31st Mar 2005 12:31
HSBC Holdings PLC31 March 2005 PART 2 Household International, Inc.-------------------------------------------------------------------------------- Our interest-only strip receivables, net of the related loss reserve andexcluding the mark-to-market adjustment recorded in accumulated othercomprehensive income, decreased $122 million in the current quarter and $410million year-to-date, compared to decreases of $79 million in the third quarterof 2003 and $289 million for the year-to-date period as securitized receivablesdecreased. Insurance revenue increased in both periods, due primarily to increased sales inour U.K. business. Investment income, which includes income on securities available for sale in ourinsurance business as well as realized gains and losses from the sale ofsecurities, was flat compared to the prior year quarter as decreases in incomedue to lower yields were substantially offset by higher gains from securitysales during the quarter. The decrease in investment income for the nine monthperiod was due to lower yields, lower gains from security sales and theamortization of purchase accounting adjustments. Derivative income (expense), which includes realized and unrealized gains andlosses on derivatives which do not qualify as effective hedges under SFAS 133 aswell as the ineffectiveness on derivatives associated with our qualifying hedgesis summarized in the tables below: THREE MONTHS ENDED SEPTEMBER 30 2004 2003---------------------------------------------------------------------------- (IN MILLIONS)Net realized gains (losses)................................. $19 $ (15)Net unrealized gains (losses)............................... 53 (596)Ineffectiveness............................................. -- (1) --- -----Total....................................................... $72 $(612) === ===== NINE MONTHS ENDED SEPTEMBER 30 2004 2003--------------------------------------------------------------------------- (IN MILLIONS)Net realized gains (losses)................................. $ 36 $ 55Net unrealized gains (losses)............................... 211 119Ineffectiveness............................................. 1 5 ---- ----Total....................................................... $248 $179 ==== ==== Derivative income increased in both periods. Compared to the prior year quarter,derivative income increased $684 million. Derivative income in the prior yearquarter was impacted by a substantial increase in the yield curve during thefirst half of the quarter causing a significant decline in the value of ourreceive fixed swaps. These swaps were terminated during the prior year quarteras part of our strategy to regain the use of shortcut accounting. Derivativeincome for the current quarter reflects the impact of lower long term rates onour portfolio of receive fixed swaps and the impact of higher short term rateson our pay fixed swap portfolio. For the nine month periods, derivative income reflects the impact of higherinterest rates and the shift in mix to a predominately pay fixed swap portfolio.These derivatives remain economic hedges of the underlying debt instruments. Fee income, which includes revenues from fee-based products such as creditcards, increased in both periods due to higher credit card fees. For the ninemonth period, higher credit card fees were partially offset by higher paymentsto merchant partners as a result of portfolio acquisitions in our retailservices business. See "Segment Results - Managed Basis" herein for additionalinformation on fee income on a managed basis. Taxpayer financial services income, increased during the nine-month period endedSeptember 30, 2004 primarily due to lower funding costs as a result of ouracquisition by HSBC. 38 Household International, Inc.-------------------------------------------------------------------------------- Other income, increased in both periods due to higher revenues from our mortgageoperations. The increase in the three month period also reflects higherenhancement services income and higher gains on miscellaneous asset sales. COSTS AND EXPENSES As discussed earlier, effective January 1, 2004, ourtechnology services employees were transferred to HSBC Technology and Services(USA) Inc. ("HTSU"). As a result, operating expenses relating to informationtechnology as well as certain item processing and statement processingactivities, which have previously been reported as salaries and employeebenefits, occupancy and equipment expenses, or other servicing andadministrative expenses are now billed to us by HTSU and reported as supportservices from HSBC affiliates. Support services from HSBC affiliates alsoincludes banking services and other miscellaneous services provided by HSBC BankUSA and other subsidiaries of HSBC. The following table summarizes total costs and expenses: INCREASE (DECREASE) --------------THREE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT %---------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Salaries and employee benefits.............................. $ 472 $ 493 $(21) (4.3)%Sales incentives............................................ 91 77 14 18.2Occupancy and equipment expenses............................ 77 95 (18) (18.9)Other marketing expenses.................................... 174 128 46 35.9Other servicing and administrative expenses................. 235 282 (47) (16.7)Support services from HSBC affiliates....................... 183 - 183 100.0Amortization of intangibles................................. 83 82 1 1.2Policyholders' benefits..................................... 