Household 10-K DEC 03 Part 1b

HSBC Holdings PLC 1 March 2004 37 2003 and 36.3 percent in 2002. In 2003, the increase in the efficiency ratio on an operating basis reflects lower securitization revenue and higher operating expenses, partially offset by higher net interest margin. The lower operating basis efficiency ratio in 2002 reflects higher revenues, partially offset by higher operating expenses to support growth. See "Reconciliations to GAAP Financial Measures" for quantitative reconciliations of our operating efficiency ratio to our owned basis GAAP efficiency ratio. Total costs and expenses included the following: Year Ended December 31, -------------------------------------------------- 2003 2002 2001 --------------- --------------- -------------- (In millions) Salaries and fringe benefits $ 1,997.9 $ 1,817.0 $ 1,597.2 Sales incentives 263.5 255.9 273.2 Occupancy and equipment expenses 399.8 371.1 337.4 Other marketing expenses 548.1 531.0 490.4 Other servicing and administrative expenses 1,148.5 888.9 716.8 Amortization of acquired intangibles and 257.8 57.8 157.6 goodwill Policyholders' benefits 376.9 368.8 302.6 HSBC acquisition related costs incurred by 198.2 - - Household Settlement charge and related expenses - 525.0 - --------- --------- --------- Total costs and expenses $ 5,190.7 $ 4,815.5 $ 3,875.2 --------- --------- --------- Salaries and fringe benefits were $2.0 billion in 2003, $1.8 billion in 2002 and $1.6 billion in 2001. The increases were primarily due to additional staffing at all businesses to support growth and compliance functions. Higher employee benefit plan expenses also contributed to the increase in 2003. Sales incentives were $263.5 million in 2003, $255.9 million in 2002 and $273.2 million in 2001. In 2003, the increase was primarily due to increases in our mortgage services business, partially offset by lower new loan volume in our branches and in our auto finance business. In 2002, the decrease was due to the terms of our 2002 branch incentive plans which, generally, had higher volume requirements than the prior-year plans. Occupancy and equipment expenses were $399.8 million in 2003, $371.1 million in 2002 and $337.4 million in 2001. In 2003, the increase was primarily the result of higher repairs and occupancy maintenance costs. In 2002, the increase was primarily due to higher rental and other expenses. Other marketing expenses include payments for advertising, direct mail programs and other marketing expenditures. These expenses were $548.1 million in 2003, $531.0 million in 2002 and $490.4 million in 2001. Increased marketing initiatives in our domestic MasterCard and Visa portfolio was the primary driver of the increases in both years. In 2002, our U.K. portfolio also reported increased marketing initiatives. Other servicing and administrative expenses were $1.1 billion in 2003, $888.9 million in 2002 and $716.8 million in 2001. Higher collection, legal, compliance and REO expenses as well as receivable growth contributed to the increases in both years. In 2003, higher third-party insurance costs also contributed to the increase. In 2002, the increase was also attributable to higher consulting expenses. Amortization of acquired intangibles and goodwill was $257.8 million in 2003, $57.8 million in 2002 and $157.6 million in 2001. In 2003, the increase was primarily attributable to amortization of acquired intangibles established as a result of the HSBC merger. In 2002, the decrease was primarily attributable to the adoption of Statement of Financial Accounting Standard No. 142, ("SFAS No. 142") "Goodwill and Other Intangible Assets," on January 1, 2002. Amortization of goodwill, which totaled $58.6 million in 2001, recorded in past business combinations ceased upon adoption of this new accounting standard. Policyholders' benefits were $376.9 million in 2003, $368.8 million in 2002 and $302.6 million in 2001. The increase in 2003 was primarily due to amortization of purchase accounting adjustments relating to our insurance business and higher policy sales in the U.K. which were partially offset by lower domestic policy 38 sales. The increase in 2002 was primarily due to and consistent with the increase in insurance revenues resulting from increased policy sales in both our domestic and U.K. businesses. HSBC acquisition related costs incurred by Household were $198.2 million in 2003. HSBC acquisition related costs include payments to executives under existing employment contracts and investment banking, legal and other costs relating to our acquisition by HSBC. Settlement charge and related expenses were $525.0 million in 2002. The charges were the result of an agreement with a multi-state working group of state attorneys general and regulatory agencies to effect a nationwide resolution of alleged violations of federal and/or state consumer protection, consumer financing and banking laws and regulations relating to real estate secured lending in our retail branch consumer lending operations as operated under the HFC and Beneficial brand names. Income taxes The effective tax rate was 35.3 percent in 2003, 30.9 percent in 2002 and 34.4 percent in 2001. The effective tax rate in 2003 was adversely impacted by the non-deductibility of certain HSBC acquisition related costs. The decrease in the effective tax rate in 2002 was largely attributable to lower state and local taxes and a reduction in noncurrent tax requirements. CREDIT QUALITY Delinquency and Charge-offs Our delinquency and net charge-off ratios reflect, among other factors, changes in the mix of loans in our portfolio, the quality of our receivables, the average age of our loans, the success of our collection and customer account management efforts, bankruptcy trends and general economic conditions. The levels of personal bankruptcies also have a direct effect on the asset quality of our overall portfolio and others in our industry. Our credit and portfolio management procedures focus on risk-based pricing and effective collection and customer account management efforts for each loan. We believe our credit and portfolio management process gives us a reasonable basis for predicting the credit quality of new accounts. This process is based on our experience with numerous marketing, credit and risk management tests. We also believe that our frequent and early contact with delinquent customers, as well as restructuring and other customer account management techniques which are designed to optimize account relationships are helpful in maximizing customer collections. Charge-Off and Nonaccrual Policies and Practices Product Charge-off Policies and Practices Nonaccrual Policy and Practices1 ----------------------------------- ----------------------------------- --------------------------------------- Real estate secured2, 4 Carrying values in excess of net Interest income accruals are suspended realizable value are charged-off at when principal or interest payments are or before the time foreclosure is more than 3 months contractually past completed or when settlement is due and resumed when the receivable reached with the borrower. If becomes less than 3 months foreclosure is not pursued, and contractually past due. there is no reasonable 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 9 months contractually delinquent. 39 Product Charge-off Policies and Practices Nonaccrual Policy and Practices1 ----------------------------------- ----------------------------------- --------------------------------------- Auto finance4 Carrying values in excess of net Interest income accruals are suspended realizable value are charged off at and the portion of previously accrued the earlier of the following: interest expected to be uncollectible â€¢ the collateral has been is written off when principal payments repossessed and sold, are more than 2 months contractually â€¢ the collateral has been past due and resumed when the in our possession for more than 90 receivable becomes less than 2 months days, or contractually past due. â€¢ the loan becomes 150 days contractually delinquent. MasterCard and Visa Generally charged-off by the end of Interest generally accrues until the month in which the account charge-off. becomes 6 months contractually delinquent. Private label3 Generally charged-off the month Interest generally accrues until following the month in which the charge-off. account becomes 9 months contractually delinquent. Beginning in the fourth quarter of 2002, we charge-off receivables originated through new domestic merchant relationships by the end of the month in which the account becomes 6 months contractually delinquent. As of December 31, 2003, approximately 21 percent of our owned domestic private label portfolio was subject to this 6- month charge-off policy. Personal non-credit card3 Generally charged-off the month Interest income accruals are suspended following the month in which the when principal or interest payments are account becomes 9 months more than 3 months contractually contractually delinquent and no delinquent. For PHLs, interest income payment received in 6 months, but accruals resume if the receivable in no event to exceed 12 months becomes less than three months contractually delinquent (except in contractually past due. For all other our United Kingdom business which personal non-credit card receivables, may be longer). 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 is also no payment received in six months, but in no event to exceed 18 months contractually delinquent. 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. Historically, we had recognized sales commission expense as a component of other servicing 40 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. Charge-off involving a bankruptcy for MasterCard and Visa receivables occurs by the end of the month 60 days after notification and, for private label receivables, by the end of the month 90 days after notification. For auto finance receivables, bankrupt accounts are charged off no later than the end of the month in which the loan becomes 210 days contractually delinquent. Subject to receipt of regulatory and other approvals, we intend to transfer substantially all of our domestic private label credit card portfolio and our General Motors and Union Privilege MasterCard and Visa portfolios to HSBC Bank USA. Contingent upon receiving regulatory approval for these asset transfers in 2004, we would also expect to adopt charge-off, loss provisioning and account management guidelines in accordance with the Uniform Retail Credit Classification and Account Management Policy issued by the FFIEC for those MasterCard and Visa and private label credit card receivables which will remain on our balance sheet. See "Developments and Trends" for further discussion. Our charge-off policies focus on maximizing the amount of cash collected from a customer while not incurring excessive collection expenses on a customer who will likely be ultimately uncollectible. We believe our policies are responsive to the specific needs of the customer segment we serve. Our real estate and auto finance charge-off policies consider customer behavior in that initiation of foreclosure or repossession activities often prompts repayment of delinquent balances. Our collection procedures and charge-off periods, however, are designed to avoid ultimate foreclosure or repossession whenever it is reasonably economically possible. With certain minor variations, our MasterCard and Visa charge-off policy