31st Mar 2005 12:30
HSBC Holdings PLC31 March 2005 PART 2 TOTAL RESTRUCTURED BY RESTRUCTURE PERIOD - DOMESTIC PORTFOLIO(1)(MANAGED BASIS) MARCH 31, DECEMBER 31, MARCH 31, 2004 2003 2003------------------------------------------------------------------------------------------------Never restructured........................................ 84.7% 84.4% 83.3%Restructured: Restructured in the last 6 months....................... 6.2 6.7 7.5 Restructured in the last 7-12 months.................... 3.9 3.8 3.6 Previously restructured beyond 12 months................ 5.2 5.1 5.6 --------- --------- --------- Total ever restructured(2).............................. 15.3 15.6 16.7 --------- --------- ---------Total..................................................... 100.0% 100.0% 100.0% ========= ========= =========TOTAL RESTRUCTURED BY PRODUCT - DOMESTIC PORTFOLIO(1)(MANAGED BASIS)(IN MILLIONS)Real estate secured....................................... $ 9,506 $ 9,548 $ 9,163Auto finance.............................................. 1,255 1,295 1,248MasterCard/Visa........................................... 505 584 549Private label............................................. 990 1,065 1,226Personal non-credit card.................................. 3,913 4,075 4,128 --------- --------- ---------Total..................................................... $ 16,169 $ 16,567 $ 16,314 ========= ========= =========(AS A PERCENT OF MANAGED RECEIVABLES)Real estate secured....................................... 18.9% 19.4% 20.0%Auto finance.............................................. 13.9 14.7 16.9MasterCard/Visa........................................... 2.8 3.1 3.4Private label............................................. 7.0 7.1 9.6Personal non-credit card.................................. 26.3 26.6 25.8 --------- --------- ---------Total(2).................................................. 15.3% 15.6% 16.7% ========= ========= ========= --------------- (1) Excludes foreign businesses, commercial and other. Amounts also include accounts as to which the delinquency status has been reset to current for reasons other than restructuring (e.g., correcting the misapplication of a timely payment.) (3) Total including foreign businesses was 14.4 percent at March 31, 2004, 14.7 percent at December 31, 2003, and 15.8 percent at March 31, 2003. 44 Household International Inc., and Subsidiaries-------------------------------------------------------------------------------- The amount of domestic and foreign managed receivables in forbearance,modification, credit card services approved consumer credit counselingaccommodations, rewrites or other account management techniques for which wehave reset delinquency and that is not included in the restructured ordelinquency statistics was approximately $1.0 billion or .8 percent of managedreceivables at March 31, 2004, $1.0 billion or .9 percent of managed receivablesat December 31, 2003 and $1.1 billion or 1.0 percent of managed receivables atMarch 31, 2003. LIQUIDITY AND CAPITAL RESOURCES-------------------------------------------------------------------------------- The funding synergies resulting from our merger with HSBC have allowed us toreduce our reliance on traditional sources to fund our growth. We continue tofocus on balancing our use of affiliate and third-party funding sources tominimize funding expense while maximizing liquidity. As discussed below, wedecreased affiliate and third-party debt and initial securitization levelsduring the current quarter as we used proceeds from the sale of real estatesecured receivables to HSBC Bank USA to assist in the funding of our businesses. Because we are now a subsidiary of HSBC, our credit spreads relative totreasuries have tightened. We recognized cash funding expense savings, primarilyas a result of these tightened credit spreads, in excess of $70 million for thecurrent quarter and less than $5 million for the prior-year quarter compared tothe funding costs we would have incurred using average spreads from the firsthalf of 2002. It is anticipated that these tightened credit spreads and otherfunding synergies will eventually enable HSBC to realize annual cash fundingexpense savings, including external fee savings, in excess of $1 billion peryear as our existing term debt matures over the course of the next few years.The portion of these savings to be realized by Household will depend in largepart upon the amount and timing of the proposed domestic private label andMasterCard and Visa credit card receivable transfers to HSBC Bank USA and otherinitiatives between Household and HSBC subsidiaries. INVESTMENT SECURITIES Investment securities totaled $6.7 billion at March 31,2004 and $11.1 billion at December 31, 2003. Included in the March 31, 2004balance was $2.2 billion dedicated to our credit card bank and $3.3 billion heldby our insurance subsidiaries. Included in the December 31, 2003 balance was$2.4 billion dedicated to our credit card bank and $3.1 billion held by ourinsurance subsidiaries. Our investment securities balance at December 31, 2003was unusually high as a result of the cash received from the $2.8 billion realestate secured loan sale to HSBC Bank USA on December 31, 2003 as well as excessliquidity. COMMERCIAL PAPER, BANK AND OTHER BORROWINGS Commercial paper, bank and otherborrowings totaled $9.1 billion at both March 31, 2004 and December 31, 2003.Included in this total was outstanding Euro commercial paper sold to customersof HSBC of $3.0 billion at March 31, 2004 and $2.8 billion at December 31, 2003. 