HSBC Fin Corp 10Q - Part 2

31st Jul 2006 18:10

HSBC Holdings PLC31 July 2006 Part 2 of 2 SEGMENT RESULTS - MANAGED BASIS-------------------------------------------------------------------------------- We have three reportable segments: Consumer, Credit Card Services andInternational. Our Consumer segment consists of our consumer lending, mortgageservices, retail services and auto finance businesses. Our Credit Card Servicessegment consists of our domestic MasterCard and Visa credit card business. OurInternational segment consists of our foreign operations in the United Kingdom,Canada, the Republic of Ireland, Slovakia, the Czech Republic and Hungary. TheAll Other caption includes our insurance and taxpayer financial services andcommercial businesses, as well as our corporate and treasury activities, each ofwhich falls below the quantitative threshold test under SFAS No. 131 fordetermining reportable segments. There have been no changes in the basis of oursegmentation or any changes in the measurement of segment profit as comparedwith the presentation in our 2005 Form 10-K. We have historically monitored our operations and evaluated trends on a managedbasis (a non-GAAP financial measure), which assumes that securitized receivableshave not been sold and are still on our balance sheet. This is because thereceivables that we securitize are subjected to underwriting standardscomparable to our owned portfolio, are serviced by operating personnel withoutregard to ownership and result in a similar credit loss exposure for us. Inaddition, we fund our operations and make certain decisions about allocatingresources such as capital on a managed basis. When reporting on a managed basis, net interest income, provision for creditlosses and fee income related to receivables securitized are reclassified fromsecuritization related revenue in our owned statement of income into theappropriate caption. CONSUMER SEGMENT The following table summarizes results for our Consumersegment: INCREASE (DECREASE) --------------------THREE MONTHS ENDED JUNE 30 2006 2005 AMOUNT %-------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net income............................................. $ 442 $ 440 $ 2 .5%Net interest income.................................... 1,851 1,699 152 8.9Securitization related revenue......................... (55) (151) 96 63.6Fee and other income................................... 330 292 38 13.0Intersegment revenues.................................. 63 26 37 100+Provision for credit losses............................ 696 580 116 20.0Total costs and expenses............................... 726 578 148 25.6Receivables............................................ 120,316 95,300 25,016 26.2Assets................................................. 121,058 96,188 24,870 25.9Net interest margin, annualized........................ 6.29% 7.27% - -Return on average managed assets....................... 1.49 1.87 - - 40 HSBC Finance Corporation-------------------------------------------------------------------------------- INCREASE (DECREASE) -------------------SIX MONTHS ENDED JUNE 30 2006 2005 AMOUNT %-------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net income................................................. $1,052 $ 874 $178 20.4%Net interest income........................................ 3,672 3,392 280 8.3Securitization related revenue............................. (104) (386) 282 73.1Fee and other income....................................... 630 577 53 9.2Intersegment revenues...................................... 120 53 67 100+Provision for credit losses................................ 1,099 963 136 14.1Total costs and expenses................................... 1,426 1,246 180 14.4Net interest margin, annualized............................ 6.37% 7.41% - -Return on average managed assets........................... 1.82 1.89 - - Our Consumer Segment reported higher net income during the six months ended June30, 2006 due to higher net interest income, higher fee and other income, andhigher securitization related revenue, partially offset by higher provision forcredit losses and higher costs and expenses. Net income was flat for the threemonths ended June 30, 2006 as a result of a more significant increase in theprovision for credit losses during the quarter as compared to the year-to-dateperiod. Net interest income increased during the three and six months ended June30, 2006 primarily due to higher average receivables, partially offset by higherinterest expense. Net interest margin decreased from the year ago periods due toa shift in mix due to growth in lower yielding receivables and product expansioninto near-prime consumer segments. Also contributing to the decrease were loweryields on auto finance receivables as we have targeted higher credit qualitycustomers. Although higher credit quality receivables generate lower yields,such receivables are expected to result in lower operating costs, delinquencyratios and charge-off. These lower yields were partially offset by higherpricing on our variable rate products. A higher cost of funds due to a risinginterest rate environment also contributed to the decrease in net interestmargin. The increase in fee and other income in the three and six months ended June 30,2006 was due to higher servicing fees from HBUS on the sold domestic privatelabel receivable portfolio and higher credit insurance commissions, partiallyoffset by lower gains on receivable sales including sales of domestic privatelabel receivable originations to HBUS. Securitization related revenue was higherin both periods due to lower amortization of prior period gains as a result ofreduced securitization levels. Costs and expenses were higher in both periodsdue to higher salary expense and higher support services from affiliates tosupport receivable growth. Our managed basis provision for credit losses, which includes both provision forowned basis receivables and over-the-life provision for receivables servicedwith limited recourse, increased during both the three and six months ended June30, 2006 due to receivable growth as well as higher charge-offs and lossestimates at our Mortgage Services business due to deteriorating performance inthe 2005 second lien and portions of the 2005 first lien real estate securedoriginations. These increases were partially offset by a reduction in theestimated loss exposure resulting from Katrina of approximately $23 million inthe three months ended June 30, 2006 and approximately $30 million in theyear-to-date period as well as a continued stable economy in the United States.We have experienced higher dollars of net charge-offs in our owned portfolioduring the six months ended June 30, 2006 due to higher receivable levels inpart due to lower securitization levels. These factors resulted in an increaseto our owned provision for credit losses compared to the prior year quarter.Over-the-life provision for credit losses for securitized receivables recordedin any given period reflects the level and product mix of securitizations inthat period. Subsequent charge-offs of securitized receivables result in adecrease in the over-the-life reserves without any corresponding increase tomanaged loss provision. For 2006, the provision for credit losses was greaterthan net charge-offs by $53 million for the three months ended June 30, 2006 andnet charge-offs were greater than the provision for credit losses by $173million for the year-to-date period. For 2005, the provision for credit losseswas greater than net charge-offs by $6 million for 41 HSBC Finance Corporation-------------------------------------------------------------------------------- the three months ended June 30, 2005 while net charge-offs were greater than theprovision for credit losses by $266 million for the year-to-date period. Managed receivables increased 4 percent to $120.3 billion at June 30, 2006 ascompared to $115.4 billion at March 31, 2006. We continued to experience stronggrowth in the second quarter of 2006 in our real estate secured portfolio inboth our Mortgage Services correspondent and Consumer Lending branch-basedbusinesses. Our auto finance portfolio also reported growth due to organicgrowth from increased volume in both the dealer network and the consumer directloan program. Personal non-credit card receivables increased as we haveincreased the availability of this product due to the stable U.S. economy. Thesuccess of several large direct mail campaigns also contributed to growth in theportfolio. Compared to June 30, 2005, managed receivables increased 26 percent. Real estategrowth was also strong compared to the year ago period as a result of stronggrowth in both our correspondent and branch-based consumer lending businesses.We continued to enter into agreements with additional correspondents to purchasetheir newly originated loans on a flow basis. However, we are currentlytightening underwriting standards on loans purchased from correspondentsincluding reducing purchases of second lien and selected higher risk products.These activities are expected to reduce the volume of correspondent purchases inthe future which may have the effect of slowing growth in the real estatesecured portfolio. Also contributing to the increase were purchases of $1.1billion from portfolio acquisition programs since the prior year quarter. Growthin our auto finance portfolio from the year ago period is due to organic growth,principally in the near-prime portfolio. This came from newly originated loansacquired from our dealer network and growth in the consumer direct loan program.Growth in our personal non-credit card portfolio was the result of increasedmarketing, including several large direct mail campaigns. Return on average managed assets ("ROMA") was 1.49 percent for the three monthsended June 30, 2006 and 1.82 percent for the six months ended June 30, 2006,compared to 1.87 percent and 1.89 percent in the year-ago periods. The decreasein the ratio in both periods is because the increase in net income discussedabove was slower than the growth in average managed assets. In accordance with Federal Financial Institutions Examination Council ("FFIEC")guidance, the required minimum monthly payment amounts for domestic privatelabel credit card accounts have changed. The implementation of these newrequirements began in the fourth quarter of 2005 and was completed in the firstquarter of 2006. As previously discussed, we sell new domestic private labelreceivable originations (excluding retail sales contracts) to HBUS on a dailybasis. Estimates of the potential impact to the business are based on numerousassumptions and take into account a number of factors which are difficult topredict, such as changes in customer behavior, which will not be fully known orunderstood until the changes have been in place for a period of time. Based oncurrent estimates, we anticipate that these changes will have an unfavorableimpact on the premiums associated with these daily sales in 2007. It is notexpected this reduction will have a material impact on either the results of theConsumer Segment or our consolidated results. 42 HSBC Finance Corporation-------------------------------------------------------------------------------- CREDIT CARD SERVICES SEGMENT The following table summarizes results for ourCredit Card Services segment. INCREASE (DECREASE) -------------THREE MONTHS ENDED JUNE 30 2006 2005 AMOUNT %---------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net income................................................. $ 310 $ 165 $ 145 87.9%Net interest income........................................ 764 507 257 50.7Securitization related revenue............................. (15) (55) 40 72.7Fee and other income....................................... 570 475 95 20.0Intersegment revenues...................................... 5 5 - -Provision for credit losses................................ 399 334 65 19.5Total costs and expenses................................... 428 333 95 28.5Receivables................................................ 25,815 19,615 6,200 31.6Assets..................................................... 25,980 19,391 6,589 34.0Net interest margin, annualized............................ 11.71% 10.20% - -Return on average managed assets........................... 