is generally consistent with credit card industry practice. Charge-off periods for our personal non-credit card and private label products were designed to be responsive to our customer needs and may be longer than bank competitors who serve a different market. Our policies have generally been consistently applied in all material respects. Our loss reserve estimates consider our charge-off policies to ensure appropriate reserves exist for products with longer charge-off lives. We believe our current charge-off policies are appropriate and result in proper loss recognition. Customer Account Management Policies and Practices Our policies and practices for the collection of consumer receivables, including our customer account management policies and practices, permit us to reset the contractual delinquency status of an account to current, based on indicia or criteria which, in our judgment, evidence continued payment probability. Such policies and practices vary by product and are designed to manage customer relationships, maximize collection opportunities and avoid foreclosure or repossession if reasonably possible. If the account subsequently experiences payment defaults, it will again become contractually delinquent. As summarized in the tables that follow, in the third quarter of 2003, we implemented certain changes to our restructuring policies. These changes are intended to eliminate and/or streamline exception provisions to our existing policies and are generally effective for receivables originated or acquired after January 1, 2003. Receivables originated or acquired prior to January 1, 2003 generally are not subject to the revised restructure and customer account management policies. However, for ease of administration, in the third quarter of 2003 our mortgage services business elected to adopt uniform policies for all products regardless of the date an account was originated or acquired. Implementation of the uniform policy by mortgage services has the effect of only counting restructures occurring on or after January 1, 2003 in assessing restructure eligibility for purposes of the limitation that no account may be restructured more than four times in a rolling 60 month period. Resetting these counters will not impact the ability of mortgage services to report historical restructure statistics. Other business units may also elect to adopt uniform policies. We do not expect the changes to have a significant impact on our business model or on our results of operations as these changes will generally be phased in as new receivables are originated or acquired. Approximately two-thirds of all restructured receivables are secured products, which may have less loss severity exposure because of the underlying collateral. Credit loss reserves take into account whether loans have been restructured, rewritten or are subject to forbearance, an external debt management plan, modification, extension or deferment. Our credit loss reserves also take into consideration the loss severity expected based on the underlying collateral, if any, for the loan. 41 Our restructuring policies and practices vary by product and are described in the table that follows. The fact that the restructuring criteria may be met for a particular account does not require us to restructure that account, and the extent to which we restructure accounts that are eligible under the criteria will vary depending upon our view of prevailing economic conditions and other factors which may change from period to period. In addition, for some products, accounts may be restructured without receipt of a payment in certain special circumstances (e.g. upon reaffirmation of a debt owed to us in connection with a Chapter 7 bankruptcy proceeding). We use account restructuring as an account and customer management tool in an effort to increase the value of our account relationships, and accordingly, the application of this tool is subject to complexities, variations and changes from time to time. These policies and practices are continually under review and assessment to assure that they meet the goals outlined above, and accordingly, we modify or permit exceptions to these general policies and practices from time to time. In addition, exceptions to these policies and practices may be made in specific situations in response to legal or regulatory agreements or orders. In the policies summarized below, "hardship restructures" and "workout restructures" refer to situations in which the payment and/or interest rate may be modified on a temporary or permanent basis. In each case, the contractual delinquency status is reset to current. "External debt management plans" refers to situations in which consumers receive assistance in negotiating or scheduling debt repayment through public or private agencies such as Consumers Credit Counseling Services. RESTRUCTURING POLICIES AND PRACTICES HISTORICAL RESTRUCTURING FOLLOWING CHANGES IMPLEMENTED IN THE THIRD POLICIES AND PRACTICES(1),(2),(3) QUARTER 2003(1),(3) --------------------------------------------------------- -------------------------------------------------------- Real estate secured Real estate secured Real Estate - Overall Real Estate - Overall â€¢ An account may be restructured if we receive â€¢ Accounts may be restructured upon receipt of two qualifying payments within the 60 days preceding the two qualifying payments within the 60 days preceding the restructure; we may restructure accounts in hardship, restructure disaster or strike situations with one qualifying payment â€¢ Accounts will be limited to four restructures or no payments in a rolling 60 month period â€¢ Accounts that have filed for Chapter 7 â€¢ Accounts generally are not eligible for bankruptcy protection may be restructured upon receipt of restructure until nine months after origination a signed reaffirmation agreement â€¢ Accounts whose borrowers have filed for â€¢ Accounts subject to a Chapter 13 plan filed Chapter 7 bankruptcy protection may be restructured upon with a bankruptcy court generally require one qualifying receipt of a signed reaffirmation agreement payment to be restructured â€¢ Accounts whose borrowers are subject to a â€¢ Except for bankruptcy reaffirmation and filed Chapter 13 plan filed with a bankruptcy court generally Chapter 13 plans, agreed automatic payment withdrawal or may be restructured upon receipt of one qualifying hardship/disaster/strike, accounts are generally limited payment to one restructure every 12 months â€¢ Except for bankruptcy reaffirmation and filed â€¢ Accounts generally are not eligible for Chapter 13 plans, accounts will generally not be restructure until on books for at least six months restructured more than once in a 12 month period Real Estate - Consumer Lending â€¢ Accounts whose borrowers agree to pay by â€¢ Accounts whose borrowers agree to pay by automatic withdrawal are generally restructured upon automatic withdrawal are generally restructured upon receipt of one qualifying payment(4) receipt of one qualifying payment Real Estate - Mortgage Services(5) â€¢Accounts will generally not be eligible for restructure until nine months after origination and six months after acquisition 42 RESTRUCTURING POLICIES AND PRACTICES HISTORICAL RESTRUCTURING FOLLOWING CHANGES IMPLEMENTED IN THE THIRD POLICIES AND PRACTICES(1),(2),(3) QUARTER 2003(1),(3) --------------------------------------------------------- -------------------------------------------------------- Auto finance Auto finance â€¢ Accounts may be extended if we receive one â€¢ Accounts may generally be extended upon qualifying payment within the 60 days preceding the receipt of two qualifying payments within the 60 days extension preceding the extension â€¢ Accounts may be extended no more than three â€¢ Accounts may be extended by no more than months at a time and by no more than three months in any three months at a time 12-month period â€¢ Accounts will be limited to four extensions â€¢ Extensions are limited to six months over the in a rolling 60 month period, but in no case will an contractual life account be extended more than a total of six months over â€¢ Accounts that have filed for Chapter 7 the life of the account bankruptcy protection may be restructured upon receipt of â€¢ Accounts will be limited to one extension a signed reaffirmation agreement every six months â€¢ Accounts will not be eligible for extension until on the books for at least six months â€¢ Accounts whose borrowers have filed for Chapter 7 bankruptcy protection may be restructured upon receipt of a signed reaffirmation agreement MasterCard and Visa MasterCard and Visa â€¢ Typically, accounts qualify for restructuring â€¢ Typically, accounts qualify for restructuring if we receive two or three qualifying payments prior to if we receive two or three qualifying payments prior to the restructure, but accounts in approved external debt the restructure, but accounts in approved external debt management programs may generally be restructured upon management programs may generally be restructured upon receipt of one qualifying payment receipt of one qualifying payment â€¢ Generally, accounts may be restructured once â€¢ Generally, accounts may be restructured once every six months every six months Private label(6) Private label(6) â€¢ An account may generally be restructured if we â€¢ Accounts originated after October 1, 2002 for receive one or more qualifying payments, depending upon certain merchants require receipt of two or three the merchant qualifying payments to be restructured, except accounts â€¢ Restructuring is limited to once every six in an approved, external debt management program may be months (or longer, depending upon the merchant) for restructured upon receipt of one qualifying payment. revolving accounts and once every 12 months for â€¢ Accounts must be on the books for nine months closed-end accounts and we must receive the equivalent of two qualifying payments within the 60 days preceding the restructure â€¢ Accounts are not eligible for subsequent restructure until 12 months after a prior restructure and upon our receipt of three qualifying payments within the 90 days preceding the restructure 43 RESTRUCTURING POLICIES AND PRACTICES HISTORICAL RESTRUCTURING FOLLOWING CHANGES IMPLEMENTED IN THE THIRD POLICIES AND PRACTICES(1),(2),(3) QUARTER 2003(1),(3) --------------------------------------------------------- -------------------------------------------------------- Personal non-credit card Personal non-credit card â€¢ Accounts may be restructured if we receive one â€¢ Accounts may be restructured upon receipt of qualifying payment within the 60 days preceding the two qualifying payments within the 60 days preceding the restructure; may restructure accounts in a hardship/ restructure disaster/strike situation with one qualifying payment or â€¢ Accounts will be limited to one restructure no payments every six months â€¢ If an account is never more than 90 days â€¢ Accounts will be limited to four restructures delinquent, it may generally be restructured up to three in a rolling 60 month period times per year â€¢ Accounts will not be eligible for restructure â€¢ If an account is ever more than 90 days until six months after origination delinquent, it may be restructured with one qualifying payment no more than four times over its life; however, generally the account may thereafter be restructured if two qualifying payments are received â€¢ Accounts subject to programs for hardship or strike