28th Feb 2005 11:30
HSBC Holdings PLC28 February 2005 Part 2 HSBC Finance Corporation--------------------------------------------------------------------------------We converted approximately $520 million of personal non-credit card loans into real estate secured loans in 2004 and $350 million in 2003. It is not our practice to rewrite or reclassify delinquent secured loans (real estate or auto) into personal non-credit card loans. RESULTS OF OPERATIONS-------------------------------------------------------------------------------- Unless noted otherwise, the following discusses amounts reported in our ownedbasis statement of income. NET INTEREST INCOME The following table summarizes net interest income: YEAR ENDED DECEMBER 31, 2004 2003 2002------------------------------------------------------------------------------------------ RESTATED (DOLLARS ARE IN MILLIONS)Finance and other interest income........................... $10,945 $10,242 $10,525Interest expense............................................ 3,143 2,928 3,871 ------- ------- -------Net interest income......................................... $ 7,802 $ 7,314 $ 6,654 ======= ======= =======Net interest margin......................................... 7.33% 7.75% 7.57% ======= ======= ======= The increase in net interest income during 2004 was due to higher averagereceivables partially offset by lower yields on our receivables, particularlyreal estate secured, auto finance and personal non-credit card receivables andhigher interest expense. The lower yields in 2004 reflect strong receivable andrefinancing growth which has occurred in an economic cycle with historically lowmarket rates, high liquidation of older, higher yielding loans, productexpansion into near-prime customer segments and competitive pricing pressuresdue to excess market capacity. All of these factors contributed to a decrease inoverall loan yields. The higher interest expense experienced in 2004 was due toa larger balance sheet partially offset by a lower cost of funds. Our purchaseaccounting fair value adjustments include both amortization of fair valueadjustments to our external debt obligations and receivables. Amortization ofpurchase accounting fair value adjustments increased net interest income by $697million in 2004 and $570 million in 2003. The increase in net interest income during 2003 was attributable to higheraverage receivables and lower cost of funds including the amortization ofpurchase accounting fair value adjustments, partially offset by lower yields onour receivables due to reduced pricing and the amortization of purchaseaccounting fair value adjustments. Net interest margin was 7.33 percent in 2004, 7.75 percent in 2003 and 7.57percent in 2002. As discussed above, lower yields on certain products drove thedecrease in 2004, partially offset by lower funding costs on our debt. Theincrease in 2003 was attributable to a lower cost of funds, including theamortization of purchase accounting fair value adjustments applied to ourexternal debt obligations, partially offset by lower yields on our receivables,particularly real estate secured, due to reduced pricing and the amortization ofpurchase accounting fair value adjustments to our receivables. Our net interest margin on an owned basis was impacted by the loss of hedgeaccounting on the hedging relationships at the time of merger. The loss of hedgeaccounting on the impacted hedging relationships reduced net interest income by$236 million in 2004 and $307 million in 2003. The following table compares ourreported net interest margin to what it otherwise would have been if hedgeaccounting had not been lost: WITHOUT LOSS OF AS HEDGE REPORTED ACCOUNTING*------------------------------------------------------------------------------------2004........................................................ 7.33% 7.55%2003........................................................ 7.75 8.082002........................................................ 7.57 7.57 --------------- * Represents a non-GAAP financial measure which is being provided for comparison of our trends and should be read in conjunction with our reported results. 40 HSBC Finance Corporation-------------------------------------------------------------------------------- Our net interest income on a managed basis includes finance income earned on ourowned receivables as well as on our securitized receivables. This finance incomeis offset by interest expense on the debt recorded on our balance sheet as wellas the contractual rate of return on the instruments issued to investors whenthe receivables were securitized. Managed basis net interest income was $10.3billion in 2004, $10.2 billion in 2003 and $9.3 billion in 2002. Managed basisnet interest margin was 7.97 percent in 2004 compared to 8.60 percent in 2003and 8.47 percent in 2002. The decrease in net interest margin in 2004 was due tolower yields on our receivables, partially offset by lower funding costs on ourdebt as discussed above. Lower funding costs and the impact of the previouslydiscussed amortization of purchase accounting adjustments were the primarydrivers of the increase in net interest margin in 2003. Net interest margin isgreater than on an owned basis because the managed basis portfolio includes moreunsecured loans which have higher yields. Our net interest margin on a managed basis was impacted by the loss of hedgeaccounting as discussed above. The following table compares our reported netinterest margin to what it otherwise would have been had hedge accounting notbeen lost: WITHOUT LOSS OF AS HEDGE REPORTED ACCOUNTING*------------------------------------------------------------------------------------2004........................................................ 7.97% 8.15%2003........................................................ 8.60 8.862002........................................................ 