45 Household International Inc., and Subsidiaries-------------------------------------------------------------------------------- DUE TO AFFILIATES AND OTHER HSBC RELATED FUNDING As of March 31, 2004, HSBCrelated funding totaled $14.1 billion, compared to $14.7 billion at December 31,2003, as detailed in the table below. MARCH 31, DECEMBER 31, 2004 2003-------------------------------------------------------------------------------------- (IN BILLIONS)Debt issued to HSBC subsidiaries: Domestic short-term borrowings......................... - $ 2.6 Drawings on bank lines in the U.K. .................... $ 3.8 3.4 Term debt.............................................. 1.3 1.3 Preferred securities issued by Household Capital Trust VIII.................................................. .3 .3 ----- ----- Total debt issued to HSBC subsidiaries................. 5.4 7.6 ----- -----Debt issued to HSBC clients: Euro commercial paper.................................. 3.0 2.8 Term debt.............................................. .5 .4 ----- ----- Total debt issued to HSBC clients...................... 3.5 3.2Preferred stock issued to HSBC.............................. 1.1 1.1Real estate secured receivable activity with HSBC Bank USA: Cash received on sales (cumulative).................... 3.7 2.8 Direct purchases from correspondents................... .4 - ----- ----- Total real estate secured receivable activity with HSBC Bank USA.............................................. 4.1 2.8 ----- -----Total HSBC related funding.................................. $14.1 $14.7 ===== ===== Proceeds from the December 2003 sale of $2.8 billion of real estate securedloans to HSBC Bank USA, which at year-end 2003 had been temporarily held asinvestment securities, were used to pay-down domestic short-term borrowings inthe first quarter of 2004. Proceeds from the March 2004 real estate securedreceivable sale were used to pay-down commercial paper balances which had beenused as temporary funding in the first quarter of 2004 and to fund various debtmaturities. In April 2004, we received $1 billion from medium-term notes with a10-year maturity sold to a subsidiary of HSBC. An additional $900 million ofmedium-term notes with maturities of 2-3 years were sold to a subsidiary of HSBCin May 2004. As of March 31, 2004, we had revolving credit facilities with HSBC of $2.5billion domestically and $4.5 billion in the U.K. There have been no draws onthe domestic line. We also had derivative contracts with a notional value ofapproximately $47.8 billion, or approximately 70 percent of total derivativecontracts, outstanding with HSBC affiliates. LONG-TERM DEBT Long-term debt (with original maturities over one year) decreasedto $77.8 billion at March 31, 2004 from $79.6 billion at December 31, 2003. Thedecrease in senior and senior subordinated debt was the result of debtmaturities and reduced issuances. Issuances during the quarter included thefollowing: - $350 million of domestic medium-term notes - $140 million of foreign currency-denominated bonds (all of which were issued to customers of HSBC) - $450 million of InterNotes(SM) (retail-oriented medium-term notes) 46 Household International Inc., and Subsidiaries-------------------------------------------------------------------------------- SELECTED CAPITAL RATIOS were as follows: MARCH 31, DECEMBER 31, 2004 2003--------------------------------------------------------------------------------------- (RESTATED) (RESTATED)TETMA(1).................................................... 7.67% 7.03%TETMA + Owned Reserves(1)................................... 10.61 9.89Tangible common equity to tangible managed assets(1)........ 5.59 5.04Common and preferred equity to owned assets................. 15.55 14.69Excluding purchase accounting adjustments: TETMA(1)............................................... 9.69 8.94 TETMA + Owned Reserves(1).............................. 12.64 11.81 Tangible common equity to tangible managed assets(1)... 7.64 6.98 --------------- (1) TETMA, TETMA + Owned Reserves and tangible common equity to tangible managed assets represent non-GAAP financial ratios that are used by Household management and certain rating agencies to evaluate capital adequacy and may differ from similarly named measures presented by other companies. See "Basis of Reporting" for additional discussion on the use of non-GAAP financial measures and "Reconciliations to GAAP Financial Measures" for quantitative reconciliations to the equivalent GAAP basis financial measure. In April 2004, Fitch Ratings revised our Rating Outlook to Positive from Stableand raised our Support Rating to "1" from "2". In addition, Fitch affirmed our"A" senior long-term and "F1" commercial paper ratings. We are committed tomaintaining at least a mid-single "A" rating and as part of that effort willcontinue to review appropriate capital levels with our rating agencies. SECURITIZATIONS AND SECURED FINANCINGS Securitizations (which are structured toreceive sale treatment under Statement of Financial Accounting Standards No.140, "Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities, a Replacement of FASB Statement No. 125," ("SFASNo. 