1st Aug 2005 16:30
HSBC Holdings PLC01 August 2005 -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------- FORM 10-Q --------------------- (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005 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 (X) No ( ) Indicate by check mark whether the registrant is an accelerated filer (asdefined in Rule 12b-2 of the Exchange Act). Yes ( ) No (X) At July 31, 2005, there were 50 shares of the registrant's common stockoutstanding, all of which were owned indirectly by HSBC Holdings plc.-------------------------------------------------------------------------------- HSBC FINANCE CORPORATION FORM 10-Q TABLE OF CONTENTS PART I. FINANCIAL INFORMATION-----------------------------------------------------------------------------------Item 1. Consolidated Financial Statements Statement of Income......................................... 3 Balance Sheet............................................... 4 Statement of Changes in Shareholders' Equity................ 5 Statement of Cash Flows..................................... 6 Notes to Consolidated Financial Statements.................. 7Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements.................................. 18 Executive Overview.......................................... 18 Basis of Reporting.......................................... 22 Receivables Review.......................................... 23 Results of Operations....................................... 24 Segment Results - Managed Basis............................. 31 Credit Quality.............................................. 38 Liquidity and Capital Resources............................. 43 Risk Management............................................. 48 Reconciliations to GAAP Financial Measures.................. 50Item 4. Controls and Procedures..................................... 54 PART II. OTHER INFORMATION-----------------------------------------------------------------------------------Item 1. Legal Proceedings........................................... 54Item 5. Other Information........................................... 56Item 6. Exhibits.................................................... 57Signature.................................................................... 58 2 PART I. FINANCIAL INFORMATION--------------------------------------------------------------------------------ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS HSBC Finance Corporation--------------------------------------------------------------------------------CONSOLIDATED STATEMENT OF INCOME THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------- ----------------- 2005 2004 2005 2004---------------------------------------------------------------------------------------------------- (IN MILLIONS) Finance and other interest income.......................... $3,139 $2,637 $6,089 $5,165Interest expense........................................... 1,104 707 2,166 1,415 ------ ------ ------ ------NET INTEREST INCOME........................................ 2,035 1,930 3,923 3,750Provision for credit losses................................ 1,031 997 1,872 1,925 ------ ------ ------ ------NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES...... 1,004 933 2,051 1,825 ------ ------ ------ ------Other revenues: Securitization revenue................................... 54 266 139 614 Insurance revenue........................................ 229 204 450 415 Investment income........................................ 33 30 66 71 Derivative income........................................ 76 124 336 176 Fee income............................................... 354 242 660 507 Taxpayer financial services revenue...................... 18 6 261 212 Other income............................................. 360 180 674 280 ------ ------ ------ ------TOTAL OTHER REVENUES....................................... 1,124 1,052 2,586 2,275 ------ ------ ------ ------Costs and expenses: Salaries and employee benefits........................... 526 457 1,023 942 Sales incentives......................................... 90 90 172 168 Occupancy and equipment expenses......................... 82 77 169 160 Other marketing expenses................................. 185 131 365 263 Other servicing and administrative expenses.............. 143 198 401 424 Support services from HSBC affiliates.................... 217 196 426 373 Amortization of intangibles.............................. 83 79 190 195 Policyholders' benefits.................................. 116 93 238 206 ------ ------ ------ ------TOTAL COSTS AND EXPENSES................................... 1,442 1,321 2,984 2,731 ------ ------ ------ ------Income before income tax expense........................... 686 664 1,653 1,369Income tax expense......................................... 214 231 555 466 ------ ------ ------ ------NET INCOME................................................. $ 472 $ 433 $1,098 $ 903 ====== ====== ====== ====== The accompanying notes are an integral part of the consolidated financialstatements. 