HSBC Fin Corp Q1 2006 10Q - 2

15th May 2006 14:31

HSBC Holdings PLC15 May 2006 PART 2 NET CHARGE-OFFS OF CONSUMER RECEIVABLES - OWNED BASIS The following table summarizes net charge-offs of consumer receivables (as apercent, annualized, of average consumer receivables): MARCH 31, DECEMBER 31, MARCH 31, 2006 2005 2005--------------------------------------------------------------------------------------------------Real estate secured......................................... .75% .66% .87%Auto finance................................................ 3.50 3.42 3.80MasterCard/Visa............................................. 4.00 7.99 7.17Private label............................................... 5.62 5.60 4.18Personal non-credit card.................................... 7.94 7.59 8.18 ---- ---- ----Total....................................................... 2.58% 3.10% 3.15% ==== ==== ====Real estate secured net charge-offs and REO expense as a percent of average real estate secured receivables........ .89% .78% 1.01% Net charge-offs as a percent, annualized, of average consumer receivablesdecreased compared to both the prior and year ago quarters primarily as a resultof lower levels of personal bankruptcy filings in our MasterCard/Visa portfoliodue to the new bankruptcy legislation in the U.S. which resulted in anacceleration of net charge-offs in the fourth quarter of 2005, a portion ofwhich would have otherwise been experienced in 2006. The net charge-off ratiofor our MasterCard/Visa portfolio was also positively impacted by thereceivables acquired in our acquisition of Metris which were subject to thereporting requirements of SOP 03-3 as discussed above. Our real estate securedportfolio experienced an increase in net charge-offs during the first quarterreflecting seasoning of the growing portfolio. The increase in net charge-offsin the personal non-credit card portfolio is due to portfolio seasoning. Total net charge-offs for the current quarter decreased from the March 2005quarter primarily due to a decrease in personal bankruptcy filings in ourMasterCard/Visa portfolio following the October 2005 enactment of new bankruptcylegislation in the United States. 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. 43 HSBC Finance Corporation-------------------------------------------------------------------------------- OWNED NONPERFORMING ASSETS MARCH 31, DECEMBER 31, MARCH 31, 2006 2005 2005-------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Nonaccrual receivables...................................... $3,525 $3,533 $2,956Accruing consumer receivables 90 or more days delinquent.... 740 621 499Renegotiated commercial loans............................... 1 - 1 ------ ------ ------Total nonperforming receivables............................. 4,266 4,154 3,456Real estate owned........................................... 563 510 509 ------ ------ ------Total nonperforming assets.................................. $4,829 $4,664 $3,965 ====== ====== ======Credit loss reserves as a percent of nonperforming receivables............................................... 104.7% 108.8% 103.6% Compared to December 31, 2005, the increase in total nonperforming assets isprimarily due to the seasoning of the Metris portfolio as discussed above.Consistent with industry practice, accruing consumer receivables 90 or more daysdelinquent includes domestic MasterCard/Visa receivables. ACCOUNT MANAGEMENT POLICIES AND PRACTICES Our policies and practices for the collection of consumer receivables, includingour customer account management policies and practices, permit us to reset thecontractual delinquency status of an account to current, based on indicia orcriteria which, in our judgment, evidence continued payment probability. Suchpolicies and practices vary by product and are designed to manage customerrelationships, maximize collection opportunities and avoid foreclosure orrepossession if reasonably possible. If the account subsequently experiencespayment defaults, it will again become contractually delinquent. The tables below summarize approximate restructuring statistics in our managedbasis domestic portfolio. We report our restructuring statistics on a managedbasis only because the receivables that we securitize are subject tounderwriting standards comparable to our owned portfolio, are generally servicedand collected without regard to ownership and result in a similar credit lossexposure for us. As previously reported, in prior periods we used certainassumptions and estimates to compile our restructure statistics. The systemiccounters used to compile the information presented below exclude from thereported statistics loans that have been reported as contractually delinquentbut have been reset to a current status because we have determined that theloans should not have been considered delinquent (e.g., payment applicationprocessing errors). When comparing restructuring statistics from differentperiods, the fact that our restructure policies and practices will change overtime, that exceptions are made to those policies and practices, and that ourdata capture methodologies have been enhanced, should be taken into account. 44 HSBC Finance Corporation-------------------------------------------------------------------------------- TOTAL RESTRUCTURED BY RESTRUCTURE PERIOD - DOMESTIC PORTFOLIO(1)(MANAGED BASIS) MARCH 31, DECEMBER 31, MARCH 31, 2006 2005 2005-------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Never restructured.......................................... 89.7% 89.5% 87.2%Restructured: Restructured in the last 6 months......................... 4.0 4.0 4.8 Restructured in the last 7-12 months...................... 2.4 2.4 3.2 Previously restructured beyond 12 months.................. 3.9 4.1 4.8 ------- ------- ------- Total ever restructured(2)................................ 10.3 10.5 12.8 ------- ------- -------Total....................................................... 100.0% 100.0% 100.0% ======= ======= =======TOTAL RESTRUCTURED BY PRODUCT - DOMESTIC PORTFOLIO(1)(MANAGED BASIS)Real estate secured......................................... $ 8,395 $ 8,334 $ 8,470Auto finance................................................ 1,712 1,688 1,560MasterCard/Visa............................................. 937 774 567Private label(3)............................................ 26 26 23Personal non-credit card.................................... 3,411 3,369 3,466 ------- ------- -------Total....................................................... $14,481 $14,191 $14,086 ======= ======= =======(AS A PERCENT OF MANAGED RECEIVABLES)Real estate secured......................................... 9.7% 10.4% 12.9%Auto finance................................................ 14.5 14.5 15.3MasterCard/Visa............................................. 3.8 3.0 3.0Private label(3)............................................ 7.3 7.3 7.0Personal non-credit card.................................... 19.9 19.9 22.3 ------- ------- -------Total(2).................................................... 10.3% 10.5% 12.8% ======= ======= ======= --------------- (1) Excludes foreign businesses, commercial and other. (2) Total including foreign businesses was 10.1 percent at March 31, 2006, 10.3 percent at December 31, 2005 and 11.9 percent at March 31, 2005. (3) Only reflects consumer lending retail sales contracts which have historically been classified as private label. All other domestic private label receivables were sold to HSBC Bank USA in December 2004. See "Credit Quality Statistics" for further information regarding owned basisand managed basis delinquency, charge-offs and nonperforming loans. The amount of domestic and foreign managed receivables in forbearance,modification, credit card services approved consumer credit counselingaccommodations, rewrites or other customer account management techniques forwhich we have reset delinquency and that is not included in the restructured ordelinquency statistics was approximately $.4 billion or .3 percent of managedreceivables at March 31, 2006 and December 31, 2005. In addition to the above, we granted an initial 30 or 60 day payment deferral(based on product) to customers living in the Katrina FEMA designated IndividualAssistance disaster areas. This deferral was extended for a period of up to 90days or longer in certain cases based on a customer's specific circumstances,consistent with our natural disaster policies. In certain cases thesearrangements have resulted in a customer's delinquency 45 HSBC Finance Corporation-------------------------------------------------------------------------------- status being reset by 30 days or more. These extended payment arrangementsaffected approximately $1.1 billion of managed receivables and are not reflectedas restructures in the table above or included in the other customer accountmanagement techniques described in the paragraph above unless the accountssubsequently qualify for restructuring under our restructure policies andprocedures as described in the 2005 Form 10-K. LIQUIDITY AND CAPITAL RESOURCES-------------------------------------------------------------------------------- We continue to focus on balancing our use of affiliate and third party fundingsources to minimize funding expense while managing liquidity. During the firstquarter of 2006, we