15th May 2006 14:30
HSBC Holdings PLC15 May 2006 PART 1 -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------- FORM 10-Q --------------------- (Mark One) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ________ COMMISSION FILE NUMBER 1-8198 --------------------- HSBC FINANCE CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 86-1052062 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.) 2700 SANDERS ROAD, PROSPECT HEIGHTS, ILLINOIS 60070 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (847) 564-5000 REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE --------------------- Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes No ( ) Indicate by check mark whether the registrant is a large accelerated filer,an accelerated filer, or a non-accelerated filer. See definition of "acceleratedfiler and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Checkone): Large accelerated filer ( ) Accelerated filer ( ) Non-acceleratedfiler Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act). Yes ( ) No As of April 30, 2006, there were 55 shares of the registrant's common stockoutstanding, all of which are owned by HSBC Investments (North America) Inc.-------------------------------------------------------------------------------- HSBC FINANCE CORPORATION FORM 10-Q TABLE OF CONTENTS PART I. FINANCIAL INFORMATION-----------------------------------------------------------------------------------Item 1. Consolidated Financial Statements 3 Statement of Income......................................... 4 Balance Sheet............................................... 5 Statement of Changes in Shareholders'('s) Equity............ 6 Statement of Cash Flows..................................... 7 Notes to Consolidated Financial Statements..................Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 20 Forward-Looking Statements.................................. 20 Executive Overview.......................................... 23 Basis of Reporting.......................................... 29 Receivables Review.......................................... 30 Results of Operations....................................... 35 Segment Results - Managed Basis............................. 40 Credit Quality.............................................. 46 Liquidity and Capital Resources............................. 49 Risk Management............................................. 52 Reconciliations to GAAP Financial Measures..................Item 4. Controls and Procedures..................................... 56 PART II. OTHER INFORMATION-----------------------------------------------------------------------------------Item 1. Legal Proceedings........................................... 56Item 1A. Risk Factors................................................ 58Item 6. Exhibits.................................................... 62Signature...... ............................................................ 63 2 PART I. FINANCIAL INFORMATION--------------------------------------------------------------------------------ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS HSBC Finance Corporation--------------------------------------------------------------------------------CONSOLIDATED STATEMENT OF INCOME THREE MONTHS ENDED MARCH 31, 2006 2005----------------------------------------------------------------------------- (IN MILLIONS)Finance and other interest income........................... $4,087 $2,950Interest expense: HSBC affiliates........................................... 153 151 Non-affiliates............................................ 1,470 911 ------ ------NET INTEREST INCOME......................................... 2,464 1,888Provision for credit losses................................. 866 841 ------ ------NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES....... 1,598 1,047 ------ ------Other revenues: Securitization related revenue............................ 71 85 Insurance revenue......................................... 230 221 Investment income......................................... 34 33 Derivative income......................................... 57 260 Fee income................................................ 392 306 Taxpayer financial services revenue....................... 234 243 Gain on receivable sales to HSBC affiliates............... 85 100 Servicing fees from HSBC affiliates....................... 108 101 Other income.............................................. 196 113 ------ ------TOTAL OTHER REVENUES........................................ 1,407 1,462 ------ ------Costs and expenses: Salaries and employee benefits............................ 581 497 Sales incentives.......................................... 80 82 Occupancy and equipment expenses.......................... 83 87 Other marketing expenses.................................. 173 180 Other servicing and administrative expenses............... 239 258 Support services from HSBC affiliates..................... 252 209 Amortization of intangibles............................... 80 107 Policyholders' benefits................................... 118 122 ------ ------TOTAL COSTS AND EXPENSES.................................... 1,606 1,542 ------ ------Income before income tax expense............................ 1,399 967Income tax expense.......................................... 511 341 ------ ------NET INCOME.................................................. $ 888 $ 626 ====== ====== The accompanying notes are an integral part of the consolidated financialstatements. 3 HSBC Finance Corporation-------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEET MARCH 31, DECEMBER 31, 2006 2005-------------------------------------------------------------------------------------- (IN MILLIONS, EXCEPT SHARE DATA)ASSETSCash........................................................ $ 476 $ 903Interest bearing deposits with banks........................ 599 384Securities purchased under agreements to resell............. 91 78Securities.................................................. 4,143 4,051Receivables, net............................................ 143,890 136,989Intangible assets, net...................................... 2,400 2,480Goodwill.................................................... 7,009 7,003Properties and equipment, net............................... 425 458Real estate owned........................................... 563 510Derivative financial assets................................. 282 234Other assets................................................ 3,802 3,579 -------- --------TOTAL ASSETS................................................ $163,680 $156,669 ======== ======== LIABILITIESDebt: Commercial paper, bank and other borrowings............... $ 14,252 $ 11,454 Due to affiliates......................................... 15,520 15,534 Long term debt (with original maturities over one year)... 107,794 105,163 -------- --------Total debt.................................................. 137,566 132,151 -------- --------Insurance policy and claim reserves......................... 1,298 1,291Derivative related liabilities.............................. 640 383Other liabilities........................................... 3,795 3,365 -------- -------- TOTAL LIABILITIES......................................... 143,299 137,190 SHAREHOLDERS' EQUITYRedeemable preferred stock, 1,501,100 shares authorized, Series B, $0.01 par value, 575,000 shares issued.......... 575 575Common shareholder's equity: Common stock, $0.01 par value, 100 shares authorized, 55 shares issued...................................... - - Additional paid-in capital............................. 17,132 17,145 Retained earnings...................................... 2,159 1,280 Accumulated other comprehensive income................. 515 479 -------- --------TOTAL COMMON SHAREHOLDER'S EQUITY........................... 19,806 18,904 -------- --------TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................. $163,680 $156,669 ======== ======== The accompanying notes are an integral part of the consolidated financialstatements. 4 HSBC Finance Corporation-------------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS'('S) EQUITY THREE MONTHS ENDED MARCH 31, 2006 2005------------------------------------------------------------------------------- (IN MILLIONS)PREFERRED STOCK Balance at beginning and end of period.................... $ 575 $ 1,100 ======= =======COMMON SHAREHOLDER'S EQUITY ADDITIONAL PAID-IN CAPITAL Balance at beginning of period......................... $17,145 $14,627 Employee benefit plans, including transfers and other................................................. (13) 46 ------- ------- Balance at end of period............................... $17,132 $14,673 ------- ------- RETAINED EARNINGS Balance at beginning of period......................... $ 1,280 $ 571 Net income............................................. 888 626 Dividends: Preferred stock...................................... (9) (18) ------- ------- Balance at end of period............................... $ 2,159 $ 1,179 ------- ------- ACCUMULATED OTHER COMPREHENSIVE INCOME Balance at beginning of period......................... $ 479 $ 643 Net change in unrealized gains (losses), net of tax, on: Derivatives classified as cash flow hedges........... 54 134 Securities available for sale and interest-only strip receivables......................................... (33) (16) Foreign currency translation adjustments............... 15 (60) ------- ------- Other comprehensive income, net of tax................. 36 58 ------- ------- Balance at end of period............................... $ 515 $ 701 ------- -------TOTAL COMMON SHAREHOLDER'S EQUITY........................... $19,806 $16,553 ------- -------COMPREHENSIVE INCOME Net income................................................ $ 888 $ 626 Other comprehensive income................................ 36 58 ------- -------COMPREHENSIVE INCOME........................................ $ 924 $ 684 ======= ======= The accompanying notes are an integral part of the consolidated financialstatements. 5 HSBC Finance Corporation-------------------------------------------------------------------------------- STATEMENT OF CASH FLOWS THREE MONTHS ENDED MARCH 31, 2006 2005--------------------------------------------------------------------------------- (IN MILLIONS)CASH FLOWS FROM OPERATING ACTIVITIESNet income.................................................. $ 888 $ 626Adjustments to reconcile net income to net cash provided by (used in) operating activities: Gain on receivable sales to HSBC affiliates............... (85) (100) Provision for credit losses............................... 866 841 Insurance policy and claim reserves....................... (49) (29) Depreciation and amortization............................. 109 142 Net change in other assets................................ (312) (235) Net change in other liabilities........................... 412 382 Excess tax benefits from share-based compensation arrangements............................................ (4) - Other, net................................................ 229 290 -------- --------Net cash provided by (used in) operating activities......... 2,054 1,917 -------- --------CASH FLOWS FROM INVESTING ACTIVITIESSecurities: Purchased................................................. (224) (178) Matured................................................... 183 95 Sold...................................................... 120 34Net change in short-term securities available for sale...... (208) 51Net change in securities purchased under agreements to resell.................................................... (13) 2,369Net change in interest bearing deposits with banks.......... (216) 284Receivables: Originations, net of collections.......................... (12,994) (11,772) Purchases and related premiums............................ (9) (8) Sales to affiliates....................................... 4,909 4,720 Net change in interest-only strip receivables............. (1) 89Cash received in sale of U.K. credit card business.......... 90 -Properties and equipment: Purchases................................................. (8) (17) Sales..................................................... 8 1 -------- --------Net cash provided by (used in) investing activities......... (8,363) (4,332) -------- --------CASH FLOWS FROM FINANCING ACTIVITIESDebt: Net change in short-term debt and deposits................ 2,800 1,593 Net change in time certificates........................... - (2) Net change in due to affiliates........................... (52) 1,430 Long term debt issued..................................... 8,278 3,984 Long term debt retired.................................... (4,961) (4,386)Redemption of company obligated mandatorily redeemable preferred securities of subsidiary trusts................. (206) -Insurance: Policyholders' benefits paid.............................. (58) (56) Cash received from policyholders.......................... 88 84Shareholders' dividends..................................... (9) -Excess tax benefits from share-based compensation arrangements.............................................. 4 - -------- --------Net cash provided by (used in) financing activities......... 5,884 2,647 -------- --------Effect of exchange rate changes on cash..................... (2) (2) -------- --------Net change in cash.......................................... (427) 230Cash at beginning of period................................. 903 392 -------- --------CASH AT END OF PERIOD....................................... $ 476 $ 622 ======== ======== The accompanying notes are an integral part of the consolidated financialstatements. 6 HSBC Finance Corporation-------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND BASIS OF PRESENTATION-------------------------------------------------------------------------------- HSBC Finance Corporation is an indirect wholly owned subsidiary of HSBC NorthAmerica Holdings Inc. ("HNAH"), which is an indirect wholly owned subsidiary ofHSBC Holdings plc ("HSBC"). The accompanying unaudited interim consolidatedfinancial statements of HSBC Finance Corporation and its subsidiaries have beenprepared in accordance with accounting principles generally accepted in theUnited States of America ("U.S. GAAP") for interim financial information andwith the instructions to Form 10-Q and Article 10 of Regulation S-X.Accordingly, they do not include all of the information and footnotes requiredby generally accepted accounting principles for complete financial statements.In the opinion of management, all normal and recurring adjustments considerednecessary for a fair presentation of financial position, results of operationsand cash flows for the interim periods have been made. HSBC Finance Corporationmay also be referred to in this Form 10-Q as "we," "us" or "our." Theseunaudited interim consolidated financial statements should be read inconjunction with our Annual Report on Form 10-K for the year ended December 31,2005 (the "2005 Form 10-K"). Certain reclassifications have been made to priorperiod amounts to conform to the current period presentation. The preparation of financial statements in conformity with U.S. GAAP requiresthe use of estimates and assumptions that affect reported amounts anddisclosures. Actual results could differ from those estimates. Interim resultsshould not be considered indicative of results in future periods. 2. SECURITIES-------------------------------------------------------------------------------- Securities consisted of the following available-for-sale investments: GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIRMARCH 31, 2006 COST GAINS LOSSES VALUE--------------------------------------------------------------------------------------------------- (IN MILLIONS)Corporate debt securities............................ $2,327 $6 $(65) $2,268Money market funds................................... 435 - - 435U.S. government sponsored enterprises(1)............. 56 - (3) 53U.S. government and Federal agency debt securities... 819 - (4) 815Non-government mortgage backed securities............ 111 - (1) 110Other................................................ 434 1 (6) 429 ------ -- ---- ------Subtotal............................................. 4,182 7 (79) 4,110Accrued investment income............................ 33 - - 33 ------ -- ---- ------Total securities available for sale.................. $4,215 $7 $(79) $4,143 ====== == ==== ====== 7 HSBC Finance Corporation-------------------------------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIRDECEMBER 31, 2005 COST GAINS LOSSES VALUE--------------------------------------------------------------------------------------------------- (IN MILLIONS)Corporate debt securities............................ $2,337 $23 $(38) $2,322Money market funds................................... 315 - - 315U.S. government sponsored enterprises(1)............. 96 - (2) 94U.S. government and Federal agency debt securities... 744 - (4) 740Non-government mortgage backed securities............ 88 - (1) 87Other................................................ 463 1 (5) 459 ------ --- ---- ------Subtotal............................................. 4,043 24 (50) 4,017Accrued investment income............................ 34 - - 34 ------ --- ---- ------Total securities available for sale.................. $4,077 $24 $(50) $4,051 ====== === ==== ====== --------------- (1) Includes primarily mortgage-backed securities issued by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. Money market funds at March 31, 2006 include $250 million which is restrictedfor the sole purpose of paying down certain secured financings at theestablished payment date. There were no such balances at December 31, 2005. A summary of gross unrealized losses and related fair values as of March 31,2006 and December 31, 2005, classified as to the length of time the losses haveexisted follows: LESS THAN ONE YEAR GREATER THAN ONE YEAR --------------------------------------- --------------------------------------- NUMBER GROSS AGGREGATE NUMBER GROSS AGGREGATE OF UNREALIZED FAIR VALUE OF OF UNREALIZED FAIR VALUE OFMARCH 31, 2006 SECURITIES LOSSES INVESTMENTS SECURITIES LOSSES INVESTMENTS--------------------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Corporate debt securities... 200 $(17) $514 517 $(48) $1,262U.S. government sponsored enterprises............... 12 (1) 31 36 (2) 76U.S. government and Federal agency debt securities.... 9 (1) 19 36 (3) 120Non-government mortgage..... 3 -(1) 4 16 (1) 21Other....................... 15 -(1) 45 46 (6) 233 LESS THAN ONE YEAR GREATER THAN ONE YEAR --------------------------------------- --------------------------------------- NUMBER GROSS AGGREGATE NUMBER GROSS AGGREGATE OF UNREALIZED FAIR VALUE OF OF UNREALIZED FAIR VALUE OFDECEMBER 31, 2005 SECURITIES LOSSES INVESTMENTS SECURITIES LOSSES INVESTMENTS--------------------------------------------------------------------------------------------------------------- (IN MILLIONS)Corporate debt securities... 