140")) and secured financings (which do not receive sale treatment underSFAS No. 140) of consumer receivables are used to limit our reliance on theunsecured debt markets and often are more cost-effective than alternativefunding sources. In a securitization, a designated pool of non-real estate consumer receivablesis removed from the balance sheet and transferred to an unaffiliated trust. Thisunaffiliated trust is a qualifying special purpose entity ("QSPE") as defined bySFAS No. 140 and, therefore, is not consolidated. The QSPE funds its receivablepurchase through the issuance of securities to investors, entitling them toreceive specified cash flows during the life of the securities. The securitiesare collateralized by the underlying receivables transferred to the QSPE. At thetime of sale, an interest-only strip receivable is recorded, representing thepresent value of the cash flows we expect to receive over the life of thesecuritized receivables, net of estimated credit losses. Under the terms of thesecuritizations, we receive annual servicing fees on the outstanding balance ofthe securitized receivables and the rights to future residual cash flows on thesold receivables after the investors receive their contractual return. Cashflows related to the interest-only strip receivables and servicing thereceivables are collected over the life of the underlying securitizedreceivables. In a secured financing, a designated pool of receivables, typically real estatesecured, are conveyed to a wholly owned limited purpose subsidiary which in turntransfers the receivables to a trust which sells interests to investors.Repayment of the debt issued by the trust is secured by the receivablestransferred. The transactions are structured as secured financings under SFASNo. 140. Therefore, the receivables and the underlying debt of the trust remainon our balance sheet. We do not recognize a gain in a secured financingtransaction. Because the receivables and the debt remain on our balance sheet,revenues and expenses are reported consistently with our owned balance sheetportfolio. Using this source of funding results in similar cash flows as issuingdebt through alternative funding sources. 47 Household International Inc., and Subsidiaries-------------------------------------------------------------------------------- Receivables securitized (excluding replenishments of certificateholderinterests) were as follows: THREE MONTHS ENDED MARCH 31, --------------- 2004 2003----------------------------------------------------------------------------- (IN MILLIONS)Auto finance................................................ - $ 411MasterCard/Visa............................................. $50 320Personal non-credit card.................................... - 510 --- ------Total....................................................... $50 $1,241 === ====== Securitization levels were much lower in 2004 as we used funding from HSBC,including proceeds from receivable sales, to assist in the funding of ouroperations. Our securitized receivables totaled $24.4 billion at March 31, 2004, compared to$26.2 billion at December 31, 2003. As of March 31, 2004, closed-end real estatesecured receivables totaling $6.2 billion secured $5.1 billion of outstandingdebt related to securitization transactions which were structured as securedfinancings. At December 31, 2003, closed-end real estate secured receivablestotaling $8.0 billion secured $6.7 billion of outstanding debt related tosecured financing transactions. Securitizations structured as sales represented21 percent of the funding associated with our managed portfolio at both March31, 2004 and December 31, 2003. Secured financings represented 4 percent of thefunding associated with our managed portfolio at March 31, 2004 and 5 percent atDecember 31, 2003. We believe the market for securities backed by receivables is a reliable,efficient and cost-effective source of funds. Securitizations and securedfinancings of consumer receivables have been, and will continue to be, a sourceof our funding and liquidity. We currently anticipate, however, that we willrely less on securitizations and secured financings in 2004 compared to 2003 andin the future as we receive funding from HSBC and its clients to partially fundour operations. Under U.K. GAAP, as reported by HSBC, securitizations aretreated as secured financings. Therefore, we may structure more of oursecuritization transactions as financings under U.S. GAAP in the future in orderto more closely align our accounting treatment with HSBC's U.K. GAAP treatmentfor these transactions. 2004 FUNDING STRATEGY Our current estimated domestic funding needs and sourcesfor 2004 are summarized in the table that follows. Because we cannot predictwith any degree of certainty the timing as to when or if all approvals will bereceived for our proposed transfer of receivables to HSBC Bank USA, thesetransfers are not contemplated in the following 2004 funding plan. If theseproposed transfers do occur, our external funding needs will decrease. (IN BILLIONS)----------------------------------------------------------------------------FUNDING NEEDS: Net asset growth.......................................... $14-16 Commercial paper, term debt and securitization maturities............................................. 24-26 Other..................................................... 2-5 ------ Total funding needs, including growth..................... $40-47 ======FUNDING SOURCES: External funding, including HSBC clients.................. $32-36 HSBC and HSBC subsidiaries................................ 8-11 ------ Total funding sources..................................... $40-47 ====== 48 HOUSEHOLD INTERNATIONAL, INC. RECONCILIATIONS TO GAAP FINANCIAL MEASURES THREE MONTHS ENDED ------------------------ MARCH 31, MARCH 31, 2004 2003-------------------------------------------------------------------------------------- (RESTATED) (RESTATED) (DOLLAR AMOUNTS ARE IN MILLIONS)RETURN ON AVERAGE ASSETS:Net income.................................................. $ 470 $ 390HSBC acquisition related costs and other merger related items incurred by Household, after-tax.................... - 167 ---------- ----------Operating net income........................................ $ 470 $ 557 ---------- ----------Average assets: Owned basis............................................... $ 119,388 $ 100,438 Serviced with limited recourse............................ 25,278 24,155 ---------- ---------- Managed basis............................................. $ 144,666 $ 124,593 ---------- ----------Return on average owned assets.............................. 1.57% 1.55%Return on average owned assets, operating basis............. 1.57 2.22Return on average managed assets............................ 1.30 1.25Return on average managed assets, operating basis........... 1.30 1.79 ========== ==========RETURN ON AVERAGE COMMON SHAREHOLDER'S EQUITY:Net income.................................................. $ 470 $ 390Dividends on preferred stock................................ (18) (22) ---------- ----------Net income available to common shareholders................. 452 368HSBC acquisition related costs and other merger related items incurred by Household............................... - 167 ---------- ----------Operating net income available to common shareholders....... $ 452 $ 535 ---------- ----------Average common shareholder's equity......................... $ 16,645 $ 9,548 ---------- ----------Return on average common shareholder's equity............... 10.9% 15.4%Return on average common shareholder's equity, operating basis..................................................... 10.9 22.4 ========== ==========NET INTEREST MARGIN:Net interest income: Owned basis............................................... $ 1,820 $ 1,628 Serviced with limited recourse............................ 754 726 ---------- ---------- Managed basis............................................. $ 2,574 $ 2,354 ---------- ----------Average interest-earning assets: Owned basis............................................... $ 99,676 $ 89,565 Serviced with limited recourse............................ 25,278 24,155 ---------- ---------- Managed basis............................................. $ 124,954 $ 113,720 ---------- ----------Owned basis net interest margin............................. 7.30% 7.27%Managed basis net interest margin........................... 8.24 8.28 ========== ==========MANAGED BASIS RISK ADJUSTED REVENUE:Net interest income......................................... $ 2,574 $ 2,354Other revenues, excluding securitization revenue............ 1,072 1,170Less: Net charge-offs....................................... (1,442) (1,272) ---------- ----------Risk adjusted revenue....................................... 2,204 2,252Average interest-earning assets............................. $ 124,954 $ 113,720 ---------- ----------Managed basis risk adjusted revenue......................... 7.06% 7.92% ========== ========== 49 HOUSEHOLD INTERNATIONAL, INC. RECONCILIATIONS TO GAAP FINANCIAL MEASURES THREE MONTHS ENDED --------------------------------------------------- MARCH 31, 2004 MARCH 31, 2003 DECEMBER 31, 2003----------------------------------------------------------------------------------------------------------------- (DOLLAR AMOUNTS ARE IN MILLIONS)CONSUMER NET CHARGE-OFF RATIO:Consumer net charge-offs: Owned basis............................................... $ 970 $ 874 $ 884 Serviced with limited recourse............................ 472 398 420 ---------- ---------- ---------- Managed basis............................................. $ 1,442 $ 1,272 $ 1,304 ---------- ---------- ----------Average consumer receivables: Owned basis............................................... $ 92,974 $ 82,920 $ 94,187 Serviced with limited recourse............................ 25,278 24,155 24,568 ---------- ---------- ---------- Managed basis............................................. $ 118,252 $ 107,075 $ 118,755 ---------- ---------- ----------Owned basis consumer net charge-off ratio................... 4.17% 4.22% 3.75%Managed basis consumer net charge-off ratio................. 4.88 4.75 4.39 ========== ========== ==========RESERVES AS A PERCENTAGE OF NET CHARGE-OFFSLoss reserves: Owned basis............................................... $ 3,753 $ 3,483 $ 3,793 Serviced with limited recourse............................ 2,159 1,776 2,374 ---------- ---------- ---------- Managed basis............................................. $ 5,912 $ 5,259 $ 6,167 ---------- ---------- ----------Net charge-offs: Owned basis............................................... $ 970 $ 874 $ 884 Serviced with limited recourse............................ 472 398 420 ---------- ---------- ---------- Managed basis............................................. $ 1,442 $ 1,272 $ 1,304 ---------- ---------- ----------Owned basis reserves as a percentage of net charge-offs..... 96.7% 99.6% 107.3%Managed basis reserves as a percentage of net charge-offs... 102.5 103.3(1) 118.2 ========== ========== ==========EFFICIENCY RATIO (RESTATED):Total costs and expenses less policyholders' benefits....... $ 1,297 $ 1,327HSBC acquisition related costs incurred by Household........ - (198) ---------- ----------Total costs and expenses less policyholders' benefits, excluding nonrecurring items.............................. $ 1,297 $ 1,129 ---------- ----------Net interest income and other revenues less policyholders' benefits: Owned basis............................................... $ 2,930 $ 2,991 Serviced with limited recourse............................ 