supplemented unsecured debt issuances with proceeds from thecontinuing sale of newly originated domestic private label receivables to HSBCBank USA, debt issued to affiliates, secured financings and higher levels ofcommercial paper as a result of the seasonal activity of our TFS business.Because we are a subsidiary of HSBC, our credit ratings have improved and ourcredit spreads relative to Treasuries have tightened compared to those weexperienced during the months leading up to the announcement of our acquisitionby HSBC. Primarily as a result of tightened credit spreads, we recognized cashfunding expense savings of approximately $214 million during the quarter endedMarch 31, 2006 and approximately $120 million during the quarter ended March 31,2005 compared to the funding costs we would have incurred using average spreadsand funding mix from the first half of 2002. These tightened credit spreads incombination with the issuance of HSBC Finance Corporation debt and other fundingsynergies including asset transfers and debt underwriting fees paid to HSBCaffiliates have enabled HSBC to realize a run rate for annual cash fundingexpense savings in excess of $1 billion per year. In the first quarter of 2006,the cash funding expense savings realized by HSBC totaled approximately $280million. Debt due to affiliates and other HSBC related funding are summarized in thefollowing table: MARCH 31, DECEMBER 31, 2006 2005-------------------------------------------------------------------------------------- (IN BILLIONS)Debt issued to HSBC subsidiaries: Drawings on bank lines in the U.K and Europe.............. $ 4.0 $ 4.2 Term debt................................................. 11.2 11.0 Preferred securities issued by Household Capital Trust VIII to HSBC........................................... .3 .3 ----- ----- Total debt outstanding to HSBC subsidiaries............... 15.5 15.5 ----- -----Debt outstanding to HSBC clients: Euro commercial paper..................................... 3.3 3.2 Term debt................................................. 1.3 1.3 ----- ----- Total debt outstanding to HSBC clients.................... 4.6 4.5Cash received on bulk and subsequent sales of domestic private label credit card receivables to HSBC Bank USA, net (cumulative).......................................... 14.5 15.7Real estate secured receivable activity with HSBC Bank USA: Cash received on sales (cumulative)....................... 3.7 3.7 Direct purchases from correspondents (cumulative)......... 4.2 4.2 Reductions in real estate secured receivables sold to HSBC Bank USA............................................... (3.7) (3.3) ----- -----Total real estate secured receivable activity with HSBC Bank USA....................................................... 4.2 4.6 ----- -----Cash received from sale of U.K. credit card business to HBEU (cumulative).............................................. 2.7 2.6Capital contribution by HINO (cumulative)................... 1.2 1.2(1) ----- -----Total HSBC related funding.................................. $42.7 $44.1 ===== ===== --------------- (1) This capital contribution was made in connection with the acquisition of Metris. 46 HSBC Finance Corporation-------------------------------------------------------------------------------- Funding from HSBC, including debt issuances to HSBC subsidiaries and clients,represented 15 percent of our total managed debt at March 31, 2006 and December31, 2005. Cash proceeds from the December 2005 sale of our managed basis U.K. credit cardreceivables to HBEU of $2.6 billion were used partially to pay down drawings onbank lines from HBEU in the U.K. and partially to fund operations. At March 31, 2006, we had a commercial paper back stop credit facility of $2.5billion from HSBC supporting domestic issuances and a revolving credit facilityof $5.3 billion from HBEU to fund our operations in the U.K. There have been nodraws on the domestic line. At March 31, 2006, $4.0 billion was outstandingunder the U.K. lines. We had derivative contracts with a notional value of $85.6billion, or approximately 96 percent of total derivative contracts, outstandingwith HSBC affiliates at March 31, 2006. At December 31, 2005, we had derivativecontracts with a notional value of $72.2 billion, or approximately 95 percent oftotal derivative contracts, outstanding with HSBC affiliates. SECURITIES AND OTHER SHORT-TERM INVESTMENTS Securities totaled $4.1 billion atMarch 31, 2006 and December 31, 2005. Securities purchased under agreements toresell totaled $91 million at March 31, 2006 and $78 million at December 31,2005. Interest bearing deposits with banks totaled $599 million at March 31,2006 and $384 million at December 31, 2005. COMMERCIAL PAPER, BANK AND OTHER BORROWINGS totaled $14.2 billion at March 31,2006 and $11.4 billion at December 31, 2005. The increase at March 31, 2006 wasa result of the funding of the seasonal activity of our TFS business. Includedin this total was outstanding Euro commercial paper sold to customers of HSBC of$3.3 billion at March 31, 2006 and $3.2 billion at December 31, 2005. LONG TERM DEBT (with original maturities over one year) increased to $107.8billion at March 31, 2006 from $105.2 billion at December 31, 2005. As part ofour overall liquidity management strategy, we continue to extend the maturity ofour liability profile. Significant third party issuances during the firstquarter of 2006 included the following: - $3.0 billion of domestic medium-term notes - $.8 billion of foreign currency-denominated bonds - $.5 billion of InterNotes(SM) (retail-oriented medium-term notes) - $2.5 billion of global debt - $1.5 billion of securities backed by real estate secured and MasterCard/Visa receivables. For accounting purposes, these transactions were structured as secured financings. In the first quarter of 2006, we redeemed the junior subordinated notes issuedto Household Capital Trust VI with an outstanding principal balance of $206million. SELECTED CAPITAL RATIOS are summarized in the following table: MARCH 31, DECEMBER 31, 2006 2005--------------------------------------------------------------------------------------TETMA(1).................................................... 7.75% 7.56%TETMA + Owned Reserves(1)................................... 10.59 10.55Tangible common equity to tangible managed assets(1)........ 6.44 6.07Common and preferred equity to owned assets................. 12.45 12.43Excluding purchase accounting adjustments: TETMA(1).................................................. 8.62 8.52 TETMA + Owned Reserves(1)................................. 11.47 11.51 Tangible common equity to tangible managed assets(1)...... 7.32 7.02 --------------- (1) TETMA, TETMA + Owned Reserves and tangible common equity to tangible managed assets represent non-GAAP financial ratios that are used by HSBC Finance Corporation management and certain rating agencies to evaluate capital adequacy and may differ from similarly named measures presented by other companies. See "Basis of Reporting" for additional discussion on the use of non-GAAP financial measures and "Reconciliations to GAAP Financial Measures" for quantitative reconciliations to the equivalent GAAP basis financial measure. 47 HSBC Finance Corporation-------------------------------------------------------------------------------- SECURITIZATIONS AND SECURED FINANCINGS Securitizations (collateralized fundingtransactions structured to receive sale treatment under Statement of FinancialAccounting Standards No. 140, "Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities, a Replacement of FASBStatement No. 125," ("SFAS No. 140")) and secured financings (collateralizedfunding transactions which do not receive sale treatment under SFAS No. 140) ofconsumer receivables have been a source of funding and liquidity for us.Securitizations and secured financings have been used to limit our reliance onthe unsecured debt markets. In a securitization, a designated pool of non-real estate consumer receivablesis removed from the balance sheet and transferred through a limited purposefinancing subsidiary to an unaffiliated trust. This unaffiliated trust is aqualifying special purpose entity ("QSPE") as defined by SFAS No. 140 and,therefore, is not consolidated. The QSPE funds its receivable purchase throughthe issuance of securities to investors, entitling them to receive specifiedcash flows during the life of the securities. The receivables transferred to theQSPE serve as collateral for the securities. At the time of sale, aninterest-only strip receivable is recorded, representing the present value ofthe cash flows we expect to receive over the life of the securitizedreceivables, net of estimated credit losses and debt service. Under the terms ofthe securitizations, we receive annual servicing fees on the outstanding balanceof the securitized receivables and the rights to future residual cash flows onthe sold receivables after the investors receive their contractual return. Cashflows related to the interest-only strip receivables and servicing thereceivables are collected over the life of the underlying securitizedreceivables. In a secured financing, a designated pool of receivables is conveyed to a whollyowned limited purpose subsidiary which in turn transfers the receivables to atrust which sells interests to