13th Nov 2006 11:04
HSBC Holdings PLC13 November 2006 Part 2 HSBC Finance Corporation -------------------------------------------------------------------------------- Policyholders' benefits increased in both periods as a result of a newreinsurance contract in our domestic operations offset by decreased salesvolumes in our domestic and U.K. operations as well as lower amortization offair value adjustments relating to our insurance business. Efficiency ratio The following table summarizes our owned basis efficiencyratio: 2006 2005-------------------------------------------------------------------------------- Three months ended September 30.................................. 41.16% 44.33%Nine months ended September 30................................... 40.86 44.47 Our owned basis efficiency ratio improved in both periods due to higher netinterest income and higher other revenues due to higher levels of receivables,partially offset by an increase in total costs and expenses to supportreceivable growth. 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 Kingdomand Canada. The All Other caption includes our insurance and taxpayer financialservices and commercial businesses, each of which falls below the quantitativethreshold test under SFAS No. 131 for determining reportable segments, as wellas our corporate and treasury activities. There have been no changes in thebasis of our segmentation or any changes in the measurement of segment profit ascompared with 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. As the level of our securitized receivables have fallen over time, managed basisand owned basis results have now largely converged. As a result, we currentlyanticipate that this Form 10-Q will be the last periodic report that containsmanaged basis results. 43 HSBC Finance Corporation -------------------------------------------------------------------------------- CONSUMER SEGMENT The following table summarizes results for our Consumersegment: INCREASE (DECREASE) --------------THREE MONTHS ENDED SEPTEMBER 30 2006 2005 AMOUNT %-------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net income...................................... $ 376 $ 308 $ 68 22.1%Net interest income............................. 1,872 1,733 139 8.0Securitization related revenue.................. (29) (171) 142 83.0Fee and other income............................ 336 307 29 9.4Intersegment revenues........................... 60 27 33 100+Provision for credit losses..................... 861 735 126 17.1Total costs and expenses........................ 744 647 97 15.0Receivables..................................... 122,288 102,733 19,555 19.0Assets.......................................... 123,009 103,424 19,585 18.9Net interest margin, annualized................. 6.14% 7.02% - -Return on average managed assets................ 1.23 1.24 - - Increase (decrease) ----------------NINE MONTHS ENDED SEPTEMBER 30 2006 2005 AMOUNT %-------------------------------------------------------------------------------------- (dollars are in millions) Net income........................................ $1,428 $1,182 $246 20.8%Net interest income............................... 5,545 5,125 420 8.2Securitization related revenue.................... (133) (557) 424 76.1Fee and other income.............................. 966 884 82 9.3Intersegment revenues............................. 180 80 100 100+Provision for credit losses....................... 1,960 1,698 262 15.4Total costs and expenses.......................... 2,170 1,893 277 14.6Net interest margin, annualized................... 6.29% 7.27% - -Return on average managed assets.................. 1.61 1.66 - - Our Consumer Segment reported higher net income in the three and nine monthsended September 30, 2006 due to higher net interest income, higher fee and otherincome and higher securitization related revenue, partially offset by higherprovision for credit losses and higher costs and expenses. Net interest incomeincreased during the three and nine months ended September 30, 2006 primarilydue to higher average receivables, partially offset by higher interest expense.Net interest margin decreased from the year ago periods due to a shift in mixdue to growth in lower yielding receivables and product expansion into near-prime consumer segments. Also contributing to the decrease were lower yields onauto finance receivables as we have targeted higher credit quality customers.Although higher credit quality receivables generate lower yields, suchreceivables are expected to result in lower operating costs, delinquency ratiosand charge-off. These lower yields were partially offset by higher pricing onour variable rate products. A higher cost of funds due to a rising interest rateenvironment also contributed to the decrease in net interest margin. The increase in fee and other income in the three and nine months endedSeptember 30, 2006 was primarily due to higher credit insurance commissions andservicing fees from HBUS on the sold domestic private label receivableportfolio. These increases were partially offset by lower gains on receivablesales to third parties and in the nine month period, lower gains on affiliateloan sales. Securitization related revenue was higher in both periods due tolower amortization related to prior period gains as a result of reducedsecuritization levels. Costs and expenses were higher in both periods due tolower deferred origination costs in our Mortgage Services business, higher realestate owned expenses, higher marketing expenses due to the launch of a new co-brand credit card in our Retail Services business ,and in the nine month period,higher salary expense and higher support services from affiliates to support 44 HSBC Finance Corporation -------------------------------------------------------------------------------- receivable growth. Additionally, the nine month period of 2005 included a lowerestimate of exposure relating to accrued finance charges associated with certainloan restructures. 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 nine months endedSeptember 30, 2006. The third quarter of 2005 was negatively impacted byincremental provision for credit losses of $125 million relating to Katrina.Excluding this, credit loss provisions increased significantly largely driven byhigher delinquency and loss estimates at our Mortgage Services business due tothe deteriorating performance in the second lien and portions of our first lien2005 and 2006 real estate secured portfolio. Also contributing to this increasewas the impact of higher receivable levels, in part due to lower securitizationlevels, and portfolio seasoning. These increases were partially offset by areduction in the estimated loss exposure resulting from Katrina of approximately$35 million in the three months ended September 30, 2006 and approximately $65million in the year-to-date period as well as the benefit of low unemploymentlevels in the United States. For 2006, the provision for credit losses wasgreater than net charge-offs by $175 million for the three months endedSeptember 30, 2006 and $2 million in the nine months ended September 30, 2006.For 2005, the provision for credit losses was greater than net charge-offs by$129 million for the three months ended September 30, 2005 while net charge-offswere greater than the provision for credit losses by $137 million for the ninemonths ended September 30, 2005. Managed receivables increased 2 percent to $122.3 billion at September 30, 2006as compared to $120.3 billion at June 30, 2006. We continued to experiencestrong growth in the third quarter of 2006 in our real estate secured portfolioin our Consumer Lending branch-based business partially offset by the plannedreduction in correspondent purchases of second lien and selected higher riskproducts which resulted in a decline in the overall portfolio balance in ourMortgage Services business. Our auto finance portfolio also reported organicgrowth from increased volume in both the dealer network and the consumer directloan program. Personal non-credit card receivables increased as a result ofincreased marketing and lower securitization levels. Compared to September 30, 2005, managed receivables increased 19 percent. Realestate growth was strong compared to the year-ago period as a result of stronggrowth in our branch-based Consumer Lending businesses in addition to stronggrowth in our correspondent business during the fourth quarter of 2005 and thefirst six months of 2006. We continued to enter into agreements with additionalcorrespondents to purchase their newly originated loans on a flow basis.However, in 2006, we began tightening underwriting standards on loans purchasedfrom correspondents including reducing purchases of second lien and selectedhigher risk segments. These activities have reduced, and will continue toreduce, the volume of correspondent purchases in the future which will have theeffect of slowing growth in the real estate secured portfolio. Also contributingto the increase were purchases of $.6 billion from portfolio acquisitionprograms in our Consumer Lending business 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. In the third quarter of 2006, our Consumer Lending business entered into anagreement to purchase Solstice Capital Group Inc. ("Solstice") with assets ofapproximately $31 million, in an all cash transaction for approximately $50million. Additional consideration may be paid based on Solstice's 2007 pre-taxincome. Solstice markets a range of mortgage and home equity products tocustomers through direct mail. This acquisition will add momentum to ourorigination growth plan by providing multiple channels to our customers. Wecompleted the acquisition of Solstice on October 4, 2006. Return on average managed assets ("ROMA") was 1.23 percent for the three monthsended September 30, 2006 and 1.61 percent for the nine months ended September30, 2006, compared to 1.24 percent and 1.66 percent in the year-ago periods. Thedecrease in the ratio in both periods is due to the increase in net incomediscussed above which grew slower than average managed assets. 