8.47 8.47 --------------- * Represents a non-GAAP financial measure which is being provided for comparison of our trends and should be read in conjunction with our reported results. Our interest earning assets expose us to interest rate risk. We try to managethis risk by borrowing money with similar interest rate and maturity profiles;however, there are instances when this cannot be achieved. When the variousrisks inherent in both the asset and the debt to do not meet our desired riskprofile, we use derivative financial instruments to manage these risks toacceptable interest rate risk levels. See "Risk Management" for additionalinformation regarding interest rate risk and derivative financial instruments. See the "Net Interest Margin" tables and "Reconciliation to GAAP FinancialMeasures" for additional information regarding our owned basis and managed basisnet interest income. PROVISION FOR CREDIT LOSSES The provision for credit losses includes currentperiod net credit losses and an amount which we believe is sufficient tomaintain reserves for losses of principal, interest and fees, including late,overlimit and annual fees, at a level that reflects known and inherent losses inthe portfolio. Growth in receivables and portfolio seasoning ultimately resultin higher provision for credit losses. The provision for credit losses may alsovary from year to year depending on a variety of additional factors includingproduct mix and the credit quality of the loans in our portfolio, historicaldelinquency roll rates, customer account management, risk management/collectionpolicies related to our loan products, economic conditions and our productvintage analysis. The following table summarizes provision for owned credit losses: YEAR ENDED DECEMBER 31, 2004 2003 2002--------------------------------------------------------------------------------------Provision for credit losses................................. $4,334 $3,967 $3,732 Our provision for credit losses increased in 2004 compared to 2003. The adoptionof FFIEC charge-off policies for our domestic private label and MasterCard/Visaportfolios resulted in a $38 million increase to loss provision in the fourthquarter of 2004 as the incremental charge-off of $158 million associated withthese products was partially offset by the release of $120 million in existingcredit loss reserves. In 2004, we recorded credit loss provision greater thannet charge-offs of $301 million. Excluding the impact of the adoption of FFIECcharge-off policies as previously discussed, credit loss provision was $421million greater than net 41 HSBC Finance Corporation-------------------------------------------------------------------------------- charge-offs. Our credit loss provision increased in 2004 due to receivablegrowth, including lower securitization levels, partially offset by improvingasset quality. Net charge-off dollars for 2004 increased $446 million ($288million excluding FFIEC) compared to 2003 as higher delinquencies due to adverseeconomic conditions which existed in 2003 migrated to charge-off in 2004, whichwas partially offset by an overall improvement in asset quality during 2004.Owned loss provision was greater than charge-offs by $380 million in 2003 and$603 million in 2002. Receivable growth, increases in personal bankruptcyfilings and the weak economy contributed to the increase in provision dollars in2003. The provision as a percent of average owned receivables was 4.28 percent in2004, 4.45 percent in 2003 and 4.52 percent in 2002. Excluding the impact ofadopting FFIEC charge-off policies as described above, the provision as apercentage of average owned receivables in 2004 would have been lower by 4 basispoints. The decrease in 2004 reflects receivable growth and improved creditquality. The decrease in 2003 reflects lower additions to loss reserves as aresult of improving charge-offs in the latter half of 2003. See "Critical Accounting Policies," "Credit Quality," "Analysis of Credit LossReserves Activity" and "Reconciliations to GAAP Financial Measures" foradditional information regarding our owned basis and managed basis loss reservesand the adoption of FFIEC policies. See Note 8, "Credit Loss Reserves" in theaccompanying consolidated financial statements for additional analysis of theowned basis and managed basis loss reserves. OTHER REVENUES The following table summarizes other revenues: YEAR ENDED DECEMBER 31, 2004 2003 2002---------------------------------------------------------------------------------------- RESTATED (IN MILLIONS)Securitization revenue...................................... $1,008 $1,461 $2,134Insurance revenue........................................... 839 746 716Investment income........................................... 137 196 182Derivative income........................................... 511 286 3Fee income.................................................. 1,091 1,064 948Taxpayer financial services income.......................... 217 185 240Other income................................................ 607 381 301Gain on bulk sale of private label receivables.............. 663 - -Loss on disposition of Thrift assets and deposits........... - - (378) ------ ------ ------Total other revenues........................................ $5,073 $4,319 $4,146 ====== ====== ====== SECURITIZATION REVENUE is the result of the securitization of our receivablesand includes the following: YEAR ENDED DECEMBER 31, 2004 2003 2002-------------------------------------------------------------------------------------- (IN MILLIONS)Net initial gains(1)........................................ $ 25 $ 176 $ 322Net replenishment gains(1).................................. 414 548 523Servicing revenue and excess spread......................... 569 737 1,289 ------ ------ ------Total....................................................... $1,008 $1,461 $2,134 ====== ====== ====== --------------- (1) Net of our estimate of probable credit losses under the recourse provisions The decrease in securitization revenue in 2004 was due to lower levels andchanges in the product mix of receivables securitized during the year, includingthe impact of higher receivables run-off and the shorter expected lives ofsecuritization trusts as a result of our decision in the third quarter of 2004to structure all new collateralized funding transactions as secured financings.However, because existing public MasterCard and Visa credit card transactionswere structured as sales to revolving trusts that require replenishments of 42 HSBC Finance Corporation-------------------------------------------------------------------------------- receivables to support previously issued securities, receivables will continueto be sold to these trusts until the revolving periods end, the last of which isexpected to occur in early 2008 based on current projections. Private labeltrusts that publicly issued securities will now be replenished by HSBC Bank USAas a result of the daily sales of new domestic private label originations toHSBC Bank USA. We will continue to replenish at reduced levels, certainnon-public personal non-credit card and MasterCard and Visa securities issued toconduits and record the resulting replenishment gains for a period of time inorder to manage liquidity. Since our securitized receivables have varying lives,it