3 HSBC Finance Corporation-------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEET JUNE 30, DECEMBER 31, 2005 2004---------------------------------------------------------------------------------------------- (IN MILLIONS, EXCEPT SHARE DATA) ASSETSCash........................................................ $ 512 $ 392Interest bearing deposits with banks........................ 413 603Securities purchased under agreements to resell............. 421 2,651Securities.................................................. 4,014 3,645Receivables, net............................................ 116,495 104,815Intangible assets, net...................................... 2,491 2,705Goodwill.................................................... 6,799 6,856Properties and equipment, net............................... 470 487Real estate owned........................................... 459 587Derivative financial assets................................. 1,698 4,049Other assets................................................ 3,971 3,400 -------- --------TOTAL ASSETS................................................ $137,743 $130,190 ======== ========LIABILITIESDebt: Deposits.................................................. $ 38 $ 47 Commercial paper, bank and other borrowings............... 10,645 9,013 Due to affiliates......................................... 16,408 13,789 Long term debt (with original maturities over one year)... 87,044 85,378 -------- --------Total debt.................................................. 114,135 108,227Insurance policy and claim reserves......................... 1,295 1,303Derivative related liabilities.............................. 397 432Other liabilities........................................... 3,427 3,287 -------- -------- TOTAL LIABILITIES......................................... 119,254 113,249SHAREHOLDERS' EQUITYRedeemable preferred stock, 1,501,100 shares authorized: Series A, $0.01 par value, 1,100 shares issued, held by HSBC Investments (North America) Inc. ................ 1,100 1,100 Series B, $0.01 par value, 575,000 shares issued at June 30, 2005......................................... 575 -Common shareholder's equity: Common stock, $0.01 par value, 100 shares authorized, 50 shares issued...................................... - - Additional paid-in capital............................. 14,662 14,627 Retained earnings...................................... 1,632 571 Accumulated other comprehensive income................. 520 643 -------- --------TOTAL COMMON SHAREHOLDER'S EQUITY........................... 16,814 15,841 -------- --------TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................. $137,743 $130,190 ======== ======== The accompanying notes are an integral part of the consolidated financialstatements. 4 HSBC Finance Corporation-------------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY SIX MONTHS ENDED JUNE 30, 2005 2004------------------------------------------------------------------------------- (IN MILLIONS) PREFERRED STOCK Balance at beginning of period............................ $ 1,100 $ 1,100 Issuance of Series B preferred stock...................... 575 - ------- ------- Balance at end of period.................................. $ 1,675 $ 1,100 ======= =======COMMON SHAREHOLDER'S EQUITY ADDITIONAL PAID-IN CAPITAL Balance at beginning of period......................... $14,627 $14,645 Issuance costs of Series B preferred stock............. (16) - Return of capital...................................... (13) (14) Employee benefit plans and other....................... 64 12 ------- ------- Balance at end of period............................... $14,662 $14,643 ------- ------- RETAINED EARNINGS Balance at beginning of period......................... $ 571 $ 1,303 Net income............................................. 1,098 903 Dividends: Preferred stock...................................... (37) (36) ------- ------- Balance at end of period............................... $ 1,632 $ 2,170 ------- ------- ACCUMULATED OTHER COMPREHENSIVE INCOME Balance at beginning of period......................... $ 643 $ 443 Net change in unrealized gains (losses) on: Derivatives classified as cash flow hedges........... 44 107 Securities available for sale and interest-only strip receivables......................................... 15 (4) Foreign currency translation adjustments............... (182) 20 ------- ------- Other comprehensive income, net of tax................. (123) 123 ------- ------- Balance at end of period............................... $ 520 $ 566 ------- -------TOTAL COMMON SHAREHOLDER'S EQUITY........................... $16,814 $17,379 ------- -------COMPREHENSIVE INCOME Net income................................................ $ 1,098 $ 903 Other comprehensive income................................ (123) 123 ------- -------COMPREHENSIVE INCOME........................................ $ 975 $ 1,026 ======= ======= The accompanying notes are an integral part of the consolidated financialstatements. 5 HSBC Finance Corporation-------------------------------------------------------------------------------- STATEMENT OF CASH FLOWS SIX MONTHS ENDED JUNE 30, 2005 2004--------------------------------------------------------------------------------- (IN MILLIONS) CASH FLOWS FROM OPERATING ACTIVITIESNet income.................................................. $ 1,098 $ 903Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for credit losses............................... 