was also
significantly impacted by lower levels of private label receivables as a result
of the sale of our domestic private label portfolio (excluding retail sales
contracts at our consumer lending business) in December 2004. Amortization of
purchase accounting fair value adjustments increased net interest income by $520
million in 2005 and $743 million in 2004.
Net interest margin was 6.56 percent in 2006, 6.73 percent in 2005 and 7.33
percent in 2004. Net interest margin decreased in both 2006 and 2005 as the
improvement in the overall yield on our receivable portfolio, as
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discussed above, was more than offset by the higher funding costs. The following
table shows the impact of these items on net interest margin:
2006 2005
--------------------------------------------------------------------------
Net interest margin - December 31, 2005 and 2004,
respectively.............................................. 6.73% 7.33%
Impact to net interest margin resulting from:
Bulk sale of domestic private label portfolio in December
2004................................................... - (.24)
Receivable pricing........................................ .32 .11
Receivable mix............................................ .07 .12
Sale of U.K. card business in December 2005............... .04 -
Metris acquisition in December 2005....................... .34 .03
Cost of funds change...................................... (.89) (.79)
Investment securities mix................................. - .06
Other..................................................... (.05) .11
---- ----
Net interest margin - December 31, 2006 and 2005,
respectively.............................................. 6.56% 6.73%
==== ====
The varying maturities and repricing frequencies of both our assets and
liabilities expose us to interest rate risk. When the various risks inherent in
both the asset and the debt do not meet our desired risk profile, we use
derivative financial instruments to manage these risks to acceptable interest
rate risk levels. See "Risk Management" for additional information regarding
interest rate risk and derivative financial instruments.
PROVISION FOR CREDIT LOSSES The provision for credit losses includes current
period net credit losses and an amount which we believe is sufficient to
maintain reserves for losses of principal, interest and fees, including late,
overlimit and annual fees, at a level that reflects known and inherent losses in
the portfolio. Growth in receivables and portfolio seasoning ultimately result
in higher provision for credit losses. The provision for credit losses may also
vary from year to year depending on a variety of additional factors including
product mix and the credit quality of the loans in our portfolio including,
historical delinquency roll rates, customer account management policies and
practices, risk management/collection policies and practices related to our loan
products, economic conditions such as national and local trends in housing
markets and interest rates, changes in laws and regulations and our analysis of
performance of products originated or acquired at various times.
The following table summarizes provision for owned credit losses:
YEAR ENDED DECEMBER 31, 2006 2005 2004
--------------------------------------------------------------------------------------
(IN MILLIONS)
Provision for credit losses................................. $6,564 $4,543 $4,334
Our provision for credit losses increased $2,021 million during 2006. The
provision for credit losses in 2005 included increased provision expense of $185
million relating to Katrina and $113 million in the fourth quarter due to
bankruptcy reform legislation. Excluding these adjustments and a subsequent
release of $90 million of Katrina reserves in 2006, the provision for credit
losses increased $2,409 million or 57 percent in 2006. The increase in the
provision for credit losses was largely driven by deterioration in the
performance of mortgage loans acquired in 2005 and 2006 by our Mortgage Services
business, particularly in the second lien and portions of the first lien
portfolios which has resulted in higher delinquency, charge-off and loss
estimates in these portfolios. This deterioration worsened considerably in the
fourth quarter of 2006, largely related to the first lien adjustable rate
mortgage portfolio as well as loans in the second lien portfolio. We have now
been able to determine that a significant number of our second lien customers
have underlying adjustable rate first mortgages that face repricing in the
near-term which has impacted the probability of repayment on the related second
lien mortgage loan. As the interest rate adjustments will occur in an
environment of substantially higher interest rates, lower home value
appreciation and tightening credit, we expect the probability of default
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for adjustable rate first mortgages subject to repricing as well as any second
lien mortgage loans that are subordinate to an adjustable rate first lien will
be greater than what we have historically experienced.
Also contributing to this increase in provision in 2006 was the impact of higher
receivable levels and normal portfolio seasoning including the Metris portfolio
acquired in December 2005. These increases were partially offset by reduced
bankruptcy filings, the benefit of stable unemployment levels in the United
States and the sale of the U.K. card business in December 2005. Net charge-off
dollars for 2006 increased $866 million compared to 2005 driven by our Mortgage
Services business, as loans originated and acquired in 2005 and early 2006 are
experiencing higher charge-offs. Also contributing to the increase in net
charge-off dollars was higher credit card charge-off due to the full year impact
of the Metris portfolio, the one-time accelerations of charge-offs at our Auto
Finance business due to a change in policy, the discontinuation of a forbearance
program at our U.K. business (see "Credit Quality" for further discussion) and
the impact of higher receivable levels and portfolio seasoning in our auto
finance and personal non-credit card portfolios. These increases were partially
offset by the impact of reduced bankruptcy levels following the spike in filings
and subsequent charge-off we experienced in the fourth quarter of 2005 as a
result of the legislation enacted in October 2005, the benefit of stable
unemployment levels in the United States, and the sale of the U.K. card business
in December 2005.
Our provision for credit losses increased during 2005 primarily due to increased
credit loss exposure as a result of Katrina and higher bankruptcy losses due to
increased bankruptcy filings as a result of a new bankruptcy law in the United
States. Excluding the increased credit loss provision related to Katrina and the
impact from the increased bankruptcy filings in 2005, our provision for credit
losses declined in 2005 as a shift in portfolio mix to higher levels of secured
receivables, primarily as a result of the sale of our domestic private label
portfolio (excluding retail sales contracts at our Consumer Lending business) in
December 2004, were partially offset by increased requirements due to receivable
growth, including lower securitization levels and higher credit loss exposure in
the U.K. Net charge-off dollars decreased in 2005 compared to 2004 primarily due
to the lower delinquency levels we experienced as a result of the strong
economy. These improvements were partially offset by receivable growth as well
as higher bankruptcy related charge-offs in the fourth quarter of 2005 as a
result of a new bankruptcy law in the United States.
We increased our credit loss reserves in both 2006 and 2005 as the provision for
credit losses was $2,045 million greater than net charge-offs in 2006 (which
included $1,668 million related to our Mortgage Services business) and $890
million greater than net charge-off in 2005. The provision as a percent of
average owned receivables was 4.31 percent in 2006, 3.76 percent in 2005 and
4.28 percent in 2004. The increase in 2006 reflects higher loss estimates and
charge-offs at our Mortgage Services business as discussed above, as well as
higher dollars of delinquency in our other businesses driven by growth and
portfolio seasoning. Reserve levels also increased due to higher early stage
delinquency consistent with the industry trend in certain Consumer Lending real
estate secured loans originated since late 2005. The decrease in 2005 reflects
receivable growth, partially offset by the impact of Katrina and higher
provision resulting from the increased bankruptcy filings as a result of new
bankruptcy legislation in the United States.
See "Critical Accounting Policies," "Credit Quality," "Analysis of Credit Loss
Reserves Activity" and "Reconciliations to U.S. GAAP Financial Measures" for
additional information regarding our loss reserves and the adoption of FFIEC
policies. See Note 7, "Credit Loss Reserves" in the accompanying consolidated
financial statements for additional analysis of loss reserves.
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OTHER REVENUES The following table summarizes other revenues:
YEAR ENDED DECEMBER 31, 2006 2005 2004
--------------------------------------------------------------------------------------
(IN MILLIONS)
Securitization related revenue.............................. $ 167 $ 211 $1,008
Insurance revenue........................................... 1,001 997 882
Investment income........................................... 274 134 137
Derivative income........................................... 190 249 511
Fee income.................................................. 1,911 1,568 1,091
Enhancement services revenue................................ 515 338 251
Taxpayer financial services revenue......................... 258 277 217
Gain on bulk sale of private label receivables.............. - - 663
Gain on receivable sales to HSBC affiliates................. 422 413 39
Servicing fees from HSBC affiliates......................... 506 440 57
Other income................................................ 179 336 307
------ ------ ------
Total other revenues........................................ $5,423 $4,963 $5,163
====== ====== ======
Securitization related revenue is the result of the securitization of our
receivables and includes the following:
YEAR ENDED DECEMBER 31, 2006 2005 2004
----------------------------------------------------------------------------------
(IN MILLIONS)
Net initial gains(1)........................................ $ - $ - $ 25
Net replenishment gains(2).................................. 30 154 414
Servicing revenue and excess spread......................... 137 57 569
---- ---- ------
Total....................................................... $167 $211 $1,008
==== ==== ======
---------------
()(1) Net initial gains reflect inherent recourse provisions of $47 million in
2004.
()(2) Net replenishment gains reflect inherent recourse provisions of $41
million in 2006, $252 million in 2005 and $850 million in 2004.
The decline in securitization related revenue in 2006 and 2005 was due to
decreases in the level of securitized receivables and higher run-off due to
shorter expected lives of securitization trusts as a result of our decision in
the third quarter of 2004 to structure all new collateralized funding
transactions as secured financings. Because existing public credit card
transactions were structured as sales to revolving trusts that require
replenishments of receivables to support previously issued securities,
receivables continue to be sold to these trusts until the revolving periods end,
the last of which is currently projected to occur in the fourth quarter of 2007.
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. While the
termination of sale treatment on new collateralized funding activity and the
reduction of sales under replenishment agreements reduced our reported net
income under U.S. GAAP, there is no impact on cash received from operations.
See Note 2, "Summary of Significant Accounting Policies," and Note 8, "Asset
Securitizations," to the accompanying consolidated financial statements and "Off
Balance Sheet Arrangements and Secured Financings" for further information on
asset securitizations.
Insurance revenue increased in 2006 primarily due to higher sales volumes and
new reinsurance activity beginning in the third quarter of 2006 in our domestic
operations. These increases in 2006 were partially offset by lower insurance
sales volumes in our U.K. operations. The increase in 2005 was due to increased
sales volumes for many of our insurance products in both our U.K. and domestic
operations.
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Investment income, which includes income on securities available for sale in our
insurance business and realized gains and losses from the sale of securities,
increased in 2006 primarily due to the $123 million gain on sale of our
investment in Kanbay. In 2005, the lower average investment balances and lower
gains from security sales were largely offset by higher yields on our
investments.
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:
2006 2005 2004
--------------------------------------------------------------------------------
(IN MILLIONS)
Net realized gains (losses)................................. $ (7) $ 52 $ 68
Mark-to-market on derivatives which do not qualify as
effective hedges.......................................... 28 156 442
Ineffectiveness............................................. 169 41 1
---- ---- ----
Total....................................................... $190 $249 $511
==== ==== ====
In 2006, derivative income decreased 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. In addition, during 2006 we have
experienced a rising interest rate environment compared to a yield cure that
generally flattened in the comparable period of 2005. The income from
ineffectiveness in both periods resulted from the designation during 2005 of a
significant number of our derivatives as effective hedges under the long-haul
method of accounting. These derivatives had not previously qualified for hedge
accounting under SFAS No. 133. In addition, all of the hedge relationships which
qualified under the shortcut method provisions of SFAS No. 133 have now been
redesignated, substantially all of which are hedges under the long-haul method
of 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. 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 year ended December 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 2006 and 2005 due to higher credit card fees, particularly
relating to our non-prime credit card portfolio due to higher levels of credit
card receivables, including the Metris portfolio acquired in December 2005 and
in 2005, improved interchange rates. Increases in 2006 were partially offset by
the impact of FFIEC guidance which limits certain fee billings for non-prime
credit card accounts and higher rewards program expenses. Increases in 2005 were
partially offset by lower private label credit card fees and higher rewards
program expenses. The lower private label credit card fees were the result of
the bulk sale of domestic private label receivables to HSBC Bank USA in December
2004.
Enhancement services revenue, which consists of ancillary credit card revenue
from products such as Account Secure Plus (debt waiver) and Identity Protection
Plan, was higher in 2006 and 2005 primarily as a result of higher levels of
credit card receivables and higher customer acceptance levels. Additionally, the
acquisition of Metris in December 2005 contributed to higher enhancement
services revenue in 2006.
Taxpayer financial services ("TFS") revenue decreased as 2005 TFS revenues
reflects gains of $24 million on the sales of certain bad debt recovery rights
to a third party. Excluding the impact of these gains in the prior year, TFS
revenue increased due to increased loan volume during the 2006 tax season. The
increase in 2005 was a result of increased loan volume in the 2005 tax season as
well as the gains on the sale of bad debt recovery rights discussed above.
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Gain on bulk sale of private label receivables resulted from the sale of $12.2
billion of domestic private label receivables including the retained interests
associated with securitized private label receivables to HSBC Bank USA in
December 2004. See Note 4, "Sale of Domestic Private Label Receivable Portfolio
and Adoption of FFIEC Policies," to the accompanying consolidated financial
statements for further information.
Gains on receivable sales to HSBC affiliates in 2006 and 2005 includes the daily
sales of domestic private label receivable originations (excluding retail sales
contracts) and certain credit card account originations to HSBC Bank USA as well
as gains on bulk sales of real estate secured receivables to HSBC Bank USA by
our Decision One mortgage operations in 2006. In 2004, gains on receivable sales
to HSBC affiliates includes the bulk sale of real estate secured receivables in
March 2004 as well as certain credit card account originations to HSBC Bank USA.
See Note 4, "Sale of Domestic Private Label Receivable Portfolio and Adoption of
FFIEC Policies," to the accompanying consolidated financial statements for
further information.
Servicing fees from HSBC affiliates represents revenue received under service
level agreements under which we service credit card and domestic private label
receivables as well as real estate secured and auto finance receivables for HSBC
affiliates. The increases primarily relate to higher levels of receivables being
serviced on behalf of HSBC Bank USA and in 2006 the servicing fees we receive
for servicing the credit card receivables sold to HBEU in December 2005.
Other income decreased in 2006 primarily due to lower gains on sales of real
estate secured receivables by our Decision One mortgage operations and an
increase in the liability for estimated losses from indemnification provisions
on Decision One loans previously sold. Lower gains on miscellaneous asset sales,
including real estate investments also contributed to the decrease in other
income. The increase in 2005 was primarily due to higher gains on miscellaneous
asset sales, including the sale of a real estate investment.
COSTS AND EXPENSES The following table summarizes total costs and expenses:
YEAR ENDED DECEMBER 31, 2006 2005 2004
--------------------------------------------------------------------------------------
(IN MILLIONS)
Salaries and employee benefits.............................. $2,333 $2,072 $1,886
Sales incentives............................................ 358 397 363
Occupancy and equipment expenses............................ 317 334 323
Other marketing expenses.................................... 814 731 636
Other servicing and administrative expenses................. 1,115 917 958
Support services from HSBC affiliates....................... 1,087 889 750
Amortization of intangibles................................. 269 345 363
Policyholders' benefits..................................... 467 456 412
------ ------ ------
Total costs and expenses.................................... $6,760 $6,141 $5,691
====== ====== ======
Salaries and employee benefits increased in 2006 and 2005 as a result of
additional staffing, primarily in our Consumer Lending, Mortgage Services,
Retail Services and Canadian operations as well as in our corporate functions to
support growth. Salaries in 2006 were also higher due to additional staffing in
our Credit Card Services operations as a result of the acquisition of Metris in
December 2005 which was partially offset by lower staffing levels in our U.K.
business as a result of the sale of the cards business in 2005.
Effective December 20, 2005, our U.K. based technology services employees were
transferred to HBEU. As a result, operating expenses relating to information
technology, which were previously reported as salaries and fringe benefits, are
now billed to us by HBEU and reported as support services from HSBC affiliates.
Sales incentives decreased in 2006 due to lower origination volumes in our
Mortgage Services business due to the decision to reduce purchases including
second lien and selected higher risk products in the second half of 2006. Also
contributing to the decrease in 2006 was lower volumes in our U.K. business
partially offset by
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increases in our Canadian operations. Sales incentives increased in 2005 due to
higher volumes in both our Consumer Lending and Mortgage Services businesses.
Occupancy and equipment expenses decreased in 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 as well as lower repairs and
maintenance costs. These decreases were partially offset by higher occupancy and
equipment expenses resulting from our acquisition of Metris in December 2005.
Occupancy and equipment expenses increased in 2005 as higher occupancy expense
and higher repairs and maintenance costs were partially offset by lower
depreciation.
Other marketing expenses includes payments for advertising, direct mail programs
and other marketing expenditures. The increase in 2006 was primarily due to
increased domestic credit card marketing expense including the Metris portfolio
acquired in December 2005, and expenses related to the launch of a co-brand
credit card in the third quarter of 2006, partially offset by decreased expenses
in our U.K. operations as a result of the sale of our U.K. card business in
December 2005. The increase in 2005 was primarily due to increased domestic
credit card marketing expenses due to higher non-prime marketing expense and
investments in new marketing initiatives. Changes in contractual marketing
responsibilities in July 2004 associated with the General Motors ("GM")
co-branded credit card also resulted in increased expenses in 2005.
Other servicing and administrative expenses increased in 2006 as a result of
higher REO expenses due to higher volumes and higher losses, higher systems
costs and higher insurance operating expense in our U.K. operations. The
increase in 2006 also reflects lower deferred origination costs at our Mortgage
Services business due to lower volumes. Other servicing and administrative
expenses decreased in 2005 due to lower REO expenses and a lower estimate of
exposure relating to accrued finance charges associated with certain loan
restructures which were partially offset by higher systems costs.
Support services from HSBC affiliates, which includes technology and other
services charged to us by HTSU since January 1, 2004 and by HBEU since December
20, 2005, increased in 2006 and 2005 primarily due to growth.
Amortization of intangibles decreased in 2006 and 2005 due to lower intangible
amortization related to our purchased credit card relationships due to a
contract renegotiation with one of our co-branded credit card partners in 2005
and lower amortization associated with an individual contractual relationship.
These decreases in 2006 were partially offset by amortization expense associated
with the Metris cardholder relationships. Additionally, 2006 amortization
expense was lower following the sale of the U.K. card business in 2005 and the
write-off related to a trade name in the U.K. in 2005.
Policyholders' benefits increased in 2006 due to higher sales volumes and new
reinsurance activity in our domestic operations beginning in the third quarter
of 2006, partially offset by decreased sales volumes in our U.K. operations as
well as lower amortization of fair value adjustments relating to our insurance
business. Policyholders' benefits increased in 2005 due to a continuing increase
in insurance sales volumes in both our U.K. and domestic operations, partially
offset by lower amortization of fair value adjustments relating to our insurance
business.
The following table summarizes our efficiency ratio:
YEAR ENDED DECEMBER 31, 2006 2005 2004
---------------------------------------------------------------------------------------
U.S. GAAP basis efficiency ratio............................ 41.55% 44.10% 42.05%
Operating basis efficiency ratio(1)......................... 41.89 44.10 43.84
---------------
(1) Represents a non-U.S. GAAP financial measure. See "Basis of Reporting" for
additional discussion on the use of this non-U.S. GAAP financial measure and
"Reconciliations to U.S. GAAP Financial Measures" for quantitative
reconciliations of our operating efficiency ratio to our owned basis U.S.
GAAP efficiency ratio.
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Our efficiency ratios improved due to higher net interest income and higher fee
income and enhancement services revenues due to higher levels of receivables,
partially offset by an increase in total costs and expenses to support
receivable growth as well as higher losses on REO properties. Our efficiency
ratio in 2005 was significantly impacted by the results of the domestic private
label receivable portfolio which was sold in December 2004. Excluding the
results of this domestic private label portfolio from both the 2005 and 2004
periods, our 2005 efficiency ratio improved 259 basis points as compared to
2004. This improvement is primarily a result of higher net interest income and
other revenues due to higher levels of owned receivables, partially offset by
the increase in total costs and expenses to support receivable growth.
INCOME TAXES Our effective tax rates were as follows:
YEAR ENDED DECEMBER 31, EFFECTIVE TAX RATE
--------------------------------------------------------------------------------
2006........................................................ 36.9%
2005........................................................ 33.5
2004........................................................ 34.0
The increase in the effective tax rate for 2006 was due to higher state income
taxes and lower tax credits as a percentage of income before taxes. The increase
in state income taxes was primarily due to an increase in the blended statutory
tax rate of our operating companies. The decrease in the effective tax rate in
2005 is attributable to lower state tax rates and lower pretax income with low
income housing tax credits remaining constant. The effective tax rate differs
from the statutory federal income tax rate primarily because of the effects of
state and local income taxes and tax credits.
SEGMENT RESULTS - IFRS MANAGEMENT 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 and other credit card
business. Our International segment consists of our foreign operations in the
United Kingdom, Canada, the Republic of Ireland, and prior to November 2006 our
operations in Slovakia, the Czech Republic and Hungary.
The composition of our business segments is consistent with that reported in our
2005 Form 10-K. However, as previously discussed, corporate goals and individual
goals of executives are currently calculated in accordance with IFRSs under
which HSBC prepares its consolidated financials statements. In 2006 we initiated
a project to refine the monthly internal management reporting process to place a
greater emphasis on IFRS Management Basis reporting (a non-U.S. GAAP financial
measure). As a result, operating results are now monitored and reviewed, trends
are being evaluated and decisions about allocating resources, such as employees,
are now being made almost exclusively on an IFRS Management Basis. As previously
discussed, IFRS Management Basis results are IFRSs results which assume that the
private label and real estate secured receivables transferred to HSBC Bank USA
have not been sold and remain on our balance sheet. Operations are monitored and
trends are evaluated on an IFRS Management Basis because the customer loan sales
to HSBC Bank USA were conducted primarily to appropriately fund prime customer
loans within HSBC and such customer loans continue to be managed and serviced by
us without regard to ownership. Therefore, we have changed the measurement of
segment profit to an IFRS Management Basis in order to align with our revised
internal reporting structure. However, we continue to monitor capital adequacy,
establish dividend policy and report to regulatory agencies on an U.S. GAAP
basis. A summary of the significant differences between U.S. GAAP and IFRSs as
they impact our results are summarized in Note 21, "Business Segments," in the
accompanying consolidated financial statements.
For comparability purposes, we have restated segment results for the year ended
December 31, 2005 to the IFRS Management Basis. When HSBC began reporting IFRS
results in 2005, it elected to take advantage of certain options available
during the year of transition from U.K. GAAP to IFRSs which provided, among
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other things, an exemption from applying certain IFRSs retrospectively.
Therefore, the segment results reported for the year ended December 31, 2004 are
presented on an IFRS Management Basis excluding the retrospective application of
IAS 32, "Financial Instruments: Presentation" and IAS 39, "Financial
Instruments: Recognition and Measurement" which took effect on January 1, 2005
and, as a result, the accounting for credit loss impairment provisioning,
deferred loan origination costs and premiums and derivative income for the year
ended December 31, 2004 remain in accordance with U.K. GAAP, HSBC's previous
basis of reporting. Credit loss provisioning under U.K. GAAP differs from IFRSs
in that IFRSs require a discounted cash flow methodology for estimating
impairment as well as accruing for future recoveries of charged-off loans on a
discounted basis. Under U.K. GAAP, only sales incentives were treated as
deferred loan origination costs which results in lower deferrals than those
reported under IFRSs. Additionally, deferred costs and fees could be amortized
over the contractual life of the underlying receivable rather than the expected
life as required under IFRSs. Derivative and hedge accounting under U.K. GAAP
differs from U.S. GAAP in many respects, including the determination of when a
hedge exists as well as the reporting of gains and losses. For a more detailed
discussion of the differences between IFRSs and U.K. GAAP, see Exhibit 99.2 to
this Form 10-K.
CONSUMER SEGMENT The following table summarizes the IFRS Management Basis
results for our Consumer segment for the years ended December 31, 2006, 2005 and
2004.
YEAR ENDED DECEMBER 31, 2006 2005 2004
--------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net income.................................................. $ 988 $ 1,981 $ 1,737
Operating net income........................................ 988 1,981 1,324
Net interest income......................................... 8,588 8,401 8,180
Other operating income...................................... 909 814 502
Intersegment revenues....................................... 242 108 101
Loan impairment charges..................................... 4,983 3,362 3,151
Operating expenses.......................................... 2,998 2,757 2,777
Customer loans.............................................. 144,573 128,095 107,769
Assets...................................................... 146,395 130,375 109,238
Net interest margin......................................... 6.23% 7.15% 8.38%
Return on average assets.................................... .71 1.68 1.77
2006 compared to 2005 Our Consumer segment reported lower net income in 2006 due
to higher loan impairment charges and operating expenses, partially offset by
higher net interest income and higher other operating income.
Loan impairment charges for the Consumer segment increased significantly during
2006. The increase in loan impairment charges was largely driven by
deterioration in the performance of mortgage loans acquired in 2005 and 2006 by
our Mortgage Services business, particularly in the second lien and portions of
the first lien portfolios which has resulted in higher delinquency, charge-off
and loss estimates in these portfolios. These increases were partially offset by
a reduction in the estimated loss exposure resulting from Katrina of
approximately $68 million in 2006 as well as the benefit of low unemployment
levels in the United States. In 2006, we increased loss reserve levels as the
provision for credit losses was greater than net charge-offs by $1,597 million,
which included $1,627 million related to our Mortgage Services business.
Operating expenses were higher in 2006 due to lower deferred loan origination
costs in our Mortgage Services business as mortgage origination volumes have
declined, higher marketing expenses due to the launch of a new co-brand credit
card in our Retail Services business, higher salary expense and higher support
services from affiliates to support growth.
Net interest income increased during 2006 primarily due to higher average
customer loans and higher overall yields, partially offset by higher interest
expense. Overall yields reflect strong growth in real estate secured
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customer loans at current market rates and a higher mix of higher yielding
second lien real estate secured loans and personal non-credit card customer
loans due to growth. These increases were partially offset by a reduction in net
interest income of $120 million due to an adjustment to recognize prepayment
penalties on real estate secured loans over the expected life of the product.
Net interest margin decreased from the prior year as the higher yields discussed
above were offset by higher interest expense due to a larger balance sheet and a
significantly higher cost of funds resulting from a rising interest rate
environment.
The increase in other operating income in 2006 was primarily due to higher
credit insurance commissions, higher late fees and a higher fair value
adjustment for our loans held for sale, partially offset by higher REO expense
due to higher volumes and losses.
Customer loans increased 13 percent to $144.6 billion at December 31, 2006 as
compared to $128.1 billion at December 31, 2005. Real estate growth in 2006 was
strong as a result of strong growth in our branch-based Consumer Lending
business. In addition, our correspondent business experienced growth during the
first six months of 2006 as management continued to focus on junior lien loans
and expanded our sources for purchasing newly originated loans from flow
correspondents. However, in the second half of 2006, management revised its
business plan and began tightening underwriting standards on loans purchased
from correspondents including reducing purchases of second lien and selected
higher risk segments. These activities have reduced, and will continue to
reduce, the volume of correspondent purchases in the future which will have the
effect of slowing growth in the real estate secured portfolio. Growth in our
branch-based Consumer Lending business reflects higher sales volumes than in the
prior year as we continue to emphasize real estate secured loans, including a
near-prime mortgage product we first introduced in 2003. Real estate secured
customer loans also increased as a result of portfolio acquisitions, including
the $2.5 billion of customer loans related to the Champion portfolio purchased
in November 2006 as well as $.4 billion in 2006 and $1.7 billion in 2005 of
purchases from a portfolio acquisition program. In addition, a decline in loan
prepayments in 2006 resulted in lower run-off rates for our real estate secured
portfolio which also contributed to overall growth. Our Auto Finance business
also reported organic growth, principally in the near-prime portfolio, from
increased volume in both the dealer network and the consumer direct loan
program. The private label portfolio increased in 2006 due to strong growth
within consumer electronics and powersports as well as new merchant signings.
Growth in our personal non-credit card portfolio was the result of increased
marketing, including several large direct mail campaigns.
In the fourth quarter of 2006, our Consumer Lending business completed the
acquisition of Solstice Capital Group Inc. ("Solstice") with assets of
approximately $49 million, in an all cash transaction for approximately $50
million. Additional consideration may be paid based on Solstice's 2007 pre-tax
income. Solstice markets a range of mortgage and home equity products to
customers through direct mail. This acquisition will add momentum to our
origination growth plan by providing an additional channel to customers.
ROA was .71 percent in 2006 and 1.68 percent in 2005. The decrease in the ROA
ratio in 2006 is due to the decrease in net income discussed above as well as
the growth in average 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. Implementation did not have a material impact on either the
results of the Consumer segment or our consolidated results.
2005 compared to 2004 Our Consumer segment reported higher operating net income
in 2005. Operating net income is a non-U.S. GAAP financial measure of net income
which excludes in 2004 the $97 million decrease in net income relating to the
adoption of FFIEC charge-off policies for our domestic private label customer
loans (excluding the retail sales contracts at our Consumer Lending business).
In 2005, the increase in operating net income was primarily due to higher other
operating income and higher net interest income, partially offset by higher loan
impairment charges.
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The increase in other operating income was due to higher late and other account
services fees and lower losses on REO properties. Additionally, as IAS 39 was
not adopted until January 1, 2005, other operating income in 2005 includes
amounts which were classified differently in 2004. Under IAS 39, interest income
and deferred loan origination fees for loans held for sale are recorded as
trading income and included in other operating income. In 2004 under U.K. GAAP,
these items were not included in other operating income but continued to be
reported as components of interest income and deferred loan origination fees.
Therefore, the 2005 results include $79 million in other operating income for
loans held for sale for which the comparable 2004 amounts were included in
interest income and deferred loan origination fees in 2004.
Net interest income increased in 2005 primarily due to higher average customer
loans, partially offset by higher interest expense. Net interest margin
decreased in 2005 as a result of lower yields on real estate secured and auto
finance customer loans as a result of competitive pressure on pricing and
product expansion into near-prime consumer segments, as well as the run-off of
higher yielding real estate secured customer loans, including second lien loans,
largely due to refinance activity. Our Auto Finance business experienced lower
yields as we targeted higher credit quality customers. Although higher credit
quality customer loans generate lower yields, such customer loans are expected
to result in lower operating costs, delinquency ratios and charge-off. The
decreases in yield for our consumer segment receivable portfolio discussed above
were partially offset by higher pricing on our variable rate products. A higher
cost of funds due to a rising interest rate environment also contributed to the
decrease in net interest margin.
Loan impairment charges increased in 2005 as a result of increased provision
requirements associated with receivable growth, the impact from Katrina and the
new bankruptcy law in the United States, which are discussed more fully below.
Excluding the impact of Katrina and the new bankruptcy law in the United States,
loan impairment charges were lower in 2005 driven by lower net charge-off due to
improved credit quality, partially offset by increased provision requirements
due to portfolio growth. In 2005 we experienced lower dollars of net charge-offs
than in the prior year. In 2005, we increased IFRS Management Basis loss
reserves as the provision for credit losses was higher than net charge-offs by
$261 million.
As previously mentioned, loan impairment charges in 2005 also reflected an
estimate of incremental credit loss exposure relating to Katrina. The
incremental provision for credit losses for Katrina in the Consumer segment in
2005 was $130 million and represented our best estimate of Katrina's impact on
our loan portfolio. In an effort to assist our customers affected by the
disaster, we initiated various programs including extended payment arrangements
for up to 90 days or more depending upon customer circumstances. These interest
and fee waivers were not material to the Consumer segment's 2005 results.
As previously discussed, the United States enacted new bankruptcy legislation
which resulted in a spike in bankruptcy filings prior to the October 2005
effective date. As a result, our 2005 fourth quarter results included an
increase of approximately $130 million in loan impairment charges due to this
spike in bankruptcy filings. However, in accordance with our charge-off policy
for real estate secured and personal non-credit card customer loans, the
associated accounts did not begin to migrate to charge-off until 2006.
Customer loans increased 19 percent to $128.1 billion at December 31, 2005 as
compared to $107.8 billion at December 31, 2004. We experienced strong growth in
2005 in our real estate secured portfolio in both our correspondent and
branch-based businesses. In 2005 we continued to focus on junior lien loans
through portfolio acquisitions and expanded our sources for purchasing newly
originated loans from flow correspondents. Growth in real estate secured
customer loans was also supplemented by purchases from a single correspondent
relationship which totaled $1.1 billion in 2005. Also contributing to the
increase were purchases of $1.7 billion in 2005 from a portfolio acquisition
program. Our auto finance portfolio also reported growth due to strong organic
growth, principally in the near-prime portfolios. This came from newly
originated loans acquired from our dealer network, growth in the consumer direct
loan program and expanded distribution through alliance channels. Our private
label portfolio experienced growth as a result of strong merchant renewals
including nine new retail merchants in 2005 as well as an increase in the
commercial card capacity. Personal non-credit card customer loans increased from
the prior year as we began to increase the availability
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of this product in the second half of 2004 as a result of an improving U.S.
economy as well as the success of several large direct mail campaigns that
occurred in 2005.
ROA was 1.68 percent in 2005 and 1.77 percent in 2004. The decrease in 2005 was
a result of the growth in average assets outpacing the increase in net income.
CREDIT CARD SERVICES SEGMENT The following table summarizes the IFRS Management
Basis results for our Credit Card Services segment for the years ended December
31, 2006, 2005 and 2004.
YEAR ENDED DECEMBER 31, 2006 2005 2004
-----------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net income.................................................. $ 1,386 $ 813 $ 521
Net interest income......................................... 3,151 2,150 2,226
Other operating income...................................... 2,360 1,892 1,581
Intersegment revenues....................................... 20 21 25
Loan impairment charges..................................... 1,500 1,453 1,786
Operating expenses.......................................... 1,841 1,315 1,205
Customer loans.............................................. 28,221 25,979 19,615
Assets...................................................... 28,780 28,453 19,702
Net interest margin......................................... 11.85% 10.42% 10.78%
Return on average assets.................................... 5.18 4.13 2.55
2006 compared to 2005 Our Credit Card Services segment reported higher net
income in 2006. The increase in net income was primarily due to higher net
interest income and higher other operating income, partially offset by higher
operating expenses and higher loan impairment charges. The acquisition of
Metris, which was completed in December 2005, contributed $147 million of net
income during 2006 as compared to $4 million in 2005.
Net interest income increased in 2006 largely as a result of the Metris
acquisition, which contributed to higher overall yields due in part to higher
levels of non-prime customer loans, partially offset by higher interest expense.
Net interest income in 2006 also benefited from the implementation in the second
quarter of 2006 of a methodology for calculating the effective interest rate for
introductory rate credit card customer loans under IFRSs over the expected life
of the product which increased net interest income by $154 million for the year.
Net interest margin increased primarily due to higher overall yields due to
increases in non-prime customer loans, including the customer loans acquired as
part of Metris, higher pricing on variable rate products and other repricing
initiatives. These increases were partially offset by a higher cost of funds.
Net interest margin in 2006 was also positively impacted by the adjustments
recorded for the effective interest rate for introductory rate MasterCard/Visa
customer loans discussed above. Although our non-prime customer loans tend to
have smaller balances, they generate higher returns both in terms of net
interest margin and fee income.
Increases in other operating income resulted from portfolio growth, including
the Metris portfolio acquired in December 2005 which has resulted in higher late
fees, higher interchange revenue and higher enhancement services revenue from
products such as Account Secure Plus (debt waiver) and Identity Protection Plan.
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.
Higher operating expenses were incurred to support receivable growth, including
the Metris portfolio acquisition, and increases in marketing expenses. The
increase in marketing expenses in 2006 was primarily due to the Metris portfolio
acquired in December 2005 and increased investment in our non-prime portfolio.
Loan impairment charges were higher in 2006. Loan impairment charges in 2005
were impacted by incremental credit loss provisions relating to the spike in
bankruptcy filings experienced in the period leading up to October 17, 2005,
which was the effective date of new bankruptcy laws in the United States and
higher
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provisions relating to Katrina. Excluding these items, provisions in 2006
nonetheless increased, reflecting receivable growth and portfolio seasoning,
including the full year impact of the Metris portfolio, partially offset by the
impact of lower levels of bankruptcy filings following the enactment of new
bankruptcy laws in October 2005, higher recoveries as a result of better rates
available in the non-performing asset sales market and a reduction of our
estimate of incremental credit loss exposure related to Katrina of approximately
$26 million. We increased loss reserves by recording loss provision greater than
net charge-off of $328 million in 2006.
Customer loans increased 9 percent to $28.2 billion at December 31, 2006
compared to $26.0 billion at December 31, 2005. The increase reflects strong
domestic organic growth in our Union Privilege as well as other non-prime
portfolios including Metris.
The increase in ROA in 2006 is primarily due to the higher net income as
discussed above, partially offset by higher average 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 phased in by December 31, 2005. These changes resulted in
lower non-prime credit card fee income in 2006. In addition, roll rate trends in
the prime book have been slightly higher than those experienced prior to the
changes in minimum payment. These changes have resulted in fluctuations in loan
impairment charges as credit loss provisions for prime accounts has increased as
a result of higher required monthly payments while the non-prime provision
decreased due to lower levels of fees incurred by customers. The impact of these
changes has not had a material impact on our consolidated results, but has had a
material impact to the Credit Card Services segment in 2006.
2005 compared to 2004 Our Credit Card Services segment reported higher net
income in 2005. The increase in net income was primarily due to higher other
operating income and lower loan impairment charges, partially offset by higher
operating expenses and lower net interest income. The acquisition of Metris,
which was completed in December 2005, did not have a significant impact to the
results of the Credit Card Services segment in 2005. Increases in other
operating income resulted from portfolio growth, higher late and overlimit fees
and improved interchange rates.
Loan impairment charges decreased in 2005 due to improved credit quality,
partially offset by receivable growth as well as the increased credit loss
provision relating to the impact of Katrina and the increased bankruptcy filings
resulting from the new bankruptcy law in the United States. We experienced
higher dollars of net charge-offs in our portfolio due to higher receivable
levels as well as the increased credit card charge-offs in the fourth quarter of
2005 which resulted from the spike in bankruptcy filings prior to the October
2005 effective date of the new bankruptcy law. We had been maintaining credit
loss reserves in anticipation of the impact this new law would have on net
charge-offs. However, the magnitude of the spike in bankruptcies experienced
immediately before the new law became effective was larger than anticipated
which resulted in an additional $100 million credit loss provision being
recorded during the third quarter of 2005. Our fourth quarter of 2005 results
included an estimated $125 million in incremental charge-offs of principal,
interest and fees attributable to bankruptcy reform which was offset by a
release of our owned credit loss reserves of $125 million. As expected, the
number of bankruptcy filings subsequent to the enactment of this new law has
decreased dramatically. In 2005, we increased our loss reserves by recording
loss provision greater than net charge-offs of $20 million.
Loan impairment charges in 2005 also reflects an estimate of incremental credit
loss exposure relating to Katrina. The incremental provision for credit losses
for Katrina in the Credit Card Services segment in 2005 was $55 million and
represented our best estimate of Katrina's impact on our loan portfolio. In an
effort to assist our customers affected by the disaster, we initiated various
programs including extended payment arrangements and interest and fee waivers
for up to 90 days or more depending upon customer circumstances. These interest
and fee waivers were not material to the Credit Card Services segment's 2005
results.
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Higher operating expenses were to support receivable growth and increases in
marketing expenses. The increase in marketing expenses was due to higher
non-prime marketing expense, investments in new marketing initiatives and
changes in contractual marketing responsibilities in July 2004 associated with
the domestic co-branded GM credit card.
Net interest income decreased due to higher interest expense in 2005 due to a
higher cost of funds, partially offset by increases in finance and interest
income. The increase in finance and interest income from our credit card
customer loans reflects increased pricing on variable yield products and higher
receivable balances. Yields increased in 2005 primarily due to increases in
non-prime receivable levels, higher pricing on variable rate products as well as
other repricing initiatives. Lower average interest earning assets due to lower
levels of low yielding investment securities and the impact of lower
amortization from receivable origination costs resulting from changes in the
contractual marketing responsibilities in July 2004 associated with the co-
branded GM credit card also contributed to the increase in yield. These
increases to net interest margin were offset by higher interest expense
resulting in lower net interest margin. Although our non-prime customer loans
tend to have smaller balances, they generate higher returns both in terms of net
interest margin and fee income.
Customer loans increased 32 percent to $26.0 billion at December 31, 2005
compared to $19.6 billion at December 31, 2004. As discussed above, the increase
was primarily due to the acquisition of Metris in December 2005 which increased
customer loans by $5.3 billion on an IFRS Management Basis. Organic growth in
our HSBC branded prime, Union Privilege and non-prime portfolios, partially
offset by the continued decline in certain older acquired portfolios, also
contributed to the increase.
The increase in ROA in 2005 was primarily due to the higher net income discussed
above as well as the impact of lower average assets. The decrease in average
assets was due to lower investment securities during 2005 as a result of the
elimination of investments dedicated to our credit card bank in 2003 resulting
from our acquisition by HSBC.
INTERNATIONAL SEGMENT The following table summarizes the IFRS Management Basis
results for our International segment for the years ended December 31, 2006,
2005 and 2004.
YEAR ENDED DECEMBER 31, 2006 2005 2004
-----------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net income.................................................. $ 42 $ 481 $ 122
Net interest income......................................... 826 971 899
Gain on sales to affiliates................................. 29 464 -
Other operating income, excluding gain on sales to
affiliates................................................ 254 306 313
Intersegment revenues....................................... 33 17 15
Loan impairment charges..................................... 535 620 408
Operating expenses.......................................... 495 635 615
Customer loans.............................................. 9,520 9,328 13,102
Assets...................................................... 10,764 10,905 14,263
Net interest margin......................................... 8.22% 7.35% 7.57%
Return on average assets.................................... .37 3.52 .98
2006 compared to 2005 Our International segment reported lower net income in
2006. However, net income in 2006 includes the $29 million gain on the sale of
the European Operations to HBEU and in 2005 includes the $464 million gain on
the sale of the U.K. credit card business to HBEU. As discussed more fully
below, the gains reported by the International segment exclude the write-off of
goodwill and intangible assets associated with these transactions. Excluding the
gain on sale from both periods, the International segment reported higher net
income in 2006 primarily due to lower loan impairment charges and lower
operating expenses, partially offset by lower net interest income and lower
other operating income. Applying constant
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currency rates, which uses the average rate of exchange for 2005 to translate
current period net income, the net income in 2006 would have been lower by $2
million.
Loan impairment charges decreased in 2006 primarily due to the sale of our U.K.
credit card business partially offset by increases due to the deterioration of
the financial circumstances of our customers across the U.K. and increases at
our Canadian business due to receivable growth. We increased loss reserves by
recording loss provision greater than net charge-offs of $3 million in 2006.
Operating expenses decreased as a result of the sale of our U.K. credit card
business in December 2005. The decrease in operating expenses was partially
offset by increased costs associated with growth in the Canadian business.
Net interest income decreased during 2006 primarily as a result of lower
receivable levels in our U.K. subsidiary. The lower receivable levels were due
to the sale of our U.K. credit card business in December 2005, including $2.5
billion in customer loans, to HBEU as discussed more fully below, as well as
decreased sales volumes in the U.K. resulting from a continuing challenging
credit environment in the U.K. This was partially offset by higher net interest
income in our Canadian operations due to growth in customer loans. Net interest
margin increased in 2006 primarily due to lower cost of funds partially offset
by the change in receivable mix resulting from the sale of our U.K. credit card
business in December 2005.
Other operating income decreased in 2006, in part, due to the aforementioned
sale of the U.K. credit card business which resulted in lower credit card fee
income partially offset by higher servicing fee income from affiliates. Other
operating income was also lower in 2006 due to lower income from our insurance
operations.
Customer loans of $9.5 billion at December 31, 2006 increased 2 percent compared
to $9.3 billion at December, 2005. Our Canadian operations experienced strong
growth in its receivable portfolios. Branch expansions, the addition of 1,000
new auto dealer relationships and the successful launch of a MasterCard credit
card program in Canada in 2005 have resulted in growth in both the secured and
unsecured receivable portfolios. The increases in our Canadian portfolio were
partially offset by lower customer loans in our U.K. operations. Our U.K. based
unsecured customer loans decreased due to continuing lower retail sales volume
following a slow down in retail consumer spending as well as the sale of $203
million of customer loans related to our European operations in November 2006 as
discussed more fully below. Applying constant currency rates, which uses the
December 31, 2005 rate of exchange to translate current customer loan balances,
customer loans would have been lower by $708 million at December 31, 2006.
ROA was .37 percent in 2006 and 3.52 percent in 2005. These ratios have been
impacted by the gains on asset sales to affiliates. Excluding the gain on sale
from both periods, ROA was essentially flat as ROA was .11 percent in 2006 and
..12 percent in 2005.
As previously disclosed, in November 2006, we sold the capital stock of our
operations in the Czech Republic, Hungary, and Slovakia to a wholly owned
subsidiary of HBEU, a U.K. based subsidiary of HSBC, for an aggregate purchase
price of approximately $46 million. The International segment recorded a gain on
sale of $29 million as a result of this transaction. As the fair value
adjustments related to purchase accounting resulting from our acquisition by
HSBC and the related amortization are allocated to Corporate, which is included
in the "All Other" caption within our segment disclosures, the gain recorded in
the International segment does not include the goodwill write-off resulting from
this transaction of $15 million on an IFRS Management Basis. We continue to
evaluate the scope of our other U.K. operations.
2005 compared to 2004 Our International segment reported higher net income in
2005. However, net income in 2005 includes the $464 million gain on the sale of
the U.K. credit card business to HBEU. As discussed more fully below, the gain
reported by the International segment excludes the write-off of goodwill and
intangible assets associated with these transactions. Excluding the gain on sale
from 2005, the International segment reported lower net income driven by a
significant decline in earnings at our U.K. subsidiary. Overall, the decrease
reflects higher loan impairment charges and higher operating expenses, partially
offset by higher
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net interest income. Applying constant currency rates, which uses the average
rate of exchange for the 2004 period to translate current period net income, net
income would have been higher by $18 million in 2005.
Loan impairment charges increased in 2005 primarily due to higher delinquency
and charge-off levels in the U.K. due to a general increase in consumer bad
debts in the U.K. market, including increased bankruptcies. We increased
reserves in 2005 by recording loss provision greater than net charge-offs of
$120 million. Operating expenses increased due to higher expenses to support
receivable growth and collection activities and increased costs associated with
branch expansions in Canada.
Net interest income increased in 2005 primarily due to higher average interest
earning assets. Net interest margin decreased in 2005 due to increased cost of
funds as well as overall lower yields on our customer loans. The lower overall
yields were due to run-off of higher yielding customer loans and competitive
pricing pressures holding down yields on our personal loans in the U.K.,
partially offset by repricing initiatives and interest-free balances not being
promoted as strongly in 2005 as in the past. Other operating income decreased
slightly as lower credit card fee income was offset by higher insurance
revenues.
In December 2005, we sold our U.K. credit card business, including $2.5 billion
of customer loans, and the associated cardholder relationships to HBEU for an
aggregate purchase price of $3.0 billion. The purchase price, which was
determined based on a comparative analysis of sales of other credit card
portfolios, was paid in a combination of cash and $261 million of preferred
stock issued by a subsidiary of HBEU with a rate of one-year Sterling LIBOR,
plus 1.30 percent. In addition to the assets referred to above, the sale also
included the account origination platform, including the marketing and credit
employees associated with this function, as well as the lease associated with
the credit card call center and the related leaseholds and call center employees
to provide customer continuity after the transfer as well as to allow HBEU
direct ownership and control of origination and customer service. We have
retained the collection operations related to the credit card operations and
have entered into a service level agreement for a period of not less than two
years to provide collection services and other support services, including
components of the compliance, financial reporting and human resource functions,
for the sold credit card operations to HBEU for a fee. Additionally, the
management teams of HBEU and our remaining U.K. operations will be jointly
involved in decision making involving card marketing to ensure that growth
objectives are met for both businesses. The International segment has recorded a
gain on sale of $464 million as a result of this transaction. As the fair value
adjustments related to purchase accounting resulting from our acquisition by
HSBC and the related amortization are allocated to Corporate, which is included
in the "All Other" caption within our segment disclosures, the gain recorded in
the International segment does not include the goodwill and intangible write-
off resulting from this transaction of $288 million.
Additionally, in a separate transaction in December 2005, we transferred our
information technology services employees in the U.K. to a subsidiary of HBEU.
As a result, subsequent to the transfer operating expenses relating to
information technology, which have previously been reported as salaries and
fringe benefits or other servicing and administrative expenses, are now billed
to us by HBEU and reported as support services from HSBC affiliates.
Customer loans of $9.3 billion at December 31, 2005 decreased 29 percent
compared to $13.1 billion at December 31, 2004. The decrease was primarily due
to the sale of the U.K. credit card business to HBEU in December 2005, which
included customer loans of $2.5 billion. In addition to the sale of our credit
card operations in the U.K., our U.K. based unsecured receivable products
decreased in 2005 due to lower retail sales volume following a slow down in
retail consumer spending in the U.K. These decreases were partially offset by
growth in the receivable portfolio in our Canadian operations. Branch expansions
in Canada in 2005 resulted in strong secured and unsecured receivable growth.
Additionally, the Canadian auto finance program, which was introduced in the
second quarter of 2004, grew to a network of over 1,000 active dealer
relationships at December 31, 2005. Also contributing to the receivable growth
in Canada was the successful launch of a MasterCard credit card program.
Applying constant currency rates, which uses the December 31, 2004 rate of
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exchange to translate current customer loan balances, customer loans would have
been higher by $648 million at December 31, 2005.
ROA was 3.52 percent in 2005 and .98 percent in 2004. Excluding gain on sale of
the U.K. credit card business in 2005, ROA was .12 percent in 2005 and .98
percent in 2004. This decrease in 2005 reflects the lower net income as
discussed above as well as higher average assets primarily due to receivable
growth.
RECONCILIATION OF SEGMENT RESULTS As previously discussed, segment results are
reported on an IFRS Management Basis. See Note 21, "Business Segments," to the
accompanying financial statements for a discussion of the differences between
IFRSs and U.S. GAAP. For segment reporting purposes, intersegment transactions
have not been eliminated. We generally account for transactions between segments
as if they were with third parties. Also see Note 21, "Business Segments," in
the accompanying consolidated financial statements for a reconciliation of our
IFRS Management Basis segment results to U.S. GAAP consolidated totals.
CREDIT QUALITY
--------------------------------------------------------------------------------
DELINQUENCY AND CHARGE-OFF POLICIES AND PRACTICES Our delinquency and net
charge-off ratios reflect, among other factors, changes in the mix of loans in
our portfolio, the quality of our receivables, the average age of our loans, the
success of our collection and customer account management efforts, bankruptcy
trends, general economic conditions such as national and local trends in housing
markets and interest rates and significant catastrophic events such as natural
disasters and global pandemics. The levels of personal bankruptcies also have a
direct effect on the asset quality of our overall portfolio and others in our
industry.
Our credit and portfolio management procedures focus on risk-based pricing and
effective collection and customer account management efforts for each loan. We
believe our credit and portfolio management process gives us a reasonable basis
for predicting the credit quality of new accounts. This process is based on our
experience with numerous marketing, credit and risk management tests. We also
believe that our frequent and early contact with delinquent customers, as well
as restructuring and other customer account management techniques which are
designed to optimize account relationships, are helpful in maximizing customer
collections. See Note 2, "Summary of Significant Accounting Policies," in the
accompanying consolidated financial statements for a description of our
charge-off and nonaccrual policies by product.
Our charge-off policies focus on maximizing the amount of cash collected from a
customer while not incurring excessive collection expenses on a customer who
will likely be ultimately uncollectible. We believe our policies are responsive
to the specific needs of the customer segment we serve. Our real estate and auto
finance charge-off policies consider customer behavior in that initiation of
foreclosure or repossession activities often prompts repayment of delinquent
balances. Our collection procedures and charge-off periods, however, are
designed to avoid ultimate foreclosure or repossession whenever it is reasonably
economically possible. Our credit card charge-off policy is consistent with
industry practice. Charge-off periods for our personal non-credit card product
and, prior to December 2004, our domestic private label credit card product were
designed to be responsive to our customer needs and may therefore be longer than
bank competitors who serve a different market. Our policies have generally been
consistently applied in all material respects. Our loss reserve estimates
consider our charge-off policies to ensure appropriate reserves exist for
products with longer charge-off lives. We believe our current charge-off
policies are appropriate and result in proper loss recognition.
DELINQUENCY
Our policies and practices for the collection of consumer receivables, including
our customer account management policies and practices, permit us to reset the
contractual delinquency status of an account to current, based on indicia or
criteria which, in our judgment, evidence continued payment probability. When we
use a customer account management technique, we may treat the account as being
contractually current
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and will not reflect it as a delinquent account in our delinquency statistics.
However, if the account subsequently experiences payment defaults and becomes at
least two months contractually delinquent, it will be reported in our
delinquency ratios. At December 31, 2006 and 2005 our two-months-and-over
contractual delinquency included $2.5 billion and $2.3 billion respectively of
restructured accounts that subsequently experienced payment defaults. See
"Customer Account Management Policies and Practices" for further detail of our
practices.
The following table summarizes two-months-and-over contractual delinquency (as a
percent of consumer receivables):
2006 2005
--------------------------------------- ---------------------------------------
DEC. 31 SEPT. 30 JUNE 30 MARCH 31 DEC. 31 SEPT. 30 JUNE 30 MARCH 31
----------------------------------------------------------------------------------------------------------
Real estate
secured(1)........... 3.54% 2.98% 2.52% 2.46% 2.72% 2.51% 2.56% 2.62%
Auto finance(2)........ 3.18 3.16 2.73 2.17 3.04 2.78 2.74 2.32
Credit card(3)......... 4.57 4.53 4.16 4.35 3.66 4.46 4.14 4.60
Private label.......... 5.31 5.61 5.42 5.50 5.43 5.22 4.91 4.71
Personal non-credit
card................. 10.17 9.69 8.93 8.86 9.40 9.18 8.84 8.63
----- ---- ---- ---- ---- ---- ---- ----
Total
consumer(2),(3)...... 4.59% 4.19% 3.71% 3.66% 3.89% 3.84% 3.78% 3.83%
===== ==== ==== ==== ==== ==== ==== ====
---------------
(1) Real estate secured two-months-and-over contractual delinquency (as a
percent of consumer receivables) are comprised of the following:
2006 2005
--------------------------------------- ---------------------------------------
DEC. 31 SEPT. 30 JUNE 30 MARCH 31 DEC. 31 SEPT. 30 JUNE 30 MARCH 31
------------------------------------------------------------------------------------------------------------------
Mortgage Services:
First lien................... 4.50% 3.81% 3.10% 2.94% 3.21% 2.87% 2.84% 2.86%
Second lien.................. 5.74 3.70 2.35 1.83 1.94 1.48 1.69 2.07
---- ---- ---- ---- ---- ---- ---- ----
Total Mortgage Services........ 4.75 3.78 2.93 2.70 2.98 2.65 2.69 2.76
Consumer Lending:
First lien................... 2.07 1.84 1.77 1.87 2.14 2.27 2.25 2.34
Second lien.................. 3.06 2.44 2.37 2.68 3.03 1.93 2.72 2.63
---- ---- ---- ---- ---- ---- ---- ----
Total Consumer Lending......... 2.21 1.92 1.85 1.99 2.26 2.23 2.31 2.38
Foreign and all other:
First lien................... 1.58 1.52 1.53 1.77 2.11 1.80 2.38 2.81
Second lien.................. 5.38 5.52 5.54 5.57 5.71 4.71 4.51 4.26
---- ---- ---- ---- ---- ---- ---- ----
Total Foreign and all other.... 4.59 4.69 4.76 4.88 5.09 4.25 4.20 4.06
---- ---- ---- ---- ---- ---- ---- ----
Total real estate secured...... 3.54% 2.98% 2.52% 2.46% 2.72% 2.51% 2.56% 2.62%
==== ==== ==== ==== ==== ==== ==== ====
(2) In December 2006, our Auto Finance business changed its charge-off policy to
provide that the principal balance of auto loans in excess of the estimated
net realizable value will be charged-off 30 days (previously 90 days) after
the financed vehicle has been repossessed if it remains unsold, unless it
becomes 150 days contractually delinquent, at which time such excess will be
charged off. This resulted in a one-time acceleration of charge-off which
totaled $24 million in December 2006. In connection with this policy change
our Auto Finance business also changed its methodology for reporting
two-months-and-over contractual delinquency to include loan balances
associated with repossessed vehicles which have not yet been written down to
net realizable value, consistent with policy. These changes resulted in an
increase of 44 basis points to the auto finance delinquency ratio and an
increase of 3 basis points to the total consumer delinquency ratio at
December 31, 2006. Prior period amounts have been restated to conform to the
current year presentation.
(3) In December 2005, we completed the acquisition of Metris which included
receivables of $5.3 billion. This event had a significant impact on this
ratio. Excluding the receivables from the Metris acquisition from the
December 2005 calculation, our consumer delinquency ratio for our credit
card portfolio was 4.01% and total consumer delinquency was 3.95%.
Compared to September 30, 2006, our total consumer delinquency increased 40
basis points at December 31, 2006 to 4.59 percent. A significant factor in the
increase in the delinquency ratio was higher real estate secured delinquency
levels primarily at our Mortgage Services business as previously discussed, as
well as higher
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personal non-credit card delinquency, partially offset by recent growth. The
increase in the Consumer Lending real estate delinquency ratio was primarily due
to the addition of the Champion portfolio. While the Champion portfolio carries
higher delinquency, its low loan-to-value ratios are expected to result in lower
charge-offs compared to the existing portfolio. Our auto finance delinquency
ratio was broadly flat with September as decreases due to the change in
charge-off policy were offset by seasonal increases in delinquency during the
fourth quarter. The increase in the credit card delinquency ratio primarily
reflects seasoning, partially offset by the benefit of seasonal receivable
growth. The decrease in private label delinquency (which primarily consists of
our foreign private label portfolio and domestic retail sales contracts that
were not sold to HSBC Bank USA in December 2004) reflects recent receivable
growth in our foreign portfolios. The increase in the personal non-credit card
delinquency ratio reflects maturation of a growing domestic portfolio as well as
slight deterioration of certain customer groups in our domestic portfolio,
partially offset by decreased delinquencies in our U.K. portfolio following the
acceleration of charge-offs related to the cancellation of a forbearance program
which provided that customers would not charge-off if certain minimum payment
conditions were met. We have implemented risk mitigation strategies in our
domestic non-credit card portfolio, including tightening credit criteria and
increased collection capacity.
Compared to December 31, 2005, our total consumer delinquency ratio increased 70
basis points. This increase was driven by higher real estate secured delinquency
levels at our Mortgage Services business, higher credit card delinquency largely
due to the Metris portfolio acquired in December 2005, higher personal non-
credit card delinquency driven by seasoning of a growing portfolio and higher
delinquency due to lower bankruptcy filings. These increases were partially
offset by receivable growth and the benefit of stable unemployment in the United
States.
See "Customer Account Management Policies and Practices" regarding the treatment
of restructured accounts and accounts subject to forbearance and other customer
account management tools. See Note 2, "Summary of Significant Accounting
Policies," for a detail of our charge-off policy by product.
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NET CHARGE-OFFS OF CONSUMER RECEIVABLES
The following table summarizes net charge-off of consumer receivables as a
percent of average consumer receivables:
2006 2005
--------------------------------------------- ---------------------------------------------
QUARTER ENDED (ANNUALIZED) QUARTER ENDED (ANNUALIZED) 2004
FULL -------------------------------------- FULL -------------------------------------- FULL
YEAR DEC. 31 SEPT. 30 JUNE 30 MAR. 31 YEAR DEC. 31 SEPT. 30 JUNE 30 MAR. 31 YEAR
-----------------------------------------------------------------------------------------------------------------------------------
Real estate secured(1).... 1.00% 1.28% .98% .97% .75% .76% .66% .75% .78% .87% 1.10%
Auto finance(2)........... 3.67 4.97 3.69 2.43 3.50 3.27 3.42 3.25 2.61 3.80 3.43
Credit card(3)............ 5.56 6.79 5.52 5.80 4.00 7.12 7.99 6.24 6.93 7.17 8.85
Private label(3).......... 5.80 6.68 5.65 5.29 5.62 4.83 5.60 5.35 4.36 4.18 6.17
Personal non-credit
card(2)................. 7.89 7.92 7.77 7.92 7.94 7.88 7.59 8.01 7.77 8.18 9.75
---- ---- ---- ---- ---- ---- ---- ---- ----- ----- ----
Total consumer(2),(3)..... 2.97% 3.46% 2.92% 2.88% 2.58% 3.03% 3.10% 2.93% 2.93% 3.15% 4.00%
==== ==== ==== ==== ==== ==== ==== ==== ===== ===== ====
Real estate charge-offs
and REO expense as a
percent of average real
estate secured
receivables............. 1.19% 1.68% 1.11% 1.04% .89% .87% .78% .88% .84% 1.01% 1.38%
==== ==== ==== ==== ==== ==== ==== ==== ===== ===== ====
---------------
(1) Real estate secured net charge-off of consumer receivables as a percent of
average consumer receivables are comprised of the following:
2006 2005
--------------------------------------------- ----
QUARTER ENDED (ANNUALIZED)
FULL -------------------------------------- FULL
YEAR DEC. 31 SEPT. 30 JUNE 30 MAR. 31 YEAR
----------------------------------------------------------------------------------------------
Mortgage Services:
First lien............................. .77% .91% .75% .73% .67% .68%
Second lien............................ 2.38 4.40 2.11 1.72 1.15 1.11
---- ---- ---- ---- ---- ----
Total Mortgage Services................. 1.12 1.66 1.06 .94 .77 .75
Consumer Lending:
First lien............................. .85 .85 .84 .98 .71 .74
Second lien............................ 1.12 1.02 1.22 1.25 1.01 1.21
---- ---- ---- ---- ---- ----
Total Consumer Lending.................. .89 .88 .90 1.02 .75 .80
Foreign and all other:
First lien............................. .54 .89 .38 .99 .24 1.04
Second lien............................ .94 1.15 .91 .81 .63 .37
---- ---- ---- ---- ---- ----
Total Foreign and all other............. .86 1.10 .81 .85 .56 .47
---- ---- ---- ---- ---- ----
Total real estate secured............... 1.00% 1.28% .98% .97% .75% .76%
==== ==== ==== ==== ==== ====
2005
--------------------------------------
QUARTER ENDED (ANNUALIZED) 2004
-------------------------------------- FULL
DEC. 31 SEPT. 30 JUNE 30 MAR. 31 YEAR
---------------------------------------- ------------------------------------------------
Mortgage Services:
First lien............................. .59% .71% .74% .72% .81%
Second lien............................ .79 .93 1.31 1.79 2.64
---- ---- ----- ----- ----
Total Mortgage Services................. .63 .74 .81 .85 1.05
Consumer Lending:
First lien............................. .68 .74 .71 .82 1.03
Second lien............................ .84 1.06 1.22 1.76 2.77
---- ---- ----- ----- ----
Total Consumer Lending.................. .70 .79 .78 .93 1.21
Foreign and all other:
First lien............................. 1.10 .96 1.06 1.14 .89
Second lien............................ .49 .36 .41 .29 .24
---- ---- ----- ----- ----
Total Foreign and all other............. .59 .45 .50 .41 .33
---- ---- ----- ----- ----
Total real estate secured............... .66% .75% .78% .87% 1.10%
==== ==== ===== ===== ====
(2) In December 2006, our Auto Finance business changed its charge-off policy to
provide that the principal balance of auto loans in excess of the estimated
net realizable value will be charged-off 30 days (previously 90 days) after
the financed vehicle has been repossessed if it remains unsold, unless it
becomes 150 days contractually delinquent, at which time such excess will be
charged off. This resulted in a one-time acceleration of charge-offs in
December 2006, which totaled $24 million. Excluding the impact of this
change the auto finance net charge-off ratio would have been 4.19 percent in
the quarter ended December 31, 2006 and 3.46 percent for the full year 2006.
Also in the fourth quarter of 2006, our U.K. business discontinued a
forbearance program related to unsecured loans. Under the forbearance
program, eligible delinquent accounts would not be subject to charge-off if
certain minimum payment conditions were met. The cancellation of this
program resulted in a one-time acceleration of charge-off which totaled $89
million. Excluding the impact of the change in the U.K. forbearance program,
the personal non-credit card net charge-off ratio would have been 6.23
percent in the quarter ended December 31, 2006 and 7.45 percent for the full
year 2006. Excluding the impact of both changes, the total consumer
charge-off ratio would have been 3.17 percent for the quarter ended December
31, 2006 and 2.89 percent for the full year 2006.
(3) The adoption of FFIEC charge-off policies for our domestic private label
(excluding retail sales contracts at our Consumer Lending business) and
credit card portfolios in December 2004 increased private label net
charge-offs by 119 basis points, credit card net charge-offs by 2 basis
points and total consumer net charge-offs by 16 basis points.
Net charge-offs as a percentage of average consumer receivables decreased 6
basis points for the full year of 2006 as compared to the full year of 2005.
Decreases in personal bankruptcy net charge-offs in our credit card portfolio
following the October 2005 bankruptcy law changes in the United States was
substantially offset by higher charge-offs in our real estate secured portfolio
and in particular at our Mortgage Services business due to the deteriorating
performance of certain loans acquired in 2005 and 2006. We anticipate the
increase in net charge-off ratio for our real estate secured portfolio will
continue in 2007 as a result of the higher delinquency
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levels we are experiencing in loans purchased by Mortgage Services in 2005 and
2006. The increase in the auto finance ratio for the full year 2006 reflects
seasoning of the portfolio and the one-time acceleration of charge-off totaling
$24 million. The decrease in the credit card net charge-off ratio reflects the
decrease in personal bankruptcy filings discussed above, as well as the positive
impact of receivable growth and higher recoveries in our credit card portfolio
as a result of increased sales volumes of recent and older charged-off accounts.
The net charge-off ratio for our private label receivables for the full year
2006 and 2005 reflects decreased average receivables and the deterioration of
the financial circumstances of some of our customers in the U.K. The personal
non-credit card charge-off ratio was broadly flat with the prior year as
increased charge-offs in both our domestic and U.K. businesses were offset by
recent growth in our domestic business. Charge-offs increased in our domestic
business due to seasoning of a growing portfolio. Charge-offs in our U.K.
business increased due to declining receivables and the deterioration of the
financial circumstances of some of our customers across the U.K. as well as the
one-time acceleration of charge-offs totaling $89 million from the cancellation
of a forbearance program in the U.K. as discussed above.
We experienced an increase in overall net charge-off dollars across all products
in 2006. Higher losses at our Mortgage Services business as discussed above, as
well as portfolio growth and seasoning in our credit card and auto finance
portfolios were major contributing factors to this increase.
The increase in real estate charge-offs and REO expense as a percent of average
real estate secured receivables in 2006 was primarily due to higher charge-offs
in our real estate secured portfolio as discussed above, as well as higher REO
expense due to higher levels of owned properties and higher losses on sales due
to the slowing housing market, including an actual decline in some markets, in
property values.
Net charge-offs as a percentage of average consumer receivables decreased 97
basis points for the full year of 2005 as compared to the full year of 2004. The
net charge-off ratio for full year 2004 was impacted by the adoption of FFIEC
charge-off policies for our domestic private label (excluding retail sales
contracts at our Consumer Lending business) and credit card portfolios.
Excluding the additional charge-offs in 2004 resulting from the adoption of
these FFIEC policies, net charge-offs for the full year 2005 decreased 81 basis
points compared to 2004 as a result of receivable growth and the positive impact
from the lower delinquency levels we have experienced as a result of a strong
economy. This was partially offset by the increased charge-offs in the fourth
quarter of 2005 for our credit card receivable portfolio resulting from the
spike in bankruptcy filings prior to the effective date of new bankruptcy
legislation in the United States. Our real estate secured portfolio experienced
a decrease in net charge-offs for full year 2005 reflecting receivables growth
and continuing strong economic conditions. The decrease in the auto finance
ratio for the full year 2005 reflects receivable growth with improved credit
quality of originations, improved collections and better underwriting standards.
The decrease in the credit card and personal non-credit card receivable net
charge-off ratios reflects the positive impact of changes in receivable mix
resulting from lower securitization levels and continued improved credit
quality. As discussed above, the decrease in the credit card ratio was partially
offset by increased net charge-offs resulting from higher bankruptcies. The net
charge-off ratio for the private label portfolio for the full year 2004 includes
the domestic private label portfolio sold to HSBC Bank USA which contributed 242
basis points to the ratio. The net charge-off ratio for our private label
receivables for the full year 2005 consists primarily of our foreign private
label portfolio which deteriorated in 2005 as a result of a general increase in
consumer bad debts in the U.K. markets, including increased bankruptcies.
We experienced a decrease in overall net charge-off dollars in 2005. This was
primarily due to lower delinquency levels we experienced as a result of the
strong economy, partially offset by higher receivable levels in 2005 as well as
higher net charge-offs in the fourth quarter of 2005 of an estimated $125
million for our credit card receivable portfolio resulting from the increased
bankruptcy filings as discussed above.
The decrease in real estate charge-offs and REO expense as a percent of average
real estate secured receivables in 2005 from the 2004 ratio was primarily due to
strong receivable growth and the continuing strong economy. The 2005 ratio was
not negatively impacted by the increased filings associated with the new
bankruptcy legislation in the United States due to the timing of the bankruptcy
filings and our charge-off policy for real estate secured receivables.
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NONPERFORMING ASSETS
AT DECEMBER 31, 2006 2005 2004
--------------------------------------------------------------------------------------
(IN MILLIONS)
Nonaccrual receivables(1),(2)............................... $4,807 $3,608 $3,084
Accruing consumer receivables 90 or more days delinquent.... 929 623 507
Renegotiated commercial loans............................... 1 - 2
------ ------ ------
Total nonperforming receivables............................. 5,737 4,231 3,593
Real estate owned........................................... 794 510 587
------ ------ ------
Total nonperforming assets.................................. $6,531 $4,741 $4,180
====== ====== ======
---------------
(1) Nonaccrual receivables are comprised of the following:
AT DECEMBER 31, 2006 2005 2004
--------------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured:
Closed-end:
First lien................................................ $1,893 $1,366 $1,295
Second lien............................................... 482 247 171
Revolving:
First lien................................................ 22 31 40
Second lien............................................... 187 63 58
------ ------ ------
Total real estate secured................................... 2,584 1,707 1,564
Auto finance................................................ 394 323 228
Credit card................................................. - - 51
Private label............................................... 76 75 78
Personal non-credit card.................................... 1,753 1,498 1,159
Commercial and other........................................ - 5 4
------ ------ ------
Total nonaccrual receivables................................ $4,807 $3,608 $3,084
====== ====== ======
(2) As previously discussed, in December 2006, our Auto Finance business changed
its charge-off policy and in connection with this policy change also changed
the methodology for reporting two-months-and-over contractual delinquency.
These changes resulted in an increase in nonaccrual receivables at December
31, 2006. Prior period amounts have been restated to conform to the current
year presentation.
The increase in total nonperforming assets in 2006 is primarily due to higher
levels of real estate secured nonaccrual receivables at our Mortgage Services
business due to the deteriorating performance of certain loans acquired in 2005
and 2006 as previously discussed. Real estate secured nonaccrual loans included
stated income loans at our Mortgage Services business of $571 million at
December 31, 2006, $125 million at December 31, 2005 and $79 million at December
31, 2004. The increase in total nonperforming assets in 2005 was primarily due
to the receivable growth we experienced in 2005 as well as the impact of the
increased bankruptcy filings on our secured and personal non-credit card
receivable portfolios. Consistent with industry practice, accruing consumer
receivables 90 or more days delinquent includes domestic credit card
receivables.
CREDIT LOSS RESERVES We maintain credit loss reserves to cover probable losses
of principal, interest and fees, including late, overlimit and annual fees.
Credit loss reserves are based on a range of estimates and are intended to be
adequate but not excessive. We estimate probable losses for owned consumer
receivables using a roll rate migration analysis that estimates the likelihood
that a loan will progress through the various stages of delinquency, or buckets,
and ultimately charge-off. This analysis considers delinquency status, loss
experience and severity and takes into account whether loans are in bankruptcy,
have been restructured or rewritten, or are subject to forbearance, an external
debt management plan, hardship, modification, extension or deferment. Our credit
loss reserves also take into consideration the loss severity expected based on
the underlying collateral, if any, for the loan in the event of default.
Delinquency status may be affected by customer account management policies and
practices, such as the restructure of accounts, forbearance agreements, extended
payment plans, modification arrangements, external debt management programs,
loan
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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, loan product features such as adjustable rate loans, economic
conditions, such as national and local trends in housing markets and interest
rates, 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 natural disasters 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.
The following table sets forth credit loss reserves for the periods indicated:
AT DECEMBER 31,
------------------------------------------
2006 2005 2004 2003 2002
----------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Credit loss reserves.............................. $6,587 $4,521 $3,625 $3,793 $3,333
Reserves as a percent of receivables.............. 4.07% 3.23% 3.39% 4.11% 4.04%
Reserves as a percent of net charge-offs.......... 145.8 123.8(2) 89.9(1) 105.7 106.5
Reserves as a percent of nonperforming loans...... 114.8 106.9 100.9 92.8 93.7
---------------
(1) In December 2004, we adopted FFIEC charge-off policies for our domestic
private label (excluding retail sales contracts at our Consumer Lending
business) and credit card portfolios and subsequently sold this domestic
private label receivable portfolio. These events had a significant impact on
this ratio. Reserves as a percentage of net charge-offs excluding net
charge-offs associated with the sold domestic private label portfolio and
charge-off relating to the adoption of FFIEC was 109.2% at December 31,
2004.
(2) The acquisition of Metris in December 2005 positively impacted this ratio.
Reserves as a percentage of net charge-offs at December 31, 2005, excluding
Metris was 118.2 percent.
Credit loss reserve levels at December 31, 2006 increased as compared to
December 31, 2005 as we recorded loss provision in excess of net charge-offs of
$2,045 million. A significant portion of the increase in credit loss reserves
resulted from higher delinquency and loss estimates at our Mortgage Services
business as previously discussed where we recorded provision in excess of net
charge-offs of $1,668 million. In addition, the higher credit loss reserve
levels were a result of higher levels of receivables due in part to lower
securitization levels and higher dollars of delinquency in our other businesses
driven by growth and portfolio seasoning including the Metris portfolio acquired
in December 2005. Reserve levels also increased due to weakening early stage
performance consistent with the industry trend in certain Consumer Lending real
estate secured loans originated since late 2005. These increases were partially
offset by significantly lower personal bankruptcy levels in the United States, a
reduction in the estimated loss exposure relating to Katrina and the benefit of
stable unemployment in the United States.
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Credit loss reserve levels of $2.1 billion at our Mortgage Services business
reflect our best estimate of losses in the portfolio at December 31, 2006. In
establishing these reserve levels we considered the severity of losses expected
to be incurred, particularly in our second lien portfolio, above our historical
experience given the current housing market trends in the United States. We also
considered the ability of borrowers to repay their first lien adjustable rate
mortgage loans at higher contractual reset rates given increases in interest
rates by the Federal Reserve Bank from June 2004 through June 2006, as well as
their ability to repay any underlying second lien mortgage outstanding. Because
first lien adjustable rate mortgage loans are generally well secured, ultimate
losses associated with such loans are dependent to a large extent on the status
of the housing market and interest rate environment. Therefore, although it is
probable that incremental losses will occur as a result of rate resets on first
lien adjustable rate mortgage loans, such losses are estimable and, therefore,
included in our credit loss reserves only in situations where the payment has
either already reset or will reset in the near term. A significant portion of
the Mortgage Services second lien mortgages are subordinate to a first lien
adjustable rate loan. For customers with second lien mortgage loans that are
subordinate to a first lien adjustable rate mortgage loan, the probability of
repayment of the second lien mortgage loan is significantly reduced. The impact
of future changes, if any, in the housing market will not have a significant
impact on the ultimate loss expected to be incurred since these loans, based on
history and other factors, are expected to behave like unsecured loans. As a
result, expected losses for these loans are included in our credit loss reserve
levels at December 31, 2006.