will take several years for these receivables to pay-off and the relatedinterest-only strip receivables to be reduced to zero. While the termination ofsale treatment on new collateralized funding activity and the reduction of salesunder replenishment agreements reduced our reported net income under U.S. GAAP,there was no impact on cash received from operations or on U.K. GAAP reportedresults. The decrease in securitization revenue in 2003 was due to decreases in the levelof initial securitizations during the year as a result of the use of alternativefunding sources, including funding from HSBC subsidiaries and clients, lowerexcess spread especially at auto finance due to higher loss estimates as aresult of certain vintages performing worse than expected and the amortizationof purchase accounting fair value adjustments on our interest-only stripreceivables. Our interest-only strip receivables, net of the related loss reserve andexcluding the mark-to-market adjustment recorded in accumulated othercomprehensive income and, in 2004, the private label portion purchased by HSBCBank USA, decreased $466 million in 2004 and $430 million in 2003. See Note 2, "Summary of Significant Accounting Policies," and Note 9, "AssetSecuritizations," to the accompanying consolidated financial statements, and"Critical Accounting Policies" and "Off Balance Sheet Arrangements and SecuredFinancings" for further information on asset securitizations. Insurance revenue increased in 2004 due to increased sales in our U.K. businesspartially offset by slightly lower revenue from our domestic operations due tothe continued run off of insurance products discontinued in prior years. Theincrease in insurance revenue in 2003 was also due to increased sales in ourU.K. business partially offset by decreased sales in our domestic portfolio as aresult of decreased originations in our branches in the first half of 2003 aswell as a general decline in the percentage of customers who purchase insurance. Investment income, which includes income on securities available for sale in ourinsurance business and realized gains and losses from the sale of securities,decreased in 2004 as a result of decreases in income due to lower yields onlower average balances, lower gains from security sales and reduced amortizationof purchase accounting fair value adjustments. In 2003, higher realized gains onsecurity sales were partially offset by lower yields including the impact of theamortization of purchase accounting fair value adjustments. Derivative income, which includes realized and unrealized gains and losses onderivatives which do not qualify as effective hedges under SFAS 133 as well asthe ineffectiveness on derivatives associated with our qualifying hedges issummarized in the table below: 2004 2003 2002 ---- ---- ---- (IN MILLIONS)Net realized gains (losses)................................. $ 68 $ 54 $-Net unrealized gains (losses)............................... 442 230 -Ineffectiveness............................................. 1 2 3 ---- ---- --Total $511 $286 $3 ==== ==== == Derivative income increased in 2004 due to an increasing interest rateenvironment and a weakening of the U.S. dollar which caused our currency swapsand pay fixed interest rate swaps, which do not qualify for hedge accountingunder SFAS 133, to increase in value. These derivatives remain economic hedgesof the underlying debt instruments. The increase in derivative income in 2003reflects the loss of hedge accounting for all pre-existing hedging relationshipsfollowing our acquisition by HSBC, including those that had previously qualifiedfor shortcut accounting under SFAS 133 prior to the merger. 43 HSBC Finance Corporation-------------------------------------------------------------------------------- Fee income, which includes revenues from fee-based products such as creditcards, increased in 2004 and 2003 due to higher credit card fees, particularlyrelating to our subprime credit card portfolio. For 2004, the higher credit cardfees were partially offset by higher payments to merchant partners as a resultof portfolio acquisitions in our retail services business. See Note 23,"Business Segments," to the accompanying consolidated financial statements foradditional information on fee income on a managed basis. Taxpayer financial services ("TFS") income increased in 2004 primarily due tolower funding costs as a result of our acquisition by HSBC. The decrease in TFSincome in 2003 was a result of higher funding costs, participation payments andcredit losses. Other income increased in 2004 and 2003. The increase in 2004 was due to higherancillary credit card revenue, higher income associated with affiliatetransactions and higher gains on miscellaneous asset sales, including thepartial sale of a real estate investment. In 2003, the increase was due tohigher loan sale revenue from our mortgage operations. Gain on bulk sale of private label receivables resulted from the sale of $12.2billion of domestic private label receivables ($15.6 billion on a managed basis)including the retained interests associated with securitized private labelreceivables to HSBC Bank USA in December 2004. See Note 5, "Sale of DomesticPrivate Label Receivable Portfolio and Adoption of FFIEC Policies," to theaccompanying consolidated financial statements for further information. Loss on disposition of Thrift assets and deposits resulted from the dispositionof substantially all of the remaining assets and deposits of the Thrift in thefourth quarter of 2002. COSTS AND EXPENSES Effective January 1, 2004, our technology services employeeswere transferred to HSBC Technology and Services (USA) Inc. ("HTSU"). As aresult, operating expenses relating to information technology as well as certainitem processing and statement processing activities, which have previously beenreported as salaries and fringe benefits, occupancy and equipment expenses, orother servicing and administrative expenses, are now billed to us by HTSU andreported as support services from HSBC affiliates. Support services from HSBCaffiliates also include banking services and other miscellaneous servicesprovided by HSBC Bank USA and other subsidiaries of HSBC. The following table summarizes total costs and expenses: YEAR ENDED DECEMBER 31, 2004 2003 2002-------------------------------------------------------------------------------------- (IN MILLIONS)Salaries and employee benefits.............................. $1,886 $1,998 $1,817Sales incentives............................................ 363 263 256Occupancy and equipment expenses............................ 