93 95 (2) (2.1) ------ ------ ---- -----Total costs and expenses.................................... $1,408 $1,252 $156 12.5% ====== ====== ==== ===== INCREASE (DECREASE) -------------------NINE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT %-------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Salaries and employee benefits............................. $1,414 $1,491 $ (77) (5.2)%Sales incentives........................................... 259 199 60 30.2Occupancy and equipment expenses........................... 237 296 (59) (19.9)Other marketing expenses................................... 437 406 31 7.6Other servicing and administrative expenses................ 659 869 (210) (24.2)Support services from HSBC affiliates...................... 556 - 556 100.0Amortization of intangibles................................ 278 174 104 59.8Policyholders' benefits.................................... 299 287 12 4.2HSBC acquisition related costs incurred by Household....... - 198 (198) (100.0) ------ ------ ----- ------Total costs and expenses................................... $4,139 $3,920 $ 219 5.6% ====== ====== ===== ====== Salaries and employee benefits decreased primarily due to the transfer of ourtechnology personnel to HTSU. Excluding this change, salaries and employeebenefits increased $40 million for the quarter and $99 million year-to-date as aresult of additional staffing, primarily in our consumer lending, mortgageservices and international businesses to support growth and in our compliancefunctions. For the nine month period, these increases were partially offset bydecreases in employee benefit expenses as a result of non-recurring expensesincurred in the first quarter of 2003 in conjunction with the merger. 39 Household International, Inc.-------------------------------------------------------------------------------- Sales incentives increased in both periods reflecting higher volumes in ourbranches. The year-to-date increase also reflects increases in our mortgageservices business. Occupancy and equipment expenses decreased in both periods primarily due to theformation of HTSU as discussed above. Other marketing expenses increased in both periods primarily due to increasedcredit card marketing, largely due to changes in marketing responsibilitiesassociated with the General Motors ("GM") co-branded credit card which willresult in higher marketing expense for the GM Card(R) in the future. Other servicing and administrative expenses decreased primarily due to thetransfer of certain item processing and statement processing services to HTSU.The decreases were partially offset by higher systems costs due to growth,higher insurance commissions and higher legal costs from the settlement ofclaims. Support services from HSBC affiliates primarily include technology and otherservices charged to us by HTSU. Amortization of intangibles was essentially flat during the quarter. Theincrease in the nine month period reflects higher amortization of intangiblesestablished in conjunction with our acquisition by HSBC. Policyholders' benefits essentially remained flat in the third quarter.Increases in policyholder benefits for the nine month period resulted fromhigher sales in our U.K. business and higher amortization of fair valueadjustments relating to our insurance business, partially offset by lowerexpenses in our domestic business. HSBC acquisition related costs incurred by Household in the first quarter of2003 include payments to executives under existing employment contracts andinvestment banking, legal and other costs relating to our acquisition by HSBC. The following table summarizes our owned basis efficiency ratio: 2004 2003------------------------------------------------------------------------------------- (RESTATED) (RESTATED)Three months ended September 30............................. 45.1% 53.5%Nine months ended September 30: GAAP Basis................................................ 44.0 44.0 Excluding HSBC acquisition related costs(1)............... 44.0 41.6 --------------- (1) Represents a non-GAAP financial measure. See "Basis of Reporting" for additional discussion on the use of this non-GAAP financial measure and "Reconciliations to GAAP Financial Measures" for quantitative reconciliations of our operating efficiency ratio to our owned basis GAAP efficiency ratio. The efficiency ratio improved during the three months ended September 30, 2004primarily as a result of significantly higher derivative income in the threemonths ended September 30, 2004, partially offset by higher operating expenses,lower securitization revenue and lower net interest income as a percentage ofaverage interest earning assets. Excluding the impact of the HSBC acquisitionrelated costs, the efficiency ratio deteriorated during the nine months endedSeptember 30, 2004 due to higher operating expenses, including higher intangibleamortization in the year-to-end period, lower securitization revenue and lowernet interest income as a percentage of average interest earning assets,partially offset by higher derivative income. SEGMENT RESULTS - MANAGED 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. 40 Household International, Inc.