Credit loss reserve levels at December 31, 2005 reflect the additional reserve
requirements resulting from higher levels of owned receivables including lower
securitization levels, higher delinquency levels in our portfolios driven by
growth and portfolio seasoning, the impact of Katrina and minimum monthly
payment changes, additional reserves resulting from the Metris acquisition and
the higher levels of personal bankruptcy filings in both the United States and
the U.K. Credit loss reserves at December 31, 2005 also reflect the sale of our
U.K. credit card business in December 2005 which decreased credit loss reserves
by $104 million. In 2005, we recorded loss provision greater than net
charge-offs of $890 million.
In 2004, we recorded loss provision greater than net charge-offs of $301
million. Excluding the impact of adopting FFIEC charge-off policies for domestic
private label (excluding retail sales contracts at our Consumer Lending
business) and credit card portfolios, we recorded loss provision $421 million
greater than net charge-offs in 2004.
Beginning in 2004 and continuing into 2005, we experienced a shift in our loan
portfolio to lower yielding receivables, particularly real estate secured and
auto finance receivables. Reserves as a percentage of receivables at December
31, 2006 were higher than at December 31, 2005 due to the impact of additional
reserve requirements in our Mortgage Services business, partially offset by
lower levels of personal bankruptcy filing in the United States and a reduction
in the estimated loss exposure estimates relating to Katrina. Reserves as a
percentage of receivables at December 31, 2005 and 2004 were lower than at
December 31, 2003 as a result of portfolio growth, partially offset in 2005 by
the impact of additional credit loss reserves relating to the impact of Katrina,
minimum monthly payment changes and increased bankruptcy filings. Reserves as a
percentage of receivables at December 31, 2003 were higher than at December 31,
2002 as a result of the sale of $2.8 billion of higher quality real estate
secured loans to HSBC Bank USA in December 2003. Had this sale not occurred,
reserves as a percentage of receivables at December 2003 would have been lower
than 2002 as a result of improving credit quality in the latter half of 2003 as
delinquency rates stabilized and charge-off levels began to improve. The trends
in the reserve ratios for 2003 and 2002 reflect the impact of the weak economy,
higher delinquency levels, and uncertainty as to the ultimate impact the
weakened economy would have on delinquency and charge-off levels.
Reserves as a percentage of nonperforming loans increased in 2006. This increase
was primarily attributable to higher reserve levels primarily as a result of
higher loss estimates in our Mortgage Services business as previously discussed.
Reserves as a percentage of nonperforming loans increased in 2005. While
nonperforming loans increased in 2005, reserve levels in 2005 increased at a
more rapid pace due to receivable growth, the
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additional reserve requirements related to Katrina and impact of increased
bankruptcy filings on our secured receivable and personal non-credit card
receivable portfolios which did not migrate to charge-off until 2006.
Reserves as a percentage of net charge-offs increased compared to 2005 as
reserve levels grew more rapidly than charge-offs primarily due to the higher
charge-offs expected in 2007 related to the deterioration in certain mortgage
loans acquired in 2005 and 2006. Reserves as a percentage of net charge-offs
increased in 2005. The 2005 ratio was significantly impacted by the acquisition
of Metris and the 2004 ratio was significantly impacted by both the sale of our
domestic private label receivable portfolio (excluding retail sales contracts)
in December 2004 as well as the adoption of FFEIC charge-off policies for our
domestic private label (excluding retail sales contracts) and credit card
portfolios. Excluding these items, reserves as a percentage of net charge-offs
increased 900 basis points. While both our reserve levels at December 31, 2005
and net charge-offs in 2005 were higher than 2004, our reserve levels grew for
the reasons discussed above more rapidly than our net charge-offs.
See the "Analysis of Credit Loss Reserves Activity," "Reconciliations to U.S.
GAAP Financial Measures" and Note 7, "Credit Loss Reserves," to the accompanying
consolidated financial statements for additional information regarding our loss
reserves.
CUSTOMER ACCOUNT MANAGEMENT POLICIES AND PRACTICES Our policies and practices
for the collection of consumer receivables, including our customer account
management policies and practices, permit us to reset the contractual
delinquency status of an account to current, based on indicia or criteria which,
in our judgment, evidence continued payment probability. Such policies and
practices vary by product and are designed to manage customer relationships,
maximize collection opportunities and avoid foreclosure or repossession if
reasonably possible. If the account subsequently experiences payment defaults,
it will again become contractually delinquent.
In the third quarter of 2003, we implemented certain changes to our
restructuring policies. These changes were intended to eliminate and/or
streamline exception provisions to our existing policies and were generally
effective for receivables originated or acquired after January 1, 2003.
Receivables originated or acquired prior to January 1, 2003 generally are not
subject to the revised restructure and customer account management policies.
However, for ease of administration, in the third quarter of 2003, our Mortgage
Services business elected to adopt uniform policies for all products regardless
of the date an account was originated or acquired. Implementation of the uniform
policy by Mortgage Services had the effect of only counting restructures
occurring on or after January 1, 2003 in assessing restructure eligibility for
purposes of the limitation that no account may be restructured more than four
times in a rolling sixty-month period. Other business units may also elect to
adopt uniform policies. The changes adopted in the third quarter of 2003 have
not had a significant impact on our business model or on our results of
operations as these changes have generally been phased in as new receivables
were originated or acquired. As discussed in more detail below, we also revised
certain policies for our domestic private label credit card and credit card
portfolios in December 2004.
As discussed previously and described more fully in the table below, we adopted
FFIEC account management policies regarding restructuring of past due accounts
for our domestic private label credit card and credit card portfolios in
December 2004. These changes have not had a significant impact on our business
model or on our results of operations.
Approximately three-fourths of all restructured receivables are secured
products, which in general have less loss severity exposure because of the
underlying collateral. Credit loss reserves take into account whether loans have
been restructured, rewritten or are subject to forbearance, an external debt
management plan, modification, extension or deferment. Our credit loss reserves
also take into consideration the loss severity expected based on the underlying
collateral, if any, for the loan.
Our restructuring policies and practices vary by product and are described in
the table that follows and reflect the revisions from the adoption of FFIEC
charge-off and account management policies for our domestic private label
(excluding retail sales contracts at our Consumer Lending business) and credit
card receivables in December 2004. The fact that the restructuring criteria may
be met for a particular account does not
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require us to restructure that account, and the extent to which we restructure
accounts that are eligible under the criteria will vary depending upon our view
of prevailing economic conditions and other factors which may change from period
to period. In addition, for some products, accounts may be restructured without
receipt of a payment in certain special circumstances (e.g. upon reaffirmation
of a debt owed to us in connection with a Chapter 7 bankruptcy proceeding). We
use account restructuring as an account and customer management tool in an
effort to increase the value of our account relationships, and accordingly, the
application of this tool is subject to complexities, variations and changes from
time to time. These policies and practices are continually under review and
assessment to assure that they meet the goals outlined above, and accordingly,
we modify or permit exceptions to these general policies and practices from time
to time. In addition, exceptions to these policies and practices may be made in
specific situations in response to legal or regulatory agreements or orders.
In the policies summarized below, "hardship restructures" and "workout
restructures" refer to situations in which the payment and/or interest rate may
be modified on a temporary or permanent basis. In each case, the contractual
delinquency status is reset to current. "External debt management plans" refers
to situations in which consumers receive assistance in negotiating or scheduling
debt repayment through public or private agencies.
RESTRUCTURING POLICIES AND PRACTICES
HISTORICAL RESTRUCTURING POLICIES FOLLOWING CHANGES IMPLEMENTED
AND PRACTICES(1),(2),(3) IN THE THIRD QUARTER 2003 AND IN DECEMBER 2004(1),(2),(3)
----------------------------------------------------------------------------------------------------------
REAL ESTATE SECURED REAL ESTATE SECURED
Real Estate - Overall Real Estate - Overall(4)
- An account may be restructured if we - Accounts may be restructured prior to the end of the
receive two qualifying payments within the monthly cycle following the receipt of two qualifying
60 days preceding the restructure; we may payments within 60 days
restructure accounts in hardship, disaster - Accounts generally are not eligible for restructure
or strike situations with one qualifying until nine months after origination
payment or no payments - Accounts will be limited to four collection
- Accounts that have filed for Chapter 7 restructures in a rolling sixty-month period
bankruptcy protection may be restructured - Accounts whose borrowers have filed for Chapter 7
upon receipt of a signed reaffirmation bankruptcy protection may be restructured upon
agreement receipt of a signed reaffirmation agreement
- Accounts subject to a Chapter 13 plan - Accounts whose borrowers are subject to a Chapter 13
filed with a bankruptcy court generally plan filed with a bankruptcy court generally may be
require one qualifying payment to be restructured upon receipt of one qualifying payment
restructured
- Except for bankruptcy reaffirmation and
filed Chapter 13 plans, agreed automatic
payment withdrawal or
hardship/disaster/strike, accounts are
generally limited to one restructure every
twelve-months
- Accounts generally are not eligible for - Except for bankruptcy reaffirmation and filed Chapter
restructure until they are on the books 13 plans, accounts will generally not be restructured
for at least six months more than once in a twelve-month period
- Accounts whose borrowers agree to pay by automatic
withdrawal are generally restructured upon receipt of
one qualifying payment after initial authorization
for automatic withdrawal(5)
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RESTRUCTURING POLICIES AND PRACTICES
HISTORICAL RESTRUCTURING POLICIES FOLLOWING CHANGES IMPLEMENTED
AND PRACTICES(1),(2),(3) IN THE THIRD QUARTER 2003 AND IN DECEMBER 2004(1),(2),(3)
----------------------------------------------------------------------------------------------------------
Real Estate - Consumer Lending Real Estate - Mortgage Services(6),(7)
- Accounts whose borrowers agree to pay by - Accounts will generally not be eligible for
automatic withdrawal are generally restructure until nine months after origination
restructured upon receipt of one
qualifying payment after initial
authorization for automatic withdrawal
AUTO FINANCE AUTO FINANCE
- Accounts may be extended if we receive one - Accounts may generally be extended upon receipt of
qualifying payment within the 60 days two qualifying payments within the 60 days preceding
preceding the extension the extension
- Accounts may be extended no more than - Accounts may be extended by no more than three months
three months at a time and by no more than at a time
three months in any twelve-month period - Accounts will be limited to four extensions in a
- Extensions are limited to six months over rolling sixty-month period, but in no case will an
the contractual life account be extended more than a total of six months
- Accounts that have filed for Chapter 7 over the life of the account
bankruptcy protection may be restructured - Accounts will be limited to one extension every six
upon receipt of a signed reaffirmation months
agreement - Accounts will not be eligible for extension until
- Accounts whose borrowers are subject to a they are on the books for at least six months
Chapter 13 plan may be restructured upon - Accounts whose borrowers have filed for Chapter 7
filing of the plan with a bankruptcy court bankruptcy protection may be restructured upon
receipt of a signed reaffirmation agreement
- Accounts whose borrowers are subject to a Chapter 13
plan may be restructured upon filing of the plan with
the bankruptcy court
CREDIT CARD CREDIT CARD
- Typically, accounts qualify for Accounts originated between January 2003 - December
restructuring if we receive two or three 2004
qualifying payments prior to the - Accounts typically qualified for restructuring if we
restructure, but accounts in approved received two or three qualifying payments prior to
external debt management programs may the restructure, but accounts in approved external
generally be restructured upon receipt of debt management programs could generally be
one qualifying payment restructured upon receipt of one qualifying payment
- Generally, accounts may be restructured - Generally, accounts could have been restructured once
once every six months every six months
Beginning in December 2004, all accounts regardless of
origination date
- Domestic accounts qualify for restructuring if we
receive three consecutive minimum monthly payments or
a lump sum equivalent
- Domestic accounts qualify for restructuring if the
account has been in existence for a minimum of nine
months and the account has not been
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RESTRUCTURING POLICIES AND PRACTICES
HISTORICAL RESTRUCTURING POLICIES FOLLOWING CHANGES IMPLEMENTED
AND PRACTICES(1),(2),(3) IN THE THIRD QUARTER 2003 AND IN DECEMBER 2004(1),(2),(3)
----------------------------------------------------------------------------------------------------------
restructured in the prior twelve months and not more
than once in the prior five years
- Domestic accounts entering third party debt
counseling programs are limited to one restructure in
a five-year period in addition to the general limits
of one restructure in a twelve-month period and two
restructures in a five-year period
PRIVATE LABEL(8) PRIVATE LABEL(8)
Private Label - Overall Private Label - Overall
- An account may generally be restructured Prior to December 2004 for accounts originated after
if we receive one or more qualifying October 2002
payments, depending upon the merchant - For certain merchants, receipt of two or three
- Restructuring is limited to once every six qualifying payments was required, except accounts in
months (or longer, depending upon the an approved external debt management program could be
merchant) for revolving accounts and once restructured upon receipt of one qualifying payment
every twelve-months for closed-end
accounts
Private Label - Consumer Lending Retail Private Label - Consumer Lending Retail Sales Contracts
Sales Contracts
- Accounts may be restructured if we/receive - Accounts may be restructured upon receipt of two
one qualifying payment within the 60 days qualifying payments within the 60 days preceding the
preceding the restructure; may restructure restructure
accounts in a hardship/disaster/strike - Accounts will be limited to one restructure every six
situation with one qualifying payment or months
no payments - Accounts will be limited to four collection
- If an account is never more than 90 days restructures in a rolling sixty-month period
delinquent, it may generally be - Accounts will not be eligible for restructure until
restructured up to three times per year six months after origination
- If an account is ever more than 90 days
delinquent, generally it may be
restructured with one qualifying payment
no more than four times over its life;
however, generally the account may
thereafter be restructured if two
qualifying payments are received
- Accounts subject to programs for hardship
or strike may require only the receipt of
reduced payments in order to be
restructured; disaster may be restructured
with no payments
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RESTRUCTURING POLICIES AND PRACTICES
HISTORICAL RESTRUCTURING POLICIES FOLLOWING CHANGES IMPLEMENTED
AND PRACTICES(1),(2),(3) IN THE THIRD QUARTER 2003 AND IN DECEMBER 2004(1),(2),(3)
----------------------------------------------------------------------------------------------------------
PERSONAL NON-CREDIT CARD PERSONAL NON-CREDIT CARD
- Accounts may be restructured if we receive - Accounts may be restructured upon receipt of two
one qualifying payment within the 60 days qualifying payments within the 60 days preceding the
preceding the restructure; may restructure restructure
accounts in a hardship/disaster/strike - Accounts will be limited to one restructure every six
situation with one qualifying payment or months
no payments - Accounts will be limited to four collection
- If an account is never more than 90 days restructures in a rolling sixty-month period
delinquent, it may generally be - Accounts will not be eligible for restructure until
restructured up to three times per year six months after origination
- If an account is ever more than 90 days
delinquent, generally it may be
restructured with one qualifying payment
no more than four times over its life;
however, generally the account may
thereafter be restructured if two
qualifying payments are received
- Accounts subject to programs for hardship
or strike may require only the receipt of
reduced payments in order to be
restructured; disaster may be restructured
with no payments
---------------
(1) We employ account restructuring and other customer account management
policies and practices as flexible customer account management tools as
criteria may vary by product line. In addition to variances in criteria by
product, criteria may also vary within a product line. Also, we continually
review our product lines and assess restructuring criteria and they are
subject to modification or exceptions from time to time. Accordingly, the
description of our account restructuring policies or practices provided in
this table should be taken only as general guidance to the restructuring
approach taken within each product line, and not as assurance that accounts
not meeting these criteria will never be restructured, that every account
meeting these criteria will in fact be restructured or that these criteria
will not change or that exceptions will not be made in individual cases. In
addition, in an effort to determine optimal customer account management
strategies, management may run more conservative tests on some or all
accounts in a product line for fixed periods of time in order to evaluate
the impact of alternative policies and practices.
(2) For our United Kingdom business, all portfolios have a consistent account
restructure policy. An account may be restructured if we receive two or more
qualifying payments within two calendar months, limited to one restructure
every 12 months, with a lifetime limit of three times. In hardship
situations an account may be restructured if a customer makes three
consecutive qualifying monthly payments within the last three calendar
months. Only one hardship restructure is permitted in the life of a loan.
There were no changes to the restructure policies of our United Kingdom
business in 2006, 2005 or 2004.
(3) Historically, policy changes are not applied to the entire portfolio on the
date of implementation but are applied to new, or recently originated or
acquired accounts. However, the policies adopted in the third quarter of
2003 for the Mortgage Services business and the fourth quarter of 2004 for
the domestic private label (excluding retail sales contracts) and credit
card portfolios were applied more broadly. The policy changes for the
Mortgage Services business which occurred in the third quarter of 2003,
unless otherwise noted, were generally applied to accounts originated or
acquired after January 1, 2003 and the historical restructuring policies and
practices are effective for all accounts originated or acquired prior to
January 1, 2003. Implementation of this uniform policy had the effect of
only counting restructures occurring on or after January 1, 2003 in
assessing restructure eligibility for the purpose of the limitation that no
account may be restructured more than four times in a rolling 60 month
period. These policy changes adopted in the third quarter of 2003 did not
have a significant impact on our business model or results of operations as
the changes are, in effect, phased in as receivables were originated or
acquired. For the adoption of FFIEC policies which occurred in the fourth
quarter of 2004, the policies were effective immediately for all receivables
in the domestic private label credit card and the credit card portfolios.
Other business units may also elect to adopt uniform policies in future
periods.
(4) In some cases, as part of the Consumer Lending Foreclosure Avoidance
Program, accounts may be restructured on receipt of one qualifying payment.
In the fourth quarter of 2006, this treatment was extended to accounts that
qualified for the Mortgage Services account modification plan, as long as it
has been at least six months since such account was originated, even if the
account had been restructured in the last twelve months. Such restructures
may be in addition to the four collection restructures in a rolling
sixty-month period. Accounts receive these restructures after proper
verification of the customer's ability to make continued payments. This
generally includes the determination and verification of the customer's
financial situation. At December 31, 2006 and 2005 Consumer Lending had $674
million and $497 million, respectively, of accounts restructured on receipt
of one qualifying payment under the Foreclosure Avoidance Program. At
December 31, 2006 Mortgage Services had $134 million of accounts
restructured on receipt of one qualifying payment under the account
modification plan.
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(5) Our Mortgage Services business implemented this policy for all accounts
effective March 1, 2004.
(6) Prior to January 1, 2003, accounts that had made at least six qualifying
payments during the life of the loan and that agreed to pay by automatic
withdrawal were generally restructured with one qualifying payment.
(7) Prior to August 2006, Mortgage Services accounts could not be restructured
until nine months after origination and six months after the loan was
acquired.
(8) For our Canadian business, private label accounts are limited to one
restructure every four months and if originated or acquired after January 1,
2003, two qualifying payments must be received, the account must be on the
books for at least six months, at least six months must have elapsed since
the last restructure, and there may be no more than four restructures in a
rolling 60 month period.
The tables below summarize approximate restructuring statistics in our managed
basis domestic portfolio. Managed basis assumes that securitized receivables
have not been sold and remain on our balance sheet. 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 the level of our securitized receivables
have fallen over time, managed basis and owned basis results have now largely
converged. 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.
TOTAL RESTRUCTURED BY RESTRUCTURE PERIOD - DOMESTIC PORTFOLIO(1)
(MANAGED BASIS)
AT DECEMBER 31, 2006 2005
---------------------------------------------------------------------------
Never restructured.......................................... 89.1% 89.5%
Restructured:
Restructured in the last 6 months......................... 4.8 4.0
Restructured in the last 7-12 months...................... 2.4 2.4
Previously restructured beyond 12 months.................. 3.7 4.1
----- -----
Total ever restructured(2)................................ 10.9 10.5
----- -----
Total....................................................... 100.0% 100.0%
===== =====
RESTRUCTURED BY PRODUCT - DOMESTIC PORTFOLIO(1)
(MANAGED BASIS)
AT DECEMBER 31, 2006 2005
---------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS
Real estate secured......................................... $10,344 11.0% $ 8,334 10.4%
Auto finance................................................ 1,881 15.1 1,688 14.5
Credit card................................................. 816 2.9 774 3.0
Private label(2)............................................ 31 10.9 26 7.3
Personal non-credit card.................................... 3,600 19.5 3,369 19.9
------- ---- ------- ----
Total(3).................................................... $16,672 10.9% $14,191 10.5%
======= ==== ======= ====
---------------
(1) Excludes foreign businesses, commercial and other.
(2) 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.
(3) Total including foreign businesses was 10.6 percent at December 31, 2006 and
10.3 percent at December 31, 2005.
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The increase in restructured loans compared to the prior year was primarily
attributable to higher levels of real estate secured restructures due to
portfolio growth and seasoning, including higher restructure levels at our
Mortgage Services business as we continue to work with our customers who, in our
judgment, evidence continued payment probability. Additionally, beginning in the
fourth quarter of 2006, we expanded the use of account modification at our
Mortgage Services business to modify the rate and/or payment on a number of
qualifying loans and restructured certain of those accounts after receipt of one
modified payment and if certain other criteria were met. Such accounts are
included in the above restructure statistics beginning in 2006. See "Credit
Quality Statistics" for further information regarding owned basis and managed
basis delinquency, charge-offs and nonperforming loans.
In addition to our restructuring policies and practices, we employ other
customer account management techniques that are similarly designed to manage
customer relationships, maximize collection opportunities and avoid foreclosure
or repossession if reasonably possible. These additional customer account
management techniques include, at our discretion, actions such as extended
payment arrangements, approved external debt management plans, forbearance,
modifications, loan rewrites and/or deferment pending a change in circumstances.
We typically use these customer account management techniques with individual
borrowers in transitional situations, usually involving borrower hardship
circumstances or temporary setbacks that are expected to affect the borrower's
ability to pay the contractually specified amount for some period of time. For
example, under a forbearance agreement, we may agree not to take certain
collection or credit agency reporting actions with respect to missed payments,
often in return for the borrower's agreeing to pay us an additional amount with
future required payments. In some cases, these additional customer account
management techniques may involve us agreeing to lower the contractual payment
amount and/or reduce the periodic interest rate. In most cases, the delinquency
status of an account is considered to be current if the borrower immediately
begins payment under the new account terms. We are actively using loan
modifications followed by an account restructure if the borrower makes one or
more modified payments in response to increased volumes within our delinquent
Mortgage Services portfolio. This account management practice is designed to
assist borrowers who may have purchased a home with an expectation of continued
real estate appreciation or income that has proven unfounded.
The amount of domestic and foreign managed receivables in forbearance,
modification, credit card services approved consumer credit counseling
accommodations, rewrites, modifications (excluding Mortgage Services in 2006) 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 $.3 billion or .2 percent of managed receivables at December 31,
2006 compared with $.4 billion or .3 percent of managed receivables at December
31, 2005.
When we use a customer account management technique, we may treat the account as
being contractually current and will not reflect it as a delinquent account in
our delinquency statistics. However, if the account subsequently experiences
payment defaults, it will again become contractually delinquent. We generally
consider loan rewrites to involve an extension of a new loan, and such new loans
are not reflected in our delinquency or restructuring statistics. Our account
management actions vary by product and are under continual review and assessment
to determine that they meet the goals outlined above.
GEOGRAPHIC CONCENTRATIONS The state of California accounts for 13 percent of our
domestic portfolio. We also have significant concentrations of domestic consumer
receivables in Florida (7%), New York (6%), Texas (5%), Ohio (5%), and
Pennsylvania (5%). Because of our centralized underwriting, collections and
processing functions, we can quickly change our credit standards and intensify
collection efforts in specific locations. We believe this lowers risks resulting
from such geographic concentrations.
Our foreign consumer operations located in the United Kingdom and the Republic
of Ireland accounted for 3 percent of consumer receivables and Canada accounted
for 2 percent of consumer receivables at December 31, 2006.
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LIQUIDITY AND CAPITAL RESOURCES
--------------------------------------------------------------------------------
While the funding synergies resulting from our acquisition by HSBC have allowed
us to reduce our reliance on traditional sources to fund our growth, our
continued success and prospects for growth are dependent upon access to the
global capital markets. Numerous factors, internal and external, may impact our
access to and the costs associated with issuing debt in these markets. These
factors may include our debt ratings, overall capital markets volatility and the
impact of overall economic conditions on our business. We continue to focus on
balancing our use of affiliate and third-party funding sources to minimize
funding expense while maximizing liquidity. As discussed below, we supplemented
unsecured debt issuance during 2006 and 2005 with proceeds from the continuing
sale of newly originated domestic private label receivables (excluding retail
sales contracts) to HSBC Bank USA following the bulk sale of this portfolio in
December 2004, debt issued to affiliates, the issuance of Series B preferred
stock, the issuance of additional common equity to HINO in both 2006 and 2005
and the sale of our U.K. credit card business to HBEU in December 2005.
Because we are a subsidiary of HSBC, our credit ratings have improved and our
credit spreads relative to Treasury Bonds 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 and improved funding
availability, we recognized cash funding expense savings of approximately $940
million during 2006, $600 million in 2005 and $350 million in 2004 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 pre-tax cash funding expense savings in excess of
$1.0 billion for the year ended December 31, 2006. Amortization of purchase
accounting fair value adjustments to our external debt obligations, reduced
interest expense by $542 million in 2006, including $62 million relating to
Metris and $656 million in 2005, including $1 million relating to Metris and
$946 million in 2004.
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Debt due to affiliates and other HSBC related funding are summarized in the
following table:
DECEMBER 31, 2006 2005
---------------------------------------------------------------------------
(IN BILLIONS)
Debt outstanding to HSBC subsidiaries:
Drawings on bank lines in the U.K. and Europe............. $ 4.3 $ 4.2
Term debt................................................. 10.6 11.0
Preferred securities issued by Household Capital Trust
VIII to HSBC........................................... .3 .3
----- -----
Total debt outstanding to HSBC subsidiaries............... 15.2 15.5
----- -----
Debt outstanding to HSBC clients:
Euro commercial paper..................................... 3.0 3.2
Term debt................................................. 1.2 1.3
----- -----
Total debt outstanding to HSBC clients.................... 4.2 4.5
Cash received on bulk and subsequent sale of domestic
private label credit card receivables to HSBC Bank USA,
net (cumulative).......................................... 17.9 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............................................... (4.7) (3.3)
----- -----
Total real estate secured receivable activity with HSBC Bank
USA....................................................... 3.2 4.6
Cash received from sale of European Operations to HBEU
affiliate................................................. -(2) -
Cash received from sale of U.K. credit card business to
HBEU...................................................... 2.7 2.6
Capital contribution by HINO................................ 1.4(1) 1.2(1)
----- -----
Total HSBC related funding.................................. $44.6 $44.1
===== =====
---------------
(1) This capital contribution was made in connection with our acquisition of
Champion Mortgage in November 2006 and our acquisition of Metris in December
2005.
(2) Less than $100 million.
At December 31, 2006, funding from HSBC, including debt issuances to HSBC
subsidiaries and clients, represented 13 percent of our total debt and preferred
stock funding. At December 31, 2005, funding from HSBC, including debt issuances
to HSBC subsidiaries and clients, represented 15 percent of our total debt and
preferred stock funding.
Cash proceeds of $46 million from the November 2006 sale of the European
Operations and the December 2005 sale of our U.K. credit card receivables to
HBEU of $2.7 billion in cash were used to partially pay down drawings on bank
lines from HBEU for the U.K. and fund operations. Proceeds received from the
bulk sale and subsequent daily sales of domestic private label credit card
receivables to HSBC Bank USA of $17.9 billion were used to pay down short-term
domestic borrowings, including outstanding commercial paper balances, and to
fund operations.
At December 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 $5.7 billion from HBEU to fund our operations in the U.K. At
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 HBEU to fund our operations in the U.K. At December 31,
2006, $4.3 billion was outstanding under the HBEU lines for the U.K. and no
balances were outstanding under the domestic lines. At December 31, 2005, $4.2
billion was outstanding under HBEU lines for the U.K. and no balances were
outstanding under the domestic lines. We had derivative contracts with a
notional value of $87.4 billion, or approximately 93 percent of total derivative
contracts, outstanding with HSBC affiliates at December 31, 2006. At December
31, 2005, we had derivative
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contracts with a notional value of $72.2 billion, or approximately 87 percent of
total derivative contracts, outstanding with HSBC affiliates
SECURITIES AND OTHER SHORT-TERM INVESTMENTS Securities totaled $4.7 billion at
December 31, 2006 and $4.1 billion at December 31, 2005 as a result of an
increase in money market funds restricted for paying down secured financings at
the established payment date. Securities purchased under agreements to resell
totaled $171 million at December 31, 2006 and $78 million at December 31, 2005.
Interest bearing deposits with banks totaled $424 million at December 31, 2006
and $384 million at December 31, 2005.
COMMERCIAL PAPER, BANK AND OTHER BORROWINGS totaled $11.1 billion at December
31, 2006 and $11.4 billion at December 31, 2005. The levels at December 31, 2006
reflect our decision to carry lower commercial paper balances. This funding
strategy also requires that bank credit facilities will at all times exceed 85%
of outstanding commercial paper and that the combination of bank credit
facilities and undrawn committed conduit facilities will, at all times, exceed
115% of outstanding commercial paper. This plan, which was reviewed with the
relevant rating agencies, resulted in an increase in our maximum outstanding
commercial paper balance. Included in this total was outstanding Euro commercial
paper sold to customers of HSBC of $3.0 billion at December 31, 2006 and $3.2
billion at December 31, 2005.
LONG TERM DEBT (with original maturities over one year) increased to $127.6
billion at December 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 issuances during 2006 included the
following:
- $7.3 billion of domestic and foreign medium-term notes
- $7.9 billion of foreign currency-denominated bonds
- $1.8 billion of InterNotes(SM) (retail-oriented medium-term notes)
- $9.3 billion of global debt
- $14.9 billion of securities backed by real estate secured, auto finance,
credit card and personal non-credit card 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. In the fourth quarter of 2006 we redeemed the junior subordinated
notes, issued to Household Capital Trust VII with an outstanding principal
balance of $206 million.
In November 2005, we issued $1.0 billion of preferred securities of Household
Capital Trust IX. The interest rate on these securities is 5.911% from the date
of issuance through November 30, 2015 and is payable semiannually beginning May
30, 2006. After November 30, 2015, the rate changes to the three-month LIBOR
rate, plus 1.926% and is payable quarterly beginning on February 28, 2016. In
June 2005, we redeemed the junior subordinated notes issued to Household Capital
Trust V with an outstanding principal balance of $309 million.
PREFERRED SHARES In June 2005, we issued 575,000 shares of Series B Preferred
Stock for $575 million. Dividends on the Series B Preferred Stock are
non-cumulative and payable quarterly at a rate of 6.36 percent commencing
September 15, 2005. The Series B Preferred Stock may be redeemed at our option
after June 23, 2010. In 2006 and 2005, we paid dividends totaling $37 million
and $17 million, respectively on the Series B Preferred Stock.
COMMON EQUITY In 2006, in connection with our purchase of the Champion
portfolio, HINO made a capital contribution of $163 million. In 2005, we issued
four shares of common equity to HINO in December 2005 in exchange for the $1.1
billion Series A Preferred Stock plus all accrued and unpaid dividends.
Additionally, in connection with our acquisition of Metris, HINO made a capital
contribution of $1.2 billion in exchange for one share of common stock.
SELECTED CAPITAL RATIOS In managing capital, we develop targets for tangible
shareholder's(s') equity to tangible managed assets ("TETMA"), tangible
shareholder's(s') equity plus owned loss reserves to tangible
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managed assets ("TETMA + Owned Reserves") and tangible common equity to tangible
managed assets. These ratio targets are based on discussions with HSBC and
rating agencies, risks inherent in the portfolio, the projected operating
environment and related risks, and any acquisition objectives. Our targets may
change from time to time to accommodate changes in the operating environment or
other considerations such as those listed above.
In 2006, Standard & Poor's Corporation raised the senior debt rating for HSBC
Finance Corporation from A to AA-, raised the senior subordinated debt rating
from A- to A+, raised the commercial paper rating from A-1 to A-1+, and raised
the Series B preferred stock rating from BBB+ to A-2. Also, during the fourth
quarter of 2006 Standard and Poor's Corporations changed our total outlook on
our issuer default rating to "positive outlook". During 2006, Moody's Investors
Service raised the rating for all of our debt with the Senior Debt Rating for
HSBC Finance Corporation raised from A1 to Aa3 and the Series B preferred stock
rating for HSBC Finance Corporation from A3 to A2. Our short-term rating was
also affirmed at Prime-1. In the third quarter of 2006, Fitch changed the total
outlook on our issuer default rating to "positive outlook" from "stable
outlook."
Selected capital ratios are summarized in the following table:
DECEMBER 31, 2006 2005
---------------------------------------------------------------------------
TETMA(1),).................................................. 7.20% 7.56%
TETMA + Owned Reserves(1),)................................. 11.08 10.55
Tangible common equity to tangible managed assets(1)........ 6.11 6.07
Common and preferred equity to owned assets................. 11.19 12.43
Excluding HSBC acquisition purchase accounting adjustments:
TETMA(1),)................................................ 7.85% 8.52%
TETMA + Owned Reserves(1),)............................... 11.73 11.51
Tangible common equity to tangible managed assets(1)...... 6.76 7.02
---------------
(1) TETMA, TETMA + Owned Reserves and tangible common equity to tangible managed
assets represent non-U.S. GAAP financial ratios that are used by HSBC
Finance Corporation management and applicable rating agencies to evaluate
capital adequacy and may differ from similarly named measures presented by
other companies. See "Basis of Reporting" for additional discussion on the
use of non-U.S. GAAP financial measures and "Reconciliations to U.S. GAAP
Financial Measures" for quantitative reconciliations to the equivalent U.S.
GAAP basis financial measure.
HSBC FINANCE CORPORATION. HSBC Finance Corporation is an indirect wholly owned
subsidiary of HSBC Holdings plc. On March 28, 2003, HSBC acquired Household
International, Inc. by way of merger in a purchase business combination.
Effective January 1, 2004, HSBC transferred its ownership interest in Household
to a wholly owned subsidiary, HSBC North America Holdings Inc., which
subsequently contributed Household to its wholly owned subsidiary, HINO. On
December 15, 2004, Household merged with its wholly owned subsidiary, Household
Finance Corporation, with Household as the surviving entity. At the time of the
merger, Household changed its name to "HSBC Finance Corporation."
HSBC Finance Corporation is the parent company that owns the outstanding common
stock of its subsidiaries. Our main source of funds is cash received from
operations and subsidiaries in the form of dividends. In addition, we receive
cash from third parties and affiliates by issuing preferred stock and debt.
HSBC Finance Corporation received cash dividends from its subsidiaries of $74
million in 2006 and $514 million in 2005.
In conjunction with the acquisition by HSBC, we issued a series of 6.50 percent
cumulative preferred stock in the amount of $1.1 billion ("Series A Preferred
Stock") to HSBC on March 28, 2003. In September 2004, HSBC North America issued
a new series of preferred stock totaling $1.1 billion to HSBC in exchange for
our Series A Preferred Stock. In October 2004, our immediate parent, HINO,
issued a new series of preferred stock to HSBC North America in exchange for our
Series A Preferred Stock. We paid dividends on our
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Series A Preferred Stock of $66 million in October 2005 and $108 million in
October 2004. On December 15, 2005, we issued 4 shares of common stock to HINO
in exchange for the $1.1 billion Series A Preferred Stock plus the accrued and
unpaid dividends and the Series A Preferred Stock was retired.
In November 2005, we issued $1.0 billion of preferred securities of Household
Capital Trust IX. The interest rate on these securities is 5.911% from the date
of issuance through November 30, 2015 and is payable semiannually beginning May
30, 2006. After November 30, 2015, the rate changes to the three-month LIBOR
rate, plus 1.926% and is payable quarterly beginning on February 28, 2016. In
June 2005, we redeemed the junior subordinated notes issued to the Household
Capital Trust V with an outstanding principal balance of $309 million.
In June 2005, we issued 575,000 shares of Series B Preferred Stock for $575
million. Dividends on the Series B Preferred Stock are non-cumulative and
payable quarterly at a rate of 6.36 percent commencing September 15, 2005. The
Series B Preferred Stock may be redeemed at our option after June 23, 2010. In
2006 and 2005, we paid dividends totaling $37 million and $17 million,
respectively, on the Series B Preferred Stock.
HSBC Finance Corporation has a number of obligations to meet with its available
cash. It must be able to service its debt and meet the capital needs of its
subsidiaries. It also must pay dividends on its preferred stock and may pay
dividends on its common stock. Dividends of $809 million were paid to HINO, our
immediate parent company, on our common stock in 2006 and $980 million were paid
in 2005. We anticipate paying future dividends to HINO, but will maintain our
capital at levels necessary to maintain current ratings either by limiting the
dividends to or through capital contributions from our parent.
At various times, we will make capital contributions to our subsidiaries to
comply with regulatory guidance, support receivable growth, maintain acceptable
investment grade ratings at the subsidiary level, or provide funding for
long-term facilities and technology improvements. HSBC Finance Corporation made
capital contributions to certain subsidiaries of $1.5 billion in 2006 and $2.2
billion in 2005.
SUBSIDIARIES At December 31, 2006, HSBC Finance Corporation had one major
subsidiary, Household Global Funding ("Global Funding"), and manages all
domestic operations. Prior to December 15, 2004, we had two major subsidiaries:
Household Finance Corporation ("HFC"), which managed all domestic operations,
and Global Funding. On December 15, 2004, HFC merged with and into Household
International which changed its name to HSBC Finance Corporation.
DOMESTIC OPERATIONS HSBC Finance Corporation's domestic operations are funded
through the collection of receivable balances; issuing commercial paper,
medium-term debt and long-term debt; borrowing under secured financing
facilities and selling consumer receivables. Domestically, HSBC Finance
Corporation markets its commercial paper primarily through an in-house sales
force. The vast majority of our domestic medium-term notes and long-term debt is
now marketed through subsidiaries of HSBC. Domestic medium-term notes may also
be marketed through our in-house sales force. Intermediate and long-term debt
may also be marketed through unaffiliated investment banks.
At December 31, 2006, advances from subsidiaries of HSBC for our domestic
operations totaled $10.6 billion. At December 31, 2005, advances from
subsidiaries of HSBC for our domestic operations totaled $11.0 billion. The
interest rates on funding from HSBC subsidiaries are market-based and comparable
to those available from unaffiliated parties.
Outstanding commercial paper related to our domestic operations totaled $10.8
billion at December 31, 2006 and $10.9 billion at December 31, 2005.
Following our acquisition by HSBC, we established a new Euro commercial paper
program, largely targeted towards HSBC clients, which expanded our European
investor base. Under the Euro commercial paper program, commercial paper
denominated in Euros, British pounds and U.S. dollars is sold to foreign
investors. Outstanding Euro commercial paper sold to customers of HSBC totaled
$3.0 billion at December 31, 2006
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and $3.2 billion at December 31, 2005. We actively manage the level of
commercial paper outstanding to ensure availability to core investors while
maintaining excess capacity within our internally-established targets as
communicated with the rating agencies.
The following table shows various debt issuances by HSBC Finance Corporation and
its domestic subsidiaries during 2006 and 2005.
2006 2005
---------------------------------------------------------------------------
(IN BILLIONS)
Medium term notes, excluding issuances to HSBC customers and
subsidiaries of HSBC...................................... $6.0 $9.5
Medium term notes issued to HSBC customers.................. - .2
Medium term notes issued to subsidiaries of HSBC............ .8 5.0
Foreign currency-denominated bonds, excluding issuances to
HSBC customers and subsidiaries of HSBC................... 7.9 5.8
Junior subordinated notes issued to the Household Capital
Trust IX.................................................. - 1.0
Foreign currency-denominated bonds issued to HSBC
customers................................................. - .2
Foreign currency-denominated bonds issued to subsidiaries of
HSBC...................................................... - -
Global debt................................................. 9.3 11.2
InterNotes(SM) (retail-oriented medium-term notes).......... 1.8 1.8
Securities backed by home equity, auto finance and credit
card and personal non-credit card receivables structured
as secured financings..................................... 14.9 9.7
Additionally, in 2005 as part of the Metris acquisition we assumed $4.6 billion
of securities backed by credit card receivables which we restructured to fail
sale treatment and are now accounted for as secured financings.
In order to eliminate future foreign exchange risk, currency swaps were used at
the time of issuance to fix in U.S. dollars substantially all
foreign-denominated notes in 2006 and 2005.
HSBC Finance Corporation issued securities backed by dedicated receivables of
$14.9 billion in 2006 and $9.7 billion in 2005. For accounting purposes, these
transactions were structured as secured financings, therefore, the receivables
and the related debt remain on our balance sheet. At December 31, 2006,
closed-end real estate secured, auto finance and credit card and personal
non-credit card receivables totaling $28.1 billion secured $21.8 billion of
outstanding debt. At December 31, 2005, closed-end real estate secured and auto
finance and credit card receivables totaling $19.7 billion secured $15.1 billion
of outstanding debt.
HSBC Finance Corporation had committed back-up lines of credit totaling $11.7
billion at December 31, 2006 for its domestic operations. Included in the
December 31, 2006 total are $2.5 billion of revolving credit facilities with
HSBC. None of these back-up lines were drawn upon in 2006. The back-up lines
expire on various dates through 2009. The most restrictive financial covenant
contained in the back-up line agreements that could restrict availability is an
obligation to maintain minimum shareholder's equity of $11.0 billion which is
substantially below our December 31, 2006 common and preferred shareholder's
equity balance of $20.1 billion.
At December 31, 2006, we had facilities with commercial and investment banks
under which our domestic operations may issue securities backed with receivables
up to $19.0 billion of receivables, including up to $15.0 billion of auto
finance, credit card and personal non-credit card and $4.0 billion of real
estate secured receivables. We increased our total conduit capacity by $3.6
billion in 2006. Conduit capacity for real estate secured receivables was
increased $1.2 billion and capacity for other products was increased $2.4
billion. The facilities are renewable at the banks' option. At December 31,
2006, $9.1 billion of auto finance, credit card, personal non-credit card and
real estate secured receivables were used in collateralized funding transactions
structured either as securitizations or secured financings under these funding
programs. In addition, we have available a $4.0 billion single seller mortgage
facility (none of which was outstanding at December 31, 2006). The amount
available under the facilities will vary based on the timing and volume of
public securitization
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transactions. Through existing term bank financing and new debt issuances, we
believe we will continue to have adequate sources of funds.
GLOBAL FUNDING Global Funding includes our foreign subsidiaries in the United
Kingdom, the Republic of Ireland and Canada. Global Funding's assets were $10.9
billion at December 31, 2006 and $10.7 billion at December 31, 2005. At December
31, 2005, Global Funding's assets included the assets of our European Operations
which, as previously discussed, were sold to HBEU in November 2006. Consolidated
shareholder's(s') equity includes the effect of translating our foreign
subsidiaries' assets, liabilities and operating results from their local
currency into U.S. dollars.
Each foreign subsidiary conducts its operations using its local currency. While
each foreign subsidiary usually borrows funds in its local currency, both our
United Kingdom and Canadian subsidiaries have historically borrowed funds in
foreign currencies. This allowed the subsidiaries to achieve a lower cost of
funds than that available at that time in their local markets. These borrowings
were converted from foreign currencies to their local currencies using currency
swaps at the time of issuance.
UNITED KINGDOM Our United Kingdom operation is funded with HBEU debt and
previously issued long-term debt. The following table summarizes the funding of
our United Kingdom operation:
2006 2005
---------------------------------------------------------------------------
(IN BILLIONS)
Due to HSBC affiliates...................................... $4.3 $4.2
Long term debt.............................................. .2 .9
At December 31, 2006, $.2 billion of long term debt was guaranteed by HSBC
Finance Corporation. HSBC Finance Corporation receives a fee for providing the
guarantee. In 2006 and 2005, our United Kingdom subsidiary primarily received
its funding directly from HSBC.
As previously discussed, in November 2006, our U.K. operations sold its European
Operations to a subsidiary of HBEU for total consideration of $46 million and
used the proceeds to partially pay down amounts due to HBEU on bank lines in the
U.K. Additionally, in December 2005, our U.K. operations sold its credit card
operations to HBEU for total consideration of $3.0 billion, including $261
million in preferred stock of a subsidiary of HBEU, and used the proceeds to
partially pay down amounts due to HBEU on bank lines in the U.K. and to pay a
cash dividend of $489 million to HSBC Finance Corporation. Our U.K. operations
also provided a dividend to HSBC Finance Corporation of $41 million of the
preferred stock received in the transaction.
CANADA Our Canadian operation is funded with commercial paper, intermediate debt
and long-term debt. Outstanding commercial paper totaled $223 million at
December 31, 2006 compared to $442 million at December 31, 2005. Intermediate
and long-term debt totaled $3.4 billion at December 31, 2006 compared to $2.5
billion at December 31, 2005. At December 31, 2006, $3.6 billion of the Canadian
subsidiary's debt was guaranteed by HSBC Finance Corporation for which it
receives a fee for providing the guarantee. Committed back-up lines of credit
for Canada were approximately $86 million at December 31, 2006. All of these
back-up lines are guaranteed by HSBC Finance Corporation and none were used in
2006. In 2006, our Canadian operations paid a dividend of $26 million to HSBC
Finance Corporation.
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2007 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 2007 are summarized in the table that follows.
(IN BILLIONS)
----------------------------------------------------------------------------
FUNDING NEEDS:
Net asset growth.......................................... $(10) - 0
Commercial paper, term debt and securitization
maturities............................................. 30 - 36
Other..................................................... 1 - 3
----------
Total funding needs......................................... $21 - 39
==========
FUNDING SOURCES:
External funding, including commercial paper.............. $20 - 36
HSBC and HSBC subsidiaries................................ 1 - 3
----------
Total funding sources....................................... $21 - 39
==========
As previously discussed, we have experienced deterioration in the performance of
mortgage loan originations in our Mortgage Services business. Numerous risk
mitigation efforts are underway in this business and we have slowed growth by
tightening underwriting criteria. These actions, combined with normal portfolio
attrition, will result in negative growth in 2007. Additionally during 2007, we
will continue to analyze the mortgage acquisition strategy. If we continue to
observe risk in specific portfolios we may choose to constrain growth in certain
portfolios. In addition, as opportunities arise we may also choose to sell
selected portfolios. Both activities could result in negative year over year
growth in the balance sheet. Commercial paper outstanding in 2007 is expected to
be in line with the December 31, 2006 balances, except during the first three
months of 2007 when commercial paper balances will be temporarily high due to
the seasonal activity of our TFS business. Approximately two-thirds of
outstanding commercial paper is expected to be domestic commercial paper sold
both directly and through dealer programs. Euro commercial paper is expected to
account for approximately one-third of outstanding commercial paper and will be
marketed predominately to HSBC clients.
Term debt issuances are expected to utilize several ongoing programs to achieve
the desired funding. Approximately 78 percent of term debt funding is expected
to be achieved through transactions including U.S. dollar global and Euro
transactions and large medium-term note ("MTN") offerings. Domestic retail note
programs are expected to account for approximately 12 percent of term debt
issuances. The remaining term debt issuances are expected to consist of smaller
domestic and foreign currency MTN offerings.
As a result of our decision in 2004 to fund all new collateralized funding
transactions as secured financings, we anticipate securitization levels will
continue to decline in 2007. Because existing public credit card transactions
were structured as sales to revolving trusts that require replenishments of
receivables to support previously issued securities, receivables will continue
to be sold to these trusts until the revolving periods end, the last of which is
currently projected to occur in the fourth quarter of 2007. In addition, we will
continue to replenish at reduced levels, certain non-public personal non-credit
card securities issued to conduits for a period of time in order to manage
liquidity. The termination of sale treatment on new collateralized funding
activity reduced our reported net income under U.S. GAAP. There was no impact,
however, on cash received from operations or on IFRS reported results. Because
we believe the market for securities backed by receivables is a reliable,
efficient and cost-effective source of funds, we will continue to use secured
financings of consumer receivables as a source of our funding and liquidity. We
anticipate that secured financings in 2007 should increase significantly over
the 2006 levels.
HSBC received regulatory approval in 2003 to provide the direct funding required
by our United Kingdom operations. Accordingly, in 2004 we eliminated all back-up
lines of credit which had previously supported our United Kingdom subsidiary.
All new funding for our United Kingdom subsidiary is now provided directly by
HSBC. Our Canadian operation will continue to fund itself independently through
traditional third-party
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funding sources such as commercial paper and medium term-notes. Funding needs in
2007 are not expected to be significant for Canada.
CAPITAL EXPENDITURES We made capital expenditures of $148 million in 2006 which
included costs related to the new office building in the Village of Mettawa,
Illinois and the Solstice acquisition. Capital expenditures in 2005 were $78
million.
COMMITMENTS We also enter into commitments to meet the financing needs of our
customers. In most cases, we have the ability to reduce or eliminate these open
lines of credit. As a result, the amounts below do not necessarily represent
future cash requirements at December 31, 2006:
(IN BILLIONS)
----------------------------------------------------------------------------
Private label, and credit cards............................. $186
Other consumer lines of credit.............................. 7
----
Open lines of credit(1)..................................... $193
====
---------------
(1) Includes an estimate for acceptance of credit offers mailed to potential
customers prior to December 31, 2006.
At December 31, 2006, our Mortgage Services business had commitments with
numerous correspondents to purchase up to $104 million of real estate secured
receivables at fair market value, subject to availability based on current
underwriting guidelines specified by our Mortgage Services business and at
prices indexed to general market rates. These commitments have terms of up to
one year and can be renewed upon mutual agreement. Also at December 31, 2006,
our Mortgage Services business had outstanding forward sales commitments
relating to real estate secured loans totaling $607 million and unused
commitments to extend credit relating to real estate secured loans to customers
(as long as certain conditions are met), totaling $1.4 billion.
At December 31, 2006, we also had a commitment to lend up to $3.0 billion to H&R
Block to fund its acquisition of a participation interest in refund anticipation
loans during the 2007 tax season.
CONTRACTUAL CASH OBLIGATIONS The following table summarizes our long-term
contractual cash obligations at December 31, 2006 by period due:
2007 2008 2009 2010 2011 THEREAFTER TOTAL
-----------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
PRINCIPAL BALANCE OF DEBT:
Due to affiliates..................... $ 4,909 $ 26 $ 2,005 $ 1,433 $ 191 $ 6,608 $ 15,172
Long term debt (including secured
financings)......................... 26,149 21,734 16,815 12,572 13,718 34,330 125,318
------- ------- ------- ------- ------- ------- --------
Total debt............................ 31,058 21,760 18,820 14,005 13,909 40,938 140,490
------- ------- ------- ------- ------- ------- --------
OPERATING LEASES:
Minimum rental payments............... 182 144 121 80 42 127 696
Minimum sublease income............... 58 36 34 15 - - 143
------- ------- ------- ------- ------- ------- --------
Total operating leases................ 124 108 87 65 42 127 553
------- ------- ------- ------- ------- ------- --------
OBLIGATIONS UNDER MERCHANT AND AFFINITY
PROGRAMS.............................. 141 137 90 84 80 334 866
NON-QUALIFIED PENSION AND POSTRETIREMENT
BENEFIT LIABILITIES(1)................ 20 23 24 26 27 847 967
------- ------- ------- ------- ------- ------- --------
TOTAL CONTRACTUAL CASH OBLIGATIONS...... $31,343 $22,028 $19,021 $14,180 $14,058 $42,246 $142,876
======= ======= ======= ======= ======= ======= ========
---------------
(1) Expected benefit payments calculated include future service component.
These cash obligations could be funded primarily through cash collections on
receivables, from the issuance of new unsecured debt or through secured
financings of receivables. Our receivables and other liquid assets generally
have shorter lives than the liabilities used to fund them.
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In January 2006, we entered into a lease for a building in the Village of
Mettawa, Illinois. The new facility will consolidate our Prospect Heights, Mount
Prospect and Deerfield offices. Construction of the building began in the spring
of 2006 and the relocation is planned for the first and second quarters of 2008.
The future lease payments for this building are currently estimated as follows:
(IN MILLIONS)
----------------------------------------------------------------------------
2008........................................................ $ 5
2009........................................................ 11
2010........................................................ 11
2011........................................................ 11
Thereafter.................................................. 115
----
$153
====
Our purchase obligations for goods and services at December 31, 2006 were not
significant.
OFF BALANCE SHEET ARRANGEMENTS AND SECURED FINANCINGS
--------------------------------------------------------------------------------
SECURITIZATIONS AND SECURED FINANCINGS Securitizations (collateralized funding
transactions structured to receive sale treatment under Statement of Financial
Accounting Standards No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, a Replacement of FASB
Statement No. 125," ("SFAS No. 140")) and secured financings (collateralized
funding transactions which do not receive sale treatment under SFAS No. 140) of
consumer receivables have been a source of funding and liquidity for us.
Securitizations and secured financings have been used to limit our reliance on
the unsecured debt markets and often are more cost-effective than alternative
funding sources.
In a securitization, a designated pool of non-real estate consumer receivables
is removed from the balance sheet and transferred through a limited purpose
financing subsidiary to an unaffiliated trust. This unaffiliated trust is a
qualifying special purpose entity ("QSPE") as defined by SFAS No. 140 and,
therefore, is not consolidated. The QSPE funds its receivable purchase through
the issuance of securities to investors, entitling them to receive specified
cash flows during the life of the securities. The receivables transferred to the
QSPE serve as collateral for the securities. At the time of sale, an
interest-only strip receivable is recorded, representing the present value of
the cash flows we expect to receive over the life of the securitized
receivables, net of estimated credit losses and debt service. Under the terms of
the securitizations, we receive annual servicing fees on the outstanding balance
of the securitized receivables and the rights to future residual cash flows on
the sold receivables after the investors receive their contractual return. Cash
flows related to the interest-only strip receivables and servicing the
receivables are collected over the life of the underlying securitized
receivables.
Certain securitization trusts, such as credit cards, are established at fixed
levels and, due to the revolving nature of the underlying receivables, require
the sale of new receivables into the trust to replace runoff so that the
principal dollar amount of the investors' interest remains unchanged. We refer
to such activity as replenishments. Once the revolving period ends, the
amortization period begins and the trust distributes principal payments, in
addition to interest, to the investors.
When loans are securitized in transactions structured as sales, we receive cash
proceeds from investors, net of transaction costs and expenses. These proceeds
are generally used to re-pay other debt and corporate obligations and to fund
new loans. The investors' shares of finance charges and fees received from the
securitized loans are collected each month and are primarily used to pay
investors for interest and credit losses and to pay us for servicing fees. We
retain any excess cash flow remaining after such payments are made to investors.
Generally, for each securitization and secured financing we utilize credit
enhancement to obtain investment grade ratings on the securities issued by the
trust. To ensure that adequate funds are available to pay investors their
contractual return, we may retain various forms of interests in assets securing
a funding transaction,
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whether structured as a securitization or a secured financing, such as
over-collateralization, subordinated series, residual interests in the
receivables (in the case of securitizations) or we may fund cash accounts. Over-
collateralization is created by transferring receivables to the trust issuing
the securities that exceed the balance of the securities to be issued.
Subordinated interests provide additional assurance of payment to investors
holding senior securities. Residual interests are also referred to as
interest-only strip receivables and represent rights to future cash flows from
receivables in a securitization trust after investors receive their contractual
return. Cash accounts can be funded by an initial deposit at the time the
transaction is established and/or from interest payments on the receivables that
exceed the investor's contractual return.
Our retained securitization interests are not in the form of securities and are
included in receivables on our consolidated balance sheets. These retained
interests were comprised of the following at December 31, 2006 and 2005:
AT DECEMBER 31,
---------------
2006 2005
-----------------------------------------------------------------------------
(IN MILLIONS)
Overcollateralization....................................... $ 52 $ 214
Interest-only strip receivables............................. 6 23
Cash spread accounts........................................ 40 150
Other subordinated interests................................ 870 2,131
---- ------
Total retained securitization interests..................... $968 $2,518
==== ======
In a secured financing, a designated pool of receivables are conveyed to a
wholly owned limited purpose subsidiary which in turn transfers the receivables
to a trust which sells interests to investors. Repayment of the debt issued by
the trust is secured by the receivables transferred. The transactions are
structured as secured financings under SFAS No. 140. Therefore, the receivables
and the underlying debt of the trust remain on our balance sheet. We do not
recognize a gain in a secured financing transaction. Because the receivables and
the debt remain on our balance sheet, revenues and expenses are reported
consistently with our owned balance sheet portfolio. Using this source of
funding results in similar cash flows as issuing debt through alternative
funding sources.
Securitizations are treated as secured financings under both IFRS and U.K. GAAP.
In order to align our accounting treatment with that of HSBC initially under
U.K. GAAP and now under IFRS, we began to structure all new collateralized
funding transactions as secured financings in the third quarter of 2004.
However, because existing public 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 the fourth
quarter of 2007. We continue to replenish at reduced levels, certain non-public
personal non-credit card and credit card securities issued to conduits and
record the resulting replenishment gains for a period of time in order to manage
liquidity. The termination of sale treatment on new collateralized funding
activity reduced our reported net income under U.S. GAAP. There was no impact,
however, on cash received from operations.
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Securitizations and secured financings were as follows:
YEAR ENDED DECEMBER 31,
--------------------------
2006 2005 2004
----------------------------------------------------------------------------------------
(IN MILLIONS)
INITIAL SECURITIZATIONS:
Credit card................................................. $ - $ - $ 550
Private label............................................... - - 190
------- ------ -------
Total....................................................... $ - $ - $ 740
======= ====== =======
REPLENISHMENT SECURITIZATIONS:
Credit card................................................. $ 2,469 $8,620 $20,378
Private label............................................... - - 9,104
Personal non-credit card.................................... 71 211 828
------- ------ -------
Total....................................................... $ 2,540 $8,831 $30,310
======= ====== =======
SECURED FINANCINGS:
Real estate secured......................................... $ 4,767 $4,516 $ 3,299
Auto finance................................................ 2,843 3,418 1,790
Credit card................................................. 4,745 1,785 -
Personal non-credit card.................................... 2,500 - -
------- ------ -------
Total....................................................... $14,855 $9,719 $ 5,089
======= ====== =======
Additionally, as part of the Metris acquisition in 2005, we assumed $4.6 billion
of securities backed by credit card receivables which we restructured to fail
sale treatment and are now accounted for as secured financings.
Our securitization levels in 2006 were lower while secured financings were
higher reflecting the decision in the third quarter of 2004 to structure all new
collateralized funding transactions as secured financings and the use of
additional sources of liquidity provided by HSBC and its subsidiaries.
Outstanding securitized receivables consisted of the following:
AT DECEMBER 31,
---------------
2006 2005
-----------------------------------------------------------------------------
(IN MILLIONS)
Auto finance................................................ $271 $1,192
Credit card................................................. 500 1,875
Personal non-credit card.................................... 178 1,007
---- ------
Total....................................................... $949 $4,074
==== ======
The following table summarizes the expected amortization of our securitized
receivables at December 31, 2006:
2007 2008 TOTAL
---------------------------------------------------------------------------------
(IN MILLIONS)
Auto finance................................................ $271 $ - $271
Credit card................................................. 250 250 500
Personal non-credit card.................................... 178 - 178
---- ---- ----
Total....................................................... $699 $250 $949
==== ==== ====
At December 31, 2006, the expected weighted-average remaining life of these
transactions was .25 years.
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The securities issued in connection with collateralized funding transactions may
pay off sooner than originally scheduled if certain events occur. For certain
auto transactions, early payoff of securities may occur if established
delinquency or loss levels are exceeded or if certain other events occur. For
all other transactions, early payoff of the securities begins if the annualized
portfolio yield drops below a base rate or if certain other events occur. We do
not presently believe that any early payoff will take place. If early payoff
occurred, our funding requirements would increase. These additional requirements
could be met through issuance of various types of debt or borrowings under
existing back-up lines of credit. We believe we would continue to have adequate
sources of funds if an early payoff event occurred.
At December 31, 2006, securitizations structured as sales represented 1 percent
and secured financings represented 14 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.
We continue to believe the market for securities backed by receivables is a
reliable, efficient and cost-effective source of funds, and we will continue to
use secured financings of consumer receivables as a source of our funding and
liquidity. However, if the market for securities backed by receivables were to
change, we may be unable to enter into new secured financings or to do so at
favorable pricing levels. Factors affecting our ability to structure
collateralized funding transactions as secured financings or to do so at
cost-effective rates include the overall credit quality of our securitized
loans, the stability of the securitization markets, the securitization market's
view of our desirability as an investment, and the legal, regulatory, accounting
and tax environments governing collateralized funding transactions.
At December 31, 2006, we had domestic facilities with commercial and investment
banks under which we may use up to $19.0 billion of our receivables in
collateralized funding transactions structured either as securitizations or
secured financings. The facilities are renewable at the banks' option. At
December 31, 2006, $9.1 billion of auto finance, credit card, personal
non-credit card and real estate secured receivables were used in collateralized
funding transactions structured either as securitizations or secured financings
under these funding programs. In addition, we have available a $4.0 billion
single seller mortgage facility (none of which was outstanding at December 31,
2006) structured as a secured financing. As a result of the sale of the U.K.
credit card receivables to HBEU in 2005 as previously discussed, we no longer
have any securitized receivables or conduit lines in the U.K. As previously
discussed, beginning in the third quarter of 2004, we decided to fund all new
collateralized funding transactions as secured financings to align our
accounting treatment with that of HSBC initially under U.K. GAAP and now under
IFRS. The amount available under the facilities will vary based on the timing
and volume of collateralized funding transactions. Through existing term bank
financing and new debt issuances, we believe we should continue to have adequate
sources of funds, which could be impacted from time to time by volatility in the
financial markets or if one or more of these facilities were unable to be
renewed.
For additional information related to our securitization activities, including
the amount of revenues and cash flows resulting from these arrangements, see
Note 8, "Asset Securitizations," to our accompanying consolidated financial
statements.
RISK MANAGEMENT
--------------------------------------------------------------------------------
Some degree of risk is inherent in virtually all of our activities. Accordingly,
we have comprehensive risk management policies and practices in place to address
potential financial risks, which include credit, liquidity, market (which
includes interest rate and foreign currency exchange risks), reputational and
operational risk (which includes compliance and technology risks). Our risk
management policies are designed to identify and analyze these risks, to set
appropriate limits and controls, and to monitor the risks and limits continually
by means of reliable and up-to-date administrative and information systems. We
continually modify and enhance our risk management policies and systems to
reflect changes in markets and products and to better overall risk management
processes. Training, individual responsibility and accountability, together with
a disciplined, conservative and constructive culture of control, lie at the
heart of our management of risk.
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Our risk management policies are primarily carried out in accordance with
practice and limits set by the HSBC Group Management Board which consists of
senior executives throughout the HSBC organization. In addition, due to the
increasingly complex business environment and the evolution of improved risk
management tools and standards, HSBC Finance Corporation has significantly
upgraded, and continues to upgrade, its risk management function. New practices
and techniques have been implemented to enhance data analysis, modeling, stress
testing, management information systems, risk self-assessment, and independent
oversight. A Chief Risk Officer is in place whose role is to establish, oversee,
and direct the various non-credit risk-related functions. The Chief Risk Officer
has dedicated senior risk leaders that independently ensure risks are
appropriately identified, measured, managed, controlled and reported.
Risk management oversight begins with the HSBC Finance Corporation Board of
Directors and its various committees, principally the Audit Committee.
Management oversight is provided by corporate and business unit risk management
committees with the participation of the Chief Risk Officer or his staff. An
HSBC Finance Corporation Risk Management Committee, chaired by the Chief
Executive Officer, focuses on credit and operational risk management strategies.
In addition, the HSBC Finance Corporation Asset Liability Committee ("ALCO")
meets regularly to review risks and approve appropriate risk management
strategies within the limits established by the HSBC Group Management Board.
CREDIT RISK MANAGEMENT Credit risk is the risk that financial loss arises from
the failure of a customer or counterparty to meet its obligations under a
contract. Our credit risk arises primarily from lending and treasury activities.
Day-to-day management of credit risk is decentralized and administered by Chief
Credit Officers in each business line. Independent oversight is provided by a
corporate Chief Retail Credit Officer who reports directly to our Chief
Executive Officer and indirectly to the Group General Manager, Head of Credit
and Risk for HSBC. We have established detailed policies to address the credit
risk that arises from our lending activities. Our credit and portfolio
management procedures focus on risk-based pricing and effective collection and
customer account management efforts for each loan. Our lending guidelines, which
delineate the credit risk we are willing to take and the related terms, are
specific not only for each product, but also take into consideration various
other factors including borrower characteristics. We also have specific policies
to ensure the establishment of appropriate credit loss reserves on a timely
basis to cover probable losses of principal, interest and fees. See "Credit
Quality" for a detailed description of our policies regarding the establishment
of credit loss reserves, our delinquency and charge-off policies and practices
and our customer account management policies and practices. Also see Note 2,
"Summary of Significant Accounting Policies," to our consolidated financial
statements for further discussion of our policies surrounding credit loss
reserves. While we develop our own policies and procedures for all of our
lending activities, they are consistent with HSBC standards and are regularly
reviewed and updated both on an HSBC Finance Corporation and HSBC level.
Counterparty credit risk is our primary exposure on our interest rate swap
portfolio. Counterparty credit risk is the risk that the counterparty to a
transaction fails to perform according to the terms of the contract. We control
counterparty credit risk in derivative instruments through established credit
approvals, risk control limits, collateral, and ongoing monitoring procedures.
Counterparty limits have been set and are closely monitored as part of the
overall risk management process and control structure. During the third quarter
of 2003 and continuing through 2006, we utilize an affiliate, HSBC Bank USA, as
the primary provider of new domestic derivative products. We have never suffered
a loss due to counterparty failure.
Currently the majority of our existing derivative contracts are with HSBC
subsidiaries, making them our primary counterparty in derivative transactions.
Most swap agreements, both with unaffiliated and affiliated third parties,
require that payments be made to, or received from, the counterparty when the
fair value of the agreement reaches a certain level. Generally, third-party swap
counterparties provide collateral in the form of cash which is recorded in our
balance sheet as other assets or derivative related liabilities and totaled $158
million at December 31, 2006 and $91 million at December 31, 2005 for
third-party counterparties. Beginning in the second quarter of 2006, when the
fair value of our agreements with affiliate counterparties require the posting
of collateral by the affiliate, it is provided in the form of cash and recorded
on the balance
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sheet, consistent with third party arrangements. Previously, the posting of
collateral by affiliates was provided in the form of securities, which were not
recorded on our balance sheet. Also during 2006, we lowered the level of the
fair value of our agreements with affiliate counterparties above which
collateral is required to be posted to $75 million. At December 31, 2006, the
fair value of our agreements with affiliate counter parties required the
affiliate to provide cash collateral of $1.0 billion, which is recorded in our
balance sheet as a component of derivative related liabilities. At December 31,
2005, the fair value of our agreements with affiliate counterparties was below
the level requiring posting of collateral. As such, at December 31, 2005, we
were not holding any swap collateral from HSBC affiliates in the form of
securities.
See Note 14, "Derivative Financial Instruments," to the accompanying
consolidated financial statements for additional information related to interest
rate risk management and Note 23, "Fair Value of Financial Instruments," for
information regarding the fair value of certain financial instruments.
LIQUIDITY RISK The management of liquidity risk is addressed in HSBC Finance
Corporation's funding management policies and practices. HSBC Finance
Corporation funds itself principally through unsecured term funding in the
markets, through secured financings and securitization transactions and through
borrowings from HSBC and HSBC clients. Generally, the lives of our assets are
shorter than the lives of the liabilities used to fund them. This initially
reduces liquidity risk by ensuring that funds are received prior to liabilities
becoming due.
Our ability to ensure continuous access to the capital markets and maintain a
diversified funding base is important in meeting our funding needs. To manage
this liquidity risk, we offer a broad line of debt products designed to meet the
needs of both institutional and retail investors. We maintain investor diversity
by placing debt directly with customers, through selected dealer programs and by
targeted issuance of large liquid transactions. Through collateralized funding
transactions, we are able to access an alternative investor base and further
diversify our funding strategies. We also maintain a comprehensive, direct
marketing program to ensure our investors receive consistent and timely
information regarding our financial performance.
The measurement and management of liquidity risk is a primary focus. Three
standard analyses are utilized to accomplish this goal. First, a rolling 60 day
funding plan is updated daily to quantify near-term needs and develop the
appropriate strategies to fund those needs. As part of this process, debt
maturity profiles (daily, monthly, annually) are generated to assist in planning
and limiting any potential rollover risk (which is the risk that we will be
unable to pay our debt or borrow additional funds as it becomes due). Second,
comprehensive plans identifying monthly funding requirements for the next twelve
months are updated at least weekly and monthly funding plans for the next two
years are maintained. These plans focus on funding projected asset growth and
drive both the timing and size of debt issuances. These plans are shared on a
regular basis with HSBC. And third, a Maximum Cumulative Outflow (MCO) analysis
is updated regularly to measure liquidity risk. Cumulative comprehensive cash
inflows are subtracted from outflows to generate a net exposure that is tracked
both monthly over the next 12 month period and annually for 5 years. Net outflow
limits are reviewed by HSBC Finance Corporation's ALCO and HSBC.
We recognize the importance of being prepared for constrained funding
environments. While the potential scenarios driving this analysis have changed
due to our affiliation with HSBC, contingency funding plans are still maintained
as part of the liquidity management process. Alternative funding strategies are
updated regularly for a rolling 12 months and assume limited access to unsecured
funding and continued access to the collateralized funding markets. These
alternative strategies are designed to enable us to achieve monthly funding
goals through controlled growth, sales of receivables and access to committed
sources of contingent liquidity including bank lines and undrawn securitization
conduits. Although our overall liquidity situation has improved significantly
since our acquisition by HSBC, the strategies and analyses utilized in the past
to successfully manage liquidity remain in place today. The combination of this
process with the funding provided by HSBC subsidiaries and clients should ensure
our access to diverse markets, investor bases and adequate funding for the
foreseeable future.
See "Liquidity and Capital Resources" for further discussion of our liquidity
position.
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MARKET RISK The objective of our market risk management process is to manage and
control market risk exposures in order to optimize return on risk while
maintaining a market profile as a provider of financial products and services.
Market risk is the risk that movements in market risk factors, including
interest rates and foreign currency exchange rates, will reduce our income or
the value of our portfolios.
Future net interest income is affected by movements in interest rates. Although
our main operations are in the U.S., we also have operations in Canada and the
U.K. which prepare their financial statements in their local currency.
Accordingly, our financial statements are affected by movements in exchange
rates between the functional currencies of these subsidiaries and the U.S.
dollar. We maintain an overall risk management strategy that uses a variety of
interest rate and currency derivative financial instruments to mitigate our
exposure to fluctuations caused by changes in interest rates and currency
exchange rates. We manage our exposure to interest rate risk primarily through
the use of interest rate swaps, but also use forwards, futures, options, and
other risk management instruments. We manage our exposure to foreign currency
exchange risk primarily through the use of currency swaps, options and forwards.
We do not use leveraged derivative financial instruments for interest rate risk
management. Since our acquisition by HSBC, we have not entered into foreign
exchange contracts to hedge our investment in foreign subsidiaries.
Prior to the acquisition by HSBC, the majority of our fair value and cash flow
hedges were effective hedges which qualified for the shortcut method of
accounting. Under the Financial Accounting Standards Board's interpretations of
SFAS No. 133, the shortcut method of accounting was no longer allowed for
interest rate swaps which were outstanding at the time of our acquisition by
HSBC. As a result of the acquisition, we were required to reestablish and
formally document the hedging relationship associated with all of our fair value
and cash flow hedging instruments and assess the effectiveness of each hedging
relationship, both at the date of the acquisition and on an ongoing basis. As a
result of deficiencies in our contemporaneous hedge documentation at the time of
acquisition, we lost the ability to apply hedge accounting to our entire cash
flow and fair value hedging portfolio that existed at the time of acquisition by
HSBC. Substantially all derivative financial instruments entered into subsequent
to the acquisition qualify as effective hedges under SFAS No. 133 and beginning
in 2005 are being accounted for under the long-haul method of accounting.
Interest rate risk is defined as the impact of changes in market interest rates
on our earnings. We use simulation models to measure the impact of changes in
interest rates on net interest income. The key assumptions used in these models
include expected loan payoff rates, loan volumes and pricing, cash flows from
derivative financial instruments and changes in market conditions. These
assumptions are based on our best estimates of actual conditions. The models
cannot precisely predict the actual impact of changes in interest rates on our
earnings because these assumptions are highly uncertain. At December 31, 2006,
our interest rate risk levels were below those allowed by our existing policy.
Customer demand for our receivable products shifts between fixed rate and
floating rate products, based on market conditions and preferences. These shifts
in loan products produce different interest rate risk exposures. We use
derivative financial instruments, principally interest rate swaps, to manage
these exposures. Interest rate futures, interest rate forwards and purchased
options are also used on a limited basis to reduce interest rate risk.
We monitor the impact that an immediate hypothetical increase or decrease in
interest rates of 25 basis points applied at the beginning of each quarter over
a 12 month period would have on our net interest income assuming a growing
balance sheet and the current interest rate risk profile. The following table
summarizes such estimated impact:
AT DECEMBER 31,
----------------
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......... $180 $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......... $ 54 $120
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These estimates include both the net interest income impact of the derivative
positions we have entered into which are considered to be effective hedges under
SFAS No. 133 and the impact of economic hedges of certain underlying debt
instruments which do not qualify for hedge accounting as previously discussed,
as if they were effective hedges under SFAS No. 133. These estimates also assume
we would not take any corrective actions in response to interest rate movements
and, therefore, exceed what most likely would occur if rates were to change by
the amount indicated.
As part of our overall risk management strategy to reduce earnings volatility,
in 2005 a significant number of our pay fixed/receive variable interest rate
swaps which had not previously qualified for hedge accounting under SFAS No.
133, have been designated as effective hedges using the long-haul method of
accounting, and certain other interest rate swaps were terminated. This will
significantly reduce the volatility of the mark-to-market on the previously
non-qualifying derivatives which have been designated as effective hedges going
forward, but will result in the recording of ineffectiveness under the long-haul
method of accounting under SFAS No. 133. In order to further reduce earnings
volatility that would otherwise result from changes in interest rates, we
continue to evaluate the steps required to regain hedge accounting treatment
under SFAS No. 133 for the remaining swaps which do not currently qualify for
hedge accounting. These derivatives remain economic hedges of the underlying
debt instruments. Use of interest rate swaps which qualify as effective hedges
under SFAS No. 133 decreased our net interest income by 4 basis points in 2006,
increased our net interest income by 24 basis points in 2005 and 49 basis points
in 2004. We will continue to manage our total interest rate risk on a basis
consistent with the risk management process employed since the acquisition.