323 400 371Other marketing expenses.................................... 636 548 531Other servicing and administrative expenses................. 868 1,149 889Support services from HSBC affiliates....................... 750 - -Amortization of intangibles................................. 363 258 58Policyholders' benefits..................................... 412 377 368Settlement charge and related expenses...................... - - 525HSBC acquisition related costs incurred by HSBC Finance Corporation............................................... - 198 - ------ ------ ------Total costs and expenses.................................... $5,601 $5,191 $4,815 ====== ====== ====== Salaries and employee benefits decreased in 2004 primarily due to the transferof our technology personnel to HTSU. Excluding this change, salaries and fringebenefits increased $126 million in 2004 as a result of additional staffing tosupport growth, primarily in our consumer lending, mortgage services andinternational 44 HSBC Finance Corporation-------------------------------------------------------------------------------- business units and in our compliance functions. In addition to the above, higheremployee benefit plan expenses also contributed to the increase in 2003. Sales incentives increased in 2004 due to higher volumes in our branches andincreases in our mortgage services business. The increase in 2003 was primarilydue to increases in our mortgage services business, partially offset by lowernew loan volume in our branches and our auto finance business. Occupancy and equipment expenses decreased in 2004 primarily due to theformation of HTSU as discussed above. The increase in 2003 was primarily theresult of higher repairs and occupancy maintenance costs. Other marketing expenses includes payments for advertising, direct mail programsand other marketing expenditures. The increase in 2004 was primarily due toincreased credit card marketing, largely due to changes in contractual marketingresponsibilities associated with the General Motors ("GM") co-branded creditcard. These changes will result in higher marketing expense for the GM Card(R)in the future. The increase in 2003 was primarily due to increased marketinginitiatives in our domestic MasterCard and Visa portfolios. Other servicing and administrative expenses decreased in 2004 primarily due tothe transfer of certain item processing and statement processing services toHTSU. This decrease was partially offset by higher systems and credit bureaucosts due to growth, higher insurance commissions and costs associated with therebranding. Higher collection, legal, compliance and REO expenses as well asreceivable growth contributed to the increase in 2003. Support services from HSBC affiliates primarily include technology and otherservices charged to us by HTSU since its inception on January 1, 2004. Amortization of intangibles increased in 2004 and 2003 due to the higheramortization of intangibles established in conjunction with the HSBC merger onMarch 28, 2003. Due to the timing of the merger, there were nine months ofamortization expense in 2003 compared with a full year of amortization expensein 2004. Policyholders' benefits increased in both 2004 and 2003 due to higher sales inour U.K. business and higher amortization of fair value adjustments relating toour insurance business, partially offset by lower expenses in our domesticbusiness. HSBC acquisition related costs incurred by HSBC Finance Corporation in the firstquarter of 2003 include payments to executives under existing employmentcontracts and investment banking, legal and other costs relating to ouracquisition by HSBC. The following table summarizes our owned basis efficiency ratio: YEAR ENDED DECEMBER 31, 2004 2003 2002------------------------------------------------------------------------------------ RESTATEDGAAP basis efficiency ratio................................. 41.6% 42.8% 42.6%Operating basis efficiency ratio(1)......................... 43.4 41.0 36.3 --------------- (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 deterioration in the efficiency ratio on an operating basis for 2004 wasprimarily attributable to an increase in operating expenses, including higherintangible amortization, lower securitization revenue and lower overall yieldson our receivables partially offset by higher derivative income. Thedeterioration in the efficiency ratio on an operating basis in 2003 reflectslower securitization revenue and higher operating expenses, partially offset byhigher net interest income and higher derivative income. 45 HSBC Finance Corporation-------------------------------------------------------------------------------- INCOME TAXES Our effective tax rates were as follows: Year ended December 31, 2004 (successor).................... 34.0%March 29 through December 31, 2003 (successor) (Restated)... 33.7January 1 through March 28, 2003 (predecessor).............. 42.5Year ended December 31, 2002 (predecessor).................. 30.9 The effective tax rate for January 1 through March 28, 2003 was adverselyimpacted by the non-deductibility of certain HSBC acquisition related costs. Thelower effective tax rate in 2002 was largely attributable to lower state andlocal taxes and a reduction in noncurrent tax requirements. 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. Our Credit Card Servicessegment consists of our domestic MasterCard and Visa credit card business. OurInternational segment consists of our foreign operations in the United Kingdom,Canada, the Republic of Ireland, the Czech Republic and Hungary. 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 in our 2003 Form10-K. The accounting policies of the reportable segments are described in Note 2,"Summary of Significant Accounting Policies," to the accompanying financialstatements. For segment reporting purposes, intersegment transactions have notbeen eliminated. We generally account for transactions between segments as ifthey were with third parties. We evaluate performance and allocate resourcesbased on income from operations after income taxes and returns on equity andmanaged assets. We provide information to management, monitor our operations and evaluate trendson a managed basis (a non-GAAP financial measure), which assumes thatsecuritized receivables have not been sold and are still on our balance sheet.We manage and evaluate our operations on a managed basis because the receivablesthat we securitize are subjected to underwriting standards comparable to ourowned portfolio, are serviced by operating personnel without regard to ownershipand result in a similar credit loss exposure for us. In addition, we fund ouroperations, review our operating results, and make decisions about allocatingresources such as employees and capital on a managed basis. When reporting on a managed basis, net interest income, provision for creditlosses and fee income related to receivables securitized are reclassified fromsecuritization revenue in our owned statement of income into the appropriatecaption. 