243 $(12) $527 392 $(26) $996U.S. government sponsored enterprises............... 32 -(1) 26 25 (2) 64U.S. government and Federal agency debt securities.... 15 (1) 49 43 (3) 139Non-government mortgage..... 3 -(1) 4 16 (1) 22Other....................... 14 (1) 78 46 (4) 181 --------------- (1) Less than $500 thousand. 8 HSBC Finance Corporation-------------------------------------------------------------------------------- The gross unrealized losses on our securities available for sale have increasedduring the first quarter of 2006 due to a general increase in interest rates.The contractual terms of these securities do not permit the issuer to settle thesecurities at a price less than the par value of the investment. Sincesubstantially all of these securities are rated A- or better, and because wehave the ability and intent to hold these investments until maturity or a marketprice recovery, these securities are not considered other-than-temporarilyimpaired. 3. RECEIVABLES-------------------------------------------------------------------------------- Receivables consisted of the following: MARCH 31, DECEMBER 31, 2006 2005-------------------------------------------------------------------------------------- (IN MILLIONS)Real estate secured......................................... $ 89,492 $ 82,826Auto finance................................................ 11,186 10,704MasterCard(1)/Visa(1)....................................... 23,449 24,110Private label............................................... 2,428 2,520Personal non-credit card.................................... 20,006 19,545Commercial and other........................................ 206 208 --------- ---------Total owned receivables..................................... 146,767 139,913HSBC acquisition purchase accounting fair value adjustments............................................... 28 63Accrued finance charges..................................... 1,871 1,831Credit loss reserve for owned receivables................... (4,468) (4,521)Unearned credit insurance premiums and claims reserves...... (480) (505)Interest-only strip receivables............................. 20 23Amounts due and deferred from receivable sales.............. 152 185 --------- ---------Total owned receivables, net................................ 143,890 136,989Receivables serviced with limited recourse.................. 3,109 4,074 --------- ---------Total managed receivables, net.............................. $ 146,999 $ 141,063 ========= ========= --------------- (1) MasterCard is a registered trademark of MasterCard International, Incorporated and Visa is a registered trademark of VISA USA, Inc. HSBC acquisition purchase accounting fair value adjustments representadjustments which have been "pushed down" to record our receivables at fairvalue on March 28, 2003, the date we were acquired by HSBC. We have a subsidiary, Decision One Mortgage Company, LLC, which directlyoriginates mortgage loans sourced by mortgage brokers and sells all loans tosecondary market purchasers, including our Mortgage Services business. Loansheld for sale to external parties by this subsidiary totaled $1.2 billion atMarch 31, 2006 and $1.7 billion at December 31, 2005 and are included in realestate secured receivables. As part of our acquisition of Metris on December 1, 2005, we acquired $5.3billion of receivables. The receivables acquired were subject to therequirements of SOP 03-3 to the extent there was evidence of deterioration ofcredit quality since origination and for which it was probable, at acquisition,that all contractually required payments would not be collected and that theassociated line of credit had been closed. The carrying amount of thesereceivables was $347 million at March 31, 2006 and $414 million at December 31,2005 and is included in the MasterCard/Visa receivables in the table above. AtMarch 31, 2006, no credit loss reserve for these acquired receivables has beenestablished as there has been no decrease 9 HSBC Finance Corporation-------------------------------------------------------------------------------- to the expected future cash flows since the acquisition. The outstandingcontractual balance of these receivables was $571 million at March 31, 2006 and$804 million at December 31, 2005. At the time of the Metris acquisition, the anticipated cash flows from theseacquired receivables exceeded the amount paid for the receivables. There were noadditions to accretable yield or reclassifications from non-accretable yieldduring the quarter ended March 31, 2006. The following summarizes the accretableyield on these receivables at March 31, 2006: (IN MILLIONS)---------------------------------------------------------------------------Accretable yield at December 31, 2005....................... $(122)Accretable yield amortized to interest income during the period.................................................... 30 -----Accretable yield at March 31, 2006.......................... $ (92) ===== Interest-only strip receivables are reported net of our estimate of probablelosses under the recourse provisions for receivables serviced with limitedrecourse. Receivables serviced with limited recourse consisted of the following: MARCH 31, DECEMBER 31, 2006 2005-------------------------------------------------------------------------------------- (IN MILLIONS)Auto finance................................................ $ 920 $1,192MasterCard/Visa............................................. 1,528 1,875Personal non-credit card.................................... 661 1,007 ------ ------Total....................................................... $3,109 $4,074 ====== ====== The combination of receivables owned and receivables serviced with limitedrecourse, which comprises our managed portfolio, is shown below: MARCH 31, DECEMBER 31, 2006 2005-------------------------------------------------------------------------------------- (IN MILLIONS)Real estate secured......................................... $ 89,492 $ 82,826Auto finance................................................ 12,106 11,896MasterCard/Visa............................................. 24,977 25,985Private label............................................... 2,428 2,520Personal non-credit card.................................... 20,667 20,552Commercial and other........................................ 206 208 -------- --------Total....................................................... $149,876 $143,987 ======== ======== We generally serve non-conforming and non-prime consumers. Such customers areindividuals who have limited credit histories, modest incomes, highdebt-to-income ratios or have experienced credit problems caused by occasionaldelinquencies, prior charge-offs, bankruptcy or other credit related actions. Asa result, the majority of our secured receivables have a high loan-to-valueratio. Due to customer demand we offer interest-only loans and expect tocontinue to do so. These interest-only loans allow customers to pay only theaccruing interest for a period of time which results in lower payments duringthe initial loan period. Depending on a customer's financial situation, thesubsequent increase in the required payment to begin making payment towards theloan principal could affect our customer's ability to repay the loan at somefuture date when the interest rate resets and/or principal payments arerequired. As with all our other non-conforming and nonprime loan products, weunderwrite and price interest only loans in a manner that is appropriate tocompensate for their higher risk. At March 31, 2006, the outstanding balance ofour interest-only loans was 10 HSBC Finance Corporation-------------------------------------------------------------------------------- $6.5 billion, or 4.3% of managed receivables. At December 31, 2005, theoutstanding balance of our interest-only loans was $4.7 billion, or 3.3% ofmanaged receivables. 4. CREDIT LOSS RESERVES-------------------------------------------------------------------------------- An analysis of credit loss reserves was as follows: THREE MONTHS ENDED MARCH 31, 2006 2005----------------------------------------------------------------------------- (IN MILLIONS)Owned receivables: Credit loss reserves at beginning of period............... $4,521 $3,625 Provision for credit losses............................... 866 841 Charge-offs............................................... (1,054) (953) Recoveries................................................ 126 90 Other, net................................................ 9 (22) ------ ------ Credit loss reserves for owned receivables................ 4,468 3,581 ------ ------Receivables serviced with limited recourse: Credit loss reserves at beginning of period............... 215 890 Provision for credit losses............................... 8 30 Charge-offs............................................... (71) (271) Recoveries................................................ 9 16 Other, net................................................ - (4) ------ ------ Credit loss reserves for receivables serviced with limited recourse............................................... 161 661 ------ ------Credit loss reserves for managed receivables................ $4,629 $4,242 ====== ====== The increase in the provision for credit losses reflects higher receivablelevels, partially offset by lower bankruptcy losses due to reduced bankruptcyfilings resulting from the enactment of new bankruptcy legislation in the UnitedStates in October 2005 and a reduction in the estimated loss exposure resultingfrom Hurricane Katrina. Further analysis of credit quality and credit loss reserves and our credit lossreserve methodology are presented in Item 2, "Management's Discussion andAnalysis of Financial Condition and Results of Operations" of this Form 10-Qunder the caption "Credit Quality." 11 HSBC Finance Corporation-------------------------------------------------------------------------------- 5. INTANGIBLE ASSETS-------------------------------------------------------------------------------- Intangible assets consisted of the following: ACCUMULATED CARRYING GROSS AMORTIZATION VALUE---------------------------------------------------------------------------------------------- (IN MILLIONS)MARCH 31, 2006Purchased credit card relationships and related programs.... $1,736 $476 $1,260Retail services merchant relationships...................... 270 163 107Other loan related relationships............................ 326 112 214Trade names................................................. 717 13 704Technology, customer lists and other contracts.............. 282 167 115 ------ ---- ------Total....................................................... $3,331 $931 $2,400 ====== ==== ======DECEMBER 31, 2005Purchased credit card relationships and related programs.... $1,736 $442 $1,294Retail services merchant relationships...................... 270 149 121Other loan related relationships............................ 326 104 222Trade names................................................. 717 13 704Technology, customer lists and other contracts.............. 282 143 139 ------ ---- ------Total....................................................... $3,331 $851 $2,480 ====== ==== ====== Estimated amortization expense associated with our intangible assets for each ofthe following years is as follows: YEAR ENDING DECEMBER 31,--------------------------------------------------------------------------- (IN MILLIONS)2006........................................................ $2692007........................................................ 2522008........................................................ 2102009........................................................ 1972010........................................................ 168Thereafter.................................................. 520 6. GOODWILL-------------------------------------------------------------------------------- Goodwill balances associated with our foreign businesses will change from periodto period due to movements in foreign exchange. Changes in estimates of the taxbasis in our assets and liabilities or other tax estimates recorded pursuant toStatement of Financial Accounting Standards Number 109, "Accounting for IncomeTaxes," may result in changes to our goodwill balances. During the first quarterof 2006, we increased our goodwill balance by approximately $2 million as aresult of such changes in tax estimates. 7. INCOME TAXES-------------------------------------------------------------------------------- Our effective tax rates were as follows: Three months ended March 31, 2006........................... 36.5%Three months ended March 31, 2005........................... 35.3 12 HSBC Finance Corporation-------------------------------------------------------------------------------- The increase in the effective tax rate for the first quarter of 2006 is due tohigher state income taxes and an increase in pretax income with slightly lowertax credits. The increase in state income taxes is primarily due to an increasein the blended statutory tax rate of our operating companies. The effective taxrate differs from the statutory federal income tax rate primarily because of theeffects of state and local income taxes and tax credits. 8. RELATED PARTY TRANSACTIONS-------------------------------------------------------------------------------- In the normal course of business, we conduct transactions with HSBC and itssubsidiaries. These transactions include funding arrangements, derivativeexecution, purchases and sales of receivables, servicing arrangements,information technology services, item and statement processing services, bankingand other miscellaneous services. The following tables present related partybalances and the income and (expense) generated by related party transactions: MARCH 31, DECEMBER 31, 2006 2005-------------------------------------------------------------------------------------- (IN MILLIONS)ASSETS, (LIABILITIES) AND EQUITY:Derivative financial assets (liability), net................ $ (479) $ (260)Affiliate preferred stock received in sale of U.K. credit card business............................................. 261 261Other assets................................................ 443 518Due to affiliates........................................... (15,520) (15,534)Other liabilities........................................... (329) (445) THREE MONTHS ENDED MARCH 31, 2006 2005--------------------------------------------------------------------------- (IN MILLIONS)INCOME/(EXPENSE):Interest expense on borrowings from HSBC and subsidiaries... $(153) $(151)Interest income on advances to HSBC affiliates.............. 5 4HSBC Bank USA: Real estate secured servicing revenues.................... 1 4 Real estate secured sourcing, underwriting and pricing revenues............................................... 2 1 Gain on daily sale of domestic private label receivable originations........................................... 77 92 Gain on daily sale of MasterCard/Visa receivables......... 8 8 Taxpayer financial services loan origination fees......... (16) (14) Domestic private label receivable servicing fees.......... 98 92 MasterCard/Visa receivable servicing fees................. 3 3 Other processing, origination and support revenues........ 7 5Support services from HSBC affiliates....................... (252) (209)HSBC Technology and Services (USA) Inc ("HTSU"): Rental revenue............................................ 11 10 Administrative services revenue........................... 3 5Other servicing fees from HSBC affiliates................... 4 2Stock based compensation expense with HSBC.................. (17) (11) The notional value of derivative contracts outstanding with HSBC subsidiariestotaled $85.6 billion at March 31, 2006 and $72.2 billion at December 31, 2005.When the fair value of our agreements with affiliate counterparties requires theposting of collateral by the affiliate, it is provided in the form ofsecurities, which are not recorded on our balance sheet. Alternately, when thefair value of our agreements with affiliate 13 HSBC Finance Corporation-------------------------------------------------------------------------------- counterparties requires us to post collateral, it is provided in the form ofcash which is recorded on our balance sheet in other assets. At March 31, 2006,the fair value of our agreements with affiliate counterparties was above thelevel requiring us to post collateral. As such at March 31, 2006, we had postedcash collateral with affiliates totaling $352 million. At December 31, 2005, thefair value of our agreements with affiliate counterparties was below the levelrequiring the posting of collateral by the affiliate. As such, at December 31,2005, we were not holding any swap collateral from HSBC affiliates in the formof securities. We have extended a line of credit of $2 billion to HSBC USA Inc. No balanceswere outstanding under this line at March 31, 2006 or December 31, 2005. Annualcommitment fees associated with this line of credit are recorded in interestincome and reflected as interest income on advances to HSBC affiliates in thetable above. We extended a revolving line of credit of $.5 billion to HTSU on June 28, 2005.The balance outstanding under this line of credit was $.4 billion at March 31,2006 and December 31, 2005 and is included in other assets. Interest incomeassociated with this line of credit is recorded in interest income and reflectedas interest income on advances to HSBC affiliates in the table above. We extended a promissory note of $.5 billion to HSBC Securities (USA) Inc.