45 HSBC Finance Corporation -------------------------------------------------------------------------------- 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. CREDIT CARD SERVICES SEGMENT The following table summarizes results for ourCredit Card Services segment. Increase (decrease) --------------THREE MONTHS ENDED SEPTEMBER 30 2006 2005 AMOUNT %-------------------------------------------------------------------------------------- (dollars are in millions) Net income........................................ $ 404 $ 138 $ 266 100+%Net interest income............................... 788 531 257 48.4Securitization related revenue.................... 1 (42) 43 100+Fee and other income.............................. 668 554 114 20.6Intersegment revenues............................. 6 5 1 20.0Provision for credit losses....................... 385 465 (80) (17.2)Total costs and expenses.......................... 447 360 87 24.2Receivables....................................... 26,434 19,971 6,463 32.4Assets............................................ 26,731 19,710 7,021 35.6Net interest margin, annualized................... 11.65% 10.27% - -Return on average managed assets.................. 6.13 2.80 - - Increase (decrease) -------------NINE MONTHS ENDED SEPTEMBER 30 2006 2005 AMOUNT %------------------------------------------------------------------------------------- (dollars are in millions) Net income.......................................... $1,019 $ 452 $567 100+%Net interest income................................. 2,321 1,545 776 50.2Securitization related revenue...................... (18) (161) 143 88.8Fee and other income................................ 1,755 1,465 290 19.8Intersegment revenues............................... 16 16 - -Provision for credit losses......................... 1,148 1,120 28 2.5Total costs and expenses............................ 1,308 1,018 290 28.5Net interest margin, annualized..................... 11.74% 10.27% - -Return on average managed assets.................... 5.21 3.10 - - Our Credit Card Services Segment reported higher net income in the three andnine months ended September 30, 2006. The increase in net income in both periodswas primarily due to higher net interest income, higher fee and other income,higher securitization related revenue and, in the three month period, lowercredit loss provision, partially offset by higher costs and expenses. Theacquisition of Metris, which was completed in December 2005, contributed $78million of net income during the current quarter and $139 million in the year-to-date period. Net interest income increased in both periods as a result of theMetris acquisition, which contributed to higher overall yields due in part tohigher levels of non-prime receivables, partially offset by higher interestexpense. Net interest margin increased in both the three and nine months endedSeptember 30, 2006 primarily due to higher overall yields 46 HSBC Finance Corporation -------------------------------------------------------------------------------- due to increases in non-prime receivables, including the receivables acquired aspart of Metris, higher pricing on variable rate products and other repricinginitiatives. These increases were partially offset by a higher cost of funds.Although our non-prime receivables tend to have smaller balances, they generatehigher returns both in terms of net interest margin and fee income. Increases infee and other income resulted from portfolio growth, including the Metrisportfolio acquired in December 2005 and higher enhancement services revenue fromproducts such as our Account Secure Plus (debt waiver) and our IdentityProtection Plan. This increase in fee income was partially offset in bothperiods by adverse impacts of limiting certain fee billings on non-prime creditcard accounts as discussed below. Securitization related revenue was higher dueto lower amortization of prior period gains as a result of reducedsecuritization levels. Our provision for credit losses was lower for the three month period endedSeptember 30, 2006. The third quarter of 2005 was negatively impacted byincremental credit loss provisions of $100 million relating to the spike inbankruptcy filings experienced in the period leading up to October 17, 2005,which was the effective date of new bankruptcy legislation in the United Statesand $55 million relating to Katrina. Excluding these items, provisions in bothperiods increased reflecting receivable growth and portfolio seasoning,including the Metris portfolio, partially offset by the impact of lower levelsof bankruptcy filings following the enactment of new bankruptcy legislation inOctober 2005, higher recoveries as a result of higher sales volume of recent andolder charged-off accounts and in the nine month period of 2006, a reduction ofour estimated loss exposure related to Katrina of approximately $25 million. Weincreased managed loss reserves by recording loss provision greater than netcharge-off of $22 million in the three months ended September 30, 2006 and $157million in the nine months ended September 30, 2006. We increased managed lossreserves by recording loss provision greater than net charge-off of $154 millionin the third quarter of 2005 and $127 million in the year-to-date 2005 period.Higher costs and expenses were to support receivable growth, includingreceivable growth associated with the Metris acquisition. Managed receivables increased 2 percent to $26.4 billion at September 30, 2006compared to $25.8 billion at June 30, 2006. The increase in the current quarterreflects organic growth in our Union Privilege, as well as other non-primeportfolios including Metris which was partially offset by the continued declinein certain older acquired portfolios. Compared to September 30, 2005, managedreceivables increased 32 percent. The increase from the year-ago period reflectsorganic growth in our HSBC branded prime, Union Privilege and non-primeportfolios as well as the acquisition of Metris in December 2005 which increasedreceivables by $5.3 billion. 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. In addition, roll rate trendsin the prime book have been slightly higher than those experienced prior to thechanges in minimum payment. These changes have resulted in fluctuations in theprovision for credit losses as credit loss provisions for prime accounts hasincreased as a result of higher required monthly payments while the non-primeprovision decreased due to lower levels of fees incurred by customers. The impact of these changes has not had a material impact on our consolidatedresults, but has had a material impact to the Credit Card Services Segment in2006. 47 HSBC Finance Corporation -------------------------------------------------------------------------------- INTERNATIONAL SEGMENT The following table summarizes results for ourInternational segment: INCREASE (DECREASE) ----------------THREE MONTHS ENDED SEPTEMBER 30 2006 2005 AMOUNT %--------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net income....................................... $ (15) $ 12 $ (27) (100+)%Net interest income.............................. 184 228 (44) (19.3)Securitization related revenue................... - 2 (2) (100.0)Fee and other income............................. 191 186 5 2.7Intersegment revenues............................ 9 4 5 100+Provision for credit losses...................... 137 137 - -Total costs and expenses......................... 243 261 (18) (6.9)Receivables...................................... 9,300 12,564 (3,264) (26.0)Assets........................................... 10,231 13,574 (3,343) (24.6)Net interest margin, annualized.................. 7.66% 7.22% - -Return on average managed assets................. (.58) .36 - - INCREASE (DECREASE) ----------------NINE MONTHS ENDED SEPTEMBER 30 2006 2005 AMOUNT %------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS) Net income........................................ $ (1) $ (11) $ 10 90.9%Net interest income............................... 544 680 (136) (20.0)Securitization related revenue.................... - 17 (17) (100.0)Fee and other income.............................. 519 542 (23) (4.2)Intersegment revenues............................. 25 11 14 100+Provision for credit losses....................... 367 468 (101) (21.6)Total costs and expenses.......................... 673 779 (106) (13.6)Net interest margin, annualized................... 