3rd Mar 2008 14:00
HSBC Holdings PLC03 March 2008 PART 3 U.S. economy and attrition in our real estate secured receivables portfoliodriven by our strategy to discontinue new correspondent channel acquisitions byour Mortgage Services business which reduced the outstanding principal balanceof the Mortgage Services loan portfolio. Our credit card portfolio also reportedan increase in the two-months-and-over contractual delinquency ratio due to thedeteriorating marketplace and broader economic conditions, a shift in mix tohigher levels of non-prime receivables, and the seasoning of a growingportfolio. The increase in two-months-and-over contractual delinquency as apercentage of consumer receivables in our auto finance portfolio reflectsseasoning of a growing portfolio and to a lesser extent the deterioration ofmarketplace and broader economic conditions as well as a seasonal trend forhigher delinquency during the second half of the year. The decrease in ourprivate label portfolio (which primarily consists of our foreign private labelportfolio and domestic retail sales contracts that were not sold to HSBC BankUSA in December 2004) reflects receivable growth in our foreign portfolios. Theincrease in delinquency in our personal non-credit card portfolio ratio reflectsmaturation of a growing domestic portfolio, and a deterioration of 2006 and 2007vintages in certain geographic regions in our domestic portfolio. Dollars ofdelinquency increased markedly compared to the prior quarter reflecting theincreases in delinquency in our real estate secured portfolios as discussedabove due in part to lower real estate secured run-off as market conditions havereduced refinancing and liquidation opportunities for our customers. Theincreases in dollars of delinquency in other products primarily reflect higherbankruptcy levels and portfolio seasoning as well as deteriorating economicconditions as well as higher levels of receivables in all products except forpersonal non-credit card receivables. Compared to December 31, 2006, our total consumer delinquency ratio increased282 basis points largely due to higher real estate secured delinquency levelsprimarily at our Mortgage Services and Consumer Lending businesses. As discussedabove, with the exception of our private label portfolio, we experienced higherdelinquency levels across all products. Our credit card portfolio reported amarked increase in the two-months-and-over contractual delinquency ratio due toa shift in mix to higher levels of non-prime receivables, seasoning of a growingportfolio, higher levels of personal bankruptcy filings as compared to theexceptionally low levels experienced in 2006 following enactment of newbankruptcy legislation in the United States in October 2005 and thedeteriorating marketplace and broader economic conditions. The increase in autofinance portfolio ratio reflects seasoning of a growing portfolio, receivablegrowth and weakening performance of certain 2006 originations. The increase indelinquency in our personal non-credit card portfolio ratio reflects maturationof a growing domestic portfolio, and a deterioration of 2006 and 2007 vintagesas discussed above. See "Customer Account Management Policies and Practices" regarding the treatmentof restructured accounts and accounts subject to forbearance and other customeraccount management tools. See Note 2, "Summary of Significant AccountingPolicies," for a detail of our charge-off policy by product. NET CHARGE-OFFS OF CONSUMER RECEIVABLES The following table summarizes net charge-off of consumer receivables as apercent of average consumer receivables: 2007 2006 ----------------------------------------------- ----------------------------------------------- QUARTER ENDED (ANNUALIZED) QUARTER ENDED (ANNUALIZED) FULL --------------------------------------- FULL --------------------------------------- YEAR DEC. 31 SEPT. 30 JUNE 30 MAR. 31 YEAR DEC. 31 SEPT. 30 JUNE 30 MAR. 31------------------------------------------------------------------------------------------------------------------------------Real estate secured(1)... 2.32% 2.96% 2.47% 2.17% 1.73% 1.00% 1.28% .98% .97% .75%Auto finance(2).......... 4.10 5.07 4.47 3.16 3.64 3.67 4.97 3.69 2.43 3.50Credit card.............. 7.28 8.17 7.00 6.85 7.08 5.56 6.79 5.52 5.80 4.00Private label............ 4.73 3.71 4.74 5.30 5.30 5.80 6.68 5.65 5.29 5.62Personal non-credit card(2)................ 8.48 9.13 8.84 8.22 7.73 7.89 7.92 7.77 7.92 7.94 ---- ---- ---- ---- ---- ---- ---- ---- ---- ----Total consumer(2)........ 4.22% 4.96% 4.37% 3.92% 3.64% 2.97% 3.45% 2.92% 2.88% 2.58% ==== ==== ==== ==== ==== ==== ==== ==== ==== ====Real estate charge-offs and REO expense as a percent of average real estate secured receivables............ 2.68% 3.79% 2.89% 2.26% 1.86% 1.19% 1.68% 1.11% 1.04% .89% ==== ==== ==== ==== ==== ==== ==== ==== ==== ==== 2005 FULL YEAR-------------------------------------Real estate secured(1)... .76%Auto finance(2).......... 3.27Credit card.............. 7.12Private label............ 4.83Personal non-credit card(2)................ 7.88 ----Total consumer(2)........ 3.03% ====Real estate charge-offs and REO expense as a percent of average real estate secured receivables............ .87% ==== -------- (1) Real estate secured net charge-off of consumer receivables as a percent of average consumer receivables are comprised of the following: 77 HSBC Finance Corporation-------------------------------------------------------------------------------- 2007 2006 ------------------------------------------------ ----------------------------------------------- QUARTER ENDED (ANNUALIZED) QUARTER ENDED (ANNUALIZED) FULL --------------------------------------- FULL --------------------------------------- YEAR DEC. 31 SEPT. 30 JUNE 30 MAR. 31 YEAR DEC. 31 SEPT. 30 JUNE 30 MAR. 31-----------------------------------------------------------------------------------------------------------------------------------Mortgage Services: First lien................. 1.60% 2.29% 1.93% 1.20% 1.17% .77% .91% .75% .73% .67% Second lien................ 12.15 17.42 13.90 11.82 7.97 2.38 4.40 2.11 1.72 1.15 ----- ----- ----- ----- ---- ---- ---- ---- ---- ----Total Mortgage Services...... 3.77 5.30 4.36 3.32 2.55 1.12 1.66 1.06 .94 .77Consumer Lending: First lien................. .79 1.04 .74 .56 .80 .85 .85 .84 .98 .71 Second lien................ 3.78 4.21 3.58 5.37 1.93 1.12 1.02 1.22 1.25 1.01 ----- ----- ----- ----- ---- ---- ---- ---- ---- ----Total Consumer Lending....... 1.20 1.47 1.13 1.22 .96 .89 .88 .90 1.02 .75Foreign and all other: First lien................. 1.05 .81 .81 1.30 1.34 .54 .89 .38 .99 .24 Second lien................ 1.35 1.23 1.39 2.23 1.29 .94 1.15 .91 .81 .63 ----- ----- ----- ----- ---- ---- ---- ---- ---- ----Total Foreign and all other.. 1.28 1.13 1.25 2.03 1.30 .86 1.10 .81 .85 .56 ----- ----- ----- ----- ---- ---- ---- ---- ---- ----Total real estate secured.... 2.32% 2.96% 2.47% 2.17% 1.73% 1.00% 1.28% .98% .97% .75% ===== ===== ===== ===== ==== ==== ==== ==== ==== ==== 2005 FULL YEAR-----------------------------------------Mortgage Services: First lien................. .68% Second lien................ 1.11 ----Total Mortgage Services...... .75Consumer Lending: First lien................. .74 Second lien................ 1.21 ----Total Consumer Lending....... .80Foreign and all other: First lien................. 1.04 Second lien................ .37 ----Total Foreign and all other.. .47 ----Total real estate secured.... .76% ==== (2) In December 2006, our Auto Finance business changed its charge-off policy to provide that the principal balance of auto loans in excess of the estimated net realizable value will be charged-off 30 days (previously 90 days) after the financed vehicle has been repossessed if it remains unsold, unless it becomes 150 days contractually delinquent, at which time such excess will be charged off. This resulted in a one-time acceleration of charge-offs in December 2006, which totaled $24 million. Excluding the impact of this change the auto finance net charge-off ratio would have been 4.19 percent in the quarter ended December 31, 2006 and 3.46 percent for the full year 2006. Also in the fourth quarter of 2006, our U.K. business discontinued a forbearance program related to unsecured loans. Under the forbearance program, eligible delinquent accounts would not be subject to charge-off if certain minimum payment conditions were met. The cancellation of this program resulted in a one-time acceleration of charge-off which totaled $89 million. Excluding the impact of the change in the U.K. forbearance program, the personal non-credit card net charge-off ratio would have been 6.23 percent in the quarter ended December 31, 2006 and 7.45 percent for the full year 2006. Excluding the impact of both changes, the total consumer charge- off ratio would have been 3.17 percent for the quarter ended December 31, 2006 and 2.89 percent for the full year 2006. Net charge-offs as a percentage of average consumer receivables increased 125basis points for the full year of 2007 as compared to the full year of 2006.With the exception of our private label portfolio, we experienced higher charge-off across all products, in particular our real estate secured and credit cardreceivable portfolios as discussed above. The increase in our Mortgages Servicesbusiness reflects the higher delinquency levels discussed above which aremigrating to charge-off and the impact of lower average receivable levels drivenby the elimination of correspondent purchases as well as the sale of $2.7billion of receivables during 2007. The increase in our Consumer Lendingbusiness reflects portfolio seasoning and higher losses in second lien loanspurchased in 2004 through the third quarter of 2006. The marked increase indelinquency in our Consumer Lending real estate secured portfolio experienced inthe second half of 2007 as a result of marketplace conditions will begin tomigrate to charge-off largely in 2008. The increase in charge-offs in the creditcard portfolio is due to a higher mix of non-prime receivables in our creditcard portfolio, portfolio seasoning, increased levels of personal bankruptcyfilings as compared to the exceptionally low levels experienced in 2006following effectiveness of a new bankruptcy law in the United States and higherreceivable balances. The increase in the auto finance portfolio is due toseasoning of a growing portfolio and weakened performance of certain 2006originations. The private label charge-off ratio decreased compared to the prioryear quarter primarily due to recent receivable growth, partially offset byportfolio seasoning. The personal non-credit card charge-off ratio increasedreflecting portfolio seasoning as well as deterioration of 2006 and 2007vintages in certain geographic regions. We experienced an increase in overall net charge-off dollars across all productsin 2007. Higher losses at our Mortgage Services and Consumer Lending businessesas discussed above, as well as portfolio growth and seasoning in our credit cardand auto finance portfolios were major contributing factors to this increase.The marked increase in delinquency in our Consumer Lending real estate securedportfolio experienced in the second half of 2007 largely as a result ofmarketplace conditions will not begin to migrate to charge-off largely until2008. The increase in real estate charge-offs and REO expense as a percent of averagereal estate secured receivables in 2007 was primarily due to higher charge-offsin our real estate secured portfolio as discussed above, as well as 78 HSBC Finance Corporation-------------------------------------------------------------------------------- higher REO expense due to higher levels of owned properties and higher losses onsales due to lower home value appreciation and in some cases home valuedepreciation. Net charge-offs as a percentage of average consumer receivables decreased 6basis points for the full year of 2006 as compared to the full year of 2005.Decreases in personal bankruptcy net charge-offs in our credit card portfoliofollowing the October 2005 bankruptcy law changes in the United States wassubstantially offset by higher charge-offs in our real estate secured portfolioand in particular at our Mortgage Services business due to the deterioratingperformance of certain loans acquired in 2005 and 2006. The increase in the autofinance ratio for the full year 2006 reflects seasoning of the portfolio and theone-time acceleration of charge-off totaling $24 million. The decrease in thecredit card net charge-off ratio reflects the decrease in personal bankruptcyfilings discussed above, as well as the positive impact of receivable growth andhigher recoveries in our credit card portfolio as a result of increased salesvolumes of recent and older charged-off accounts. The net charge-off ratio forour private label receivables for the full year 2006 and 2005 reflects decreasedaverage receivables and the deterioration of the financial circumstances of someof our customers in the U.K. The personal non-credit card charge-off ratio wasbroadly flat with the prior year as increased charge-offs in both our domesticand U.K. businesses were offset by recent growth in our domestic business.Charge-offs increased in our domestic business due to seasoning of a growingportfolio. Charge-offs in our U.K. business increased due to decliningreceivables and the deterioration of the financial circumstances of some of ourcustomers across the U.K. as well as the one-time acceleration of charge-offstotaling $89 million from the cancellation of a forbearance program in the U.K.as discussed above. We experienced an increase in overall net charge-off dollars across all productsin 2006. Higher losses at our Mortgage Services business as discussed above, aswell as portfolio growth and seasoning in our credit card and auto financeportfolios were major contributing factors to this increase. The increase in real estate charge-offs and REO expense as a percent of averagereal estate secured receivables in 2006 was primarily due to higher charge-offsin our real estate secured portfolio as discussed above, as well as higher REOexpense due to higher levels of owned properties and higher losses on sales dueto the slowing housing market, including an actual decline in property values insome markets. 79 HSBC Finance Corporation-------------------------------------------------------------------------------- NONPERFORMING ASSETS AT DECEMBER 31, 2007 2006 2005--------------------------------------------------------------------------------------- (IN MILLIONS)Nonaccrual receivables(1)................................. $7,562 $4,807 $3,608Accruing consumer receivables 90 or more days delinquent.. 1,277 930 623 ------ ------ ------Total nonperforming receivables........................... 8,839 5,737 4,231Real estate owned......................................... 1,023 670 510 ------ ------ ------Total nonperforming assets................................ $9,862 $6,407 $4,741 ====== ====== ====== -------- (1) Nonaccrual receivables are comprised of the following: AT DECEMBER 31, 2007 2006 2005---------------------------------------------------------------------------------------- (IN MILLIONS)Real estate secured:Closed-end: First lien............................................... $3,387 $1,893 $1,366 Second lien.............................................. 901 482 247Revolving: First lien............................................... 20 22 31 Second lien.............................................. 349 187 63 ------ ------ ------Total real estate secured.................................. 4,657 2,584 1,707Auto finance............................................... 483 394 323Private label.............................................. 74 76 75Personal non-credit card................................... 2,348 1,753 1,498Commercial and other....................................... - - 5 ------ ------ ------Total nonaccrual receivables............................... $7,562 $4,807 $3,608 ====== ====== ====== With the exception of private label receivables, all products reported higherlevels of nonperforming assets in 2007 primarily due to higher overalldelinquency levels as discussed above. Real estate secured nonaccrual loansincluded stated income loans at our Mortgage Services business of $1,194 millionat December 31, 2007, $571 million at December 31, 2006, and $125 million atDecember 31, 2005. Consistent with industry practice, accruing consumerreceivables 90 or more days delinquent includes domestic credit cardreceivables. CREDIT LOSS RESERVES We maintain credit loss reserves to cover probable lossesof principal, interest and fees, including late, overlimit and annual fees.Credit loss reserves are based on a range of estimates and are intended to beadequate but not excessive. We estimate probable losses for consumer receivablesusing a roll rate migration analysis that estimates the likelihood that a loanwill progress through the various stages of delinquency, or buckets, andultimately charge-off based upon recent historical performance experience ofother loans in our portfolio. This analysis considers delinquency status, lossexperience and severity and takes into account whether loans are in bankruptcy,have been restructured or rewritten, or are subject to forbearance, an externaldebt management plan, hardship, modification, extension or deferment. Our creditloss reserves also take into consideration the loss severity expected based onthe underlying collateral, if any, for the loan in the event of default.Delinquency status may be affected by customer account management policies andpractices, such as the restructure of accounts, forbearance agreements, extendedpayment plans, modification arrangements, external debt management programs,loan rewrites and deferments. When customer account management policies orchanges thereto, shift loans from a "higher" delinquency bucket to a "lower"delinquency bucket, this will be reflected in our roll rate statistics. To theextent that restructured accounts have a greater propensity to roll to higherdelinquency buckets, this will be captured in the roll rates. Since the lossreserve is computed based on the composite of all of these calculations, thisincrease in roll rate will be applied to receivables in all respectivedelinquency buckets, which will increase the overall reserve level. In addition,loss reserves on consumer receivables are maintained to reflect our judgment ofportfolio risk factors that may not be fully reflected in the statistical rollrate calculation or when historical trends 80 HSBC Finance Corporation-------------------------------------------------------------------------------- are not reflective of current inherent losses in the portfolio. Risk factorsconsidered in establishing loss reserves on consumer receivables include recentgrowth, product mix, unemployment rates, bankruptcy trends, geographicconcentrations, loan product features such as adjustable rate loans, economicconditions, such as national and local trends in housing markets and interestrates, portfolio seasoning, account management policies and practices, currentlevels of charge-offs and delinquencies, changes in laws and regulations andother items which can affect consumer payment patterns on outstandingreceivables, such as natural disasters and global pandemics. While our credit loss reserves are available to absorb losses in the entireportfolio, we specifically consider the credit quality and other risk factorsfor each of our products. We recognize the different inherent losscharacteristics in each of our products as well as customer account managementpolicies and practices and risk management/collection practices. Charge-offpolicies are also considered when establishing loss reserve requirements toensure the appropriate reserves exist for products with longer charge-offperiods. We also consider key ratios such as reserves to nonperforming loans andreserves as a percentage of net charge-offs and months coverage ratios indeveloping our loss reserve estimate. Loss reserve estimates are reviewedperiodically and adjustments are reported in earnings when they become known. Asthese estimates are influenced by factors outside of our control, such asconsumer payment patterns and economic conditions, there is uncertainty inherentin these estimates, making it reasonably possible that they could change. The following table sets forth credit loss reserves for the periods indicated: AT DECEMBER 31, ------------------------------------------------- 2007 2006 2005 2004 2003----------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Credit loss reserves....................... $10,905 $6,587 $4,521 $3,625 $3,793Reserves as a percent of receivables....... 