253 407 ---------- ---------- Managed basis............................................. $ 3,183 $ 3,398 ---------- ----------Owned basis efficiency ratio................................ 44.3% 44.4%Owned basis efficiency ratio, operating basis............... 44.3 37.7Managed basis efficiency ratio.............................. 40.7 39.1Managed basis efficiency ratio, operating basis............. 40.7 33.2 ========== ========== (1) Ratio does not recompute based on numbers presented due to rounding. 50 HOUSEHOLD INTERNATIONAL, INC. RECONCILIATIONS TO GAAP FINANCIAL MEASURES MARCH 31, DECEMBER 31, MARCH 31, 2004 2003 2003------------------------------------------------------------------------------------------------ (DOLLAR AMOUNTS ARE IN MILLIONS)TWO-MONTHS-AND-OVER-CONTRACTUAL DELINQUENCY:Consumer two-months-and-over-contractual delinquency: Owned basis........................................... $ 4,671 $ 4,936 $ 4,567 Serviced with limited recourse........................ 1,280 1,432 1,178 ---------- ---------- ---------- Managed basis......................................... $ 5,951 $ 6,368 $ 5,745 ---------- ---------- ----------Consumer receivables: Owned basis........................................... $ 93,299 $ 92,012 $ 83,023 Serviced with limited recourse........................ 24,357 26,201 24,256 ---------- ---------- ---------- Managed basis......................................... $ 117,656 $ 118,213 $ 107,279 ---------- ---------- ----------Consumer two-months-and-over-contractual delinquency: Owned basis........................................... 5.01% 5.36% 5.50% Managed basis......................................... 5.06 5.39 5.36 ========== ========== ==========RESERVES AS A PERCENTAGE OF RECEIVABLES:Loss reserves: Owned basis........................................... $ 3,753 $ 3,793 $ 3,483 Serviced with limited recourse........................ 2,159 2,374 1,776 ---------- ---------- ---------- Managed basis......................................... $ 5,912 $ 6,167 $ 5,259 ---------- ---------- ----------Receivables: Owned basis........................................... $ 93,650 $ 92,378 $ 83,438 Serviced with limited recourse........................ 24,357 26,201 24,256 ---------- ---------- ---------- Managed basis......................................... $ 118,007 $ 118,579 $ 107,694 ---------- ---------- ----------Reserves as a percentage of receivables: Owned basis........................................... 4.01% 4.11% 4.17% Managed basis......................................... 5.01 5.20 4.88 ========== ========== ==========RESERVES AS A PERCENTAGE OF NONPERFORMING LOANS:Loss reserves: Owned basis........................................... $ 3,753 $ 3,793 $ 3,483 Serviced with limited recourse........................ 2,159 2,374 1,776 ---------- ---------- ---------- Managed basis......................................... $ 5,912 $ 6,167 $ 5,259 ---------- ---------- ----------Nonperforming loans: Owned basis........................................... $ 3,881 $ 4,050 $ 3,760 Serviced with limited recourse........................ 1,055 1,176 967 ---------- ---------- ---------- Managed basis......................................... $ 4,936 $ 5,226 $ 4,727 ---------- ---------- ----------Reserves as a percentage of nonperforming loans: Owned basis........................................... 96.7% 93.7% 92.6% Managed basis......................................... 119.8 118.0 111.3 ========== ========== ========== 51 HOUSEHOLD INTERNATIONAL, INC. RECONCILIATIONS TO GAAP FINANCIAL MEASURES MARCH 31, DECEMBER 31, 2004 2003--------------------------------------------------------------------------------------- (RESTATED) (RESTATED) (DOLLAR AMOUNTS ARE IN MILLIONS)TANGIBLE COMMON EQUITY:Common shareholder's equity................................. $ 16,909 $ 16,391Exclude: Unrealized losses on cash flow hedging instruments........ 27 10 Unrealized gains on investments and interest-only strip receivables............................................. (216) (167) Intangible assets......................................... (2,749) (2,856) Goodwill.................................................. (6,853) (6,697) ---------- ----------Tangible common equity...................................... 7,118 6,681Purchase accounting adjustments............................. 2,595 2,548 ---------- ----------Tangible common equity, excluding purchase accounting adjustments............................................... $ 9,713 $ 9,229 ========== ==========TANGIBLE SHAREHOLDER'S EQUITY:Tangible common equity...................................... $ 7,118 $ 6,681Preferred stock............................................. 1,100 1,100Mandatorily redeemable preferred securities of Household Capital Trusts............................................ 1,029 1,031Adjustable Conversion-Rate Equity Security Units............ 522 519 ---------- ----------Tangible shareholder's equity............................... 9,769 9,331Purchase accounting adjustments............................. 2,541 2,492 ---------- ----------Tangible shareholder's equity, excluding purchase accounting adjustments............................................... $ 12,310 $ 11,823 ========== ==========TANGIBLE SHAREHOLDER'S EQUITY PLUS OWNED LOSS RESERVES:Tangible shareholder's equity............................... $ 9,769 $ 9,331Owned loss reserves......................................... 3,753 3,793 ---------- ----------Tangible shareholder's equity plus owned loss reserves...... 