7.61% 7.05% - -Return on average managed assets.................. (.01) (.10) - - Our International Segment reported a net loss in the three and nine months endedSeptember 30, 2006. The losses in both periods reflect lower net interest incomeand lower securitization related revenue partially offset by lower total costsand expenses and in the nine month period, lower provision for credit losses andlower fee and other income. Applying constant currency rates, which uses theaverage rate of exchange for the three and nine month periods ended September30, 2005 to translate current period net income, the net income would have beenlower by $4 million for the three month period ended September 30, 2006 andwould not have resulted in a materially different net loss for the year-to-dateperiod. 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 in December 2005, including $3.1 billion in managed receivables to HBEUas well as lower receivable levels resulting from decreased sales volumes in theU.K. including the impact of a continuing challenging credit environment in theU.K. This was partially offset by higher net interest income in our Canadianoperations due to growth in receivables. Net interest margin increased in bothperiods primarily due to lower cost of funds partially offset by the change inreceivable mix resulting from the sale of our U.K. credit card business inDecember 2005. Lower securitization related revenue in both periods is theresult of the December 2005 sale of our U.K. credit card business to HBEU. Forthe three month period, higher fee and other income in our Canadian business andincreased insurance revenues in our U.K. business primarily due to favorableforeign exchange was partially offset by lower credit card fee income, as aresult of the sale of the U.K. card business. For the nine month period, fee andother income decreased primarily due to lower credit card fee income as a resultof the impact of the aforementioned sale of the U.K. credit card business. 48 HSBC Finance Corporation -------------------------------------------------------------------------------- Provision for credit losses was flat for the three month period as increasedprovision for credit losses due to the deterioration of the financialcircumstances of our customers across the U.K. and increases at our Canadianbusiness due to receivable growth were partially offset by decreases toprovision from lower receivable levels as a result of the sale of the U.K.credit card business. The decrease in the nine month period ended September 30,2006 was primarily due to the sale of our U.K. credit card business partiallyoffset by increases as previously discussed. We increased managed loss reservesby recording loss provision greater than net charge-offs of $19 million for thecurrent quarter and $41 million year-to-date, compared with $3 million and $111million in the year-ago periods. Total costs and expenses decreased as a resultof the sale of our U.K. credit card business in December 2005. The decrease intotal costs and expenses was partially offset by increased costs associated withgrowth in the Canadian business. Managed receivables of $9.3 billion at September 30, 2006 decreased 2 percentcompared to $9.5 billion at June 30, 2006 and decreased 26 percent from theyear-ago period. Receivables in both periods decreased as our U.K. basedreceivable products continued to decline due to lower retail sales volumefollowing a slow down in retail consumer spending and the December 2005 sale ofthe U.K. credit card business as well as the classification in September 2006,of $194 million of receivables related to our European Operations as "Held forSale." These decreases were partially offset by growth in the receivableportfolio in our Canadian operations. Branch expansions and the successfullaunch of a MasterCard credit card program in Canada in 2005 have resulted ingrowth in both the secured and unsecured receivable portfolios. The decrease in ROMA for the three month period reflects the lower net income asdiscussed above, and lower average managed assets as a result of the sale of ourU.K. credit card business in December 2005. The increase in ROMA for the ninemonth period ended September 30, 2006 is the result of improvement in our netloss and lower average managed assets as discussed above. In the third quarter of 2006, as part of our continuing evaluation of strategicalternatives with respect to our U.K. and European operations, we agreed to sellall of the capital stock of our operations in the Czech Republic, Hungary, andSlovakia (the "European Operations") to a wholly owned subsidiary of HSBC Bankplc ("HBEU"), a U.K. based subsidiary of HSBC, for an aggregate purchase priceof approximately $46 million. The sale closed in early November 2006. Becausethe sale of this business is between affiliates under common control, thepremium received in excess of the book value of the stock transferred will berecorded as an increase to additional paid-in capital and will not be reflectedin earnings. At September 30, 2006, we have classified the European Operationsas "Held for Sale" and combined assets of $207 million and liabilities of $178million related to the businesses separately in our consolidated balance sheetwithin other assets and other liabilities. 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 ultimately charge-off. This analysis considers delinquency status, loss experience and severityand takes into account whether loans are in bankruptcy, have been restructuredor rewritten, or are subject to forbearance, an external debt management plan,hardship, modification, extension or deferment. Our credit loss reserves alsotake into consideration the loss severity expected based on the underlyingcollateral, if any, for the loan in the event of default. Delinquency status maybe affected by customer account management policies and practices, such as therestructure of accounts, forbearance agreements, extended payment plans,modification arrangements, external debt management programs, loan rewrites anddeferments. If customer account management policies or changes thereto, shiftloans from a "higher" delinquency bucket to a "lower" delinquency bucket, thiswill be reflected in our roll rate statistics. To the extent that restructuredaccounts have a greater propensity to roll to higher delinquency buckets, thiswill be captured in the roll rates. Since the loss reserve is computed based onthe composite of all of these calculations, this increase in roll rate will beapplied to receivables in all respective delinquency buckets, which willincrease the 49 HSBC Finance Corporation -------------------------------------------------------------------------------- overall reserve level. In addition, loss reserves on consumer receivables aremaintained to reflect our judgment of portfolio risk factors that may not befully reflected in the statistical roll rate calculation. Risk factorsconsidered in establishing loss reserves on consumer receivables include recentgrowth, product mix, bankruptcy trends, geographic concentrations, economicconditions, portfolio seasoning, account management policies and practices,current levels of charge-offs and delinquencies, changes in laws and regulationsand other items which can affect consumer payment patterns on outstandingreceivables, such as the impact of natural disasters like Katrina and globalpandemics. 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 4, "Receivables," in theaccompanying consolidated financial statements for receivables by product typeand Note 5, "Credit Loss Reserves," for an analysis of changes in the creditloss reserves. The following table summarizes owned basis credit loss reserves: SEPTEMBER 30, JUNE 30, SEPTEMBER 30, 2006 2006 2005--------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Owned credit loss reserves......................... $4,885 $4,649 $4,220Reserves as a percent of: Receivables...................................... 3.11% 3.02% 3.28% Net charge-offs(1)............................... 107.3 107.6 117.0 Nonperforming loans.............................. 98.5 106.8 110.0 -------- (1) Quarter-to-date, annualized. Owned Credit loss reserves at September 30, 2006 increased as compared to June30, 2006 as the provision for owned credit losses was $246 million higher thannet charge-offs. The increase in owned credit loss reserves in the currentquarter reflects higher loss estimates in our Mortgage Services business due tothe deteriorating performance in the second lien and portions of the first lienreal estate secured loans originated and acquired in 2005 and 2006, higherlevels of owned receivables due in part to lower securitization levels,portfolio seasoning, higher overall delinquency levels in our portfolio drivenby seasonality and growth and higher personal bankruptcy filings. This increasewas partially offset by a reduction in the estimated loss exposure resultingfrom Katrina. Owned credit loss reserves at September 30, 2006 increased as compared toSeptember 30, 2005 resulting from the deteriorating performance of certain loansat our Mortgage Services business as discussed above, the higher levels of ownedreceivables, including lower securitization levels, portfolio seasoning, higheroverall delinquency levels in our portfolio driven by growth and the impact ofMetris which was acquired in December 2005. These increases were partiallyoffset by significantly lower personal bankruptcy levels, a reduction in theestimated loss exposure resulting from Katrina, the benefits of low unemploymentin the United States and the impact of the sale of our U.K. credit card businessin December 2005 which decreased credit loss reserves by $104 million. Reserves as a percentage of receivables at September 30, 2006 were higher thanat June 30, 2006 reflecting additional reserve requirements resulting from thedeterioration in the performance of certain 2005 originations and higher overalldelinquency levels driven by seasonality and growth. Reserves as a percentage ofreceivables at September 30, 2006 were lower than at September 30, 2005 as theimpact of additional reserves discussed above 50 HSBC Finance Corporation -------------------------------------------------------------------------------- was more than offset by lower levels of personal bankruptcy filing in the UnitedStates in the first nine months of 2006 and a reduction in the estimated lossexposure resulting from Katrina. Reserves as a percentage of nonperforming loans at September 30, 2006 decreasedfrom the prior periods. The decrease was primarily attributable to higher levelsof real estate nonperforming loans which, due to their secured nature, carry alower reserve requirement compared to unsecured loans. 