31st Mar 2005 12:31
HSBC Holdings PLC31 March 2005 PART 1 -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q/A (Mark One)(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to________ COMMISSION FILE NUMBER 1-8198 HSBC FINANCE CORPORATION (FORMERLY KNOWN AS HOUSEHOLD INTERNATIONAL, INC.) (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 86-1052062 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.) 2700 SANDERS ROAD, PROSPECT HEIGHTS, ILLINOIS 60070 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (847) 564-5000 REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes (X) No ( ) Indicate by check mark whether the registrant is an accelerated filer (asdefined in Rule 12b-2 of the Exchange Act). Yes ( ) No (X) At October 31, 2004, there were 50 shares of the registrant's common stockoutstanding, all of which were indirectly owned by HSBC Holdings plc. THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONH(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM 10-Q WITH THEREDUCED DISCLOSURE FORMAT.-------------------------------------------------------------------------------- HOUSEHOLD INTERNATIONAL, INC. FORM 10-Q/A TABLE OF CONTENTS PART I. FINANCIAL INFORMATION-----------------------------------------------------------------------------------Item 1. Consolidated Financial Statements: Statement of Income......................................... 4 Balance Sheet............................................... 5 Statement of Changes in Shareholder's(s') Equity............ 6 Statement of Cash Flows..................................... 7 Notes to Consolidated Financial Statements.................. 8Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations: Forward-Looking Statements.................................. 21 Restatement................................................. 21 Executive Overview.......................................... 22 Basis of Reporting.......................................... 27 Receivables Review.......................................... 33 Results of Operations....................................... 34 Segment Results - Managed Basis............................. 40 Credit Quality.............................................. 47 Liquidity and Capital Resources............................. 52 Risk Management............................................. 56 Reconciliations to GAAP Financial Measures.................. 58Item 4. Controls and Procedures..................................... 62 PART II. OTHER INFORMATION-----------------------------------------------------------------------------------Item 1. Legal Proceedings........................................... 62Item 5. Other Information........................................... 64Item 6. Exhibits and Reports on Form 8-K............................ 65Signature.................................................................... 66 2 EXPLANATORY NOTE HSBC Finance Corporation (formerly known as Household International, Inc.) isfiling this amended Quarterly Report on Form 10-Q/A to reflect the restatementof its unaudited consolidated financial statements for the periods covered bythis report. Please see Note 2 to the Consolidated Financial Statements and the"Restatement" section included in Item 2, Management's Discussion and Analysisof Financial Condition and Results of Operations below for a detailed discussionof the restatement. As more fully described therein, we have restated allreported periods since our acquisition by HSBC Holdings plc on March 28, 2003 toeliminate hedge accounting on all hedging relationships outstanding on that dateand certain fair value swaps entered into after that date. This restatement issolely the result of the failure to satisfy certain technical requirements ofStatement of Financial Accounting Standards No. 133, "Accounting for DerivativeInstruments and Hedging Activities." This amended Quarterly Report on Form 10-Q/A restates the Quarterly Report onForm 10-Q for the quarter ended September 30, 2004. We have not modified orupdated the disclosures in the original Quarterly Report on Form 10-Q except asrequired to give effect to the restatement. As a result, this amended QuarterlyReport on Form 10-Q/A contains forward-looking information that has not beenupdated for events subsequent to the date of the original filing, and allinformation contained in this amended Quarterly Report on Form 10-Q/A and theoriginal Quarterly Report on Form 10-Q is subject to updating and supplementingas provided in the periodic reports that we have filed and will file with theSecurities and Exchange Commission after the original filing date of theQuarterly Report on Form 10-Q. 3 PART I. FINANCIAL INFORMATION-------------------------------------------------------------------------------- ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS Household International, Inc.