28th Feb 2005 11:31
HSBC Holdings PLC28 February 2005 Part 4 HSBC Finance Corporation-------------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF INCOME MARCH 29 JANUARY 1 YEAR ENDED THROUGH THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 28, DECEMBER 31, 2004 2003 2003 2002----------------------------------------------------------------------------------------------------------- (SUCCESSOR) (SUCCESSOR) (PREDECESSOR) (PREDECESSOR) (RESTATED) (IN MILLIONS)Finance and other interest income............. $10,945 $7,773 $2,469 $10,525Interest expense.............................. 3,143 2,031 897 3,871 ------- ------ ------ -------NET INTEREST INCOME........................... 7,802 5,742 1,572 6,654Provision for credit losses................... 4,334 2,991 976 3,732 ------- ------ ------ -------NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES...................................... 3,468 2,751 596 2,922 ------- ------ ------ -------Other revenues: Securitization revenue...................... 1,008 1,027 434 2,134 Insurance revenue........................... 839 575 171 716 Investment income........................... 137 116 80 182 Derivative income........................... 511 284 2 3 Fee income.................................. 1,091 784 280 948 Taxpayer financial services income.......... 217 4 181 240 Other income................................ 607 317 64 301 Gain on bulk sale of private label receivables.............................. 663 - - - Loss on disposition of Thrift assets and deposits................................. - - - (378) ------- ------ ------ -------TOTAL OTHER REVENUES.......................... 5,073 3,107 1,212 4,146 ------- ------ ------ -------Costs and expenses: Salaries and employee benefits.............. 1,886 1,507 491 1,817 Sales incentives............................ 363 226 37 256 Occupancy and equipment expenses............ 323 302 98 371 Other marketing expenses.................... 636 409 139 531 Other servicing and administrative expenses................................. 868 835 314 889 Support services from HSBC affiliates....... 750 - - - Amortization of intangibles................. 363 246 12 58 Policyholders' benefits..................... 412 286 91 368 Settlement charge and related expenses...... - - - 525 HSBC acquisition related costs incurred by HSBC Finance Corporation................. - - 198 - ------- ------ ------ -------TOTAL COSTS AND EXPENSES...................... 5,601 3,811 1,380 4,815 ------- ------ ------ -------Income before income tax expense.............. 2,940 2,047 428 2,253Income tax expense............................ 1,000 690 182 695 ------- ------ ------ -------NET INCOME.................................... $ 1,940 $1,357 $ 246 $ 1,558 ======= ====== ====== ======= The accompanying notes are an integral part of the consolidated financialstatements. 108 HSBC Finance Corporation-------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEET YEAR ENDED DECEMBER 31, 2004 2003--------------------------------------------------------------------------------------- (SUCCESSOR) (SUCCESSOR) (RESTATED) (IN MILLIONS, EXCEPT SHARE DATA)ASSETSCash........................................................ $ 392 $ 463Securities purchased under agreements to resell............. 2,651 -Securities.................................................. 4,327 11,073Receivables, net............................................ 104,815 91,027Intangible assets, net...................................... 2,705 2,856Goodwill.................................................... 6,856 6,697Properties and equipment, net............................... 487 527Real estate owned........................................... 587 631Derivative financial assets................................. 4,049 3,016Other assets................................................ 3,321 2,762 -------- --------TOTAL ASSETS................................................ $130,190 $119,052 ======== ========LIABILITIESDebt: Deposits.................................................. $ 47 $ 232 Commercial paper, bank and other borrowings............... 9,013 9,122 Due to affiliates......................................... 13,789 7,589 Long term debt (with original maturities over one year)... 85,378 79,632 -------- --------Total debt.................................................. 108,227 96,575 -------- --------Insurance policy and claim reserves......................... 1,303 1,258Derivative related liabilities.............................. 432 597Other liabilities........................................... 3,287 3,131 -------- -------- TOTAL LIABILITIES......................................... 113,249 101,561 -------- --------SHAREHOLDER'S EQUITYRedeemable preferred stock held by HINO (held by HSBC at December 31, 2003)........................................ 1,100 1,100Common shareholder's equity: Common stock, $0.01 par value, 100 shares authorized, 50 shares issued...................................... - - Additional paid-in capital............................. 14,627 14,645 Retained earnings...................................... 571 1,303 Accumulated other comprehensive income................. 643 443 -------- --------TOTAL COMMON SHAREHOLDER'S EQUITY........................... 15,841 16,391 -------- --------TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY.................. $130,190 $119,052 ======== ======== The accompanying notes are an integral part of the consolidated financialstatements. 