HSBC also has certain limits and benchmarks that serve as guidelines in
determining the appropriate levels of interest rate risk. One such limit is
expressed in terms of the Present Value of a Basis Point ("PVBP"), which
reflects the change in value of the balance sheet for a one basis point movement
in all interest rates. Our PVBP limit as of December 31, 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
December 31, 2006, we had a PVBP position of $1.1 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:
2006 2005
---------------------------------------------------------------------------
(IN MILLIONS)
Risk related to our portfolio of ineffective hedges......... $(1.8) $(1.4)
Risk for all other remaining assets and liabilities......... 2.9 2.3
----- -----
Total PVBP risk............................................. $ 1.1 $ .9
===== =====
Foreign currency exchange risk refers to the potential changes in current and
future earnings or capital arising from movements in foreign exchange rates. We
enter into foreign exchange rate forward contracts and currency swaps to
minimize currency risk associated with changes in the value of
foreign-denominated liabilities. Currency swaps convert principal and interest
payments on debt issued from one currency to another. For example, we may issue
Euro-denominated debt and then execute a currency swap to convert the obligation
to U.S. dollars. Prior to the acquisition, we had periodically entered into
foreign exchange contracts to hedge portions of our investments in our United
Kingdom and Canada subsidiaries. We estimate that a 10 percent adverse change in
the British pound/U.S. dollar and Canadian dollar/U.S. dollar exchange rate
would result in a decrease in common shareholder's(s') equity of $159 million at
December 31, 2006 and $162 million at December 31, 2005 and would not have a
material impact on net income.
We have issued debt in a variety of currencies and simultaneously executed
currency swaps to hedge the future interest and principal payments. As a result
of the loss of hedge accounting on currency swaps outstanding at the time of our
acquisition, the recognition of the change in the currency risk on these swaps
is recorded differently than the corresponding risk on the underlying foreign
denominated debt. Currency risk on the swap is now recognized immediately on the
net present value of all future swap payments. On the
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corresponding debt, currency risk is recognized on the principal outstanding
which is converted at the period end spot translation rate and on the interest
accrual which is converted at the average spot rate for the reporting period.
OPERATIONAL RISK Operational risk is the risk of loss arising through fraud,
unauthorized activities, error, omission, inefficiency, systems failure or from
external events. It is inherent in every business organization and covers a wide
spectrum of issues.
HSBC Finance Corporation has established an independent Operational Risk
Management function, headed by a Corporate Operational Risk Coordinator
reporting directly to the Chief Risk Officer and indirectly to the Head of
Operational Risk for HSBC. The Operational Risk Coordinator provides independent
functional oversight by managing the following activities:
- maintaining a network of business line Operational Risk Coordinators;
- developing scoring and risk assessment tools and databases;
- providing training and developing awareness; and
- independently reviewing and reporting the assessments of operational
risks.
An Operational Risk Management Committee, chaired by the Operational Risk
Coordinator and Chief Risk Officer, is responsible for oversight of the
operational risks being taken, the analytic tools used to monitor those risks,
and reporting. Business unit line management is responsible for managing and
controlling all risks and for communicating and implementing all control
standards. This is supported by an independent program of periodic reviews
undertaken by Internal Audit. We also monitor external operations risk events
which take place to ensure that we remain in line with best practice and take
account of lessons learned from publicized operational failures within the
financial services industry. We also maintain and test emergency policies and
procedures to support operations and our personnel in the event of disasters.
COMPLIANCE RISK Compliance Risk is the risk arising from failure to comply with
relevant laws, regulations, and regulatory requirements governing the conduct of
specific businesses. It is a composite risk that can result in regulatory
sanctions, financial penalties, litigation exposure and loss of reputation.
Compliance risk is inherent throughout the HSBC Finance Corporation
organization.
Consistent with HSBC's commitment to ensure adherence with applicable regulatory
requirements for all of its world-wide affiliates, HSBC Finance Corporation has
implemented a multi-faceted Compliance Risk Management Program. This program
addresses the following priorities, among other issues:
- anti-money laundering (AML) regulations;
- fair lending and consumer protection laws;
- dealings with affiliates;
- permissible activities; and
- conflicts of interest.
The independent Corporate Compliance function is headed by a Chief Compliance
Officer who reports directly to the Chief Compliance Officer of HSBC North
America, who in turn reports to the Chief Risk Officer and the Head of
Compliance for HSBC. The Corporate Compliance function is supported by various
compliance teams assigned to individual business units. The Corporate Compliance
function is responsible for the following activities:
- advising management on compliance matters;
- providing independent assessment and monitoring; and
- reporting compliance issues to HSBC Finance Corporation senior management
and Board of Directors, as well as to HSBC Compliance.
The overall Corporate Compliance program elements include identification,
assessment, monitoring, control and mitigation of the risk and timely resolution
of the results of risk events. These functions are generally performed by
business line management, with oversight provided by Corporate Compliance.
Controls for mitigating compliance risk are incorporated into business operating
policies and procedures. Processes are in place to ensure controls are
appropriately updated to reflect changes in regulatory requirements as well as
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changes in business practices, including new or revised products, services and
marketing programs. A wide range of compliance training is provided to relevant
staff, including mandated programs for such areas as anti-money laundering, fair
lending and privacy. A separate Corporate Compliance Control Unit, along with
Internal Audit, tests the effectiveness of the overall Compliance Risk
Management Program through continuous monitoring and periodic target audits.
REPUTATIONAL RISK The safeguarding of our reputation is of paramount importance
to our continued prosperity and is the responsibility of every member of our
staff. Reputational risk can arise from social, ethical or environmental issues,
or as a consequence of operations risk events. Our good reputation depends upon
the way in which we conduct our business, but can also be affected by the way in
which customers, to whom we provide financial services, conduct themselves.
Reputational risk is considered and assessed by the HSBC Group Management Board,
our Board of Directors and senior management during the establishment of
standards for all major aspects of business and the formulation of policy. These
policies, which are an integral part of the internal control systems, are
communicated through manuals and statements of policy, internal communication
and training. The policies set out operational procedures in all areas of
reputational risk, including money laundering deterrence, environmental impact,
anti-corruption measures and employee relations.
We have established a strong internal control structure to minimize the risk of
operational and financial failure and to ensure that a full appraisal of
reputational risk is made before strategic decisions are taken. The HSBC
internal audit function monitors compliance with our policies and standards.
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GLOSSARY OF TERMS
Affinity Credit Card - A MasterCard or Visa account jointly sponsored by the
issuer of the card and an organization whose members share a common interest
(e.g., the AFL-CIO Union Plus(R) credit card program).
Auto Finance Loans - Closed-end loans secured by a first lien on a vehicle.
Basis point - A unit that is commonly used to calculate changes in interest
rates. The relationship between percentage changes and basis points can be
summarized as a 1 percent change equals a 100 basis point change or .01 percent
equals 1 basis point.
Co-Branded Credit Card - A MasterCard, Visa or American Express account that is
jointly sponsored by the issuer of the card and another corporation (e.g., the
GM Card(R)). The account holder typically receives some form of added benefit
for using the card.
Consumer Net Charge-off Ratio - Net charge-offs of consumer receivables divided
by average consumer receivables outstanding.
Contractual Delinquency - A method of determining aging of past due accounts
based on the status of payments under the loan. Delinquency status may be
affected by customer account management policies and practices such as the
restructure of accounts, forbearance agreements, extended payment plans,
modification arrangements, external debt management plans, loan rewrites and
deferments.
Efficiency Ratio - Ratio of total costs and expenses less policyholders'
benefits to net interest income and other revenues less policyholders' benefits.
Enhancement Services Income - Ancillary credit card revenue from products such
as Account Secure (debt waiver) and Identity Protection Plan.
Fee Income - Income associated with interchange on credit cards and late and
other fees from the origination, acquisition or servicing of loans.
Foreign Exchange Contract - A contract used to minimize our exposure to changes
in foreign currency exchange rates.
Futures Contract - An exchange-traded contract to buy or sell a stated amount of
a financial instrument or index at a specified future date and price.
HBEU - HSBC Bank plc, a U.K. based subsidiary of HSBC Holdings plc.
HINO - HSBC Investments (North America) Inc., which is the immediate parent of
HSBC Finance Corporation.
HSBC North America - HSBC North America Holdings Inc. and the immediate parent
of HINO.
HSBC - HSBC Holdings plc.
HSBC Bank USA - HSBC Bank USA, National Association
HTSU - HSBC Technology and Services (USA) Inc., which provides information
technology services to all subsidiaries of HSBC North America and other
subsidiaries of HSBC.
Goodwill - Represents the purchase price over the fair value of identifiable
assets acquired less liabilities assumed from business combinations.
IFRS Management Basis - A non-U.S. GAAP measure of reporting results in
accordance with IFRSs and assumes the private label and real estate secured
receivables transferred to HSBC Bank USA have not been sold and remain on our
balance sheet.
Intangible Assets - Assets (not including financial assets) that lack physical
substance. Our acquired intangibles include purchased credit card relationships
and related programs, merchant relationships in our retail services business,
other loan related relationships, trade names, technology, customer lists and
other contracts.
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Interchange Fees - Fees received for processing a credit card transaction
through the MasterCard, Visa, American Express or Discover network.
Interest-only Strip Receivables - Represent our contractual right to receive
interest and other cash flows from our securitization trusts after the investors
receive their contractual return.
Interest Rate Swap - Contract between two parties to exchange interest payments
on a stated principal amount (notional principal) for a specified period.
Typically, one party makes fixed rate payments, while the other party makes
payments using a variable rate.
LIBOR - London Interbank Offered Rate. A widely quoted market rate which is
frequently the index used to determine the rate at which we borrow funds.
Liquidity - A measure of how quickly we can convert assets to cash or raise
additional cash by issuing debt.
Managed Receivables - The sum of receivables on our balance sheet and those that
we service for investors as part of our asset securitization program.
MasterCard, Visa, American Express and Discover Receivables - Receivables
generated through customer usage of MasterCard , Visa, American Express and
Discover credit cards.
Near-prime receivables - A portion of our non-prime receivable portfolio which
is comprised of customers with somewhat stronger credit scores than our other
customers that are priced at rates generally below the rates offered on our
non-prime products.
Net Interest Income - Interest income from receivables and noninsurance
investment securities reduced by interest expense.
Net Interest Margin - Net interest income as a percentage of average
interest-earning assets.
Nonaccrual Loans - Loans on which we no longer accrue interest because ultimate
collection is unlikely.
Non-prime receivables - Receivables which have been priced above the standard
interest rates charged to prime customers due to a higher than average risk for
default as a result of the customer's credit history and the value of
collateral, if applicable.
Options - A contract giving the owner the right, but not the obligation, to buy
or sell a specified item at a fixed price for a specified period.
Owned Receivables - Receivables held on our balance sheet.
Personal Homeowner Loan ("PHL") - A high loan-to-value real estate loan that has
been underwritten and priced as an unsecured loan. These loans are reported as
personal non-credit card receivables.
Personal Non-Credit Card Receivables - Unsecured lines of credit or closed-end
loans made to individuals.
Portfolio Seasoning - Relates to the aging of origination vintages. Loss
patterns emerge slowly over time as new accounts are booked.
Private Label Credit Card - A line of credit made available to customers of
retail merchants evidenced by a credit card bearing the merchant's name.
Real Estate Secured Loan - Closed-end loans and revolving lines of credit
secured by first or subordinate liens on residential real estate.
Receivables Serviced with Limited Recourse - Receivables we have securitized in
transactions structured as sales and for which we have some level of potential
loss if defaults occur.
Return on Average Common Shareholder's(s') Equity - Net income less dividends on
preferred stock divided by average common shareholder's(s') equity.
Return on Average Assets - Net income divided by average owned assets.
Secured Financing - The process where interests in a dedicated pool of financial
assets are sold to investors. Generally, the receivables are transferred through
a limited purpose financing subsidiary to a trust that issues
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interests that are sold to investors. These transactions do not receive sale
treatment under SFAS No. 140. The receivables and related debt remain on our
balance sheet.
Securitization - The process where interests in a dedicated pool of financial
assets, typically credit card, auto or personal non-credit card receivables, are
sold to investors. Generally, the receivables are sold to a trust that issues
interests that are sold to investors. These transactions are structured to
receive sale treatment under SFAS No. 140. The receivables are then removed from
our balance sheet.
Securitization Related Revenue - Includes income associated with current and
prior period securitizations structured as sales of receivables with limited
recourse. Such income includes gains on sales, net of our estimate of probable
credit losses under the recourse provisions, servicing income and excess spread
relating to those receivables.
Stated Income (low documentation) - Loans for which reduced documentation of
income is accepted during the underwriting process.
Tangible Common Equity - Common shareholder's(s') equity (excluding unrealized
gains and losses on investments and cash flow hedging instruments and any
minimum pension liability) less acquired intangibles and goodwill.
Tangible Shareholder's(s') Equity - Tangible common equity, preferred stock, and
company obligated mandatorily redeemable preferred securities of subsidiary
trusts (including amounts due to affiliates) adjusted for HSBC acquisition
purchase accounting adjustments.
Tangible Managed Assets - Total managed assets less acquired intangibles,
goodwill and derivative financial assets.
Taxpayer Financial Services ("TFS") Revenue - Our taxpayer financial services
business provides consumer tax refund lending in the United States. This income
primarily consists of fees received from the consumer for origination of a short
term loan which will be repaid from their Federal income tax return refund.
Whole Loan Sales - Sales of loans to third parties without recourse. Typically,
these sales are made pursuant to our liquidity or capital management plans.
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CREDIT QUALITY STATISTICS
2006 2005 2004 2003 2002
--------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
OWNED TWO-MONTH-AND-OVER CONTRACTUAL DELINQUENCY RATIOS
Real estate secured(1)...................................... 3.54% 2.72% 2.96% 4.33% 3.91%
Auto finance................................................ 3.18 3.04 3.03 3.39 5.44
Credit card(2).............................................. 4.57 3.66 4.88 5.76 5.97
Private label............................................... 5.31 5.43 4.13 5.42 6.36
Personal non-credit card.................................... 10.17 9.40 8.69 10.01 8.95
------ ------ ------ ------ ------
Total consumer(2)........................................... 4.59% 3.89% 4.13% 5.40% 5.37%
====== ====== ====== ====== ======
RATIO OF OWNED NET CHARGE-OFFS TO AVERAGE OWNED RECEIVABLES
FOR THE YEAR
Real estate secured(3)...................................... 1.00% .76% 1.10% .99% .91%
Auto finance................................................ 3.67 3.27 3.43 4.91 6.00
Credit card(4).............................................. 5.56 7.12 8.85 9.18 9.46
Private label(4)............................................ 5.80 4.83 6.17 5.75 6.28
Personal non-credit card.................................... 7.89 7.88 9.75 9.89 8.26
------ ------ ------ ------ ------
Total consumer(4)........................................... 2.97 3.03 4.00 4.06 3.81
Commercial.................................................. .43 2.60 - .46 (.40)
------ ------ ------ ------ ------
Total....................................................... 2.97% 3.03% 3.98% 4.05% 3.79%
====== ====== ====== ====== ======
REAL ESTATE CHARGE-OFFS AND REO EXPENSE AS A PERCENT OF
AVERAGE REAL ESTATE SECURED RECEIVABLES................... 1.19% .87% 1.38% 1.42% 1.29%
------ ------ ------ ------ ------
NONACCRUAL OWNED RECEIVABLES
Domestic:
Real estate secured(5).................................... $2,461 $1,601 $1,489 $1,777 $1,367
Auto finance.............................................. 389 320 227 140 110
Private label............................................. 31 31 24 43 38
Personal non-credit card.................................. 1,444 1,190 908 898 902
Foreign..................................................... 482 463 432 316 264
------ ------ ------ ------ ------
Total consumer.............................................. 4,807 3,605 3,080 3,174 2,681
Commercial and other........................................ - 3 4 6 15
------ ------ ------ ------ ------
Total....................................................... $4,807 $3,608 $3,084 $3,180 $2,696
====== ====== ====== ====== ======
ACCRUING CONSUMER OWNED RECEIVABLES 90 OR MORE DAYS
DELINQUENT
Domestic:
Credit card............................................... $ 894 $ 585 $ 469 $ 429 $ 343
Private label............................................. - - - 443 491
Foreign..................................................... 35 38 38 32 27
------ ------ ------ ------ ------
Total....................................................... $ 929 $ 623 $ 507 $ 904 $ 861
====== ====== ====== ====== ======
REAL ESTATE OWNED
Domestic.................................................... $ 785 $ 506 $ 583 $ 627 $ 424
Foreign..................................................... 9 4 4 4 3
------ ------ ------ ------ ------
Total....................................................... $ 794 $ 510 $ 587 $ 631 $ 427
====== ====== ====== ====== ======
RENEGOTIATED COMMERCIAL LOANS............................... $ 1 $ - $ 2 $ 2 $ 1
====== ====== ====== ====== ======
---------------
(1) Real estate secured two-months-and-over contractual delinquency (as a
percent of consumer receivables) are comprised of the following:
2006 2005 2004 2003 2002
----------------------------------------------------------------------------------------------
Mortgage Services:
First lien.................................................. 4.50% 3.21% 3.26% 5.49% 5.23%
Second lien................................................. 5.74 1.94 2.47 4.90 4.23
---- ---- ---- ---- ----
Total Mortgage Services..................................... 4.75 2.98 3.16 5.40 5.02
Consumer Lending:
First lien.................................................. 2.07 2.14 2.69 3.40 3.11
Second lien................................................. 3.06 3.03 3.02 5.07 3.62
---- ---- ---- ---- ----
Total Consumer Lending...................................... 2.21 2.26 2.73 3.59 3.18
Foreign and all other:
First lien.................................................. 1.58 2.11 1.95 3.14 3.29
Second lien................................................. 5.38 5.71 3.94 4.03 5.23
---- ---- ---- ---- ----
Total Foreign and all other................................. 4.59 5.09 3.66 3.91 4.96
---- ---- ---- ---- ----
Total real estate secured................................... 3.54% 2.72% 2.96% 4.33% 3.91%
==== ==== ==== ==== ====
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HSBC FINANCE CORPORATION AND SUBSIDIARIES
(2) In December 2005, we completed the acquisition of Metris which included
receivables of $5.3 billion. This event had a significant impact on this
ratio. Excluding the receivables from the Metris acquisition from this
calculation, our consumer delinquency ratio for our credit card portfolio
was 4.01% and total consumer delinquency was 3.89%.
(3) Real estate secured net charge-off of consumer receivables as a percent of
average consumer receivables are comprised of the following:
2006 2005 2004 2003 2002
----------------------------------------------------------------------------------------------
Mortgage Services:
First lien.................................................. .77% .68% .81% .54% .69%
Second lien................................................. 2.38 1.11 2.64 2.89 2.59
---- ---- ---- ---- ----
Total Mortgage Services..................................... 1.12 .75 1.05 .94 1.08
Consumer Lending:
First lien.................................................. .85 .74 1.03 .89 .66
Second lien................................................. 1.12 1.21 2.77 2.44 1.78
---- ---- ---- ---- ----
Total Consumer Lending...................................... .89 .80 1.21 1.07 .82
Foreign and all other:
First lien.................................................. .54 1.04 .89 1.19 .96
Second lien................................................. .94 .37 .24 .38 .45
---- ---- ---- ---- ----
Total Foreign and all other................................. .86 .47 .33 .50 .52
---- ---- ---- ---- ----
Total real estate secured................................... 1.00% .76% 1.10% .99% .91%
==== ==== ==== ==== ====
(4) The adoption of FFIEC charge-off policies for our domestic private label
(excluding retail sales contracts at our consumer lending business) and
credit card portfolios in December 2004 increased private label net
charge-offs by $155 million (119 basis points) and credit card net
charge-offs by $3 million (2 basis points) and total consumer net
charge-offs by $158 million (16 basis points) for the year ended December
31, 2004.
(5) Domestic real estate nonaccrual receivables are comprised of the following:
2006 2005 2004 2003 2002
--------------------------------------------------------------------------------------------------------
Real estate secured:
Closed-end:
First lien................................................. $1,884 $1,359 $1,287 $1,437 $1,111
Second lien................................................ 369 148 105 121 149
Revolving:
First lien................................................. 22 31 40 92 44
Second lien................................................ 186 63 57 127 63
------ ------ ------ ------ ------
Total real estate secured.................................. $2,461 $1,601 $1,489 $1,777 $1,367
====== ====== ====== ====== ======
102
HSBC FINANCE CORPORATION AND SUBSIDIARIES
ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY
2006 2005 2004 2003 2002
------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
TOTAL CREDIT LOSS RESERVES AT JANUARY 1..................... $4,521 $3,625 $3,793 $3,333 $2,663
------ ------ ------ ------ ------
PROVISION FOR CREDIT LOSSES................................. 6,564 4,543 4,334 3,967 3,732
------ ------ ------ ------ ------
CHARGE-OFFS
Domestic:
Real estate secured(1)..................................... (931) (569) (629) (496) (430)
Auto finance............................................... (468) (311) (204) (148) (159)
Credit card(2)............................................. (1,665) (1,339) (1,082) (936) (736)
Private label(2)........................................... (43) (33) (788) (684) (650)
Personal non-credit card................................... (1,455) (1,333) (1,350) (1,354) (1,193)
Foreign..................................................... (600) (509) (355) (257) (223)
------ ------ ------ ------ ------
Total consumer.............................................. (5,162) (4,094) (4,408) (3,875) (3,391)
Commercial and other........................................ (2) (6) (1) (3) (2)
------ ------ ------ ------ ------
Total receivables charged off............................... (5,164) (4,100) (4,409) (3,878) (3,393)
------ ------ ------ ------ ------
RECOVERIES
Domestic:
Real estate secured(3)..................................... 33 27 18 10 7
Auto finance............................................... 50 18 6 5 7
Credit card................................................ 274 157 103 87 59
Private label.............................................. 13 6 79 72 48
Personal non-credit card................................... 216 171 120 82 92
Foreign..................................................... 59 68 50 34 49
------ ------ ------ ------ ------
Total consumer.............................................. 645 447 376 290 262
Commercial and other........................................ - - - 1 2
------ ------ ------ ------ ------
Total recoveries on receivables............................. 645 447 376 291 264
OTHER, NET.................................................. 21 6 (469) 80 67
------ ------ ------ ------ ------
CREDIT LOSS RESERVES
Domestic:
Real estate secured........................................ 2,365 718 645 670 551
Auto finance............................................... 241 222 181 172 126
Credit card................................................ 1,864 1,576 1,205 806 649
Private label.............................................. 38 36 28 519 527
Personal non-credit card................................... 1,732 1,652 1,237 1,348 1,275
Foreign..................................................... 346 312 316 247 172
------ ------ ------ ------ ------
Total consumer.............................................. 6,586 4,516 3,612 3,762 3,300
Commercial and other........................................ 1 5 13 31 33
------ ------ ------ ------ ------
TOTAL CREDIT LOSS RESERVES AT DECEMBER 31................... $6,587 $4,521 $3,625 $3,793 $3,333
====== ====== ====== ====== ======
RATIO OF CREDIT LOSS RESERVES TO:
Net charge-offs............................................. 145.8% 123.8%(4) 89.9%(5) 105.7% 106.5%
Receivables:
Consumer................................................... 4.07 3.23 3.39 4.09 4.02
Commercial................................................. .60 2.67 8.90 6.80 6.64
------ ------ ------ ------ ------
Total...................................................... 4.07% 3.23% 3.39% 4.11% 4.04%
====== ====== ====== ====== ======
Nonperforming loans:
Consumer................................................... 114.8% 106.8% 100.7% 92.2% 93.1%
Commercial................................................. 100.0 166.7 260.0 620.0 275.0
------ ------ ------ ------ ------
Total...................................................... 114.8% 106.9% 100.9% 92.8% 93.7%
====== ====== ====== ====== ======
---------------
(1) Domestic real estate secured charge-offs can be further analyzed as follows:
2006 2005 2004 2003 2002
---------------------------------------------------------------------------------------------------
Closed end:
First lien................................................. $(582) $(421) $(418) $(279) $(242)
Second lien................................................ (256) (105) (151) (152) (109)
Revolving:
First lien................................................. (17) (22) (34) (35) (17)
Second lien................................................ (76) (21) (26) (30) (62)
----- ----- ----- ----- -----
Total....................................................... $(931) $(569) $(629) $(496) $(430)
===== ===== ===== ===== =====
(2) Includes $3 million of credit card and $155 million of private label
charge-off relating to the adoption of FFIEC charge-off policies in December
2004.
(3) Domestic recoveries can be further analyzed as follows:
2006 2005 2004 2003 2002
----------------------------------------------------------------------------------------------
Closed end:
First lien................................................. $11 $11 $ 5 $ 3 $1
Second lien................................................ 15 10 8 5 4
Revolving:
First lien................................................. 2 2 2 - 1
Second lien................................................ 5 4 3 2 1
--- --- --- --- --
Total....................................................... $33 $27 $18 $10 $7
=== === === === ==
(4) The acquisition of Metris in December 2005 has positively impacted this
ratio. Reserves as a percentage of net charge-offs excluding Metris was
118.2 percent.
(5) In December 2004 we adopted FFIEC charge-off policies for our domestic
private label (excluding retail sales contracts at our consumer lending
business) and credit card portfolios and subsequently sold this domestic
private label receivable portfolio. These events had a significant impact on
this ratio. Reserves as a percentage of net charge-offs excluding net
charge-offs associated with the sold domestic private label portfolio and
charge-off relating to the adoption of FFIEC was 109.2% at December 31,
2004.
103
HSBC FINANCE CORPORATION AND SUBSIDIARIES
NET INTEREST MARGIN - 2006 COMPARED TO 2005
FINANCE AND
AVERAGE INTEREST INCOME/ INCREASE/ (DECREASE) DUE TO:
OUTSTANDING(1) AVERAGE RATE INTEREST EXPENSE ------------------------------------
------------------- ------------- ----------------- VOLUME RATE
2006 2005 2006 2005 2006 2005 VARIANCE VARIANCE(2) VARIANCE(2)
-------------------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Receivables:
Real estate
secured.......... $ 92,318 $73,097 8.6% 8.4% $ 7,912 $ 6,155 $1,757 $1,646 $ 111
Auto finance....... 11,660 9,074 12.0 11.8 1,405 1,067 338 311 27
Credit card........ 25,065 17,823 16.3 13.9 4,086 2,479 1,607 1,129 478
Private label...... 2,492 2,948 9.6 9.4 239 278 (39) (44) 5
Personal non-credit
card............. 20,611 17,558 19.0 18.4 3,926 3,226 700 578 122
Commercial and
other............ 195 255 2.1 2.4 4 6 (2) (1) (1)
Purchase accounting
adjustments...... - 134 - - (124) (139) 15 15 -
-------- -------- ---- ---- ------- ------- ------ ------ ------
Total receivables.... 152,341 120,889 11.5 10.8 17,448 13,072 4,376 3,565 811
Noninsurance
investments........ 2,958 3,694 3.9 3.9 114 144 (30) (28) (2)
-------- -------- ---- ---- ------- ------- ------ ------ ------
Total
interest-earning
assets (excluding
insurance
investments)....... $155,299 $124,583 11.3% 10.6% $17,562 $13,216 $4,346 $3,437 $ 909
Insurance
investments........ 3,105 3,159
Other assets......... 11,609 12,058
-------- --------
TOTAL ASSETS......... $170,013 $139,800
======== ========
Debt:
Commercial paper... $ 12,344 $11,877 5.0% 3.4% $ 612 $ 399 $ 213 $ 16 $ 197
Bank and other
borrowings....... 494 111 3.3(6) 2.5(6) 16 3 13 12 1
Due to
affiliates....... 15,459 16,654 6.0 4.3 929 713 216 (54) 270
Long term debt
(with original
maturities over
one year)........ 115,900 86,207 5.0 4.3 5,817 3,717 2,100 1,430 670
-------- -------- ---- ---- ------- ------- ------ ------ ------
Total debt........... $144,197 $114,849 5.1% 4.2% $ 7,374 $ 4,832 $2,542 $1,379 $1,163
Other liabilities.... 5,362 6,649
-------- --------
Total liabilities.... 149,559 121,498
Preferred
securities......... 575 1,366
Common
shareholder's(s')
equity............. 19,879 16,936
-------- --------
TOTAL LIABILITIES AND
SHAREHOLDER'S(S')
EQUITY............. $170,013 $139,800
======== ========
NET INTEREST
MARGIN(3)(5)....... 6.6% 6.7% $10,188 $ 8,384 $1,804 $2,058 $ (254)
==== ==== ======= ======= ====== ====== ======
INTEREST
SPREADS(4)......... 6.2% 6.4%
==== ====
---------------
(1) Nonaccrual loans are included in average outstanding balances.
(2) Rate/volume variance is allocated based on the percentage relationship of
changes in volume and changes in rate to the total interest variance. For
total receivables, total interest-earning assets and total debt, the rate
and volume variances are calculated based on the relative weighting of the
individual components comprising these totals. These totals do not represent
an arithmetic sum of the individual components.
(3) Represents net interest income as a percent of average interest-earning
assets
(4) Represents the difference between the yield earned on interest-earning
assets and the cost of the debt used to fund the assets
(5) The net interest margin analysis includes the following for foreign
businesses:
2006 2005
-------------------------------------------------------------------------------
Average interest-earning assets............................. $ 9,657 $12,098
Average interest-bearing liabilities........................ 8,150 10,231
Net interest income......................................... 691 754
Net interest margin......................................... 7.2% 6.2%
(6) Average rate does not recompute from the dollar figures presented due to
rounding.
104
HSBC FINANCE CORPORATION AND SUBSIDIARIES
NET INTEREST MARGIN - 2005 COMPARED TO 2004
FINANCE AND INTEREST
AVERAGE AVERAGE INCOME/INTEREST INCREASE/(DECREASE) DUE TO:
OUTSTANDING(1) RATE EXPENSE ------------------------------------
------------------- ----------- --------------------- VOLUME RATE
2005 2004 2005 2004 2005 2004 VARIANCE VARIANCE(2) VARIANCE(2)
--------------------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Receivables:
Real estate secured... $ 73,097 $ 56,303 8.4% 8.8% $ 6,155 $ 4,974 $1,181 $1,424 $ (243)
Auto finance.......... 9,074 5,785 11.8 12.2 1,067 706 361 388 (27)
Credit card........... 17,823 11,575 13.9 13.6 2,479 1,572 907 868 39
Private label......... 2,948 13,029 9.4 10.8 278 1,407 (1,129) (970) (159)
Personal non-credit
card................ 17,558 14,194 18.4 16.7 3,226 2,374 852 602 250
Commercial and
other............... 255 354 2.4 2.5 6 9 (3) (2) (1)
HSBC acquisition
purchase accounting
adjustments......... 134 319 - - (139) (201) 62 62 -
-------- -------- ---- ---- ------- ------- ------ ------ -------
Total receivables....... 120,889 101,559 10.8 10.7 13,072 10,841 2,231 2,089 142
Noninsurance
investments........... 3,694 4,853 3.9 2.1 144 104 40 (29) 69
-------- -------- ---- ---- ------- ------- ------ ------ -------
Total interest-earning
assets (excluding
insurance
investments).......... $124,583 $106,412 10.6% 10.3% $13,216 $10,945 $2,271 $1,940 $ 331
Insurance investments... 3,159 3,165
Other assets............ 12,058 14,344
-------- --------
TOTAL ASSETS............ $139,800 $123,921
======== ========
Debt:
Commercial paper...... $ 11,877 $ 11,403 3.4% 1.8% $ 399 $ 210 $ 189 $ 9 $ 180
Bank and other
borrowings.......... 111 126 2.5(6) 1.9(6) 3 3 - - -
Due to affiliates..... 16,654 8,752 4.3 3.9 713 343 370 336 34
Long term debt (with
original maturities
over one year)...... 86,207 79,834 4.3 3.3 3,717 2,587 1,130 222 908
-------- -------- ---- ---- ------- ------- ------ ------ -------
Total debt.............. $114,849 $100,115 4.2% 3.1% $ 4,832 $ 3,143 $1,689 $ 495 $ 1,194
Other liabilities....... 6,649 5,703
-------- --------
Total liabilities....... 121,498 105,818
Preferred securities.... 1,366 1,100
Common shareholder's(s')
equity................ 16,936 17,003
-------- --------
TOTAL LIABILITIES AND
SHAREHOLDER'S(S')
EQUITY................ $139,800 $123,921
======== ========
NET INTEREST
MARGIN(3)(5).......... 6.7% 7.3% $ 8,384 $ 7,802 $ 582 $1,445 $ (863)
==== ==== ======= ======= ====== ====== =======
INTEREST SPREAD - OWNED
BASIS(4).............. 6.4% 7.2%
==== ====
---------------
(1) Nonaccrual loans are included in average outstanding balances.
(2) Rate/volume variance is allocated based on the percentage relationship of
changes in volume and changes in rate to the total interest variance. For
total receivables, total interest-earning assets and total debt, the rate
and volume variances are calculated based on the relative weighting of the
individual components comprising these totals. These totals do not represent
an arithmetic sum of the individual components.
(3) Represents net interest income as a percent of average interest-earning
assets
(4) Represents the difference between the yield earned on interest-earning
assets and the cost of the debt used to fund the assets
(5) The net interest margin analysis includes the following for foreign
businesses:
2005 2004
-------------------------------------------------------------------------------
Average interest-earning assets............................. $12,098 $10,728
Average interest-bearing liabilities........................ 10,231 9,127
Net interest income......................................... 754 712
Net interest margin......................................... 6.2% 6.8%
(6) Average rate does not recompute from the dollar figures presented due to
rounding.
105
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO U.S. GAAP FINANCIAL MEASURES
Our consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States ("U.S. GAAP"). In addition to
the U.S. GAAP financial results reported in our consolidated financial
statements, MD&A includes reference to the following information which is
presented on a non-U.S. GAAP basis:
OPERATING RESULTS, PERCENTAGES AND RATIOS Certain percentages and ratios have
been presented on an operating basis and have been calculated using "operating
net income", a non-U.S. GAAP financial measure. "Operating net income" is net
income excluding certain nonrecurring items. These nonrecurring items are also
excluded in calculating our operating basis efficiency ratios. We believe that
excluding these items helps readers of our financial statements to understand
better the results and trends of our underlying business.
IFRS MANAGEMENT BASIS A non-U.S. GAAP measure of reporting results in accordance
with IFRSs and assumes the private label and real estate secured receivables
transferred to HSBC Bank USA have not been sold and remain on our balance sheet.
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-U.S. GAAP financial measures that are used by
HSBC Finance Corporation management or applicable rating agencies to evaluate
capital adequacy. Managed assets assume that securitized receivables have not
been sold and are still on our balance sheet. These ratios may differ from
similarly named measures presented by other companies. The most directly
comparable U.S. GAAP financial measure is common and preferred equity to owned
assets.
We and certain rating agencies also monitor our equity ratios excluding the
impact of HSBC acquisition purchase accounting adjustments. We do so because we
believe that the HSBC acquisition purchase accounting adjustments represent
non-cash transactions which do not affect our business operations, cash flows or
ability to meet our debt obligations.
Preferred securities issued by certain non-consolidated trusts are considered
equity in the TETMA and TETMA + Owned Reserves calculations because of their
long-term subordinated nature and the ability to defer dividends. Previously,
our Adjustable Conversion-Rate Equity Security Units, adjusted for HSBC
acquisition purchase accounting adjustments, were also considered equity in
these calculations. Beginning in the third quarter of 2005, and with the
agreement of applicable rating agencies, we have refined our definition of TETMA
and TETMA + Owned Reserves to exclude the Adjustable Conversion-Rate Equity
Security Units as this more accurately reflects the impact of these items on our
equity. Prior period amounts have been revised to reflect the current period
presentation.
QUANTITATIVE RECONCILIATIONS OF NON-U.S. GAAP FINANCIAL MEASURES TO U.S. GAAP
FINANCIAL MEASURES For a reconciliation of IFRS Management Basis results to the
comparable owned basis amounts, see Note 21, "Business Segments," to the
accompanying consolidated financial statements. Reconciliations of selected
owned basis and operating basis financial ratios and our equity ratios follow.
106
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO U.S. GAAP FINANCIAL MEASURES
SELECTED FINANCIAL DATA AND STATISTICS
2006 2005 2004 2003 2002
------------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
RETURN ON AVERAGE COMMON SHAREHOLDER'S(S') EQUITY:
Net income.................................................. $ 1,443 $ 1,772 $ 1,940 $ 1,603 $ 1,558
Dividends on preferred stock.............................. (37) (83) (72) (76) (63)
-------- -------- -------- -------- --------
Net income available to common shareholders................. $ 1,406 $ 1,689 $ 1,868 $ 1,527 $ 1,495
Gain on sale of investment in Kanbay........................ (78) - - - -
Gain on bulk sale of private label receivables.............. - - (423) - -
Adoption of FFIEC charge-off policies for domestic private
label (excluding retail sales contracts) and credit card
portfolios................................................ - - 121 - -
HSBC acquisition related costs and other merger related
items incurred by HSBC Finance Corporation................ - - - 167 -
Settlement charge and related expenses...................... - - - - 333
Loss on the disposition of Thrift assets and deposits....... - - - - 240
-------- -------- -------- -------- --------
Operating net income available to common shareholders....... $ 1,328 $ 1,689 $ 1,566 $ 1,694 $ 2,068
-------- -------- -------- -------- --------
Average common shareholder's(s') equity..................... $ 19,879 $ 16,936 $ 17,003 $ 14,022 $ 8,640
-------- -------- -------- -------- --------
Return on average common shareholder's(s') equity........... 7.07% 9.97% 10.99% 10.89% 17.30%
Return on average common shareholder's(s') equity,
operating basis............................................. 6.68 9.97 9.21 12.08 23.94
======== ======== ======== ======== ========
RETURN ON AVERAGE ASSETS:
Net income.................................................. $ 1,443 $ 1,772 $ 1,940 $ 1,603 $ 1,558
Operating net income........................................ 1,365 1,772 1,638 1,770 2,131
-------- -------- -------- -------- --------
Average owned assets........................................ $170,013 $139,800 $123,921 $110,097 $ 96,304
-------- -------- -------- -------- --------
Return on average assets.................................... .85% 1.27% 1.57% 1.46% 1.62%
Return on average assets, operating basis................... .80 1.27 1.32 1.61 2.21
======== ======== ======== ======== ========
EFFICIENCY RATIO:
Total costs and expenses less policyholders' benefits....... $ 6,293 $ 5,685 $ 5,279 $ 4,853 $ 4,473
HSBC acquisition related costs and other merger related
items incurred by HSBC Finance Corporation.............. - - - (198) -
Settlement charge and related expenses.................... - - - - (525)
-------- -------- -------- -------- --------
Total costs and expenses less policyholders' benefits,
excluding nonrecurring items............................ $ 6,293 $ 5,685 $ 5,279 $ 4,655 $ 3,948
-------- -------- -------- -------- --------
Net interest income and other revenues less policyholders'
benefits.................................................. $ 15,144 $ 12,891 $ 12,553 $ 11,295 $ 10,458
Nonrecurring items:
Gain on sale of investment in Kanbay.................... (123) - - - -
Gain on bulk sale of private label receivables.......... - - (663) - -
Adoption of FFIEC charge-off policies for domestic
private label (excluding retail sales contracts) and
credit card portfolios................................ - - 151 - -
Loss on the disposition of Thrift assets and deposits... - - - - 378
Net interest income and other revenues less policyholders'
benefits, excluding nonrecurring items.................. $ 15,021 $ 12,891 $ 12,041 $ 11,295 $ 10,836
Efficiency ratio............................................ 41.55% 44.10% 42.05% 42.97% 42.77%
Efficiency ratio, operating basis........................... 41.89 44.10 43.84 41.21 36.43
======== ======== ======== ======== ========
107
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO U.S. GAAP FINANCIAL MEASURES
EQUITY RATIOS
2006 2005 2004 2003 2002
------------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
TANGIBLE COMMON EQUITY:
Common shareholder's(s') equity............................. $ 19,515 $ 18,904 $ 15,841 $ 16,391 $ 9,222
Exclude:
Unrealized (gains) losses on cash flow hedging
instruments............................................. 61 (260) (119) 10 737
Minimum pension liability................................. 1 - 4 - 30
Unrealized gains on investments and interest-only strip
receivables............................................. 23 3 (53) (167) (319)
Intangibles assets........................................ (2,218) (2,480) (2,705) (2,856) (386)
Goodwill.................................................. (7,010) (7,003) (6,856) (6,697) (1,122)
-------- -------- -------- -------- --------
Tangible common equity...................................... 10,372 9,164 6,112 6,681 8,162
Purchase accounting adjustments............................. 1,105 1,441 2,227 2,548 -
-------- -------- -------- -------- --------
Tangible common equity, excluding HSBC acquisition purchase
accounting adjustments.................................... $ 11,477 $ 10,605 $ 8,339 $ 9,229 $ 8,162
======== ======== ======== ======== ========
TANGIBLE SHAREHOLDER'S(S') EQUITY:
Tangible common equity...................................... $ 10,372 $ 9,164 $ 6,112 $ 6,681 $ 8,162
Preferred stock............................................. 575 575 1,100 1,100 1,193
Mandatorily redeemable preferred securities of Household
Capital Trusts............................................ 1,275 1,679 994 1,031 975
Adjustable Conversion-Rate Equity Security Units............ - - - - 511
-------- -------- -------- -------- --------
Tangible shareholder's(s') equity........................... 12,222 11,418 8,206 8,812 10,841
HSBC acquisition purchase accounting adjustments............ 1,105 1,438 2,208 2,492 -
-------- -------- -------- -------- --------
Tangible shareholder's(s') equity, excluding purchase
accounting adjustments.................................... $ 13,327 $ 12,856 $ 10,414 $ 11,304 $ 10,841
======== ======== ======== ======== ========
TANGIBLE SHAREHOLDER'S(S') EQUITY PLUS OWNED LOSS RESERVES:
Tangible shareholder's(s') equity........................... $ 12,222 $ 11,418 $ 8,206 $ 8,812 $ 10,841
Owned loss reserves......................................... 6,587 4,521 3,625 3,793 3,333
-------- -------- -------- -------- --------
Tangible shareholder's(s') equity plus owned loss
reserves.................................................. 18,809 15,939 11,831 12,605 14,174
HSBC acquisition purchase accounting adjustments............ 1,105 1,438 2,208 2,492 -
-------- -------- -------- -------- --------
Tangible shareholder's(s') equity plus owned loss reserves,
excluding purchase accounting adjustments................. $ 19,914 $ 17,377 $ 14,039 $ 15,097 $ 14,174
======== ======== ======== ======== ========
TANGIBLE MANAGED ASSETS:
Owned assets................................................ $179,459 $156,669 $130,190 $119,052 $ 97,860
Receivables serviced with limited recourse.................. 949 4,074 14,225 26,201 24,934
-------- -------- -------- -------- --------
Managed assets.............................................. 180,408 160,743 144,415 145,253 122,794
Exclude:
Intangible assets......................................... (2,218) (2,480) (2,705) (2,856) (386)
Goodwill.................................................. (7,010) (7,003) (6,856) (6,697) (1,122)
Derivative financial assets............................... (1,461) (234) (4,049) (3,016) (1,864)
-------- -------- -------- -------- --------
Tangible managed assets..................................... 169,719 151,026 130,805 132,684 119,422
HSBC acquisition purchase accounting adjustments............ 64 (52) (202) (431) -
-------- -------- -------- -------- --------
Tangible managed assets, excluding purchase accounting
adjustments............................................... $169,783 $150,974 $130,603 $132,253 $119,422
======== ======== ======== ======== ========
EQUITY RATIOS:
Common and preferred equity to owned assets................. 11.19% 12.43% 13.01% 14.69% 10.64%
Tangible common equity to tangible managed assets........... 6.11 6.07 4.67 5.04 6.83
Tangible shareholder's(s') equity to tangible managed
assets.................................................... 7.20 7.56 6.27 6.64 9.08
Tangible shareholder's(s') equity plus owned loss reserves
to tangible managed assets................................ 11.08 10.55 9.04 9.50 11.87
Excluding HSBC acquisition purchase accounting adjustments:
Tangible common equity to tangible managed assets......... 6.76 7.02 6.38 6.98 6.83
Tangible shareholder's(s') equity to tangible managed
assets.................................................. 7.85 8.52 7.97 8.55 9.08
Tangible shareholder's(s') equity plus owned loss reserves
to tangible managed assets.............................. 11.73 11.51 10.75 11.42 11.87
======== ======== ======== ======== ========
108
HSBC Finance Corporation
--------------------------------------------------------------------------------
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
--------------------------------------------------------------------------------
Information required by this Item is included in sections of Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations on the following pages: "Liquidity and Capital Resources", pages
79-88, "Off Balance Sheet Arrangements and Secured Financings", pages 88-91 and
"Risk Management", pages 91-97.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
--------------------------------------------------------------------------------
Our 2006 Financial Statements meet the requirements of Regulation S-X. The 2006
Financial Statements and supplementary financial information specified by Item
302 of Regulation S-K are set forth below.
109
HSBC Finance Corporation
--------------------------------------------------------------------------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholder
HSBC Finance Corporation:
We have audited the accompanying consolidated balance sheets of HSBC Finance
Corporation (a Delaware corporation), an indirect wholly-owned subsidiary of
HSBC Holdings plc, and subsidiaries as of December 31, 2006 and 2005 and the
related consolidated statements of income, changes in shareholder's equity, and
cash flows for each of the years in the three-year period ended December 31,
2006. These consolidated financial statements are the responsibility of HSBC
Finance Corporation's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of HSBC Finance Corporation's
internal control over financial reporting. Accordingly, we express no such
opinion. An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the aforementioned consolidated financial statements present
fairly, in all material respects, the financial position of HSBC Finance
Corporation and subsidiaries as of December 31, 2006 and 2005, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2006, in conformity with U.S. generally accepted
accounting principles.
/s/ KPMG LLP
Chicago, Illinois
March 2, 2007
110
HSBC Finance Corporation
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF INCOME
YEAR ENDED DECEMBER 31, 2006 2005 2004
----------------------------------------------------------------------------------------------------
(IN MILLIONS)
Finance and other interest income....................... $17,562 $13,216 $10,945
Interest expense:
HSBC affiliates....................................... 929 713 343
Non-affiliates........................................ 6,445 4,119 2,800
------- ------- -------
NET INTEREST INCOME..................................... 10,188 8,384 7,802
Provision for credit losses............................. 6,564 4,543 4,334
------- ------- -------
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES... 3,624 3,841 3,468
------- ------- -------
Other revenues:
Securitization revenue................................ 167 211 1,008
Insurance revenue..................................... 1,001 997 882
Investment income..................................... 274 134 137
Derivative income..................................... 190 249 511
Fee income............................................ 1,911 1,568 1,091
Enhancement services revenue.......................... 515 338 251
Taxpayer financial services revenue................... 258 277 217
Gain on bulk sale of private label receivables........ - - 663
Gain on receivable sales to HSBC affiliates........... 422 413 39
Servicing and other fees from HSBC affiliates......... 506 440 57
Other income.......................................... 179 336 307
------- ------- -------
TOTAL OTHER REVENUES.................................... 5,423 4,963 5,163
------- ------- -------
Costs and expenses:
Salaries and employee benefits........................ 2,333 2,072 1,886
Sales incentives...................................... 358 397 363
Occupancy and equipment expenses...................... 317 334 323
Other marketing expenses.............................. 814 731 636
Other servicing and administrative expenses........... 1,115 917 958
Support services from HSBC affiliates................. 1,087 889 750
Amortization of intangibles........................... 269 345 363
Policyholders' benefits............................... 467 456 412
------- ------- -------
TOTAL COSTS AND EXPENSES................................ 6,760 6,141 5,691
------- ------- -------
Income before income tax expense........................ 2,287 2,663 2,940
Income tax expense...................................... 844 891 1,000
------- ------- -------
NET INCOME.............................................. $ 1,443 $ 1,772 $ 1,940
======= ======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
111
HSBC Finance Corporation
--------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET
YEAR ENDED DECEMBER 31, 2006 2005
---------------------------------------------------------------------------------
(IN MILLIONS,
EXCEPT SHARE DATA)
ASSETS
Cash........................................................ $ 871 $ 903
Interest bearing deposits with banks........................ 424 384
Securities purchased under agreements to resell............. 171 78
Securities.................................................. 4,695 4,051
Receivables, net............................................ 157,262 136,989
Intangible assets, net...................................... 2,218 2,480
Goodwill.................................................... 7,010 7,003
Properties and equipment, net............................... 426 458
Real estate owned........................................... 794 510
Derivative financial assets................................. 1,461 234
Other assets................................................ 4,127 3,579
-------- --------
TOTAL ASSETS................................................ $179,459 $156,669
======== ========
LIABILITIES
Debt:
Commercial paper, bank and other borrowings............... $ 11,055 $ 11,454
Due to affiliates......................................... 15,172 15,534
Long term debt (with original maturities over one year)... 127,590 105,163
-------- --------
Total debt.................................................. 153,817 132,151
-------- --------
Insurance policy and claim reserves......................... 1,319 1,291
Derivative related liabilities.............................. 1,222 383
Liability for pension benefits.............................. 355 341
Other liabilities........................................... 2,656 3,024
-------- --------
TOTAL LIABILITIES........................................... 159,369 137,190
-------- --------
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................................ 17,279 17,145
Retained earnings......................................... 1,877 1,280
Accumulated other comprehensive income.................... 359 479
-------- --------
TOTAL COMMON SHAREHOLDER'S EQUITY........................... 19,515 18,904
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................. $179,459 $156,669
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
112
HSBC Finance Corporation
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDER'S(S') EQUITY
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2006 2005 2004
--------------------------------------------------------------------------------------------------------
(IN MILLIONS)
PREFERRED STOCK
Balance at beginning of period............................ $ 575 $ 1,100 $ 1,100
Issuance of Series B preferred stock...................... - 575 -
Exchange of Series A preferred stock for common stock..... - (1,100) -
------- ------- -------
Balance at end of period.................................. $ 575 $ 575 $ 1,100
======= ======= =======
COMMON SHAREHOLDER'S EQUITY
COMMON STOCK
Balance at beginning of period.......................... $ - $ - $ -
Exchange of common stock for Series A preferred stock... - - -
------- ------- -------
Balance at end of period................................ $ - $ - $ -
------- ------- -------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of period.......................... $17,145 $14,627 $14,645
Premium on sale of European Operations to affiliate..... 13 - -
Premium on sale of U.K. credit card business to
affiliate............................................. - 182 -
Exchange of common stock for Series A preferred stock... - 1,112 -
Capital contribution from parent company................ 163 1,200 -
Return of capital to HSBC............................... (49) (19) (31)
Employee benefit plans, including transfers and other... 7 59 13
Issuance costs of Series B preferred stock.............. - (16) -
------- ------- -------
Balance at end of period................................ $17,279 $17,145 $14,627
------- ------- -------
RETAINED EARNINGS
Balance at beginning of period.......................... $ 1,280 $ 571 $ 1,303
Net income.............................................. 1,443 1,772 1,940
Dividends:
Preferred stock....................................... (37) (83) (72)
Common stock.......................................... (809) (980) (2,600)
------- ------- -------
Balance at end of period................................ $ 1,877 $ 1,280 $ 571
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance at beginning of period.......................... $ 479 $ 643 $ 443
Net change in unrealized gains (losses) on:
Derivatives classified as cash flow hedges.......... (321) 141 130
Securities available for sale and interest-only
strip receivables................................. (21) (56) (114)
Minimum pension liability............................. - 4 (4)
Adjustment to initially apply FASB statement No. 158,
net of tax.......................................... (1) - -
Foreign currency translation adjustment............... 223 (253) 188
------- ------- -------
Other comprehensive income, net of tax.................. (120) (164) 200
Balance at end of period................................ $ 359 $ 479 $ 643
------- ------- -------
TOTAL COMMON SHAREHOLDER'S EQUITY........................... $19,515 $18,904 $15,841
======= ======= =======
COMPREHENSIVE INCOME
Net income.................................................. $ 1,443 $ 1,772 $ 1,940
Other comprehensive (loss) income........................... (120) (164) 200
------- ------- -------
COMPREHENSIVE INCOME........................................ $ 1,323 $ 1,608 $ 2,140
======= ======= =======
PREFERRED STOCK
Balance at beginning of period............................ 575 1,100 1,100
Issuance of Series B preferred stock...................... - 575 -
Exchange of Series A preferred stock to common stock...... - (1,100) -
------- ------- -------
Balance at end of period.................................. 575 575 1,100
======= ======= =======
COMMON STOCK
ISSUED
Balance at beginning of period.......................... 55 50 50
Issuance of common stock to parent...................... - 5 -
------- ------- -------
Balance at end of period................................ 55 55 50
------- ------- -------
The accompanying notes are an integral part of the consolidated financial
statements.
113
HSBC Finance Corporation
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2006 2005 2004
--------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income.................................................. $ 1,443 $ 1,772 $ 1,940
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Provision for credit losses................................ 6,564 4,543 4,334
Gain on bulk sale of private label receivables............. - - (663)
Gain on receivable sales to HSBC affiliates................ (422) (413) (39)
Gain on sale of investment in Kanbay International,
Inc. .................................................... (123) - -
Insurance policy and claim reserves........................ (240) (222) (170)
Depreciation and amortization.............................. 385 457 483
Deferred income tax (benefit) provision.................... (560) (366) 348
Net change in other assets................................. (615) 326 (696)
Net change in other liabilities............................ 155 393 23
Net change in loans held for sale.......................... 78 (672) (376)
Net change in derivative related assets and liabilities.... 937 (524) (497)
Excess tax benefits from share-based compensation
arrangements............................................. (16) - -
Other, net................................................. 728 434 1,394
-------- ------- --------
Net cash provided by (used in) operating activities......... 8,314 5,728 6,081
-------- ------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Securities:
Purchased.................................................. (2,071) (852) (1,363)
Matured.................................................... 1,847 646 1,375
Sold....................................................... 492 429 854
Net change in short-term securities available for sale...... (606) (472) 5,372
Net change in securities purchased under agreements to
resell..................................................... (93) 2,573 (2,651)
Net change in interest bearing deposits with banks.......... (5) 187 466
Receivables:
Originations, net of collections........................... (23,978) (33,511) (18,742)
Purchases and related premiums............................. (3,225) (1,053) (608)
Initial securitizations.................................... - - 740
Net change in interest-only strip receivables.............. (5) 253 466
Cash received in sale of European Operations................ 46 - -
Cash received in sale of U.K. credit card business.......... 90 2,627 -
Net cash paid for acquisition of Metris..................... - (1,572) -
Net cash paid for acquisition of Solstice................... (50) - -
Properties and equipment:
Purchases.................................................. (102) (78) (96)
Sales...................................................... 26 7 4
-------- ------- --------
Net cash provided by (used in) investing activities......... (27,634) (30,816) (14,183)
-------- ------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Debt:
Net change in short-term debt and deposits................. (411) 2,381 (341)
Net change in due to affiliates............................ (846) 2,435 5,716
Long term debt issued...................................... 41,138 40,214 19,916
Long term debt retired..................................... (19,663) (20,967) (14,628)
Issuance of company obligated mandatorily redeemable
preferred securities of subsidiary trusts to HSBC........ -- 1,031 -
Redemption of company obligated mandatorily redeemable
preferred securities of subsidiary trusts................ (412) (309) -
Insurance:
Policyholders' benefits paid............................... (264) (250) (194)
Cash received from policyholders........................... 393 380 265
Capital contribution from parent............................ 163 1,200
Shareholder's(s') dividends................................. (846) (1,063) (2,708)
Issuance of preferred stock................................. - 559 -
Excess tax benefits from share-based compensation
arrangements............................................... 16 - -
-------- ------- --------
Net cash provided by (used in) financing activities......... 19,268 25,611 8,026
-------- ------- --------
Effect of exchange rate changes on cash..................... 20 (12) 5
-------- ------- --------
Net change in cash.......................................... (32) 511 (71)
Cash at beginning of period................................. 903 392 463
-------- ------- --------
CASH AT END OF PERIOD....................................... $ 871 $ 903 $ 392
======== ======= ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid............................................... $ 7,454 $ 5,233 $ 3,468
Income taxes paid........................................... 1,406 1,119 842
-------- ------- --------
SUPPLEMENTAL NONCASH FINANCING AND CAPITAL ACTIVITIES:
Affiliate preferred stock received in sale of U.K. credit
card business.............................................. $ - $ 261 $ -
Exchange of preferred for common stock...................... - 1,112 -
======== ======= ========
The accompanying notes are an integral part of the consolidated financial
statements.
114
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
--------------------------------------------------------------------------------
HSBC Finance Corporation (formerly Household International, Inc.) and its
subsidiaries were acquired by a wholly owned subsidiary of HSBC Holdings plc
("HSBC") on March 28, 2003 in a purchase business combination recorded under the
"push-down" method of accounting, which resulted in a new basis of accounting
for the "successor" period beginning March 29, 2003.
HSBC Finance Corporation and subsidiaries, is an indirect wholly owned
subsidiary of HSBC North America Holdings Inc. ("HSBC North America"), which is
an indirect wholly-owned subsidiary of HSBC. HSBC Finance Corporation provides
middle-market consumers with several types of loan products in the United
States, the United Kingdom, Canada, and the Republic of Ireland. HSBC Finance
Corporation may also be referred to in these notes to the consolidated financial
statements as "we," "us" or "our." Our lending products include real estate
secured loans, auto finance loans, MasterCard*, Visa*, American Express* and
Discover* credit card loans ("Credit Card"), private label credit card loans,
including retail sales contracts, and personal non-credit card loans. We also
initiate tax refund anticipation loans and other related products in the United
States and offer credit and specialty insurance in the United States, the United
Kingdom and Canada. We have three reportable segments: Consumer, Credit Card
Services, and International. Our Consumer segment consists of our branch-based
consumer lending, mortgage services, retail services, and auto finance
businesses. Our Credit Card Services segment consists of our domestic credit
card business. Our International segment consists of our foreign operations in
Canada, the United Kingdom ("U.K."), the Republic of Ireland and prior to
November 9, 2006 our operations in Slovakia, the Czech Republic and Hungary.
During 2004, Household International, Inc. ("Household") rebranded the majority
of its U.S. and Canadian businesses to the HSBC brand. Businesses previously
operating under the Household name are now called HSBC. Our consumer lending
business retained the HFC and Beneficial brands in the United States,
accompanied by the HSBC Group's endorsement signature, "Member HSBC Group." The
single brand has allowed HSBC in North America to better align its businesses,
provided a stronger platform to service customers and advanced growth. The HSBC
brand also positions us to expand the products and services offered to our
customers. As part of this initiative, Household changed its name to HSBC
Finance Corporation in December 2004.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
--------------------------------------------------------------------------------
BASIS OF PRESENTATION The consolidated financial statements include the accounts
of HSBC Finance Corporation and all subsidiaries including all variable interest
entities in which we are the primary beneficiary as defined by Financial
Accounting Standards Board Interpretation No. 46 (Revised). Unaffiliated trusts
to which we have transferred securitized receivables which are qualifying
special purpose entities ("QSPEs") as defined by Statement of Financial
Accounting Standards ("SFAS") No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities," are not consolidated.
All significant intercompany accounts and transactions have been eliminated.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates. Certain reclassifications have been made to prior year amounts to
conform to the current period presentation.
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL Securities purchased under
agreements to resell are treated as collateralized financing transactions and
are carried at the amounts at which the securities were acquired plus accrued
interest. Interest income earned on these securities is included in net interest
income.
---------------
* MasterCard is a registered trademark of MasterCard International,
Incorporated; VISA is a registered trademark of Visa USA, Inc; American
Express is a registered trademark of American Express Company and Discover is
a registered trademark of Novus Credit Services, Inc.
115
INVESTMENT SECURITIES We maintain investment portfolios (comprised primarily of
debt securities and money market funds) in both our noninsurance and insurance
operations. Our entire investment securities portfolio was classified as
available-for-sale at December 31, 2006 and 2005. Available-for-sale investments
are intended to be invested for an indefinite period but may be sold in response
to events we expect to occur in the foreseeable future. These investments are
carried at fair value. Unrealized holding gains and losses on available-for-sale
investments are recorded as adjustments to common shareholder's equity in
accumulated other comprehensive income, net of income taxes. Any decline in the
fair value of investments which is deemed to be other than temporary is charged
against current earnings.
Cost of investment securities sold is determined using the specific
identification method. Interest income earned on the noninsurance investment
portfolio is classified in the statements of income in net interest income.
Realized gains and losses from the investment portfolio and investment income
from the insurance portfolio are recorded in investment income. Accrued
investment income is classified with investment securities.
RECEIVABLES Finance receivables are carried at amortized cost which represents
the principal amount outstanding, net of any unearned income, charge-offs,
unamortized deferred fees and costs on originated loans, purchase accounting
fair value adjustments as a result of our acquisition by HSBC and premiums or
discounts on purchased loans. Finance receivables are further reduced by credit
loss reserves and unearned credit insurance premiums and claims reserves
applicable to credit risks on our consumer receivables. Receivables held for
sale are carried at the lower of aggregate cost or market value and remain
presented as receivables in the consolidated balance sheet. Finance income is
recognized using the effective yield method. Premiums and discounts, including
purchase accounting adjustments on receivables, are recognized as adjustments to
the yield of the related receivables. Origination fees, which include points on
real estate secured loans, are deferred and generally amortized to finance
income over the estimated life of the related receivables, except to the extent
they offset directly related lending costs. Net deferred origination fees,
excluding credit card, totaled $150 million at December 31, 2006 and $94 million
at December 31, 2005. Credit card annual fees are netted with direct lending
costs, deferred, and amortized on a straight-line basis over one year. Deferred
credit card annual fees, net of direct lending costs related to these
receivables, totaled $233 million at December 31, 2006 and $191 million at
December 31, 2005.
Insurance reserves and unearned premiums applicable to credit risks on consumer
receivables are treated as a reduction of receivables in the balance sheet,
since payments on such policies generally are used to reduce outstanding
receivables.
PROVISION AND CREDIT LOSS RESERVES Provision for credit losses on owned
receivables is made in an amount sufficient to maintain credit loss reserves at
a level considered adequate, but not excessive, to cover probable losses of
principal, interest and fees, including late, overlimit and annual fees, in the
existing owned portfolio. We estimate probable losses for owned consumer
receivables using a roll rate migration analysis that estimates the likelihood
that a loan will progress through the various stages of delinquency, or buckets,
and ultimately charge-off. This analysis considers delinquency status, loss
experience and severity and takes into account whether loans are in bankruptcy,
have been restructured, rewritten or are subject to forbearance, an external
debt management plan, hardship, modification, extension or deferment. Our credit
loss reserves also take into consideration the loss severity expected based on
the underlying collateral, if any, for the loan in the event of default.
Delinquency status may be affected by customer account management policies and
practices, such as the restructure of accounts, forbearance agreements, extended
payment plans, modification arrangements, loan rewrites and deferments. When
customer account management policies or changes thereto, shift loans from a
"higher" delinquency bucket to a "lower" delinquency bucket, this will be
reflected in our roll rate statistics. To the extent that restructured accounts
have a greater propensity to roll to higher delinquency buckets, this will be
captured in the roll rates. Since the loss reserve is computed based on the
composite of all these calculations, this increase in roll rate will be applied
to receivables in all respective buckets, which will increase the overall
reserve level. In addition, loss reserves on consumer receivables are maintained
to reflect our judgment of portfolio risk factors which may not be fully
reflected in the statistical roll rate calculation. Risk factors considered in
establishing loss reserves on consumer receivables include recent growth,
product mix, bankruptcy trends, geographic concentrations, loan product features
such as adjustable rate loans,
116
economic conditions such as national and local trends in housing markets and
interest rates, portfolio seasoning, account management policies and practices
and 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 natural disasters and global pandemics. For
commercial loans, probable losses are calculated using estimates of amounts and
timing of future cash flows expected to be received on loans.
While our credit loss reserves are available to absorb losses in the entire
portfolio, we specifically consider the credit quality and other risk factors
for each of our products. We recognize the different inherent loss
characteristics in each of our products as well as customer account management
policies and practices and risk management/collection practices. Charge-off
policies are also considered when establishing loss reserve requirements to
ensure appropriate allowances exist for products with longer charge-off periods.
We also consider key ratios such as reserves to nonperforming loans and reserves
as a percentage of net charge-offs in developing our loss reserve estimate. Loss
reserve estimates are reviewed periodically and adjustments are reported in
earnings when they become known. As these estimates are influenced by factors
outside our control, such as consumer payment patterns and economic conditions,
there is uncertainty inherent in these estimates, making it reasonably possible
that they could change.
CHARGE-OFF AND NONACCRUAL POLICIES AND PRACTICES Our consumer charge-off and
nonaccrual policies vary by product and are summarized below:
PRODUCT CHARGE-OFF POLICIES AND PRACTICES NONACCRUAL POLICIES AND PRACTICES(1)
-------------------------------------------------------------------------------------------------------
Real estate Secured(2) Carrying values in excess of net Interest income accruals are
realizable value are charged-off suspended when principal or interest
at or before the time foreclosure payments are more than three months
is completed or when settlement contractually past due and resumed
is reached with the borrower. If when the receivable becomes less
foreclosure is not pursued (which than three months contractually past
frequently occurs on loans in the due.
second lien position), and there
is no reasonable expectation for
recovery (insurance claim, title
claim, pre-discharge bankrupt
account), generally the account
will be charged-off by the end of
the month in which the account
becomes eight months
contractually delinquent.
Auto finance(3)(6) Carrying values in excess of net Interest income accruals are
realizable value are charged off suspended and the portion of
at the earlier of the following: previously accrued interest expected
to be uncollectible is written off
- the collateral has been when principal payments are more
repossessed and sold, than two months contractually past
due and resumed when the receivable
- the collateral has been in our becomes less than two months
possession for more than 30 contractually past due
days (prior to December 2006,
90 days), or
- the loan becomes 150 days
contractually delinquent.
Credit card(5) Generally charged-off by the end Interest generally accrues until
of the month in which the account charge-off.
becomes six months contractually
delinquent.
117
PRODUCT CHARGE-OFF POLICIES AND PRACTICES NONACCRUAL POLICIES AND PRACTICES(1)
-------------------------------------------------------------------------------------------------------
Private label(4,5) Subsequent to the adoption of Interest generally accrues until
FFIEC policies in December 2004, charge-off, except for retail sales
domestic receivables (excluding contracts at our Consumer Lending
retail sales contracts at our business. Interest income accruals
Consumer Lending business) are for retail sales contracts are
charged-off by the end of the suspended when principal or interest
month in which the account payments are more than three months
becomes six months contractually contractually delinquent. After
delinquent. Our domestic private suspension, interest income is
label receivable portfolio generally recorded as collected.
(excluding retail sales contracts
at our Consumer Lending business)
was sold to HSBC Bank USA ("HSBC
Bank USA") on December 29, 2004.
Prior to December 2004,
receivables were generally
charged-off the month following
the month in which the account
became nine months contractually
delinquent, however, receivables
originated through new domestic
merchant relationships beginning
in the fourth quarter of 2002
were charged-off by the end of
the month in which the account
became six months contractually
delinquent.
Retail sales contracts at our
Consumer Lending business
generally charge-off the month
following the month in which the
account becomes nine months
contractually delinquent and no
payment received in six months,
but in no event to exceed 12
months contractually delinquent.
Personal non-credit card(4) Generally charged-off the month Interest income accruals are
following the month in which the suspended when principal or interest
account becomes nine months payments are more than three months
contractually delinquent and no contractually delinquent. For PHLs,
payment received in six months, interest income accruals resume if
but in no event to exceed 12 the receivable becomes less than
months contractually delinquent. three months contractually past due.
For all other personal non-credit
card receivables for which income
accruals are suspended, interest
income is generally recorded as
collected.
118
---------------
(1) For our United Kingdom business, interest income accruals are suspended when
principal or interest payments are more than three months contractually
delinquent.
(2) For our United Kingdom business, real estate secured carrying values in
excess of net realizable value are charged-off at time of sale.
(3) Our Auto Finance charge-off policy was changed in December 2006. Prior to
December 2006, carrying values in excess of net realizable value were
charged-off at the earlier of a) sale; b) the collateral having been in our
possession for more than 90 days; or c) the loan becoming 150 days
contractually delinquent. Charge-offs of $24 million were recorded in
December 2006 to reflect this policy change.
(4) For our Canada business, the private label and personal non-credit card
charge-off policy prior to December 2004 required a charge-off of an account
the month following the month in which the account becomes nine months
contractually delinquent and no payment was received in six months, but in
no event was an account to exceed 18 months contractually delinquent. In
December 2004, the policy was revised to charge-off accounts the month
following the month in which the account becomes nine months contractually
delinquent and no payment is received in six months but in no event is an
account to exceed 12 months contractually delinquent. This policy change was
not part of the adoption of FFIEC policies discussed in Note 4 and its
impact was not material to our net income.
(5) For our United Kingdom business, delinquent credit card accounts (prior to
their sale in December 2005) were charged-off the month following the month
in which the account becomes six months contractually delinquent. Delinquent
private label receivables are charged-off the month following the month in
which the account becomes nine months contractually delinquent.
(6) For our Canada business, carrying values in excess of net realizable value
are charged-off at the earlier of a) sale; b) the collateral having been in
our possession for more than 90 days; or c) the loan becoming 150 days
contractually delinquent and the interest income accruals on auto loans are
suspended and the portion of previously accrued interest expected to be
uncollectible is written off when principal payments are more than three
months contractually past due and resumed when the receivables become less
than three months contractually past due.
Charge-off involving a bankruptcy for our domestic private label (excluding
retail sales contracts at our Consumer Lending business) and credit card
receivables subsequent to the adoption of FFIEC charge-off policies in December
2004 occurs by the end of the month 60 days after notification or 180 days
delinquent, whichever is sooner. For domestic auto finance receivables, bankrupt
accounts are charged off no later than the end of the month in which the loan
becomes 210 days contractually delinquent. Charge-off involving a bankruptcy for
our real estate secured and personal non-credit card receivables are consistent
with the credit charge-off policy for these products. Prior to December 2004,
charge-offs involving a bankruptcy for our domestic private label (excluding
retail sales contracts at our Consumer Lending business) receivables occurred by
the end of the month 90 days after notification. Our domestic private label
receivable portfolio (excluding retail sales contracts at our Consumer Lending
business) was sold to HSBC Bank USA on December 29, 2004.
RECEIVABLES SOLD AND SERVICED WITH LIMITED RECOURSE AND SECURITIZATION RELATED
REVENUE Certain receivables have been securitized and sold to investors with
limited recourse. We have retained the servicing rights to these receivables.
Recourse is limited to our rights to future cash flow and any subordinated
interest that we may retain. Upon sale, these receivables are removed from the
balance sheet and a gain on sale is recognized for the difference between the
carrying value of the receivables and the adjusted sales proceeds. The adjusted
sales proceeds include cash received and the present value estimate of future
cash flows to be received over the lives of the sold receivables. Future cash
flows are based on estimates of prepayments, the impact of interest rate
movements on yields of receivables and securities issued, delinquency of
receivables sold, servicing fees and other factors. The resulting gain is also
adjusted by a provision for estimated probable losses under the recourse
provisions. This provision and the related reserve for receivables serviced with
limited recourse are established at the time of sale to cover all probable
credit losses over-the-life of the receivables sold based on historical
experience and estimates of expected future performance. The reserves are
reviewed periodically by evaluating the estimated future cash flows of each
securitized pool to ensure that there is sufficient remaining cash flow to cover
estimated future credit losses. Any changes to the estimates for the reserve for
receivables serviced with limited recourse are made in the period they become
known. Gains on sale net of recourse provisions, servicing income and excess
spread relating to securitized receivables are reported in the accompanying
consolidated statements of income as securitization revenue.
In connection with these transactions, we record an interest-only strip
receivable, representing our contractual right to receive interest and other
cash flows from our securitization trusts. Our interest-only strip receivables
are reported at fair value using discounted cash flow estimates as a separate
component of receivables net of our estimate of probable losses under the
recourse provisions. Cash flow estimates include estimates of prepayments, the
impact of interest rate movements on yields of receivables and securities
issued, delinquency of receivables sold, servicing fees and estimated probable
losses under the recourse provisions. Unrealized gains and losses are recorded
as adjustments to common shareholder's equity in accumulated other comprehensive
income, net of income taxes. Our interest-only strip receivables are reviewed
for impairment
119
quarterly or earlier if events indicate that the carrying value may not be
recovered. Any decline in the fair value of the interest-only strip receivable
which is deemed to be other than temporary is charged against current earnings.
We have also, in certain cases, retained other subordinated interests in these
securitizations. Neither the interest-only strip receivables nor the other
subordinated interests are in the form of securities.
In order to align our accounting treatment with that of HSBC initially under
U.K. GAAP and now under International Financial Reporting Standards ("IFRSs),
starting in the third quarter of 2004 we began to structure all new
collateralized funding transactions as secured financings. However, because
existing public credit card transactions were structured as sales to revolving
trusts that require replenishments to support previously issued securities,
receivables continue to be sold to these trusts until the revolving periods end,
the last of which is expected to occur in the fourth quarter of 2007. We
continue to replenish, at reduced levels, personal non-credit card securities
issued to conduits and record the resulting replenishment gains.
PROPERTIES AND EQUIPMENT, NET Properties and equipment are recorded at cost, net
of accumulated depreciation and amortization. As a result of our acquisition by
HSBC, the amortized cost of our properties and equipment was adjusted to fair
market value and accumulated depreciation and amortization on a "predecessor"
basis was eliminated at the time of the acquisition. For financial reporting
purposes, depreciation is provided on a straight-line basis over the estimated
useful lives of the assets which generally range from 3 to 40 years. Leasehold
improvements are amortized over the lesser of the economic useful life of the
improvement or the term of the lease. Maintenance and repairs are expensed as
incurred.
REPOSSESSED COLLATERAL Real estate owned is valued at the lower of cost or fair
value less estimated costs to sell. These values are periodically reviewed and
reduced, if necessary. Costs of holding real estate and related gains and losses
on disposition are credited or charged to operations as incurred as a component
of operating expense. Repossessed vehicles, net of loss reserves when
applicable, are recorded at the lower of the estimated fair market value or the
outstanding receivable balance.
INSURANCE Insurance revenues on monthly premium insurance policies are
recognized when billed. Insurance revenues on the remaining insurance contracts
are recorded as unearned premiums and recognized into income based on the nature
and terms of the underlying contracts. Liabilities for credit insurance policies
are based upon estimated settlement amounts for both reported and incurred but
not yet reported losses. Liabilities for future benefits on annuity contracts
and specialty and corporate owned life insurance products are based on actuarial
assumptions as to investment yields, mortality and withdrawals.