1,872 1,925 Insurance policy and claim reserves....................... (142) (69) Depreciation and amortization............................. 257 253 Net change in interest-only strip receivables............. 174 288 Net change in other assets................................ (620) (315) Net change in other liabilities........................... 224 (289) Other, net................................................ (233) (541) -------- --------Net cash provided by (used in) operating activities......... 2,630 2,155 -------- --------CASH FLOWS FROM INVESTING ACTIVITIESSecurities: Purchased................................................. (363) (971) Matured................................................... 224 1,078 Sold...................................................... 79 497Net change in interest bearing deposits with banks.......... (317) 571Net change in short-term securities available for sale...... 170 3,296Net change in securities purchased under agreements to resell.................................................... 2,230 (341)Receivables: Originations, net of collections.......................... (29,896) (26,068) Purchases and related premiums............................ (38) (542) Initial and fill-up securitizations....................... 5,189 16,719 Sales to affiliates....................................... 9,885 856Properties and equipment: Purchases................................................. (42) (32) Sales..................................................... 2 1 -------- --------Net cash provided by (used in) investing activities......... (12,877) (4,936) -------- --------CASH FLOWS FROM FINANCING ACTIVITIESDebt: Net change in short-term debt and deposits................ 1,632 1,105 Net change in time certificates........................... (2) (155) Net change in due to affiliates........................... 3,164 1,122 Long term debt issued..................................... 16,450 7,630 Long term debt retired.................................... (11,231) (7,316)Redemption of company obligated mandatorily redeemable preferred securities of subsidiary trusts................. (309) -Insurance: Policyholders' benefits paid.............................. (68) (89) Cash received from policyholders.......................... 181 121Issuance of Series B preferred stock........................ 559 - -------- --------Net cash provided by (used in) financing activities......... 10,376 2,418 -------- --------Effect of exchange rate changes on cash..................... (9) 10 -------- --------Net change in cash.......................................... 120 (353)Cash at beginning of period................................. 392 463 -------- --------CASH AT END OF PERIOD....................................... $ 512 $ 110 ======== ======== The accompanying notes are an integral part of the consolidated financialstatements. 6 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 a wholly owned subsidiary of HSBCHoldings plc ("HSBC"). The accompanying unaudited interim consolidated financialstatements of HSBC Finance Corporation and its subsidiaries have been preparedin accordance with accounting principles generally accepted in the United Statesof America ("U.S. GAAP") for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they donot include all of the information and footnotes required by generally acceptedaccounting principles for complete financial statements. In the opinion ofmanagement, all normal and recurring adjustments considered necessary for a fairpresentation of financial position, results of operations and cash flows for theinterim periods have been made. HSBC Finance Corporation may also be referred toin this Form 10-Q as "we," "us" or "our." These unaudited interim consolidatedfinancial statements should be read in conjunction with our Annual Report onForm 10-K for the year ended December 31, 2004 (the "2004 Form 10-K"). Certainreclassifications have been made to prior period amounts to conform to thecurrent 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. Interim financial statement disclosures required by U.S. GAAP regarding segmentsare included in the Management's Discussion and Analysis of Financial Conditionand Results of Operations ("MD&A") section of this Form 10-Q. 2. SECURITIES-------------------------------------------------------------------------------- Securities consisted of the following available-for-sale investments: GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIRJUNE 30, 2005 COST GAINS LOSSES VALUE--------------------------------------------------------------------------------------------------- (IN MILLIONS) Corporate debt securities............................ $2,562 $52 $(18) $2,596Money market funds................................... 268 - - 268U.S. government sponsored enterprises(1)............. 84 - (1) 83U.S. government and federal agency debt securities... 593 2 (2) 593Non-government mortgage backed securities............ 109 - - 109Other................................................ 332 3 (4) 331 ------ --- ---- ------Subtotal............................................. 