may require only the receipt of reduced payments in order to be restructured; disaster may be restructured with no payments -------------- (1) We employ account restructuring and other customer account management policies and practices as flexible customer account management tools. In addition to variances in criteria by product, criteria may also vary within a product line (for example, in our private label credit card business, criteria may vary from merchant to merchant). Also, we continually review our product lines and assess restructuring criteria and they are subject to modification or exceptions from time to time. Accordingly, the description of our account restructuring policies or practices provided in this table should be taken only as general guidance to the restructuring approach taken within each product line, and not as assurance that accounts not meeting these criteria will never be restructured, that every account meeting these criteria will in fact be restructured or that these criteria will not change or that exceptions will not be made in individual cases. In addition, in an effort to determine optimal customer account management strategies, management may run more conservative tests on some or all accounts in a product line for fixed periods of time in order to evaluate the impact of alternative policies and practices. (2) For our United Kingdom business, all portfolios have a consistent account restructure policy. An account may be restructured if we receive two or more qualifying payments within two calendar months, limited to one restructure every 12 months, with a lifetime limit of three times. In hardship situations an account may be restructured if a customer makes three consecutive qualifying monthly payments within the last three calendar months. Only one hardship restructure is permitted in the life of a loan. There were no changes to the restructure policies of our United Kingdom business in 2003. (3) Generally, policy changes will not be applied to the entire portfolio on the date of implementation and may be applied to new, or recently originated or acquired accounts. However, for ease of administration, in the third quarter of 2003 our mortgage services business elected to adopt uniform policies for all products regardless of the date an account was originated or acquired. Implementation of the uniform policy has the effect of only counting restructures occurring on or after January 1, 2003 in assessing restructure eligibility for the purpose of the limitation that no account may be restructured more than four times in a rolling 60 month period. Resetting these counters will not impact the ability of mortgage services to report historical restructure statistics. Other business units may also elect to adopt uniform policies. Unless otherwise noted, the revisions to the restructure policies and practices implemented in the third quarter 2003 will generally be applied only to accounts originated or acquired after January 1, 2003 and the historical restructuring policies and practices are effective for all accounts originated or acquired prior to January 1, 2003. We do not expect the changes to have a significant impact on our business 44 model or results of operations as these changes will generally be phased in as receivables are originated or acquired. (4) Our mortgage services business implemented this policy for all accounts effective March 1, 2004. (5) Prior to January 1, 2003, accounts that had made at least six qualifying payments during the life of the loan and that agreed to pay by automatic withdrawal were generally restructured with one qualifying payment. (6) For our Canadian business, private label is limited to one restructure every four months. For private label accounts in our Canadian business originated or acquired after January 1, 2003, two qualifying payments must be received, the account must be on the books for at least six months, at least six months must have elapsed since the last restructure, and there may be no more than four restructures in a rolling 60 month period. In addition to our restructuring policies and practices, we employ other customer account management techniques, which we typically use on a more limited basis, that are similarly designed to manage customer relationships, maximize collection opportunities and avoid foreclosure or repossession if reasonably possible. These additional customer account management techniques include, at our discretion, actions such as extended payment arrangements, approved external debt management plans, forbearance, modifications, loan rewrites and/or deferment pending a change in circumstances. We typically use these customer account management techniques with individual borrowers in transitional situations, usually involving borrower hardship circumstances or temporary setbacks that are expected to affect the borrower's ability to pay the contractually specified amount for some period of time. These actions vary by product and are under continual review and assessment to determine that they meet the goals outlined above. For example, under a forbearance agreement, we may agree not to take certain collection or credit agency reporting actions with respect to missed payments, often in return for the borrower's agreeing to pay us an extra amount in connection with making future payments. In some cases, these additional customer account management techniques may involve us agreeing to lower the contractual payment amount and/or reduce the periodic interest rate. In most cases, the delinquency status of an account is considered to be current if the borrower immediately begins payment under the new account terms, although if the agreed terms are not adhered to by the customer the account status may be reversed and collection action resumed. When we use a customer account management technique, we may treat the account as being contractually current and will not reflect it as a delinquent account in our delinquency statistics. However, if the account subsequently experiences payment defaults, it will again become contractually delinquent. We generally consider loan rewrites to involve an extension of a new loan, and such new loans are not reflected in our delinquency or restructuring statistics. The tables below summarize approximate restructuring statistics in our managed basis domestic portfolio. We report our restructuring statistics on a managed basis only because the receivables that we securitize are subject to underwriting standards comparable to our owned portfolio, are serviced and collected without regard to ownership and result in a similar credit loss exposure for us. Our restructure statistics are compiled using certain assumptions and estimates and we continue to enhance our ability to capture restructure data across all business units. When comparing restructuring statistics from different periods, the fact that our restructure policies and practices will change over time, that exceptions are made to those policies and practices, and that our data capture methodologies will be enhanced over time, should be taken into account. Further, to the best of our knowledge, most of our competitors do not disclose account restructuring, reaging, loan rewriting, forbearance, modification, deferment or extended payment information comparable to the information we have disclosed, and the lack of such disclosure by other lenders may limit the ability to draw meaningful conclusions about us and our business based solely on data or information regarding account restructuring statistics or policies. 45 Total Restructured by Restructure Period - Domestic Portfolio(1) (Managed Basis) At December 31, -------------------------- 2003 2002 ----------- ----------- Never restructured 84.4 % 84.4 % Restructured: Restructured in the last 6 months 6.7 6.5 Restructured in the last 7-12 months 3.8 4.1 Previously restructured beyond 12 months 5.1 5.0 ----- ----- Total ever restructured(2) 15.6 15.6 ----- ----- Total 100.0 % 100.0 % ----- ----- Total Restructured by Product - Domestic Portfolio(1) (Managed Basis) At December 31, ------------------------------------------------------------ 2003 2002 ---------------------------- ---------------------------- (Dollar amounts are stated in millions) Real estate secured $ 9,548.5 19.4% $ 8,473.2 19.0% Auto finance 1,295.5 14.7 1,242.9 16.7 MasterCard/Visa 583.7 3.1 540.8 3.2 Private label 1,064.6 7.1 1,255.4 9.7 Personal non-credit card 4,074.9 26.6 3,768.1 23.0 -------- ----- -------- ----- Total(2) $ 16,567.2 15.6% $ 15,280.4 15.6% -------- ----- -------- ----- -------------- (1) Excludes foreign businesses, commercial and other. Amounts also include accounts as to which the delinquency status has been reset to current for reasons other than restructuring (e.g. correcting the misapplication of a timely payment). (2) Total including foreign businesses was 14.7 percent at December 31, 2003 and 14.8 percent at December 31, 2002. See "Credit Quality Statistics" for further information regarding owned basis and managed basis delinquency, charge-offs and nonperforming loans. The amount of domestic and foreign managed receivables in forbearance, modification, credit card services approved consumer credit counseling accommodations, rewrites or other customer account management techniques for which we have reset delinquency and that is not included in the restructured or delinquency statistics was approximately $1.0 billion or .9% of managed receivables at December 31, 2003 compared with approximately $900 million or .8% of managed receivables at December 31, 2002. 46 Consumer Two-Month-and-Over Contractual Delinquency Ratios - Owned Basis(1) 2003 2002 ------------------------------------------ ----------------------------------------- Dec. 31 Sept. 30 June 30 March 31 Dec. 31 Sept. 30 June 30 March 31 --------- -------- -------- -------- -------- -------- -------- -------- Real estate secured 4.33 % 4.20 % 4.27 % 4.15 % 3.91 % 3.22 % 2.78 % 2.88 % Auto finance 2.51 2.14 2.49 2.75 3.96 3.33 2.99 2.04 MasterCard/Visa 5.76 5.99 5.97 6.87 5.97 6.36 6.13 6.54 Private label 5.42 5.59 5.45 6.06 6.36 6.84 6.19 6.33 Personal non-credit 10.01 9.96 9.39 9.23 8.95 8.38 8.69 8.78 card ----- ---- ---- ---- ---- ---- ---- ---- Total consumer 5.36 % 5.36 % 5.38 % 5.50 % 5.34 % 4.87 % 4.53 % 4.63 % ----- ---- ---- ---- ---- ---- ---- ---- -------------- (1) Our policies and practices for the collection of consumer receivables, including our customer account management policies and practices, permit us to reset the contractual delinquency status of an account to current, based on indicia or criteria which, in our judgment, evidence continued payment probability. When we use a customer account management technique, we may treat the account as being contractually current and will not reflect it as a delinquent account in our delinquency statistics. However, if the account subsequently experiences payment defaults and becomes at least two months contractually delinquent, it will be reported in our delinquency ratios. Compared to September 30, 2003, our total consumer delinquency ratio was flat at December 31, 2003. Excluding the impact of the sale of $2.8 billion of our higher quality non-conforming real estate secured loans to HSBC Bank USA on December 31, 2003, real estate delinquency ratio would have decreased to 4.11 percent and our total delinquency ratio would have decreased to 5.21 percent. Both credit card portfolios showed quarterly declines