31st Mar 2005 12:30
HSBC Holdings PLC31 March 2005 -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q/A (Mark One)(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to________ COMMISSION FILE NUMBER 1-8198 HSBC FINANCE CORPORATION (FORMERLY KNOWN AS HOUSEHOLD INTERNATIONAL, INC.) (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 86-1052062 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.) 2700 SANDERS ROAD, PROSPECT HEIGHTS, ILLINOIS 60070 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (847) 564-5000 REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes (X) No ( ) Indicate by check mark whether the registrant is an accelerated filer (asdefined in Rule 12b-2 of the Exchange Act). Yes ( ) No (X) At July 31, 2004, there were 50 shares of the registrant's common stockoutstanding, all of which were indirectly owned by HSBC Holdings plc. THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONH(1)(A) AND (B) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM 10-Q WITH THEREDUCED DISCLOSURE FORMAT.-------------------------------------------------------------------------------- HOUSEHOLD INTERNATIONAL, INC. FORM 10-Q/A TABLE OF CONTENTS PART I FINANCIAL INFORMATION-----------------------------------------------------------------------------------Item 1. Consolidated Financial Statements Statement of Income....................................... 4 Balance Sheet............................................. 5 Statement of Changes in Shareholder's(s') Equity.......... 6 Statement of Cash Flows................................... 7 Notes to Consolidated Financial Statements................ 8Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements................................ 20 Restatement............................................... 20 Executive Overview........................................ 21 Basis of Reporting........................................ 25 Receivables Review........................................ 30 Results of Operations..................................... 31 Segment Results - Managed Basis........................... 38 Credit Quality............................................ 44 Liquidity and Capital Resources........................... 52 Risk Management........................................... 56 Reconciliations to GAAP Financial Measures................ 58Item 4. Controls and Procedures..................................... 62PART II OTHER INFORMATION-----------------------------------------------------------------------------------Item 1. Legal Proceedings........................................... 62Item 6. Exhibits and Reports on Form 8-K............................ 65Signature.................................................................... 66 2 EXPLANATORY NOTE HSBC Finance Corporation (formerly known as Household International, Inc.) isfiling this amended Quarterly Report on Form 10-Q/A to reflect the restatementof its unaudited consolidated financial statements for the periods covered bythis report. Please see Note 2 to the Consolidated Financial Statements and the"Restatement" section included in Item 2, Management's Discussion and Analysisof Financial Condition and Results of Operations below for a detailed discussionof the restatement. As more fully described therein, we have restated allreported periods since our acquisition by HSBC Holdings plc on March 28, 2003 toeliminate hedge accounting on all hedging relationships outstanding on that dateand certain fair value swaps entered into after that date. This restatement issolely the result of the failure to satisfy certain technical requirements ofStatement of Financial Accounting Standards No. 133, "Accounting for DerivativeInstruments and Hedging Activities." This amended Quarterly Report on Form 10-Q/A restates the Quarterly Report onForm 10-Q for the quarter ended June 30, 2004. We have not modified or updatedthe disclosures in the original Quarterly Report on Form 10-Q except as requiredto give effect to the restatement. As a result, this amended Quarterly Report onForm 10-Q/A contains forward-looking information that has not been updated forevents subsequent to the date of the original filing, and all informationcontained in this amended Quarterly Report on Form 10-Q/A and the originalQuarterly Report on Form 10-Q is subject to updating and supplementing asprovided in the periodic reports that we have filed and will file with theSecurities and Exchange Commission after the original filing date of theQuarterly Report on Form 10-Q. 3 PART I. FINANCIAL INFORMATION--------------------------------------------------------------------------------ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS Household International, Inc.--------------------------------------------------------------------------------CONSOLIDATED STATEMENT OF INCOME THREE MONTHS ENDED SIX MONTHS MARCH 29 JANUARY 1 JUNE 30, ENDED THROUGH THROUGH ------------------------- JUNE 30, JUNE 30, MARCH 28, 2004 2003 2004 2003 2003---------------------------------------------------------------------------------------------------------- (SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (PREDECESSOR) (RESTATED) (RESTATED) (RESTATED) (RESTATED) (IN MILLIONS)Finance and other interest income........................... $ 2,637 $ 2,503 $ 5,165 $ 2,578 $ 2,469Interest expense................... 