15th May 2007 07:01
HSBC Holdings PLC15 May 2007 PART 2 RECEIVABLES REVIEW-------------------------------------------------------------------------------- The following table summarizes receivables at March 31, 2007 and increases(decreases) over prior periods: INCREASES (DECREASES) FROM --------------------------------- DECEMBER 31, MARCH 31, 2006 2006 MARCH 31, --------------- --------------- 2007 $ % $ %------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Real estate secured(1)...................... $ 96,329 $(1,432) (1.5)% $ 6,837 7.6%Auto finance................................ 12,633 129 1.0 1,447 12.9Credit card................................. 27,293 (421) (1.5) 3,844 16.4Private label............................... 2,500 (9) (.4) 72 3.0Personal non-credit card(2)................. 21,201 (166) (.8) 1,195 6.0Commercial and other........................ 158 (23) (12.7) (48) (23.3) -------- ------- ----- ------- -----Total owned receivables..................... $160,114 $(1,922) (1.2)% $13,347 9.1% ======== ======= ===== ======= ===== -------- ()(1) Mortgage Services purchases receivables originated by other lenders referred to as correspondents. In December, the business was aligned under common executive management with our Consumer Lending business. In March 2007, we announced that Mortgage Services was ceasing correspondent channel acquisitions of receivables. Consumer Lending is a distinct business that sources, underwrites and closes 35 HSBC Finance Corporation -------------------------------------------------------------------------------- loans through a network of 1,396 branch offices located throughout the United States. The Mortgage Services and Consumer Lending businesses comprise the majority of our real estate secured portfolio as shown in the following table: INCREASES (DECREASES) FROM ------------------------------- DECEMBER 31, MARCH 31, 2006 2006 MARCH 31, -------------- -------------- 2007 $ % $ %------------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS) Mortgage Services.................................. $44,674 $(3,294) (6.9)% $(1,784) (3.8)%Consumer Lending................................... 47,924 1,698 3.7 7,994 20.0Foreign and all other.............................. 3,731 164 4.6 627 20.2 ------- ------- ---- ------- ----Total real estate secured.......................... $96,329 $(1,432) (1.5)% $ 6,837 7.6% ======= ======= ==== ======= ==== -------- ()(2) Personal non-credit card receivables are comprised of the following: INCREASES (DECREASES) FROM ----------------------------- DECEMBER 31, MARCH 31, 2006 2006 MARCH 31, ------------ -------------- 2007 $ % $ %---------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Domestic personal non-credit card.................. $13,871 $ 108 .8% $1,927 16.1%Union Plus personal non-credit card................ 213 (22) (9.4) (85) (28.5)Personal homeowner loans........................... 4,181 (66) (1.6) (60) (1.4)Foreign personal non-credit card................... 2,936 (186) (6.0) (587) (16.7) ------- ----- ---- ------ -----Total personal non-credit card..................... $21,201 $(166) (.8)% $1,195 6.0% ======= ===== ==== ====== ===== Real estate secured receivables can be further analyzed as follows: INCREASES (DECREASES) FROM ------------------------------- DECEMBER 31, MARCH 31, 2006 2006 MARCH 31, -------------- -------------- 2007 $ % $ %------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Real estate secured: Closed-end: First lien............................... $77,201 $ (700) (.9)% $6,591 9.3% Second lien.............................. 14,756 (334) (2.2) 561 4.0 Revolving: First lien............................... 509 (47) (8.5) (79) (13.4) Second lien.............................. 3,863 (351) (8.3) (236) (5.8) ------- ------- ---- ------ -----Total real estate secured..................... $96,329 $(1,432) (1.5)% $6,837 7.6% ======= ======= ==== ====== ===== 36 HSBC Finance Corporation -------------------------------------------------------------------------------- The following table summarizes various real estate secured receivablesinformation for our Mortgage Services and Consumer Lending businesses: MARCH 31, 2007 DECEMBER 31, 2006 MARCH 31, 2006 ------------------- ------------------- ------------------- MORTGAGE CONSUMER MORTGAGE CONSUMER MORTGAGE CONSUMER SERVICES LENDING SERVICES LENDING SERVICES LENDING-------------------------------------------------------------------------------------------------- (IN MILLIONS) Fixed rate....................... $20,518(1) $44,236(2) $21,733(1) $42,675(2) $19,714 $38,033Adjustable rate.................. 24,156 3,688 26,235 3,551 26,744 1,897 ------- ------- ------- ------- ------- -------Total............................ $44,674 $47,924 $47,968 $46,226 $46,458 $39,930 ======= ======= ======= ======= ======= =======First lien....................... $35,630 $41,294 $38,031 $39,684 $36,444 $34,181Second lien...................... 9,044 6,630 9,937 6,542 10,014 5,749 ------- ------- ------- ------- ------- -------Total............................ $44,674 $47,924 $47,968 $46,226 $46,458 $39,930 ======= ======= ======= ======= ======= =======Adjustable rate.................. $18,141 $ 3,688 $20,108 $ 3,551 $20,024 $ 1,897Interest only.................... 6,015 - 6,127 - 6,720 - ------- ------- ------- ------- ------- -------Total adjustable rate............ $24,156 $ 3,688 $26,235 $ 3,551 $26,744 $ 1,897 ======= ======= ======= ======= ======= =======Total stated income.............. $11,063 $ - $11,772 $ - $11,637 $ - ======= ======= ======= ======= ======= ======= -------- ()(1) Includes fixed rate interest-only loans of $48 million at March 31, 2007 and $32 million at December 31, 2006. ()(2) Includes fixed rate interest-only loans of $54 million at March 31, 2007 and $46 million at December 31, 2006. At March 31, 2007, real estate secured loans originated and acquired subsequentto December 31, 2004 by our Mortgage Services business accounted forapproximately 73 percent of total Mortgage Services receivables in a first lienand approximately 88 percent of total Mortgage Services receivables in a secondlien position. At December 31, 2006, real estate secured loans originated andacquired subsequent to December 31, 2004 by our Mortgage Services businessaccounted for approximately 70 percent of total Mortgage Services receivables ina first lien and approximately 90 percent of total Mortgage Services receivablesin a second lien position. RECEIVABLE INCREASES (DECREASES) SINCE MARCH 31, 2006 Real estate securedreceivables increased significantly over the year-ago period driven by growth inour branch business. Growth in our branch-based Consumer Lending businessimproved due to higher sales volumes as we continue to emphasize real estatesecured loans, including a near-prime mortgage product, as well as a decline inloan prepayments due to the higher interest rate environment which resulted inlower run-off rates. Also contributing to the increase was the acquisition ofthe $2.5 billion Champion portfolio in November 2006. Our Mortgage Servicescorrespondent business experienced growth through June 2006 as managementcontinued to focus on junior lien loans through portfolio acquisitions andexpanded sources for purchasing newly originated loans from flow correspondents.In the second half of 2006, management revised its business plan and reducedpurchases of second lien and selected higher risk products which has resulted inattrition in the Mortgage Services portfolio. As previously discussed, in March2007, we announced our decision to discontinue correspondent channelacquisitions by our Mortgage Services business. However, our Decision Onewholesale channel and our Consumer Lending retail channel will continue. Theseactions, combined with normal portfolio attrition will result in significantreductions in the principal balance of our Mortgage Services loan portfolioduring 2007. We have also experienced strong real estate secured growth in ourforeign real estate secured receivables as a result of our continuing Canadianbranch operation expansions. Auto finance receivables increased over the year-ago period due to organicgrowth principally in the near-prime portfolio as a result of increases in newlyoriginated loans acquired from our dealer network and growth in the consumerdirect loan program. Additionally as compared to the year-ago period, weexperienced continued growth from the expansion of an auto finance program inCanada. Credit card receivables reflect strong domestic organic growth in ourUnion Privilege and non-prime portfolios including Metris as well as continuedgrowth in our Canadian credit card receivables. Lower securitization levels alsocontributed to the increase as compared to the 37 HSBC Finance Corporation -------------------------------------------------------------------------------- year-ago period. Private label receivables increased as compared to March 31,2006 as a result of growth in our Canadian business and changes in the foreignexchange rate since March 31, 2006, partially offset by the termination of newdomestic retail sales contract originations in October 2006 and lower retailsales volumes in the U.K. Personal non-credit card receivables increased as aresult of increased marketing, including several large direct mail campaigns andchanges in the foreign exchange rate since March 31, 2006. RECEIVABLE INCREASES (DECREASES) SINCE DECEMBER 31, 2006 Real estate securedreceivables have decreased since December 31, 2006. As discussed above, actionstaken at our Mortgage Services business combined with normal portfolioattrition, resulted in a decline in the overall portfolio balance at ourMortgage Services business since December 31, 2006. These decreases werepartially offset by real estate secured growth in our Consumer Lending business.In addition, the decline in loan prepayments has continued during the firstquarter of 2007 which has resulted in lower run-off rates for our real estatesecured portfolio. Growth in our auto finance portfolio reflects organic growthand increased volume. The decrease in our credit card receivables reflectsnormal seasonal run-off, partially offset by growth in our non-prime portfoliosincluding Metris. Private label receivables decreased due to the termination ofnew domestic retail sales contract originations in October 2006 partially offsetby growth in our U.K. private label portfolio. Personal non-credit cardreceivables decreased primarily due to lower levels of foreign personal non-credit card receivables. RESULTS OF OPERATIONS-------------------------------------------------------------------------------- Unless noted otherwise, the following discusses amounts reported in ourconsolidated statement of income. NET INTEREST INCOME The following table summarizes net interest income: INCREASE (DECREASE) -------------THREE MONTHS ENDED MARCH 31, 2007 (1) 2006 (1) AMOUNT %------------------------------------------------------------------------------------------- Finance and other interest income......... $4,712 11.42% $4,087 11.10% $625 15.3%Interest expense.......................... 2,071 5.02 1,623 4.41 448 27.6 ------ ----- ------ ----- ---- ----Net interest income....................... $2,641 6.40% $2,464 6.69% $177 7.2% ====== ===== ====== ===== ==== ==== -------- ()(1) % Columns: comparison to average owned interest-earning assets. The increase in net interest income during the quarter ended March 31, 2007 wasdue to higher average receivables and higher overall yields, partially offset byhigher interest expense. Overall yields increased due to increases in our rateson fixed and variable rate products which reflected market movements and variousother repricing initiatives. Yields were also favorably impacted by receivablemix with increased levels of higher yielding products such as credit cards, duein part to reduced securitization levels and higher levels of average secondlien real estate secured loans. Overall yield improvements were partially offsetby the impact of growth in non-performing assets. The higher interest expense,which contributed to lower net interest margin, was due to a larger balancesheet and a significantly higher cost of funds due to a rising interest rateenvironment. This was partially offset by the adoption of SFAS No. 159, whichresulted in $76 million of realized losses on swaps which previously wereaccounted for as effective hedges under SFAS No. 133 and reported as interestexpense now being reported in other revenues. In addition, as part of ouroverall liquidity management strategy, we continue to extend the maturity of ourliability profile which results in higher interest expense. Our purchaseaccounting fair value adjustments include both amortization of fair valueadjustments to our external debt obligations and receivables. Amortization ofpurchase accounting fair value adjustments increased net interest income by $46million during the quarter ended March 31, 2007 and $114 million during thequarter ended March 31, 2006. Net interest margin was 6.40 percent during the three months ended March 31,2007 compared to 6.69 percent in the year-ago period. Net interest margindecreased in the first quarter of 2007 as the improvement in the overall yieldon 38 HSBC Finance Corporation -------------------------------------------------------------------------------- our receivable portfolio, as discussed above, was more than offset by the higherfunding costs. The following table shows the impact of these items on netinterest margin: 2007 2006-------------------------------------------------------------------------------- Net interest margin - March 31, 2006 and 2005, respectively........ 6.69% 6.68%Impact to net interest margin resulting from: Receivable pricing............................................... .20 .32 Receivable mix................................................... .03 .08 Sale of U.K. card business in December 2005...................... - .04 Metris acquisition in December 2005.............................. - .36 Cost of funds change............................................. (.61) (.67) Investment securities mix........................................ - - Other............................................................ .09 (.12) ---- ----Net interest margin - March 31, 2007 and 2006, respectively........ 