("HSI") on June 27, 2005. This promissory note was repaid during July 2005. Wealso extended a promissory note of $.5 billion to HSI on September 29, 2005.This promissory note was repaid during October 2005. We extended an additionalpromissory note of $150 million to HSI on December 28, 2005. This note wasrepaid during January 2006. At each reporting date these promissory notes wereincluded in other assets. Interest income associated with this line of credit isrecorded in interest income and reflected as interest income on advances to HSBCaffiliates in the table above. On March 31, 2005, we extended a line of credit of $.4 billion to HSBCInvestments (North America) Inc. ("HINO") which was repaid during the secondquarter of 2005. Interest income associated with this line of credit is recordedin interest income and reflected as interest income on advances to HSBCaffiliates in the table above. Due to affiliates includes amounts owed to subsidiaries of HSBC (other thanpreferred stock). At March 31, 2006 and December 31, 2005, we had a commercial paper back stopcredit facility of $2.5 billion from HSBC supporting domestic issuances and arevolving credit facility of $5.3 billion from HSBC Bank plc ("HBEU") to fundour operations in the U.K. As of March 31, 2006, $4.0 billion was outstandingunder the U.K. lines and no balances were outstanding on the domestic lines. Asof December 31, 2005, $4.2 billion was outstanding under the U.K. lines and nobalances were outstanding on the domestic lines. Annual commitment feerequirements to support availability of these lines are included as a componentof Interest expense -- HSBC affiliates. In December 2005, we sold our U.K. credit card business, including $2.5 billionof receivables ($3.1 billion on a managed basis), the associated cardholderrelationships and the related retained interests in securitized credit cardreceivables to HBEU, a U.K. based subsidiary of HSBC, for an aggregate purchaseprice of $3.0 billion. The purchase price, which was determined based on acomparative analysis of sales of other credit card portfolios, was paid in acombination of cash and $261 million of preferred stock issued by a subsidiaryof HBEU with a rate of one-year Sterling LIBOR, plus 1.30 percent. In additionto the assets referred to above, the sale also included the account originationplatform, including the marketing and credit employees associated with thisfunction, as well as the lease associated with the credit card call center andrelated leaseholds and call center employees to provide customer continuityafter the transfer as well as to allow HBEU direct ownership and control oforigination and customer service. We have retained the collection operationsrelated to the credit card operations and have entered into a service levelagreement for a period of not less than two years to provide collection servicesand other support services, including components of the compliance, financialreporting and human resource functions, for the sold credit card operations, toHBEU for a fee. Additionally, the management teams of HBEU and our remainingU.K. operations will be jointly involved in decision making involving cardmarketing to ensure that growth objectives are met for both businesses. Becausethe sale of this business is between affiliates under common control, thepremium of 14 HSBC Finance Corporation-------------------------------------------------------------------------------- $182 million received in excess of the book value of the assets transferred,including the goodwill assigned to this business, was recorded as an increase toadditional paid in capital and was not included in earnings. In December 2004, we sold our domestic private label receivable portfolio(excluding retail sales contracts at our consumer lending business), includingthe retained interests associated with our securitized domestic private labelreceivables to HSBC Bank USA. We continue to service the sold private labelreceivables and receive servicing fee income from HSBC Bank USA. As of March 31,2006, we were servicing $15.9 billion of domestic private label receivables forHSBC Bank USA. We received servicing fee income from HSBC Bank USA of $98million during the three month period ended March 31, 2006 and $92 millionduring the three month period ended March 31, 2005. We continue to maintain therelated customer account relationships and, therefore, sell new domestic privatelabel receivable originations (excluding retail sales contracts) to HSBC BankUSA on a daily basis. We sold $4,396 million of private label receivables toHSBC Bank USA in the first quarter of 2006 and $4,253 million during the firstquarter of 2005. The gains associated with the sale of these receivables arereflected in the table above and are recorded in Gain on receivable sales toHSBC affiliates. In 2003 and 2004, we sold approximately $3.7 billion of real estate securedreceivables from our mortgage services business to HSBC Bank USA. Under aseparate servicing agreement, we have agreed to service all real estate securedreceivables sold to HSBC Bank USA including all business it purchased from ourcorrespondents. As of March 31, 2006, we were servicing $4.2 billion of realestate secured receivables for HSBC Bank USA. We also received fees from HSBCBank USA pursuant to a service level agreement under which we sourced,underwrote and priced $.6 billion of real estate secured receivables purchasedby HSBC Bank USA during the three months ended March 31, 2005. The servicing feerevenue associated with these receivables is recorded in Servicing fees fromHSBC affiliates and is reflected as real estate secured servicing revenues inthe above table. Fees received for sourcing, underwriting and pricing thereceivables have been recorded as other income and are reflected as real estatesecured sourcing, underwriting and pricing revenues in the above table.Purchases of real estate secured receivables from our correspondents by HSBCBank USA were discontinued effective September 1, 2005. We continue to servicethe receivables HSBC Bank USA previously purchased from these correspondents. Under various service level agreements, we also provide various services to HSBCBank USA. These services include credit card servicing and processing activitiesthrough our credit card services business, loan origination and servicingthrough our auto finance business and other operational and administrativesupport. Fees received for these services are reported as servicing fees fromHSBC affiliates and are included in the table above. During 2003, Household Capital Trust VIII issued $275 million in mandatorilyredeemable preferred securities to HSBC. Interest expense recorded on theunderlying junior subordinated notes totaled $4 million during both three monthperiods ended March 31, 2006 and 2005 and is included in interest expense onborrowings from HSBC and subsidiaries in the table above. During the third quarter of 2004, our Canadian business began to originate andservice auto loans for an HSBC affiliate in Canada. Fees received for theseservices of $3 million for the three months ended March 31, 2006 and $2 millionfor the three months ended March 31, 2005 are included in other income and arereflected in the above table as other servicing fees from HSBC affiliates. Effective October 1, 2004, HSBC Bank USA became the originating lender for loansinitiated by our taxpayer financial services business for clients of variousthird party tax preparers. We purchase the loans originated by HSBC Bank USAdaily for a fee. Origination fees paid to HSBC Bank USA totaled $16 millionduring the three months ended March 31, 2006 and $14 million during the threemonths ended March 31, 2005 and are included as an offset to Taxpayer financialservices revenue and are reflected as taxpayer financial services loanorigination fees in the above table. On July 1, 2004, HSBC Bank Nevada, National Association ("HBNV"), formerly knownas Household Bank (SB), N.A., purchased the account relationships associatedwith $970 million of MasterCard and Visa credit 15 HSBC Finance Corporation-------------------------------------------------------------------------------- card receivables from HSBC Bank USA for approximately $99 million, which areincluded in intangible assets. The receivables continue to be owned by HSBC BankUSA. Originations of new accounts and receivables are made by HBNV and newreceivables are sold daily to HSBC Bank USA. We sold $513 million of credit cardreceivables to HSBC Bank USA during the three months ended March 31, 2006 and$467 million of credit card receivables to HSBC Bank USA during the three monthsended March 31, 2005. The gains associated with the sale of these receivablesare reflected in the table above and are recorded in Gain on receivables salesto HSBC affiliates. Effective January 1, 2004, our technology services employees, as well astechnology services employees from other HSBC entities in North America, weretransferred to HTSU. In addition, technology related assets and softwarepurchased subsequent to January 1, 2004 are generally purchased and owned byHTSU. Technology related assets owned by HSBC Finance Corporation prior toJanuary 1, 2004 currently remain in place and were not transferred to HTSU. Inaddition to information technology services, HTSU also provides certain itemprocessing and statement processing activities to us pursuant to a masterservice level agreement. Support services from HSBC affiliates includes servicesprovided by HTSU as well as banking services and other miscellaneous servicesprovided by HSBC Bank USA and other subsidiaries of HSBC. We also receiverevenue from HTSU for rent on certain office space, which has been recorded as areduction of occupancy and equipment expenses, and for certain administrativecosts, which has been recorded as other income. In December 2005, we transferred our information technology services employeesin the U.K. to a subsidiary of HBEU. Subsequent to the transfer, operatingexpenses relating to information technology, which have previously been reportedas salaries and fringe benefits or other servicing and administrative expenses,are now billed to us by HBEU and reported as support services from HSBCaffiliates. Additionally, during the first quarter of 2006, the informationtechnology equipment in the U.K. was sold to HBEU for a purchase price equal tothe book value of these assets of $8 million. In addition, we utilize HSBC Markets (USA) Inc., a related HSBC entity, to leadmanage the underwriting of a majority of our ongoing debt issuances. Fees paidfor such services totaled approximately $15 million for the three months endedMarch 31, 2006 and approximately $3 million for the three months ended March 31,2005. These fees are amortized over the life of the related debt as a componentof interest expense in the table above. Domestic employees of HSBC Finance Corporation participate in a defined benefitpension plan sponsored by HNAH. See Note 9, "Pension and Other PostretirementBenefits," for additional information on this pension plan. Employees of HSBC Finance Corporation participate in one or more stockcompensation plans sponsored by HSBC. Our share of the expense of these planswas $17 million for the three months ended March 31, 2006 and $11 million forthe prior year quarter. These expenses are recorded in salary and employeebenefits and are reflected in the above table. As of March 31, 2006, the totalcompensation cost related to non-vested stock based compensation awards wasapproximately $205 million and will be recognized into compensation expense overa weighted-average period of 3.26 years. A more complete description of theseplans is included in the 2005 Form 10-K. 9. PENSION AND OTHER POSTRETIREMENT BENEFITS-------------------------------------------------------------------------------- Effective January 1, 2005, the two previously separate domestic defined benefitpension plans of HSBC Finance Corporation and HSBC Bank USA were combined into asingle HNAH defined benefit pension plan which facilitated the development of aunified employee benefit policy and unified employee benefit plan for HSBCcompanies operating in the United States. 16 HSBC Finance Corporation-------------------------------------------------------------------------------- The components of pension expense for the domestic defined benefit pension planreflected in our consolidated statement of income are shown in the table belowand reflect the portion of the pension expense of the combined HNAH pension planwhich has been allocated to HSBC Finance Corporation: THREE MONTHS ENDED MARCH 31, 2006 2005---------------------------------------------------------------------------- (IN MILLIONS)Service cost - benefits earned during the period............ $ 13 $ 12Interest cost............................................... 15 13Expected return on assets................................... (20) (19)Recognized (gains) losses................................... 3 - ---- ----Net periodic benefit cost................................... $ 11 $ 6 ==== ==== Components of the net periodic benefit cost for our postretirement benefitsother than pensions are as follows: THREE MONTHS ENDED MARCH 31, 2006 2005---------------------------------------------------------------------------- (IN MILLIONS)Service cost - benefits earned during the period............ $1 $1Interest cost............................................... 4 4Expected return on assets................................... - -Recognized (gains) losses................................... - - -- --Net periodic benefit cost................................... $5 $5 == == 10. BUSINESS SEGMENTS-------------------------------------------------------------------------------- We have three reportable segments: Consumer, Credit Card Services andInternational. Our Consumer segment consists of our consumer lending, mortgageservices, retail services and auto finance businesses. Our Credit Card Servicessegment consists of our domestic MasterCard and Visa credit card business. OurInternational segment consists of our foreign operations in the United Kingdom,Canada, Ireland and the remainder of Europe. The All Other caption includes ourinsurance and taxpayer financial services and commercial businesses, as well asour corporate and treasury activities, each of which falls below thequantitative threshold test under SFAS No. 131 for determining reportablesegments. There have been no changes in the basis of our segmentation or anychanges in the measurement of segment profit as compared with the presentationin 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 generally serviced by operating personnelwithout regard to ownership and result in a similar credit loss exposure for us.In addition, we fund our operations, and make decisions about allocating certainresources such as capital on a managed basis. When reporting on a managed basis,net interest income, provision for credit losses and fee income related toreceivables securitized are reclassified from securitization related revenue inour owned statement of income into the appropriate caption. 17 HSBC Finance Corporation-------------------------------------------------------------------------------- Fair value adjustments related to purchase accounting resulting from ouracquisition by HSBC and related amortization have been allocated to Corporate,which is included in the "All Other" caption within our segment disclosure.Reconciliations of our managed basis segment results to managed basis and ownedbasis consolidated totals are as follows: MANAGED CREDIT ADJUSTMENTS/ BASIS CARD RECONCILING CONSOLIDATED CONSUMER SERVICES INTERNATIONAL ALL OTHER ITEMS TOTALS------------------------------------------------------------------------------------------------------ (IN MILLIONS)THREE MONTHS ENDED MARCH 31, 2006Net interest income.... $ 1,822 $ 769 $ 182 $ (206) $ - $ 2,567Securitization related revenue.............. (49) (3) - (2) - (54)Fee and other income... 299 517 113 505 (68)(1) 1,366Intersegment revenues............. 57 5 7 (1) (68)(1) -Provision for credit losses............... 403 365 106 (2) 2(5) 874Total costs and expenses............. 699 433 175 299 - 1,606Net income............. 609 305 7 11 (44) 888Receivables............ 115,435 25,146 9,096 199 - 149,876Assets................. 116,218 25,488 10,091 23,515 (8,523)(2) 166,789 -------- ------- ------- ------- ------- --------THREE MONTHS ENDED MARCH 31, 2005Net interest income.... $ 1,693 $ 506 $ 229 $ (208) $ - $ 2,220Securitization related revenue.............. (235) (64) 10 (19) - (308)Fee and other income... 285 436 131 650 (34)(1) 1,468Intersegment revenues............. 26 5 4 (1) (34)(1) -Provision for credit losses............... 383 321 165 - 2(5) 871Total costs and expenses............. 668 324 216 334 - 1,542Net income............. 433 148 (9) 77 (23) 626Receivables............ 91,226 19,114 13,041 266 - 123,647Assets................. 92,368 18,970 13,939 26,804 (8,592)(2) 143,489 -------- ------- ------- ------- ------- -------- OWNED BASIS SECURITIZATION CONSOLIDATED ADJUSTMENTS TOTALS----------------------- ----------------------------- (IN MILLIONS)THREE MONTHS ENDED MARCNet interest income.... $ (103)(3) $ 2,464Securitization related revenue.............. 125(3) 71Fee and other income... (30)(3) 1,336Intersegment revenues............. - -Provision for credit losses............... (8)(3) 866Total costs and expenses............. - 1,606Net income............. - 888Receivables............ (3,109)(4) 146,767Assets................. (3,109)(4) 163,680 -------- --------THREE MONTHS ENDED MARCNet interest income.... $ (332)(3) $ 1,888Securitization related revenue.............. 393(3) 85Fee and other income... (91)(3) 1,377Intersegment revenues............. - -Provision for credit losses............... (30)(3) 841Total costs and expenses............. - 1,542Net income............. - 626Receivables............ (11,486)(4) 112,161Assets................. (11,486)(4) 132,003 -------- -------- --------------- (1) Eliminates intersegment revenues. (2) Eliminates investments in subsidiaries and intercompany borrowings. (3) Reclassifies net interest income, fee income and provision for credit losses relating to securitized receivables to other revenues. (4) Represents receivables serviced with limited recourse. (5) Eliminates bad debt recovery sales between operating segments. 11. NEW ACCOUNTING PRONOUNCEMENTS-------------------------------------------------------------------------------- Effective January 1, 2006, we adopted FASB Statement No. 123 (Revised),"Share-Based Payment," ("SFAS No. 123R"). Because we had previously adopted thefair value method of accounting for all equity based awards, the adoption ofSFAS No. 123R did not have a significant impact on our operations or cash flow.Substantially all of the disclosure requirements of SFAS No. 123R were includedin our 2005 Form 10-K. In addition to changes in the Statement of Cash Flows asrequired by SFAS No. 123R, other disclosure requirements which were not includedin our 2005 Form 10-K are included in Note 8, "Related Party Transactions." Effective January 1, 2006, we adopted FASB Statement No. 154, "AccountingChanges and Error Corrections: a replacement of APB Opinion No. 20 and FASBStatement No. 3" ("SFAS No. 154"). The adoption of SFAS No 154 did not have anyimpact on our financial position or results of operations. 18 HSBC Finance Corporation-------------------------------------------------------------------------------- Effective January 1, 2006, we adopted FASB Staff Position Nos. FAS 115-1 and FAS124-1 ("FSP 115-1 and FSP 124-1"), "The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments," in response to EmergingIssues Task Force 03-1, "The Meaning of Other-Than-Temporary Impairment and ItsApplication to Certain Investments." The adoption of the impairment guidancecontained in FSP 115-1 and FSP 124-1 did not have a material impact on ourfinancial position or results of operations. In February 2006, the FASB issued FASB Statement No. 155, "Accounting forCertain Hybrid Financial Instruments" ("SFAS No. 155"). SFAS No. 155 permitscompanies to elect to measure at fair value entire financial instrumentscontaining embedded derivatives that would otherwise have to be bifurcated andaccounted for separately. SFAS No. 155 also requires companies to identifyinterests in securitized financial assets that are free standing derivatives orcontain embedded derivatives that would have to be accounted for separately,clarifies which interest - and principal - only strips are subject to SFAS No.133, and amends SFAS No 140 to revise the conditions of a qualifying specialpurpose entity. SFAS No. 155 is effective for all financial instruments acquiredor issued after the beginning of a company's first fiscal year that begins afterSeptember 15, 2006. Early adoption is permitted as of the beginning of acompany's fiscal year, provided the company has not yet issued financialstatements for that fiscal year. We elected to early adopt SFAS No. 155effective January 1, 2006. The adoption of SFAS No. 155 did not have asignificant impact on our financial position or results of operations. In March 2006, the FASB issued FASB Statement No. 156, "Accounting for Servicingof Financial Assets," ("SFAS No. 156"). SFAS No. 156, which is an amendment toSFAS No. 140, addresses the recognition and measurement of separately recognizedservicing assets and liabilities and provides an approach to simplify theefforts to obtain hedge-like (offset) accounting. SFAS No. 156 is effective forfinancial years beginning after September 15, 2006, with early adoptionpermitted. As we do not currently have servicing assets recorded on our balancesheet, SFAS No. 156 will not have any impact on our financial position orresults of operations. 