1st Aug 2005 16:31
HSBC Holdings PLC01 August 2005 Part 2 of 2 LIQUIDITY AND CAPITAL RESOURCES-------------------------------------------------------------------------------- We continue to focus on balancing our use of affiliate and third-party fundingsources to minimize funding expense while maximizing liquidity. As discussedbelow, we supplemented unsecured debt issuance during the 43 HSBC Finance Corporation-------------------------------------------------------------------------------- six months ended June 30, 2005 with proceeds from the sale of our domesticprivate label receivable portfolio to HSBC Bank USA in December 2004, debtissued to affiliates, higher levels of commercial paper and the issuance ofSeries B preferred stock. Because we are now a subsidiary of HSBC, our credit spreads relative toTreasuries have tightened compared to those we experienced during the monthsleading up to the announcement of our acquisition by HSBC. Primarily as a resultof these tightened credit spreads, we recognized cash funding expense savings ofapproximately $252 million in the six months ended June 30, 2005 ($132 millionin the three months ended June 30, 2005) and approximately $140 million in thesix months ended June 30, 2004 ($70 million in the three months ended June 30,2004) compared to the funding costs we would have incurred using average spreadsand funding mix from the first half of 2002. It is anticipated that thesetightened credit spreads and other funding synergies including asset transferswill eventually enable HSBC to realize annual cash funding expense savings,including external fee savings, in excess of $1 billion per year as our existingterm debt matures over the course of the next few years. The portion of thesesavings to be realized by HSBC Finance Corporation will depend in large partupon the amount and timing of various initiatives between HSBC FinanceCorporation and other HSBC subsidiaries. Debt due to affiliates and other HSBC related funding are summarized in thefollowing table: JUNE 30, DECEMBER 31, 2005 2004------------------------------------------------------------------------------------- (IN BILLIONS) Debt issued to HSBC subsidiaries: Drawings on bank lines in the U.K. ....................... $ 6.9 $ 7.5 Term debt................................................. 9.2 6.0 Preferred securities issued by Household Capital Trust VIII................................................... .3 .3 ----- ----- Total debt issued to HSBC subsidiaries.................... 16.4 13.8 ----- -----Debt issued to HSBC clients: Euro commercial paper..................................... 3.5 2.6 Term debt................................................. 1.0 .8 ----- ----- Total debt issued to HSBC clients......................... 4.5 3.4Preferred stock held by HSBC Investments (North America) Inc. ..................................................... 1.1 1.1Cash received on bulk and subsequent sales of domestic private label receivables to HSBC Bank USA, net (cumulative).............................................. 13.1 12.4Real estate secured receivable activity with HSBC Bank USA: Cash received on sales (cumulative)....................... 3.7 3.7 Direct purchases from correspondents (cumulative)......... 3.9 2.8 Run-off of real estate secured receivable activity with HSBC Bank USA.......................................... (2.5) (1.5) ----- -----Total real estate secured receivable activity with HSBC Bank USA....................................................... 5.1 5.0 ----- -----Total HSBC related funding.................................. $40.2 $35.7 ===== ===== At June 30, 2005, funding from HSBC, including debt issuances to HSBCsubsidiaries and clients and preferred stock held by HSBC Investments (NorthAmerica) Inc. ("HINO") but excluding cash received on asset sales to HSBCsubsidiaries, represented 18 percent of our total managed debt and preferredstock funding. At December 31, 2004, funding from HSBC, including debt issuancesto HSBC subsidiaries and clients and preferred stock held by HINO but excludingcash received on asset sales to HSBC subsidiaries, represented 15 percent of ourtotal managed debt and preferred stock funding. In addition to the HSBC related funding received, we have extended lines ofcredit and promissory notes to other HSBC subsidiaries at interest ratescomparable to third-party rates for notes with similar terms. At 44 HSBC Finance Corporation-------------------------------------------------------------------------------- June 30, 2005, $1.5 billion was outstanding under these agreements compared to$.6 billion outstanding at December 31, 2004. Proceeds from the December 2004 domestic private label bulk receivable sale toHSBC Bank USA of $12.4 billion were used to pay down short-term domesticborrowings, including outstanding commercial paper balances, and to fundoperations. Excess liquidity from the sale was used to temporarily fundavailable for sale investments at December 31, 2004. As of June 30, 2005, we had revolving credit facilities of $2.5 billion fromHSBC domestically and $10.0 billion from HSBC subsidiaries in the U.K. Therehave been no draws on the domestic line. At June 30, 2005, $6.9 billion wasoutstanding under the U.K. lines. We had derivative contracts with a notionalvalue of $58.4 billion, or approximately 94 percent of total derivativecontracts, outstanding with HSBC affiliates at June 30, 2005. We had derivativecontracts with a notional value of $62.6 billion, or approximately 87 percent oftotal derivative contracts, outstanding with HSBC affiliates at December 31,2004. SECURITIES totaled $4.0 billion at June 30, 2005 and $3.6 billion at December31, 2004. Securities purchased under agreements to resell totaled $.4 billion atJune 30, 2005 and $2.7 billion at December 31, 2004. Interest bearing depositswith banks totaled $.4 billion at June 30, 2005 and $.6 billion at December 31,2004. Our total investment balances at December 31, 2004 were high as a resultof the timing of the bulk sale of the domestic private label receivableportfolio to HSBC Bank USA on December 29, 2004. COMMERCIAL PAPER, BANK AND OTHER BORROWINGS totaled $10.6 billion at June 30,2005 and $9.0 billion at December 31, 2004. The increase at June 30, 2005 was aresult of higher levels of short-term notes outstanding as well as higher levelsof commercial paper as compared to the lower levels outstanding at December 31,2004 as the proceeds from the sale of the domestic private label loan portfolioto HSBC Bank USA were used to reduce the outstanding balances. Included in thistotal was outstanding Euro commercial paper sold to customers of HSBC of $3.5billion at June 30, 2005 and $2.6 billion at December 31, 2004. During the second quarter of 2005, all three major domestic rating agenciesapproved a plan which allows us to increase our commercial paper issuances as aresult of lowering the coverage ratio of bank credit facilities to outstandingcommercial paper from 100% to 80%. This plan also assumes that the combinationof bank credit facilities and undrawn conduit facilities will, at all times,exceed 115% of outstanding commercial paper. This approved plan will result inan increase in our maximum outstanding commercial paper balance to in excess of$12.0 billion. LONG TERM DEBT (with original maturities over one year) increased to $87.0billion at June 30, 2005 from $85.4 billion at December 31, 2004. Significantthird party issuance during the six months ended June 30, 2005 included thefollowing: - $6.7 billion of domestic and foreign medium-term notes - $1.2 billion of foreign currency-denominated bonds - $.7 billion of InterNotes(SM) (retail-oriented medium-term notes) - $5.5 billion of global debt - $2.4 billion of securities backed by real estate secured, auto finance, and MasterCard/Visa receivables. For accounting purposes, these transactions were structured as secured financings. In June 2005, we redeemed the junior subordinated notes issued to the HouseholdCapital Trust V with an outstanding principal balance of $309 million. PREFERRED SHARES In June 2005, we issued 575,000 shares of Series B PreferredStock for $575 million. 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, 2005. 45 HSBC Finance Corporation-------------------------------------------------------------------------------- SELECTED CAPITAL RATIOS are summarized in the following table: JUNE 30, DECEMBER 31, 2005 2004------------------------------------------------------------------------------------- TETMA(1).................................................... 7.52% 6.68%TETMA + Owned Reserves(1)................................... 10.29 9.45Tangible common equity to tangible managed assets(1)........ 5.38 4.67Common and preferred equity to owned assets................. 13.42 13.01Excluding purchase accounting adjustments: TETMA(1).................................................. 8.78 8.38 TETMA + Owned Reserves(1)................................. 11.55 11.16 Tangible common equity to tangible managed assets(1)...... 6.64 6.38 --------------- (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. 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 used to limit our reliance on the unsecured debtmarkets. 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 are conveyed to awholly owned limited purpose subsidiary, which in turn transfers the receivablesto a trust that sells interests to investors. Repayment of the debt issued bythe trust is secured by the receivables transferred. The transactions arestructured as secured financings under SFAS No. 140. Therefore, the receivablesand the underlying debt of the trust remain on our balance sheet. We do notrecognize a gain in a secured financing transaction. Because the receivables andthe debt remain on our balance sheet, revenues and expenses are reportedconsistently with our owned balance sheet portfolio. Using this source offunding results in similar cash flows as issuing debt through alternativefunding sources. Under IFRS and prior to 2005 under U.K. GAAP, our securitizations are treated assecured financings. In order to align our accounting treatment with that ofHSBC, starting in the third quarter of 2004 we began to structure all newcollateralized funding transactions as secured financings. However, becauseexisting public MasterCard and Visa credit card transactions were structured assales to revolving trusts that require replenishments of receivables to supportpreviously issued securities, receivables will continue to be sold to 46 HSBC Finance