6.40% 6.69% ==== ==== The varying maturities and repricing frequencies of both our assets andliabilities expose us to interest rate risk. When the various risks inherent inboth the asset and the debt do not meet our desired risk profile, we usederivative financial instruments to manage these risks to acceptable interestrate risk levels. See "Risk Management" for additional information regardinginterest rate risk and derivative financial instruments. PROVISION FOR CREDIT LOSSES The following table summarizes provision for creditlosses: INCREASE (DECREASE) --------------- 2007 2006 AMOUNT %-------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Three months ended March 31,......................... $1,700 $866 $834 96.3% Our provision for credit losses increased significantly during the first quarterof 2007 compared to the year-ago quarter due to higher levels of receivables duein part to lower securitization levels, higher levels of delinquency driven bygrowth, normal portfolio seasoning and the progression of portions of ourMortgage Services portfolio purchased in 2005 and 2006 into various stages ofdelinquency and charge-off, a higher mix of second lien product in MortgageServices, increased levels of personal bankruptcy filings as compared to theexceptionally low filing levels experienced in the first quarter of 2006 as aresult of the new bankruptcy law in the United States which went into effect inOctober 2005, and weaker early stage performance in certain Consumer Lendingreal estate secured loans originated since late 2005 consistent with theindustry trends for fixed rate mortgages. Beginning in the second quarter of 2006, we began to experience a deteriorationin the performance of mortgage loans acquired in 2005 by our Mortgage Servicesbusiness, particularly in the second lien and portions of the first lienportfolio which, later in the year, began to affect the same components of loansoriginated in 2006 by this business, which resulted in higher delinquency,charge-offs and loss estimates in these portfolios. In the first quarter of2007, we have seen higher levels of net charge-off in these components as thehigher delinquency we began to experience in the prior year is now beginning tomigrate to charge-off and continuing increased delinquency although the rate ofincrease in delinquency has slowed from prior quarters. Our provision for creditlosses in the first quarter of 2007 also reflects higher loss estimates insecond lien loans purchased in 2004 through the third quarter of 2006 by ourConsumer Lending business which increased credit loss reserves $87 millionduring the quarter. At March 31, 2007, the outstanding principal balance ofsecond lien loans acquired by the Consumer Lending business during this periodwas approximately $1.5 billion. Our provision for credit losses in the firstquarter also reflects the impact from a refinement in the methodology used tocalculate roll rate percentages at our United Kingdom business which increasedcredit loss reserves $117 million which we believe reflects a better estimate ofprobable losses currently inherent in the loan portfolio. Net charge-off dollars increased $560 million during the three months endedMarch 31, 2007 as compared to the year-ago quarter. This increase was driven byour Mortgage Services business, as loans originated and acquired in 39 HSBC Finance Corporation -------------------------------------------------------------------------------- 2005 and early 2006 are progressing to charge-off as well as higher receivablelevels, portfolio seasoning in our credit card portfolio and increased levels ofpersonal bankruptcy filings as compared to the exceptionally low filing levelsexperienced in the first quarter of 2006 as a result of the new bankruptcy lawin the United States. The provision for credit losses may vary from quarter toquarter depending on the product mix and credit quality of loans in ourportfolio. See "Credit Quality" included in this MD&A for further discussion offactors affecting the provision for credit losses. OTHER REVENUES The following table summarizes other revenues: INCREASE (DECREASE) --------------THREE MONTHS ENDED MARCH 31, 2007 2006 AMOUNT %-------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Securitization related revenue...................... $ 21 $ 71 $(50) (70.4)%Insurance revenue................................... 230 244 (14) (5.7)Investment income................................... 26 34 (8) (23.5)Derivative income (expense)......................... (7) 57 (64) (100+)Gain (loss) on debt designated at fair value and related derivatives............................... 144 - 144 100.0Fee income.......................................... 573 382 191 50.0Enhancement services revenue........................ 148 123 25 20.3Taxpayer financial services revenue................. 239 234 5 2.1Gain on receivable sales to HSBC affiliates......... 95 85 10 11.8Servicing and other fees from HSBC affiliates....... 133 118 15 12.7Other income........................................ 40 73 (33) (45.2) ------ ------ ---- -----Total other revenues................................ $1,642 $1,421 $221 15.6% ====== ====== ==== ===== SECURITIZATION RELATED REVENUE is the result of the securitization of ourreceivables and includes the following: INCREASE (DECREASE) ----------------THREE MONTHS ENDED MARCH 31, 2007 2006 AMOUNT %--------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net replenishment gains(1)............................. $ 8 $15 $ (7) (46.7)%Servicing revenue and excess spread.................... 13 56 (43) (76.8) --- --- ---- -----Total.................................................. $21 $71 $(50) (70.4)% === === ==== ===== -------- ()(1) Net replenishment gains reflect inherent recourse provisions of $5 million in the first quarter of 2007 and $14 million in the first quarter of 2006. The decline in securitization related revenue in the three months ended March31, 2007 was due to decreases in the level of securitized receivables as aresult of our decision in the third quarter of 2004 to structure all newcollateralized funding transactions as secured financings. Because existingpublic credit card transactions were structured as sales to revolving truststhat require replenishments of receivables to support previously issuedsecurities, receivables continue to be sold to these trusts until the revolvingperiods end, the last of which is currently projected to occur in the fourthquarter of 2007. While the termination of sale treatment on new collateralizedfunding activity and the reduction of sales under replenishment agreementsreduced our reported net income, there is no impact on cash received fromoperations. Insurance revenue decreased in the first three months of 2007 primarily due tolower insurance sales volumes in our U.K. operations, including a planned phaseout of the use of a specific broker between January and April 2007. Insurancerevenue in our domestic operations was essentially flat as increases in premiumsin the quarter were more than offset by the cancellation effective January 1,2007 of a policy whereby we pay for losses which exceed a threshold specified inthe policy. 40 HSBC Finance Corporation -------------------------------------------------------------------------------- Investment income, which includes income on securities available for sale in ourinsurance business and realized gains and losses from the sale of securities,decreased in the first three months of 2007 primarily due to lower averageinvestment levels. Derivative income includes realized and unrealized gains and losses onderivatives which do not qualify as effective hedges under SFAS No. 133 as wellas the ineffectiveness on derivatives which are qualifying hedges. Prior to theelection of FVO reporting for certain fixed rate debt, we accounted for therealized gains and losses on swaps associated with this debt which qualified aseffective hedges under SFAS No. 133 in interest expense and any ineffectivenesswhich resulted from changes in the fair value of the swaps as compared tochanges in the interest rate component value of the debt was recorded as acomponent of derivative income. With the adoption of SFAS No. 159 beginning inJanuary 2007, we eliminated hedge accounting on these swaps and as a result,realized and unrealized gains and losses on these derivatives are now includedin Gain (loss) on debt designated at fair value and related derivatives in theconsolidated statement of income which impacts the comparability of derivativeincome between periods. Derivative income is summarized in the table below: THREE MONTHS ENDED MARCH 31, 2007 2006-------------------------------------------------------------------------------- (IN MILLIONS) Net realized gains (losses)........................................ $(9) $ 4Mark-to-market on derivatives which do not qualify as effective hedges........................................................... 5 (10)Ineffectiveness.................................................... (3) 63 --- ----Total.............................................................. $(7) $ 57 === ==== Derivative income decreased in the three months ended March 31, 2007 due tochanges in the interest rate curve and to the adoption of SFAS No. 159. Risinginterest rates during the fourth quarter of 2005 and the first half of 2006caused the net outgoing payments on pay variable/received fix economic hedges toincrease during the three month period ended March 31, 2007 as compared to theyear-ago period. Furthermore, as discussed above, the mark-to-market on theswaps associated with debt we have now designated at fair value, as well as themark-to-market on the interest rate component of the debt, which accounted forthe majority of the ineffectiveness recorded in the first quarter of 2006, isnow reported in the consolidated income statement as Gain (loss) on debtdesignated at fair value and related derivatives. Additionally, subsequent toMarch 31, 2006, we have redesignated all remaining short cut hedge relationshipsas hedges under the long-haul method of accounting. Redesignation of swaps aseffective hedges reduces the overall volatility of reported mark-to-marketincome, although re-establishing such swaps as long-haul hedges createsvolatility as a result of hedge ineffectiveness. Net income volatility, whether based on changes in interest rates for swapswhich do not qualify for hedge accounting, the ineffectiveness recorded on ourqualifying hedges under the long haul method of accounting or the impact fromadopting SFAS No. 159, affects the comparability of our reported results betweenperiods. Accordingly, derivative income for the three months ended March 31,2007 should not be considered indicative of the results for any future periods. Gain (loss) on debt designated at fair value and related derivatives reflectsfair value changes on our fixed rate debt accounted for under FVO as a result ofadopting SFAS No. 159 effective January 1, 2007 as well as the fair valuechanges and realized gains (losses) on the related derivatives associated withdebt designated at fair value. Prior to the election of FVO reporting forcertain fixed rate debt, we accounted for the realized gains and losses on swapsassociated with this debt which qualified as effective hedges under SFAS No. 133in interest expense and any ineffectiveness which resulted from changes in thevalue of the swaps as compared to changes in the interest rate 41 HSBC Finance Corporation -------------------------------------------------------------------------------- component value of the debt was recorded in derivative income. These componentsare summarized in the table below: THREE MONTHS ENDED MARCH 31, 2007 2006-------------------------------------------------------------------------------- (IN MILLIONS) Mark-to-market on debt designated at fair value: Interest rate component......................................... $(142) $- Credit risk component........................................... 244 - ----- --Total mark-to-market on debt designated at fair value............. 102 -Mark-to-market on the related derivatives......................... 118 -Net realized gains (losses) on the related derivatives............ (76) - ----- --Total............................................................. $ 144 $- ===== == The changes in the fair value of the debt associated with interest rates and thechange in the value of the related derivatives reflects a decline in the LIBORcurve during the first quarter of 2007. The changes in credit risk were due to ageneral widening of financial sector, fixed income credit spreads in combinationwith specific spread widening attributable to our participation in the subprimemortgage market. Fee income, which includes revenues from fee-based products such as creditcards, increased in the three months ended March 31, 2007 due to higher creditcard fees, particularly relating to our non-prime credit card portfolios due tohigher levels of credit card receivables. Enhancement services revenue, which consists of ancillary credit card revenuefrom products such as Account Secure Plus (debt protection) and IdentityProtection Plan, was higher in the three months ended March 31, 2007 primarilyas a result of higher levels of credit card receivables and higher customeracceptance levels. Taxpayer financial services ("TFS") revenue increased during the three monthsended March 31, 2007 due to increased loan volume in the 2007 tax season. Gain on receivable sales to HSBC affiliates includes the daily sales of domesticprivate label receivable originations (excluding retail sales contracts) andcertain credit card account originations to HSBC Bank USA. The increase in thefirst quarter of 2007 reflects higher sales volumes of domestic private labelreceivable and credit card account originations as well as higher rates on ourcredit card account originations. Servicing and other fees from HSBC represents revenue received under servicelevel agreements under which we service credit card and domestic private labelreceivables as well as real estate secured and auto finance receivables for HSBCaffiliates. The increases primarily relate to higher levels of receivables beingserviced on behalf of HSBC Bank USA. Other income decreased in the first quarter of 2007 primarily due to lower gainson sales of real estate secured receivables by our Decision One mortgageoperations. 42 HSBC Finance Corporation -------------------------------------------------------------------------------- COSTS AND EXPENSES The following table summarizes total costs and expenses: INCREASE (DECREASE) --------------THREE MONTHS ENDED MARCH 31, 2007 2006 AMOUNT %-------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Salaries and employee benefits...................... $ 609 $ 581 $ 28 4.8%Sales incentives.................................... 68 80 (12) (15.0)Occupancy and equipment expenses.................... 78 83 (5) (6.0)Other marketing expenses............................ 220 173 47 27.2Other servicing and administrative expenses......... 263 253 10 4.0Support services from HSBC affiliates............... 285 252 33 13.1Amortization of intangibles......................... 63 80 (17) (21.3)Policyholders' benefits............................. 124 118 6 5.1 ------ ------ ---- -----Total costs and expenses............................ $1,710 $1,620 $ 90 5.6% ====== ====== ==== ===== Salaries and employee benefits increased in the first quarter of 2007 as aresult of additional staffing, primarily in our Consumer Lending, RetailServices and Canadian operations as well as in our corporate functions tosupport the growth which has occurred since March 2006. Salary and employeebenefits for the first quarter of 2007 also includes employee severance,including benefits for employees to be terminated as part of the announcement inMarch 2007 to discontinue correspondent channel acquisitions by our MortgageServices business. These increases were partially offset by lower salary expensein our Credit Card Services operations due to the completion of the integrationof the Metris acquisition which occurred in December 2005. Sales incentives decreased in the first quarter of 2007 due to lower originationvolumes in our Mortgage Services business due to the decision to reducepurchases including second lien and selected higher risk products in the secondhalf of 2006 as well as lower volumes in our Consumer Lending business. AsMortgage Services terminates loan acquisitions, sales incentives will decreasein the future. Occupancy and equipment expenses decreased in the first quarter of 2007 due tolower repairs and maintenance costs as well as lower depreciation and utilityexpenses. These decreases were partially offset by higher rental expenses. Other marketing expenses includes payments for advertising, direct mail programsand other marketing expenditures. The increase in the first quarter of 2007 wasprimarily due to increased domestic credit card and co-branded credit cardmarketing expenses. Other servicing and administrative expenses increased during the three monthsended March 31, 2007 due to higher systems costs and lower deferrals fororigination costs due to lower volumes as well as a valuation adjustment of $31million to record our investment in the U.K. Insurance Operations at the lowerof cost or market as a result of designating this operation as "Held for Sale."These increases were partially offset by lower insurance operating expense inour domestic operations and an increase in our estimate of interest receivableof approximately $55 million relating to various contingent tax items with thetaxing authority. Support services from HSBC affiliates includes technology and other servicescharged to us by HSBC Technology and Services (USA) Inc. ("HTSU"), whichincreased in the first quarter of 2007 primarily due to growth. Amortization of intangibles decreased in the first quarter of 2007 as anindividual contractual relationship became fully amortized in the first quarterof 2006. Policyholders' benefits increased in the first quarter of 2007 for both ourdomestic and U.K. operations. The increase in our domestic operations was due toan increase in claims reserves for expected losses. The increase in our U.K.operations was due to higher claims in the current quarter, partially offset bylower sales volumes. 43 HSBC Finance Corporation -------------------------------------------------------------------------------- Efficiency ratio The following table summarizes our owned basis efficiencyratio: 2007 2006-------------------------------------------------------------------------------- Three months ended March 31...................................... 38.13% 39.87% Our efficiency ratio improved compared to the prior year quarter. Excluding the$244 million change in fair value on the fixed rate debt related to credit riskresulting from the adoption of SFAS No. 159, the efficiency ratio for the threemonths ended March 31, 2007 deteriorated from the prior year quarter by 64 basispoints. The deterioration was a result of higher provision for credit losses andhigher costs and expenses to support receivable growth, partially offset byhigher net interest income and higher fee income and enhancement servicesrevenues due to higher levels of receivables. SEGMENT RESULTS - IFRS MANAGEMENT BASIS-------------------------------------------------------------------------------- We have three reportable segments: Consumer, Credit Card Services andInternational. Our Consumer segment consists of our Consumer Lending, MortgageServices, Retail Services and Auto Finance businesses. Our Credit Card Servicessegment consists of our domestic MasterCard, Visa and Discover credit cardbusiness. Our International segment consists of our foreign operations in theUnited Kingdom, Canada, the Republic of Ireland and prior to November 9, 2006,our operations in Slovakia, the Czech Republic and Hungary. The All Othercaption includes our Insurance and Taxpayer Financial Services and Commercialbusinesses, each of which falls below the quantitative threshold test under SFASNo. 131 for determining reportable segments, as well as our corporate andtreasury activities. There have been no changes in the basis of our segmentationor any changes in the measurement of segment profit as compared with thepresentation in our 2006 Form 10-K. Our segment results are presented on an IFRS Management Basis (a non-U.S. GAAPfinancial measure) as operating results are monitored and reviewed, trends areevaluated and decisions about allocating resources such as employees are madealmost exclusively on an IFRS Management Basis. IFRS Management Basis resultsare IFRSs results which assume that the private label and real estate securedreceivables transferred to HSBC Bank USA have not been sold and remain on ourbalance sheet. Operations are monitored and trends are evaluated on an IFRSManagement Basis because the customer loan sales to HSBC Bank USA were conductedprimarily to appropriately fund prime customer loans within HSBC and suchcustomer loans continue to be managed and serviced by us without regard toownership. However, we continue to monitor capital adequacy, establish dividendpolicy and report to regulatory agencies on a U.S. GAAP basis. A summary of thesignificant differences between U.S. GAAP and IFRSs as they impact our resultsare summarized in Note 11, "Business Segments." CONSUMER SEGMENT The following table summarizes the IFRS Management Basisresults for our Consumer segment: INCREASE (DECREASE) ---------------THREE MONTHS ENDED MARCH 31 2007 2006 AMOUNT %--------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net income...................................... $ 238 $ 719 $ (481) (66.9)%Net interest income............................. 2,158 2,182 (24) (1.1)Other operating income.......................... 192 238 (46) (19.3)Loan impairment charges......................... 1,220 550 670 100.0+Operating expenses.............................. 759 737 22 3.0Intersegment revenues........................... 58 57 1 1.8Customer loans.................................. 142,407 134,132 8,275 6.2Assets.......................................... 142,182 135,874 6,308 4.6Net interest margin, annualized................. 6.00% 6.62% - -Return on average assets........................ .66 2.15 - - 44 HSBC Finance Corporation -------------------------------------------------------------------------------- Our Consumer segment reported lower net income in the first quarter of 2007 dueto higher loan impairment charges, lower net interest income, lower otheroperating income and higher operating expenses. Loan impairment charges for the Consumer segment increased significantly duringthe first quarter of 2007 as compared to the year-ago quarter. The increase inloan impairment charges was driven by the progression of mortgage loans acquiredin 2005 and 2006 by our Mortgage Services business, particularly in the secondlien and portions of the first lien portfolios, to various stages of delinquencyand to charge-off. Also contributing to the increase was higher loss estimatesat our Consumer Lending business due to receivable growth, portfolio seasoningas well as higher loss estimates in second lien loans purchased in 2004 throughthe third quarter of 2006 which increased credit loss reserves $87 millionduring the quarter. At March 31, 2007, the outstanding principal balance ofsecond lien loans acquired by the Consumer Lending business during this periodwas approximately $1.5 billion. Loan impairment charges during the first quarterof 2006 benefited from historically low levels of bankruptcy filings followingthe enactment of new bankruptcy law in the United States which became effectivein the fourth quarter of 2005. In the first quarter of 2007, we increased lossreserve levels as the provision for credit losses was greater than net charge-offs by $139 million. Net interest income decreased during the first quarter of 2007 as higher financeand other interest income primarily due to higher average customer loans andhigher overall yields was more than offset by higher interest expense. Overallyields reflect growth in real estate secured customer loans at current marketrates and a greater mix of higher yielding second lien real estate secured loansand personal non-credit card customer loans due to growth. The higher interestexpense was due to a larger balance sheet and a significantly higher cost offunds due to a rising interest rate environment. The decrease in net interestmargin was a result of the cost of funds increasing more rapidly than ourability to increase receivable yields. The decrease in other operating income inthe three months ended March 31, 2007 was primarily due to lower gains on salesof real estate secured receivables by our Decision One mortgage operations,partially offset by higher late and overlimit fees. Operating expenses werehigher in the first quarter of 2007 primarily due to lower deferred loanorigination costs as mortgage origination volumes have declined. Customer loans for our Consumer segment can be further analyzed as follows: INCREASES (DECREASES) FROM ----------------------------- DECEMBER 31, MARCH 31, 2006 2006 MARCH 31, -------------- ------------ 2007 $ % $ %------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS) Real estate secured............................ $ 94,159 $(1,212) (1.3)% $5,139 5.8%Auto finance................................... 12,557 90 .7 732 6.2Private label, including co-branded cards...... 17,477 (979) (5.3) 1,158 7.1Personal non-credit card....................... 18,214 (65) (.4) 1,246 7.3 -------- ------- ---- ------ ---Total customer loans........................... $142,407 $(2,166) (1.5)% $8,275 6.2% ======== ======= ==== ====== === -------- ()(1) Real estate secured receivables are comprised of the following: INCREASES (DECREASES) FROM ------------------------------- DECEMBER 31, MARCH 31, 2006 2006 MARCH 31, -------------- -------------- 2007 $ % $ %------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Mortgage Services............................. $46,555 $(2,917) (5.9)% $(2,775) (5.6)%Consumer Lending.............................. 47,604 1,705 3.7 7,914 19.9 ------- ------- ---- ------- ----Total real estate secured..................... $94,159 $(1,212) (1.3)% $ 5,139 5.8% ======= ======= ==== ======= ==== Customer loans decreased 2 percent at March 31, 2007 as compared to $144.6billion at December 31, 2006. Real estate secured loans decreased at March 31,2007 as compared to the prior quarter. The decrease in real estate 45 HSBC Finance Corporation -------------------------------------------------------------------------------- secured loans was primarily at our Mortgage Services business as we havecontinued to tighten underwriting standards for loans purchased fromcorrespondents, which included the reduction of purchases of second lien andselected higher risk segments. Additionally, in March 2007, we announced ourdecision to discontinue all loan acquisitions by our Mortgage Services business.Although we will continue the current operating strategies for our Decision Onewholesale channel, this will result in significant reductions in our MortgageServices real estate portfolio throughout 2007 and in subsequent years. Thedecreases in real estate secured loans at our Mortgage Services business werepartially offset by increases in the real estate secured portfolio at ourConsumer Lending business as a result of sales volumes in excess of run-off. Inaddition, the decline in loan prepayments has continued during the first quarterof 2007 which has resulted in lower run-off rates for our real estate securedportfolio. Growth in our auto finance portfolio reflects organic growth andincreased volume. The decrease in our private label portfolio is due to normalseasonal run-off, partially offset by growth in the co-branded card portfoliolaunched by our Retail Services operations during 2006. Compared to March 31, 2006, customer loans increased 6 percent. Real estategrowth in 2006 was strong as a result of strong growth in our branch-basedConsumer Lending business. In addition, our correspondent business experiencedgrowth through June 2006 as management continued to focus on junior lien loansand expanded our sources for purchasing newly originated loans from flowcorrespondents. However, as previously discussed above, in the second half of2006, management revised its business plan and began tightening underwritingstandards on loans purchased from correspondents including reducing purchases ofsecond lien and selected higher risk segments. Growth in our branch-basedConsumer Lending business reflects strong sales volumes as we continue toemphasize real estate secured loans, including a near-prime mortgage product.Real estate secured customer loans also increased as a result of the acquisitionof the $2.5 billion Champion portfolio in November 2006. In addition, a declinein loan prepayments in 2006 resulted in lower run-off rates for our real estatesecured portfolio which also contributed to overall growth. Our Auto Financebusiness also reported organic growth, principally in the near-prime portfolio,from increased volume in both the dealer network and the consumer direct loanprogram. The private label portfolio increased from the year-ago quarter due toorganic growth and the co-branded card portfolio launched by our Retail Servicesoperations during 2006. Growth in our personal non-credit card portfolio was theresult of increased marketing, including several large direct mail campaigns. ROA was .66 percent for the first quarter of 2007, compared to 2.15 percent inthe year-ago period. The decrease in the ROA ratio in the first quarter of 2007is primarily due to the increase in loan impairment charges as discussed above,as well as higher average assets. CREDIT CARD SERVICES SEGMENT The following table summarizes the IFRS ManagementBasis results for our Credit Card Services segment: INCREASE (DECREASE) -------------THREE MONTHS ENDED MARCH 31 2007 2006 AMOUNT %-------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net income......................................... $ 389 $ 332 $ 57 17.2%Net interest income................................ 821 732 89 12.2Other operating income............................. 698 478 220 46.0Loan impairment charges............................ 420 249 171 68.7Operating expenses................................. 483 434 49 11.3Intersegment revenues.............................. 5 5 - -Customer loans..................................... 27,843 24,874 2,969 11.9Assets............................................. 27,793 25,477 2,316 9.1Net interest margin, annualized.................... 