707 689 1,415 708 897 -------- -------- -------- -------- --------NET INTEREST INCOME................ 1,930 1,814 3,750 1,870 1,572Provision for credit losses........ 997 1,039 1,925 1,073 976 -------- -------- -------- -------- --------NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES................ 933 775 1,825 797 596 -------- -------- -------- -------- --------Other revenues: Securitization revenue........... 266 284 614 293 434 Insurance revenue................ 204 183 415 189 171 Investment income................ 30 33 71 34 80 Derivative income................ 124 574 176 789 2 Fee income....................... 242 228 507 237 280 Taxpayer financial services income........................ 6 3 212 3 181 Other income..................... 180 86 280 91 64 -------- -------- -------- -------- --------TOTAL OTHER REVENUES............... 1,052 1,391 2,275 1,636 1,212 -------- -------- -------- -------- --------Costs and expenses: Salaries and employee benefits... 457 489 942 507 491 Sales incentives................. 90 83 168 85 37 Occupancy and equipment expenses...................... 77 100 160 103 98 Other marketing expenses......... 131 135 263 139 139 Other servicing and administrative expenses....... 198 264 424 273 314 Support services from HSBC affiliates.................... 196 - 373 - - Amortization of intangibles...... 79 78 195 80 12 Policyholders' benefits.......... 93 98 206 101 91 HSBC acquisition related costs incurred by Household......... - - - - 198 -------- -------- -------- -------- --------TOTAL COSTS AND EXPENSES........... 1,321 1,247 2,731 1,288 1,380 -------- -------- -------- -------- --------Income before income tax expense... 664 919 1,369 1,145 428Income tax expense................. 231 320 466 402 182 -------- -------- -------- -------- --------NET INCOME......................... $ 433 $ 599 $ 903 $ 743 $ 246 ======== ======== ======== ======== ======== The accompanying notes are an integral part of the consolidated financialstatements. 4 CONSOLIDATED BALANCE SHEET JUNE 30, DECEMBER 31, 2004 2003---------------------------------------------------------------------------------------------- (SUCCESSOR) (SUCCESSOR) (RESTATED) (IN MILLIONS, EXCEPT SHARE DATA)ASSETSCash........................................................ $ 110 $ 463Securities.................................................. 6,923 11,073Receivables, net............................................ 97,639 91,027Intangible assets, net...................................... 2,668 2,856Goodwill.................................................... 6,821 6,697Properties and equipment, net............................... 491 527Real estate owned........................................... 624 631Derivative financial assets................................. 2,158 3,016Other assets................................................ 3,099 2,762 -------- --------TOTAL ASSETS................................................ $120,533 $119,052 ======== ========LIABILITIESDebt: Deposits.................................................. $ 56 $ 232 Commercial paper, bank and other borrowings............... 10,259 9,122 Due to affiliates......................................... 8,765 7,589 Long term debt (with original maturities over one year)... 78,271 79,632 -------- --------Total debt.................................................. 97,351 96,575 -------- --------Insurance policy and claim reserves......................... 1,304 1,258Derivative related liabilities.............................. 354 597Other liabilities........................................... 3,045 3,131 -------- -------- TOTAL LIABILITIES......................................... 102,054 101,561 -------- --------SHAREHOLDER'S EQUITYPreferred stock held by HSBC................................ 1,100 1,100Common shareholder's equity: Common stock, $0.01 par value, 100 shares authorized, 50 shares issued...................................... - - Additional paid-in capital............................. 14,643 14,645 Retained earnings...................................... 2,170 1,303 Accumulated other comprehensive income................. 566 443 -------- --------TOTAL COMMON SHAREHOLDER'S EQUITY........................... 17,379 16,391 -------- --------TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY.................. $120,533 $119,052 ======== ======== The accompanying notes are an integral part of the consolidated financialstatements. 5 CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDER'S(S') EQUITY SIX MONTHS MARCH 29 JANUARY 1 ENDED THROUGH THROUGH JUNE 30, JUNE 30, MARCH 28, 2004 2003 2003--------------------------------------------------------------------------------------------------------- (SUCCESSOR) (PREDECESSOR) (SUCCESSOR) (RESTATED) (RESTATED) (IN MILLIONS)PREFERRED STOCK Balance at beginning of period............................ $ 1,100 $ 1,100 $ 1,193 Reclassification of preferred stock issuance costs........ - - 21 Redemption of preferred stock............................. - - (114) ------- ------- ------- Balance at end of period.................................. $ 1,100 $ 1,100 $ 1,100 ======= ======= =======COMMON SHAREHOLDER'S(S') EQUITY COMMON STOCK Balance at beginning of period.......................... $ - $ - $ 552 Effect of push-down accounting of HSBC's purchase price on net assets......................................... - - (552) ------- ------- ------- Balance at end of period................................ $ - $ - $ - ------- ------- ------- ADDITIONAL PAID-IN CAPITAL Balance at beginning of period.......................... $14,645 $14,661 $ 1,911 Return of capital to HSBC............................... (14) (8) - Employee benefit plans and other........................ 12 6 10 Reclassification of preferred stock issuance costs...... - - (21) Effect of push-down accounting of HSBC's purchase price on net assets......................................... - - 12,761 ------- ------- ------- Balance at end of period................................ $14,643 $14,659 $14,661 ------- ------- ------- RETAINED EARNINGS Balance at beginning of period.......................... $ 1,303 $ - $ 9,885 Net income.............................................. 903 743 246 Dividends: Preferred at stated rates............................. (36) (18) (22) Common, $.8694 per share.............................. - - (412) Effect of push-down accounting of HSBC's purchase price on net assets......................................... - - (9,697) ------- ------- ------- Balance at end of period................................ $ 2,170 $ 725 $ - ------- ------- ------- ACCUMULATED OTHER COMPREHENSIVE INCOME Balance at beginning of period.......................... $ 443 $ - $ (695) Net change in unrealized gains (losses) on: Derivatives classified as cash flow hedges......... 107 5 101 Securities available for sale and interest-only strip receivables................................ (4) 140 (25) Minimum pension liability............................. - - - Foreign currency translation adjustment............... 20 77 (24) ------- ------- ------- Other comprehensive income, net of tax.................. 123 222 52 Effect of push-down accounting of HSBC's purchase price on net assets......................................... - - 643 ------- ------- ------- Balance at end of period................................ $ 566 $ 222 $ - ------- ------- ------- COMMON STOCK IN TREASURY Balance at beginning of period.......................... - - $(2,431) Exercise of stock options............................... - - 12 Issuance of common stock for employee benefit plans..... - - 12 Purchase of treasury stock.............................. - - (164) Effect of push-down accounting of HSBC's purchase price on net assets......................................... - - 2,571 ------- ------- ------- Balance at end of period................................ - - - ------- ------- -------TOTAL COMMON SHAREHOLDER'S EQUITY........................... $17,379 $15,606 $14,661 ======= ======= =======COMPREHENSIVE INCOMENet income.................................................. $ 903 $ 743 $ 246Other comprehensive income.................................. 123 222 52 ------- ------- -------COMPREHENSIVE INCOME........................................ $ 1,026 $ 965 $ 298 ======= ======= ======= The accompanying notes are an integral part of the consolidated financialstatements. 6 CONSOLIDATED STATEMENT OF CASH FLOWS SIX MONTHS MARCH 29 JANUARY 1 ENDED THROUGH THROUGH JUNE 30, JUNE 30, MARCH 28, 2004 2003 2003------------------------------------------------------------------------------------------------------- (SUCCESSOR) (SUCCESSOR) (PREDECESSOR) (RESTATED) (RESTATED) (IN MILLIONS)CASH FLOWS FROM OPERATING ACTIVITIESNet income.................................................. $ 903 $ 743 $ 246Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for credit losses............................... 1,925 1,073 976 Insurance policy and claim reserves....................... (69) (94) 47 Depreciation and amortization............................. 253 121 53 Net change in interest-only strip receivables............. 288 180 30 Net change in other assets................................ (315) (208) (593) Net change in other liabilities........................... (289) (357) 616 Other, net................................................ (541) 919 84 ---------- ---------- ---------Net cash provided by (used in) operating activities......... 2,155 2,377 1,459 ---------- ---------- ---------CASH FLOWS FROM INVESTING ACTIVITIESSecurities: Purchased................................................. (971) (1,269) (1,047) Matured................................................... 1,078 661 584 Sold...................................................... 497 235 768Net change in short-term securities available for sale...... 3,526 1,556 (375)Receivables: Originations, net of collections.......................... (26,068) (12,869) (8,255) Purchases and related premiums............................ (542) (1,832) (129) Initial and fill-up securitizations....................... 