4.82 3.42 - - INCREASE (DECREASE) -------------SIX MONTHS ENDED JUNE 30 2006 2005 AMOUNT %--------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net income.................................................. $ 615 $ 313 $302 96.5%Net interest income......................................... 1,533 1,013 520 51.3Securitization related revenue.............................. (18) (119) 101 84.9Fee and other income........................................ 1,087 912 175 19.2Intersegment revenues....................................... 10 11 (1) (9.1)Provision for credit losses................................. 763 655 108 16.5Total costs and expenses.................................... 861 657 204 31.1Net interest margin, annualized............................. 11.79% 10.27% - -Return on average managed assets............................ 4.74 3.24 - - Our Credit Card Services Segment reported higher net income in the three and sixmonths ended June 30, 2006. The increase in net income in both periods wasprimarily due to higher net interest income, higher fee and other income andhigher securitization related revenue partially offset by higher provision forcredit losses and higher costs and expenses. The acquisition of Metris, whichwas completed in December 2005, contributed $38 million of net income during thecurrent quarter and $61 million in the year-to-date period. Net interest incomeincreased in both periods as a result of the Metris acquisition, whichcontributed to higher overall yields due in part to higher levels of near-primereceivables, partially offset by higher interest expense. Net interest marginincreased in both the three and six months ended June 30, 2006 primarily due tohigher overall yields due to increases in non-prime receivable levels, includingthe receivables acquired as part of Metris, higher pricing on variable rateproducts and other repricing initiatives, such as reduced levels of promotionalrate balances in 2006. These increases were partially offset by a higher cost offunds. Although our non-prime receivables tend to have smaller balances, theygenerate higher returns both in terms of net interest margin and fee income.Increases in fee and other income resulted from portfolio growth, including theMetris receivable portfolios acquired in December 2005, and improvements ininterchange rates since June 2005. This increase in fee income was partiallyoffset in both periods by adverse impacts of limiting certain fee billings onnon-prime credit card accounts as discussed below. Securitization relatedrevenue was higher due to lower amortization of prior period gains as a resultof reduce securitization levels. Our provision for credit losses was higher inthe three and six months ended June 30, 2006 as a result of portfolio growth, 43 HSBC Finance Corporation-------------------------------------------------------------------------------- including additions from the Metris acquisition, partially offset by a reductionin our estimated loss exposure related to Katrina of approximately $2 million inthe three months ended June 30, 2006 and approximately $25 million in theyear-to-date period and the impact of lower levels of bankruptcy filingsfollowing the enactment of new bankruptcy legislation in October 2005. Weincreased managed loss reserves by recording loss provision greater than netcharge-off of $31 million in the three months ended June 30, 2006 and $135million in the six months ended June 30, 2006. The increase in loss provision isrelated to the Metris acquisition, partly offset by a decrease in loss provisionfor the other portfolios. We decreased managed loss reserves by recording lossprovision less than net charge-off of $3 million in the second quarter of 2005and $26 million in the year-to-date 2005 period. Higher costs and expenses wereto support receivable growth. Managed receivables increased 3 percent to $25.8 billion at June 30, 2006compared to $25.1 billion at March 31, 2006. The increase in the current quarterreflects organic growth in our General Motors, Union Privilege and non-primeportfolios, which was partially offset by the continued decline in certain olderacquired portfolios. Compared to June 30, 2005, managed receivables increased 32percent. The increase from the year-ago period reflects organic growth in ourHSBC branded prime, Union Privilege and non-prime portfolios as well as theacquisition of Metris in December 2005 which increased receivables by $5.3billion. The increase in ROMA in both periods is primarily due to higher net income asdiscussed above. In accordance with FFIEC guidance, our credit card services business adopted aplan to phase in changes to the required minimum monthly payment amount andlimit certain fee billings for non-prime credit card accounts. Theimplementation of these new requirements began in July 2005 with therequirements fully phased in by December 31, 2005. These changes have resultedin lower non-prime credit card fee income in 2006. Roll rate trends in the primebook have been higher than those experienced prior to the changes in minimumpayment, especially in regard to early stage delinquency. These changes willresult in fluctuations in the provision for credit losses in future periods ascredit loss provisions for prime accounts will increase as a result of higherrequired monthly payments while the non-prime provision decreases due to lowerlevels of fees incurred by customers. Although we do not expect this will have amaterial impact on our consolidated results, the impact to the Credit CardServices Segment in 2006 is currently expected to be material. INTERNATIONAL SEGMENT The following table summarizes results for ourInternational segment: INCREASE (DECREASE) --------------------THREE MONTHS ENDED JUNE 30 2006 2005 AMOUNT %-------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net income.............................................. $ 7 $ (14) $ 21 100+%Net interest income..................................... 178 224 (46) (20.5)Securitization related revenue.......................... - 4 (4) (100.0)Fee and other income.................................... 173 190 (17) (8.9)Intersegment revenues................................... 9 4 5 100+Provision for credit losses............................. 123 166 (43) (25.9)Total costs and expenses................................ 213 266 (53) (19.9)Receivables............................................. 9,545 12,581 (3,036) (24.1)Assets.................................................. 10,257 13,492 (3,235) (24.0)Net interest margin, annualized......................... 7.38% 6.93% - -Return on average managed assets........................ .26 (.41) - - 44 HSBC Finance Corporation-------------------------------------------------------------------------------- INCREASE (DECREASE) --------------------SIX MONTHS ENDED JUNE 30 2006 2005 AMOUNT %-------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net income.............................................. $ 14 $ (23) $ 37 100+%Net interest income..................................... 360 453 (93) (20.5)Securitization related revenue.......................... - 14 (14) (100.0)Fee and other income.................................... 328 356 (28) (7.9)Intersegment revenues................................... 16 7 9 100+Provision for credit losses............................. 230 331 (101) (30.5)Total costs and expenses................................ 430 518 (88) (17.0)Net interest margin, annualized......................... 7.60% 6.97 - -Return on average managed assets........................ .27 (.33) - - Our International Segment reported net income in the three and six months endedJune 30, 2006 after losses of $14 million and $23 million in the year-agoperiods. The increase in net income reflects lower total costs and expenses andlower provision for credit losses, partially offset by lower net interestincome, lower fee and other income, and lower securitization related revenue asa result of the December 2005 sale of our U.K. credit card business to HBEU.Applying constant currency rates, which uses the average rate of exchange forthe three and six month periods ended June 30, 2005 to translate current periodnet income, the net income would have been lower by $2 million for both thethree months and year-to-date period ended June 30, 2006. Net interest income decreased during both periods primarily as a result of lowerreceivable levels in our U.K. subsidiary due to the sale of our U.K. credit cardbusiness including $3.1 billion in managed receivables to HBEU as well as lowerreceivable levels resulting from lower retail sales volumes in the U.K. This waspartially offset by higher net interest income in our Canadian operations due tohigher receivable levels. Net interest margin increased in both periods due tothe change in receivable mix resulting from the sale of our U.K credit cardbusiness in December 2005 as well as a decreased cost of funds. Provision forcredit losses decreased in the three and six month periods ended June 30, 2006primarily due to the lower receivable balance as a result of the sale of ourU.K. credit card business. We increased managed loss reserves by recording lossprovision greater than net charge-offs of $14 million for the current quarterand $22 million year-to-date, compared with $53 million and $108 million in theyear-ago periods. Fee and other income and total costs and expenses decreased asa result of the sale of our U.K. credit card business in December 2005. Thedecrease in total costs and expenses was partially offset by increased costsassociated with growth in the Canadian business. Managed receivables of $9.5 billion at June 30, 2006 increased 4 percentcompared to $9.1 billion at March 31, 2006. Receivables at June 30, 2006 werepositively impacted by changes in the foreign exchange rate since March 31,2006. Applying constant currency rates, which uses the exchange rate at March31, 2006 to translate current receivables, the receivable balance would havebeen lower by $527 million at June 30, 2006. Excluding the impact of foreignexchange rates, in the second quarter of 2006, our U.K. based receivableproducts continued to decrease due to lower retail sales volume following a slowdown in retail consumer spending in the U.K. These decreases were partiallyoffset by growth in the receivable portfolio in our Canadian operations. Branchexpansions in Canada in 2005 have resulted in growth in both the secured andunsecured receivable portfolios. Compared to June 30, 2005, managed receivables decreased 24 percent. Applyingconstant currency rates, which uses the exchange rate at June 30, 2005 totranslate current receivables, the receivable balance would have been lower by$514 million at June 30, 2006. Excluding the impact of foreign exchange rates,receivables decreased due to the sale of our U.K. credit card business as wellas lower retail sales volumes in the U.K. These decreases were partially offsetby receivable growth in our Canadian operations as discussed above as well asfrom the successful launch of a MasterCard credit card program in Canada in2005. 