--------------------------------------------------------------------------------CONSOLIDATED STATEMENT OF INCOME THREE MONTHS ENDED NINE MONTHS MARCH 29 JANUARY 1 SEPTEMBER 30, ENDED THROUGH THROUGH ------------------------- SEPTEMBER 30, SEPTEMBER 30, MARCH 28, 2004 2003 2004 2003 2003----------------------------------------------------------------------------------------------------------- (SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (PREDECESSOR) (RESTATED) (RESTATED) (RESTATED) (RESTATED) (IN MILLIONS)Finance and other interest income........................ $2,779 $2,570 $7,944 $5,148 $2,469Interest expense................ 810 654 2,225 1,362 897 ------ ------ ------ ------ ------NET INTEREST INCOME............. 1,969 1,916 5,719 3,786 1,572Provision for credit losses..... 1,123 1,001 3,048 2,074 976 ------ ------ ------ ------ ------NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES... 846 915 2,671 1,712 596 ------ ------ ------ ------ ------Other revenues: Securitization revenue........ 267 387 881 680 434 Insurance revenue............. 203 193 618 382 171 Investment income............. 36 37 107 71 80 Derivative income (expense)... 72 (612) 248 177 2 Fee income.................... 302 266 809 503 280 Taxpayer financial services (expense) income........... (3) 2 209 5 181 Other income.................. 163 68 443 159 64 ------ ------ ------ ------ ------TOTAL OTHER REVENUES............ 1,040 341 3,315 1,977 1,212 ------ ------ ------ ------ ------Costs and expenses: Salaries and employee benefits................... 472 493 1,414 1,000 491 Sales incentives.............. 91 77 259 162 37 Occupancy and equipment expenses................... 77 95 237 198 98 Other marketing expenses...... 174 128 437 267 139 Other servicing and administrative expenses.... 235 282 659 555 314 Support services from HSBC affiliates................. 183 - 556 - - Amortization of intangibles... 83 82 278 162 12 Policyholders' benefits....... 93 95 299 196 91 HSBC acquisition related costs incurred by Household...... - - - - 198 ------ ------ ------ ------ ------TOTAL COSTS AND EXPENSES........ 1,408 1,252 4,139 2,540 1,380 ------ ------ ------ ------ ------Income before income tax expense....................... 478 4 1,847 1,149 428Income tax expense (benefit).... 153 (18) 619 384 182 ------ ------ ------ ------ ------NET INCOME...................... $ 325 $ 22 $1,228 $ 765 $ 246 ====== ====== ====== ====== ====== The accompanying notes are an integral part of the consolidated financialstatements. 4 Household International, Inc.-------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEET SEPTEMBER 30, DECEMBER 31, 2004 2003---------------------------------------------------------------------------------------------- (SUCCESSOR) (SUCCESSOR) (RESTATED) (IN MILLIONS, EXCEPT SHARE DATA)ASSETSCash........................................................ $ 274 $ 463Securities.................................................. 6,916 11,073Receivables, net............................................ 104,225 91,027Intangible assets, net...................................... 2,684 2,856Goodwill.................................................... 6,811 6,697Properties and equipment, net............................... 476 527Real estate owned........................................... 601 631Derivative financial assets................................. 3,001 3,016Other assets................................................ 2,740 2,762 -------- --------TOTAL ASSETS................................................ $127,728 $119,052 ======== ========LIABILITIESDebt: Deposits.................................................. $ 51 $ 232 Commercial paper, bank and other borrowings............... 14,507 9,122 Due to affiliates, net.................................... 11,371 7,589 Long term debt (with original maturities over one year)... 78,781 79,632 -------- --------Total debt.................................................. 104,710 96,575 -------- --------Insurance policy and claim reserves......................... 1,299 1,258Derivative related liabilities.............................. 346 597Other liabilities........................................... 3,546 3,131 -------- -------- TOTAL LIABILITIES......................................... 109,901 101,561 -------- --------SHAREHOLDER'S EQUITYPreferred stock held by HNAH (held by HSBC at December 31, 2003)..................................................... 1,100 1,100Common shareholder's equity: Common stock, $0.01 par value, 100 shares authorized, 50 shares issued...................................... - - Additional paid-in capital............................. 14,635 14,645 Retained earnings...................................... 1,627 1,303 Accumulated other comprehensive income................. 465 443 -------- --------TOTAL COMMON SHAREHOLDER'S EQUITY........................... 16,727 16,391 -------- --------TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY.................. $127,728 $119,052 ======== ======== The accompanying notes are an integral part of the consolidated financialstatements. 5 Household International, Inc.