46 HSBC Finance Corporation-------------------------------------------------------------------------------- CONSUMER SEGMENT The following table summarizes results for our Consumersegment: YEAR ENDED DECEMBER 31, 2004 2003 2002----------------------------------------------------------------------------------------- (IN MILLIONS)Net income.................................................. $ 1,563 $ 1,061 $ 838Operating net income........................................ 1,247 1,061 1,411Net interest income......................................... 7,699 7,333 6,976Securitization revenue...................................... (1,433) 337 597Fee and other income, excluding gain on the bulk sale of domestic private label receivables and loss on disposition of Thrift assets and deposits............................. 638 664 644Gain on bulk sale of private label receivables.............. 683 - -Loss on disposition of Thrift assets and deposits........... - - 378Intersegment revenues....................................... 101 107 145Provision for credit losses................................. 2,575 4,275 3,903Settlement charge and related expenses...................... - - 525Total costs and expenses, excluding settlement charge and related expenses.......................................... 2,528 2,358 2,044Receivables................................................. 87,839 87,104 79,448Assets...................................................... 89,809 89,791 82,685Net interest margin......................................... 8.20% 8.59% 8.68%Return on average managed assets............................ 1.64 1.22 1.02 Our Consumer Segment reported higher net income in 2004 and 2003. Operating netincome (a non-GAAP financial measure of net income excluding the gain on thebulk sale of the domestic private label portfolio and the impact of adoption ofFFIEC charge-off policies for our domestic private label portfolio in 2004 andthe settlement charge and related expenses and the Thrift disposition loss in2002) increased in 2004 but decreased in 2003. In 2004, the increase inoperating net income was due to increases in net interest income and decreasesin provision for credit losses which were partially offset by higher operatingexpenses and substantially lower securitization revenue. Net interest incomeincreased primarily due to higher receivable levels. Net interest margin,however, decreased primarily due to faster growth in lower yielding real estatesecured lending, lower yields on real estate secured, auto finance and personalnon-credit card receivables as a result of competitive pressure on pricing, aswell as the run off of higher yielding real estate secured receivables,including second lien loans largely due to refinance activity. Our auto financebusiness experienced lower yields as we have targeted lower yielding but highercredit quality customers. These decreases were partially offset by lower cost offunds. Securitization revenue decreased in 2004 as a result of a significantdecline in receivables securitized, including the impact of higher run-off dueto shorter expected lives as a result of our decision to structure all newcollateralized funding transactions as secured financings beginning in the thirdquarter of 2004. Securitization levels were also lower in 2004 as we usedfunding from HSBC, including proceeds from sales of receivables, to assist inthe funding of our operations. Operating expenses increased in 2004 as theresult of additional operating costs to support the increased receivable levels,including higher salaries and sales incentives. As previously discussed, in December 2004, we adopted FFIEC charge-off policiesfor our domestic private label credit card portfolio which resulted in areduction to net income of $120 million and subsequently sold the portfolio toHSBC Bank USA. We recorded a pre-tax gain of $663 million on the sale. See"Credit Quality" and Note 5, "Sale of Domestic Private Label ReceivablePortfolio and Adoption of FFIEC Policies," to the accompanying consolidatedfinancial statements for further discussion of the adoption of FFIEC charge-offpolicies and the portfolio sale. Our managed basis provision for credit losses, which includes both provision forowned receivables and over-the-life provision for receivables serviced withlimited recourse, decreased in 2004 as a result of 47 HSBC Finance Corporation-------------------------------------------------------------------------------- improving credit quality, changes in securitization levels and a corporateadjustment to decrease owned reserve levels. This was modestly offset by theimpact of adoption of FFIEC charge-off policies which increased managed basisprovision $81 million. We experienced higher dollars of net charge-offs in ourowned portfolio during 2004. This was in part because of the acceleration ofcharge-off upon adoption of FFIEC charge-off policies for our domestic privatelabel portfolio, but also as a result of higher levels of owned receivables andthe higher delinquency levels in 2003 which progressed to charge-off in 2004.Our overall owned provision for credit losses was $57 million lower than netcharge-offs as charge-offs are a lagging indicator of credit quality.Over-the-life provisions for credit losses for securitized receivables recordedin any given period reflect the level and product mix of securitizations in thatperiod. Subsequent charge-offs of such receivables result in a decrease in theover-the-life reserves without any corresponding increase to managed lossprovision. The combination of these factors, including changes in securitizationlevels, resulted in an overall decrease in managed loss reserves as netcharge-offs were greater than the provision for credit losses by $1,229 millionin 2004. In 2003, we increased managed loss reserves by recording provisiongreater than net charge-offs of $768 million. Compared to operating net income in 2002, the decline in net income in 2003 wasdue to higher provisions for credit losses, lower securitization revenue andhigher operating expenses, partially offset by higher net interest income andfee and other income. The increase in provision in 2003 was the result