45 HSBC Finance Corporation-------------------------------------------------------------------------------- The increase in ROMA for both periods reflects the higher net income asdiscussed above, and lower average managed assets as a result of the sale of ourU.K. credit card business in December 2005. As part of ongoing integration efforts with HSBC, we have begun working withHSBC to determine if funding synergies and management efficiencies could beachieved by transferring our Czech, Hungarian and Slovakian operations to HBEU.As of the date of this filing, a decision has not been made regarding thepotential transfer of these operations. We anticipate that a decision regardingthis potential transfer will be reached in the third quarter of 2006. CREDIT QUALITY-------------------------------------------------------------------------------- CREDIT LOSS RESERVES We maintain credit loss reserves to cover probable losses of principal, interestand fees, including late, overlimit and annual fees. Credit loss reserves arebased 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 ratemigration analysis that estimates the likelihood that a loan will progressthrough the various stages of delinquency, or buckets, and ultimatelycharge-off. This analysis considers delinquency status, loss experience andseverity and takes into account whether loans are in bankruptcy, have beenrestructured or rewritten, or are subject to forbearance, an external debtmanagement plan, hardship, modification, extension or deferment. Our credit lossreserves also take into consideration the loss severity expected based on theunderlying collateral, if any, for the loan in the event of default. Delinquencystatus may be affected by customer account management policies and practices,such as the restructure of accounts, forbearance agreements, extended paymentplans, modification arrangements, external debt management programs, loanrewrites and deferments. If customer account management policies, or changesthereto, shift loans from a "higher" delinquency bucket to a "lower" delinquencybucket, this will be reflected in our roll rate statistics. To the extent thatrestructured accounts have a greater propensity to roll to higher delinquencybuckets, this will be captured in the roll rates. Since the loss reserve iscomputed based on the composite of all of these calculations, this increase inroll rate will be applied to receivables in all respective delinquency buckets,which will increase the overall reserve level. In addition, loss reserves onconsumer receivables are maintained to reflect our judgment of portfolio riskfactors that may not be fully reflected in the statistical roll ratecalculation. Risk factors considered in establishing loss reserves on consumerreceivables include recent growth, product mix, bankruptcy trends, geographicconcentrations, economic conditions, portfolio seasoning, account managementpolicies and practices, current levels of charge-offs and delinquencies, changesin laws and regulations and other items which can affect consumer paymentpatterns on outstanding receivables, such as the impact of natural disasters,such as Katrina and global pandemics. While our credit loss reserves are available to absorb losses in the entireportfolio, we specifically consider the credit quality and other risk factorsfor each of our products. We recognize the different inherent losscharacteristics in each of our products as well as customer account managementpolicies and practices and risk management/collection practices. Charge-offpolicies are also considered when establishing loss reserve requirements toensure the appropriate reserves exist for products with longer charge-offperiods. We also consider key ratios such as reserves to nonperforming loans andreserves as a percentage of net charge-offs in developing our loss reserveestimate. Loss reserve estimates are reviewed periodically and adjustments arereported in earnings when they become known. As these estimates are influencedby factors outside of our control, such as consumer payment patterns andeconomic conditions, there is uncertainty inherent in these estimates, making itreasonably possible that they could change. See Note 3, "Receivables," in theaccompanying consolidated financial statements for receivables by product typeand Note 4, "Credit Loss Reserves," for an analysis of changes in the creditloss reserves. 46 HSBC Finance Corporation-------------------------------------------------------------------------------- The following table summarizes owned basis credit loss reserves: JUNE 30, MARCH 31, JUNE 30, 2006 2006 2005-------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Owned credit loss reserves.................................. $4,649 $4,468 $3,756Reserves as a percent of: Receivables............................................... 3.02% 3.04% 3.16% Net charge-offs(1)........................................ 107.6(2) 120.4(2) 111.3 Nonperforming loans....................................... 106.8 104.7 107.6 --------------- (1) Quarter-to-date, annualized. (2) The acquisition of Metris in December 2005 has positively impacted this ratio. Reserves as a percentage of net charge-offs excluding Metris were 107.2 percent at June 30, 2006 and 112.8 percent at March 31, 2006. Owned credit loss reserves at June 30, 2006 increased as compared to March 31,2006 as the provision for owned credit losses was $168 million higher than netcharge-offs. The increase in owned credit loss reserves in the current quarterreflects higher levels of owned receivables, due in part to lower securitizationlevels, portfolio seasoning and higher delinquency levels in our portfoliodriven by growth, as well as higher loss estimates due to the deterioratingperformance in the 2005 second lien and portions of the 2005 first lien realestate secured originations in our Mortgage Services business. This increase waspartially offset by a reduction in the estimated loss exposure resulting fromKatrina and the continued shift in mix to higher levels of secured receivables. Owned credit loss reserves at June 30, 2006 increased as compared to June 30,2005 resulting from higher levels of owned receivables, including lowersecuritization levels, deterioration in the performance of certain 2005originations at our Mortgage Services business as discussed above, the impact ofKatrina, anticipated impacts from minimum monthly payment changes, and theMetris acquisition. These increases were partially offset by significantly lowerpersonal bankruptcy levels, the benefits of a stable U.S. economy, including lowunemployment levels, and the impact of the sale of our U.K. credit card businessin December 2005 which decreased credit loss reserves by $104 million. Beginning in 2004 and continuing in 2005, we have changed the mix in our loanportfolio to receivables that have a lower loss rate and consequently are pricedat a lower yield, particularly real estate secured and auto finance receivables.Reserves as a percentage of receivables at June 30, 2006 were lower than atMarch 31, 2006 and June 30, 2005 as a result of recent portfolio growth, ahigher mix of real estate secured receivables and lower levels of personalbankruptcy filings in the United States in the first six months of 2006. Reserves as a percentage of net charge-offs at June 30, 2006 decreased fromMarch 31, 2006. The June 30, 2006 and March 31, 2006 ratios were impacted by theacquisition of Metris in December 2005 as more fully discussed below. Excludingthe Metris acquisition in both periods, reserves as a percentage of netcharge-offs decreased 560 basis points. The decrease is attributable to highercharge-off levels in the second quarter due to the seasoning of our portfolios,particularly real estate secured. Reserves as a percentage of receivables andreserves as a percentage of nonperforming loans are consistent with the priorquarter. 47 HSBC Finance Corporation-------------------------------------------------------------------------------- For securitized receivables, we also record a provision for estimated probablelosses that we expect to incur under the recourse provisions. The followingtable summarizes managed credit loss reserves: JUNE 30, MARCH 31, JUNE 30, 2006 2006 2005-------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Managed credit loss reserves................................ $4,740 $4,629 $4,281Reserves as a percent of: Receivables............................................... 3.04% 3.09% 3.35% Net charge-offs(1)........................................ 105.7(2) 116.9(2) 104.1 Nonperforming loans....................................... 106.6 105.4 110.2 --------------- (1) Quarter-to-date, annualized. (2) The acquisition of Metris in December 2005 has positively impacted this ratio. Reserves as a percentage of net charge-offs excluding Metris were 105.0 percent at June 30, 2006 and 109.7 percent at March 31, 2006. Managed credit loss reserves at June 30, 2006 also increased compared to March31, 2006 and June 30, 2005 due to the increases in owned credit loss reservesdiscussed above and the impact of lower reserves on securitized receivables as aresult of run-off. Securitized receivables of $1.9 billion at June 30, 2006decreased from $3.1 billion at March 31, 2006 and $9.0 billion at June 30, 2005. See "Basis of Reporting" for additional discussion on the use of non-GAAPfinancial measures and "Reconciliations to GAAP Financial Measures" forquantitative reconciliations of the non-GAAP financial measures to thecomparable GAAP basis financial measure. DELINQUENCY - OWNED BASIS The following table summarizes two-months-and-over contractual delinquency (as apercent of consumer receivables): JUNE 30, MARCH 31, JUNE 30, 2006 2006 2005-------------------------------------------------------------------------------------------------- Real estate secured......................................... 2.52% 2.46% 2.56%Auto finance................................................ 2.25 1.65 2.08MasterCard/Visa............................................. 4.16 4.35 4.14Private label............................................... 5.42 5.50 4.91Personal non-credit card.................................... 8.93 8.86 8.84 ---- ---- ----Total....................................................... 3.68% 3.62% 3.73% ==== ==== ==== Total owned delinquency increased $340 million and the two-months-and-overcontractual delinquency ratio increased 6 basis points compared to the priorquarter. The increase in the delinquency ratio was driven by higher real estatesecured delinquency levels at our Mortgage Services business due to thedeteriorating performance of certain 2005 originations as previously discussed.These increases were partially offset by recent strong receivable originationsand the continuing stable economy in the United States. The increase in thedelinquency ratio of our auto finance portfolio reflects seasonal patternspartially offset by receivable growth. The decrease in the MasterCard/Visadelinquency ratio primarily reflects the impact of the minimum monthly paymentchanges on our non-prime portfolios as the lower fee assessments have reducedthe delinquent balances outstanding. These improvements were partially offset bythe seasoning of the Metris portfolio purchased in December 2005 as furtherdescribed below. The decrease in the delinquency ratio in our private labelreceivables (which primarily consists of our foreign private label portfoliothat was not sold to HBUS in December 2004) reflects increased receivables inour Canadian operations. The increase in the personal non-credit carddelinquency ratio reflects the deterioration of the financial circumstances ofour 48 HSBC Finance Corporation-------------------------------------------------------------------------------- customers across the U.K, partially offset by lower bankruptcy levels and thecontinued stable economic conditions in the U.S. As noted above, the MasterCard/Visa delinquencies ratios in 2006 reflect thenormal seasoning of the Metris portfolio purchased in December 2005. Thereceivables acquired as part of our acquisition of Metris were subject to therequirements of Statement of Position 03-3, "Accounting for Certain Loans orDebt Securities Acquired in a Transfer" ("SOP 03-3"). In accordance with SOP03-3, our investment in any acquired receivables which showed evidence of creditdeterioration at the time of acquisition was based on the net cash flowsexpected to be collected. The negative impacts to delinquency and charge-offreflect the seasoning of the receivables we acquired which did not show anyevidence of credit deterioration at the time of the acquisition, a portion ofwhich, as expected, have now become delinquent and have begun to charge-off. Compared to the year-ago period, total delinquency ratio decreased 5 basispoints. The improvements are generally the result of portfolio growth, thebenefit of a stable U.S. economy including low unemployment levels, and lowerbankruptcy levels due to the new bankruptcy legislation enacted in 2005,partially offset by higher delinquency at our Mortgage Services business as morefully discussed above. NET CHARGE-OFFS OF CONSUMER RECEIVABLES - OWNED BASIS The following table summarizes net charge-offs of consumer receivables (as apercent, annualized, of average consumer receivables): JUNE 30, MARCH 31, JUNE 30, 2006 2006 2005-------------------------------------------------------------------------------------------------- Real estate secured......................................... .97% .75% .78%Auto finance................................................ 2.43 3.50 2.61MasterCard/Visa............................................. 5.80 4.00 6.93Private label............................................... 5.29 5.62 4.36Personal non-credit card.................................... 7.92 7.94 7.77 ---- ---- ----Total....................................................... 