-------------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDER'S(S') EQUITY NINE MONTHS MARCH 29 JANUARY 1 ENDED THROUGH THROUGH SEPTEMBER 30, SEPTEMBER 30, MARCH 28, 2004 2003 2003----------------------------------------------------------------------------------------------------------- SUCCESSOR SUCCESSOR (PREDECESSOR) (RESTATED) (RESTATED) (IN MILLIONS)PREFERRED STOCK Balance at beginning of period............................ $ 1,100 $ 1,100 $ 1,193 Reclassification of preferred stock issuance costs........ - - 21 Redemption of preferred stock............................. - - (114) ------- ------- ------- Balance at end of period.................................. $ 1,100 $ 1,100 $ 1,100 ======= ======= =======COMMON SHAREHOLDER'S(S') EQUITY COMMON STOCK Balance at beginning of period.......................... - - $ 552 Effect of push-down accounting of HSBC's purchase price on net assets......................................... - - (552) ------- ------- ------- Balance at end of period................................ - - $ - ------- ------- ------- ADDITIONAL PAID-IN CAPITAL Balance at beginning of period.......................... $14,645 $14,661 $ 1,911 Return of capital to HSBC............................... (31) (18) - Employee benefit plans and other........................ 21 14 10 Reclassification of preferred stock issuance costs...... - - (21) Effect of push-down accounting of HSBC's purchase price on net assets......................................... - - 12,761 ------- ------- ------- Balance at end of period................................ $14,635 $14,657 $14,661 ------- ------- ------- RETAINED EARNINGS Balance at beginning of period.......................... $ 1,303 $ - $ 9,885 Net income.............................................. 1,228 765 246 Dividends: Preferred stock....................................... (54) (36) (22) Common stock.......................................... (850) - (412) Effect of push-down accounting of HSBC's purchase price on net assets......................................... - - (9,697) ------- ------- ------- Balance at end of period................................ $ 1,627 $ 729 $ - ------- ------- ------- ACCUMULATED OTHER COMPREHENSIVE INCOME Balance at beginning of period.......................... $ 443 $ - $ (695) Net change in unrealized gains (losses) on: Derivatives classified as cash flow hedges.......... 44 - 101 Securities available for sale and interest-only strip receivables................................. (38) 114 (25) Foreign currency translation adjustment............... 16 81 (24) ------- ------- ------- Other comprehensive income, net of tax.................. 22 195 52 Effect of push-down accounting of HSBC's purchase price on net assets......................................... - - 643 ------- ------- ------- Balance at end of period................................ $ 465 $ 195 $ - ------- ------- ------- COMMON STOCK IN TREASURY Balance at beginning of period.......................... - - $(2,431) Exercise of stock options............................... - - 12 Issuance of common stock for employee benefit plans..... - - 12 Purchase of treasury stock.............................. - - (164) Effect of push-down accounting of HSBC's purchase price on net assets......................................... - - 2,571 ------- ------- ------- Balance at end of period................................ - - $ - ------- ------- -------TOTAL COMMON SHAREHOLDER'S(S') EQUITY....................... $16,727 $15,581 $14,661 ======= ======= =======COMPREHENSIVE INCOMENet income.................................................. $ 1,228 $ 765 $ 246Other comprehensive income.................................. 22 195 52 ------- ------- -------COMPREHENSIVE INCOME........................................ $ 1,250 $ 960 $ 298 ======= ======= ======= The accompanying notes are an integral part of the consolidated financialstatements. 6 Household International, Inc.-------------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF CASH FLOWS NINE MONTHS MARCH 29 JANUARY 1 ENDED THROUGH THROUGH SEPTEMBER 30, SEPTEMBER 30, MARCH 28, 2004 2003 2003----------------------------------------------------------------------------------------------------------- (SUCCESSOR) (SUCCESSOR) (PREDECESSOR) (RESTATED) (RESTATED) (IN MILLIONS)CASH FLOWS FROM OPERATING ACTIVITIESNet income.................................................. $ 1,228 $ 765 $ 246Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for credit losses............................... 3,048 2,074 976 Insurance policy and claim reserves....................... (138) (123) 47 Depreciation and amortization............................. 367 232 53 Net change in interest-only strip receivables............. 410 259 30 Net change in other assets................................ 49 781 (593) Net change in other liabilities........................... 182 (771) 616 Other, net................................................ (520) (73) 84 -------- -------- -------Net cash provided by (used in) operating activities......... 