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: SEPTEMBER 30, JUNE 30, SEPTEMBER 30, 2006 2006 2005--------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Managed credit loss reserves....................... $4,946 $4,740 $4,571Reserves as a percent of: Receivables...................................... 3.13% 3.04% 3.37% Net charge-offs(1)............................... 105.9 105.7 108.6 Nonperforming loans.............................. 98.4 106.6 110.3 -------- (1) Quarter-to-date, annualized. Managed credit loss reserves at September 30, 2006 also increased compared toJune 30, 2006 and September 30, 2005 due to the increases in owned credit lossreserves discussed above partially offset by the impact of lower reserves onsecuritized receivables as a result of run-off. Securitized receivables of $1.3billion at September 30, 2006 decreased from $1.9 billion at June 30, 2006 and$6.8 billion at September 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): SEPTEMBER 30, JUNE 30, SEPTEMBER 30, 2006 2006 2005--------------------------------------------------------------------------------------------- Real estate secured................................ 2.98% 2.52% 2.51%Auto finance....................................... 2.54 2.25 2.09MasterCard/Visa.................................... 4.53 4.16 4.46Private label...................................... 5.61 5.42 5.22Personal non-credit card........................... 9.69 8.93 9.18 ---- ---- ----Total.............................................. 4.14% 3.68% 3.78% ==== ==== ==== Total owned delinquency increased $843 million and the two-months-and-overcontractual delinquency ratio increased 46 basis points compared to the priorquarter. A significant factor in the increase in the delinquency ratio was thehigher real estate secured delinquency levels at our Mortgage Services businessas previously discussed, as well as higher personal non-credit card delinquency,partially offset by recent growth. The increase in the delinquency ratio of ourauto finance portfolio reflects normal seasonal patterns coupled with lowergrowth partially offset by the benefit of low unemployment in the United States.The increase in the MasterCard/Visa delinquency ratio primarily reflects changesin receivable mix and a seasonal increase in delinquencies during the thirdquarter partially offset by receivable growth. The increase in the delinquencyratio in our private label receivables (which primarily consists of our foreignprivate label portfolio that was not sold to HBUS in December 2004) primarilyreflects increased delinquencies and declining receivables in both our domesticand U.K. portfolios. 51 HSBC Finance Corporation -------------------------------------------------------------------------------- The increase in the personal non-credit card delinquency ratio reflects thedeterioration of the financial circumstances of our customers across the U.K. aswell as seasoning in our domestic portfolio. Compared to the year-ago period, the total delinquency ratio increased 36 basispoints. This increase was driven by higher real estate secured delinquencylevels at our Mortgage Services business and higher MasterCard/Visa delinquencylargely due to the impact of Metris, partially offset by portfolio growth, thebenefit of low unemployment in the United States and lower bankruptcy levels dueto the new bankruptcy legislation enacted in 2005. 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): SEPTEMBER 30, JUNE 30, SEPTEMBER 30, 2006 2006 2005--------------------------------------------------------------------------------------------- Real estate secured................................ .98% .97% .75%Auto finance....................................... 3.69 2.43 3.25MasterCard/Visa.................................... 5.52 5.80 6.24Private label...................................... 5.65 5.29 5.35Personal non-credit card........................... 7.77 7.92 8.01 ---- ---- ----Total.............................................. 2.92% 2.88% 2.93% ==== ==== ====Real estate secured net charge-offs and REO expense as a percent of average real estate secured receivables...................................... 1.11% 1.04% .88% Net charge-offs as a percent, annualized, of average consumer receivablesincreased compared to the quarter ended June 30, 2006 largely due to higher realestate secured and auto finance net charge-offs, partially offset by lowerMasterCard/Visa and personal non-credit card net charge-offs. The net charge-offratio for our real estate secured portfolio increased slightly compared with theprior quarter as higher losses on certain 2005 originations in our MortgageServices business were offset by lower losses as a percentage of averagereceivables across other parts of our domestic real estate secured portfolio. Weanticipate the increase in the net charge-off ratio for our real estate securedportfolio to continue as a result of the higher delinquency levels we areexperiencing in these Mortgage Services originations. The increase in autofinance net charge-offs reflects a seasonal pattern of higher charge-offs in thethird quarter. The net charge-off ratio for our MasterCard/Visa portfoliodecreased 28 basis points as compared to the prior quarter primarily due torecent receivable growth and higher recoveries as a result of increased salesvolume of recent and older charged-off accounts. Excluding the impact of theincreased sales, our MasterCard/Visa net charge-off ratio would have increaseddue to higher bankruptcy levels and the continued seasoning of the receivablesacquired in our acquisition of Metris which were subject to the requirements ofSOP 03-3. The increase in net charge-offs for the private label portfolioreflects declining receivables and the deterioration of the financialcircumstances of our customers across the U.K. as well as higher losses in ourCanadian business. The decrease in the net charge-offs for personal non-creditcard was primarily due to recent portfolio growth in our domestic portfolio. Total net charge-offs as a percentage, annualized, of average consumerreceivables for the quarter was flat compared with the September 2005 quarter.Decreases in personal bankruptcy filings in our MasterCard/Visa portfoliofollowing the October 2005 enactment of new bankruptcy legislation in the UnitedStates was substantially offset by higher net charge-offs in our real estatesecured portfolio and in particular at our Mortgage Services business due toportfolio seasoning and higher than expected losses on certain 2005 real estatesecured loans as well as higher net charge-offs in our auto finance portfoliodue to the seasoning of a growing portfolio. 52 HSBC Finance Corporation -------------------------------------------------------------------------------- OWNED NONPERFORMING ASSETS SEPTEMBER 30, JUNE 30, SEPTEMBER 30, 2006 2006 2005--------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Nonaccrual receivables............................. $4,124 $3,595 $3,273Accruing consumer receivables 90 or more days delinquent....................................... 835 758 563Renegotiated commercial loans...................... 1 1 - ------ ------ ------Total nonperforming receivables.................... 4,960 4,354 3,836Real estate owned.................................. 740 620 462 ------ ------ ------Total nonperforming assets......................... $5,700 $4,974 $4,298 ====== ====== ======Credit loss reserves as a percent of nonperforming receivables...................................... 98.5% 106.8% 110.0% Compared to June 30, 2006 and September 2005, the increase in totalnonperforming assets is primarily due to higher levels of real estate securedreceivables as previously discussed. Compared to September 2005, the increase innonperforming assets was also impacted by growth in receivables including theMetris portfolio purchased in 2005. Consistent with industry practice, accruingconsumer receivables 90 or more days delinquent includes domesticMasterCard/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. 53 HSBC Finance Corporation -------------------------------------------------------------------------------- TOTAL RESTRUCTURED BY RESTRUCTURE PERIOD - DOMESTIC PORTFOLIO(1) (MANAGED BASIS) SEPTEMBER 30, JUNE 30, SEPTEMBER 30, 2006 2006 2005-------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Never restructured................................ 