ofincreased levels of receivables, higher provision for credit losses onsecuritized receivables, including higher estimated losses at auto finance, andhigher levels of charge-off due, in part, to a weak economy. The decrease insecuritization revenue in 2003 was due to a significant decrease in initialsecuritization volume, primarily in our auto finance business as a result ofalternative funding including HSBC subsidiaries and customers. The increase innet interest income and fee and other income in 2003 was due to the growth inaverage receivables we experienced during the year. Operating expenses(excluding the 2002 attorney general settlement charge and related expenses)increased as a result of additional operating costs to support the receivablegrowth and higher legal and compliance costs. Managed receivables increased 1 percent compared to $87.1 billion at December31, 2003. The rate of increase in managed receivables was impacted by the saleof $15.6 billion in domestic private label receivables to HSBC Bank USA inDecember of 2004. Had this sale not taken place, managed receivables would haveincreased by $16.3 billion or 19 percent in 2004. We experienced strong growthin 2004 in our real estate secured receivables in both our correspondent andbranch-based consumer lending businesses, which was partially offset by $2.8billion of correspondent receivables purchased directly by HSBC Bank USA (aportion of which we otherwise would have purchased). Growth in our correspondentbusiness was supplemented by purchases from a single correspondent relationshipwhich totaled $2.6 billion in 2004. We also experienced solid growth in autofinance receivables though our dealer network and increased direct mailsolicitations. Personal non-credit card receivables also experienced growth in2004 as we began to increase availability of this product in the second half ofthe year as a result of an improving economy. Prior to the sale of the domesticportfolio in December 2004, our private label receivables increased due toorganic growth through existing merchants and a $.5 billion portfolioacquisition. Managed receivables increased 10 percent to $87.1 billion at December 31, 2003compared to $79.4 billion at December 31, 2002. The managed receivable growth in2003 was driven primarily by growth in real estate secured receivables in ourcorrespondent business. In 2003, our branch-based consumer lending businessreported strong real estate secured originations in the second half of 2003following weak sales momentum in the first half of 2003 as a result of ourintentional fourth quarter 2002 slowdown and higher run-off. Real estate growthin 2003 was impacted by the $2.8 billion loan sale to HSBC Bank USA to utilizeHSBC liquidity. Our private label portfolio also reported strong growth in 2003as a result of portfolio acquisitions as well as organic growth. Return of average managed assets ("ROMA") was 1.64 percent in 2004, 1.22 percentin 2003 and 1.02 percent in 2002. The increase in the ratio reflects higherlevels of net income. On an operating basis, ROMA was 1.32 percent in 2004, 1.22percent in 2003 and 1.71 percent in 2002. The increase in ROMA on 48 HSBC Finance Corporation-------------------------------------------------------------------------------- an operating basis in 2004 reflects the higher operating net income as discussedabove. The decline in ROMA on an operating basis in 2003 reflects lowersecuritization revenue and higher provision for credit losses and operatingexpenses. CREDIT CARD SERVICES SEGMENT The following table summarizes results for ourCredit Card Services segment. YEAR ENDED DECEMBER 31, 2004 2003 2002----------------------------------------------------------------------------------------- (IN MILLIONS)Net income.................................................. $ 380 $ 500 $ 414Operating net income........................................ 381 500 414Net interest income......................................... 2,070 1,954 1,768Securitization revenue...................................... (338) (6) 61Fee and other income........................................ 1,731 1,537 1,320Intersegment revenues....................................... 25 30 34Provision for credit losses................................. 1,625 1,598 1,428Total costs and expenses.................................... 1,238 1,099 1,054Receivables................................................. 19,670 19,552 18,071Assets...................................................... 20,049 22,505 21,079Net interest margin......................................... 10.00% 9.87% 9.84%Return on average managed assets............................ 1.82 2.44 2.20 Our Credit Card Services segment reported lower net income and operating netincome (a non-GAAP financial measure of net income excluding the impact ofadopting FFIEC charge-off policies) in 2004. The decrease in net income was dueto lower securitization levels and higher operating expenses, particularlymarketing expenses, partially offset by increases in net interest income as wellas fee and other income. Increases in net interest income as well as fee andother income in 2004 resulted from higher subprime receivable levels. Netinterest margin increased compared to 2003 due to higher subprime receivablelevels and lower funding costs. Although our subprime receivables tend to havesmaller balances, they generate higher returns both in terms of net interestmargin and fee income. Securitization revenue declined as a result of a declinein receivables securitized, including higher run-off due to shorter expectedlives. Our provision for credit losses was flat in 2004 as reductions due toimproving credit quality and changes in securitization levels were offset byhigher levels of subprime receivables which carry a higher reserve requirementand a corporate adjustment to increase owned reserve levels. We increasedmanaged loss reserves by recording loss provision greater than net charge-off of$123 million in 2004. Our Credit Card Segment reported higher net income in 2003 compared to 2002. Theincrease was due primarily to higher net interest income and fee and otherincome, partially offset by higher provision for credit losses and lowersecuritization revenue. The higher provision for credit losses was due toincreased receivable levels as well as the continued weak economy that wasexperienced in 2003. We increased managed loss reserves by recording lossprovision greater than charge-offs of $153 million in 2003. Growth inreceivables drove the increase in both net interest income and fee and otherincome in 2003 The decrease in securitization revenue in 2003 was also due to adecline in initial securitization volume in 2003. As previously discussed, in December 2004, we adopted FFIEC charge-off policiesfor the remainder of our domestic MasterCard and Visa portfolio, which resultedin an immaterial reduction to net income. See "Credit Quality" for furtherdiscussion of the FFIEC policies and the impact of their adoption. Managed receivables of $19.7 billion at December 31, 2004 were flat compared to$19.6 billion at December 31, 2003. In 2004, increases in our AFL-CIO Union Plusportfolios, subprime and prime portfolios were substantially offset by thecontinued decline in certain older acquired portfolios. Receivable growth in2003 reflects strong growth in our GM portfolio, portfolio acquisitions totaling$.9 billion and organic growth in our subprime and AFL-CIO Union Plusportfolios. 