-------------------------------------------------------------------------------- Our Credit Card Services segment consists of our domestic MasterCard and Visacredit card business. Our International segment consists of our foreignoperations in the United Kingdom, Canada, Ireland and the remainder of Europe. Effective January 1, 2004, our direct lending business, which has previouslybeen reported in our "All Other" caption, was consolidated into our consumerlending business and as a result is now included in our Consumer segment. Priorperiods have not been restated as the impact was not material. There have beenno other changes in the basis of our segmentation or any changes in themeasurement of segment profit as compared with the presentation of our 2003financial information included in our 2004 Form 10-K. We monitor our operations and evaluate trends on a managed basis (a non-GAAPfinancial measure), which assumes that securitized receivables have not beensold and are still on our balance sheet. We manage and evaluate our operationson a managed basis because the receivables that we securitize are subjected tounderwriting standards comparable to our owned portfolio, are serviced byoperating personnel without regard to ownership and result in a similar creditloss exposure for us. In addition, we fund our operations, review our operatingresults, and make decisions about allocating resources such as employees andcapital on a managed basis. When reporting on a managed basis, net interestincome, provision for credit losses and fee income related to receivablessecuritized are reclassified from securitization revenue in our owned statementof income into the appropriate caption. CONSUMER SEGMENT The following table summarizes results for our Consumersegment: INCREASE (DECREASE) -------------------THREE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT %------------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS)Net income............................................ $ 294 $ 287 $ 7 2.4%Net interest income................................... 1,956 1,875 81 4.3Securitization revenue................................ (547) (42) (505) (100+)Fee and other income.................................. 187 153 34 22.2Intersegment revenues................................. 26 27 (1) (3.7)Provision for credit losses........................... 506 920 (414) (45.0)Total costs and expenses.............................. 619 606 13 2.1Receivables........................................... 95,946 87,739 8,207 9.4Assets................................................ 98,099 90,108 7,991 8.9Net interest income as a percent of average interest-earning assets, annualized................. 8.20% 8.65% - -Return on average managed assets...................... 1.22 1.30 - - INCREASE (DECREASE) -------------------NINE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT %----------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Net income............................................. $ 855 $ 679 $ 176 25.9%Net interest income.................................... 5,735 5,417 318 5.9Securitization revenue................................. (1,089) 12 (1,101) (100+)Fee and other income................................... 516 467 49 10.5Intersegment revenues.................................. 74 82 (8) (9.8)Provision for credit losses............................ 1,905 3,042 (1,137) (37.4)Total costs and expenses............................... 1,892 1,765 127 7.2Net interest income as a percent of average interest-earning assets, annualized.................. 8.33% 8.63% - -Return on average managed assets....................... 1.22 1.06 - - 41 Household International, Inc.-------------------------------------------------------------------------------- Our Consumer segment reported higher net income in both periods. Increases innet interest income as well as fee and other income and decreases in provisionfor credit losses were partially offset by higher operating expenses andsubstantially lower securitization revenue. Net interest income increasedprimarily due to higher receivable levels. Net interest income as a percent ofaverage interest-earning assets, however, decreased primarily due to loweryields on real estate secured and auto finance receivables as a result ofreduced pricing and higher levels of near-prime receivables, as well as therun-off of higher yielding real estate secured receivables, including secondlien loans largely due to refinance activity. For the three month period,increased cost of funds due to a rising interest rate environment alsocontributed to the decrease. Our auto finance business reported lower netinterest income as a percent of average interest-earning assets as we havetargeted lower yielding but higher credit quality customers. Securitizationrevenue decreased in both periods as a result of a significant decline inreceivables securitized, including the impact of higher run-off due to shorterexpected lives, as a result of our decision to structure all new collateralizedfunding transactions as secured financings beginning in the third quarter of2004. Initial securitization levels were lower in the first nine months of 2004as we used funding from HSBC, including proceeds from receivable sales, toassist in the funding of our operations. Operating expenses increased as theresult of additional operating costs to support the increased receivable levelsincluding higher salaries and sales incentives. During the nine months ended September 30, 2004, we experienced improved creditquality. Our managed basis provision for credit losses, which includes bothprovision for owned basis receivables and over-the-life provision forreceivables serviced with limited recourse, decreased in both the quarter andyear-to-date periods as a result of improving credit quality and changes insecuritization levels. Partially offsetting the decrease in managed lossprovision was an increase in estimated losses on securitized receivables at autofinance in both periods. We have experienced higher dollars of net charge-offsin our owned portfolio during the first nine months of 2004 as a result ofhigher delinquency levels in prior quarters and higher levels of ownedreceivables. However, our overall owned provision for credit losses was lowerthan net charge-offs because charge-offs are a lagging indicator of creditquality. Over-the-life provisions for credit losses for securitized receivablesrecorded in any given period reflect the level and product mix ofsecuritizations in