2.88% 2.58% 2.93% ==== ==== ====Real estate secured net charge-offs and REO expense as a percent of average real estate secured receivables........ 1.04% .89% .84% Net charge-offs as a percent, annualized, of average consumer receivablesincreased compared to the quarter ended March 31, 2006 primarily due to higherlosses in our real estate secured and MasterCard/Visa portfolios. Our realestate secured portfolio experienced an increase in net charge-offs reflectingseasoning of the growing portfolio as well as higher than expected losses oncertain 2005 originations in our Mortgage Services business. We anticipate thenet charge-off ratio for our real estate secured portfolio to increase throughthe remainder of 2006 as a result of the higher delinquency levels we areexperiencing in these 2005 loans. The net charge-off ratio for ourMasterCard/Visa portfolio increased 180 basis points as compared to the priorquarter primarily due to the expected seasoning of the receivables acquired inour acquisition of Metris which were subject to the reporting requirements ofSOP 03-3 as discussed above. Excluding the impact of the Metris portfolio inboth periods, the net charge-off ratio for our MasterCard/Visa portfolioincreased 71 basis points at June 30, 2006 as compared to March 31, 2006 due tothe increase in bankruptcy filings in the second quarter of 2006 followinghistorically low levels of bankruptcy filings subsequent to the new bankruptcylegislation in the U.S. as discussed above. The decrease in auto finance netcharge-offs reflects a seasonal pattern related to higher charge-offs in thefirst quarter. The decrease in net charge-offs for the private label portfolioreflects higher levels of average receivables in our Canadian operations. Total net charge-offs for the current quarter decreased from the June 2005quarter primarily due to a decrease in personal bankruptcy filings in ourMasterCard/Visa portfolio following the October 2005 enactment of new bankruptcylegislation in the United States. This was partially offset by higher netcharge-offs in our real estate 49 HSBC Finance Corporation-------------------------------------------------------------------------------- secured and personal non-credit card portfolios due to portfolio seasoning andin the case of our real estate secured portfolio, higher than expected losses oncertain 2005 loans as explained above. OWNED NONPERFORMING ASSETS JUNE 30, MARCH 31, JUNE 30, 2006 2006 2005-------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Nonaccrual receivables...................................... $3,595 $3,525 $3,008Accruing consumer receivables 90 or more days delinquent.... 758 740 482Renegotiated commercial loans............................... 1 1 1 ------ ------ ------Total nonperforming receivables............................. 4,354 4,266 3,491Real estate owned........................................... 620 563 459 ------ ------ ------Total nonperforming assets.................................. $4,974 $4,829 $3,950 ====== ====== ======Credit loss reserves as a percent of nonperforming receivables............................................... 106.8% 104.7% 107.6% Compared to March 31, 2006, the increase in total nonperforming assets isprimarily due to seasonal patterns in delinquency in our auto receivables andincreased real estate owned. Compared to June 2005, the increase innonperforming assets is primarily due to the growth in receivables we haveexperienced and the seasoning of the Metris portfolio. Consistent with industrypractice, accruing consumer receivables 90 or more days delinquent includesdomestic MasterCard/Visa receivables. ACCOUNT MANAGEMENT POLICIES AND PRACTICES Our policies and practices for the collection of consumer receivables, includingour customer account management policies and practices, permit us to reset thecontractual delinquency status of an account to current, based on indicia orcriteria which, in our judgment, evidence continued payment probability. Suchpolicies and practices vary by product and are designed to manage customerrelationships, maximize collection opportunities and avoid foreclosure orrepossession if reasonably possible. If the account subsequently experiencespayment defaults, it will again become contractually delinquent. The tables below summarize approximate restructuring statistics in our managedbasis domestic portfolio. We report our restructuring statistics on a managedbasis only because the receivables that we securitize are subject tounderwriting standards comparable to our owned portfolio, are generally servicedand collected without regard to ownership and result in a similar credit lossexposure for us. As previously reported, in prior periods we used certainassumptions and estimates to compile our restructure statistics. The systemiccounters used to compile the information presented below exclude from thereported statistics loans that have been reported as contractually delinquentbut have been reset to a current status because we have determined that theloans should not have been considered delinquent (e.g., payment applicationprocessing errors). When comparing restructuring statistics from differentperiods, the fact that our restructure policies and practices will change overtime, that exceptions are made to those policies and practices, and that ourdata capture methodologies have been enhanced, should be taken into account. 50 HSBC Finance Corporation-------------------------------------------------------------------------------- TOTAL RESTRUCTURED BY RESTRUCTURE PERIOD - DOMESTIC PORTFOLIO(1)(MANAGED BASIS) JUNE 30, MARCH 31, JUNE 30, 2006 2006 2005--------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Never restructured.......................................... 90.0% 89.7% 88.0%Restructured: Restructured in the last 6 months......................... 3.7 4.0 4.2 Restructured in the last 7-12 months...................... 2.6 2.4 3.3 Previously restructured beyond 12 months.................. 3.7 3.9 4.5 ------- ------- ------- Total ever restructured(2)................................ 10.0 10.3 12.0 ------- ------- -------Total....................................................... 100.0% 100.0% 100.0% ======= ======= =======TOTAL RESTRUCTURED BY PRODUCT - DOMESTIC PORTFOLIO(1)(MANAGED BASIS)Real estate secured......................................... $ 8,449 $ 8,395 $ 8,277Auto finance................................................ 1,735 1,712 1,585MasterCard/Visa............................................. 928 937 526Private label(3)............................................ 27 26 24Personal non-credit card.................................... 3,421 3,411 3,396 ------- ------- -------Total....................................................... $14,560 $14,481 $13,808 ======= ======= =======(AS A PERCENT OF MANAGED RECEIVABLES)Real estate secured......................................... 9.3% 9.7% 12.0%Auto finance................................................ 14.3 14.5 14.9MasterCard/Visa............................................. 3.6 3.8 2.7Private label(3)............................................ 7.5 7.3 7.1Personal non-credit card.................................... 19.5 19.9 21.6 ------- ------- -------Total(2).................................................... 10.0% 10.3% 12.0% ======= ======= ======= --------------- (1) Excludes foreign businesses, commercial and other. (2) Total including foreign businesses was 9.7 percent at June 30, 2006, 10.1 percent at March 31, 2006, and 11.3 percent at June 30, 2005. (3) Only reflects consumer lending retail sales contracts which have historically been classified as private label. All other domestic private label receivables were sold to HBUS in December 2004. See "Credit Quality Statistics" for further information regarding owned basisand managed basis delinquency, charge-offs and nonperforming loans. The amount of domestic and foreign managed receivables in forbearance,modification, credit card services approved consumer credit counselingaccommodations, rewrites or other customer account management techniques forwhich we have reset delinquency and that is not included in the restructured ordelinquency statistics was approximately $.4 billion or .3 percent of managedreceivables at June 30, 2006, March 31, 2006 and June 30, 2005. In addition to the above, we granted an initial 30 or 60 day payment deferral(based on product) to customers living in the Katrina FEMA designated IndividualAssistance disaster areas. This deferral was extended for a period of up to 90days or longer in certain cases based on a customer's specific circumstances,consistent with our natural disaster policies. In certain cases thesearrangements have resulted in a customer's delinquency 51 HSBC Finance Corporation-------------------------------------------------------------------------------- status being reset by 30 days or more. These extended payment arrangementsaffected approximately $1.1 billion of managed receivables and are not reflectedas restructures in the table above or included in the other customer accountmanagement techniques described in the paragraph above unless the accountssubsequently qualify for restructuring under our restructure policies andprocedures as described in the 2005 Form 10-K. LIQUIDITY AND CAPITAL RESOURCES-------------------------------------------------------------------------------- We continue to focus on balancing our use of affiliate and third party fundingsources to minimize funding expense while managing liquidity. During the secondquarter of 2006, we supplemented unsecured debt issuances with proceeds from thecontinuing sale of newly originated domestic private label receivables to HBUS,debt issued to affiliates, secured financings and higher levels of commercialpaper. Because we are a subsidiary of HSBC, our credit ratings have improved andour credit spreads relative to Treasuries have tightened compared to those weexperienced during the months leading up to the announcement of our acquisitionby HSBC. Primarily as a result of tightened credit spreads and improved fundingavailability, we recognized cash funding expense savings of approximately $439million during the six months ended June 30, 2006 (approximately $225 million inthe three months ended June 30, 2006) and approximately $252 million during thesix months ended June 30, 2005 (approximately $132 million in the three monthsended June 30, 2005) compared to the funding costs we would have incurred usingaverage spreads and funding mix from the first half of 2002. These tightenedcredit spreads in combination with the issuance of HSBC Finance Corporation debtand other funding synergies including asset transfers and debt underwriting feespaid to HSBC affiliates have enabled HSBC to realize a pre-tax 2006 run rate forannual cash funding expense savings in excess of $1 billion per year. In the sixmonths ended June 30, 2006, the cash funding expense savings realized by HSBCtotaled approximately $571 million. 52 HSBC Finance Corporation-------------------------------------------------------------------------------- Debt due to affiliates and other HSBC related funding is summarized in thefollowing table: JUNE 30, DECEMBER 31, 2006 2005 -------- ------------------------------------------------------------------------------------------------- (IN BILLIONS) Debt issued to HSBC subsidiaries: Drawings on bank lines in the U.K and Europe.............. $ 4.3 $ 4.2 Term debt................................................. 11.1 11.0 Preferred securities issued by Household Capital Trust VIII to HSBC........................................... .3 .3 ----- ----- Total debt outstanding to HSBC subsidiaries............... 15.7 15.5 ----- -----Debt outstanding to HSBC clients: Euro commercial paper..................................... .3 3.2 Term debt................................................. 1.3 1.3 ----- ----- Total debt outstanding to HSBC clients.................... 1.6 4.5Cash received on bulk and subsequent sales of domestic private label credit card receivables to HBUS, net (cumulative).............................................. 15.7 15.7Real estate secured receivable activity with HBUS: 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 HBUS................................................... (4.1) (3.3) ----- -----Total real estate secured receivable activity with HBUS..... 3.8 4.6 ----- -----Cash received from sale of U.K. credit card business to HBEU (cumulative).............................................. 