49 HSBC Finance Corporation-------------------------------------------------------------------------------- ROMA decreased in 2004 compared to 2003 reflecting the lower net income asdiscussed above. The improvement in ROMA in 2003 compared to 2002 reflectshigher net interest margin and fee income, partially offset by higher provisionfor credit losses. INTERNATIONAL SEGMENT The following table summarizes results for ourInternational segment: YEAR ENDED DECEMBER 31, 2004 2003 2002----------------------------------------------------------------------------------------- (IN MILLIONS)Net income.................................................. $ 95 $ 170 $ 231Net interest income......................................... 797 753 641Securitization revenue...................................... (88) 17 47Fee and other income........................................ 503 380 371Intersegment revenues....................................... 15 12 10Provision for credit losses................................. 336 359 280Total costs and expenses.................................... 726 530 456Receivables................................................. 13,263 11,003 8,769Assets...................................................... 14,236 11,923 10,011Net interest margin......................................... 6.69% 7.44% 8.06%Return on average managed assets............................ .76 1.57 2.60 Our International segment reported lower net income in 2004 and 2003. In bothyears, the decrease in net income reflects higher operating expenses and lowersecuritization revenue partially offset by increased fee and other income, andhigher net interest income. Net income in 2004 also reflects lower provision forcredit losses. However, provision for credit losses increased in 2003. Applyingconstant currency rates, which uses the average rate of exchange for the 2003period to translate current period net income, net income would have been lowerby $6 million in 2004. Applying constant currency rates for the 2002 period totranslate 2003 income, net income for 2003 would have been lower by $18 million. Net interest income increased in 2004 and 2003 due to higher receivable levels,partially offset by a slightly higher cost of funds in 2004. Net interest margindecreased in 2004 and 2003 due to run off of higher yielding receivables,competitive pricing pressures on our personal loans in the U.K. and a highercost of funds. In 2004, this was partially offset by increased yields on creditcards as interest-free balances were not promoted as strongly as in the past.Securitization revenue also declined in 2004 and 2003 as a result of lowerlevels of securitized receivables. Fee and other income increased in both yearsprimarily due to higher insurance revenues. Provision for credit lossesdecreased in 2004 due to changes in securitization levels, partially offset by ahigher provision for credit losses on owned receivables due to receivable growthand higher delinquency and charge-off levels in the U.K. We decreased managedloss reserves in 2004 by recording loss provision less than net charge-offs of$29 million. We increased managed loss reserves in 2003 by recording lossprovision greater than charge-offs of $69 million due to receivable growth.Total costs and expenses increased in 2004 and 2003 primarily due to highersalary expenses to support receivable growth, including the full year impact in2004 of operating costs associated with a 2003 private label portfolioacquisition, and higher policyholder benefits because of increased insurancesales volumes. The increase in costs and expenses in 2003 also reflectsadditional cost associated with a 2003 private label portfolio acquisition. Managed receivables of $13.3 billion at December 31, 2004 increased 20.5 percentcompared to $11.0 billion at December 31, 2003. The increase during 2004 was dueto strong growth in real estate secured and MasterCard/Visa as well as growthfrom the introduction of auto finance receivables in Canada. Receivable growthin both years reflects positive foreign exchange translation impacts of $1.0billion at December 31, 2004 compared to December 31, 2003 foreign exchangerates and $1.2 billion at December 31, 2003 compared to December 31, 2002foreign exchange rates. Additionally in 2003, all products reported growth,including a $.4 billion private label portfolio acquisition in the U.K. in thesecond quarter of 2003. 50 HSBC Finance Corporation-------------------------------------------------------------------------------- The decrease in ROMA for 2004 and 2003 reflects the lower net income asdiscussed above. RECONCILIATION OF MANAGED BASIS SEGMENT RESULTS As discussed above, we monitorour operations on a managed basis. Therefore, an adjustment is required toreconcile the managed financial information to our reported financialinformation in our consolidated financial statements. This adjustmentreclassifies net interest income, fee income and loss provision intosecuritization revenue. See Note 23, "Business Segments," in the accompanyingconsolidated financial statements for a reconciliation of our managed basissegment results to managed basis and owned basis consolidated totals. CREDIT QUALITY-------------------------------------------------------------------------------- ADOPTION OF FFIEC CHARGE-OFF AND ACCOUNT MANAGEMENT POLICIES Upon receipt ofregulatory approval for the sale of our domestic private label portfolio to HSBCBank USA in December 2004, we adopted charge-off and account managementguidelines in accordance with the Uniform Retail Credit Classification andAccount Management Policy issued by the Federal Financial InstitutionsExamination Council for our domestic private label and our MasterCard and Visaportfolios. FFIEC policies require that