11.74% 11.40% - -Return on average assets........................... 5.54 4.99 - - 46 HSBC Finance Corporation -------------------------------------------------------------------------------- Our Credit Card Services segment reported higher net income in the first quarterof 2007. The increase in net income was primarily due to higher net interestincome and higher other operating income, partially offset by higher loanimpairment charges and higher operating expenses. Net interest income increased in the three months ended March 31, 2007 largelyas a result of higher overall yields due in part to higher levels of non-primecustomer loans, partially offset by higher interest expense. Net interest marginincreased primarily due to higher overall yields due to increases in non-primecustomer loans, higher pricing on variable rate products and other repricinginitiatives. These increases were partially offset by a higher cost of funds.Although our non-prime customer loans tend to have smaller balances, theygenerate higher returns both in terms of net interest margin and fee income. Increases in other operating income resulted from portfolio growth whichresulted in higher late fees, higher overlimit fees and higher enhancementservices revenue from products such as Account Secure Plus (debt waiver) andIdentity Protection Plan. Higher operating expenses were also incurred tosupport receivable growth including increases in marketing expenses. Theincrease in marketing expenses in the first quarter of 2007 was due to increasedinvestment in our non-prime portfolio. Loan impairment charges were higher in the first quarter of 2007 due to highernet charge-off reflecting receivable growth and portfolio seasoning as well asan increase in bankruptcy filings as compared to the year-ago period whichbenefited from reduced levels of personal bankruptcy filings following theenactment of new bankruptcy law in the United States which went into effect inOctober 2005. We reduced loss reserves by recording loss provision less than netcharge-off of $27 million in the first quarter of 2007 as overall consumer loansoutstanding declined due to normal seasonal run-off. Customer loans decreased 1 percent to $27.8 billion compared to $28.2 billion atDecember 31, 2006. The decrease during the quarter was due primarily to normalseasonal run-off, partially offset by growth in our non-prime portfolio,including Metris. Compared to March 31, 2006, customer loans increased 12percent. The increase reflects strong domestic organic growth in our UnionPrivilege as well as other non-prime portfolios, including Metris. The increase in ROA in the first quarter of 2007 is primarily due to the highernet income as discussed above, partially offset by higher average assets. INTERNATIONAL SEGMENT The following table summarizes the IFRS Management Basisresults for our International segment: INCREASE (DECREASE) ----------------THREE MONTHS ENDED MARCH 31 2007 2006 AMOUNT %--------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net (loss) income................................ $ (90) $ 22 $(112) (100.0+)%Net interest income.............................. 204 210 (6) (2.9)Other operating income........................... 47 41 6 14.6Loan impairment charges.......................... 248 104 144 100.0+Operating expenses............................... 128 112 16 14.3Intersegment revenues............................ 5 7 (2) (28.6)Customer loans................................... 9,506 9,176 330 3.6Assets........................................... 10,238 10,900 (662) (6.1)Net interest margin, annualized.................. 8.20% 8.52% - -Return on average assets......................... (3.43) .79 - - Our International segment reported lower net income in the first quarter of 2007primarily due to higher loan impairment charges, higher operating expenses andlower net interest income, partially offset by higher other 47 HSBC Finance Corporation -------------------------------------------------------------------------------- operating income. Applying constant currency rates, which uses the average rateof exchange for the 2006 quarter to translate current period net income, the netloss in the first quarter of 2007 would have been lower by $13 million. Loan impairment charges increased in the first quarter of 2007 primarily due toa refinement in the methodology used to calculate roll rate percentages by ourU. K. operations which increased credit loss reserves $117 million and which webelieve reflects a better estimate of probable losses currently inherent in theloan portfolio. Despite the challenging financial circumstances faced by some ofour customers in the U.K., the performance of our U.K. loan portfolios asmeasured by delinquency and charge-offs was steady during the first quarter of2007. Loss reserves at our Canadian operations increased $3 million due toreceivable growth. Net interest income decreased during the first quarter of 2007 primarily as aresult of lower receivable levels in our U.K. subsidiary and higher interestexpense. The lower receivable levels were due to decreased sales volumes in theU.K. resulting from a continuing challenging credit environment in the U.K. aswell as the sale of our European Operations in November 2006. This was partiallyoffset by higher net interest income in our Canadian operations due to growth incustomer loans. Net interest margin decreased in the first quarter of 2007primarily due to lower yields on customer loans due to a focus over the last sixmonths on secured lending, which have lower yields, rather than unsecuredlending, the impact of the sale of the European Operations in November 2006 aswell as a higher cost of funds. Other operating income increased in the first quarter of 2007, due to highercredit card fee income in our Canadian operations, partially offset by lowerinsurance revenues in the U.K. due to lower sales volumes and a planned phaseout of the use of a specific broker between January and April 2007. Operatingexpenses increased to support receivable growth. Customer loans for our International segment can be further analyzed as follows: INCREASES (DECREASES) FROM ---------------------------- DECEMBER 31, MARCH 31, 2006 2006 MARCH 31, ------------ ------------- 2007 $ % $ %------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS) Real estate secured............................. $3,717 $ 165 4.6% $ 624 20.2%Auto finance.................................... 233 (13) (5.3) 69 42.1Credit card..................................... 2,255 25 1.1 188 9.1Private label................................... 303 (7) (2.3) 30 11.0Personal non-credit card........................ 2,998 (184) (5.8) (581) (16.2) ------ ----- ---- ----- -----Total customer loans............................ $9,506 $ (14) (.1)% $ 330 3.6% ====== ===== ==== ===== ===== Customer loans were $9.5 billion at March 31, 2007 and December 31, 2006.Increases in both the secured and unsecured portfolios of our Canadianoperations were offset by lower personal non-credit card loans in our U.K.operations. Applying constant currency rates, customer loans at March 31, 2007would not have been materially different using December 31, 2006 exchange rates. Compared to March 31, 2006, receivables increased 4 percent primarily as aresult of foreign exchange impacts. Applying constant currency rates, customerloans at March 31, 2007 would have been approximately $670 million lower.Excluding the positive foreign exchange impacts, lower customer loans in ourU.K. operations were partially offset by higher customer loans in our Canadianbusiness. Our U.K. based private label loans decreased due to continuing lowerretail sales volume following a slow down in retail consumer spending. Lowerpersonal non-credit card loans in the U.K. reflect lower volumes as the U.K.branch network has placed a greater emphasis on secured lending. Additionally,receivable levels at March 31, 2007 reflect the sale in November 2006 of $203million of customer loans related to our European operations. The increase inour Canadian business is due to growth in both the secured and unsecuredcustomer loan portfolios of our Canadian operations. 48 HSBC Finance Corporation -------------------------------------------------------------------------------- ROA was (3.43) percent for the first quarter of 2007 compared to .79 percent inthe year-ago period. The decrease in the ROA ratio in the first quarter of 2007is primarily due to the increase in loan impairment charges as discussed above,partially offset by lower average assets. As part of our continuing evaluation of strategic alternatives with respect toour U.K. operations, we have entered into a non-binding agreement to sell thecapital stock of our U.K. Insurance Operations to a third party for cash. Thesales price will be determined, in part, based on the actual net book value ofthe assets sold at the time the sale is closed which is anticipated in the thirdquarter of 2007. The agreement also provides for the purchaser to distributeinsurance products through our U.K. branch network for which we will receivecommission revenue. The sale is subject to satisfactory completion of final duediligence, the execution of a definitive agreement, and any regulatory approvalsthat may be required. At March 31, 2007, we have classified the U.K. InsuranceOperations as "Held for Sale" which included $470 million of assets andliabilities of $236 million within the International segment. After taking intoconsideration the goodwill allocated to the U.K. Insurance Operations of $79million, which is included in the "All Other" caption within our segmentdisclosures, the carrying value of the U.K. Insurance Operations was higher thanthe estimated purchase price based on the March 31, 2007 net book value. Theadjustment of $37 million to record our investment in these operations at thelower of cost or market has been recorded in the "All Other" caption. Wecontinue to evaluate the scope of our other U.K. operations. CREDIT QUALITY-------------------------------------------------------------------------------- CREDIT LOSS RESERVES We maintain credit loss reserves to cover probable losses of principal, interestand fees, including late, overlimit and annual fees. Credit loss reserves arebased on a range of estimates and are intended to be adequate but not excessive.We estimate probable losses for consumer receivables using a roll rate migrationanalysis that estimates the likelihood that a loan will progress through thevarious stages of delinquency, or buckets, and ultimately charge-off. Thisanalysis considers delinquency status, loss experience and severity and takesinto account whether loans are in bankruptcy, have been restructured orrewritten, or are subject to forbearance, an external debt management plan,hardship, modification, extension or deferment. Our credit loss reserves alsotake into consideration the loss severity expected based on the underlyingcollateral, if any, for the loan in the event of default. Delinquency status maybe affected by customer account management policies and practices, such as therestructure of accounts, forbearance agreements, extended payment plans,modification arrangements, external debt management programs, loan rewrites anddeferments. If customer account management policies, or changes thereto, shiftloans from a "higher" delinquency bucket to a "lower" delinquency bucket, thiswill be reflected in our roll rate statistics. To the extent that restructuredaccounts have a greater propensity to roll to higher delinquency buckets, thiswill be captured in the roll rates. Since the loss reserve is computed based onthe composite of all of these calculations, this increase in roll rate will beapplied to receivables in all respective delinquency buckets, which willincrease the overall reserve level. In addition, loss reserves on consumerreceivables are maintained to reflect our judgment of portfolio risk factorsthat may not be fully reflected in the statistical roll rate calculation. Riskfactors considered in establishing loss reserves on consumer receivables includerecent growth, product mix, bankruptcy trends, geographic concentrations, loanproduct features such as adjustable rate loans, economic conditions, such asnational and local trends in housing markets and interest rates, portfolioseasoning, account management policies and practices, current levels of charge-offs and delinquencies, changes in laws and regulations and other items whichcan affect consumer payment patterns on outstanding receivables, such as naturaldisasters 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,reserves as a percentage of net charge-offs and number of months charge-offcoverage in developing our loss reserve estimate. Loss reserve estimates arereviewed periodically and adjustments are reported in earnings when they becomeknown. As these estimates are influenced by factors outside of our 49 HSBC Finance Corporation -------------------------------------------------------------------------------- control, such as consumer payment patterns and economic conditions, there isuncertainty inherent in these estimates, making it reasonably possible that theycould change. The following table summarizes credit loss reserves: MARCH 31, DECEMBER 31, MARCH 31, 2007 2006 2006------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS) Owned credit loss reserves.......................... $6,798 $6,587 $4,468Reserves as a percent of: Receivables....................................... 4.25% 4.07% 3.04% Net charge-offs(1)................................ 114.2 119.9 120.4 Nonperforming loans............................... 