INTANGIBLE ASSETS Intangible assets consist of purchased credit card
relationships and related programs, retail services merchant relationships,
other loan related relationships, trade names, technology, customer lists and
other contracts. The trade names are not subject to amortization, as we believe
they have indefinite lives. The remaining intangible assets are being amortized
over their estimated useful lives either on a straight-line basis or in
proportion to the underlying revenues generated. These useful lives range from 5
years for retail services merchant relationships to approximately 10 years for
certain loan related relationships. Intangible assets are reviewed for
impairment using discounted cash flows annually, or earlier if events indicate
that the carrying amounts may not be recoverable. We consider significant and
long-term changes in industry and economic conditions to be our primary
indicator of potential impairment. Impairment charges, when required, are
calculated using discounted cash flows.
GOODWILL Goodwill represents the purchase price over the fair value of
identifiable assets acquired less liabilities assumed from business
combinations. Goodwill is not amortized, but is reviewed for impairment annually
using discounted cash flows but impairment may be reviewed earlier if
circumstances indicate that the carrying amount may not be recoverable. We
consider significant and long-term changes in industry and economic conditions
to be our primary indicator of potential impairment.
DERIVATIVE FINANCIAL INSTRUMENTS All derivatives are recognized on the balance
sheet at their fair value. At the inception of the hedging relationship, we
designate the derivative as a fair value hedge, a cash flow hedge, or if the
derivative does not quality in a hedging relationship, a non-hedging derivative.
Fair value hedges include hedges of the fair value of a recognized asset or
liability and certain foreign currency hedges. Cash flow hedges
120
include hedges of the variability of cash flows to be received or paid related
to a recognized asset or liability and certain foreign currency hedges. Changes
in the fair value of derivatives designated as fair value hedges, along with the
change in fair value on the hedged risk, are recorded in current period
earnings.
Changes in the fair value of derivatives designated as cash flow hedges, to the
extent effective as a hedge, are recorded in accumulated other comprehensive
income and reclassified into earnings in the period during which the hedged item
affects earnings. Changes in the fair value of derivative instruments not
designated as hedging instruments and ineffective portions of changes in the
fair value of hedging instruments are recognized in other revenue as derivative
income in the current period.
For derivative instruments designated as hedges, we formally document all
relationships between hedging instruments and hedged items. This documentation
includes our risk management objective and strategy for undertaking various
hedge transactions, as well as how hedge effectiveness and ineffectiveness will
be measured. This process includes linking derivatives to specific assets and
liabilities on the balance sheet. We also formally assess, both at the hedge's
inception and on a quarterly basis, whether the derivatives that are used in
hedging transactions are highly effective in offsetting changes in fair values
or cash flows of hedged items. This assessment is conducted using statistical
regression analysis. When as a result of the quarterly assessment, it is
determined that a derivative is not highly effective as a hedge or that it has
ceased to be a highly effective hedge, we discontinue hedge accounting as of the
beginning of the quarter in which such determination was made.
When hedge accounting is discontinued because it is determined that the
derivative no longer qualifies as an effective hedge, the derivative will
continue to be carried on the balance sheet at its fair value, with changes in
its fair value recognized in current period earnings. For fair value hedges, the
formerly hedged asset or liability will no longer be adjusted for changes in
fair value and any previously recorded adjustments to the carrying value of the
hedged asset or liability will be amortized in the same manner that the hedged
item affects income. For cash flow hedges, amounts previously recorded in
accumulated other comprehensive income will be reclassified into income in the
same manner that the hedged item affects income.
If the hedging instrument is terminated early, the derivative is removed from
the balance sheet. Accounting for the adjustments to the hedged asset or
liability or adjustments to accumulated other comprehensive income are the same
as described above when a derivative no longer qualifies as an effective hedge.
If the hedged asset or liability is sold or extinguished, the derivative will
continue to be carried on the balance sheet at its fair value, with changes in
its fair value recognized in current period earnings. The hedged item, including
previously recorded mark-to-market adjustments, is derecognized immediately as a
component of the gain or loss upon disposition.
FOREIGN CURRENCY TRANSLATION We have foreign subsidiaries located in the United
Kingdom and Canada. The functional currency for each foreign subsidiary is its
local currency. Assets and liabilities of these subsidiaries are translated at
the rate of exchange in effect on the balance sheet date. Translation
adjustments resulting from this process are accumulated in common
shareholder's(s') equity as a component of accumulated other comprehensive
income. Income and expenses are translated at the average rate of exchange
prevailing during the year.
Effects of foreign currency translation in the statements of cash flows are
offset against the cumulative foreign currency adjustment, except for the impact
on cash. Foreign currency transaction gains and losses are included in income as
they occur.
STOCK-BASED COMPENSATION We account for all of our stock based compensation
awards including share options, restricted share awards and the employee stock
purchase plan using the fair value method in accordance with Statement of
Financial Accounting Standards No. 123(Revised 2004) "Share-Based Payment"
(SFAS123(R)"). The fair value of the awards granted is recognized as expense
over the vesting period generally either three or four years for options and
three or five years for restricted share awards. The fair value of each option
granted, measured at the grant date, is calculated using a binomial lattice
methodology that is based on the underlying assumptions of the Black-Scholes
option pricing model.
121
Compensation expense relating to restricted share awards is based upon the
market value of the share on the date of grant.
In 2004, we began to consider forfeitures for all stock awards granted
subsequent to March 28, 2003 as part of our estimate of compensation expense
rather than adjust compensation expense as forfeitures occur. The cumulative
impact of the change was not material.
INCOME TAXES HSBC Finance Corporation is included in HSBC North America's
consolidated federal income tax return and in various state income tax returns.
In addition, HSBC Finance Corporation files some unconsolidated state tax
returns. Deferred tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect. Investment
tax credits generated by leveraged leases are accounted for using the deferral
method. Changes in estimates of the basis in our assets and liabilities or other
estimates recorded at the date of our acquisition by HSBC or our acquisition of
Metris are adjusted against goodwill.
TRANSACTIONS WITH RELATED PARTIES In the normal course of business, we enter
into transactions with HSBC and its subsidiaries. These transactions occur at
prevailing market rates and include funding arrangements, derivative execution,
purchases and sales of receivables, servicing arrangements, information
technology services, item processing and statement processing services, banking
and other miscellaneous services.
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.
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.
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. We elected to early adopt SFAS No. 156 effective January 1, 2006. As
we do not have servicing assets recorded on our balance sheet the early adoption
of SFAS No. 156 did not have any impact on our financial position or results of
operations.
122
In September 2006, the FASB issued FASB Statement No. 158, "Employer's
Accounting for Defined Benefit Pension and Other Postretirement Plans," ("SFAS
No. 158"). SFAS No. 158 requires balance sheet recognition of the funded status
of pension and other postretirement benefits with the offset to accumulated
other comprehensive income. Employers will recognize actuarial gains and losses,
prior service cost, and any remaining transition amounts when recognizing a
plan's funded status. SFAS No. 158 is effective for fiscal years ending after
December 15, 2006. We adopted SFAS No. 158 effective December 31, 2006. The
adoption of SFAS No. 158 resulted in a reduction of accumulated other
comprehensive income within common shareholder's equity of $1 million at
December 31, 2006.
In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109" ("FIN
No. 48"). FIN No. 48 establishes threshold and measurement attributes for
financial statement measurement and recognition of tax positions taken or
expected to be taken in a tax return. FIN No. 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. FIN No. 48 is effective for fiscal years
beginning after December 15, 2006. We adopted FIN No. 48 on January 1, 2007. The
adoption of FIN 48 will not have a significant impact on the financial results
of the Company and will not result in a significant cumulative effect adjustment
to the January 1, 2007 balance of retained earnings. However, it will result in
the reclassification of $65 million of deferred tax liability to current tax
liability to account for uncertainty in the timing of tax benefits as well as
the reclassification of $141 million of deferred tax asset to current tax asset
to account for highly certain pending adjustments in the timing of tax benefits.
In September 2006, the FASB issued FASB Statement No. 157, "Fair Value
Measurements," ("SFAS No. 157"). SFAS No. 157 establishes a single authoritative
definition of value, sets out a framework for measuring fair value, and requires
additional disclosures about fair-value measurements. SFAS No. 157 is effective
for fiscal years beginning after November 15, 2007, and interim periods within
those years. Early application is permissible only if no annual or interim
financial statements have been issued for the earlier periods. We are
considering whether to elect early adoption of this pronouncement and are
currently evaluating the impact that adoption of SFAS No. 157 will have on our
financial position and results of operations.
In September 2006, the U.S. Securities and Exchange Commission issued Staff
Accounting Bulletin No. 108, "Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial
Statements" ("SAB 108"). SAB 108 addresses how the effects of prior year
uncorrected misstatements should be considered when quantifying misstatements in
current year financial statements. SAB 108 requires companies to quantify
misstatements using both the balance sheet and income statement approaches and
to evaluate whether either approach results in quantifying an error that is
material in light of relevant quantitative and qualitative factors. SAB 108 is
effective for fiscal years ending after November 15, 2006. The adoption of SAB
108 did not have an impact on our financial position or results of operations.
In February, 2007, the FASB issued FASB Statement No. 159, "The Fair Value
Option for Financial Assets and Financial Liabilities," ("SFAS No. 159") which
creates an alternative measurement treatment for certain financial assets and
financial liabilities. SFAS No. 159 permits fair value to be used for both the
initial and subsequent measurements on an instrument by instrument basis, with
changes in the fair value to be recognized in earnings as those changes occur.
This election is referred to as the fair value option. SFAS No. 159 also
requires additional disclosures to compensate for the lack of comparability that
will arise from the use of the fair value option. SFAS No. 159 is effective for
fiscal years beginning after November 15, 2007, with early adoption permitted.
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 are considering whether to elect early adoption of this pronouncement
and are currently evaluating the impact that the adoption of SFAS No. 159 will
have on our financial position and results of operations. We anticipate that we
would apply SFAS No. 159 largely to certain fixed rate debt which are already
accounted for at fair value under IFRSs. Based on our latest analysis, we
currently estimate that such election would result in a cumulative-effect
after-tax reduction to the January 1, 2007 opening balance of retained earnings
of approximately $550 million.
123
3. BUSINESS ACQUISITIONS AND DIVESTITURES
--------------------------------------------------------------------------------
SALE OF EUROPEAN OPERATIONS On November 9, 2006, as part of our continuing
evaluation of strategic alternatives with respect to our U.K. and European
operations, we sold all of the capital stock of our operations in the Czech
Republic, Hungary, and Slovakia (the "European Operations") to a wholly owned
subsidiary of HSBC Bank plc ("HBEU"), a U.K. based subsidiary of HSBC, for an
aggregate purchase price of approximately $46 million. The assets consisted
primarily of $199 million of receivables and goodwill which totaled
approximately $13 million at November 9, 2006. The liabilities consisted
primarily of debt which totaled $179 million at November 9, 2006. HBEU assumed
all the liabilities of the European Operations as a result of this transaction.
Because the sale of this business is between affiliates under common control,
the premium received in excess of the book value of the stock transferred of $13
million, including the goodwill assigned to this business, was recorded as an
increase to additional paid-in capital and will not be reflected in earnings.
Our European Operations are reported in the International Segment.
The following summarizes the operating results of our European Operations for
the periods presented:
PERIOD ENDED YEAR ENDED YEAR ENDED
NOVEMBER 9, DECEMBER 31, DECEMBER 31,
2006 2005 2004
-----------------------------------------------------------------------------------------------------
(IN MILLIONS)
Net interest income...................................... $24 $ 22 $ 10
Income before income tax expense......................... (5) (8) (11)
Income tax expense....................................... - (3) 2
Net loss................................................. (5) (11) (9)
ACQUISITION OF SOLSTICE CAPITAL GROUP INC ("SOLSTICE") On October 4, 2006 our
Consumer Lending business purchased Solstice with assets of approximately $49
million, in an all cash transaction for approximately $50 million. Additional
consideration may be paid based on Solstice's 2007 pre-tax income. Solstice
markets a range of mortgage and home equity products to customers through direct
mail. This acquisition will add momentum to our origination growth plan by
providing an additional channel to customers. The results of Solstice are
included in our consolidated financial statements beginning October 4, 2006.
The purchase price was allocated to the assets and liabilities acquired based on
their estimated fair values at the acquisition date. These fair value
adjustments represent current estimates and are subject to further adjustment as
our valuation data is finalized. Goodwill associated with the Solstice
acquisition is not tax deductible. The initial purchase price allocations may be
adjusted within one year of the purchase date for changes in estimates of the
fair value of assets acquired and liabilities assumed. The following table
summarizes the estimated fair values of the acquired and liabilities assumed as
a result of the acquisition of Solstice:
(IN MILLIONS)
---------------------------------------------------------------------------
ASSETS ACQUIRED:
Cash........................................................ $11
Receivables, net............................................ 37
Goodwill.................................................... 46
Properties and equipment.................................... 1
---
Total assets acquired..................................... $95
===
LIABILITIES ASSUMED:
Other liabilities........................................... $45
---
Total liabilities assumed................................. $45
===
TOTAL PURCHASE PRICE........................................ $50
===
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ACQUISITION OF METRIS COMPANIES INC. On December 1, 2005, we acquired the
outstanding capital stock of Metris Companies Inc. ("Metris"), a provider of
financial products and services to middle market consumers throughout the United
States, in an all-cash transaction for $1.6 billion. HSBC Investments (North
America) Inc. ("HINO") made a capital contribution of $1.2 billion to fund a
portion of the purchase price. This acquisition expanded our presence in the
near-prime credit card market and strengthened our capabilities to serve the
full spectrum of credit card customers. The results of Metris are included in
our consolidated financial statements beginning December 1, 2005.
The purchase price was allocated to the assets and liabilities acquired based on
their estimated fair values at the acquisition date. These preliminary fair
values were estimated, in part, based on third party valuation data. Goodwill
associated with the Metris acquisition is not tax deductible. In the third
quarter of 2006, we made an adjustment to our estimated fair value related to
Metris following an adverse judgment in litigation involving Metris that
preceded the merger. This adjustment resulted in a net increase to goodwill of
approximately $25 million. Since the one-year anniversary of the Metris
acquisition was completed during the fourth quarter of 2006, no further
acquisition-related adjustments to the purchase price will occur, except for
changes in estimates for the tax basis in our assets and liabilities or other
tax estimates recorded at the date of the Metris acquisition pursuant to
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes."
SALE OF U.K. CREDIT CARD BUSINESS In December 2005, we sold our U.K. credit card
business, including $2.5 billion of receivables, the associated cardholder
relationships and the related retained interests in securitized credit card
receivables to HSBC Bank plc ("HBEU"), a U.K. based subsidiary of HSBC, for an
aggregate purchase price of $3.0 billion. The purchase price, which was
determined based on a comparative analysis of sales of other credit card
portfolios, was paid in a combination of cash and $261 million of preferred
stock issued by a subsidiary of HBEU with a rate of one-year Sterling LIBOR,
plus 1.30 percent. In addition to the assets referred to above, the sale also
included the account origination platform, including the marketing and credit
employees associated with this function, as well as the lease associated with
the credit card call center and the related leaseholds and call center employees
to provide customer continuity after the transfer as well as to allow HBEU
direct ownership and control of origination and customer service. We have
retained the collection operations related to the credit card operations and
have entered into a service level agreement for a period of not less than two
years to provide collection services and other support services, including
components of the compliance, financial reporting and human resource functions,
for the sold credit card operations to HBEU for a fee. Additionally, the
management teams of HBEU and our remaining U.K. operations will be jointly
involved in decision making involving card marketing to ensure that growth
objectives are met for both businesses. Because the sale of this business is
between affiliates under common control, the premium received in excess of the
book value of the assets transferred of $182 million, including the goodwill
assigned to this business, was recorded as an increase to additional paid in
capital and has not been included in earnings. As a result of this sale, our net
interest income, fee income and provision for credit losses related to the U.K.
credit card business has been reduced, while other income has increased by the
receipt of servicing and support services revenue from HBEU. The net effect of
this sale did not result in a material reduction of net income of our
consolidated results.
4. SALE OF DOMESTIC PRIVATE LABEL RECEIVABLE PORTFOLIO AND ADOPTION OF FFIEC
POLICIES
--------------------------------------------------------------------------------
On December 29, 2004, we sold our domestic private label receivable portfolio
(excluding retail sales contracts at our Consumer Lending business), including
the retained interests associated with securitized private label receivables, to
HSBC Bank USA for an aggregate purchase price of $12.4 billion and recorded a
gain of $663 million ($423 million after-tax). Included in this gain was the
release of $505 million in credit loss reserves associated with the portfolio.
The domestic private label receivable portfolio sold consisted of receivables
with a balance of $12.2 billion. The purchase price was determined based upon an
independent valuation opinion.
We retained the customer relationships and by agreement will continue to sell
additional domestic private label receivable originations (excluding retail
sales contracts) generated under current and future private label
125
accounts to HSBC Bank USA on a daily basis at fair market value. We will also
service the receivables for HSBC Bank USA for a fee under a service agreement
that was reviewed by the staff of the Board of Governors of the Federal Reserve
Board (the "Federal Reserve Board".)
Upon receipt of regulatory approval for the sale of this domestic private label
receivable portfolio, we adopted charge-off and account management policies in
accordance with the Uniform Retail Credit Classification and Account Management
Policy issued by the Federal Financial Institutions Examination Council ("FFIEC
Policies") for our domestic private label (excluding retail sales contracts at
our Consumer Lending business) and credit card portfolios. The adoption of FFIEC
charge-off policies for our domestic private label (excluding retail sales
contracts at our Consumer Lending business) and credit card receivables resulted
in a reduction to our 2004 net income of $121 million.
5. SECURITIES
--------------------------------------------------------------------------------
Securities consisted of the following available-for-sale investments:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 2006 COST GAINS LOSSES VALUE
---------------------------------------------------------------------------------------------------
(IN MILLIONS)
Corporate debt securities............................ $2,373 $10 $(39) $2,344
Money market funds................................... 1,051 - - 1,051
U.S. government sponsored enterprises(1)............. 179 - (2) 177
U.S. government and Federal agency debt securities... 144 - (1) 143
Non-government mortgage backed securities............ 367 - (1) 366
Other................................................ 578 2 (4) 576
------ --- ---- ------
Subtotal............................................. 4,692 12 (47) 4,657
Accrued investment income............................ 38 - - 38
------ --- ---- ------
Total securities available for sale.................. $4,730 $12 $(47) $4,695
====== === ==== ======
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.
Proceeds from the sale of available-for-sale investments totaled approximately
$.5 billion in 2006, $.4 billion in 2005 and $.9 billion in 2004. We realized
gross gains of $125 million in 2006, $12 million in 2005 and $15 million in
2004. We realized gross losses of $2 million in 2006, $12 million in 2005 and $3
million in 2004.
126
Money market funds at December 31, 2006 include $854 million which is restricted
for the sole purpose of paying down certain secured financings at the
established payment date. There were no such restricted balances at December 31,
2005.
A summary of gross unrealized losses and related fair values as of December 31,
2006, classified as to the length of time the losses have existed is presented
in the following table:
LESS THAN ONE YEAR GREATER THAN ONE YEAR
--------------------------------------- ---------------------------------------
GROSS AGGREGATE GROSS AGGREGATE
NUMBER OF UNREALIZED FAIR VALUE OF NUMBER OF UNREALIZED FAIR VALUE OF
DECEMBER 31, 2006 SECURITIES LOSSES INVESTMENTS SECURITIES LOSSES INVESTMENTS
-------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Corporate debt
securities.............. 130 $(5) $433 503 $(34) $1,151
U.S. government sponsored
enterprises............. 19 -(1) 77 22 (2) 84
U.S. government and
Federal agency debt
securities.............. 10 -(1) 27 30 (1) 54
Non-government mortgage... 20 -(1) 78 25 (1) 40
Other..................... 18 -(1) 89 55 (4) 195
LESS THAN ONE YEAR GREATER THAN ONE YEAR
--------------------------------------- ---------------------------------------
GROSS AGGREGATE GROSS AGGREGATE
NUMBER OF UNREALIZED FAIR VALUE OF NUMBER OF UNREALIZED FAIR VALUE OF
DECEMBER 31, 2005 SECURITIES LOSSES INVESTMENTS SECURITIES LOSSES INVESTMENTS
-------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Corporate debt
securities.............. 272 $(14) $695 381 $(24) $898
U.S. government sponsored
enterprises............. 11 -(1) 28 25 (2) 64
U.S. government and
Federal agency debt
securities.............. 18 (1) 71 40 (3) 117
Non-government mortgage... 3 -(1) 4 16 (1) 22
Other..................... 12 (1) 49 49 (4) 148
---------------
(1) Less than $500 thousand.
The gross unrealized losses on our securities available for sale were flat
during 2006. The contractual terms of these securities do not permit the issuer
to settle the securities at a price less than the par value of the investment.
Since substantially all of these securities are rated A- or better, and because
we have the ability and intent to hold these investments until maturity or a
market price recovery, these securities are not considered other-than
temporarily impaired.
The amortized cost of our securities available for sale was adjusted to fair
market value at the time of the merger with HSBC. See Note 23, "Fair Value of
Financial Instruments," for further discussion of the relationship between the
fair value of our assets and liabilities.
127
Contractual maturities of and yields on investments in debt securities were as
follows:
AT DECEMBER 31, 2006
----------------------------------------------------
DUE AFTER 1 AFTER 5
WITHIN BUT WITHIN BUT WITHIN AFTER
1 YEAR 5 YEARS 10 YEARS 10 YEARS TOTAL
----------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Corporate debt securities:
Amortized cost.............................. $474 $1,054 $247 $598 $2,373
Fair value.................................. 472 1,036 242 594 2,344
Yield(1).................................... 3.68% 4.47% 5.29% 5.60% 4.68%
U.S. government sponsored enterprises:
Amortized cost.............................. $ 50 $ 69 $ 5 $ 55 $ 179
Fair value.................................. 49 69 5 54 177
Yield(1).................................... 4.59% 4.98% 5.05% 4.33% 4.68%
U.S. government and Federal agency debt
securities:
Amortized cost.............................. $ 32 $ 28 $ 21 $ 63 $ 144
Fair value.................................. 31 28 21 63 143
Yield(1).................................... 4.58% 3.66% 4.53% 4.85% 4.51%
---------------
(1) Computed by dividing annualized interest by the amortized cost of respective
investment securities.
6. RECEIVABLES
--------------------------------------------------------------------------------
Receivables consisted of the following:
AT DECEMBER 31,
-------------------
2006 2005
---------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured......................................... $ 97,761 $ 82,826
Auto finance................................................ 12,504 10,704
Credit card................................................. 27,714 24,110
Private label............................................... 2,509 2,520
Personal non-credit card.................................... 21,367 19,545
Commercial and other........................................ 181 208
-------- --------
Total receivables........................................... 162,036 139,913
HSBC acquisition purchase accounting fair value
adjustments............................................... (60) 63
Accrued finance charges..................................... 2,228 1,831
Credit loss reserve for owned receivables................... (6,587) (4,521)
Unearned credit insurance premiums and claims reserves...... (412) (505)
Interest-only strip receivables............................. 6 23
Amounts due and deferred from receivable sales.............. 51 185
-------- --------
Total receivables, net...................................... $157,262 $136,989
======== ========
HSBC acquisition purchase accounting fair value adjustments represent
adjustments which have been "pushed down" to record our receivables at fair
value at the date of acquisition by HSBC.
We have a subsidiary, Decision One Mortgage Company, LLC, which directly
originates mortgage loans sourced by mortgage brokers and sells all loans to
secondary market purchasers, including our Mortgage Services businesses. Loans
held for sale to external parties by this subsidiary totaled $1.6 billion at
128
December 31, 2006 and $1.7 billion at December 31, 2005 and are included in real
estate secured receivables. At December 31, 2006 our Consumer Lending business
also had loans held for sale totaling $32 million as a result of the Solstice
purchase.
In November 2006, we sold our European Operations, including $199 million of
receivables to a wholly owned subsidiary of HBEU. In December 2005, we sold our
U.K. based credit card operations, including $2.5 billion of receivables and the
related retained interests in securitized credit card receivables to HBEU. See
Note 3, "Business Acquisitions and Divestitures," for additional information
regarding these sales.
In November 2006, we acquired $2.5 billion of real estate secured receivables
from Champion Mortgage ("Champion") a division of KeyBank, N.A. and as part of
our acquisition of Metris on December 1, 2005, we acquired $5.3 billion of
receivables. These receivables acquired 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") to the extent there was evidence of
deterioration of credit quality since origination and for which it was probable,
at acquisition, that all contractually required payments would not be collected
and that the associated line of credit had been closed.
The following table summarizes, for Champion, the outstanding receivable
balances, the cash flows expected to be collected and the fair value of the
receivables to which SOP 03-3 has been applied:
(IN MILLIONS)
---------------------------------------------------------------------------
Outstanding contractual receivable balance at acquisition... $ 152
Cash flows expected to be collected at acquisition.......... 136
Basis in acquired receivables at acquisition................ 117
The carrying amount of Champion real estate secured receivables subject to the
requirements of SOP 03-3 was $116 million at December 31, 2006 and is included
in the real estate secured receivables in the table above. The outstanding
contractual balance of these receivables was $143 million at December 31, 2006.
At December 31, 2006, no credit loss reserve for the acquired receivables
subject to SOP 03-3 has been established as there has been no decrease to the
expected future cash flows since the acquisition.
As discussed more fully in Note 3, "Business Acquisitions and Divestitures," as
part of our acquisition of Metris on December 1, 2005, we acquired $5.3 billion
of receivables. The carrying amount of the credit card receivables which were
subject to SOP 03-3 was $223 million at December 31, 2006 and $414 million at
December 31, 2005 and is included in the credit card receivables in the table
above. The outstanding contractual balance of these receivables was $334 million
at December 31, 2006 and $804 million at December 31, 2005. At December 31,
2006, no credit loss reserve for the acquired receivables subject to SOP 03-3
has been established as there has been no decrease to the expected future cash
flows since the acquisition. There was a reclassification to accretable yield
from non-accretable difference during 2006. This reclassification from
non-accretable difference represents an increase to the estimated cash flows to
be collected on the underlying Metris portfolio.
The following summarizes the accretable yield on Metris and Champion receivables
at December 31, 2006:
(IN MILLIONS)
---------------------------------------------------------------------------
Accretable yield at December 31, 2005....................... $(122)
Accretable yield additions during the period................ (19)
Accretable yield amortized to interest income during the
period.................................................... 100
Reclassification from non-accretable difference............. (35)
-----
Accretable yield at December 31, 2006....................... $ (76)
=====
129
Real estate secured receivables are comprised of the following:
AT DECEMBER 31,
-----------------
2006 2005
-------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured:
Closed-end:
First lien............................................. $77,901 $66,819
Second lien............................................ 15,090 11,815
Revolving:
First lien............................................. 556 626
Second lien............................................ 4,214 3,566
------- -------
Total real estate secured receivables..................... $97,761 $82,826
======= =======
Foreign receivables included in receivables were as follows:
AT DECEMBER 31,
---------------------------------------------------
UNITED KINGDOM AND
THE REST OF EUROPE CANADA
------------------------ ------------------------
2006 2005 2004 2006 2005 2004
-----------------------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured....................... $1,786 $1,654 $1,832 $1,766 $1,380 $1,042
Auto finance.............................. - - - 311 270 54
Credit card............................... - - 2,264 215 147 -
Private label............................. 1,333 1,330 2,249 887 834 821
Personal non-credit card.................. 2,425 3,038 3,562 697 607 517
Commercial and other...................... - - - - - 2
------ ------ ------ ------ ------ ------
Total..................................... $5,544 $6,022 $9,907 $3,876 $3,238 $2,436
====== ====== ====== ====== ====== ======
Foreign receivables represented 6 percent of receivables at December 31, 2006
and 7 percent of receivables at December 31, 2005.
Receivables serviced with limited recourse consisted of the following:
AT DECEMBER 31,
---------------
2006 2005
-----------------------------------------------------------------------------
(IN MILLIONS)
Auto finance................................................ $271 $1,192
Credit card................................................. 500 1,875
Personal non-credit card.................................... 178 1,007
---- ------
Total....................................................... $949 $4,074
==== ======
We maintain facilities with third parties which provide for the securitization
or secured financing of receivables on both a revolving and non-revolving basis
totaling $19.0 billion, of which $9.1 billion were utilized at December 31,
2006. The amount available under these facilities will vary based on the timing
and volume of public securitization or secured financing transactions and our
general liquidity plans.
130
Contractual maturities of our receivables were as follows:
AT DECEMBER 31, 2006
--------------------------------------------------------------------
2007 2008 2009 2010 2011 THEREAFTER TOTAL
-----------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured.................. $ 528 $ 479 $ 388 $ 423 $ 591 $ 95,352 $ 97,761
Auto finance......................... 2,983 2,744 2,496 2,100 1,487 694 12,504
Credit card.......................... 3,768 2,961 2,503 2,132 1,828 14,522 27,714
Private label........................ 1,167 532 349 216 118 127 2,509
Personal non-credit card............. 2,448 1,640 2,394 3,922 6,035 4,928 21,367
Commercial and other................. 1 - 45 58 - 77 181
------- ------ ------ ------ ------- -------- --------
Total................................ $10,895 $8,356 $8,175 $8,851 $10,059 $115,700 $162,036
======= ====== ====== ====== ======= ======== ========
A substantial portion of consumer receivables, based on our experience, will be
renewed or repaid prior to contractual maturity. The above maturity schedule
should not be regarded as a forecast of future cash collections.
The following table summarizes contractual maturities of receivables due after
one year by repricing characteristic:
AT DECEMBER 31, 2006
---------------------
OVER 1 BUT
WITHIN OVER
5 YEARS 5 YEARS
-----------------------------------------------------------------------------------
(IN MILLIONS)
Receivables at predetermined interest rates................. $26,977 $ 95,521
Receivables at floating or adjustable rates................. 8,464 20,179
------- --------
Total....................................................... $35,441 $115,700
======= ========
Nonaccrual consumer receivables totaled $4.8 billion (including $482 million
relating to foreign operations) at December 31, 2006 and $3.5 billion (including
$463 million relating to foreign operations) at December 31, 2005. Interest
income that would have been recorded if such nonaccrual receivables had been
current and in accordance with contractual terms was approximately $639 million
(including $72 million relating to foreign operations) in 2006 and $475 million
(including $66 million relating to foreign operations) in 2005. Interest income
that was included in finance and other interest income prior to these loans
being placed on nonaccrual status was approximately $338 million (including $36
million relating to foreign operations) in 2006 and $229 million (including $31
million relating to foreign operations) in 2005. For an analysis of reserves for
credit losses, see our "Analysis of Credit Loss Reserves Activity" in
Management's Discussion and Analysis and Note 7, "Credit Loss Reserves."
Interest-only strip receivables are reported net of our estimate of probable
losses under the recourse provisions for receivables serviced with limited
recourse. Reductions to our interest-only strip receivables in 2006 reflect the
impact of reduced securitization levels, including our decision in 2004 to
structure new collateralized funding transactions as secured financings.
Amounts due and deferred from receivable sales include assets established for
certain receivable sales, including funds deposited in spread accounts, and net
customer payments due from (to) the securitization trustee.
We issued securities backed by dedicated home equity loan receivables of $4.8
billion in 2006 and $4.5 billion in 2005. We issued securities backed by
dedicated auto finance loan receivables of $2.8 billion in 2006 and $3.4 billion
in 2005. We issued securities backed by dedicated credit card receivables of
$4.8 billion in 2006 and $1.8 billion in 2005. We issued securities backed by
dedicated personal non-credit card receivables of $2.5 billion in 2006. For
accounting purposes, these transactions were structured as secured financings,
131
therefore, the receivables and the related debt remain on our balance sheet.
Additionally, as part of the Metris acquisition in 2005, we assumed $4.6 billion
of securities backed by credit card receivables which were accounted for as
secured financings. Real estate secured receivables included closed-end real
estate secured receivables totaling $9.7 billion at December 31, 2006 and $7.5
billion at December 31, 2005 that secured the outstanding debt related to these
transactions. Auto finance receivables totaling $6.0 billion at December 31,
2006 and $5.1 billion at December 31, 2005 secured the outstanding debt related
to these transactions. Credit card receivables totaling $8.9 billion at December
31, 2006 and $7.1 billion at December 31, 2005 secured the outstanding debt
related to these transactions. Personal non-credit card receivables of $3.5
billion at December 31, 2006 secured the outstanding debt related to these
transactions. There were no transactions structured as secured financings in
2005 for personal non-credit card receivables.
7. CREDIT LOSS RESERVES
--------------------------------------------------------------------------------
An analysis of credit loss reserves was as follows:
AT DECEMBER 31,
------------------------
2006 2005 2004
--------------------------------------------------------------------------------------
(IN MILLIONS)
Credit loss reserves at beginning of period................. $4,521 $3,625 $3,793
Provision for credit losses................................. 6,564 4,543 4,334
Charge-offs................................................. (5,164) (4,100) (4,409)
Recoveries.................................................. 645 447 376
Other, net.................................................. 21 6 (469)
------ ------ ------
Credit loss reserves at end of period....................... $6,587 $4,521 $3,625
------ ------ ------
Further analysis of credit quality and credit loss reserves is presented in Item
7, "Management's Discussion and Analysis of Financial Condition and Results of
Operations" of Form 10-K under the caption "Credit Quality."
8. ASSET SECURITIZATIONS
--------------------------------------------------------------------------------
We have sold receivables in various securitization transactions. We continue to
service and receive servicing fees on the outstanding balance of these
securitized receivables. We also retain rights to future cash flows arising from
these receivables after the investors receive their contractual return. We have
also, in certain cases, retained other subordinated interests in these
securitizations. These transactions result in the recording of an interest-only
strip receivable which represents the value of the future residual cash flows
from securitized receivables. The investors and the securitization trusts have
only limited recourse to our assets for failure of debtors to pay. That recourse
is limited to our rights to future cash flow and any subordinated interest we
retain. Servicing assets and liabilities are not recognized in conjunction with
our securitizations since we receive adequate compensation relative to current
market rates to service the receivables sold. See Note 2, "Summary of
Significant Accounting Policies," for further discussion on our accounting for
interest-only strip receivables.
In the third quarter of 2004, we began to structure all new collateralized
funding transactions as secured financings. However, because existing public
credit card transactions were structured as sales to revolving trusts that
require replenishments of receivables to support previously issued securities,
receivables will continue to be sold to these trusts until the revolving periods
end, the last of which is expected to occur in the fourth quarter of 2007. In
addition, we continue to replenish at reduced levels, certain non-public
personal non-credit card securities issued to conduits and record the resulting
replenishment gains.
Securitization related revenue includes income associated with the current and
prior period securitization of receivables with limited recourse structured as
sales. Such income includes gains on sales, net of our estimate of probable
credit losses under the recourse provisions, servicing income and excess spread
relating to those receivables.
132
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2006 2005 2004
--------------------------------------------------------------------------------------------------------
Net initial gains(1)........................................ $ - $ - $ 25
Net replenishment gains(2).................................. 30 154 414
Servicing revenue and excess spread......................... 137 57 569
---- ---- ------
Total securitization related revenue........................ $167 $211 $1,008
==== ==== ======
---------------
(1) Net initial gains reflect inherent recourse provisions of $47 million in
2004.
(2) Net replenishment gains reflect inherent recourse provisions of $41 million
in 2006, $252 million in 2005 and $850 million in 2004.
Net initial gains represent gross initial gains net of our estimate of probable
credit losses under the recourse provisions. There were no net initial gains in
2006 or 2005. Net initial gains and the key economic assumptions used in
measuring the net initial gains from securitizations for 2004 were as follows:
AUTO CREDIT PRIVATE
YEAR ENDED DECEMBER 31, FINANCE CARD LABEL TOTAL
------------------------------------------------------------------------------------------------
2004
Net initial gains (in millions)............................. $ 6(2) $ 14 $ 5 $25
Key economic assumptions:(1)
Weighted-average life (in years).......................... 2.1 .3 .4
Payment speed............................................. 35.0% 93.5% 93.5%
Expected credit losses (annual rate)...................... 5.7 4.9 4.8
Discount rate on cash flows............................... 10.0 9.0 10.0
Cost of funds............................................. 3.0 1.5 1.4
---------------
(1) Weighted-average annual rates for securitizations entered into during the
period for securitizations of loans with similar characteristics.
(2) In 2004, auto finance was involved in a securitization which later was
restructured as a secured financing. The initial gain reflected above was
the gain on the initial transaction that remained after the securitization
was restructured, as required under Emerging Issues Task Force Issue No.
02-9.
Certain securitization trusts, such as credit cards, are established at fixed
levels and require frequent sales of new receivables into the trust to replace
receivable run-off. These replenishments totaled $2.5 billion in 2006, $8.8
billion in 2005 and $30.3 billion in 2004.
133
Cash flows received from securitization trusts were as follows:
PERSONAL
REAL ESTATE AUTO CREDIT PRIVATE NON-CREDIT
YEAR ENDED DECEMBER 31, SECURED FINANCE CARD LABEL CARD TOTAL
-------------------------------------------------------------------------------------------------------
(IN MILLIONS)
2006
Proceeds from initial
securitizations...................... $- $ - $ - $ - $ - $ -
Servicing fees received................ - 16 22 - 10 48
Other cash flow received on retained
interests(1)......................... - 97 108 - 18 223
2005
Proceeds from initial
securitizations...................... $- $ - $ - $ - $ - $ -
Servicing fees received................ - 45 97 - 46 188
Other cash flow received on retained
interests(1)......................... - 40 243 - 52 335
2004
Proceeds from initial
securitizations...................... $- $ -(2) $550 $190 $ - $ 740
Servicing fees received................ 1 86 185 93 161 526
Other cash flow received on retained
interests(1)......................... 4 (1) 696 252 80 1,031
---------------
(1) Other cash flows include all cash flows from interest-only strip
receivables, excluding servicing fees.
(2) In 2004, auto finance was involved in a securitization which was later
restructured as a secured financing. These transactions are reported net in
the table above.
At December 31, 2006, the sensitivity of the current fair value of the
interest-only strip receivables to an immediate 10 percent and 20 percent
unfavorable change in assumptions are presented in the table below. These
sensitivities are based on assumptions used to value our interest-only strip
receivables at December 31, 2006.
PERSONAL
AUTO CREDIT NON-CREDIT
FINANCE CARD CARD
-------------------------------------------------------------------------------------------
Carrying value (fair value) of interest-only strip
receivables............................................... $ (4) $ 9 $ 1
Weighted-average life (in years)............................ .7 .3 .3
Payment speed assumption (annual rate)...................... 74.3% 98.9% 99.2%
Impact on fair value of 10% adverse change................ $ - $ (1) $ -
Impact on fair value of 20% adverse change................ (1) (2) -
Expected credit losses (annual rate)........................ 10.0% 3.7% 9.8%
Impact on fair value of 10% adverse change................ $ (2) $ - $ -
Impact on fair value of 20% adverse change................ (3) (1) (1)
Discount rate on residual cash flows (annual rate).......... 10.0% 9.0% 11.0%
Impact on fair value of 10% adverse change................ $ - $ - $ -
Impact on fair value of 20% adverse change................ (1) - -
Variable returns to investors (annual rate)................. - 4.7% 6.0%
Impact on fair value of 10% adverse change................ $ - $ (1) $ -
Impact on fair value of 20% adverse change................ - (1) (1)
These sensitivities are hypothetical and should not be considered to be
predictive of future performance. As the figures indicate, the change in fair
value based on a 10 percent variation in assumptions cannot necessarily be
extrapolated because the relationship of the change in assumption to the change
in fair value may not be
134
linear. Also, in this table, the effect of a variation in a particular
assumption on the fair value of the residual cash flow is calculated
independently from any change in another assumption. In reality, changes in one
factor may contribute to changes in another (for example, increases in market
interest rates may result in lower prepayments) which might magnify or
counteract the sensitivities. Furthermore, the estimated fair values as
disclosed should not be considered indicative of future earnings on these
assets.
Static pool credit losses are calculated by summing actual and projected future
credit losses and dividing them by the original balance of each pool of asset.
Due to the short term revolving nature of credit card receivables, the
weighted-average percentage of static pool credit losses is not considered to be
materially different from the weighted-average charge-off assumptions used in
determining the fair value of our interest-only strip receivables in the table
above. At December 31, 2006, static pool credit losses for auto finance loans
securitized in 2003 were estimated to be 10.0 percent.
Receivables and two-month-and-over contractual delinquency for our owned and
serviced with limited recourse receivables were as follows:
AT DECEMBER 31,
-----------------------------------------------------
2006 2005
------------------------- -------------------------
RECEIVABLES DELINQUENT RECEIVABLES DELINQUENT
OUTSTANDING RECEIVABLES OUTSTANDING RECEIVABLES
--------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
OWNED RECEIVABLES:
First mortgage(1).............................. $ 15 3.01% $ 21 8.41%
Real estate secured............................ 97,761 3.54 82,826 2.72
Auto finance................................... 12,504 3.18 10,704 3.04
Credit card.................................... 27,714 4.57 24,110 3.66
Private label.................................. 2,509 5.31 2,520 5.43
Personal non-credit card....................... 21,367 10.17 19,545 9.40
-------- ----- -------- -----
Total consumer................................. 161,870 4.59 139,726 3.89
Commercial..................................... 166 - 187 -
-------- ----- -------- -----
Total owned receivables.......................... $162,036 4.59% $139,913 3.89%
======== ===== ======== =====
RECEIVABLES SERVICED WITH LIMITED RECOURSE:
Auto finance................................... $ 271 6.64% $ 1,192 7.55%
Credit card.................................... 500 2.00 1,875 1.60
Personal non-credit card....................... 178 14.61 1,007 12.41
-------- ----- -------- -----
Total receivables serviced with limited
recourse....................................... $ 949 5.69% $ 4,074 6.01%
======== ===== ======== =====
---------------
(1) Includes our liquidating legacy first and reverse mortgage portfolios.
135
Average receivables and net charge-offs for our owned and serviced with limited
recourse receivables were as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
2006 2005
------------------------- -------------------------
AVERAGE NET AVERAGE NET
RECEIVABLES CHARGE-OFFS RECEIVABLES CHARGE-OFFS
--------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
OWNED RECEIVABLES:
First mortgage(1).............................. $ 18 1.28% $ 24 .90%
Real estate secured............................ 92,318 1.00 73,097 .76
Auto finance................................... 11,660 3.67 9,074 3.27
Credit card.................................... 25,065 5.56 17,823 7.12
Private label.................................. 2,492 5.80 2,948 4.83
Personal non-credit card....................... 20,611 7.89 17,558 7.88
-------- ----- -------- -----
Total consumer.............................. 152,164 2.97 120,524 3.03
Commercial..................................... 177 .43 231 2.60
-------- ----- -------- -----
Total owned receivables.......................... $152,341 2.97% $120,755 3.03%
======== ===== ======== =====
RECEIVABLES SERVICED WITH LIMITED RECOURSE:
Real estate secured............................ $ - -% $ 23 -%
Auto finance................................... 720 10.28 1,863 10.90
Credit card.................................... 974 3.49 4,871 5.52
Personal non-credit card....................... 498 9.24 2,398 9.84
-------- ----- -------- -----
Total receivables serviced with limited
recourse....................................... $ 2,192 7.03% $ 9,155 7.73%
======== ===== ======== =====
---------------
(1) Includes our liquidating legacy first and reverse mortgage portfolios.
9. PROPERTIES AND EQUIPMENT, NET
--------------------------------------------------------------------------------
AT
DECEMBER 31,
------------------- DEPRECIABLE
2006 2005 LIFE
-----------------------------------------------------------------------------------------------
(IN MILLIONS)
Land........................................................ $ 29 $ 28 -
Buildings and improvements.................................. 315 288 10-40 years
Furniture and equipment..................................... 146 376 3-10
---- ----
Total....................................................... 490 692
Accumulated depreciation and amortization................... 64 234
---- ----
Properties and equipment, net............................... $426 $458
==== ====
Depreciation and amortization expense totaled $115 million in 2006, $131 million
in 2005 and $127 million in 2004.
136
10. INTANGIBLE ASSETS
--------------------------------------------------------------------------------
Intangible assets consisted of the following:
ACCUMULATED CARRYING
DECEMBER 31, 2006 GROSS AMORTIZATION VALUE
----------------------------------------------------------------------------------------------
(IN MILLIONS)
Purchased credit card relationships and related programs.... $1,736 $ 580 $1,156
Retail services merchant relationships...................... 270 203 67
Other loan related relationships............................ 333 135 198
Trade names................................................. 717 13 704
Technology, customer lists and other contracts.............. 282 189 93
------ ------ ------
Total....................................................... $3,338 $1,120 $2,218
====== ====== ======
ACCUMULATED CARRYING
DECEMBER 31, 2005 GROSS AMORTIZATION VALUE
----------------------------------------------------------------------------------------------
(IN MILLIONS)
Purchased credit card relationships and related programs.... $1,736 $442 $1,294
Retail services merchant relationships...................... 270 149 121
Other loan related relationships............................ 326 104 222
Trade names................................................. 717 13 704
Technology, customer lists and other contracts.............. 282 143 139
------ ---- ------
Total....................................................... $3,331 $851 $2,480
====== ==== ======
During the third quarter of 2006, we completed our annual impairment test of
intangible assets. As a result of our testing, we determined that the fair value
of each intangible asset exceeded its carrying value. Therefore we have
concluded that none of our intangible assets are impaired.
Weighted-average amortization periods for our intangible assets as of December
31, 2006 were as follows:
(IN MONTHS)
--------------------------------------------------------------------------
Purchased credit card relationships and related programs.... 106
Retail services merchant relationships...................... 60
Other loan related relationships............................ 109
Technology, customer lists and other contracts.............. 85
Intangible assets........................................... 95
Intangible amortization expense totaled $269 million in 2006, $345 million in
2005 and $363 million in 2004.
The trade names are not subject to amortization as we believe they have
indefinite lives. The remaining acquired intangibles are being amortized as
applicable over their estimated useful lives either on a straight-line basis or
in proportion to the underlying revenues generated. These useful lives range
from 5 years for retail services merchant relationships to approximately 10
years for certain loan related relationships. Our purchased credit card
relationships have estimated residual values of $162 million as of December 31,
2006.
137
Estimated amortization expense associated with our intangible assets for each of
the following years is as follows:
YEAR ENDING DECEMBER 31, (IN MILLIONS)
---------------------------------------------------------------------------
2007........................................................ $253
2008........................................................ 211
2009........................................................ 198
2010........................................................ 169
2011........................................................ 169
Thereafter.................................................. 354
11. 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 at the date
of our acquisition by HSBC or our acquisition of Metris are adjusted against
goodwill pursuant to Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes."
Changes in the carrying amount of goodwill are as follows:
2006 2005
-----------------------------------------------------------------------------
(IN MILLIONS)
Balance at beginning of year................................ $7,003 $6,856
Adjustment to Metris purchase price......................... 21 -
Acquisitions - 2006 Solstice; 2005 primarily Metris......... 46 533
Goodwill allocated to our European Operations sold to
HBEU...................................................... (13) -
Goodwill allocated to the U.K. credit card business sold to
HBEU...................................................... - (218)
Change in estimate of the tax basis of assets and
liabilities recorded in the HSBC acquisition.............. (89) (76)
Change in estimate of the tax basis of assets and
liabilities recorded in the Metris acquisition............ (13) -
Impact of foreign currency translation...................... 55 (92)
------ ------
Balance at end of year...................................... $7,010 $7,003
====== ======
Goodwill established as a result of our acquisition by HSBC has not been
allocated to or included in the reported results of our reportable segments as
the acquisition by HSBC was outside of the ongoing operational activities of our
reportable segments. This is consistent with management's view of our reportable
segment results. Goodwill relating to acquisitions, such as Metris and Solstice
are included in the reported respective segment results as these acquisitions
specifically related to the operations and is consistent with management's view
of the segment results. See Note 21, "Business Segments," for further
information on goodwill by reportable segment.
During the third quarter of 2006, we completed our annual impairment test of
goodwill. For purposes of this test, we assigned the goodwill established as a
result of our acquisition by HSBC to our reporting units (as defined in SFAS No.
142, "Goodwill and Other Intangible Assets"). The fair value of each of the
reporting units to which goodwill was assigned exceeded its carrying value
including goodwill, resulting in a conclusion that none of our goodwill is
impaired.
As required by SFAS No. 142, "Goodwill and Other Intangible Assets," subsequent
to the sale of our European Operations we performed an interim goodwill
impairment test for our remaining U.K. operations. As the estimated fair value
of our remaining U.K. operations exceeded its carrying value subsequent to the
sale, we concluded that the remaining goodwill assigned to this reporting unit
was not impaired. As previously
138
reported, we continue to evaluate the scope of our U.K. operations and, as a
result, it is reasonably possible we could make changes in the future.
As a result of the adverse change in the business climate experienced by our
Mortgage Services business in the second half of 2006, we performed an interim
goodwill impairment test for this reporting unit as of December 31, 2006. As the
estimated fair value of our Mortgage Services business exceeded our carrying
value, we concluded that the remaining goodwill assigned to this reporting unit
was not impaired. We are currently evaluating the most effective structure for
our Mortgage Services operations which, depending upon the outcome, may change
the scope and size of this business going forward.
12. COMMERCIAL PAPER, BANK AND OTHER BORROWINGS
--------------------------------------------------------------------------------
COMMERCIAL BANK AND OTHER
PAPER BORROWINGS TOTAL
-------------------------------------------------------------------------------------------------
(IN MILLIONS)
2006
Balance................................................... $11,012 $ 43 $11,055
Highest aggregate month-end balance....................... 17,530
Average borrowings........................................ 12,344 494 12,838
Weighted-average interest rate:
At year-end............................................. 5.3% 2.8% 5.3%
Paid during year........................................ 5.0 3.3 4.9
2005
Balance................................................... $11,360 $ 94 $11,454
Highest aggregate month-end balance....................... 14,801
Average borrowings........................................ 11,877 111 11,988
Weighted-average interest rate:
At year-end............................................. 4.2% 3.9% 4.2%
Paid during year........................................ 3.4 2.5 3.4
2004
Balance................................................... $ 8,969 $ 91 $ 9,060
Highest aggregate month-end balance....................... 16,173
Average borrowings........................................ 11,403 126 11,529
Weighted-average interest rate:
At year-end............................................. 2.2% 2.5% 2.2%
Paid during year........................................ 1.8 1.9 1.8
Commercial paper included obligations of foreign subsidiaries of $223 million at
December 31, 2006, $442 million at December 31, 2005 and $248 million at
December 31, 2004. Bank and other borrowings included obligations of foreign
subsidiaries of $35 million at December 31, 2006, $55 million at December 31,
2005 and $52 million at December 31, 2004. At December 31, 2006 deposits of $36
million, primarily held by our U.K. business, have been classified as bank and
other borrowings due to their short-term nature. Prior period amounts have been
reclassified to conform to the current presentation.
Interest expense for commercial paper, bank and other borrowings totaled $628
million in 2006, $402 million in 2005 and $213 million in 2004.
We maintain various bank credit agreements primarily to support commercial paper
borrowings and also to provide funding in the U.K. We had committed back-up
lines and other bank lines of $17.0 billion at December 31, 2006, including $7.7
billion with HSBC and subsidiaries and $16.3 billion at December 31, 2005,
including $8.0 billion with HSBC and subsidiaries. Our U.K. subsidiary had drawn
$4.3 billion at December 31, 2006 and $4.2 billion on its bank lines of credit
at December 31, 2005 which are included in
139
Due to Affiliates for both periods. Formal credit lines are reviewed annually
and expire at various dates through 2009. Borrowings under these lines generally
are available at a surcharge over LIBOR. The most restrictive financial
covenants contained in the back-up line agreements that could restrict
availability is an obligation to maintain minimum common and preferred
shareholder's equity of $11.0 billion which is substantially below our December
31, 2006 common and preferred shareholders' equity balance of $20.1 billion.
Because our U.K. subsidiary receives its funding directly from HSBC, we
eliminated all third-party back-up lines at our U.K. subsidiary in 2004. Annual
commitment fee requirements to support availability of these lines at December
31, 2006 totaled $8 million and included $1 million for the HSBC lines. Annual
commitment fee requirements to support availability of these lines at December
31, 2005 totaled $9 million and included $2 million for the HSBC lines.
13. LONG TERM DEBT (WITH ORIGINAL MATURITIES OVER ONE YEAR)
--------------------------------------------------------------------------------
AT DECEMBER 31,
--------------------
2006 2005
----------------------------------------------------------------------------------
(IN MILLIONS)
SENIOR DEBT
FIXED RATE:
8.875% Adjustable Conversion-Rate Equity Security
Units................................................. $ 542 $ 541
Secured financings:
3.00% to 3.99%; due 2007 to 2008..................... 195 3,947
4.00% to 4.49%; due 2007 to 2010..................... 1,312 2,254
4.50% to 4.99%; due 2007 to 2011..................... 3,956 1,024
Other fixed rate senior debt:
2.40% to 3.99%; due 2007 to 2010..................... 6,880 2,864
4.00% to 4.99%; due 2007 to 2023..................... 16,806 21,902
5.00% to 5.49%; due 2007 to 2023..................... 16,657 6,188
5.50% to 5.99%; due 2007 to 2024..................... 16,031 7,188
6.00% to 6.49%; due 2007 to 2033..................... 9,591 8,453
6.50% to 6.99%; due 2007 to 2033..................... 4,981 8,076
7.00% to 7.49%; due 2007 to 2032..................... 3,364 4,587
7.50% to 7.99%; due 2007 to 2032..................... 3,249 4,906
8.00% to 9.00%; due 2007 to 2012..................... 1,263 1,244
VARIABLE INTEREST RATE:
Secured financings - 2.63% to 5.28%; due 2007 to
2010.................................................. 16,364 7,893
Other variable interest rate senior debt - 2.16% to
6.73%; due 2007 to 2018............................... 24,666 21,488
JUNIOR SUBORDINATED NOTES ISSUED TO CAPITAL TRUSTS.......... 1,031 1,443
UNAMORTIZED DISCOUNT........................................ (377) (341)
HSBC ACQUISITION PURCHASE ACCOUNTING FAIR VALUE
ADJUSTMENTS............................................... 1,079 1,506
-------- --------
TOTAL LONG TERM DEBT........................................ $127,590 $105,163
======== ========
HSBC acquisition purchase accounting fair value adjustments represent
adjustments which have been "pushed down" to record our long term debt at fair
value at the date of our acquisition by HSBC.
Secured financings of $21.8 billion at December 31, 2006 are secured by $28.1
billion of real estate secured, auto finance, credit card and personal
non-credit card receivables. Secured financings of $15.1 billion at December 31,
2005 are secured by $19.7 billion of real estate secured, auto finance and
credit card receivables.
140
At December 31, 2006, long term debt included carrying value adjustments
relating to derivative financial instruments which decreased the debt balance by
$1.3 billion and a foreign currency translation adjustment relating to our
foreign denominated debt which increased the debt balance by $2.4 billion. At
December 31, 2005, long term debt included carrying value adjustments relating
to derivative financial instruments which decreased the debt balance by $862
million and a foreign currency translation adjustment relating to our foreign
denominated debt which increased the debt balance by $272 million.
Weighted-average interest rates were 5.5 percent at December 31, 2006 and 5.3
percent at December 31, 2005 (excluding HSBC acquisition purchase accounting
adjustments). Interest expense for long term debt was $5.8 billion in 2006, $3.7
billion in 2005, $2.6 billion in 2004. The most restrictive financial covenants
contained in the terms of our debt agreements are the maintenance of a minimum
common and preferred shareholder's equity of $11.0 billion which is
substantially lower than our common and preferred shareholders' equity balance
of $20.1 billion at December 31, 2006. Debt denominated in a foreign currency is
included in the applicable rate category based on the effective U.S. dollar
equivalent rate as summarized in Note 14, "Derivative Financial Instruments."
In 2002, we issued $541 million of 8.875 percent Adjustable Conversion-Rate
Equity Security Units. Each Adjustable Conversion-Rate Equity Security Unit
consisted initially of a contract to purchase, for $25, a number of shares of
HSBC Finance Corporation (formerly known as Household International, Inc.)
common stock on February 15, 2006 and a senior note issued by our then wholly
owned subsidiary, Household Finance Corporation, with a principal amount of $25.
In November 2005 we remarketed the notes and reset the rate. All remaining stock
purchase contracts matured on February 15, 2006 and HSBC issued ordinary shares
for the remaining stock purchase contracts on that date.
The following table summarizes our junior subordinated notes issued to capital
trusts ("Junior Subordinated Notes") and the related company obligated
mandatorily redeemable preferred securities ("Preferred Securities"):
HOUSEHOLD CAPITAL
TRUST IX
("HCT IX")
-------------------------------------------------------------------------------
(DOLLARS ARE
IN MILLIONS)
JUNIOR SUBORDINATED NOTES:
Principal balance......................................... $ 1,031
Interest rate............................................. 5.91%
Redeemable by issuer...................................... November 2015
Stated maturity........................................... November 2035
PREFERRED SECURITIES:
Rate...................................................... 5.91%
Face value................................................ $ 1,000
Issue date................................................ November 2005
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. In the fourth quarter of 2006, we redeemed the junior subordinated
notes issued to Household Capital Trust VII with an outstanding principal
balance of $206 million.
The Preferred Securities must be redeemed when the Junior Subordinated Notes are
paid. The Junior Subordinated Notes have a stated maturity date, but are
redeemable by us, in whole or in part, beginning on the dates indicated above at
which time the Preferred Securities are callable at par ($25 per Preferred
Security) plus accrued and unpaid dividends. Dividends on the Preferred
Securities are cumulative, payable quarterly in arrears, and are deferrable at
our option for up to five years. We cannot pay dividends on our preferred and
common stocks during such deferments. The Preferred Securities have a
liquidation value of $25 per preferred security. Our obligations with respect to
the Junior Subordinated Notes, when considered
141
together with certain undertakings of HSBC Finance Corporation with respect to
the Trusts, constitute full and unconditional guarantees by us of the Trusts'
obligations under the respective Preferred Securities.
Maturities of long term debt at December 31, 2006 were as follows:
(IN MILLIONS)
---------------------------------------------------------------------------
2007........................................................ $ 26,555
2008........................................................ 22,136
2009........................................................ 17,128
2010........................................................ 12,824
2011........................................................ 13,960
Thereafter.................................................. 34,987
--------
Total....................................................... $127,590
========
Certain components of our long term debt may be redeemed prior to its stated
maturity.
14. DERIVATIVE FINANCIAL INSTRUMENTS
--------------------------------------------------------------------------------
Our business activities involve analysis, evaluation, acceptance and management
of some degree of risk or combination of risks. Accordingly, we have
comprehensive risk management policies to address potential financial risks,
which include credit risk (which includes counterparty credit risk), liquidity
risk, market risk, and operational risks. Our risk management policy is designed
to identify and analyze these risks, to set appropriate limits and controls, and
to monitor the risks and limits continually by means of reliable and up-to-date
administrative and information systems. Our risk management policies are
primarily carried out in accordance with practice and limits set by the HSBC
Group Management Board. The HSBC Finance Corporation Asset Liability Committee
("ALCO") meets regularly to review risks and approve appropriate risk management
strategies within the limits established by the HSBC Group Management Board.
Additionally, our Audit Committee receives regular reports on our liquidity
positions in relation to the established limits. In accordance with the policies
and strategies established by ALCO, in the normal course of business, we enter
into various transactions involving derivative financial instruments. These
derivative financial instruments primarily are used to manage our market risk.
For further information on our strategies for managing interest rate and foreign
exchange rate risk, see the "Risk Management" section within our Management's
Discussion and Analysis of Financial Condition and Results of Operations.
OBJECTIVES FOR HOLDING DERIVATIVE FINANCIAL INSTRUMENTS Market risk (which
includes interest rate and foreign currency exchange risks) is the possibility
that a change in interest rates or foreign exchange rates will cause a financial
instrument to decrease in value or become more costly to settle. Customer demand
for our receivable products shifts between fixed rate and floating rate
products, based on market conditions and preferences. These shifts in loan
products result in different funding strategies and produce different interest
rate risk exposures. We maintain an overall risk management strategy that uses a
variety of interest rate and currency derivative financial instruments to
mitigate our exposure to fluctuations caused by changes in interest rates and
currency exchange rates. We manage our exposure to interest rate risk primarily
through the use of interest rate swaps, but also use forwards, futures, options,
and other risk management instruments. We manage our exposure to foreign
currency exchange risk primarily through the use of currency swaps, options and
forwards. We do not use leveraged derivative financial instruments for interest
rate risk management.
Interest rate swaps are contractual agreements between two counterparties for
the exchange of periodic interest payments generally based on a notional
principal amount and agreed-upon fixed or floating rates. The majority of our
interest rate swaps are used to manage our exposure to changes in interest rates
by converting floating rate debt to fixed rate or by converting fixed rate debt
to floating rate. We have also entered into currency swaps to convert both
principal and interest payments on debt issued from one currency to the
appropriate functional currency.
142
Forwards and futures are agreements between two parties, committing one to sell
and the other to buy a specific quantity of an instrument on some future date.
The parties agree to buy or sell at a specified price in the future, and their
profit or loss is determined by the difference between the arranged price and
the level of the spot price when the contract is settled. We have used both
interest rate and foreign exchange rate forward contracts as well as interest
rate futures contracts. We use foreign exchange rate forward contracts to reduce
our exposure to foreign currency exchange risk. Interest rate forward and
futures contracts are used to hedge resets of interest rates on our floating
rate assets and liabilities. Cash requirements for forward contracts include the
receipt or payment of cash upon the sale or purchase of the instrument.
Purchased options grant the purchaser the right, but not the obligation, to
either purchase or sell a financial instrument at a specified price within a
specified period. The seller of the option has written a contract which creates
an obligation to either sell or purchase the financial instrument at the
agreed-upon price if, and when, the purchaser exercises the option. We use caps
to limit the risk associated with an increase in rates and floors to limit the
risk associated with a decrease in rates.
CREDIT RISK By utilizing derivative financial instruments, we are exposed to
counterparty credit risk. Counterparty credit risk is our primary exposure on
our interest rate swap portfolio. Counterparty credit risk is the risk that the
counterparty to a transaction fails to perform according to the terms of the
contract. We control the counterparty credit (or repayment) risk in derivative
instruments through established credit approvals, risk control limits,
collateral, and ongoing monitoring procedures. Our exposure to credit risk for
futures is limited as these contracts are traded on organized exchanges. Each
day, changes in futures contract values are settled in cash. In contrast, swap
agreements and forward contracts have credit risk relating to the performance of
the counterparty. We utilize an affiliate, HSBC Bank USA, as the primary
provider of new domestic derivative products. We have never suffered a loss due
to counterparty failure.
At December 31, 2006, most of our existing derivative contracts are with HSBC
subsidiaries, making them our primary counterparty in derivative transactions.
Most swap agreements require that payments be made to, or received from, the
counterparty when the fair value of the agreement reaches a certain level.
Generally, third-party swap counterparties provide collateral in the form of
cash which is recorded in our balance sheet as other assets or derivative
related liabilities and totaled a net liability of $158 million at December 31,
2006 for third-party counterparties. Beginning in the second quarter of 2006,
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 cash and
recorded on the balance sheet, consistent with third party arrangements.
Previously, the posting of collateral by affiliates was provided in the form of
securities, which were not recorded on our balance sheet. Also during 2006, we
lowered the fair value of our agreements with affiliate counterparties above
which collateral is required to be posted to $75 million. At December 31, 2006,
the fair value of our agreements with affiliate counterparties required the
affiliate to provide cash collateral of $1.0 billion which is recorded in our
balance sheet as a component of derivative related liabilities. At December 31,
2006, we had derivative contracts with a notional value of approximately $94.4
billion, including $86.3 billion outstanding with HSBC Bank USA. Derivative
financial instruments are generally expressed in terms of notional principal or
contract amounts which are much larger than the amounts potentially at risk for
nonpayment by counterparties.
FAIR VALUE AND CASH FLOW HEDGES To manage our exposure to changes in interest
rates, we enter into interest rate swap agreements and currency swaps which have
been designated as fair value or cash flow hedges under SFAS No. 133. Prior to
the acquisition by HSBC, the majority of our fair value and cash flow hedges
were effective hedges which qualified for the shortcut method of accounting.
Under the Financial Accounting Standards Board's interpretations of SFAS No.
133, the shortcut method of accounting was no longer allowed for interest rate
swaps which were outstanding at the time of the acquisition by HSBC. As a result
of the acquisition, we were required to reestablish and formally document the
hedging relationship associated with all of our fair value and cash flow hedging
instruments and assess the effectiveness of each hedging relationship, both at
inception of the hedge relationship and on an ongoing basis. Due to deficiencies
in our contemporaneous hedge documentation at the time of acquisition, we lost
the ability to apply hedge accounting to our entire cash flow and fair value
hedging portfolio that existed at the time of acquisition by HSBC. During 2005,
we reestablished hedge treatment under the long haul method of accounting for a
significant number of the
143
derivatives in this portfolio. We currently utilize the long-haul method to test
effectiveness of all derivatives designated as hedges.
Fair value hedges include interest rate swaps which convert our fixed rate debt
to variable rate debt and currency swaps which convert debt issued from one
currency into pay variable debt of the appropriate functional currency. Hedge
ineffectiveness associated with fair value hedges is recorded in other revenues
as derivative income and was a gain of $252 million ($159 million after tax) in
2006, a gain of $117 million ($75 million after tax) in 2005 and a gain of $.6
million ($.4 million after tax) in 2004. All of our fair value hedges were
associated with debt during 2006, 2005 and 2004. We recorded fair value
adjustments for unexpired fair value hedges which decreased the carrying value
of our debt by $292 million at December 31, 2006 and $695 million at December
31, 2005.
Cash flow hedges include interest rate swaps which convert our variable rate
debt to fixed rate debt and currency swaps which convert debt issued from one
currency into pay fixed debt of the appropriate functional currency. Gains and
(losses) on unexpired derivative instruments designated as cash flow hedges (net
of tax) are reported in accumulated other comprehensive income and totaled a
gain of $256 million ($161 million after tax) at December 31, 2006 and $237
million ($151 million after tax) at December 31, 2005. We expect $121 million
($76 million after tax) of currently unrealized net gains will be reclassified
to earnings within one year, however, these unrealized gains will be offset by
increased interest expense associated with the variable cash flows of the hedged
items and will result in no significant net economic impact to our earnings.
Hedge ineffectiveness associated with cash flow hedges recorded in other
revenues as derivative income was a loss of $83 million ($53 million after tax)
in 2006, a loss of $76 million ($49 million after tax) in 2005 and was
immaterial in 2004.
At December 31, 2006, $1,461 million of derivative instruments, at fair value,
were recorded as derivative financial assets and $58 million as derivative
related liabilities. At December 31, 2005, $234 million of derivative
instruments, at fair value, were recorded in derivative financial assets and
$292 million in derivative related liabilities.
Information related to deferred gains and losses before taxes on terminated
derivatives was as follows:
2006 2005
----------------------------------------------------------------------------------
(IN MILLIONS)
Deferred gains.............................................. $ 156 $ 180
Deferred losses............................................. 176 196
Weighted-average amortization period:
Deferred gains............................................ 7 years 6 years
Deferred losses........................................... 6 years 6 years
Increases (decreases) to carrying values resulting from net
deferred gains and losses:
Long term debt............................................ $ (47) $ (25)
Accumulated other comprehensive income.................... 27 9
144
Information related to deferred gains and losses before taxes on discontinued
hedges was as follows:
2006 2005
----------------------------------------------------------------------------------
(IN MILLIONS)
Deferred gains.............................................. $ 269 $ 331
Deferred losses............................................. 1,052 232
Weighted-average amortization period:
Deferred gains............................................ 5 years 4 years
Deferred losses........................................... 5 years 5 years
Increases (decreases) to carrying values resulting from net
deferred gains and losses:
Long term debt............................................ $ (941) $ (76)
Accumulated other comprehensive income.................... 158 175
Amortization of net deferred gains (losses) totaled ($80) million in 2006, ($12)
million in 2005, ($23) million in 2004.
NON-QUALIFYING HEDGING ACTIVITIES We may use forward rate agreements, interest
rate caps, exchange traded options, and interest rate and currency swaps which
are not designated as hedges under SFAS No. 133, either because they do not
qualify as effective hedges or because we lost the ability to apply hedge
accounting following our acquisition by HSBC as discussed above. These financial
instruments are economic hedges but do not qualify for hedge accounting and are
primarily used to minimize our exposure to changes in interest rates and
currency exchange rates. Unrealized and realized gains (losses) on derivatives
which were not designated as hedges are reported in other revenues as derivative
income and totaled $21 million ($14 million after tax) in 2006, $208 million
($133 million after tax) in 2005 and $510 million ($324 million after tax) in
2004.
DERIVATIVE INCOME Derivative income as discussed above includes realized and
unrealized gains and losses on derivatives which do not qualify as effective
hedges under SFAS No. 133 as well as the ineffectiveness on derivatives
associated with our qualifying hedges and is summarized in the table below:
2006 2005 2004
--------------------------------------------------------------------------------
(IN MILLIONS)
Net realized gains (losses)................................. $ (7) $ 52 $ 68
Mark-to-market on derivatives which do not qualify as
effective hedges.......................................... 28 156 442
Ineffectiveness............................................. 169 41 1
---- ---- ----
Total....................................................... $190 $249 $511
==== ==== ====
Net income volatility, whether based on changes in interest rates for swaps
which do not qualify for hedge accounting or ineffectiveness recorded on our
qualifying hedges under the long-haul method of accounting, impacts the
comparability of our reported results between periods. Accordingly, derivative
income for the year ended December 31, 2006 should not be considered indicative
of the results for any future periods.
145
DERIVATIVE FINANCIAL INSTRUMENTS The following table summarizes derivative
financial instrument activity:
EXCHANGE TRADED NON-EXCHANGE TRADED
------------------------------ ------------------------------------------
INTEREST RATE FOREIGN EXCHANGE
FUTURES CONTRACTS INTEREST RATE CONTRACTS
------------------ OPTIONS RATE CURRENCY --------------------
PURCHASED SOLD PURCHASED SWAPS SWAPS PURCHASED SOLD
-------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
2006
Notional amount, 2005........... $ - $ - $ 4,870 $ 49,468 $21,719 $ 1,633 $ 465
New contracts................... - - - - - - -
New contracts purchased from
subsidiaries of HSBC........... - - 20,205 61,205 8,687 2,071 5,694
Matured or expired contracts.... - - (17,675) (5,319) (4,291) (2,851) (5,710)
Terminated contracts............ - - (2,800) (49,571) - - -
Change in Notional amount....... - - - 1,217 (1,274) - -
Change in foreign exchange
rate........................... - - - - - 221 134
In-substance maturities(1)...... - - - - - - -
Assignment of contracts to
subsidiaries of HSBC........... - - - - - - -
- - - - - - -
---- ---- ------- -------- ------- -------- --------
Notional amount, 2006........... $ - $ - $ 4,600 $ 57,000 $24,841 $ 1,074 $ 583
==== ==== ======= ======== ======= ======== ========
Fair value, 2006(3):
Fair value hedges.............. $ - $ - $ - $ (740) $ (26) $ - $ -
Cash flow hedges............... - - - 14 1,976 - -
Net investment in foreign
operations................... - - - - - - -
Non-hedging derivatives........ - - - (64) 244 4 (6)
---- ---- ------- -------- ------- -------- --------
Total.......................... $ - $ - $ - $ (790) $ 2,194 $ 4 $ (6)
==== ==== ======= ======== ======= ======== ========
2005
Notional amount, 2004........... $ - $ - $ 1,691 $ 45,253 $18,150 $ 1,146 $ 614
New contracts................... - - - 1 - - -
New contracts purchased from
subsidiaries of HSBC........... - - 5,570 25,373 6,824 1,113 4,860
Matured or expired contracts.... - - (2,391) (5,657) (3,255) (482) (4,762)
Terminated contracts............ - - - (15,502) - (144) (247)
In-substance maturities(1)...... - - - - - - -
Assignment of contracts to
subsidiaries of HSBC........... - - - - - - -
- - - - - - -
---- ---- ------- -------- ------- -------- --------
Notional amount, 2005........... $ - $ - $ 4,870 $ 49,468 $21,719 $ 1,633 $ 465
==== ==== ======= ======== ======= ======== ========
Fair value, 2005(3):
Fair value hedges.............. $ - $ - $ - $ (612) $ (178) $ - $ -
Cash flow hedges............... - - - 103 658 (22) -
Net investment in foreign
operations................... - - - - - - -
Non-hedging derivatives........ - - - (31) 24 - -
---- ---- ------- -------- ------- -------- --------
Total.......................... $ - $ - $ - $ (540) $ 504 $ (22) $ -
==== ==== ======= ======== ======= ======== ========
2004
Notional amount, 2003........... $ - $ - $ 1,900 $ 41,312 $16,538 $ 1,223 $ 594
New contracts................... - - - - - 1,628 1,432
New contracts purchased from
subsidiaries of HSBC........... - - 3,491 29,607 11,457 17,988 8,778
Matured or expired contracts.... - - (3,700) (7,568) (1,407) (14,343) (4,840)
Terminated contracts............ - - - (7,211) (5,333) - -
In-substance maturities(1)...... - - - - - (5,350) (5,350)
Assignment of contracts to
subsidiaries of HSBC........... - - - (10,887) (3,105) - -
---- ---- ------- -------- ------- -------- --------
Notional amount, 2004........... $ - $ - $ 1,691 $ 45,253 $18,150 $ 1,146 $ 614
==== ==== ======= ======== ======= ======== ========
Fair value, 2004(3):
Fair value hedges.............. $ - $ - $ - $ (46) $ - $ - $ (2)
Cash flow hedges............... - - - 12 403 24 -
Non-hedging derivatives........ - - - (81) 3,670 - -
---- ---- ------- -------- ------- -------- --------
Total.......................... $ - $ - $ - $ (115) $ 4,073 $ 24 $ (2)
==== ==== ======= ======== ======= ======== ========
NON-EXCHANGE TRADED
----------------------------
INTEREST RATE
FORWARD CONTRACTS CAPS
------------------ AND
PURCHASED SOLD FLOORS TOTAL
-------------------------------- ---------------------------------------
(IN MILLIONS)
2006
Notional amount, 2005........... $ 172 $ - $10,700 $ 89,027
New contracts................... - - - -
New contracts purchased from
subsidiaries of HSBC........... 1,344 - 65 99,271
Matured or expired contracts.... - - (4,505) (40,351)
Terminated contracts............ (1,516) - - (53,887)
Change in Notional amount....... - - - (57)
Change in foreign exchange
rate........................... - - - 355
In-substance maturities(1)...... - - - -
Assignment of contracts to
subsidiaries of HSBC........... - - - -
- - - -
------- ---- ------- --------
Notional amount, 2006........... $ 0 $ - $ 6,260 $ 94,358
======= ==== ======= ========
Fair value, 2006(3):
Fair value hedges.............. $ - $ - $ - $ (766)
Cash flow hedges............... - - - 1,990
Net investment in foreign
operations................... - - - -
Non-hedging derivatives........ - - 1 179
------- ---- ------- --------
Total.......................... $ - $ - $ 1 $ 1,403
======= ==== ======= ========
2005
Notional amount, 2004........... $ 374 $ - $ 4,380 $ 71,608
New contracts................... - - 30 31
New contracts purchased from
subsidiaries of HSBC........... 1,707 - 8,433 53,880
Matured or expired contracts.... - - (1,894) (18,441)
Terminated contracts............ (1,909) - (249) (18,051)
In-substance maturities(1)...... - - - -
Assignment of contracts to
subsidiaries of HSBC........... - - - -
- - - -
------- ---- ------- --------
Notional amount, 2005........... $ 172 $ - $10,700 $ 89,027
======= ==== ======= ========
Fair value, 2005(3):
Fair value hedges.............. $ - $ - $ - $ (790)
Cash flow hedges............... - - - 739
Net investment in foreign
operations................... - - - -
Non-hedging derivatives........ - - - (7)
------- ---- ------- --------
Total.......................... $ - $ - $ - $ (58)
======= ==== ======= ========
2004
Notional amount, 2003........... $ 174 $ - $ 6,627 $ 68,368
New contracts................... - - - 3,060
New contracts purchased from
subsidiaries of HSBC........... 1,643 - 444 73,408
Matured or expired contracts.... (1,443) - (2,691) (35,992)
Terminated contracts............ - - - (12,544)
In-substance maturities(1)...... - - - (10,700)
Assignment of contracts to
subsidiaries of HSBC........... - - - (13,992)
------- ---- ------- --------
Notional amount, 2004........... $ 374 $ - $ 4,380 $ 71,608
======= ==== ======= ========
Fair value, 2004(3):
Fair value hedges.............. $ - $ - $ - $ (48)
Cash flow hedges............... - - - 439
Non-hedging derivatives........ - - - 3,589
------- ---- ------- --------
Total.......................... $ - $ - $ - $ 3,980
======= ==== ======= ========
---------------
(1) Represent contracts terminated as the market execution technique of closing
the transaction either (a) just prior to maturity to avoid delivery of the
underlying instrument or (b) at the maturity of the underlying items being
hedged.