89.8% 90.0% 88.9%Restructured: Restructured in the last 6 months............... 3.9 3.7 4.0 Restructured in the last 7-12 months............ 2.6 2.6 2.9 Previously restructured beyond 12 months........ 3.7 3.7 4.2 ------- ------- ------- Total ever restructured(2)...................... 10.2 10.0 11.1 ------- ------- -------Total............................................. 100.0% 100.0% 100.0% ======= ======= =======TOTAL RESTRUCTURED BY PRODUCT - DOMESTIC PORTFOLIO(1)(MANAGED BASIS)Real estate secured............................... $ 8,915 $ 8,449 $ 8,205Auto finance...................................... 1,799 1,735 1,593MasterCard/Visa................................... 901 928 484Private label(3).................................. 28 27 24Personal non-credit card.......................... 3,477 3,421 3,353 ------- ------- -------Total............................................. $15,120 $14,560 $13,659 ======= ======= =======(AS A PERCENT OF MANAGED RECEIVABLES)Real estate secured............................... 9.7% 9.3% 10.9%Auto finance...................................... 14.6 14.3 14.0MasterCard/Visa................................... 3.4 3.6 2.5Private label(3).................................. 7.9 7.5 7.0Personal non-credit card.......................... 19.3 19.5 20.6 ------- ------- -------Total(2).......................................... 10.2% 10.0% 11.1% ======= ======= ======= -------- (1) Excludes foreign businesses, commercial and other. (2) Total including foreign businesses was 9.9 percent at September 30, 2006, 9.7 percent at June 30, 2006 and 10.5 percent at September 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. The increase in restructured loans compared to the prior periods was primarilyattributable to higher levels of real estate secured restructures due toportfolio growth and seasoning, including higher restructure levels at ourMortgage Services business as we continue to work with our customers who, in ourjudgment, evidence continued payment probability. See "Credit QualityStatistics" for further information regarding owned basis and managed basisdelinquency, 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 .2 percent of managedreceivables at September 30, 2006, and approximately $.4 billion or .3 percentof managed receivables at June 30, 2006 and September 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 54 HSBC Finance Corporation -------------------------------------------------------------------------------- disaster policies. In certain cases these arrangements have resulted in acustomer's delinquency status being reset by 30 days or more. These extendedpayment arrangements affected approximately $1.1 billion of managed receivablesand are not reflected as restructures in the table above or included in theother customer account management techniques described in the paragraph aboveunless the accounts subsequently qualify for restructuring under our restructurepolicies and procedures as described in the 2005 Form 10-K. LIQUIDITY AND CAPITAL RESOURCES-------------------------------------------------------------------------------- We continue to focus on balancing our use of affiliate and third party fundingsources to minimize funding expense while managing liquidity. During the thirdquarter of 2006, we supplemented unsecured public debt issuances with proceedsfrom the continuing sale of newly originated domestic private label receivablesto HBUS, debt issued to affiliates and secured financings. Because we are asubsidiary of HSBC, our credit ratings have improved and our credit spreadsrelative to Treasuries have tightened compared to those we experienced duringthe months leading up to the announcement of our acquisition by HSBC. Primarilyas a result of tightened credit spreads and improved funding availability, werecognized cash funding expense savings of approximately $687 million during thenine months ended September 30, 2006 (approximately $248 million during thethree months ended September 30, 2006) and approximately $407 million during thenine months ended September 30, 2005 (approximately $155 million during thethree months ended September 30, 2005) compared to the funding costs we wouldhave incurred using average spreads and funding mix from the first half of 2002.These tightened credit spreads in combination with the issuance of HSBC FinanceCorporation debt and other funding synergies including asset transfers and debtunderwriting fees paid to HSBC affiliates have enabled HSBC to realize a pre-tax2006 run rate for annual cash funding expense savings in excess of $1 billionper year. In the nine months ended September 30, 2006, the cash funding expensesavings realized by HSBC totaled approximately $881 million. Debt due to affiliates and other HSBC related funding is summarized in thefollowing table: SEPTEMBER 30, DECEMBER 31, 2006 2005---------------------------------------------------------------------------------------- (IN BILLIONS) Debt issued to HSBC subsidiaries: Drawings on bank lines in the U.K. and Europe........... $ 4.1 $ 4.2 Term debt............................................... 10.3 11.0 Preferred securities issued by Household Capital Trust VIII to HSBC......................................... .3 .3 ----- ----- Total debt outstanding to HSBC subsidiaries............. 14.7 15.5 ----- -----Debt outstanding to HSBC clients: Euro commercial paper................................... 3.1 3.2 Term debt............................................... 1.3 1.3 ----- ----- Total debt outstanding to HSBC clients.................. 4.4 4.5Cash received on bulk and subsequent sales of domestic private label credit card receivables to HBUS, net (cumulative)............................................ 16.4 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................................................. (4.4) (3.3) ----- -----Total real estate secured receivable activity with HBUS... 3.5 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................................ $42.9 $44.1 ===== ===== -------- (1) This capital contribution was made in December 2005 in connection with the acquisition of Metris. 55 HSBC Finance Corporation -------------------------------------------------------------------------------- Funding from HSBC, including debt issuances to HSBC subsidiaries and clients,represented 13 percent of our total managed debt at September 30, 2006 and 15percent at December 31, 2005. The decrease in funding from HSBC is primarily dueto the repayment of debt during the third quarter. At September 30, 2006, we had a commercial paper back stop credit facility of$2.5 billion from HSBC supporting domestic issuances and a revolving creditfacility of $5.3 billion from HBEU to fund our operations in the U.K. There havebeen no draws on the domestic lines. At September 30, 2006, $4.1 billion wasoutstanding under the U.K. lines. We had derivative contracts with a notionalvalue of $94.0 billion, or approximately 93 percent of total derivativecontracts, outstanding with HSBC affiliates at September 30, 2006. At December31, 2005, we had derivative contracts with a notional value of $72.2 billion, orapproximately 87 percent of total derivative contracts, outstanding with HSBCaffiliates. SECURITIES AND OTHER SHORT-TERM INVESTMENTS Securities increased to $4.9 billionat September 30, 2006 from $4.1 billion at December 31, 2005 as a result of anincrease in money market funds restricted for paying down certain securedfinancings at the established payment date. Securities purchased underagreements to resell totaled $1 million at September 30, 2006 and $78 million atDecember 31, 2005. Interest bearing deposits with banks totaled $393 million atSeptember 30, 2006 and $384 million at December 31, 2005. COMMERCIAL PAPER, BANK AND OTHER BORROWINGS totaled $11.1 billion at September30, 2006 and $11.4 billion at December 31, 2005. The levels at September 30,2006 reflect our decision to carry lower commercial paper balances in accordancewith our funding strategy. Included in this total was outstanding Eurocommercial paper sold to customers of HSBC of $3.1 billion at September 30, 2006and $3.2 billion at December 31, 2005. LONG TERM DEBT (with original maturities over one year) increased to $122.3billion at September 30, 2006 from $105.2 billion at December 31, 2005. As partof our overall liquidity management strategy, we continue to extend the maturityof our liability profile. Significant third party issuances during the ninemonths ended September 30, 2006 included the following: - $6.8 billion of domestic and foreign medium-term notes - $5.7 billion of foreign currency-denominated bonds - $1.5 billion of InterNotes(SM) (retail-oriented medium-term notes) - $4.8 billion of global debt - $11.9 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 issued to Household Capital Trust VI with an outstanding principal balance of $206 million. In October 2006, we called for redemption of the junior subordinated notes issued to Household Capital Trust VII with an outstanding principal balance of $206 million. These notes will be repaid in the fourth quarter of 2006. SELECTED CAPITAL RATIOS are summarized in the following table: SEPTEMBER 30, DECEMBER 31, 2006 2005---------------------------------------------------------------------------------------- TETMA(1).................................................. 