investors. Repayment of the debt issued by thetrust is secured by the receivables transferred. The transactions are structuredas secured financings under SFAS No. 140. Therefore, the receivables and theunderlying debt of the trust remain on our balance sheet. We do not recognize again in a secured financing transaction. Because the receivables and the debtremain on our balance sheet, revenues and expenses are reported consistentlywith our owned balance sheet portfolio. Using this source of funding results insimilar cash flows as issuing debt through alternative funding sources. Securitizations are treated as secured financings under both IFRSs and U.K.GAAP. In order to align our accounting treatment with that of HSBC initiallyunder U.K. GAAP and now under IFRSs, we began to structure all newcollateralized funding transactions as secured financings in the third quarterof 2004. However, because existing public MasterCard and Visa credit cardtransactions were structured as sales to revolving trusts that requirereplenishments of receivables to support previously issued securities,receivables will continue to be sold to these trusts and the resultingreplenishment gains recorded until the revolving periods end, the last of whichis currently projected to occur in early 2008. We will continue to replenish atreduced levels, certain non-public personal non-credit card and MasterCard/ Visasecurities issued to conduits and record the resulting replenishment gains for aperiod of time in order to manage liquidity. Since our securitized receivableshave varying lives, it will take time for these receivables to pay-off and therelated interest-only strip receivables to be reduced to zero. The terminationof sale treatment on new collateralized funding activity reduced our reportednet income under U.S. GAAP. There was no impact, however, on cash received.Because we believe the market for securities backed by receivables is areliable, efficient and cost-effective source of funds, we will continue to usesecured financings of consumer receivables as a source of our funding andliquidity. 48 HSBC Finance Corporation-------------------------------------------------------------------------------- There were no securitizations (excluding replenishments of certificateholderinterests) during the first quarter of 2006 or 2005. Secured financings aresummarized in the following table: THREE MONTHS ENDED MARCH 31 2006 2005---------------------------------------------------------------------------- (IN MILLIONS)SECURED FINANCINGS:Real estate secured......................................... $ 350 $ -MasterCard/Visa............................................. 1,120 -Auto finance................................................ - - ------ -----Total....................................................... $1,470 $ - ====== ===== Our securitized receivables totaled $3.1 billion at March 31, 2006 compared to$4.1 billion at December 31, 2005. As of March 31, 2006, outstanding securedfinancings of $15.1 billion were secured by $21.4 billion of real estatesecured, auto finance and MasterCard/Visa receivables. Secured financings of$15.1 billion at December 31, 2005 were secured by $21.8 billion of real estatesecured, auto finance and MasterCard/Visa receivables. At March 31, 2006,securitizations structured as sales represented 2 percent and secured financingsrepresented 11 percent of the funding associated with our managed fundingportfolio. At December 31, 2005, securitizations structured as sales represented3 percent and secured financings represented 11 percent of the fundingassociated with our managed funding portfolio. 2006 FUNDING STRATEGY As discussed previously, the acquisition by HSBC hasimproved our access to the capital markets as well as expanded our access to aworldwide pool of potential investors. Our current estimated domestic fundingneeds and sources for 2006 are summarized in the table that follows: ACTUAL ESTIMATED JANUARY 1 APRIL 1 THROUGH THROUGH ESTIMATED MARCH 31, DECEMBER 31, FULL YEAR 2006 2006 2006-------------------------------------------------------------------------------------------------- (IN BILLIONS)FUNDING NEEDS: Net asset growth.......................................... $ 4 $ 9 - 19 $13 - 23 Commercial paper, term debt and securitization maturities............................................. 16 14 - 20 30 - 36 Other..................................................... - 1 - 3 1 - 3 --- -------- -------- Total funding needs....................................... $20 $24 - 42 $44 - 62 === ======== ========FUNDING SOURCES: External funding, including commercial paper.............. $20 $23 - 37 $43 - 57 HSBC and HSBC subsidiaries................................ - 1 - 5 1 - 5 --- -------- -------- Total funding sources..................................... $20 $24 - 42 $44 - 62 === ======== ======== RISK MANAGEMENT-------------------------------------------------------------------------------- CREDIT RISK There have been no significant changes in our approach to creditrisk management since December 31, 2005. At March 31, 2006, we had derivative contracts with a notional value ofapproximately $89.0 billion, including $85.6 billion outstanding with HSBCaffiliates. Most swap agreements, both with unaffiliated and affiliated thirdparties, require that payments be made to, or received from, the counterpartywhen the fair value of the agreement reaches a certain level. Generally,third-party swap counterparties provide collateral in the form of cash which isrecorded in our balance sheet as other assets or derivative related liabilitiesand totaled $90 million at March 31, 2006 and $91 million at December 31, 2005.When the fair value of our agreements 49 HSBC Finance Corporation-------------------------------------------------------------------------------- with affiliate counterparties requires the posting of collateral by theaffiliate, it is provided in the form of securities, which are not recorded onour balance sheet. Alternately, when the fair value of our agreements withaffiliate counterparties requires us to post collateral, it is provided in theform of cash which is recorded on our balance sheet in other assets. At March31, 2006, the fair value of our agreements with affiliate counterparties wasabove the level that requires us to post collateral. As such at March 31, 2006,we had posted cash collateral with affiliates totaling $352 million. At December31, 2005, the fair value of our agreements with affiliate counterparties wasbelow the level requiring the posting of collateral by the affiliate. As such,at December 31, 2005, we were not holding any swap collateral from HSBCaffiliates in the form of securities. LIQUIDITY RISK There have been no significant changes in our approach toliquidity risk since December 31, 2005. MARKET RISK HSBC Group has certain limits and benchmarks that serve asguidelines in determining the appropriate levels of interest rate risk. One suchlimit is expressed in terms of the Present Value of a Basis Point ("PVBP"),which reflects the change in value of the balance sheet for a one basis pointmovement in all interest rates. Our PVBP limit as of March 31, 2006 was $2million, which includes the risk associated with hedging instruments. Thus, fora one basis point change in interest rates, the policy dictates that the valueof the balance sheet shall not increase or decrease by more than $2 million. Asof March 31, 2006 and December 31, 2005, we had a PVBP position of less than $1million reflecting the impact of a one basis point increase in interest rates. While the total PVBP position will not change as a result of the loss of hedgeaccounting following our acquisition by HSBC, the following table shows thecomponents of PVBP: MARCH 31, DECEMBER 31, 2006 2005-------------------------------------------------------------------------------------- (IN MILLIONS)Risk related to our portfolio of ineffective hedges......... $(1.9) $(1.4)Risk for all other remaining assets and liabilities......... 1.9 2.3 ----- -----Total PVBP risk............................................. $ - $ .9 ===== ===== We also monitor the impact that an immediate hypothetical increase or decreasein interest rates of 25 basis points applied at the beginning of each quarterover a 12 month period would have on our net interest income assuming a growingbalance sheet and the current interest rate risk profile. The following tablesummarizes such estimated impact: MARCH 31, DECEMBER 31, 2006 2005-------------------------------------------------------------------------------------- (IN MILLIONS)Decrease in net interest income following a hypothetical 25 basis points rise in interest rates applied at the beginning of each quarter over the next 12 months............................................ $ 89 $213Increase in net interest income following a hypothetical 25 basis points fall in interest rates applied at the beginning of each quarter over the next 12 months............................................ $197 $120 These estimates include both the net interest income impact of the derivativepositions we have entered into which are considered to be effective hedges underSFAS No. 133 and the impact of economic hedges of certain underlying debtinstruments which do not qualify for hedge accounting as previously discussed,as if they were effective hedges under SFAS No. 133. These estimates also assumewe would not take any corrective actions in response to interest rate movementsand, therefore, exceed what most likely would occur if rates were to change bythe amount indicated. 