(2) Under the Financial Accounting Standards Board's interpretations of SFAS No.
133, the shortcut method of accounting was no longer allowed for interest
rate swaps which were outstanding at the time of the acquisition by HSBC.
(3) (Bracketed) unbracketed amounts represent amounts to be (paid) received by
us had these positions been closed out at the respective balance sheet date.
Bracketed amounts do not necessarily represent risk of loss as the fair
value of the derivative financial instrument and the items being hedged must
be evaluated together. See Note 23, "Fair Value of Financial Instruments,"
for further discussion of the relationship between the fair value of our
assets and liabilities.
146
We operate in three functional currencies, the U.S. dollar, the British pound
and the Canadian dollar. The U.S. dollar is the functional currency for
exchange-traded interest rate futures contracts and options. Non-exchange traded
instruments are restated in U.S. dollars by country as follows:
FOREIGN EXCHANGE INTEREST RATE
RATE CONTRACTS FORWARD OTHER RISK
INTEREST RATE CURRENCY ---------------- CONTRACTS MANAGEMENT
SWAPS SWAPS PURCHASED SOLD PURCHASED INSTRUMENTS
---------------------------------------------------------------------------------------------------------
(IN MILLIONS)
2006
United States................. $54,703 $24,841 $1,068 $571 $ - $ 6,260
Canada........................ 1,207 - 6 12 - -
United Kingdom................ 1,090 - - - - -
------- ------- ------ ---- ---- -------
$57,000 $24,841 $1,074 $583 $ - $ 6,260
======= ======= ====== ==== ==== =======
2005
United States................. $47,693 $21,175 $1,622 $465 $ - $10,700
Canada........................ 855 - 11 - 172 -
United Kingdom................ 920 544 - - - -
------- ------- ------ ---- ---- -------
$49,468 $21,719 $1,633 $465 $172 $10,700
======= ======= ====== ==== ==== =======
2004
United States................. $42,365 $17,543 $1,146 $599 $ - $ 4,345
Canada........................ 582 - - 15 374 -
United Kingdom................ 2,306 607 - - - 35
------- ------- ------ ---- ---- -------
$45,253 $18,150 $1,146 $614 $374 $ 4,380
======= ======= ====== ==== ==== =======
Long term debt hedged using derivative financial instruments which qualify for
hedge accounting at December 31, 2006 included debt of $51.0 billion hedged by
interest rate swaps and debt of $22.7 billion hedged by currency swaps. The
significant terms of the derivative financial instruments have been designed to
match those of the related asset or liability.
The following table summarizes the maturities and related weighted-average
receive/pay rates of interest rate swaps outstanding at December 31, 2006:
2007 2008 2009 2010 2011 2012 THEREAFTER TOTAL
------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
PAY A FIXED RATE/RECEIVE A
FLOATING RATE:
Notional value.............. $8,650 $10,220 $ 6,963 $ 232 $ 153 $ 15 $ 436 $26,669
Weighted-average receive
rate...................... 5.34% 5.36% 5.05% 2.08% 2.08% 2.06% 2.14% 5.17%
Weighted-average pay rate... 4.75 5.03 5.17 4.10 4.36 4.21 4.98 4.96
------ ------- ------- ------ ------ ------ ------- -------
PAY A FLOATING RATE/RECEIVE A
FIXED RATE:
Notional value.............. $ 484 $ 2,584 $ 5,657 $3,119 $5,550 $3,159 $ 9,778 $30,331
Weighted-average receive
rate...................... 3.13 3.71 4.19 4.28 4.55 4.45 5.18 4.56
Weighted-average pay rate... 5.38 5.30 5.12 5.38 5.45 5.37 5.31 5.31
------ ------- ------- ------ ------ ------ ------- -------
Total notional value........ $9,134 $12,804 $12,620 $3,351 $5,703 $3,174 $10,214 $57,000
====== ======= ======= ====== ====== ====== ======= =======
TOTAL WEIGHTED-AVERAGE RATES
ON SWAPS:
Receive rate................ 5.22% 5.03% 4.67% 4.13% 4.48% 4.44% 5.05% 4.84%
Pay rate.................... 4.78 5.08 5.15 5.29 5.42 5.37 5.29 5.15
147
The floating rates that we pay or receive are based on spot rates from
independent market sources for the index contained in each interest rate swap
contract, which generally are based on either 1, 3 or 6-month LIBOR. These
current floating rates are different than the floating rates in effect when the
contracts were initiated. Changes in spot rates impact the variable rate
information disclosed above. However, these changes in spot rates also impact
the interest rate on the underlying assets or liabilities.
In addition to the information included in the tables above, we had unused
commitments to extend credit related to real estate secured loans totaling $1.4
billion at December 31, 2006 and $1.4 billion at December 31, 2005. Commitments
to extend credit are agreements, with fixed expiration dates, to lend to a
customer as long as there is no violation of any condition established in the
agreement. These commitments are considered derivative instruments in accordance
with SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities" ("SFAS No. 149) and, as a result, are recorded on our
balance sheet at fair market value which resulted in a liability of $2.7 million
at December 31, 2006 and a liability of $.3 million at December 31 2005.
We also had outstanding forward sales commitments related to real estate secured
loans totaling $607 million at December 31, 2006 and $450 million as of December
31, 2005. Forward sales commitments are considered derivative instruments under
SFAS No. 149 and, as a result, are recorded on our balance sheet at fair market
value which resulted in an asset of $1.4 million at December 31, 2006 and an
asset of $.4 million at December 31, 2005.
15. INCOME TAXES
--------------------------------------------------------------------------------
Total income taxes were:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2006 2005 2004
----------------------------------------------------------------------------------------------------
(IN MILLIONS)
Provision for income taxes related to operations........ $ 844 $891 $1,000
Income taxes related to adjustments included in common
shareholder's equity:
Unrealized gains (losses) on investments and
interest-only strip receivables, net............... (11) (29) (71)
Unrealized gains (losses) on cash flow hedging
instruments........................................ (192) 74 61
Minimum pension liability............................. - 2 (2)
Adjustment to initially apply FASB Statement No.
158................................................ 1 - -
Foreign currency translation adjustments.............. (9) (6) 12
Exercise of stock based compensation.................. (21) (9) (18)
Tax on sale of European Operations to affiliate....... 3 - -
Tax on sale of U.K. credit card business to
affiliate.......................................... - (21) -
----- ---- ------
Total................................................... $ 615 $902 $ 982
===== ==== ======
148
Provisions for income taxes related to operations were:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2006 2005 2004
----------------------------------------------------------------------------------------------------
(IN MILLIONS)
CURRENT
United States........................................... $1,396 $1,253 $ 593
Foreign................................................. 8 4 59
------ ------ ------
Total current........................................... 1,404 1,257 652
------ ------ ------
DEFERRED
United States........................................... (541) (396) 348
Foreign................................................. (19) 30 -
------ ------ ------
Total deferred.......................................... (560) (366) 348
------ ------ ------
Total income taxes...................................... $ 844 $ 891 $1,000
====== ====== ======
The significant components of deferred provisions attributable to income from
operations were:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2006 2005 2004
----------------------------------------------------------------------------------------------------
(IN MILLIONS)
Deferred income tax (benefit) provision (excluding the
effects of other components).......................... $(566) $(342) $348
Adjustment of valuation allowance....................... 2 (2) -
Change in operating loss carryforwards.................. 8 (12) -
Adjustment to statutory tax rate........................ (4) (10) -
----- ----- ----
Deferred income tax provision........................... $(560) $(366) $348
===== ===== ====
Income before income taxes were:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2006 2005 2004
----------------------------------------------------------------------------------------------------
(IN MILLIONS)
United States........................................... $2,361 $2,560 $2,786
Foreign................................................. (74) 103 154
------ ------ ------
Total income before income taxes........................ $2,287 $2,663 $2,940
====== ====== ======
Effective tax rates are analyzed as follows:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2006 2005 2004
----------------------------------------------------------------------------------------------------
(IN MILLIONS)
Statutory Federal income tax rate....................... 35.0% 35.0% 35.0%
Increase (decrease) in rate resulting from:
State and local taxes, net of Federal benefit......... 4.1 .9 1.4
Low income housing and other tax credits.............. (3.5) (3.2) (2.9)
Other................................................. 1.3 .8 .5
---- ---- ----
Effective tax rate...................................... 36.9% 33.5% 34.0%
==== ==== ====
149
Temporary differences which gave rise to a significant portion of deferred tax
assets and liabilities were as follows:
AT DECEMBER 31,
---------------
2006 2005
-----------------------------------------------------------------------------
(IN MILLIONS)
DEFERRED TAX ASSETS
Credit loss reserves........................................ $2,053 $1,438
Other reserves.............................................. 84 129
Market value adjustment..................................... 311 95
Other....................................................... 549 509
------ ------
Total deferred tax assets................................... 2,997 2,171
Valuation allowance......................................... (25) (28)
------ ------
Total deferred tax assets net of valuation allowance........ 2,972 2,143
------ ------
DEFERRED TAX LIABILITIES
Intangibles................................................. 838 779
Fee income.................................................. 568 545
Deferred loan origination costs............................. 312 239
Receivables................................................. 97 163
Other....................................................... 181 262
------ ------
Total deferred tax liabilities.............................. 1,996 1,988
------ ------
Net deferred tax asset...................................... $ 976 $ 155
====== ======
Based upon the level of historical taxable income and the reversal of the
deferred tax liabilities over the periods over which the deferred tax assets are
deductible, management believes that it is more likely than not we would realize
the benefits of these deductible differences net of the valuation allowance
noted above.
Provision for U.S. income tax had not been made on net undistributed earnings of
foreign subsidiaries of $178 million at December 31, 2006 and $293 million at
December 31, 2005. We have determined that no U.S. tax liability will arise upon
repatriation of these earnings.
The American Jobs Creation Act of 2004 (the "AJCA") included provisions to allow
a deduction of 85% of certain foreign earnings that are repatriated in 2004 or
2005. We elected to apply this provision to a $489 million distribution in
December 2005 by our U.K. subsidiary. Tax of $26 million related to this
distribution is included as part of the current 2005 U.S. tax expense shown
above.
At December 31, 2006, we had net operating loss carryforwards of $740 million
for state tax purposes which expire as follows: $226 million in 2007-2011; $162
million in 2012-2016; $201 million in 2017-2021 and $151 million in 2022 and
forward.
16. REDEEMABLE PREFERRED STOCK
--------------------------------------------------------------------------------
On December 15, 2005, we issued four shares of common stock to HINO in exchange
for the Series A Preferred Stock. See Note 18, "Related Party Transactions," for
further discussion.
In June 2005, we issued 575,000 shares of 6.36 percent Non-Cumulative Preferred
Stock, Series B ("Series B Preferred Stock"). Dividends on the Series B
Preferred Stock are non-cumulative and payable quarterly at a rate of 6.36
percent commencing September 15, 2005. The Series B Preferred Stock may be
redeemed at our option after June 23, 2010 at $1,000 per share, plus accrued
dividends. The redemption and liquidation value is $1,000 per share plus accrued
and unpaid dividends. The holders of Series B Preferred Stock are entitled to
payment before any capital distribution is made to the common shareholder and
have no voting rights except for the right to elect two additional members to
the board of directors in the event that dividends have not been declared and
paid for six quarters, or as otherwise provided by law. Additionally, as long as
any shares of the Series B Preferred Stock are outstanding, the authorization,
creation or issuance of any class or series of
150
stock which would rank prior to the Series B Preferred Stock with respect to
dividends or amounts payable upon liquidation or dissolution of HSBC Finance
Corporation must be approved by the holders of at least two-thirds of the shares
of Series B Preferred Stock outstanding at that time. Related issuance costs of
$16 million have been recorded as a reduction of additional paid-in capital. In
2006, we declared dividends totaling $37 million on the Series B Preferred Stock
which were paid prior to December 31, 2006. In 2005, we declared dividends
totaling $17 million on the Series B Preferred Stock which were paid prior to
December 31, 2005.
17. ACCUMULATED OTHER COMPREHENSIVE INCOME
--------------------------------------------------------------------------------
Accumulated other comprehensive income includes certain items that are reported
directly within a separate component of shareholders' equity. The following
table presents changes in accumulated other comprehensive income balances.
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2006 2005 2004
--------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Unrealized gains (losses) on investments and interest-only
strip receivables:
Balance at beginning of period............................ $ (2) $ 54 $ 168
Other comprehensive income for period:
Net unrealized holding gains (losses) arising during
period, net of tax of $(34) million, $29 million and
$67 million, respectively............................. 57 (56) (106)
Reclassification adjustment for gains realized in net
income, net of taxes of $45 million, $- million and $4
million, respectively................................. (78) - (8)
----- ----- -----
Total other comprehensive income for period............... (21) (56) (114)
----- ----- -----
Balance at end of period.................................. (23) (2) 54
----- ----- -----
Unrealized gains (losses) on cash flow hedging instruments:
Balance at beginning of period............................ 260 119 (11)
Other comprehensive income for period:
Net gains (losses) arising during period, net of tax of
$124 million, $(92) million and $(34) million
respectively.......................................... (204) 173 72
Reclassification adjustment for gains (losses) realized
in net income, net of tax of $68 million, $18 million
and $(27) million, respectively....................... (117) (32) 58
----- ----- -----
Total other comprehensive income for period............... (321) 141 130
----- ----- -----
Balance at end of period.................................. (61) 260 119
----- ----- -----
Pension liability:
Balance at beginning of period............................ - (4) -
Other comprehensive income for period:
Pension liability settlement adjustment, net of tax of
$- million, $(2) million and $2 million,
respectively.......................................... - 4 (4)
----- ----- -----
Adjustment to initially apply FASB Statement No. 158, net
of tax of $(1) million.................................. (1) - -
Total other comprehensive income for period............... (1) 4 (4)
----- ----- -----
Balance at end of period.................................. (1) - (4)
----- ----- -----
Foreign currency translation adjustments:
Balance at beginning of period............................ 221 474 286
Other comprehensive income for period:
Translation gains (losses), net of tax of $9 million, $6
million and $(12) million, respectively............... 223 (253) 188
----- ----- -----
Total other comprehensive income for period............... 223 (253) 188
----- ----- -----
Balance at end of period.................................. 444 221 474
----- ----- -----
Total accumulated other comprehensive income (loss) at end
of period................................................. $ 359 $ 479 $ 643
===== ===== =====
151
18. RELATED PARTY TRANSACTIONS
--------------------------------------------------------------------------------
In the normal course of business, we conduct transactions with HSBC and its
subsidiaries. These transactions occur at prevailing market rates and terms and
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:
AT DECEMBER 31, 2006 2005
---------------------------------------------------------------------------------
(IN MILLIONS)
ASSETS, (LIABILITIES) AND EQUITY:
Derivative financial assets (liability), net................ $ 234 $ (260)
Affiliate preferred stock received in sale of U.K. credit
card business(1).......................................... 294 261
Other assets................................................ 528 518
Due to affiliates........................................... (15,172) (15,534)
Other liabilities........................................... (506) (271)
Premium on sale of European Operation in 2006 and U.K.
credit card business in 2005 to affiliates recorded as an
increase to additional paid in capital.................... 13 182
---------------
(1) Balance will fluctuate due to foreign currency exchange rate impact.
FOR THE YEAR ENDED DECEMBER 31, 2006 2005 2004
-------------------------------------------------------------------------------------
INCOME/(EXPENSE):
Interest expense on borrowings from HSBC and subsidiaries... $ (929) $(713) $(343)
Interest income on advances to HSBC affiliates.............. 25 37 5
Dividend income from affiliate preferred stock.............. 18 - -
HSBC Bank USA:
Real estate secured servicing, sourcing, underwriting and
pricing revenues....................................... 12 19 17
Gain on bulk sales of real estate secured receivables..... 17 - 15
Gain on bulk sale of domestic private label receivable
portfolio.............................................. - - 663
Gain on daily sale of domestic private label receivable
originations........................................... 367 379 3
Gain on daily sale of credit card receivables............. 38 34 21
Taxpayer financial services loan origination and other
fees................................................... (18) (15) -
Domestic private label receivable servicing and related
fees................................................... 393 368 3
Other servicing, processing, origination and support
revenues............................................... 73 28 16
Support services from HSBC affiliates, primarily HSBC
Technology and Services (USA) Inc. ("HTSU")............... (1,087) (889) (750)
HTSU:
Rental revenue............................................ 45 42 33
Administrative services revenue........................... 12 14 18
Servicing and other fees from other HSBC affiliates....... 16 11 3
Stock based compensation expense with HSBC.................. (100) (66) (45)
The notional value of derivative contracts outstanding with HSBC subsidiaries
totaled $87.4 billion at December 31, 2006 and $72.2 billion at December 31,
2005. Beginning in the second quarter of 2006, 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 cash and recorded on our balance
sheet, consistent with third party arrangements. Previously, the posting of
collateral by affiliates was provided in the form of securities, which were not
recorded on our balance sheet. Also during 2006, we lowered the level of the
fair value of our agreements with affiliate counterparties above which
collateral is required to be posted to $75 million. At December 31, 2006,
152
the fair value of our agreements with affiliate counterparties required the
affiliate to provide cash collateral of $1.0 billion which is recorded in our
balance sheet as a component of derivative related liabilities. At December 31,
2005, the fair value of our agreements with affiliate counterparties was below
the level requiring posting of collateral. As such, at December 31, 2005, we
were not holding any swap collateral from HSBC affiliates in the form of cash or
securities.
We extended a line of credit of $2 billion to HSBC USA Inc. at interest rates
comparable to third-party rates for a line of credit with similar terms. This
line expired in July of 2006 and was not renewed. No balances were outstanding
under this line at December 31, 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.
We extended a revolving line of credit of $.5 billion to HTSU on June 28, 2005
at interest rates comparable to third-party rates for a line of credit with
similar terms. The balance outstanding under this line of credit was $.5 billion
and $.4 billion at December 31, 2006 and 2005 respectively and is included in
other assets. Interest income associated with this line of credit is recorded in
interest income and reflected as Interest income on advances to HSBC affiliates
in the table above.
We extended a promissory note of $.5 billion to HSBC Securities (USA) Inc.
("HSI") on June 27, 2005 at interest rates comparable to third-party rates for a
line of credit with similar terms. This promissory note was repaid during July
2005. We also extended a promissory note of $.5 billion to HSI on September 29,
2005. This promissory note was repaid during October 2005. We extended an
additional promissory note of $.2 billion 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 HINO which was
repaid during the second quarter of 2005. This line of credit was at interest
rates comparable to third-party rates for a line of credit with similar terms.
During the second quarter of 2004, we made advances to our immediate parent,
HINO, totaling $266 million which were repaid during the third quarter of 2004.
Interest income associated with these lines of credit is recorded in interest
income and reflected as Interest income on advances to HSBC affiliates in the
table above.
Due to affiliates includes amounts owed to subsidiaries of HSBC (other than
preferred stock). This funding was at interest rates (both the underlying
benchmark rate and credit spreads) comparable to third-party rates for debt with
similar maturities.
At December 31, 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 $5.7 billion from HBEU to fund our operations in the U.K. At
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 HBEU to fund our operations in the U.K. As of December 31,
2006, $4.3 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 on the U.K. lines and no balances were outstanding on the domestic
lines. Annual commitment fee requirements to support availability of these lines
totaled $1 million in 2006 and $2 million in 2005 and are included as a
component of Interest expense on borrowings from HSBC and subsidiaries.
On November 9, 2006, as part of our continuing evaluation of strategic
alternatives with respect to our U.K. and European operations, we sold all of
the capital stock of our operations in the Czech Republic, Hungary, and Slovakia
(the "European Operations") to a wholly owned subsidiary of HBEU for an
aggregate purchase price of approximately $46 million. Because the sale of this
business is between affiliates under common control, the premium received in
excess of the book value of the stock transferred was recorded as an increase to
additional paid-in capital and was not reflected in earnings. The assets
consisted primarily of $199 million of receivables and goodwill which totaled
approximately $13 million. The liabilities consisted primarily of debt which
totaled $179 million. HBEU assumed all the liabilities of the European
Operations as a result of this transaction. We do not anticipate that the net
effect of this sale will result in a material reduction of net income of our
consolidated results.
153
In December 2005, we sold our U.K. credit card business, including $2.5 billion
of receivables, the associated cardholder relationships and the related retained
interests in securitized credit card receivables to HBEU for an aggregate
purchase price of $3.0 billion. The purchase price, which was determined based
on a comparative analysis of sales of other credit card portfolios, was paid in
a combination of cash and $261 million of preferred stock issued by a subsidiary
of HBEU with a rate of one-year Sterling LIBOR, plus 1.30 percent. In addition
to the assets referred to above, the sale also included the account origination
platform, including the marketing and credit employees associated with this
function, as well as the lease associated with the credit card call center and
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. We received $30 million in 2006 under this service level
agreement. Additionally, the management teams of HBEU and our remaining U.K.
operations will be jointly involved in decision making involving card marketing
to ensure that growth objectives are met for both businesses. Because the sale
of this business is between affiliates under common control, the premium
received in excess of the book value of the assets transferred of $182 million,
including the goodwill assigned to this business, has been recorded as an
increase to additional paid in capital and has not been included in earnings.
In December 2004, we sold our domestic private label receivable portfolio
(excluding retail sales contracts at our Consumer Lending business), including
the retained interests associated with our securitized domestic private label
receivables to HSBC Bank USA for $12.4 billion. We recorded an after-tax gain on
the sale of $423 million in 2004. See Note 4, "Sale of Domestic Private Label
Receivable Portfolio and Adoption of FFIEC Policies." We continue to service the
sold private label receivables and receive servicing and related fee income from
HSBC Bank USA for these services. As of December 31, 2006, we were servicing
$18.1 billion of domestic private label receivables and as of December 31, 2005,
we were servicing $17.1 billion of domestic private label receivables for HSBC
Bank USA. We received servicing and related fee income from HSBC Bank USA of
$393 million in 2006 and $368 million during December 2005. Servicing and
related fee income is reflected as Domestic private label receivable servicing
and related fees in the table above. We continue to maintain the related
customer account relationships and, therefore, sell new domestic private label
receivable originations (excluding retail sales contracts) to HSBC Bank USA on a
daily basis. We sold $21.6 billion of private label receivables to HSBC Bank USA
in 2006 and $21.1 billion during 2005. The gains associated with the sale of
these receivables are reflected in the table above and are recorded in Gain on
daily sale of domestic private label receivable originations.
In the fourth quarter of 2006 we sold approximately $669 million of real estate
secured receivables originated by our subsidiary, Decision One Mortgage Company,
LLC, to HSBC Bank USA and recorded a pre-tax gain of $17 million on the sale.
In the first quarter of 2004, we sold approximately $.9 billion of real estate
secured receivables from our Mortgage Services business to HSBC Bank USA and
recorded a pre-tax gain of $15 million on the sale. Under a separate servicing
agreement, we have agreed to service all real estate secured receivables sold to
HSBC Bank USA including all future business it purchases from our
correspondents. As of December 31, 2006, we were servicing $3.3 billion of real
estate secured receivables for HSBC Bank USA. We also received fees from HSBC
Bank USA pursuant to a service level agreement under which we sourced,
underwrote and priced $1.5 billion of real estate secured receivables purchased
by HSBC Bank USA during 2005 and $2.8 billion in 2004. The fee revenue
associated with these receivables is recorded in servicing fees from HSBC
affiliates and are reflected as Real estate secured servicing, 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.
154
Fees received for these services are reported as servicing fees from HSBC
affiliates and are reflected as Other servicing, processing, origination and
support revenues in the table above.
During 2003, Household Capital Trust VIII issued $275 million in mandatorily
redeemable preferred securities to HSBC. The terms of this issuance were as
follows:
(DOLLARS ARE IN MILLIONS)
----------------------------------------------------------------------------------------
Junior Subordinated Notes:
Principal balance......................................... $284
Redeemable by issuer...................................... September 26, 2008
Stated maturity........................................... November 15, 2033
Preferred Securities:
Rate...................................................... 6.375%
Face value................................................ $275
Issue date................................................ September 2003
Interest expense recorded on the underlying junior subordinated notes totaled
$18 million in 2006, 2005 and 2004. The interest expense for the Household
Capital Trust VIII is included in interest expense - HSBC affiliates in the
consolidated statement of income and is reflected as a component of Interest
expense on borrowings from HSBC and subsidiaries in the table above.
During 2004, our Canadian business began to originate and service auto loans for
an HSBC affiliate in Canada. Fees received for these services are included in
other income and are reflected in Servicing and other fees from other HSBC
affiliates in the above table.
Effective October 1, 2004, HSBC Bank USA became the originating lender for loans
initiated by our taxpayer financial services business for clients of various
third party tax preparers. We purchase the loans originated by HSBC Bank USA
daily for a fee. Origination fees paid to HSBC Bank USA totaled $18 million in
2006 and $15 million in 2005. These origination fees are included as an offset
to taxpayer financial services revenue and are reflected as Taxpayer financial
services loan origination and other 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 credit card receivables from HSBC Bank USA for
approximately $99 million, which are included in intangible assets. The
receivables continue to be owned by HSBC Bank USA. We service these receivables
for HSBC Bank USA and receive servicing and related fee income from HSBC Bank
USA. As of December 31, 2006 we were servicing $1.2 billion of credit card
receivables for 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 $2,298
million of credit card receivables to HSBC Bank USA in 2006, $2,055 million in
2005 and $1,029 million in 2004. The gains associated with the sale of these
receivables are reflected in the table above and are recorded in Gain on daily
sale of credit card receivables.
Effective January 1, 2004, our technology services employees, as well as
technology services employees from other HSBC entities in North America, were
transferred to HTSU. In addition, technology related assets and software
purchased subsequent to January 1, 2004 are generally purchased and owned by
HTSU. Technology related assets owned by HSBC Finance Corporation prior to
January 1, 2004 currently remain in place and were not transferred to HTSU. In
addition to information technology services, HTSU also provides certain item
processing and statement processing activities to us pursuant to a master
service level agreement. Support services from HSBC affiliates includes services
provided by HTSU as well as banking services and other miscellaneous services
provided by HSBC Bank USA and other subsidiaries of HSBC. We also receive
revenue from HTSU for rent on certain office space, which has been recorded as a
reduction of occupancy and equipment expenses, and for certain administrative
costs, which has been recorded as other income.
Additionally, in a separate transaction in December 2005, we transferred our
information technology services employees in the U.K. to a subsidiary of HBEU.
Subsequent to the transfer, operating expenses relating to
155
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 a majority of our ongoing debt issuances. Fees paid for such services
totaled approximately $48 million in 2006, $59 million in 2005 and $18 million
in 2004. These fees are amortized over the life of the related debt.
In consideration of HSBC transferring sufficient funds to make the payments with
respect to certain HSBC Finance Corporation preferred stock, we issued the
Series A Preferred Stock in the amount of $1.1 billion to HSBC on March 28,
2003. In September 2004, HSBC North America issued a new series of preferred
stock totaling $1.1 billion to HSBC in exchange for our outstanding Series A
Preferred Stock. In October 2004, our immediate parent, HINO, issued a new
series of preferred stock to HSBC North America in exchange for our Series A
Preferred Stock. We paid dividends on our Series A Preferred Stock of $66
million in October 2005 and $108 million in October 2004. On December 15, 2005,
we issued four shares of common stock to HINO in exchange for the Series A
Preferred Stock.
Domestic employees of HSBC Finance Corporation participate in a defined benefit
pension plan sponsored by HSBC North America. See Note 20, "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 $100 million in 2006, $66 million in 2005 and $45 million in 2004. These
expenses are recorded in salary and employee benefits and are reflected in the
above table as Stock based compensation expense with HSBC.
19. STOCK OPTION PLANS
--------------------------------------------------------------------------------
STOCK OPTION PLANS The HSBC Holdings Group Share Option Plan (the "Group Share
Option Plan"), which replaced the former Household stock option plans, was a
long-term incentive compensation plan available to certain employees prior to
2005. Grants were usually made annually. At the 2005 HSBC Annual Meeting of
Stockholders, HSBC adopted and the shareholders' approved the HSBC Share Plan
("Group Share Plan") to replace this plan. During 2006 and 2005, no further
options were granted to employees although stock option grants from previous
years remain in effect subject to the same conditions as before. In lieu of
options, in 2006 and 2005, these employees received grants of shares of HSBC
stock subject to certain vesting conditions as discussed further below. Options
granted to employees in 2004 vest 100% upon the attainment of certain company
performance conditions in either year 3, 4 or 5 and expire ten years from the
date of grant. If the performance conditions are not met in year 5, the options
will be forfeited. Options are granted at market value. Compensation expense
related to the Group Share Option Plan, which is recognized over the vesting
period, totaled $6 million in 2006, $6 million in 2005 and $8 million in 2004.
156
Information with respect to the Group Share Option Plan is as follows:
2006 2005 2004
--------------------- --------------------- ---------------------
WEIGHTED- WEIGHTED- WEIGHTED-
HSBC AVERAGE HSBC AVERAGE HSBC AVERAGE
ORDINARY PRICE PER ORDINARY PRICE PER ORDINARY PRICE PER
SHARES SHARE SHARES SHARE SHARES SHARE
----------------------------------------------------------------------------------------------------
Outstanding at beginning of
year....................... 6,100,800 $14.97 6,245,800 $14.96 4,069,800 $15.31
Granted...................... - - - - 2,638,000 14.37
Exercised.................... - - - - - -
Transferred.................. - - (105,000) 14.64 (462,000) 14.69
Expired or canceled.......... (40,000) 14.37 (40,000) 14.37 - -
--------- ------ --------- ------ --------- ------
Outstanding at end of year... 6,060,800 14.97 6,100,800 14.97 6,245,800 14.96
========= ====== ========= ====== ========= ======
Exercisable at end of year... 2,909,850 $15.31 - $ - - $ -
========= ====== ========= ====== ========= ======
Weighted-average fair value
of options granted......... $ - $ - $ 2.68
====== ====== ======
The transfers shown above relate to employees who have transferred to other HSBC
entities during each year. The transfers in 2005 primarily relate to certain of
our U.K. employees who were transferred to HBEU as part of the sale of our U.K.
credit card business in December 2005. The transfers in 2004 relate to our
technology services employees who were transferred to HTSU effective January 1,
2004.
The following table summarizes information about stock options outstanding under
the Group Share Option Plan at December 31, 2006.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------- -----------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
RANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE OUTSTANDING PRICE
-------------------------------------------------------------------------------------------------------
$12.51-15.00............................ 2,181,000 7.34 14.37 - $ -
$15.01-17.50............................ 3,879,800 6.85 15.31 2,909,850 $15.31
The fair value of each option granted under the Group Share Option Plan in 2004,
measured at the grant date, was calculated using a binomial lattice methodology
that is based on the underlying assumptions of the Black-Scholes option pricing
model. When modeling options with vesting that are dependent on attainment of
certain performance conditions over a period of time, these performance targets
are incorporated into the model using Monte-Carlo simulation. The expected life
of options depends on the behavior of option holders, which is incorporated into
the option model consistent with historic observable data. The fair values are
inherently subjective and uncertain due to the assumptions made and the
limitations of the model used. The significant weighted average assumptions used
to estimate the fair value of the options granted by year are as follows:
2006 2005 2004
----------------------------------------------------------------------------------------
Risk-free interest rate..................................... - - 4.9%
Expected life............................................... - - 6.9 years
Expected volatility......................................... - - 25.0%
Prior to our acquisition by HSBC, certain employees were eligible to participate
in the former Household stock option plan. Employee stock options generally
vested equally over four years and expired 10 years from the date of grant. Upon
completion of our acquisition by HSBC, all options granted prior to November
2002 vested and became outstanding options to purchase HSBC ordinary shares.
Options granted under the former Household plan subsequent to October 2002 were
converted into options to purchase ordinary shares of HSBC, but did not vest
under the change in control. Compensation expense related to the former
Household
157
plan totaled $3 million in 2006, $6 million in 2005 and $8 million in 2004. All
shares under the former Household plan fully vested in 2006.
Information with respect to stock options granted under the former Household
plan is as follows:
2006 2005 2004
---------------------- ---------------------- ----------------------
WEIGHTED- WEIGHTED- WEIGHTED-
HSBC AVERAGE HSBC AVERAGE HSBC AVERAGE
ORDINARY PRICE PER ORDINARY PRICE PER ORDINARY PRICE PER
SHARES SHARE SHARES SHARE SHARES SHARE
----------------------------------------------------------------------------------------------------
Outstanding at beginning
of year................. 36,032,006 $16.09 38,865,993 $15.71 45,194,343 $14.76
Granted................... - - - - - -
Exercised................. (9,825,954) 12.73 (2,609,665) 10.92 (5,780,935) 8.43
Transferred in/(out)...... 47,580 8.62 (142,292) 12.15 (517,321) 14.58
Expired or canceled....... (258,043) 16.78 (82,030) 7.97 (30,094) 10.66
---------- ------ ---------- ------ ---------- ------
Outstanding at end of
year.................... 25,995,589 $17.34 36,032,006 $16.09 38,865,993 $15.71
========== ====== ========== ====== ========== ======
Exercisable at end of
year.................... 25,995,589 $17.34 34,479,337 $16.21 35,373,778 $16.21
========== ====== ========== ====== ========== ======
The transfers shown above primarily relate to employees who have transferred
between HTSU and us during each year and to certain of our U.K. employees who
were transferred to HBEU as part of the sale of our U.K. credit card business in
December 2005.
The following table summarizes information about the number of HSBC ordinary
shares subject to outstanding stock options under the former Household plan, at
December 31, 2006:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------- -----------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
RANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE OUTSTANDING PRICE
-------------------------------------------------------------------------------------------------------
$1.00 - $5.00........................... 8,576 1.64 1.88 8,576 1.88
$5.01 - $10.00.......................... 465,504 .86 9.38 465,504 9.38
$10.01 - $12.50......................... 3,106,302 5.67 10.68 3,106,302 10.68
$12.51 - $15.00......................... 2,920,776 1.79 13.90 2,920,776 13.90
$15.01 - $17.50......................... 5,799,498 2.64 16.97 5,799,498 16.97
$17.51 - $20.00......................... 6,287,589 3.84 18.41 6,287,589 18.41
$20.01 - $25.00......................... 7,407,344 4.87 21.37 7,407,344 21.37
RESTRICTED SHARE PLANS Subsequent to our acquisition by HSBC, key employees are
also provided awards in the form of restricted shares ("RSRs") under HSBC's
Restricted Share Plan prior to 2005 and under the Group Share Plan beginning in
2005. Annual awards to employees in 2005 and 2006 are fully vested after three
years. We also issue a small number of off-cycle grants each year for
recruitment, retention and reward. These RSR awards vest over a varying period
of time depending on the nature of the award, the longest of which vests over a
five year period. Annual awards to employees in 2004 vest over five years
contingent upon the achievement of certain company performance targets.
158
Information with respect to RSRs awarded under HSBC's Restricted Share
Plan/Group Share Plan, all of which are in HSBC ordinary shares, is as follows:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2006 2005 2004
--------------------------------------------------------------------------------------------------
RSRs awarded.......................................... 4,959,838 6,669,152 2,996,878
Weighted-average fair market value per share.......... $ 16.96 $ 15.86 $ 15.09
RSRs outstanding at December 31....................... 14,326,693 11,787,706 7,030,688
Compensation cost: (in millions)
Pre-tax............................................. $ 82 $ 42 $ 17
After-tax........................................... 52 27 11
Prior to the merger, Household's executive compensation plans also provided for
issuance of RSRs which entitled an employee to receive a stated number of shares
of Household common stock if the employee satisfied the conditions set by the
Compensation Committee for the award. Upon completion of the merger with HSBC,
all RSRs granted under the former Household plan prior to November 2002 vested
and became outstanding shares of HSBC. RSRs granted under the former Household
plan subsequent to October 2002 were converted into rights to receive HSBC
ordinary shares. Upon vesting, the employee can elect to receive either HSBC
ordinary shares or American depository shares.
Information with respect to RSRs awarded under the pre-merger Household plan,
all of which are in HSBC ordinary shares, is as follows:
2006 2005 2004
----------------------------------------------------------------------------------------------
RSRs awarded.............................................. - - -
Weighted-average fair market value per share.............. $ - $ - $ -
RSRs outstanding at December 31........................... 653,900 1,309,073 2,238,628
Compensation cost: (in millions)
Pre-tax................................................. $ 4 $ 6 $ 8
After-tax............................................... 2 4 5
EMPLOYEE STOCK PURCHASE PLANS The HSBC Holdings Savings-Related Share Option
Plan (the "HSBC Sharesave Plan"), which replaced the former Household employee
stock purchase plan, allows eligible employees to enter into savings contracts
to save up to approximately $450 per month, with the option to use the savings
to acquire ordinary shares of HSBC at the end of the contract period. There are
currently three types of plans offered which allow the participant to select
saving contracts of a 1, 3 or 5 year length. The 1 year contract period was
offered for the first time in 2006. The options for the 1 year plan are
automatically exercised if the current share price is at or above the strike
price, which is at a 15 percent discount to the fair market value of the shares
on grant date. If the current share price is below the strike price, the
participants have the ability to exercise the option during the six months
following the maturity date if the share price rises. The options under the 3
and 5 year plans are exercisable within six months following the third or fifth
year, respectively, of the commencement of the related savings contract, at a 20
percent discount for options granted in 2006, 2005 and 2004. HSBC ordinary
shares granted and the related fair value of the options for 2006, 2005 and 2004
are presented below:
2006 2005 2004
------------------------ ------------------------ ------------------------
HSBC FAIR VALUE HSBC HSBC HSBC FAIR VALUE
ORDINARY PER SHARE OF ORDINARY ORDINARY ORDINARY PER SHARE OF
SHARES SHARES SHARES SHARES SHARES SHARES
GRANTED GRANTED GRANTED GRANTED GRANTED GRANTED
--------------------------------------------------------------------------------------------------------
1 year vesting period... 296,410 2.60 - - - -
3 year vesting period... 598,814 3.42 1,064,168 3.73 1,124,776 $3.44
5 year vesting period... 124,563 3.49 236,782 3.78 303,981 $3.80
159
Compensation expense related to the grants under the HSBC Sharesave Plan totaled
$5 million in 2006, $6 million in 2005 and $5 million in 2004.
The fair value of each option granted under the HSBC Sharesave Plan was
estimated as of the date of grant using a third party option pricing model:
2006 2005 2004
----------------------------------------------------------------------------------------------------
Risk-free interest rate........................ 5.0% 4.3% 4.9%
Expected life.................................. 1, 3 OR 5 YEARS 3 or 5 years 3 or 5 years
Expected volatility............................ 17.0% 20.0% 25.0%
20. PENSION AND OTHER POSTRETIREMENT BENEFITS
--------------------------------------------------------------------------------
DEFINED BENEFIT PENSION PLANS We adopted FASB Statement No. 158, "Employer's
Accounting for Defined Benefit Pension and Other Postretirement Plans," ("SFAS
No. 158") on December 31, 2006. SFAS No. 158 requires balance sheet recognition
of the funded status of pension and other postretirement benefits with the
offset to accumulated other comprehensive income. The adoption of SFAS No. 158
at December 31, 2006 had no impact on our pension liability. Deferred tax
liabilities increased by $1 million and shareholder's equity was decreased by $1
million through accumulated other comprehensive income.
In November 2004, sponsorship of the domestic defined benefit pension plan of
HSBC Finance Corporation and the domestic defined benefit pension plan of HSBC
Bank USA were transferred to HSBC North America. Effective January 1, 2005, the
two separate plans were combined into a single HSBC North America defined
benefit pension plan which facilitates the development of a unified employee
benefit policy and unified employee benefit plan administration for HSBC
companies operating in the United States. As a result, the pension liability
relating to our domestic defined benefit plan of $49 million, net of tax, was
transferred to HSBC North America as a capital transaction in the first quarter
of 2005.
The components of pension expense for the domestic defined benefit plan
reflected in our consolidated statement of income are shown in the table below.
The pension expense for the years ended December 31, 2006 and 2005 reflects the
portion of the pension expense of the combined HSBC North America pension plan
which has been allocated to HSBC Finance Corporation.
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2006 2005 2004
----------------------------------------------------------------------------------------------------
(IN MILLIONS)
Service cost - benefits earned during the period........ $48 $46 $52
Interest cost on projected benefit obligation........... 60 54 46
Expected return on assets............................... (77) (78) (82)
Amortization of prior service cost...................... - - -
Recognized losses (gains)............................... 15 4 (5)
--- --- ---
Pension expense......................................... $46 $26 $11
=== === ===
The information and activity presented below as of and for the years ended
December 31, 2006 and 2005 relates to the post-merger HSBC North America defined
benefit pension plan, unless noted otherwise. The information and activity
presented as of December 31, 2004 reflect the pre-merger HSBC Finance
Corporation domestic defined benefit pension plan balances and activity.
160
The assumptions used in determining pension expense of the domestic defined
benefit plan are as follows:
2006 2005 2004
-----------------------------------------------------------------------------------------------------
(POST-MERGER) (POST-MERGER) (PRE-MERGER)
Discount rate.......................................... 5.70% 6.00% 6.25%
Salary increase assumption............................. 3.75 3.75 3.75
Expected long-term rate of return on plan assets....... 8.00 8.33 8.75
HSBC North America retains both an unrelated third party as well as an affiliate
to provide investment consulting services. Given the plan's current allocation
of equity and fixed income securities and using investment return assumptions
which are based on long term historical data, the long term expected return for
plan assets is reasonable. The funded status of the post-merger HSBC North
America pension plan and not the interests of HSBC Finance Corporation at
December 31, 2006 was a liability of $130 million.
A reconciliation of beginning and ending balances of the fair value of plan
assets associated with the domestic defined benefit pension plan is shown below.
The activity shown below reflects the activity of the merged HSBC North America
plan.
YEAR ENDED
DECEMBER 31,
---------------
2006 2005
-----------------------------------------------------------------------------
(IN MILLIONS)
Fair value of plan assets at beginning of year.............. $2,383 $1,000
Transfer in of assets from the former HSBC Bank USA pension
plan...................................................... - 1,304
Actual return on plan assets................................ 246 168
Employer contributions...................................... - -
Benefits paid............................................... (62) (89)
------ ------
Fair value of plan assets at end of year.................... $2,567 $2,383
====== ======
It is currently not anticipated that employer contributions to the domestic
defined benefit plan will be made in 2007.
The allocation of the domestic pension plan assets at December 31, 2006 and 2005
is as follows:
PERCENTAGE OF
PLAN ASSETS AT
DECEMBER 31,
--------------
2006 2005
----------------------------------------------------------------------------
Equity securities........................................... 69% 69%
Debt securities............................................. 30 31
Other....................................................... 1 -
--- ---
Total....................................................... 100% 100%
=== ===
There were no investments in HSBC ordinary shares or American depository shares
at December 31, 2006 or 2005.
The primary objective of the defined benefit pension plan is to provide eligible
employees with regular pension benefits. Since the domestic plans are governed
by the Employee Retirement Income Security Act of 1974 ("ERISA"), ERISA
regulations serve as guidance for the management of plan assets. Consistent with
prudent standards of preservation of capital and maintenance of liquidity, the
goals of the plans are to earn the highest possible rate of return consistent
with the tolerance for risk as determined by the investment committee in its
role as a fiduciary. In carrying out these objectives, short-term fluctuations
in the value of plan assets are considered secondary to long-term investment
results. Both a third party and an affiliate are used to provide investment
consulting services such as recommendations on the type of funds to be invested
in
161
and monitoring the performance of fund managers. In order to achieve the return
objectives of the plans, the plans are diversified to ensure that adverse
results from one security or security class will not have an unduly detrimental
effect on the entire investment portfolio. Assets are diversified by type,
characteristic and number of investments as well as by investment style of
management organization. Equity securities are invested in large, mid and small
capitalization domestic stocks as well as international stocks.
A reconciliation of beginning and ending balances of the projected benefit
obligation of the domestic defined benefit pension plan is shown below and
reflects the projected benefit obligation of the merged HSBC North America plan.
YEAR ENDED
DECEMBER 31,
----------------
2006 2005
------------------------------------------------------------------------------
(IN MILLIONS)
Projected benefit obligation at beginning of year........... $2,530 $1,019
Transfer in from the HSBC Bank USA defined benefit plan..... - 1,174
Service cost................................................ 102 94
Interest cost............................................... 145 130
Actuarial (gains) losses.................................... (17) 202
Benefits paid............................................... (62) (89)
------ ------
Projected benefit obligation at end of year................. $2,698 $2,530
====== ======
Our share of the projected benefit obligation at December 31, 2006 is
approximately $1.1 billion. The accumulated benefit obligation for the
post-merger domestic HSBC North America defined benefit pension plan was $2.4
billion at December 31, 2006 and $2.2 billion at December 31, 2005. Our share of
the accumulated benefit obligation was approximately $1.0 billion at December
31, 2006 and $1.1 billion at December 31, 2005.
Estimated future benefit payments for the HSBC North America domestic defined
benefit plan and HSBC Finance Corporation's share of those payments are as
follows:
HSBC HSBC FINANCE
NORTH CORPORATION'S
AMERICA SHARE
-------------------------------------------------------------------------------------
(IN MILLIONS)
2007........................................................ $122 $ 61
2008........................................................ 130 65
2009........................................................ 137 68
2010........................................................ 144 71
2011........................................................ 156 76
2012-2016................................................... 927 433
The assumptions used in determining the projected benefit obligation of the
domestic defined benefit plans at December 31 are as follows:
2006 2005 2004
-----------------------------------------------------------------------------------------------------
(POST-MERGER) (POST-MERGER) (PRE-MERGER)
Discount rate.......................................... 5.90% 5.70% 6.00%
Salary increase assumption............................. 3.75 3.75 3.75
FOREIGN DEFINED BENEFIT PENSION PLANS We sponsor additional defined benefit
pension plans for our foreign based employees. Pension expense for our foreign
defined benefit pension plans was $2 million in 2006, $2 million in 2005 and $2
million in 2004. For our foreign defined benefit pension plans, the fair value
of plan assets was $160 million at December 31, 2006 and $135 million at
December 31, 2005. The projected benefit
162
obligation for our foreign defined benefit pension plans was $191 million at
December 31, 2006 and $164 million at December 31, 2005.
SUPPLEMENTAL RETIREMENT PLAN A non-qualified supplemental retirement plan is
also provided. This plan, which is currently unfunded, provides eligible
employees defined pension benefits outside the qualified retirement plan.
Benefits are based on average earnings, years of service and age at retirement.
The projected benefit obligation was $92 million at December 31, 2006 and $73
million at December 31, 2005. Pension expense related to the supplemental
retirement plan was $11 million in 2006 and 2005 and $19 million in 2004. An
additional minimum liability of $6 million related to this plan was recognized
in 2004 and reversed in 2005.
DEFINED CONTRIBUTION PLANS Various 401(k) savings plans and profit sharing plans
exist for employees meeting certain eligibility requirements. Under these plans,
each participant's contribution is matched by the company up to a maximum of 6
percent of the participant's compensation. Company contributions are in the form
of cash. Total expense for these plans for HSBC Finance Corporation was $98
million in 2006, $91 million in 2005 and $82 million in 2004.
Effective January 1, 2005, HSBC Finance Corporation's 401(k) savings plans
merged with the HSBC Bank USA's 401(k) savings plan under HSBC North America.
POSTRETIREMENT PLANS OTHER THAN PENSIONS Our employees also participate in plans
which provide medical, dental and life insurance benefits to retirees and
eligible dependents. These plans cover substantially all employees who meet
certain age and vested service requirements. We have instituted dollar limits on
our payments under the plans to control the cost of future medical benefits.
The net postretirement benefit cost included the following:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2006 2005 2004
----------------------------------------------------------------------------------------------------
(IN MILLIONS)
Service cost - benefits earned during the period........ $ 6 $ 5 $ 4
Interest cost........................................... 14 15 13
Expected return on assets............................... - - -
Amortization of prior service cost...................... - - -
Recognized (gains) losses............................... - - -
--- --- ---
Net periodic postretirement benefit cost................ $20 $20 $17
=== === ===
The assumptions used in determining the net periodic postretirement benefit cost
for our domestic postretirement benefit plans are as follows:
2006 2005 2004
----------------------------------------------------------------------------------------------------
(POST-MERGER) (POST-MERGER) (PRE-MERGER)
Discount rate......................................... 5.70% 6.00% 6.25%
Salary increase assumption............................ 3.75 3.75 3.75
163
A reconciliation of the beginning and ending balances of the accumulated
postretirement benefit obligation is as follows:
YEAR ENDED
DECEMBER 31,
-------------
2006 2005
---------------------------------------------------------------------------
(IN MILLIONS)
Accumulated benefit obligation at beginning of year......... $242 $254
Service cost................................................ 6 5
Interest cost............................................... 14 15
Foreign currency exchange rate changes...................... - 1
Actuarial gains............................................. (8) (15)
Benefits paid............................................... (22) (18)
---- ----
Accumulated benefit obligation at end of year............... $232 $242
==== ====
Our postretirement benefit plans are funded on a pay-as-you-go basis. We
currently estimate that we will pay benefits of approximately $16 million
relating to our postretirement benefit plans in 2007. The funded status of our
postretirement benefit plans was a liability of $232 million at December 31,
2006.
Estimated future benefit payments for our domestic plans are as follows:
(IN MILLIONS)
----------------------------------------------------------------------------
2007........................................................ $16
2008........................................................ 17
2009........................................................ 18
2010........................................................ 18
2011........................................................ 18
2012-2016................................................... 92
The assumptions used in determining the benefit obligation of our domestic
postretirement benefit plans at December 31 are as follows:
2006 2005 2002
--------------------------------------------------------------------------------
Discount rate............................................... 5.90% 5.70% 6.00%
Salary increase assumption.................................. 3.75 3.75 3.75
A 10.4 percent annual rate of increase in the gross cost of covered health care
benefits was assumed for 2007. This rate of increase is assumed to decline
gradually to 5.0 percent in 2014.
Assumed health care cost trend rates have an effect on the amounts reported for
health care plans. A one-percentage point change in assumed health care cost
trend rates would increase (decrease) service and interest costs and the
postretirement benefit obligation as follows:
ONE PERCENT ONE PERCENT
INCREASE DECREASE
---------------------------------------------------------------------------------------
(IN MILLIONS)
Effect on total of service and interest cost components..... $.5 $(.4)
Effect on postretirement benefit obligation................. 6 (6)
21. BUSINESS SEGMENTS
--------------------------------------------------------------------------------
We have three reportable segments: Consumer, Credit Card Services, and
International. Our segments are managed separately and are characterized by
different middle-market consumer lending products, origination processes, and
locations. Our Consumer segment consists of our Consumer Lending, Mortgage
Services, Retail Services, and Auto Finance businesses. Our Credit Card Services
segment consists of our domestic
164
MasterCard and Visa and other credit card business. Our International segment
consists of our foreign operations in Canada, the United Kingdom, the Republic
of Ireland and prior to November 9, 2006, our operations in Slovakia, the Czech
Republic and Hungary. The Consumer segment provides real estate secured,
automobile secured, personal non-credit card and private label loans. Loans are
offered with both revolving and closed-end terms and with fixed or variable
interest rates. Loans are originated through branch locations, correspondents,
mortgage brokers, direct mail, telemarketing, independent merchants or
automobile dealers. The Credit Card Services segment offers MasterCard and Visa
and other credit card loans throughout the United States primarily via strategic
affinity and co-branding relationships, direct mail, and our branch network to
non-prime customers. We also cross sell our credit cards to existing real estate
secured, private label and tax services customers. The International segment
offers secured and unsecured lines of credit and secured and unsecured
closed-end loans primarily in the United Kingdom, Canada and the Republic of
Ireland. In addition, the United Kingdom operation offers credit insurance in
connection with all loan products. All segments offer products and service
customers through the Internet. The All Other caption includes our insurance and
taxpayer financial services and commercial businesses, each of which falls below
the quantitative threshold tests under Statement of Financial Accounting
Standard No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS No. 131"), for determining reportable segments, as well as
our corporate and treasury activities. 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.
The composition of our business segments is consistent with that reported in our
2005 Form 10-K. However, corporate goals and individual goals of executives are
currently calculated in accordance with IFRSs under which HSBC prepares its
consolidated financial statements. In 2006 we initiated a project to refine the
monthly internal management reporting process to place a greater emphasis on
IFRS management basis reporting (a non-U.S. GAAP financial measure) ("IFRS
Management Basis"). As a result, operating results are now being monitored and
reviewed, trends are being evaluated and decisions about allocating resources,
such as employees, are being made almost exclusively on an IFRS Management
Basis. IFRS Management Basis results are IFRSs results which assume that the
private label and real estate secured receivables transferred to HSBC Bank USA
have not been sold and remain on our balance sheet. Operations are monitored and
trends are evaluated on an IFRS Management Basis because the customer loan sales
to HSBC Bank USA were conducted primarily to appropriately fund prime customer
loans within HSBC and such customer loans continue to be managed and serviced by
us without regard to ownership. Therefore, we have changed the measurement of
segment profit to IFRS Management Basis in order to align with our revised
internal reporting structure. However, we continue to monitor capital adequacy,
establish dividend policy and report to regulatory agencies on an U.S. GAAP
basis. A summary of the significant differences between U.S. GAAP and IFRSs as
they impact our results are summarized below:
Securitizations - On an IFRSs basis, securitized receivables are treated as
owned. Any gains recorded under U.S. GAAP on these transactions are
reversed. An owned loss reserve is established. 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.
Derivatives and hedge accounting (including fair value adjustments) - The
IFRSs derivative accounting model is similar to U.S. GAAP requirements, but
IFRSs does not permit use of the short-cut method of hedge effectiveness
testing. Unlike U.S. GAAP, IFRSs permits hedge accounting for hedges of
forecasted cash flows. The differences between U.S. GAAP and IFRSs relate
primarily to the fact that a different population of derivatives qualified
for hedge accounting under IFRSs than U.S. GAAP throughout the period and
that HSBC Finance Corporation elected the fair value option under IFRSs on
a significant portion of its fixed rate debt which was being hedged by
receive fixed swaps. U.S. GAAP does not currently permit the use of the
fair value option.
Intangible assets - Intangible assets under IFRSs are significantly lower
than that under U.S. GAAP as the newly created intangibles associated with
our acquisition by HSBC are reflected in goodwill for IFRSs therefore,
amortization of intangible assets is lower under IFRSs.
165
Purchase accounting adjustments - There are differences in the valuation of
assets and liabilities under U.K. GAAP (which were carried forward into
IFRSs) and U.S. GAAP which result in a different amortization for the HSBC
acquisition. Additionally there are differences in the valuation of assets
and liabilities under IFRSs and U.S. GAAP resulting from the Metris
acquisition in December 2005.
Deferred loan origination costs and premiums - Under IFRSs loan origination
cost deferrals are more stringent and result in lower costs being deferred
than permitted under U.S. GAAP. In addition, all deferred loan origination
fees, costs and loan premiums must be recognized based on the expected life
of the receivables under IFRSs as part of the effective interest
calculation while under U.S. GAAP they may be amortized on either a
contractual or expected life basis.
Credit loss impairment provisioning - IFRSs requires a discounted cash flow
methodology for estimating impairment on pools of homogeneous customer
loans which requires the incorporation of the time value of money relating
to recovery estimates. Also under IFRSs, future recoveries on charged-off
loans are accrued for on a discounted basis and interest is recorded based
on collectibility.
Loans held for resale - IFRSs requires loans held for resale to be treated
as trading assets and recorded at their fair market value. Under U.S. GAAP,
loans held for resale are designated as loans on the balance sheet and
recorded at the lower of amortized cost or market. Under U.S. GAAP, the
income and expenses related to loans held for sale are reported similarly
to loans held for investment. Under IFRSs, the income and expenses related
to loans held for sale are reported in other operating income.
Interest recognition - The calculation of effective interest rates under
IFRS 39 requires an estimate of "all fees and points paid or recovered
between parties to the contract" that are an integral part of the effective
interest rate be included. In 2006, we implemented a methodology for
calculating the effective interest rate for introductory rate credit card
receivables under IFRS over the expected life of the product. Also in 2006,
we implemented a methodology to include prepayment penalties as part of the
effective interest rate and recognize such penalties over the expected life
of the receivables. U.S. GAAP generally prohibits recognition of interest
income to the extent the net interest in the loan would increase to an
amount greater than the amount at which the borrower could settle the
obligation. Also under U.S. GAAP, prepayment penalties are generally
recognized as received.
Other - There are other less significant differences between IFRS and U.S.
GAAP relating to pension expense, changes in tax estimates and other less
significant items.
See "Basis of Reporting" in Item 7. Management's Discussion and Analysis of
Financial Condition and results of Operations in this 2006 Form 10-K for a more
complete discussion of differences between U.S. GAAP and IFRSs.
For comparability purposes, we have restated segment results for the year ended
December 31, 2005 to the IFRS Management Basis. When HSBC began reporting IFRS
results in 2005, it elected to take advantage of certain options available
during the year of transition from U.K. GAAP to IFRSs which provided, among
other things, an exemption from applying certain IFRSs retrospectively.
Therefore, the segment results reported for the year ended December 31, 2004 are
presented on an IFRS Management Basis excluding the retrospective application of
IAS 32, "Financial Instruments: Presentation" and IAS 39, "Financial
Instruments: Recognition and Measurement which took effect on January 1, 2005
and, as a result, the accounting for credit loss impairment provisioning,
deferred loan origination costs and premiums and derivative income for the year
ended December 31, 2004 remain in accordance with U.K. GAAP, HSBC's previous
basis of reporting. Credit loss provisioning under U.K. GAAP differs from IFRSs
in that IFRSs require a discounted cash flow methodology for estimating
impairment as well as accruing for future recoveries of charged-off loans on a
discounted basis. Under U.K. GAAP only sales incentives were treated as deferred
loan origination costs which results in lower deferrals than those reported
under IFRSs. Additionally, deferred costs and fees could be amortized over the
contractual life of the underlying receivable rather than the expected life as
required under IFRSs. Derivative and hedge accounting under U.K. GAAP differs
from U.S. GAAP in many respects, including the determination of when a hedge
exists as well as the reporting of gains and losses. For a more detailed
discussion of the differences between IFRSs and U.K. GAAP, see Exhibit 99.2 to
this Form 10-K.
166
For segment reporting purposes, intersegment transactions have not been
eliminated. We generally account for transactions between segments as if they
were with third parties.
Reconciliation of our IFRS Management Basis segment results to the U.S. GAAP
consolidated totals are as follows:
IFRS
MANAGEMENT
CREDIT ADJUSTMENTS/ BASIS MANAGEMENT
CARD INTER- ALL RECONCILING CONSOLIDATED BASIS IFRS
CONSUMER SERVICES NATIONAL OTHER ITEMS TOTALS ADJUSTMENTS(7) ADJUSTMENTS(6)
------------------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
YEAR ENDED DECEMBER 31, 2006
Net interest
income.............. $ 8,588 $ 3,151 $ 826 $ (768)(10) $ - $ 11,797 $ (1,254) $ (228)
Other operating
income (Total other
revenues)........... 909 2,360 283 705 (291)(2) 3,966 299 180
Loan impairment
charges (Provision
for credit
losses)............. 4,983 1,500 535 (2) 6(3) 7,022 (646) 225
Operating expenses
(Total costs and
expenses)........... 2,998 1,841 495 588 - 5,922 (22) (28)
Income tax expense
(benefit)........... 528 784 37 (326) (110)(4) 913 (89) 20
Net income........... 988 1,386 42 (323) (187) 1,906 (198) (265)
Operating net
income(1)........... 988 1,386 42 (401) (187) 1,828 (198) (265)
Customer loans
(Receivables)....... 144,573 28,221 9,520 199 - 182,513 (21,372) 895
Assets............... 146,395 28,780 10,764 29,944 (8,197)(5) 207,686 (21,931) (5,871)
Intersegment
revenues............ 242 20 33 (4) (291)(2) - - -
Depreciation and
amortization........ 34 67 17 120 - 238 - 179
Goodwill............. 46 530 11 9,510 - 10,097 - (3,087)
Expenditures for
long-lived
assets(8)........... 76 1 13 58 - 148 - -
-------- ------- ------- ------- ------- -------- -------- --------
YEAR ENDED DECEMBER 31, 2005
Net interest
income.............. $ 8,401 $ 2,150 $ 971 $ (834) $ - $ 10,688 $ (1,438) $ (734)
Other operating
income (Total other
revenues)........... 814 1,892 770 602 (140)(2) 3,938 500 (443)
Loan impairment
charges (Provision
for credit
losses)............. 3,362 1,453 620 (41) 9(3) 5,403 (629) (291)
Operating expenses
(Total costs and
expenses)........... 2,757 1,315 635 574 - 5,281 (23) 107
Income tax expense
(benefit)........... 1,115 461 5 (364) (54)(4) 1,163 (94) (178)
Net income........... 1,981 813 481 (401) (95) 2,779 (192) (815)
Operating net
income(1)........... 1,981 813 481 (401) (95) 2,779 (192) (815)
Customer loans
(Receivables)....... 128,095 25,979 9,328 211 - 163,613 (20,306) (3,394)
Assets............... 130,375 28,453 10,905 26,634 (8,220)(5) 188,147 (20,247) (10,725)
Intersegment
revenues............ 108 21 17 (6) (140)(2) - - -
Depreciation and
amortization........ 44 26 30 143 - 243 - 275
Goodwill............. - 521 11 9,464 - 9,996 - (2,993)
Expenditures for
long-lived
assets(8)........... 24 525 32 28 - 609 - 2
-------- ------- ------- ------- ------- -------- -------- --------
IFRS U.S. GAAP
RECLASS- CONSOLIDATED
IFICATIONS(9) TOTALS
--------------------- -------------------------------
(IN MILLIONS)
YEAR ENDED DECEMBER 3
Net interest
income.............. $ (127) $ 10,188
Other operating
income (Total other
revenues)........... 978 5,423
Loan impairment
charges (Provision
for credit
losses)............. (37) 6,564
Operating expenses
(Total costs and
expenses)........... 888 6,760
Income tax expense
(benefit)........... - 844
Net income........... - 1,443
Operating net
income(1)........... - 1,365
Customer loans
(Receivables)....... - 162,036
Assets............... (425) 179,459
Intersegment
revenues............ - -
Depreciation and
amortization........ (32) 385
Goodwill............. - 7,010
Expenditures for
long-lived
assets(8)........... - 148
-------- --------
YEAR ENDED DECEMBER 3
Net interest
income.............. $ (132) $ 8,384
Other operating
income (Total other
revenues)........... 968 4,963
Loan impairment
charges (Provision
for credit
losses)............. 60 4,543
Operating expenses
(Total costs and
expenses)........... 776 6,141
Income tax expense
(benefit)........... - 891
Net income........... - 1,772
Operating net
income(1)........... - 1,772
Customer loans
(Receivables)....... - 139,913
Assets............... (506) 156,669
Intersegment
revenues............ - -
Depreciation and
amortization........ (61) 457
Goodwill............. - 7,003
Expenditures for
long-lived
assets(8)........... - 611
-------- --------
167
IFRS
MANAGEMENT
CREDIT ADJUSTMENTS/ BASIS MANAGEMENT
CARD INTER- ALL RECONCILING CONSOLIDATED BASIS IFRS
CONSUMER SERVICES NATIONAL OTHER ITEMS TOTALS ADJUSTMENTS(7) ADJUSTMENTS(6)
------------------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
YEAR ENDED DECEMBER 31, 2004
Net interest
income.............. $ 8,180 $ 2,226 $ 899 $ (49) $ - $ 11,256 $ (192) $ (3,132)
Other operating
income (Total other
revenues)........... 502 1,581 313 528 (137)(2) 2,787 571 521
Loan impairment
charges (Provision
for credit
losses)............. 3,151 1,786 408 (2) 2(3) 5,345 (139) (1,185)
Operating expenses
(Total costs and
expenses)........... 2,777 1,205 615 490 - 5,087 - (237)
Income tax expense
(benefit)........... 1,017 295 67 (125) (50)(4) 1,204 185 (389)
Net income........... 1,737 521 122 116 (89) 2,407 333 (800)
Operating net
income(1)........... 1,324 522 122 132 (89) 2,011 333 (706)
Customer loans
(Receivables)....... 107,769 19,615 13,102 308 - 140,794 (17,225) (16,714)
Assets............... 109,238 19,702 14,263 31,103 (8,212)(5) 166,094 (17,270) (18,005)
Intersegment
revenues............ 101 25 15 (4) (137)(2) - - -
Depreciation and
amortization........ 33 54 40 102 - 229 - 289
Goodwill............. 876 249 1 8,615 - 9,741 - (2,885)
Expenditures for
long-lived
assets(8)........... 18 4 20 54 - 96 - -
-------- ------- ------- ------- ------- -------- -------- --------
IFRS U.S. GAAP
RECLASS- CONSOLIDATED
IFICATIONS(9) TOTALS
--------------------- -------------------------------
(IN MILLIONS)
YEAR ENDED DECEMBER 3
Net interest
income.............. $ (130) $ 7,802
Other operating
income (Total other
revenues)........... 1,284 5,163
Loan impairment
charges (Provision
for credit
losses)............. 313 4,334
Operating expenses
(Total costs and
expenses)........... 841 5,691
Income tax expense
(benefit)........... - 1,000
Net income........... - 1,940
Operating net
income(1)........... - 1,638
Customer loans
(Receivables)....... - 106,855
Assets............... (629) 130,190
Intersegment
revenues............ - -
Depreciation and
amortization........ (35) 483
Goodwill............. - 6,856
Expenditures for
long-lived
assets(8)........... - 96
-------- --------
---------------
(1) This non-U.S. GAAP financial measure is provided for comparison of our
operating trends only and should be read in conjunction with our owned basis
U.S. GAAP financial information. Operating net income in 2004 excludes the
gain on the bulk sale of domestic private label credit card receivables of
$423 million (after-tax) and the impact of the adoption of FFIEC charge-off
policies for the domestic private label (excluding retail sales contracts at
our consumer lending business) and credit card portfolios of $121 million
(after-tax). See "Basis of Reporting" for additional discussion on the use
of non-U.S. GAAP financial measures.
(2) Eliminates intersegment revenues.
(3) Eliminates bad debt recovery sales between operating segments.
(4) Tax benefit associated with items comprising adjustments/reconciling items.
(5) Eliminates investments in subsidiaries and intercompany borrowings.
(6) IFRS Adjustments, which have been described more fully above, consist of the
following:
PROVISION TOTAL INCOME
NET FOR COSTS TAX OPERATING
INTEREST OTHER CREDIT AND EXPENSE NET NET
INCOME REVENUES LOSSES EXPENSES (BENEFIT) INCOME INCOME
--------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
YEAR ENDED DECEMBER 31, 2006
Securitizations........................ $ (244) $ 89 $ 25 $ - $ (62) $(118) $(118)
Derivatives and hedge accounting....... (31) 277 - - 91 155 155
Intangible assets...................... - - - 179 (66) (113) (113)
Purchase accounting.................... 202 64 195 (4) 25 50 50
Deferred loan origination costs and
premiums.............................. (156) 2 - (199) 16 29 29
Credit loss impairment provisioning.... (39) (3) 12 - (20) (34) (34)
Loans held for resale.................. 125 (202) - (32) (17) (28) (28)
Interest recognition................... (38) (16) - - (20) (34) (34)
Other.................................. (47) (31) (7) 28 73 (172) (172)
------- ------- ------- ----- ----- ----- -----
Total.................................. $ (228) $ 180 $ 225 $ (28) $ 20 $(265) $(265)
======= ======= ======= ===== ===== ===== =====
TOTAL
RECEIVABLES ASSETS
--------------------------------------- ----------------------
(IN MILLIONS)
YEAR ENDED DECEMBER 31, 2006
Securitizations........................ $ (948) $ (1,232)
Derivatives and hedge accounting....... - (2,966)
Intangible assets...................... - (1,494)
Purchase accounting.................... 118 (38)
Deferred loan origination costs and
premiums.............................. 457 457
Credit loss impairment provisioning.... (295) (298)
Loans held for resale.................. 1,584 38
Interest recognition................... (53) (53)
Other.................................. 32 (285)
-------- --------
Total.................................. $ 895 $ (5,871)
======== ========
168
PROVISION TOTAL INCOME
NET FOR COSTS TAX OPERATING
INTEREST OTHER CREDIT AND EXPENSE NET NET
INCOME REVENUES LOSSES EXPENSES (BENEFIT) INCOME INCOME
--------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
YEAR ENDED DECEMBER 31, 2005
Securitizations........................ $ (900) $ (137) $ (315) $ - $(265) $(457) $(457)
Derivatives and hedge accounting....... (41) (60) - - (43) (58) (58)
Intangible assets...................... - - - 272 (100) (172) (172)
Purchase accounting.................... 314 240 51 (15) 138 380 380
Deferred loan origination costs and
premiums.............................. (197) 2 - (187) (2) (6) (6)
Credit loss impairment provisioning.... (55) 34 (42) - 10 11 11
Loans held for resale.................. 126 (79) - 44 1 2 2
Interest recognition................... - - - - - - -
Other.................................. 19 (443) 15 (7) 83 (515) (515)
------- ------- ------- ----- ----- ----- -----
Total.................................. $ (734) $ (443) $ (291) $ 107 $(178) $(815) $(815)
======= ======= ======= ===== ===== ===== =====
YEAR ENDED DECEMBER 31, 2004
Securitizations........................ $(2,462) $ 220 $(1,164) $ - $(390) $(688) $(688)
Derivatives and hedge accounting....... (365) 511 - - 54 92 92
Intangible assets...................... - - - - - - -
Purchase accounting.................... 226 (169) - 289 (71) (161) (177)
Deferred loan origination costs and
premiums.............................. (472) (3) - (511) 13 23 23
Credit loss impairment provisioning.... - - - - - - -
Loans held for resale.................. - - - - - - -
Prepayment penalty..................... - - - - - - -
Interest recognition................... (17) - (7) - (4) (6) (6)
Other.................................. (42) (38) (14) (15) 9 (60) 50
------- ------- ------- ----- ----- ----- -----
Total.................................. $(3,132) $ 521 $(1,185) $(237) $(389) $(800) $ 706
======= ======= ======= ===== ===== ===== =====
TOTAL
RECEIVABLES ASSETS
--------------------------------------- ----------------------
(IN MILLIONS)
YEAR ENDED DECEMBER 31, 2005
Securitizations........................ $ (5,415) $ (7,251)
Derivatives and hedge accounting....... - (2,719)
Intangible assets...................... - (1,222)
Purchase accounting.................... 162 (114)
Deferred loan origination costs and
premiums.............................. 430 430
Credit loss impairment provisioning.... (280) (232)
Loans held for resale.................. 1,723 -
Interest recognition................... - -
Other.................................. (14) 383
-------- --------
Total.................................. $ (3,394) $(10,725)
======== ========
YEAR ENDED DECEMBER 31, 2004
Securitizations........................ $(17,552) $(16,417)
Derivatives and hedge accounting....... - 159
Intangible assets...................... - (775)
Purchase accounting.................... - (265)
Deferred loan origination costs and
premiums.............................. 597 568
Credit loss impairment provisioning.... -
Loans held for resale.................. - -
Prepayment penalty..................... - -
Interest recognition................... - 92
Other.................................. 241 (1,367)
-------- --------
Total.................................. $(16,714) $(18,005)
======== ========
(7) Management Basis Adjustments, which represent the private label and real
estate secured receivables transferred to HBUS, consist of the following:
PROVISION TOTAL INCOME
NET FOR COSTS TAX OPERATING
INTEREST OTHER CREDIT AND EXPENSE NET NET
INCOME REVENUES LOSSES EXPENSES (BENEFIT) INCOME INCOME
-----------------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
YEAR ENDED DECEMBER 31, 2006
Private label receivables....................... $(1,175) $287 $(623) $(17) $(75) $(173) $(173)
Real estate secured receivables................. (99) 12 (23) (5) (21) (38) (38)
Other........................................... 20 - - - 7 13 13
------- ---- ----- ---- ---- ----- -----
Total........................................... $(1,254) $299 $(646) $(22) $(89) $(198) $(198)
======= ==== ===== ==== ==== ===== =====
YEAR ENDED DECEMBER 31, 2005
Private label receivables....................... $(1,310) $483 $(594) $(22) $(66) $(145) $(145)
Real estate secured receivables................. (159) 17 (35) (1) (39) (67) (67)
Other........................................... 31 - - - 11 20 20
------- ---- ----- ---- ---- ----- -----
Total........................................... $(1,438) $500 $(629) $(23) $(94) $(192) $(192)
======= ==== ===== ==== ==== ===== =====
YEAR ENDED DECEMBER 31, 2004
Private label receivables....................... $ (9) $559 $(125) $ - $244 $ 431 $ 431
Real estate secured receivables................. (180) 32 (14) - (51) (83) (83)
Other........................................... (3) (20) - - (8) (15) (15)
------- ---- ----- ---- ---- ----- -----
Total........................................... $ (192) $571 $(139) $ - $185 $ 333 $ 333
======= ==== ===== ==== ==== ===== =====
TOTAL
RECEIVABLES ASSETS
------------------------------------------------ ----------------------
(IN MILLIONS)
YEAR ENDED DECEMBER 31, 2006
Private label receivables....................... $(18,125) $(18,653)
Real estate secured receivables................. (3,247) (3,278)
Other........................................... - -
-------- --------
Total........................................... $(21,372) $(21,931)
======== ========
YEAR ENDED DECEMBER 31, 2005
Private label receivables....................... $(15,762) $(15,673)
Real estate secured receivables................. (4,544) (4,571)
Other........................................... - (3)
-------- --------
Total........................................... $(20,306) $(20,247)
======== ========
YEAR ENDED DECEMBER 31, 2004
Private label receivables....................... $ 12,217 $(12,225)
Real estate secured receivables................. (5,008) (5,031)
Other........................................... - (14)
-------- --------
Total........................................... $(17,225) $(17,270)
======== ========
(8) Includes goodwill associated with purchase business combinations other than
the HSBC merger as well as capital expenditures.