6.98%(3) 4.07%(3) 3.23% 3.39% 4.11%Reserves as a percent of net charge-offs... 162.4(3) 145.8(3) 123.8(2) 89.9(1) 105.7Reserves as a percent of nonperforming loans.................................... 123.4 114.8 106.9 100.9 92.8 -------- (1) In December 2004, we adopted FFIEC charge-off policies for our domestic private label (excluding retail sales contracts at our Consumer Lending business) and credit card portfolios and subsequently sold this domestic private label receivable portfolio. These events had a significant impact on this ratio. Reserves as a percentage of net charge-offs excluding net charge-offs associated with the sold domestic private label portfolio and charge-off relating to the adoption of FFIEC was 109.2% at December 31, 2004. (2) The acquisition of Metris in December 2005 positively impacted this ratio. Reserves as a percentage of net charge-offs at December 31, 2005, excluding Metris was 118.2 percent. (3) This ratio was positively impacted in 2007 and 2006 by markedly higher credit loss reserves at our Mortgage Services business and, in 2007, at our Consumer Lending business. Credit loss reserves at December 31, 2007 increased as compared to December 31,2006 as we recorded loss provision in excess of net charge-offs of $4,310million. The increase was primarily a result of the higher delinquency and lossestimates in our domestic real estate secured receivable portfolio, our ConsumerLending personal non-credit card portfolio and our domestic credit cardreceivable portfolio as previously discussed. In addition, the higher creditloss reserve levels reflect higher dollars of delinquency due to higher levelsof delinquent receivables driven by portfolio seasoning and increased levels ofpersonal bankruptcy filings as compared to the exceptionally low levelsexperienced in 2006 following enactment of new bankruptcy legislation in theUnited States in October 2005, partially offset by lower overall receivables.Higher credit loss reserves at December 31, 2007 also reflect a higher mix ofnon-prime receivables in our Credit Card Services business. As previously discussed, we are experiencing higher delinquency and lossestimates at our Mortgage Services and Consumer Lending businesses as comparedto the year-ago period. In establishing reserve levels, we considered theseverity of losses expected to be incurred above our historical experience giventhe current housing market trends in the United States. During the second halfof 2007, unprecedented turmoil in the mortgage lending industry resulted inreduced liquidity in the marketplace for subprime mortgages. In response,lenders have markedly tightened underwriting standards and reduced theavailability of subprime mortgages. As fewer financing options currently existin the marketplace for subprime customers, properties are remaining on themarket for longer periods of time 81 HSBC Finance Corporation-------------------------------------------------------------------------------- which contributes to home price depreciation. Therefore, it is now generallybelieved that the slowdown in the housing market will be deeper in terms of itsimpact on housing prices and the duration of this slowdown will extend through2008. For some of our customers, the ability to refinance and access equity intheir homes is no longer an option as home price appreciation remains stagnantin many markets and depreciates in others. As a result, the impact of theseindustry trends on our portfolio has worsened, resulting in higher charge-offand loss estimates in our Mortgage Services and Consumer Lending real estatesecured receivable portfolios. We have considered these factors in establishingour credit loss reserve levels. We also considered the ability of borrowers to repay their first lien adjustablerate mortgage loans at potentially higher contractual reset rates givenfluctuations in interest rates since origination, as well as their ability torepay any underlying second lien mortgage outstanding. Because first lienadjustable rate mortgage loans are generally well secured, ultimate lossesassociated with such loans are dependent to a large extent on the status of thehousing market and interest rate environment. Therefore, although it is probablethat incremental losses will occur as a result of rate resets on first lienadjustable rate mortgage loans, such losses are estimable and, therefore,included in our credit loss reserves only in situations where the payment haseither already reset or will reset in the near term. Additionally, a significantportion of our second lien Mortgage Services mortgages are subordinate to afirst lien adjustable rate loan. For customers with second lien mortgage loansthat are subordinate to a first lien adjustable rate mortgage loan, theprobability of repayment of the second lien mortgage loan is significantlyreduced. The impact of future changes, if any, in the housing market will nothave a significant impact on the ultimate loss expected to be incurred sincethese loans, based on history and other factors, are expected to perform likeunsecured loans. Credit loss reserve levels at December 31, 2006 increased as compared toDecember 31, 2005 as we recorded loss provision in excess of net charge-offs of$2,045 million. A significant portion of the increase in credit loss reservesresulted from higher delinquency and loss estimates at our Mortgage Servicesbusiness as previously discussed where we recorded provision in excess of netcharge-offs of $1,668 million. In addition, the higher credit loss reservelevels were a result of higher levels of receivables due in part to lowersecuritization levels and higher dollars of delinquency in our other businessesdriven by growth and portfolio seasoning including the Metris portfolio acquiredin December 2005. Reserve levels also increased due to weakening early stageperformance consistent with the industry trend in certain Consumer Lending realestate secured loans originated since late 2005. These increases were partiallyoffset by significantly lower personal bankruptcy levels in the United States, areduction in the estimated loss exposure relating to Hurricane Katrina and thebenefit of stable unemployment in the United States. Credit loss reserve levels at December 31, 2005 reflect the additional reserverequirements resulting from higher levels of owned receivables including lowersecuritization levels, higher delinquency levels in our portfolios driven bygrowth and portfolio seasoning, the impact of Hurricane Katrina and minimummonthly payment changes, additional reserves resulting from the Metrisacquisition and the higher levels of personal bankruptcy filings in both theUnited States and the U.K. Credit loss reserves at December 31, 2005 alsoreflect the sale of our U.K. credit card business in December 2005 whichdecreased credit loss reserves by $104 million. In 2005, we recorded lossprovision greater than net charge-offs of $890 million. In 2004, we recorded loss provision greater than net charge-offs of $301million. Excluding the impact of adopting FFIEC charge-off policies for domesticprivate label (excluding retail sales contracts at our Consumer Lendingbusiness) and credit card portfolios, we recorded loss provision $421 milliongreater than net charge-offs in 2004. Reserves as a percentage of receivables at December 31, 2007 were higher than atDecember 31, 2006 due to the impact of the additional reserve requirementsprimarily in our Mortgage Services, Consumer Lending and Credit Card Servicesbusinesses as discussed above. Reserves as a percentage of receivables atDecember 31, 2006 were higher than at December 31, 2005 due to the impact of theadditional reserve requirements in our Mortgage Services business, partiallyoffset by lower levels of personal bankruptcy filing in the United States and areduction in the estimated loss exposure estimates relating to HurricaneKatrina. Reserves as a percentage of receivables at December 31, 2005 and 2004were lower than at December 31, 2003 as a result of portfolio growth, partiallyoffset in 2005 by the impact of additional credit loss reserves relating to theimpact of Hurricane Katrina, minimum monthly payment changes and increasedbankruptcy filings. 82 HSBC Finance Corporation-------------------------------------------------------------------------------- Reserves as a percentage of nonperforming loans increased in 2007 as reservelevels increased at a higher rate than the increase in nonperforming loansdriven by higher loss estimates in our Consumer Lending, Mortgage Services andCredit Card Services portfolios due to the marketplace and broader economicconditions. Reserves as a percentage of nonperforming loans increased in 2006attributable to higher reserve levels primarily as a result of higher lossestimates in our Mortgage Services business. Reserves as a percentage ofnonperforming loans increased in 2005. While nonperforming loans increased in2005, reserve levels in 2005 increased at a more rapid pace due to receivablegrowth, the additional reserve requirements related to Hurricane Katrina andimpact of increased bankruptcy filings on our secured receivable and personalnon-credit card receivable portfolios which did not migrate to charge-off until2006. Reserves as a percentage of net charge-offs were higher in 2007 as the increasein reserve levels outpaced the increase in net charge-off during the yearprimarily due to the significant increases in reserve levels in the second halfof 2007 resulting from the marketplace conditions and rising unemployment ratesas described above. Reserves as a percentage of net charge-offs increased in2006 as compared to 2005 as reserve levels grew more rapidly than charge-offsprimarily due to the higher charge-offs expected in 2007 related to thedeterioration in certain mortgage loans acquired in 2005 and 2006. Reserves as apercentage of net charge-offs increased in 2005. The 2005 ratio wassignificantly impacted by the acquisition of Metris and the 2004 ratio wassignificantly impacted by both the sale of our domestic private label receivableportfolio (excluding retail sales contracts) in December 2004 as well as theadoption of FFEIC charge-off policies for our domestic private label (excludingretail sales contracts) and credit card portfolios. Excluding these items,reserves as a percentage of net charge-offs increased 900 basis points. Whileboth our reserve levels at December 31, 2005 and net charge-offs in 2005 werehigher than 2004, our reserve levels grew for the reasons discussed above morerapidly than our net charge-offs. See the "Analysis of Credit Loss Reserves Activity," "Reconciliations to U.S.GAAP Financial Measures" and Note 7, "Credit Loss Reserves," to the accompanyingconsolidated financial statements for additional information regarding our lossreserves. CUSTOMER ACCOUNT MANAGEMENT POLICIES AND PRACTICES Our policies and practicesfor the collection of consumer receivables, including our customer accountmanagement policies and practices, permit us to modify the terms of loans,either temporarily or permanently, and/or to reset the contractual delinquencystatus of an account to current, based on indicia or criteria which, in ourjudgment, evidence continued payment probability. Such restructuring policiesand practices vary by product and are designed to manage customer relationships,maximize collection opportunities and avoid foreclosure or repossession ifreasonably possible. If the account subsequently experiences payment defaults,it will again become contractually delinquent. In the third quarter of 2003, we implemented certain changes to ourrestructuring policies. These changes were intended to eliminate and/orstreamline exception provisions to our existing policies and were generallyeffective for receivables originated or acquired after January 1, 2003.Receivables originated or acquired prior to January 1, 2003 generally are notsubject to the revised restructure and customer account management policies.However, for ease of administration, in the third quarter of 2003, our MortgageServices business elected to adopt uniform policies for all products regardlessof the date an account was originated or acquired. Implementation of the uniformpolicy by Mortgage Services had the effect of only counting restructuresoccurring on or after January 1, 2003 in assessing restructure eligibility forpurposes of the limitation that no account may be restructured more than fourtimes in a rolling sixty-month period. Other business units may also elect toadopt uniform policies. The changes adopted in the third quarter of 2003 havenot had a significant impact on our business model or on our results ofoperations as these changes have generally been phased in as new receivableswere originated or acquired. As described more fully in the table below, weadopted FFIEC account management policies regarding restructuring of past dueaccounts for our domestic private label credit card and credit card portfoliosin December 2004. These changes have not had a significant impact on ourbusiness model or on our results of operations. Currently, approximately three-fourths of all restructured receivables aresecured products, which in general have less loss severity exposure because ofthe underlying collateral. Credit loss reserves take into account whether loanshave been restructured, rewritten or are subject to forbearance, an externaldebt management plan, modification, 83 HSBC Finance Corporation-------------------------------------------------------------------------------- extension or deferment. Our credit loss reserves also take into considerationthe loss severity expected based on the underlying collateral, if any, for theloan. Our restructuring policies and practices vary by product and are described inthe table that follows and reflect the revisions from the adoption of FFIECcharge-off and account management policies for our domestic private label(excluding retail sales contracts at our Consumer Lending business) and creditcard receivables in December 2004. The fact that the restructuring criteria maybe met for a particular account does not require us to restructure that account,and the extent to which we restructure accounts that are eligible under thecriteria will vary depending upon our view of prevailing economic conditions andother factors which may change from period to period. In addition, for someproducts, accounts may be restructured without receipt of a payment in certainspecial circumstances (e.g. upon reaffirmation of a debt owed to us inconnection with a Chapter 7 bankruptcy proceeding). We use account restructuringas an account and customer management tool in an effort to increase the value ofour account relationships, and accordingly, the application of this tool issubject to complexities, variations and changes from time to time. Thesepolicies and practices are continually under review and assessment to assurethat they meet the goals outlined above, and accordingly, we modify or permitexceptions to these general policies and practices from time to time. Inaddition, exceptions to these policies and practices may be made in specificsituations in response to legal or regulatory agreements or orders. In the policies summarized below, "hardship restructures" and "workoutrestructures" refer to situations in which the payment and/or interest rate maybe modified on a temporary or permanent basis. In each case, the contractualdelinquency status is reset to current. "External debt management plans" refersto situations in which consumers receive assistance in negotiating or schedulingdebt repayment through public or private agencies. RESTRUCTURING POLICIES AND PRACTICES FOLLOWING CHANGES IMPLEMENTED HISTORICAL RESTRUCTURING POLICIES IN THE THIRD QUARTER 2003 AND IN DECEMBER AND PRACTICES(1),(2),(3) 2004(1),(2),(3)--------------------------------------------------------------------------------------REAL ESTATE SECURED REAL ESTATE SECURED Real Estate - Overall Real Estate - Overall(4) - An account may be restructured if we - Accounts may be restructured prior receive two qualifying payments to the end of the monthly cycle within the 60 days preceding the following the receipt of two restructure; we may restructure qualifying payments within 60 days accounts in hardship, disaster or strike situations with one - Accounts generally are not eligible qualifying payment or no payments for restructure until nine months after origination - Accounts that have filed for Chapter 7 bankruptcy protection may be - Accounts will be limited to four restructured upon receipt of a collection restructures in a rolling signed reaffirmation agreement sixty-month period - Accounts subject to a Chapter 13 - Accounts whose borrowers have filed plan filed with a bankruptcy court for Chapter 7 bankruptcy protection generally require one qualifying may be restructured upon receipt of payment to be restructured a signed reaffirmation agreement - Except for bankruptcy reaffirmation - Accounts whose borrowers are subject and filed Chapter 13 plans, agreed to a Chapter 13 plan filed with a automatic payment withdrawal or bankruptcy court generally may be hardship/disaster/strike, accounts restructured upon receipt of one are generally limited to one qualifying payment restructure every twelve-months - Except for bankruptcy reaffirmation - Accounts generally are not eligible and filed Chapter 13 plans, accounts for restructure until they are on will generally not be restructured the books for at least six months more than once in a twelve-month period - Accounts whose borrowers agree to pay by automatic withdrawal are generally restructured upon receipt of one qualifying payment after initial authorization for automatic withdrawal(5) 84 HSBC Finance Corporation-------------------------------------------------------------------------------- RESTRUCTURING POLICIES AND PRACTICES FOLLOWING CHANGES IMPLEMENTED HISTORICAL RESTRUCTURING POLICIES IN THE THIRD QUARTER 2003 AND IN DECEMBER AND PRACTICES(1),(2),(3) 2004(1),(2),(3)-------------------------------------------------------------------------------------- Real Estate - Consumer Lending Real Estate - Mortgage Services(6),(7) - Accounts whose borrowers agree to pay by automatic withdrawal are - Accounts will generally not be generally restructured upon receipt eligible for restructure until nine of one qualifying payment after months after origination initial authorization for automatic withdrawal - Qualifying accounts may be restructured if less than 30 days delinquent. AUTO FINANCE AUTO FINANCE - Accounts may be extended if we - Accounts may generally be extended receive one qualifying payment upon receipt of two qualifying within the 60 days preceding the payments within the 60 days extension preceding the extension - Accounts may be extended no more - Accounts may be extended by no more than three months at a time and by than three months at a time no more than three months in any twelve-month period - Accounts will be limited to four extensions in a rolling sixty-month - Extensions are limited to six months period, but in no case will an over the contractual life account be extended more than a total of six months over the life of - Accounts that have filed for Chapter the account 7 bankruptcy protection may be restructured upon receipt of a - Accounts will be limited to one signed reaffirmation agreement extension every six months - Accounts whose borrowers are subject - Accounts will not be eligible for to a Chapter 13 plan may be extension until they are on the restructured upon filing of the plan books for at least six months with a bankruptcy court - Accounts whose borrowers have filed for Chapter 7 bankruptcy protection may be restructured upon receipt of a signed reaffirmation agreement - Accounts whose borrowers are subject to a Chapter 13 plan may be restructured upon filing of the plan with the bankruptcy court 85 HSBC Finance Corporation-------------------------------------------------------------------------------- RESTRUCTURING POLICIES AND PRACTICES FOLLOWING CHANGES IMPLEMENTED HISTORICAL RESTRUCTURING POLICIES IN THE THIRD QUARTER 2003 AND IN DECEMBER AND PRACTICES(1),(2),(3) 2004(1),(2),(3)-------------------------------------------------------------------------------------- CREDIT CARD CREDIT CARD - Typically, accounts qualify for Accounts originated between January restructuring if we receive two or 2003 - December 2004 three qualifying payments prior to the restructure, but accounts in - Accounts typically qualified for approved external debt management restructuring if we received two or programs may generally be three qualifying payments prior to restructured upon receipt of one the restructure, but accounts in qualifying payment approved external debt management programs could generally be - Generally, accounts may be restructured upon receipt of one restructured once every six months qualifying payment - Generally, accounts could have been restructured once every six months Beginning in December 2004, all accounts regardless of origination date - Domestic accounts qualify for restructuring if we receive three consecutive minimum monthly payments or a lump sum equivalent - Domestic accounts qualify for restructuring if the account has been in existence for a minimum of nine months and the account has not been restructured in the prior twelve months and not more than once in the prior five years - Domestic accounts entering third party debt counseling programs are limited to one restructure in a five-year period in addition to the general limits of one restructure in a twelve-month period and two restructures in a five-year period PRIVATE LABEL(8) PRIVATE LABEL(8) Private Label - Overall Private Label - Overall - An account may generally be Prior to December 2004 for accounts restructured if we receive one or originated after October 2002 more qualifying payments, depending upon the merchant - For certain merchants, receipt of two or three qualifying payments was - Restructuring is limited to once required, except accounts in an every six months (or longer, approved external debt management depending upon the merchant) for program could be restructured upon revolving accounts and once every receipt of one qualifying payment twelve-months for closed-end accounts 86 HSBC Finance Corporation-------------------------------------------------------------------------------- RESTRUCTURING POLICIES AND PRACTICES FOLLOWING CHANGES IMPLEMENTED HISTORICAL RESTRUCTURING POLICIES IN THE THIRD QUARTER 2003 AND IN DECEMBER AND PRACTICES(1),(2),(3) 2004(1),(2),(3)-------------------------------------------------------------------------------------- Private Label - Consumer Lending Retail Private Label - Consumer Lending Sales Contracts Retail Sales Contracts - Accounts may be restructured if - Accounts may be restructured upon we/receive one qualifying payment receipt of two qualifying payments within the 60 days preceding the within the 60 days preceding the restructure; may restructure restructure accounts in a hardship/disaster/strike situation - Accounts will be limited to one with one qualifying payment or no restructure every six months payments - Accounts will be limited to four - If an account is never more than 90 collection restructures in a rolling days delinquent, it may generally be sixty-month period restructured up to three times per year - Accounts will not be eligible for restructure until six months after - If an account is ever more than 90 origination days delinquent, generally it may be restructured with one qualifying payment no more than four times over its life; however, generally the account may thereafter be restructured if two qualifying payments are received - Accounts subject to programs for hardship or strike may require only the receipt of reduced payments in order to be restructured; disaster may be restructured with no payments PERSONAL NON-CREDIT CARD PERSONAL NON-CREDIT CARD - Accounts may be restructured if we - Accounts may be restructured upon receive one qualifying payment receipt of two qualifying payments within the 60 days preceding the within the 60 days preceding the restructure; may restructure restructure accounts in a hardship/disaster/strike situation - Accounts will be limited to one with one qualifying payment or no restructure every six months payments - Accounts will be limited to four - If an account is never more than 90 collection restructures in a rolling days delinquent, it may generally be sixty-month period restructured up to three times per year - Accounts will not be eligible for restructure until six months after - If an account is ever more than 90 origination days delinquent, generally it may be restructured with one qualifying payment no more than four times over its life; however, generally the account may thereafter be restructured if two qualifying payments are received - Accounts subject to programs for hardship or strike may require only the receipt of reduced payments in order to be restructured; disaster may be restructured with no payments -------- (1) We employ account restructuring and other customer account management policies and practices as flexible customer account management tools as criteria may vary by product line. In addition to variances in criteria by product, criteria may also vary within a product line. Also, we continually review our product lines and assess restructuring criteria and they are subject to modification or exceptions from time to time. Accordingly, the description of our account restructuring policies or practices provided in this table should be taken only as general guidance to the restructuring approach taken within each product line, and not as assurance that accounts not meeting these criteria will never be restructured, that every account meeting these criteria will in fact be restructured or that these criteria will not change or that exceptions will not be made in individual cases. In addition, in an effort to determine optimal customer account management strategies, management may 87 HSBC Finance Corporation-------------------------------------------------------------------------------- run more conservative tests on some or all accounts in a product line for fixed periods of time in order to evaluate the impact of alternative policies and practices. (2) For our United Kingdom business, all portfolios have a consistent account restructure policy. An account may be restructured if we receive two or more qualifying payments within two calendar months, limited to one restructure every 12 months, with a lifetime limit of three times. Prior to October 1, 2007, an account in a hardship situation could be restructured if a customer made three consecutive qualifying monthly payments within the last three calendar months. Only one hardship restructure is permitted in the life of a loan. After October 1, 2007 hardship restructures were discontinued. Pending hardship restructures were processed through December 31, 2007. (3) Historically, policy changes are not applied to the entire portfolio on the date of implementation but are applied to new, or recently originated or acquired accounts. However, the policies adopted in the third quarter of 2003 for the Mortgage Services business and the fourth quarter of 2004 for the domestic private label (excluding retail sales contracts) and credit card portfolios were applied more broadly. The policy changes for the Mortgage Services business which occurred in the third quarter of 2003, unless otherwise noted, were generally applied to accounts originated or acquired after January 1, 2003 and the historical restructuring policies and practices are effective for all accounts originated or acquired prior to January 1, 2003. Implementation of this uniform policy had the effect of only counting restructures occurring on or after January 1, 2003 in assessing restructure eligibility for the purpose of the limitation that no account may be restructured more than four times in a rolling 60 month period. These policy changes adopted in the third quarter of 2003 did not have a significant impact on our business model or results of operations as the changes are, in effect, phased in as receivables were originated or acquired. For the adoption of FFIEC policies which occurred in the fourth quarter of 2004, the policies were effective immediately for all receivables in the domestic private label credit card and the credit card portfolios. Other business units may also elect to adopt uniform policies in future periods. (4) In some cases, as part of the Consumer Lending Foreclosure Avoidance Program implemented in 2003, accounts may be restructured on receipt of one qualifying payment. In the fourth quarter of 2006, this treatment was extended to accounts that qualified for the Mortgage Services account modification plan, as long as it has been at least six months since such account was originated, even if the account had been restructured in the last twelve months. Such restructures may be in addition to the four collection restructures in a rolling sixty-month period. Accounts receive these restructures after proper verification of the customer's ability to make continued payments. This generally includes the determination and verification of the customer's financial situation. At December 31, 2007 and 2006 Consumer Lending had $981 million and $674 million, respectively, of accounts restructured on receipt of one qualifying payment under the Foreclosure Avoidance Program. At December 31, 2007 and 2006 Mortgage Services had $647 million and $134 million of accounts restructured on receipt of one qualifying payment under the account modification plan. (5) Our Mortgage Services business implemented this policy for all accounts effective March 1, 2004. Effective January 1, 2008 for real estate overall, the program that allowed accounts whose borrowers agree to pay by automatic withdrawal to be restructured upon receipt of one qualifying payment after initial authorization for automatic withdrawal was discontinued. (6) Prior to January 1, 2003, accounts that had made at least six qualifying payments during the life of the loan and that agreed to pay by automatic withdrawal were generally restructured with one qualifying payment. (7) Prior to August 2006, Mortgage Services accounts could not be restructured until nine months after origination and six months after the loan was acquired. (8) For our Canadian business, private label accounts are limited to one restructure every four months and if originated or acquired after January 1, 2003, two qualifying payments must be received, the account must be on the books for at least six months, at least six months must have elapsed since the last restructure, and there may be no more than four restructures in a rolling 60 month period. The tables below summarize approximate restructuring statistics in our managedbasis domestic portfolio. Managed basis assumes that securitized receivableshave not been sold and remain on our balance sheet. We report our restructuringstatistics on a managed basis only because the receivables that we securitizeare subject to underwriting standards comparable to our owned portfolio, aregenerally serviced and collected without regard to ownership and result in asimilar credit loss exposure for us. As the level of our securitized receivableshave fallen over time, managed basis and owned basis results have now largelyconverged. As previously reported, in prior periods we used certain assumptionsand estimates to compile our restructure statistics. The systemic counters usedto compile the information presented below exclude from the reported statisticsloans that have been reported as contractually delinquent but have been reset toa current status because we have determined that the loans should not have beenconsidered delinquent (e.g., payment application processing errors). Whencomparing restructuring statistics from different periods, the fact that ourrestructure policies and practices will change over time, that exceptions aremade to those policies and practices, and that our data capture methodologieshave been enhanced, should be taken into account. 88 HSBC Finance Corporation-------------------------------------------------------------------------------- TOTAL RESTRUCTURED BY RESTRUCTURE PERIOD - DOMESTIC PORTFOLIO(1)(MANAGED BASIS) AT DECEMBER 31, 2007 2006----------------------------------------------------------------------------------Never restructured............................................... 83.6% 89.1%Restructured: Restructured in the last 6 months.............................. 7.3 4.8 Restructured in the last 7-12 months........................... 4.5 2.4 Previously restructured beyond 12 months....................... 4.6 3.7 ----- ----- Total ever restructured........................................ 16.4 10.9 ----- -----Total............................................................ 100.0% 100.0% ===== ===== RESTRUCTURED BY PRODUCT - DOMESTIC PORTFOLIO(1)(MANAGED BASIS) AT DECEMBER 31, 2007 2006------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS)Real estate secured(3)............................... $16,790 19.9% $10,344 11.0%Auto finance......................................... 2,145 16.6 1,881 15.1Credit card.......................................... 788 2.6 816 2.9Private label........................................ 27 18.4 31 10.9Personal non-credit card............................. 4,098 22.7 3,600 19.5 ------- ---- ------- ----Total(2)............................................. $23,848 16.4% $16,672 10.9% ======= ==== ======= ==== -------- (1) Excludes foreign businesses, commercial and other. (2) Total including foreign businesses was 15.8 percent at December 31, 2007 and 10.6 percent at December 31, 2006. (3) The Mortgage Services and Consumer Lending businesses real estate secured restructures are as shown in the following table: DECEMBER 31, DECEMBER 31, 2007 2006------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Mortgage Services....................................... $ 7,682 $ 3,963Consumer Lending........................................ 9,108 6,381 ------- -------Total real estate secured............................... $16,790 $10,344 ======= ======= The increase in restructured loans in 2007 was primarily attributable to highercontractual delinquency due to weak loan performing portfolio growth andseasoning, including our Mortgage Services and Consumer Lending businesses as wecontinue to work with our customers who, in our judgment, evidence continuedpayment probability. Additionally, beginning in the fourth quarter of 2006, weexpanded the use of account modification at our Mortgage Services business tomodify the rate and/or payment on a number of qualifying delinquent loans andrestructured certain of those accounts after receipt of one modified payment andif certain other criteria were met. Such accounts are included in the aboverestructure statistics. At December 31, 2007, we have approximately 6,900accounts in our Mortgage Services real estate secured portfolio andapproximately 18,300 accounts in our Consumer Lending real estate securedportfolio which have been restructured where the delinquency status was resetand whose loan terms were also modified. The outstanding receivable balance ofthese restructured and modified loans was $960 million in our Mortgage Servicesreal estate secured portfolio and $1.9 billion in our Consumer Lending realestate secured portfolio at December 31, 2007. At December 31, 2007 and 2006 ourtwo-months-and-over contractual delinquency included $4.5 billion and $2.5billion respectively of restructured 89 HSBC Finance Corporation-------------------------------------------------------------------------------- accounts that subsequently experienced payment defaults. We anticipate thisnumber will continue to increase as restructure volumes increase as discussedabove. Loans included in the table above which have been granted a permanentmodification, a twelve-month modification, or two or more consecutive six-monthmodifications, are considered troubled debt restructurings for purposes ofdetermining loss reserve estimates under SFAS No. 114, "Accounting by Creditorsfor Impairment of a Loan." For additional information related to our troubleddebt restructurings, see Note 6, "Receivables," to our accompanying consolidatedfinancial statements. See "Credit Quality Statistics" for further information regarding owned basisdelinquency, charge-offs and nonperforming loans. In addition to our restructuring policies and practices, we employ othercustomer account management techniques that are similarly designed to managecustomer relationships, maximize collection opportunities and avoid foreclosureor repossession if reasonably possible. These additional customer accountmanagement techniques include, at our discretion, actions such as extendedpayment arrangements, approved external debt management plans, forbearance,modifications, loan rewrites and/or deferment pending a change in circumstances.We typically use these customer account management techniques with individualborrowers in transitional situations, usually involving borrower hardshipcircumstances or temporary setbacks that are expected to affect the borrower'sability to pay the contractually specified amount for some period of time. Forexample, under a forbearance agreement, we may agree not to take certaincollection or credit agency reporting actions with respect to missed payments,often in return for the borrower's agreeing to pay us an additional amount withfuture required payments. In some cases, these additional customer accountmanagement techniques may involve us agreeing to lower the contractual paymentamount and/or reduce the periodic interest rate. In most cases, the delinquencystatus of an account is considered to be current if the borrower immediatelybegins payment under the new account terms. We are actively using loanmodifications followed by an account restructure if the borrower makes one ormore modified payments in response to increased volumes within our delinquentMortgage Services portfolio. This account management practice is designed