13,522 13,124Purchase accounting adjustments............................. 2,541 2,492 ---------- ----------Tangible shareholder's equity plus owned loss reserves, excluding purchase accounting adjustments................. $ 16,063 $ 15,616 ========== ==========TANGIBLE MANAGED ASSETS:Owned assets................................................ $ 115,835 $ 119,052Receivables serviced with limited recourse.................. 24,357 26,001 ---------- ----------Managed assets.............................................. 140,192 145,253Exclude: Intangible assets......................................... (2,749) (2,856) Goodwill.................................................. (6,853) (6,697) Derivative financial assets............................... (3,152) (3,016) ---------- ----------Tangible managed assets..................................... 127,438 132,684Purchase accounting adjustments............................. (371) (431) ---------- ----------Tangible managed assets, excluding purchase accounting adjustments............................................... $ 127,067 $ 132,253 ========== ==========EQUITY RATIOS:Common and preferred equity to owned assets................. 15.55% 14.69%Tangible common equity to tangible managed assets........... 5.59 5.04Tangible shareholder's equity to tangible managed assets ("TETMA")................................................. 7.67 7.03Tangible shareholder's equity plus owned loss reserves to tangible managed assets ("TETMA + Owned Reserves")........ 10.61 9.89Excluding purchase accounting adjustments: Tangible common equity to tangible managed assets......... 7.64 6.98 TETMA..................................................... 9.69 8.94 TETMA + Owned Reserves.................................... 12.64 11.81 ========== ========== 52 ITEM 4. CONTROLS AND PROCEDURES-------------------------------------------------------------------------------- DISCLOSURE CONTROLS As of the end of the period covered by this report, with theparticipation of our Chief Executive Officer and Chief Financial Officer, weevaluated the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Rule 13a-15(e) of the Securities ExchangeAct of 1934). Based upon that evaluation, our Chief Executive Officer and ourChief Financial Officer concluded that as of the end of such period, ourdisclosure controls and procedures were effective in timely alerting them tomaterial information relating to Household International, Inc. required to beincluded in our periodic reports with the Securities and Exchange Commission. As a result of a subsequent evaluation of the effectiveness of our disclosurecontrols and procedures as of the end of the period covered by our Annual Reporton Form 10-K for the year ended December 31, 2004, with the participation of ourChief Executive Officer and Chief Financial Officer, we identified a materialweakness in our internal controls over financial reporting relating to theprocess of establishing and maintaining effective hedges under the "shortcut"method of accounting pursuant to Statement of Financial Accounting Standards No.133, "Accounting for Derivative Instruments and Hedging Activities." As aresult, and as set forth in Note 2 to the Consolidated Financial Statements andthe "Restatement" section included in Item 2, Management's Discussion andAnalysis of Financial Condition and Results of Operations, we have restated ourunaudited consolidated financial statements for the periods covered by thisreport. We have also undertaken remedial action to address and correct theweakness in our internal controls over this process. INTERNAL CONTROLS In the process of finalizing our quarterly results and thepurchase price allocation resulting from our merger with HSBC, we identifiedcertain matters indicative of control weaknesses. On investigation and analysis,our inquiries indicated some weaknesses in internal controls as related tocertain of our processes and we reported these to the Audit Committee.Consequently, we determined that certain adjustments to prior fair valueestimates were necessary which resulted in a net increase to goodwill in theapproximate amount of $141 million. The adjustments related principally towriting off several aged items remaining on intercompany accounts and tocorrecting errors noted in respect of various marketing, rent and payrollaccruals that arose over several prior periods. Management has undertaken measures to strengthen the corporation's internalcontrols by dedicating additional personnel to the account reconciliationfunction and by reinforcing the corporation's accounting policies governing suchitems. Management and the Audit Committee continue to review these exceptions todetermine whether additional measures are required. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS-------------------------------------------------------------------------------- GENERAL We are parties to various legal proceedings resulting from ordinarybusiness activities relating to our current and/or former operations. Certain ofthese actions 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. MERGER LITIGATION Several lawsuits were filed alleging violations of law withrespect to the merger with HSBC. We believe that the claims lack merit and thedefendants deny the substantive allegations of the lawsuits. These lawsuits aredescribed below. Between August 27, 2002 and January 15, 2003, derivative lawsuits on behalf ofthe company and class actions on behalf of Household common stockholders werefiled against Household and certain of its officers and directors. See Bailey v.Aldinger, et al., No 02 CH 16476 (Circuit Court, Cook County, Illinois, ChanceryDivision); McLaughlin v. Aldinger, et al., No. 02 CH 20683 (Circuit Court, CookCounty, Illinois, Chancery Division); Pace v. Aldinger, et al., No. 02 CH 19270(Circuit Court, Cook 53 County, Illinois, Chancery Division); Williamson v. Aldinger, et al., No. 03600331 (United States District Court for the Northern District of Illinois). Thelawsuits principally asserted claims for breach of fiduciary duty in connectionwith our restatement of earnings announced on August 14, 2002, the allegedlyimproper lending practices by Household's subsidiaries and the alleged failureby certain Household officers to take appropriate steps to maximize the value ofthe merger transaction between Household and HSBC Holdings plc announced onNovember 14, 2002. On March 18, 2003, a memorandum of understanding was signedby the parties containing the essential terms of the settlement of all fourlawsuits. Those settlement terms included a $55 million reduction in thetermination fee for the Household-HSBC merger, a supplemental disclosure toHousehold shareholders in the supplemental Household proxy statement, aconfirmation from Goldman Sachs stating that as of the date of the confirmationit was aware of nothing that would cause it to withdraw its November 14, 2002opinion about the fairness of the Household-HSBC merger to Household's commonshareholders and payment by the defendants of plaintiff's costs relating tonotice to stockholders as well as $2.0 million in attorneys fees for plaintiffs'counsel. A stipulation reflecting the settlement was signed by the parties on September22, 2003 and the Circuit Court, Cook County, Illinois, Chancery Divisionpreliminarily approved the settlement of the Bailey, McLaughlin and Pacelawsuits on September 29, 2003 and directed that notice be provided to Householdstockholders and class members. Following the distribution of the notice, theCircuit Court, Cook County, Illinois, Chancery Division held a settlementfairness hearing on December 23, 2003. Issuance of a final judgment orderapproving the settlement of the Bailey, McLaughlin and Pace lawsuits is stillpending. The United States District Court for the Northern District of Illinoishas delayed further action in the Williamson lawsuit until the state courtactions are resolved. CONSUMER LENDING LITIGATION During the past several years, the press has widelyreported certain industry related concerns that may impact us. Some of theseinvolve the amount of litigation instituted against finance and insurancecompanies operating in certain states and the large awards obtained from juriesin those states (Alabama and Mississippi are illustrative). Like other companiesin this industry, some of our subsidiaries are involved in a number of lawsuitspending against them in these states. The Alabama and Mississippi cases, inparticular, generally allege inadequate disclosure or misrepresentation offinancing terms. In some suits, other parties are also named as defendants.Unspecified compensatory and punitive damages are sought. Several of these suitspurport to be class actions or have multiple plaintiffs. The judicial climate inthese states is such that the outcome of all of these cases is unpredictable.Although our subsidiaries believe they have substantive legal defenses to theseclaims and are prepared to defend each case vigorously, a number of such caseshave been settled or otherwise resolved for amounts that in the aggregate arenot material to our operations. Appropriate insurance carriers have beennotified of each claim, and a number of reservations of rights letters have beenreceived. Certain of the financing of merchandise claims have been partiallycovered by insurance. On November 25, 2003, we announced the proposed settlement of nationwide classaction litigation with the Association of Community Organizations for Reform Now("ACORN") and certain borrowers relating to the mortgage lending practices ofHFC's retail branch consumer lending operations (the "ACORN SettlementAgreement"). Pursuant to the ACORN Settlement Agreement, HFC will providemonetary relief for certain class members who did not participate in thesettlement with the state attorneys general and regulatory agencies, asdescribed above, and non-monetary relief for all class members, including thosewho participated in the settlement, amongst other relief. The ACORN SettlementAgreement was approved by the United States District Court for the NorthernDistrict of California on April 30, 2004. The agreed upon relief will not have amaterial impact to our financial condition or operating model. SECURITIES LITIGATION In August 2002, we restated previously reportedconsolidated financial statements. The restatement related to certain MasterCardand Visa co-branding and affinity credit card relationships and a third partymarketing agreement, which were entered into between 1992 and 1999. All werepart of our Credit Card Services segment. In consultation with our priorauditors, Arthur Andersen LLP, we treated payments made in connection with theseagreements as prepaid assets and amortized them in accordance with theunderlying economics of the agreements. Our current auditor, KPMG LLP, advised 54 us that, in its view, these payments should have either been charged againstearnings at the time they were made or amortized over a shorter period of time.The restatement resulted in a $155.8 million, after-tax, retroactive reductionto retained earnings at December 31, 1998. As a result of the restatement, andother corporate events, including, e.g. the 2002 settlement with 50 states andthe District of Columbia relating to real estate lending practices, Household,and its directors, certain officers and former auditors, have been involved invarious legal proceedings, some of which purport to be class actions. A numberof these actions allege violations of federal securities laws, were filedbetween August and October 2002, and seek to recover damages in respect ofallegedly false and misleading statements about our common stock. To date, noneof the class claims has been certified. 