(9) Represents differences in balance sheet and income statement presentation
between IFRS and U.S. GAAP.
(10)In 2006, the "All Other" caption includes a cumulative adjustment to net
interest income of approximately $207 million, largely to correct the
amortization of purchase accounting adjustments related to certain debt that
was not included in the fair value option adjustments under IFRSs in 2005. A
portion of the amount recognized would otherwise have been recorded for the
year ended December 31, 2005.
169
22. COMMITMENTS AND CONTINGENT LIABILITIES
--------------------------------------------------------------------------------
LEASE OBLIGATIONS: We lease certain offices, buildings and equipment for periods
which generally do not exceed 25 years. The leases have various renewal options.
The office space leases generally require us to pay certain operating expenses.
Net rental expense under operating leases was $134 million in 2006, $132 million
in 2005 and $117 million in 2004.
We have lease obligations on certain office space which has been subleased
through the end of the lease period. Under these agreements, the sublessee has
assumed future rental obligations on the lease.
Future net minimum lease commitments under noncancelable operating lease
arrangements were:
MINIMUM MINIMUM
RENTAL SUBLEASE
YEAR ENDING DECEMBER 31, PAYMENTS INCOME NET
----------------------------------------------------------------------------------------
(IN MILLIONS)
2007........................................................ $182 $ 58 $124
2008........................................................ 144 36 108
2009........................................................ 121 34 87
2010........................................................ 80 15 65
2011........................................................ 42 - 42
Thereafter.................................................. 127 - 127
---- ---- ----
Net minimum lease commitments............................... $696 $143 $553
==== ==== ====
In January 2006 we entered into a lease for a building in the Village of
Mettawa, Illinois. The new facility will consolidate our Prospect Heights, Mount
Prospect and Deerfield offices. Construction of the building began in the spring
of 2006 and the relocation is planned for the first and second quarters of 2008.
The future lease payments for this building are currently estimated as follows:
(IN MILLIONS)
----------------------------------------------------------------------------
2008........................................................ $ 5
2009........................................................ 11
2010........................................................ 11
2011........................................................ 11
Thereafter.................................................. 115
----
$153
====
LITIGATION: Both we and certain of our subsidiaries are parties to various legal
proceedings resulting from ordinary business activities relating to our current
and/or former operations which affect all three of our reportable segments.
Certain of these activities are or purport to be class actions seeking damages
in significant amounts. These actions include assertions concerning violations
of laws and/or unfair treatment of consumers.
Due to the uncertainties in litigation and other factors, we cannot be certain
that we will ultimately prevail in each instance. Also, as the ultimate
resolution of these proceedings is influenced by factors that are outside of our
control, it is reasonably possible our estimated liability under these
proceedings may change. However, based upon our current knowledge, our defenses
to these actions have merit and any adverse decision should not materially
affect our consolidated financial condition, results of operations or cash
flows.
OTHER COMMITMENTS: At December 31, 2006, our Mortgage Services business had
commitments with numerous correspondents to purchase up to $104 million of real
estate secured receivables at fair market value, subject to availability based
on underwriting guidelines specified by our mortgage services business. These
commitments have terms of up to one year and can be renewed upon mutual
agreement. Also at
170
December 31, 2006 our Mortgage Services business had outstanding forward sales
commitments relating to real estate secured loans totaling $607 million.
At December 31, 2006, we have a commitment to lend up to $3.0 billion to H&R
Block to fund the purchase of a participation interest in refund anticipation
loans.
23. FAIR VALUE OF FINANCIAL INSTRUMENTS
--------------------------------------------------------------------------------
We have estimated the fair value of our financial instruments in accordance with
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments" ("SFAS No.
107"). Fair value estimates, methods and assumptions set forth below for our
financial instruments are made solely to comply with the requirements of SFAS
No. 107 and should be read in conjunction with the financial statements and
notes in this Annual Report.
A significant portion of our financial instruments do not have a quoted market
price. For these items, fair values were estimated by discounting estimated
future cash flows at estimated current market discount rates. Assumptions used
to estimate future cash flows are consistent with management's assessments
regarding ultimate collectibility of assets and related interest and with
estimates of product lives and repricing characteristics used in our
asset/liability management process. All assumptions are based on historical
experience adjusted for future expectations. Assumptions used to determine fair
values for financial instruments for which no active market exists are
inherently judgmental and changes in these assumptions could significantly
affect fair value calculations.
As required under generally accepted accounting principles, a number of other
assets recorded on the balance sheets (such as acquired credit card
relationships, the value of consumer lending relationships for originated
receivables and the franchise values of our business units) are not considered
financial instruments and, accordingly, are not valued for purposes of this
disclosure. However, on March 29, 2003, as a result of our acquisition by HSBC,
these other assets were adjusted to their fair market value based, in part, on
third party valuation data, under the "push-down" method of accounting. We
believe there continues to be substantial value associated with these assets
based on current market conditions and historical experience. Accordingly, the
estimated fair value of financial instruments, as disclosed, does not fully
represent our entire value, nor the changes in our entire value.
171
The following is a summary of the carrying value and estimated fair value of our
financial instruments:
AT DECEMBER 31,
-------------------------------------------------------------------------
2006 2005
----------------------------------- -----------------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
VALUE FAIR VALUE DIFFERENCE VALUE FAIR VALUE DIFFERENCE
-----------------------------------------------------------------------------------------------------
(IN MILLIONS)
ASSETS:
Cash...................... $ 871 $ 871 $ - $ 903 $ 903 $ -
Interest bearing deposits
with banks.............. 424 424 - 384 384 -
Securities purchased under
agreements to resell.... 171 171 - 78 78 -
Securities................ 4,695 4,695 - 4,051 4,051 -
Receivables............... 157,262 154,858 (2,404) 136,989 137,710 721
Due from affiliates....... 528 528 - 518 518 -
Derivative financial
assets.................. 1,461 1,461 - 234 234 -
LIABILITIES:
Commercial paper, bank and
other borrowings........ (11,055) (11,055) - (11,454) (11,454) -
Due to affiliates......... (15,172) (15,308) (136) (15,534) (15,568) (34)
Long term debt............ (127,590) (129,008) (1,418) (105,163) (106,314) (1,151)
Insurance policy and claim
reserves................ (1,319) (1,362) (43) (1,291) (1,336) (45)
Derivative financial
liabilities............. (58) (58) - (292) (292) -
CASH: Carrying value approximates fair value due to cash's liquid nature.
INTEREST BEARING DEPOSITS WITH BANKS: Carrying value approximates fair value due
to the asset's liquid nature.
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL: The fair value of securities
purchased under agreements to resell approximates carrying value due to their
short-term maturity.
SECURITIES: Securities are classified as available-for-sale and are carried at
fair value on the balance sheets. Fair values are based on quoted market prices
or dealer quotes. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.
RECEIVABLES: The fair value of adjustable rate receivables generally
approximates carrying value because interest rates on these receivables adjust
with changing market interest rates. The fair value of fixed rate consumer
receivables was estimated by discounting future expected cash flows at interest
rates which approximate the current interest rates that would achieve a similar
return on assets with comparable risk characteristics. Receivables also includes
our interest-only strip receivables. The interest-only strip receivables are
carried at fair value on our balance sheets. Fair value is based on an estimate
of the present value of future cash flows associated with securitizations of
certain real estate secured, auto finance, credit card, private label and
personal non-credit card receivables.
DUE FROM AFFILIATES: Carrying value approximates fair value because the interest
rates on these receivables adjust with changing market interest rates.
COMMERCIAL PAPER, BANK AND OTHER BORROWINGS: The fair value of these instruments
approximates existing carrying value because interest rates on these instruments
adjust with changes in market interest rates due to their short-term maturity or
repricing characteristics. At December 31, 2006 deposits have been classified as
bank and other borrowings due to their short-term nature. Prior period amounts
have been reclassed to conform to the current presentation.
172
DUE TO AFFILIATES: The estimated fair value of our debt instruments due to
affiliates was determined by discounting future expected cash flows at current
interest rates offered for similar types of debt instruments. Carrying value is
typically used to estimate the fair value of floating rate debt.
LONG TERM DEBT: The estimated fair value of our fixed rate debt instruments was
determined using either quoted market prices or by discounting future expected
cash flows at current interest rates offered for similar types of debt
instruments. Carrying value is typically used to estimate the fair value of
floating rate debt.
INSURANCE POLICY AND CLAIM RESERVES: The fair value of insurance reserves for
periodic payment annuities was estimated by discounting future expected cash
flows at estimated market interest rates at December 31, 2006 and 2005. The fair
value of other insurance reserves is not required to be determined in accordance
with SFAS No. 107.
DERIVATIVE FINANCIAL ASSETS AND LIABILITIES: All derivative financial assets and
liabilities, which exclude amounts receivable from or payable to swap
counterparties, are carried at fair value on the balance sheet. Where practical,
quoted market prices were used to determine fair value of these instruments. For
non-exchange traded contracts, fair value was determined using discounted cash
flow modeling techniques in lieu of market value quotes. We enter into foreign
exchange contracts to hedge our exposure to currency risk on foreign denominated
debt. We also enter into interest rate contracts to hedge our exposure to
interest rate risk on assets and liabilities, including debt. As a result,
decreases/increases in the fair value of derivative financial instruments which
have been designated as effective hedges are offset by a corresponding
increase/decrease in the fair value of the individual asset or liability being
hedged. See Note 14, "Derivative Financial Instruments," for additional
discussion of the nature of these items.
24. CONCENTRATION OF CREDIT RISK
--------------------------------------------------------------------------------
A concentration of credit risk is defined as a significant credit exposure with
an individual or group engaged in similar activities or having similar economic
characteristics that would cause their ability to meet contractual obligations
to be similarly affected by changes in economic or other conditions.
We generally serve non-conforming and non-prime consumers. Such customers are
individuals who have limited credit histories, modest incomes, high
debt-to-income ratios or have experienced credit problems caused by occasional
delinquencies, prior charge-offs, bankruptcy or other credit related actions. As
a result, the majority of our secured receivables have a high loan-to-value
ratio. Due to customer demand we offer interest-only loans and expect to
continue to do so. These interest-only loans allow customers to pay only the
accruing interest for a period of time which results in lower payments during
the initial loan period. Depending on a customer's financial situation, the
subsequent increase in the required payment to begin making payment towards the
loan principal could affect our customer's ability to repay the loan at some
future date when the interest rate resets and/or principal payments are
required. As with all our other non-conforming and nonprime loan products, we
underwrite and price interest-only loans in a manner that is appropriate to
compensate for their higher risk. At December 31, 2006, the outstanding balance
of our interest-only loans was $6.2 billion, or 4 percent of receivables. At
December 31, 2005, the outstanding balance of our interest-only loans was $4.9
billion, or 3 percent of receivables.
Also due to customer demand, we offer adjustable rate mortgage loans which
allows us to adjust pricing on the receivable in line with market movements. At
December 31, 2006, we had approximately $29.8 billion in adjustable rate
mortgage loans at our Consumer Lending and Mortgage Services businesses. In 2007
and 2008, approximately $10.8 billion and $5.1 billion, respectively, of our
adjustable rate mortgage loans will experience their first interest rate reset
based on receivable levels outstanding at December 31, 2006. In addition, our
analysis indicates that a significant portion of the second lien mortgages in
our Mortgage Services portfolio at December 31, 2006 are subordinated to first
lien adjustable rate mortgages that will face a rate reset in the next three
years. As interest rates have risen over the last three years, many adjustable
rate loans are expected to require a significantly higher monthly payment
following their first adjustment. A customer's financial situation at the time
of the interest rate reset could affect our customer's ability to repay the loan
after the adjustment.
173
Additionally during 2006 and 2005 we increased our portfolio of stated income
(low documentation) loans. Stated income loans have a lower income documentation
requirement during the underwriting process and, accordingly, carry a higher
risk of default if the customer has not accurately reflected their income. We
price stated income loans in a manner that is appropriate to compensate for
their higher risk. The outstanding balance of our stated income loan portfolio
was $11.8 billon at December 31, 2006 and $7.3 billion at December 31, 2005.
Because we primarily lend to consumers, we do not have receivables from any
industry group that equal or exceed 10 percent of total receivables at December
31, 2006 and 2005. We lend nationwide and our receivables are distributed as
follows at December 31, 2006:
PERCENT OF TOTAL
DOMESTIC
STATE/REGION RECEIVABLES
-------------------------------------------------------------------------------
California.................................................. 13%
Midwest (IL, IN, IA, KS, MI, MN, MO, NE, ND, OH, SD, WI).... 23
Southeast (AL, FL, GA, KY, MS, NC, SC, TN).................. 20
Middle Atlantic (DE, DC, MD, NJ, PA, VA, WV)................ 15
Southwest (AZ, AR, LA, NM, OK, TX).......................... 10
Northeast (CT, ME, MA, NH, NY, RI, VT)...................... 11
West (AK, CO, HI, ID, MT, NV, OR, UT, WA, WY)............... 8
25. GEOGRAPHIC DATA
--------------------------------------------------------------------------------
The tables below summarize our owned basis assets, revenues and income before
income taxes by material country. Purchase accounting adjustments are reported
within the appropriate country.
AT DECEMBER 31,
----------------------------------------------------------
IDENTIFIABLE ASSETS LONG-LIVED ASSETS(1)
------------------------------ -------------------------
2006 2005 2004 2006 2005 2004
-----------------------------------------------------------------------------------------------
(IN MILLIONS)
United States...................... $168,597 $145,955 $115,938 $9,046 $9,382 $ 8,974
United Kingdom..................... 6,592 7,006 11,468 452 403 942
Canada............................. 4,181 3,479 2,581 157 153 129
Europe............................. 89 229 203 - 3 3
-------- -------- -------- ------ ------ -------
Total.............................. $179,459 $156,669 $130,190 $9,655 $9,941 $10,048
======== ======== ======== ====== ====== =======
---------------
(1) Includes properties and equipment, goodwill and acquired intangibles.
YEAR ENDED DECEMBER 31,
---------------------------------------------------------
REVENUES INCOME BEFORE INCOME TAXES
--------------------------- ---------------------------
2006 2005 2004 2006 2005 2004
--------------------------------------------------------------------------------------------------
(IN MILLIONS)
United States.......................... $21,130 $15,961 $14,326 $2,330 $2,609 $2,858
United Kingdom......................... 1,222 1,737 1,426 (170) (37) 6
Canada................................. 601 450 340 129 96 82
Europe................................. 32 31 16 (2) (5) (6)
------- ------- ------- ------ ------ ------
Total.................................. $22,985 $18,179 $16,108 $2,287 $2,663 $2,940
======= ======= ======= ====== ====== ======
174
HSBC Finance Corporation
--------------------------------------------------------------------------------
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
THREE THREE THREE THREE THREE THREE THREE THREE
MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED ENDED ENDED ENDED ENDED
DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
2006 2006 2006 2006 2005 2005 2005 2005
---------------------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Finance and other interest income....... $4,629 $4,535 $4,311 $4,087 $3,725 $3,402 $3,139 $2,950
Interest expense:
HSBC affiliates....................... 320 283 173 153 206 222 134 151
Non-affiliates........................ 1,736 1,650 1,589 1,470 1,221 1,017 970 911
------ ------ ------ ------ ------ ------ ------ ------
Net interest income..................... 2,573 2,602 2,549 2,464 2,298 2,163 2,035 1,888
Provision for credit losses on owned
receivables........................... 3,066 1,384 1,248 866 1,310 1,361 1,031 841
------ ------ ------ ------ ------ ------ ------ ------
Net interest income after provision for
credit losses......................... (493) 1,218 1,301 1,598 988 802 1,004 1,047
------ ------ ------ ------ ------ ------ ------ ------
Other revenues:.........................
Securitization related revenue.......... 21 24 51 71 31 41 54 85
Insurance revenue....................... 251 280 226 244 257 251 255 234
Investment income....................... 175 31 34 34 35 33 33 33
Derivative income (expense)............. 72 68 (7) 57 (34) (53) 76 260
Fee income.............................. 558 542 429 382 469 439 354 306
Enhancement services revenue............ 133 129 130 123 98 86 79 75
Taxpayer financial services income...... - 4 20 234 17 (1) 18 243
Gain on receivable sales to HSBC
affiliates............................ 139 101 97 85 105 99 109 100
Servicing and other fees from HSBC
affiliates............................ 151 121 116 118 111 109 109 111
Other income............................ (7) 34 79 73 86 135 74 41
------ ------ ------ ------ ------ ------ ------ ------
Total other revenues.................... 1,493 1,334 1,175 1,421 1,175 1,139 1,161 1,488
------ ------ ------ ------ ------ ------ ------ ------
Costs and expenses:
Salaries and fringe benefits............ 617 571 564 581 536 513 526 497
Sales incentives........................ 86 94 98 80 108 117 90 82
Occupancy and equipment expense......... 77 78 79 83 82 83 82 87
Other marketing expenses................ 268 197 176 173 170 196 185 180
Other servicing and administrative
expenses.............................. 353 287 222 253 267 186 180 284
Support services from HSBC
affiliates............................ 304 261 270 252 237 226 217 209
Amortization of acquired
intangibles........................... 63 63 63 80 65 90 83 107
Policyholders' benefits................. 119 123 107 118 109 109 116 122
------ ------ ------ ------ ------ ------ ------ ------
Total costs and expenses................ 1,887 1,674 1,579 1,620 1,574 1,520 1,479 1,568
------ ------ ------ ------ ------ ------ ------ ------
Income before income taxes.............. (887) 878 897 1,399 589 421 686 967
Income taxes............................ (323) 327 329 511 196 140 214 341
------ ------ ------ ------ ------ ------ ------ ------
Net income.............................. $ (564) $ 551 $ 568 $ 888 $ 393 $ 281 $ 472 $ 626
====== ====== ====== ====== ====== ====== ====== ======
Operating net income(1)................. $ (642) $ 551 $ 568 $ 888 $ 393 $ 281 $ 472 $ 626
====== ====== ====== ====== ====== ====== ====== ======
---------------
(1)Operating net income is a non-U.S. GAAP financial measure and is provided for
comparison of our operating trends only and should be read in conjunction
with our owned basis U.S. GAAP financial information. For the three months
ended December 31, 2006, operating net income excludes the $78 million
(after-tax) gain on the sale of our investment in Kanbay.
175
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
--------------------------------------------------------------------------------
There were no disagreements on accounting and financial disclosure matters
between HSBC Finance Corporation and its independent accountants during 2006.
ITEM 9A. CONTROLS AND PROCEDURES.
--------------------------------------------------------------------------------
We maintain a system of internal and disclosure controls and procedures designed
to ensure that information required to be disclosed by HSBC Finance Corporation
in the reports we file or submit under the Securities Exchange Act of 1934, as
amended, (the "Exchange Act"), is recorded, processed, summarized and reported
on a timely basis. Our Board of Directors, operating through its audit
committee, which is composed entirely of independent outside directors, provides
oversight to our financial reporting process.
We conducted an evaluation, with the participation of the Chief Executive
Officer and Chief Financial Officer, of the effectiveness of our disclosure
controls and procedures as of the end of the period covered by this report.
Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures were effective as
of the end of the period covered by this report so as to alert them in a timely
fashion to material information required to be disclosed in reports we file
under the Exchange Act.
There have been no significant changes in our internal and disclosure controls
or in other factors which could significantly affect internal and disclosure
controls subsequent to the date that we carried out our evaluation.
HSBC Finance Corporation continues the process to complete a thorough review of
its internal controls as part of its preparation for compliance with the
requirements of Section 404 of the Sarbanes-Oxley Act of 2002. Section 404
requires our management to report on, and our external auditors to attest to,
the effectiveness of our internal control structure and procedures for financial
reporting. As a non-accelerated filer under Rule 12b-2 of the Exchange Act, our
first report under Section 404 will be contained in our Form 10-K for the period
ended December 31, 2007.
ITEM 9B. OTHER INFORMATION.
--------------------------------------------------------------------------------
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
--------------------------------------------------------------------------------
DIRECTORS
Set forth below is certain biographical information relating to the members of
HSBC Finance Corporation's Board of Directors. Each director is elected
annually. There are no family relationships among the directors.
WILLIAM R. P. DALTON, age 63, joined HSBC Finance Corporation's Board in April
2003. Mr. Dalton retired in May 2004 as an Executive Director of HSBC Holdings
plc, a position he held from April 1998. He also served HSBC as Global Head of
Personal Financial Services from August 2000 to May 2004. From April 1998 to
January 2004 he was Chief Executive of HSBC Bank plc. Mr. Dalton held positions
with various HSBC entities for 25 years.
Mr. Dalton is a member of the Compensation Committee.
GARY G. DILLON, age 72, joined HSBC Finance Corporation's Board in 1984. Mr.
Dillon retired as Chairman of the Board of Schwitzer Group (a manufacturer of
engine components) in March 1999. He had served as Chairman of Schwitzer from
1991 and Chief Executive Officer of Schwitzer from 1989. From 1989 to 1997 he
also served as President of Schwitzer. Prior to 1989 he was President and Chief
Executive Officer of Household Manufacturing, Inc., the former diversified
manufacturing subsidiary of HSBC Finance Corporation.
176
Mr. Dillon is currently a member of the Compensation, Executive and Audit
Committees and will retire from the Board in April 2007.
J. DUDLEY FISHBURN, age 60, joined HSBC Finance Corporation's Board in 1995. Mr.
Fishburn became Chairman of the Board of HFC Bank Ltd. (HSBC Finance
Corporation's primary subsidiary in the United Kingdom) in 1998. He is also on
the Board of HSBC Bank (UK) plc. He previously served as the Conservative Member
of Parliament for Kensington in London from 1988 to 1997. Prior to entering
Parliament, Mr. Fishburn was Executive Editor for The Economist Newspaper Ltd.
from 1979 until 1988. He is also a Director of Altria Inc., Henderson Smaller
Companies Investment Trust plc and Beazley Group plc. He is a trustee of the
Foundation for Liver Research, The Peabody Trust and Reading University.
Mr. Fishburn is a member of the Nominating & Governance Committee.
DOUGLAS J. FLINT, age 51, joined HSBC Finance Corporation's Board in February
2007. Mr. Flint serves as the Group Finance Director with responsibility for
strategy, investor relations, finance and tax at HSBC. He joined HSBC as an
executive Director in 1995. Mr. Flint chaired the Financial Reporting Council's
review of the Turnbull Guidance on Internal Control, served on the Accounting
Standards Board and the Standards Advisory Council of the International
Accounting Standards Board from 2001 to 2004 and is former partner in KPMG. He
is a non-executive Director of BP plc since January 2005.
Mr. Flint is an ex-officio non-voting member of the Audit Committee.
CYRUS F. FREIDHEIM, JR., age 71, joined HSBC Finance Corporation's Board in
1992. He currently serves as the Chief Executive Officer of the Sun-Times Media
Group Inc., and is a member of the Board since October 2005. Mr. Freidheim
served as Chairman of the Board and Chief Executive Officer of Chiquita Brands
International, Inc. from March 2002 until January 2004 and Chairman until May
2004. In March 2002, he retired as Vice Chairman of Booz, Allen & Hamilton, Inc.
(a management consulting firm), with which he had been affiliated since 1966. He
is also a Director of Allegheny Energy, Inc. and Virgin America Inc. He is a
Trustee for The Brookings Institution, Rush University Medical Center, Chicago
Council on Global Affairs and the Chicago Symphony Orchestra. Mr. Freidheim is a
Member of the Advisory Council of the Mendosa School of Business at the
University of Notre Dame, The Economic Club of Chicago and The Commercial Club
of Chicago, Council of Foreign Relations.
Mr. Freidheim is the Lead Director and as such is the Chair of the Executive
Committee and an ex-officio member of the Audit, Compensation and Nominating and
Governance Committees.
ROBERT K. HERDMAN, age 58, joined HSBC Finance Corporation's Board in 2004. He
also serves as a member of the Board of Directors of HSBC North America Holdings
Inc. Mr. Herdman is a partner and Managing Director of Kalorama Partners LLC, a
Washington, D.C. consulting firm. Mr. Herdman was the Chief Accountant of the
U.S. Securities and Exchange Commission from October 2001 to November 2002. The
Chief Accountant serves as the principal advisor to the Commission on accounting
and auditing matters, and is responsible for formulating and administering the
accounting program and policies of the Commission. Prior to joining the SEC, Mr.
Herdman was Ernst & Young's Vice Chairman of Professional Practice for its
Assurance and Advisory Business Services (AABS) practice in the Americas and the
Global Director of AABS Professional Practice for Ernst & Young International.
Mr. Herdman was the senior E&Y partner responsible for the firms' relationships
with the SEC, Financial Accounting Standards Board (FASB) and American Institute
of Certified Public Accountants (AICPA). He was on the AICPA's SEC Practice
Section Executive Committee (1995-2001) and a member of the AICPA's Board of
Directors (2000-2001).
Mr. Herdman is Chair of the Audit Committee.
GEORGE A. LORCH, age 65, joined HSBC Finance Corporation's Board in 1994. He
also serves as a member of the Board of Directors of HSBC North America Holdings
Inc. From May 2000 until August 2000, Mr. Lorch served as Chairman, President
and Chief Executive Officer of Armstrong Holdings, Inc. (the parent of Armstrong
World Industries, Inc.). Mr. Lorch served as Chairman of the Board, Chief
Executive Officer and President of Armstrong World Industries, Inc. (a
manufacturer of interior finishes) from 1994 and President
177
and Chief Executive Officer from 1993 until May 1994. Mr. Lorch is a Director of
The Williams Companies, Inc., Autoliv, Inc. and Pfizer Inc.
Mr. Lorch is Chair of the Compensation Committee and a member of the Nominating
& Governance Committee.
LARREE M. RENDA, age 48, joined HSBC Finance Corporation's Board in 2001. Ms.
Renda has been employed by Safeway Inc. since 1974. She became Executive Vice
President, Chief Strategist and Administrative Officer of Safeway, Inc. in
November, 2005. Prior to her current position she served as Executive Vice
President for Retail Operations, Human Resources, Public Affairs, Labor and
Government Relations since 1999. Prior to this position, she was a Senior Vice
President from 1994 to 1999, and a Vice President from 1991 to 1994. She is also
a director and Chairwoman of the Board of The Safeway Foundation and serves on
the board of directors for Casa Ley, S.A. de C.V. Ms. Renda is a member of the
Retailing Initiative Advisory Board of the Wharton School of Business and serves
as a Trustee on the National Joint Labor Management Committee. Additionally she
serves on the board of directors of both the California and U.S. Chamber of
Commerce and serves as a National Vice President of the Muscular Dystrophy
Association.
Ms. Renda is Chair of the Nominating & Governance Committee and a member of the
Audit Committee.
MICHAEL R. P. SMITH, age 50, joined HSBC Finance Corporation's Board in 2006.
Mr. Smith joined the HSBC Group in 1978 and since that time has held a wide
variety of posts in Hong Kong, the Asia-Pacific region, the UK, Australia, the
Middle East and South America. Mr. Smith is the President and Chief Executive
Officer of The Hongkong and Shanghai Banking Corporation. He became Chairman of
HSBC Bank Malaysia Berhad and a director of HSBC Bank Australia Limited in
January 2004 and Chairman of Hang Seng Bank Limited in April 2005 and in June
2005, he took on the role of Global Head of Commercial Banking for the HSBC
Group, positions he continues to hold. Mr. Smith is a member of VISA
International Asia Pacific Regional Board, as well as a Fellow of the Hong Kong
Management Association. He is Head of Advisory Council of Asia Investment
Corporation and a member of Chongqing Mayor's International Economic Advisory
Council.
178
EXECUTIVE OFFICERS
Information regarding the executive officers of HSBC Finance Corporation as of
March 5, 2007 is presented in the following table.
-----------------------------------------------------------------------------------------------
YEAR
NAME AGE APPOINTED PRESENT POSITION
-----------------------------------------------------------------------------------------------
Brendan P. McDonagh 48 2007 Chief Executive Officer
Andrew C. Armishaw 44 2004 Group Executive - Chief Information Officer
Patrick A. Cozza 51 2004 Group Executive
Thomas M. Detelich 50 2002 Group Executive
Walter G. Menezes 61 2004 Group Executive
David D. Gibbons 51 2007 Senior Executive Vice President - Corporate Risk
and Compliance
Kenneth H. Robin 60 1989 Senior Executive Vice President - General Counsel
& Corporate Secretary
Christopher D. Spooner 56 2006 Senior Executive Vice President
Anthony J. Murphy 47 2007 Senior Executive Vice President - Portfolio
Management
Steven B. Gonabe 55 2005 Executive Vice President - Administration
Lisa M. Sodeika 43 2004 Executive Vice President - Corporate Affairs
Mark A. Melas 50 2007 Executive Vice President - Corporate Real Estate
John J. Haines 43 2004 Managing Director - Auto Finance
Joseph W. Hoff 56 2005 Managing Director - Retail Services
Gary R. Esposito 46 2005 Managing Director - Mortgage Services
Patrick J. Burke 45 2006 Managing Director - Card Services
Thomas M. Kimble 58 2007 Managing Director - Strategic Cost Initiative and
Global Resourcing
Beverley A. Sibblies 45 2004 Senior Vice President - Chief Financial Officer
William H. Kesler 55 2006 Senior Vice President - Treasurer
James E. Binyon 43 2006 Vice President and Chief Accounting Officer
-----------------------------------------------------------------------------------------------
Brendan P. McDonagh, Chief Executive Officer of HSBC Finance Corporation since
February 2007. Mr. McDonagh served as Chief Operating Officer of HSBC Finance
Corporation prior to his appointment as Chief Executive Officer in February
2007. From December 2006 to February 2007, Mr. McDonagh held the title of Group
Executive of HSBC Finance Corporation. From October 2004 to December 2006 he
served as Chief Operating Officer of HSBC Bank USA. He is also a Group General
Manager of HSBC Holdings plc having been appointed as such in August 2005. An
international manager for the HSBC Group for more than twenty five years, Mr.
McDonagh began his career with HSBC in 1979, completing various assignments
throughout the world. In September 2002, he transferred to the United States to
run the retail and commercial banking operations of HSBC Bank USA. Mr. McDonagh
is active in several US and Ireland organizations including the New York
Regional Board of the American Ireland Fund and USA Board of Co-operation
Ireland. Mr. McDonagh is Chairman-elect of the Consumer Bankers Association.
Andrew C. Armishaw, Group Executive and Chief Information Officer of HSBC
Finance Corporation and Senior Executive Vice President and Chief Information
Officer of HSBC North America Holdings Inc. since January 2004. From January
2001 to December 2003 Mr. Armishaw was Head of Global Resourcing for HSBC and
from 1994 to 1999 was Chief Executive Officer of First Direct (a subsidiary of
HSBC) and Chief Information Officer of First Direct.
Patrick A. Cozza, Group Executive of HSBC Finance Corporation since April 2004.
Prior to that Mr. Cozza became President - Refund Lending and Insurance Services
in 2002 and Managing Director and Chief
179
Executive Officer - Refund Lending in 2000. He also serves on the board of
directors of Junior Achievement in New Jersey, Cancer Hope Network, Somerset
Business Partnership and American Council of Life Insurers PAC. Mr. Cozza serves
as board member and officer of Household Life Insurance Company, First Central
National Life Insurance Company and HSBC Insurance Company of Delaware, all
subsidiaries of HSBC Finance Corporation.
Thomas M. Detelich, Group Executive, Consumer and Mortgage Lending of HSBC
Finance Corporation since August 2006. Mr. Detelich is also a Group General
Manager for HSBC since October 1, 2006. He became Group Executive, Consumer
Lending in July 2002. Mr. Detelich also held the positions of Managing Director
at Beneficial Corporation from March 2000 to July 2002 and Managing Director of
Household Finance Corporation from January 1999 to July 2002 and regional
general manager of consumer lending in 1998. Mr. Detelich was formerly with
Transamerica for 21 years, becoming Executive Vice President of Branch
Operations in 1997.
Walter G. Menezes, Group Executive of HSBC Finance Corporation since April 2004
and is responsible for HSBC Finance Corporation's credit card and private label
credit card operations. Mr. Menezes is also a Group General Manager for HSBC
since October 1, 2006. Mr. Menezes held the title of President and Chief
Executive Officer for Auto Finance from 2002 to August 2004 and Managing
Director and Chief Credit Officer of Credit Card Services since from 1998 to
2002. He joined HSBC Finance Corporation in 1996 as National Director
Collections - Credit Card Services.
David D. Gibbons, Senior Executive Vice President, Corporate Risk and Compliance
of HSBC Finance Corporation and of HSBC North America Holdings Inc. since
February 2007. Prior to that Mr. Gibbons was Senior Executive Vice President,
Chief Risk Officer of HSBC Finance Corporation and of HSBC North America
Holdings Inc. since March 2004. Mr. Gibbons served as Deputy Comptroller for
Special Supervision from October 2002 to March 2004, was with the Office of the
Comptroller of the Currency from September 1977 to March 2004 and served as
Deputy Comptroller of the Currency for Credit Risk from 1997 to 2002.
Kenneth H. Robin, Senior Executive Vice President, General Counsel and Corporate
Secretary of HSBC Finance Corporation since May 2003 and Senior Executive Vice
President, General Counsel and Corporate Secretary of HSBC North America
Holdings Inc. since January 2004. Prior to that Mr. Robin was Senior Vice
President, General Counsel and Secretary of HSBC Finance Corporation, since
1993.
Christopher D. Spooner, Senior Executive Vice President of HSBC Finance
Corporation and Senior Executive Vice President and Chief Financial Officer of
HSBC North America Holdings Inc. since December 2006. Mr. Spooner has held
various positions since arriving at HSBC in 1994 including Group Tax Controller
and Head of Group Financial Planning and Tax for HSBC Holdings plc., a position
he continues to hold.
Anthony J. Murphy, Senior Executive Vice President - Portfolio Management for
HSBC Finance Corporation since February 2007. Prior to his appointment to this
position, Mr. Murphy was President and Chief Executive Officer of HSBC
Securities (USA) Inc. and Chief Operating Officer of CIBM Americas. He was also
Co-Head of Corporate, Investment Banking and Markets (CIBM Americas) since
November 2004. Mr. Murphy has been with the HSBC Group since 1990. Prior to his
appointment as Chief Executive Officer of HSBC Securities (USA) Inc. in April
2003, Mr. Murphy served as Chief Strategic Officer of CIBM Americas from 2000.
Prior to that assignment, he was Head of Market Risk Management for HSBC Bank
plc and HSBC Investment Bank in London from 1996.
Steven B. Gonabe, Executive Vice President of Administration of HSBC Finance
Corporation and of HSBC North America Holdings Inc. since July 2005. From June
1997 to July 2005 Mr. Gonabe was Vice President of Human Resources for HSBC
credit card services, auto finance and mortgage services businesses. Mr. Gonabe
has served on the board of directors for the United Way of Monterey County and
is a member of the Junior Achievement of Silicon Valley and Monterey Bay,
California. He is currently involved with Students in Free Enterprise (SIFE), an
organization designed to develop an understanding of the principles of financial
education for young people.
Lisa M. Sodeika, Executive Vice President of Corporate Affairs of HSBC Finance
Corporation and of HSBC North America Holdings Inc. since June 2005. Ms. Sodeika
directs HSBC North America's public affairs,
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employee communications, government relations, consumer advocacy, community
development and philanthropic services activities. From January 2003 to June
2005 Ms. Sodeika was Senior Vice President - Corporate Affairs and Vice
President - Consumer Affairs. Since joining HSBC Finance Corporation, Ms.
Sodeika has held management positions in a variety of operational areas within
the consumer finance and retail services businesses including marketing,
collections, quality assurance and compliance, underwriting and human resources.
Ms. Sodeika serves as chairperson of the Federal Reserve Board's Consumer
Advisory Council.
Mark A. Melas, Executive Vice President - Corporate Real Estate, North America
since 2000. Prior to that, Mr. Melas held the position of Senior Vice President
from April 1995. From 1978 through March 1995 he was employed at New York
Telephone (NYNEX) as an Area Operations Manager in Corporate Real Estate.
John J. Haines, Managing Director of Auto Finance of HSBC Finance Corporation
since joining HSBC Finance Corporation in August 2004. From May 1989 to August
2004 Mr. Haines worked for General Electric where most recently he was Senior
Vice President - Products and Services for General Electric Fleet Services and
Senior Vice President - North American Operations for General Electric Fleet
Services. Mr. Haines is a member of the Automotive Finance Committee of the
Consumer Bankers Association. Mr. Haines is on the Board of Directors of the San
Diego Chamber of Commerce, United Way and NP Strategies, a non-profit
organization.
Joseph W. Hoff, Managing Director of Retail Services of HSBC Finance Corporation
since March 2005. Mr. Hoff served as Chief Financial Officer for the Retail
Services business from April 1995 to March 2005. He has been with HSBC Finance
Corporation since 1976 in various accounting and corporate finance positions.
Gary R. Esposito, Managing Director and Chief Executive Officer of Mortgage
Services for HSBC North America Holdings Inc. From 2002 to 2005, Mr. Esposito
held the positions of Managing Director - U.S. branch operations for the
Consumer Lending business and was the President, Chief Executive Officer and
Chairman for HSBC Canada from October 2000 to November 2003. He was also
National Director, branch and retail operations from 1998 through 2000. He has
been with HSBC Finance Corporation since 1982.
Patrick J. Burke, Managing Director and Chief Executive Officer of Credit Card
Services for HSBC Finance since January 2006. He was appointed President and
Chief Executive Officer of HSBC Financial Limited Canada in January 2003 until
July 2006. Patrick was appointed Chief Financial Officer with HFC Bank Limited
from 2000 until 2003. From the start of his career with HSBC in 1989, Patrick
has served the company in many roles including Deputy Director of Mergers and
Acquisitions and Vice President of Strategy and Development.
Thomas M. Kimble, Managing Director - Strategic Cost Initiative and Global
Resourcing of HSBC Finance Corporation and of HSBC North America Holdings Inc.
since February 2007. Prior to his appointment to this position, since July 2006
Mr. Kimble served as the Managing Director - Global Projects and Operations for
HSBC North America Holdings Inc. and prior to that, Managing Director of
Operations for Household/ HSBC Card Services for eight years. Mr. Kimble has
been active in the Salinas Valley Chamber of Commerce and is a past president of
the Chamber. He is also a Past President of Shelter Outreach Plus, a domestic
violence shelter.
Beverley A. Sibblies, Senior Vice President and Chief Financial Officer of HSBC
Finance Corporation and Executive Vice President of Finance of HSBC North
America Holdings Inc. since October 2005. Ms. Sibblies joined HSBC Finance
Corporation in November 2004 as the Senior Vice President and Chief Accounting
Officer. Prior to joining HSBC Finance Corporation, she served as Executive Vice
President and Chief Financial Officer for EMC Mortgage from June 2000 to
February 2004. Prior to that, she served as a partner in the financial services
practice of Deloitte & Touche, LLP from July 1997 to June 2000.
William H. Kesler, Senior Vice President - Treasurer since April 1, 2006. Mr.
Kesler joined HSBC Finance Corporation in 1992 and since that time has held
various treasury management positions. He is a trustee of the Hospice of
Northeastern Illinois Foundation and serves on the Foundation's executive
committee.
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James E. Binyon, Vice President and Chief Accounting Officer since February
2006, and from September 2004 was Vice President and Controller of Corporate
Finance. From November 2001 to August 2004 he served as Finance Director of
First Direct, and from February 1995 to October 2001 was Senior Area Accounting
Manager, and Manager - Balance Sheet Management for HSBC Hong Kong. Mr. Binyon
was Manager-Asset Management & Funding, and Manager - Treasury Audit Department
between 1992 and 1995. Prior to joining HSBC, Mr. Binyon spent five years at
KPMG.
CORPORATE GOVERNANCE
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BOARD OF DIRECTORS - COMMITTEES AND CHARTERS
The Board of Directors of HSBC Finance Corporation has four standing committees:
the Audit Committee, the Compensation Committee, the Nominating and Governance
Committee and the Executive Committee. The charters of the above-mentioned
committees, as well as our Corporate Governance Standards, are available on our
website at www.hsbcusa.com or upon written request made to HSBC Finance
Corporation, 2700 Sanders Road, Prospect Heights, Illinois 60070, Attention:
Corporate Secretary.
Audit Committee
The primary purpose of the audit committee is to assist the Board of Directors
in fulfilling its oversight responsibilities relating to HSBC Finance
Corporation's system of internal controls over financial reporting and its
accounting, auditing and financial reporting practices. The audit committee is
currently comprised of the following independent Directors (as defined by HSBC
Finance Corporation's Corporate Governance Standards which are based upon the
rules of the New York Stock Exchange): Gary G. Dillon, Robert K. Herdman and
Larree M. Renda. In addition, Cyrus F. Freidheim, Jr., Lead Director, and
Douglas J. Flint, Group Finance Director of HSBC, are non-voting members of the
audit committee. The Board has determined that each of these individuals is
financially literate. The Board of Directors has determined that Robert K.
Herdman qualifies as an audit committee financial expert.
Compensation Committee
The primary purpose of the Compensation Committee is to assist the Board of
Directors in discharging its responsibilities related to the compensation of the
Chief Executive Officer of HSBC Finance Corporation and the officers that are
direct reports to the Chief Executive Officer and such other officers as may be
designated by the Board of Directors. The Compensation Committee is currently
comprised of the following directors: George A. Lorch (Chair), William R. P.
Dalton, Gary G. Dillon and Cyrus F. Freidheim, Jr. (ex-officio member). With the
exception of Mr. Dalton, all members of the Compensation Committee are
independent directors under HSBC Finance Corporation's Corporate Governance
Standards.
The Charter of the Compensation Committee lists the primary responsibilities,
powers and authorities of the Compensation Committee. The listed items include
(i) review and approve corporate goals and performance objectives relevant to
the compensation of the Chief Executive Officer and executive officers, evaluate
the performance of the Chief Executive Officer and executive officers in light
of those goals and objectives, and review its findings with the Board of
Directors in executive session, (ii) submit recommendations concerning base
salary, performance-based cash and long term equity-based incentive awards for
the Chief Executive Officer and executive officers to the Remuneration Committee
of HSBC ("REMCO") for approval, (iii) recommend to REMCO equity incentives under
HSBC plans to all employees, except those awards that the Chief Executive
Officer may determine based upon a delegation of authority by REMCO, (iv) review
and approve benefits and perquisites of the Chief Executive Officer and
executive officers to the extent such benefits are not available to all
employees, (v) recommend to the Board of Directors and REMCO the creation or
amendment of any welfare, or tax qualified employee benefit plan or program of
HSBC Finance Corporation, or any long-term executive compensation plan or
program of HSBC Finance Corporation whose participants include the Chief
Executive Officer or executive officers, (vi) review and recommend to REMCO any
employment and severance contracts for the Chief Executive Officer and executive
officers, as well as any severance payouts to such officers, (vii) review and
consider "best practices" of peer companies
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with respect to compensation philosophies, policies and practices, (viii) review
management's Compensation Discussion and Analysis ("CD&A") to be included in
HSBC Finance Corporation's Annual Report on Form 10-K, discuss the CD&A's
content with management, and prepare the Compensation Committee Report
concerning the CD&A and recommend to the Board of Directors that the CD&A be
included in the annual report on Form 10-K and (ix) engage in an annual self
assessment with the goal for continuing improvement, and to review and assess
the adequacy of this charter at least annually and recommend any proposed
changes to the Board of Directors for approval.
The Compensation Committee may in its discretion retain and discharge
consultants to assist the Compensation Committee in evaluating director, Chief
Executive Officer or executive officer compensation and to determine the
appropriate terms of engagement and the fees to be paid to such consultants. The
Chief Executive Officer is given full authority, which may be delegated, to
establish the compensation and salary ranges for all other employees of HSBC
Finance Corporation and its subsidiaries whose salaries are not subject to
review by the Compensation Committee and approval by REMCO. For more information
about the compensation policy of HSBC Finance Corporation please see Item 11.
Executive Compensation - Compensation Discussion and Analysis.
Nominating and Governance Committee
The primary purpose of the Nominating and Governance Committee is to assist the
Board of Directors of HSBC Finance Corporation in discharging its
responsibilities related to identifying and nominating members of the Board of
Directors to the Board, recommending the composition of each committee of the
Board of Directors and the Chair of each committee, establishing and reviewing
HSBC Finance Corporation's corporate governance and making recommendations to
the Board of Directors regarding compensation for service of the non-executive
Board members. The Nominating and Governance Committee ensures that HSBC Finance
Corporation maintains "best practices" with respect to corporate governance in
order to ensure effective representation of its stakeholders.
The Nominating and Governance Committee is currently comprised of the following
directors: J. Dudley Fishburn, Cyrus F. Freidheim, Jr. (ex-officio member),
George A. Lorch and Larree M. Renda (Chair). With the exception of Mr. Fishburn,
all members of the Nominating and Governance Committee are independent directors
under HSBC Finance Corporation's Corporate Governance Standards.
Executive Committee
The Executive Committee may exercise the powers and authority of the Board of
Directors in the management of the business and affairs of the corporation
during the intervals between meetings of the Board of Directors. Messrs. Gary G.
Dillon and Cyrus F. Freidheim, Jr. are members of the Executive Committee.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act, as amended, requires certain of our
Directors, executive officers and any persons who own more than ten percent of a
registered class of our equity securities to report their initial ownership and
any subsequent change to the SEC and the New York Stock Exchange ("NYSE"). With
respect to the 6.36% Series B Preferred Stock of HSBC Finance Corporation, we
reviewed copies of all reports furnished to us and obtained written
representations from our Directors and executive officers that no other reports
were required. Based solely on a review of copies of such forms furnished to us
and written representations from the applicable Directors and executive
officers, all required reports of changes in beneficial ownership were filed on
a timely basis for the 2006 fiscal year.
CODE OF ETHICS
HSBC Finance Corporation's Board of Directors has adopted a Code of Ethics for
Senior Financial Officers. That Code of Ethics is incorporated by reference in
Exhibit 14 to this Annual Report on Form 10-K. HSBC Finance Corporation also has
a general code of ethics applicable to all employees that is referred to as its
Statement of Business Principles and Code of Ethics. That document is available
on our website at
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www.hsbcusa.com or upon written request made to HSBC Finance Corporation, 2700
Sanders Road, Prospect Heights, Illinois 60070, Attention: Corporate Secretary.
ITEM 11. EXECUTIVE COMPENSATION.
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COMPENSATION DISCUSSION AND ANALYSIS ("2006 CD&A")
The following discussion summarizes the principles, objectives and factors
considered by HSBC Finance Corporation in evaluating and determining the
compensation of executive officers in 2006. Specific compensation information
relating to Siddharth N. Mehta, Chairman and Chief Executive Officer of HSBC
Finance Corporation until February 15, 2007; Thomas M. Detelich and Walter G.
Menezes, Group Executives; Kenneth H. Robin, Senior Executive Vice President,
General Counsel and Corporate Secretary; and Beverley A. Sibblies, Senior Vice
President and Chief Financial Officer, is contained in this portion of the Form
10-K.
OVERSIGHT OF COMPENSATION DECISIONS
HSBC Finance Corporation is a wholly owned subsidiary of HSBC Holdings plc
("HSBC"). The Board of Directors of HSBC has the authority to delegate any of
its powers, authorities and judgments to any committee consisting of one or more
directors and has established a Remuneration Committee ("REMCO") for the purpose
of setting the remuneration policy for HSBC and its subsidiaries and the
compensation of senior executives. REMCO's responsibilities include reviewing
and approving performance-based remuneration by reference to corporate goals and
objectives established by the Board of Directors of HSBC from time to time and
approving overall market positioning of the compensation package, individual
base salaries and increases, and annual and long-term incentive/bonus
arrangements for certain executives, including Messrs. Mehta, Detelich, Menezes
and Robin. In November 2006, REMCO delegated its authority for approval of
salaries and annual cash incentive awards relating to certain classes of
executives to Michael F. Geoghegan, the HSBC Group Chief Executive (the "HSBC
CEO"). However, REMCO retained exclusive authority over compensation of the more
senior executives within HSBC and its subsidiaries. As a result, REMCO had
authority over the compensation of Messrs. Mehta, Detelich and Menezes in 2006
while the HSBC CEO had authority over Mr. Robin. REMCO has exclusive authority
with respect to all long-term incentive plan awards involving interests in HSBC
ordinary shares.
The members of REMCO in 2006 were Sir Mark Moody-Stuart (Chairman), W.K.L. Fung,
S. Hintze, Sir John Kemp-Welch (until retirement on May 26, 2006) and J.D.
Coombe (effective as of June 1, 2006), all of whom were or are non-executive
directors of HSBC. REMCO has retained the services of Towers Perrin, a human
resource consulting firm, to provide independent advice on executive
compensation issues.
The Compensation Committee of the Board of Directors of HSBC Finance Corporation
(the "Compensation Committee") seeks to ensure that our compensation policies
and practices support the objectives of HSBC Finance Corporation's compensation
program, which is based upon compensation objectives established by REMCO. The
Compensation Committee makes advisory recommendations for all compensation to be
paid to our Chief Executive Officer and each of his direct reports.
Throughout the year, management of our Human Resources Department consults with
HSBC Human Resources executives concerning compensation policies and specific
awards for certain executives. Our Human Resources executives work with the
Compensation Committee to prepare a comprehensive annual compensation package
for Mr. Mehta and each executive officer that reports to him. This package is
prepared and late in each calendar year is forwarded to HSBC Human Resources
management for submission to REMCO and the HSBC CEO, as appropriate, and
includes advisory recommendations for salary for the ensuing calendar year, a
preliminary performance-based cash award and an equity-based long-term incentive
award. As the performance-based cash award is dependent upon satisfaction of
objectives that cannot be evaluated until the end of the performance measurement
year, the final determination of that component of
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compensation is not made until the Compensation Committee receives reports from
management concerning satisfaction of corporate, business unit and individual
objectives in January. REMCO or the HSBC CEO, as appropriate, will approve or
revise the advisory recommendations provided by the Compensation Committee. The
terms of compensation for Ms. Sibblies are proposed by the Chief Financial
Officer of HSBC North America Holdings Inc., in consultation with our Human
Resources executives, and is approved by the HSBC Finance Corporation Chief
Executive Officer.
The Compensation Committee is comprised of the following individuals: George A.
Lorch (Chair), William R. P. Dalton, Gary G. Dillon and Cyrus F. Freidheim, Jr.
(ex-officio member). During 2006, with the exception of Mr. Dalton, the
Compensation Committee was composed of independent directors, as defined under
HSBC Finance Corporation's Corporate Governance Standards. Additional
information with regard to the Compensation Committee, including a description
of its responsibilities under the its charter, is contained in the section of
this Form 10-K entitled Item 10. Directors, Executive Officers and Corporate
Governance -- Corporate Governance.
OBJECTIVES OF HSBC FINANCE CORPORATION'S COMPENSATION PROGRAM
Our compensation program is designed to support the successful recruitment,
development, and retention of high performing executive talent and to incent
those executives to achieve HSBC Finance Corporation's short-term business
objectives and to optimize its long-term financial returns. We design our
compensation programs to be competitive with a comparator group of benchmark
financial institutions. HSBC Finance Corporation's comparator group is comprised
of U.S.-based organizations that compete with us for business, customers, and
executive talent. Our comparator group includes American Express Company, Bank
of America Corporation, Capital One Financial Corporation, Countrywide Financial
Corporation, Citigroup, Inc., FifthThird Bancorp, JP Morgan Chase, MBNA
Corporation, National City Corporation, US Bancorp, Wachovia Corporation and
Wells Fargo & Company (collectively, the "Comparator Group"). While most of
these organizations are publicly held companies, our operations are of
comparable scale and complexity and our compensation program is designed to
provide the flexibility to offer compensation that is competitive with the
Comparator Group so that we may attract and retain the highest performing
executives.
The philosophy underlying our executive compensation program which is designed
to promote the compensation objectives of our parent, HSBC, is as follows:
Link to Company Performance
We seek to offer competitive base salaries with a significant portion of
variable compensation components determined by measuring performance of the
executives, their business unit(s), HSBC Finance Corporation and HSBC. The
performance-based cash compensation plans that are more fully described under
Elements of Compensation - Annual Performance-Based Awards, emphasize revenue
and expense growth, net income, receivable growth, profits, and other key
performance measures. Other considerations taken into account in setting
compensation policies and making compensation decisions include demonstrated
leadership, future potential, adherence to HSBC's ethical standards and the
ability to leverage capabilities across businesses. Corporate, business unit
and/or individual goals are established at the beginning of each year.
Compensation plans motivate our executives to improve the overall performance
and profitability of HSBC as well as the specific region, unit, or function to
which they are assigned. Each executive's individual performance and
contribution is considered in making salary adjustments and determining the
amount of annual performance bonus paid and the value of HSBC equity shares
granted each year.
We have historically used grants of stock options and restricted shares to
reward and provide longer term incentives for our executives. However, in 2005,
HSBC adopted a new philosophy to provide only restricted shares, called
"Achievement Shares", which vest on a specified date if the executive remains
employed through that date and "Performance Shares" that require continued
employment and satisfaction of corporate performance conditions designed to
reinforce a long-term focus on HSBC's Managing for Growth strategy and
delivering value to its shareholders. Performance shares are granted to the most
senior executives whose
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business units have the ability to have a direct impact on HSBC's consolidated
results. Achievement share awards are granted to other high performing
executives.
Competitive Compensation Levels and Marketplace Research
We endeavor to maintain compensation programs that are competitive with our
Comparator Group. We operate in a highly competitive business environment, in
which our Comparator Group and other financial services companies continuously
look to gain market share and competitive advantage by hiring top executive
talent. On an annual basis and as needed when recruiting, we compare the
compensation for our executive officers to that of executives with similar
responsibilities and scope of business. In 2006 the Compensation Committee
considered comparative data from a general industry survey of 340 non-financial
services companies, a financial services survey of 150 companies and a survey of
our Comparator Group to help establish compensation levels for our executives.
We research the types of compensation programs provided by other companies,
compensation levels for executives, details of certain compensation programs,
historical marketplace compensation trends, marketplace practices regarding pay
mix, stock vesting terms, equity ownership levels, the amount of pay that is
derived from equity incentives and the benefits provided to executives. We also
research different aspects of performance, including the relationship between
performance and pay, a comparison of HSBC Finance Corporation's historical
performance to our Comparator Group, and types of performance measures that are
used by other companies for their annual and long-term incentive programs.
Research data is gathered from several different sources, including general
surveys of the marketplace and through retained compensation consultants.
Our compensation programs generally provide executives with the opportunity to
earn a base salary that is near the 50th percentile average of our Comparator
Group. We believe this represents a competitive base salary for meeting general
business objectives. However, total compensation, which includes incentive
awards, is targeted to be in the 75th percentile if we, HSBC and the executive
meet established performance goals. This provides greater incentive to achieve
higher performance standards and the specific goals established by the
Compensation Committee each year. The level of compensation paid to an executive
from year to year will differ based upon performance. This year-to-year
difference stems mainly from HSBC Finance Corporation's and/or an individual
business unit's performance results and, for individuals eligible for
performance-based stock awards, awards may vary based upon HSBC's performance
results. Compensation levels will also increase or decrease based on the
executive's individual performance and level of responsibility.
We also track the amount of an executive's compensation that is subject to
multi-year vesting restrictions and the Compensation Committee considers a
wealth accumulation analysis and total annual compensation summary for each
executive. This information helps the Compensation Committee to gauge our
ability to retain highly talented executives and provide advice on competitive
compensation packages to REMCO or to the HSBC CEO, as appropriate.
Repricing of Stock Options and Timing of Option Grants
The exercise price of stock options under historical Household International,
Inc. option plans was based upon the stock price on the date the option grant
was approved. For HSBC discretionary option plans, the exercise price of awards
made in 2003 and 2004 was the higher of the average market value for ordinary
shares on the five business days preceding the grant date or the market value on
the date of the grant.
HSBC also offers all employees a plan in which options to acquire ordinary
shares are awarded when an employee commits to contribute up to L250 (or the
equivalent) each month for one, three or five years. At the end of the term, the
accumulated amount, plus interest, may be used to purchase shares under the
option, if the employee chooses to do so. The exercise price for such options is
the average market value for ordinary shares on the five business days preceding
the date of the invitation to participate, less a 15-20% discount (depending
upon the term).
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We do not, and our parent, HSBC does not, reprice stock option grants. In
addition, we and HSBC have never engaged in the practice known as "back-dating"
of stock option grants.
Dilution from Equity-Based Compensation
While dilution is not a primary factor in determining award amounts, there are
limits to the number of shares that can be issued under HSBC equity programs
which were established by vote of HSBC shareholders in 2005.
Perquisites
It is our philosophy to provide few perquisites to executives. The perquisites
we provide are intended to help executives be more productive and efficient or
to protect HSBC Finance Corporation and its executives from certain business
risks and potential threats. Our review of competitive market data indicates
that the perquisites provided to executives are reasonable and within market
practice. See the Summary Compensation Table below for further information on
perquisites awarded to our executives.
Retirement Benefits
We offer a pension retirement plan that executives may participate in that
provides a benefit equal to that provided to all employees of HSBC Finance
Corporation. However, both qualified and non-qualified defined benefit plans are
maintained so that this level of pension benefit can be continued without regard
to certain Internal Revenue Service limits. Executives and other highly
compensated employees can elect to participate in a nonqualified deferred
compensation plan, where such employees can elect to defer the receipt of earned
compensation to a future date. We also maintain a qualified 401(k) plan with
company matching contributions. Another nonqualified deferred compensation plan
provides executives and other highly compensated employees with a company
matching contribution (based on the level of the employee's election to defer
earned compensation to the qualified 401(k) plan) to the extent that such
company contributions cannot be allocated to the 401(k) plan because of certain
Internal Revenue Service limits. We do not pay any above-market or preferential
interest in connection with deferred amounts.
Employment Contracts and Severance Protection
Certain executive officers, including Mr. Mehta, have employment agreements with
HSBC Finance Corporation. The main purpose of the employment agreements is to
protect us from certain business risks (threats from competitors, loss of
confidentiality or trade secrets, disparagement, solicitation of customers and
employees) and to define our right to terminate the employment relationship. The
employment agreements also protect executives from certain risks, such as a
change in control of HSBC Finance Corporation and death or disability. Certain
other executives, including Mr. Menezes, have entered into agreements that only
provide additional severance benefits upon a change of control of HSBC Finance
Corporation. The terms of Messrs. Mehta's and Menezes' employment agreements are
contained in the descriptions of their compensation under the heading
Compensation of Officers Reported in the Summary Compensation Table.
Role of Executive Officers and External Consultants in Compensation Decisions
HSBC Finance Corporation has engaged Strategic Consulting Group, an executive
compensation consulting firm, to provide comparator data and to assist in the
development of competitive compensation packages for our executives. In
addition, in late 2006 the Compensation Committee independently retained
Frederic W. Cook & Co., Inc., to provide compensation consulting services.
Recommendations and comparative data provided by these consultants are reviewed
by the Chief Executive Officer and the Executive Vice President, Administration
of HSBC Finance Corporation, to assist them in making initial recommendations
for compensation of executives to the Compensation Committee. The Chief
Executive Officer is not present when the Compensation Committee receives
comparative data or establishes recommendations for the Chief Executive
Officer's compensation. As discussed above, the Compensation Committee prepares
an annual compensation package for our Chief Executive Officer and his direct
reports. The compensation proposals are forwarded to HSBC's Group General
Manager of Human Resources who provides this information to the
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HSBC CEO for review. As permitted under the terms of REMCO's delegation of
authority, the HSBC CEO may approve cash components of compensation for certain
officers, including Mr. Robin. Cash components for Mr. Mehta (until February 15,
2007) and Messrs. Detelich and Menezes, as well as equity-based advisory
recommendations for all executives are forwarded to REMCO for approval. The HSBC
Group General Manager of Human Resources subsequently informs HSBC Finance Human
Resources executives of approved compensation awards. REMCO is provided with
comparator information from Towers Perrin which obtains compensation data for
executive positions with companies of similar size and complexity that are
subsidiaries of peer financial services companies. In addition, market data has
been obtained from American Express Company, Bank of America Corporation, Bank
One Corporation, BB&T Corporation, Capital One Financial, Citigroup, Inc.
Countrywide Financial Corporation, FifthThird Bancorp, KeyCorp, LaSalle Bank
Corporation, Merrill Lynch & Co., Inc., National City Corporation, The PNC
Financial Services Group Inc., Royal Bank of Canada, State Street Corporation,
Sun Trust Banks, Inc., US Bancorp, Wachovia Corporation, Washington Mutual Inc.
and Wells Fargo & Company. Comparator and market data is used by REMCO to
evaluate the competitiveness of proposed executive compensation.
Accounting Considerations
We adopted the fair value method of accounting under Statement of Financial
Accounting Standards No. 123 (revised 2004), "Share Based Payment" ("SFAS
123(R)") effective January 1, 2006. SFAS 123(R) applies to all equity
instruments granted to employees beginning January 1, 2006 and does not apply to
awards granted in prior periods before the effective date, except to the extent
that prior periods' awards are modified, repurchased or cancelled after the
required effective date. Prior to 2006, we adopted the fair value method of
accounting prospectively in 2002 for all new equity instruments granted to
employees as provided under Statement of Financial Accounting Standards No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure (an
amendment of FASB Statement No. 123)." The Board of Directors believes that this
treatment reflects greater accuracy and transparency of the cost of these
incentives and promotes better corporate governance.
Tax Considerations
Limitations on the deductibility of compensation paid to executive officers
under Section 162(m) of the Internal Revenue Code is not applicable to HSBC
Finance Corporation, as it is not a public corporation as defined by Section
162(m). As such, all compensation to our executive officers is deductible for
federal income tax purposes, unless there are excess golden parachute payments
under Section 4999 of the Internal Revenue Code following a change in control.
ELEMENTS OF COMPENSATION
We strive for a pay mix that reflects our pay-for-performance philosophy and
results-oriented culture. We attract and retain executives that are highly
motivated to achieve results, and our compensation programs support that
environment.
Our philosophy is to place a significant amount of compensation at risk to
ensure that company performance objectives are met. In line with our
pay-for-performance philosophy, on average, approximately 20% of executive
compensation is base salary and 80% of compensation for top executives relates
to short-term and long-term incentives where the amount paid is based upon
defined performance goals. In the case of the HSBC Finance Corporation Chief
Executive Officer, approximately 90% of compensation is targeted to be
performance-based. Of the 80% incentive compensation, on average, approximately
45% of such compensation relates to long-term incentives, while approximately
35% relates to short-term incentives. Our allocation between short-term and
long-term incentives is based on our need to recognize past performance
(short-term incentives) in conjunction with our need to motivate and retain our
talent (long-term incentives). We believe these allocations are competitive
within the market and reinforce our pay-for-performance philosophy which
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requires that a greater part of compensation is at risk and aligns executives'
interests with those of HSBC's shareholders.
The primary elements of executive compensation are base salary, annual
non-equity performance-based awards, and long-term equity-based incentives. In
limited circumstances, discretionary bonuses may also be awarded. In addition,
executives are eligible to receive company funded retirement benefits that are
offered to all employees. Perquisites are not a significant component of
compensation. In establishing executive compensation packages, the Compensation
Committee provides advisory recommendations and ultimately REMCO and/or the HSBC
CEO approve remuneration under each element based on what they believe is an
appropriate balance between performance-based compensation and other forms of
compensation, the level of responsibility and individual contribution of the
executive and competitive practice in the marketplace for executives from
companies of similar industry, size, and complexity as HSBC Finance Corporation.
Base Salary
Base salary is reviewed annually and increases, if any, are based on corporate
and individual performance. When establishing base salaries for executives,
consideration is given to compensation paid for similar positions at companies
included in compensation surveys of our Comparator Group, targeting the 50th
percentile, which the Compensation Committee believes, when combined with
significant performance-based compensation opportunities, enables HSBC Finance
Corporation to attract and retain high performing executives. In addition, other
factors such as individual and corporate performance, potential for future
advancement, specific job responsibilities, length of time in current position,
individual pay history, and comparison to comparable internal positions
(internal equity) influences the final base salary recommendations for
individual executives.
Annual Performance-Based Awards
Annual non-equity performance-based awards are paid in cash upon satisfaction of
individual, business unit, corporate financial and operational goals. Superior
performance is encouraged by placing a significant part of the executive's total
compensation at risk. In the event certain quantitative or qualitative
performance goals are not met, annual performance awards may be less than the
maximum permitted.
Performance goals are set based on prior year's performance, expectations for
the upcoming year, our annual business plan, the HSBC Managing for Growth
business strategy, and objectives related to building value for HSBC
shareholders. The general concept is if both HSBC Finance Corporation and the
executive perform well for the year, the performance award earned should be at a
high level. If either HSBC Finance Corporation or the executive does not perform
well, the award earned should be at a low level.
In support of our pay-for-performance philosophy, we have two annual non-equity
performance-based award programs: the Executive Bonus Pool and the Management
Incentive Program.
EXECUTIVE BONUS POOL The Executive Bonus Pool is an annual cash incentive plan
that is comprised primarily of corporate and business quantitative goals, as
well as one or more qualitative objective goals. The quantitative business and
corporate factors are specific measures of performance that relate to near and
long-term business unit and corporate profitability. The qualitative objective
goals include cross-business initiatives that create revenue, leverage talent
across businesses and share and support execution of "best practices" and/or
adopt another business' "best practice."
Eligibility in the Executive Bonus Pool is determined annually based on
responsibility. Participants are limited to the Chief Executive Officer and his
or her direct reports. In 2006, there were ten participants in the Executive
Bonus Pool, including Messrs. Mehta, Detelich, Menezes and Robin. At the
beginning of each year the Compensation Committee establishes allocations for
the participants in the Executive Bonus Pool based upon data for our Comparator
Group, the relative responsibilities of our executives and the opportunity of
each executive to impact the operating results. The assigned allocations with
respect to the Executive Bonus Pool for Messrs. Mehta, Detelich, Menezes and
Robin in 2006 were 20%, 12%, 12% and 6% respectively.
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The maximum potential aggregate award to all participants in the Executive Bonus
Pool each year is equal to 5% of HSBC Finance Corporation's net income that
exceeds the net income required to achieve a 12% return on average common
stockholder's equity (the "Available Bonus Pool"). The Compensation Committee
recommends actual bonus awards under the Executive Bonus Pool by comparing our
results to the Comparator Group and by evaluating the performance of each
participating executive against the quantitative financial objectives and the
qualitative objectives established at the beginning of each year. The
Compensation Committee is not required to recommend that any, or all, of the
Available Bonus Pool be actually paid out in any year regardless of our
financial performance. Historically, actual aggregate payout awarded to
executives has been less than half of the Available Bonus Pool. An executive's
level of participation in the Executive Bonus Pool does not impact his or her
base salary or long-term incentive compensation. Payouts from the Executive
Bonus Pool are made in February following the measurement year.
In any year, if the return on equity achieved by HSBC Finance Corporation is
less than the designated threshold set by the Compensation Committee, no bonus
will be paid under the Executive Bonus Pool. In 2006, IFRS Management Basis net
income of $2,562 million was required to achieve a 12% return on average common
stockholder's equity. In January 2007, the Compensation Committee provided
advisory recommendations for awards under the Executive Bonus Pool based upon
preliminary 2006 results. In early February it was determined that the return on
average stockholder's equity threshold was not met and the bonus pool was not
funded. However, the Compensation Committee recommended and the HSBC CEO
subsequently agreed that certain executives should receive a discretionary bonus
award equal to the amount that would have been paid if the Executive Bonus Pool
had been funded. REMCO ratified these payments at a meeting held on March 1,
2007. This decision was based upon several factors, including the need to ensure
the continuity of management following the resignation of Mr. Mehta, performance
within the areas of responsibility of the individuals, recognition that the
executives to receive payments were not responsible for the events that led to
the failure to meet the return on average stockholder's equity threshold and
that the executive management team of HSBC Finance Corporation was to receive
reduced long-term equity based awards as a result of the disappointing
consolidated performance of HSBC Finance Corporation. As a result, Messrs.
Detelich, Menezes and Robin received discretionary bonus awards in February
2007.
Under the Executive Bonus Plan, Messrs. Mehta, Detelich, Menezes and Robin
shared several common quantitative financial and operating performance
objectives for the consolidated results of HSBC Finance Corporation. Those
objectives are set out below, but because the average stockholder's equity
threshold was not met and no award could be made under the Executive Bonus Plan,
these objectives were not specifically considered in making the discretionary
bonus awards to Messrs. Detelich, Menezes and Robin.
Those corporate objectives for 2006 were:
Objective
- Profit Before Tax
- Net Income
- Return on Equity
- Receivables Growth
- Revenue Growth
- Expense Growth
- Efficiency Ratio
- The greater of: Reserves to Charge-offs and Reserves to Non-performing
Loans
- Net Charge-off
Messrs. Mehta, Detelich and Menezes had additional common quantitative goals,
Mr. Mehta's relating to the consolidated results of HSBC Finance Corporation
shown above, while Mr. Detelich's were measured on the performance of the
Consumer Lending business and Mr. Menezes' were based upon the performance of
both the Credit Card Services and Retail Services businesses. The quantitative
goals for each were:
- Business Net Income
- Business Revenue
- Business Expense Growth
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- Business Net Charge-off
- Business Two-Month-and-Over Delinquency
- Business Return on Managed Assets
Messrs. Mehta, Detelich, Menezes and Robin shared a common qualitative objective
to leverage capabilities across businesses by initiating or supporting cross
business initiatives that created revenue, leveraging talent across businesses
and sharing and supporting the execution of best practices among HSBC North
America businesses and/or adopting a best practice.
MANAGEMENT INCENTIVE PROGRAM The Management Incentive Program is an annual cash
incentive plan that uses quantitative and qualitative goals to motivate
employees who have a significant role in the corporation that do not participate
in the Executive Bonus Plan. The quantitative objectives may include meeting
revenue and/or receivable targeted growth, a targeted loss reserve ratio, a
targeted equity to managed assets ratio, a targeted earnings per share,
reduction in expenses and charge-offs by specified percentages, specified net
income and operating efficiency ratios for HSBC Finance Corporation and/or the
executive's respective business unit, and an increase in the number of our
products used by each customer. The quantitative objectives often coincide with
those of executives participating in the Executive Bonus Pool. Qualitative
objectives may include key strategic business initiatives or projects for the
executive's respective business unit. Award opportunity and payouts are
determined as a percentage of base salary and are based on comparison to other
internal comparable positions (internal equity) and external market practices.
Cash incentive awards under the Management Incentive Program are paid in
February of the year following the measurement year.
Ms. Sibblies participated in the Management Incentive Program in 2006. A
discussion of the quantitative and qualitative objectives for Ms. Sibblies, and
the performance against those goals can be found below under the heading
Compensation of Officers Reported in the Summary Compensation Table - Chief
Financial Officer Compensation.
Long-term Incentives
Long-term incentive compensation is awarded through grants of HSBC equity
instruments. The purpose of equity-based incentives is to help HSBC Finance
Corporation attract and retain outstanding employees and to promote the growth
and success of our business over a period of time by aligning the financial
interests of these employees with HSBC's shareholders. Historically, equity
incentives were awarded through stock options and restricted share grants.
All stock options granted prior to November 2002 vested in full upon the merger
of HSBC Finance Corporation and HSBC, and options granted in November 2002 have
subsequently vested in full. From the time of the merger in March 2003 to 2005,
options on HSBC ordinary shares were granted to certain executives and
restricted shares to others. The awarded options have an exercise price equal to
the greater of the average market value of HSBC ordinary shares on the five
business days prior to the grant of the option and the market value of HSBC
ordinary shares on the grant date. Option without a performance condition
typically vest in 3, 4 or 5 equal installments based on continued employment and
expire ten years from the grant date. However, certain options awarded to key
executives had a "total shareholder return" performance vesting condition and
only vest if and when the condition is satisfied. No stock options were granted
to executive officers in 2005 or 2006 in conjunction with HSBC's philosophical
shift on the form of equity based compensation.
Awards of restricted shares is another form of long-term incentive compensation
utilized to compensate and incent our employees. When restricted shares are
granted to an executive officer, the underlying shares are held in a trust for
the benefit of the employee and are released only after the defined vesting
conditions are met at the end of the holding period. While in such trust,
dividend equivalents are paid on all underlying shares of restricted stock at
the same rate paid to ordinary shareholders. The dividend equivalents are paid
in the form of additional shares for awards made after 2004 and in cash paid to
the executive for all prior awards.
There are three types of restricted shares used by HSBC: those with a time
vesting condition awarded to recognize significant contribution to HSBC Finance
Corporation ("Achievement Shares"), those with time
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and performance-based vesting conditions ("Performance Shares"), and those with
a time vesting condition for retention purposes ("Retention Awards").
Achievement Shares are awarded to key executives as part of the annual pay
review process in recognition of past performance and to further motivate and
retain executives. The amount granted is based on general guidelines established
by REMCO which include a percentage of base pay, position within HSBC Finance
Corporation and potential for growth. Performance Shares are awarded to key
executives whose performance can have a direct impact on HSBC's consolidated
results and in 2006, within HSBC Finance Corporation, only the Chief Executive
Officer and certain of his direct reports received such awards. Retention Awards
have typically not been granted on an annual basis but rather have been granted
on an as needed basis. No Retention Awards were granted to executive officers in
2006.
As described above, Performance Shares are awarded to an executive and vesting
of those shares is based on achievement of defined levels of future performance
of HSBC. Performance Shares are divided into two equal parts subject to distinct
performance conditions measured over a three year period. A total shareholder
return award, which accounts for 50% of each Performance Share award, will vest
in whole or in part (based on a sliding scale of 0% to 100%) depending upon how
the growth in HSBC's share value, plus declared dividends, compares to the
average shareholder return of a defined competitor group which for 2006 grants
was comprised of 28 major banking institutions including: ABN AMRO Holding N.V.,
Banco Bilbao Vizcaya Argentaria, S.A., Banco Santander Central Hispano S.A.,
Bank of America Corporation, The Bank of New York Company, Inc., Barclays PLC,
BNP Paribas S.A., Citigroup, Inc., Credit Agricole SA, Credit Suisse Group,
Deutsche Bank AG, HBOS plc, JP Morgan Chase, Lloyds TSB Group plc, Mitsubishi
Tokyo Financial Group Inc., Mizuho Financial Group Inc., Morgan Stanley,
National Australia Bank Limited, Royal Bank of Canada, The Royal Bank of
Scotland Group plc, Societe Generale, Standard Chartered PLC, UBS AG, Unicredito
Italiano, US Bancorp, Wachovia Corporation, Wells Fargo & Company and Westpac
Banking Corporation.