that period. Subsequent charge-offs of such receivablesresult in a decrease in the over-the-life reserves without any correspondingincrease to managed loss provision. The combination of these factors, includingchanges in securitization levels, resulted in a decrease in managed lossreserves as net charge-offs were greater than the provision for credit losses by$414 million for the quarter and $895 million year-to-date. For 2003, weincreased managed loss reserves by recording loss provision greater than netcharge-offs of $23 million for the quarter and $394 million year-to-date. Managed receivables increased 4 percent compared to $92.2 billion at June 30,2004. Growth during the quarter was driven by higher real estate securedreceivables in both our correspondent and branch-based consumer lendingbusinesses which was partially offset by $.7 billion of correspondentreceivables purchased directly by HSBC Bank USA (a portion of which we otherwisewould have purchased). Growth in our correspondent business was supplemented bypurchases from a single correspondent relationship which totaled $.6 billion inthe quarter. We also experienced solid growth in auto finance receivables thoughour dealer network as well as in private label receivables. Personal non-creditcard receivables also experienced growth as we began to increase availability ofthe product as a result of an improving economy. Compared to September 30, 2003, managed receivables increased 9 percent.Receivable growth was strongest in our real estate secured portfolio. Realestate secured receivable levels reflect sales to HSBC Bank USA totaling $3.7billion and $2.2 billion of correspondent receivables purchased directly by HSBCBank USA, a portion of which we otherwise would have purchased. Real estategrowth also benefited from purchases associated with a single correspondentrelationship which totaled $1.9 billion year-to-date. Our auto finance portfolioalso reported strong growth as a result of newly originated loans acquired fromour 42 Household International, Inc.-------------------------------------------------------------------------------- dealer network and strategic alliances established during 2003. Increases inprivate label receivables were the result of portfolio acquisitions as well asorganic growth. The decrease in return on average managed assets ("ROMA") for the quarterreflects a higher rate of increase in average managed assets than in net incomeas discussed above. For the year-to-date period, the increase in ROMA reflectshigher income as discussed above. CREDIT CARD SERVICES SEGMENT The following table summarizes results for ourCredit Card Services segment. INCREASE (DECREASE) --------------------THREE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT %------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Net income............................................. $ 134 $ 144 $ (10) (6.9)%Net interest income.................................... 519 490 29 5.9Securitization revenue................................. (77) 11 (88) (100+)Fee and other income................................... 460 392 68 17.3Intersegment revenues.................................. 6 6 - -Provision for credit losses............................ 364 400 (36) (9.0)Total costs and expenses............................... 328 268 60 22.4Receivables............................................ 18,509 18,285 224 1.2Assets................................................. 20,620 20,826 (206) (1.0)Net interest income as a percent of average interest-earning assets, annualized.................. 10.24% 10.00% - -Return on average managed assets....................... 2.60 2.85 - - INCREASE (DECREASE) --------------------NINE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT %------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Net income............................................... $ 391 $ 366 $ 25 6.8%Net interest income...................................... 1,561 1,441 120 8.3Securitization revenue................................... (222) 4 (226) (100+)Fee and other income..................................... 1,271 1,116 155 13.9Intersegment revenues.................................... 20 22 (2) (9.1)Provision for credit losses.............................. 1,105 1,175 (70) (6.0)Total costs and expenses................................. 890 806 84 10.4Net interest income as a percent of average interest-earning assets, annualized.................... 10.10% 9.87% - -Return on average managed assets......................... 2.50 2.42 - - Our Credit Card Services segment reported lower net income during the quarterbut higher net income year-to-date. The decrease in net income during thequarter was due to the impact of lower securitization levels and higheroperating expenses, particularly marketing expenses, partially offset byincreases in net interest income and fee and other income and lower credit lossprovision. The trends in net interest income, fee and other income,securitization revenue, credit loss provision and operating expenses wereconsistent in both the quarter and the year-to-date periods. Net income and ROMAfor the year-to-date period, however, were higher than in the year ago periodbut lower for the quarter. This is because the decreases in the level ofreceivables securitized, coupled with the increased marketing expense were moresignificant in the quarter than in the year-to-date period. Increases in netinterest income as well as fee and other income in both periods resulted fromhigher receivable levels and product mix, with the increase 43 Household International, Inc.