Corporation-------------------------------------------------------------------------------- these trusts until the revolving periods end, the last of which is expected tooccur in 2008 based on current projections. Private label trusts that publiclyissued securities are now replenished by HSBC Bank USA as a result of the dailysale of new domestic private label credit card originations to HSBC Bank USA. Wewill continue to replenish at reduced levels certain non-public personalnon-credit card and MasterCard and Visa securities issued to conduits and recordthe resulting replenishment gains for a period of time in order to manageliquidity. Since our securitized receivables have varying lives, it will takeseveral years for these receivables to pay-off and the related interest-onlystrip receivables to be reduced to zero. The termination of sale treatment onnew collateralized funding activity reduced our reported net income under U.S.GAAP. There is no impact, however, on cash received from operations. Because webelieve the market for securities backed by receivables is a reliable, efficientand cost-effective source of funds, we will continue to use secured financingsof consumer receivables as a source of our funding and liquidity. As previously discussed, securitization levels were much lower in the six monthsended June 30, 2005 as a result of the use of alternate funding sources,including funding from HSBC subsidiaries, and our decision to structure all newcollateralized funding transactions as secured financings beginning in the thirdquarter of 2004. Securitizations (excluding replenishments of certificateholder interests) andsecured financings are summarized in the following table: THREE MONTHS ENDED JUNE 30, 2005 2004------------------------------------------------------------------------------ (IN MILLIONS) INITIAL SECURITIZATIONS:Auto finance................................................ $ - $ 300MasterCard/Visa............................................. - 500Private label............................................... - 190Personal non-credit card.................................... - - ------ ------Total....................................................... $ - $ 990 ====== ======SECURED FINANCINGS:Real estate secured......................................... $ 919 $1,750Auto finance................................................ 998 -MasterCard/Visa............................................. 500 - ------ ------Total....................................................... $2.417 $1,750 ====== ====== SIX MONTHS ENDED JUNE 30, 2005 2004------------------------------------------------------------------------------ (IN MILLIONS) INITIAL SECURITIZATIONS:Auto finance................................................ $ - $ 300MasterCard/Visa............................................. - 550Private label............................................... - 190Personal non-credit card.................................... - - ------ ------Total....................................................... $ - $1,040 ====== ======SECURED FINANCINGS:Real estate secured......................................... $ 919 $1,750Auto finance................................................ 998 -MasterCard/Visa............................................. 500 - ------ ------Total....................................................... $2,417 $1,750 ====== ====== 47 HSBC Finance Corporation-------------------------------------------------------------------------------- Our securitized receivables totaled $9.0 billion at June 30, 2005 compared to$14.2 billion at December 31, 2004. As of June 30, 2005, secured financings of$5.6 billion are secured by $10.8 billion of real estate secured, auto financeand MasterCard/Visa receivables. Secured financings of $7.3 billion at December31, 2004 are secured by $10.3 billion of real estate secured and auto financereceivables. At June 30, 2005, securitizations structured as sales represented 7percent and secured financings represented 5 percent of the funding associatedwith our managed funding portfolio. At December 31, 2004, securitizationsstructured as sales represented 12 percent and secured financings represented 6percent of the funding associated with our managed funding portfolio. 2005 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 2005 are summarized in the table that follows: ACTUAL ESTIMATED JANUARY 1 JULY 1 THROUGH THROUGH ESTIMATED JUNE 30, DECEMBER 31, FULL YEAR 2005 2005 2005-------------------------------------------------------------------------------------------------- (IN BILLIONS) FUNDING NEEDS: Net asset growth.......................................... $ 8 $ 8 - 11 $16 - 19 Commercial paper, term debt and securitization maturities............................................. 18 10 - 15 28 - 33 Other..................................................... 1 1 - 3 2 - 4 --- -------- -------- Total funding needs, including growth..................... $27 $19 - 29 $46 - 56 === ======== ========FUNDING SOURCES: External funding, including HSBC clients.................. $24 $18 - 26 $42 - 50 HSBC and HSBC subsidiaries................................ 