The earnings per share award accounts for 50% of each Performance Share award
and is measured using a defined formula based on HSBC's earnings per share
growth over the three-year period as compared to the base-year earnings per
share, which is earnings per share for the year prior to the year the
Performance Shares are granted. None of the earnings per share Performance
Shares will vest unless a minimum earnings per share is reached at the end of
three years.
REMCO maintains discretion to determine that a Performance Share award will not
vest unless REMCO is satisfied that HSBC's financial performance has shown
sustained improvement since the date of the award. REMCO may also waive, amend
or relax performance conditions if it believes the performance conditions have
become unfair or impractical and believes it appropriate to do so. Due to the
probability of one or both of the performance conditions not being met in part
or in full, grants of Performance Shares are for a greater number of shares than
Achievement Share grants. The expected value of Performance Shares is equal to
44% of the face value. Additional information concerning the conditions to
vesting of Performance Share awards is contained in Footnote 2 to the Grants of
Plan Based Awards table on page 200.
COMPENSATION OF OFFICERS REPORTED IN THE SUMMARY COMPENSATION TABLE
Below is a summary of the factors that affected the compensation earned by the
executive officers listed in the Summary Compensation Table in 2006. In
determining the compensation of each of our executives, management and the
Compensation Committee evaluated competitive levels of compensation for officers
managing operations or functions of similar size and complexity and the
importance of retaining executives with the strategic, leadership and financial
skills to ensure our continued growth and success and their potential for
assumption of additional responsibilities.
Chief Executive Officer Compensation
On February 15, 2007, Mr. Mehta resigned as the Chief Executive Officer of HSBC
Finance Corporation. Until that time, he participated in the same programs and
generally received compensation based on the same factors as the other executive
officers. However, Mr. Mehta's overall compensation level reflected his greater
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degree of policy- and decision-making authority, his higher level of
responsibility with respect to the strategic direction of HSBC Finance
Corporation and his ultimate responsibility for our financial and operational
results.
In January 2006, the Compensation Committee made an advisory recommendation to
REMCO that Mr. Mehta's base salary be increased by $100,000 to its 2006
annualized level of $1,000,000. In reviewing Mr. Mehta's base salary, the
Compensation Committee considered competitive compensation levels and found Mr.
Mehta's then current base salary was below the 50th percentile among
similarly-placed executives in each of the surveys considered, including a
survey of our Comparator Group. The raise placed his base salary at the 50th
percentile of the Comparator Group. REMCO approved the increase in Mr. Mehta's
base salary in February 2006.
Also in January 2006, the Compensation Committee made an advisory recommendation
that Mr. Mehta receive a grant of Performance Shares valued at $4,000,000. The
recommendation reflected the Compensation Committee's view of the value of his
long-term contribution to, and leadership of HSBC Finance Corporation, HSBC
North America Holdings Inc. and HSBC as it seeks to expand the consumer finance
business to appropriate markets worldwide. The recommendation further reflected
the Compensation Committee's desire to retain Mr. Mehta and to incent continued
exceptional performance. On January 23, 2006, REMCO met and considered the
proposed equity based awards for all HSBC executives and awarded Mr. Mehta
Performance Shares with a grant date value of $4,000,010. In making the award,
REMCO also considered internal equity of compensation paid to management peers
within HSBC and its subsidiaries and external benchmarking as described above.
As discussed above, Mr. Mehta's maximum cash performance-based incentive
opportunity for 2006 was 20% of the Executive Bonus Pool, or $7,240,000. Under
his employment agreement (discussed below), Mr. Mehta was entitled to a bonus
guaranteed to be not less than $1,875,000. At a January 2007 meeting, the
Compensation Committee established Mr. Mehta's Annual Cash Incentive Based Award
at $1,875,000. In establishing that recommendation, the Compensation Committee
considered the overall results of HSBC Finance Corporation for 2006 and the
impact of the performance of the Mortgage Services business. However, due to the
disappointing results of the Mortgage Services business, Mr. Mehta voluntarily
waived his right to a guaranteed bonus under his employment agreement.
Other compensation paid to Mr. Mehta in 2006, including perquisites such as a
car allowance and life insurance premiums, was consistent with perquisites paid
to similarly-placed executive officers within and outside of HSBC.
Mr. Mehta had an employment agreement which was scheduled to expire on March 28,
2008. Pursuant to his agreement, Mr. Mehta was to serve as Chairman and Chief
Executive Officer of HSBC Finance Corporation and also Chief Executive Officer
of HSBC North America Holdings Inc. The terms of that agreement are summarized
below.
As stated above, Mr. Mehta resigned as of February 15, 2007. The terms of the
severance arrangements agreed with Mr. Mehta will be described in HSBC Finance
Corporation's 2007 Form 10-K.
During the term of the employment agreement, Mr. Mehta was entitled to receive
an annual base salary (which as of January 1, 2006 was increased to $1 million),
and an annual bonus of at least $1,875,000 (75 percent of the annual average of
his bonus earned in 2003, 2004 and 2005). During the term of the agreement, Mr.
Mehta was eligible to participate in any equity-based incentive compensation
plan or program of HSBC as in effect from time to time for similarly situated
senior executives of HSBC Finance Corporation, as approved by REMCO. In
addition, during the term of the agreement, Mr. Mehta was eligible to
participate in the various retirement, medical, disability and life insurance
plans, programs and arrangements in accordance with the terms of HSBC Finance
Corporation's benefit plans.
Under the terms of the employment agreement, if Mr. Mehta's employment was
terminated by HSBC Finance Corporation other than for "cause" or disability, or
he resigned for "good reason," subject to his execution of a general release in
favor of HSBC Finance Corporation and its affiliates, Mr. Mehta was to
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continue to receive his base salary and annual bonus described above as if he
had remained employed until March 28, 2008. In addition, to the extent permitted
under the terms of the applicable plans, Mr. Mehta's welfare benefits, umbrella
liability insurance and automobile and financial counseling allowances were to
continue until March 28, 2008, unless he became eligible to participate in
similar plans of another employer prior to that date.
In 2003 and 2005, Mr. Mehta was awarded Retention Awards of HSBC restricted
shares with values of $5 and $8 million, respectively, in each case based on the
closing price of HSBC ordinary shares as of the date of the grant. The 2003
award was to vest in five equal installments on March 28 of each year through
2008. The 2005 award was to vest in five equal installments on March 26 of each
year through 2010. Each award was to vest in full upon termination of Mr.
Mehta's employment by HSBC Finance Corporation other than for cause or , with
respect to the 2003 award, by Mr. Mehta due to a material breach by HSBC Finance
Corporation of Mr. Mehta's employment agreement, or with respect to the 2005
award, by Mr. Mehta for good reason.
Chief Financial Officer Compensation
The Chief Financial Officer of HSBC Finance Corporation, Ms. Beverley A.
Sibblies, participates in general benefits available to officers of the
corporation and the Management Incentive Program. Her cash compensation is
determined by Mr. Mehta upon recommendation of the Chief Financial Officer of
HSBC North America Holdings Inc. in consultation with Human Resources
executives. As with all executives, REMCO has authority over Ms. Sibblies'
Achievement Share awards.
Ms. Sibblies' base salary in 2006 was $375,000. Ms. Sibblies was promoted to
Chief Financial Officer in September 2005 and received a salary increase
reflective of her increased responsibilities at that time. Based upon that
increase and review of comparator data, she did not receive a salary increase in
2006.
Ms. Sibblies' cash incentive compensation under the Management Incentive Program
is determined based upon satisfaction of quantitative and qualitative objectives
that provide for a target cash award equal to 75% of her base salary, up to a
maximum of 150% of base salary. Ms. Sibblies' cash incentive compensation
required satisfaction of objectives that included: the corporation achieving a
targeted net income goal, leveraging talent and promoting collaboration among
HSBC North America management, support of diversity initiatives, effective
implementation of SOX 404 internal controls testing and documentation,
development of mentoring, talent management and succession planning programs
within the Corporate Finance function, design and implementation of enhancements
to accounting processes, oversight of improved clarity of financial disclosures,
and development of accounting staff through participation in HSBC finance
training programs. Management assessed Ms. Sibblies' and HSBC Finance
Corporation's performance against the objectives and found that there was
complete or substantial satisfaction of each. Ms. Sibblies was awarded cash
incentive compensation equal to 145% of her base salary, or $543,750, which was
paid to her in February 2007.
In March 2006, Ms. Sibblies was granted Achievement Shares with a grant date
value of $500,000, which vest in three years and have no performance conditions.
This reflected management's recognition of the value of her contribution to and
leadership of HSBC Finance Corporation, HSBC's desire to retain Ms. Sibblies and
to incent outstanding performance.
Other compensation paid to Ms. Sibblies, including perquisites such as life
insurance premiums, is consistent with perquisites paid to similarly-placed
executive officers within and outside of HSBC.
Mr. Thomas M. Detelich's Compensation
In 2006, Mr. Detelich's base salary remained the same as 2005, at $650,000. For
2006, the Compensation Committee reviewed competitive compensation levels and
found Mr. Detelich's then current cash compensation level was above the 50th
percentile among similarly-placed executives in our Comparator Group. In keeping
with the goal of maintaining executive base salaries in the 50th percentile, it
did not recommend an increase to his salary.
On January 23, 2006, REMCO approved the Compensation Committee's advisory
recommendation that Mr. Detelich receive Performance Shares with a grant date
value of $1,775,687. The award is subject to three-
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year performance vesting conditions. The vesting criteria of the Performance
Shares is set out in Footnote 2 to the Grants and Plan-based Awards Table on
page 200. The grant reflects REMCO's view of the value of Mr. Detelich's
expected long-term contribution to and leadership of HSBC North America, and
HSBC's desire to retain Mr. Detelich and incent exceptional performance.
As discussed above, Mr. Detelich's maximum cash incentive under the 2006
Executive Bonus Pool was 12% of the available Bonus Pool, or $4,344,000. Based
upon preliminary results of HSBC Finance Corporation, the Compensation Committee
made an advisory recommendation that Mr. Detelich receive a bonus of $2 million.
The Compensation Committee made the award recommendation in recognition of
excellent results within the Consumer Lending business in 2006. In considering
Mr. Detelich's award, the Compensation Committee considered Mr. Detelich's
individual performance, demonstrated leadership, future potential, adherence to
HSBC's ethical standards and the ability to leverage capabilities across
businesses. REMCO agreed with the Compensation Committee's assessment and
approved the award. However, in early February 2007 it was determined that the
return on average stockholder's equity threshold was not met and the Executive
Bonus Pool was not funded. As a result, Mr. Detelich was not entitled to an
award under the plan. Subsequently, the Compensation Committee recommended and
the HSBC CEO agreed that Mr. Detelich should receive a discretionary bonus award
in the amount of $2 million. REMCO ratified these payments at a meeting held on
March 1, 2007. This award was made in recognition of the need to ensure the
continuity of management following the resignation of Mr. Mehta, superior
performance of the Consumer Lending operations under Mr. Detelich's management
and recognition that Mr. Detelich had no responsibility for the events that led
to the failure to meet the return on average stockholder's equity threshold and
the fact that Mr. Detelich's equity award was reduced as a result of the
disappointing consolidated performance of HSBC Finance Corporation.
Other compensation paid to Mr. Detelich, including perquisites such as life
insurance premiums, is consistent with perquisites paid to similarly-placed
executive officers within and outside of HSBC.
Mr. Walter G. Menezes' Compensation
In February 2006, in recognition of his assumption of responsibility of the Card
Services and Retail Services businesses, Mr. Menezes' base salary increased by
$50,000 to its current level of $650,000. To determine Mr. Menezes' base salary,
the Compensation Committee reviewed competitive compensation levels and found
Mr. Menezes' then current cash compensation level fell below the 50th percentile
among similarly-placed executives in our Comparator Group. The Compensation
Committee also considered that Mr. Menezes' base salary was below Mr. Detelich's
who the Compensation Committee deemed to have comparable responsibilities. REMCO
concurred with the Compensation Committee's assessment and, as a result, his
base salary was increased.
On January 23, 2006, REMCO approved the Compensation Committee's advisory
recommendation that Mr. Menezes receive Performance Shares with a grant date
value of $1,775,687. The award is subject to three-year performance vesting
conditions. The vesting criteria of the Performance Shares is set out in
Footnote 2 of the Grants and Plan-based Awards Table on page 200. The grant
reflects REMCO's view of the value of Mr. Menezes' expected long-term
contribution to and leadership of HSBC North America, and HSBC's desire to
retain Mr. Menezes and incent exceptional performance.
As discussed above, Mr. Menezes' maximum cash incentive under the 2006 Executive
Bonus Pool was 12% of the available Bonus Pool, or $4,344,000. Based upon
preliminary results of HSBC Finance Corporation, the Compensation Committee made
an advisory recommendation that Mr. Menezes receive a bonus of $2 million. The
Compensation Committee made the award recommendation in recognition of excellent
results within the Credit Card and Retail Services businesses in 2006. In
considering Mr. Menezes' award, the Compensation Committee considered Mr.
Menezes' individual performance, demonstrated leadership, future potential,
adherence to HSBC's ethical standards and the ability to leverage capabilities
across businesses. REMCO agreed with the Compensation Committee's assessment and
approved the award. However, in early February 2007 it was determined that the
return on average stockholder's equity threshold was not met and the Executive
Bonus Pool was not funded. As a result, Mr. Menezes was not entitled to an award
under the plan. Subsequently, the Compensation Committee recommended and the
HSBC CEO agreed that
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Mr. Menezes should receive a discretionary bonus award in the amount of $2
million. REMCO ratified these payments at a meeting held on March 1, 2007. This
award was made in recognition of the need to ensure the continuity of management
following the resignation of Mr. Mehta, superior performance of the Credit Card
and Retail Services operations under Mr. Menezes' management and recognition
that Mr. Menezes had no responsibility for the events that led to the failure to
meet the return on average stockholder's equity threshold and the fact that Mr.
Menezes' equity award was reduced as a result of the disappointing consolidated
performance of HSBC Finance Corporation.
Other compensation paid to Mr. Menezes, including perquisites such as life
insurance premiums, is consistent with perquisites paid to similarly-placed
executive officers within and outside of HSBC.
Mr. Menezes, has an employment protection agreement pursuant to which if, during
the 18 month period following a change in control of HSBC Finance Corporation,
Mr. Menezes' employment is terminated due to a "qualifying termination" (which
includes a termination other than for "cause" or disability, or resignation by
Mr. Menezes for "good reason"), he will be entitled to receive a cash payment
consisting of:
- A pro rata annual bonus through the date of termination, based on the
highest of the annual bonuses payable during the three years preceding
the year in which the termination occurs;
- A payment equal to 1.5 times the sum of the applicable base salary and
highest annual bonus; and
- A payment equal to the value of 18 months of additional employer
contributions under HSBC North America's tax-qualified and supplemental
defined contribution plans.
In addition, upon a qualifying termination following a change in control, Mr.
Menezes will be entitled to continued welfare benefit coverage for 18 months
after the date of termination, 18 months of additional age and service credit
under HSBC North America's tax-qualified and supplemental defined benefit
retirement plans, and outplacement services. If any amounts or benefits received
under the employment protection agreement or otherwise are subject to the excise
tax imposed under section 4999 of the Internal Revenue Code, an additional
payment will be made to restore Mr. Menezes to the after-tax position in which
he would have been if the excise tax had not been imposed. However, if a small
reduction in the amount payable would render the excise tax inapplicable, then
this reduction will be made instead.
Mr. Kenneth H. Robin's Compensation
In January 2006, Mr. Robin's base salary remained the same as 2005, at $600,000.
In making the decision to not increase Mr. Robin's base salary, the Compensation
Committee reviewed competitive compensation levels and found Mr. Robin's base
salary was above the 50th percentile among similarly-placed executives in our
Comparator Group. In keeping with the goal of maintaining executive base
salaries in the 50th percentile, it did not recommend an increase to his salary.
On January 23, 2006, REMCO approved the Compensation Committee's advisory
recommendation that Mr. Robin receive Performance Shares with a grant date value
of $1,250,522. The award is subject to three-year performance vesting
conditions. The vesting criteria of the Performance Shares is set out in
Footnote 2 to the Grants and Plan-based Awards Table on page 200. The grant
reflects REMCO's view of the value of his long-term contribution to and
leadership of HSBC North America and HSBC's desire to retain Mr. Robin and to
incent his performance.
As discussed above, Mr. Robin's maximum cash incentive under the 2006 Executive
Bonus Pool was 6% of the Available Bonus Pool, or $2,172,000. Based upon
preliminary results of HSBC Finance Corporation, the Compensation Committee made
an advisory recommendation that Mr. Robin receive a bonus of $1 million. The
Compensation Committee made the award recommendation in recognition of the value
of Mr. Robin's strategic insight and his effective management of legal risk
within the corporation. In considering Mr. Robin's award, the Compensation
Committee considered Mr. Robin's individual performance, demonstrated
leadership, future potential, adherence to HSBC's ethical standards and the
ability to leverage capabilities across businesses. REMCO agreed with the
Compensation Committee's assessment and approved the award. However, in early
February 2007 it was determined that the return on average stockholder's equity
threshold was not met and the Executive Bonus Pool was not funded. As a result,
Mr. Robin was not entitled to an award under the plan. Subsequently, the
Compensation Committee recommended and the HSBC CEO
196
agreed that Mr. Robin should receive a discretionary bonus award in the amount
of $1 million. REMCO ratified these payments at a meeting held on March 1, 2007.
This award was made in recognition of the need to ensure the continuity of
management following the resignation of Mr. Mehta and recognition that Mr. Robin
had no responsibility for the events that led to the failure to meet the return
on average stockholder's equity threshold and the fact that Mr. Robin's equity
award was reduced as a result of the disappointing consolidated performance of
HSBC Finance Corporation.
Other compensation paid to Mr. Robin, including perquisites such as life
insurance premiums, is consistent with perquisites paid to similarly-placed
executive officers within and outside of HSBC.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The primary purpose of the Compensation Committee is to assist the Board of
Directors in discharging its responsibilities related to the compensation of the
Chief Executive Officer of HSBC Finance Corporation and the officers that are
direct reports to the Chief Executive Officer and such other officers as may be
designated by the Board of Directors. The Compensation Committee is currently
comprised of the following directors: George A. Lorch (Chair), William R. P.
Dalton, Gary G. Dillon and Cyrus F. Freidheim, Jr. (ex-officio member).
No member of the Compensation Committee served as an officer or employee of HSBC
Finance Corporation in 2006. Due to Mr. Dalton's prior service as Director and
executive officer of HSBC, which terminated on May 28, 2004, Mr. Dalton is not
considered an independent Director of HSBC Finance Corporation. Additional
information with regard to the Compensation Committee is contained in the
section of this Form 10-K entitled Item 10. Directors, Executive Officers and
Corporate Governance - Corporate Governance.
COMPENSATION COMMITTEE REPORT
We, the Compensation Committee of the Board of Directors of HSBC Finance
Corporation, have reviewed and discussed the Compensation Discussion and
Analysis ("2006 CD&A") set forth above with management, and based on such review
and discussion, have recommended to the Board of Directors that the 2006 CD&A be
included in this Annual Report on Form 10-K.
Compensation Committee
George A. Lorch (Chair)
William R. P. Dalton
Gary G. Dillon
Cyrus F. Freidheim, Jr. (ex-officio
member)
197
EXECUTIVE COMPENSATION
The following tables and narrative text discuss the compensation awarded to,
earned by or paid to (i) Mr. Mehta, who served as our Chief Executive Officer
during 2006, (ii) Ms. Sibblies, who served as our Chief Financial Officer during
2006 and (iii) our three other most highly compensated executive officers who
served as executive officers, all as of December 31, 2006.
SUMMARY COMPENSATION TABLE
CHANGE IN
PENSION VALUE
AND
NON-EQUITY NONQUALIFIED
INCENTIVE DEFERRED
STOCK OPTION PLAN COMPENSATION
NAME AND SALARY BONUS AWARDS AWARDS COMPENSATION EARNINGS
PRINCIPAL POSITION YEAR ($) $(1) ($)(2) ($)(3) ($)(4) ($)(5)
---------------------------------------------------------------------------------------------------------------------
SIDDHARTH N. MEHTA....... 2006 $984,615 $ - $3,684,906 $1,575,292 $ - $ 351,288
Chairman & Chief
Executive Officer
BEVERLEY A. SIBBLIES..... 2006 $375,000 $ - $ 216,824 $ - $ 543,750 $ 17,269
Senior Vice President -
Chief Financial Officer
THOMAS M. DETELICH....... 2006 $650,000 $2,000,000 $2,069,519 $ 787,646 $ - $1,158,293
Group Executive, Consumer
and Direct Lending
WALTER G. MENEZES........ 2006 $642,308 $2,000,000 $1,476,173 $ 394,302 $ - $1,311,749
Group Executive, Card
Services
KENNETH H. ROBIN......... 2006 $600,000 $1,000,000 $1,889,505 $ 787,646 $ - $1,070,148
Senior Executive Officer,
General Counsel and
Corporate Secretary
ALL OTHER
NAME AND COMPENSATION TOTAL
PRINCIPAL POSITION ($)(6) ($)
------------------------- -------------------------
SIDDHARTH N. MEHTA....... $290,962 $6,887,063
Chairman & Chief
Executive Officer
BEVERLEY A. SIBBLIES..... $ 54,303 $1,207,146
Senior Vice President -
Chief Financial Officer
THOMAS M. DETELICH....... $162,774 $6,828,232
Group Executive, Consumer
and Direct Lending
WALTER G. MENEZES........ $151,568 $5,976,100
Group Executive, Card
Services
KENNETH H. ROBIN......... $134,791 $5,482,090
Senior Executive Officer,
General Counsel and
Corporate Secretary
---------------
(1) The amounts disclosed for Messrs., Detelich, Menezes and Robin represent the
discretionary incentive bonus relating to 2006 performance but paid in
February 2007.
(2) The values reflected in the table above are the amounts of compensation
expense amortized in 2006 for accounting purposes under FAS 123R for
outstanding restricted stock grants made in the years 2003, 2004, 2005 and
2006. A portion of the expense reflected for Messrs. Mehta, Detelich,
Menezes and Robin relates to Performance Shares granted in 2005 and 2006
that will vest in whole or in part three years from the date of grant if all
or some of the performance conditions are met as follows: 50% of the award
is subject to a total shareholder return measure ("TSR") against a
comparator group. HSBC Finance Corporation's comparator group is comprised
of U.S.-based organizations that compete with us for business, customers,
and executive talent. The Performance Share comparator group includes: ABN
AMRO Holding N.V., Banco Bilbao Vizcaya Argentaria, S.A., Banco Santander
Central Hispano S.A., Bank of America Corporation, The Bank of New York
Company, Inc., Barclays PLC, BNP Paribas S.A., Citigroup, Inc., Credit
Agricole SA, Credit Suisse Group, Deutsche Bank AG, HBOS plc, JP Morgan
Chase, Lloyds TSB Group plc, Mitsubishi Tokyo Financial Group Inc., Mizuho
Financial Group Inc., Morgan Stanley, National Australia Bank Limited, Royal
Bank of Canada, The Royal Bank of Scotland Group plc, Societe Generale,
Standard Chartered PLC, UBS AG, Unicredito Italiano, US Bancorp, Wachovia
Corporation, Wells Fargo & Company and Westpac Banking Corporation.
Depending on HSBC's ranking against the comparator group at the end of the
performance period, the TSR portion of the grant may vest on a sliding scale
from 100% to 0%. The remaining 50% of the award is subject to satisfaction
of an earnings per share measure ("EPS") and may vest based on an
incremental EPS percentage in accordance with a defined formula. If the
aggregate incremental EPS is less than 24%, the EPS portion will be
forfeited and if it is 52% or more, the EPS component will vest in full. We
have reduced the amount of expense related to the Performance Shares that
would have been recorded by 50% due to the probability of a 0% vest on the
TSR portion and a 100% vest on the EPS portion for both years 2005 and 2006.
HSBC Finance Corporation records expense over the three year period based on
the fair value which is 100% of the face value on the date of the award. The
remaining grants are non-performance-based awards and are subject to various
time vesting conditions as disclosed in the footnotes to the Outstanding
Equity Awards at Fiscal Year End Table and will be released as long as the
named executive officer is still in the employ of HSBC Finance Corporation
at the time of vesting. HSBC Finance Corporation records expense based on
the fair value over the vesting period which is 100% of the face value on
the date of the award. Dividend equivalents, in the form of cash or
additional shares, are paid on all underlying shares of restricted stock at
the same rate as paid to ordinary share shareholders.
198
(3) HSBC and HSBC Finance Corporation's current philosophy is to reward
executive officers with restricted shares, called "Achievement Shares" or
"Performance Shares". HSBC last issued stock options to HSBC Finance
Corporation's named executive officers in 2004. The amounts reflected above
are the amounts of compensation expense amortized in 2006 for accounting
purposes under FAS 123R for outstanding stock option grants made in 2002 and
2003. The methodology of the valuation of these options was based on a
Black-Scholes model for each of the respective years. The stock option grant
made to certain named executive officers in 2004 is performance-based with
100% of the condition tested on Total Shareholder Return in 2007. The amount
of compensation expense amortized in 2006 for accounting purposes under FAS
123R has been excluded from the amounts shown above due to the probability
of the performance condition not being satisfied. The performance condition
will be subject to a re-test in 2008, and again in 2009, and must be
satisfied in order for the shares to vest.
(4) The amount disclosed for Ms. Sibblies represents the incentive bonus earned
in 2006 but paid in February 2007 under the Management Incentive Program.
(5) The HSBC-North America (U.S.) Retirement Income Plan ("RIP") and the
Household Supplemental Retirement Income Plan ("SRIP") are described under
Savings and Pension Plans on page 206.
Increase in values by plan for each participant are: Mr. Mehta - $26,541
(RIP), $324,747 (SRIP); Ms. Sibblies - $4,725 (RIP), $12,544 (SRIP); Mr.
Detelich - $43,845 (RIP), $1,114,448 (SRIP); Mr. Menezes - $72,502 (RIP),
$1,239,247 (SRIP); Mr. Robin - $75,017 (RIP) $995,131 (SRIP).
(6) Components of All Other Compensation are disclosed in the aggregate. All
Other Compensation includes such items as financial planning services,
physical exams, club initiation fees, expatriate benefits, and car
allowances. The following itemizes benefits that individually or in the
aggregate for each executive officer exceeds $10,000: Car allowances for
Messrs. Mehta and Robin were $11,000 each in 2006. Messrs. Detelich and
Menezes and Ms. Sibblies are not eligible for a car allowance. Personal use
of aircraft for Mr. Mehta was $2,598, for Mr. Detelich was $1,922 and for
Mr. Menezes was $4,844. Club Dues and Membership Fees for Mr. Mehta in 2006
was $11,000. Personal use of Corporate Apartment was $720 for Mr. Detelich
and $1,800 for Mr. Menezes in 2006. Personal use of Corporate Limo for Mr.
Mehta was $8,000. Financial Counseling for Messrs. Mehta, Detelich and
Menezes was $10,000, $3,500 and $8,000, respectively. Executive Tax Services
for Mr. Robin in 2006 was $4,000. Executive Physical expenses for Mr. Mehta
was $1,527, for Mr. Menezes was $691 and for Ms. Sibblies was $1,428.
Messrs. Mehta, Detelich, Menezes and Robin each received Executive Umbrella
Liability Coverage in the amount of $10 million at a cost of $1,850 for
2006.
The total in the All Other Compensation column also includes life insurance
premiums paid by HSBC Finance Corporation in 2006 for the benefit of
executives as follows: Mr. Mehta, $5,910; Mr. Detelich, $7,782; Mr. Menezes,
$17,844; Mr. Robin, $12,941 and Ms. Sibblies, $3,375. All Other Compensation
also includes HSBC Finance Corporation's contribution for the named
executive officer's participation in the HSBC-North America (U.S.) Tax
Reduction Investment Plan ("TRIP") and the Supplemental Household
International Tax Reduction Investment Plan ("STRIP") in 2006 as follows:
Mr. Mehta, $239,077; Mr. Detelich, $147,000; Mr. Menezes, $116,538; Mr.
Robin, $105,000 and Ms. Sibblies, $49,500.
TRIP and STRIP are described under Savings and Pension Plans - Deferred
Compensation Plans on page 207.
199
GRANTS OF PLAN-BASED AWARDS TABLE
ESTIMATED FUTURE PAYOUTS UNDER NON-EQUITY ESTIMATED FUTURE PAYOUTS UNDER EQUITY
INCENTIVE PLAN AWARDS(1) INCENTIVE PLAN AWARDS(2)
----------------------------------------- ----------------------------------------
THRESHOLD TARGET MAXIMUM THRESHOLD TARGET MAXIMUM
NAME GRANT DATE ($) ($) ($) (#)(4) (#) (#)
------------------------------------------------------------------------------------------------------------------------------
SIDDHARTH N. MEHTA......... 3/6/06 0 N/A $7,240,000 66,657 N/A 222,189
Chairman & Chief Executive
Officer
BEVERLEY A. SIBBLIES....... 3/31/06 0 $ 281,250 $ 562,500 N/A N/A N/A
Senior Vice President -
Chief Financial Officer
THOMAS M. DETELICH......... 3/31/06 0 N/A $4,344,000 30,254 N/A 100,848
Group Executive, Consumer
and Direct Lending
WALTER G. MENEZES.......... 3/31/06 0 N/A $4,344,000 30,254 N/A 100,848
Group Executive, Card
Services and Retail
Services
KENNETH H. ROBIN........... 3/31/06 0 N/A $2,172,000 21,356 N/A 71,187
Senior Executive Officer,
General Counsel and
Corporate Secretary
ALL OTHER
ALL OTHER STOCK OPTION AWARDS: GRANT DATE
AWARDS: NUMBER OF FAIR VALUE
NUMBER OF SECURITIES OF STOCK
SHARES OF STOCK UNDERLYING AND OPTION
OR UNITS OPTIONS AWARDS
NAME (#) (#) ($)(3)
--------------------------- ----------------------------------------------
SIDDHARTH N. MEHTA......... N/A N/A $4,000,010
Chairman & Chief Executive
Officer
BEVERLEY A. SIBBLIES....... 29,513(5) N/A $ 500,000(5)
Senior Vice President -
Chief Financial Officer
THOMAS M. DETELICH......... N/A N/A $1,775,687
Group Executive, Consumer
and Direct Lending
WALTER G. MENEZES.......... N/A N/A $1,775,687
Group Executive, Card
Services and Retail
Services
KENNETH H. ROBIN........... N/A N/A $1,250,522
Senior Executive Officer,
General Counsel and
Corporate Secretary
---------------
(1) Messrs. Mehta, Detelich, Menezes and Robin participate in the Executive
Bonus Pool. As discussed in the 2006 CD&A, this plan is an annual cash
incentive plan that is comprised mainly of corporate and business
quantitative goals and qualitative goals. For 2006, the quantitative goals
were not met and therefore no awards were made under this plan. Ms. Sibblies
participates in the Management Incentive Program. As discussed in the 2006
CD&A, the Management Incentive Program is an annual cash incentive plan that
is comprised of both quantitative and qualitative individual, business unit
or company objectives which are determined at the beginning of the year with
each objective being assigned a target and maximum payout based upon a
percentage of base salary. The percentage of target and maximum payout is
determined by the market data for the position the executive officer holds
and will not change unless the executive officer changes into a position
which has a different target and maximum payout. Typically the maximum
payout is a 1x, 2x or 3x multiplier of target. Ms. Sibblies' actual award
for 2006 was $543,750.
(2) Reflects the award of Performance Shares granted to Messrs. Mehta, Detelich,
Menezes and Robin. As discussed in the 2006 CD&A and in Footnote 2 to the
Summary Compensation Table, Performance Shares are subject to two
performance conditions, each of which trigger potential payout of 50% of the
aggregate award: the first objective is based upon Total Shareholder Return
("TSR") and the second objective is based upon earnings per share ("EPS"),
both measured over a three year performance period. TSR means the growth in
share value and declared dividend income on the shares, measured in
Sterling, during the three year performance period and is based on HSBC's
ranking against a comparator group of 28 major banks as listed on page 192.
The calculation of the share price component within HSBC's TSR will be the
average market price over the 20 dealing days commencing on the day when
HSBC's annual results are announced with the end point being the average
market price over the 20 dealing days commencing on the day on which the
annual results of HSBC are announced three years later. The TSR portion of
the award will vest on a sliding scale based on HSBC's relative ranking
against the comparator group at the end of the three year period. If HSBC is
ranked 1st through 7th the vesting percentage will be 100%. If HSBC is
ranked 8th through 14th, the vesting percentage will fall by 10% per rank.
If HSBC is ranked 15th through 28th, the vesting percentage will be zero.
The percentage of the TSR which will vest is defined in the following
formula:
((X-Z) x (A-B)) + B
(Y-Z)
where:
X = the TSR performance of HSBC
Z = the TSR performance of the bank immediately below X
Y = the TSR performance of the bank immediately above X
A = the vesting percentage linked to the ranking of Y as detailed above
B = the vesting percentage linked to the ranking of Z as detailed above
The second performance condition is based upon EPS, which for purposes of
awarding Performance Shares is the profit, excluding goodwill amortization
attributable to shareholder's return, divided by the weighted average number
of shares in issue and held outside HSBC during the performance year. The
base measure will be the EPS for the financial year preceding that in which
the award is made. EPS will then be compared over the three consecutive
financial years commencing with the year in which the award is made.
Incremental EPS will be calculated by expressing, as a percentage of the EPS
of the base year, the difference in each year of the measurement period
between the EPS of that year and the EPS of the base year. These percentages
will be aggregated to arrive at the
200
total incremental EPS for the measurement period. The percentage of the EPS
objective that will vest will be in accordance with the following formula:
30+2.5(X-24) where: 30% is the minimum proportion of the EPS objective which
may vest and X is the aggregate incremental EPS from the base year to the end
of the measurement period between and including 24% and 52%. If the aggregate
incremental EPS in accordance with the formula is less than 24% then the EPS
objective will be forfeited and if it is more than 52% then the EPS objective
will vest in full.
(3) The total grant date fair value reflected for Mr. Mehta is based on 100% of
the fair market value of the underlying HSBC ordinary shares on March 6,
2006 (the date of grant) of GBP9.909706 and converted into U.S. dollars
using the GBP exchange rate as of the time of funding the grant (1.816677).
The total grant date fair value reflected for Messrs. Detelich, Menezes and
Robin and Ms. Sibblies is based on 100% of the fair market value of the
underlying HSBC ordinary shares on March 31, 2006 (the date of grant) of
GBP9.6697 and converted into U.S. dollars using the GBP exchange rate as of
the time of funding the grant (1.816677).
(4) As described in Footnote 2 above, the executives could receive no awards
under the equity incentive plan. However, the numbers presented under
"Threshold" represent the minimum awards the executives could receive if the
minimum (i.e., 30%) of either of the performance conditions is met.
(5) Reflects the award of Achievement Shares granted to Ms. Sibblies, which
award consists of shares of restricted stock that vest in full at the end of
a three year period from the date of grant. The award amount of Achievement
Shares is based on the executive officer's position within the organization,
base salary, performance rating and scope for growth. At the executive
level, officers eligible to receive Achievement Shares are eligible for
awards ranging from 50% up to 300% of base salary. For both plans,
additional shares are awarded in amounts equivalent to the same dividend
rate on ordinary shares.
201
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END TABLE
STOCK AWARDS
----------------------------
OPTION AWARDS
-------------------------------------------------------------------------------------------------
EQUITY
INCENTIVE
PLAN AWARDS:
NUMBER OF NUMBER OF NUMBER OF NUMBER OF MARKET VALUE
SECURITIES SECURITIES SECURITIES SHARES OR OF SHARES OR
UNDERLYING UNDERLYING UNDERLYING UNITS OF UNITS OF STOCK
UNEXERCISED UNEXERCISED UNEXERCISED OPTION OPTION STOCK THAT THAT HAVE
OPTIONS (#) OPTIONS (#) UNEARNED EXERCISE EXPIRATION HAVE NOT NOT
NAME EXERCISABLE UNEXERCISABLE OPTIONS (#) PRICE ($) DATE VESTED (#) VESTED ($)(1)
--------------------------------------------------------------------------------------------------------------------------------
SIDDHARTH N. MEHTA 802,500(2) 0 - $17.08 06/15/08 - -
Chairman &
Chief Executive Officer 358,450(2) 0 - $13.71 11/09/08 - -
331,700(2) 0 - $16.96 11/08/09 - -
401,250(2) 0 - $18.40 11/13/10 - -
535,000(2) 0 - $21.37 11/12/11 - -
535,000(2) 0 - $10.66 11/20/12 - -
306,000(3) 102,000 - GBP9.1350 11/03/13 - -
- - 204,000(4) GBP8.2830 04/30/14 - -
- - - - - 188,562(5) $3,437,485
- - - - - 403,308(6) $7,352,305
- - - - - - -
- - - - - - -
--------------------------------------------------------------------------------------------------------------------------------
BEVERLEY A. SIBBLIES - - - - - 29,513(9) $ 538,022
Senior Vice President -
Chief Financial Officer - - - - - 29,936(10) $ 545,733
--------------------------------------------------------------------------------------------------------------------------------
THOMAS M. DETELICH 53,500(2) 0 - $13.71 11/09/08 - -
Group Executive,
Consumer and Direct Lending 60,188(2) 0 - $16.96 11/08/09 - -
66,875(2) 0 - $18.40 11/13/10 - -
93,625(2) 0 - $21.37 11/12/11 - -
267,500(2) 0 - $10.66 11/20/12 - -
153,000(3) 51,000 - GBP9.1350 11/03/13 - -
- - 102,000(4) GBP8.2830 04/30/14 - -
- - - - - 141,421(5) $2,578,105
- - - - - 201,654(6) $3,676,152
- - - - - - -
- - - - - - -
--------------------------------------------------------------------------------------------------------------------------------
WALTER G. MENEZES 48,150(2) 0 - $13.71 11/09/08 - -
Group Executive,
Card Services 66,875(2) 0 - $16.96 11/08/09 - -
74,900(2) 0 - $18.40 11/13/10 - -
107,000(2) 0 - $21.37 11/12/11 - -
107,000(2) 0 - $10.66 11/20/12 - -
112,500(3) 37,500 - GBP9.1350 11/03/13 - -
150,000(4) GBP8.2830 04/30/14 - -
- - - - - 44,584(11) $ 812,766
- - - - - 201,654(6) $3,676,152
- - - - - - -
- - - - - - -
--------------------------------------------------------------------------------------------------------------------------------
KENNETH H. ROBIN 160,500(2) - - $16.96 11/08/09 - -
Senior Executive Officer,
General Counsel and
Corporate Secretary 200,625(2) - - $18.40 11/13/10 - -
240,750(2) - - $21.37 11/12/11 - -
66,875(2) - - $10.66 11/20/12 - -
153,000(3) 51,000 GBP9.1350 11/03/13 - -
- - 102,000(4) GBP8.2830 04/30/14 - -
- - - - - 63,017(12) $1,148,800
- - - - - - -
- - - - - - -
--------------------------------------------------------------------------------------------------------------------------------
STOCK AWARDS
-------------------------------
EQUITY
--------------------------- EQUITY INCENTIVE PLAN
INCENTIVE PLAN AWARDS:
AWARDS: MARKET OR
NUMBER OF PAYOUT VALUE
UNEARNED OF UNEARNED
SHARES, UNITS SHARES, UNITS
OR OTHER OR OTHER
RIGHTS THAT RIGHTS THAT
HAVE NOT HAVE NOT
NAME VESTED (#) VESTED ($)(1)
--------------------------- -------------------------------
SIDDHARTH N. MEHTA - -
Chairman &
Chief Executive Officer - -
- -
- -
- -
- -
- -
- -
- -
- -
190,079(7) $3,465,140
222,189(8) $4,050,505
---------------------------
BEVERLEY A. SIBBLIES - -
Senior Vice President -
Chief Financial Officer - -
---------------------------
THOMAS M. DETELICH - -
Group Executive,
Consumer and Direct Lending - -
- -
- -
- -
- -
- -
95,040(7) $1,732,579
100,848(8) $1,838,459
---------------------------
WALTER G. MENEZES - -
Group Executive,
Card Services - -
- -
- -
- -
- -
- -
- -
- -
95,040(7) $1,732,579
100,848(8) $1,838,459
---------------------------
KENNETH H. ROBIN - -
Senior Executive Officer,
General Counsel and
Corporate Secretary - -
- -
- -
- -
- -
- -
76,032(7) $1,386,063
71,187(8) $1,297,739
---------------------------
(1) The market value of the shares on December 29, 2006 was GBP9.31 and the
exchange rate from GBP to U.S. dollars was 1.958, which equates to a U.S.
dollars share price of $18.23 per share.
(2) Reflects fully vested options.
(3) Seventy-five percent of this award vested on November 3, 2006. The remaining
25% of the award will vest on November 3, 2007.
(4) This award will vest in full, subject to satisfaction of performance
conditions, on the third anniversary of the date of grant, which was April
30, 2004. If the performance conditions are not satisfied on the third
anniversary, the performance conditions will be re-tested on the fourth and
fifth anniversaries of the date of grant. If the performance conditions are
not met on the fifth anniversary of the date of grant, the options will be
forfeited.
(5) Twenty percent of this award vested on each of March 31, 2004, March 31,
2005 and March 31, 2006. Twenty percent of this award will vest on each of
March 30, 2007 and May 31, 2008.
202
(6) Twenty percent of this award vested on May 26, 2006. Twenty percent of this
award will vest on each of May 25, 2007, May 26, 2008, May 26, 2009 and May
26, 2010.
(7) These awards will vest in part or in full on March 31, 2008 if performance
conditions are met.
(8) These awards will vest in part or in full on March 31, 2009 if performance
conditions are met.
(9) This award vests in full on March 31, 2008.
(10) This award vests in full on March 31, 2009.
(11) Thirty-three percent of this award vested on February 14, 2006 and 33%
vested on February 14, 2007. The remaining 34% will vest on February 14,
2008.
(12) Fifty percent of this award vested on May 26, 2006. The remaining 50% will
vest on May 25, 2007.
203
OPTION EXERCISES AND STOCK VESTED TABLE
OPTION AWARDS STOCK AWARDS
------------------------------------- ------------------------------------
NUMBER OF SHARES VALUE REALIZED NUMBER OF SHARES VALUE REALIZED
ACQUIRED ON EXERCISE ON EXERCISE ACQUIRED ON VESTING ON VESTING
NAME (#) ($)(1) (#)(2) ($)(1)(2)
-------------------------------------------------------------------------------------------------------------
SIDDHARTH N. MEHTA............. 0 0 214,935(3) $3,692,196
Chairman & Chief Executive
Officer
BEVERLEY A. SIBBLIES........... 0 0 0 0
Senior Vice President - Chief
Financial Officer
THOMAS M. DETELICH............. 0 0 134,861(4) $2,311,557
Group Executive, Consumer and
Direct Lending
WALTER G. MENEZES.............. 48,150(5) $ 175,489 74,968(6) $1,292,504
Group Executive, Card Services
KENNETH H. ROBIN............... 660,725(7) $3,885,272 120,092(8) $2,065,621
Senior Executive Officer,
General Counsel and Corporate
Secretary
---------------
(1) Value realized on exercise or vesting uses the GBP fair market value on the
date of exercise/release and the exchange rate from GBP to U.S. dollars on
the date of settlement.
(2) Includes the release of additional awards accumulated over vesting period.
(3) Includes the release of 94,280 shares granted on April 15, 2003 and 100,827
shares granted on May 26, 2005. Remaining shares are release of additional
awards accumulated over the vesting period.
(4) Includes the release of 71,710 shares granted on April 15, 2003 and 50,413
shares granted on May 26, 2005. Remaining shares are release of additional
awards accumulated over the vesting period.
(5) Includes exercise of stock options granted on November 10, 1997.
(6) Includes the release of 22,291 shares granted on February 14, 2003 and
50,413 shares granted on May 26, 2005. Remaining shares are release of
additional awards accumulated over the vesting period.
(7) Includes the exercise of 120,375 stock options granted on November 11, 1996,
200,625 stock options granted on November 20, 2002, 160,500 stock options
granted on November 10, 1997 and 179,225 stock options granted on November
9, 1998.
(8) Includes the release of 47,141 shares granted on April 15, 2003 and 63,016
shares granted on May 26, 2005. Remaining shares are release of additional
awards accumulated over the vesting period.
204
PENSION BENEFITS
PAYMENTS
NUMBER OF PRESENT VALUE OF DURING LAST
YEARS CREDITED ACCUMULATED BENEFIT FISCAL YEAR
NAME PLAN NAME(4) SERVICE ($) ($)
---------------------------------------------------------------------------------------------------------
SIDDHARTH N. MEHTA....... RIP-Household New 8.5 $ 133,162 $ 0
Chairman & Chief SRIP-Household New 8.5 $1,729,179
Executive Officer
BEVERLEY A. RIP-Account Based 2.2 $ 12,453
SIBBLIES(1)............ $ 0
Senior Vice President - SRIP-Account Based 2.2 $ 16,252
Chief Financial Officer
THOMAS M. DETELICH....... RIP-Household New 30.4 $ 401,208 $ 0
Group Executive, Consumer SRIP-Household New 30.4 $3,713,123
and Direct Lending
WALTER G. MENEZES(2)..... RIP-Household New 10.2 $ 363,478 $ 0
Group Executive, Card SRIP-Household New 10.2 $2,720,078
Services
KENNETH H. ROBIN(3)...... RIP-Household Old 17.1 $ 965,551 $ 0
Senior Executive Officer, SRIP-Household Old 17.1 $6,270,582
General Counsel and
Corporate Secretary
---------------
(1) Not yet vested; will be vested upon completion of three years of eligible
service which is expected to occur in the second half of 2007.
(2) Value of age 65 benefit. Participant is also eligible for an immediate early
retirement benefit with value of $418,305 (RIP) and $3,138,082 (SRIP).
(3) Value of age 65 benefit. Participant is also eligible for an immediate early
retirement benefit with value of $1,186,386 (RIP) and $7,734,619 (SRIP).
(4) Plans described under Savings and Pension Plans on page 206.
205
SAVINGS AND PENSION PLANS
Retirement Income Plan (RIP)
The HSBC-North America (U.S.) Retirement Income Plan ("RIP") is a
non-contributory, defined benefit pension plan for employees of HSBC North
America and its U.S. subsidiaries who are at least 21 years of age with one year
of service and not part of a collective bargaining unit. Benefits are determined
under a number of different formulas that vary based on year of hire and
employer.
Supplemental Retirement Income Plan (SRIP)
The Household Supplemental Retirement Income Plan ("SRIP") is a non-qualified
retirement plan that is designed to provide benefits that are precluded from
being paid to legacy Household employees by the RIP due to legal constraints
applicable to all qualified plans. For example, the maximum amount of
compensation during 2006 that can be used to determine a qualified plan benefit
is $220,000, and the maximum annual benefit commencing at age 65 in 2006 is
$175,000. SRIP benefits are calculated without regard to these limits. The
resulting benefit is then reduced by the value of qualified benefits payable by
RIP so that there is no duplication of payments. Benefits are paid in a lump sum
for retired executives covered by a Household Old, Household New, or Account
Based Formula.
Formulas for Calculating Benefits
HOUSEHOLD OLD FORMULA: Applies to executives who were hired prior to January 1,
1990 by Household International, Inc. The benefit at age 65 is determined under
whichever formula, A or B below, provides the higher amount.
A. The normal retirement benefit at age 65 is the sum of (i) 51% of average
salary that does not exceed the integration amount and (ii) 57% of average
salary in excess of the integration amount. For this purpose, the
integration amount is an average of the Social Security taxable wage bases
for the 35 year period ending with the year of retirement. The benefit is
reduced pro rata for executives who retire with less than 15 years of
service. If an executive has more than 30 years of service, the benefit
percentages in the formula, (the 51% and 57%) are increased 1/24 of 1
percentage point for each month of service in excess of 30 years, but not
more than 5 percentage points. The benefit percentages are reduced for
retirement prior to age 65.
B. The normal retirement benefit at age 65 is determined under (a) below,
limited to a maximum amount determined in (b):
a. 55% of average salary, reduced pro rata for less than 15 years of
service, and increased 1/24 of 1 percentage point for each month
in excess of 30 years, but not more than 5 percentage points; the
benefit percentage of 55% is reduced for retirement prior to age
65.
b. The amount determined in (a) is reduced as needed so that when
added to 50% of the primary Social Security benefit, the total
does not exceed 65% of the average salary. This maximum is applied
for payments following the age at which full Social Security
benefits are available.
Both formulas use an average of salaries for the 48 highest consecutive months
selected from the 120 consecutive months preceding date of retirement; for this
purpose, salary includes total base wages and bonuses.
For executives who were participants on January 1, 1978, had attained age 35 and
had at least 10 years of employment, the minimum normal retirement benefit is
55% of final average salary. For this purpose, salary does not include bonuses
and the average is based on 60 consecutive months, rather than 48.
Executives who are at least age 50 with 15 years of service or at least age 55
with 10 years of service may retire before age 65, in which case the benefits
are reduced.
206
HOUSEHOLD NEW FORMULA: Applies to executives who were hired after December 31,
1989, but prior to January 1, 2000, by Household International, Inc. The normal
retirement benefit at age 65 is the sum of (i) 51% of average salary that does
not exceed the integration amount and (ii) 57% of average salary in excess of
the integration amount. For this purpose, salaries include total base wages and
bonuses and are averaged over the 48 highest consecutive months selected from
the 120 consecutive months preceding date of retirement. The integration amount
is an average of the Social Security taxable wage bases for the 35 year period
ending with the year of retirement. The benefit is reduced pro rata for
executives who retire with less than 30 years of service. If an executive has
more than 30 years of service, the percentages in the formula, (the 51% and 57%)
are increased 1/24 of 1 percentage point for each month of service in excess of
30 years, but not more than 5 percentage points. Executives who are at least age
55 with 10 or more years of service may retire before age 65 in which case the
benefit percentages (51% and 57%) are reduced.
ACCOUNT BASED FORMULA: Applies to executives who were hired by Household
International Inc. after December 31, 1999. It also applies to executives who
were hired by HSBC Bank USA, National Association after December 31, 1996 and
became participants in the Retirement Income Plan on January 1, 2005, or were
hired by HSBC after March 28, 2003. The formula provides for a notional account
that accumulates 2% of annual salary for each calendar year of employment. For
this purpose, salary includes total base wages and bonuses. At the end of each
calendar year, interest is credited on the notional account using the value of
the account at the beginning of the year. The interest rate is based on the
lesser of average yields for 10-year and 30-year Treasury bonds during September
of the preceding calendar year. The notional account is payable at termination
of employment for any reason after three years of service although payment may
be deferred to age 65.
PROVISIONS APPLICABLE TO ALL FORMULAS: The amount of salary used to determine
benefits is subject to an annual maximum that varies by calendar year. The limit
for 2006 is $220,000. The limit for years after 2006 will increase from
time-to-time as specified by IRS regulations. Benefits are payable as a life
annuity, or for married participants, a reduced life annuity with 50% continued
to a surviving spouse. Participants (with spousal consent, if married) may
choose from a variety of other optional forms of payment, which are all designed
to be equivalent in value if paid over an average lifetime. Retired executives
covered by a Household Old, Household New or Account Based Formula may elect a
lump sum form of payment (spousal consent is needed for married executives).
Present Value of Accumulated Benefits
For the Account Based formula: The value of the notional account balances
currently available on December 31, 2006.
For other formulas: The present value of benefit payable at assumed retirement
using interest and mortality assumptions consistent with those used for
financial reporting purposes under SFAS 87 with respect to HSBC Finance
Corporation's audited financial statements for the period ending December 31,
2006. However, no discount has been assumed for separation prior to retirement
due to death, disability or termination of employment. Further, the amount of
the benefit so valued is the portion of the benefit at assumed retirement that
has accrued in proportion to service earned on December 31, 2006.
Deferred Compensation Plans
TAX REDUCTION INVESTMENT PLAN HSBC North America maintains the HSBC-North
America (U.S.) Tax Reduction Investment Plan ("TRIP"), which is a deferred
profit-sharing and savings plan for its eligible employees. With certain
exceptions, a U.S. employee who has been employed for 30 days and who is not
part of a collective bargaining unit may contribute into TRIP, on a pre-tax and
after-tax basis, up to 40% (15% if highly compensated) of the participant's cash
compensation (subject to a maximum annual pre-tax contribution by a participant
of $15,000, as adjusted for cost of living increases, and certain other
limitations imposed by the Internal Revenue Code) and invest such contributions
in separate equity or income funds.
207
If the employee has been employed for at least one year, HSBC Finance
Corporation contributes 3% of compensation on behalf of each participant who
contributes 1% and matches any additional participant contributions up to 4% of
compensation. However, matching contributions will not exceed 6% of a
participant's compensation if the participant contributes 4% or more of
compensation. The plan provides for immediate vesting of all contributions. With
certain exceptions, a participant's after-tax contributions which have not been
matched by us can be withdrawn at any time. Both our matching contributions made
prior to 1999 and the participant's after-tax contributions which have been
matched may be withdrawn after five years of participation in the plan. A
participant's pre-tax contributions and our matching contributions after 1998
may not be withdrawn except for an immediate financial hardship, upon
termination of employment, or after attaining age 59 1/2. Participants may
borrow from their TRIP accounts under certain circumstances.
SUPPLEMENTAL TAX REDUCTION INVESTMENT PLAN HSBC North America also maintains the
Supplemental Household International Tax Reduction Investment Plan ("STRIP")
which is an unfunded plan for eligible employees of HSBC Finance Corporation and
its participating subsidiaries whose participation in TRIP is limited by the
Internal Revenue Code. Only matching contributions required to be made by us
pursuant to the basic TRIP formula are invested in STRIP through a credit to a
bookkeeping account maintained by us which deems such contributions to be
invested in equity or income funds selected by the participant.
NON-QUALIFIED DEFERRED COMPENSATION PLAN HSBC North America Holdings Inc.
maintains a Non-Qualified Deferred Compensation Plan for the highly compensated
employees in the organization, including executives of HSBC Finance Corporation.
The named executive officers are eligible to contribute up to 80% of their
salary and/or cash bonus compensation in any plan year. Participants are
required to make an irrevocable election with regard to an amount or percentage
of compensation to be deferred and the timing and manner of future payout. Two
types of distributions are permitted under the plan, either a scheduled
in-service withdrawal which must be scheduled at least 2 years after the end of
the plan year in which the deferral is made, or payment upon termination of
employment. For either the scheduled in-service withdrawal or payment upon
termination, the participant may elect either a lump sum payment or if the
participant has made at least $25,000 of contributions and has over 10 years of
service, he may request installment payments over 10 years. Due to the unfunded
nature of the plan, participant elections are deemed investments whose gains or
losses are calculated by reference to actual earnings of the investment choices.
The deemed investment choices are reviewed on a periodic basis by the Investment
Committee for the Plan which consists of members chosen by the Board or
Directors or Chief Executive Officer of HSBC North America Holdings Inc. and are
chosen based on a conservative mix of funds and currently include Van Kampen
Real Estate Securities - A Shares, Oppenheimer Global - A Shares, AIM Small Cap
Growth - Class A, HSBC Investor Small Cap Equity - Class Y, Fidelity Advisor Mid
Cap Stock - Class A, Dreyfus S&P 500 Index, HSBC Investor Growth &
Income - Class Y, HSBC Investor Fixed Income - Class Y and HSBC Investor Money
Market - Class Y. In order to provide the participants with the maximum amount
of protection under an unfunded plan, a Rabbi Trust has been established where
the participant contributions are segregated from the general assets of HSBC
Finance Corporation. The Investment Committee for the plan endeavors to invest
the contributions in a manner consistent with the participant's deemed elections
reducing the likelihood of an underfunded plan.
208
NONQUALIFIED DEFINED CONTRIBUTION
AND OTHER NONQUALIFIED DEFERRED COMPENSATION PLANS
SUPPLEMENTAL
NONQUALIFIED TAX
DEFERRED REDUCTION
COMPENSATION INVESTMENT
PLAN(1) PLAN(2)
EXECUTIVE REGISTRANT AGGREGATE AGGREGATE AGGREGATE
CONTRIBUTIONS CONTRIBUTIONS EARNINGS WITHDRAWALS/ BALANCE
NAME IN 2006 ($) IN 2006 ($) IN 2006 ($) DISTRIBUTIONS ($) AT 2006 ($)
-------------------------------------------------------------------------------------------------------------
SIDDHARTH N. MEHTA............ 0 $228,077 $203,181 0 $2,063,650
Chairman &
Chief Executive Officer
BEVERLEY A. SIBBLIES.......... 0 $ 38,500 $ 2,375 0 $ 41,507
Senior Vice President - Chief
Financial Officer
THOMAS M. DETELICH............ 0 $136,000 $257,694 $193,424(3) $3,050,292
Group Executive, Consumer and
Direct Lending
WALTER G. MENEZES............. 0 $105,538 $150,742 0 $1,723,722
Group Executive, Card Services
KENNETH H. ROBIN.............. 0 $ 94,000 $ 55,238 0 $ 986,539
Senior Executive Officer,
General Counsel and Corporate
Secretary
---------------
(1) The NonQualified Deferred Compensation Plan is described under Savings and
Pension Plans on page 206. The executive officers have made contributions to
the plan, but elected not to make contributions in 2006.
(2) The Supplemental Tax Reduction Investment Plan (STRIP) is described under
Savings and Pension Plans on page 206. Company contributions are invested in
STRIP through a credit to a bookkeeping account, which deems such
contributions to be invested in equity or income mutual funds selected by
the participant. For this purpose, compensation includes amounts that would
be compensation but for the fact they were deferred under the terms of the
HSBC North America Non-Qualified Deferred Compensation Plan. Distributions
are made in a lump sum upon termination of employment.
(3) Amount represents a scheduled in-service withdrawal from the HSBC
Non-Qualified Deferred Compensation Plan.
209
POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE-IN-CONTROL
SIDDHARTH N. MEHTA
INVOLUNTARY VOLUNTARY
NOT FOR FOR GOOD
EXECUTIVE BENEFITS AND VOLUNTARY NORMAL CAUSE FOR CAUSE REASON
PAYMENTS UPON TERMINATION TERMINATION DISABILITY RETIREMENT TERMINATION TERMINATION TERMINATION DEATH
-----------------------------------------------------------------------------------------------------------------------------
CASH COMPENSATION
Base Salary................ - - - $ 1,250,000(1) - $ 1,250,000(1) -
Short Term Incentive....... - - - $ 2,343,750(1) - $ 2,343,750(1) -
LONG TERM INCENTIVE
Performance Shares(6)...... - $3,033,958(2) -- $ 3,033,958(2) - $ 3,033,958(2) $ 7,515,646(3)
Stock Options:
Unvested and Accelerated... - - - $ 446,145(4) - $ 446,145(4) $ 446,145(4)
Restricted Stock(6):
Unvested and Accelerated... - - - $10,789,790(5) - $10,789,790(5) $10,789,790(5)
BENEFITS AND PERKS
Healthcare................. - - - $ 28,336 - $ 28,336 -
Life Insurance............. - - - $ 1,800 - $ 1,800 -
Company Car and Driver..... - - - $ 13,750 - $ 13,750 -
Financial Planning......... - - - $ 20,000 - $ 20,000 -
Aircraft Usage............. - - - - - - -
Umbrella Liability......... - - - $ 3,700 - $ 3,700 -
CHANGE IN
EXECUTIVE BENEFITS AND CONTROL
PAYMENTS UPON TERMINATION TERMINATION
---------------------------
CASH COMPENSATION
Base Salary................ -
Short Term Incentive....... -
LONG TERM INCENTIVE
Performance Shares(6)...... $3,033,958(2)
Stock Options:
Unvested and Accelerated... -
Restricted Stock(6):
Unvested and Accelerated... -
BENEFITS AND PERKS
Healthcare................. -
Life Insurance............. -
Company Car and Driver..... -
Financial Planning......... -
Aircraft Usage............. -
Umbrella Liability......... -
---------------
(1) Mr. Mehta has an employment agreement which stipulates that he will receive
his current salary and 75% of the average of his bonus in the years 2003,
2004 and 2005 from the date of termination through March 28, 2008. The
figures above assume a termination date of December 31, 2006.
(2) The figures above represent the pro-rata portion of the Performance Shares,
assuming "good leaver" status is granted by REMCO, that would vest three
years from the date of grant assuming a termination date of December 31,
2006 and the performance conditions being met on a 100% basis, and are
calculated using the closing price of HSBC ordinary shares and exchange rate
on December 29, 2006. For an explanation of the performance conditions
please refer to Footnote 2 of the Grants of Plan-Based Awards Table.
(3) The figure above represents a full vest of the Performance Shares that would
vest three years from the date of grant assuming a termination date of
December 31, 2006 and is calculated using the closing price of HSBC ordinary
shares and exchange rate on December 29, 2006.
(4) In the event of death, the figure represents accelerated vesting of 100% of
the outstanding, unvested stock options assuming the difference between the
strike price and the fair market value of HSBC ordinary shares on December
29, 2006. The amounts represent outstanding unvested stock options that
would continue to vest according to schedule, if REMCO approves such
continued vesting, if a termination was involuntary not for cause or
voluntary for good reason, and assumes the satisfaction of all applicable
performance conditions.
(5) The figures above represent a full vest of the outstanding restricted shares
assuming a termination date of December 31, 2006 and are calculated using
the closing price of HSBC ordinary shares and exchange rate on December 29,
2006.
(6) Does not include additional awards accumulated through December 31, 2006,
the assumed date of termination.
210
BEVERLEY SIBBLIES
INVOLUNTARY VOLUNTARY FOR
EXECUTIVE BENEFITS AND VOLUNTARY NORMAL NOT FOR CAUSE FOR CAUSE GOOD REASON
PAYMENTS UPON TERMINATION TERMINATION DISABILITY RETIREMENT TERMINATION TERMINATION TERMINATION
-------------------------------------------------------------------------------------------------------------------------
CASH COMPENSATION
Base Salary........................ - - - $187,500(1) - -
Short Term Incentive............... - - - $562,500(1) - -
LONG TERM INCENTIVE
Restricted Stock:(4)
Unvested and Accelerated........... - $450,279(2) - $450,279(2) - $450,279(2)
CHANGE IN
EXECUTIVE BENEFITS AND CONTROL
PAYMENTS UPON TERMINATION DEATH TERMINATION
-----------------------------------
CASH COMPENSATION
Base Salary........................ - -
Short Term Incentive............... - -
LONG TERM INCENTIVE
Restricted Stock:(4)
Unvested and Accelerated........... $1,083,755(3) $450,279(2)
---------------
(1) Under the terms of the HSBC Severance Policy, Ms. Sibblies will receive 26
weeks of her current salary upon separation from the company and a pro-rata
amount of her earned bonus. The figures above represent the bonus payment at
maximum assuming a termination date of December 31, 2006.
(2) The figures above represent accelerated vesting of a pro-rata portion of the
outstanding restricted shares assuming a termination date of December 31,
2006 and are calculated using the closing price of HSBC ordinary shares and
exchange rate on December 29, 2006.
(3) The figure above represents a full vest of the outstanding restricted shares
assuming a termination date of December 31, 2006 and is calculated using the
closing price of HSBC ordinary shares and exchange rate on December 29,
2006.
(4) Does not include additional awards accumulated through December 31, 2006,
the assumed date of termination.
THOMAS DETELICH
EARLY INVOLUNTARY VOLUNTARY FOR
EXECUTIVE BENEFITS AND VOLUNTARY RETIREMENT/ NORMAL NOT FOR CAUSE FOR CAUSE GOOD REASON
PAYMENTS UPON TERMINATION TERMINATION DISABILITY RETIREMENT TERMINATION TERMINATION TERMINATION
-----------------------------------------------------------------------------------------------------------------------
CASH COMPENSATION
Base Salary..................... - - - $ 650,000(1) - -
Short Term Incentive............ - - - $2,000,000(1) - -
LONG TERM INCENTIVE
Performance Shares(6)........... - $1,470,286(2) - $1,470,286(2) - $1,470,286(2)
Stock Options:
Unvested and Accelerated........ - - - $ 222,583(4) - $ 222,583(4)
Restricted Stock:(6)
Unvested and Accelerated........ - - - $6,254,257(5) - $6,254,257(5)
CHANGE IN
EXECUTIVE BENEFITS AND CONTROL
PAYMENTS UPON TERMINATION DEATH TERMINATION
--------------------------------
CASH COMPENSATION
Base Salary..................... - -
Short Term Incentive............ - -
LONG TERM INCENTIVE
Performance Shares(6)........... $3,571,038(3) $1,470,286(2)
Stock Options:
Unvested and Accelerated........ $ 222,583(4)
Restricted Stock:(6)
Unvested and Accelerated........ $6,254,257(5) -
---------------
(1) Under the terms of the HSBC Severance Policy, Mr. Detelich will receive 52
weeks of his current salary upon separation from the company and a pro-rata
amount of his earned bonus. The figures above represent the bonus payment
earned in 2006 assuming a termination date of December 31, 2006.
(2) The figures above represent the pro-rata portion of the Performance Shares,
assuming "good leaver" status is granted by REMCO, that would vest three
years from the date of grant assuming a termination date of December 31,
2006 and the performance conditions being met on a 100% basis, and are
calculated using the closing price of HSBC ordinary shares and exchange rate
on December 29, 2006. For an explanation of the performance conditions
please refer to Footnote 2 of the Grants of Plan-Based Awards Table.
(3) The figure above represents a full vest of the Performance Shares that would
vest three years from the date of grant assuming a termination date of
December 31, 2006 and is calculated using the closing price of HSBC ordinary
shares and exchange rate on December 29, 2006.
(4) In the event of death, the figure represents accelerated vesting of 100% of
the outstanding, unvested stock options assuming the difference between the
strike price and the fair market value of HSBC ordinary shares on December
29, 2006. The amounts represent outstanding unvested stock options that
would continue to vest according to schedule, if REMCO approves such
continued vesting, if a termination was involuntary not for cause or
voluntary for good reason, and assumes the satisfaction of all applicable
performance conditions.
(5) The figures above represent a full vest of the outstanding restricted shares
assuming a termination date of December 31, 2006 and assuming "good leaver"
status is granted by REMCO. The figures are calculated using the closing
price of HSBC ordinary shares and exchange rate on December 29, 2006.
(6) Does not include additional awards accumulated through December 31, 2006,
the assumed date of termination.
211
WALTER G. MENEZES
EARLY INVOLUNTARY VOLUNTARY GOOD
EXECUTIVE BENEFITS AND PAYMENTS VOLUNTARY RETIREMENT/ NORMAL NOT FOR CAUSE FOR CAUSE REASON
UPON TERMINATION TERMINATION DISABILITY RETIREMENT TERMINATION TERMINATION TERMINATION
-----------------------------------------------------------------------------------------------------------------------
CASH COMPENSATION
Base Salary................... - - - $ 450,000(1) - -
Short Term Incentive.......... - - - $2,000,000(1) - -
LONG TERM INCENTIVE
Performance Shares(9)......... - $1,470,286(2) - $1,470,286(2) - $1,470,286(2)()
Stock Options:
Unvested and Accelerated...... - - - $ 314,479(4) - $ 314,479(4)
Restricted Stock:(9)
Unvested and Accelerated...... - - - $4,488,918(5) - $4,488,918(5)
BENEFITS AND PERKS
Incremental Retirement
Benefit...................... - - - - - -
Post Retirement Health Care... - - - - - -
Healthcare.................... - - - - - -
Life Insurance................ - - - - - -
CHANGE IN
EXECUTIVE BENEFITS AND PAYMENTS CONTROL
UPON TERMINATION DEATH TERMINATION
-------------------------------
CASH COMPENSATION
Base Salary................... - $ 975,000(1)
Short Term Incentive.......... - $3,250,000(1)
LONG TERM INCENTIVE
Performance Shares(9)......... $3,571,038(3)() $1,470,286(2)
Stock Options:
Unvested and Accelerated...... $ 314,479(4) -
Restricted Stock:(9)
Unvested and Accelerated...... $4,488,918(5) -
BENEFITS AND PERKS
Incremental Retirement
Benefit...................... - $1,572,547(6)
Post Retirement Health Care... - -
Healthcare.................... - $ 17,046(7)
Life Insurance................ - $ 157,680(8)
---------------
(1) See description of Mr. Menezes' Employment Protection Agreement on page 196.
Under the terms of the HSBC Severance Policy, Mr. Menezes will receive 36
weeks of his current salary upon separation from the company and a pro-rata
amount of his earned bonus. The figures above represent the bonus payment
earned in 2006 assuming a termination date of December 31, 2006.
(2) The figures above represent the pro-rata portion of the Performance Shares,
assuming "good leaver" status is granted by REMCO, that would vest three
years from the date of grant assuming a termination date of December 31,
2006 and the performance conditions being met on a 100% basis, and are
calculated using the closing price of HSBC ordinary shares and exchange rate
on December 29, 2006. For an explanation of the performance conditions
please refer to Footnote 2 of the Grants of Plan-Based Awards Table.
(3) The figure above represents a full vest of the Performance Shares that would
vest three years from the date of grant assuming a termination date of
December 31, 2006 and is calculated using the closing price of HSBC ordinary
shares and exchange rate on December 29, 2006.
(4) In the event of death, the figure above represents accelerated vesting of
100% of the outstanding, unvested stock options assuming the difference
between the strike price and the fair market value of HSBC ordinary shares
on December 29, 2006. The amounts represent outstanding unvested stock
options that would continue to vest according to schedule, if REMCO approves
such continued vesting, if a termination was involuntary not for cause or
voluntary for good reason, and assumes the satisfaction of all applicable
performance conditions.
(5) The figures above represent a full vest of the outstanding restricted shares
assuming a termination date of December 31, 2006 and assuming "good leaver"
status is granted by REMCO. The figures are calculated using the closing
price of HSBC ordinary shares and exchange rate on December 29, 2006.
(6) Mr. Menezes has an employment agreement providing an additional 18 months of
service and pay toward his retirement benefit. He would be entitled to an
additional $10,733 per month if a termination due to a change in control
occurred on December 31, 2006. The present value of this benefit was
determined by HSBC Finance Corporation's actuaries to be $1,572,547.
(7) Mr. Menezes has an employment agreement providing an additional 18 months of
healthcare coverage for himself and his family with a total value of $13,256
if a termination due to a change in control occurred on December 31, 2006.
The value of this healthcare is calculated based on the medical plan's COBRA
rates. In addition, Mr. Menezes' agreement provides for annual physicals at
the company's expense throughout the 18 month period. The value of two
physicals is $3,790. This value is based on a rate negotiated through HSBC
Finance Corporation's executive physical program.
(8) Mr. Menezes' employment agreement provides for $2 million of life insurance
coverage for himself for 18 months, if a termination due to a change in
control occurred on December 31, 2006, with a total value of $157,680. This
value is based on the cost to convert the company-provided group life
insurance to an individual policy for 18 months.
(9) Does not include additional awards accumulated through December 31, 2006,
the assumed date of termination.
212
KENNETH H. ROBIN
EARLY INVOLUNTARY VOLUNTARY FOR
EXECUTIVE BENEFITS AND VOLUNTARY RETIREMENT/ NORMAL NOT FOR CAUSE FOR CAUSE GOOD REASON
PAYMENT UPON TERMINATION TERMINATION DISABILITY RETIREMENT TERMINATION TERMINATION TERMINATION
-----------------------------------------------------------------------------------------------------------------------
CASH COMPENSATION
Base Salary..................... - - - $ 392,308(1) - -
Short Term Incentive............ - - - $1,000,000(1) - -
LONG TERM INCENTIVE
Performance Shares(6)........... - $1,132,472(2) - $1,132,472(2) - $1,132,472(2)
Stock Options:
Unvested and Accelerated........ - - - $ 222,583(4) - $ 222,583(4)
Restricted Stock(6):
Unvested and Accelerated........ - - - $1,148,800(5) - $1,148,800(5)
CHANGE IN
EXECUTIVE BENEFITS AND CONTROL
PAYMENT UPON TERMINATION DEATH TERMINATION
--------------------------------
CASH COMPENSATION
Base Salary..................... - -
Short Term Incentive............ - -
LONG TERM INCENTIVE
Performance Shares(6)........... $2,683,802(3) $1,132,472(2)
Stock Options:
Unvested and Accelerated........ $ 222,583(4) -
Restricted Stock(6):
Unvested and Accelerated........ $1,148,800(5) -
---------------
(1) Under the terms of the HSBC Severance Policy, Mr. Robin will receive 34
weeks of his current salary upon separation from the company and a pro-rata
amount of his earned bonus. The figures above represent the bonus payment
earned in 2006 assuming a termination date of December 31, 2006
(2) The figures above represent the pro-rata portion of the Performance Shares,
assuming "good leaver" status is granted by REMCO, that would vest three
years from the date of grant assuming a termination date of December 31,
2006 and the performance conditions being met on a 100% basis and are
calculated using the closing price of HSBC ordinary shares and exchange rate
on December 29, 2006. For an explanation of the performance conditions
please refer to Footnote 2 of the Grants of Plan-Based Awards Table.
(3)The figure above represents a full vest of the Performance Shares that would
vest three years from the date of grant assuming a termination date of
December 31, 2006 and is calculated using the closing price of HSBC ordinary
shares and exchange rate on December 29, 2006.
(4)In the event of death, the figure represents accelerated vesting of 100% of
the outstanding, unvested stock options assuming the difference between the
strike price and the fair market value of HSBC ordinary shares on December
29, 2006. The amounts represent outstanding unvested stock options that would
continue to vest according to schedule, if REMCO approves such continued
vesting, if a termination was involuntary not for cause or voluntary for good
reason, and assumes the satisfaction of all applicable performance
conditions.
(5)The figures above represent a full vest of the outstanding restricted shares
assuming a termination date of December 31, 2006 and assuming "good leaver"
status is granted by REMCO. The figures are calculated using the closing
price of HSBC ordinary shares and exchange rate on December 29, 2006.
(6)Does not include additional awards accumulated through December 31, 2006, the
assumed date of termination.
213
DIRECTOR COMPENSATION
The following table and narrative text discusses the compensation awarded to,
earned by or paid to our Directors in 2006.
DIRECTOR COMPENSATION
CHANGE IN
PENSION VALUE
AND NONQUALIFIED
FEES EARNED STOCK OPTION DEFERRED ALL OTHER
OR PAID IN AWARDS AWARDS COMPENSATION COMPENSATION TOTAL
NAME CASH(1) ($)(2) ($)(3) EARNINGS ($)(4) ($)
-------------------------------------------------------------------------------------------------------
William R. P. Dalton....... $170,000 -- -- -- 0 $170,000
Gary G. Dillon............. $185,000 -- -- -- $ 1,850 $186,850
J. Dudley Fishburn......... $170,000 -- -- -- 0 $170,000
Cyrus F. Freidheim, Jr. ... $232,000 -- -- -- $45,819 $277,819
Robert K. Herdman.......... $195,000 -- -- -- 0 $195,000
Alan W. Jebson(5).......... -- -- -- -- -- --
George A. Lorch............ $185,000 -- -- -- $ 2,570 $187,570
Siddharth N. Mehta(5)...... -- -- -- -- -- --
Larree M. Renda............ $200,000 -- -- -- $ 1,850 $201,850
---------------
(1) In 2006, the non-management Directors of HSBC Finance Corporation received
an annual cash retainer of $170,000 (with the exception of Mr. Freidheim,
who as Chair of the Executive Committee receives a retainer of $182,000). In
addition to the Board retainer, Mr. Dillon received an additional $15,000
for his membership in the Audit Committee, Mr. Lorch received an additional
$15,000 as Chair of the Compensation Committee, Ms. Renda received an
additional $15,000 as Chair of the Nominating & Governance Committee, and an
additional $15,000 for her membership on the Audit Committee, Mr. Herdman
received an additional $25,000 as Chair of the Audit Committee, and Mr.