toassist borrowers who may have purchased a home with an expectation of continuedreal estate appreciation or income that has proven unfounded. The amount of domestic and foreign managed receivables in forbearance,modification, rewrites, modifications or other customer account managementtechniques for which we have reset delinquency and that is not included in therestructured or delinquency statistics was approximately $.3 billion or .2percent of managed receivables at December 31, 2007 and 2006. When we use a customer account management technique, we may treat the account asbeing contractually current and will not reflect it as a delinquent account inour delinquency statistics. However, if the account subsequently experiencespayment defaults, it will again become contractually delinquent. We generallyconsider loan rewrites to involve an extension of a new loan, and such new loansare not reflected in our delinquency or restructuring statistics. Our accountmanagement actions vary by product and are under continual review and assessmentto determine that they meet the goals outlined above. As part of our risk mitigation efforts relating to the affected components ofthe Mortgage Services portfolio, in October 2006 we established a new programspecifically designed to meet the needs of select customers with ARMs. We areproactively writing and calling customers who have adjustable rate mortgageloans nearing the first reset that we expect will be the most impacted by a rateadjustment. Through a variety of means, we assess their ability to make theadjusted payment and, as appropriate and in accordance with defined policies, wemodify the loans, allowing time for the customer to seek alternative financingor improve their individual situation. These loan modifications primarilyinvolve a twelve-month temporary interest rate relief by either maintaining thecurrent interest rate for the entire twelve-month period or resetting theinterest rate for the twelve-month period to a rate lower than originallyrequired at the first reset date. At the end of the twelve-month period, theinterest rate on the loan will reset in accordance with the original loan termsunless the borrower qualifies for and is granted a new modification. In 2007, wehave made more than 33,000 outbound contacts and modified more than 8,500 loanswith an aggregate balance of $1.4 billion. Since the inception of this programwe have made more than 41,000 outbound 90 HSBC Finance Corporation-------------------------------------------------------------------------------- contacts and modified more than 10,300 loans with an aggregate balance of $1.6billion. These loans are not included in the table above, as we have not resetdelinquency on these loans as they were not contractually delinquent at the timeof the modification. However, if the loan had been restructured in the past forother reasons, it is included in the table above. We also continue to manage aForeclosure Avoidance Program for delinquent Consumer Lending customers designedto provide relief to qualifying homeowners through either loan restructuring ormodification. We also support a variety of national and local efforts inhomeownership preservation and foreclosure avoidance. GEOGRAPHIC CONCENTRATIONS The following table reflects the percentage ofdomestic consumer receivables by state which individually account for 5 percentor greater of our domestic portfolio. PERCENT OF TOTAL DOMESTICSTATE RECEIVABLES------------------------------------------------------------------------------------California........................................................ 12%Florida........................................................... 7New York.......................................................... 6Ohio.............................................................. 5Pennsylvania...................................................... 5Texas............................................................. 5 Because of our centralized underwriting, collections and processing functions,we can quickly change our credit standards and intensify collection efforts inspecific locations. We believe this lowers risks resulting from such geographicconcentrations. Our foreign consumer operations located in the United Kingdom and the Republicof Ireland accounted for 3 percent of consumer receivables and Canada accountedfor 3 percent of consumer receivables at December 31, 2007. LIQUIDITY AND CAPITAL RESOURCES-------------------------------------------------------------------------------- While the funding synergies resulting from our acquisition by HSBC have allowedus to reduce our reliance on traditional sources to fund our asset levels, ourcontinued success is dependent upon access to the global capital markets.Numerous factors, internal and external, may impact our access to and the costsassociated with issuing debt in these markets. These factors may include ourdebt ratings, overall capital markets volatility and the impact of overalleconomic conditions on our business. We continue to focus on balancing our useof affiliate and third-party funding sources to minimize funding expense whilemaximizing liquidity. As discussed below, we supplemented unsecured debtissuance during 2007 and 2006 with proceeds from the continuing sale of newlyoriginated domestic private label receivables (excluding retail sales contracts)to HSBC Bank USA, debt issued to affiliates, the issuance of additional commonequity to HINO and, in 2007, the sale of $2.7 billion of loans from our MortgageServices loan portfolio. 91 HSBC Finance Corporation-------------------------------------------------------------------------------- Debt due to affiliates and other HSBC related funding are summarized in thefollowing table: DECEMBER 31, 2007 2006---------------------------------------------------------------------------------- (IN BILLIONS)Debt outstanding to HSBC subsidiaries: Drawings on bank lines in the U.K. and Europe.................. $ 3.5 $ 4.3 Term debt...................................................... 11.1 10.6 Preferred securities issued by Household Capital Trust VIII to HSBC........................................................ .3 .3 ----- ----- Total debt outstanding to HSBC subsidiaries.................... 14.9 15.2 ----- -----Debt outstanding to HSBC clients: Euro commercial paper.......................................... 2.0 3.0 Term debt...................................................... .8 1.2 ----- ----- Total debt outstanding to HSBC clients......................... 2.8 4.2Cash received on bulk and subsequent sale of domestic private label credit card receivables to HSBC Bank USA, net (cumulative)................................................... 19.2 17.9Real estate secured receivable activity with HSBC Bank USA: Cash received on sales (cumulative)............................ 3.7 3.7 Direct purchases from correspondents (cumulative).............. 4.2 4.2 Reductions in real estate secured receivables sold to HSBC Bank USA......................................................... (5.4) (4.7) ----- -----Total real estate secured receivable activity with HSBC Bank USA............................................................ 2.5 3.2Cash received from sale of European Operations to HBEU affiliate...................................................... -((2)) -(2)Cash received from sale of U.K. credit card business to HBEU..... 2.7 2.7Capital contribution by HINO..................................... 2.4(1) 1.4(1) ----- -----Total HSBC related funding....................................... $44.5 $44.6 ===== ===== -------- (1) Capital contributions were made in 2007 to support ongoing operations and in 2006 in connection with our acquisition of the Champion portfolio. (2) Less than $100 million. At December 31, 2007 and 2006, funding from HSBC, including debt issuances toHSBC subsidiaries and clients, represented 13 percent of our total debt andpreferred stock funding. Cash proceeds of $2.7 billion during 2007 from the sale of loans from ourMortgage Services loan portfolio and $206 million from the November 2007 sale ofthe U.K. Insurance Operations were used to partially pay down drawings on banklines from HBEU for the U.K. Cash proceeds of $46 million from the November 2006sale of the European Operations and $2.7 billion from the December 2005 sale ofour U.K. credit card receivables to HBEU were used to partially pay downdrawings on bank lines from HBEU for the U.K. Proceeds received from the bulksale and subsequent daily sales of domestic private label credit cardreceivables to HSBC Bank USA of $19.2 billion were used to pay down short-termdomestic borrowings, including outstanding commercial paper balances. Proceedsfrom each of these transactions were also used to fund ongoing operations. At December 31, 2007 and 2006, we had a commercial paper back stop creditfacility of $2.5 billion from HSBC supporting domestic issuances and a revolvingcredit facility of $5.7 billion from HBEU to fund our operations in the U.K. InJanuary 2008, the revolving credit facility from HBEU decreased to $4.5 billion.At December 31, 2007, $3.5 billion was outstanding under the HBEU lines for theU.K. and no balances were outstanding under the domestic lines. At December 31,2006, $4.3 billion was outstanding under the HBEU lines for the U.K. and nobalances were outstanding under the domestic lines. We had derivative contractswith a notional value of $91.8 billion, or approximately 97 percent of totalderivative contracts, outstanding with HSBC affiliates at 92 HSBC Finance Corporation-------------------------------------------------------------------------------- December 31, 2007. We had derivative contracts with a notional value of $87.4billion, or approximately 93 percent of total derivative contracts, outstandingwith HSBC affiliates at December 31, 2006. SECURITIES AND OTHER SHORT-TERM INVESTMENTS Securities totaled $3.2 billion atDecember 31, 2007 and $4.7 billion at December 31, 2006. Securities purchasedunder agreements to resell totaled $1.5 billion at December 31, 2007 and $171million at December 31, 2006. Interest bearing deposits with banks totaled $335million at December 31, 2007 and $424 million at December 31, 2006. The decreasein securities and interest bearing deposits with banks is due to the sale of theU.K. Insurance Operations which had securities and interest bearing depositswith banks of $441 million at the time of the sale as well as the use of moneymarket funds of $854 million at December 31, 2006 to pay down secured financingsduring 2007. The increase in securities purchased under agreements to resell isdue to the decision to generate additional liquidity based on current marketconditions. COMMERCIAL PAPER, BANK AND OTHER BORROWINGS totaled $8.4 billion at December 31,2007 and $11.1 billion at December 31, 2006. Included in this total wasoutstanding Euro commercial paper sold to customers of HSBC of $2.0 billion atDecember 31, 2007 and $3.0 billion at December 31, 2006. Commercial paperbalances were lower at December 31, 2007 as a result of lower short term fundingrequirements due to a reduction in the overall size of the balance sheet. Ourfunding strategy requires that committed bank credit facilities will at alltimes exceed 80 percent of outstanding commercial paper and that the combinationof bank credit facilities and undrawn committed conduit facilities will, at alltimes, exceed 115 percent of outstanding commercial paper. LONG TERM DEBT (with original maturities over one year) decreased to $123.3billion at December 31, 2007 from $127.6 billion at December 31, 2006.Significant issuances during 2007 included the following: - $.4 billion of domestic and foreign medium-term notes - $2.4 billion of foreign currency-denominated bonds - $1.2 billion of InterNotes(SM) (retail-oriented medium-term notes) - $4.0 billion of global debt - $10.4 billion of securities backed by real estate secured, auto finance, credit card and personal non-credit card receivables. For accounting purposes, these transactions were structured as secured financings. In the first quarter of 2006, we redeemed the junior subordinated notes, issuedto Household Capital Trust VI with an outstanding principal balance of $206million. In the fourth quarter of 2006 we redeemed the junior subordinatednotes, issued to Household Capital Trust VII with an outstanding principalbalance of $206 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 are non-cumulative and payable quarterly at a rate of 6.36 percent commencing September15, 2005. The Series B Preferred Stock may be redeemed at our option after June23, 2010. In 2007 and 2006, we paid dividends each year totaling $37 million onthe Series B Preferred Stock. COMMON EQUITY In the first quarter of 2007, HINO made a capital contribution of$200 million and in the fourth quarter of 2007 made an additional capitalcontribution of $750 million, each in exchange for one share of common stock.These capital contributions were to support ongoing operations and to maintaincapital at levels we believe are prudent in the current market conditions. In2006, in connection with our purchase of the Champion portfolio, HINO made acapital contribution of $163 million. Subsequent to December 31, 2007, HINO madea capital contribution of $1.6 billion in exchange for one share of commonstock. SELECTED CAPITAL RATIOS In managing capital, we develop targets for tangibleshareholder's(s') equity plus owned loss reserves to tangible managed assets("TETMA + Owned Reserves") and tangible common equity to tangible managed assetsexcluding HSBC acquisition purchase accounting adjustments. These ratio targetsare based on discussions with HSBC and rating agencies, risks inherent in theportfolio, the projected operating environment and related risks, and anyacquisition objectives. We and certain rating agencies monitor ratios excludingthe impact of the HSBC acquisition purchase accounting adjustments as we believethat they represent non-cash transactions which do not affect our businessoperations, cash flows or ability to meet our debt obligations. These ratiosalso exclude the equity impact of SFAS No. 115, "Accounting for CertainInvestments in Debt and Equity Securities," 93 HSBC Finance Corporation-------------------------------------------------------------------------------- the equity impact of SFAS No. 133, "Accounting for Derivative Instruments andHedging Activities," and the impact of the adoption of SFAS No. 159, "The FairValue Option for Financial Assets and Liabilities," including the subsequentchanges in fair value recognized in earnings associated with debt for which weelected the fair value option and the related derivatives. Preferred securitiesissued by certain non-consolidated trusts are also considered equity in theTETMA + Owned Reserves calculations because of their long-term subordinatednature and our ability to defer dividends. Managed assets include owned assetsplus loans which we have sold and service with limited recourse. Our targets maychange from time to time to accommodate changes in the operating environment orother considerations such as those listed above. In the fourth quarter of 2007,Moody's, Standard & Poor's and Fitch changed the total outlook on our issuerdefault rating from "positive" to "stable." Selected capital ratios are summarized in the following table: DECEMBER 31, 2007 2006----------------------------------------------------------------------------------TETMA + Owned Reserves(1),(2).................................... 13.98% 11.02%Tangible common equity to tangible managed assets(1)............. 6.09 6.08Common and preferred equity to owned assets...................... 8.56 11.21Excluding HSBC acquisition purchase accounting adjustments: TETMA + Owned Reserves(1),..................................... 14.18 11.67 Tangible common equity to tangible managed assets(1),(2)....... 6.27 6.72 -------- (1) TETMA + Owned Reserves and tangible common equity to tangible managed assets excluding HSBC acquisition purchase accounting adjustments represent non-U.S. GAAP financial ratios that are used by HSBC Finance Corporation management and applicable 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-U.S. GAAP financial measures and "Reconciliations to U.S. GAAP Financial Measures" for quantitative reconciliations to the equivalent U.S. GAAP basis financial measure. (2) On a proforma basis, if the capital contribution on February 12, 2008 of $1.6 billion had instead been received on December 31, 2007, our TETMA + Owned Reserves ratio would have been 99 basis points higher and our tangible common equity to tangible managed assets ratio, excluding HSBC acquisition purchase accounting adjustments would have been 99 basis points higher. HSBC FINANCE CORPORATION. HSBC Finance Corporation is an indirect wholly ownedsubsidiary of HSBC Holdings plc. On March 28, 2003, HSBC acquired HouseholdInternational, Inc. by way of merger in a purchase business combination.Effective January 1, 2004, HSBC transferred its ownership interest in Householdto a wholly owned subsidiary, HSBC North America Holdings Inc., whichsubsequently contributed Household to its wholly owned subsidiary, HINO. OnDecember 15, 2004, Household merged with its wholly owned subsidiary, HouseholdFinance Corporation, with Household as the surviving entity. At the time of themerger, Household changed its name to "HSBC Finance Corporation." HSBC Finance Corporation is the parent company that owns the outstanding commonstock of its subsidiaries. Our main source of funds is cash received fromoperations and subsidiaries in the form of dividends. In addition, we receivecash from third parties and affiliates by issuing preferred stock and debt. HSBC Finance Corporation received cash dividends from its subsidiaries of $169million in 2007 and $74 million in 2006. In conjunction with the acquisition by HSBC, we issued a series of 6.50 percentcumulative preferred stock in the amount of $1.1 billion ("Series A PreferredStock") to HSBC on March 28, 2003. In September 2004, HSBC North America issueda new series of preferred stock totaling $1.1 billion to HSBC in exchange forour Series A Preferred Stock. In October 2004, our immediate parent, HINO,issued a new series of preferred stock to HSBC North America in exchange for ourSeries A Preferred Stock. On December 15, 2005, we issued 4 shares of commonstock to HINO in exchange for the $1.1 billion Series A Preferred Stock plus theaccrued and unpaid dividends and the Series A Preferred Stock was retired. 