4,626 3,144 1,459 -------- -------- -------CASH FLOWS FROM INVESTING ACTIVITIESSecurities: Purchased................................................. (1,152) (2,771) (1,047) Matured................................................... 1,179 2,107 584 Sold...................................................... 790 470 768Net change in short-term securities available for sale...... 3,323 960 (375)Receivables: Originations, net of collections.......................... (42,123) (27,386) (8,255) Purchases and related premiums............................ (597) (2,070) (129) Initial and fill-up securitizations....................... 24,250 18,320 7,300 Sales to affiliates....................................... 1,371 - -Properties and equipment: Purchases................................................. (55) (70) (21) Sales..................................................... 2 5 - -------- -------- -------Net cash provided by (used in) investing activities......... (13,012) (10,435) (1,175) -------- -------- -------CASH FLOWS FROM FINANCING ACTIVITIESDebt: Net change in short-term debt and deposits................ 5,343 3,024 (514) Net change in time certificates........................... (155) 97 150 Net change in due to affiliates, net...................... 3,760 5,818 - Long term debt issued..................................... 12,603 9,558 4,361 Long term debt retired.................................... (12,581) (11,337) (4,030) Issuance of company obligated mandatorily redeemable preferred securities of subsidiary trusts to HSBC....... - 275 - Redemption of company obligated mandatorily redeemable preferred securities of subsidiary trusts............... - (275) -Insurance: Policyholders' benefits paid.............................. (124) (106) (36) Cash received from policyholders.......................... 194 84 33Shareholder's(s') dividends................................. (850) (293) (141)Redemption of preferred stock............................... - - (114)Purchase of treasury stock.................................. - - (164)Issuance of common stock for employee benefit plans......... - - 62 -------- -------- -------Net cash provided by (used in) financing activities......... 8,190 6,845 (393) -------- -------- -------Effect of exchange rate changes on cash..................... 7 41 (15) -------- -------- -------Net change in cash.......................................... (189) (405) (124)Cash at beginning of period................................. 463 674 798 -------- -------- -------CASH AT END OF PERIOD....................................... $ 274 $ 269 $ 674 ======== ======== ======= The accompanying notes are an integral part of the consolidated financialstatements. 7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND BASIS OF PRESENTATION-------------------------------------------------------------------------------- The accompanying unaudited interim consolidated financial statements ofHousehold International, Inc. and its subsidiaries (collectively, "Household")have been prepared in accordance with accounting principles generally acceptedin the United States of America ("U.S. GAAP") for interim financial informationand with the instructions to Form 10-Q and Article 10 of Regulation S-X.Accordingly, they do not include all of the information and footnotes requiredby generally accepted accounting principles for complete financial statements.In the opinion of management, all normal and recurring adjustments considerednecessary for a fair presentation of financial position, results of operationsand cash flows for the interim periods have been made. Household may also bereferred to in this Form 10-Q/A as "we," "us" or "our." These unaudited interimconsolidated financial statements should be read in conjunction with the 2003financial information included in our Annual Report on Form 10-K for the yearended December 31, 2004 (the "2004 Form 10-K"). Household International, Inc. is an indirect wholly owned subsidiary of HSBCHoldings plc ("HSBC"). Household was acquired by HSBC on March 28, 2003 in apurchase business combination recorded under the "push-down" method ofaccounting, which resulted in a new basis of accounting for the "successor"period beginning March 29, 2003. Information relating to all "predecessor"periods prior to the acquisition is presented using our historical basis ofaccounting, which impacts comparability to our successor period. The preparation of financial statements in conformity with U.S. GAAP requiresthe use of estimates and assumptions that affect reported amounts anddisclosures. Actual results could differ from those estimates. Interim resultsshould not be considered indicative of results in future periods. Interim financial statement disclosures required by U.S. GAAP regarding segmentsare included in the Management's Discussion and Analysis of Financial Conditionand Results of Operations ("MD&A") section of this Form 10-Q/A. Certain reclassifications have been made to prior period amounts to conform tothe current period presentation. Immaterial adjustments have been made todecrease finance income and increase securitization revenue as reported in priorperiods. These adjustments reflect corrections after discovery of a systemprogramming error in the posting of finance income between owned receivables andreceivables serviced with limited recourse. Reported net income for all priorperiods was not affected. 