2.7 2.6Capital contribution by HINO subsequent to our acquisition by HSBC in March 2003 (cumulative)........................ 1.2(1) 1.2(1) ----- -----Total HSBC related funding.................................. $40.7 $44.1 ===== ===== --------------- (1) This capital contribution was made in December 2005 in connection with the acquisition of Metris. Funding from HSBC, including debt issuances to HSBC subsidiaries and clients,represented 12 percent of our total managed debt at June 30, 2006 and 15 percentat December 31, 2005. The decrease in funding from HSBC is due to the suspensionof certain of our Euro commercial paper programs in the second quarter of 2006due to pending changes to the settlement process. These programs will bereinstated during the third quarter of 2006. Cash proceeds from the December 2005 sale of our managed basis U.K. credit cardreceivables to HBEU of $2.6 billion were used partially to pay down drawings onbank lines from HBEU in the U.K. and partially to fund operations. At June 30, 2006, we had a commercial paper back stop credit facility of $2.5billion from HSBC supporting domestic issuances and a revolving credit facilityof $5.3 billion from HBEU to fund our operations in the U.K. There have been nodraws on the domestic line. At June 30, 2006, $4.3 billion was outstanding underthe U.K. lines. We had derivative contracts with a notional value of $94.9billion, or approximately 92 percent of total derivative contracts, outstandingwith HSBC affiliates at June 30, 2006. At December 31, 2005, we had derivativecontracts with a notional value of $72.2 billion, or approximately 87 percent oftotal derivative contracts, outstanding with HSBC affiliates. SECURITIES AND OTHER SHORT-TERM INVESTMENTS Securities totaled $4.4 billion atJune 30, 2006 and $4.1 billion at December 31, 2005. Securities purchased underagreements to resell totaled $6 million at June 30, 2006 and $78 million atDecember 31, 2005. Interest bearing deposits with banks totaled $448 million atJune 30, 2006 and $384 million at December 31, 2005. 53 HSBC Finance Corporation-------------------------------------------------------------------------------- COMMERCIAL PAPER, BANK AND OTHER BORROWINGS totaled $13.4 billion at June 30,2006 and $11.4 billion at December 31, 2005. The increase at June 30, 2006 isdue to a decision to carry higher commercial paper balances in accordance withour funding strategy. Included in this total was outstanding Euro commercialpaper sold to customers of HSBC of $271 million at June 30, 2006 and $3.2billion at December 31, 2005. The lower levels of Euro commercial paper sold tocustomers of HSBC at June 30, 2006 is due to the suspension of certain of ourEuro commercial paper programs in the second quarter of 2006 due to pendingchanges to the settlement process. These programs will be reinstated during thethird quarter of 2006. LONG TERM DEBT (with original maturities over one year) increased to $115.6billion at June 30, 2006 from $105.2 billion at December 31, 2005. As part ofour overall liquidity management strategy, we continue to extend the maturity ofour liability profile. Significant third party issuances during the six monthsended June 30, 2006 included the following: - $5.8 billion of domestic and foreign medium-term notes - $3.5 billion of foreign currency-denominated bonds - $.9 billion of InterNotes(SM) (retail-oriented medium-term notes) - $4.0 billion of global debt - $5.9 billion of securities backed by real estate secured, auto finance, MasterCard/Visa 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 issuedto Household Capital Trust VI with an outstanding principal balance of $206million. SELECTED CAPITAL RATIOS are summarized in the following table: JUNE 30, DECEMBER 31, 2006 2005------------------------------------------------------------------------------------- TETMA(1).................................................... 7.67% 7.56%TETMA + Owned Reserves(1)................................... 10.53 10.55Tangible common equity to tangible managed assets(1)........ 6.41 6.07Common and preferred equity to owned assets................. 12.10 12.43Excluding purchase accounting adjustments: TETMA(1).................................................. 8.47 8.52 TETMA + Owned Reserves(1)................................. 11.33 11.51 Tangible common equity to tangible managed assets(1)...... 7.21 7.02 --------------- (1) TETMA, TETMA + Owned Reserves and tangible common equity to tangible managed assets represent non-GAAP financial ratios that are used by HSBC Finance Corporation management and certain rating agencies to evaluate capital adequacy and may differ from similarly named measures presented by other companies. See "Basis of Reporting" for additional discussion on the use of non-GAAP financial measures and "Reconciliations to GAAP Financial Measures" for quantitative reconciliations to the equivalent GAAP basis financial measure. In 2006, Standard & Poor's Corporation raised the senior debt rating for HSBCFinance Corporation from A to AA-, raised the senior subordinated debt ratingfrom A- to A+, raised the commercial paper rating from A-1 to A-1+, and raisedthe Series B preferred stock rating from BBB+ to A. Also during 2006, Moody'sInvestors Service raised the rating for all of our debt with the Senior DebtRating for HSBC Finance Corporation raised from A1 to Aa3 and the Series Bpreferred stock rating for HSBC Finance Corporation from A3 to A2. Ourshort-term rating was also affirmed at Prime-1. SECURITIZATIONS AND SECURED FINANCINGS Securitizations (collateralized fundingtransactions structured to receive sale treatment under Statement of FinancialAccounting Standards No. 140, "Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities, a Replacement of FASBStatement No. 125," ("SFAS No. 140")) and secured financings (collateralizedfunding transactions which do not receive sale treatment under SFAS No. 140) ofconsumer receivables have been a source of funding 54 HSBC Finance Corporation-------------------------------------------------------------------------------- and liquidity for us. Securitizations and secured financings have been used tolimit our reliance on the unsecured debt markets. In a securitization, a designated pool of non-real estate secured consumerreceivables is removed from the balance sheet and transferred through a limitedpurpose financing subsidiary to an unaffiliated trust. This unaffiliated trustis a qualifying special purpose entity ("QSPE") as defined by SFAS No. 140 and,therefore, is not consolidated. The QSPE funds its receivable purchase throughthe issuance of securities to investors, entitling them to receive specifiedcash flows during the life of the securities. The receivables transferred to theQSPE serve as collateral for the securities. At the time of sale, aninterest-only strip receivable is recorded, representing the present value ofthe cash flows we expect to receive over the life of the securitizedreceivables, net of estimated credit losses and debt service. Under the terms ofthe securitizations, we receive annual servicing fees on the outstanding balanceof the securitized receivables and the rights to future residual cash flows onthe sold receivables after the investors receive their contractual return. Cashflows related to the interest-only strip receivables and servicing thereceivables are collected over the life of the underlying securitizedreceivables. In a secured financing, a designated pool of receivables is conveyed to a whollyowned limited purpose subsidiary which in turn transfers the receivables to atrust which sells interests to investors. Repayment of the debt issued by thetrust is secured by the receivables transferred. The transactions are structuredas secured financings under SFAS No. 140. Therefore, the receivables and theunderlying debt of the trust remain on our balance sheet. We do not recognize again in a secured financing transaction. Because the receivables and the debtremain on our balance sheet, revenues and expenses are reported consistentlywith our owned balance sheet portfolio. Using this source of funding results insimilar cash flows as issuing debt through alternative funding sources. Securitizations are treated as secured financings under IFRSs and previouslyunder U.K. GAAP. In order to align our accounting treatment with that of HSBCinitially under U.K. GAAP and now under IFRSs, we began to structure all newcollateralized funding transactions as secured financings in the third quarterof 2004. However, because existing public MasterCard and Visa credit cardtransactions were structured as sales to revolving trusts that requirereplenishments of receivables to support previously issued securities,receivables will continue to be sold to these trusts and the resultingreplenishment gains recorded until the revolving periods end, the last of whichis currently projected to occur in the fourth quarter of 2007. We will continueto replenish at reduced levels, certain personal non-credit card and MasterCard/Visa securities privately issued to conduits and record the resultingreplenishment gains for a period of time in order to manage liquidity. Since oursecuritized receivables have varying lives, it will take time for thesereceivables to pay-off and the related interest-only strip receivables to bereduced to zero. The termination of sale treatment on new collateralized fundingactivity reduced our reported net income under U.S. GAAP. There was no impact,however, on cash received. Because we believe the market for securities backedby receivables is a reliable, efficient and cost-effective source of funds, wewill continue to use secured financings of consumer receivables as a source ofour funding and liquidity. 55 HSBC Finance Corporation-------------------------------------------------------------------------------- There were no securitizations (excluding replenishments of certificateholderinterests) during the three or six months ended June 30, 2006 or June 30, 2005.Secured financings are summarized in the following table: THREE MONTHS ENDED JUNE 30, 2006 2005----------------------------------------------------------------------------- (IN MILLIONS) SECURED FINANCINGS:Real estate secured......................................... $ - $ 919Auto finance................................................ 944 998MasterCard/Visa............................................. 985 500Personal non-credit card.................................... 2,500 - ------ ------Total....................................................... $4,429 $2,417 ====== ====== SIX MONTHS ENDED JUNE 30, 2006 2005----------------------------------------------------------------------------- (IN MILLIONS) SECURED FINANCINGS:Real estate secured......................................... $ 350 $ 919Auto finance................................................ 944 998MasterCard/Visa............................................. 2,105 500Personal non-credit card.................................... 2,500 - ------ ------Total....................................................... $5,899 $2,417 ====== ====== Our securitized receivables totaled $1.9 billion at June 30, 2006 compared to$4.1 billion at December 31, 2005. As of June 30, 2006, outstanding securedfinancings of $17.3 billion were secured by $27.2 billion of real estatesecured, auto finance, MasterCard/Visa and personal non-credit card receivables.Secured financings of $15.1 billion at December 31, 2005 were secured by $21.8billion of real estate secured, auto finance and MasterCard/Visa receivables. AtJune 30, 2006, securitizations structured as sales represented 1 percent andsecured financings represented 12 percent of the funding associated with ourmanaged funding portfolio. At December 31, 2005, securitizations structured assales represented 3 percent and secured financings represented 11 percent of thefunding associated with our managed funding portfolio. COMMITMENTS We also enter into commitments to meet the financing needs of ourcustomers. In most cases, we have the ability to reduce or eliminate these openlines of credit. As a result, the amounts below do not necessarily representfuture cash requirements: JUNE 30, DECEMBER 31, 2006 2005------------------------------------------------------------------------------------- (IN BILLIONS) Private label, MasterCard and Visa credit cards............. $180.7 $176.2Other consumer lines of credit.............................. 