19 HSBC Finance Corporation-------------------------------------------------------------------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-------------------------------------------------------------------------------- FORWARD-LOOKING STATEMENTS-------------------------------------------------------------------------------- Management's Discussion and Analysis of Financial Condition and Results ofOperations ("MD&A") should be read in conjunction with the consolidatedfinancial statements, notes and tables included elsewhere in this report andwith our Annual Report on Form 10-K for the year ended December 31, 2005 (the"2005 Form 10-K"). MD&A may contain certain statements that may beforward-looking in nature within the meaning of the Private SecuritiesLitigation Reform Act of 1995. In addition, we may make or approve certainstatements in future filings with the SEC, in press releases, or oral or writtenpresentations by representatives of HSBC Finance Corporation that are notstatements of historical fact and may also constitute forward-lookingstatements. Words such as "may", "will", "should", "would", "could", "intends","believe", "expects", "estimates", "targeted", "plans", "anticipates", "goal"and similar expressions are intended to identify forward-looking statements butshould not be considered as the only means through which these statements may bemade. These matters or statements will relate to our future financial condition,results of operations, plans, objectives, performance or business developmentsand will involve known and unknown risks, uncertainties and other factors thatmay cause our actual results, performance or achievements to be materiallydifferent from that which was expressed or implied by such forward-lookingstatements. Forward-looking statements are based on our current views andassumptions and speak only as of the date they are made. HSBC FinanceCorporation undertakes no obligation to update any forward-looking statement toreflect subsequent circumstances or events. Unless noted, the discussion of ourfinancial condition and results of operations included in MD&A are presented onan owned basis of reporting. EXECUTIVE OVERVIEW-------------------------------------------------------------------------------- HSBC Finance Corporation is an indirect wholly owned subsidiary of HSBC Holdingsplc ("HSBC"). HSBC Finance Corporation may also be referred to in MD&A as "we","us", or "our". In addition to owned basis reporting, we also monitor ouroperations and evaluate trends on a managed basis (a non-GAAP financialmeasure), which assumes that securitized receivables have not been sold and arestill on our balance sheet. See "Basis of Reporting" for further discussion ofthe reasons we use this non-GAAP financial measure. Net income was $888 million for the quarter ended March 31, 2006, an increase of42 percent, compared to $626 million in the prior year quarter. The increase innet income was due to higher net interest income partially offset by lower otherrevenues, a higher provision for credit losses and higher costs and expenses.The increase in net interest income was due to growth in average receivables andan improvement in the overall yield on the portfolio, partially offset by ahigher interest expense. Overall yields increased due to increases in our rateson variable rate products which were in line with market movements and variousother repricing initiatives, such as reduced levels of promotional rate balancesin 2006. Changes in receivable mix also contributed to the increase in yield dueto the impact of increased levels of higher yielding MasterCard/Visa due tolower securitization levels and our acquisition of Metris Companies, Inc.("Metris") in December 2005. Interest expense increased due to a larger balancesheet and a significantly higher cost of funds in line with market movements.Our net interest margin was 6.69 percent for the three months ended March 31,2006 compared to 6.68 percent for the three months ended March 31, 2005. Netinterest margin was flat as the improvement in overall yields on our receivablesdiscussed above was offset by the higher funding costs. The increase in provision for credit losses resulted from receivable growth,partially offset by lower bankruptcy losses as a result of reduced filings and,as discussed more fully below, a reduction in the estimated loss exposureresulting from Hurricane Katrina ("Katrina"). The decrease in other revenues isprimarily due to lower derivative income partially offset by higher fee andother income. The decrease in derivative income was primarily due to asignificant reduction during 2005 in the population of interest rate swaps whichdo not qualify for hedge accounting under SFAS No. 133, which reduces incomevolatility. Fee income was higher as a result of higher credit card fees due tohigher volume in our MasterCard/Visa portfolios, primarily resulting from ouracquisition of Metris in December 2005, and improvements in interchange rates,partially offset by 20 HSBC Finance Corporation-------------------------------------------------------------------------------- the impact of new FFIEC guidance which limits certain fee billings for non-primecredit card accounts. Other income was higher primarily due to higher ancillarycredit card revenue. Costs and expenses increased primarily to supportreceivables growth including our acquisition of Metris in December 2005.Amortization of purchase accounting fair value adjustments increased net incomeby $22 million for the quarter ended March 31, 2006, which included $5 millionrelated to our acquisition of Metris in December 2005, compared to a decrease innet income of $9 million for the quarter ended March 31, 2005. During the first quarter of 2006, we continued to assess the financial impact ofKatrina on our customers living in the Katrina FEMA designated IndividualAssistance disaster areas, including the related payment patterns of thesecustomers. As a result of these continuing assessments, including customercontact and the collection of more information associated with the propertieslocated in the FEMA designated area, as applicable, we have reduced our estimateof credit loss exposure by approximately $30 million. We will continue to reviewour estimate of credit loss exposure relating to Katrina and any adjustmentswill be reported in earnings when they become known. Our return on average owned assets ("ROA") was 2.18 percent for the quarterended March 31, 2006 compared to 1.90 percent for the quarter ended March 31,2005. Return on averaged managed assets ("ROMA") (a non-GAAP financial measurewhich assumes that securitized receivables have not been sold and are still onour balance sheet) was 2.14 percent for the quarter ended March 31, 2006compared to 1.73 percent in the year-ago period. ROA and ROMA increased duringthe quarter ended March 31, 2006 as net income growth, primarily due to highernet interest income, outpaced the growth in average owned and managed assetsduring the period. The financial information set forth below summarizes selected financialhighlights of HSBC Finance Corporation as of March 31, 2006 and 2005 and for thethree month periods ended March 31, 2006 and 2005. THREE MONTHS ENDED MARCH 31, 2006 2005---------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)NET INCOME:................................................. $ 888 $ 626OWNED BASIS RATIOS: Return on average owned assets ("ROA").................... 2.18% 1.90% Return on average common shareholder's(s') equity ("ROE")................................................. 18.14 15.04 Net interest margin....................................... 6.69 6.68 Consumer net charge-off ratio, annualized................. 2.58 3.15 Efficiency ratio(1)....................................... 39.65 43.99MANAGED BASIS RATIOS:(2) Return on average managed assets ("ROMA")................. 2.14% 1.73% Net interest margin....................................... 6.81 7.06 Risk adjusted revenue..................................... 7.67 7.39 Consumer net charge-off ratio, annualized................. 2.69 3.65 Efficiency ratio(1)....................................... 39.56 43.59 AS OF MARCH 31, 2006 2005--------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)RECEIVABLES: Owned basis............................................... $146,767 $112,161 Managed basis(2).......................................... 149,876 123,647TWO-MONTH-AND-OVER CONTRACTUAL DELINQUENCY RATIOS: OWNED BASIS............................................... 3.62% 3.78% MANAGED BASIS(2).......................................... 3.65 3.93 --------------- (1) Ratio of total costs and expenses less policyholders' benefits to net interest income and other revenues less policyholders' benefits. (2) Managed basis reporting is a non-GAAP financial measure. See "Basis of Reporting" for additional discussion on the use of this non-GAAP financial measure and "Reconciliations to GAAP Financial Measures" for quantitative reconciliations to the equivalent GAAP basis financial measure. 21 HSBC Finance Corporation-------------------------------------------------------------------------------- Owned receivables were $146.8 billion at March 31, 2006, $139.9 billion atDecember 31, 2005, and $112.2 billion at March 31, 2005. With the exception ofprivate label, we experienced growth in all our receivable products compared toMarch 31, 2005, with real estate secured receivables being the primarycontributor to the growth. Real estate secured receivables do not includepurchases of correspondent receivables directly by HSBC Bank USA of $.9 billionsince March 31, 2005, a portion of which we otherwise would have purchased.Purchases of real estate secured receivables from our correspondents by HSBCBank USA were discontinued effective September 1, 2005. Lower securitizationlevels as well as the acquisition of Metris in December 2005 also contributed tothe increase in owned receivables. Real estate secured receivables were also theprimary contributor to growth as compared to December 31, 2005, which waspartially offset by normal seasonal run-off in our MasterCard/Visa. Our owned basis two-months-and-over-contractual delinquency ratio decreasedcompared to both the prior quarter and the prior year quarter. The decrease is aresult of lower bankruptcy levels following the spike in bankruptcy filings thatoccurred after the enactment of new bankruptcy legislation in the United Statesin October 2005, receivable growth and the continuing strong economy in theUnited States. The decrease compared to the prior quarter also reflects seasonalimprovements in collections as customers use their tax refunds to reduce theiroutstanding balances. Dollars of delinquency also decreased compared to theprior quarter. Net charge-offs as a percentage of average consumer receivables for the quarterdecreased from the prior year quarter largely as a result of lower bankruptcyfilings in our MasterCard/Visa portfolio due to the new bankruptcy legislationin the United States which we believe resulted in an acceleration of netcharge-offs in the fourth quarter of 2005, a portion of which would haveotherwise been experienced in 2006. Also contributing to the decrease wasportfolio growth and the positive impact from the lower delinquency levels weexperienced throughout 2005 as a result of a strong economy. Our owned basis efficiency ratio improved compared to the prior year quarter dueto higher net interest income due to higher levels of receivables, partiallyoffset by an increase in total costs and expenses to support receivable growthas well as lower other revenues, primarily due to lower derivative income. During the first quarter of 2006, we supplemented unsecured debt issuances withproceeds from the continuing sale of newly originated domestic private labelreceivables to HSBC Bank USA, debt issued to affiliates, increased levels ofsecured financings and higher levels of commercial paper as a result of theseasonal activity of our TFS business. Because we are a subsidiary of HSBC, ourcredit ratings have improved and our credit spreads relative to Treasuries havetightened compared to those we experienced during the months leading up to theannouncement of our acquisition by HSBC. Primarily as a result of tightenedcredit spreads, we recognized cash funding expense savings of approximately $214million during the quarter ended March 31, 2006 and approximately $120 millionduring the quarter ended March 31, 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 runrate for annual cash funding expense savings in excess of $1 billion per year.In the first quarter of 2006, the cash funding expense savings realized by HSBCtotaled approximately $280 million. Securitization of consumer receivables has been a source of funding andliquidity for us. In order to align our accounting treatment with that of HSBCinitially under U.K. GAAP and now under International Financial ReportingStandards ("IFRSs"), starting in the third quarter of 2004 we began to structureall new collateralized funding transactions as secured financings. However,because existing public MasterCard and Visa credit card transactions werestructured as sales to revolving trusts that require replenishments of 22 HSBC Finance Corporation-------------------------------------------------------------------------------- receivables to support previously issued securities, receivables will continueto be sold to these trusts until the revolving periods end, the last of which iscurrently projected to occur in 2008. We will continue to replenish at reducedlevels certain non-public personal non-credit card securities issued to conduitsand record the resulting replenishment gains for a period of time in order tomanage liquidity. Since our securitized receivables have varying lives, it willtake time for all securitized receivables to pay-off and the relatedinterest-only strip receivables to be reduced to zero. While the termination ofsale treatment on new collateralized funding transactions reduced our reportednet income under U.S. GAAP, there is no impact on cash received. BASIS OF REPORTING-------------------------------------------------------------------------------- Our consolidated financial statements are prepared in accordance with accountingprinciples generally accepted in the United States ("U.S. GAAP"). Unless noted,the discussion of our financial condition and results of operations included inMD&A are presented on an owned basis of reporting. MANAGED BASIS REPORTING We have historically monitored our operations andevaluated trends on a managed basis (a non-GAAP financial measure), whichassumes that securitized receivables have not been sold and remain on ourbalance sheet. This is because the receivables that we securitize are subjectedto underwriting standards comparable to our owned portfolio, are serviced byoperating personnel without regard to ownership and result in a similar creditloss exposure for us. In addition, we fund our operations and make certaindecisions about allocating resources 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. Additionally, charge-off and delinquency associated withthese receivables are included in our managed basis credit quality statistics. Debt analysts, rating agencies and fixed income investors have also historicallyevaluated our operations on a managed basis for the reasons discussed above andhave historically requested managed basis information from us. We believe thatmanaged basis information enables such investors and other interested parties tobetter understand the performance and quality of our entire loan portfolio andis important to understanding the quality of originations and the related creditrisk inherent in our owned and securitized portfolios. As the level of oursecuritized receivables falls over time, managed basis and owned basis resultswill eventually converge. We also now report "Management Basis" results (anon-GAAP financial measure) in Reports on Form 8-K with our quarterly results.Management Basis reporting, in addition to managed basis adjustments, assumesthe private label and real estate secured receivables transferred to HSBC BankUSA have not been sold and remain on balance sheet. As we continue to manage andservice receivables sold to HSBC Bank USA, we make decisions about allocatingcertain resources, such as employees, on a Management Basis. EQUITY RATIOS Tangible shareholder's(s') equity to tangible managed assets("TETMA"), tangible shareholder's(s') equity plus owned loss reserves totangible managed assets ("TETMA + Owned Reserves") and tangible common equity totangible managed assets are non-GAAP financial measures that are used by HSBCFinance Corporation management and certain rating agencies to evaluate capitaladequacy. These ratios may differ from similarly named measures presented byother companies. The most directly comparable GAAP financial measure is commonand preferred equity to owned assets. We and certain rating agencies also monitor our equity ratios excluding theimpact of the HSBC acquisition purchase accounting adjustments. We do so becausewe believe that the HSBC acquisition purchase accounting adjustments representnon-cash transactions which do not affect our business operations, cash flows orability to meet our debt obligations. Preferred securities issued by certain non-consolidated trusts are consideredequity in the TETMA and TETMA + Owned Reserves calculations because of theirlong-term subordinated nature and the ability to defer dividends. Prior to ouracquisition by HSBC, our Adjustable Conversion-Rate Equity Security Units 23 HSBC Finance Corporation-------------------------------------------------------------------------------- were also considered equity in these calculations. TETMA and TETMA + OwnedReserves exclude the Adjustable Conversion-Rate Equity Security Units for allperiods subsequent to our acquisition by HSBC as this more accurately reflectsthe impact of these items on our equity post acquisition. INTERNATIONAL FINANCIAL REPORTING STANDARDS Because HSBC reports results inaccordance with IFRSs and IFRSs results are used in measuring and rewardingperformance of employees, our management also separately monitors net incomeunder IFRSs (a non-U.S. GAAP financial measure). The following table reconcilesour net income on a U.S. GAAP basis to net income on an IFRSs basis: THREE MONTHS ENDED MARCH 31, 2006-------------------------------------------------------------------------------- (IN MILLIONS)Net income - U.S. GAAP basis................................ $888Adjustments, net of tax: Securitizations........................................... 21 Derivatives and hedge accounting (including fair value adjustments)........................................... (71) Intangible assets......................................... 36 Purchase accounting adjustments........................... 56 Loan origination.......................................... (20) Loan impairment........................................... 9 Other..................................................... 11 ----Net income - IFRSs basis.................................... $930 ==== Significant differences between U.S. GAAP and IFRSs are as follows: SECURITIZATIONS IFRSs - The recognition of securitized assets is governed by a three-step process, which may be applied to the whole asset, or a part of an asset: - If the rights to the cash flows arising from securitized assets have been transferred to a third party, and all the risks and rewards of the assets have been transferred, the assets concerned are derecognized. - If the rights to the cash flows are retained by HSBC but there is a contractual obligation to pay them to another party, the securitized assets concerned are derecognized if certain conditions are met such as, for example, when there is no obligation to pay amounts to the eventual recipient unless an equivalent amount is collected from the original asset. - If some significant risks and rewards of ownership have been transferred, but some have also been retained, it must be determined whether or not control has been retained. If control has been retained, HSBC continues to recognize the asset to the extent of its continuing involvement; if not, the asset is derecognized. - The impact from securitizations resulting in higher net income under IFRSs is due to the recognition of income on securitized receivables under U.S. GAAP in prior periods. US GAAP - SFAS 140 "Accounting for Transfers and Servicing of Finance Assets and Extinguishments of Liabilities" requires that receivables that are sold to a special purpose entity ("SPE") and securitized can only be derecognized and a gain or loss on sale recognized if the originator has surrendered control over the securitized assets. 24 HSBC Finance Corporation-------------------------------------------------------------------------------- - Control is surrendered over transferred assets if, and only if, all of the following conditions are met: - The transferred assets are put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership. - Each holder of interests in the transferee (i.e. holder of issued notes) has the right to pledge or exchange their beneficial interests, and no condition constrains this right and provides more than a trivial benefit to the transferor. - The transferor does not maintain effective control over the assets through either an agreement that obligates the transferor to repurchase or to redeem them before their maturity or through the ability to unilaterally cause the holder to return specific assets, other than through a clean-up call. - If these conditions are not met the securitized assets should continue to be consolidated. - When HSBC retains an interest in the securitized assets, such as a servicing right or the right to residual cash flows from the special purpose entity, HSBC recognizes this interest at fair value on sale of the assets to the SPE. DERIVATIVES AND HEDGE ACCOUNTING IFRSs - Derivatives are recognized initially, and are subsequently remeasured, at fair value. Fair values of exchange-traded derivatives are obtained from quoted market prices. Fair values of over-the-counter ("OTC") derivatives are obtained using valuation techniques, including discounted cash flow models and option pricing models. - In the normal course of business, the fair value of a derivative on initial recognition is considered to be the transaction price (that is the fair value of the consideration given or received). However, in certain circumstances the fair value of an instrument will be evidenced by comparison with other observable current market transactions in the same instrument (without modification or repackaging) or will be based on a valuation technique whose variables include only data from observable markets, including interest rate yield curves, option volatilities and currency rates. When such evidence exists, HSBC recognizes a trading profit or loss on inception of the derivative. When unobservable market data have a significant impact on the valuation of derivatives, the entire initial change in fair value indicated by the valuation model is not recognized immediately in the income statement but is recognized over the life of the transaction on an appropriate basis or recognized in the income statement when the inputs become observable, or when the transaction matures or is closed out. - Derivatives may be embedded in other financial instruments; for example, a convertible bond has an embedded conversion option. An embedded derivative is treated as a separate derivative when its economic characteristics and risks are not clearly and closely related to those of the host contract, its terms are the same as those of a stand-alone derivative, and the combined contract is not held for trading or designated at fair value through profit and loss. These embedded derivatives are measured at fair value with changes in fair value recognized in the income statement. - Derivatives are classified as assets when their fair value is positive, or as liabilities when their fair value is negative. Derivative assets and liabilities arising from different transactions are only netted if the transactions are with the same counterparty, a legal right of offset exists, and the cash flows are intended to be settled on a net basis. - The method of recognizing the resulting fair value gains or losses depends on whether the derivative is held for trading, or is designated as a hedging instrument and, if so, the nature of the risk being hedged. All gains and losses from changes in the fair value of derivatives held for trading are recognized in the income statement. When derivatives are designated as hedges, HSBC classifies them as either: (i) hedges of the change in fair value of recognized assets or liabilities or firm commitments ("fair value hedge"); (ii) hedges of the variability in highly probable future cash flows attributable to a recognized asset or liability, or a forecast transaction ("cash flow hedge"); or (iii) hedges of net investments in a foreign operation ("net investment hedge"). Hedge accounting is applied to derivatives designated as hedging instruments in a fair value, cash flow or net investment hedge provided certain criteria are met. 25 HSBC Finance Corporation-------------------------------------------------------------------------------- Hedge Accounting: - It is HSBC's policy to document, at the inception of a hedge, the relationship between the hedging instruments and hedged items, as well as the risk management objective and strategy for undertaking the hedge. The policy also requires documentation of the assessment, both at hedge inception and on an ongoing basis, of whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items attributable to the hedged risks. Fair value hedge: - Changes in the fair value of derivatives that are designated and qualify as fair value hedging instruments are recorded in the income statement, together with changes in the fair values of the assets or liabilities or groups thereof that are attributable to the hedged risks. - If the hedging relationship no longer meets the criteria for hedge accounting, the cumulative adjustment to the carrying amount of a hedged item is amortized to the income statement based on a recalculated effective interest rate over the residual period to maturity, unless the hedged item has been derecognized whereby it is released to the income statement immediately. Cash flow hedge: - The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges are recognized in equity. Any gain or loss relating to an ineffective portion is recognized immediately in the income statement. - Amounts accumulated in equity are recycled to the income statement in the periods in which the hedged item will affect the income statement. However, when the forecast transaction that is hedged results in the recognition of a non-financial asset or a non-financial liability, the gains and losses previously deferred in equity are transferred from equity and included in the initial measurement of the cost of the asset or liability. - When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in equity at that time remains in equity until the forecast transaction is ultimately recognized in the income statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was reported in equity is immediately transferred to the income statement. Net investment hedge: - Hedges of net investments in foreign operations are accounted for in a similar manner to cash flow hedges. Any gain or loss on the hedging instrument relating to the effective portion of the hedge is recognized in equity; the gain or loss relating to the ineffective portion is recognized immediately in the income statement. Gains and losses accumulated in equity are included in the income statement on the disposal of the foreign operation. Hedge effectiveness testing: - IAS 39 requires that at inception and throughout its life, each hedge must be expected to be highly effective (prospective effectiveness) to qualify for hedge accounting. Actual effectiveness (retrospective effectiveness) must also be demonstrated on an ongoing basis. - The documentation of each hedging relationship sets out how the effectiveness of the hedge is assessed. - For prospective effectiveness, the hedging instrument must be expected to be highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged risk during the period for which the hedge is designated. For retrospective effectiveness, the changes in fair value or cash flows must offset each other in the range of 80 per cent to 125 per cent for the hedge to be deemed effective. Derivatives that do not qualify for hedge accounting: - All gains and losses from changes in the fair value of any derivatives that do not qualify for hedge accounting are recognized immediately in the income statement. 26 HSBC Finance Corporation-------------------------------------------------------------------------------- US GAAP - The accounting under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" is generally consistent with that under IAS 39, which HSBC has followed in its IFRSs reporting from January 1, 2005, as described above. However, specific assumptions regarding hedge effectiveness under US GAAP are not permitted by IAS 39. - The requirements of SFAS No. 133 have been effective from January 1, 2001. - The US GAAP 'shortcut method' permits an assumption of zero ineffectiveness in hedges of interest rate risk with an interest rate swap provided specific criteria have been met. IAS 39 does not permit such an assumption, requiring a measurement of actual ineffectiveness at each designated effectiveness testing date. - In addition, IFRSs allows greater flexibility in the designation of the hedged item. Under US GAAP, all contractual cash flows must form part of the designated relationship, whereas IAS 39 permits the designation of identifiable benchmark interest cash flows only. - Under US GAAP, derivatives receivable and payable with the same counterparty may be reported net on the balance sheet when there is an executed ISDA Master Netting Arrangement covering enforceable jurisdictions. These contracts do not meet the requirements for set off under IAS 32 and hence are presented gross on the balance sheet for IFRSs. DESIGNATION OF FINANCIAL ASSETS AND LIABILITIES AT FAIR VALUE THROUGH PROFIT ANDLOSS IFRSs - Under IAS 39, a financial instrument, other than one held for trading, is classified in this category if it meets the criteria set out below, and is so designated by management. An entity may designate financial instruments at fair value where the designation: - eliminates or significantly reduces a measurement or recognition inconsistency that would otherwise arise from measuring financial assets or financial liabilities or recognizing the gains and losses on them on different bases; or - applies to a group of financial assets, financial liabilities or both that is managed and its performance evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and where information about that group of financial instruments is provided internally on that basis to management; or - relates to financial instruments containing one or more embedded derivatives that significantly modify the cash flows resulting from those financial instruments. - Financial assets and financial liabilities so designated are recognized initially at fair value, with transaction costs taken directly to the income statement, and are subsequently remeasured at fair value. This designation, once made, is irrevocable in respect of the financial instruments to which it relates. Financial assets and financial liabilities are recognized using trade date accounting. - Gains and losses from changes in the fair value of such assets and liabilities are recognized in the income statement as they arise, together with related interest income and expense and dividends. US GAAP - There are no provisions in US GAAP to make an election similar to that in IAS 39. - Generally, for financial assets to be measured at fair value with gains and losses recognized immediately in the income statement, they must meet the definition of trading securities in SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities". Financial liabilities are generally reported at amortized cost under US GAAP. 27 HSBC Finance Corporation-------------------------------------------------------------------------------- GOODWILL, PURCHASE ACCOUNTING AND INTANGIBLES IFRSs - Prior to 1998, goodwill under UK GAAP was written off against equity. HSBC did not elect to reinstate this goodwill on its balance sheet upon transition to IFRSs. From January 1, 1998 to December 31, 2003 goodwill was capitalized and amortized over its useful life. The carrying amount of goodwill existing at December 31, 2003 under UK GAAP was carried forward under the transition rules of IFRS from January 1, 2004, subject to certain adjustments. - IFRS 3 "Business Combinations" requires that goodwill should not be amortized but should be tested for impairment at least annually at the reporting unit level by applying a test based on recoverable amounts. - Quoted securities issued as part of the purchase consideration are fair valued for the purpose of determining the cost of acquisition at their market price on the date the transaction is completed. US GAAP - Up to June 30, 2001, goodwill acquired was capitalized and amortized over its useful life which could not exceed 25 years. The amortization of previously acquired goodwill ceased with effect from December 31, 2001. - Quoted securities issued as part of the purchase consideration are fair valued for the purpose of determining the cost of acquisition at their average market price over a reasonable period before and after the date on which the terms of the acquisition are agreed and announced. - Changes in tax estimates of the basis in assets and liabilities or other tax estimates recorded at the date of acquisition by HSBC are adjusted against goodwill. LOAN ORIGINATION IFRSs - Certain loan fee income and incremental directly attributable loan origination costs are amortized to the income statement over the life of the loan as part of the effective interest calculation under IAS 39. US GAAP - Certain loan fee income and direct but not necessarily incremental loan origination costs, including an apportionment of overheads, are amortized to the profit and loss account over the life of the loan as an adjustment to interest income (SFAS No. 91 "Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases".) LOAN IMPAIRMENT IFRSs - When statistical models, using historic loss rates adjusted for economic conditions, provide evidence of impairment in portfolios of loans, their values are written down to their net recoverable amount. The net recoverable amount is the present value of the estimated future recoveries discounted at the portfolio's original effective interest rate. The calculations include a reasonable estimate of recoveries on loans individually identified for write-off pursuant to HSBC's credit guidelines. US GAAP - Where the delinquency status of loans in a portfolio is such that there is no realistic prospect of recovery, the loans are written off in full, or to recoverable value where collateral exists. Delinquency depends on the number of days payment is overdue. The delinquency status is applied consistently across similar loan products in accordance with HSBC's credit guidelines. When local regulators mandate the delinquency status at which write-off must occur for different retail loan products and these regulations reasonably reflect estimable recoveries on individual loans, this basis of measuring loan impairment is reflected in US GAAP accounting. Cash recoveries relating to pools of such written-off loans, if any, are reported as loan recoveries upon collection. 28 HSBC Finance Corporation-------------------------------------------------------------------------------- QUANTITATIVE RECONCILIATIONS OF NON-GAAP FINANCIAL MEASURES TO GAAP FINANCIALMEASURES For a reconciliation of managed basis net interest income, fee incomeand provision for credit losses to the comparable owned basis amounts, see Note10, "Business Segments," to the accompanying consolidated financial statements.For a reconciliation of our owned loan portfolio by product to our managed loanportfolio, see Note 3, "Receivables," to the accompanying consolidated financialstatements. For additional quantitative reconciliations of non-GAAP financialmeasures presented herein to the equivalent GAAP basis financial measures, see"Reconciliations to GAAP Financial Measures." RECEIVABLES REVIEW-------------------------------------------------------------------------------- The following table summarizes owned receivables at March 31, 2006 and increases(decreases) over prior periods: INCREASES (DECREASES) FROM ------------------------------- DECEMBER 31, MARCH 31, 2005 2005 MARCH 31, ------------- --------------- 2006 $ % $ %----------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Real estate secured............................... $ 89,492 $6,666 8.0% $21,006 30.7%Auto finance...................................... 