in the delinquency ratios as a result of the benefit of seasonal receivable growth. Though not yet reflected in our delinquency rates at December 31, 2003, early roll rates in all of our products showed improvement in the fourth quarter as a result of improvements in the economy and better underwriting in some products. We believe these improvements, together with loan growth, may result in lower delinquency rates in the first half of 2004. Compared to December 31, 2002, total consumer delinquency was essentially flat, but would have declined 13 basis points excluding the previously discussed $2.8 billion real estate secured loan sale. Real estate secured delinquency rates also reflect the $2.8 billion loan sale as well as higher levels of receivables in foreclosure. Auto finance delinquency reflects the positive impact of strategic alliance acquisitions, tightened underwriting and lower securitization levels. The decrease in our MasterCard and Visa portfolio reflects receivable growth, including portfolio acquisitions, and improvements in the U.K. These improvements were partially offset by a growing percentage of subprime receivables in our portfolio. Though subprime delinquency rates were relatively stable during 2003, these receivables continue to have higher delinquency rates than our prime MasterCard and Visa receivables. Private label delinquency rates reflect improved underwriting, collections and credit models. The increase in our personal non-credit card portfolio reflects continued maturation of the portfolio as well as reduced originations. See "Credit Quality Statistics - Managed Basis" for additional information regarding our managed basis credit quality. See "Customer Account Management Policies and Practices" regarding the treatment of restructured accounts and accounts subject to forbearance and other customer account management tools. 47 Consumer Net Charge-off Ratios - Owned Basis 2003 2002 ------------------------------------------- ---------------------------------------------- Quarter Ended (Annualized) Quarter Ended (Annualized) 2001 Full ------------------------------------- Full --------------------------------------- Full Year Dec. 31 Sept. 30 June 30 Mar. 31 Year Dec. 31 Sept. 30 June 30 Mar. 31 Year ---- ------- -------- ------- ------- ---- ------- -------- ------- ------- ---- Real estate .99% .94% .91% 1.03% 1.12% .91% 1.10% 1.03% .85% .65% .52% secured(1) Auto 4.91 3.36 4.62 5.30 7.71 6.00 8.50 5.50 4.80 5.63 4.00 finance(1) MasterCard/ 9.18 8.55 8.61 10.43 9.26 9.46 9.02 9.21 9.94 9.73 8.17 Visa Private 5.75 5.05 5.35 6.41 6.27 6.28 6.35 6.65 5.86 6.25 5.59 label Personal 9.89 10.11 10.55 9.87 9.04 8.26 7.74 8.96 8.59 7.71 6.81 non-credit card ---- ------- -------- ------- ------- ---- ------- -------- ------- ------- ---- Total 4.06% 3.75% 3.98% 4.34% 4.22% 3.81% 3.87% 3.98% 3.76% 3.61% 3.32% consumer(1) ---- ------- -------- ------- ------- ---- ------- -------- ------- ------- ---- Real estate 1.42% 1.37% 1.35% 1.46% 1.52% 1.29% 1.47% 1.38% 1.23% 1.05% .84% charge-offs and REO expense as a percent of average real estate secured receivables ---- ------- -------- ------- ------- ---- ------- -------- ------- ------- ---- (1) As discussed in "New Accounting Pronouncements", we adopted FSP 144-1 in November 2003. The adoption increased real estate charge-offs by $9.1 million and auto finance charge-offs by $1.2 million for the quarter ended December 31, 2003. The adoption increased real estate charge-offs by 7 basis points for the quarter ended December 31, 2003 and 1 basis point for the full year 2003, auto finance charge-offs by 12 basis points for the quarter ended December 31, 2003 and 4 basis points for the full year 2003, and total consumer charge-offs by 4 basis points for the quarter ended December 31, 2003 and 1 basis point for the full year 2003. The impact on prior periods was not material. For the full year, higher levels of new bankruptcy filings and the weak economy, including higher unemployment, continued to negatively affect charge-off rates in all products while average receivable growth positively impacted all products except personal non-credit card. Average receivable growth includes portfolio acquisitions in our MasterCard and Visa and private label portfolios and newly originated loans acquired from strategic alliances in our auto finance portfolio. Auto finance charge-off rates also reflect improved underwriting and lower securitization levels. Loss severities on repossessed vehicles in our auto finance business remain high, but were stable during 2003. Our private label charge-off rates also reflect improved underwriting, collections and credit models. Charge-off rates in our personal non-credit card portfolio reflect continued maturation of the portfolio as well as reduced originations. The increase in real estate charge-offs and REO expense as a percent of average real estate secured receivables over the 2002 ratio was the result of the seasoning of our portfolios, higher loss severities and higher bankruptcy filings. The increases in charge-off ratios in 2002 compared to 2001 reflect the weak economy and higher bankruptcy filings. Though we took a number of steps designed to reduce our credit losses, including tightening underwriting, reducing unused credit lines, strengthening risk model capabilities and adding collectors, the weak economy, including higher bankruptcy rates, resulted in higher charge-off ratios in all of our products. The increase in the auto finance ratio was due in part to higher loss severities on repossessed vehicles. The increase in the MasterCard and Visa ratio reflects a higher percentage of subprime receivables in the portfolio. Though subprime charge-off rates declined in 2002, these receivables have higher loss rates than other MasterCard and Visa receivables. Charge-offs in our personal non-credit card portfolio increased more than our other unsecured products because our typical personal non-credit card customer is less resilient and, therefore, more exposed to economic downturns. The increase in real estate charge-offs and REO expense as a percent of average real estate secured receivables over the 2001 ratio was the result of the seasoning of our portfolios, higher loss severities, especially in second lien mortgages, and higher bankruptcy filings. See "Credit Quality Statistics - Managed Basis" for additional information regarding our managed basis credit quality. 48 Credit Loss Reserves We maintain credit loss reserves to cover probable losses of principal, interest and fees, including late, overlimit and annual fees. Credit loss reserves are based on a range of estimates and are intended to be adequate but not excessive. We estimate probable losses for owned consumer receivables using a roll rate migration analysis that estimates the likelihood that a loan will progress through the various stages of delinquency, or buckets, and ultimately charge off. This analysis considers delinquency status, loss experience and severity and takes into account whether loans are in bankruptcy, have been restructured or rewritten, or are subject to forbearance, an external debt management plan, hardship, modification, extension or deferment. Our credit loss reserves also take into consideration the loss severity expected based on the underlying collateral, if any, for the loan in the event of default. Delinquency status may be affected by customer account management policies and practices, such as the restructure of accounts, forbearance agreements, extended payment plans, modification arrangements, consumer credit counseling accommodations, loan rewrites and deferments. If customer account management policies, or changes thereto, shift loans from a "higher" delinquency bucket to a "lower" delinquency bucket, this will be reflected in our roll rate statistics. To the extent that restructured accounts have a greater propensity to roll to higher delinquency buckets, this will be captured in the roll rates. Since the loss reserve is computed based on the composite of all of these calculations, this increase in roll rate will be applied to receivables in all respective delinquency buckets, which will increase the overall reserve level. In addition, loss reserves on consumer receivables are maintained to reflect our judgment of portfolio risk factors that may not be fully reflected in the statistical roll rate calculation. Risk factors considered in establishing loss reserves on consumer receivables include recent growth, product mix, bankruptcy trends, geographic concentrations, economic conditions, portfolio seasoning and current levels of charge-offs and delinquencies. While our credit loss reserves are available to absorb losses in the entire portfolio, we specifically consider the credit quality and other risk factors for each of our products. We recognize the different inherent loss characteristics in each of our products as well as customer account management policies and practices and risk management/collection practices. Charge-off policies are also considered when establishing loss reserve requirements to ensure the appropriate reserves exist for products with longer charge-off periods. We also consider key ratios such as reserves to nonperforming loans and reserves as a percentage of net charge-offs in developing our loss reserve estimate. Loss reserve estimates are reviewed periodically and adjustments are reported in earnings when they become known. As these estimates are influenced by factors outside of our control, such as consumer payment patterns and economic conditions, there is uncertainty inherent in these estimates, making it reasonably possible that they could change. The following table sets forth owned basis credit loss reserves for the periods indicated: At December 31, ------------------------------------------------------------------- 2003 2002 2001 2000 1999 ----------- ----------- ----------- ----------- ----------- (All dollar amounts are stated in millions) Owned credit loss reserves $ 3,793.1 $ 3,332.6 $ 2,663.1 $ 2,111.9 $ 1,757.0 Reserves as a percent of 4.11 % 4.04 % 3.33 % 3.14 % 3.36 % receivables Reserves as a percent of 105.7 106.5 110.5 109.9 101.1 net charge-offs Reserves as a percent of 93.7 94.5 92.7 91.1 87.9 nonperforming loans We increased credit loss reserves by recording owned loss provision greater than charge-offs of $379.4 million in 2003 and $602.9 million in 2002. Reserve levels at December 31, 2003 reflect receivable growth as well as consideration of key ratios such as reserves as a percentage of net charge-offs and reserves as a percentage of nonperforming loans. Reserves as a percentage of receivables at December 31, 2003 were higher than at December 31, 2002 as a result of the sale of $2.8 billion of higher quality real estate secured loans to HSBC Bank USA in December 2003. Had this sale not occurred, reserves as a percentage of receivables at December 2003 would have been lower than 2002 as a result of improving credit quality in the latter half of 2003 as delinquency rates stabilized and charge-off levels improved. Our loan portfolio has experienced a continued shift in product mix to real estate secured receivables. Real estate secured receivables, which historically have had lower loss rates than unsecured loans, represented 49 55 percent of our receivables at December 31, 2003 compared to 47 percent at December 31, 1999. The ratios in 2002 and 2001 reflect the impact of the weak economy, higher delinquency levels, and