50 HSBC Finance Corporation-------------------------------------------------------------------------------- As part of our overall risk management strategy to reduce earnings volatility,in 2005 a significant number of our pay fixed/receive variable interest rateswaps which had not previously qualified for hedge accounting under SFAS No.133, have been designated as effective hedges using the long-haul method ofaccounting, and certain other interest rate swaps were terminated. This willsignificantly reduce the volatility of the mark-to-market on the previouslynon-qualifying derivatives which have been designated as effective hedges goingforward, but will result in the recording of ineffectiveness under the long-haulmethod of accounting under SFAS No. 133. In order to further reduce earningsvolatility that would otherwise result from changes in interest rates, wecontinue to evaluate the steps required to regain hedge accounting treatmentunder SFAS No. 133 for the remaining swaps which do not currently qualify forhedge accounting. These derivatives remain economic hedges of the underlyingdebt instruments. We will continue to manage our total interest rate risk on abasis consistent with the risk management process employed since theacquisition. INSURANCE RISK The principal insurance risk we face is that the cost of claimscombined with acquisition and administration costs may exceed the aggregateamount of premiums received and investment income earned. We manage ourinsurance risks through the application of formal pricing, underwriting, andclaims procedures. These procedures are also designed to ensure compliance withregulations. OPERATIONAL RISK There has been no significant change in our approach tooperational risk management since December 31, 2005. 51 HSBC FINANCE CORPORATION RECONCILIATIONS TO GAAP FINANCIAL MEASURES THREE MONTHS ENDED ------------------------- MARCH 31, MARCH 31, 2006 2005--------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)RETURN ON AVERAGE ASSETS:Net income.................................................. $ 888 $ 626 -------- --------Average assets: Owned basis............................................... $162,688 $131,954 Serviced with limited recourse............................ 3,505 12,884 -------- -------- Managed basis............................................. $166,193 $144,838 -------- --------Return on average owned assets.............................. 2.18% 1.90%Return on average managed assets............................ 2.14 1.73 ======== ========RETURN ON AVERAGE COMMON SHAREHOLDER'S(S') EQUITY:Net income.................................................. $ 888 $ 626Dividends on preferred stock................................ (9) (18) -------- --------Net income available to common shareholders................. $ 879 $ 608 -------- --------Average common shareholder's(s') equity..................... $ 19,379 $ 16,170 -------- --------Return on average common shareholder's(s') equity........... 18.14% 15.04% ======== ========NET INTEREST MARGIN:Net interest income: Owned basis............................................... $ 2,464 $ 1,888 Serviced with limited recourse............................ 103 332 -------- -------- Managed basis............................................. $ 2,567 $ 2,220 -------- --------Average interest-earning assets: Owned basis............................................... $147,266 $112,985 Serviced with limited recourse............................ 3,505 12,884 -------- -------- Managed basis............................................. $150,771 $125,869 -------- --------Owned basis net interest margin............................. 6.69% 6.68%Managed basis net interest margin........................... 6.81 7.06 ======== ========MANAGED BASIS RISK ADJUSTED REVENUE:Net interest income......................................... $ 2,567 $ 2,220Other revenues.............................................. 1,312 1,160Excluding: Securitization related revenue............................ 54 308 Mark-to-market on derivatives which do not qualify as effective hedges and ineffectiveness associated with qualifying hedges under SFAS No. 133................... (53) (245) Net charge-offs........................................... (990) (1,118) -------- --------Risk adjusted revenue....................................... 2,890 2,325Average interest-earning assets............................. $150,771 $125,869 -------- --------Managed basis risk adjusted revenue......................... 7.67% 7.39% ======== ======== 52 HSBC FINANCE CORPORATION RECONCILIATIONS TO GAAP FINANCIAL MEASURES THREE MONTHS ENDED ------------------------------------ MARCH 31, MARCH 31, DECEMBER 31, 2006 2005 2005------------------------------------------------------------------------------------------------- (DOLLAR AMOUNTS ARE IN MILLIONS)CONSUMER NET CHARGE-OFF RATIO:Consumer net charge-offs: Owned basis.............................................. $ 928 $ 856 $ 1,044 Serviced with limited recourse........................... 62 255 119 -------- -------- -------- Managed basis............................................ $ 990 $ 1,111 $ 1,163 -------- -------- --------Average consumer receivables: Owned basis.............................................. $143,893 $108,928 $134,647 Serviced with limited recourse........................... 3,505 12,884 5,757 -------- -------- -------- Managed basis............................................ $147,398 $121,812 $140,404 -------- -------- --------Owned basis consumer net charge-off ratio.................. 2.58% 3.15% 3.10%Managed basis consumer net charge-off ratio................ 2.69 3.65 3.31 ======== ======== ========RESERVES AS A PERCENTAGE OF NET CHARGE-OFFSLoss reserves: Owned basis.............................................. $ 4,468 $ 3,581 $ 4,521 Serviced with limited recourse........................... 161 661 215 -------- -------- -------- Managed basis............................................ $ 4,629 $ 4,242 $ 4,736 -------- -------- --------Net charge-offs: Owned basis.............................................. $ 928 $ 863 $ 1,044 Serviced with limited recourse........................... 62 255 119 -------- -------- -------- Managed basis............................................ $ 990 $ 1,118 $ 1,163 -------- -------- --------Owned basis reserves as a percentage of net charge-offs.... 120.4% 103.7% 108.3%Managed basis reserves as a percentage of net charge-offs.............................................. 116.9 94.9 101.8 ======== ======== ========EFFICIENCY RATIO:Total costs and expenses less policyholders' benefits...... $ 1,488 $ 1,420 $ 1,433 -------- -------- --------Net interest income and other revenues less policyholders' benefits: Owned basis.............................................. $ 3,753 $ 3,228 $ 3,332 Serviced with limited recourse........................... 8 30 48 -------- -------- -------- Managed basis............................................ $ 3,761 $ 3,258 $ 3,380 -------- -------- --------Owned basis efficiency ratio............................... 39.65% 43.99% 43.01%Managed basis efficiency ratio............................. 39.56 43.59 42.40 ======== ======== ======== 53 HSBC FINANCE CORPORATION RECONCILIATIONS TO GAAP FINANCIAL MEASURES MARCH 31, DECEMBER 31, MARCH 31, 2006 2005 2005---------------------------------------------------------------------------------------------------------- (DOLLAR AMOUNTS ARE IN MILLIONS)TWO-MONTHS-AND-OVER-CONTRACTUAL DELINQUENCY:Consumer two-months-and-over-contractual delinquency: Owned basis.............................................. $ 5,312 $ 5,366 $ 4,229 Serviced with limited recourse........................... 153 234 626 -------- -------- -------- Managed basis............................................ $ 5,465 $ 5,600 $ 4,855 -------- -------- --------Consumer receivables: Owned basis.............................................. $146,580 $139,726 $111,911 Serviced with limited recourse........................... 3,109 4,074 11,486 -------- -------- -------- Managed basis............................................ $149,689 $143,800 $123,397 -------- -------- --------Consumer two-months-and-over-contractual delinquency: Owned basis.............................................. 3.62% 3.84% 3.78% Managed basis............................................ 3.65 3.89 3.93 ======== ======== ========RESERVES AS A PERCENTAGE OF RECEIVABLES:Loss reserves: Owned basis.............................................. $ 4,468 $ 4,521 $ 3,581 Serviced with limited recourse........................... 161 215 661 -------- -------- -------- Managed basis............................................ $ 4,629 $ 4,736 $ 4,242 -------- -------- --------Receivables: Owned basis.............................................. $146,767 $139,913 $112,161 Serviced with limited recourse........................... 3,109 4,074 11,486 -------- -------- -------- Managed basis............................................ $149,876 $143,987 $123,647 -------- -------- --------Reserves as a percentage of receivables: Owned basis.............................................. 