3 1 - 3 4 - 6 --- -------- -------- Total funding sources..................................... $27 $19 - 29 $46 - 56 === ======== ======== RISK MANAGEMENT-------------------------------------------------------------------------------- CREDIT RISK There have been no significant changes in our approach to creditrisk management since December 31, 2004. At June 30, 2005, we had derivative contracts with a notional value ofapproximately $62.0 billion, including $58.4 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 $347 million at June 30, 2005. Affiliate swap counterpartiesgenerally provide collateral in the form of securities which are not recorded onour balance sheet. At June 30, 2005, the fair value of our agreements withaffiliate counterparties was below the level requiring payment of collateral. Assuch at June, 30, 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, 2004. MARKET RISK HSBC has certain limits and benchmarks that serve as guidelines indetermining appropriate levels of interest rate risk. One such limit isexpressed in terms of the Present Value of a Basis Point ("PVBP"), whichreflects the change in value of the balance sheet for a one basis point movementin all interest rates. Our total PVBP limit as of June 30, 2005 was $2 million,which includes risk associated with hedging instruments. Thus, for a one basispoint change in interest rates, the policy dictates that the value of 48 HSBC Finance Corporation-------------------------------------------------------------------------------- the balance sheet shall not increase or decrease by more than $2 million. OurPVBP position at both June 30, 2005 and December 31, 2004 was less than $1million. While the total PVBP position was not impacted by the loss of hedge accountingfor certain derivative financial instruments at the time of our acquisition byHSBC, the portfolio of ineffective hedges remaining at June 30, 2005 representPVBP risk of ($4.7) million. The interest rate risk remaining for all otherassets and liabilities, including effective hedges, results in an offsettingPVBP risk of $5.0 million. Therefore, at June 30, 2005 we had a net PVBPposition of less than $1 million, which is within our PVBP limit of $2 million. We also monitor the impact that a hypothetical increase or decrease in interestrates of 25 basis points applied at the beginning of each quarter over a 12month period would have on our net interest income. The following tablesummarizes such estimated impact: JUNE 30, DECEMBER 31, 2005 2004------------------------------------------------------------------------------------- (IN MILLIONS) Decrease in net interest income following a hypothetical 25 basis points rise in interest rates applied on a quarterly basis over the next 12 months............................. $ 149 $ 176Increase in net interest income following a hypothetical 25 basis points fall in interest rates applied on a quarterly basis over the next 12 months............................. $ 88 $ 169 These estimates include both the net interest income impact of the derivativepositions we have entered into which are considered to be effective hedges underSFAS 133 and the impact of economic hedges of certain underlying debtinstruments which do not qualify for hedge accounting as if they were effectivehedges under SFAS 133. These estimates also assume we would not take anycorrective actions in response to interest rate movements and, therefore, exceedwhat most likely would occur if rates were to change by the amount indicated. Net interest income at risk has changed as a result of the loss of hedgeaccounting on a portfolio of economic hedges. At June 30, 2005, our net interestincome sensitivity to a hypothetical 25 basis point rise in rates applied on aquarterly basis over the next 12 months is a decrease of $139 million as opposedto the amount reported above, and the sensitivity to a hypothetical 25 basispoint fall in rates applied on a quarterly basis over the next 12 months is anincrease of $78 million as opposed to the amount reported above. At December 31,2004, our net interest income sensitivity to a hypothetical 25 basis point risein rates applied on a quarterly basis over the next 12 months is a decrease of$190 million as opposed to the amount reported above, and the sensitivity to ahypothetical 25 basis point fall in rates applied on a quarterly basis over thenext 12 months is an increase of $186 million as opposed to the amount reportedabove. This sensitivity only considers changes in interest rates and does notconsider changes from other variables, such as exchange rates that may impactmargin. The decrease in exposure to rising interest rates results primarily fromthe reclassification of the pay fixed/receive floating interest rate swaps,which do not qualify for hedge accounting under SFAS 133. We have reduced ourexposure during the second quarter of 2005 by regaining hedge accountingtreatment for a significant number of our cash flow hedges as well asterminating other derivative instruments. We continue to evaluate the stepsrequired to regain hedge accounting treatment under SFAS 133 for the remainingcash flow hedges which do not qualify for hedge accounting under SFAS 133 wherepossible. We will continue to manage our total interest rate risk on a basisconsistent with the risk management process employed since the acquisition. OPERATIONAL RISK There has been no significant change in our approach tooperational risk management since December 31, 2004. 