uncertainty as to the ultimate impact the weakened economy would have on delinquency and charge-off levels. The ratios in 2000 and 1999 reflect improving credit quality trends and the benefits of the continued run-off of our undifferentiated Household Bank branded MasterCard and Visa portfolio. For securitized receivables, we also record a provision for estimated probable losses that we expect to incur under the recourse provisions. The following table sets forth managed credit loss reserves for the periods indicated: At December 31, ------------------------------------------------------------------- 2003 2002 2001 2000 1999 ----------- ----------- ----------- ----------- ----------- (All dollar amounts are stated in millions) Managed credit loss $ 6,166.6 $ 5,092.1 $ 3,811.4 $ 3,194.2 $ 2,666.6 reserves Reserves as a percent of 5.20 % 4.74 % 3.78 % 3.65 % 3.72 % receivables Reserves as a percent of 117.4 113.8 110.7 111.1 98.2 net charge-offs Reserves as a percent of 118.0 112.6 105.0 107.0 100.1 nonperforming loans See the "Analysis of Credit Loss Reserves Activity" and "Reconciliations to GAAP Financial Measures" for additional information regarding our owned basis and managed basis loss reserves. Owned Nonperforming Assets At December 31, ----------------------------------------------------------- 2003 2002 2001 ----------------- ----------------- ----------------- (All dollar amounts are stated in millions) Nonaccrual receivables $ 3,143.6 $ 2,665.9 $ 2,027.5 Accruing consumer receivables 90 or more 904.5 860.7 844.1 days delinquent Renegotiated commercial loans 1.6 1.3 2.1 ------- ------- ------- Total nonperforming receivables 4,049.7 3,527.9 2,873.7 Real estate owned 631.2 427.1 398.9 ------- ------- ------- Total nonperforming assets $ 4,680.9 $ 3,955.0 $ 3,272.6 ------- ------- ------- The increase in nonaccrual receivables is primarily attributable to increases in our real estate secured and personal non-credit card portfolios. Accruing consumer receivables 90 or more days delinquent includes domestic MasterCard and Visa and private label credit card receivables, consistent with industry practice. The increase in total nonperforming assets is attributable to growth in our owned portfolio. Geographic Concentrations The state of California accounts for 14 percent of our domestic owned portfolio. No other state accounts for more than 10 percent of either our domestic owned or managed portfolio. Because of our centralized underwriting, collections and processing functions, we can quickly change our credit standards and intensify collection efforts in specific locations. We believe this lowers risks resulting from such geographic concentrations. Our foreign consumer operations located in the United Kingdom and Europe accounted for 8 percent of owned consumer receivables and Canada accounted for 2 percent of owned consumer receivables at December 31, 2003. LIQUIDITY AND CAPITAL RESOURCES Our continued success and prospects for growth are largely dependent upon access to the global capital markets. Numerous factors, internal and external, may impact our access to and the costs associated with issuing debt in these markets. These factors may include our debt ratings, overall economic conditions, overall 50 capital markets volatility and the effectiveness of our management of credit risks inherent in our customer base. The merger with HSBC has improved our access to the capital markets and lowered our funding costs. In addition to providing several important sources of direct funding, our affiliation with HSBC is also expanding access to a worldwide pool of potential investors. While these new funding synergies will reduce our reliance on traditional sources to fund our growth, we are focused on balancing our use of affiliate and third-party funding sources to minimize funding expense while maximizing liquidity. Because we are now a subsidiary of HSBC, our credit spreads relative to treasuries have tightened since the merger. In 2003, these tightened credit spreads have resulted in cash funding expense savings of approximately $125 million compared to the funding costs we would have incurred using average spreads from the first half of 2002. It is anticipated that these tightened credit spreads and other funding synergies will eventually enable HSBC to realize annual cash funding expense savings, including external fee savings, in excess of $1 billion per year as our existing term debt matures over the course of the next few years. The portion of these savings to be realized by Household will depend in large part upon the amount and timing of the proposed domestic private label and MasterCard and Visa credit card receivable transfers to HSBC Bank USA and other initiatives between Household and HSBC subsidiaries. Amortization of purchase accounting fair value adjustments to our external debt obligations, including derivative financial instruments, as a result of the HSBC merger reduced interest expense by $884.9 million in 2003. As of December 31, 2003, we had received $14.7 billion in HSBC related funding as detailed in the table below. We also implemented revolving credit facilities with HSBC of $2.5 billion domestically and $4.5 billion in the U.K. (In billions) Debt issued to HSBC subsidiaries: Domestic short-term borrowings $ 2.7 Drawings on bank lines in the U.K. 3.4 Term debt 1.3 Preferred securities issued by Household Capital Trust .3 VIII ---- Total debt issued to HSBC subsidiaries 7.6 ---- Debt issued to HSBC clients: Euro commercial paper 2.8 Term debt .4 ---- Total debt issued to HSBC clients 3.2 Preferred stock issued to HSBC 1.1 Cash received on sale of real estate secured loans to HSBC 2.8 Bank USA ---- Total HSBC related funding $ 14.7 ---- We maintained an investment security liquidity portfolio of $7.9 billion at December 31, 2003, including $2.4 billion which is dedicated to our credit card bank. Our investment securities balance at December 31, 2003 was unusually high as a result of the cash received from the $2.8 billion real estate secured loan sale to HSBC Bank USA on December 31, 2003 as well as excess liquidity. Our insurance subsidiaries also held an additional $3.1 billion in investment securities at December 31, 2003. In managing capital, we develop targets for tangible shareholder's(s') equity to tangible managed assets ("TETMA"), tangible shareholder's(s') equity plus owned loss reserves to tangible managed assets ("TETMA + Owned Reserves") and tangible common equity to tangible managed assets. These ratio targets are based on discussions with HSBC and rating agencies, risks inherent in the portfolio, the projected operating environment and related risks, and any acquisition objectives. Our targets may change from time to time to accommodate changes in the operating environment or other considerations such as those listed above. 51 We are committed to maintaining at least a mid-single "A" rating and as part of that effort will continue to review appropriate capital levels with our rating agencies. Selected capital ratios were as follows(1): At December 31, -------------------------- 2003 2002 ----------- ----------- TETMA 7.08 % 9.08 % TETMA + Owned Reserves 9.94 11.87 Tangible common equity to tangible managed assets 5.08 6.83 Common and preferred equity to owned assets 14.82 10.64 Excluding purchase accounting adjustments: TETMA 8.89 9.08 TETMA + Owned Reserves 11.76 11.87 Tangible common equity to tangible managed assets 6.93 6.83 -------------- (1) These capital ratios (excluding common and preferred equity to owned assets) represent non-GAAP financial ratios that are used by Household management and certain rating agencies to evaluate capital adequacy and may differ from similarly named measures presented by other companies. See "Reconciliations to GAAP Financial Measures" for additional discussion and quantitative reconciliations to the equivalent GAAP basis financial measure. Following completion of the merger with HSBC, Standard & Poor's upgraded our long-term debt rating to "A" and our short-term debt rating to "A-1"; Moody's Investors Service ("Moody's) placed our long-term debt ratings on review for possible upgrade and Fitch Ratings confirmed our debt ratings and removed us from "Ratings Watch Evolving". These revised ratings and actions also apply to our principal borrowing subsidiaries, including Household Finance Corporation ("HFC"). In June 2003, Moody's upgraded our senior debt rating from A3 to A2 and HFC's senior debt rating from A2 to A1. Parent Company Household International, Inc. is the holding or parent company that owns the outstanding common stock of its subsidiaries. The parent company's main source of funds is cash received from its subsidiaries in the form of dividends and intercompany borrowings. In addition, the parent company may receive cash from third parties or affiliates by issuing preferred stock and debt. The parent company received dividends from its subsidiaries of $158.8 million in 2003 and $1.3 billion, including $945 million in connection with the disposition of the assets and deposits of the Thrift, in 2002. Dividends from subsidiaries are managed to ensure subsidiaries are adequately capitalized. During the first quarter of 2003, in conjunction with our acquisition by HSBC, the parent company redeemed outstanding shares of its $4.30, $4.50 and 5.00 percent cumulative preferred stock pursuant to their respective terms. Additionally, outstanding shares of its 7.625, 7.60, 7.50 and 8.25 percent preferred stock were converted into the right to receive cash from HSBC in an amount equal to their liquidation value, plus accrued and unpaid dividends up to but not including the effective date of the merger which was an aggregate amount of $1.1 billion. In consideration of HSBC transferring sufficient funds to make the payments described above with respect to the 7.625, 7.60, 7.50, and 8.25 percent preferred stock, the parent company issued a new series of 6.50 percent cumulative preferred stock in the amount of $1.1 billion to HSBC on March 28, 2003. The parent company issued $350 million of 7.625 percent cumulative preferred stock in September 2002 and $400 million of 7.60 percent cumulative preferred stock in March 2002. In August 2003, the parent company redeemed Household Capital Trusts I and IV. The preferred securities issued by these Trusts totaled $275 million and were replaced with $275 million of 6.375% preferred securities of Household Capital Trust VIII which were issued to HSBC. The parent company issued 18.7 million shares of common stock in October 2002. 