116.1 114.8 103.3 -------- ()(1) Quarter-to-date, annualized. Credit loss reserve levels at March 31, 2007 increased as compared to December31, 2006 as we recorded loss provision in excess of net charge-offs of $212million during the three months ended March 31, 2007. This increase was largelydue to higher reserve requirements in our Consumer Lending and United Kingdombusinesses. At our Consumer Lending business, we recorded loss provision inexcess of net charge-offs of $115 million primarily due to higher loss estimatesin second lien loans purchased from 2004 through the third quarter of 2006. AtMarch 31, 2007, the outstanding principal balance of second lien loans acquiredby the Consumer Lending business during this period was approximately $1.5billion. Our United Kingdom business recorded loss provision in excess of netcharge-off of $106 million which was largely attributable to a refinement in themethodology used to calculate roll rate percentages which we believe reflects abetter estimate of probable loss currently inherent in the loan portfolio. Werecorded loss provision in excess of net charge-offs at our Mortgage Servicesbusiness of $55 million primarily due to continued higher delinquency levels aspreviously discussed although the rate of increase has slowed from priorquarters. These increases were partially offset by the impact of normal seasonalrun-off in our credit card portfolio as well as seasonal improvements in ourcollection activities in the first quarter as customers across our businessesuse their tax refunds to reduce their outstanding balances. Credit loss reserves at March 31, 2007 increased significantly as compared toMarch 31, 2006 primarily as a result of the higher delinquency and lossestimates at our Mortgage Services business. In addition, the higher credit lossreserve levels are the result of higher levels of receivables due in part tolower securitization levels, higher dollars of delinquency in our otherbusinesses driven by growth and portfolio seasoning, weakening early stageperformance consistent with the industry trend in certain Consumer Lending realestate secured loans originated since late 2005 and increased levels of personalbankruptcy filings as compared to the exceptionally low levels experienced inthe first quarter of 2006 following enactment of new bankruptcy legislation inthe United States. As previously discussed, we are experiencing higher delinquency and lossestimates at our Mortgage Services business as compared to the year-ago period.Credit loss reserve levels of $2.1 billion at our Mortgage Services business atMarch 31, 2007, which are consistent with our credit loss reserve levels atDecember 31, 2006, reflect our best estimate of losses in the portfolio. Inestablishing these reserve levels we considered the severity of losses expectedto be incurred, particularly in our second lien portfolio, above our historicalexperience given the current housing market trends in the United States. We alsoconsidered the ability of borrowers to repay their first lien adjustable ratemortgage loans at higher contractual reset rates given increases in interestrates by the Federal Reserve Bank from June 2004 through June 2006, as well astheir ability to repay any underlying second lien mortgage outstanding. Becausefirst lien adjustable rate mortgage loans are generally well secured, ultimatelosses associated with such loans are dependent to a large extent on the statusof the housing market and interest rate environment. Therefore, although it isprobable that incremental losses will occur as a result of rate resets on firstlien adjustable 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. A significant portion ofthe Mortgage Services second lien mortgages are subordinate to a first lienadjustable rate loan. For customers with second lien mortgage loans that aresubordinate to a first lien adjustable rate mortgage loan, the probability ofrepayment of the second lien 50 HSBC Finance Corporation -------------------------------------------------------------------------------- mortgage loan is significantly reduced. The impact of future changes, if any, inthe housing market will not have a significant impact on the ultimate lossexpected to be incurred since these loans, based on history and other factors,are expected to behave like unsecured loans. As a result, expected losses forthese second lien loans held in our Mortgage Services portfolio are included inour credit loss reserve levels at March 31, 2007. Reserves as a percentage of receivables at March 31, 2007 were higher than atMarch 31, 2006 and December 31, 2006 due to the impact of additional reserverequirements as discussed above and, compared to December 31, 2006, lowerreceivable levels. Reserves as a percentage of net charge-offs decreased ascompared to March 31, 2006 as the higher net charge-offs in our Credit CardServices and Mortgage Services business in the first quarter of 2007 more thanoffset the increase in reserves, primarily at our Mortgage Services business.The increase in charge-offs in our Credit Card Services business is due toincreased levels of personal bankruptcy filings as compared to the exceptionallylow levels experienced in the first quarter of 2006 following enactment of thenew bankruptcy law in the United States. Compared to December 31, 2006, reservesas a percentage of net charge-offs decreased slightly as charge-offs increasedmore rapidly than reserve levels during the quarter. Reserves as a percentage ofnonperforming loans increased as compared to both March 31, 2006 and December31, 2006 as reserve levels grew more rapidly than nonperforming loans primarilydue to the higher reserve requirements in our Consumer Lending and UnitedKingdom businesses as previously discussed. DELINQUENCY The following table summarizes two-months-and-over contractual delinquency (as apercent of consumer receivables): MARCH 31, DECEMBER 31, MARCH 31, 2007 2006 2006------------------------------------------------------------------------------------------ Real estate secured(1).............................. 3.73% 3.54% 2.46%Auto finance........................................ 2.32 3.18 2.17Credit card......................................... 4.53 4.57 4.35Private label....................................... 5.27 5.31 5.50Personal non-credit card............................ 10.21 10.17 8.86 ----- ----- ----Total consumer...................................... 4.64% 4.59% 3.66% ===== ===== ==== -------- ()(1) Real estate secured two-months-and-over contractual delinquency (as a percent of consumer receivables) are comprised of the following: MARCH 31, DECEMBER 31, MARCH 31, 2007 2006 2006------------------------------------------------------------------------------------------- Mortgage Services: First lien......................................... 4.98% 4.50% 2.94% Second lien........................................ 6.69 5.74 1.83 ---- ---- ----Total Mortgage Services.............................. 5.33 4.75 2.70Consumer Lending: First lien......................................... 2.01 2.07 1.87 Second lien........................................ 3.32 3.06 2.68 ---- ---- ----Total Consumer Lending............................... 2.20 2.21 1.99Foreign and all other: First lien......................................... 1.65 1.58 1.77 Second lien........................................ 5.07 5.38 5.57 ---- ---- ----Total Foreign and all other.......................... 4.35 4.59 4.88 ---- ---- ----Total real estate secured............................ 3.73% 3.54% 2.46% ==== ==== ==== Total delinquency increased 5 basis points, compared to the prior quarter. Theincrease was due to higher real estate secured delinquency levels primarily atour Mortgage Services business as previously discussed, partially offset bylower delinquency levels at our Auto Finance business. Two-months-and-overcontractual delinquency as a 51 HSBC Finance Corporation -------------------------------------------------------------------------------- percentage of consumer receivables was broadly flat in the quarter across allour other products which included seasonal improvements in our collectionactivities in the first quarter as customers use their tax refunds to reducetheir outstanding balances. The decrease in our auto finance portfolio ratioreflects seasonal improvements in collection activities as well as the impact ofthe change in the charge-off policy in the fourth quarter of 2006 as accountsare now charging off sooner. The increase in delinquency in our personal non-credit card portfolio ratio reflects maturation of a growing domestic portfolioas well as slight deterioration of certain customer groups in our domesticportfolio. Dollars of delinquency decreased slightly compared to the priorquarter as increases in delinquency in our real estate secured portfolios weremore than offset by decreases in other products, particularly in our autofinance portfolio, as discussed above. Compared to the year-ago period, total delinquency increased 98 basis pointslargely due to higher real estate secured delinquency levels primarily at ourMortgage Services business as previously discussed. With the exception of ourprivate label portfolio, all products reported higher delinquency levels due tohigher receivable levels. Additionally, the increase in the Consumer Lendingreal estate delinquency ratio reflects the addition of the Champion portfolio.While the Champion portfolio carries higher delinquency, its low loan-to-valueratios are expected to result in lower charge-offs compared to the existingportfolio. The increase in our auto finance and credit card delinquency ratiosis due to the seasoning of a growing portfolio. The increase in the credit carddelinquency levels is also due to higher bankruptcy levels. 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 as well as deterioration of certaincustomer groups in our domestic portfolio. NET CHARGE-OFFS OF CONSUMER RECEIVABLES The following table summarizes net charge-offs of consumer receivables (as apercent, annualized, of average consumer receivables): MARCH 31, DECEMBER 31, MARCH 31, 2007 2006 2006------------------------------------------------------------------------------------------ Real estate secured(1).............................. 1.74% 1.28% .75%Auto finance(2)..................................... 3.64 4.97 3.50Credit card......................................... 7.08 6.79 4.00Private label(2).................................... 5.87 6.68 5.62Personal non-credit card(2)......................... 7.96 7.92 7.94 ---- ---- ----Total(2)............................................ 3.69% 3.46% 2.58% ==== ==== ====Real estate secured net charge-offs and REO expense as a percent of average real estate secured receivables....................................... 1.86% 1.68% .89% -------- ()(1) Real estate secured net charge-off of consumer receivables as a percent, annualized, of average consumer receivables are comprised of the following: 52 HSBC Finance Corporation -------------------------------------------------------------------------------- MARCH 31, DECEMBER 31, MARCH 31, 2007 2006 2006------------------------------------------------------------------------------------------- Mortgage Services: First lien......................................... 1.17% .91% .67% Second lien........................................ 7.97 4.40 1.15 ---- ---- ----Total Mortgage Services.............................. 2.55 1.66 .77Consumer Lending: First lien......................................... .80 .85 .71 Second lien........................................ 1.93 1.02 1.01 ---- ---- ----Total Consumer Lending............................... .96 .88 .75Foreign and all other: First lien......................................... 1.34 .89 .24 Second lien........................................ 1.29 1.15 .63 ---- ---- ----Total Foreign and all other.......................... 1.30 1.10 .56 ---- ---- ----Total real estate secured............................ 1.74% 1.28% .75% ==== ==== ==== -------- ()(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. 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 private label net charge-off ratio would have been 5.85 percent and the personal non-credit card net charge-off ratio would have been 6.32 percent in the quarter ended December 31, 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. Net charge-offs as a percent, annualized, of average consumer receivablesincreased 23 basis points compared to the prior quarter primarily due to highercharge-offs in our real estate secured portfolios, in particular at our MortgageServices business due to the progression to charge-off of certain loans acquiredin 2005 and 2006. We anticipate the increase in the net charge-off ratio for ourreal estate secured portfolio will continue throughout 2007 as the loanspurchased by Mortgage Services in 2005 and 2006 continue to progress to variousstages of delinquency and ultimately charge-off. The increase in the ConsumerLending real estate secured net charge-off ratio was primarily due to portfolioseasoning. The charge-off ratio for our Auto Finance business decreased due tothe seasonal improvements in collection activities in the first quarter as wellas the impact of the one-time acceleration of charge-offs in December 2006related to the change in the charge-off policy described above. The increase inour credit card ratio is due to the seasoning of a growing portfolio, partiallyoffset by seasonal improvements in collection activities. Excluding the impactof the discontinuance of a forbearance program in our U.K. business in the priorquarter, the private label charge-off ratio was essentially flat compared to theprior quarter. Excluding the impact of the discontinuance of a forbearanceprogram in our U.K. business in the prior quarter, the personal non-credit cardcharge-off ratio increased reflecting portfolio seasoning as well as a slightdeterioration of certain customer groups in our domestic portfolio. As compared to the prior year quarter, net charge-offs as a percent, annualized,of average consumer receivables increased 111 basis points primarily due tohigher charge-offs in our real estate secured portfolios, as discussed above, aswell as higher charge-offs in our credit card portfolio. The increase in charge-offs in the credit card portfolio is due to increased levels of personalbankruptcy filings as compared to the exceptionally low levels experienced inthe first quarter of 2006 following enactment of the new bankruptcy law in theUnited States. The increase in the auto finance portfolio is due to seasoning ofa growing portfolio. 53 HSBC Finance Corporation -------------------------------------------------------------------------------- NONPERFORMING ASSETS MARCH 31, DECEMBER 31, MARCH 31, 2007 2006 2006------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS) Nonaccrual receivables(1),(2)....................... $4,945 $4,807 $3,582Accruing consumer receivables 90 or more days delinquent........................................ 909 929 742Renegotiated commercial loans....................... 1 1 1 ------ ------ ------Total nonperforming receivables..................... 5,855 5,737 4,325Real estate owned................................... 863 794 563 ------ ------ ------Total nonperforming assets.......................... $6,718 $6,531 $4,888 ====== ====== ======Credit loss reserves as a percent of nonperforming receivables....................................... 116.1% 114.8% 103.3% -------- ()(1) Nonaccrual receivables are comprised of the following: MARCH 31, DECEMBER 31, MARCH 31, 2007 2006 2006------------------------------------------------------------------------------------------- (IN MILLIONS) Real estate secured:Closed-end: First lien......................................... $2,032 $1,893 $1,352 Second lien........................................ 521 482 320Revolving: First lien......................................... 17 22 29 Second lien........................................ 225 187 72 ------ ------ ------Total real estate secured............................ 2,795 2,584 1,773Auto finance......................................... 291 394 241Credit card.......................................... - - -Private label........................................ 