11,186 482 4.5 3,079 38.0MasterCard/Visa................................... 23,449 (661) (2.7) 7,895 50.8Private label..................................... 2,428 (92) (3.7) (702) (22.4)Personal non-credit card(1)....................... 20,006 461 2.4 3,398 20.5Commercial and other.............................. 206 (2) (1.0) (70) (25.4) -------- ------ ---- ------- -----Total owned receivables........................... $146,767 $6,854 4.9% $34,606 30.9% ======== ====== ==== ======= ===== --------------- (1) Personal non-credit card receivables are comprised of the following: INCREASES (DECREASES) FROM ------------------------------ DECEMBER 31, MARCH 31, 2005 2005 MARCH 31, ------------- -------------- 2006 $ % $ %----------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Domestic personal non-credit card.................. $11,944 $ 550 4.8% $3,510 41.6%Union Plus personal non-credit card................ 298 (35) (10.5) (128) (30.0)Personal homeowner loans........................... 4,241 68 1.6 551 14.9Foreign personal non-credit card................... 3,523 (122) (3.3) (535) (13.2) ------- ----- ----- ------ -----Total personal non-credit card..................... $20,006 $ 461 2.4% $3,398 20.5% ======= ===== ===== ====== ===== RECEIVABLE INCREASES (DECREASES) SINCE MARCH 31, 2005 Driven by growth in ourcorrespondent and branch businesses, real estate secured receivables increasedover the year-ago period. Real estate secured receivable levels do not includeHSBC Bank USA's purchase of receivables directly from correspondents totaling$.9 billion since March 31, 2005, a portion of which we otherwise would havepurchased. Purchases of real estate secured receivables from our correspondentsby HSBC Bank USA were discontinued effective September 1, 2005. Real estatesecured receivable levels in our branch-based consumer lending business improvedbecause of higher sales volumes as we continue to emphasize real estate securedloans, including near-prime mortgage products. Also contributing to the increasewere purchases of $1.6 billion from portfolio acquisition programs since theprior year quarter. We have continued to focus on increasing our mix of juniorlien loans through portfolio acquisitions and continue to expand our sources forpurchasing newly originated loans from flow correspondents. Auto financereceivables increased over the year-ago period due to organic growth principallyin the near-prime portfolio. This came from newly originated loans acquired fromour 29 HSBC Finance Corporation-------------------------------------------------------------------------------- dealer network, growth in the consumer direct loan program and lowersecuritization levels. Additionally, we have experienced continued growth fromthe expansion of our auto finance program in Canada. MasterCard and Visareceivables growth reflects the $5.3 billion of receivables acquired as part ofour acquisition of Metris in December 2005, strong domestic organic growthespecially in our HSBC branded prime, Union Privilege and non-prime portfolios,lower securitization levels and the successful launch of a MasterCard/Visaprogram in Canada in 2005. These increases were partially offset by the sale ofour U.K. credit card business in December 2005 which included $2.2 billion ofMasterCard/Visa receivables. Private label receivables decreased from the yearago period as a result of lower retail sales volumes in the U.K., the sale ofour U.K. credit card business in December 2005, which included $300 million ofprivate label receivables, and changes in the foreign exchange rate since March31, 2005. Personal non-credit card receivables increased from the year-agoperiod as a result of increased marketing, including several large direct mailcampaigns, lower securitization levels and changes in the foreign exchange ratesince March 31, 2005 for our foreign personal non-credit card receivables. RECEIVABLE INCREASES (DECREASES) SINCE DECEMBER 31, 2005 Both our correspondentand branch businesses reported growth in their real estate secured portfolios asdiscussed above. Contributing to the increase in real estate secured receivablelevels were purchases of $.5 billion from portfolio acquisition programs sinceDecember 31, 2005. Growth in our auto finance portfolio reflects lower levels ofsecuritizations, organic growth and increased volume in both the dealer networkand the consumer direct loan program. The decrease in our MasterCard/Visaportfolio reflects normal seasonal run-off, partially offset by lowersecuritization levels. Our foreign private label portfolio decreased due todecreases in retail sales volume in the U.K. Personal non-credit cardreceivables increased as a result of increased marketing and lowersecuritization levels. RESULTS OF OPERATIONS-------------------------------------------------------------------------------- Unless noted otherwise, the following discusses amounts reported in our ownedbasis statement of income. NET INTEREST INCOME The following table summarizes net interest income: INCREASE (DECREASE) -------------------THREE MONTHS ENDED MARCH 31, 2006 (1) 2005 (1) AMOUNT %---------------------------------------------------------------------------------------------------Finance and other interest income........... $4,087 11.10% $2,950 10.44% $1,137 38.5%Interest expense............................ 1,623 4.41 1,062 3.76 561 52.8 ------ ----- ------ ----- ------ ----Net interest income......................... $2,464 6.69% $1,888 6.68% $ 576 30.5% ====== ===== ====== ===== ====== ==== --------------- (1) % Columns: comparison to average owned interest-earning assets. The increase in net interest income during the quarter ended March 31, 2006 wasdue to higher average receivables and a higher overall yield, partially offsetby higher interest expense. Overall yields increased due to increases in ourrates on variable rate products which were in line with market movements andvarious other repricing initiatives, such as reduced levels of promotional ratebalances in 2006. Changes in receivable mix also contributed to the increase inyield due to the impact of increased levels of higher yielding MasterCard/ Visadue to lower securitization levels and our acquisition of Metris in December2005. The higher interest expense was due to a larger balance sheet and asignificantly higher cost of funds due to a rising interest rate environment. Inaddition, as part of our overall liquidity management strategy, we continue toextend the maturity of our liability profile which results in higher interestexpense. Our purchase accounting fair value adjustments include bothamortization of fair value adjustments to our external debt obligations andreceivables. Amortization of purchase accounting fair value adjustmentsincreased net interest income by $114 million, which included $17 millionrelating to Metris, during the quarter ended March 31, 2006 and $113 millionduring the quarter ended March 31, 2005. 30 HSBC Finance Corporation-------------------------------------------------------------------------------- Net interest margin, annualized, was primarily flat during the three monthsended March 31, 2006 as compared to the year-ago period as the improvement inthe overall yield on our receivable portfolio, as discussed above, was offset bythe higher funding costs. The following table shows the impact of these items onnet interest margin at March 31, 2006: Net interest margin for the three months ended March 31, 2005...................................................... 6.68%Impact to net interest margin resulting from: Sale of U.K. credit card business in December 2005........ .04 Metris acquisition in December 2005....................... .36 Receivable pricing........................................ .32 Receivable mix............................................ .08 Cost of funds............................................. (.67) Other..................................................... (.12) ----Net interest margin for the three months ended March 31, 2006...................................................... 6.69% ==== Our net interest income on a managed basis includes finance income earned on ourowned receivables as well as on our securitized receivables. This finance incomeis offset by interest expense on the debt recorded on our balance sheet as wellas the contractual rate of return on the instruments issued to investors whenthe receivables were securitized. Managed basis net interest income was $2.6billion in the three months ended March 31, 2006, an increase of 16 percent from$2.2 billion in the three months ended March 31, 2005. Managed basis netinterest margin, annualized, was 6.81 percent in the first quarter of 2006,compared to 7.06 percent in the year-ago period. The decrease was due to higherfunding costs due to a larger managed basis balance sheet and a rising interestrate environment, partially offset by the higher yields on our receivables asdiscussed above. The following table shows the impact of these items on our netinterest margin on a managed basis at March 31, 2006: Net interest margin for the three months ended March 31, 2005...................................................... 7.06%Impact to net interest margin resulting from: Sale of U.K. credit card business in December 2005........ .03 Metris acquisition in December 2005....................... .35 Receivable pricing........................................ .34 Receivable mix............................................ (.23) Cost of funds............................................. (.74) Other..................................................... - ----Net interest margin for the three months ended March 31, 2006...................................................... 6.81% ==== Net interest margin on a managed basis is greater than on an owned basis becausethe managed basis portfolio includes relatively more unsecured loans, which havehigher yields. The effect on net interest margin of receivable mix is greater ona managed basis because on an owned basis, the impact of higher levels of higheryielding MasterCard/Visa receivables due to lower securitization levels isoffsetting the impact of higher levels of lower yielding correspondent realestate secured receivables that we see in our managed portfolio. Managed basis risk adjusted revenue (a non-GAAP financial measure whichrepresents net interest income, plus other revenues, excluding securitizationrelated revenue and the mark-to-market on derivatives which do not qualify aseffective hedges and ineffectiveness associated with qualifying hedges underSFAS No. 133, less net charge-offs as a percentage of average interest earningassets) increased to 7.67 percent at March 31, 2006 from 7.39 percent at March31, 2005. Managed basis risk adjusted revenue increased as the positive creditand delinquency trends due to the continuing strong economy in the United Statesas well as lower bankruptcy losses as a result of reduced filings in the UnitedStates led to lower charge-offs which more than compensated 31 HSBC Finance Corporation-------------------------------------------------------------------------------- for the decline in net interest margin discussed above. See "Basis of Reporting"for additional discussion on the use of non-GAAP financial measures. PROVISION FOR CREDIT LOSSES The following table summarizes provision for creditlosses: INCREASE (DECREASE) ------------------- 2006 2005 AMOUNT %---------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Three months ended March 31,............................... $866 $841 $25 3.0% Our provision for credit losses increased during the first quarter of 2006. Theincrease in the provision for credit losses reflects higher receivable levels,partially offset by a significant decline in bankruptcy filings, a continuedstrong economy in the United States and a reduction in the estimated lossexposure resulting from Katrina. The provision as a percent of average ownedreceivables, annualized, was 2.40 percent in the first quarter of 2006, comparedto 3.08 percent in the year-ago period. During the current quarter, credit lossreserves decreased as the provision for owned credit losses was $62 million lessthan net charge-offs. In the first quarter of 2005, the provision for ownedcredit losses was $22 million less than net charge-offs. The provision forcredit losses may vary from quarter to quarter depending on the product mix andcredit quality of loans in our portfolio. See "Credit Quality" included in thisMD&A for further discussion of factors affecting the provision for creditlosses. OTHER REVENUES The following table summarizes other revenues: INCREASE (DECREASE) -------------------THREE MONTHS ENDED MARCH 31, 2006 2005 AMOUNT %-------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Securitization related revenue............................. $ 71 $ 85 $ (14) (16.5)%Insurance revenue.......................................... 230 221 9 4.1Investment income.......................................... 34 33 1 3.0Derivative income.......................................... 57 260 (203) (78.1)Fee income................................................. 392 306 86 28.1Taxpayer financial services revenue........................ 234 243 (9) (3.7)Gain on receivable sales to HSBC affiliates................ 85 100 (15) (15.0)Servicing fees from HSBC affiliates........................ 108 101 7 6.9Other income............................................... 196 113 83 73.5 ------ ------ ----- -----Total other revenues....................................... $1,407 $1,462 $ (55) (3.8)% ====== ====== ===== ===== Securitization related revenue is the result of the securitization of ourreceivables and includes the following: INCREASE (DECREASE) -------------------THREE MONTHS ENDED MARCH 31, 2006 2005 AMOUNT %--------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Net initial gains........................................... $ - $ - $ - -Net replenishment gains(1).................................. 15 53 (38) (71.7)%Servicing revenue and excess spread......................... 56 32 24 75.0 --- --- ---- -----Total....................................................... $71 $85 $(14) (16.5)% === === ==== ===== --------------- (1) Net replenishment gains reflect inherent recourse provisions of $14 million in the first quarter of 2006 and $86 million in the first quarter of 2005. The decline in securitization related revenue in 2006 was due to decreases inthe level of securitized receivables as a result of our decision in the thirdquarter of 2004 to structure all new collateralized funding transactions assecured financings. Because existing public MasterCard and Visa credit cardtransactions were 32 HSBC Finance Corporation-------------------------------------------------------------------------------- structured as sales to revolving trusts that require replenishments ofreceivables to support previously issued securities, receivables will continueto be sold to these trusts until the revolving periods end, the last of which iscurrently projected to occur in 2008. We will continue to replenish at reducedlevels, certain non-public personal non-credit card securities issued toconduits and record the resulting replenishment gains for a period of time inorder to manage liquidity. Since our securitized receivables have varying lives,it will take time for all securitized receivables to pay-off and the relatedinterest-only strip receivables to be reduced to zero. While the termination ofsale treatment on new collateralized funding transactions reduced our reportednet income under U.S. GAAP, there is no impact on cash received. Insurance revenue was relatively flat during the first quarter of 2006 asincreased revenue in our domestic operations resulting from higher volume in ourdebt cancellation products and life insurance line were partially offset by adecrease in sales volumes in our U.K. operations. Investment income, which includes income on securities available for sale in ourinsurance business and realized gains and losses from the sale of securities,was essentially flat in the first quarter of 2006 as lower average insurancebalances were offset by increases in interest rates. Derivative income, which includes realized and unrealized gains and losses onderivatives which do not qualify as effective hedges under SFAS No. 133 as wellas the ineffectiveness on derivatives associated with our qualifying hedges, issummarized in the table below: THREE MONTHS ENDED MARCH 31, 2006 2005--------------------------------------------------------------------------- (IN MILLIONS)Net realized gains (losses)................................. $ 4 $ 15Mark-to-market on derivatives which do not qualify as effective hedges.......................................... (10) 245Ineffectiveness............................................. 