52 The parent company has a number of obligations to meet with its available cash. It must be able to service its debt and meet the capital needs of its subsidiaries. It also must pay dividends on its preferred stock and may pay dividends on its common stock. No dividends were paid to HSBC on our common stock as a result of the negative tax consequences of paying such dividends in 2003 following the merger. The parent company paid $434.0 million in common and preferred dividends prior to the merger in 2003 and $509.7 million in common and preferred dividends in 2002. We anticipate paying future dividends to HSBC, but will maintain our capital at levels necessary to maintain at least a mid-single "A" rating either by limiting the dividends to or through capital contributions from our parent. At various times, the parent company will make capital contributions to its subsidiaries to comply with regulatory guidance, support receivable growth, maintain acceptable investment grade ratings at the subsidiary level, or provide funding for long-term facilities and technology improvements. No capital contributions to subsidiaries were made by the parent company in 2003. In 2002, the parent company made capital contributions of $900 million to its Thrift subsidiary and HFC made a $250 million capital contribution to its banking subsidiary. In connection with the disposition of Thrift assets and deposits in the fourth quarter of 2002, a dividend of $945 million was received by the parent company. At December 31, 2002, the parent company had agreements to purchase, on a forward basis, approximately 4.9 million shares of its common stock at a weighted-average forward price of $53.05 per share. As a result of settlements under these forward contracts, the parent company received 2.9 million shares of Household common stock at an average cost of $57.34 per share during the period January 1 through March 28, 2003, 4.7 million shares at an average cost of $58.91 per share during 2002 and 9.8 million shares at an average cost of $47.03 per share in 2001. Upon completion of our acquisition by HSBC, outstanding forward agreements were converted into agreements to purchase HSBC Ordinary Shares on a forward basis. At that time, a liability was established as part of the purchase accounting adjustments for the estimated settlement value of the forward contracts outstanding. On April 30, 2003, the parent company elected to net cash settle all open forward purchase agreements with the counterparty which resulted in a payment of approximately $36.7 million being made to the counterparty. Subsidiaries We have two major subsidiaries: HFC and Household Global Funding ("Global"). HFC HFC funds its operations by collecting receivable balances; issuing commercial paper, medium-term debt and long-term debt; securitizing and selling consumer receivables; borrowing under secured financing facilities; and receiving capital contributions from its parent. HFC domestically markets its commercial paper primarily through an in-house sales force. The vast majority of HFC's domestic medium-term notes and long-term debt is now marketed through subsidiaries of HSBC. Domestic medium-term notes may also be marketed through HFC's in-house sales force and investment banks. Long-term debt may also be marketed through investment banks. At December 31, 2003, advances from subsidiaries of HSBC to HFC totaled $3.9 billion. The interest rates on this funding are market-based and comparable to those available from unaffiliated parties. HFC's outstanding commercial paper totaled $7.9 billion at December 31, 2003, a $3.8 billion increase from the December 31, 2002 balance of $4.1 billion. The increase is attributable to the upgrade of our debt ratings following the HSBC merger which expanded our universe of potential buyers and to a new Euro commercial paper program which has expanded our European base. Under the new Euro commercial paper program, commercial paper denominated in Euros, British pounds and U.S. dollars are sold to foreign investors. At December 31, 2003, outstanding Euro commercial paper totaled $2.8 billion, all of which had been sold to clients of HSBC. HFC actively manages the level of commercial paper outstanding to ensure availability to core investors and proper use of any excess capacity within internally-established targets. During 2003, HFC issued $3.8 billion in domestic medium-term notes, $6.4 billion in foreign currency-denominated bonds (including $1.3 billion issued to subsidiaries of HSBC and $370 million issued to HSBC clients) and $5.1 billion in global debt. HFC also issued $2.1 billion of InterNotesSM (retail-oriented medium-term notes). In order to eliminate future foreign exchange risk, currency swaps were used at the time of issuance to fix in U.S. dollar terms substantially all foreign-denominated notes. 53 HFC issued securities backed by dedicated receivables of $3.3 billion in 2003 and $7.5 billion in 2002. For accounting purposes, these transactions were structured as secured financings, therefore, the receivables and the related debt remain on HFC's balance sheet. At December 31, 2003, closed-end real estate secured receivables totaling $8.0 billion secured $6.7 billion of outstanding debt. At December 31, 2002, closed-end real estate secured receivables totaling $8.5 billion secured $7.5 billion of outstanding debt related to these transactions. In 2002, HFC also issued $542 million of 8.875 percent Adjustable Conversion-Rate Equity Security Units. HFC had committed back-up lines of credit totaling $10.1 billion at December 31, 2003. Included in this total is a $2.5 billion revolving credit facility with HSBC. None of these back-up lines were drawn upon in 2003. HFC's back-up lines expire on various dates through 2007 and do not contain independent financial covenants that could restrict availability other than an obligation to maintain maintenance of minimum shareholder's equity of $5.8 billion which is substantially below HFC's December 31, 2003 shareholder's equity balance of $13.7 billion. At December 31, 2003, HFC had facilities with commercial and investment banks under which it may securitize up to $16.1 billion of receivables, including up to $14.4 billion of auto finance, MasterCard, Visa, private label and personal non-credit card receivables and $1.75 billion of real estate secured receivables. As a result of additional liquidity capacity now available from HSBC and its subsidiaries, HFC reduced its total conduit capacity by $3.4 billion in 2003. Conduit capacity for real estate secured receivables was decreased $4.5 billion and capacity for other products was increased $1.1 billion. The facilities are renewable at the banks' option. At December 31, 2003, $11.5 billion of auto finance, MasterCard and Visa, private label and personal non-credit card receivables and $.75 billion of real estate secured receivables were securitized under these programs. The amount available under the facilities will vary based on the timing and volume of public securitization transactions. Through existing term bank financing and new debt issuances, we believe HFC should continue to have adequate sources of funds. On July 1, 2002, Household combined all of its credit card banks into a single credit card banking subsidiary of HFC. We believe the combination of the banks streamlines and simplifies our regulatory structure as well as optimizes capital and liquidity management. Global Global includes our foreign subsidiaries in the United Kingdom, Canada and Europe. Global's assets were $12.0 billion at year-end 2003 and $8.5 billion at year-end 2002. Consolidated shareholder's(s') equity includes the effect of translating our foreign subsidiaries' assets, liabilities and operating results from their local currency into U.S. dollars. We periodically enter into foreign exchange contracts to hedge portions of our investment in foreign subsidiaries. Each foreign subsidiary conducts its operations using its local currency. While each foreign subsidiary usually borrows funds in its local currency, both our United Kingdom and Canadian subsidiaries have borrowed funds directly in the United States capital markets. This allowed the subsidiaries to achieve a lower cost of funds than that available at that time in their local markets. These borrowings were converted from U.S. dollars to their local currencies using currency swaps at the time of issuance. United Kingdom Our United Kingdom operation is funded with wholesale deposits, commercial paper, HSBC subsidiary debt, short and intermediate-term bank lines of credit, long-term debt and securitizations of receivables. Deposits were $230.5 million at December 31, 2003 and $762.7 million at December 31, 2002. Commercial paper, bank and other borrowings at year-end 2003 were $.8 billion compared to $1.6 billion a year ago. Amounts due to subsidiaries of HSBC totaled $3.4 billion at December 31, 2003. Senior debt was $2.4 billion at December 31, 2003 and $2.8 billion at December 31, 2002. At December 31, 2003, $.9 billion of the United Kingdom's total debt was guaranteed by the parent company and $2.4 billion was guaranteed by HFC. HFC receives a fee for providing the guarantee. At December 31, 2003, committed back-up lines of credit for the United Kingdom totaled approximately $5.3 billion, including $4.5 billion with HSBC subsidiaries. $4.1 billion, including $3.4 billion on the HSBC lines, were used at December 31, 2003. The HSBC lines have varying maturities through 2007. Because we 54 expect our United Kingdom subsidiary to receive its 2004 funding directly from HSBC, we expect to eliminate these third-party back-up lines in 2004. At December 31, 2003, the U.K. had securitized receivables totaling $1.1 billion, including $.1 billion securitized under conduit facilities with commercial banks which have not been renewed as a result of funding available from HSBC. Canada Our Canadian operation is funded with commercial paper, intermediate debt and long-term debt. Outstanding commercial paper totaled $307.2 million at December 31, 2003 compared to $431.3 million a year ago. Intermediate and long-term debt totaled $1.5 billion at year-end 2003 compared to $970.8 million a year ago. At December 31, 2003, $1.8 billion of the Canadian subsidiary's debt was guaranteed by HFC, who receives a fee for providing the guarantee. Committed back-up lines of credit for Canada were approximately $385.5 million at December 31, 2003. All of these back-up lines are guaranteed by HFC and none were used in 2003. 2004 Funding Strategy As previously discussed, the merger with HSBC has improved our access to the capital markets as well as expanded our access to a worldwide pool of potential investors. Our estimated domestic funding needs and sources for 2004, which reflect these new markets, are summarized in the table that follows. Because we cannot predict with any degree of certainty the timing as to when or if regulatory approval will be received for our proposed transfer of receivables to HSBC Bank USA, these transfers are not contemplated in the following 2004 funding plan. If these proposed transfers do occur, our external funding needs will decrease. (In billions) -------------------- Funding needs: Net asset growth $ 14-16 Commercial paper, term debt and securitization 24-26 maturities Other 2-5 ----- Total funding needs, including growth $ 40-47 ----- Funding sources: External funding, including HSBC clients $ 34-38 HSBC and HSBC subsidiaries 6-9 ----- Total funding sources $ 40-47 ----- Except during our RAL season when commercial paper balances will be temporarily high, commercial paper outstanding in 2004 is expected to be consistent with post-merger balances. Approximately two-thirds of outstanding commercial paper is expected to be domestic commercial paper sold both directly and through dealer programs. Euro commercial paper, introduced in 2003, is expected to account for approximately one-third of outstanding commercial paper and will be marketed predominately to HSBC clients. Term debt issuances are expected to utilize several ongoing programs to achieve the required funding. Approximately one-half of term debt funding is expected to be achieved through issuance of up to 10 large U.S. dollar global and Euro transactions. Domestic and foreign retail note programs are expected to account for up to 20 percent of term debt issuances. The remaining term debt