-------------------------------------------------------------------------------- in net interest income partially offset in the quarter by higher cost of fundsdue to a rising interest rate environment. Provision for credit losses alsodecreased in both periods as a result of improving credit quality and changes insecuritization levels. We increased managed loss reserves for the quarter byrecording loss provision greater than net charge-offs of $15 million and wedecreased managed loss reserves year-to-date by recording loss provision lessthan net charge-offs of $6 million. For 2003, we increased managed loss reservesby recording loss provision greater than net charge-offs of $43 million for thequarter and $98 million year-to-date. Securitization revenue declined in bothperiods as a result of a decline in receivables securitized, including higherrun-off due to shorter expected lives. Managed receivables of $18.5 billion increased .8 percent compared to $18.4billion at June 30, 2004. The increase during the quarter was due to growth inour subprime and internally branded prime portfolios which was substantiallyoffset by the continued decline in certain old acquired portfolios. Although oursubprime receivables tend to have smaller balances, they generate higherreturns. Compared to September 30, 2003, managed receivables increased 1.2percent. Receivables growth was largely attributable to organic growth in oursubprime portfolios which was partially offset by the continued decline in theseold acquired portfolios. INTERNATIONAL SEGMENT The following table summarizes results for ourInternational segment: INCREASE (DECREASE) --------------------THREE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT %------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Net income............................................. $ 18 $ 42 $ (24) (57.1)%Net interest income.................................... 185 190 (5) (2.6)Securitization revenue................................. (87) 2 (89) (100+)Fee and other income................................... 130 98 32 32.7Intersegment revenues.................................. 4 3 1 33.3Provision for credit losses............................ 19 101 (82) (81.2)Total costs and expenses............................... 181 128 53 41.4Receivables............................................ 11,833 10,180 1,653 16.2Assets................................................. 12,770 11,053 1,717 15.5Net interest income as a percent of average interest-earning assets, annualized.................. 6.29% 7.45% - -Return on average managed assets....................... .57 1.54 - - INCREASE (DECREASE) -------------------NINE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT %----------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Net income................................................. $ 80 $116 $(36) (31.0)%Net interest income........................................ 583 549 34 6.2Securitization revenue..................................... (92) 13 (105) (100+)Fee and other income....................................... 369 276 93 33.7Intersegment revenues...................................... 10 9 1 11.1Provision for credit losses................................ 207 271 (64) (23.6)Total costs and expenses................................... 527 394 133 33.8Net interest income as a percent of average interest-earning assets, annualized...................... 6.76% 7.37% - -Return on average managed assets........................... .86 1.46 - - 44 Household International, Inc.-------------------------------------------------------------------------------- Our International segment reported lower net income in both periods. Thedecrease in net income reflects higher operating expenses and lowersecuritization revenue partially offset by increased fee and other income, lowerprovision for credit losses and, for the nine month period, higher net interestincome. Applying constant currency rates, which uses the average rate ofexchange for the 2003 period to translate current period net income, net incomewould have been lower by $2 million in the current quarter and $7 millionyear-to-date. Net interest income decreased during the quarter as increases innet interest income due to higher receivable levels were more than offset byhigher cost of funds due to a rising interest rate environment. Net interestincome increased during the nine month period due to higher receivable levelspartially offset by higher cost of funds. Net interest income as a percent ofaverage interest-earning assets, annualized, decreased in both periods due tolower pricing, run-off of higher yielding receivables, the mix of personalnon-credit card receivables and a higher cost of funds. Securitization revenuedeclined as a result of lower levels of securitized receivables. Fee and otherincome increased primarily due to higher insurance revenues. Provision forcredit losses decreased due to reduced securitization levels, partially offsetby a higher provision for credit losses on owned receivables due to receivablegrowth. We decreased managed loss reserves by recording loss provision less thannet charge-offs of $74 million for the quarter and $52 million year-to-date. For2003, we increased managed loss reserves by recording loss provision greaterthan net charge-offs of $26 million for the quarter and $56 millionyear-to-date. Total costs and expenses increased primarily due to higher salaryexpenses to support receivable activity and higher policyholder benefits, whichresulted from increased insurance sales volumes. Managed receivables increased 4 percent compared to $11.4 billion at June 30,2004 primarily due to growth in our private label and personal non-credit cardportfolios. Compared to September 30, 2003, managed receivables increased 16percent due to strong growth in our real estate secured and personal non-creditcard portfolios since September 30, 2003 partially offset by a