2. RESTATEMENT-------------------------------------------------------------------------------- We have restated our consolidated financial statements for the previouslyreported period March 29, 2003 through December 31, 2003, the previouslyreported quarterly periods ended June 30, 2004 and March 31, 2004 and the threeand nine month periods ended September 30, 2004. This amended Quarterly Reporton Form 10-Q/A and the exhibits included herewith include all adjustmentsrelating to the restatement for the periods covered by this report. During the fourth quarter of 2004, as part of our preparation for theimplementation of International Financial Reporting Standards ("IFRS") by HSBCfrom January 1, 2005, we undertook a review of our hedging activities to confirmconformity with the accounting requirements of IFRS, which differ in severalrespects from the hedge accounting requirements under U.S. GAAP as set out inStatement of Financial Accounting Standards No. 133, "Accounting for DerivativeInstruments and Hedging Activities," ("SFAS 133"). As a result of this review,management determined that there were some deficiencies in the documentationrequired to support hedge accounting under U.S. GAAP. These documentationdeficiencies arose following our acquisition by HSBC. As a consequence of theacquisition, pre-existing hedging relationships, including hedging relationshipsthat had previously qualified under the "shortcut" method of accounting pursuantto SFAS 133, were required to be reestablished. At that time there was somedebate in the accounting profession regarding the detailed technicalrequirements resulting from a business combination. We consulted with ourindependent accountants, KPMG LLP, in reaching a determination of 8 what was required in order to comply with SFAS 133. Following this, we took theactions we believed were necessary to maintain hedge accounting for all of ourhistorical hedging relationships in our consolidated financial statements forthe period ended December 31, 2003 and those consolidated financial statementsreceived an unqualified audit opinion. Management, having determined during the fourth quarter of 2004 that there werecertain documentation deficiencies, engaged independent expert consultants toadvise on the continuing effectiveness of the identified hedging relationships.As a result of this assessment, we concluded that a substantial number of ourhedges met the correlation effectiveness requirements of SFAS 133 throughout theperiod following our acquisition by HSBC. However, we also determined inconjunction with KPMG LLP that, although a substantial number of the impactedhedges satisfied the correlation effectiveness requirement of SFAS 133, therewere technical deficiencies in the documentation that could not be correctedretroactively or disregarded notwithstanding the proven effectiveness of thehedging relationships in place and, consequently, that the requirements of SFAS133 were not met and that hedge accounting was not appropriate during the periodthese documentation deficiencies existed. We have therefore determined that weshould restate all the reported periods since our acquisition by HSBC toeliminate hedge accounting on all hedging relationships outstanding at March 29,2003 and certain fair value swaps entered into after that date. This wasaccomplished primarily by reclassifying the mark to market of the changes infair market value of the affected derivative financial instruments previouslyclassified in either debt or other comprehensive income into current periodearnings. The period to period changes in the fair value of these derivative financialinstruments have been recognized as either an increase or decrease in ourcurrent period earnings through derivative income. As part of the restatementprocess, we have reclassified all previous hedging results reflected in interestexpense associated with the affected derivative financial instruments toderivative income. Our independent registered public accounting firm hasreviewed the September 30, 2004 financial results and has provided us a reviewreport under Statement on Auditing Standards No. 100, which review report isattached to this amended Quarterly Report on Form 10-Q/A as Exhibit 99.2. The restatement effect on our pre-tax income and net income is summarized below. RESTATEMENTS TO REPORTED INCOME----------------------------------------------------------------------------------------------------- % CHANGE PRE-TAX TAX EFFECT AFTER-TAX TO REPORTED ------- ---------- --------- ----------- (DOLLARS IN MILLIONS)March 29 through September 30, 2003.................. $(126) $ 46 $(80) (9.5)%Nine months ended September 30, 2004................. 