94 HSBC Finance Corporation-------------------------------------------------------------------------------- In November 2005, we issued $1.0 billion of preferred securities of HouseholdCapital Trust IX. The interest rate on these securities is 5.911% from the dateof issuance through November 30, 2015 and is payable semiannually beginning May30, 2006. After November 30, 2015, the rate changes to the three-month LIBORrate, plus 1.926% and is payable quarterly beginning on February 28, 2016. InJune 2005, we redeemed the junior subordinated notes issued to the HouseholdCapital Trust V with an outstanding principal balance of $309 million. In June 2005, we issued 575,000 shares of Series B Preferred Stock for $575million. Dividends on the Series B Preferred Stock are non-cumulative andpayable quarterly at a rate of 6.36 percent commencing September 15, 2005. TheSeries B Preferred Stock may be redeemed at our option after June 23, 2010. In2007 and 2006, we paid dividends each year totaling $37 million on the Series BPreferred Stock. HSBC Finance Corporation has a number of obligations to meet with its availablecash. It must be able to service its debt and meet the capital needs of itssubsidiaries. It also must pay dividends on its preferred stock and may paydividends on its common stock. Dividends of $812 million were paid to HINO, ourimmediate parent company, on our common stock in 2007 and $809 million were paidin 2006. We anticipate paying future dividends to HINO, but will maintain ourcapital at levels that we perceive to be consistent with our current ratingseither by limiting the dividends to or through capital contributions from ourparent. At various times, we will make capital contributions to our subsidiaries tocomply with regulatory guidance, support receivable growth, maintain acceptableinvestment grade ratings at the subsidiary level, or provide funding for long-term facilities and technology improvements. HSBC Finance Corporation madecapital contributions to certain subsidiaries of $.5 billion in 2007 and $1.5billion in 2006. SUBSIDIARIES At December 31, 2007, HSBC Finance Corporation had one majorsubsidiary, Household Global Funding ("Global Funding") which holds allinternational operations. Prior to December 15, 2004, we had two majorsubsidiaries: Household Finance Corporation ("HFC"), which managed all domesticoperations, and Global Funding. On December 15, 2004, HFC merged with and intoHousehold International which changed its name to HSBC Finance Corporation. DOMESTIC OPERATIONS HSBC Finance Corporation manages all domestic operationsdirectly and funds these businesses primarily through the collection ofreceivable balances; issuing commercial paper, medium-term debt and long-termdebt; borrowing under secured financing facilities and selling consumerreceivables. Domestically, HSBC Finance Corporation markets its commercial paperprimarily through an in-house sales force. The vast majority of our domesticmedium-term notes and long-term debt is now marketed through subsidiaries ofHSBC. Intermediate and long-term debt may also be marketed through unaffiliatedinvestment banks. At December 31, 2007, advances from subsidiaries of HSBC for our domesticoperations totaled $11.1 billion. At December 31, 2006, advances fromsubsidiaries of HSBC for our domestic operations totaled $10.6 billion. Theinterest rates on funding from HSBC subsidiaries are market-based and comparableto those available from unaffiliated parties. Outstanding commercial paper related to our domestic operations totaled $7.8billion at December 31, 2007 and $10.8 billion at December 31, 2006. Following our acquisition by HSBC, we established a new Euro commercial paperprogram, largely targeted towards HSBC clients, which expanded our Europeaninvestor base. Under the Euro commercial paper program, commercial paperdenominated in Euros, British pounds, Swiss francs and U.S. dollars is sold toforeign investors. Outstanding Euro commercial paper sold to customers of HSBCtotaled $2.0 billion at December 31, 2007 and $3.0 billion at December 31, 2006.The decrease in Euro commercial paper outstanding was due to a cost differentialthat made domestic commercial paper a more cost efficient source of funding. Weactively manage the level of commercial paper outstanding to ensure availabilityto core investors while maintaining excess capacity within our internally-established targets as communicated with the rating agencies. 95 HSBC Finance Corporation-------------------------------------------------------------------------------- The following table shows various debt issuances by HSBC Finance Corporation andits domestic subsidiaries during 2007 and 2006. 2007 2006-------------------------------------------------------------------------------- (IN BILLIONS)Medium term notes, excluding issuances to HSBC customers and subsidiaries of HSBC........................................... $ - $ 6.0Medium term notes issued to subsidiaries of HSBC................. 1.1 .8Foreign currency-denominated bonds, excluding issuances to HSBC customers and subsidiaries of HSBC............................. 2.4 7.9Global debt...................................................... 4.0 9.3InterNotes(SM) (retail-oriented medium-term notes)............... 1.2 1.8Securities backed by real estate secured, auto finance, credit card and personal non-credit card receivables structured as secured financings............................................. 10.4 14.9 In order to eliminate future foreign exchange risk, currency swaps were used atthe time of issuance to fix in U.S. dollars substantially all foreign-denominated notes in 2007 and 2006. HSBC Finance Corporation issued securities backed by dedicated receivables of$10.4 billion in 2007 and $14.9 billion in 2006. For accounting purposes, thesetransactions were structured as secured financings, therefore, the receivablesand the related debt remain on our balance sheet. At December 31, 2007, closed-end real estate secured, auto finance, credit card and personal non-credit cardreceivables totaling $30.9 billion secured $23.2 billion of outstanding debt. AtDecember 31, 2006, closed-end real estate secured, auto finance, credit card andpersonal non-credit card receivables totaling $28.1 billion secured $21.8billion of outstanding debt. HSBC Finance Corporation had committed back-up lines of credit totaling $11.7billion at December 31, 2007 for its domestic operations. Included in theDecember 31, 2007 total are $2.5 billion of revolving credit facilities withHSBC. None of these back-up lines were drawn upon in 2007. The back-up linesexpire on various dates through 2010. The most restrictive financial covenantcontained in the back-up line agreements that could restrict availability is anobligation to maintain a minimum shareholder's(s') equity plus the outstandingtrust preferred stock of $11.0 billion. At December 31, 2007, minimumshareholder's(s') equity balance plus outstanding trust preferred stock was$15.4 billion which is substantially above the required minimum balance. In2008, $2.9 billion of back-up lines from third parties are scheduled to expire.Due to the condition of the subprime credit markets, we anticipate a portion ofthese lines will not be renewed. We do not expect this reduction will have asignificant impact on the availability of short term funding. At December 31, 2007, we had conduit credit facilities with commercial andinvestment banks under which our domestic operations may issue securities backedwith up to $17.4 billion of receivables, including up to $14.2 billion of autofinance, credit card and personal non-credit card and $3.2 billion of realestate secured receivables. Our total conduit capacity decreased by $1.6 billionin 2007. Conduit capacity for real estate secured receivables was decreased $.7billion and capacity for other products was decreased $.9 billion. Thesereductions are primarily the result of decisions by the providing institutionsto reduce their overall exposure to subprime receivables. The facilities arerenewable at the banks' option. At December 31, 2007, $11.2 billion of autofinance, credit card, personal non-credit card and real estate securedreceivables were used in collateralized funding transactions structured eitheras securitizations or secured financings under these funding programs. Theamount available under the facilities will vary based on the timing and volumeof public securitization transactions. We also anticipate a reduction in theavailable conduit credit facilities as they mature throughout 2008 due tocontinuing concerns about subprime credit quality. For the conduit creditfacilities that do renew, credit performance requirements will be morerestrictive and pricing will increase to reflect the quality of the underlyingassets. Our 2008 funding plan incorporates the anticipated reductions in thesefacilities. 96 HSBC Finance Corporation-------------------------------------------------------------------------------- GLOBAL FUNDING Global Funding includes our foreign subsidiaries in the UnitedKingdom, the Republic of Ireland and Canada. Global Funding's assets were $10.8billion at December 31, 2007 and $10.9 billion at December 31, 2006.Consolidated shareholder's equity includes the effect of translating our foreignsubsidiaries' assets, liabilities and operating results from their localcurrency into U.S. dollars. Each foreign subsidiary conducts its operations using its local currency. Whileeach foreign subsidiary usually borrows funds in its local currency, both ourUnited Kingdom and Canadian subsidiaries have historically borrowed funds inforeign currencies. This allowed the subsidiaries to achieve a lower cost offunds than that available at that time in their local markets. These borrowingswere converted from foreign currencies to their local currencies using currencyswaps at the time of issuance. UNITED KINGDOM Our United Kingdom operation is funded with HBEU debt andpreviously issued long-term debt. The following table summarizes the funding ofour United Kingdom operation: 2007 2006-------------------------------------------------------------------------------- (IN BILLIONS)Due to HSBC affiliates............................................. $3.5 $4.3Long term debt..................................................... .2 .2 At December 31, 2007, $.2 billion of long term debt was guaranteed by HSBCFinance Corporation. HSBC Finance Corporation receives a fee for providing theguarantee. In 2007 and 2006, our United Kingdom subsidiary primarily receivedits funding directly from HSBC. As previously discussed, in November 2007, we sold our U.K. Insurance Operationsto Aviva for approximately $206 million and used the proceeds to partially paydown amounts due to HBEU on bank lines in the U.K. Additionally, in November2006, our U.K. operations sold its European Operations to a subsidiary of HBEUfor total consideration of $46 million and used the proceeds to partially paydown amounts due to HBEU on bank lines in the U.K. CANADA Our Canadian operation is funded with commercial paper, intermediate andlong-term debt. Outstanding commercial paper totaled $673 million at December31, 2007 compared to $223 million at December 31, 2006. Given disruptions in theCanadian debt markets in the second half of 2007, we elected to increase thelevel of funding generated through commercial paper issuance. We anticipatereducing the level of Canadian commercial paper outstanding over the first halfof 2008. Intermediate and long-term debt totaled $4.1 billion at December 31,2007 compared to $3.4 billion at December 31, 2006. At December 31, 2007, $4.8billion of the Canadian subsidiary's debt was guaranteed by HSBC FinanceCorporation for which it receives a fee for providing the guarantee. Committedback-up lines of credit for Canada were approximately $102 million at December31, 2007. All of these back-up lines are guaranteed by HSBC Finance Corporationand none were used in 2007. In 2007, our Canadian operations declared a dividendof $51 million to be paid to HSBC Finance Corporation in 2008. 97 HSBC Finance Corporation-------------------------------------------------------------------------------- 2008 FUNDING STRATEGY As discussed previously, the acquisition by HSBC markedlyimproved 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 2008 are summarized in the table that follows. (IN BILLIONS)------------------------------------------------------------------------------------FUNDING NEEDS: Net asset growth/(attrition)..................................... (18) - (10) Commercial paper and term debt maturities........................ 26 - 28 Secured financings and conduit facility maturities............... 12 - 16 Other............................................................ (1) - 3 -----------Total funding needs................................................ $19 - 37 ===========FUNDING SOURCES: Commercial paper and term debt issuance.......................... 7 - 19 Secured financings and conduit facility renewals................. 12 - 16 HSBC and HSBC subsidiaries....................................... 0 - 2 -----------Total funding sources.............................................. $19 - 37 =========== As previously discussed, we have experienced deterioration in the performance ofmortgage loan originations in our Mortgage Services and Consumer Lendingbusinesses. As a result in 2007, we decided to discontinue new correspondentchannel acquisitions and cease operations of Decision One. Additionally, we haveeliminated certain product offerings and tightened underwriting criteria in ourConsumer Lending business. These actions, combined with normal portfolioattrition and risk mitigation efforts, will result in a continued reduction inour aggregate portfolio in 2008. As opportunities arise, we may also considerthe possibility of selling selected portfolios, similar to the $2.7 billionsales of real estate secured receivables completed in 2007. Constrained riskappetite as well as any decisions to sell selected portfolios will result inattrition in the balance sheet during 2008. Commercial paper outstanding in 2008 is expected to be lower than 2007 balances,except during the first three months of 2008 when commercial paper balances willbe temporarily high due to the seasonal activity of our TFS business. Themajority of outstanding commercial paper is expected to be directly placed,domestic commercial paper. Euro commercial paper will continue to be marketedpredominately to HSBC clients. Term debt issuances are expected to utilize several ongoing programs to achievethe desired funding in 2008. Approximately 79 percent of term debt funding isexpected to be achieved through transactions including U.S. dollar global andEuro transactions and large medium-term note ("MTN") offerings. Domestic retailnote programs are expected to account for approximately 11 percent of term debtissuances. The remaining term debt issuances are expected to consist of smallerdomestic and foreign currency MTN offerings. HSBC received regulatory approval in 2003 to provide the direct funding requiredby our United Kingdom operations. Accordingly, in 2004 we eliminated all back-uplines of credit which had previously supported our United Kingdom subsidiary.All new funding for our United Kingdom subsidiary is now provided directly byHSBC. Our Canadian operation will continue to fund itself independently throughtraditional third-party funding sources such as commercial paper and mediumterm-notes. Canadian funding needs in 2008 are expected to be in line with 2007levels. CAPITAL EXPENDITURES We made capital expenditures of $135 million in 2007 whichincluded costs related to the new office building in the Village of Mettawa,Illinois of $89 million. Capital expenditures in 2006 were $102 million whichincluded costs related to the new office building in the Village of Mettawa,Illinois of $29 million. 98 HSBC Finance Corporation-------------------------------------------------------------------------------- COMMITMENTS We also enter into commitments to meet the financing needs of ourcustomers. In most cases, we have the ability to reduce or eliminate these openlines of credit. As a result, the amounts below do not necessarily representfuture cash requirements at December 31, 2007: (IN BILLIONS)-----------------------------------------------------------------------------------Private label, and credit cards..................................... 162Other consumer lines of credit...................................... 9 ----Open lines of credit(1)............................................. $171 ==== -------- (1) Includes an estimate for acceptance of credit offers mailed to potential customers prior to December 31, 2007. In January 2008, we extended a line of credit to H&R Block for up to $3.0billion to fund the purchase of a participation interest in refund anticipationloans. This available credit outstanding under this line will step down to $120million as of March 30, 2008 and expires on June 30, 2008. Additionally, in theevent the balance outstanding under this line of credit falls below $60 million,the line of credit may be terminated earlier. CONTRACTUAL CASH OBLIGATIONS The following table summarizes our long-termcontractual cash obligations at December 31, 2007 by period due: 2008 2009 2010 2011 2012 THEREAFTER TOTAL------------------------------------------------------------------------------------------------------------ (IN MILLIONS)PRINCIPAL BALANCE OF DEBT: Due to affiliates.......... $ 3,543 $ 2,031 $ 1,551 $ 619 $ 1,250 $ 5,908 $ 14,902 Long term debt (including secured financings)..... 32,844 23,821 15,773 12,808 11,443 26,759 123,448 ------- ------- ------- ------- ------- ------- -------- Total debt................. 36,387 25,852 17,324 13,427 12,693 32,667 138,350 ------- ------- ------- ------- ------- ------- --------OPERATING LEASES: Minimum rental payments.... 161 127 94 61 34 107 584 Minimum sublease income.... 37 27 15 5 2 - 86 ------- ------- ------- ------- ------- ------- -------- Total operating leases..... 124 100 79 56 32 107 498 ------- ------- ------- ------- ------- ------- --------OBLIGATIONS UNDER MERCHANT AND AFFINITY PROGRAMS...... 139 126 124 119 117 339 964NON-QUALIFIED PENSION AND POSTRETIREMENT BENEFIT LIABILITIES(1)............. 31 27 36 36 40 993 1,163 ------- ------- ------- ------- ------- ------- --------TOTAL CONTRACTUAL CASH OBLIGATIONS................ $36,681 $26,105 $17,563 $13,638 $12,882 $34,106 $140,975 ======= ======= ======= ======= ======= ======= ======== -------- (1) Expected benefit payments calculated include future service component. These cash obligations could be funded primarily through cash collections onreceivables, from the issuance of new unsecured debt or through securedfinancings of receivables. Our receivables and other liquid assets generallyhave shorter lives than the liabilities used to fund them. 99 HSBC Finance Corporation-------------------------------------------------------------------------------- In January 2006, we entered into a lease for a building in the Village ofMettawa, Illinois. The new facility will consolidate our Prospect Heights, MountProspect and Deerfield offices. Construction of the building began in the springof 2006 and the relocation is planned for the first and second quarters of 2008.The future lease payments for this building are currently estimated as follows: (IN MILLIONS)-----------------------------------------------------------------------------------2008................................................................ $ 52009................................................................ 112010................................................................ 112011................................................................ 11Thereafter.......................................................... 115 ---- $153 ==== Our purchase obligations for goods and services at December 31, 2007 were notsignificant. OFF BALANCE SHEET ARRANGEMENTS AND SECURED FINANCINGS-------------------------------------------------------------------------------- SECURITIZATIONS AND SECURED FINANCINGS Securitizations (collateralized fundingtransactions structured to receive sale treatment under Statement of FinancialAccounting Standards No. 140, "Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities, a Replacement of FASBStatement No. 125," ("SFAS No. 140")) and secured financings (collateralizedfunding transactions which do not receive sale treatment under SFAS No. 140) ofconsumer receivables have been a source of funding and liquidity for us.Securitizations and secured financings have been used to limit our reliance onthe unsecured debt markets and can be more cost-effective sources of alternativefunds. 