decline in ourMasterCard/Visa portfolio. Applying constant currency rates, managed receivablesat September 30, 2004 would have been $.1 billion lower using June 30, 2004exchange rates and $.9 billion lower using September 30, 2003 exchange rates. The decrease in ROMA reflects lower net income as discussed above. RECONCILIATION OF MANAGED BASIS SEGMENT RESULTS Income statement informationincluded in the table for the nine months ended September 30, 2003 combinesJanuary 1 through March 28, 2003 (the "predecessor period") and March 29 toSeptember 30, 2003 (the "successor period") in order to present "combined"financial results for the nine months ended September 30, 2003. Fair valueadjustments related to purchase accounting and related amortization have beenallocated to Corporate, which is included in the "All Other" caption within oursegment disclosure. As a result, managed and owned basis consolidated totals forthe nine months ended September 30, 2003 include combined information from boththe "successor" and "predecessor" periods which impacts comparability to thecurrent period. 45 Household International, Inc.-------------------------------------------------------------------------------- Reconciliations of our managed basis segment results to managed basis and ownedbasis consolidated totals are as follows: MANAGED CREDIT ADJUSTMENTS/ BASIS CARD INTER- ALL RECONCILING CONSOLIDATED CONSUMER SERVICES NATIONAL OTHER ITEMS TOTALS------------------------------------------------------------------------------------------------------- (IN MILLIONS)THREE MONTHS ENDED SEPTEMBER 30, 2004 (RESTATED)Net interest income............ $1,956 $ 519 $ 185 $ (110) $ - $ 2,550Securitization revenue......... (547) (77) (87) (31) - (742)Fee and other income........... 187 460 130 227 (35)(2) 969Intersegment revenues.......... 26 6 4 (1) (35)(2) -Provision for credit losses.... 506 364 19 1 1(3) 891Total costs and expenses....... 619 328 181 280 - 1,408Net income..................... 294 134 18 (98) (23) 325Receivables.................... 95,946 18,509 11,833 324 - 126,612Assets......................... 98,099 20,620 12,770 25,030 (8,616)(4) 147,903 ------ ------- ------- ------- ------- --------THREE MONTHS ENDED SEPTEMBER 30, 2003 (RESTATED)Net interest income............ $1,875 $ 490 $ 190 $ 76 $ - $ 2,631Securitization revenue......... (42) 11 2 (71) - (100)Fee and other income........... 153 392 98 (461) (36)(2) 146Intersegment revenues.......... 27 6 3 - (36)(2) -Provision for credit losses.... 920 400 101 (2) 2(3) 1,421Total costs and expenses....... 606 268 128 250 - 1,252Net income..................... 287 144 42 (427) (24) 22Receivables.................... 87,739 18,285 10,180 933 - 117,137Assets......................... 90,108 20,826 11,053 25,294 (8,764)(4) 138,517 ------ ------- ------- ------- ------- --------NINE MONTHS ENDED SEPTEMBER 30, 2004 (RESTATED)Net interest income............ $5,735 $ 1,561 $ 583 $ (173) $ - $ 7,706Securitization revenue......... (1,089) (222) (92) (124) - (1,527)Fee and other income........... 516 1,271 369 969 (101)(2) 3,024Intersegment revenues.......... 74 20 10 (3) (101)(2) -Provision for credit losses.... 1,905 1,105 207 (1) 1(3) 3,217Total costs and expenses....... 1,892 890 527 830 - 4,139Net income..................... 855 391 80 (32) (66) 1,228 ------ ------- ------- ------- ------- --------NINE MONTHS ENDED SEPTEMBER 30, 2003 (RESTATED)Net interest income............ $5,417 $ 1,441 $ 549 $ 112 $ - $ 7,519Securitization revenue......... 12 4 13 (147) - (118)Fee and other income........... 467 1,116 276 843 (112)(2) 2,590Intersegment revenues.......... 82 22 9 (1) (112)(2) -Provision for credit losses.... 3,042 1,175 271 - 6(3) 4,494Total costs and expenses....... 1,765 806 394 955 - 3,920HSBC acquisition related costs incurred by Household........ - - - 198 - 198Net income..................... 679 366 116 (75) (75) 1,011Operating net income(1)........ 679 366 116 92 (75) 1,178 OWNED BASIS SECURITIZATION CONSOLIDATED ADJUSTMENTS TOTALS------------------------------- ----------------------------- (IN MILLIONS)THREE MONTHS ENDED SEPTEMBER 30, 2004 (RESTATED)Net interest income............ $ (581)(5) $ 1,969Securitization revenue......... 1,009(5) 267Fee and other income........... (196)(5) 773Intersegment revenues.......... - -Provision for credit losses.... 232(5) 1,123Total costs and expenses....... - 1,408Net income..................... - 325Receivables.................... (20,175)(6) 106,437Assets......................... (20,175)(6) 127,728 -------- --------THREE MONTHS ENDED SEPTEMBER 30, 2003 (RESTATED)Net interest income............ $ (715)(5) $ 1,916Securitization revenue......... 487(5) 387Fee and other income........... (192)(5) (46)Intersegment revenues.......... - -Provision for credit losses.... (420)(5) 1,001Total costs and expenses....... - 1,252Net income..................... - 22Receivables.................... (24,109)(6) 93,028Assets......................... (24,109)(6) 114,408 -------- --------NINE MONTHS ENDED SEPTEMBER 30, 2004 (RESTATED)Net interest income............ $ (1,987)(5) $ 5,719Securitization revenue......... 2,408(5) 881Fee and other income........... (590)(5) 2,434Intersegment revenues.......... - -Provision for credit losses.... (169)(5) 3,048Total costs and expenses....... - 4,139Net income..................... - 1,228 -------- --------NINE MONTHS ENDED SEPTEMBER 30, 2003 (RESTATED)Net interest income............ $ (2,161)(5) $ 5,358Securitization revenue......... 1,232(5) 1,114Fee and other income........... (515)(5) 2,075Intersegment revenues.......... - -Provision for credit losses.... (1,444)(5) 3,050Total costs and expenses....... - 3,920HSBC acquisition related costs incurred by Household........ - 198Net income..................... - 1,011Operating net income(1)........ - 1,178 --------------- (1) This non-GAAP financial measure is provided for comparison of our operating trends only and should be read in conjunction with our owned basis GAAP financial information. Operating net income excludes $167 million (after-tax) of HSBC acquisition related costs and other merger related items incurred by Household in 2003. See "Basis of Reporting" for additional discussion on the use of non-GAAP financial measures. 46 Household International, Inc.-------------------------------------------------------------------------------- (2) Eliminates intersegment revenues.(3) Eliminates bad debt recovery sales between operating segments.(4) Eliminates investments in subsidiaries and intercompany borrowings.(5) Reclassifies net interest income, fee income and provision for credit losses relating to securitized receivables to other revenues.(6) Represents receivables serviced with limited recourse. CREDIT QUALITY-------------------------------------------------------------------------------- Subject to receipt of regulatory approvals, we intend to transfer our domesticprivate label credit card portfolio to HSBC Bank USA in 2004. Contingent uponreceiving regulatory approval for this asset transfer, we will adopt charge-offand account management guidelines in accordance with the Uniform Retail CreditClassification and Account Management Policy issued by the FFIEC for our entiredomestic private label and MasterCard and Visa portfolios. See "ExecutiveOverview" for further discussion. 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.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. See Note 4, "Receivables," in theaccompanying consolidated financial statements for receivables by product typeand Note 5, "Credit Loss Reserves," for our credit loss reserve methodology andan analysis of changes in the credit loss reserves. The following table summarizes owned basis credit losses: SEPTEMBER 30, JUNE 30, SEPTEMBER 30, 2004 2004 2003---------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Owned credit loss reserves................................ $3,953 $3,795 $3,779Reserves as a percent of: Receivables............................................. 3.71% 3.82% 4.06% Net charge-offs(1)...................................... 102.0 98.2 105.1 Nonperforming loans..................................... 104.1 103.0 92.6 --------------- (1) Quarter-to-date, annualized During the quarter ended September 30, 2004, credit loss reserves increased asthe provision for owned credit losses was $154 million greater than netcharge-offs reflecting growth in our loan portfolio, partially offset byimproved asset quality. In the quarter ended September 30, 2003, provision forowned credit losses was $102 million greater than net charge-offs. Reservelevels at September 30, 2004 reflect the factors discussed above. 47 Household International, Inc.-------------------------------------------------------------------------------- For securitized receivables, we also record a provision for estimated probablelosses that we expect to incur under the recourse provisions. The followingtable summarizes managed credit loss reserves: SEPTEMBER 30, JUNE 30, SEPTEMBER 30, 2004 2004 2003------------------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Managed credit loss reserves.............................. $5,199 $5,699 $5,733Reserves as a percent of: Receivables............................................. 4.11% 4.66% 4.89% Net charge-offs(1)...................................... 95.4 104.2 107.4 Nonperforming loans..................................... 111.1 122.8 111.7 --------------- (1) Quarter-to-date, annualized During the quarter ended September 30, 2004, managed credit loss reservesdecreased as a result of changes in securitization levels. See "Basis of Reporting" for additional discussion on the use of non-GAAPfinancial measures and "Reconciliations to GAAP Financial Measures" forquantitative reconciliations of the non-GAAP financial measures to thecomparable GAAP basis financial measure. DELINQUENCY - OWNED BASIS The following table summarizes two-months-and-over contractual delinquency (as apercent of consumer receivables): SEPTEMBER 30, JUNE 30, SEPTEMBER 30, 2004 2004 2003-------------------------------------------------------------------------------------------------------------Real estate secured....................................... 3.27% 3.39% 4.20%Auto finance.............................................. 1.81 2.12 2.14MasterCard/Visa........................................... 5.84 5.83 5.99Private label............................................. 4.72 5.00 5.59Personal non-credit card.................................. 8.83 8.92 9.96 ---- ---- ----Total..................................................... 4.43% 4.57% 5.36% ==== ==== ==== Total owned delinquency decreased 14 basis points compared to the prior quarter.This decrease is consistent with improvements in early delinquency roll ratetrends we began to experience in the fourth quarter of 2003 as a result ofimprovements in the economy and better underwriting, including both improvedmodeling and improved credit quality of originations. The overall decrease inour real estate secured portfolio reflects receivable growth and improvedcollection efforts which were partially offset by the seasoning and maturationof the portfolio. The decrease in auto finance delinquencies reflects the impactof tightened underwriting, higher receivable levels and lower securitizationlevels. Auto finance delinquency in June 2004 was also adversely impacted bychanges in collections operations. The decrease in private label delinquencyreflects receivable growth as well as improved underwriting, collections andcredit models. The decrease in personal non-credit card delinquency reflects thepositive impact of receivable growth as well as improved collection efforts. Compared to a year ago, total delinquency decreased 93 basis points as allproducts reported lower delinquency levels. The improvements are generally theresult of improvements in the economy and better underwriting. 