47 (17) 30 2.5Quarter ended September 30, 2003..................... (708) 258 (450) (95.3)Quarter ended September 30, 2004..................... 5 (2) 3 .9 A detailed summary of the impact of the restatement on our consolidatedstatement of income and on our consolidated balance sheet is as follows: MARCH 29, 2003 THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED THROUGH SEPTEMBER 30, 2004 SEPTEMBER 30, 2003 SEPTEMBER 30, 2004 SEPTEMBER 30, 2003 --------------------- --------------------- --------------------- --------------------- AS AS AS AS PREVIOUSLY AS PREVIOUSLY AS PREVIOUSLY AS PREVIOUSLY AS REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED------------------------------------------------------------------------------------------------------------------------ (IN MILLIONS)Consolidated Statement of Income: Net interest income.... $ 2,035 $ 1,969 $ 2,014* $ 1,916 $ 5,924 $ 5,719 $ 4,017* $ 3,786 Other revenues......... 969 1,040 951* 341 3,064 3,315 1,873* 1,977 Income before income tax expense.......... 473 478 712 4 1,800 1,847 1,275 1,149 Income tax expense..... 151 153 240 (18) 602 619 430 384 Net income............. 322 325 472 22 1,198 1,228 845 765 9 AT SEPTEMBER 30, 2004 AT DECEMBER 31, 2003 --------------------- --------------------- AS AS PREVIOUSLY AS PREVIOUSLY AS REPORTED RESTATED REPORTED RESTATED------------------------------------------------------------------------------------------------------ (IN MILLIONS)Consolidated Balance Sheet: Derivative financial assets.......................... $ 3,033 $3,001.. $ 3,118 $ 3,016 Long-term debt....................................... 78,516 78,781.. 79,464 79,632 Derivative related liabilities....................... 353 346.... 600 597 Other liabilities.................................... 3,651 3,546.. 3,228 3,131 Common shareholder's equity.......................... 16,912 16,727.. 16,561 16,391 --------------- * Certain reclassifications have been made to prior period amounts to conform to the current year presentation. The resulting accounting does not reflect the economic reality of our hedgingactivity and has no impact on the timing or amount of operating cash flows orcash flows under any debt or derivative contract. It does not affect our abilityto make required payments on our outstanding debt obligations. Furthermore, oureconomic risk management strategies have not required amendment. 3. SECURITIES-------------------------------------------------------------------------------- Securities consisted of the following available-for-sale investments: GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIRSEPTEMBER 30, 2004 COST GAINS LOSSES VALUE--------------------------------------------------------------------------------------------------- (IN MILLIONS)Corporate debt securities............................ $2,393 $26 $ (9) $2,410Money market funds................................... 749 - - 749Time deposits........................................ 132 - - 132U.S. government and federal agency debt securities... 2,355 - (2) 2,353Non-government mortgage backed securities............ 84 - - 84Other................................................ 1,155 1 (2) 1,154 ------ --- ---- ------Subtotal............................................. 6,868 27 (13) 6,882Accrued investment income............................ 34 - - 34 ------ --- ---- ------Total securities available for sale.................. $6,902 $27 $(13) $6,916 ====== === ==== ====== GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIRDECEMBER 31, 2003 COST GAINS LOSSES VALUE--------------------------------------------------------------------------------------------------- (IN MILLIONS)Corporate debt securities........................... $ 5,641 $11 $ - $ 5,652Money market funds.................................. 794 - - 794Time deposits....................................... 952 - - 952U.S. government and federal agency debt securities........................................ 2,430 - (2) 2,428Marketable equity securities........................ 14 4 - 18Non-government mortgage backed securities........... 389 - - 389Other............................................... 794 2 - 796 ------- --- --- -------Subtotal............................................ 11,014 17 (2) 11,029Accrued investment income........................... 44 - - 44 ------- --- --- -------Total securities available for sale................. $11,058 $17 $(2) $11,073 ======= === === ======= 10 A summary of gross unrealized losses and related fair values as of September 30,2004, classified as to the length of time the losses have existed follows: LESS THAN ONE YEAR GREATER THAN ONE YEAR --------------------------------------- --------------------------------------- GROSS AGGREGATE GROSS AGGREGATE NUMBER OF UNREALIZED FAIR VALUE OF NUMBER OF UNREALIZED FAIR VALUE OFSEPTEMBER 30, 2004 SECURITIES LOSSES INVESTMENTS SECURITIES LOSSES INVESTMENTS------------------------------------------------------------------------------------------------------------- (IN MILLIONS)Corporate debt securities.............. 