49 HSBC FINANCIAL CORPORATION RECONCILIATIONS TO GAAP FINANCIAL MEASURES THREE MONTHS ENDED SIX MONTHS ENDED ------------------------- ------------------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 2005 2004 2005 2004---------------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) RETURN ON AVERAGE ASSETS:Net income......................................... $ 472 $ 433 $ 1,098 $ 903 ======== ======== ======== ========Average assets: Owned basis...................................... $134,834 $117,467 $133,394 $118,428 Serviced with limited recourse................... 10,203 23,568 11,543 24,422 -------- -------- -------- -------- Managed basis.................................... $145,037 $141,035 $144,937 $142,850 ======== ======== ======== ========Return on average owned assets..................... 1.40% 1.47% 1.65% 1.52%Return on average managed assets................... 1.30 1.23 1.52 1.26RETURN ON AVERAGE COMMON SHAREHOLDER'S EQUITY:Net income......................................... $ 472 $ 433 $ 1,098 $ 903Dividends on preferred stock....................... (19) (18) (37) (36) -------- -------- -------- --------Net income available to common shareholders........ $ 453 $ 415 $ 1,061 $ 867 ======== ======== ======== ========Average common shareholder's equity................ $ 16,671 $ 17,160 $ 16,421 $ 16,903Return on average common shareholder's equity...... 10.87% 9.67% 12.92% 10.26%NET INTEREST INCOME:Net interest income: Owned basis...................................... $ 2,035 $ 1,930 $ 3,923 $ 3,750 Serviced with limited recourse................... 249 652 581 1,406 -------- -------- -------- -------- Managed basis.................................... $ 2,284 $ 2,582 $ 4,504 $ 5,156 ======== ======== ======== ========Average interest-earning assets: Owned basis...................................... $119,523 $101,238 $116,254 $100,457 Serviced with limited recourse................... 10,203 23,568 11,543 24,422 -------- -------- -------- -------- Managed basis.................................... $129,726 $124,806 $127,797 $124,879 ======== ======== ======== ========Owned basis net interest margin.................... 6.81% 7.63% 6.75% 7.47%Managed basis net interest margin.................. 7.04 8.28 7.05 8.26MANAGED BASIS RISK ADJUSTED REVENUE:Net interest income................................ $ 2,284 $ 2,582 $ 4,504 $ 5,156Other revenues, excluding securitization revenue and derivative income............................ 1,068 860 2,276 1,879Less: Net charge-offs.............................. (1,028) (1,367) (2,146) (2,809) -------- -------- -------- --------Risk adjusted revenue.............................. $ 2,324 $ 2,075 $ 4,634 $ 4,226 ======== ======== ======== ========Average interest-earning assets.................... $129,726 $124,806 $127,797 $124,879Managed basis risk adjusted revenue................ 7.17% 6.65% 7.25% 6.77% 50 HSBC FINANCIAL CORPORATION RECONCILIATIONS TO GAAP FINANCIAL MEASURES THREE MONTHS ENDED SIX MONTHS ENDED ---------------------------------------- ------------------------- JUNE 30, MARCH 31, JUNE 30, JUNE 30, JUNE 30, 2005 2005 2004 2005 2004-------------------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) CONSUMER NET CHARGE-OFF RATIO:Consumer net charge-offs: Owned basis........................... $ 844 $ 856 $ 966 $ 1,700 $ 1,936 Serviced with limited recourse........ 184 255 401 439 873 -------- -------- -------- -------- -------- Managed basis......................... $ 1,028 $ 1,111 $ 1,367 $ 2,139 $ 2,809 ======== ======== ======== ======== ========Average consumer receivables: Owned basis........................... $115,354 $108,928 $ 96,189 $112,141 $ 94,581 Serviced with limited recourse........ 10,203 12,884 23,568 11,543 24,422 -------- -------- -------- -------- -------- Managed basis......................... $125,557 $121,812 $119,757 $123,684 $119,003 ======== ======== ======== ======== ========Owned basis consumer net charge-off ratio................................. 2.93% 3.15% 4.02% 3.03% 4.09%Managed basis consumer net charge-off ratio................................. 3.28 3.65 4.57 3.46 4.72 ======== ======== ======== ======== ========RESERVES AS A PERCENT OF NET CHARGE-OFFSLoss reserves: Owned basis........................... $ 3,756 $ 3,581 $ 3,795 $ 3,756 $ 3,795 Serviced with limited recourse........ 525 661 1,904 525 1,904 -------- -------- -------- -------- -------- Managed basis......................... $ 4,281 $ 4,242 $ 5,699 $ 4,281 $ 5,699 ======== ======== ======== ======== ========Net charge-offs: Owned basis........................... $ 844 $ 863 $ 966 $ 1,707 $ 1,936 Serviced with limited recourse........ 184 255 401 439 873 -------- -------- -------- -------- -------- Managed basis......................... $ 1,028 $ 1,118 $ 1,367 $ 2,146 $ 2,809 ======== ======== ======== ======== ========Owned basis reserves as a percent of net charge-offs........................... 111.3% 103.7% 98.2% 110.0% 98.0%Managed basis reserves as a percent of net charge-offs....................... 104.1 94.9 104.2 99.7 101.4EFFICIENCY RATIO:Total costs and expenses less policyholders' benefits............... $ 1,326 $ 1,420 $ 1,228 $ 2,746 $ 2,525 ======== ======== ======== ======== ========Net interest income and other revenues less policyholders' benefits: Owned basis........................... $ 3,043 $ 3,228 $ 2,889 $ 6,271 $ 5,819 Serviced with limited recourse........ 