3,948 57 (25) 3,980Accrued investment income............................ 34 - - 34 ------ --- ---- ------Total securities available for sale.................. $3,982 $57 $(25) $4,014 ====== === ==== ====== 7 GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIRDECEMBER 31, 2004 COST GAINS LOSSES VALUE--------------------------------------------------------------------------------------------------- (IN MILLIONS) Corporate debt securities............................ $2,520 $27 $(14) $2,533Money market funds................................... 230 - - 230U.S. government sponsored enterprises(1)............. 49 - - 49U.S. government and federal agency debt securities... 344 - (3) 341Non-government mortgage backed securities............ 74 - (1) 73Other................................................ 385 1 (3) 383 ------ --- ---- ------Subtotal............................................. 3,602 28 (21) 3,609Accrued investment income............................ 36 - - 36 ------ --- ---- ------Total securities available for sale.................. $3,638 $28 $(21) $3,645 ====== === ==== ====== --------------- (1) Includes primarily mortgage-backed securities issued by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. A summary of gross unrealized losses and related fair values as of June 30, 2005and December 31, 2004, classified as to the length of time the losses haveexisted follows: LESS THAN ONE YEAR GREATER THAN ONE YEAR --------------------------------------- --------------------------------------- GROSS AGGREGATE GROSS AGGREGATE NUMBER OF UNREALIZED FAIR VALUE OF NUMBER OF UNREALIZED FAIR VALUE OFJUNE 30, 2005 SECURITIES LOSSES INVESTMENTS SECURITIES LOSSES INVESTMENTS------------------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Corporate debt securities.............. 137 $(3) $283 325 $(15) $833U.S. government sponsored enterprises............. 31 (1) 74 - - -U.S. government and federal agency debt securities.............. - - - 34 (2) 112Other..................... - - - 48 (4) 232 LESS THAN ONE YEAR GREATER THAN ONE YEAR --------------------------------------- --------------------------------------- GROSS AGGREGATE GROSS AGGREGATE NUMBER OF UNREALIZED FAIR VALUE OF NUMBER OF UNREALIZED FAIR VALUE OFDECEMBER 31, 2004 SECURITIES LOSSES INVESTMENTS SECURITIES LOSSES INVESTMENTS------------------------------------------------------------------------------------------------------------- (IN MILLIONS) Corporate debt securities.............. 254 $(6) $636 218 $(8) $647U.S. government and federal agency debt securities.............. - - - 61 (3) 278Non-government mortgage backed securities....... - - - 3 (1) 6Other..................... 21 (2) 114 42 (1) 130 The gross unrealized losses on our securities available for sale have increasedslightly due to a general increase in short- and medium-term interest ratesduring the six months ended June 30, 2005. The contractual terms of thesesecurities do not permit the issuer to settle the securities at a price lessthan the par value of the investment. Since substantially all of thesesecurities are rated A- or better, and because we have the ability and intent tohold these investments until maturity or a market price recovery, thesesecurities are not considered other than temporarily impaired. 8 3. RECEIVABLES-------------------------------------------------------------------------------- Receivables consisted of the following: JUNE 30, DECEMBER 31, 2005 2004------------------------------------------------------------------------------------- (IN MILLIONS) Real estate secured......................................... $ 71,930 $ 64,820Auto finance................................................ 8,997 7,544MasterCard(1)/Visa(1)....................................... 17,421 14,635Private label............................................... 2,905 3,411Personal non-credit card.................................... 17,255 16,128Commercial and other........................................ 253 317 -------- --------Total owned receivables..................................... 118,761 106,855Purchase accounting fair value adjustments.................. 134 201Accrued finance charges..................................... 1,548 1,394Credit loss reserve for owned receivables................... (3,756) (3,625)Unearned credit insurance premiums and claims reserves...... (580) (631)Interest-only strip receivables............................. 151 323Amounts due and deferred from receivable sales.............. 237 298 -------- --------Total owned receivables, net................................ 116,495 104,815Receivables serviced with limited recourse.................. 