109 HSBC Finance Corporation--------------------------------------------------------------------------------CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDER'S(S') EQUITY MARCH 29 JANUARY 1 YEAR ENDED THROUGH THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 28, DECEMBER 31, 2004 2003 2003 2002------------------------------------------------------------------------------------------------------------------------ (SUCCESSOR) (SUCCESSOR) (PREDECESSOR) (PREDECESSOR) (RESTATED) (IN MILLIONS)PREFERRED STOCK Balance at beginning of period............................. $ 1,100 $ 1,100 $ 1,193 $ 456 Reclassification of preferred stock issuance costs......... - - 21 - Issuance of preferred stock................................ - - - 737 Redemption of preferred stock.............................. - - (114) - ------- ----------- ------------- ------------ Balance at end of period................................... $ 1,100 $ 1,100 $ 1,100 $ 1,193 ======= =========== ============= ============COMMON SHAREHOLDER'S(S') EQUITY COMMON STOCK Balance at beginning of period........................... $ - $ - $ 552 $ 552 Effect of push-down accounting of HSBC's purchase price on net assets.......................................... - - (552) - ------- ----------- ------------- ------------ Balance at end of period................................. $ - $ - $ - $ 552 ------- ----------- ------------- ------------ ADDITIONAL PAID-IN CAPITAL Balance at beginning of period........................... $14,645 $ 14,661 $ 1,911 $ 2,030 Return of capital to HSBC................................ (31) (41) - - Employee benefit plans and other......................... 13 25 10 50 Reclassification of preferred stock issuance costs....... - - (21) - Issuance of preferred stock.............................. - - - (11) Exercise of stock options................................ - - 5 Common stock offering.................................... - - - (194) Issuance of adjustable conversion rate equity security units.................................................. - - - 31 Effect of push-down accounting of HSBC's purchase price on net assets.......................................... - - 12,761 - ------- ----------- ------------- ------------ Balance at end of period................................. $14,627 $ 14,645 $ 14,661 $ 1,911 ------- ----------- ------------- ------------ RETAINED EARNINGS Balance at beginning of period........................... 1,303 $ - $ 9,885 $ 8,838 Net income............................................... 1,940 1,357 246 1,558 Dividends: Preferred stock........................................ (72) (54) (22) (63) Common stock........................................... (2,600) - (412) (448) Effect of push-down accounting of HSBC's purchase price on net assets.......................................... - - (9,697) - ------- ----------- ------------- ------------ Balance at end of period................................. $ 571 $ 1,303 $ - $ 9,885 ------- ----------- ------------- ------------ ACCUMULATED OTHER COMPREHENSIVE INCOME Balance at beginning of period........................... $ 443 $ - $ (695) $ (732) Net change in unrealized gains (losses) on: Derivatives classified as cash flow hedges........... 130 (11) 101 (37) Securities available for sale and interest-only strip receivables......................................... (114) 168 (25) 96 Minimum pension liability.............................. (4) - - (31) Foreign currency translation adjustment................ 188 286 (24) 9 ------- ----------- ------------- ------------ Other comprehensive income, net of tax................... 200 443 52 37 Effect of push-down accounting of HSBC's purchase price on net assets.......................................... - - 643 - ------- ----------- ------------- ------------ Balance at end of period................................. $ 643 $ 443 $ - $ (695) ------- ----------- ------------- ------------ COMMON STOCK IN TREASURY Balance at beginning of period........................... - - $ (2,431) $ (2,844) Exercise of stock options................................ - - 12 2 Issuance of common stock for employee benefit plans...... - - 12 97 Common stock offering.................................... - - - 594 Purchase of treasury stock............................... - - (164) (280) Effect of push-down accounting of HSBC's purchase price on net assets.......................................... - - 2,571 - ------- ----------- ------------- ------------ Balance at end of period................................. - - - (2,431) ------- ----------- ------------- ------------TOTAL COMMON SHAREHOLDER'S(S') EQUITY....................... $15,841 $ 16,391 $ 14,661 $ 9,222 ======= =========== ============= ============COMPREHENSIVE INCOMENet income.................................................. $ 1,940 $ 1,357 $ 246 $ 1,558Other comprehensive income.................................. 200 443 52 37 ------- ----------- ------------- ------------COMPREHENSIVE INCOME........................................ $ 2,140 $ 1,800 $ 298 $ 1,595 ======= =========== ============= ============ The accompanying notes are an integral part of the consolidated financialstatements. 