3.04% 3.23% 3.19% Managed basis............................................ 3.09 3.29 3.43 ======== ======== ========RESERVES AS A PERCENTAGE OF NONPERFORMING LOANS:Loss reserves: Owned basis.............................................. $ 4,468 $ 4,521 $ 3,581 Serviced with limited recourse........................... 161 215 661 -------- -------- -------- Managed basis............................................ $ 4,629 $ 4,736 $ 4,242 -------- -------- --------Nonperforming loans: Owned basis.............................................. $ 4,266 $ 4,154 $ 3,456 Serviced with limited recourse........................... 126 197 511 -------- -------- -------- Managed basis............................................ $ 4,392 $ 4,351 $ 3,967 -------- -------- --------Reserves as a percentage of nonperforming loans: Owned basis.............................................. 104.7% 108.8% 103.6% Managed basis............................................ 105.4 108.8 106.9 ======== ======== ======== 54 HSBC FINANCE CORPORATION RECONCILIATIONS TO GAAP FINANCIAL MEASURES MARCH 31, DECEMBER 31, 2006 2005---------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)TANGIBLE COMMON EQUITY:Common shareholder's equity................................. $ 19,806 $ 18,904Exclude: Unrealized (gains) losses on cash flow hedging instruments............................................. (313) (260) Minimum pension liability................................. - - Unrealized gains on investments and interest-only strip receivables............................................. 35 3 Intangible assets......................................... (2,400) (2,480) Goodwill.................................................. (7,009) (7,003) -------- --------Tangible common equity...................................... 10,119 9,164HSBC acquisition purchase accounting adjustments............ 1,379 1,441 -------- --------Tangible common equity, excluding HSBC acquisition purchase accounting adjustments.................................... $ 11,498 $ 10,605 ======== ========TANGIBLE SHAREHOLDER'S(S') EQUITY:Tangible common equity...................................... $ 10,119 $ 9,164Preferred stock............................................. 575 575Mandatorily redeemable preferred securities of Household Capital Trusts............................................ 1,478 1,679 -------- --------Tangible shareholder's(s') equity........................... 12,172 11,418HSBC acquisition purchase accounting adjustments............ 1,376 1,438 -------- --------Tangible shareholder's(s') equity, excluding HSBC acquisition purchase accounting adjustments............... $ 13,548 $ 12,856 ======== ========TANGIBLE SHAREHOLDER'S(S') EQUITY PLUS OWNED LOSS RESERVES:Tangible shareholder's(s') equity........................... $ 12,172 $ 11,418Owned loss reserves......................................... 4,468 4,521 -------- --------Tangible shareholder's(s') equity plus owned loss reserves.................................................. 16,640 15,939HSBC acquisition purchase accounting adjustments............ 1,376 1,438 -------- --------Tangible shareholder's(s') equity plus owned loss reserves, excluding HSBC acquisition purchase accounting adjustments............................................... $ 18,016 $ 17,377 ======== ========TANGIBLE MANAGED ASSETS:Owned assets................................................ $163,680 $156,669Receivables serviced with limited recourse.................. 3,109 4,074 -------- --------Managed assets.............................................. 166,789 160,743Exclude: Intangible assets......................................... (2,400) (2,480) Goodwill.................................................. (7,009) (7,003) Derivative financial assets............................... (282) (234) -------- --------Tangible managed assets..................................... 157,098 151,026HSBC acquisition purchase accounting adjustments............ (14) (52) -------- --------Tangible managed assets, excluding HSBC acquisition purchase accounting adjustments.................................... $157,084 $150,974 ======== ========EQUITY RATIOS:Common and preferred equity to owned assets................. 12.45% 12.43%Tangible common equity to tangible managed assets........... 6.44 6.07Tangible shareholder's(s') equity to tangible managed assets ("TETMA")................................................. 7.75 7.56Tangible shareholder's(s') equity plus owned loss reserves to tangible managed assets ("TETMA + Owned Reserves")..... 10.59 10.55Excluding HSBC acquisition purchase accounting adjustments: Tangible common equity to tangible managed assets......... 7.32 7.02 TETMA..................................................... 8.62 8.52 TETMA + Owned Reserves.................................... 11.47 11.51 ======== ======== 55 HSBC Finance Corporation-------------------------------------------------------------------------------- ITEM 4. CONTROLS AND PROCEDURES-------------------------------------------------------------------------------- We maintain a system of internal and disclosure controls and procedures designedto ensure that information required to be disclosed by HSBC Finance Corporationin the reports we file or submit under the Securities Exchange Act of 1934, asamended, (the "Exchange Act"), is recorded, processed, summarized and reportedon a timely basis. Our Board of Directors, operating through its auditcommittee, which is composed entirely of independent outside directors, providesoversight to our financial reporting process. We conducted an evaluation, with the participation of the Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of our disclosurecontrols and procedures as of the end of the period covered by this report.Based upon that evaluation, the Chief Executive Officer and Chief FinancialOfficer concluded that our disclosure controls and procedures were effective asof the end of the period covered by this report so as to alert them in a timelyfashion to material information required to be disclosed in reports we fileunder the Exchange Act. There have been no significant changes in our internal and disclosure controlsor in other factors which could significantly affect internal and disclosurecontrols subsequent to the date that we carried out our evaluation. HSBC Finance Corporation continues the process to complete a thorough review ofits internal controls as part of its preparation for compliance with therequirements of Section 404 of the Sarbanes-Oxley Act of 2002. Section 404requires our management to report on, and our external auditors to attest to,the effectiveness of our internal control structure and procedures for financialreporting. As a non-accelerated filer under Rule 12b-2 of the Exchange Act, ourfirst report under Section 404 will be contained in our Form 10-K for the periodended December 31, 2007. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS-------------------------------------------------------------------------------- GENERAL We are parties to various legal proceedings resulting from ordinary businessactivities relating to our current and/or former operations. Certain of theseactions are or purport to be class actions seeking damages in very largeamounts. These actions assert violations of laws and/or unfair treatment ofconsumers. Due to the uncertainties in litigation and other factors, we cannotbe certain that we will ultimately prevail in each instance. We believe that ourdefenses to these actions have merit and any adverse decision should notmaterially affect our consolidated financial condition. CONSUMER LITIGATION During the past several years, the press has widely reported certain industryrelated concerns that may impact us. Some of these involve the amount oflitigation instituted against lenders and insurance companies operating incertain states and the large awards obtained from juries in those states. Likeother companies in this industry, some of our subsidiaries are involved in anumber of lawsuits pending against them in these states. The cases, inparticular, generally allege inadequate disclosure or misrepresentation offinancing terms. In some suits, other parties are also named as defendants.Unspecified compensatory and punitive damages are sought. Several of these suitspurport to be class actions or have multiple plaintiffs. The judicial climate inthese states is such that the outcome of all of these cases is unpredictable.Although our subsidiaries believe they have substantive legal defenses to theseclaims and are prepared to defend each case vigorously, a number of such caseshave been settled or otherwise resolved for amounts that in the aggregate arenot material to our operations. Appropriate insurance carriers have beennotified as appropriate, and a number of reservations of rights letters havebeen received. 56 HSBC Finance Corporation-------------------------------------------------------------------------------- CREDIT CARD SERVICES LITIGATION Since June 2005, HSBC Finance Corporation, HSBC North America Holdings Inc., andHSBC Holdings plc., as well as other banks and the Visa and Master Cardassociations, were named as defendants in four class actions filed inConnecticut and the Eastern District of New York; Photos Etc. Corp. et al. v.Visa U.S.A., Inc., et al. (D. Conn. No. 3:05-CV-01007 (WWE)): NationalAssociation of Convenience Stores, et al. v. Visa U.S.A., Inc., et al.