77 76 77Personal non-credit card............................. 1,782 1,753 1,490Commercial and other................................. - - 1 ------ ------ ------Total nonaccrual receivables......................... $4,945 $4,807 $3,582 ====== ====== ====== -------- ()(2) As previously discussed, in December 2006, our Auto Finance business changed its charge-off policy and in connection with this policy change also changed the methodology for reporting two-months-and-over contractual delinquency. These changes resulted in an increase in nonaccrual receivables at December 31, 2006. Prior period amounts have been restated to conform to the current year presentation. Compared to December 31, 2006, the increase in total nonperforming assets is dueto higher levels of real estate secured nonaccrual receivables at our MortgageServices business due to the progression of certain loans acquired in 2005 and2006 to various stages of delinquency as previously discussed. Real estatesecured nonaccrual loans included stated income loans at our Mortgage Servicesbusiness of $682 million at March 31, 2007, $571 million at December 31, 2006,and $194 million at March 31, 2006. Consistent with industry practice, accruingconsumer receivables 90 or more days delinquent includes domestic credit cardreceivables. ACCOUNT MANAGEMENT POLICIES AND PRACTICES Our policies and practices for the collection of consumer receivables, includingour customer account management policies and practices, permit us to reset thecontractual delinquency status of an account to current, based on indicia orcriteria which, in our judgment, evidence continued payment probability. Suchpolicies and practices vary by product and are designed to manage customerrelationships, maximize collection opportunities and avoid foreclosure orrepossession if reasonably possible. If the account subsequently experiencespayment defaults, it will again become contractually delinquent. 54 HSBC Finance Corporation -------------------------------------------------------------------------------- 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. 55 HSBC Finance Corporation -------------------------------------------------------------------------------- TOTAL RESTRUCTURED BY RESTRUCTURE PERIOD - DOMESTIC PORTFOLIO(1) (MANAGED BASIS) MARCH 31, DECEMBER 31, MARCH 31, 2007 2006 2006------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS) Never restructured.................................. 87.9% 89.1% 89.7%Restructured: Restructured in the last 6 months................. 5.6 4.8 4.0 Restructured in the last 7-12 months.............. 2.8 2.4 2.4 Previously restructured beyond 12 months.......... 3.7 3.7 3.9 ------- ------- ------- Total ever restructured(2)........................ 12.1 10.9 10.3 ------- ------- -------Total............................................... 100.0% 100.0% 100.0% ======= ======= =======TOTAL RESTRUCTURED BY PRODUCT - DOMESTIC PORTFOLIO(1)(MANAGED BASIS)Real estate secured................................. $11,779 $10,344 $ 8,395Auto finance........................................ 1,919 1,881 1,712Credit card......................................... 802 816 937Private label(3).................................... 30 31 26Personal non-credit card............................ 3,722 3,600 3,411 ------- ------- -------Total............................................... $18,252 $16,672 $14,481 ======= ======= =======(AS A PERCENT OF MANAGED RECEIVABLES)Real estate secured................................. 12.7% 11.0% 9.7%Auto finance........................................ 15.3 15.1 14.5Credit card......................................... 2.9 2.9 3.8Private label(3).................................... 11.5 10.9 7.3Personal non-credit card............................ 20.3 19.5 19.9 ------- ------- -------Total(2)............................................ 12.1% 10.9% 10.3% ======= ======= ======= -------- ()(1) Excludes foreign businesses, commercial and other.()(2) Total including foreign businesses was 11.7 percent at March 31, 2007, 10.6 percent at December 31, 2006 and 10.1 percent at March 31, 2006.()(3) Only reflects consumer lending retail sales contracts which have historically been classified as private label. All other domestic private label receivables were sold to HSBC Bank USA in December 2004. The increase in restructured loans was primarily attributable to higher levelsof real estate secured restructures due to portfolio growth and seasoning,including higher restructure levels at our Mortgage Services business 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 loans and restructuredcertain of those accounts after receipt of one modified payment and if certainother criteria were met. Such accounts are included in the above restructurestatistics beginning in the fourth quarter of 2006. See "Credit Quality Statistics" for further information regarding owned basisand managed basis delinquency, charge-offs and nonperforming loans. The amount of domestic and foreign managed receivables in forbearance,modification (excluding Mortgage Services for March 31, 2007 and December 31,2006), credit card services approved consumer credit counseling accommodations,rewrites or other customer account management techniques for which we have resetdelinquency and that is not included in the restructured or delinquencystatistics was approximately $.3 billion or .2 percent of managed receivables atMarch 31, 2007 and December 31, 2006, and $.4 billion or .3 percent of managedreceivables at March 31, 2006. 56 HSBC Finance Corporation -------------------------------------------------------------------------------- LIQUIDITY AND CAPITAL RESOURCES-------------------------------------------------------------------------------- We continue to focus on balancing our use of affiliate and third party fundingsources to minimize funding expense while managing liquidity. During the firstquarter of 2007, we supplemented unsecured debt issuances with proceeds from thecontinuing sale of newly originated domestic private label receivables to HSBCBank USA, debt issued to affiliates and increased levels of secured financings. Debt due to affiliates and other HSBC related funding are summarized in thefollowing table: MARCH 31, DECEMBER 31, 2007 2006-------------------------------------------------------------------------------------- (IN BILLIONS) Debt issued to HSBC subsidiaries: Drawings on bank lines in the U.K. and Europe............. $ 4.2 $ 4.3 Term debt................................................. 10.6 10.6 Preferred securities issued by Household Capital Trust VIII to HSBC........................................... .3 .3 ----- ----- Total debt outstanding to HSBC subsidiaries............... 15.1 15.2 ----- -----Debt outstanding to HSBC clients: Euro commercial paper..................................... 2.9 3.0 Term debt................................................. 1.1 1.2 ----- ----- Total debt outstanding to HSBC clients.................... 4.0 4.2Cash received on bulk and subsequent sales of domestic private label credit card receivables to HSBC Bank USA, net (cumulative).......................................... 17.2 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............................................... (4.9) (4.7) ----- -----Total real estate secured receivable activity with HSBC Bank USA....................................................... 3.0 3.2 ----- -----Cash received from sale of European Operations to HBEU affiliate................................................. -(1) -(1)Cash received from sale of U.K. credit card business to HBEU...................................................... 2.7 2.7Capital contribution by HSBC Investments (North America) Inc. ("HINO") (cumulative)................................ 1.6 1.4 ----- -----Total HSBC related funding.................................. $43.6 $44.6 ===== ===== -------- ()(1) Less than $100 million. Funding from HSBC, including debt issuances to HSBC subsidiaries and clients,represented 13 percent of our total debt and preferred stock funding at March31, 2007 and December 31, 2006. Cash proceeds of $46 million from the November 2006 sale of the EuropeanOperations and the December 2005 sale of our U.K. credit card receivables toHBEU of $2.7 billion in cash were used to partially pay down drawings on banklines from HBEU for the U.K. and fund operations. Proceeds received from thebulk sale and subsequent daily sales of domestic private label credit cardreceivables to HSBC Bank USA of $17.9 billion were used to pay down short-termdomestic borrowings, including outstanding commercial paper balances, and tofund operations. At March 31, 2007, we had a commercial paper back stop credit facility of $2.5billion from HSBC supporting domestic issuances and a revolving credit facilityof $5.7 billion from HBEU to fund our operations in the U.K. At March 31, 2007,$4.2 billion was outstanding under the HBEU lines for the U.K. and no balanceswere outstanding under the domestic lines. At March 31, 2007, we had derivativecontracts with a notional value of $83.0 billion, or approximately 87 percent oftotal derivative contracts, outstanding with HSBC affiliates. At December 31,2006, we 57 HSBC Finance Corporation -------------------------------------------------------------------------------- had derivative contracts with a notional value of $82.8 billion, orapproximately 88 percent of total derivative contracts, outstanding with HSBCaffiliates. SECURITIES AND OTHER SHORT-TERM INVESTMENTS Securities totaled $4.1 billion atMarch 31, 2007 and $4.7 billion at December 31, 2006. Securities purchased underagreements to resell totaled $59 million at March 31, 2007 and $171 million atDecember 31, 2006. Interest bearing deposits with banks totaled $87 million atMarch 31, 2007 and $424 million at December 31, 2006. The decreases insecurities and interest bearing deposits with banks is largely due to thereclassification of the assets of the U.K. Insurance Operations which at March31, 2007 are classified as "Held for Sale." COMMERCIAL PAPER, BANK AND OTHER BORROWINGS totaled $10.9 billion at March 31,2007 and $11.1 billion at December 31, 2006. Our funding strategy requires thatbank credit facilities will at all times exceed 85% of outstanding commercialpaper and that the combination of bank credit facilities and undrawn committedconduit facilities will, at all times, exceed 115% of outstanding commercialpaper. Included in this total was outstanding Euro commercial paper sold tocustomers of HSBC of $2.9 billion at March 31, 2007 and $3.0 billion at December31, 2006. LONG TERM DEBT (with original maturities over one year) decreased to $125.5billion at March 31, 2007 from $127.6 billion at December 31, 2006. Significantissuances during the first quarter of 2007 included the following: - $.2 billion of InterNotes(SM) (retail-oriented medium-term notes) - $1.0 billion of global debt - $3.1 billion of securities backed by 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. COMMON EQUITY In the first quarter of 2007, HINO made a capital contribution of$200 million to support ongoing operations. In 2006, in connection with ourpurchase of the Champion portfolio, HINO made a capital contribution of $163million. SELECTED CAPITAL RATIOS In managing capital, we develop targets for tangibleshareholder's(s') equity to tangible managed assets ("TETMA"), tangibleshareholder's(s') equity plus owned loss reserves to tangible managed assets("TETMA + Owned Reserves") and tangible common equity to tangible managedassets. These ratio targets are based on discussions with HSBC and ratingagencies, risks inherent in the portfolio, the projected operating environmentand related risks, and any acquisition objectives. These ratios exclude theequity impact of SFAS No. 115, "Accounting for Certain Investments in Debt andEquity Securities," 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 credit risk on debtfor which we elected the fair value option. Preferred securities issued bycertain non-consolidated trusts are also considered equity in the TETMA andTETMA + 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. We and certainrating agencies also monitor our equity ratios excluding the impact of the HSBCacquisition purchase accounting adjustments. We do so because we believe thatthe HSBC acquisition purchase accounting adjustments represent non-cashtransactions which do not affect our business operations, cash flows or abilityto meet our debt obligations. Our targets may change from time to time toaccommodate changes in the operating environment or other considerations such asthose listed above. 58 HSBC Finance Corporation -------------------------------------------------------------------------------- SELECTED CAPITAL RATIOS are summarized in the following table: MARCH 31, DECEMBER 31, 2007 2006-------------------------------------------------------------------------------------- TETMA(1).................................................... 7.49% 7.16%TETMA + Owned Reserves(1)................................... 11.55 11.02Tangible common equity to tangible managed assets(1)........ 6.39 6.08Common and preferred equity to owned assets................. 11.09 11.13Excluding purchase accounting adjustments: TETMA(1).................................................. 8.07% 7.80% TETMA + Owned Reserves(1)................................. 12.13 11.66 Tangible common equity to tangible managed assets(1)...... 6.96 6.72 -------- ()(1) TETMA, TETMA + Owned Reserves and tangible common equity to tangible managed assets represent non-U.S.GAAP financial ratios that are used by HSBC Finance Corporation management and certain rating agencies to evaluate capital adequacy and may differ from similarly named measures presented by other companies. See "Basis of Reporting" for additional discussion on the use of non-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. 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 often are more cost-effective than 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 will continue to be sold to thesetrusts and the resulting replenishment gains recorded until the revolvingperiods end, the last of which is currently projected to occur in the fourthquarter of 2007. The termination of sale treatment on new collateralized fundingactivity reduced our reported net income under U.S. GAAP. There was no impact,however, on cash received from operations. Because we believe the market forsecurities backed by receivables is a reliable, efficient and cost-effectivesource of funds, we will continue to use secured financings of consumerreceivables as a source of our funding and liquidity. There were no securitizations (excluding replenishments of certificateholderinterests) during the first quarter of 2007 or 2006. Secured financings aresummarized in the following table: THREE MONTHS ENDED MARCH 31 2007 2006--------------------------------------------------------------------------------- (IN MILLIONS) SECURED FINANCINGS:Real estate secured............................................. $ - $ 350Credit card..................................................... 1,890 1,120Auto finance.................................................... 