110 HSBC Finance Corporation--------------------------------------------------------------------------------CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDER'S(S') EQUITY (CONTINUED) MARCH 29 JANUARY 1 YEAR ENDED THROUGH THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 28, DECEMBER 31,SHARES OUTSTANDING 2004 2003 2003 2002------------------------------------------------------------------------------------------------------------- (SUCCESSOR) (SUCCESSOR) (RESTATED) (PREDECESSOR) (PREDECESSOR)PREFERRED STOCK Balance at beginning of period................ 1,100 1,100,000 2,448,279 1,698,279 Issuance of preferred stock................... - - - 750,000 Redemption of preferred stock................. - - (1,348,279) - Conversion of preferred stock to right to receive cash................................ - (1,100,000) - - Issuance of preferred stock................... - 1,100 - - ----- ---------- ------------ ----------- Balance at end of period...................... 1,100 1,100 1,100,000 2,448,279 ===== ========== ============ ===========COMMON STOCK ISSUED Balance at beginning of period.............. 50 50 551,811,025 551,684,740 Exercise of stock options................... - - 3,557 126,285 Cancellation of common stock................ - - (551,814,582) - Issuance of common stock.................... - - 50 - ----- ---------- ------------ ----------- Balance at end of period.................... 50 50 50 551,811,025 ----- ---------- ------------ ----------- IN TREASURY Balance at beginning of period.............. - - (77,197,686) (94,560,437) Exercise of stock options................... - - 435,530 604,692 Issuance of common stock for employee benefit plans............................. - - 1,464,984 2,803,859 Common stock offering....................... - - - 18,700,000 Purchase of treasury stock.................. - - (2,861,400) (4,745,800) Issuance of common stock for restricted stock rights which vested upon change in control................................... - - 2,342,890 - Cancellation of common stock................ - - 75,815,682 - ----- ---------- ------------ ----------- Balance at end of period.................... - - - (77,197,686) ----- ---------- ------------ -----------NET COMMON STOCK OUTSTANDING.................... 50 50 50 474,613,339 ===== ========== ============ =========== The accompanying notes are an integral part of the consolidated financialstatements. 111 HSBC Finance Corporation--------------------------------------------------------------------------------CONSOLIDATED STATEMENT OF CASH FLOWS MARCH 29 JANUARY 1 YEAR ENDED THROUGH THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 28, DECEMBER 31, 2004 2003 2003 2002------------------------------------------------------------------------------------------------------------------------ (SUCCESSOR) (SUCCESSOR) (PREDECESSOR) (PREDECESSOR) (RESTATED) (IN MILLIONS)CASH FLOWS FROM OPERATING ACTIVITIESNet income.................................................. $ 1,940 $ 1,357 $ 246 $ 1,558Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for credit losses................................ 4,334 2,991 976 3,732 Gain on bulk sale of private label receivables............. (663) - - - Insurance policy and claim reserves........................ (170) (196) 47 16 Depreciation and amortization.............................. 483 344 53 233 Deferred income tax provision.............................. 348 (83) 90 (120) Net change in interest-only strip receivables.............. 466 400 30 (199) Net change in other assets................................. (694) 899 (593) (136) Net change in other liabilities............................ 23 (735) 526 325 Other, net................................................. 897 120 84 1,996 -------- -------- ------- --------Net cash provided by (used in) operating activities......... 6,964 5,097 1,459 7,405 -------- -------- ------- --------CASH FLOWS FROM INVESTING ACTIVITIESSecurities: Purchased.................................................. (1,363) (4,750) (1,047) (5,288) Matured.................................................... 1,375 3,403 584 2,161 Sold....................................................... 853 687 768 642Net change in short-term securities available for sale...... 535 (2,684) (375) (1,254)Net change in securities purchased under agreements to resell..................................................... 2,651 - - -Receivables: Originations, net of collections........................... (63,756) (41,644) (8,255) (47,363) Purchases and related premiums............................. (608) (2,473) (129) (1,073) Initial and fill-up securitizations........................ 31,060 30,338 7,300 36,278 Whole loan sales........................................... - - - 6,287 Sales to affiliates........................................ 14,279 2,844 - -Properties and equipment: Purchases.................................................. (96) (94) (21) (159) Sales...................................................... 4 6 - 20 -------- -------- ------- --------Net cash provided by (used in) investing activities......... (15,066) (14,367) (1,175) (9,749) -------- -------- ------- --------CASH FLOWS FROM FINANCING ACTIVITIESDebt: Net change in short-term debt and deposits................. (180) 3,284 (514) (6,232) Net change in time certificates............................ (161) (708) 150 (1,410) Disposition of Thrift deposits............................. - - - (4,259) Net change in due to affiliates............................ 