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. The amendedcomplaint purports to assert claims under the federal securities laws, on behalfof all persons who purchased or otherwise acquired Household securities betweenOctober 23, 1997 and October 11, 2002, arising out of alleged false andmisleading statements in connection with Household's sales and lendingpractices, the 2002 state settlement agreement referred to above, therestatement and the HSBC merger. The amended complaint, which also names asdefendants Arthur Andersen LLP, Goldman, Sachs & Co., and Merrill Lynch, Pierce,Fenner & Smith, Inc., fails to specify the amount of damages sought. In May2003, we, and other defendants, filed a motion to dismiss the complaint. OnMarch 19, 2004, the Court granted in part, and denied in part the defendant'smotion 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.Discovery has begun. Other actions arising out of the restatement, which purport to assert claimsunder ERISA on behalf of participants in Household's Tax Reduction InvestmentPlan, have been consolidated into a single purported class action, In reHousehold International, Inc. ERISA Litigation, Master File No. 02 C 7921 (N.D.Ill). A consolidated and amended complaint was filed against Household, WilliamAldinger and individuals on the Administrative Investment Committee of the plan.The consolidated complaint purports to assert claims under ERISA that aresimilar to the claims in the Jaffe case. Essentially, the plaintiffs allege thatthe defendants breached their fiduciary duties to the plan by investing inHousehold stock and failing to disclose information to Plan participants. Amotion to dismiss the complaint was filed in June 2003. On March 30, 2004, theCourt granted in part, and denied in part, the defendants' motion to dismiss thecomplaint. The Court dismissed all claims alleging that some or all of thedefendants breached their co-fiduciary obligations; misrepresented the prudenceof investing in Household stock; failed to disclose nonpublic informationregarding alleged accounting and lending improprieties; and failed to provideother defendants with non-public information. The claims that remain essentiallyallege that some or all of the defendants failed to prudently manage plan assetsby continuing to invest in, or provide matching contributions of, Householdstock. Discovery has begun. On June 27, 2003, a case entitled, West Virginia Laborers Pension Trust Fund v.Caspersen, et al., was filed in the Chancery Division of the Circuit Court ofCook County, Illinois as case number 03CH10808. This purported class actionnames as defendants the directors of Beneficial Corporation at the time of the1998 merger of Beneficial Corporation into a subsidiary of Household, and claimsthat those directors' due diligence of the Company at the time they consideredthe merger was inadequate. The Complaint claims that as a result of some of thesecurities law and other violations alleged in the Jaffe case, the Company'scommon shares lost value. Under the merger agreement with BeneficialCorporation, we assumed the defense of this litigation. In September of 2003,the defendants filed a motion to dismiss. Plaintiffs conducted limited discoveryrelating to the jurisdictional issues raised in the defendants' motion todismiss. Briefs for that motion are being prepared. The insurance carriers forBeneficial Corporation have been notified of the action. 55 With respect to these securities litigation matters, we believe that we havenot, and our officers and directors have not, committed any wrongdoing and ineach instance there will be no finding of improper activities that may result ina material liability to us or any of our officers or directors. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K-------------------------------------------------------------------------------- (a) Exhibits 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. 99.2 Report of KPMG LLP, independent registered public accounting firm. 99.3 Letter of independent registered public accounting firm, KPMG LLP, regarding unaudited interim financial information. (b) Reports on Form 8-K During the first quarter of 2004, the Registrant filed a Current Report on Form8-K on March 1, 2004 with respect to the financial supplement pertaining to thefinancial results of Household International, Inc. for the quarter and twelvemonths ended December 31, 2003. 56 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 (formerly known as Household International, Inc.) (Registrant) Date: March 31, 2005 /s/ Simon C. Penney -------------------------------------- Simon C. Penney Senior Executive Vice President and Chief Financial Officer 57 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. 99.2 Report of KPMG LLP, independent registered public accounting firm. 99.3 Letter of independent registered public accounting firm, KPMG LLP, regarding unaudited interim financial information. EXHIBIT 12 HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS THREERelated Shares:
HSBC Holdings