52 30 148 82 401 -------- -------- -------- -------- -------- Managed basis......................... $ 3,095 $ 3,258 $ 3,037 $ 6,353 $ 6,220 ======== ======== ======== ======== ========Owned basis efficiency ratio............ 43.58% 43.99% 42.51% 43.79% 43.39%Managed basis efficiency ratio.......... 42.84 43.59 40.43 43.22 40.59 51 HSBC FINANCIAL CORPORATION RECONCILIATIONS TO GAAP FINANCIAL MEASURES JUNE 30, MARCH 31, JUNE 30, 2005 2005 2004------------------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS) TWO-MONTHS-AND-OVER-CONTRACTUAL DELINQUENCY:Consumer two-months-and-over-contractual delinquency: Owned basis............................................... $ 4,419 $ 4,229 $ 4,534 Serviced with limited recourse............................ 484 626 1,194 -------- -------- -------- Managed basis............................................. $ 4,903 $ 4,855 $ 5,728 ======== ======== ========Consumer receivables: Owned basis............................................... $118,532 $111,911 $ 99,115 Serviced with limited recourse............................ 8,980 11,486 22,836 -------- -------- -------- Managed basis............................................. $127,512 $123,397 $121,951 ======== ======== ========Consumer two-months-and-over-contractual delinquency: Owned basis............................................... 3.73% 3.78% 4.57% Managed basis............................................. 3.85 3.93 4.70RESERVES AS A PERCENT OF RECEIVABLES:Loss reserves: Owned basis............................................... $ 3,756 $ 3,581 $ 3,795 Serviced with limited recourse............................ 525 661 1,904 -------- -------- -------- Managed basis............................................. $ 4,281 $ 4,242 $ 5,699 ======== ======== ========Receivables: Owned basis............................................... $118,761 $112,161 $ 99,432 Serviced with limited recourse............................ 8,980 11,486 22,836 -------- -------- -------- Managed basis............................................. $127,741 $123,647 $122,268 ======== ======== ========Reserves as a percent of receivables: Owned basis............................................... 3.16% 3.19% 3.82% Managed basis............................................. 3.35 3.43 4.66RESERVES AS A PERCENT OF NONPERFORMING LOANS:Loss reserves: Owned basis............................................... $ 3,756 $ 3,581 $ 3,795 Serviced with limited recourse............................ 525 661 1,904 -------- -------- -------- Managed basis............................................. $ 4,281 $ 4,242 $ 5,699 ======== ======== ========Nonperforming loans: Owned basis............................................... $ 3,491 $ 3,456 $ 3,684 Serviced with limited recourse............................ 395 511 958 -------- -------- -------- Managed basis............................................. $ 3,886 $ 3,967 $ 4,642 ======== ======== ========Reserves as a percent of nonperforming loans: Owned basis............................................... 107.6% 103.6% 103.0% Managed basis............................................. 110.2 106.9 122.8 52 HSBC FINANCIAL CORPORATION RECONCILIATIONS TO GAAP FINANCIAL MEASURES JUNE 30, DECEMBER 31, 2005 2004------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) TANGIBLE COMMON EQUITY:Common shareholder's equity................................. $ 16,814 $ 15,841Exclude: Unrealized (gains) losses on cash flow hedging instruments............................................ (163) (119) Minimum pension liability................................. 4 4 Unrealized gains on investments and interest-only strip receivables............................................ (69) (53) Intangible assets......................................... (2,491) (2,705) Goodwill.................................................. (6,799) (6,856) -------- --------Tangible common equity...................................... 7,296 6,112Purchase accounting adjustments............................. 1,706 2,227 -------- --------Tangible common equity, excluding purchase accounting adjustments............................................... $ 9,002 $ 8,339 ======== ========TANGIBLE SHAREHOLDERS' EQUITY:Tangible common equity...................................... $ 7,296 $ 6,112Preferred stock............................................. 1,675 1,100Mandatorily redeemable preferred securities of Household Capital Trusts............................................ 704 994Adjustable Conversion-Rate Equity Security Units............ 535 530 -------- --------Tangible shareholder's equity............................... 10,210 8,736Purchase accounting adjustments............................. 1,698 2,208 -------- --------Tangible shareholders' equity, excluding purchase accounting adjustments............................................... $ 11,908 $ 10,944 ======== ========TANGIBLE SHAREHOLDERS' EQUITY PLUS OWNED LOSS RESERVES:Tangible shareholders' equity............................... $ 10,210 $ 8,736Owned loss reserves......................................... 3,756 3,625 -------- --------Tangible shareholders' equity plus owned loss reserves...... 