5,716 7,023 - - Long term debt issued...................................... 19,916 15,559 4,361 30,620 Long term debt retired..................................... (14,628) (15,789) (4,030) (16,276) Issuance of company obligated mandatorily redeemable preferred securities of subsidiary trusts to HSBC........ - 275 - - Redemption of company obligated mandatorily redeemable preferred securities of subsidiary trusts................ - (275) - -Insurance: Policyholders' benefits paid............................... (194) (121) (36) (286) Cash received from policyholders........................... 265 127 33 92Shareholder's(s') dividends................................. (2,708) (293) (141) (510)Issuance of preferred stock................................. - - - 726Redemption of preferred stock............................... - - (114) -Common stock offering....................................... - - - 400Purchase of treasury stock.................................. - - (164) (280)Issuance of common stock for employee benefit plans......... - - 62 136 -------- -------- ------- --------Net cash provided by (used in) financing activities......... 8,026 9,082 (393) 2,721 -------- -------- ------- --------Effect of exchange rate changes on cash..................... 5 (23) (15) (123) -------- -------- ------- --------Net change in cash.......................................... (71) (211) (124) 254Cash at beginning of period................................. 463 674 798 544 -------- -------- ------- --------CASH AT END OF PERIOD....................................... $ 392 $ 463 $ 674 $ 798 ======== ======== ======= ========SUPPLEMENTAL CASH FLOW INFORMATION:Interest paid............................................... $ 3,468 $ 2,582 $ 897 $ 3,995Income taxes paid........................................... 842 600 40 864 -------- -------- ------- --------SUPPLEMENTAL NONCASH FINANCING AND CAPITAL ACTIVITIES:Push-down of purchase price by HSBC......................... $ - $ - $14,661 $ -Exchange of preferred stock for preferred stock issued to HSBC....................................................... - - 1,100 - ======== ======== ======= ======== The accompanying notes are an integral part of the consolidated financialstatements. 112NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION-------------------------------------------------------------------------------- HSBC Finance Corporation (formerly Household International, Inc.) and itssubsidiaries were acquired by a wholly owned subsidiary of HSBC Holdings plc("HSBC") on March 28, 2003 in a purchase business combination recorded under the"push-down" method of accounting, which resulted in a new basis of accountingfor the "successor" period beginning March 29, 2003. Information relating to all"predecessor" periods prior to the acquisition is presented using the historicalbasis of accounting. On September 30, 2004, Household International, Inc. ("Household") commenced therebranding of the majority of its U.S. and Canadian businesses to the HSBCbrand. Businesses previously operating under the Household name are now calledHSBC. Our consumer lending business has retained the HFC and Beneficial brands,accompanied by the HSBC Group's endorsement signature, "Member HSBC Group." Thesingle brand allows HSBC in North America to better align its businesses,providing a stronger platform to service customers and advance growth. The HSBCbrand also positions us to expand the products and services offered to ourcustomers. As part of this initiative, Household changed its name to HSBCFinance Corporation in December 2004. HSBC Finance Corporation and subsidiaries, is an indirect wholly ownedsubsidiary of HSBC North America Holdings Inc. ("HNAH"), which is a wholly-ownedsubsidiary of HSBC. HSBC Finance Corporation provides middle-market consumerswith several types of loan products in the United States, the United Kingdom,Canada, the Republic of Ireland, the Czech Republic and Hungary. HSBC FinanceCorporation may also be referred to in these notes to the consolidated financialstatements as "we," "us" or "our." Our lending products include real estatesecured loans, auto finance loans, MasterCard* and Visa* credit card loans,private label credit card loans and personal non-credit card loans. We alsoinitiate tax refund anticipation loans in the United States and offer credit andspecialty insurance in the United States, the United Kingdom and Canada. We havethree reportable segments: Consumer, Credit Card Services, and International.Our Consumer segment consists of our branch-based 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("U.K."), the Republic of Ireland, the Czech Republic, Hungary and Canada. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES-------------------------------------------------------------------------------- BASIS OF PRESENTATION The consolidated financial statements include theaccounts of HSBC Finance Corporation and all subsidiaries including all variableinterest entities in which we are the primary beneficiary as defined byFinancial Accounting Standards Board Interpretation ("FASB") No. 46 (Revised).Unaffiliated trusts to which we have transferred securitized receivables whichare qualifying special purpose entities ("QSPE") as defined by Statement ofFinancial Accounting Standards ("SFAS") No. 140, "Accounting for Transfers andServicing of Financial Assets and Extinguishments of Liabilities, a Replacementof FASB Statement No. 125," are not consolidated. All significant intercompanyaccounts and transactions have been eliminated. The preparation of financial statements in conformity with accounting principlesgenerally accepted in the United States ("U.S. GAAP") requires management tomake estimates and assumptions that affect the amounts reported in the financialstatements and accompanying notes. Actual results could differ from thoseestimates. 