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, an interest-only strip receivable is recorded, representing the present value of the cashflows we expect to receive over the life of the securitized receivables, net ofestimated credit losses and debt service. Under the terms of thesecuritizations, we receive annual servicing fees on the outstanding balance ofthe securitized receivables and the rights to future residual cash flows on thesold 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. Certain securitization trusts, such as credit cards, are established at fixedlevels and, due to the revolving nature of the underlying receivables, requirethe sale of new receivables into the trust to replace runoff so that theprincipal dollar amount of the investors' interest remains unchanged. We referto such activity as replenishments. Once the revolving period ends, theamortization period begins and the trust distributes principal payments, inaddition to interest, to the investors. When loans are securitized in transactions structured as sales, we receive cashproceeds from investors, net of transaction costs and expenses. These proceedsare generally used to re-pay other debt and corporate obligations and to fundnew loans. The investors' shares of finance charges and fees received from thesecuritized loans are collected each month and are primarily used to payinvestors for interest and credit losses and to pay us for servicing fees. Weretain any excess cash flow remaining after such payments are made to investors. Generally, for each securitization and secured financing we utilize creditenhancement to obtain investment grade ratings on the securities issued by thetrust. To ensure that adequate funds are available to pay investors theircontractual return, we may retain various forms of interests in assets securinga funding transaction, whether structured as a securitization or a securedfinancing, such as over-collateralization, subordinated series, residual 100 HSBC Finance Corporation-------------------------------------------------------------------------------- interests in the receivables (in the case of securitizations) or we may fundcash accounts. Over-collateralization is created by transferring receivables tothe trust issuing the securities that exceed the balance of the securities to beissued. Subordinated interests provide additional assurance of payment toinvestors holding senior securities. Residual interests are also referred to asinterest-only strip receivables and represent rights to future cash flows fromreceivables in a securitization trust after investors receive their contractualreturn. Cash accounts can be funded by an initial deposit at the time thetransaction is established and/or from interest payments on the receivables thatexceed the investor's contractual return. Our retained securitization interests are included in receivables on ourconsolidated balance sheets. These retained interests were comprised of thefollowing at December 31, 2007 and 2006: AT DECEMBER 31, ------------- 2007 2006--------------------------------------------------------------------------------- (IN MILLIONS)Overcollateralization............................................. $16 $ 52Interest-only strip receivables................................... - 6Cash spread accounts.............................................. 2 40Other subordinated interests...................................... - 870 --- ----Total retained securitization interests........................... $18 $968 === ==== 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 which 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. Securitizations are treated as secured financings under both IFRS and U.K. GAAP.In order to align our accounting treatment with that of HSBC initially underU.K. GAAP and now under IFRS, we began to structure all new collateralizedfunding transactions as secured financings in the third quarter of 2004.However, because existing public credit card transactions were structured assales to revolving trusts that require replenishments of receivables to supportpreviously issued securities, receivables continued to be sold to these trustsand the resulting replenishment gains recorded until the revolving periodsended, the last of which occurred in September of 2007. The termination of saletreatment on new collateralized funding activity reduced our reported net incomeunder U.S. GAAP. There was no impact, however, on cash received from operations. 101 HSBC Finance Corporation-------------------------------------------------------------------------------- Replenishment securitizations and secured financings were as follows: YEAR ENDED DECEMBER 31, -------------------------- 2007 2006 2005------------------------------------------------------------------------------------ (IN MILLIONS)REPLENISHMENT SECURITIZATIONS:Credit card............................................. $ 1,540 $ 2,469 $8,620Personal non-credit card................................ 5 71 211 ------- ------- ------Total................................................... $ 1,545 $ 2,540 $8,831 ======= ======= ======SECURED FINANCINGS:Real estate secured..................................... $ 3,283 $ 4,767 $4,516Auto finance............................................ 1,596 2,843 3,418Credit card............................................. 4,168 4,745 1,785Personal non-credit card................................ 1,310 2,500 - ------- ------- ------Total................................................... $10,357 $14,855 $9,719 ======= ======= ====== Additionally, as part of the Metris acquisition in 2005, we assumed $4.6 billionof securities backed by credit card receivables which we restructured so thatthey are now accounted for as secured financings. Outstanding securitized receivables consisted of the following: AT DECEMBER 31, ----------- 2007 2006------------------------------------------------------------------------------- (IN MILLIONS)Auto finance...................................................... $ - $271Credit card....................................................... 124 500Personal non-credit card.......................................... - 178 ---- ----Total............................................................. $124 $949 ==== ==== Our remaining securitized receivable credit card trust began its amortizationperiod in October 2007 and was fully amortized in January 2008. The securities issued in connection with collateralized funding transactions maypay off sooner than originally scheduled if certain events occur. For certainauto and personal non-credit card transactions, early payoff of securities mayoccur if established delinquency or loss levels are exceeded or if certain otherevents occur. For all other transactions, early payoff of the securities beginsif the annualized portfolio yield drops below a base rate or if certain otherevents occur. Presently we do not anticipate that any early payoff will takeplace. If early payoff occurred, our funding requirements would increase. Theseadditional requirements could be met through issuance of various types of debtor borrowings under existing back-up lines of credit. We believe we wouldcontinue to have adequate sources of funds if an early payoff event occurred. At December 31, 2007, securitizations structured as sales represented less than1 percent and secured financings represented 16 percent of the fundingassociated with our managed funding portfolio. At December 31, 2006,securitizations structured as sales represented 1 percent and secured financingsrepresented 14 percent of the funding associated with our managed fundingportfolio. We will continue to use secured financings of consumer receivables as a sourceof our funding and liquidity. However, if the market for securities backed byreceivables were to change, we may be unable to enter into new securedfinancings or to do so at favorable pricing levels. Factors affecting ourability to structure collateralized funding transactions as secured financingsor to do so at cost-effective rates include the overall credit quality of oursecuritized loans, the stability of the securitization markets, thesecuritization market's view of our desirability as an 102 HSBC Finance Corporation-------------------------------------------------------------------------------- investment, and the legal, regulatory, accounting and tax environments governingcollateralized funding transactions. At December 31, 2007, we had domestic facilities with commercial and investmentbanks under which we may use up to $17.4 billion of our receivables incollateralized funding transactions structured either as securitizations orsecured financings. The facilities are renewable at the banks' option. Theamount available under the facilities will vary based on the timing and volumeof collateralized funding transactions. As discussed above, we anticipate someof these facilities which expire in 2008 will not be renewed. Our 2008 fundingplan incorporates the anticipated reductions in these facilities. For additional information related to our securitization activities, includingthe amount of revenues and cash flows resulting from these arrangements, seeNote 8, "Asset Securitizations," to our accompanying consolidated financialstatements. RISK MANAGEMENT-------------------------------------------------------------------------------- Some degree of risk is inherent in virtually all of our activities. Accordingly,we have comprehensive risk management policies and practices in place to addresspotential financial risks, which include credit, liquidity, market (whichincludes interest rate and foreign currency exchange risks), reputational andoperational risk (which includes compliance and technology risks). Our riskmanagement policies are designed to identify and analyze these risks, to setappropriate limits and controls, and to monitor the risks and limits continuallyby means of reliable and up-to-date administrative and information systems. Wecontinually modify and enhance our risk management policies and systems toreflect changes in markets and products and to better overall risk managementprocesses. Training, individual responsibility and accountability, together witha disciplined, conservative and constructive culture of control, lie at theheart of our management of risk. Our risk management policies are primarily carried out in accordance withpractice and limits set by the HSBC Group Management Board which consists ofsenior executives throughout the HSBC organization. In addition, due to theincreasingly complex business environment and the evolution of improved riskmanagement tools and standards, HSBC Finance Corporation has significantlyupgraded, and continues to upgrade, its risk management function. New practicesand techniques have been implemented to enhance data analysis, modeling, stresstesting, management information systems, risk self-assessment, and independentoversight. Senior managers independently ensure risks are appropriatelyidentified, measured, reported and managed. Risk management oversight begins with the HSBC Finance Corporation Board ofDirectors and its various committees, principally the Audit Committee.Management oversight is provided by corporate and business unit risk managementcommittees with the participation of the Chief Operating Officer or his staff.An HSBC Finance Corporation Risk Management Committee, chaired by the ChiefOperating Officer, focuses on credit and operational risk management strategies.In addition, the HSBC Finance Corporation Asset Liability Committee ("ALCO")meets regularly to review risks and approve appropriate risk managementstrategies within the limits established by the HSBC Group Management Board. CREDIT RISK MANAGEMENT Credit risk is the risk that financial loss arises fromthe failure of a customer or counterparty to meet its obligations under acontract. Our credit risk arises primarily from lending and treasury activities. Day-to-day management of credit risk is administered by Chief Credit Officers ineach business line who have solid reporting lines to both the business lineChief Executive Officer and the Chief Retail Credit Officer. Independentoversight is provided by the corporate Chief Retail Credit Officer who reportsto our Chief Operating Officer and indirectly to the Group Managing Director,Head of Credit Risk for HSBC globally. The Chief Retail Credit Officer mayoverride business unit credit policy decisions. An appeal process exists throughthe Chief Operating Officer and Chief Executive Officer of the business to theGroup Managing Director, Head of Credit Risk. We have established detailedpolicies to address the credit risk that arises from our lending activities. Ourcredit and portfolio management procedures focus on sound underwriting,effective collections and customer account management efforts for each loan. Ourlending guidelines, which delineate the credit risk we are willing to take andthe related terms, are specific 103 HSBC Finance Corporation-------------------------------------------------------------------------------- not only for each product, but also take into consideration various otherfactors including borrower characteristics. We also have specific policies toensure the establishment of appropriate credit loss reserves on a timely basisto cover probable losses of principal, interest and fees. See "Credit Quality"for a detailed description of our policies regarding the establishment of creditloss reserves, our delinquency and charge-off policies and practices and ourcustomer account management policies and practices. Also see Note 2, "Summary ofSignificant Accounting Policies," to our consolidated financial statements forfurther discussion of our policies surrounding credit loss reserves. While wedevelop our own policies and procedures for all of our lending activities, theyare consistent with HSBC standards and are regularly reviewed and updated bothon an HSBC Finance Corporation and HSBC level. Counterparty credit risk is our primary exposure on our interest rate swapportfolio. Counterparty credit risk is the risk that the counterparty to atransaction fails to perform according to the terms of the contract. We controlcounterparty credit risk in derivative instruments through established creditapprovals, risk control limits, collateral, and ongoing monitoring procedures.Counterparty limits have been set and are closely monitored as part of theoverall risk management process and control structure. We utilize an affiliate,HSBC Bank USA, as the primary provider of domestic derivative products. We havenever suffered a loss due to counterparty failure. Currently the majority of our existing derivative contracts are with HSBCsubsidiaries, making them our primary counterparty in derivative transactions.Most swap agreements, both with unaffiliated and affiliated third parties,require that payments be made to, or received from, the counterparty when thefair value of the agreement reaches a certain level. Generally, third-party swapcounterparties provide collateral in the form of cash which is recorded in ourbalance sheet as other assets or derivative related liabilities. At December 31,2007, we provided third party swap counterparties with $51 million collateral.At December 31, 2006, third party counterparties had provided $158 million incollateral to us. Beginning with the second quarter of 2006, when the fair valueof our agreements with affiliate counterparties require the posting ofcollateral, it is provided in the form of cash and recorded on the balancesheet, consistent with third party arrangements. At December 31, 2007, the fairvalue of our agreements with affiliate counterparties required the affiliate toprovide cash collateral of $3.8 billion which is offset against the fair valueamount recognized for derivative instruments that have been offset under thesame master netting arrangement in accordance with FASB Staff Position No. FIN39-1, "Amendment of FASB Interpretation No. 39," ("FSP 39-1") and recorded inour balance sheet as a component of derivative related assets. At December 31,2006, the fair value of our agreements with affiliate counterparties requiredthe affiliate to provide cash collateral of $1.0 billion which was offsetagainst the fair value amount recognized for derivative instruments that havebeen offset under the same master netting arrangement in accordance with FSP 39-1 and recorded in our balance sheet as a component of derivative related assets. See Note 14, "Derivative Financial Instruments," to the accompanyingconsolidated financial statements for additional information related to interestrate risk management and Note 23, "Fair Value Measurements," for informationregarding the fair value of our financial instruments. LIQUIDITY RISK The management of liquidity risk is addressed in HSBC FinanceCorporation's funding management policies and practices. HSBC FinanceCorporation funds itself principally through unsecured term funding in themarkets, through secured financings and through borrowings from HSBC and HSBCclients. Generally, the lives of our assets are shorter than the lives of theliabilities used to fund them. This initially reduces liquidity risk by ensuringthat funds are received prior to liabilities becoming due. Our ability to ensure continuous access to the capital markets and maintain adiversified funding base is important in meeting our funding needs. To managethis liquidity risk, we offer a broad line of debt products designed to meet theneeds of both institutional and retail investors. We maintain investor diversityby placing debt directly with customers, through selected dealer programs and bytargeted issuance of large liquid transactions on a global basis. Throughcollateralized funding transactions, we are able to access an alternativeinvestor base and further diversify our funding sources. We also maintain acomprehensive, direct marketing program to ensure our investors receiveconsistent and timely information regarding our financial performance. The measurement and management of liquidity risk is a primary focus. Threestandard analyses are utilized to accomplish this goal. First, a rolling 60 dayfunding plan is updated daily to quantify near-term needs and develop 104 HSBC Finance Corporation-------------------------------------------------------------------------------- the appropriate strategies to fund those needs. As part of this process, debtmaturity profiles (daily, monthly, annually) are generated to assist in planningand limiting any potential rollover risk (which is the risk that we will beunable to pay our debt or borrow additional funds as it becomes due). Second,comprehensive plans identifying monthly funding requirements for the next twelvemonths are updated at least weekly and monthly funding plans for the next twoyears are maintained. These plans focus on funding projected asset growth anddebt maturities and drive both the timing and size of debt issuances. Theseplans are shared on a regular basis with HSBC. And third, a Maximum CumulativeOutflow (MCO) analysis is updated regularly to measure liquidity risk.Cumulative comprehensive cash inflows are subtracted from outflows to generate anet exposure that is tracked both monthly over the next 12 month period andannually for 5 years. Net outflow limits are reviewed by HSBC FinanceCorporation's ALCO and HSBC. We recognize the importance of being prepared for constrained fundingenvironments. While the potential scenarios driving this analysis have changeddue to our affiliation with HSBC, contingency funding plans are still maintainedas part of the liquidity management process. Alternative funding strategies areupdated regularly for a