13,966 12,361Purchase accounting adjustments............................. 1,698 2,208 -------- --------Tangible shareholders' equity plus owned loss reserves, excluding purchase accounting adjustments................. $ 15,664 $ 14,569 ======== ========TANGIBLE MANAGED ASSETS:Owned assets................................................ $137,743 $130,190Receivables serviced with limited recourse.................. 8,980 14,225 -------- --------Managed assets.............................................. 146,723 144,415Exclude: Intangible assets......................................... (2,491) (2,705) Goodwill.................................................. (6,799) (6,856) Derivative financial assets............................... (1,698) (4,049) -------- --------Tangible managed assets..................................... 135,735 130,805Purchase accounting adjustments............................. (131) (202) -------- --------Tangible managed assets, excluding purchase accounting adjustments............................................... $135,604 $130,603 ======== ========EQUITY RATIOS:Common and preferred equity to owned assets................. 13.42% 13.01%Tangible common equity to tangible managed assets........... 5.38 4.67Tangible shareholders' equity to tangible managed assets ("TETMA")................................................. 7.52 6.68Tangible shareholders' equity plus owned loss reserves to tangible managed assets ("TETMA + Owned Reserves")........ 10.29 9.45Excluding purchase accounting adjustments: Tangible common equity to tangible managed assets......................... 6.64 6.38 TETMA..................................................... 8.78 8.38 TETMA + Owned Reserves.................................... 11.55 11.16 ======== ======== 53 ITEM 4. CONTROLS AND PROCEDURES-------------------------------------------------------------------------------- DISCLOSURE CONTROLS We conducted an evaluation, with the participation of theChief Executive Officer and Chief Financial Officer, of the effectiveness of ourdisclosure controls and procedures as of the end of the period covered by thisreport. Our disclosure controls and procedures are designed to ensure thatinformation required to be disclosed by HSBC Finance Corporation in the reportswe file under the Securities Exchange Act of 1934, as amended (the "ExchangeAct"), is recorded, processed, summarized and reported on a timely basis. Basedupon that evaluation, the Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures were effective as of theend of the period covered by this report so as to alert them in a timely fashionto material information required to be disclosed in reports we file under theExchange Act. INTERNAL CONTROLS There have not been any changes in our internal control overfinancial reporting during the fiscal quarter to which this report relates thathave materially affected, or are reasonably likely to materially affect, ourinternal controls over financial reporting. 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 LENDING 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 finance 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 of each claim, and a number of reservations of rights letters have beenreceived. Certain of the financing of merchandise claims have been partiallycovered by insurance. In a case decided on March 31, 2004 and published on May 13, the Appellate Courtof Illinois, First District (Cook County), ruled in U.S. Bank NationalAssociation v. Clark, et al., that certain lenders (which did not include anysubsidiaries of HSBC Finance Corporation) violated the Illinois Interest Act byimposing points and finance charge fees in excess of 3% of the principal amounton loans with an interest rate in excess of 8%. The Appellate Court held for thefirst time that when the Illinois legislature made amendments to the late feeprovisions of the Interest Act in 1992, Illinois opted out of the FederalDepository Institutions Deregulation and Monetary Control Act of 1980 ("DIDMCA")and, in "certain instances," the Federal Alternative Mortgage Transaction ParityAct of 1982 ("AMTPA"). DIDMCA and AMTPA each contain provisions that preemptcertain state laws unless state legislatures took affirmative action to"opt-out" of the federal preemptions within specified time frames. The Courtfound that as a result of 1992 legislative action, the State's 3% restriction onpoints and finance charge fees are now enforceable in Illinois. The AppellateCourt's 54 ruling reversed the trial court's decision, which had relied on previousopinions of the Illinois Attorney General, the Illinois Office of Banks and RealEstate, and other courts. Should the decision stand and be applied retroactivelythroughout Illinois, lenders would be required to make refunds to customers whohad a closed-end real estate secured first mortgage loan of double the interestpaid or contracted for, whichever is greater. The plaintiffs in the Clark casefiled a notice of appeal with the Illinois Supreme Court which the courtaccepted. Briefing in the Illinois Supreme Court is underway. We reportedpreviously that three cases and one counterclaim were filed against subsidiariesof HSBC Finance Corporation based upon the Clark decision: Wilkes