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. --------------- * MasterCard is a registered trademark of MasterCard International, Incorporated and VISA is a registered trademark of VISA USA, Inc. 113SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL Securities purchased underagreements to resell are treated as collateralized financing transactions andare carried at the amounts at which the securities were acquired plus accruedinterest. Interest income earned on these securities is included in net interestincome. INVESTMENT SECURITIES We maintain investment portfolios (comprised primarily ofdebt securities and money market funds) in both our noninsurance and insuranceoperations. Our entire investment securities portfolio was classified asavailable-for-sale at December 31, 2004 and 2003. Available-for-sale investmentsare intended to be invested for an indefinite period but may be sold in responseto events we expect to occur in the foreseeable future. These investments arecarried at fair value. Unrealized holding gains and losses on available-for-saleinvestments are recorded as adjustments to common shareholder's(s') equity inaccumulated other comprehensive income, net of income taxes. Any decline in thefair value of investments which is deemed to be other than temporary is chargedagainst current earnings. Cost of investment securities sold is determined using the specificidentification method. Interest income earned on the noninsurance investmentportfolio is classified in the statements of income in net interest income.Realized gains and losses from the investment portfolio and investment incomefrom the insurance portfolio are recorded in investment income. Accruedinvestment income is classified with investment securities. RECEIVABLES Receivables are carried at amortized cost. As a result of the mergerwith HSBC, the amortized cost of our receivables was adjusted to fair marketvalue at the time of the merger. Finance income is recognized using theeffective yield method. Premiums and discounts, including purchase accountingfair value adjustments on receivables, are recognized as adjustments to theyield of the related receivables. Origination fees, which include points on realestate secured loans, are deferred and amortized to finance income over theestimated life of the related receivables, except to the extent they offsetdirectly related lending costs. Net deferred origination fees, excludingMasterCard and Visa, totaled $43 million at December 31, 2004 and $172 millionat December 31, 2003. MasterCard and Visa annual fees are netted with directlending costs, deferred, and amortized on a straight-line basis over one year.Deferred MasterCard and Visa annual fees, net of direct lending costs related tothese receivables, totaled $107 million at December 31, 2004 and $57 million atDecember 31, 2003. Insurance reserves and unearned premiums applicable to credit risks on consumerreceivables are treated as a reduction of receivables in the balance sheet,since payments on such policies generally are used to reduce outstandingreceivables. PROVISION AND CREDIT LOSS RESERVES Provision for credit losses on ownedreceivables is made in an amount sufficient to maintain credit loss reserves ata level considered adequate, but not excessive, to cover probable losses ofprincipal, interest and fees, including late, overlimit and annual fees, in theexisting owned portfolio. We estimate probable losses for owned consumerreceivables using a roll rate migration analysis that estimates the likelihoodthat a loan will progress through the various stages of delinquency, or buckets,and ultimately charge off. This analysis considers delinquency status, lossexperience and severity and takes into account whether loans are in bankruptcy,have been restructured, rewritten or are subject to forbearance, an externaldebt management plan, hardship, modification, extension or deferment. Our creditloss reserves also take into consideration the loss severity expected based onthe underlying collateral, if any, for the loan in the event of default.Delinquency status may be affected by customer account management policies andpractices, such as the restructure of accounts, forbearance agreements, extendedpayment plans, modification arrangements, external debt management programs,loan rewrites and deferments. When customer account management policies, orchanges thereto, shift loans from a "higher" delinquency bucket to a "lower"delinquency bucket, this will be reflected in our roll rate statistics. To theextent that restructured accounts have a greater propensity to roll to higherdelinquency buckets, this will be captured in the roll rates. Since the lossreserve is computed based on the composite of all of these calculations, thisincrease in roll rate will be applied to receivables in all respectivedelinquency buckets, which will increase the overall reserve level. In addition,loss reserves on consumer receivables are maintained to reflect our judgment ofportfolio risk factors which may not be fully reflected in the statistical rollrate calculation. Risk factors considered in establishing loss reserves onconsumer receivables include recent growth, product mix, bankruptcy trends,geographic concentrations, 114economic conditions, portfolio seasoning, account management policies andpractices and current levels of charge-offs and delinquencies. For commercialloans, probable losses are calculated using estimates of amounts and timing offuture cash flows expected to be received on loans. 