7.1 15.0 ------ ------Open lines of credit(1)..................................... $187.8 191.2 ====== ====== --------------- (1) Includes an estimate for acceptance of credit offers mailed to potential customers prior to June 30, 2006 and December 31, 2005. 56 HSBC Finance Corporation-------------------------------------------------------------------------------- 2006 FUNDING STRATEGY Our current estimated domestic funding needs and sourcesfor 2006 are summarized in the table that follows: ACTUAL ESTIMATED JANUARY 1 JULY 1 THROUGH THROUGH ESTIMATED JUNE 30, DECEMBER 31, FULL YEAR 2006 2006 2006-------------------------------------------------------------------------------------------------- (IN BILLIONS) FUNDING NEEDS: Net asset growth.......................................... $12 $ 1 - 11 $13 - 23 Commercial paper, term debt and securitization maturities............................................. 21 9 - 15 30 - 36 Other..................................................... 0 1 - 3 1 - 3 --- -------- -------- Total funding needs....................................... $33 $11 - 29 $44 - 62 === ======== ========FUNDING SOURCES: External funding, including commercial paper.............. $32 $11 - 25 $43 - 57 HSBC and HSBC subsidiaries................................ 1 0 - 4 1 - 5 --- -------- -------- Total funding sources..................................... $33 $11 - 29 $44 - 62 === ======== ======== RISK MANAGEMENT-------------------------------------------------------------------------------- CREDIT RISK There have been no significant changes in our approach to creditrisk management since December 31, 2005. At June 30, 2006, we had derivative contracts with a notional value ofapproximately $103.6 billion, including $94.9 billion outstanding with HSBCaffiliates. Most swap agreements, both with unaffiliated and affiliated thirdparties, require that payments be made to, or received from, the counterpartywhen the fair value of the agreement reaches a certain level. Generally,third-party swap counterparties provide collateral in the form of cash which isrecorded in our balance sheet as other assets or derivative related liabilitiesand totaled $110 million at June 30, 2006 and $91 million at December 31, 2005.When the fair value of our agreements with affiliate counterparties requires usto post collateral, it is provided in the form of cash which is recorded on ourbalance sheet in other assets. Beginning in the second quarter of 2006, when thefair value of our agreements with affiliate counterparties requires the postingof collateral by the affiliate, it is provided in the form of cash. Previously,the posting of collateral by affiliates was provided in the form of securities,which were not recorded on our balance sheet. At June 30, 2006 and December 31,2005, the fair value of our agreements with affiliate counterparties was belowthe level requiring the posting of collateral. LIQUIDITY RISK There have been no significant changes in our approach toliquidity risk since December 31, 2005. MARKET RISK HSBC Group has certain limits and benchmarks that serve asguidelines in determining the appropriate levels of interest rate risk. One suchlimit 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 pointmovement in all interest rates. Our PVBP limit as of June 30, 2006 was $2million, which includes the risk associated with hedging instruments. Thus, fora one basis point change in interest rates, the policy dictates that the valueof the balance sheet shall not increase or decrease by more than $2 million. Asof June 30, 2006 we had a PVBP position of $1.3 million reflecting the impact ofa one basis point increase in interest rates. At December 31, 2005, we had aPVBP position of less than $1 million reflecting the impact of a one basis pointincrease in interest rates. 57 HSBC Finance Corporation-------------------------------------------------------------------------------- While the total PVBP position will not change as a result of the loss of hedgeaccounting following our acquisition by HSBC, the following table shows thecomponents of PVBP: JUNE 30, DECEMBER 31, 2006 2005------------------------------------------------------------------------------------- (IN MILLIONS) Risk related to our portfolio of ineffective hedges......... $(1.9) $(1.4)Risk for all other remaining assets and liabilities......... 3.2 2.3 ----- -----Total PVBP risk............................................. $ 1.3 $ .9 ===== ===== We also monitor the impact that an immediate hypothetical increase or decreasein interest rates of 25 basis points applied at the beginning of each quarterover a 12 month period would have on our net interest income assuming a growingbalance sheet and the current interest rate risk profile. The following tablesummarizes such estimated impact: JUNE 30, 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......... $201 $213Increase 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......... $ 80 $120 These estimates include both the net interest income impact of the derivativepositions we have entered into which are considered to be effective hedges underSFAS No. 133 and the impact of economic hedges of certain underlying debtinstruments which do not qualify for hedge accounting as previously discussed,as if they were effective hedges under SFAS No. 133. These estimates also assumewe would not take any corrective actions in response to interest rate movementsand, therefore, exceed what most likely would occur if rates were to change bythe amount indicated. As part of our overall risk management strategy to reduce earnings volatility,in 2005 a significant number of our derivatives which had not previouslyqualified for hedge accounting under SFAS No. 133, have been designated aseffective hedges using the long-haul method of accounting, and certain otherinterest rate swaps were terminated. This will significantly reduce thevolatility of the mark-to-market on the previously non-qualifying derivativeswhich have been designated as effective hedges going forward, but will result inthe recording of ineffectiveness under the long-haul method of accounting underSFAS No. 133. In order to further reduce earnings volatility that wouldotherwise result from changes in interest rates, we continue to evaluate thesteps required to regain hedge accounting treatment under SFAS No. 133 for theremaining swaps which do not currently qualify for hedge accounting. Thesederivatives remain economic hedges of the underlying debt instruments. We willcontinue to manage our total interest rate risk on a basis consistent with therisk management process employed since the acquisition. INSURANCE RISK The principal insurance risk we face is that the cost of claimscombined with acquisition and administration costs may exceed the aggregateamount of premiums received and investment income earned. We manage ourinsurance risks through the application of formal pricing, underwriting, andclaims procedures. These procedures are also designed to ensure compliance withregulations. OPERATIONAL RISK There has been no significant change in our approach tooperational risk management since December 31, 2005. 58 HSBC FINANCE CORPORATION RECONCILIATIONS TO GAAP FINANCIAL MEASURES THREE MONTHS ENDED SIX MONTHS ENDED ------------------- ------------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 2006 2005 2006 2005---------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) RETURN ON AVERAGE ASSETS:Net income......................................... $ 568 $ 472 $ 1,456 $ 1,098 ======== ======== ======== ========Average assets: Owned basis...................................... $167,505 $134,834 $165,097 $133,394 Serviced with limited recourse................... 2,620 10,203 3,062 11,543 -------- -------- -------- -------- Managed basis.................................... $170,125 $145,037 $168,159 $144,937 ======== ======== ======== ========Return on average owned assets..................... 1.36% 1.40% 1.76% 1.65%Return on average managed assets................... 1.34 1.30 1.73 1.52RETURN ON AVERAGE COMMON SHAREHOLDER'S EQUITY:Net income......................................... $ 568 $ 472 $ 1,456 $ 1,098Dividends on preferred stock....................... (9) (19) (18) (37) -------- -------- -------- --------Net income available to common shareholders........ $ 559 $ 453 $ 1,438 $ 1,061 ======== ======== ======== ========Average common shareholder's equity................ $ 19,975 $ 16,671 $ 19,677 $ 16,421Return on average common shareholder's equity...... 11.19% 10.87% 14.62% 12.92%NET INTEREST INCOME:Net interest income: Owned basis...................................... $ 2,549 $ 2,035 $ 5,013 $ 3,923 Serviced with limited recourse................... 67 249 170 581 -------- -------- -------- -------- Managed basis.................................... $ 2,616 $ 2,284 $ 5,183 $ 4,504 ======== ======== ======== ========Average interest-earning assets: Owned basis...................................... $153,021 $119,523 $150,144 $116,254 Serviced with limited recourse................... 2,620 10,203 3,062 11,543 -------- -------- -------- -------- Managed basis.................................... $155,641 $129,726 $153,206 $127,797 ======== ======== ======== ========Owned basis net interest margin.................... 6.66% 6.81% 6.68% 6.75%Managed basis net interest margin.................. 6.72 7.04 6.77 7.05MANAGED BASIS RISK ADJUSTED REVENUE:Net interest income................................ $ 2,616 $ 2,284 $ 5,183 $ 4,504Other revenues..................................... 1,103 976 2,459 2,172Excluding: Securitization related revenue................... 71 217 125 525 Mark-to-market on derivatives which do not qualify as effective hedges and ineffectiveness associated with qualifying hedges under SFAS No. 133..................... 9 (58) (44) (303) Net charge-offs.................................. (1,121) (1,028) (2,111) (2,146) -------- -------- -------- --------Risk adjusted revenue.............................. $ 2,678 $ 2,391 $ 5,612 $ 4,752 ======== ======== ======== ========Average interest-earning assets.................... $155,641 $129,726 $153,206 $127,797Managed basis risk adjusted revenue................ 6.88% 7.37 7.33% 7.44 59 HSBC FINANCE CORPORATION RECONCILIATIONS TO GAAP FINANCIAL MEASURES THREE MONTHS ENDED SIX MONTHS ENDED ------------------------------- ------------------- JUNE 30, MARCH 31, JUNE 30, JUNE 30, JUNE 30, 2006 2006 2005 2006 2005----------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) CONSUMER NET CHARGE-OFF RATIO:Consumer net charge-offs: Owned basis........................... $ 1,079 $ 928 $ 844 $ 2,007 $ 1,700 Serviced with limited recourse........ 41 62 184 103 439 -------- -------- -------- -------- -------- Managed basis......................... $ 1,120 $ 990 $ 1,028 $ 2,110 $ 2,139 ======== ======== ======== ======== ========Average consumer receivables: Owned basis........................... $149,933 $143,893 $115,354 $146,913 $112,141 Serviced with limited recourse........ 2,620 3,505 10,203 3,062 11,543 -------- -------- -------- -------- -------- Managed basis......................... $152,553 $147,398 $125,557 $149,975 $123,684 ======== ======== ======== ======== ========Owned basis consumer net charge-off ratio................................. 2.88% 2.58% 2.93% 2.73% 3.03%Managed basis consumer net charge-off ratio................................. 2.94 2.69 3.28 2.81 3.46 ======== ======== ======== ======== ========RESERVES AS A PERCENT OF NET CHARGE-OFFSLoss reserves: Owned basis........................... $ 4,649 $ 4,468 $ 3,756 $ 4,649 $ 3,756 Serviced with limited recourse........ 91 161 525 91 525 -------- -------- -------- -------- -------- Managed basis......................... $ 4,740 $ 4,629 $ 4,281 $ 4,740 $ 4,281 ======== ======== ======== ======== ========Net charge-offs: Owned basis........................... $ 1,080 $ 928 $ 844 $ 2,008 $ 1,707 Serviced with limited recourse........ 