(E.D.N.Y.No. 05-CV 4520 (JG)); Jethro Holdings, Inc., et al. v. Visa U.S.A., Inc. etal.(E.D.N.Y. No. 05-CV-4521 (JG)); and American Booksellers Ass'n v. VisaU.S.A., Inc. et al. (E.D.N.Y. No. 05-CV-5391 (JG)). Numerous other complaintscontaining similar allegations (in which no HSBC entity is named) were filedacross the country against Visa, MasterCard and other banks. These actionsprincipally allege that the imposition of a no-surcharge rule by theassociations and/or the establishment of the interchange fee charged for creditcard transactions causes the merchant discount fee paid by retailers to be setat supracompetitive levels in violation of the Federal antitrust laws. Inresponse to motions of the plaintiffs on October 19, 2005, the Judicial Panel onMultidistrict Litigation (the "MDL Panel") issued an order consolidating thesesuits and transferred all of the cases to the Eastern District of New York. Theconsolidated case is: In re Payment Card Interchange Fee and Merchant DiscountAntitrust Litigation, MDL 1720, E.D.N.Y. A consolidated, amended complaint wasfiled by the plaintiffs on April 24, 2006. At this time, we are unable toquantify the potential impact from this action, if any. SECURITIES LITIGATION In August 2002, we restated previously reported consolidated financialstatements. The restatement related to certain MasterCard and Visa co-brandingand affinity credit card relationships and a third party marketing agreement,which were entered into between 1992 and 1999. All were part of our Credit CardServices segment. In consultation with our prior auditors, Arthur Andersen LLP,we treated payments made in connection with these agreements as prepaid assetsand amortized them in accordance with the underlying economics of theagreements. Our current auditor, KPMG LLP, advised us that, in its view, thesepayments should have either been charged against earnings at the time they weremade or amortized over a shorter period of time. The restatement resulted in a$155.8 million, after-tax, retroactive reduction to retained earnings atDecember 31, 1998. As a result of the restatement, and other corporate events,including, e.g., the 2002 settlement with 50 states and the District of Columbiarelating to real estate lending practices, HSBC Finance Corporation, and itsdirectors, certain officers and former auditors, have been involved in variouslegal proceedings, some of which purport to be class actions. A number of theseactions allege violations of Federal securities laws, were filed between Augustand October 2002, and seek to recover damages in respect of allegedly false andmisleading statements about our common stock. These legal actions have beenconsolidated into a single purported class action, Jaffe v. HouseholdInternational, Inc., et al., No. 02 C 5893 (N.D. Ill., filed August 19, 2002),and a consolidated and amended complaint was filed on March 7, 2003. On December3, 2004, the court signed the parties' stipulation to certify a class withrespect to the claims brought under sec.10 and sec.20 of the Securities ExchangeAct of 1934. The parties stipulated that plaintiffs will not seek to certify aclass with respect to the claims brought under sec.11 and sec.15 of theSecurities Act of 1933 in this action or otherwise. The amended complaint purports to assert claims under the Federal securitieslaws, on behalf of all persons who purchased or otherwise acquired oursecurities between October 23, 1997 and October 11, 2002, arising out of allegedfalse and misleading statements in connection with our sales and lendingpractices, the 2002 state settlement agreement referred to above, therestatement and the HSBC merger. The amended complaint, which also names asdefendants Arthur Andersen LLP, Goldman, Sachs & Co., and Merrill Lynch, Pierce,Fenner & Smith, Inc., fails to specify the amount of damages sought. In May2003, we, and other defendants, filed a motion to dismiss the complaint. OnMarch 19, 2004, the Court granted in part, and denied in part the defendants'motion to dismiss the complaint. The Court dismissed all claims against MerrillLynch, Pierce, Fenner & Smith, Inc. and Goldman Sachs & Co. The Court alsodismissed certain claims alleging strict liability for alleged misrepresentationof material facts based on statute of limitations grounds. The claims thatremain against some or all of the defendants essentially allege the defendantsknowingly made 57 HSBC Finance Corporation-------------------------------------------------------------------------------- a false statement of a material fact in conjunction with the purchase or sale ofsecurities, that the plaintiffs justifiably relied on such statement, the falsestatement(s) caused the plaintiffs' damages, and that some or all of thedefendants should be liable for those alleged statements. On February 28, 2006,the Court has also dismissed all alleged sec.10 claims that arose prior to July30, 1999, shortening the class period by 22 months. The discovery schedulecurrently provides that all factual discovery must be completed by May 12, 2006and expert witness discovery must be completed by July 24, 2006. However, weexpect those deadlines to be extended. Separately, one of the defendants, ArthurAndersen, entered into a settlement of the claims against Andersen. Thissettlement is subject to Court approval. At this time, we are unable to quantifythe potential impact from this action, if any. With respect to this securities litigation, we believe that we have not, and ourofficers and directors have not, committed any wrongdoing and in each instancethere will be no finding of improper activities that may result in a materialliability to us or any of our officers or directors. On June 27, 2003, a case entitled, West Virginia Laborers Pension Trust Fund v.Caspersen, et al, was filed in the Chancery Division of the Circuit Court ofCook County, Illinois as case number 03CH10808. This purported class actionnamed as defendants the directors of Beneficial Corporation at the time of the1998 merger of Beneficial Corporation into a subsidiary of HSBC FinanceCorporation, and claimed that those directors' due diligence of HSBC FinanceCorporation at the time they considered the merger was inadequate. The Complaintclaimed that as a result of some of the securities law and other violationsalleged in the Jaffe case, HSBC Finance Corporation common shares lost value.Pursuant to the merger agreement with Beneficial Corporation, we assumed thedefense of this litigation. In September of 2003, the defendants filed a motionto dismiss which was granted on June 15, 2004 based upon a lack of personaljurisdiction over the defendants. The plaintiffs appealed that decision. On May11, 2005, the appellate court affirmed the trial court's ruling. The time forany further appeals expired. In addition, on June 30, 2004, a case entitled,Employer-Teamsters Local Nos. 175 & 505 Pension Trust Fund v. Caspersen, et al,was filed in the Superior Court of New Jersey, Law Division, Somerset County asCase Number L9479-04. Other than the change in plaintiff, the suit wassubstantially identical to the foregoing West Virginia Laborer's Pension TrustFund case, and was brought by the same principal law firm that brought thatsuit. The defendants' motion to dismiss was granted on February 10, 2005. Afterbriefing and oral argument, on February 24, 2006 the appellate court affirmedthe trial court's ruling dismissing the complaint. The time for further appealshas expired. ITEM 1A. RISK FACTORS-------------------------------------------------------------------------------- Risk factors were provided in our 2005 Form 10-K; however, the followingdiscussion provides a more detailed description of some of the important riskfactors that could affect our actual results and could cause our results to varymaterially from those expressed in public statements or documents. However,other factors besides those discussed below or elsewhere in other of our reportsfiled or furnished with the SEC, could affect our business or results. Thereader should not consider any description of such factors to be a complete setof all potential risks that may face HSBC Finance Corporation. GENERAL BUSINESS, ECONOMIC, POLITICAL AND MARKET CONDITIONS. Our business andearnings are affected by general business, economic, market and politicalconditions in the United States and abroad. Given the concentration of ourbusiness activities in the United States, we are particularly exposed todownturns in the United States economy. For example in a poor economicenvironment there is greater likelihood that more of our customers orcounterparties could become delinquent on their loans or other obligations tous, which, in turn, could result in higher level of charge-offs and provisionfor credit losses, all of which would adversely affect our earnings. Generalbusiness, economic and market conditions that could affect us include short-termand long-term interest rates, inflation, recession, monetary supply,fluctuations in both debt and equity capital markets in which we fund ouroperations, market value of consumer owned real estate throughout the UnitedStates, consumer perception as to the availability of credit and the ease offiling of bankruptcy. Certain changes to these conditions could diminish demandfor