1,069 -Personal non-credit card........................................ 110 - ------ ------Total........................................................... $3,069 $1,470 ====== ====== Our securitized receivables totaled $795 million at March 31, 2007 compared to$949 million at December 31, 2006. As of March 31, 2007, outstanding securedfinancings of $23.4 billion were secured by $30.1 billion of real estatesecured, auto finance, credit card and personal non-credit card receivables.Secured financings of 59 HSBC Finance Corporation -------------------------------------------------------------------------------- $21.8 billion at December 31, 2006 were secured by $28.1 billion of real estatesecured, auto finance, credit card and personal non-credit card receivables. AtMarch 31, 2007, securitizations structured as sales represented 1 percent andsecured financings represented 15 percent of the funding associated with ourmanaged funding portfolio. At December 31, 2006, securitizations structured assales represented 1 percent and secured financings represented 14 percent of thefunding associated with our managed funding portfolio. 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. MARCH 31, DECEMBER 31, 2007 2006-------------------------------------------------------------------------------------- (IN BILLIONS) Private label, and credit cards............................. $190 $186Other consumer lines of credit.............................. 7 7 ---- ----Open lines of credit(1)..................................... $197 $193 ==== ==== -------- ()(1) Includes an estimate for acceptance of credit offers mailed to potential customers prior to March 31, 2007 and December 31, 2006, respectively. At March 31, 2007, our Mortgage Services business had commitments with numerouscorrespondents to purchase up to $188 million of real estate secured receivablesat fair market value, subject to availability based on current underwritingguidelines specified by our Mortgage Services business and at prices indexed togeneral market rates. These commitments have terms of up to one year, the lastof which expires in June, 2007. Also at March 31, 2007, our Mortgage Servicesbusiness had outstanding forward sales commitments relating to real estatesecured loans totaling $352 million and unused commitments to extend creditrelating to real estate secured loans to customers (as long as certainconditions are met), totaling $740 million. At March 31, 2007, we also had a commitment to lend up to $120 million to H&RBlock to fund its acquisition of a participation interest in refund anticipationloans for the 2007 tax season. At March 31, 2007, H&R Block had $72 millionoutstanding under this commitment which is due no later than June 30, 2007. 2007 FUNDING STRATEGY Our current estimated domestic funding needs and sourcesfor 2007 are summarized in the table that follows: ACTUAL ESTIMATED JANUARY 1 APRIL 1 THROUGH THROUGH ESTIMATED MARCH 31, DECEMBER 31, FULL YEAR 2007 2007 2007------------------------------------------------------------------------------------------ (IN BILLIONS) FUNDING NEEDS: Net asset growth.................................. $(3) $(7) - 3 $(10) -0 Commercial paper, term debt and securitization maturities..................................... 19 11 - 17 30 - 36 Other............................................. (1) 2 - 4 1 - 3 --- -------- -------- Total funding needs............................... $15 $ 6 - 24 $ 21 -39 === ======== ========FUNDING SOURCES: External funding, including commercial paper...... $15 $ 5 - 21 $20 - 36 HSBC and HSBC subsidiaries........................ - 1 - 3 1 - 3 --- -------- -------- Total funding sources............................. $15 $ 6 - 24 $21 - 39 === ======== ======== As previously discussed, we have experienced deterioration in the performance ofmortgage loan originations in our Mortgage Services business and in March 2007announced our decision to discontinue loan acquisitions by that 60 HSBC Finance Corporation -------------------------------------------------------------------------------- business. These actions, combined with normal portfolio attrition and riskmitigation efforts we began in the second half of 2006, will result in negativegrowth in our aggregate portfolio in 2007. As opportunities arise, we may alsochoose to sell selected portfolios. Future decisions to constrain growth inadditional portfolios as well as decisions to sell selected portfolios wouldalso result in negative year over year growth in the balance sheet. RISK MANAGEMENT-------------------------------------------------------------------------------- CREDIT RISK There have been no significant changes in our approach to creditrisk management since December 31, 2006. At March 31, 2007, we had derivative contracts with a notional value ofapproximately $95.3 billion, including $83.0 billion outstanding with HSBCaffiliates. Most swap agreements, both with unaffiliated and affiliated thirdparties, require that payments be made to, or received from, the counterpartywhen the fair value of the agreement reaches a certain level. Generally, third-party swap counterparties provide collateral in the form of cash which isrecorded in our balance sheet as other assets or derivative related liabilitiesand totaled $131 million at March 31, 2007 and $158 million at December 31, 2006for third-party counterparties. Beginning in the second quarter of 2006, whenthe fair value of our agreements with affiliate counterparties require theposting of collateral by the affiliate, it is provided in the form of cash andrecorded on the balance sheet, consistent with third party arrangements. AtMarch 31, 2007, the fair value of our agreements with affiliate counter partiesrequired the affiliate to provide cash collateral of $1.2 billion, which isrecorded in our balance sheet as a component of derivative related liabilities.At December 31, 2006, the fair value of our agreements with affiliate counterparties required the affiliate to provide cash collateral of $1.0 billion, whichis recorded in our balance sheet as a component of derivative relatedliabilities. LIQUIDITY RISK There have been no significant changes in our approach toliquidity risk since December 31, 2006. MARKET RISK HSBC 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 March 31, 2007 was $2 million, whichincludes the risk associated with hedging instruments. Thus, for a one basispoint change in interest rates, the policy dictates that the value of thebalance sheet shall not increase or decrease by more than $2 million. As ofMarch 31, 2007, we had a PVBP position of less than $1 million reflecting theimpact of a one basis point increase in interest rates. As of December 31, 2006,we had a PVBP position of $1.1 million. The total PVBP position will not change as a result of the early adoption ofSFAS No. 159, however instruments previously accounted for on an accrual basiswill now be accounted for under the fair value option election. As a result, thePVBP risk for March 31, 2007, summarized in the table below, reflects arealignment of instruments from December 31, 2007, between accrual and mark-to-market. Total PVBP risk is lower as a result of normal risk management actions.The following table shows the components of PVBP: MARCH 31, DECEMBER 31, 2007 2006-------------------------------------------------------------------------------------- (IN MILLIONS) Risk related to our portfolio of balance sheet items marked- to-market................................................. $ .5 $(1.8)Risk for all other remaining assets and liabilities......... (.5) 2.9 ---- -----Total PVBP risk............................................. $ - $ 1.1 ==== ===== We also monitor the impact that an immediate hypothetical increase or decreasein interest rates of 25 basis points applied at the beginning of each quarterover a 12 month period would have on our net interest income assuming a 61 HSBC Finance Corporation -------------------------------------------------------------------------------- growing balance sheet and the current interest rate risk profile. The followingtable summarizes such estimated impact: MARCH 31, 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......... $217 $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......... $ 88 $ 54 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. OPERATIONAL RISK There has been no significant change in our approach tooperational risk management since December 31, 2006. COMPLIANCE RISK There has been no significant change in our approach tocompliance risk management since December 31, 2006. REPUTATIONAL RISK There has been no significant change in our approach toreputational risk management since December 31, 2006. 62 HSBC FINANCE CORPORATION RECONCILIATIONS TO U.S. GAAP FINANCIAL MEASURES MARCH 31, DECEMBER 31, 2007 2006-------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) TANGIBLE COMMON EQUITY:Common shareholder's equity................................. $ 19,108 $ 19,515Exclude: Fair value option adjustment.............................. 462 - Unrealized (gains) losses on cash flow hedging instruments............................................ 188 61 Minimum pension liability................................. 1 1 Unrealized gains on investments and interest-only strip receivables............................................ 16 23 Intangible assets......................................... (2,165) (2,218) Goodwill.................................................. (6,905) (7,010) -------- --------Tangible common equity...................................... 10,705 10,372HSBC acquisition purchase accounting adjustments............ 960 1,105 -------- --------Tangible common equity, excluding HSBC acquisition purchase accounting adjustments.................................... $ 11,665 $ 11,477 ======== ========TANGIBLE SHAREHOLDER'S(S') EQUITY:Tangible common equity...................................... $ 10,705 $ 10,372Preferred stock............................................. 575 575Mandatorily redeemable preferred securities of Household Capital Trusts............................................ 1,275 1,275 -------- --------Tangible shareholder's(s') equity........................... 12,555 12,222HSBC acquisition purchase accounting adjustments............ 960 1,105 -------- --------Tangible shareholder's(s') equity, excluding HSBC acquisition purchase accounting adjustments............... $ 13,515 $ 13,327 ======== ========TANGIBLE SHAREHOLDER'S(S') EQUITY PLUS OWNED LOSS RESERVES:Tangible shareholder's(s') equity........................... $ 12,555 $ 12,222Owned loss reserves......................................... 6,798 6,587 -------- --------Tangible shareholder's(s') equity plus owned loss reserves.. 19,353 18,809HSBC acquisition purchase accounting adjustments............ 960 1,105 -------- --------Tangible shareholder's(s') equity plus owned loss reserves, excluding HSBC acquisition purchase accounting adjustments............................................... $ 20,313 $ 19,914 ======== ========TANGIBLE MANAGED ASSETS:Owned assets................................................ $177,488 $180,435Receivables serviced with limited recourse.................. 795 949 -------- --------Managed assets.............................................. 178,283 181,384Exclude: Intangible assets......................................... (2,165) (2,218) Goodwill.................................................. (6,905) (7,010) Derivative financial assets............................... (1,676) (1,461) -------- --------Tangible managed assets..................................... 167,537 170,695HSBC acquisition purchase accounting adjustments............ (23) 64 -------- --------Tangible managed assets, excluding HSBC acquisition purchase accounting adjustments.................................... $167,514 $170,759 ======== ========EQUITY RATIOS:Common and preferred equity to owned assets................. 11.09% 11.13%Tangible common equity to tangible managed assets........... 6.39 6.08Tangible shareholder's(s') equity to tangible managed assets ("TETMA")................................................. 7.49 7.16Tangible shareholder's(s') equity plus owned loss reserves to tangible managed assets ("TETMA + Owned Reserves")..... 11.55 11.02Excluding HSBC acquisition purchase accounting adjustments: Tangible common equity to tangible managed assets......... 6.96 6.72 TETMA..................................................... 8.07 7.80 TETMA + Owned Reserves.................................... 12.13 11.66 ======== ======== 63 HSBC Finance Corporation -------------------------------------------------------------------------------- ITEM 4. CONTROLS AND PROCEDURES-------------------------------------------------------------------------------- We maintain a system of internal and disclosure controls and procedures designedto ensure that information required to be disclosed by HSBC Finance Corporationin the reports we file or submit under the Securities Exchange Act of 1934, asamended, (the "Exchange Act"), is recorded, processed, summarized and reportedon a timely basis. Our Board of Directors, operating through its auditcommittee, which is composed entirely of independent outside directors, providesoversight to our financial reporting process. We conducted an evaluation, with the participation of the Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of our disclosurecontrols and procedures as of the end of the period covered by this report.Based upon that evaluation, the Chief Executive Officer and Chief FinancialOfficer concluded that our disclosure controls and procedures were effective asof the end of the period covered by this report so as to alert them in a timelyfashion to material information required to be disclosed in reports we fileunder the Exchange Act. There have been no significant changes in our internal and disclosure controlsor in other factors which could significantly affect internal and disclosurecontrols subsequent to the date that we carried out our evaluation. HSBC Finance Corporation continues the process to complete a thorough review ofits internal controls as part of its preparation for compliance with therequirements of Section 404 of the Sarbanes-Oxley Act of 2002. Section 404requires our management to report on, and our external auditors to attest to,the effectiveness of our internal control structure and procedures for financialreporting. As a non-accelerated filer under Rule 12b-2 of the Exchange Act, ourfirst report under Section 404 will be contained in our Form 10-K for the periodended December 31, 2007. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS-------------------------------------------------------------------------------- GENERAL We are parties to various legal proceedings resulting from ordinary businessactivities relating to our current and/or former operations. Certain of theseactions are or purport to be class actions seeking damages in very largeamounts. These actions assert violations of laws and/or unfair treatment ofconsumers. Due to the uncertainties in litigation and other factors, we cannotbe certain that we will ultimately prevail in each instance. We believe that ourdefenses to these actions have merit and any adverse decision should notmaterially affect our consolidated financial condition. CONSUMER LITIGATION During the past several years, the press has widely reported certain industryrelated concerns that may impact us. Some of these involve the amount oflitigation instituted against lenders and insurance companies operating incertain states and the large awards obtained from juries in those states. Likeother companies in this industry, some of our subsidiaries are involved inlawsuits pending against them in these states. The cases, in particular,generally allege inadequate disclosure or misrepresentation of financing terms.In some suits, other parties are also named as defendants. Unspecifiedcompensatory and punitive damages are sought. Several of these suits purport tobe class actions or have multiple plaintiffs. The judicial climate in thesestates is such that the outcome of all of these cases is unpredictable. Althoughour subsidiaries believe they have substantive legal defenses to these claimsand are prepared to defend each case vigorously, a number of such cases havebeen settled or otherwise resolved for amounts that in the aggregate are notmaterial to our operations. Insurance carriers have been notified asappropriate, and from time to time reservations of rights letters have beenreceived. CREDIT CARD SERVICES LITIGATION Since June 2005, HSBC Finance Corporation, HSBC North America, and HSBC, as wellas other banks and the Visa and Master Card associations, were named asdefendants in four class actions filed in Connecticut and the Eastern Districtof New York; Photos Etc. Corp. et al. v. Visa U.S.A., Inc., et al. (D. Conn. No.3:05-CV-01007 64 HSBC Finance Corporation -------------------------------------------------------------------------------- (WWE)): National Association of Convenience Stores, et al. v. Visa U.S.A., Inc.,et al. (E.D.N.Y. No. 05-CV 4520 (JG)); Jethro Holdings, Inc., et al. v. VisaU.S.A., Inc. et al. (E.D.N.Y. No. 05-CV-4521 (JG)); and American BooksellersAss'n v. Visa U.S.A., Inc. et al. (E.D.N.Y. No. 05-CV-5391 (JG)). Numerous othercomplaints containing similar allegations (in which no HSBC entity is named)were filed across the country against Visa, MasterCard and other banks. Theseactions principally allege that the imposition of a no-surcharge rule by theassociations and/or the establishment of the interchange fee charged for creditcard transactions causes the merchant discount fee paid by retailers to be setat supracompetitive levels in violation of the Federal antitrust laws. Inresponse to motions of the plaintiffs on October 19, 2005, the Judicial Panel onMultidistrict Litigation (the "MDL Panel") issued an order consolidating thesesuits and transferred all of the cases to the Eastern District of New York. Theconsolidated case is: In re Payment Card Interchange Fee and Merchant DiscountAntitrust Litigation, MDL 1720, E.D.N.Y. A consolidated, amended complaint wasfiled by the plaintiffs on April 24, 2006. Discovery has begun. At this time, weare unable to quantify the potential impact from this action, if any. SECURITIES LITIGATION In August 2002, we restated previously reported consolidated financialstatements. The restatement related to certain MasterCard and Visa co-brandingand affinity credit card relationships and a third party marketing agreement,which were entered into between 1992 and 1999. All were part of our Credit CardServices segment. In consultation with our prior auditors, Arthur Andersen LLP,we treated payments made in connection with these agreements as prepaid assetsand amortized them in accordance with the underlying economics of theagreements. Our current auditor, KPMG LLP, advised us that, in its view, thesepayments should have either been charged against earnings at the time they weremade or amortized over a shorter period of time. The restatement resulted in a$155.8 million, after-tax, retroactive reduction to retained earnings atDecember 31, 1998. As a result of the restatement, and other corporate events,including, e.g., the 2002 settlement with 50 states and the District of Columbiarelating to real estate lending practices, HSBC Finance Corporation, and itsdirectors, certain officers and former auditors, have been involved in variouslegal proceedings, some of which purport to be class actions. A number of theseactions allege violations of Federal securities laws, were filed between Augustand October 2002, and seek to recover damages in respect of allegedly false andmisleading statements about our common stock. These legal actions have beenconsolidated into a single purported class action, Jaffe v. HouseholdInternational, Inc., et al., No. 02 C 5893 (N.D. Ill., filed August 19, 2002),and a consolidated and amended complaint was filed on March 7, 2003. On December3, 2004, the court signed the parties' stipulation to certify a class withrespect to the claims brought under sec.10 and sec.20 of the Securities ExchangeAct of 1934. The parties stipulated that plaintiffs will not seek to certify aclass with respect to the claims brought under sec.11 and sec.15 of theSecurities Act of 1933 in this action or otherwise. The amended complaint purports to assert claims under the Federal securitieslaws, on behalf of all persons who purchased or otherwise acquired oursecurities between October 23, 1997 and October 11, 2002, arising out of allegedfalse and misleading statements in connection with our collection, sales andlending practices, the 2002 state settlement agreement referred to above, therestatement and the HSBC merger. The amended complaint, which also names asdefendants Arthur Andersen LLP, Goldman, Sachs & Co., and Merrill Lynch, Pierce,Fenner & Smith, Inc., fails to specify the amount of damages sought. In May2003, we, and other defendants, filed a motion to dismiss the complaint. OnMarch 19, 2004, the Court granted in part, and denied in part the defendants'motion to dismiss the complaint. The Court dismissed all claims against MerrillLynch, Pierce, Fenner & Smith, Inc. and Goldman Sachs & Co. The Court alsodismissed certain claims alleging strict liability for alleged misrepresentationof material facts based on statute of limitations grounds. The claims thatremain against some or all of the defendants essentially allege the defendantsknowingly made a false statement of a material fact in conjunction with thepurchase or sale of securities, that the plaintiffs justifiably relied on suchstatement, the false statement(s) caused the plaintiffs' damages, and that someor all of the defendants should be liable for those alleged statements. OnFebruary 28, 2006, the Court also dismissed all alleged sec.10 claims that aroseprior to July 30, 1999, shortening the class period by 22 months. The bulk offact discovery concluded on January 31, 2007. Expert discovery is expected toconclude on September 14, 2007. Separately, one of the defendants, ArthurAndersen LLP, entered into a 65 HSBC Finance Corporation -------------------------------------------------------------------------------- settlement of the claims against Arthur Andersen. This settlement received Courtapproval in April 2006. At this time we are unable to quantify the potentialimpact from this action, if any. With respect to this securities litigation, we believe that we have not, and ourofficers and directors have not, committed any wrongdoing and in each instancethere will be no finding of improper activities that may result in a materialliability to us or any of our officers or directors. ITEM 6. EXHIBITS-------------------------------------------------------------------------------- Exhibits included in this Report: 12 Statement of Computation of Ratio of Earnings to Fixed Charges and to Combined Fixed Charges and Preferred Stock Dividends 31 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.1 Debt and Preferred Stock Securities Ratings 66 HSBC Finance Corporation -------------------------------------------------------------------------------- SIGNATURE-------------------------------------------------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized. HSBC FINANCE CORPORATION (Registrant) /s/ Beverley A. Sibblies ---------------------------------------- Beverley A. Sibblies Senior Vice President and Chief Financial Officer Date: May 14, 2007 67 HSBC Finance Corporation -------------------------------------------------------------------------------- EXHIBIT INDEX-------------------------------------------------------------------------------- 12 Statement of Computation of Ratio of Earnings to Fixed Charges and to Combined Fixed Charges and Preferred Stock Dividends 31 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.1 Debt and Preferred Stock Securities Ratings 68 HSBC Finance Corporation -------------------------------------------------------------------------------- EXHIBIT 12 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS THREE MONTHS ENDED MARCH 31, 2007 2006--------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net income...................................................... $ 541 $ 888Income tax expense.............................................. 332 511 ------ ------Income before income tax expense................................ 873 1,399 ------ ------Fixed charges: Interest expense.............................................. 2,071 1,623 Interest portion of rentals(1)................................ 18 16 ------ ------Total fixed charges............................................. 2,089 1,639 ------ ------Total earnings as defined....................................... $2,962 $3,038 ====== ======Ratio of earnings to fixed charges.............................. 1.42 1.85Preferred stock dividends(2).................................... 15 14Ratio of earnings to combined fixed charges and preferred stock dividends..................................................... 1.41 1.84 -------- (1) Represents one-third of rentals, which approximates the portion representing interest. (2) Preferred stock dividends are grossed up to their pretax equivalents. HSBC Finance Corporation -------------------------------------------------------------------------------- EXHIBIT 31 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION OF CHIEF EXECUTIVE OFFICER I, Brendan P. McDonagh, Chief Executive Officer of HSBC Finance Corporation,certify that: 1. I have reviewed this report on Form 10-Q of HSBC Finance Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 14, 2007 /s/ BRENDAN P. MCDONAGH ---------------------------------------- Brendan P. McDonagh Chief Executive Officer HSBC Finance Corporation -------------------------------------------------------------------------------- CERTIFICATION OF CHIEF FINANCIAL OFFICER I, Beverley A. Sibblies, Senior Vice President and Chief Financial Officer ofHSBC Finance Corporation, certify that: 1. I have reviewed this report on Form 10-Q of HSBC Finance Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 14, 2007 /s/ BEVERLEY A. SIBBLIES ---------------------------------------- Beverley A. Sibblies Senior Executive Vice President and Chief Financial Officer HSBC Finance Corporation -------------------------------------------------------------------------------- EXHIBIT 32 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The certification set forth below is being submitted in connection with the HSBCFinance Corporation (the "Company") Quarterly Report on Form 10-Q for the periodending March 31, 2007 as filed with the Securities and Exchange Commission onthe date hereof (the "Report") for the purpose of complying with Rule 13a-14(b)or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the "Exchange Act")and Section 1350 of Chapter 63 of Title 18 of the United States Code. I, Brendan P. McDonagh, Chief Executive Officer of the Company, certify that: 1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of HSBC Finance Corporation. May 14, 2007 /s/ BRENDAN P. MCDONAGH ---------------------------------------- Brendan P. McDonagh Chief Executive Officer HSBC Finance Corporation -------------------------------------------------------------------------------- CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The certification set forth below is being submitted in connection with the HSBCFinance Corporation (the "Company") Quarterly Report on Form 10-Q for the periodending March 31, 2007 as filed with the Securities and Exchange Commission onthe date hereof (the "Report") for the purpose of complying with Rule 13a-14(b)or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the "Exchange Act")and Section 1350 of Chapter 63 of Title 18 of the United States Code. I, Beverley A. Sibblies, Senior Vice President and Chief Financial Officer ofthe Company, certify that: 1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of HSBC Finance Corporation. May 14, 2007 /s/ BEVERLEY A. SIBBLIES ---------------------------------------- Beverley A. Sibblies Senior Vice President and Chief Financial Officer This certification accompanies each Report pursuant to Section 906 of theSarbanes-Oxley Act of 2002 and shall not, except to the extent required by theSarbanes-Oxley Act of 2002, be deemed filed by HSBC Finance Corporation forpurposes of Section 18 of the Securities Exchange Act of 1934, as amended. Signed originals of these written statements required by Section 906 of theSarbanes-Oxley Act of 2002 have been provided to HSBC Finance Corporation andwill be retained by HSBC Finance Corporation and furnished to the Securities andExchange Commission or its staff upon request. HSBC Finance Corporation -------------------------------------------------------------------------------- EXHIBIT 99.1 DEBT AND PREFERRED STOCK SECURITIES RATINGS STANDARD & MOODY'S POOR'S INVESTORS CORPORATION SERVICE FITCH, INC. DBRS, INC.------------------------------------------------------------------------------------------------- AS OF MARCH 31, 2007HSBC Finance Corporation Senior debt.............................. AA- Aa3 AA- AA (low) Senior subordinated debt................. A+ A2 A+ * Commercial paper......................... A-1+ P-1 F-1+ R-1 (middle) Series B preferred stock................. A-2 A2 A+ *HFC Bank Limited Senior debt.............................. AA- Aa3 AA- * Commercial paper......................... A-1+ P-1 F-1+ *HSBC Financial Corporation Limited Senior notes and term loans.............. * * * AA (low) Commercial paper......................... * * * R-1 (middle) -------- ()* Not rated by this agency. This information is provided by RNS The company news service from the London Stock ExchangeRelated Shares:
HSBC Holdings