41 62 184 103 439 -------- -------- -------- -------- -------- Managed basis......................... $ 1,121 $ 990 $ 1,028 $ 2,111 $ 2,146 ======== ======== ======== ======== ========Owned basis reserves as a percent of net charge-offs........................... 107.6% 120.4% 111.3% 115.8% 110.0%Managed basis reserves as a percent of net charge-offs....................... 105.7 116.9 104.1 112.3 99.7EFFICIENCY RATIO:Total costs and expenses less policyholders' benefits............... $ 1,496 $ 1,532 $ 1,375 $ 3,028 $ 2,831 ======== ======== ======== ======== ========Net interest income and other revenues less policyholders' benefits: Owned basis........................... $ 3,641 $ 3,797 $ 3,092 $ 7,438 $ 6,356 Serviced with limited recourse........ (29) 8 52 (21) 82 -------- -------- -------- -------- -------- Managed basis......................... $ 3,612 $ 3,805 $ 3,144 $ 7,417 $ 6,438 ======== ======== ======== ======== ========Owned basis efficiency ratio............ 41.09% 40.35% 44.47% 40.71% 44.54%Managed basis efficiency ratio.......... 41.42 40.26 43.73 40.83 43.97 60 HSBC FINANCE CORPORATION RECONCILIATIONS TO GAAP FINANCIAL MEASURES JUNE 30, MARCH 31, JUNE 30, 2006 2006 2005------------------------------------------------------------------------------------------------ (DOLLAR AMOUNTS ARE IN MILLIONS) TWO-MONTHS-AND-OVER-CONTRACTUAL DELINQUENCY:Consumer two-months-and-over-contractual delinquency: Owned basis............................................... $ 5,652 $ 5,312 $ 4,419 Serviced with limited recourse............................ 110 153 484 -------- -------- -------- Managed basis............................................. $ 5,762 $ 5,465 $ 4,903 -------- -------- --------Consumer receivables: Owned basis............................................... $153,779 $146,580 $118,532 Serviced with limited recourse............................ 1,911 3,109 8,980 -------- -------- -------- Managed basis............................................. $155,690 $149,689 $127,512 -------- -------- --------Consumer two-months-and-over-contractual delinquency: Owned basis............................................... 3.68% 3.62% 3.73% Managed basis............................................. 3.70 3.65 3.85 ======== ======== ========RESERVES AS A PERCENTAGE OF RECEIVABLES:Loss reserves: Owned basis............................................... $ 4,649 $ 4,468 $ 3,756 Serviced with limited recourse............................ 91 161 525 -------- -------- -------- Managed basis............................................. $ 4,740 $ 4,629 $ 4,281 -------- -------- --------Receivables: Owned basis............................................... $153,959 $146,767 $118,761 Serviced with limited recourse............................ 1,911 3,109 8,980 -------- -------- -------- Managed basis............................................. $155,870 $149,876 $127,741 -------- -------- --------Reserves as a percentage of receivables: Owned basis............................................... 3.02% 3.04% 3.16% Managed basis............................................. 3.04 3.09 3.35 ======== ======== ========RESERVES AS A PERCENTAGE OF NONPERFORMING LOANS:Loss reserves: Owned basis............................................... $ 4,649 $ 4,468 $ 3,756 Serviced with limited recourse............................ 91 161 525 -------- -------- -------- Managed basis............................................. $ 4,740 $ 4,629 $ 4,281 -------- -------- --------Nonperforming loans: Owned basis............................................... $ 4,354 $ 4,266 $ 3,491 Serviced with limited recourse............................ 92 126 395 -------- -------- -------- Managed basis............................................. $ 4,446 $ 4,392 $ 3,886 -------- -------- --------Reserves as a percentage of nonperforming loans: Owned basis............................................... 106.8% 104.7% 107.6% Managed basis............................................. 106.6 105.4 110.2 ======== ======== ======== 61 HSBC FINANCE CORPORATION RECONCILIATIONS TO GAAP FINANCIAL MEASURES JUNE 30, DECEMBER 31, 2006 2005--------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) TANGIBLE COMMON EQUITY:Common shareholder's equity................................. $ 20,085 $ 18,904Exclude: Unrealized (gains) losses on cash flow hedging instruments............................................. (361) (260) Minimum pension liability................................. - - Unrealized gains on investments and interest-only strip receivables............................................. 62 3 Intangible assets......................................... (2,337) (2,480) Goodwill.................................................. (7,023) (7,003) -------- --------Tangible common equity...................................... 10,426 9,164HSBC acquisition purchase accounting adjustments............ 1,302 1,441 -------- --------Tangible common equity, excluding HSBC acquisition purchase accounting adjustments.................................... $ 11,728 $ 10,605 ======== ========TANGIBLE SHAREHOLDER'S(S') EQUITY:Tangible common equity...................................... $ 10,426 $ 9,164Preferred stock............................................. 575 575Mandatorily redeemable preferred securities of Household Capital Trusts............................................ 1,477 1,679 -------- --------Tangible shareholder's(s') equity........................... 12,478 11,418HSBC acquisition purchase accounting adjustments............ 1,301 1,438 -------- --------Tangible shareholder's(s') equity, excluding HSBC acquisition purchase accounting adjustments............... $ 13,779 $ 12,856 ======== ========TANGIBLE SHAREHOLDER'S(S') EQUITY PLUS OWNED LOSS RESERVES:Tangible shareholder's(s') equity........................... $ 12,478 $ 11,418Owned loss reserves......................................... 4,649 4,521 -------- --------Tangible shareholder's(s') equity plus owned loss reserves.................................................. 17,127 15,939HSBC acquisition purchase accounting adjustments............ 1,301 1,438 -------- --------Tangible shareholder's(s') equity plus owned loss reserves, excluding HSBC acquisition purchase accounting adjustments............................................... $ 18,428 $ 17,377 ======== ========TANGIBLE MANAGED ASSETS:Owned assets................................................ $170,694 $156,669Receivables serviced with limited recourse.................. 1,911 4,074 -------- --------Managed assets.............................................. 172,605 160,743Exclude: Intangible assets......................................... (2,337) (2,480) Goodwill.................................................. (7,023) (7,003) Derivative financial assets............................... (573) (234) -------- --------Tangible managed assets..................................... 162,672 151,026HSBC acquisition purchase accounting adjustments............ 16 (52) -------- --------Tangible managed assets, excluding HSBC acquisition purchase accounting adjustments.................................... $162,688 $150,974 ======== ========EQUITY RATIOS:Common and preferred equity to owned assets................. 12.10% 12.43%Tangible common equity to tangible managed assets........... 6.41 6.07Tangible shareholder's(s') equity to tangible managed assets ("TETMA")................................................. 7.67 7.56Tangible shareholder's(s') equity plus owned loss reserves to tangible managed assets ("TETMA + Owned Reserves")..... 10.53 10.55Excluding HSBC acquisition purchase accounting adjustments: Tangible common equity to tangible managed assets......... 7.21 7.02 TETMA..................................................... 8.47 8.52 TETMA + Owned Reserves.................................... 11.33 11.51 ======== ======== 62 HSBC Finance Corporation-------------------------------------------------------------------------------- ITEM 4. CONTROLS AND PROCEDURES-------------------------------------------------------------------------------- We maintain a system of internal and disclosure controls and procedures designedto ensure that information required to be disclosed by HSBC Finance Corporationin the reports we file or submit under the Securities Exchange Act of 1934, asamended, (the "Exchange Act"), is recorded, processed, summarized and reportedon a timely basis. Our Board of Directors, operating through its auditcommittee, which is composed entirely of independent outside directors, providesoversight to our financial reporting process. We conducted an evaluation, with the participation of the Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of our disclosurecontrols and procedures as of the end of the period covered by this report.Based upon that evaluation, the Chief Executive Officer and Chief FinancialOfficer concluded that our disclosure controls and procedures were effective asof the end of the period covered by this report so as to alert them in a timelyfashion to material information required to be disclosed in reports we fileunder the Exchange Act. There were no changes in our internal controls over financial reporting duringthe period covered by this report that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting. HSBC Finance Corporation continues the process to complete a thorough review ofits internal controls as part of its preparation for compliance with therequirements of Section 404 of the Sarbanes-Oxley Act of 2002. Section 404requires our management to report on, and our external auditors to attest to,the effectiveness of our internal control structure and procedures for financialreporting. As a non-accelerated filer under Rule 12b-2 of the Exchange Act, ourfirst report under Section 404 will be contained in our Form 10-K for the periodended December 31, 2007. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS-------------------------------------------------------------------------------- GENERAL We are parties to various legal proceedings resulting from ordinary businessactivities relating to our current and/or former operations. Certain of theseactions are or purport to be class actions seeking damages in very largeamounts. These actions assert violations of laws and/or unfair treatment ofconsumers. Due to the uncertainties in litigation and other factors, we cannotbe certain that we will ultimately prevail in each instance. We believe that ourdefenses to these actions have merit and any adverse decision should notmaterially affect our consolidated financial condition. CONSUMER LITIGATION During the past several years, the press has widely reported certain industryrelated concerns that may impact us. Some of these involve the amount oflitigation instituted against lenders and insurance companies operating incertain states and the large awards obtained from juries in those states. Likeother companies in this industry, some of our subsidiaries are involved in anumber of lawsuits pending against them in these states. The cases, inparticular, generally allege inadequate disclosure or misrepresentation offinancing terms. In some suits, other parties are also named as defendants.Unspecified compensatory and punitive damages are sought. Several of these suitspurport to be class actions or have multiple plaintiffs. The judicial climate inthese states is such that the outcome of all of these cases is unpredictable.Although our subsidiaries believe they have substantive legal defenses to theseclaims and are prepared to defend each case vigorously, a number of such caseshave been settled or otherwise resolved for amounts that in the aggregate arenot material to our operations. Appropriate insurance carriers have beennotified as appropriate, and a number of reservations of rights letters havebeen received. 