rolling 12 months and assume limited access to unsecuredfunding and continued access to the collateralized funding markets. Thesealternative strategies are designed to enable us to achieve monthly fundinggoals through controlled growth, sales of receivables and access to committedsources of contingent liquidity including bank lines and undrawn securitizationconduits. Although our overall liquidity situation has improved significantlysince our acquisition by HSBC, the strategies and analyses utilized in the pastto successfully manage liquidity remain in place today. The combination of thisprocess with the funding provided by HSBC subsidiaries and clients should ensureour access to diverse markets and investor bases thereby allowing us to meet ourfunding requirements. See "Liquidity and Capital Resources" for further discussion of our liquidityposition. MARKET RISK The objective of our market risk management process is to manage andcontrol market risk exposures in order to optimize return on risk whilemaintaining a market profile as a provider of financial products and services.Market risk is the risk that movements in market risk factors, includinginterest rates and foreign currency exchange rates, will reduce our income orthe value of our portfolios. Future net interest income is affected by movements in interest rates. Althoughour main operations are in the U.S., we also have operations in Canada and theU.K. which prepare their financial statements in their local currency.Accordingly, our financial statements are affected by movements in exchangerates between the functional currencies of these subsidiaries and the U.S.dollar. We maintain an overall risk management strategy that uses a variety ofinterest rate and currency derivative financial instruments to mitigate ourexposure to fluctuations caused by changes in interest rates and currencyexchange rates. We manage our exposure to interest rate risk primarily throughthe use of interest rate swaps, but also use forwards, futures, options, andother risk management instruments. We manage our exposure to foreign currencyexchange risk primarily through the use of currency swaps, options and forwards.We do not use leveraged derivative financial instruments for interest rate riskmanagement. Since our acquisition by HSBC, we have not entered into foreignexchange contracts to hedge our investment in foreign subsidiaries. Interest rate risk is defined as the impact of changes in market interest rateson our earnings. We use simulation models to measure the impact of anticipatedchanges in interest rates on net interest income and execute appropriate riskmanagement actions. The key assumptions used in these models include expectedloan payoff rates, loan volumes and pricing, cash flows from derivativefinancial instruments and changes in market conditions. While these assumptionsare based on our best estimates of future conditions, we can not preciselypredict our earnings due to the uncertainty inherent in the macro economicenvironment. At December 31, 2007, our net interest margin at risk was incompliance with the guidelines defined in our existing policy. Customer demand for our receivable products shifts between fixed rate andfloating rate products, based on market conditions and preferences. These shiftsin loan products produce different interest rate risk exposures. We usederivative financial instruments, principally interest rate swaps, to managethese exposures. Interest rate futures, interest rate forwards and purchasedoptions are also used on a limited basis to manage interest rate risk. 105 HSBC Finance Corporation-------------------------------------------------------------------------------- We monitor the impact that an immediate hypothetical increase or decrease ininterest rates of 25 basis points applied at the beginning of each quarter overa 12 month period would have on our net interest income assuming for 2007 adeclining balance sheet and the current interest rate risk profile. Thefollowing table summarizes such estimated impact: AT DECEMBER 31, ----------- 2007 2006------------------------------------------------------------------------------- (IN MILLIONS)Decrease in net interest income following a hypothetical 25 basis points rise in interest rates applied at the beginning of each quarter over the next 12 months................................. $153 $180Increase in net interest income following a hypothetical 25 basis points fall in interest rates applied at the beginning of each quarter over the next 12 months................................. 132 54 In the December 2006 calculation, looking forward through 2007, a significantportion of the ARM portfolio was eligible for repricing. At that time it wasanticipated that the ARM portfolio would prepay and therefore create lessbenefit to net interest income in a falling interest rate environment. In theDecember 2007 calculation, looking forward through 2008, a greater volume ofARMs are expected to remain on the books due to fewer refinancing optionsavailable to subprime customers. As a result, the total benefit to net interestincome has increased in the declining rate scenario. However, we anticipatehigher levels of delinquency and loan impairment charges as these remain on thebooks longer. These estimates include the impact of debt and the corresponding derivativeinstruments accounted for using the fair value option under SFAS No. 159. Theseestimates also assume we would not take any corrective actions in response tointerest rate movements and, therefore, exceed what most likely would occur ifrates were to change by the amount indicated. A principal considerationsupporting this analysis is the projected prepayment of loan balances for agiven economic scenario. Individual loan underwriting standards in combinationwith housing valuations and macroeconomic factors related to available mortgagecredit are the key assumptions driving these prepayment projections. While wehave utilized a number of sources to refine these projections, we cannotcurrently project prepayment rates with a high degree of certainty in alleconomic environments given recent, significant changes in both subprimemortgage underwriting standards and property valuations across the country. HSBC also has certain limits and benchmarks that serve as guidelines indetermining the 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 PVBP limit as of December 31, 2007 was $2 million,which includes the risk associated with hedging instruments. Thus, for a onebasis point change in interest rates, the policy dictates that the value of thebalance sheet shall not increase or decrease by more than $2 million. As ofDecember 31, 2007, we had a PVBP position of $(1.7) million reflecting theimpact of a one basis point increase in interest rates. This increase wasprimarily due to an anticipated extension in the average lives of mortgages heldin both the Consumer Lending and Mortgage Services portfolios. While the total PVBP position will not change as a result of the loss of hedgeaccounting following our acquisition by HSBC, the following table shows thecomponents of PVBP: 2007 2006--------------------------------------------------------------------------------- (IN MILLIONS)Risk related to our portfolio of balance sheet items marked-to- market.......................................................... $ (.2) $(1.8)Risk for all other remaining assets and liabilities............... (1.5) 2.9 ----- -----Total PVBP risk................................................... $(1.7) $ 1.1 ===== ===== Foreign currency exchange risk refers to the potential changes in current andfuture earnings or capital arising from movements in foreign exchange rates. Weenter into foreign exchange rate forward contracts and currency swaps tominimize currency risk associated with changes in the value of foreign-denominated liabilities. Currency swaps convert principal and interest paymentson debt issued from one currency to another. For example, we may issue Euro-denominated debt and then execute a currency swap to convert the obligation toU.S. dollars. We estimate that 106 HSBC Finance Corporation-------------------------------------------------------------------------------- a 10 percent adverse change in the British pound/U.S. dollar and Canadiandollar/U.S. dollar exchange rates would result in a decrease in commonshareholder's equity of $160 million at December 31, 2007 and $159 million atDecember 31, 2006 and would not have a material impact on net income. We have issued debt in a variety of currencies and simultaneously executedcurrency swaps to hedge the future interest and principal payments. As a resultof the loss of hedge accounting on currency swaps outstanding at the time of ouracquisition, the recognition of the change in the currency risk on these swapsis recorded differently than the corresponding risk on the underlying foreigndenominated debt. Currency risk on the swap is now recognized immediately in thenet present value of all future swap payments. On the corresponding debt,currency risk is recognized on the principal outstanding which is converted atthe period end spot translation rate and on the interest accrual which isconverted at the average spot rate for the reporting period. OPERATIONAL RISK Operational risk is the risk of loss arising through fraud,unauthorized activities, error, omission, inefficiency, systems failure or fromexternal events. It is inherent in every business organization and covers a widespectrum of issues. HSBC Finance Corporation has established an independent Operational RiskManagement function, headed by a Corporate Operational Risk Coordinatorreporting directly to the Chief Operating Officer and indirectly to the Head ofOperational Risk for HSBC. The Operational Risk Coordinator provides independentfunctional oversight by managing the following activities: - maintaining a network of business line Operational Risk Coordinators; - developing scoring and risk assessment tools and databases; - providing training and developing awareness; and - independently reviewing and reporting the assessments of operational risks. An Operational Risk Management Committee is responsible for oversight of theoperational risks being taken, the analytic tools used to monitor those risks,and reporting. Business unit line management is responsible for managing andcontrolling all risks and for communicating and implementing all controlstandards. This is supported by an independent program of periodic reviewsundertaken by Internal Audit. We also monitor external operations risk eventswhich take place to ensure that we remain in line with best practice and takeaccount of lessons learned from publicized operational failures within thefinancial services industry. We also maintain and test emergency policies andprocedures to support operations and our personnel in the event of disasters. COMPLIANCE RISK Compliance risk is the risk arising from failure to comply withrelevant laws, regulations, and regulatory requirements governing the conduct ofspecific businesses. It is a composite risk that can result in regulatorysanctions, financial penalties, litigation exposure and loss of reputation.Compliance risk is inherent throughout the HSBC Finance Corporationorganization. Consistent with HSBC's commitment to ensure adherence with applicable regulatoryrequirements for all of its world-wide affiliates, HSBC Finance Corporation hasimplemented a multi-faceted Compliance Risk Management Program. This programaddresses the following priorities, among other issues: - anti-money laundering (AML) regulations; - fair lending and consumer protection laws; - dealings with affiliates; - permissible activities; and - conflicts of interest. The independent Corporate Compliance function is headed by a Chief ComplianceOfficer who reports to the Chief Operating Officer, the Chief Compliance Officerof HSBC North America and the Head of Compliance for HSBC. The CorporateCompliance function is supported by various compliance teams assigned toindividual business units. The Corporate Compliance function is responsible forthe following activities: - advising management on compliance matters; - providing independent assessment and monitoring; and 107 HSBC Finance Corporation-------------------------------------------------------------------------------- - reporting compliance issues to HSBC Finance Corporation senior management and Board of Directors, as well as to HSBC Compliance. The overall Corporate Compliance program elements include identification,assessment, monitoring, control and mitigation of the risk and timely resolutionof the results of risk events. These functions are generally performed bybusiness line management, with oversight provided by Corporate Compliance.Controls for mitigating compliance risk are incorporated into business operatingpolicies and procedures. Processes are in place to ensure controls areappropriately updated to reflect changes in regulatory requirements as well aschanges in business practices, including new or revised products, services andmarketing programs. A wide range of compliance training is provided to relevantstaff, including mandated programs for such areas as anti-money laundering, fairlending and privacy. A separate Corporate Compliance Control Unit, along withInternal Audit, tests the effectiveness of the overall Compliance RiskManagement Program through continuous monitoring and periodic target audits. REPUTATIONAL RISK The safeguarding of our reputation is of paramount importanceto our continued prosperity and is the responsibility of every member of ourstaff. Reputational risk can arise from social, ethical or environmental issues,or as a consequence of operations risk events. Our good reputation depends uponthe way in which we conduct our business, but can also be affected by the way inwhich customers, to whom we provide financial services, conduct themselves. Reputational risk is considered and assessed by the HSBC Group Management Board,our Board of Directors and senior management during the establishment ofstandards for all major aspects of business and the formulation of policy. Thesepolicies, which are an integral part of the internal control systems, arecommunicated through manuals and statements of policy, internal communicationand training. The policies set out operational procedures in all areas ofreputational risk, including money laundering deterrence, environmental impact,anti-corruption measures and employee relations. We have established a strong internal control structure to minimize the risk ofoperational and financial failure and to ensure that a full appraisal ofreputational risk is made before strategic decisions are taken. The HSBCinternal audit function monitors compliance with our policies and standards. 108 HSBC Finance Corporation-------------------------------------------------------------------------------- GLOSSARY OF TERMS Affinity Credit Card - A MasterCard or Visa account jointly sponsored by theissuer of the card and an organization whose members share a common interest(e.g., the AFL-CIO Union Plus(R) credit card program). Auto Finance Loans - Closed-end loans secured by a first lien on a vehicle. Basis point - A unit that is commonly used to calculate changes in interestrates. The relationship between percentage changes and basis points can besummarized as a 1 percent change equals a 100 basis point change or .01 percentequals 1 basis point. Co-Branded Credit Card - A MasterCard, Visa or American Express account that isjointly sponsored by the issuer of the card and another corporation (e.g., theGM Card(R)). The account holder typically receives some form of added benefitfor using the card. Consumer Net Charge-off Ratio - Net charge-offs of consumer receivables dividedby average consumer receivables outstanding. Contractual Delinquency - A method of determining aging of past due accountsbased on the status of payments under the loan. Delinquency status may beaffected by customer account management policies and practices such as therestructure of accounts, forbearance agreements, extended payment plans,modification arrangements, external debt management plans, loan rewrites anddeferments. Efficiency Ratio - Ratio of total costs and expenses less policyholders'benefits to net interest income and other revenues less policyholders' benefits. Enhancement Services Income - Ancillary credit card revenue from products suchas Account Secure (debt protection) and Identity Protection Plan. Fee Income - Income associated with interchange on credit cards and late andother fees from the origination, acquisition or servicing of loans. Foreign Exchange Contract - A contract used to minimize our exposure to changesin foreign currency exchange rates. Futures Contract - An exchange-traded contract to buy or sell a stated amount ofa financial instrument or index at a specified future date and price. HBEU - HSBC Bank plc, a U.K. based subsidiary of HSBC Holdings plc. HINO - HSBC Investments (North America) Inc., which is the immediate parent ofHSBC Finance Corporation. HSBC North America - HSBC North America Holdings Inc. and the immediate parentof HINO. HSBC - HSBC Holdings plc. HSBC Bank USA - HSBC Bank USA, National Association HTSU - HSBC Technology & Services (USA) Inc., which provides informationtechnology services to all subsidiaries of HSBC North America and othersubsidiaries of HSBC. Goodwill - Represents the purchase price over the fair value of identifiableassets acquired less liabilities assumed from business combinations. IFRS Management Basis - A non-U.S. GAAP measure of reporting results inaccordance with IFRSs and assumes the private label and real estate securedreceivables transferred to HSBC Bank USA have not been sold and remain on ourbalance sheet. IFRS Management Basis also assumes that all purchase accountingfair value adjustments relating to our acquisition by HSBC have been "pusheddown" to HSBC Finance Corporation. 