our products and services, or increase the cost to provide such products orservices. Political conditions also can impact our earnings. Acts or threats ofwar or 58 HSBC Finance Corporation-------------------------------------------------------------------------------- terrorism, as well as actions taken by the United States or other governments inresponse to such acts or threats, could affect business and economic conditionsin the United States. FEDERAL AND STATE REGULATION. We operate in a highly regulated environment.Changes in federal, state and local laws and regulations affecting banking,consumer credit, bankruptcy, privacy, consumer protection or other matters couldmaterially impact our performance. Specifically, attempts by local, state andnational regulatory agencies to control alleged "predatory" or discriminatorylending practices through broad or targeted legislative or regulatoryinitiatives aimed at lenders operation in consumer lending markets, includingnon-traditional mortgage products or tax refund anticipation loans, could affectus in a substantial and unpredictable ways, including limiting the types ofconsumer loan products we can offer. In addition, there may be amendments to,and new interpretations of risk-based capital guidelines and reportinginstructions, including changes in response to Basel II Capital Accords. Wecannot determine whether such legislative or regulatory initiatives will beinstituted or predict the impact of such initiatives would have on our results. CHANGES IN ACCOUNTING STANDARDS. Our accounting policies and methods arefundamental to how we record and report our financial condition and results ofoperations. From time to time the Financial Accounting Standards Board ("FASB"),the SEC and our bank regulators, including the Office of Comptroller of theCurrency and the Board of Governors of the Federal Reserve System, change thefinancial accounting and reporting standards that govern the preparation ofexternal financial statements. These changes are beyond our control, can be hardto predict and could materially impact how we report our financial results andcondition. We could be required to apply a new or revised standardretroactively, resulting in our restating prior period financial statements inmaterial amounts. COMPETITION. We operate in a highly competitive environment and we expectcompetitive conditions to continue to intensify as continued merger activity inthe financial services industry produces larger, better-capitalized and moregeographically-diverse companies, including lenders with access to governmentsponsored organizations for our consumer segment, that are capable of offering awider array of consumer financial products and services at competitive prices.In addition, the traditional segregation of the financial services industry intoprime and non-prime segments has eroded and in the future is expected tocontinue to do so, further increasing competition for our core customer base.Such competition may impact the terms, rates, costs and/or profits historicallyincluded in the loan products we offer or purchase. There can be no assurancethat the significant and increasing competition in the financial servicesindustry will not materially adversely affect our future results of operations. MANAGEMENT PROJECTIONS. Pursuant to U.S. GAAP, our management is required to usecertain estimates in preparing our financial statements, including accountingestimates to determine loan loss reserves, reserves related to futurelitigation, and the fair market value of certain assets and liabilities, amongother items. In particular, loan loss reserve estimates are judgmental and areinfluenced by factors outside our control. As result, estimates could change aseconomic conditions change. If our management's determined values for such itemsturn out to be substantially inaccurate, we may experience unexpected losseswhich could be material. LAWSUITS AND REGULATORY INVESTIGATIONS AND PROCEEDINGS. HSBC Finance Corporationor one of our subsidiaries is named as a defendant in various legal actions,including class actions and other litigation or disputes with third parties, aswell as investigations or proceedings brought by regulatory agencies. These orother future actions brought against us may result in judgments, settlements,fines, penalties or other results, including additional compliance requirements,adverse to us which could materially adversely affect our business, financialcondition or results of operation, or cause us serious reputational harm. OPERATIONAL RISKS. Our businesses are dependent on our ability to process alarge number of increasingly complex transactions. If any of our financial,accounting, or other data processing systems fail or have other significantshortcomings, we could be materially adversely affected. We are similarlydependent on our employees. We could be materially adversely affected if anemployee causes a significant operational break-down or failure, either as aresult of human error or where an individual purposefully sabotages orfraudulently 59 HSBC Finance Corporation-------------------------------------------------------------------------------- manipulates our operations or systems. Third parties with which we do businesscould also be sources of operational risk to us, including relating tobreak-downs or failures of such parties' own systems or employees. Any of theseoccurrences could result in diminished ability by us to operate one or more ofour businesses, potential liability to clients, reputational damage andregulatory intervention, all of which could materially adversely affect us. We may also be subject to disruptions of our operating systems arising fromevents that are wholly or partially beyond our control, which may include, forexample, computer viruses or electrical or telecommunications outages or naturaldisasters, such as Hurricane Katrina, or events arising from local or regionalpolitics, including terrorist acts. Such disruptions may give rise to losses inservice to customers, inability to collect our receivables in affected areas andother loss or liability to us. In a company as large and complex as ours, lapses or deficiencies in internalcontrol over financial reporting are likely to occur from time to time, andthere is no assurance that significant deficiencies or material weaknesses ininternal controls may not occur in the future. In addition there is the risk that our controls and procedures as well asbusiness continuity and data security systems prove to be inadequate. Any suchfailure could affect our operations and could materially adversely affect ourresults of operations by requiring us to expend significant resources to correctthe defect, as well as by exposing us to litigation or losses not covered byinsurance. Changes to operational practices from time to time, such as determinations tosell receivables from our domestic private label portfolio, structuring all newcollateralized funding transactions as secured financings, or changes to ourcustomer account management and risk management/collection policies andpractices could materially impact our performance and results. For instance, itis unclear what impact, if any, the raising of the minimum payment on our creditcard accounts which was effective in January 2006 will have. LIQUIDITY. Our liquidity is critical to our ability to operate our businesses,grow and be profitable. A compromise to our liquidity could therefore have anegative effect on us. Potential conditions that could negatively affect ourliquidity include diminished access to capital markets, unforeseen cash orcapital requirements, an inability to sell assets and an inability to obtainexpected funding from HSBC subsidiaries and clients. Our credit ratings are an important part of maintaining our liquidity, as areduction in our credit ratings would also negatively affect our liquidity. Acredit ratings downgrade, depending on its severity, could potentially increaseborrowing costs, limit access to capital markets, require cash payments orcollateral posting, and permit termination of certain contracts material to us. ACQUISITION INTEGRATION. We have in the past and may in the future seek to growour business by acquiring other businesses or loan portfolios, such as ouracquisition of Metris Companies, Inc. ("Metris") in 2005. There can be noassurance that our acquisitions will have the anticipated positive results,including results relating to: the total cost of integration; the time requiredto complete the integration; the amount of longer-term cost savings; or theoverall performance of the combined entity. Integration of an acquired businesscan be complex and costly, sometimes including combining relevant accounting anddata processing systems and management controls, as well as managing relevantrelationships with clients, suppliers and other business partners, as well aswith employees. There is no assurance that our most recent acquisitions or that any businessesor portfolios acquired in the future will be successfully integrated and willresult in all of the positive benefits anticipated. If we are not able tointegrate successfully our past and any future acquisitions, there is the riskour results of operations could be materially and adversely affected. RISK MANAGEMENT. We seek to monitor and control our risk exposure through