Freidheim received an additional $50,000 as the Lead Director and Chair of
the Executive Committee. HSBC Finance Corporation does not pay additional
compensation for committee membership or meeting attendance fees to its
Directors. Directors who are employees of HSBC Finance Corporation or any of
its affiliates do not receive additional compensation related to their Board
service. In February 2006, the Board reviewed its directors' compensation
scheme relative to other same sized financial and professional service
organizations and determined to make no changes to the current compensation
structure.
Directors have the ability to defer up to 100% of their annual retainers
and/or fees into the HSBC-North America Directors Non-Qualified Deferred
Compensation Plan. Under this plan, pre-tax dollars may be deferred with the
choice of receiving payouts while still serving HSBC Finance Corporation
according to a schedule established by the Director at the time of deferral
or a distribution after leaving the Board in either lump sum, quarterly or
annual installments. For 2006, Mr. Dillon deferred 100% of his retainer and
Audit Committee fees.
(2) HSBC Finance Corporation does not grant stock awards to its non-management
directors nor do any portion of employee directors stock awards reflect
services related to the Board. Prior to the merger with HSBC, non-management
Directors could elect to receive all or a portion of their cash compensation
in shares of common stock of Household International, Inc., defer it under
the Deferred Fee Plan for Directors or purchase options to acquire common
stock (as reflected in Footnote 3 below). Under the Deferred Fee Plan,
Directors were permitted to invest their deferred compensation in either
units of phantom shares of the common stock of HSBC Finance Corporation
(then called Household International, Inc.), with dividends credited toward
additional stock units, or cash, with interest credited at a market rate set
under the plan. Prior to 1995, HSBC Finance Corporation offered a Directors'
Retirement Income Plan where the present value of each Director's accrued
benefit was deposited into the Deferred Phantom Stock Plan for Directors.
Under the Deferred Phantom Stock Plan, Directors with less than ten years of
service received 750 phantom shares of common stock of Household
International, Inc. annually during the first ten years of service as a
Director. In January 1997, the Board eliminated this and all future Director
retirement benefits. All payouts to Directors earned under the Deferred
Phantom Stock Plan will be made only when a Director leaves the Board due to
death, retirement or resignation and will be paid in HSBC ordinary shares
either in a lump sum or in installments as selected by the Director.
Following the acquisition, all rights to receive common stock of Household
International, Inc. under both plans described above were converted into
rights to receive HSBC ordinary shares. In May 2004, when the plans were
rolled into a non-qualified deferred compensation plan for Directors, those
rights were revised into rights to receive American Depository Shares in
HSBC ordinary shares, each of which represents five ordinary shares. No new
shares may be issued under the plans. As of December 31, 2006, 14,452
American Depository Shares were held in the deferred compensation plan
account for Directors. Specifically, Messrs. Dillon, Fishburn, and Lorch
held 7,578, 810, and 6,038 American Depository Shares, respectively, and Ms.
Renda held 26 American Depository Shares.
214
(3) HSBC Finance Corporation does not grant stock option awards to its
non-management directors. As referenced in Footnote 2 above, as of December
31, 2006, 326,351 Stock Options were outstanding which were granted pursuant
to the historical Directors Deferred Fee Plan. Specifically, Messrs. Dillon,
Fishburn, and Lorch held options to purchase 69,550, 90,950 and 125,726 HSBC
ordinary shares respectively, and Ms. Renda held options to purchase 40,125
HSBC ordinary shares.
(4) Components of All Other Compensation are disclosed in the aggregate. All
Other Compensation includes such items as personal use of aircraft and a
corporate apartment. The following itemizes benefits to our Directors in
2006: Personal use of Corporate Apartment by Mr. Lorch was $720 in 2006.
None of our directors had personal use of the corporate aircraft or
limousine for 2006. All Other Compensation for Mr. Freidheim includes
$43,969 in quarterly scheduled deferred compensation disbursements. We
provide each Director with $250,000 of accidental death and dismemberment
insurance and a $10,000,000 personal excess liability insurance policy for
which the company paid premium is $1,850 per annum for each participating
director. Under HSBC Finance Corporation's Matching Gift Program, for all
directors elected prior to 2005, we match charitable gifts to qualified
organizations (subject to a maximum of $10,000 per year), with a double
match for the first $500 donated to higher education institutions (both
public and private) and eligible non-profit organizations which promote
neighborhood revitalization or economic development for low and moderate
income populations. Each current independent Director may ask us to
contribute up to $10,000 annually to charities of the Director's choice
which qualify under our philanthropic program.
(5) Employee Directors do not derive any compensation from their Board service.
215
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
--------------------------------------------------------------------------------
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
HSBC Finance Corporation's common stock is 100% owned by HSBC Investments (North
America) Inc. ("HINO"). HINO is an indirect wholly owned subsidiary of HSBC.
SECURITY OWNERSHIP BY MANAGEMENT
--------------------------------------------------------------------------------
The following table lists the beneficial ownership, as of January 31, 2007, of
HSBC ordinary shares or interests in ordinary shares and Series B Preferred
Stock of HSBC Finance Corporation by each director and the executive officers
named in the Summary Compensation Table on page 198, individually, and the
directors and executive officers as a group. Each of the individuals listed
below and all directors and executive officers as a group own less than 1% of
the ordinary shares of HSBC and the Series B Preferred Stock of HSBC Finance
Corporation.
HSBC SHARES HSBC
NUMBER OF THAT MAY BE RESTRICTED SERIES B
SHARES ACQUIRED WITHIN SHARES PREFERRED OF
BENEFICIALLY 60 DAYS BY RELEASED NUMBER OF TOTAL HSBC HSBC
OWNED OF HSBC EXERCISE OF WITHIN ORDINARY SHARE ORDINARY FINANCE
HOLDINGS PLC(1)(2) OPTIONS(4) 60 DAYS(5) EQUIVALENTS(6) SHARES CORPORATION
------------------------------------------------------------------------------------------------------------------------
DIRECTORS
William R. P. Dalton.... 106,679 - - - 106,679 -
Gary G. Dillon.......... 218,050 69,550 - 37,890 325,490 -
J. Dudley Fishburn...... 15,678 90,950 - 4,050 110,678 -
Douglas J. Flint........ 72,622 - - - 72,622 -
Cyrus F. Freidheim,
Jr.................... - - - - - -
Robert K. Herdman....... - - - - - -
George A. Lorch......... 13,605 125,726 - 30,190 169,521 -
Siddharth N. Mehta...... 268,976 3,269,900 107,912 61,120 3,707,908 -
Larree M. Renda......... 8,250 40,125 - 130 48,505 50(3)
Michael R. P. Smith..... 145,029 - 37,873(1) - 182,902 -
NAMED EXECUTIVE OFFICERS
Beverley A. Sibblies.... - - - - - -
Thomas M. Detelich...... - 694,688 80,934 4,109 779,731 -
Walter G. Menezes....... 128,108 516,425 22,291 - 666,824 -
Kenneth H. Robin........ 194,015 821,750 - 68,129 1,083,894 -
ALL DIRECTORS AND
EXECUTIVE OFFICERS AS
A GROUP............... 1,449,458(7) 7,112,464 315,469 285,582 9,162,973 50
---------------
(1) Directors and executive officers have sole voting and investment power over
the shares listed above, except that the number of ordinary shares held by
spouses, children and charitable or family foundations in which voting and
investment power is shared (or presumed to be shared) is as follows: Mr.
Dalton, 56,019; Mr. Lorch, 13,605; Ms. Renda, 8,250; Mr. Smith, 182,902; Mr.
Robin, 1,070; other executive officers, 11,507; and Directors and executive
officers as a group, 273,353.
(2) Some of the shares included in the table above were held in American
Depository Shares, each of which represents five HSBC ordinary shares.
(3) Represents 2000 Depositary Shares, each representing one-fortieth of a share
of 6.36% Non-Cumulative Preferred Stock, Series B.
(4) Represents the number of ordinary shares that may be acquired by HSBC
Finance Corporation's Directors and executive officers through April 1, 2007
pursuant to the exercise of stock options.
(5) Represents the number of ordinary shares that may be acquired by HSBC
Finance Corporation's Directors and executive officers through April 1, 2007
pursuant to the satisfaction of certain conditions.
(6) Represents the number of ordinary share equivalents owned by executive
officers under HSBC-North America (U.S.) Tax Reduction Investment Plan
(TRIP) and HSBC North America Employee Non-Qualified Deferred Compensation
Plan and by Directors under HSBC North America Directors Non-Qualified
Deferred Compensation Plan. Some of the shares included in the table above
were held in American Depository Shares, each of which represents five HSBC
ordinary shares.
(7) Of the amount of shares reported, 15,608 shares are pledged as security.
216
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE.
--------------------------------------------------------------------------------
TRANSACTIONS WITH RELATED PERSONS
During our fiscal year ended December 31, 2006, HSBC Finance Corporation was not
a participant in any transaction, and there is currently no proposed
transaction, in which the amount involved exceeded or will exceed $120,000, and
in which a director or an executive officer, or a member of the immediate family
of a director or an executive officer, had or will have a direct or indirect
material interest, other than the agreements with Messrs. Mehta and Menezes
described in Item 11. Executive Compensation - Compensation Discussion and
Analysis - Compensation of Officers Reported in the Summary Compensation Table.
HSBC Finance Corporation maintains a written Policy for the Review, Approval or
Ratification of Transactions with Related Persons which provides that any
"Transaction with a Related Person" must be reviewed and approved or ratified in
accordance with specified procedures. The term "Transaction with a Related
Person" includes any transaction, arrangement or relationship, or series of
similar transactions, arrangements or relationships, in which (1) the aggregate
dollar amount involved will or may be expected to exceed $120,000 in any
calendar year, (2) HSBC Finance Corporation or any of its subsidiaries is, or is
proposed to be, a participant, and (3) a director or an executive officer, or a
member of the immediate family of a director or an executive officer, has or
will have a direct or indirect material interest (other than solely as a result
of being a director or a less than 10 percent beneficial owner of another
entity). The following are specifically excluded from the definition of
Transaction with a Related Person:
- compensation paid to directors and executive officers reportable under
rules and regulations promulgated by the Securities and Exchange
Commission;
- transactions with other companies if the only relationship of the
director, executive officer or family member to the other company is as
an employee (other than an executive officer), director or beneficial
owner of less than 10 percent of such other company's equity securities;
- charitable contributions, grants or endowments by HSBC Finance
Corporation or any of its subsidiaries to charitable organizations,
foundations or universities if the only relationship of the director,
executive officer or family member to the organization, foundation or
university is as an employee (other than an executive officer) or a
director;
- transactions where the interest of the director, executive officer or
family member arises solely from the ownership of HSBC Finance
Corporation's equity securities and all holders of such securities
received or will receive the same benefit on a pro rata basis;
- transactions where the rates or charges involved are determined by
competitive bids; and
- transactions involving services as a bank depositary of funds, transfer
agent, registrar, trustee under a trust indenture or similar services.
The policy requires each director and executive officer to notify the Office of
the General Counsel in writing of any Transaction with a Related Person in which
the director, executive officer or an immediate family member has or will have
an interest and to provide specified details of the transaction. The Office of
the General Counsel, through the Corporate Secretary, will deliver a copy of the
notice to the Chair of the Nominating and Governance Committee of the Board of
Directors. The Nominating and Governance Committee will review the facts of each
proposed Transaction with a Related Person at each regularly scheduled committee
meeting and approve, ratify or disapprove the transaction.
The vote of a majority of disinterested members of the Nominating and Governance
Committee is required for the approval or ratification of any Transaction with a
Related Person. The Nominating and Governance Committee may approve or ratify a
transaction if the committee determines, in its business judgment, based on the
review of all available information, that the transaction is fair and reasonable
to, and consistent with the best interests of, HSBC Finance Corporation and its
subsidiaries. In making this determination, the Nominating and Governance
Committee will consider, among other things, (i) the business purpose of the
transaction, (ii) whether the transaction is entered into on an arms-length
basis and on terms no less favorable than terms generally available to an
unaffiliated third-party under the same or similar circumstances, (iii) whether
the interest of the director, executive officer or family member in the
transaction is material and (iv) whether the transaction would violate any
provision of the HSBC North America Holdings Inc.
217
Statement of Business Principles and Code of Ethics, the HSBC Finance
Corporation Code of Ethics for Senior Financial Officers or the HSBC Finance
Corporation Corporate Governance Standards, as applicable.
In any case where the Nominating and Governance Committee determines not to
approve or ratify a transaction, the matter will be referred to the Office of
the General Counsel for review and consultation regarding the appropriate
disposition of such transaction including, but not limited to, termination of
the transaction, rescission of the transaction or modification of the
transaction in a manner that would permit it to be ratified and approved.
DIRECTOR INDEPENDENCE
The HSBC Finance Corporation Corporate Governance Standards, together with the
charters of committees of the Board of Directors, provide the framework for our
corporate governance. Director independence is defined in the HSBC Finance
Corporation Corporate Governance Standards which are based upon the rules of the
New York Stock Exchange. The HSBC Finance Corporation Corporate Governance
Standards are available on our website at www.hsbcusa.com or upon written
request made to HSBC Finance Corporation, 2700 Sanders Road, Prospect Heights,
Illinois 60070, Attention: Corporate Secretary.
According to the HSBC Finance Corporation Corporate Governance Standards, a
majority of the members of the Board of Directors must be independent. The
composition requirement for each committee of the Board of Directors is as
follows:
COMMITTEE INDEPENDENCE/MEMBER REQUIREMENTS
------------------------------------------------------------------------------------------------------
Audit Committee.................................... Chair and all voting members
Compensation Committee............................. Chair and a majority of members
Nominating and Governance Committee................ Chair and a majority of members
Executive Committee................................ 100% independent directors and the Chairman and
Chief Executive Officer
Messrs. Dillon, Freidheim, Herdman, Lorch and Ms. Renda are considered to be
independent directors. Mr. Dalton served as Executive Director of HSBC until May
2004, Mr. Fishburn serves as chairman of the board of HFC Bank Ltd. and is a
member of the board of HSBC Bank plc, Mr. Flint serves as Group Finance Director
at HSBC and Mr. Smith is the President and Chief Executive Officer of the
Hongkong and Shanghai Banking Corporation. Because of the positions held by
Messrs. Dalton, Fishburn, Flint and Smith, they are not considered to be
independent directors.
See Item 10. Directors, Executive Officers and Corporate Governance - Corporate
Governance - Board of Directors - Committees and Charters for more information
about our Board of Directors and its committees.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
--------------------------------------------------------------------------------
AUDIT FEES. The aggregate amount billed by our principal accountant, KPMG LLP,
for audit services performed during the fiscal years ended December 31, 2006 and
2005 was $7,278,000 and $6,785,000, respectively. Audit services include the
auditing of financial statements, quarterly reviews, statutory audits, and the
preparation of comfort letters, consents and review of registration statements.
AUDIT RELATED FEES. The aggregate amount billed by KPMG LLP in connection with
audit related services performed during the fiscal years ended December 31, 2006
and 2005 was $1,453,000 and $1,272,000, respectively. Audit related services
include employee benefit plan audits, and audit or attestation services not
required by statute or regulation.
TAX FEES. Total fees billed by KPMG LLP for tax related services for the fiscal
years ended December 31, 2006 and 2005 were $127,000 and $658,000, respectively.
These services include tax related research, general tax services in connection
with transactions and legislation and tax services for review of Federal and
state tax accounts for possible overassessment of interest and/or penalties.
218
ALL OTHER. Other than those fees described above, there were no other fees
billed for services performed by KPMG LLP during the fiscal years ended December
31, 2006 and December 31, 2005.
All of the fees described above were approved by HSBC Finance Corporation's
audit committee.
AUDIT COMMITTEE PRE-APPROVAL POLICIES AND PROCEDURES. HSBC Finance Corporation's
audit committee pre-approves the audit and non-audit services performed by KPMG
LLP, our principal accountants, in order to assure that the provision of such
services does not impair KPMG LLP's independence. Unless a type of service to be
provided by KPMG LLP has received general pre-approval, it will require specific
pre-approval by the audit committee. In addition, any proposed services
exceeding pre-approval cost levels will require specific pre-approval by the
audit committee.
The term of any pre-approval is 12 months from the date of pre-approval, unless
the audit committee specifically provides for a different period. The audit
committee will periodically revise the list of pre-approved services, based on
subsequent determinations, and has delegated pre-approval authority to the Chair
of the audit committee. In the event the Chair of the audit committee exercises
such delegated authority, he will report such pre-approval decisions to the
audit committee at its next scheduled meeting. The audit committee does not
delegate its responsibilities to pre-approve services performed by the
independent auditor to management.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
--------------------------------------------------------------------------------
(a)(1) Financial Statements.
The consolidated financial statements listed below, together with an opinion of
KPMG LLP dated March 6, 2006 with respect thereto, are included in this Form
10-K pursuant to Item 8. Financial Statements and Supplementary Data of this
Form 10-K.
HSBC FINANCE CORPORATION AND SUBSIDIARIES:
Report of Independent Registered Public Accounting Firm
Consolidated Statement of Income
Consolidated Balance Sheet
Consolidated Statement of Cash Flows
Consolidated Statement of Changes in Shareholder's(s') Equity
Notes to Consolidated Financial Statements
Selected Quarterly Financial Data (Unaudited)
(a)(2) Not applicable
(a)(3) Exhibits.
3(i) Amended and Restated Certificate of Incorporation of HSBC
Finance Corporation effective as of December 15, 2004, as
amended (incorporated by reference to Exhibit 3.1 of HSBC
Finance Corporation's Current Report on Form 8-K filed June
22, 2005 and Exhibit 3.1(b) of HSBC Finance Corporation's
Current Report on Form 8-K filed December 19, 2005).
3(ii) Bylaws of HSBC Finance Corporation, as amended December 14,
2006.
4.1 Amended and Restated Standard Multiple-Series Indenture
Provisions for Senior Debt Securities of HSBC Finance
Corporation dated as of December 15, 2004 (incorporated by
reference to Exhibit 4.1 of Amendment No. 1 to HSBC Finance
Corporation's Registration Statements on Form S-3 Nos.
333-120494, 333-120495 and 333-120496 filed December 16,
2004).
219
4.2* Amended and Restated Indenture for Senior Debt Securities
dated as of December 15, 2004 between HSBC Finance
Corporation and JPMorgan Chase Bank, N.A., as Trustee
(incorporated by reference to Exhibit 4.2 of Amendment No. 1
to HSBC Finance Corporation's Registration Statements on
Form S-3 Nos. 333-120495 and 333-120496 filed December 16,
2004).
4.3 The principal amount of debt outstanding under each other
instrument defining the rights of Holders of our long-term
senior and senior subordinated debt does not exceed 10
percent of our total assets. HSBC Finance Corporation agrees
to furnish to the Securities and Exchange Commission, upon
request, a copy of each instrument defining the rights of
holders of our long-term senior and senior subordinated
debt.
12 Statement of Computation of Ratio of Earnings to Fixed
Charges and to Combined Fixed Charges and Preferred Stock
Dividends.
14 Code of Ethics for Senior Financial Officers (incorporated
by reference to Exhibit 14 of HSBC Finance Corporation's
Annual Report on Form 10-K for the year ended December 31,
2004 filed February 28, 2005).
21 Subsidiaries of HSBC Finance Corporation.
23 Consent of KPMG LLP, Independent Registered Public
Accounting Firm.
24 Power of Attorney (included on page 220 of this Form 10-K).
31 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
99.1 Ratings of HSBC Finance Corporation and its significant
subsidiaries.
99.2 Explanation of Differences between U.K. GAAP and IFRSs, an
excerpt from Footnote 46, "Transitions to IFRSs," contained
in HSBC Holdings Annual Report on Form 20-F for the year
ended December 31, 2005.
Upon receiving a written request, we will furnish copies of the exhibits
referred to above free of charge. Requests should be made to HSBC Finance
Corporation, 2700 Sanders Road, Prospect Heights, Illinois 60070, Attention:
Corporate Secretary.
---------------
* Substantially identical indentures exist with U.S. Bank National Association,
BNY Midwest Trust Company and JPMorgan Trust Company, National Association.
220
SIGNATURES
--------------------------------------------------------------------------------
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, HSBC Finance Corporation has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized on this, the 5th day
of March, 2007.
HSBC FINANCE CORPORATION
By: /s/ Brendan P. McDonagh
------------------------------------
Brendan P. McDonagh
Chief Executive Officer
Each person whose signature appears below constitutes and appoints P.D. Schwartz
as his/her true and lawful attorney-in-fact and agent, with full power of
substitution and resubstitution, for him/her in his/her name, place and stead,
in any and all capacities, to sign and file, with the Securities and Exchange
Commission, this Form 10-K and any and all amendments and exhibits thereto, and
all documents in connection therewith, granting unto each such attorney-in-fact
and agent full power and authority to do and perform each and every act and
thing requisite and necessary to be done, as fully to all intents and purposes
as he/she might or could do in person, hereby ratifying and confirming all that
such attorney-in-fact and agent or their substitutes may lawfully do or cause to
be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of HSBC Finance
Corporation and in the capacities indicated on the 5th day of March, 2007.
SIGNATURE TITLE
--------------------------------------------------------------------------------------------------------
/s/ B.P. MCDONAGH Chief Executive Officer
------------------------------------------------------ (as Principal Executive Officer)
(B.P. McDonagh)
/s/ D.J. FLINT Chairman and Director
------------------------------------------------------
(D.J. Flint)
/s/ W. R. P. DALTON Director
------------------------------------------------------
(W. R. P. Dalton)
/s/ G. G. DILLON Director
------------------------------------------------------
(G. G. Dillon)
/s/ J. D. FISHBURN Director
------------------------------------------------------
(J. D. Fishburn)
/s/ C. F. FREIDHEIM, JR. Director
------------------------------------------------------
(C. F. Freidheim, Jr.)
/s/ R. K. HERDMAN Director
------------------------------------------------------
(R. K. Herdman)
/s/ G. A. LORCH Director
------------------------------------------------------
(G. A. Lorch)
221
SIGNATURE TITLE
--------------------------------------------------------------------------------------------------------
/s/ L. M. RENDA Director
------------------------------------------------------
(L. M. Renda)
/s/ M.R.P. SMITH Director
------------------------------------------------------
(M.R.P. Smith)
/s/ B. A. SIBBLIES Senior Vice President and Chief Financial
------------------------------------------------------ Officer
(B. A. Sibblies)
/s/ J. E. BINYON Vice President and Chief Accounting Officer
------------------------------------------------------
(J. E. Binyon)
222
EXHIBIT INDEX
--------------------------------------------------------------------------------
3(i) Amended and Restated Certificate of Incorporation of HSBC
Finance Corporation effective as of December 15, 2004, as
amended (incorporated by reference to Exhibit 3.1 of HSBC
Finance Corporation's Current Report on Form 8-K filed June
22, 2005 and Exhibit 3.1(b) of HSBC Finance Corporation's
Current Report on Form 8-K filed December 19, 2005).
3(ii) Bylaws of HSBC Finance Corporation, as amended December 14,
2006.
4.1 Amended and Restated Standard Multiple-Series Indenture
Provisions for Senior Debt Securities of HSBC Finance
Corporation dated as of December 15, 2004 (incorporated by
reference to Exhibit 4.1 of Amendment No. 1 to HSBC Finance
Corporation's Registration Statements on Form S-3 Nos.
333-120494, 333-120495 and 333-120496 filed December 16,
2004).
4.2* Amended and Restated Indenture for Senior Debt Securities
dated as of December 15, 2004 between HSBC Finance
Corporation and JPMorgan Chase Bank, N.A., as Trustee
(incorporated by reference to Exhibit 4.2 of Amendment No. 1
to HSBC Finance Corporation's Registration Statements on
Form S-3 Nos. 333-120495 and 333-120496 filed December 16,
2004).
4.3 The principal amount of debt outstanding under each other
instrument defining the rights of Holders of our long-term
senior and senior subordinated debt does not exceed 10
percent of our total assets. HSBC Finance Corporation agrees
to furnish to the Securities and Exchange Commission, upon
request, a copy of each instrument defining the rights of
holders of our long-term senior and senior subordinated
debt.
12 Statement of Computation of Ratio of Earnings to Fixed
Charges and to Combined Fixed Charges and Preferred Stock
Dividends.
14 Code of Ethics for Senior Financial Officers (incorporated
by reference to Exhibit 14 of HSBC Finance Corporation's
Annual Report on Form 10-K for the year ended December 31,
2004 filed February 28, 2005).
21 Subsidiaries of HSBC Finance Corporation.
23 Consent of KPMG LLP, Independent Registered Public
Accounting Firm.
24 Power of Attorney (included on page 220 of this Form 10-K).
31 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
99.1 Ratings of HSBC Finance Corporation and its significant
subsidiaries.
99.2 Explanation of Differences between U.K. GAAP and IFRSs, an
excerpt from Footnote 46, "Transition to IFRSs," contained
in HSBC Holdings Annual Report on Form 20-F for the year
ended December 31, 2005.
---------------
* Substantially identical indentures exist with U.S. Bank National Association,
BNY Midwest Trust Company and JPMorgan Trust Company, National Association.
EXHIBIT 3(II)
HSBC FINANCE CORPORATION
BYLAWS
---------------------
(AS IN EFFECT DECEMBER 14, 2006)
1
---------------------
BYLAWS OF
HSBC FINANCE CORPORATION
---------------------
ARTICLE I.
DEFINITIONS, PLACES OF MEETINGS.
SECTION 1. Definitions. When used herein, "Board" shall mean the Board of
Directors of this Corporation, and "Chairman" shall mean Chairman of the Board
of Directors.
SECTION 2. Places of Meetings of Stockholders and Directors. Unless the Board
shall fix another place for the holding of the meeting, meetings of stockholders
and of the Board shall be held at the Corporation's headquarters, Prospect
Heights, Cook County, Illinois, or at such other place specified by the person
or persons calling the meeting.
ARTICLE II.
STOCKHOLDERS MEETINGS.
SECTION 1. Annual Meeting of Stockholders. The annual meeting of stockholders
shall be held on such date and at such time as is fixed by the Board. Any
previously scheduled annual meeting of stockholders may be postponed by
resolution of the Board of Directors upon public announcement given prior to the
date previously scheduled for such annual meeting of stockholders.
SECTION 2. Special Meetings.
CALL. Special meetings of the stockholders may be called at any time by the
Chief Executive Officer or a majority of the Board of Directors. Any previously
scheduled special meeting of stockholders may be postponed by resolution of the
Board of Directors upon notice to the stockholders given prior to the date
previously scheduled for such special meeting of stockholders.
REQUISITES OF CALL. A call for a special meeting of stockholders shall be in
writing, filed with the Secretary, and shall specify the time and place of
holding such meeting and the purpose or purposes for which it is called.
SECTION 3. Notice of Meetings. Written notice of a meeting of stockholders
setting forth the place, date, and hour of the meeting and the purpose or
purposes for which the meeting is called shall be mailed not less than ten nor
more than sixty days before the date of the meeting to each stockholder entitled
to vote at the meeting.
SECTION 4. Quorum and Adjournments. At any meeting of stockholders, the
holders of a majority of all the outstanding shares entitled to vote, present in
person or by proxy, shall constitute a quorum for the transaction of business,
and a majority of such quorum shall prevail except as otherwise required by law,
the Certificate of Incorporation, or the bylaws.
If the stockholders necessary for a quorum shall fail to be present at the time
and place fixed for any meeting, the holders of a majority of the shares
entitled to vote who are present in person or by proxy may adjourn the meeting
from time to time, until a quorum is present, provided, however, that any
stockholders' meeting, annual or special, whether or not a quorum is present,
may be adjourned from time to time by the Chairman of the meeting. At any
adjourned meeting, any business may be transacted which might have been
transacted at the original meeting.
2
SECTION 5. Polls. The date and time of the opening and the closing of the
polls for each matter upon which the stockholders will vote at a meeting shall
be announced at the meeting. No ballot, proxies or votes, nor any revocations
thereof or changes thereto, shall be accepted by the inspectors after the
closing of the polls unless the Court of Chancery of the State of Delaware upon
application by a stockholder shall determine otherwise.
ARTICLE III.
BOARD OF DIRECTORS.
SECTION 1. General Powers. The business and affairs of this Corporation shall
be managed under the direction of the Board.
NUMBER. The number of directors shall be fixed from time to time by resolution
of the Board.
TENURE. The directors shall be elected at the annual meeting of stockholders,
except as provided in Section 5 of this Article III, and each director shall
hold office until his successor is elected and qualified or until his earlier
resignation or removal.
SECTION 2. Regular Meetings of the Board. Regular meetings of the Board shall
be held at such times and places as the Board may fix. No notice shall be
required.
SECTION 3. Special Meetings of the Board. Special meetings of the Board shall
be held whenever called by the Chairman of the Board or Chief Executive Officer
or any four or more directors. At least twenty-four hours written notice or oral
notice of each special meeting shall be given to each director. If mailed,
notice must be deposited in the United States mail at least seventy-two hours
before the meeting.
SECTION 4. Quorum. A majority of the members of the Board if the total number
is odd or one-half thereof if the total number is even shall constitute a quorum
for the transaction of business, but if at any meeting of the Board there is
less than a quorum the majority of those present may adjourn the meeting from
time to time until a quorum is present. At any such adjourned meeting, a quorum
being present, any business may be transacted which might have been transacted
at the original meeting.
Except as otherwise provided by law, the Certificate of Incorporation, or the
bylaws, all actions of the Board shall be decided by vote of a majority of those
present.
SECTION 5. Vacancies. When any vacancy occurs among the Board, the remaining
members of the Board may elect a director to fill each such vacancy at any
regular meeting of the Board, or at a special meeting called for that purpose. A
director elected to fill a vacancy shall serve for the unexpired portion of the
term of his predecessor in office.
SECTION 6. Removal of Directors. Any director may be removed either with or
without cause, at any time, by a vote of the holders of a majority of the shares
of the Corporation at any meeting of stockholders called for that purpose.
SECTION 7. Committees. The Board may, by resolution passed by a majority of
the entire Board, designate one or more committees of directors which to the
extent provided in the resolution shall have and may exercise powers and
authority of the Board in the management of the business and affairs of the
Corporation.
SECTION 8. Action of the Board. Except as otherwise provided by law, corporate
action to be taken by the Board shall mean such action at a meeting of the
Board. Any action required or permitted to be taken by the Board may be taken
without a meeting if all members of the Board consent in writing to a resolution
authorizing the action. The resolution and the written consents thereto shall be
filed with the minutes of the proceedings of the Board. Any one or more members
of the Board may participate in a meeting of the Board by means of a conference
telephone or similar communications equipment allowing all persons participating
in the meeting to hear each other at the same time. Participation by such means
shall constitute presence in person at a meeting.
3
ARTICLE IV.
OFFICERS.
SECTION 1. Officers. The Policy Making Officers of the Corporation shall be
appointed by the Board of Directors. The Board of Directors shall also appoint
General Officers to manage the day-to-day business functions of the Corporation.
Policy Making Officers shall have the authority to appoint other Assistant
Officers to assist in the ministerial aspects of their area of responsibilities.
The Policy Making Officers of the Corporation shall include the Chief Executive
Officer, the Chief Operating Officer (if any), the Chief Financial Officer, the
President (if any), any Vice Chairman, any Senior Executive Vice President, any
Executive Vice President, any Group Executive, any Managing Director, the
General Counsel, the Chief Accounting Officer (if any), and the Treasurer. The
General Officers of the Corporation shall be any Senior Vice President, any Vice
President, the Controller, the Chief Governance Officer (if any) and the
Secretary. Any person holding the title of Chairman or Chief Executive Officer
shall be a director of the Corporation.
The Board may from time to time designate, employ, or appoint such other
officers and assistant officers, agents, employees, counsel, and attorneys at
law or in fact as it shall deem desirable for such periods and on such terms as
it may deem advisable, and such persons shall have such titles, only such power
and authority, and perform such duties as the Board may determine.
SECTION 2. Duties of Chairman of the Board. The Chairman shall sign and issue,
jointly with the President (if any), all reports to the stockholders and shall
preside at all meetings of stockholders and of the Board. He shall, in general,
perform duties incident to the office of Chairman as may be prescribed by the
Board.
SECTION 3. Duties of Chief Executive Officer. At the next meeting of the Board
following the Annual Meeting of Stockholders, or other meeting at which Policy
Making Officers are or may be elected, the Board shall designate the Chairman or
the President (if any) as the Chief Executive Officer of the Corporation. The
Chief Executive Officer shall have general authority over all matters relating
to the business and affairs of the Corporation subject to the control and
direction of the Board. In the absence or inability of the Chief Executive
Officer to act, the Chair of the Executive Committee of the Board shall perform
the duties of the Chief Executive Officer.
SECTION 4. Duties of President. The President, if one is appointed by the
Board, shall, in general, perform all duties incident to the office of President
and shall perform such other duties as may be prescribed by the Board. In the
absence or inability of the Chairman, or the Chair of the Executive Committee in
accordance with Section 3 above, to act, the President shall perform the duties
of the Chairman and Chief Executive Officer for such time period as required.
SECTION 5. Duties of a Vice Chairman. A Vice Chairman, if one is appointed by
the Board, shall, in general, perform all duties incident to the office of a
Vice Chairman and shall perform such other duties as may be prescribed by the
Board. In the absence or inability of the President or the Chair of the
Executive Committee to act as the Chief Executive Officer in accordance with
Sections 3 and 4 above, the most senior Vice Chairman, as designated by the
Chairman, shall perform the duties of the Chief Executive Officer and Chairman
for such time period as required.
SECTION 6. Duties of Senior Executive Vice Presidents, Executive Vice
Presidents, Group Executives and Senior Vice Presidents. Each Senior Executive
Vice President, Executive Vice President, Group Executive and Senior Vice
President shall have such powers and perform such duties as may be prescribed by
the Chief Executive Officer of the Corporation or the Board. The order of
seniority, if any, among the Senior Executive Vice Presidents, Executive Vice
Presidents, Group Executives and Senior Vice Presidents shall be as designated
from time to time by the Chief Executive Officer of the Corporation. In the
absence or inability of any Vice Chairman to act as the Chief Executive Officer
as may be required in accordance with Section 5 above, the senior of the Senior
Executive Vice Presidents, Executive Vice Presidents, Group Executives and
4
Senior Vice Presidents, if one has been so designated, shall perform the duties
of the Chief Executive Officer and Chairman for such time period as required.
SECTION 7. Duties of Secretary. The Secretary shall record the proceedings of
meetings of the stockholders and directors, give notices of meetings, and shall,
in general, perform all duties incident to the office of Secretary and such
other duties as may be prescribed by the Board.
SECTION 8. Duties of Treasurer. The Treasurer shall have custody of all funds,
securities, evidences of indebtedness, and other similar property of the
Corporation, and shall, in general, perform all duties incident to the office of
Treasurer and such other duties as may be prescribed by the Board.
ARTICLE V.
STOCK AND STOCK CERTIFICATES.
SECTION 1. Transfers. Shares of stock shall be transferable on the books of
the Corporation only by the person named in the certificate or by an attorney,
lawfully constituted in writing, and upon surrender of the certificate therefor.
Every person becoming a stockholder by such transfer shall, in proportion to his
shares, succeed to all rights of the prior holder of such shares.
SECTION 2. Stock Certificates. The certificates of stock of the Corporation
shall be numbered and shall be entered in the books of the Corporation as they
are issued. They shall exhibit the holder's name and number of shares and shall
be signed by the President or Vice President and the Secretary or Treasurer.
Every certificate shall have noted thereon any information required to be set
forth by the applicable law. If the Corporation has a transfer agent or an
assistant transfer agent or a transfer clerk acting on its behalf and a
registrar, the signature of any such officer may be a facsimile. In case any
officer or officers who shall have signed, or whose facsimile signature or
signatures shall have been used on any such certificate or certificates shall
cease to be such officer or officers of the Corporation, whether because of
death, resignation or otherwise, before such certificate or certificates shall
have been delivered by the Corporation, such certificate or certificates may
nevertheless be adopted by the Corporation and be issued and delivered as though
the person or persons who signed such certificate or certificates or whose
facsimile signatures shall have been used thereon had not ceased to be such
officer or officers of the Corporation.
SECTION 3. Fixing Record Date.
(A) In order that the Corporation may determine the stockholders entitled to
notice of or to vote at any meeting of stockholders or any adjournment thereof,
or to express consent to corporate action in writing without a meeting, or
entitled to receive payment of any dividend or other distribution or allotment
of any rights, or entitled to exercise any rights in respect of any change,
conversion or exchange of stock or for the purpose of any other lawful action,
the Board may fix, in advance, a record date, which shall not be more than sixty
nor less than ten days before the date of such meeting, nor more than sixty days
prior to any other action.
(B) If no record date is fixed:
(1) The record date for determining stockholders entitled to notice of
or to vote at a meeting of stockholders shall be at the close of business
on the day next preceding the day on which notice is given, or, if notice
is waived, at the close of business on the day next preceding the day on
which the meeting is held.
(2) The record date for determining stockholders for any other purpose
shall be at the close of business on the day on which the Board adopts the
resolution relating thereto.
SECTION 4. Registered Shareholders. The Corporation shall be entitled to treat
the holder of record of any share or shares of stock as the holder in fact
thereof and, accordingly, shall not be bound to recognize any equitable or other
claim to or interest in such share on the part of any other person, whether or
not it shall have express or other notice thereof, save as expressly provided by
the law.
5
SECTION 5. Lost Certificates. Any person claiming a certificate of stock to be
lost or destroyed shall make an affidavit or affirmation of that fact and
advertise the same in such manner as the Board may require, and the Board may,
in its discretion, require the owner of the lost or destroyed certificate, or
his legal representative, to give the Corporation a bond, sufficient to
indemnify the Corporation against any claim that may be made against it on
account of the alleged loss of any such certificate. A new certificate of the
same tenor and for the same number of shares as the one alleged to be lost or
destroyed may be issued without requiring any bond when, in the judgment of the
Board, it is proper so to do.
ARTICLE VI.
EMERGENCY BYLAWS.
SECTION 1. When Operative. Notwithstanding any different provision in the
preceding Articles of the bylaws or in the Certificate of Incorporation, the
emergency bylaws provided in this Article VI shall be operative during any
emergency resulting from an attack on the United States or on a locality in
which the Corporation conducts its business or customarily holds meetings of its
Board or its stockholders, or during any nuclear or atomic disaster, or during
the existence of any catastrophe, or other similar emergency condition, as a
result of which a quorum of the Board or a standing committee thereof cannot
readily be convened for action.
SECTION 2. Board Meetings. During any such emergency, a meeting of the Board
may be called by any director or, if necessary, by any officer who is not a
director. The meeting shall be held at such time and place, within or without
Cook County, Illinois, specified by the person calling the meeting and in the
notice of the meeting which shall be given to such of the directors as it may be
feasible to reach at the time and by such means as may be feasible at the time,
including publication or radio. Such advance notice shall be given as, in the
judgment of the person calling the meeting, circumstances permit. Two directors
shall constitute a quorum for the transaction of business. To the extent
required to constitute a quorum at the meeting, the officers present shall be
deemed, in order of rank and within the same rank in order of seniority,
directors for the meeting.
SECTION 3. Amendments to Emergency Bylaws. These emergency bylaws may be
amended, either before or during any emergency, to make any further or different
provision that may be practical and necessary for the circumstances of the
emergency.
ARTICLE VII.
CONSENTS TO CORPORATE ACTION.
SECTION 1. Action by Written Consent. Unless otherwise provided in the
Certificate of Incorporation, any action which is required to be or may be taken
at any annual or special meeting of stockholders of the Corporation, subject to
the provisions of Sections (2) and (3) of this Article VII, may be taken without
a meeting, without prior notice and without a vote if a consent in writing,
setting forth the action so taken, shall have been signed by the holders of
outstanding stock having not less than the minimum number of votes that would be
necessary to authorize or to take such action at a meeting at which all shares
entitled to vote thereon were present and voted; provided, however, that prompt
notice of the taking of the corporate action without a meeting and by less than
unanimous written consent shall be given to those stockholders who have not
consented in writing.
SECTION 2. Determination of Record Date for Action by Written Consent. The
record date for determining stockholders entitled to express consent to
corporate action in writing without a meeting shall be fixed by the Board of
Directors of the Corporation. Any stockholder seeking to have the stockholders
authorize or take corporate action by written consent without a meeting shall,
by written notice to the Secretary, request the Board of Directors to fix a
record date. Upon receipt of such a request, the Secretary shall, as promptly as
practicable, call a special meeting of the Board of Directors to be held as
promptly as practicable. At such meeting, the Board of Directors shall fix a
record date as provided in Section 213(b) (or
6
its successor provision) of the Delaware General Corporation Law; that record
date, however, shall not be more than 10 days after the date upon which the
resolution fixing the record date is adopted by the Board nor more than 15 days
from the date of the receipt of the stockholder's request. Should the Board fail
to fix a record date as provided for in this Section 2, then the record date
shall be the day on which the first written consent is duly delivered pursuant
to Section 213(b) (or its successor provision) of the Delaware General
Corporation Law, or, if prior action is required by the Board with respect to
such matter, the record date shall be at the close of business on the day on
which the Board adopts the resolution taking such action.
SECTION 3. Procedures for Written Consent. In the event of the delivery to the
Corporation of a written consent or consents purporting to represent the
requisite voting power to authorize or take corporate action and/or related
revocations, the Secretary of the Corporation shall provide for the safekeeping
of such consents and revocations.
ARTICLE VIII.
MISCELLANEOUS PROVISIONS.
SECTION 1. Waiver of Notice. Whenever notice is required to be given, a
written waiver thereof signed by the person entitled to notice, whether before
or after the time stated therein, shall be deemed equivalent to notice.
Attendance of a person at a meeting shall constitute a waiver of notice of such
meeting, except when the person attends a meeting for the express purpose of
objecting, at the beginning of the meeting, to the transaction of any business
because the meeting is not lawfully called or convened.
SECTION 2. Corporate Seal. The corporate seal shall have inscribed thereon the
name of the Corporation, the year of its organization and the words "Corporate
Seal, Delaware". The seal may be used by causing it or a facsimile thereof to be
impressed or affixed or in any manner reproduced.
SECTION 3. Fiscal Year. The Fiscal Year of the Corporation shall be the
calendar year.
SECTION 4. Records. The Bylaws and the proceedings of all meetings of the
stockholders and the Board shall be recorded in appropriate minute books
provided for the purpose. The minutes of each meeting shall be signed by the
Secretary or other officer appointed to act as Secretary of the meeting.
SECTION 5. Amendments. The Bylaws may be added to, amended, altered or
repealed at any regular meeting of the Board, by a vote of a majority of the
total number of the directors, or at any meeting of stockholders, duly called
and held, by a majority of the stock represented at such meeting.
7
EXHIBIT 12
HSBC FINANCE CORPORATION
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND TO
COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
MARCH 29 JANUARY 1
YEAR ENDED YEAR ENDED YEAR ENDED THROUGH THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 28,
2006 2005 2004 2003 2003 2002
---------------------------------------------------------------------------------------------------------------------------
(SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (PREDECESSOR) (PREDECESSOR)
(IN MILLIONS)
Net income..................... $1,443 $1,772 $1,940 $1,357 $ 246 $1,558
Income taxes................... 844 891 1,000 690 182 695
------ ------ ------ ------ ------ ------
Income before income taxes..... 2,287 2,663 2,940 2,047 428 2,253
------ ------ ------ ------ ------ ------
Fixed charges:
Interest expense............. 7,374 4,832 3,143 2,031 898 3,879
Interest portion of
rentals(1)................. 59 61 54 40 18 68
------ ------ ------ ------ ------ ------
Total fixed charges............ 7,433 4,893 3,197 2,071 916 3,947
------ ------ ------ ------ ------ ------
Total earnings as defined...... $9,720 $7,556 $6,137 $4,118 $1,344 $6,200
Ratio of earnings to fixed
charges...................... 1.31(3) 1.54 1.92(4) 1.99 1.47(5) 1.57(6)
====== ====== ====== ====== ====== ======
Preferred stock dividends(2)... 58 125 108 86 32 91
====== ====== ====== ====== ====== ======
Ratio of earnings to combined
fixed charges and preferred
stock dividends.............. 1.30(3) 1.51 1.86(4) 1.91 1.42(5) 1.54(6)
====== ====== ====== ====== ====== ======
---------------
(1) Represents one-third of rentals, which approximates the portion representing
interest.
(2) Preferred stock dividends are grossed up to their pretax equivalents.
(3) The 2006 ratios have been positively impacted by the $78 million (after-tax)
gain on sale of our investment in Kanbay. Excluding this item, our ratio of
earnings to fixed charges would have been 1.30 percent and our ratio of
earnings to combined fixed charges and preferred stock dividends would have
been 1.29 percent. These non-U.S. GAAP financial ratios are provided for
comparison of our operating trends only.
(4) The 2004 ratios have been negatively impacted by $121 million (after-tax)
from the adoption of FFIEC charge-off policies for our domestic private
label (excluding retail sales contracts at our consumer lending business)
and credit card portfolios in December 2004 and positively impacted by the
$423 million (after-tax) gain on the bulk sale of our domestic private label
receivables (excluding retail sales contracts at our consumer lending
business) to HSBC Bank USA in December 2004. Excluding these items, our
ratio of earnings to fixed charges would have been 1.83 percent and our
ratio of earnings to combined fixed charges and preferred stock dividends
would have been 1.77 percent. These non-U.S. GAAP financial ratios are
provided for comparison of our operating trends only.
(5) The 2003 ratios have been negatively impacted by the $167 million
(after-tax) of HSBC acquisition related costs and other merger related items
incurred by HSBC Finance Corporation. Excluding these charges, our ratio of
earnings to fixed charges would have been 1.69 percent and our ratio of
earnings to combined fixed charges and preferred stock dividends would have
been 1.63 percent. These non-U.S. GAAP financial ratios are provided for
comparison of our operating trends only.
(6) The 2002 ratios have been negatively impacted by the $333 million
(after-tax) settlement charge and related expenses and the $240 million
(after-tax) loss on the disposition of Thrift assets and deposits. Excluding
these charges, our ratio of earnings to fixed charges would have been 1.80
percent and our ratio of earnings to combined fixed charges and preferred
stock dividends would have been 1.76 percent. These non-U.S. GAAP financial
ratios are provided for comparison of our operating trends only.
EXHIBIT 21
SUBSIDIARIES OF HSBC FINANCE CORPORATION
US -- STATE
NAMES OF SUBSIDIARIES ORGANIZED
--------------------- --------------
AHLIC Investment Holdings Corporation....................... Delaware
B.I.G. Insurance Agency, Inc. .............................. Ohio
Beaver Valley, Inc. ........................................ Delaware
Bencharge Credit Service Holding Company.................... Delaware
Beneficial Alabama Inc. .................................... Alabama
Beneficial Arizona Inc. .................................... Delaware
Beneficial California Inc. ................................. Delaware
Beneficial Colorado Inc. ................................... Delaware
Beneficial Commercial Corporation........................... Delaware
Beneficial Commercial Holding Corporation................... Delaware
Beneficial Company LLC (f/k/a Beneficial Corporation)....... Delaware
Beneficial Connecticut Inc. ................................ Delaware
Beneficial Consumer Discount Company........................ Pennsylvania
dba BMC of PA
Beneficial Credit Services Inc. ............................ Delaware
Beneficial Credit Services of Connecticut Inc. ............. Delaware
Beneficial Credit Services of Mississippi Inc. ............. Delaware
Beneficial Credit Services of South Carolina Inc. .......... Delaware
Beneficial Delaware Inc. ................................... Delaware
Beneficial Direct, Inc. .................................... New Jersey
Beneficial Discount Co. of Virginia......................... Delaware
Beneficial Facilities Corporation........................... New Jersey
Beneficial Finance Co. ..................................... Delaware
Beneficial Finance Co. of West Virginia..................... Delaware
Beneficial Finance Services, Inc. .......................... Kansas
Beneficial Florida Inc. .................................... Delaware
Beneficial Franchise Company Inc. .......................... Delaware
Beneficial Georgia Inc. .................................... Delaware
Beneficial Hawaii Inc. ..................................... Delaware
Beneficial Homeowner Service Corporation.................... Delaware
Beneficial Idaho Inc. ...................................... Delaware
Beneficial Illinois Inc. ................................... Delaware
Beneficial Income Tax Service Holding Co., Inc. ............ Delaware
Beneficial Indiana Inc. .................................... Delaware
dba Beneficial Mortgage Co. of Indiana
Beneficial Investment Co. .................................. Delaware
Beneficial Iowa Inc. ....................................... Iowa
Beneficial Kansas Inc. ..................................... Kansas
Beneficial Kentucky Inc. ................................... Delaware
Beneficial Leasing Group, Inc. ............................. Delaware
Beneficial Loan & Thrift Co. ............................... Minnesota
Beneficial Loan Corporation of Kentucky..................... Kentucky
US -- STATE
NAMES OF SUBSIDIARIES ORGANIZED
--------------------- --------------
Beneficial Louisiana Inc. .................................. Delaware
Beneficial Maine Inc. ...................................... Delaware
dba Beneficial Credit Services of Maine
Beneficial Management Corporation........................... Delaware
Beneficial Management Corporation of America................ Delaware
Beneficial Management Headquarters, Inc. ................... New Jersey
Beneficial Management Institute, Inc. ...................... New York
Beneficial Mark Holding Inc. ............................... Delaware
Beneficial Maryland Inc. ................................... Delaware
Beneficial Massachusetts Inc. .............................. Delaware
Beneficial Michigan Inc. ................................... Delaware
Beneficial Mississippi Inc. ................................ Delaware
Beneficial Missouri, Inc. .................................. Delaware
Beneficial Montana Inc. .................................... Delaware
Beneficial Mortgage Co. of Arizona.......................... Delaware
Beneficial Mortgage Co. of Colorado......................... Delaware
Beneficial Mortgage Co. of Connecticut...................... Delaware
Beneficial Mortgage Co. of Florida.......................... Delaware
Beneficial Mortgage Co. of Georgia.......................... Delaware
Beneficial Mortgage Co. of Idaho............................ Delaware
Beneficial Mortgage Co. of Indiana.......................... Delaware
Beneficial Mortgage Co. of Kansas, Inc. .................... Delaware
Beneficial Mortgage Co. of Louisiana........................ Delaware
Beneficial Mortgage Co. of Maryland......................... Delaware
Beneficial Mortgage Co. of Massachusetts.................... Delaware
Beneficial Mortgage Co. of Mississippi...................... Delaware
Beneficial Mortgage Co. of Missouri, Inc. .................. Delaware
Beneficial Mortgage Co. of Nevada........................... Delaware
Beneficial Mortgage Co. of New Hampshire.................... Delaware
Beneficial Mortgage Co. of North Carolina................... Delaware
Beneficial Mortgage Co. of Oklahoma......................... Delaware
Beneficial Mortgage Co. of Rhode Island..................... Delaware
Beneficial Mortgage Co. of South Carolina................... Delaware
Beneficial Mortgage Co. of Texas............................ Delaware
Beneficial Mortgage Co. of Utah............................. Delaware
Beneficial Mortgage Co. of Virginia......................... Delaware
Beneficial Mortgage Corporation............................. Delaware
Beneficial Mortgage Holding Company......................... Delaware
Beneficial Nebraska Inc. ................................... Nebraska
dba BFC Mortgage of Nebraska
Beneficial Nevada Inc. ..................................... Delaware
Beneficial New Hampshire Inc. .............................. Delaware
Beneficial New Jersey Inc. ................................. Delaware
dba Beneficial Mortgage Co.
Beneficial New Mexico Inc. ................................. Delaware
US -- STATE
NAMES OF SUBSIDIARIES ORGANIZED
--------------------- --------------
Beneficial New York Inc. ................................... New York
Beneficial North Carolina Inc. ............................. Delaware
Beneficial Ohio Inc. ....................................... Delaware
Beneficial Oklahoma Inc. ................................... Delaware
Beneficial Oregon Inc. ..................................... Delaware
Beneficial Real Estate Joint Venture, Inc. ................. Delaware
Beneficial Rhode Island Inc. ............................... Delaware
Beneficial South Carolina Inc. ............................. Delaware
Beneficial South Dakota Inc. ............................... Delaware
Beneficial Systems Development Corporation.................. Delaware
Beneficial Technology Corporation........................... Delaware
Beneficial Tennessee Inc. .................................. Tennessee
Beneficial Texas Inc. ...................................... Texas
Beneficial Trademark Co. ................................... Delaware
Beneficial Utah Inc. ....................................... Delaware
Beneficial Vermont Inc. .................................... Delaware
Beneficial Virginia Inc. ................................... Delaware
Beneficial Washington Inc. ................................. Delaware
Beneficial West Virginia, Inc. ............................. West Virginia
Beneficial Wisconsin Inc. .................................. Delaware
Beneficial Wyoming Inc. .................................... Wyoming
Benevest Escrow Company..................................... Delaware
BFC Agency, Inc. ........................................... Delaware
BFC Insurance Agency of Nevada.............................. Nevada
BMC Holding Company......................................... Delaware
Bon Secour Properties Inc. ................................. Alabama
Cal-Pacific Services, Inc. ................................. California
Capital Financial Services Inc. ............................ Nevada
dba Capital Financial Services I Inc.
dba Capital Financial Services No. 1 Inc.
dba CFSI, Inc.
dba HB Financial Services
Central Insurance Administrators, Inc. ..................... Delaware
Chattanooga Valley Associates............................... Tennessee
Com Realty, Inc. ........................................... Delaware
Craig-Hallum Corporation.................................... Delaware
Decision One Loan Company of Minnesota...................... Minnesota
Decision One Mortgage Company............................... North Carolina
Decision One Mortgage Company, LLC.......................... North Carolina
Eighth HFC Leasing Corporation.............................. Delaware
Eleventh Avenue Properties Corporation...................... Delaware
Fifth HFC Leasing Corporation............................... Delaware
Financial Network Alliance, L.L.P. ......................... Illinois
First Central National Life Insurance Company of New York... New York
FNA Consumer Discount Company............................... Pennsylvania
US -- STATE
NAMES OF SUBSIDIARIES ORGANIZED
--------------------- --------------
Fourteenth HFC Leasing Corporation.......................... Delaware
Fourth HFC Leasing Corporation.............................. Delaware
H I Venture Four, Inc. ..................................... Florida
H I Venture One, Inc. ...................................... Florida
H I Venture Three, Inc. .................................... Florida
Hamilton Investments, Inc. ................................. Delaware
Harbour Island Inc. ........................................ Florida
HFC Agency of Missouri, Inc. ............................... Missouri
HFC Commercial Realty, Inc. ................................ Delaware
HFC Company LLC (f/k/a Household Group, Inc.)............... Delaware
HFC Leasing, Inc. .......................................... Delaware
HFS Investments, Inc. ...................................... Nevada
HFTA Consumer Discount Co. ................................. Pennsylvania
HFTA Corporation............................................ Delaware
HFTA Eighth Corporation..................................... Ohio
HFTA Fifth Corporation...................................... Nevada
HFTA First Financial Corp. ................................. California
HFTA Fourth Corporation..................................... Minnesota
HFTA Ninth Corporation...................................... West Virginia
HFTA Second Corporation..................................... Alabama
HFTA Seventh Corporation.................................... New Jersey
HFTA Sixth Corporation...................................... Nevada
HFTA Tenth Corporation...................................... Washington
HFTA Third Corporation...................................... Delaware
Household Acquisition Corporation........................... Delaware
Household Affinity Funding Corporation III.................. Delaware
Household Aviation, LLC..................................... Delaware
Household Business Services, Inc. .......................... Delaware
Household Capital Markets LLC............................... Delaware
Household Commercial Financial Services, Inc. .............. Delaware
Household Commercial of California, Inc. ................... California
Household Consumer Loan Corporation......................... Nevada
Household Consumer Loan Corporation II...................... Delaware
Household Credit Services Overseas, Inc. ................... Delaware
Household Finance Consumer Discount Company................. Pennsylvania
Household Finance Corporation II............................ Delaware
dba Household Finance Corporation of Virginia
Household Finance Corporation III........................... Delaware
dba HFC Mortgage of Nebraska
dba Household Mortgage Services
dba HSBC Mortgage
Household Finance Corporation of Alabama.................... Alabama
Household Finance Corporation of California................. Delaware
Household Finance Corporation of Nevada..................... Delaware
Household Finance Corporation of West Virginia.............. West Virginia
US -- STATE
NAMES OF SUBSIDIARIES ORGANIZED
--------------------- --------------
Household Finance Industrial Loan Company................... Washington
Household Finance Industrial Loan Company of Iowa........... Iowa
Household Finance Realty Corporation of Nevada.............. Delaware
Household Finance Realty Corporation of New York............ Delaware
Household Financial Center Inc. ............................ Tennessee
Household Global Funding, Inc. ............................. Delaware
Household Industrial Finance Company........................ Minnesota
Household Industrial Loan Co. of Kentucky................... Kentucky
Household Insurance Agency, Inc. ........................... Michigan
Household Insurance Agency, Inc. Nevada..................... Nevada
Household Insurance Group Holding Company................... Delaware
Household Insurance Group, Inc. ............................ Delaware
Household Investment Funding, Inc. ......................... Delaware
Household Ireland Holdings Inc. ............................ Delaware
Household Life Insurance Co. of Arizona..................... Arizona
Household Life Insurance Company............................ Michigan
Household Life Insurance Company of Delaware................ Delaware
Household OPEB I, Inc. ..................................... Illinois
Household Pooling Corporation............................... Nevada
Household Realty Corporation................................ Delaware
dba Household Realty Corporation of Virginia
Household Recovery Services Corporation..................... Delaware
Household REIT Corporation.................................. Nevada
Household Relocation Management, Inc. ...................... Illinois
Household Servicing, Inc. .................................. Delaware
Household Tax Masters Acquisition Corporation............... Delaware
Housekey Financial Corporation.............................. Illinois
HSBC -- GR Corp. (f/k/a Household Financial Group, Ltd.).... Delaware
HSBC Affinity Corporation I (f/k/a HFC Card Funding
Corporation).............................................. Delaware
HSBC Auto Accounts Inc. (f/k/a OFL-A Receivables Corp.)..... Delaware
HSBC Auto Credit Inc. (f/k/a Household Automotive Credit
Corporation).............................................. Delaware
HSBC Auto Finance Inc. (f/k/a Household Automotive Finance
Corporation).............................................. Delaware
HSBC Auto Receivables Corporation (f/k/a Household Auto
Receivables Corporation).................................. Nevada
HSBC Bank Nevada, N. A. (f/k/a Household Bank (SB), N.A.)... United States
HSBC Card Services Inc. (f/k/a Household Credit Services,
Inc.)..................................................... Delaware
HSBC Card Services (II) Inc. (f/k/a Household Credit
Services II, Inc.)........................................ Oregon
HSBC Card Services (III) Inc. (f/k/a Household Card
Services, Inc.)........................................... Nevada
HSBC Consumer Lending (USA) Inc. ........................... Delaware
HSBC Credit Center, Inc. ................................... Delaware
HSBC Home Equity Loan Correspondent Corporation I (f/k/a
HSBC Mortgage Funding Corporation I )..................... Delaware
HSBC Home Equity Loan Corporation I (f/k/a HFC Revolving
Corporation).............................................. Delaware
HSBC Home Equity Loan Corporation II (f/k/a Household
Receivables Acquisition Company).......................... Delaware
HSBC Insurance Company of Delaware (f/k/a Service General
Insurance Company)........................................ Ohio
HSBC Mortgage Services Inc. (f/k/a Household Financial
Services Inc.)............................................ Delaware
US -- STATE
NAMES OF SUBSIDIARIES ORGANIZED
--------------------- --------------
HSBC Mortgage Services Warehouse Lending Inc. (f/k/a HFC
Funding Corporation)...................................... Delaware
HSBC Pay Services, Inc. (f/k/a Household Payroll Services,
Inc.)..................................................... Delaware
HSBC Private Label Corporation (f/k/a Household
Corporation).............................................. Delaware
HSBC Receivables Acquisition Company I (f/k/a Household
Receivables Acquisition Company II........................ Delaware
HSBC Receivables Funding Inc. I (f/k/a Household Receivables
Funding, Inc. III)........................................ Delaware
HSBC Retail Services Inc. (f/k/a Household Retail Services,
Inc.)..................................................... Delaware
HSBC Single Seller Depositor (USA) LLC...................... Delaware
HSBC Taxpayer Financial Services Inc. (f/k/a Household Tax
Masters Inc.)............................................. Delaware
HSBC TFS I 2005 LLC......................................... Delaware
HSBC TFS I LLC.............................................. Delaware
HSBC TFS II 2005 LLC........................................ Delaware
HSBC TFS II LLC............................................. Delaware
Hull 752 Corporation........................................ Delaware
Hull 753 Corporation........................................ Delaware
JV Mortgage Capital Consumer Discount Company............... Pennsylvania
JV Mortgage Capital, Inc. .................................. Delaware
JV Mortgage Capital, L.P. .................................. Delaware
KMD Center, Inc. ........................................... Delaware
Leasing at Sixty-First Corporation.......................... Delaware
Macray Corporation.......................................... California
magnUS Services, Inc. ...................................... Delaware
MES Insurance Agency, LLC................................... Delaware
Metris Receivables, Inc. ................................... Delaware
Moore's Realty Inc. ........................................ Delaware
Mortgage One Corporation.................................... Delaware
Mortgage Two Corporation.................................... Delaware
MTX LLC..................................................... Delaware
Neil Corporation............................................ Delaware
Nineteenth HFC Leasing Corporation.......................... Delaware
North Indemnity Insurance Company........................... Delaware
Old K & B Corporation....................................... Michigan
Pacific Agency, Inc. ....................................... Nevada
Pacific Finance Loans....................................... California
Pargen Corporation.......................................... California
Personal Mortgage Corporation............................... Delaware
Personal Mortgage Holding Company........................... Delaware
PPSG Corporation............................................ Delaware
Properties on Twenty-Second Corporation..................... Delaware
Real Estate Collateral Management Company................... Delaware
Renaissance Bankcard Services of Kentucky................... Kentucky
Service Administrators, Inc. (USA).......................... Colorado
Service Management Corporation.............................. Ohio
Seven Acres Leasing Corporation............................. Delaware
Seventh HFC Leasing Corporation............................. Delaware
US -- STATE
NAMES OF SUBSIDIARIES ORGANIZED
--------------------- --------------
Silliman Corporation........................................ Delaware
Sixth HFC Leasing Corporation............................... Delaware
Solstice Capital Group, Inc. ............................... Delaware
South Property Corporation.................................. Delaware
Southwest Beneficial Finance, Inc. ......................... Illinois
Southwest Texas General Agency, Inc. ....................... Texas
SPE 1 2005 Manager Inc. .................................... Delaware
SPE 1 Manager Inc. ......................................... Delaware
Tampa Island Transit Company, Inc. ......................... Florida
Tenth Leasing Corporation................................... Delaware
Third HFC Leasing Corporation............................... Delaware
Thirteenth HFC Leasing Corporation.......................... Delaware
Twenty-Sixth Place Corporation.............................. Delaware
Valley Properties Corporation............................... Tennessee
Wasco Properties, Inc. ..................................... Delaware
NON-US AFFILIATES
NAMES OF SUBSIDIARIES COUNTRY ORGANIZED
--------------------- -----------------
Amstelveen FSC, Ltd. ....................................... Bermuda
B&Q Financial Services Limited.............................. England
Beneficial Limited.......................................... England
Beneficial Premium Services Limited......................... England
BFC Insurance (Life) Limited................................ Ireland
BFC Insurance Limited....................................... Ireland
BFC Ireland (Holdings) Limited.............................. Ireland
BFC Pension Plan (Ireland) Limited.......................... Ireland
BFC Reinsurance Limited..................................... Ireland
D.L.R.S. Limited............................................ England
Endeavour Personal Finance Limited.......................... England
Hamilton Financial Planning Services Ltd. .................. England
Hamilton Insurance Company Limited.......................... England
Hamilton Life Assurance Company Limited..................... England
HFC Bank Limited............................................ England
HFC Financial Services Holdings (Ireland) Limited........... Ireland
HFC Pension Plan (Ireland) Limited.......................... Ireland
HFC Pension Plan Limited.................................... England
Household (Jersey) Limited.................................. Channel Island
Household Commercial Canada, Inc. .......................... Canada
Household Computer Services Limited......................... England
Household Finance Limited................................... England
Household Funding plc....................................... England
Household Global Holdings, BV............................... Netherlands
Household International Europe Limited...................... England
Household Investments Limited............................... England
Household Leasing Limited................................... England
NAMES OF SUBSIDIARIES COUNTRY ORGANIZED
--------------------- -----------------
Household Management Corporation Limited.................... England & Wales
Household Overseas Limited.................................. England
Household Realty Corporation Limited........................ Canada
Household Trust Company..................................... Canada
HSBC Finance Corporation Canada (f/k/a Household Finance
Corporation of Canada).................................... Canada
HSBC Financial Corporation Limited (f/k/a Household
Financial Corporation Limited)............................ Canada
HSBC Retail Services Limited (f/k/a Household Financial
Corporation Inc.)......................................... Canada
ICOM Limited................................................ Bermuda
Invis Inc. ................................................. Canada
Night Watch FSC, Ltd. ...................................... Bermuda
Sterling Credit Limited..................................... England
Sterling Credit Management Limited.......................... England
Sterling Mortgages Limited.................................. England
EXHIBIT 23
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors of HSBC Finance Corporation:
We consent to the incorporation of our report dated March 2, 2007, included in
this Annual Report on Form 10-K of HSBC Finance Corporation (the Company) as of
December 31, 2006 and 2005 and for each of the years in the three-year period
ended December 31, 2006, into the Company's previously filed Registration
Statements No. 2-86383, No. 33-21343, No. 33-45454, No. 33-45455, No. 33-52211,
No. 33-58727, No. 333-00397, No. 333-03673, No. 333-36589, No. 333-39639, No.
333-47073, No. 333-58291, No. 333-58289, No. 333-58287, No. 333-30600, No.
333-50000, No. 333-70794, No. 333-71198, No. 333-83474 and No. 333-99107 on Form
S-8 and Registration Statements No. 33-55043, No. 33-55561, No. 33-64175, No.
333-02161, No. 333-14459, No. 333-47945, No. 333-59453, No. 333-60543, No.
333-72453, No. 333-82119, No. 333-33240, No. 333-45740, No. 333-56152, No.
333-61964, No. 333-73746, No. 333-75328, No. 333-85886, No. 333-111413, No.
33-44066, No. 33-57249, No. 333-01025, No. 333-27305, No. 333-33052, No.
333-53862, No. 333-60510, No. 333-100737, No. 333-120494, No. 333-120495, No.
333-120496 , No. 333-130580 and No. 333-128369 on Form S-3.
/s/ KPMG LLP
Chicago, Illinois
March 2, 2007
EXHIBIT 31
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Brendan P. McDonagh, Chief Executive Officer of HSBC Finance Corporation,
certify that:
1. I have reviewed this annual report on Form 10-K of HSBC Finance
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this annual report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) disclosed in this annual report any change in the registrant's
internal control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal control
over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal controls over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: March 5, 2007
/s/ BRENDAN P. MCDONAGH
--------------------------------------
Brendan P. McDonagh
Chief Executive Officer
EXHIBIT 31
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Beverley A. Sibblies, Senior Vice President and Chief Financial Officer of
HSBC Finance Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of HSBC Finance
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this annual report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) disclosed in this annual report any change in the registrant's
internal control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal control
over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal controls over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: March 5, 2007
/s/ BEVERLEY A. SIBBLIES
--------------------------------------
Beverley A. Sibblies
Senior Executive Vice President
and Chief Financial Officer
EXHIBIT 32
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The certification set forth below is being submitted in connection with the HSBC
Finance Corporation (the "Company") Annual Report on Form 10-K for the fiscal
year ended December 31, 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, Brendan P. McDonagh, Chief Executive Officer of the Company, certify that:
1. the Report fully complies with the requirements of Section 13(a) or
15(d) of the Exchange Act; and
2. the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of
HSBC Finance Corporation.
March 5, 2007
/s/ BRENDAN P. MCDONAGH
--------------------------------------
Brendan P. McDonagh
Chief Executive Officer
This certification accompanies each Report pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the
Sarbanes-Oxley Act of 2002, be deemed filed by HSBC Finance Corporation for
purposes of Section 18 of the Securities Exchange Act of 1934, as amended.
Signed originals of these written statements required by Section 906 of the
Sarbanes-Oxley Act of 2002 have been provided to HSBC Finance Corporation and
will be retained by HSBC Finance Corporation and furnished to the Securities and
Exchange Commission or its staff upon request.
EXHIBIT 32
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The certification set forth below is being submitted in connection with the HSBC
Finance Corporation (the "Company") Annual Report on Form 10-K for the fiscal
year ended December 31, 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.
March 5, 2007
/s/ BEVERLEY A. SIBBLIES
--------------------------------------
Beverley A. Sibblies
Senior Vice President
and Chief Financial Officer
This certification accompanies each Report pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the
Sarbanes-Oxley Act of 2002, be deemed filed by HSBC Finance Corporation for
purposes of Section 18 of the Securities Exchange Act of 1934, as amended.
Signed originals of these written statements required by Section 906 of the
Sarbanes-Oxley Act of 2002 have been provided to HSBC Finance Corporation and
will be retained by HSBC Finance Corporation and furnished to the Securities and
Exchange Commission or its staff upon request.
EXHIBIT 99.1
HSBC FINANCE CORPORATION AND SUBSIDIARIES
DEBT AND PREFERRED STOCK SECURITIES RATINGS
STANDARD & MOODY'S DOMINION
POOR'S INVESTORS BOARD RATING
CORPORATION SERVICE FITCH, INC. SERVICE
------------------------------------------------------------------------------------------------------
AS OF MARCH 5, 2007
HSBC Finance Corporation
Senior debt................................... AA- 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...................... A-2 A2 A+ *
HFC Bank Limited
Senior debt................................... AA- Aa3 AA- *
Commercial paper.............................. A-1+ P-1 F-1+ *
HSBC Financial Corporation Limited
Senior notes and term loans................... * * * AA (low)
Commercial paper.............................. * * * R-1 (middle)
---------------
* Not rated by this agency.
EXHIBIT 99.2
EXPLANATION OF DIFFERENCES BETWEEN U.K. GAAP AND IFRSS,--
AN EXCERPT FROM FOOTNOTE 46, "TRANSITION TO IFRSS," CONTAINED IN HSBC HOLDINGS
ANNUAL REPORT ON FORM 20-F FOR THE YEAR ENDED DECEMBER 31, 2005.
DERIVATIVES AND HEDGE ACCOUNTING
Under UK GAAP derivatives were classified as trading or non-trading. Trading
derivatives were reported at market value in the balance sheet, with movements
in market value recognised immediately in the income statement. Non-trading
derivatives, which were transacted for hedging and risk management purposes,
were accounted for on an accruals basis, equivalent to the assets, liabilities
or net positions being hedged.
IAS 39 requires that all derivatives be recognised at fair value in the balance
sheet as assets or liabilities. The accounting for changes in the fair value of
a derivative depends on the intended use of the derivative and its resulting
designation, as described in Note 2(k).
INVESTMENT SECURITIES
Debt securities and equity shares intended to be held on a continuing basis
under UK GAAP were disclosed as investment securities and included in the
balance sheet at cost less provision for any permanent diminution in value.
Other debt securities and equity shares held for trading purposes were included
in the balance sheet at market value.
Under IAS 39, all investment securities (debt securities and equity shares) are
classified and disclosed within one of the following three categories:
'held-to-maturity'; 'available-for-sale'; or 'at fair value through profit or
loss'.
FAIR VALUE OPTION
Under IAS 39, financial assets and financial liabilities may be designated at
fair value if they meet the criteria set out in the 'Amendment to IAS 39
Financial Instruments; Recognition and Measurement; The Fair Value Option' ('the
Amendment'). HSBC has designated at fair value at 1 January 2005 certain loans
and advances to customers, financial investments, and some own debt issued which
satisfied the criteria in the Amendment.
FEE INCOME
Fee income was previously accounted for in the period when receivable, except
when charged to cover the costs of a continuing service to, or risk borne for,
the customer, or was interest in nature. In these cases, income was recognised
on an appropriate basis over the relevant period. Under IFRSs, the main change
in accounting relates to loan fee income and incremental directly attributable
loan origination costs, which are amortised to the income statement over the
expected life of the loan as part of the effective interest calculation.
NON-EQUITY MINORITY INTEREST RECLASSIFICATION
Preference shares issued by subsidiaries were previously classified in the
balance sheet as non-equity minority interests with preference share dividends
recorded as non-equity minority interests in the income statement. Under IAS 32,
preference shares are generally classified in the balance sheet as liabilities.
LOAN IMPAIRMENT
Under HSBC's UK GAAP accounting policies, loans in the consumer finance business
were written off to the income statement in accordance with a predetermined
overdue status.
Under IAS 39, impairment losses are recognised when an entity has objective
evidence that an advance is impaired. Impairment under IAS 39 is calculated on a
discounted future cash flow basis and does not result in an impaired loan being
fully written off until it is considered that cash flows will no longer be
received.
INSURANCE
Under UK GAAP, a value was placed on HSBC's interest in long-term assurance
business, including a valuation of the discounted future earnings expected to
emerge from business currently in force. From 1 January 2005, only long-term
contracts meeting the definition of an insurance contract under IFRS 4 continue
to be accounted for in this way. Long-term contracts not transferring
significant insurance risk, referred to as investment contracts, are accounted
for as financial instruments. Accordingly, it is no longer possible to include
for such contracts an asset representing the value of the discounted future
earnings expected to emerge from business currently in force, lending to a
reduction in equity of US$192 million. Income on such contracts will be
recognised in later periods, as investment management fees and incremental
directly attributable costs are spread over the period in which the services are
provided.
OFFSETTING OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES
Under UK GAAP the netting of asset and liability balances in the balance sheet
is only allowed when there is the ability to insist on net settlement. Under IAS
32 the offsetting of financial assets and financial liabilities is only allowed
when there is a legally enforceable right to offset and the intention to settle
net. The change from an ability to insist on net settlement to an intention to
settle on a net basis is not in line with market practice in a number of areas.
Acceptances were accounted for on a net basis under UK GAAP. There was no
grossing up of the amount to be paid and the amount receivable from the
originator, and thus no balance appeared on the balance sheet for these
products. Under IAS 39 it is necessary to recognise a liability for acceptances
from the date of acceptance. A corresponding asset due from the originator is
also recognised.