109 HSBC Finance Corporation-------------------------------------------------------------------------------- Intangible Assets - Assets (not including financial assets) that lack physicalsubstance. Our acquired intangibles include purchased credit card relationshipsand related programs, merchant relationships in our retail services business,other loan related relationships, trade names, technology, customer lists andother contracts. Interchange Fees - Fees received for processing a credit card transactionthrough the MasterCard, Visa, American Express or Discover network. Interest-only Strip Receivables - Represent our contractual right to receiveinterest and other cash flows from our securitization trusts after the investorsreceive their contractual return. Interest Rate Swap - Contract between two parties to exchange interest paymentson a stated principal amount (notional principal) for a specified period.Typically, one party makes fixed rate payments, while the other party makespayments using a variable rate. LIBOR - London Interbank Offered Rate. A widely quoted market rate which isfrequently the index used to determine the rate at which we borrow funds. Liquidity - A measure of how quickly we can convert assets to cash or raiseadditional cash by issuing debt. Managed Receivables - The sum of receivables on our balance sheet and those thatwe service for investors as part of our asset securitization program. MasterCard, Visa, American Express and Discover Receivables - Receivablesgenerated through customer usage of MasterCard, Visa, American Express andDiscover credit cards. Near-prime receivables - A portion of our non-prime receivable portfolio whichis comprised of customers with somewhat stronger credit scores than our othercustomers that are priced at rates generally below the rates offered on our non-prime products. Net Interest Income - Interest income from receivables and noninsuranceinvestment securities reduced by interest expense. Net Interest Margin - Net interest income as a percentage of average interest-earning assets. Nonaccrual Loans - Loans on which we no longer accrue interest because ultimatecollection is unlikely. Non-prime receivables - Receivables which have been priced above the standardinterest rates charged to prime customers due to a higher than average risk fordefault as a result of the customer's credit history and the value ofcollateral, if applicable. Options - A contract giving the owner the right, but not the obligation, to buyor sell a specified item at a fixed price for a specified period. Owned Receivables - Receivables held on our balance sheet. Personal Homeowner Loan ("PHL") - A high loan-to-value real estate loan that hasbeen underwritten and priced as an unsecured loan. These loans are reported aspersonal non-credit card receivables. Personal Non-Credit Card Receivables - Unsecured lines of credit or closed-endloans made to individuals. Portfolio Seasoning - Relates to the aging of origination vintages. Losspatterns emerge slowly over time as new accounts are booked. Private Label Credit Card - A line of credit made available to customers ofretail merchants evidenced by a credit card bearing the merchant's name. Real Estate Secured Loan - Closed-end loans and revolving lines of creditsecured by first or subordinate liens on residential real estate. Receivables Serviced with Limited Recourse - Receivables we have securitized intransactions structured as sales and for which we have some level of potentialloss if defaults occur. 110 HSBC Finance Corporation-------------------------------------------------------------------------------- Return on Average Common Shareholder's Equity - Net income less dividends onpreferred stock divided by average common shareholder's equity. Return on Average Assets - Net income divided by average owned assets. Secured Financing - The process where interests in a dedicated pool of financialassets are sold to investors. Generally, the receivables are transferred througha limited purpose financing subsidiary to a trust that issues interests that aresold to investors. These transactions do not receive sale treatment under SFASNo. 140. The receivables and related debt remain on our balance sheet. Securitization - The process where interests in a dedicated pool of financialassets, typically credit card, auto or personal non-credit card receivables, aresold to investors. Generally, the receivables are sold to a trust that issuesinterests that are sold to investors. These transactions are structured toreceive sale treatment under SFAS No. 140. The receivables are then removed fromour balance sheet. Securitization Related Revenue - Includes income associated with current andprior period securitizations structured as sales of receivables with limitedrecourse. Such income includes gains on sales, net of our estimate of probablecredit losses under the recourse provisions, servicing income and excess spreadrelating to those receivables. Stated Income (low documentation) - Loans underwritten based upon the loanapplicant's representation of annual income, which is not verified by receipt ofsupporting documentation. Tangible Common Equity - Common shareholder's equity (excluding unrealized gainsand losses on investments and cash flow hedging instruments, any minimum pensionliability and the impact of adoption of SFAS No. 159, including subsequentchanges in fair value recognized in earnings associated with credit risk) lessacquired intangibles and goodwill. Tangible Shareholder's(s') Equity - Tangible common equity, preferred stock, andcompany obligated mandatorily redeemable preferred securities of subsidiarytrusts (including amounts due to affiliates) adjusted for HSBC acquisitionpurchase accounting adjustments. Tangible Managed Assets - Total managed assets less acquired intangibles,goodwill and derivative financial assets. Taxpayer Financial Services ("TFS") Revenue - Our taxpayer financial servicesbusiness provides consumer tax refund lending in the United States. This incomeprimarily consists of fees received from the consumer for a short term loanwhich will be repaid from their Federal income tax return refund. Whole Loan Sales - Sales of loans to third parties without recourse. Typically,these sales are made pursuant to our liquidity or capital management plans. 111 HSBC FINANCE CORPORATION AND SUBSIDIARIES CREDIT QUALITY STATISTICS 2007 2006 2005 2004 2003----------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)TWO-MONTH-AND-OVER CONTRACTUAL DELINQUENCY RATIOSReal estate secured(1)............................. 7.08% 3.54% 2.72% 2.96% 4.33%Auto finance....................................... 3.67 3.18 3.04 3.03 3.39Credit card(2)..................................... 5.77 4.57 3.66 4.88 5.76Private label...................................... 4.26 5.31 5.43 4.13 5.42Personal non-credit card........................... 14.13 10.17 9.40 8.69 10.01 ------ ------ ------ ------ ------Total consumer(2).................................. 7.41% 4.59% 3.89% 4.13% 5.40% ====== ====== ====== ====== ======RATIO OF NET CHARGE-OFFS TO AVERAGE RECEIVABLES FOR THE YEARReal estate secured(3)............................. 2.32% 1.00% .76% 1.10% .99%Auto finance(6).................................... 4.10 3.67 3.27 3.43 4.91Credit card(4)..................................... 7.28 5.56 7.12 8.85 9.18Private label(4)................................... 4.73 5.80 4.83 6.17 5.75Personal non-credit card(6)........................ 8.48 7.89 7.88 9.75 9.89 ------ ------ ------ ------ ------Total consumer(4)(6)............................... 4.22 2.97 3.03 4.00 4.06Commercial......................................... - .43 2.60 - .46 ------ ------ ------ ------ ------Total.............................................. 4.21% 2.97% 3.03% 3.98% 4.05% ====== ====== ====== ====== ======REAL ESTATE CHARGE-OFFS AND REO EXPENSE AS A PERCENT OF AVERAGE REAL ESTATE SECURED RECEIVABLES...................................... 2.68% 1.19% .87% 1.38% 1.42% ------ ------ ------ ------ ------NONACCRUAL RECEIVABLESDomestic: Real estate secured(5)........................... $4,526 $2,461 $1,601 $1,489 $1,777 Auto finance..................................... 480 389 320 227 140 Private label.................................... 25 31 31 24 43 Personal non-credit card......................... 2,092 1,444 1,190 908 898Foreign............................................ 439 482 463 432 316 ------ ------ ------ ------ ------Total consumer..................................... 7,562 4,807 3,605 3,080 3,174Commercial and other............................... - - 3 4 6 ------ ------ ------ ------ ------Total.............................................. $7,562 $4,807 $3,608 $3,084 $3,180 ====== ====== ====== ====== ======ACCRUING CONSUMER RECEIVABLES 90 OR MORE DAYS DELINQUENTDomestic: Credit card...................................... $1,240 $ 894 $ 585 $ 469 $ 429 Private label.................................... - - - - 443Foreign............................................ 37 35 38 38 32 ------ ------ ------ ------ ------Total.............................................. $1,277 $ 929 $ 623 $ 507 $ 904 ====== ====== ====== ====== ======REAL ESTATE OWNEDDomestic........................................... $1,008 $ 785 $ 506 $ 583 $ 627Foreign............................................ 15 9 4 4 4 ------ ------ ------ ------ ------Total.............................................. $1,023 $ 794 $ 510 $ 587 $ 631 ====== ====== ====== ====== ======RENEGOTIATED COMMERCIAL LOANS...................... $ - $ 1 $ - $ 2 $ 2 ====== ====== ====== ====== ====== -------- ((1) Real estate secured two-months-and-over contractual delinquency (as a percent of consumer receivables) are comprised of the following: 2007 2006 2005 2004 2003--------------------------------------------------------------------------------------------Mortgage Services:First lien............................................... 10.91% 4.50% 3.21% 3.26% 5.49%Second lien.............................................. 15.43 5.74 1.94 2.47 4.90 ----- ---- ---- ---- ----Total Mortgage Services.................................. 11.80 4.75 2.98 3.16 5.40Consumer Lending:First lien............................................... 3.72 2.07 2.14 2.69 3.40Second lien.............................................. 6.93 3.06 3.03 3.02 5.07 ----- ---- ---- ---- ----Total Consumer Lending................................... 4.15 2.21 2.26 2.73 3.59Foreign and all other:First lien............................................... 2.62 1.58 2.11 1.95 3.14Second lien.............................................. 4.59 5.38 5.71 3.94 4.03 ----- ---- ---- ---- ----Total Foreign and all other.............................. 4.12 4.59 5.09 3.66 3.91 ----- ---- ---- ---- ----Total real estate secured................................ 7.08% 3.54% 2.72% 2.96% 4.33% ===== ==== ==== ==== ==== 112 HSBC FINANCE CORPORATION AND SUBSIDIARIES CREDIT QUALITY STATISTICS (CONTINUED) (2) In December 2005, we completed the acquisition of Metris which included receivables of $5.3 billion. This event had a significant impact on this ratio. Excluding the receivables from the Metris acquisition from this calculation, our consumer delinquency ratio for our credit card portfolio was 4.01% and total consumer delinquency was 3.89%. (3) Real estate secured net charge-off of consumer receivables as a percent of average consumer receivables are comprised of the following: 2007 2006 2005 2004 2003--------------------------------------------------------------------------------------------Mortgage Services:First lien............................................... 1.60% .77% .68% .81% .54%Second lien.............................................. 12.15 2.38 1.11 2.64 2.89 ----- ---- ---- ---- ----Total Mortgage Services.................................. 3.77 1.12 .75 1.05 .94Consumer Lending:First lien............................................... .79 .85 .74 1.03 .89Second lien.............................................. 3.78 1.12 1.21 2.77 2.44 ----- ---- ---- ---- ----Total Consumer Lending................................... 1.20 .89 .80 1.21 1.07Foreign and all other:First lien............................................... 1.05 .54 1.04 .89 1.19Second lien.............................................. 1.35 .94 .37 .24 .38 ----- ---- ---- ---- ----Total Foreign and all other.............................. 1.28 .86 .47 .33 .50 ----- ---- ---- ---- ----Total real estate secured................................ 2.32% 1.00% .76% 1.10% .99% ===== ==== ==== ==== ==== (4) The adoption of FFIEC charge-off policies for our domestic private label (excluding retail sales contracts at our consumer lending business) and credit card portfolios in December 2004 increased private label net charge- offs by $155 million (119 basis points) and credit card net charge-offs by $3 million (2 basis points) and total consumer net charge-offs by $158 million (16 basis points) for the year ended December 31, 2004. (5) Domestic real estate nonaccrual receivables are comprised of the following: 2007 2006 2005 2004 2003------------------------------------------------------------------------------------------------Real estate secured:Closed-end: First lien........................................ $3,367 $1,884 $1,359 $1,287 $1,437 Second lien....................................... 790 369 148 105 121Revolving: First lien........................................ 20 22 31 40 92 Second lien....................................... 349 186 63 57 127 ------ ------ ------ ------ ------ Total real estate secured......................... $4,526 $2,461 $1,601 $1,489 $1,777 ====== ====== ====== ====== ====== (6) In December 2006, our Auto Finance business changed its charge-off policy to provide that the principal balance of auto loans in excess of the estimated net realizable value will be charged-off 30 days (previously 90 days) after the financed vehicle has been repossessed if it remains unsold, unless it becomes 150 days contractually delinquent, at which time such excess will be charged off. This resulted in a one-time acceleration of charge-offs in December 2006, which totaled $24 million. Excluding the impact of this change the auto finance net charge-off ratio would have been 4.19 percent in the quarter ended December 31, 2006 and 3.46 percent for the full year 2006. Also in the fourth quarter of 2006, our U.K. business discontinued a forbearance program related to unsecured loans. Under the forbearance program, eligible delinquent accounts would not be subject to charge-off if certain minimum payment conditions were met. The cancellation of this program resulted in a one-time acceleration of charge-off which totaled $89 million. Excluding the impact of the change in the U.K. forbearance program, the personal non-credit card net charge-off ratio would have been 6.23 percent in the quarter ended December 31, 2006 and 7.45 percent for the full year 2006. Excluding the impact of both changes, the total consumer charge- off ratio would have been 3.17 percent for the quarter ended December 31, 2006 and 2.89 percent for the full year 2006. 113 HSBC FINANCE CORPORATION AND SUBSIDIARIES ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY 2007 2006 2005 2004 2003-------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)TOTAL CREDIT LOSS RESERVES AT JANUARY 1.......... $ 6,587 $ 4,521 $ 3,625 $ 3,793 $ 3,333 ------- ------- ------- ------- -------PROVISION FOR CREDIT LOSSES...................... 11,026 6,564 4,543 4,334 3,967 ------- ------- ------- ------- -------CHARGE-OFFS Domestic: Real estate secured(1)......................... (2,199) (931) (569) (629) (496) Auto finance................................... (595) (468) (311) (204) (148) Credit card(2)................................. (2,463) (1,665) (1,339) (1,082) (936) Private label(2)............................... (45) (43) (33) (788) (684) Personal non-credit card....................... (1,729) (1,455) (1,333) (1,350) (1,354)Foreign.......................................... (575) (600) (509) (355) (257) ------- ------- ------- ------- -------Total consumer................................... (7,606) (5,162) (4,094) (4,408) (3,875)Commercial and other............................. - (2) (6) (1) (3) ------- ------- ------- ------- -------Total receivables charged off.................... (7,606) (5,164) (4,100) (4,409) (3,878) ------- ------- ------- ------- -------RECOVERIESDomestic: Real estate secured(3)......................... 72 33 27 18 10 Auto finance................................... 80 50 18 6 5 Credit card.................................... 383 274 157 103 87 Private label.................................. 9 13 6 79 72 Personal non-credit card....................... 211 216 171 120 82Foreign.......................................... 135 59 68 50 34 ------- ------- ------- ------- -------Total consumer................................... 890 645 447 376 290Commercial and other............................. - - - - 1 ------- ------- ------- ------- -------Total recoveries on receivables.................. 890 645 447 376 291OTHER, NET....................................... 8 21 6 (469) 80 ------- ------- ------- ------- -------CREDIT LOSS RESERVESDomestic: Real estate secured............................ 5,119 2,365 718 645 670 Auto finance................................... 254 241 222 181 172 Credit card.................................... 2,635 1,864 1,576 1,205 806 Private label.................................. 26 38 36 28 519 Personal non-credit card....................... 2,378 1,732 1,652 1,237 1,348Foreign.......................................... 492 346 312 316 247 ------- ------- ------- ------- -------Total consumer................................... 10,904 6,586 4,516 3,612 3,762Commercial and other............................. 1 1 5 13 31 ------- ------- ------- ------- -------TOTAL CREDIT LOSS RESERVES AT DECEMBER 31........ $10,905 $ 6,587 $ 4,521 $ 3,625 $ 3,793 ======= ======= ======= ======= =======RATIO OF CREDIT LOSS RESERVES TO:Net charge-offs(6)............................... 162.4% 145.8% 123.8%(4) 89.9%(5) 105.7%Receivables: Consumer(6).................................... 6.99 4.07 3.23 3.39 4.09 Commercial..................................... .76 .60 2.67 8.90 6.80 ------- ------- ------- ------- ------- Total(6)....................................... 6.98% 4.07% 3.23% 3.39% 4.11% ======= ======= ======= ======= =======Nonperforming loans: Consumer....................................... 123.4% 114.8% 106.8% 100.7% 92.2% Commercial..................................... - 100.0 166.7 260.0 620.0 ------- ------- ------- ------- ------- Total.......................................... 123.4% 114.8% 106.9% 100.9% 92.8% ======= ======= ======= ======= ======= -------- (1) Domestic real estate secured charge-offs can be further analyzed as follows: 2007 2006 2005 2004 2003-----------------------------------------------------------------------------------------------Closed end: First lien.......................................... $ (879) $(582) $(421) $(418) $(279) Second lien......................................... (928) (256) (105) (151) (152)Revolving: First lien.......................................... (20) (17) (22) (34) (35) Second lien......................................... (372) (76) (21) (26) (30) ------- ----- ----- ----- -----Total................................................. $(2,199) $(931) $(569) $(629) $(496) ======= ===== ===== ===== ===== (2) Includes $3 million of credit card and $155 million of private label charge- off relating to the adoption of FFIEC charge-off policies in December 2004. 114 HSBC FINANCE CORPORATION AND SUBSIDIARIES ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY (CONTINUED) (3) Domestic real estate recoveries can be further analyzed as follows: 2007 2006 2005 2004 2003--------------------------------------------------------------------------------------------Closed end: First lien.............................................. $45 $11 $11 $ 5 $ 3 Second lien............................................. 20 15 10 8 5Revolving: First lien.............................................. 2 2 2 2 - Second lien............................................. 5 5 4 3 2 --- --- --- --- ---Total..................................................... $72 $33 $27 $18 $10 === === === === === (4) The acquisition of Metris in December 2005 has positively impacted this ratio. Reserves as a percentage of net charge-offs excluding Metris was 118.2 percent. (5) In December 2004 we adopted FFIEC charge-off policies for our domestic private label (excluding retail sales contracts at our consumer lending business) and credit card portfolios and subsequently sold this domestic private label receivable portfolio. These events had a significant impact on this ratio. Reserves as a percentage of net charge-offs excluding net charge-offs associated with the sold domestic private label portfolio and charge-off relating to the adoption of FFIEC was 109.2% at December 31, 2004. (6) This ratio was positively impacted in 2007 and 2006 by markedly higher credit loss reserves at our Mortgage Services business and, in 2007, at our Consumer Lending business. 115 MORE TO FOLLOW This information is provided by RNS The company news service from the London Stock ExchangeRelated Shares:
HSBC Holdings