avariety of separate but complementary financial, credit, operational, complianceand legal reporting systems, including models and programs that predict loandelinquency and loss. While we employ a broad and diversified set of riskmonitoring and risk mitigation techniques, those techniques and the judgmentsthat accompany their 60 HSBC Finance Corporation-------------------------------------------------------------------------------- application cannot anticipate every economic and financial outcome or thespecifics and timing of such outcomes. Accordingly, our ability to successfullyidentify and manage risks facing us is an important factor that cansignificantly impact our results. EMPLOYEE RETENTION. Our employees are our most important resource and, in manyareas of the financial services industry, competition for qualified personnel isintense. If we were unable to continue to retain and attract qualified employeesto support the various functions of our business, including the credit riskanalysis, underwriting, servicing, collection and sales, our performance,including our competitive position, could be materially adversely affected. REPUTATIONAL RISK. Our ability to attract and retain customers and transact withour counterparties could be adversely affected to the extent our reputation isdamaged. Our failure to address, or to appear to fail to address, various issuesthat could give rise to reputational risk could cause harm to us and ourbusiness prospects. These issues include, but are not limited to, appropriatelyaddressing potential conflicts of interest, legal and regulatory requirements,ethical issues, money-laundering, privacy, record-keeping, sales and tradingpractices, and the proper identification of the legal, reputational, credit,liquidity and market risks inherent in our products. The failure to addressappropriately these issues could make our customers unwilling to do businesswith us, which could adversely affect our results. 61 HSBC Finance Corporation-------------------------------------------------------------------------------- ITEM 6. EXHIBITS-------------------------------------------------------------------------------- Exhibits included in this Report: 12 Statement of Computation of Ratio of Earnings to Fixed Charges and to Combined Fixed Charges and Preferred Stock Dividends 31 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.1 Debt and Preferred Stock Securities Ratings 62 HSBC Finance Corporation-------------------------------------------------------------------------------- SIGNATURE-------------------------------------------------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized. HSBC FINANCE CORPORATION (Registrant) /s/ Beverley A. Sibblies -------------------------------------- Beverley A. Sibblies Senior Vice President and Chief Financial Officer Date: May 12, 2006 63 HSBC Finance Corporation-------------------------------------------------------------------------------- EXHIBIT INDEX-------------------------------------------------------------------------------- 12 Statement of Computation of Ratio of Earnings to Fixed Charges and to Combined Fixed Charges and Preferred Stock Dividends 31 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.1 Debt and Preferred Stock Securities Ratings 64 HSBC Finance Corporation-------------------------------------------------------------------------------- EXHIBIT 12 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS THREE MONTHS ENDED MARCH 31, ------------------- 2006 2005--------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Net income.................................................. $ 888 $ 626Income tax expense.......................................... 511 341 ------ ------Income before income tax expense............................ 1,399 967 ------ ------Fixed charges: Interest expense.......................................... 1,623 1,062 Interest portion of rentals(1)............................ 16 15 ------ ------Total fixed charges......................................... 1,639 1,077 ------ ------Total earnings as defined................................... $3,038 $2,044 ====== ======Ratio of earnings to fixed charges.......................... 1.85 1.90Preferred stock dividends(2)................................ 14 28Ratio of earnings to combined fixed charges and preferred stock dividends........................................... 1.84 1.85 --------------- (1) Represents one-third of rentals, which approximates the portion representing interest. (2) Preferred stock dividends are grossed up to their pretax equivalents. HSBC Finance Corporation-------------------------------------------------------------------------------- EXHIBIT 31 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION OF CHIEF EXECUTIVE OFFICER I, Siddharth N. Mehta, Chairman and Chief Executive Officer of HSBC FinanceCorporation, certify that: 1. I have reviewed this report on Form 10-Q of HSBC Finance Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 12, 2006 /s/ SIDDHARTH N. MEHTA -------------------------------------- Siddharth N. Mehta Chairman and Chief Executive Officer HSBC Finance Corporation-------------------------------------------------------------------------------- CERTIFICATION OF CHIEF FINANCIAL OFFICER I, Beverley A. Sibblies, Senior Vice President and Chief Financial Officer ofHSBC Finance Corporation, certify that: 1. I have reviewed this report on Form 10-Q of HSBC Finance Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 12, 2006 /s/ BEVERLEY A. SIBBLIES -------------------------------------- Beverley A. Sibblies Senior Executive Vice President and Chief Financial Officer HSBC Finance Corporation-------------------------------------------------------------------------------- EXHIBIT 32 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The certification set forth below is being submitted in connection with the HSBCFinance Corporation (the "Company") Quarterly Report on Form 10-Q for the periodending March 31, 2006 as filed with the Securities and Exchange Commission onthe date hereof (the "Report") for the purpose of complying with Rule 13a-14(b)or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the "Exchange Act")and Section 1350 of Chapter 63 of Title 18 of the United States Code. I, Siddharth N. Mehta, Chairman and Chief Executive Officer of the Company,certify that: 1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of HSBC Finance Corporation. May 12, 2006 /s/ SIDDHARTH N. MEHTA ---------------------------------------------- Siddharth N. Mehta Chairman and Chief Executive Officer HSBC Finance Corporation-------------------------------------------------------------------------------- CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The certification set forth below is being submitted in connection with the HSBCFinance Corporation (the "Company") Quarterly Report on Form 10-Q for the periodending March 31, 2006 as filed with the Securities and Exchange Commission onthe date hereof (the "Report") for the purpose of complying with Rule 13a-14(b)or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the "Exchange Act")and Section 1350 of Chapter 63 of Title 18 of the United States Code. I, Beverley A. Sibblies, Senior Vice President and Chief Financial Officer ofthe Company, certify that: 1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of HSBC Finance Corporation. May 12, 2006 /s/ BEVERLEY A. SIBBLIES ---------------------------------------------- Beverley A. Sibblies Senior Vice President and Chief Financial Officer This certification accompanies each Report pursuant to Section 906 of theSarbanes-Oxley Act of 2002 and shall not, except to the extent required by theSarbanes-Oxley Act of 2002, be deemed filed by HSBC Finance Corporation forpurposes of Section 18 of the Securities Exchange Act of 1934, as amended. Signed originals of these written statements required by Section 906 of theSarbanes-Oxley Act of 2002 have been provided to HSBC Finance Corporation andwill be retained by HSBC Finance Corporation and furnished to the Securities andExchange Commission or its staff upon request. HSBC Finance Corporation-------------------------------------------------------------------------------- EXHIBIT 99.1 DEBT AND PREFERRED STOCK SECURITIES RATINGS STANDARD & MOODY'S POOR'S INVESTORS DOMINION BOARD CORPORATION SERVICE FITCH, INC. RATING SERVICE-------------------------------------------------------------------------------------------------------AS OF MARCH 31, 2006HSBC Finance Corporation Senior debt.................................. A Aa3 AA- AA (low) Senior subordinated debt..................... A- A2 A+ * Commercial paper............................. A-1 P-1 F-1+ R-1 (middle) Series B preferred stock..................... BBB+ A3 A+ *HFC Bank Limited Senior debt.................................. A Aa3 AA- * Commercial paper............................. A-1 P-1 F-1+ *HSBC Bank Nevada, National Association Senior debt.................................. A A1 AA- *HSBC Financial Corporation Limited Senior notes and term loans.................. * * * AA (low) Commercial paper............................. * * * R-1 (middle) --------------- * Not rated by this agency. This information is provided by RNS The company news service from the London Stock Exchange

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