16,719 9,156 7,300 Sales to affiliates....................................... 856 - -Properties and equipment: Purchases................................................. (32) (28) (21) Sales..................................................... 1 2 - ---------- ---------- ---------Net cash provided by (used in) investing activities......... (4,936) (4,388) (1,175) ---------- ---------- ---------CASH FLOWS FROM FINANCING ACTIVITIESDebt: Net change in short-term debt and deposits................ 1,105 1,978 (514) Net change in time certificates........................... (155) 194 150 Net change in debt due to affiliates...................... 1,122 3,296 - Long term debt issued..................................... 7,630 991 4,361 Long term debt retired.................................... (7,316) (4,563) (4,030)Insurance: Policyholders' benefits paid.............................. (89) (64) (36) Cash received from policyholders.......................... 121 92 33Shareholders' dividends..................................... - (311) (141)Redemption of preferred stock............................... - - (114)Purchase of treasury stock.................................. - - (164)Issuance of common stock for employee benefit plans......... - - 62 ---------- ---------- ---------Net cash provided by (used in) financing activities......... 2,418 1,613 (393) ---------- ---------- ---------Effect of exchange rate changes on cash..................... 10 32 (15) ---------- ---------- ---------Net change in cash.......................................... (353) (366) (124)Cash at beginning of period................................. 463 674 798 ---------- ---------- ---------CASH AT END OF PERIOD....................................... $ 110 $ 308 $ 674 ========== ========== ========= The accompanying notes are an integral part of the consolidated financialstatements. 7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND BASIS OF PRESENTATION-------------------------------------------------------------------------------- The accompanying unaudited interim consolidated financial statements ofHousehold International, Inc. and its subsidiaries (collectively, "Household")have been prepared in accordance with accounting principles generally acceptedin the United States of America ("U.S. GAAP") for interim financial informationand with the instructions to Form 10-Q and Article 10 of Regulation S-X.Accordingly, they do not include all of the information and footnotes requiredby generally accepted accounting principles for complete financial statements.In the opinion of management, all normal and recurring adjustments considerednecessary for a fair presentation of financial position, results of operationsand cash flows for the interim periods have been made. Household may also bereferred to in this Form 10-Q/A as "we," "us" or "our." These unaudited interimconsolidated financial statements should be read in conjunction with the 2003financial information included in our Annual Report on Form 10-K for the yearended December 31, 2004 (the "2004 Form 10-K"). Household International, Inc. is an indirect wholly owned subsidiary of HSBCHoldings plc ("HSBC"). Household was acquired by HSBC on March 28, 2003 in apurchase business combination recorded under the "push-down" method ofaccounting, which resulted in a new basis of accounting for the "successor"period beginning March 29, 2003. Information relating to all "predecessor"periods prior to the acquisition is presented using our historical basis ofaccounting, which impacts comparability to our successor period. The preparation of financial statements in conformity with U.S. GAAP requiresthe use of estimates and assumptions that affect reported amounts anddisclosures. Actual results could differ from those estimates. Interim resultsshould not be considered indicative of results in future periods. Interim financial statement disclosures required by U.S. GAAP regarding segmentsare included in the Management's Discussion and Analysis of Financial Conditionand Results of Operations ("MD&A") section of this Form 10-Q/A. Certain reclassifications have been made to prior period amounts to conform tothe current period presentation. Immaterial adjustments have been made todecrease finance income and increase securitization revenue as reported in priorperiods. These adjustments reflect corrections after discovery of a systemprogramming error in the posting of finance income between owned receivables andreceivables serviced with limited recourse. Reported net income for all priorperiods was not affected by these adjustments. 