7.77% 7.56%TETMA + Owned Reserves(1)................................. 10.72 10.55Tangible common equity to tangible managed assets(1)...... 6.53 6.07Common and preferred equity to owned assets............... 11.91 12.43Excluding purchase accounting adjustments: TETMA(1)................................................ 8.52 8.52 TETMA + Owned Reserves(1)............................... 11.46 11.51 Tangible common equity to tangible managed assets(1).... 7.28 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. 56 HSBC Finance Corporation -------------------------------------------------------------------------------- In 2006, Standard & Poor's Corporation raised the senior debt rating for HSBC Finance Corporation from A to AA-, raised the senior subordinated debt rating from A- to A+, raised the commercial paper rating from A-1 to A-1+, and raised the Series B preferred stock rating from BBB+ to A. Also during 2006, Moody's Investors Service raised the rating for all of our debt with the Senior Debt Rating for HSBC Finance Corporation raised from A1 to Aa3 and the Series B preferred stock rating for HSBC Finance Corporation from A3 to A2. Our short-term rating was also affirmed at Prime-1. In the third quarter of 2006, Fitch changed the total outlook on our issuer default rating to "positive outlook" from "stable outlook." SECURITIZATIONS AND SECURED FINANCINGS Securitizations (collateralized funding transactions structured to receive sale treatment under Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a Replacement of FASB Statement No. 125," ("SFAS No. 140")) and secured financings (collateralized funding transactions which do not receive sale treatment under SFAS No. 140) of consumer receivables have been a source of funding and liquidity for us. Securitizations and secured financings have been used to limit our reliance on the unsecured debt markets. In a securitization, a designated pool of non-real estate secured consumer receivables is removed from the balance sheet and transferred through a limited purpose financing subsidiary to an unaffiliated trust. This unaffiliated trust is a qualifying special purpose entity ("QSPE") as defined by SFAS No. 140 and, therefore, is not consolidated. The QSPE funds its receivable purchase through the issuance of securities to investors, entitling them to receive specified cash flows during the life of the securities. The receivables transferred to the QSPE serve as collateral for the securities. At the time of sale, an interest-only strip receivable is recorded, representing the present value of the cash flows we expect to receive over the life of the securitized receivables, net of estimated credit losses and debt service. Under the terms of the securitizations, we receive annual servicing fees on the outstanding balance of the securitized receivables and the rights to future residual cash flows on the sold receivables after the investors receive their contractual return. Cash flows related to the interest-only strip receivables and servicing the receivables are collected over the life of the underlying securitized receivables. In a secured financing, a designated pool of receivables is conveyed to a wholly owned limited purpose subsidiary which in turn transfers the receivables to a trust which sells interests to investors. Repayment of the debt issued by the trust is secured by the receivables transferred. The transactions are structured as secured financings under SFAS No. 140. Therefore, the receivables and the underlying debt of the trust remain on our balance sheet. We do not recognize a gain in a secured financing transaction. Because the receivables and the debt remain on our balance sheet, revenues and expenses are reported consistently with our owned balance sheet portfolio. Using this source of funding results in similar cash flows as issuing debt through alternative funding sources. Securitizations are treated as secured financings under IFRSs and previously under U.K. GAAP. In order to align our accounting treatment with that of HSBC initially under U.K. GAAP and now under IFRSs, we began to structure all new collateralized funding transactions as secured financings in the third quarter of 2004. However, because existing public MasterCard and Visa credit card transactions were structured as sales to revolving trusts that require replenishments of receivables to support previously issued securities, receivables will continue to be sold to these trusts and the resulting replenishment gains recorded until the revolving periods end, the last of which is currently projected to occur in the fourth quarter of 2007. We will continue to replenish at reduced levels, certain personal non-credit card and MasterCard/Visa securities privately issued to conduits and record the resulting replenishment gains for a period of time in order to manage liquidity. Since our securitized receivables have varying lives, it will take time for these receivables to pay-off and the related interest-only strip receivables to be reduced to zero. The termination of sale treatment on new collateralized funding activity reduced our reported net income under U.S. GAAP. There was no impact, however, on cash received. Because we believe the market for securities backed by receivables is a reliable, efficient and cost-effective source of funds, we will continue to use secured financings of consumer receivables as a source of our funding and liquidity. 57 HSBC Finance Corporation -------------------------------------------------------------------------------- There were no securitizations (excluding replenishments of certificateholder interests) during the three or nine months ended September 30, 2006 or September 30, 2005. Secured financings are summarized in the following table: THREE MONTHS ENDED SEPTEMBER 30, 2006 2005--------------------------------------------------------------------------------- (IN MILLIONS) SECURED FINANCINGS:Real estate secured............................................. $2,304 $1,321Auto finance.................................................... 1,060 945MasterCard/Visa................................................. 2,640 750Personal non-credit card........................................ - - ------ ------Total........................................................... $6,004 $3,016 ====== ====== NINE MONTHS ENDED SEPTEMBER 30, 2006 2005--------------------------------------------------------------------------------- (IN MILLIONS) SECURED FINANCINGS:Real estate secured............................................ $ 2,654 $2,240Auto finance................................................... 2,004 1,943MasterCard/Visa................................................ 4,745 1,250Personal non-credit card....................................... 2,500 - ------- ------Total.......................................................... $11,903 $5,433 ======= ====== Our securitized receivables totaled $1.3 billion at September 30, 2006 comparedto $4.1 billion at December 31, 2005. As of September 30, 2006, outstandingsecured financings of $20.7 billion were secured by $26.6 billion of real estatesecured, auto finance, MasterCard/Visa and personal non-credit card receivablesand investment securities of $949 million. Secured financings of $15.1 billionat December 31, 2005 were secured by $19.7 billion of real estate secured, autofinance and MasterCard/Visa receivables. At September 30, 2006, securitizationsstructured as sales represented 1 percent and secured financings represented 14percent of the funding associated with our managed funding portfolio. AtDecember 31, 2005, securitizations structured as sales represented 3 percent andsecured financings represented 11 percent of the funding associated with ourmanaged 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: SEPTEMBER 30, DECEMBER 31, 2006 2005---------------------------------------------------------------------------------------- (IN BILLIONS) Private label, MasterCard and Visa credit cards........... $184.3 $176.2Other consumer lines of credit............................ 7.2 15.0 ------ ------Open lines of credit(1)................................... $191.5 191.2 ====== ====== -------- (1) Includes an estimate for acceptance of credit offers mailed to potential customers prior to September 30, 2006 and December 31, 2005. 58 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 OCTOBER 1 THROUGH THROUGH ESTIMATED SEPTEMBER 30, DECEMBER 31, FULL YEAR 2006 2006 2006-------------------------------------------------------------------------------------------- (IN BILLIONS) FUNDING NEEDS: Net asset growth................................ $14 $ 2 - 4 $16 - 18 Commercial paper, term debt and securitization maturities................................... 27 5 - 6 32 - 33 Other........................................... (1) 1 - 2 0 - 1 --- ------- -------- Total funding needs............................. $40 $8 - 12 $48 - 52 === ======= ========FUNDING SOURCES: External funding, including commercial paper.... $39 $8 - 10 $47 - 49 HSBC and HSBC subsidiaries...................... 