8,980 14,225 -------- --------Total managed receivables, net.............................. $125,475 $119,040 ======== ======== --------------- (1) MasterCard is a registered trademark of MasterCard International, Incorporated and Visa is a registered trademark of VISA USA, Inc. Purchase accounting fair value adjustments represent adjustments which have been"pushed down" to record our receivables at fair value on March 28, 2003, thedate we were acquired by HSBC. Interest-only strip receivables are reported net of our estimate of probablelosses under the recourse provisions for receivables serviced with limitedrecourse. Our estimate of the recourse obligation totaled $525 million at June30, 2005 and $890 million at December 31, 2004. Interest-only strip receivablesalso included fair value mark-to-market adjustments, which increased the balanceby $78 million at June 30, 2005 and $76 million at December 31, 2004. Receivables serviced with limited recourse consisted of the following: JUNE 30, DECEMBER 31, 2005 2004------------------------------------------------------------------------------------- (IN MILLIONS) Real estate secured......................................... $ - $ 81Auto finance................................................ 1,819 2,679MasterCard/Visa............................................. 4,752 7,583Personal non-credit card.................................... 2,409 3,882 ------ -------Total....................................................... $8,980 $14,225 ====== ======= 9 The combination of receivables owned and receivables serviced with limitedrecourse, which comprises our managed portfolio, is shown below: JUNE 30, DECEMBER 31, 2005 2004------------------------------------------------------------------------------------- (IN MILLIONS) Real estate secured......................................... $ 71,930 $ 64,901Auto finance................................................ 10,816 10,223MasterCard/Visa............................................. 22,173 22,218Private label............................................... 2,905 3,411Personal non-credit card.................................... 19,664 20,010Commercial and other........................................ 253 317 -------- --------Total....................................................... $127,741 $121,080 ======== ======== 4. CREDIT LOSS RESERVES-------------------------------------------------------------------------------- An analysis of credit loss reserves was as follows: THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------ ----------------- 2005 2004 2005 2004------------------------------------------------------------------------------------------------ (IN MILLIONS) Owned receivables: Credit loss reserves at beginning of period........... $3,581 $ 3,753 $ 3,625 $ 3,793 Provision for credit losses........................... 1,031 997 1,872 1,925 Charge-offs........................................... (961) (1,057) (1,914) (2,108) Recoveries............................................ 117 92 207 172 Other, net............................................ (12) 10 (34) 13 ------ ------- ------- ------- Credit loss reserves for owned receivables............ 3,756 3,795 3,756 3,795 ------ ------- ------- -------Receivables serviced with limited recourse: Credit loss reserves at beginning of period........... 661 2,159 890 2,374 Provision for credit losses........................... 52 148 82 401 Charge-offs........................................... (201) (426) (472) (925) Recoveries............................................ 17 24 33 52 Other, net............................................ (4) (1) (8) 2 ------ ------- ------- ------- Credit loss reserves for receivables serviced with limited recourse................................... 525 1,904 525 1,904 ------ ------- ------- -------Credit loss reserves for managed receivables............ $4,281 $ 5,699 $ 4,281 $ 5,699 ====== ======= ======= ======= The provision for credit losses on owned receivables and overall reserve levelsin 2005 reflect the impact of the bulk sale of our domestic private labelreceivables to HSBC Bank USA, National Association ("HSBC Bank USA") in December2004 as well as the impact of receivable growth. Reductions to the provision forcredit losses and overall reserve levels on receivables serviced with limitedrecourse in 2005 reflect the impact of the bulk sale discussed above, as well asthe impact of reduced securitization levels, including our decision to structurenew collateralized funding transactions as secured financings. 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." 10 5. INTANGIBLE ASSETS-------------------------------------------------------------------------------- Intangible assets consisted of the following: ACCUMULATED CARRYING GROSS AMORTIZATION VALUE---------------------------------------------------------------------------------------------- (IN MILLIONS) JUNE 30, 2005Purchased credit card relationships and related programs.... $1,696 $462 $1,234Retail services merchant relationships...................... 270 122 148Other loan related relationships............................ 326 87 239Trade names................................................. 717 - 717Technology, customer lists and other contracts.............. 281 128 153 ------ ---- ------Total....................................................... $3,290 $799 $2,491 ====== ==== ====== DECEMBER 31, 2004Purchased credit card relationships and related programs.... $1,723 $355 $1,368Retail services merchant relationships...................... 270 95 175Other loan related relationships............................ 326 71 255Trade names................................................. 718 - 718Technology, customer lists and other contracts.............. 