2. RESTATEMENT-------------------------------------------------------------------------------- We have restated our consolidated financial statements for the previouslyreported period March 29, 2003 through December 31, 2003, the previouslyreported quarterly period ended March 31, 2004 and the three and six monthperiods ended June 30, 2004. This amended Quarterly Report on Form 10-Q/A andthe exhibits included herewith include all adjustments relating to therestatement for the periods covered by this report. During the fourth quarter of 2004, as part of our preparation for theimplementation of International Financial Reporting Standards ("IFRS") by HSBCfrom January 1, 2005, we undertook a review of our hedging activities to confirmconformity with the accounting requirements of IFRS, which differ in severalrespects from the hedge accounting requirements under U.S. GAAP as set out inStatement of Financial Accounting Standards No. 133, "Accounting for DerivativeInstruments and Hedging Activities," ("SFAS 133"). As a result of this review,management determined that there were some deficiencies in the documentationrequired to support hedge accounting under U.S. GAAP. These documentationdeficiencies arose following our acquisition by HSBC. As a consequence of theacquisition, pre-existing hedging relationships, including hedging relationshipsthat had previously qualified under the "shortcut" method of accounting pursuantto SFAS 133, were required to be reestablished. At that time there was somedebate in the accounting profession regarding the detailed technicalrequirements resulting from a 8 business combination. We consulted with our independent accountants, KPMG LLP,in reaching a determination of what was required in order to comply with SFAS133. Following this, we took the actions we believed were necessary to maintainhedge accounting for all of our historical hedging relationships in ourconsolidated financial statements for the period ended December 31, 2003 andthose consolidated financial statements received an unqualified audit opinion. Management, having determined during the fourth quarter of 2004 that there werecertain documentation deficiencies, engaged independent expert consultants toadvise on the continuing effectiveness of the identified hedging relationships.As a result of this assessment, we concluded that a substantial number of ourhedges met the correlation effectiveness requirements of SFAS 133 throughout theperiod following our acquisition by HSBC. However, we also determined inconjunction with KPMG LLP that, although a substantial number of the impactedhedges satisfied the correlation effectiveness requirement of SFAS 133, therewere technical deficiencies in the documentation that could not be correctedretroactively or disregarded notwithstanding the proven effectiveness of thehedging relationships in place and, consequently, that the requirements of SFAS133 were not met and that hedge accounting was not appropriate during the periodthese documentation deficiencies existed. We have therefore determined that weshould restate all the reported periods since our acquisition by HSBC toeliminate hedge accounting on all hedging relationships outstanding at March 29,2003 and certain fair value swaps entered into after that date. This wasaccomplished primarily by reclassifying the mark to market of the changes infair market value of the affected derivative financial instruments previouslyclassified in either debt or other comprehensive income into current periodearnings. The period to period changes in the fair value of these derivative financialinstruments have been recognized as either an increase or decrease in ourcurrent period earnings through derivative income. As part of the restatementprocess, we have reclassified all previous hedging results reflected in interestexpense associated with the affected derivative financial instruments toderivative income. Our independent registered public accounting firm hasreviewed the June 30, 2004 financial results and has provided us a review reportunder Statement on Auditing Standards No. 100, which review report is attachedto this amended Quarterly Report on Form 10-Q/A as Exhibit 99.2. The restatement effect on our pre-tax income and net income is summarized below: RESTATEMENTS TO REPORTED INCOME ---------------------------------------------- % CHANGE PRE-TAX TAX EFFECT AFTER-TAX TO REPORTED----------------------------------------------------------------------------------------------------- (IN MILLIONS)March 29, 2003 through June 30, 2003................. $582 $ (212) $370 99.2%Six months ended June 30, 2004....................... 42 (15) 27 3.1Quarter ended June 30, 2003.......................... 370 (135) 235 64.6Quarter ended June 30, 2004.......................... 59 (21) 38 9.6 9 A detailed summary of the impact of the restatement on our consolidatedstatement of income and on our consolidated balance sheet is as follows: QUARTER ENDED QUARTER ENDED SIX MONTHS ENDED MARCH 29, 2003 JUNE 30, 2004 JUNE 30, 2003 JUNE 30, 2004 THROUGH JUNE 30, 2003 --------------------- --------------------- --------------------- --------------------- AS AS AS AS PREVIOUSLY AS PREVIOUSLY AS PREVIOUSLY AS PREVIOUSLY AS REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED--------------------------------------------------------------------------------------------------------------------- (IN MILLIONS)Consolidated Statement of Income: Net interest income........... $1,998* $1,930 $1,943* $1,814 $3,889* $3,750 $2,003* $1,870 Other revenues...... 926* 1,052 893* 1,391 2,095* 2,275 922* 1,636 Income before income tax expense...... 605 664 549 919 1,327 1,369 563 1,145 Income tax expense.......... 