121 $(3) $305 195 $(6) $566U.S. government and federal agency debt securities.............. - - - 62 (2) 309Other..................... 24 (1) 147 42 (1) 98 Gross unrealized losses on our securities available for sale have increasedduring the nine months ended September 30, 2004 due to a general increase ininterest rates. Since substantially all of these securities are rated A- orbetter, no permanent impairment is expected to be realized. The amortized cost of our securities available for sale was adjusted to fairmarket value at the time of the merger with HSBC. As a result, at December 31,2003 gross unrealized losses had existed less than one year. 4. RECEIVABLES-------------------------------------------------------------------------------- Receivables consisted of the following: SEPTEMBER 30, DECEMBER 31, 2004 2003------------------------------------------------------------------------------------------ (IN MILLIONS)Real estate secured......................................... $ 58,726 $ 51,221Auto finance................................................ 6,823 4,138MasterCard(1)/Visa(1)....................................... 11,666 11,182Private label............................................... 14,000 12,604Personal non-credit card.................................... 14,888 12,832Commercial and other........................................ 334 401 -------- --------Total owned receivables..................................... 106,437 92,378Purchase accounting fair value adjustments.................. 272 419Accrued finance charges..................................... 1,489 1,432Credit loss reserve for owned receivables................... (3,953) (3,793)Unearned credit insurance premiums and claims reserves...... (620) (703)Interest-only strip receivables............................. 559 1,036Amounts due and deferred from receivable sales.............. 41 258 -------- --------Total owned receivables, net................................ 104,225 91,027Receivables serviced with limited recourse.................. 20,175 26,201 -------- --------Total managed receivables, net.............................. $124,400 $117,228 ======== ======== --------------- (1) MasterCard is a registered trademark of MasterCard International, Incorporated and Visa is a registered trademark of VISA USA, Inc. Purchase accounting fair value adjustments represent adjustments which have been"pushed down" to record our receivables at fair value at the date of acquisitionby HSBC. Interest-only strip receivables are reported net of our estimate of probablelosses under the recourse provisions for receivables serviced with limitedrecourse. Our estimate of the recourse obligation totaled 11 $1,246 million at September 30, 2004 and $2,374 million at December 31, 2003.Interest-only strip receivables also included fair value mark-to-marketadjustments which increased the balance by $190 million at September 30, 2004and $257 million at December 31, 2003. Receivables serviced with limited recourse consisted of the following: SEPTEMBER 30, DECEMBER 31, 2004 2003------------------------------------------------------------------------------------------ (IN MILLIONS)Real estate secured......................................... $ 165 $ 194Auto finance................................................ 3,060 4,675MasterCard/Visa............................................. 8,843 9,967Private label............................................... 3,921 5,261Personal non-credit card.................................... 4,186 6,104 ------- -------Total....................................................... $20,175 $26,201 ======= ======= The combination of receivables owned and receivables serviced with limitedrecourse, which comprises our managed portfolio, is shown below: SEPTEMBER 30, DECEMBER 31, 2004 2003------------------------------------------------------------------------------------------ (IN MILLIONS)Real estate secured......................................... $ 58,891 $ 51,415Auto finance................................................ 9,883 8,813MasterCard/Visa............................................. 20,509 21,149Private label............................................... 17,921 17,865Personal non-credit card.................................... 19,074 18,936Commercial and other........................................ 334 401 -------- --------Total....................................................... $126,612 $118,579 ======== ======== 12 5. CREDIT LOSS RESERVES-------------------------------------------------------------------------------- An analysis of credit loss reserves was as follows: THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------------- 2004 2003 2004 2003-------------------------------------------------------------------------------------------------- (IN MILLIONS)Owned receivables: Credit loss reserves at beginning of period....... $ 3,795 $3,659 $ 3,793 $ 3,333 Provision for credit losses....................... 