1 0 - 2 1 - 3 --- ------- -------- Total funding sources........................... $40 $8 - 12 $48 - 52 === ======= ======== RISK MANAGEMENT-------------------------------------------------------------------------------- CREDIT RISK There have been no significant changes in our approach to creditrisk management since December 31, 2005. At September 30, 2006, we had derivative contracts with a notional value ofapproximately $101.6 billion, including $94.0 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 derivative related liabilities and totaled $180million at September 30, 2006 and $91 million at December 31, 2005. When thefair value of our agreements with affiliate counterparties requires us to postcollateral, it is provided in the form of cash which is recorded on our balancesheet in other assets and totaled $64 million at September 30, 2006 and $0million at December 31, 2005. 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 consistentwith third party treatment. Previously, the posting of collateral by affiliateswas provided in the form of securities, which were not recorded on our balancesheet. At September 30, 2006, the fair value of our agreements with affiliatecounterparties required the affiliate to provide cash collateral of $129 millionwhich is recorded in our balance sheet as derivative related liabilities, whileat December 31, 2005, the fair value of our agreements with affiliatecounterparties was below the 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 September 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 September 30, 2006 we had a PVBP position of $.7 million reflecting theimpact of a one basis point increase in interest rates. At December 31, 2005, wealso had a PVBP position of less than $1 million reflecting the impact of a onebasis point increase in interest rates. 59 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: SEPTEMBER 30, DECEMBER 31, 2006 2005---------------------------------------------------------------------------------------- (IN MILLIONS) Risk related to our portfolio of ineffective hedges....... $(1.8) $(1.4)Risk for all other remaining assets and liabilities....... 2.5 2.3 ----- -----Total PVBP risk........................................... $ .7 $ .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: SEPTEMBER 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....... $193 $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....... $ 60 $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 has significantly reduced 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. These derivatives remain economic hedges of the underlying debtinstruments. We will continue to manage our total interest rate risk on a basisconsistent with the risk 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. 60 HSBC FINANCE CORPORATION RECONCILIATION TO GAAP FINANCIAL MEASURES THREE MONTHS ENDED NINE MONTHS ENDED ----------------------------- ----------------------------- SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 2006 2005 2006 2005-------------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) RETURN ON AVERAGE ASSETS:Net income............................... $ 551 $ 281 $ 2,007 $ 1,379 ======== ======== ======== ========Average assets: Owned basis............................ $172,746 $141,765 $167,647 $136,185 Serviced with limited recourse......... 1,493 7,779 2,539 10,288 -------- -------- -------- -------- Managed basis.......................... $174,239 $149,544 $170,186 $146,473 ======== ======== ======== ========Return on average owned assets........... 1.28% .79% 1.60% 1.35%Return on average managed assets......... 1.26 .75 1.57 1.26RETURN ON AVERAGE COMMON SHAREHOLDER'S EQUITY:Net income............................... $ 551 $ 281 $ 2,007 $ 1,379Dividends on preferred stock............. (9) (25) (27) (62) -------- -------- -------- --------Net income available to common shareholders........................... $ 542 $ 256 $ 1,980 $ 1,317 ======== ======== ======== ========Average common shareholder's equity...... $ 20,131 $ 16,973 $ 19,828 $ 16,605 ======== ======== ======== ========Return on average common shareholder's equity................................. 10.77% 6.03% 13.31% 10.58%NET INTEREST INCOME:Net interest income: Owned basis............................ $ 2,602 $ 2,163 $ 7,615 $ 6,086 Serviced with limited recourse......... 37 177 207 758 -------- -------- -------- -------- Managed basis.......................... $ 2,639 $ 2,340 $ 7,822 $ 6,844 ======== ======== ======== ========Average interest-earning assets: Owned basis............................ $158,722 $127,038 $153,003 $119,848 Serviced with limited recourse......... 1,493 7,779 2,539 10,288 -------- -------- -------- -------- Managed basis.......................... $160,215 $134,817 $155,542 $130,136 ======== ======== ======== ========Owned basis net interest margin.......... 6.56% 6.81% 6.64% 6.77%Managed basis net interest margin........ 6.59 6.94 6.71 7.01MANAGED BASIS RISK ADJUSTED REVENUE:Net interest income...................... $ 2,639 $ 2,340 $ 7,822 $ 6,844Other revenues........................... 1,328 947 3,787 3,119Excluding: Securitization related revenue......... 29 217 154 742 Mark-to-market on derivatives which do not qualify as effective hedges and ineffectiveness associated with qualifying hedges under SFAS No. 133................................. (72) 66 (116) (237) Net charge-offs........................ (1,168) (1,052) (3,279) (3,198) -------- -------- -------- --------Risk adjusted revenue.................... $ 2,756 $ 2,518 $ 8,368 $ 7,270 ======== ======== ======== ========Average interest-earning assets.......... $160,215 $134,817 $155,542 $130,136Managed basis risk adjusted revenue...... 6.88% 7.47% 7.17% 7.45% 61 HSBC FINANCE CORPORATION RECONCILIATION TO GAAP FINANCIAL MEASURES THREE MONTHS ENDED NINE MONTHS ENDED -------------------------------------- ---------------------------- SEPTEMBER 30, JUNE 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 2006 2006 2005 2006 2005------------------------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS) CONSUMER NET CHARGE-OFF RATIO:Consumer net charge-offs: Owned basis......................... $ 1,138 $ 1,079 $ 902 $ 3,145 $ 2,602 Serviced with limited recourse...... 30 41 150 133 589 -------- -------- -------- -------- -------- Managed basis....................... $ 1,168 $ 1,120 $ 1,052 $ 3,278 $ 3,191 ======== ======== ======== ======== ========Average consumer receivables: Owned basis......................... $155,913 $149,933 $123,163 $149,913 $115,815 Serviced with limited recourse...... 1,493 2,620 7,779 2,539 10,288 -------- -------- -------- -------- -------- Managed basis....................... $157,406 $152,553 $130,942 $152,452 $126,103 ======== ======== ======== ======== ========Owned basis consumer net charge-off ratio............................... 2.92% 2.88% 2.93% 2.80% 3.00%Managed basis consumer net charge-off ratio............................... 2.97 2.94 3.21 2.87 3.37RESERVES AS A PERCENT OF NET CHARGE- OFFSLoss reserves: Owned basis......................... $ 4,885 $ 4,649 $ 4,220 $ 4,885 $ 4,220 Serviced with limited recourse...... 61 91 351 61 351 -------- -------- -------- -------- -------- Managed basis....................... $ 4,946 $ 4,740 $ 4,571 $ 4,946 $ 4,571 ======== ======== ======== ======== ========Net charge-offs: Owned basis......................... $ 1,138 $ 1,080 $ 902 $ 3,146 $ 2,609 Serviced with limited recourse...... 30 41 150 133 589 -------- -------- -------- -------- -------- Managed basis....................... $ 1,168 $ 1,121 $ 1,052 $ 3,279 $ 3,198 ======== ======== ======== ======== ========Owned basis reserves as a percent of net charge-offs..................... 107.3% 107.6% 117.0% 116.5% 121.3%Managed basis reserves as a percent of net charge-offs..................... 105.9 105.7 108.6 113.1 107.2EFFICIENCY RATIO:Total costs and expenses less policyholders' benefits............. $ 1,582 $ 1,496 $ 1,419 $ 4,610 $ 4,250 ======== ======== ======== ======== ========Net interest income and other revenues less policyholders' benefits: Owned basis......................... $ 3,844 $ 3,641 $ 3,201 $ 11,282 $ 9,557 Serviced with limited recourse...... -- (29) (23) (21) 59 -------- -------- -------- -------- -------- Managed basis....................... $ 3,844 $ 3,612 $ 3,178 $ 11,261 $ 9,616 ======== ======== ======== ======== ========Owned basis efficiency ratio.......... 41.16% 41.09% 44.33% 40.86% 44.47%Managed basis efficiency ratio........ 41.16 41.42 44.65 40.94 44.20 62 HSBC FINANCE CORPORATION RECONCILIATION TO GAAP FINANCIAL MEASURES SEPTEMBER 30, JUNE 30, SEPTEMBER 30, 2006 2006 2005-------------------------------------------------------------------------------------------- (DOLLAR AMOUNTS ARE IN MILLIONS) TWO-MONTHS-AND-OVER-CONTRACTUAL DELINQUENCY:Consumer two-months-and-over-contractual delinquency: Owned basis..................................... $ 6,495 $ 5,652 $ 4,861 Serviced with limited recourse.................. 78 110 376 -------- -------- -------- Managed basis................................... $ 6,573 $ 5,762 $ 5,237 -------- -------- --------Consumer receivables: Owned basis..................................... $156,760 $153,779 $128,524 Serviced with limited recourse.................. 1,274 1,911 6,759 -------- -------- -------- Managed basis................................... $158,034 $155,690 $135,283 -------- -------- --------Consumer two-months-and-over-contractual delinquency: Owned basis..................................... 4.14% 3.68% 3.78% Managed basis................................... 