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 appropriate allowances exist for products with longer charge-off periods.We also consider key ratios such as reserves to nonperforming loans and reservesas a percentage of net charge-offs in developing our loss reserve estimate. Lossreserve estimates are reviewed periodically and adjustments are reported inearnings when they become known. As these estimates are influenced by factorsoutside our control, such as consumer payment patterns and economic conditions,there is uncertainty inherent in these estimates, making it reasonably possiblethat they could change. CHARGE-OFF AND NONACCRUAL POLICIES AND PRACTICES In December 2004, upon receiptof regulatory approval for the sale of our domestic private label portfolio toHSBC Bank USA, National Association ("HSBC Bank USA"), we adopted charge-off andaccount management policies in accordance with the Uniform Retail CreditClassification and Account Management Policy issued by the Federal FinancialInstitutions Examination Council ("FFIEC") for our domestic private label andMasterCard/Visa portfolios. See Note 5, "Sale of Domestic Private LabelReceivable Portfolio and Adoption of FFIEC Policies." Our consumer charge-off and nonaccrual policies vary by product and aresummarized below: PRODUCT CHARGE-OFF POLICIES AND PRACTICES NONACCRUAL POLICIES AND PRACTICES(1)-------------------------------------------------------------------------------------------------------Real estate Secured(2,4) Carrying values in excess of net Interest income accruals are realizable value are charged-off suspended when principal or interest at or before the time foreclosure payments are more than three months is completed or when settlement contractually past due and resumed is reached with the borrower. If when the receivable becomes less foreclosure is not pursued, and than three months contractually past there is no reasonable due. expectation for recovery(insurance claim, title claim, pre-discharge bankrupt account), generally the account will be charged-off by the end of the month in which the account becomes nine months contractually delinquent.Auto finance(4) Carrying values in excess of net Interest income accruals are realizable value are charged off suspended and the portion of at the earlier of the following: previously accrued interest expected - the collateral has been to be uncollectible is written off repossessed and sold, when principal payments are more - the collateral has been in our than two months contractually past possession for more than 90 due and resumed when the receivable days, or becomes less than two months - the loan becomes 150 days contractually past due. contractually delinquent.MasterCard and Visa(5) Generally charged-off by the end Interest generally accrues until of the month in which the account charge-off. becomes six months contractually delinquent. 115PRODUCT CHARGE-OFF POLICIES AND PRACTICES NONACCRUAL POLICIES AND PRACTICES(1)-------------------------------------------------------------------------------------------------------Private label(3, 5) Prior to December 2004, Interest generally accrues until receivables were generally charge-off. charged-off the month following the month in which the account became nine months contractually delinquent. Beginning in the fourth quarter of 2002, receivables originated through new domestic merchant relationships were charged-off by the end of the month in which the account became six months contractually delinquent. Subsequent to the adoption of FFIEC policies in December 2004, domestic receivables are charged- off by the end of the month in which the account becomes six months contractually delinquent.Personal non-credit card(3) Generally charged-off the month Interest income accruals are following the month in which the suspended when principal or interest account becomes nine months payments are more than three months contractually delinquent and no contractually delinquent. For PHLs, payment received in six months, interest income accruals resume if but in no event to exceed 12 the receivable becomes less than months contractually delinquent three months contractually past due. (except in our United Kingdom For all other personal non- credit business which may be longer). card receivables for which income accruals are suspended, interest income is generally recorded as collected. --------------- (1) For our United Kingdom business, interest income accruals are suspended when principal or interest payments are more than three months contractually delinquent. (2) For our United Kingdom business, real estate secured carrying values in excess of net realizable value are charged-off at time of sale. (3) For our Canada business, the private label and personal