63 - ---- ----Total....................................................... $ 57 $260 ==== ==== Derivative income decreased in 2006 primarily due to a significant reductionduring 2005 in the population of interest rate swaps which do not qualify forhedge accounting under SFAS No. 133. The income from ineffectiveness in thefirst quarter of 2006 resulted from the designation during 2005 of a significantnumber of our derivatives, which had previously not qualified for hedgeaccounting under SFAS No. 133, as effective hedges under the long-haul method ofaccounting. In addition, substantially all of the hedge relationships whichqualified under the shortcut method provisions of SFAS No. 133 have now beenredesignated as hedges under the long-haul method of hedge accounting.Redesignation of swaps as effective hedges reduces the overall volatility ofreported mark-to-market income, although establishing such swaps as long-haulhedges creates volatility as a result of hedge ineffectiveness. For certain newhedging relationships, however, we continued to experience income volatilityduring the period before hedging documentation was put in place. We are workingto improve this process and reduce the delay between executing the swap andestablishing hedge accounting. Additionally, we continue to evaluate the stepsrequired to regain hedge accounting treatment under SFAS No. 133 for a portionof the remaining swaps which do not currently qualify for hedge accounting. Allderivatives are economic hedges of the underlying debt instruments regardless ofthe accounting treatment. Net income volatility, whether based on changes in interest rates for swapswhich do not qualify for hedge accounting or ineffectiveness recorded on ourqualifying hedges under the long haul method of accounting, impacts thecomparability of our reported results between periods. Accordingly, derivativeincome for the three months ended March 31, 2006 should not be consideredindicative of the results for any future periods. Fee income, which includes revenues from fee-based products such as creditcards, increased in the first quarter of 2006 due to higher credit card fees,particularly relating to our non-prime credit card portfolio, due to higherlevels of MasterCard/Visa credit card receivables, primarily as a result of ouracquisition of Metris in December 2005 and in improvements in the interchangerates after the first quarter of 2005. These increases were partially offset bythe impact of new FFIEC guidance which limits certain fee billings for non-prime 33 HSBC Finance Corporation-------------------------------------------------------------------------------- credit card accounts. See "Segment Results - Managed Basis" for additionalinformation on fee income on a managed basis. Taxpayer financial services ("TFS") revenue decreased during the three monthsended March 31, 2006 as TFS revenue during the three months ended March 31, 2005reflects a gain of $24 million on the sale of certain bad debt recovery rightsto a third party. Excluding the impact of this gain in the prior year quarter,TFS revenue increased in the first quarter 2006 due to increased loan volume inthe 2006 tax season. Gain on receivable sales to HSBC affiliates includes the daily sales of domesticprivate label receivable originations (excluding retail sales contracts) andcertain MasterCard/Visa account originations to HSBC Bank USA. The decrease inthe gain on receivable sales to HSBC affiliates primarily reflects lower pricingon the daily sales of domestic private label receivable originations during thefirst quarter of 2006. Pricing for the daily sale of domestic private labelreceivable originations has been negatively impacted by higher funding costs aswell as lower returns on new merchant relationships. Servicing fees from HSBC affiliates represents revenue received under servicelevel agreements under which we service MasterCard/Visa credit card and domesticprivate label receivables as well as real estate secured and auto financereceivables for HSBC affiliates. The increases relate to higher levels ofreceivables being serviced during the first quarter of 2006. Other income increased in the first quarter of 2006 primarily due to higherancillary credit card revenue as a result of higher levels of MasterCard/Visareceivables, including the acquisition of Metris in December 2005, and highergains on miscellaneous asset sales, including the partial sale of a real estateinvestment. COSTS AND EXPENSES Effective December 20, 2005, our U.K. based technologyservices employees were transferred to HSBC Bank plc ("HBEU"). As a result,operating expenses relating to information technology, which have previouslybeen reported as salaries and fringe benefits, are now billed to us by HBEU andreported as support services from HSBC affiliates. The following table summarizes total costs and expenses: INCREASE (DECREASE) --------------THREE MONTHS ENDED MARCH 31, 2006 2005 AMOUNT %---------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Salaries and employee benefits.............................. $ 581 $ 497 $ 84 16.9%Sales incentives............................................ 80 82 (2) (2.4)Occupancy and equipment expenses............................ 83 87 (4) (4.6)Other marketing expenses.................................... 173 180 (7) (3.9)Other servicing and administrative expenses................. 239 258 (19) (7.4)Support services from HSBC affiliates....................... 252 209 43 20.6Amortization of intangibles................................. 80 107 (27) (25.2)Policyholders' benefits..................................... 118 122 (4) (3.3) ------ ------ ---- -----Total costs and expenses.................................... $1,606 $1,542 $ 64 4.2% ====== ====== ==== ===== Salaries and employee benefits increased in the first quarter of 2006 as aresult of additional staffing in our consumer lending, mortgage services, retailservices and Canadian operations to support growth as well as additionalstaffing in our credit card services operations as a result of the acquisitionof Metris in December 2005. These increases were offset by lower salaries andemployee benefits expense in our U.K. operations as a result of the sale of ourU.K. credit card business and the transfer of our U.K. based technology servicesemployees to HBEU in December 2005. 34 HSBC Finance Corporation-------------------------------------------------------------------------------- Sales incentives were essentially flat during the first quarter of 2006 ashigher volumes in our consumer lending branches and Canadian business wereoffset by a decrease in sales incentives in our mortgage services business aswell as our U.K. operations. Occupancy and equipment expenses decreased in the first quarter of 2006 as aresult of the sale of our U.K. credit card business in December 2005 whichincluded the lease associated with the credit card call center. This decreasewas partially offset by higher occupancy and equipment expenses resulting fromour acquisition of Metris in December 2005. Other marketing expenses includes payments for advertising, direct mail programsand other marketing expenditures. The decrease in the first quarter of 2006 wasprimarily due to decreased marketing expenses in our U.K. operations as a resultof the sale of our U.K. credit card business in December 2005. Other servicing and administrative expenses decreased during the three monthsended March 31, 2006 as compared to the year-ago period. During the firstquarter of 2006 we incurred lower professional services fees, including lowerlegal and consulting expenses and a lower provision for fraud losses which waspartially offset by higher insurance operating expenses and higher REO expenses. Support services from HSBC affiliates, includes technology and other servicescharged to us by HSBC Technology and Services (USA) Inc. ("HTSU"), whichincreased in the first quarter of 2006 primarily due to receivable growth.Additionally, in the first quarter of 2006, support services from HSBCaffiliates also includes certain information technology operating expenses forour U.K. operations charged to us by HBEU. Amortization of intangibles decreased in the first quarter of 2006 as a resultof lower intangible amortization for our purchased credit card relationships dueto a contract renegotiation with one of our co-branded credit card partners,lower amortization related to an individual contractual relationship and loweramortization associated with our U.K. operations as a result of the sale of ourU.K. credit card business in December 2005. These decreases were partiallyoffset by increased amortization associated with the Metris cardholderrelationships. Policyholders' benefits decreased slightly in the first quarter of 2006primarily due to lower amortization of fair value adjustments relating to ourinsurance business. Efficiency ratio The following table summarizes our owned basis efficiencyratio: 2006 2005---------------------------------------------------------------------------Three months ended March 31................................. 39.65% 43.99% Our owned basis efficiency ratio improved compared to the prior year quarter dueto higher net interest income due to higher levels of receivables, partiallyoffset by an increase in total costs and expenses to support receivable growthas well as lower other revenues, primarily due to lower derivative income. SEGMENT RESULTS - MANAGED BASIS-------------------------------------------------------------------------------- We have three reportable segments: Consumer, Credit Card Services andInternational. Our Consumer segment consists of our consumer lending, mortgageservices, retail services and auto finance businesses. Our Credit Card Servicessegment consists of our domestic MasterCard and Visa credit card business. OurInternational segment consists of our foreign operations in the United Kingdom,Canada, the Republic of Ireland, Slovakia, the Czech Republic and Hungary. TheAll Other caption includes our insurance and taxpayer financial services andcommercial businesses, as well as our corporate and treasury activities, each ofwhich falls below the quantitative threshold test under SFAS No. 131 fordetermining reportable segments. There have been no changes in the basis of oursegmentation or any changes in the measurement of segment profit as comparedwith the presentation in our 2005 Form 10-K. We have historically monitored our operations and evaluated trends on a managedbasis (a non-GAAP financial measure), which assumes that securitized receivableshave not been sold and are still on our balance 35 HSBC Finance Corporation-------------------------------------------------------------------------------- sheet. This is because the receivables that we securitize are subjected tounderwriting standards comparable to our owned portfolio, are serviced byoperating personnel without regard to ownership and result in a similar creditloss exposure for us. In addition, we fund our operations and make certaindecisions about allocating resources such as capital on a managed basis. When reporting on a managed basis, net interest income, provision for creditlosses and fee income related to receivables securitized are reclassified fromsecuritization related revenue in our owned statement of income into theappropriate caption. CONSUMER SEGMENT The following table summarizes results for our Consumersegment: INCREASE (DECREASE) --------------------THREE MONTHS ENDED MARCH 31 2006 2005 AMOUNT %-------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Net income............................................. $ 609 $ 433 $ 176 40.6%Net interest income.................................... 1,822 1,693 129 7.6Securitization related revenue......................... (49) (235) 186 79.1Fee and other income................................... 299 285 14 4.9Intersegment revenues.................................. 57 26 31 100+Provision for credit losses............................ 403 383 20 5.2Total costs and expenses............................... 699 668 31 4.6Receivables............................................ 115,435 91,226 24,209 26.5Assets................................................. 116,218 92,368 23,850 25.8Net interest margin, annualized........................ 6.46% 7.54% - -Return on average managed assets....................... 2.16 1.91 - - Our Consumer Segment reported higher net income in the first quarter of 2006 dueto higher net interest income, higher fee and other income, and highersecuritization related revenue, partially offset by higher provision for creditlosses and higher costs and expenses. Net interest income increased during thequarter ended March 31, 2006 primarily due to higher average receivables,partially offset by higher interest expense. Net interest margin decreased fromthe year ago period due to a shift in mix due to growth in lower yieldingreceivables and product expansion into near-prime consumer segments. Alsocontributing to the decrease were lower yields on auto finance receivables as wehave targeted higher credit quality customers. Although higher credit qualityreceivables generate lower yields, such receivables are expected to result inlower operating costs, delinquency ratios and charge-off. These lower yieldswere partially offset by higher pricing on our variable rate products. A highercost of funds due to a rising interest rate environment also contributed to thedecrease in net interest margin. The increase in fee and other income in the first quarter of 2006 is due tohigher servicing fees from HSBC Bank USA on the sold domestic private labelreceivable portfolio and higher credit insurance commissions, partially offsetby lower gains on receivable sales including sales of domestic private labelreceivable originations to HSBC Bank USA. Securitization related revenue washigher due to lower amortization of prior period gains as a result of reducedsecuritization levels. Costs and expenses were higher due to higher salaryexpense and higher support services from affiliates. 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 the first quarter of 2006 due toreceivable growth, partially offset by lower levels of bankruptcy filings in theUnited States in the first quarter of 2006 and a reduction in the estimated lossexposure resulting from Katrina of approximately $7 million. We have experiencedhigher dollars of net charge-offs in our owned portfolio during the firstquarter of 2006 due to lower securitization levels. These factors have been morethan offset by the impact of the lower delinquency levels we have experienced inthe first quarter of 2006 driven by a significant decline in bankruptcy filingsand a continued strong economy in the United States which resulted in a decreaseto our owned provision for credit losses compared to the prior year quarter.Over-the-life provision for credit losses 36 HSBC Finance Corporation-------------------------------------------------------------------------------- for securitized receivables recorded in any given period reflects the level andproduct mix of securitizations in that period. Subsequent charge-offs ofsecuritized receivables result in a decrease in the over-the-life reserveswithout any corresponding increase to managed loss provision. In the firstquarter of 2006, we decreased managed loss reserves as net charge-offs weregreater than the provision for credit losses by $226 million. Net charge-offswere greater than the provision for credit losses by $272 million for the threemonths ended March 31, 2005. Managed receivables increased 7 percent to $115.4 billion at March 31, 2006 ascompared to $108.3 billion at December 31, 2005. We continued to experiencestrong growth in the first quarter of 2006 in our real estate secured portfolioin both our correspondent and branch-based consumer lending businesses. We havecontinued to focus on increasing our mix of junior lien loans through portfolioacquisitions and continue to expand our sources for purchasing newly originatedloans from flow correspondents. Contributing to the increase were purchases of$.5 billion from portfolio acquisition programs since the prior quarter. Ourauto finance portfolio also reported growth due to organic growth and increasedvolume in both the dealer network and the consumer direct loan program. Personalnon-credit card receivables increased from the prior year as we have increasedthe availability of this product due to the strong U.S. economy. The success ofseveral large direct mail campaigns also contributed to growth in the portfolio. Compared to March 31, 2005, managed receivables increased 27 percent. Realestate growth was also strong compared to the year ago period as a result ofstrong growth in both our correspondent and branch-based consumer lendingbusinesses. We have continued to focus on increasing our mix of junior lienloans through portfolio acquisitions and continue to expand our sources forpurchasing newly originated loans from flow correspondents. Real estate securedreceivable levels at March 31, 2006 do not include $.9 billion of correspondentreceivables purchased directly by HSBC Bank USA since March 31, 2005, a portionof which we otherwise would have purchased. Also contributing to the increasewere purchases of $1.6 billion from portfolio acquisition programs since theprior year quarter. Growth in our auto finance portfolio from the year agoperiod is due to organic growth, principally in the near-prime portfolio. Thiscame from newly originated loans acquired from our dealer network and growth inthe consumer loan program. Growth in our personal non-credit card portfolio wasthe result of increased marketing, including several large direct mailcampaigns. Return on average managed assets ("ROMA") was 2.16 percent for the first quarterof 2006, compared to 1.91 percent in the year-ago period. The increase in theratio in the first quarter of 2006 is due to the increase in net incomediscussed above which grew faster than average managed assets. In accordance with Federal Financial Institutions Examination Council ("FFIEC")guidance, the required minimum monthly payment amounts for domestic 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 HSBC Bank USA on adaily basis. Estimates of the potential impact to the business are based onnumerous assumptions and take into account a number of factors which aredifficult to predict, such as changes in customer behavior, which will not befully known or understood until the changes have been in place for a period oftime. Based on current estimates, we anticipate that these changes will have anunfavorable impact on the premiums associated with these daily sales in 2007. Itis not expected this reduction will have a material impact on either the resultsof the Consumer Segment or our consolidated results. 37 HSBC Finance Corporation-------------------------------------------------------------------------------- CREDIT CARD SERVICES SEGMENT The following table summarizes results for ourCredit Card Services segment. INCREASE (DECREASE) --------------------THREE MONTHS ENDED MARCH 31 2006 2005 AMOUNT %--------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Net income............................................... $ 305 $ 148 $ 157 100+%Net interest income...................................... 769 506 263 52.0Securitization related revenue........................... (3) (64) 61 95.3Fee and other income..................................... 517 436 81 18.6Intersegment revenues.................................... 5 5 - -Provision for credit losses.............................. 365 321 44 13.7Total costs and expenses................................. 433 324 109 33.6Receivables.............................................. 25,146 19,114 6,032 31.6Assets................................................... 25,488 18,970 6,518 34.4Net interest margin, annualized.......................... 11.86% 10.34% - -Return on average managed assets......................... 4.67 3.06 - - Our Credit Card Services Segment reported higher net income in the first quarterof 2006. The increase in net income was primarily due to higher net interestincome, higher fee and other income and higher securitization related revenuepartially offset by higher provision for credit losses and higher costs andexpenses. The acquisition of Metris, which was completed in December 2005,contributed $23 million of net income during the quarter. Net interest incomeincreased as a result of the Metris acquisition, which contributed to higheroverall yields due in part to higher levels of near-prime receivables, partiallyoffset by higher interest expense. Net interest margin increased in the firstquarter of 2006 primarily due to higher overall yields due to increases innon-prime receivable levels, including the receivables acquired as part ofMetris, higher pricing on variable rate products and other repricinginitiatives, such as reduced levels of promotional rate balances in 2006. Theseincreases were partially offset by a higher cost of funds. Although ournon-prime receivables tend to have smaller balances, they generate higherreturns both in terms of net interest margin and fee income. Increases in feeand other income resulted from portfolio growth, including the Metris receivableportfolios acquired in December 2005, and improvements in interchange ratessince March 2005. This increase in fee income was partially offset by adverseimpacts of limiting certain fee billings on non-prime credit card accounts asdiscussed below. Our provision for credit losses was higher in the first quarterof 2006 as a result of portfolio growth, including additions from the Metrisacquisition, partially offset by a reduction in our estimated loss exposurerelated to Katrina of approximately $23 million and the impact of lower levelsof bankruptcy filings in the first quarter of 2006. We increased managed lossreserves by recording loss provision greater than net charge-off of $104 millionin the first quarter of 2006. The increase in loss provision is related to theMetris acquisition, partly offset by a decrease in loss provision for the otherportfolios. In the first quarter of 2005, we decreased managed loss reserves byrecording loss provision less than net charge-off of $23 million. Higher costsand expenses were to support receivable growth. Managed receivables decreased 4 percent to $25.1 billion at March 31, 2006compared to $26.2 billion at December 31, 2005. The decrease during the quarterwas due primarily to normal seasonal run-off. Compared to March 31, 2005,managed receivables increased 32 percent. This increase was due to organicgrowth in our HSBC branded prime, Union Privilege and non-prime portfolios, andalso due to the acquisition of Metris in December 2005 which increasedreceivables by $5.3 billion. The increase in ROMA in the first quarter of 2006 is primarily due to higher netincome discussed above which grew faster than average managed assets. 