1,123 1,001 3,048 3,050 Charge-offs....................................... (1,068) (976) (3,176) (2,908) Recoveries........................................ 99 77 271 204 Other, net........................................ 4 18 17 100 ------- ------ ------- ------- Credit loss reserves for owned receivables........ 3,953 3,779 3,953 3,779 ------- ------ ------- -------Receivables serviced with limited recourse: Credit loss reserves at beginning of period....... 1,904 1,980 2,374 1,759 Provision for credit losses....................... (232) 420 169 1,444 Charge-offs....................................... (418) (459) (1,343) (1,314) Recoveries........................................ 24 24 76 68 Other, net........................................ (32) (11) (30) (3) ------- ------ ------- ------- Credit loss reserves for receivables serviced with limited recourse............................... 1,246 1,954 1,246 1,954 ------- ------ ------- -------Credit loss reserves for managed receivables........ $ 5,199 $5,733 $ 5,199 $ 5,733 ======= ====== ======= ======= Reductions to the provision for credit losses and overall reserve levels onreceivables serviced with limited recourse in 2004 reflect the impact of reducedsecuritization levels, including our decision to structure new collateralizedfunding transactions as secured financings. 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 of owned consumer receivables using a roll ratemigration analysis that estimates the likelihood that a loan will progressthrough the various stages of delinquency, or buckets, and ultimately chargeoff. This analysis considers delinquency status, loss experience and severityand takes into account whether loans are in bankruptcy, have been restructuredor rewritten, 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, consumer credit counseling accommodations, loanrewrites and deferments. When customer account management policies, or changesthereto, shift loans from a "higher" delinquency bucket to a "lower" delinquencybucket, this is reflected in our roll rate statistics. To the extent thatrestructured accounts have a greater propensity to roll to higher delinquencybuckets, this is captured in the roll rates. Since the loss reserve is computedbased on the composite of all of these calculations, this increase in roll rateis applied to receivables in all respective delinquency buckets, which increasesthe overall reserve level. In addition, loss reserves on consumer receivablesare maintained to reflect our judgment of portfolio risk factors that may not befully reflected in the statistical roll rate calculation. Risk factorsconsidered in establishing overall loss reserves on consumer receivables includerecent growth, product mix, bankruptcy trends, geographic concentrations,economic conditions, portfolio seasoning, account management policies andpractices and current levels of charge-offs and delinquencies. 13 While our credit loss reserves are available to absorb losses in the entireportfolio, we specifically consider the credit quality and other risk factorsfor each of our products. We recognize the different inherent losscharacteristics in each of our products as well as customer account managementpolicies and practices and risk management/collection practices. Charge-offpolicies are also considered when establishing loss reserve requirements toensure the appropriate reserves exist for products with longer charge-offperiods. We also consider key ratios such as reserves to nonperforming loans andreserves as a percent of net charge-offs in developing our loss reserveestimates. Loss reserve estimates are reviewed periodically and adjustments arereported in earnings when they become known. As these estimates are influencedby factors outside of our control, such as consumer payment patterns andeconomic conditions, there is uncertainty inherent in these estimates, making itreasonably possible that they could change. 6. INTANGIBLE ASSETS-------------------------------------------------------------------------------- Intangible assets consisted of the following: ACCUMULATED CARRYINGSEPTEMBER 30, 2004 GROSS AMORTIZATION VALUE---------------------------------------------------------------------------------------------- (IN MILLIONS)Purchased credit card relationships and related programs.... $1,615 $296 $1,319Retail services merchant relationships...................... 270 82 188Other loan related relationships............................ 326 62 264Trade names................................................. 717 - 717Technology, customer lists and other contracts.............. 281 85 196 ------ ---- ------Total....................................................... $3,209 $525 $2,684 ====== ==== ====== AMORTIZATION CARRYINGDECEMBER 31, 2003 GROSS ACCUMULATED VALUE---------------------------------------------------------------------------------------------- (IN MILLIONS)Related Shares:
HSBC Holdings