v. HouseholdFinance Corporation III, et al., Circuit Court of Cook County, Illinois,Chancery Division, filed on June 18, 2004 (purported class action); Aslam v.Accredited Home Lenders, Inc., et al., Circuit Court of Cook County, Illinois,Chancery Division, filed on June 11, 2004 (purported class action); MERS Inc. asnominee for HFC v. Gloss, Circuit Court of DuPage County, Illinois (filed as aforeclosure counterclaim in September, 2004); and Morris, et al. v. HouseholdMortgage Services, Inc., U.S. District Court for the Northern District ofIllinois, filed on June 22, 2004. These matters have all been settled forimmaterial amounts and have been dismissed. CREDIT CARD LITIGATION On November 15, 2004, a matter entitled American Express Travel Related ServicesCompany, Inc. v. Visa U.S.A. Inc., et al. was filed in the U.S. District Courtfor the Southern District of New York. This case alleges that HSBC FinanceCorporation, Household Bank (SB), N.A. and others violated Sections 1 and 2 ofthe Sherman Act by conspiring to monopolize and unreasonably restrain trade byallegedly implementing and enforcing an agreement requiring any United Statesbank that issues Visa or MasterCard general cards to refuse to issue such cardsfrom competitors, such as American Express and Discover. Plaintiff seeks adeclaration that defendants in this action (including Visa, MasterCard and otherbanks belonging to those associations), have violated the antitrust laws, andrequests an injunction restraining the defendants, their directors, officers,employees, agents, successors, owners and members from "continuing ormaintaining in any manner, directly or indirectly, the rules, policies, andagreements at issue," and seeks "full compensation for damages it has sustained,from each Defendant, jointly, severally," for each of plaintiff's claims, in anamount "to be trebled according to law, plus interest, attorneys' fees and costsof suit". On February 18, 2005, the Defendants filed a motion to dismiss thecomplaint for failure to state a cause of action. At this time, we are unable toquantify the potential impact from this action, if any. On June 22, 2005, a matter entitled Photos Etc. Corporation, et al. v. VISAU.S.A. Inc., et al. was filed in the U.S. District Court for the District ofConnecticut as case number 305CV1007. This purported class action named asdefendants VISA, MasterCard and a number of alleged members of thoseassociations, including HSBC Finance Corporation and two of its affiliates. Thecase seeks certification of a class of retail merchants that operate commercialbusinesses throughout the United States and alleges the defendants engage in ananti-competitive conspiracy to fix the level of "interchange fees" charged bythe associations. At this time, we are unable to quantify the potential impactfrom 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 55 securities laws, were filed between August and October 2002, and seek to recoverdamages in respect of allegedly false and misleading statements about our commonstock. These legal actions have been consolidated into a single purported classaction, Jaffe v. Household International, Inc., et al., No. 02 C 5893 (N.D.Ill., filed August 19, 2002), and a consolidated and amended complaint was filedon March 7, 2003. On December 3, 2004, the court signed the parties' stipulationto certify a class with respect to the claims brought under sec.10 and sec.20 ofthe Securities Exchange Act of 1934. The parties stipulated that plaintiffs willnot seek to certify a class with respect to the claims brought under sec.11 andsec.15 of the Securities Act of 1933 in this action or otherwise. The amended complaint purports to assert claims under the federal securitieslaws, on behalf of all persons who purchased or otherwise acquired oursecurities between October 23, 1997 and October 11, 2002, arising out of allegedfalse and misleading statements in connection with our sales and lendingpractices, the 2002 state settlement agreement referred to above, therestatement and the HSBC merger. The amended complaint, which also names asdefendants Arthur Andersen LLP, Goldman, Sachs & Co., and Merrill Lynch, Pierce,Fenner & Smith, Inc., fails to specify the amount of damages sought. In May2003, we, and other defendants, filed a motion to dismiss the complaint. OnMarch 19, 2004, the Court granted in part, and denied in part the defendants'motion to dismiss the complaint. The Court dismissed all claims against MerrillLynch, Pierce, Fenner & Smith, Inc. and Goldman Sachs & Co. The Court alsodismissed certain claims alleging strict liability for alleged misrepresentationof material facts based on statute of limitations grounds. The claims thatremain against some or all of the defendants essentially allege the defendantsknowingly made a false statement of a material fact in conjunction with thepurchase or sale of securities, that the plaintiffs justifiably relied on suchstatement, the false statement(s) caused the plaintiffs' damages, and that someor all of the defendants should be liable for those alleged statements. TheCourt has ordered that all factual discovery must be completed by January 13,2006 and expert witness discovery must be completed by July 24, 2006.Related Shares:
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