63 HSBC Finance Corporation-------------------------------------------------------------------------------- CREDIT CARD SERVICES LITIGATION Since June 2005, HSBC Finance Corporation, HSBC North America Holdings Inc., andHSBC Holdings plc., as well as other banks and the Visa and Master Cardassociations, were named as defendants in four class actions filed inConnecticut 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)): NationalAssociation 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 complaintscontaining similar allegations (in which no HSBC entity is named) were filedacross the country against Visa, MasterCard and other banks. These actionsprincipally allege that the imposition of a no-surcharge rule by theassociations and/or the establishment of the interchange fee charged for creditcard transactions causes the merchant discount fee paid by retailers to be setat supracompetitive levels in violation of the Federal antitrust laws. Inresponse to motions of the plaintiffs on October 19, 2005, the Judicial Panel onMultidistrict Litigation (the "MDL Panel") issued an order consolidating thesesuits and transferred all of the cases to the Eastern District of New York. Theconsolidated case is: In re Payment Card Interchange Fee and Merchant DiscountAntitrust Litigation, MDL 1720, E.D.N.Y. A consolidated, amended complaint wasfiled by the plaintiffs on April 24, 2006. At this time, we are unable toquantify the potential impact from this action, if any. SECURITIES LITIGATION In August 2002, we restated previously reported consolidated financialstatements. The restatement related to certain MasterCard and Visa co-brandingand affinity credit card relationships and a third party marketing agreement,which were entered into between 1992 and 1999. All were part of our Credit CardServices segment. In consultation with our prior auditors, Arthur Andersen LLP,we treated payments made in connection with these agreements as prepaid assetsand amortized them in accordance with the underlying economics of theagreements. Our current auditor, KPMG LLP, advised us that, in its view, thesepayments should have either been charged against earnings at the time they weremade or amortized over a shorter period of time. The restatement resulted in a$155.8 million, after-tax, retroactive reduction to retained earnings atDecember 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 Columbiarelating to real estate lending practices, HSBC Finance Corporation, and itsdirectors, certain officers and former auditors, have been involved in variouslegal proceedings, some of which purport to be class actions. A number of theseactions allege violations of Federal securities laws, were filed between Augustand October 2002, and seek to recover damages in respect of allegedly false andmisleading statements about our common stock. These legal actions have beenconsolidated into a single purported class action, Jaffe v. HouseholdInternational, 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 December3, 2004, the court signed the parties' stipulation to certify a class withrespect to the claims brought under sec.10 and sec.20 of the Securities ExchangeAct of 1934. The parties stipulated that plaintiffs will not seek to certify aclass with respect to the claims brought under sec.11 and sec.15 of theSecurities Act of 1933 in this action or otherwise. The amended complaint purports to assert claims under the Federal securitieslaws, on behalf of all persons who purchased or otherwise acquired oursecurities between October 23, 1997 and October 11, 2002, arising out of allegedfalse and misleading statements in connection with our sales and lendingpractices, the 2002 state settlement agreement referred to above, therestatement and the HSBC merger. The amended complaint, which also names asdefendants Arthur Andersen LLP, Goldman, Sachs & Co., and Merrill Lynch, Pierce,Fenner & Smith, Inc., fails to specify the amount of damages sought. In May2003, we, and other defendants, filed a motion to dismiss the complaint. OnMarch 19, 2004, the Court granted in part, and denied in part the defendants'motion to dismiss the complaint. The Court dismissed all claims against MerrillLynch, Pierce, Fenner & Smith, Inc. and Goldman Sachs & Co. The Court alsodismissed certain claims alleging strict liability for alleged misrepresentationof material facts based on statute of limitations grounds. The claims thatremain against some or all of the defendants essentially allege the defendantsknowingly made 64 HSBC Finance Corporation-------------------------------------------------------------------------------- a false statement of a material fact in conjunction with the purchase or sale ofsecurities, that the plaintiffs justifiably relied on such statement, the falsestatement(s) caused the plaintiffs' damages, and that some or all of thedefendants should be liable for those alleged statements. On February 28, 2006,the Court has also dismissed all alleged sec.10 claims that arose prior to July30, 1999, shortening the class period by 22 months. The discovery schedule hasbeen extended and no final cut-off has been established at this time.Separately, one of the defendants, Arthur Andersen, entered into a settlement ofthe claims against Andersen. This settlement received Court approval in April2006. At this time, we are unable to quantify the potential impact from thisaction, if any. With respect to this securities litigation, we believe that we have not, and ourofficers and directors have not, committed any wrongdoing and in each instancethere will be no finding of improper activities that may result in a materialliability to us or any of our officers or directors. ITEM 1A. RISK FACTORS-------------------------------------------------------------------------------- Risk factors were set forth in the Form 10-Q for the period ended March 31,2006. There have been no material changes from the risk factors disclosed inthat Form 10-Q. 65 HSBC Finance Corporation-------------------------------------------------------------------------------- ITEM 6. EXHIBITS-------------------------------------------------------------------------------- Exhibits included in this Report: 12 Statement of Computation of Ratio of Earnings to Fixed Charges and to Combined Fixed Charges and Preferred Stock Dividends 31 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.1 Debt and Preferred Stock Securities Ratings 66 HSBC Finance Corporation-------------------------------------------------------------------------------- SIGNATURE-------------------------------------------------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized. HSBC FINANCE CORPORATION (Registrant) /s/ Beverley A. Sibblies -------------------------------------- Beverley A. Sibblies Senior Vice President and Chief Financial Officer Date: July 31, 2006 67 HSBC Finance Corporation-------------------------------------------------------------------------------- EXHIBIT INDEX-------------------------------------------------------------------------------- 12 Statement of Computation of Ratio of Earnings to Fixed Charges and to Combined Fixed Charges and Preferred Stock Dividends 31 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.1 Debt and Preferred Stock Securities Ratings 68 HSBC Finance Corporation-------------------------------------------------------------------------------- EXHIBIT 12 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS SIX MONTHS ENDED JUNE 30, ----------------- 2006 2005------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net income.................................................. $1,456 $1,098Income tax expense.......................................... 840 555 ------ ------Income before income tax expense............................ 2,296 1,653 ------ ------Fixed charges: Interest expense.......................................... 3,385 2,166 Interest portion of rentals(1)............................ 29 30 ------ ------Total fixed charges......................................... 3,414 2,196 ------ ------Total earnings as defined................................... $5,710 $3,849 ====== ======Ratio of earnings to fixed charges.......................... 1.67 1.75Preferred stock dividends(2)................................ 29 55Ratio of earnings to combined fixed charges and preferred stock dividends........................................... 1.66 1.71 --------------- (1) Represents one-third of rentals, which approximates the portion representing interest. (2) Preferred stock dividends are grossed up to their pretax equivalents. HSBC Finance Corporation-------------------------------------------------------------------------------- EXHIBIT 31 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION OF CHIEF EXECUTIVE OFFICER I, Siddharth N. Mehta, Chairman and Chief Executive Officer of HSBC FinanceCorporation, certify that: 1. I have reviewed this report on Form 10-Q of HSBC Finance Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: July 31, 2006 /s/ SIDDHARTH N. MEHTA -------------------------------------- Siddharth N. Mehta Chairman and Chief Executive Officer HSBC Finance Corporation-------------------------------------------------------------------------------- CERTIFICATION OF CHIEF FINANCIAL OFFICER I, Beverley A. Sibblies, Senior Vice President and Chief Financial Officer ofHSBC Finance Corporation, certify that: 1. I have reviewed this report on Form 10-Q of HSBC Finance Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: July 31, 2006 /s/ BEVERLEY A. SIBBLIES -------------------------------------- Beverley A. Sibblies Senior Vice President and Chief Financial Officer HSBC Finance Corporation-------------------------------------------------------------------------------- EXHIBIT 32 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The certification set forth below is being submitted in connection with the HSBCFinance Corporation (the "Company") Quarterly Report on Form 10-Q for the periodending March 31, 2006 as filed with the Securities and Exchange Commission onthe date hereof (the "Report") for the purpose of complying with Rule 13a-14(b)or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the "Exchange Act")and Section 1350 of Chapter 63 of Title 18 of the United States Code. I, Siddharth N. Mehta, Chairman and Chief Executive Officer of the Company,certify that: 1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of HSBC Finance Corporation. July 31, 2006 /s/ SIDDHARTH N. MEHTA ---------------------------------------------- Siddharth N. Mehta Chairman and Chief Executive Officer This certification accompanies each Report pursuant to Section 906 of theSarbanes-Oxley Act of 2002 and shall not, except to the extent required by theSarbanes-Oxley Act of 2002, be deemed filed by HSBC Finance Corporation forpurposes of Section 18 of the Securities Exchange Act of 1934, as amended. Signed originals of these written statements required by Section 906 of theSarbanes-Oxley Act of 2002 have been provided to HSBC Finance Corporation andwill be retained by HSBC Finance Corporation and furnished to the Securities andExchange Commission or its staff upon request. HSBC Finance Corporation-------------------------------------------------------------------------------- CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The certification set forth below is being submitted in connection with the HSBCFinance Corporation (the "Company") Quarterly Report on Form 10-Q for the periodending March 31, 2006 as filed with the Securities and Exchange Commission onthe 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 ofthe 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. July 31, 2006 /s/ BEVERLEY A. SIBBLIES ---------------------------------------------- Beverley A. Sibblies Senior Vice President and Chief Financial Officer This certification accompanies each Report pursuant to Section 906 of theSarbanes-Oxley Act of 2002 and shall not, except to the extent required by theSarbanes-Oxley Act of 2002, be deemed filed by HSBC Finance Corporation forpurposes of Section 18 of the Securities Exchange Act of 1934, as amended. Signed originals of these written statements required by Section 906 of theSarbanes-Oxley Act of 2002 have been provided to HSBC Finance Corporation andwill be retained by HSBC Finance Corporation and furnished to the Securities andExchange Commission or its staff upon request. HSBC Finance Corporation-------------------------------------------------------------------------------- EXHIBIT 99.1 DEBT AND PREFERRED STOCK SECURITIES RATINGS STANDARD & MOODY'S POOR'S INVESTORS DOMINION BOARD CORPORATION SERVICE FITCH, INC. RATING SERVICE------------------------------------------------------------------------------------------------------- AS OF JUNE 30, 2006HSBC 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 A2 A+ *HFC Bank Limited Senior debt.................................. AA- Aa3 AA- * Commercial paper............................. A-1+ P-1 F-1+ *HSBC Bank Nevada, National Association Senior debt.................................. AA- A1 AA- *HSBC Financial Corporation Limited Senior notes and term loans.................. * * * AA (low) Commercial paper............................. * * * R-1 (middle) --------------- * Not rated by this agency. This information is provided by RNS The company news service from the London Stock Exchange

---

Related Shares:

HSBC Holdings