48 Household International, Inc.-------------------------------------------------------------------------------- NET CHARGE-OFFS OF CONSUMER RECEIVABLES - OWNED BASIS The following table summarizes net charge-offs of consumer receivables (as apercent, annualized, of average consumer receivables): SEPTEMBER 30, JUNE 30, SEPTEMBER 30, 2004 2004 2003-------------------------------------------------------------------------------------------------------------Real estate secured....................................... 1.19% 1.04% .91%Auto finance.............................................. 3.66 3.05 4.62MasterCard/Visa........................................... 8.50 9.91 8.61Private label............................................. 4.79 5.06 5.35Personal non-credit card.................................. 9.50 10.59 10.55 ---- ----- -----Total..................................................... 3.77% 4.02% 3.98% ==== ===== =====Real estate secured net charge-offs and REO expense as a percent of average real estate secured receivables...... 1.31% 1.47% 1.35% Net charge-offs decreased 25 basis points compared to the quarter ended June 30,2004 as the lower delinquency levels we have been experiencing due to animproving economy are having an impact on charge-offs. Our real estate securedportfolio experienced an increase in net charge-offs during the third quarterreflecting lower estimates of net realizable value as a result of processchanges to better estimate property values at the time of foreclosure which hasresulted in an increase in real estate net charge-offs compared to the previousquarter. The increase in auto finance net charge-offs reflects the impact ofhigher delinquency levels in the second quarter which have progressed tocharge-off. The decrease in MasterCard/Visa reflects the impact of higher netcharge-offs in the second quarter due to seasonality. In addition to economicconditions, the decrease in net charge-offs in personal non-credit card is aresult of improved credit quality and portfolio stabilization. Total net charge-offs for the current quarter decreased from September 2003 netcharge-offs levels due to an improving economy and a decrease in the percentageof the portfolio comprised of personal non-credit card receivables, which have ahigher net charge-off rate than other products in our portfolio. In addition,auto finance, MasterCard and Visa, private label and personal non-credit cardreported lower net charge-off levels generally as a result of receivable growth,improved collections and better underwriting, including both improved modelingand improved credit quality of originations. The decrease in auto finance netcharge-offs also reflects the decision to target lower yielding but highercredit quality customers as well as improved used auto prices which resulted inlower loss severities. The increase in our real estate secured portfolioreflects lower estimates of net realizable value at the time of foreclosure. OWNED NONPERFORMING ASSETS SEPTEMBER 30, JUNE 30, SEPTEMBER 30, 2004 2004 2003---------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS)Nonaccrual receivables.................................... $2,891 $2,833 $3,197Accruing consumer receivables 90 or more days delinquent.............................................. 905 849 883Renegotiated commercial loans............................. 1 2 2 ------ ------ ------Total nonperforming receivables........................... 3,797 3,684 4,082Real estate owned......................................... 601 624 543 ------ ------ ------Total nonperforming assets................................ $4,398 $4,308 $4,625 ====== ====== ======Credit loss reserves as a percent of nonperforming receivables............................................. 104.1% 103.0% 92.6% 49 Household International, Inc.-------------------------------------------------------------------------------- Compared to June 30, 2004, the increase in nonaccrual receivables and totalnonperforming assets is primarily attributable to an increase in our real estatesecured portfolio due to growth. Compared to September 30, 2003, the decrease innonaccrual receivables and total nonperforming assets is primarily due toimproved credit quality and collection efforts partially offset by growth.Accruing consumer receivables 90 or more days delinquent includes domesticMasterCard and Visa and private label credit card receivables, consistent withindustry practice. 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. The tables below summarize approximate restructuring statistics in our managedbasis domestic portfolio. We report our restructuring statistics on a managedbasis only because the receivables that we securitize are subject tounderwriting standards comparable to our owned portfolio, are serviced andcollected without regard to ownership and result in a similar credit lossexposure for us. As previously reported, in prior periods we used certainassumptions and estimates to compile our restructure statistics. We also statedthat we continue to enhance our ability to capture and segment restructure dataacross all business units. In the tables that follow, the restructure statisticspresented for June 30, 2004 and September 30, 2004 have been compiled usingenhanced systemic counters and refined assumptions and estimates. As a result ofRelated Shares:
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