4.16 3.70 3.87 ======== ======== ========RESERVES AS A PERCENTAGE OF RECEIVABLES:Loss reserves: Owned basis..................................... $ 4,885 $ 4,649 $ 4,220 Serviced with limited recourse.................. 61 91 351 -------- -------- -------- Managed basis................................... $ 4,946 $ 4,740 $ 4,571 -------- -------- --------Receivables: Owned basis..................................... $156,929 $153,959 $128,722 Serviced with limited recourse.................. 1,274 1,911 6,759 -------- -------- -------- Managed basis................................... $158,203 $155,870 $135,481 -------- -------- --------Reserves as a percentage of receivables: Owned basis..................................... 3.11% 3.02% 3.28% Managed basis................................... 3.13 3.04 3.37 ======== ======== ========RESERVES AS A PERCENTAGE OF NONPERFORMING LOANS:Loss reserves: Owned basis..................................... $ 4,885 $ 4,649 $ 4,220 Serviced with limited recourse.................. 61 91 351 -------- -------- -------- Managed basis................................... $ 4,946 $ 4,740 $ 4,571 -------- -------- --------Nonperforming loans: Owned basis..................................... $ 4,960 $ 4,354 $ 3,836 Serviced with limited recourse.................. 66 92 309 -------- -------- -------- Managed basis................................... $ 5,026 $ 4,446 $ 4,145 -------- -------- --------Reserves as a percentage of nonperforming loans: Owned basis..................................... 98.5% 106.8% 110.0% Managed basis................................... 98.4 106.6 110.3 ======== ======== ======== 63 HSBC FINANCE CORPORATION RECONCILIATION TO GAAP FINANCIAL MEASURES DECEMBER 31, SEPTEMBER 30, 2005 2006 ---------------------------------------------------------------------------------------------------- (dollars are in millions) TANGIBLE COMMON EQUITY:Common shareholder's equity............................... $ 20,178 $ 18,904Exclude: Unrealized (gains) losses on cash flow hedging instruments.......................................... (22) (260) Minimum pension liability............................... - - Unrealized gains on investments and interest-only strip receivables.......................................... (24) 3 Intangible assets....................................... (2,274) (2,480) Goodwill................................................ (7,038) (7,003) -------- --------Tangible common equity.................................... 10,820 9,164HSBC acquisition purchase accounting adjustments.......... 1,234 1,441 -------- --------Tangible common equity, excluding HSBC acquisition purchase accounting adjustments......................... $ 12,054 $ 10,605 ======== ========TANGIBLE SHAREHOLDER'S(S') EQUITY:Tangible common equity.................................... $ 10,820 $ 9,164Preferred stock........................................... 575 575Mandatorily redeemable preferred securities of Household Capital Trusts.......................................... 1,476 1,679 -------- --------Tangible shareholder's(s') equity......................... 12,871 11,418HSBC acquisition purchase accounting adjustments.......... 1,233 1,438 -------- --------Tangible shareholder's(s') equity, excluding HSBC acquisition purchase accounting adjustments............. $ 14,104 $ 12,856 ======== ========TANGIBLE SHAREHOLDER'S(S') EQUITY PLUS OWNED LOSS RESERVES:Tangible shareholder's(s') equity......................... $ 12,871 $ 11,418Owned loss reserves....................................... 4,885 4,521 -------- --------Tangible shareholder's(s') equity plus owned loss reserves................................................ 17,756 15,939HSBC acquisition purchase accounting adjustments.......... 1,233 1,438 -------- --------Tangible shareholder's(s') equity plus owned loss reserves, excluding HSBC acquisition purchase accounting adjustments............................................. $ 18,989 $ 17,377 ======== ========TANGIBLE MANAGED ASSETS:Owned assets.............................................. $174,280 $156,669Receivables serviced with limited recourse................ 1,274 4,074 -------- --------Managed assets............................................ 175,554 160,743Exclude: Intangible assets....................................... (2,274) (2,480) Goodwill................................................ (7,038) (7,003) Derivative financial assets............................. (648) (234) -------- --------Tangible managed assets................................... 165,594 151,026HSBC acquisition purchase accounting adjustments.......... 33 (52) -------- --------Tangible managed assets, excluding HSBC acquisition purchase accounting adjustments......................... $165,627 $150,974 ======== ========EQUITY RATIOS:Common and preferred equity to owned assets............... 11.91% 12.43%Tangible common equity to tangible managed assets......... 6.53 6.07Tangible shareholder's(s') equity to tangible managed assets ("TETMA")........................................ 7.77 7.56Tangible shareholder's(s') equity plus owned loss reserves to tangible managed assets ("TETMA + Owned Reserves")... 10.72 10.55Excluding HSBC acquisition purchase accounting adjustments: Tangible common equity to tangible managed assets....... 7.28 7.02 TETMA................................................... 8.52 8.52 TETMA + Owned Reserves.................................. 11.46 11.51 ======== ======== 64 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 management report under Section 404 will be contained in our Form 10-K forthe period ended 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. 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 65 HSBC Finance Corporation -------------------------------------------------------------------------------- in Connecticut and the Eastern District of New York; Photos Etc. Corp. et al. v.Visa U.S.A., Inc., et al. (D. Conn. No. 3:05-CV-01007 (WWE)): 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. etal. (E.D.N.Y. No. 05-CV-4521 (JG)); and American Booksellers Ass'n v. VisaU.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. Discovery has begun. At this time, weare unable to quantify 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 a false statement of a material fact in conjunction with thepurchase or sale of securities, that the plaintiffs justifiably relied on suchstatement, the false statement(s) caused the plaintiffs' damages, and that someor all of the defendants should be liable for those alleged statements. OnFebruary 28, 2006, the Court has also dismissed all alleged sec.10 claims thatarose prior to July 30, 1999, shortening the class period by 22 months. Thefinal discovery cut-off has been set for January 31, 2007 this time. Separately,one of the defendants, Arthur Andersen, entered into a settlement of the claimsagainst Andersen. This settlement 66 received Court approval in April 2006. At this time, we are unable to quantifythe potential impact from this action, 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. 67 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 68 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: November 13, 2006 69 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 70 HSBC Finance Corporation -------------------------------------------------------------------------------- EXHIBIT 12 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS NINE MONTHS ENDED SEPTEMBER 30, --------------- 2006 2005--------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net income...................................................... $2,007 $1,379Income tax expense.............................................. 1,167 695 ------ ------Income before income tax expense................................ 3,174 2,074 ------ ------Fixed charges: Interest expense.............................................. 5,318 3,405 Interest portion of rentals(1)................................ 44 45 ------ ------Total fixed charges............................................. 5,362 3,450 ------ ------Total earnings as defined....................................... $8,536 $5,524 ====== ======Ratio of earnings to fixed charges.............................. 1.59 1.60Preferred stock dividends(2).................................... 43 93Ratio of earnings to combined fixed charges and preferred stock dividends..................................................... 1.58 1.56 -------- (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: November 13, 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: November 13, 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 September 30, 2006 as filed with the Securities and Exchange Commissionon the date hereof (the "Report") for the purpose of complying with Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the "ExchangeAct") 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. November 13, 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 September 30, 2006 as filed with the Securities and Exchange Commissionon the date hereof (the "Report") for the purpose of complying with Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the "ExchangeAct") 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. November 13, 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 SEPTEMBER 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 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 ExchangeRelated Shares:
HSBC Holdings