210 231 185 320 451 466 190 402 Net income.......... 395 433 364 599 876 903 373 743 AT JUNE 30, 2004 AT DECEMBER 31, 2003 --------------------- --------------------- AS AS PREVIOUSLY AS PREVIOUSLY AS REPORTED RESTATED REPORTED RESTATED------------------------------------------------------------------------------------------------------ (IN MILLIONS)Consolidated Balance Sheet: Derivative financial assets.......................... $ 2,178 $ 2,158 $ 3,118 $ 3,016 Long-term debt....................................... 77,807 78,271 79,464 79,632 Derivative related liabilities....................... 481 354 600 597 Other liabilities.................................... 3,174 3,045 3,228 3,131 Common shareholder's equity.......................... 17,607 17,379 16,561 16,391 --------------- * Certain reclassifications have been made to prior period amounts to conform to the current year presentation. The resulting accounting does not reflect the economic reality of our hedgingactivity and has no impact on the timing or amount of operating cash flows orcash flows under any debt or derivative contract. It does not affect our abilityto make required payments on our outstanding debt obligations. Furthermore, oureconomic risk management strategies have not required amendment. 10 3. SECURITIES-------------------------------------------------------------------------------- Securities consisted of the following available-for-sale investments: GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIRJUNE 30, 2004 COST GAINS LOSSES VALUE--------------------------------------------------------------------------------------------------- (IN MILLIONS)Corporate debt securities............................ $2,499 $7 $(39) $2,467Money market funds................................... 815 - - 815Time deposits........................................ 60 - - 60U.S. government and federal agency debt securities... 2,521 - (7) 2,514Non-government mortgage backed securities............ 84 - - 84Other................................................ 945 - (6) 939 ------ -- ---- ------Subtotal............................................. 6,924 7 (52) 6,879Accrued investment income............................ 44 - - 44 ------ -- ---- ------Total securities available for sale.................. $6,968 $7 $(52) $6,923 ====== == ==== ====== GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIRDECEMBER 31, 2003 COST GAINS LOSSES VALUE--------------------------------------------------------------------------------------------------- (IN MILLIONS)Corporate debt securities........................... $ 5,641 $11 $ - $ 5,652Money market funds.................................. 794 - - 794Time deposits....................................... 952 - - 952U.S. government and federal agency debt securities........................................ 2,430 - (2) 2,428Marketable equity securities........................ 14 4 - 18Non-government mortgage backed securities........... 389 - - 389Other............................................... 794 2 - 796 ------- --- --- -------Subtotal............................................ 11,014 17 (2) 11,029Accrued investment income........................... 44 - - 44 ------- --- --- -------Total securities available for sale................. $11,058 $17 $(2) $11,073 ======= === === ======= A summary of gross unrealized losses and related fair values as of June 30,2004, classified as to the length of time the losses have existed follows: LESS THAN ONE YEAR GREATER THAN ONE YEAR --------------------------------------- --------------------------------------- GROSS AGGREGATE GROSS AGGREGATE NUMBER OF UNREALIZED FAIR VALUE OF NUMBER OF UNREALIZED FAIR VALUE OFJUNE 30, 2004 SECURITIES LOSSES INVESTMENTS SECURITIES LOSSES INVESTMENTS------------------------------------------------------------------------------------------------------------------ (IN MILLIONS)Corporate debt securities...... 550 $(38) $1,714 20 $(1) $17Time deposits.................. 8 - 31 - - -U.S. government and federal agency debt securities....... 78 (6) 374 18 (1) 56Non-government mortgage backed securities................... 8 - 20 - - -Other.......................... 76 (6) 339 - - - Gross unrealized losses on our securities available for sale have increasedduring the first half of 2004 due to a general increase in interest rates. Sincesubstantially all of these securities are rated A- or better, no permanentimpairment is expected to be realized. 11 The amortized cost of our securities available for sale was adjusted to fairmarket value at the time of the merger with HSBC. As a result, at December 31,2003 gross unrealized losses had existed less than one year. 4. RECEIVABLES-------------------------------------------------------------------------------- Receivables consisted of the following: JUNE 30, DECEMBER 31, 2004 2003------------------------------------------------------------------------------------- (IN MILLIONS)Real estate secured......................................... $ 56,033 $ 51,221Auto finance................................................ 5,459 4,138MasterCard(1)/Visa(1)....................................... 