private label and MasterCard/Visa credit cardaccounts be charged-off no later than the end of the month in which the accountbecomes 180 days delinquent. For accounts involving a bankruptcy, charge-offshould occur by the end of the month 60 days after notification or 180 daysdelinquent, whichever is sooner. Certain domestic MasterCard and Visa portfolioswere following FFIEC charge-off policies prior to December 2004. Domesticprivate label receivables originated through new merchant relationships afterOctober 2002, which represented 18.8 percent of the portfolio at the sale date,were also following the 180-day charge-off policy. The remainder of our domesticprivate label credit card receivable portfolio previously charged-offreceivables the month following the month in which the account became 9 monthscontractually delinquent. Prior to the adoption of the FFIEC charge-offpolicies, our private label credit card portfolio recorded charge-off involvinga bankruptcy by the end of the month 90 days after bankruptcy notification wasreceived. The adoption of FFIEC charge-off policies for our domestic private label andMasterCard/Visa receivables resulted in a reduction to our net income ofapproximately $121 million as summarized below: PRIVATE MASTERCARD LABEL AND VISA PORTFOLIO PORTFOLIO TOTAL-------------------------------------------------------------------------------------------- (IN MILLIONS)Net interest income: Reversal of finance charge income on charged-off accounts(1)............................................ $ (45) $(1) $ (46)Other income: Reversal of fee income on charged-off accounts(1)......... (40) -- (40) Impact of FFIEC policies on securitized receivables(2).... (64) (2) (66)Provision for credit losses: Owned charge-offs to comply with FFIEC policies........... (155) (3) (158) Release of owned credit loss reserves..................... 116 4 120Tax benefit................................................. 68 1 69 ----- --- -----Reduction to net income..................................... $(120) $(1) $(121) ===== === ===== --------------- (1) Accrued finance charges and fee income are reversed against the related revenue lines. (2) Represents charge-off of principal, interest and fees on securitized receivables. The adoption of FFIEC account management policies for our domestic private labeland MasterCard/Visa receivables revises existing policies regardingrestructuring of past due accounts for certain receivables on a go-forwardbasis. Certain domestic MasterCard/Visa receivables were following thesepolicies prior to December 2004. The requirements before such accounts can nowbe re-aged are as follows: (a) the borrower is required to make threeconsecutive minimum monthly payments or a lump sum equivalent; (b) the accountmust be in 51 HSBC Finance Corporation-------------------------------------------------------------------------------- existence for a minimum of nine months; and (c) the account should not bere-aged more than once within any twelve-month period and not more than twice ina five-year period. An account may be re-aged after it enters a work-outprogram, including internal and third party debt counseling services, but onlyafter receipt of at least three consecutive minimum monthly payments or theequivalent cumulative amount, as agreed upon under the work-out or debtmanagement program. Re-aging for work-out purposes may be limited to once in afive-year period and is in addition to the once in twelve months and twice infive year limits. We do not expect the adoption of FFIEC charge-off and account managementpolicies for our domestic private label and MasterCard and Visa portfolios tohave a significant impact on our business model or on our results of operationsor our cash flows in future periods. DELINQUENCY AND CHARGE-OFF POLICIES AND PRACTICES Our delinquency and netcharge-off ratios reflect, among other factors, changes in the mix of loans inour portfolio, the quality of our receivables, the average age of our loans, thesuccess of our collection and customer account management efforts, bankruptcytrends and general economic conditions. The levels of personal bankruptcies alsohave a direct effect on the asset quality of our overall portfolio and others inour industry. Our credit and portfolio management procedures focus on risk-based pricing andeffective collection and customer account management efforts for each loan. Webelieve our credit and portfolio management process gives us a reasonable basisfor predicting the credit quality of new accounts. This process is based on ourexperience with numerous marketing, credit and risk management tests. We alsobelieve that our frequent and early contact with delinquent customers, as wellas restructuring and other customer account management techniques which aredesigned to optimize account relationships, are helpful in maximizing customercollections. See Note 2, "Summary of Significant Accounting Policies," in theaccompanying consolidated financial statements for a description of ourcharge-off and nonaccrual policies by product. Our charge-off policies focus on maximizing the amount of cash collected from acustomer while not incurring excessive collection expenses on a customer whowill likely be ultimately uncollectible. We believe our policies are responsiveto the specific needs of the customer segment we serve. Our real estate and autofinance charge-off policies consider customer behavior in that initiation offoreclosure or repossession activities often prompts repayment of delinquentbalances. Our collection procedures and charge-off periods, however, aredesigned to avoid ultimate foreclosure or repossession whenever it is reasonablyeconomically possible. Our MasterCard/ Visa charge-off policy is generallyconsistent with industry practice. Charge-off periods for our personal non-credit card product and, prior to December 2004, our domestic private labelproduct were designed to be responsive to our customer needs and may thereforebe longer than bank competitors who serve a different market. Except asdiscussed above, our policies have generally been consistently applied in allmaterial respects. Our loss reserve estimates consider our charge-off policiesto ensure appropriate reserves exist for products with longer charge-off lives.We believe our current charge-off policies are appropriate and result in properloss recognition. DELINQUENCY - OWNED BASIS 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. When weuse a customer account management technique, we may treat the account as beingRelated Shares:
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