non-credit card charge-off policy prior to December 2004 required a charge-off of an account where no payment was received in six months, but in no event was an account to exceed 18 months contractually delinquent. In December 2004, the policy was revised to charge-off accounts when no payment is received in six months but in no event is an account to exceed 12 months contractually delinquent. This policy change was not part of the adoption of FFIEC policies discussed in Note 5 and its impact was not material to our net income. (4) In November 2003, the FASB issued FASB Staff Position Number 144-1, "Determination of Cost Basis for Foreclosed Assets under FASB Statement No. 15, and the Measurement of Cumulative Losses Previously Recognized Under Paragraph 37 of FASB Statement No. 144" ("FSP 144-1"). Under FSP 144-1, sales commissions related to the sale of foreclosed assets are recognized as a charge-off through the provision for credit losses. Previously, we had recognized sales commission expense as a component of other servicing and administrative expenses in our statements of income. We adopted FSP 144-1 in November 2003. The adoption had no significant impact on our net income. (5) For our United Kingdom business, delinquent MasterCard/Visa accounts are charged-off the month following the month in which the account becomes six months contractually delinquent and delinquent private label receivables are charged-off the month following the month in which the account becomes nine months contractually delinquent. Charge-off involving a bankruptcy for our domestic private label and MasterCardand Visa receivables occurs by the end of the month 60 days after notificationor 180 days delinquent, whichever is sooner. For auto finance receivables,bankrupt accounts are charged off no later than the end of the month in whichthe loan becomes 210 days contractually delinquent. Prior to December 2004,charge-offs involving a bankruptcy for our domestic private label receivablesoccurred by the end of the month 90 days after notification. 116RECEIVABLES SOLD AND SERVICED WITH LIMITED RECOURSE AND SECURITIZATIONREVENUE Certain real estate secured, auto finance, MasterCard and Visa, privatelabel and personal non-credit card receivables have been securitized and sold toinvestors with limited recourse. We have retained the servicing rights to thesereceivables. Recourse is limited to our rights to future cash flow and anysubordinated interest that we may retain. Upon sale, the receivables are removedfrom the balance sheet and a gain on sale is recognized for the differencebetween the carrying value of the receivables and the adjusted sales proceeds.The adjusted sales proceeds include cash received and the present value estimateof future cash flows to be received over the lives of the sold receivables.Future cash flows are based on estimates of prepayments, the impact of interestrate movements on yields of receivables and securities issued, delinquency ofreceivables sold, servicing fees and other factors. The resulting gain is alsoadjusted by a provision for estimated probable losses under the recourseprovision. This provision and the related reserve for receivables serviced withlimited recourse are established at the time of sale to cover all probablecredit losses over-the-life of the receivables sold based on historicalexperience and estimates of expected future performance. The methodologies varydepending upon the type of receivable sold, using either historical monthly netcharge-off rates applied to the expected balances to be received over theremaining life of the receivable or a historical static pool analysis. Thereserves are reviewed periodically by evaluating the estimated future cash flowsof each securitized pool to ensure that there is sufficient remaining cash flowto cover estimated future credit losses. Any changes to the estimates for thereserve for receivables serviced with limited recourse are made in the periodthey become known. Gains on sale net of recourse provisions, servicing incomeand excess spread relating to securitized receivables are reported in theaccompanying consolidated statements of income as securitization revenue. In connection with these transactions, we record an interest-only stripreceivable, representing our contractual right to receive interest and othercash flows from our securitization trusts. Our interest-only strip receivablesare reported at fair value using discounted cash flow estimates as a separatecomponent of receivables net of our estimate of probable losses under therecourse provisions. Cash flow estimates include estimates of prepayments, theimpact of interest rate movements on yields of receivables and securitiesissued, delinquency of receivables sold, servicing fees and estimated probablelosses under the recourse provisions. Unrealized gains and losses are recordedas adjustments to common shareholder's(s') equity in accumulated othercomprehensive income, net of income taxes. Our interest-only strip receivablesare reviewed for impairment quarterly or earlier if events indicate that thecarrying value may not be recovered. Any decline in the fair value of theinterest-only strip receivable which is deemed to be other than temporary ischarged against current earnings. We have also, in certain cases, retained other subordinated interests in thesesecuritizations. Neither the interest-only strip