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 38 HSBC Finance Corporation-------------------------------------------------------------------------------- phased in by December 31, 2005. Estimates of the potential impact to thebusiness are based on numerous assumptions and take into account a number offactors which are difficult to predict, such as changes in customer behavior andimpact of other issuers implementing requirements, which will not be fully knownor understood until the changes have been in place for a period of time. Thesechanges have resulted in lower non-prime credit card fee income in the firstquarter of 2006. It is anticipated that the changes will result in fluctuationsin the provision for credit losses in future periods as credit loss provisionsfor prime accounts will increase as a result of higher required monthly paymentswhile the non-prime provision decreases due to lower levels of fees incurred bycustomers. Although we do not expect this will have a material impact on ourconsolidated results, the impact to the Credit Card Services Segment in 2006will be material. INTERNATIONAL SEGMENT The following table summarizes results for ourInternational segment: INCREASE (DECREASE) --------------------THREE MONTHS ENDED MARCH 31, 2006 2005 AMOUNT %-------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Net income (loss)....................................... $ 7 $ (9) $ 16 100+%Net interest income..................................... 182 229 (47) (20.5)Securitization related revenue.......................... - 10 (10) (100.0)Fee and other income.................................... 113 131 (18) (13.7)Intersegment revenues................................... 7 4 3 75.0Provision for credit losses............................. 106 165 (59) (35.8)Total costs and expenses................................ 175 216 (41) (19.0)Receivables............................................. 9,096 13,041 (3,945) (30.3)Assets.................................................. 10,091 13,939 (3,848) (27.6)Net interest margin annualized.......................... 7.78% 7.02% - -Return on average managed assets........................ .27 (.25) - - Our International segment reported net income in the first quarter of 2006 aftera loss of $9 million in the prior year quarter. The increase in net incomereflects lower total costs and expenses and lower provision for credit losses,partially offset by lower fee and other income and lower net interest income asa result of the December 2005 sale of our U.K. credit card business to HBEU.Applying constant currency rates, which uses the average rate of exchange forthe 2005 quarter to translate current period net income, the net income wouldhave been lower by $2 million in 2006. Net interest income decreased during the quarter primarily as a result of lowerreceivable levels in our U.K. subsidiary due to the sale of our U.K. credit cardbusiness including $3.1 billion in managed receivables to HBEU as well as lowerreceivable levels resulting from lower retail sales volumes in the U.K. This waspartially offset by higher net interest income in our Canadian operations due tohigher receivable levels. Net interest margin increased in the first quarter of2006 due to the change in receivable mix resulting from the sale of our U.Kcredit card business in December 2005 as well as a decreased cost of funds.Provision for credit losses decreased in the first quarter of 2006 primarily dueto the lower receivable balance as a result of the sale of our U.K. credit cardbusiness. We increased managed loss reserves by recording loss provision greaterthan net charge-offs of $8 million for the first quarter of 2006 and comparedwith $55 million in the year-ago period. Fee and other income and total costsand expenses decreased as a result of the sale of our U.K. credit card businessin December 2005. The decrease in total costs and expenses was partially offsetby increased costs associated with growth in the Canadian business. Managed receivables of $9.1 billion at March 31, 2006 decreased 2 percentcompared to $9.3 billion at December 31, 2005. In the first quarter of 2006, ourU.K. based unsecured receivable products decreased due to lower retail salesvolume following a slow down in retail consumer spending in the U.K. Thesedecreases were partially offset by growth in the receivable portfolio in ourCanadian operations. Branch expansions in Canada in 2005 have resulted in growthin both the secured and unsecured receivable portfolios. Compared to 39 HSBC Finance Corporation-------------------------------------------------------------------------------- March 31, 2005, receivables decreased 30 percent due to the sale of our U.K.credit card business as well as lower retail sales volumes in the U.K. Thesedecreases were partially offset by receivable growth in our Canadian operationsas discussed above as well as from the successful launch of a MasterCard/Visacredit card program in 2005. Applying constant currency rates, managedreceivables at March 31, 2006 would have been $42 million lower using December31, 2005 exchange rates and $375 million higher using March 31, 2005 exchangerates. The increase in ROMA for the first quarter of 2006 reflects the higher netincome as discussed above, and lower average managed assets as a result of thesale of our U.K. credit card business in December 2005. CREDIT QUALITY-------------------------------------------------------------------------------- CREDIT LOSS RESERVES We maintain credit loss reserves to cover probable losses of principal, interestand fees, including late, overlimit and annual fees. Credit loss reserves arebased on a range of estimates and are intended to be adequate but not excessive.We estimate probable losses for owned consumer receivables using a roll ratemigration analysis that estimates the likelihood that a loan will progressthrough the various stages of delinquency, or buckets, and ultimatelycharge-off. This analysis considers delinquency status, loss experience andseverity and takes into account whether loans are in bankruptcy, have beenrestructured or rewritten, or are subject to forbearance, an external debtmanagement plan, hardship, modification, extension or deferment. Our credit lossreserves also take into consideration the loss severity expected based on theunderlying collateral, if any, for the loan in the event of default. Delinquencystatus may be affected by customer account management policies and practices,such as the restructure of accounts, forbearance agreements, extended paymentplans, modification arrangements, external debt management programs, loanrewrites and deferments. If customer account management policies, or changesthereto, shift loans from a "higher" delinquency bucket to a "lower" delinquencybucket, this will be reflected in our roll rate statistics. To the extent thatrestructured accounts have a greater propensity to roll to higher delinquencybuckets, this will be captured in the roll rates. Since the loss reserve iscomputed based on the composite of all of these calculations, this increase inroll rate will be applied to receivables in all respective delinquency buckets,which will increase the overall reserve level. In addition, loss reserves onconsumer receivables are maintained to reflect our judgment of portfolio riskfactors that may not be fully reflected in the statistical roll ratecalculation. Risk factors considered in establishing loss reserves on consumerreceivables include recent growth, product mix, bankruptcy trends, geographicconcentrations, economic conditions, portfolio seasoning, account managementpolicies and practices, current levels of charge-offs and delinquencies, changesin laws and regulations and other items which can affect consumer paymentpatterns on outstanding receivables, such as the impact of natural disasters,such as Katrina and global pandemics. While our credit loss reserves are available to absorb losses in the entireportfolio, we specifically consider the credit quality and other risk factorsfor each of our products. We recognize the different inherent losscharacteristics in each of our products as well as customer account managementpolicies and practices and risk management/collection practices. Charge-offpolicies are also considered when establishing loss reserve requirements toensure the appropriate reserves exist for products with longer charge-offperiods. We also consider key ratios such as reserves to nonperforming loans andreserves as a percentage of net charge-offs in developing our loss reserveestimate. Loss reserve estimates are reviewed periodically and adjustments arereported in earnings when they become known. As these estimates are influencedby factors outside of our control, such as consumer payment patterns andeconomic conditions, there is uncertainty inherent in these estimates, making itreasonably possible that they could change. See Note 3, "Receivables," in theaccompanying consolidated financial statements for receivables by product typeand Note 4, "Credit Loss Reserves," for an analysis of changes in the creditloss reserves. 40 HSBC Finance Corporation-------------------------------------------------------------------------------- The following table summarizes owned basis credit loss reserves: MARCH 31, DECEMBER 31, MARCH 31, 2006 2005 2005-------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Owned credit loss reserves.................................. $4,468 $4,521 $3,581Reserves as a percent of: Receivables............................................... 3.04% 3.23% 3.19% Net charge-offs(1)........................................ 120.4(2) 108.3(2) 103.7 Nonperforming loans....................................... 104.7 108.8 103.6 --------------- (1) Quarter-to-date, annualized. (2) The acquisition of Metris in December 2005 has positively impacted this ratio. Reserves as a percentage of net charge-offs excluding Metris was 112.8 percent at March 31, 2006 and 103.7 percent at December 31, 2005. Owned credit loss reserves at March 31, 2006 decreased as compared to December31, 2005 as the provision for owned credit losses was $62 million lower than netcharge-offs reflecting lower delinquency levels as a result of lower bankruptcylevels following the enactment of the new bankruptcy legislation in 2005, areduction in the estimated loss exposure resulting from Katrina and seasonalimprovements in our collection activities. Owned credit loss reserves at March31, 2006 increased as compared to March 31, 2005 resulting from higher levels ofowned receivables, including lower securitization levels, additional reservesresulting from the impact of Katrina, anticipated impacts from minimum monthlypayment changes, and the Metris acquisition. These increases were partiallyoffset by significantly lower personal bankruptcy levels, the benefits of astrong U.S. economy, including low unemployment levels, and the impact of thesale of our U.K. credit card business in December 2005 which decreased creditloss reserves by $104 million. Beginning in 2004 and continuing in 2005, we have changed the mix in our loanportfolio to higher credit quality and lower yielding receivables, particularlyreal estate secured and auto finance receivables. Reserves as a percentage ofreceivables at March 31, 2006 were lower than at December 31, 2005 and March 31,2005 as a result of recent portfolio growth and lower levels of personalbankruptcy filings in the United States in the first quarter of 2006. Reserves as a percentage of net charge-offs increased in 2006. The December 31,2005 ratio was significantly impacted by the acquisition of Metris in December2005. Excluding the Metris acquisition in both periods, reserves as a percentageof net charge-offs increased 910 basis points. While both our reserve levels atMarch 31, 2006 and net charge-offs in the first quarter of 2006 decreased ascompared to the fourth quarter of 2005, net charge-offs decreased at a morerapid pace than our reserve levels. The fourth quarter of 2005 net charge-offlevels were impacted by the spike in MasterCard/Visa charge-offs following theincrease in personal bankruptcy filings prior to the effective date of newbankruptcy legislation in the U.S., a portion of which was an acceleration ofMasterCard/Visa net charge-offs that would otherwise have been experienced infuture periods. As a result, charge-off levels in the first quarter of 2006benefited from the acceleration of these charge-offs which occurred in thefourth quarter of 2005. 41 HSBC Finance Corporation-------------------------------------------------------------------------------- For securitized receivables, we also record a provision for estimated probablelosses that we expect to incur under the recourse provisions. The followingtable summarizes managed credit loss reserves: MARCH 31, DECEMBER 31, MARCH 31, 2006 2005 2005-------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Managed credit loss reserves................................ $4,629 $4,736 $4,242Reserves as a percent of: Receivables............................................... 3.09% 3.29% 3.43% Net charge-offs(1)........................................ 116.9(2) 101.8(2) 94.9 Nonperforming loans....................................... 105.4 108.8 106.9 --------------- (1) Quarter-to-date, annualized. (2) The acquisition of Metris in December 2005 has positively impacted this ratio. Reserves as a percentage of net charge-offs excluding Metris was 109.7 percent at March 31, 2006 and 97.7 percent at December 31, 2005. Managed credit loss reserves at March 31, 2006 also decreased compared toDecember 31, 2005 due to the decreases in owned credit loss reserves discussedabove and the impact of lower reserves on securitized receivables as a result ofrun-off. Managed credit loss reserves at March 31, 2006 increased as compared tothe prior year quarter due to the increases in owned credit loss reservesdiscussed above, partially offset by lower reserves on securitized receivablesas a result of run-off. Securitized receivables of $3.1 billion at March 31,2006 decreased from $4.1 billion at December 31, 2005 and $11.5 billion at March31, 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): MARCH 31, DECEMBER 31, MARCH 31, 2006 2005 2005--------------------------------------------------------------------------------------------------Real estate secured......................................... 2.46% 2.72% 2.62%Auto finance................................................ 1.65 2.34 1.65MasterCard/Visa(1).......................................... 4.35 3.66 4.60Private label............................................... 5.50 5.43 4.71Personal non-credit card.................................... 8.86 9.40 8.63 ---- ---- ----Total(1).................................................... 3.62% 3.84% 3.78% ==== ==== ==== --------------- (1) In December 2005, we completed the acquisition of Metris which included receivables of $5.3 billion. This event had a significant impact on this ratio. Excluding the receivables from the Metris acquisition from this calculation, our consumer delinquency ratio for our MasterCard/Visa portfolio was 4.01% and total consumer delinquency was 3.89% at December 31, 2005. Total owned delinquency decreased $53 million, or 22 basis points, compared tothe prior quarter. The decrease is a combination of lower bankruptcy levelsfollowing the enactment of new bankruptcy legislation in 2005, receivable growthand the continuing strong economy in the United States. Delinquency was alsofavorably impacted by seasonal improvements in our collection activities in thefirst quarter as customers use their tax refunds to reduce their outstandingbalances. The overall decrease in delinquency of our real estate secured andauto finance portfolios reflects receivable growth, seasonal improvement incollection results and continued strong economic conditions. The increase inMasterCard/Visa delinquencies primarily reflects the seasoning of the Metrisportfolio purchased in December 2005 as further described below. The increase in 42 HSBC Finance Corporation-------------------------------------------------------------------------------- delinquency in our private label receivables (which primarily consists of ourforeign private label portfolio that was not sold to HSBC Bank USA in December2004) reflects declining receivables and the deterioration of the financialcircumstances of our customers across the U.K. The decrease in personalnon-credit card delinquencies reflects the positive impact of receivable growthas well as seasonal improvements in collection results, lower bankruptcy filingsand the continued strong economic conditions in the U.S. As noted above, the increase in MasterCard/Visa delinquencies reflects theseasoning of the Metris portfolio purchased in December 2005. The receivablesacquired as part of our acquisition of Metris were subject to the requirementsof Statement of Position 03-3, "Accounting for Certain Loans or Debt SecuritiesAcquired in a Transfer" ("SOP 03-3"). In accordance with SOP 03-3, ourinvestment in any acquired receivables which showed evidence of creditdeterioration at the time of acquisition was based on the net cash flowsexpected to be collected. The increase in delinquency reflects the seasoning ofthe receivables we acquired which did not show any evidence of creditdeterioration at the time of the acquisition, a portion of which have now becomedelinquent. Compared to the year-ago period, total delinquency decreased 16 basis points asmost products reported lower delinquency levels. The improvements are generallythe result of portfolio growth, the benefit of a strong U.S. economy includinglow unemployment levels, and lower bankruptcy levels due to the new bankruptcylegislation as discussed above. 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