10,816 11,182Private label............................................... 12,759 12,604Personal non-credit card.................................... 14,019 12,832Commercial and other........................................ 346 401 -------- --------Total owned receivables..................................... 99,432 92,378Purchase accounting fair value adjustments.................. 323 419Accrued finance charges..................................... 1,409 1,432Credit loss reserve for owned receivables................... (3,795) (3,793)Unearned credit insurance premiums and claims reserves...... (644) (703)Interest-only strip receivables............................. 794 1,036Amounts due and deferred from receivable sales.............. 120 258 -------- --------Total owned receivables, net................................ 97,639 91,027Receivables serviced with limited recourse.................. 22,836 26,201 -------- --------Total managed receivables, net.............................. $120,475 $117,228 ======== ======== --------------- (1) MasterCard is a registered trademark of MasterCard International, Incorporated and Visa is a registered trademark of VISA USA, Inc. Purchase accounting fair value adjustments represent adjustments which have been"pushed down" to record our receivables at fair value at the date of acquisitionby HSBC. Interest-only strip receivables are reported net of our estimate of probablelosses under the recourse provisions for receivables serviced with limitedrecourse. Our estimate of the recourse obligation totaled $1.9 billion at June30, 2004 and $2.4 billion at December 31, 2003. Interest-only strip receivablesalso included fair value mark-to-market adjustments which increased the balanceby $302 million at June 30, 2004 and $257 million at December 31, 2003. Receivables serviced with limited recourse consisted of the following: JUNE 30, DECEMBER 31, 2004 2003-------------------------------------------------------------------------------------- (IN MILLIONS)Real estate secured......................................... $ 176 $ 194Auto finance................................................ 3,877 4,675MasterCard/Visa............................................. 9,345 9,967Private label............................................... 4,723 5,261Personal non-credit card.................................... 4,715 6,104 --------- ---------Total....................................................... $ 22,836 $ 26,201 ========= ========= 12 The combination of receivables owned and receivables serviced with limitedrecourse, which comprises our managed portfolio, is shown below: JUNE 30, DECEMBER 31, 2004 2003--------------------------------------------------------------------------------------- (IN MILLIONS)Real estate secured......................................... $ 56,209 $ 51,415Auto finance................................................ 9,336 8,813MasterCard/Visa............................................. 20,161 21,149Private label............................................... 17,482 17,865Personal non-credit card.................................... 18,734 18,936Commercial and other........................................ 346 401 ---------- ----------Total....................................................... $ 122,268 $ 118,579 ========== ========== 5. CREDIT LOSS RESERVES-------------------------------------------------------------------------------- An analysis of credit loss reserves was as follows: THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------------------------------------- 2004 2003 2004 2003------------------------------------------------------------------------------------------------ (IN MILLIONS)Owned receivables: Credit loss reserves at beginning of period........... $ 3,753 $3,483 $ 3,793 $ 3,333 Provision for credit losses........................... 997 1,039 1,925 2,049 Charge-offs........................................... (1,057) (997) (2,108) (1,932) Recoveries............................................ 92 66 172 127 Other, net............................................ 10 68 13 82 ------- ------ ------- ------- Credit loss reserves for owned receivables............ 3,795 3,659 3,795 3,659 ------- ------ ------- -------Receivables serviced with limited recourse: Credit loss reserves at beginning of period........... 2,159 1,776 2,374 1,760 Provision for credit losses........................... 148 617 401 1,024 Charge-offs........................................... (426) (436) (925) (855) Recoveries............................................ 24 24 52 44 Other, net............................................ (1) (1) 2 7 ------- ------ ------- ------- Credit loss reserves for receivables serviced with limited recourse................................... 1,904 1,980 1,904 1,980 ------- ------ ------- -------Credit loss reserves for managed receivables............ $ 5,699 $5,639 $ 5,699 $ 5,639 ======= ====== ======= ======= We maintain credit loss reserves to cover probable losses of principal, interestand fees, including late, overlimit and annual fees. Credit loss reserves arebased on a range of estimates and are intended to be adequate but not excessive.We estimate probable losses of owned consumer receivables using a roll ratemigration analysis that estimates the likelihood that a loan will progressthrough the various stages of delinquency, or buckets, and ultimately chargeoff. This analysis considers delinquency status, loss experience and severityand takes into account whether loans are in bankruptcy, have been restructuredor rewritten, or are subject to forbearance, an external debt management plan,hardship, modification, extension or deferment. Our credit loss reserves alsotake into consideration the loss severity expected based on the underlyingcollateral, if any, for the loan in the event of default. Delinquency status maybe affected by customer account management policies and practices, such as therestructure of accounts, forbearance agreements, extended payment plans,modification arrangements, consumer credit counseling 13 accommodations, loan rewrites and deferments. When customer account managementpolicies, or changes thereto, shift loans from a "higher" delinquency bucket toa "lower" delinquency bucket, this is reflected in our roll rate statistics. Tothe extent that restructured accounts have a greater propensity to roll tohigher delinquency buckets, this is captured in the roll rates. Since the lossreserve is computed based on the composite of all of these calculations, thisincrease in roll rate is applied to receivables in all respective delinquencybuckets, which increases the overall reserve level. In addition, loss reserveson consumer receivables are maintained to reflect our judgment of portfolio riskfactors that may not be fully reflected in the statistical roll ratecalculation. Risk factors considered in establishing overall loss reserves onconsumer receivables include recent growth, product mix, bankruptcy trends,geographic concentrations, economic conditions, portfolio seasoning, accountmanagement policies and practices and current levels of charge-offs anddelinquencies. While our credit loss reserves are available to absorb losses in the entireportfolio, we specifically consider the credit quality and other risk factorsfor each of our products. We recognize the different inherent losscharacteristics in each of our products as well as customer account managementpolicies and practices and risk management/collection practices. Charge-offpolicies are also considered when establishing loss reserve requirements toensure the appropriate reserves exist for products with longer charge-offperiods. We also consider key ratios such as reserves to nonperforming loans andreserves as a percent of net charge-offs in developing our loss reserveestimates. Loss reserve estimates are reviewed periodically and adjustments arereported in earnings when they become known. As these estimates are influencedby factors outside of our control, such as consumer payment patterns andeconomic conditions, there is uncertainty inherent in these estimates, making itreasonably possible that they could change. 6. INTANGIBLE ASSETS-------------------------------------------------------------------------------- Intangible assets consisted of the following: ACCUMULATED CARRYINGJUNE 30, 2004 GROSS AMORTIZATION VALUE------------------------------------------------------------------------------------------------ (IN MILLIONS)Purchased credit card relationships and related programs.... $ 1,517 $ 244 $ 1,273Retail services merchant relationships...................... 270 68 202Other loan related relationships............................ 326 53 273Trade names................................................. 717 - 717Technology, customer lists and other contracts.............. 281 78 203 -------- ------ --------Intangible assets........................................... $ 3,111 $ 443 $ 2,668 ======== ====== ======== ACCUMULATED CARRYINGDECEMBER 31, 2003 GROSS AMORTIZATION VALUE------------------------------------------------------------------------------------------------ (IN MILLIONS)Purchased credit card relationships and related programs.... $ 1,512 $ 149 $ 1,363Retail services merchant relationships...................... 270 41 229Other loan related relationships............................ 326 34 292Trade names................................................. 717 - 717Technology, customer lists and other contracts.............. 281 26 255 -------- ------ --------Intangible assets........................................... $ 3,106 $ 250 $ 2,856 ======== ====== ======== 14 Estimated amortization expense associated with our intangible assets for each ofthe following years is as follows: YEAR ENDING DECEMBER 31, (IN MILLIONS)2004........................................................ $ 3562005........................................................ 3352006........................................................ 3272007........................................................ 3102008........................................................ 215 7. GOODWILL-------------------------------------------------------------------------------- Goodwill balances associated with our foreign businesses will change from periodRelated Shares:
HSBC Holdings