issuances are expected to consist of domestic and foreign currency medium-term note ("MTN") offerings. Securitization levels in 2004 are expected to remain consistent with 2003 levels. Most asset classes will again be securitized and a single seller asset backed security conduit program will be introduced to provide an additional source of funding. HSBC has received regulatory approval to provide the direct funding required by our United Kingdom operations. Accordingly, we plan to eliminate third-party credit lines, and the related expense, supporting our United Kingdom subsidiary in 2004. Our Canadian operation will continue to fund itself independently 55 through traditional third-party funding sources such as commercial paper and medium term-notes. Funding needs in 2004 are not expected to be significant for Canada. Capital Expenditures We made capital expenditures of $116 million in 2003 and $159 million in 2002. OFF-BALANCE-SHEET ARRANGEMENTS (INCLUDING SECURITIZATIONS AND COMMITMENTS), SECURED FINANCINGS AND CONTRACTUAL CASH OBLIGATIONS Securitizations and Secured Financings Securitizations (which are structured to receive sale treatment under Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a Replacement of FASB Statement No. 125," ("SFAS No. 140")) and secured financings (which do not receive sale treatment under SFAS No. 140) of consumer receivables have been, and will continue to be, a source of funding and liquidity for us. Securitizations and secured financings are used to limit our reliance on the debt and equity markets and often are more cost-effective than alternative funding sources. At December 31, 2003, securitizations structured as sales represented 21 percent and secured financings represented 5 percent of the funding associated with our managed portfolio. At December 31, 2002, securitizations structured as sales represented 23 percent and secured financings represented 7 percent of the funding associated with our managed portfolio. In a securitization, a designated pool of non-real estate consumer receivables is removed from the balance sheet and transferred to an unaffiliated trust. This unaffiliated trust is a qualifying special purpose entity ("QSPE") as defined by SFAS No. 140 and, therefore, is not consolidated. The QSPE funds its receivable purchase through the issuance of securities to investors, entitling them to receive specified cash flows during the life of the securities. The securities are collateralized by the underlying receivables transferred to the QSPE. At the time of sale, an interest-only strip receivable is recorded, representing the present value of the cash flows we expect to receive over the life of the securitized receivables, net of estimated credit losses. Under U.K. GAAP as reported by HSBC, securitizations are treated as secured financings. Certain securitization trusts, such as credit cards, are established at fixed levels and, due to the revolving nature of the underlying receivables, require the sale of new receivables into the trust to replace runoff so that the principal dollar amount of the investors' interest remains unchanged. We refer to such activity as replenishments. Once the revolving period ends, the amortization period begins and the trust distributes principal payments to the investors. When loans are securitized in transactions structured as sales, we receive cash proceeds from investors, net of transaction costs and expenses. These proceeds are generally used to re-pay other debt and corporate obligations and to fund new loans. The investors' shares of finance charges and fees received from the securitized loans are collected each month and are primarily used to pay investors for interest and credit losses and to pay us for servicing fees. We retain any excess cash flow remaining after such payments are made to investors. To help ensure that adequate funds are available to meet the cash needs of the QSPE, we may retain various forms of interests in securitized assets through overcollateralization, subordinated series, residual interests or spread accounts which provide credit enhancement to investors. Overcollateralization is created when the underlying receivables transferred to a QSPE exceed issued securities. The retention of a subordinated interest provides additional assurance of payment to senior security holders. Residual interests are also referred to as interest-only strip receivables and are rights to future cash flows arising from the securitized receivables after the investors receive their contractual return. Spread accounts are cash accounts which are funded from initial deposits from proceeds at the time of sale and/or from excess spread that would otherwise be returned to us. Investors and the securitization trusts have only limited recourse to our assets for failure of debtors to pay. That recourse is limited to our rights to future cash flows and any other subordinated interest that we may retain. Cash flows related to the interest-only strip receivables and the servicing of receivables are collected over the life of the underlying securitized receivables. 56 Our retained securitization interests are not in the form of securities and are included in receivables on our consolidated balance sheets. These retained interests were comprised of the following at December 31, 2003 and 2002: At December 31, ------------------------------- 2003 2002 -------------- ------------- (In millions) Overcollateralization $ 1,684.2 $ 2,143.8 Interest-only strip receivables 953.6 1,147.8 Cash spread accounts 222.7 296.4 Other subordinated interests 4,107.1 2,639.6 ------- ------- Total retained securitization interests $ 6,967.6 $ 6,227.6 ------- ------- In a secured financing, a designated pool of receivables, typically real estate secured, are conveyed to a wholly owned limited purpose subsidiary which in turn transfers the receivables to a trust which sells interests to investors. Repayment of the debt issued by the trust is secured by the receivables transferred. The transactions are structured as secured financings under SFAS No. 140. Therefore, the receivables and the underlying debt of the trust remain on our balance sheet. We do not recognize a gain in a secured financing transaction. Because the receivables and the debt remain on our balance sheet, revenues and expenses are reported consistently with our owned balance sheet portfolio. Using this source of funding results in similar cash flows as issuing debt through alternative funding sources. We believe the market for securities backed by receivables is a reliable, efficient and cost-effective source of funds. However, if the market for securities backed by receivables were to change, we may be unable to securitize our receivables or to do so at favorable pricing levels. Factors affecting our ability to securitize receivables or to do so at cost-effective rates include the overall credit quality of our securitized loans, the stability of the securitization markets, the securitization market's view of our desirability as an investment, and the legal, regulatory, accounting and tax environments governing securitization transactions. Securitizations and secured financings of consumer receivables have been, and will continue to be, a source of our funding and liquidity. Securitization and secured financing levels in 2004 are expected to remain consistent with 2003 levels. We currently anticipate, however, that we will rely less on securitizations and secured financings in the future as we receive funding from HSBC and its clients to partially fund our operations. Under U.K. GAAP, as reported by HSBC, securitizations are treated as secured financings. Therefore, we may structure more of our securitization transactions as financings under U.S. GAAP in the future in order to more closely align our accounting treatment with HSBC's U.K. GAAP treatment. Our securitization and secured financing activity in 2002 exceeded that of both 2003 and 2001. The lower levels in 2003 compared to 2002 reflected the use of additional sources of liquidity provided by HSBC and its subsidiaries. The higher levels in 2002 compared to 2001 reflect our liquidity management plans and were often a more cost-effective source of funding than traditional medium and long-term unsecured debt funding sources. 57 Securitizations and secured financings were as follows: Year Ended December 31, ---------------------------------------------------- 2003 2002 2001 ---------------- ---------------- -------------- (In millions) Initial Securitizations: Auto finance $ 1,523.0 $ 3,288.6 $ 2,573.9 MasterCard/Visa 670.0 1,557.4 261.1 Private label 1,250.0 1,747.2 500.0 Personal non-credit card 3,320.0 3,560.7 2,123.6 -------- -------- -------- Total $ 6,763.0 $ 10,153.9 $ 5,458.6 -------- -------- -------- Replenishment Securitizations: MasterCard/Visa $ 23,432.6 $ 23,647.8 $ 23,030.7 Private label 6,767.3 2,151.2 1,417.6 Personal non-credit card 674.8 325.4 261.0 -------- -------- -------- Total $ 30,874.7 $ 26,124.4 $ 24,709.3 -------- -------- -------- Secured financings - Real estate $ 3,260.0 $ 7,548.6 $ 1,471.0 secured -------- -------- -------- Outstanding securitized receivables consisted of the following: At December 31, ---------------------------------- 2003 2002 ---------------- --------------- (In millions) Real estate secured $ 193.6 $ 456.2 Auto finance 4,674.8 5,418.6 MasterCard/Visa 9,966.7 10,006.1 Private label 5,261.3 3,577.1 Personal non-credit card 6,104.0 5,475.5 -------- -------- Total $ 26,200.4 $ 24,933.5 -------- -------- The following table summarizes the expected amortization of our securitized receivables at December 31, 2003: 2004 2005 2006 2007 2008 Thereafter Total --------- --------- ----------- ------------ ---------- ---------- ---------- (In millions) Real estate secured $ 116.2 $ 77.4 - - - - $ 193.6 Auto finance 1,962.5 1,349.4 $ 1,052.1 $ 310.8 - - 4,674.8 MasterCard/ Visa 3,355.7 3,843.2 1,579.6 854.2 $ 334.0 - 9,966.7 Private label 1,497.1 1,506.1 1,821.1 437.0 - - 5,261.3 Personal non-credit 2,475.6 1,615.7 930.2 488.1 345.2 $ 249.2 6,104.0 card --------- --------- ----------- ------------ ---------- ---------- ---------- Total $ 9,407.1 $ 8,391.8 $ 5,383.0 $ 2,090.1 $ 679.2 $ 249.2 $ 26,200.4 --------- --------- ----------- ------------ ---------- ---------- ---------- At December 31, 2003, the expected weighted-average remaining life of these transactions was 1.64 years. The securities issued with our securitizations may pay off sooner than originally scheduled if certain events occur. For certain auto securitizations, early payoff of securities may occur if established delinquency or loss levels are exceeded. For all other securitizations, early payoff of the securities begins if the annualized portfolio yield drops below a base rate or if certain other events occur. We do not presently believe that any early payoff will take place. If early payoff occurred, our funding requirements would increase. These additional requirements could be met through new securitizations, issuance of various types of debt or borrowings under existing back-up lines of credit. We believe we would continue to have adequate sources of funds if an early payoff event occurred. 