281 92 189 ------ ---- ------Total....................................................... $3,318 $613 $2,705 ====== ==== ====== Estimated amortization expense associated with our intangible assets for each ofthe following years is as follows: YEAR ENDING DECEMBER 31,--------------------------------------------------------------------------- (IN MILLIONS) 2005........................................................ $3512006........................................................ 3432007........................................................ 3252008........................................................ 2302009........................................................ 122Thereafter.................................................. 366 6. GOODWILL-------------------------------------------------------------------------------- Goodwill balances associated with our foreign businesses will change from periodto period due to movements in foreign exchange. Since the one-year anniversaryof our acquisition by HSBC was completed in the first quarter of 2004, nofurther acquisition-related adjustments to our goodwill balance will occur,except for changes in estimates of the tax basis in our assets and liabilitiesor other tax estimates recorded at the date of our acquisition by HSBC, pursuantto Statement of Financial Accounting Standards Number 109, "Accounting forIncome Taxes." During the second quarter of 2005, we reduced our goodwillbalance by approximately $11 million as a result of such changes in taxestimates. As part of ongoing integration efforts with HSBC, we have begun working withHSBC to determine if funding synergies and management efficiencies could beachieved by transferring our U.K. and European operations to a U.K. basedsubsidiary of HSBC. As required by SFAS No. 142, "Goodwill and Other IntangibleAssets," we performed an interim goodwill impairment test for our U.K. andEuropean operations during the second quarter of 2005. As the estimated fairvalue of our U.K. and European operations exceeded its carrying amount, weconcluded that the related goodwill assigned to this reporting unit was notimpaired. As of the date 11 of this filing, a decision has not been made regarding the potential transfer ofthe U.K. and European operations. 7. INCOME TAXES-------------------------------------------------------------------------------- Our effective tax rates were as follows: THREE MONTHS SIX MONTHS ENDED ENDED JUNE 30, JUNE 30, ------------- ----------- 2005 2004 2005 2004----------------------------------------------------------------------------------------- Effective tax rate.......................................... 31.2% 34.8% 33.6% 34.0% The decrease in the effective tax rate in both periods is primarily due to lowerstate tax rates, partially offset by higher pretax income without acorresponding increase in low income housing tax credits. The effective tax ratediffers from the statutory federal income tax rate primarily because of theeffects of state and local income taxes and tax credits. 8. REDEEMABLE PREFERRED STOCK-------------------------------------------------------------------------------- We have 1,501,100 shares of preferred stock authorized for issuance. In March2003, 1,100 shares of Series A Cumulative Preferred Stock were issued to HSBCand are now held by HSBC Investments (North America) Inc. In June 2005, weissued 575,000 shares of 6.36% Non-Cumulative Preferred Stock, Series B ("SeriesB Preferred Stock"). Dividends on the Series B Preferred Stock arenon-cumulative and payable quarterly at a rate of 6.36 percent commencingSeptember 15, 2005. The Series B Preferred Stock may be redeemed at our optionafter June 23, 2010 at $1,000 per share, plus accrued dividends. The redemptionand liquidation value is $1,000 per share plus accrued and unpaid dividends. Theholders of Series B Preferred Stock are entitled to payment before any capitaldistribution is made to the common shareholder and have no voting rights exceptfor the right to elect two additional members to the board of directors in theevent that dividends have not been declared and paid for six quarters, or asotherwise provided by law. Additionally, as long as any shares of the Series BPreferred Stock are outstanding, the authorization, creation or issuance of anyclass or series of stock which would rank prior to the Series B Preferred Stockwith respect to dividends or amounts payable upon liquidation or dissolution ofHSBC Finance Corporation must be approved by at least two-thirds of the sharesof Series B Preferred Stock outstanding at that time. Related issuance costs of$16 million have been recorded as a reduction of additional paid-in capital. 9. RELATED PARTY TRANSACTIONS-------------------------------------------------------------------------------- In the normal course of business, we conduct transactions with HSBC and itssubsidiaries. These transactions include funding arrangements, purchases andsales of receivables, servicing arrangements, information technology services,item and statement processing services, banking and other miscellaneousservices. The following tables present related party balances and the income and(expense) generated by related party transactions: JUNE 30, DECEMBER 31, 2005 2004------------------------------------------------------------------------------------- (IN MILLIONS) ASSETS, (LIABILITIES) AND EQUITY:Derivative financial assets, net............................ $ 1,220 $ 3,297Other assets................................................ 1,532 604Due to affiliates........................................... (16,408) (13,789)Other liabilities........................................... (273) (168)Series A preferred stock.................................... 1,100 1,100 12 THREE MONTHS SIX MONTHS ENDED ENDED JUNE 30, JUNE 30, ------------- ------------- 2005 2004 2005 2004------------------------------------------------------------------------------------------- (IN MILLIONS) INCOME/(EXPENSE):Interest expense on borrowings from HSBC and subsidiaries... $(134) $ (66) $(285) $(118)Interest income on advances to HSBC affiliates.............. 7 - 11 -HSBC Bank USA: Real estate secured servicing revenues.................... 4 3 8 6 Real estate secured sourcing, underwriting and pricing revenues............................................... 1 2 2 2 Gain on daily sale of domestic private label receivable originations........................................... 100 - 192 - Gain on sale of real estate secured and MasterCard/Visa receivables............................................ 9 - 17 - Taxpayer financial services loan origination fees......... (1) - (15) - Domestic private label receivable servicing fees.......... 89 - 181 - Other servicing, processing, origination and support revenues............................................... 6 3 14 5Support services from HSBC affiliates, primarily HSBC Technology and Services (USA) Inc. ("HTSU")............... (217) (196) (426) (374)HTSU: Rental revenue............................................ 8 8 18 16 Administrative services revenue........................... 7 5 12 8Other income from HSBC affiliates........................... 1 - 3 - The notional value of derivative contracts outstanding with HSBC subsidiariestotaled $58.4 billion at June 30, 2005 and $62.6 billion at December 31, 2004.Affiliate swap counterparties provide collateral in the form of securities,which are not recorded on our balance sheet. At June 30, 2005, the fair value ofour agreements with affiliate counterparties was below the level requiringpayment of collateral. As such at June, 30, 2005, we were not holding any swapcollateral from HSBC affiliates in the form of securities. At December 31, 2004,affiliate swap counterparties had provided collateral in the form of securities,which were not recorded on our balance sheet, totaling $2.2 billion. We have extended a line of credit of $2 billion to HSBC USA, Inc. at interestrates comparable to third-party rates for a line of credit with similar terms.The balance outstanding under this line was $.6 billion at June 30, 2005 andDecember 31, 2004 and is included in other assets. Interest income associatedwith this line of credit is recorded in interest income and reflected asinterest income on HSBC USA, Inc. advances in the table above. We extended a revolving line of credit of $.5 billion to HTSU on June 28, 2005at interest rates comparable to third-party rates for a line of credit withsimilar terms. The balance outstanding under this line of credit was $.4 billionat June 30, 2005 and is included in other assets. We extended a promissory note of $.5 billion to HSBC Securities (USA) Inc.("HSI") on June 27, 2005 at interest rates comparable to third-party rates for anote with similar terms. The entire $.5 billion note was outstanding at June 30,2005 and included in other assets. This line of credit was repaid during July2005. We extended a line of credit of $.4 billion to HSBC Investments (North America)Inc. on March 31, 2005 which was repaid during the second quarter of 2005. Thisline of credit was at interest rates comparable to third-party rates for a lineof credit with similar terms. Due to affiliates also includes amounts owed to subsidiaries of HSBC (other thanpreferred stock). This funding was at interest rates (both the underlyingbenchmark rate and credit spreads) comparable to third-party rates for debt withsimilar maturities. At June 30, 2005, we had revolving credit facilities of $2.5 billion from HSBCdomestically and $10.0 billion from HSBC in the U.K., of which $6.9 billion wasoutstanding under the U.K. lines and no balances were 13 outstanding on the domestic lines. As of December 31, 2004, $7.4 billion wasoutstanding under the U.K. lines and no balances were outstanding on thedomestic lines. Annual commitment fee requirements to support availability ofthese lines are paid on a quarterly basis. Expense recognized for commitmentfees totaled $.4 million for the three months ended June 30, 2005 and 2004, and$.8 million for the six months ended June 30, 2005 and 2004. Commitment feeexpense is included as a component of interest expense. In the first quarter of 2004, we sold approximately $.9 billion of real estatesecured receivables from our mortgage services business to HSBC Bank USA andrecorded a pre-tax gain of $15 million on the sale. Under a separate servicingagreement, we have agreed to service all real estate secured receivables sold toHSBC Bank