receivables nor the othersubordinated interests are in the form of securities. In order to align our accounting treatment with that of HSBC under U.K. GAAP(and beginning in 2005 International Financial Reporting Standards), we began tostructure all new funding utilizing securitization as secured financingsbeginning in the third quarter of 2004. However, because existing publicMasterCard and Visa credit card transactions were structured as sales torevolving trusts that require replenishments to support previously issuedsecurities, receivables will continue to be sold to these trusts until therevolving periods end. We have continued to replenish, at reduced levels,certain non-public personal non-credit card and MasterCard and Visa securitiesissued to conduits and recorded the resulting replenishment gains in order tomanage liquidity. PROPERTIES AND EQUIPMENT, NET Properties and equipment are recorded at cost, netof accumulated depreciation and amortization. As a result of our acquisition byHSBC, the amortized cost of our properties and equipment was adjusted to fairmarket value and accumulated depreciation and amortization on a "predecessor"basis was eliminated at the time of the merger. For financial reportingpurposes, depreciation is provided on a straight-line basis over the estimateduseful lives of the assets which generally range from 3 to 40 years. Leaseholdimprovements are amortized over the lesser of the economic useful life of theimprovement or the term of the lease. Maintenance and repairs are expensed asincurred. REPOSSESSED COLLATERAL Real estate owned is valued at the lower of cost or fairvalue less estimated costs to sell. These values are periodically reviewed andreduced, if necessary. Costs of holding real estate and related 117 gains and losses on disposition are credited or charged to operations asincurred as a component of operating expense. Repossessed vehicles, net of lossreserves when applicable, are recorded at the lower of the estimated fair marketvalue or the outstanding receivable balance. INSURANCE Insurance revenues on monthly premium insurance policies arerecognized when billed. Insurance revenues on the remaining insurance contractsare recorded as unearned premiums and recognized into income based on the natureand terms of the underlying contracts. Liabilities for credit insurance policiesare based upon estimated settlement amounts for both reported and incurred butnot yet reported losses. Liabilities for future benefits on annuity contractsand specialty and corporate owned life insurance products are based on actuarialassumptions as to investment yields, mortality and withdrawals. INTANGIBLE ASSETS Intangible assets consist of purchased credit cardrelationships and related programs, retail services merchant relationships,other loan related relationships, trade names, technology, customer lists andother contracts. The trade names are not subject to amortization as we believethey have infinite lives. The remaining intangible assets are being amortizedover their estimated useful lives either on a straight-line basis or inproportion to the underlying revenues generated. These useful lives range from 5years for retail services merchant relationships to approximately 10 years forcertain loan related relationships. Intangible assets are reviewed forimpairment using discounted cash flows annually or earlier if events indicatethat the carrying amounts may not be recoverable. We consider significant andlong-term changes in industry and economic conditions to be our primaryindicator of potential impairment. Impairment charges, when required, arecalculated using discounted cash flows. GOODWILL Goodwill represents the purchase price over the fair value ofidentifiable assets acquired less liabilities assumed from businesscombinations. Goodwill is not amortized, but is reviewed for impairment annuallyusing discounted cash flows but impairment may be reviewed earlier ifcircumstances indicate that the carrying amount may not be recoverable. Weconsider significant and long-term changes in industry and economic conditionsto be our primary indicator of potential impairment. TREASURY STOCK Prior to the merger with HSBC, repurchases of treasury stock wereaccounted for using the cost method with common stock in treasury classified inthe balance sheets as a reduction of common shareholders' equity. Treasury stockwas reissued at average cost. DERIVATIVE FINANCIAL INSTRUMENTS All derivatives are recognized on the balancesheet at their fair value. On the date the derivative contract is entered into,we designate the derivative as a fair value hedge, a cash flow hedge, a hedge ofa net investment in a foreign operation, or a non-hedging derivative. Fair valuehedges include hedges of the fair value of a recognized asset or liability andcertain foreign currency hedges. Cash flow hedges include hedges of thevariability of cash flows to be received or paid related to a recognized assetor liability and certain foreign currency hedges. Changes in the fair value ofderivatives designated as fair value hedges, along with the change in fair valueon the hedged asset or liability that is attributable to the hedged risk, arerecorded in current period earnings. Changes in the fair value of derivatives designated as cash flow hedges, to theextent effective as a hedge, are recorded in accumulated other comprehensiveRelated Shares:
HSBC Holdings