USA including all future business they purchase from ourcorrespondents. As of June 30, 2005, we were servicing $5.1 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 $.5 billion of real estate secured receivables purchasedby HSBC Bank USA during the three months ended June 30, 2005 and $1.1 billionduring the three months ended June 30, 2004. We sourced, underwrote and priced$1.1 billion of real estate secured receivables purchased by HSBC Bank USAduring the six months ended June 30, 2005 and $1.5 billion during the six monthsended June 30, 2004. These revenues have been recorded as other income and arereflected as real estate secured servicing revenues and real estate securedsourcing, underwriting and pricing revenues from HSBC Bank USA in the abovetable. In December 2004, we sold our domestic private label receivable portfolio,including the retained interests associated with our securitized domesticprivate label receivables, to HSBC Bank USA. We continue to service the soldprivate label receivables and receive servicing fee income from HSBC Bank USAfor these services. As of June 30, 2005, we were servicing $15.1 billion ofdomestic private label receivables for HSBC Bank USA. Servicing fee income fromHSBC Bank USA received for the three month period ended June 30, 2005 of $89million and $181 million for the six months ended June 30, 2005 is included inthe table above as a component of other servicing, processing, origination andsupport revenues from HSBC Bank USA. We continue to maintain the relatedcustomer account relationships and, therefore, sell new domestic private labelreceivable originations to HSBC Bank USA on a daily basis. We sold $4,685million of private label receivables to HSBC Bank USA during the three monthsended June 30, 2005 and $8,938 million in the year-to-date period. The gainsassociated with the sale of these receivables are reflected in the table aboveand are recorded in other income. Under several service level agreements, we also provide services to HSBC BankUSA. 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 other income and areincluded in the table above as a component of other servicing, processing,origination and support revenues from HSBC Bank USA. 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 June 30, 2005 and 2004 and $8 million for both six month periodsended June 30, 2005 and 2004. The interest expense for the Household CapitalTrust VIII is included in interest expense on borrowings from HSBC andsubsidiaries 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 $1 million for the three months ended June 30, 2005 and $3 millionfor the six months ended June 30, 2005 are included in other income and arereflected in other income from HSBC affiliates in the above table. 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 $1 millionduring the three months ended June 30, 2005 and $15 million during the sixmonths ended June 30, 2005. These origination fees are included as an offset totaxpayer financial services revenue and are reflected as taxpayer financialservices loan origination fees in the above table. 14 On July 1, 2004, HSBC Bank Nevada, National Association ("HOBN"), formerly knownas Household Bank (SB), N.A., purchased the account relationships associatedwith $970 million of MasterCard and Visa credit card receivables from HSBC BankUSA for approximately $99 million, which are included in intangible assets. Thereceivables continue to be owned by HSBC Bank USA. Originations of new accountsand receivables are made by HOBN and new receivables are sold daily to HSBC BankUSA. We sold $480 million of credit card receivables to HSBC Bank USA during thethree months ended June 30, 2005 and $947 million in the year-to-date period.The gains associated with the sale of these receivables are reflected in thetable above and are recorded in other income. 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 certain office space which we have rented to them, whichhas been recorded as a reduction of occupancy and equipment expenses, and forcertain administrative costs, which has been recorded as other income. In addition, we utilize a related HSBC entity to lead manage substantially allongoing debt issuances. Fees paid to HSBC and its subsidiaries for such servicestotaled approximately $23 million for the three months ended June 30, 2005 and$26 million for the six months ended June 30, 2005. Fees paid for such servicestotaled approximately $3 million for the three months ended June 30, 2004 and $6million for the six months ended June 30, 2004. These fees are amortized overthe life of the related debt as a component of interest expense. Employees of HSBC Finance Corporation participate in one or more stockcompensation plans sponsored by HSBC. Our share of the expense of these planswas $36 million for the six months ended June 30, 2005 and $25 million for theyear-ago period. 10. PENSION AND OTHER POSTRETIREMENT BENEFITS-------------------------------------------------------------------------------- In November 2004, sponsorship of the U.S. defined benefit pension plan of HSBCFinance Corporation and the U.S. defined benefit pension plan of HSBC Bank USARelated Shares:
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