58 At December 31, 2003, we had domestic facilities with commercial and investment banks under which we may securitize up to $16.1 billion of receivables. We may securitize up to $14.4 billion of auto finance, MasterCard and Visa, private label and personal non-credit card receivables and $1.75 billion of real estate secured receivables. Draws on the real estate conduit facilities are structured as secured financings for accounting purposes. The facilities are renewable at the banks' option. At December 31, 2003, $11.5 billion of auto finance, MasterCard and Visa, private label, and personal non-credit card receivables and $.75 billion of real estate secured receivables were securitized under these programs. The U.K. also had $.1 billion in receivables securitized under former conduit lines which have not been renewed as a result of funding available from HSBC. The amount available under the facilities will vary based on the timing and volume of public securitization and secured financing transactions. Through existing term bank financing and new debt issuances, we believe we should continue to have adequate sources of funds, which could be impacted from time to time by volatility in the financial markets, if one or more of these facilities were unable to be renewed. Commitments We also enter into commitments to meet the financing needs of our customers. In most cases, we have the ability to reduce or eliminate these open lines of credit. As a result, the amounts below do not necessarily represent future cash requirements: At December 31, 2003 --------------------------- (In billions) MasterCard and Visa and private label credit cards $ 145.0 Other consumer lines of credit 3.4 ----- Open lines of credit $ 148.4 ----- At December 31, 2003, our mortgage services business had commitments with numerous correspondents to purchase up to $1.8 billion of real estate secured receivables at fair market value, subject to availability based on underwriting guidelines specified by our mortgage services business and at prices indexed to general market rates. These commitments have terms of up to one year and can be renewed upon mutual agreement. Contractual Cash Obligations The following table summarizes our long-term contractual cash obligations at December 31, 2003 by period due: 2004 2005 2006 2007 2008 Thereafter Total --------- --------- ----------- ------------ ---------- ---------- ---------- (In millions) Principal balance of debt: Time certificates $ 157.7 $ 1.8 - $ 8.9 - - $ 168.4 of deposit Due to affiliates 6,336.3 - 728.0 - - 525.0 7,589.3 Senior and senior 11,999.3 11,528.9 $ 8,575.0 6,081.0 $ 9,335.8 $ 25,337.7 72,857.7 subordinated debt (including secured financings) --------- --------- ----------- ------------ ---------- ---------- ---------- Total debt 18,493.3 11,530.7 9,303.0 6,089.9 9,335.8 25,862.7 80,615.4 --------- --------- ----------- ------------ ---------- ---------- ---------- Operating leases: Minimum rental 170.2 134.1 122.0 90.5 75.2 229.1 821.1 payments Minimum sublease 24.4 23.6 23.2 23.1 23.0 39.6 156.9 income --------- --------- ----------- ------------ ---------- ---------- ---------- Total operating 145.8 110.5 98.8 67.4 52.2 189.5 664.2 leases --------- --------- ----------- ------------ ---------- ---------- ---------- Obligations under 128.0 131.4 134.9 138.5 135.6 489.2 1,157.6 merchant and affinity programs Non-qualified 22.6 27.5 26.4 26.7 30.7 986.9 1,120.8 pension and postretirement benefit liabilities(1) --------- --------- ----------- ------------ ---------- ---------- ---------- Total contractual $ 18,789.7 $ 11,800.1 $ 9,563.1 $ 6,322.5 $ 9,554.3 $ 27,528.3 $ 83,558.0 cash obligations --------- --------- ----------- ------------ ---------- ---------- ---------- (1) Expected benefit payments calculated include future service component. 59 These cash obligations could be funded primarily through cash collections on receivables, from the issuance of new debt or through securitizations or sales of receivables. Our receivables and other liquid assets generally have shorter lives than the liabilities used to fund them. Our purchase obligations for goods and services at December 31, 2003 were not significant. RISK MANAGEMENT We have a comprehensive program to address potential financial risks, such as liquidity, interest rate, currency and counterparty credit risk. Historically, the Finance Committee of the Board of Directors had set acceptable limits for each of these risks annually and reviewed the limits semi-annually. As a result of the active involvement of and guidelines provided by HSBC, the Finance Committee was dissolved in the first quarter of 2004. In addition, the Household Asset Liability Committee ("ALCO"), meets regularly to review risks and approve appropriate risk management strategies within limits established by the Board of Directors and HSBC. Liquidity Risk Generally, the lives of our assets are shorter than the lives of the liabilities used to fund them. This initially reduces liquidity risk by ensuring that funds are received prior to liabilities becoming due. Our ability to ensure continuous access to the capital markets and maintain a diversified funding base is important in meeting our funding needs. To manage this liquidity risk, we offer a broad line of debt products designed to meet the needs of both institutional and retail investors. We maintain investor diversity by placing paper directly with customers, through selected dealer programs and by targeted issuance of large liquid transactions. Through the issuance of securitizations and secured financings, we are able to access an alternative investor base and further diversify our funding strategies. We also maintain a comprehensive, direct marketing program to ensure our investors receive consistent and timely information regarding our financial performance. The measurement and management of liquidity risk is a primary focus. Three standard analyses are utilized to accomplish this goal. First, a rolling 60 day funding plan is updated daily to quantify near-term needs and develop the appropriate measures to fund those needs. As part of this process, debt maturity profiles (daily, monthly, annually) are generated to assist in planning and limiting any potential rollover risk (which is the risk that we will be unable to pay our debt or borrow additional funds as it becomes due). Second, comprehensive plans identifying monthly funding requirements for the next two years are updated. These plans focus on funding projected asset growth and drive both the timing and size of debt issuances. And third, a Maximum Cumulative Outflow (MCO) analysis is updated regularly to measure liquidity risk. Cumulative comprehensive cash inflows are subtracted from outflows to generate a net exposure that is tracked both monthly over the next 12 month period and annually for 5 years. Net outflow limits are reviewed by Household's Asset Liability Committee and HSBC. We recognize the importance of being prepared for constrained funding environments. While the potential scenarios driving this analysis have changed due to our affiliation with HSBC, contingency funding plans are still maintained as part of the liquidity management process. Alternative funding strategies are updated regularly for a rolling 12 months and assume limited access to unsecured funding and continued access to the securitization markets. These alternative strategies are designed to enable us to achieve monthly funding goals through controlled growth, sales of receivables and access to committed sources of contingent liquidity including bank lines and undrawn securitization conduits. Although our overall liquidity situation has improved significantly over the past twelve months, the strategies and analyses utilized in the past to successfully manage liquidity remain in place today. The combination of this process with the funding provided by HSBC subsidiaries and clients should ensure our access to diverse markets, investor bases and adequate funding for the foreseeable future. See "Liquidity and Capital Resources" for further discussion of our liquidity position. Interest Rate and Currency Risk We maintain an overall risk management strategy that uses a variety of interest rate and currency derivative financial instruments to mitigate our exposure to fluctuations caused by changes in interest rates and currency exchange rates. We manage our exposure to interest rate risk primarily 60 through the use of interest rate swaps, but also use forwards, futures, options, and other risk management instruments. We manage our exposure to currency risk primarily through the use of currency swaps, options and forwards. We do not speculate on interest rate or foreign currency market exposure and we do not use exotic or leveraged derivative financial instruments. Interest rate risk is defined as the impact of changes in market interest rates on our earnings. We use simulation models to measure the impact of changes in interest rates on net interest margin. The key assumptions used in these models include expected loan payoff rates, loan volumes and pricing, cash flows from derivative financial instruments and changes in market conditions. These assumptions are based on our best estimates of actual conditions. The models cannot precisely predict the actual impact of changes in interest rates on our earnings because these assumptions are highly uncertain. At December 31, 2003, our interest rate risk levels were substantially below those allowed by our existing policy. HSBC also has certain limits and benchmarks that serve as guidelines in determining the appropriate levels of interest rate risk. One such limit is expressed in terms of the Present Value of a Basis Point ("PVBP"), which reflects the change in value of the balance sheet for a one basis point movement in all interest rates. Our PVBP limit as of December 31, 2003 was $4.0 million, which includes limits associated with financial instruments. Thus, for a one basis point change in interest rates, the policy dictates that the value of the balance sheet shall not increase or decrease by more than $4.0 million. As of December 31, 2003, we had a PVBP position of $.7 million reflecting the impact of a one basis point increase in interest rates. We estimate that our after-tax earnings would decline by about $70 million at December 31, 2003 and $53 million at December 31, 2002 following a gradual 100 basis point increase in interest rates over a twelve month period and would increase by about $83 million at December 31, 2003 and $52 million at December 31, 2002 following a gradual 100 basis point decrease in interest rates. These estimates include the impact of the derivative positions we have entered into. These estimates also assume we would not take any corrective action to lessen the impact and, therefore, exceed what most likely would occur if rates were to change by the amount indicated. We generally fund our assets with liabilities that have similar interest rate features, but different maturities. This initially reduces interest rate risk. Over time, however, customer demand for our receivable products shifts between fixed rate and floating rate products, based on market conditions and preferences. These shifts in loan products produce different interest rate risk exposures. We use derivative financial instruments, principally swaps, to manage these exposures. Interest rate futures, interest rate forwards and purchased options are also used on a limited basis to reduce interest rate risk. Prior to the merger with HSBC, the majority of our fair value and cash flow hedges were effective hedges which qualified for shortcut accounting under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS No. 133"). Under the Financial Accounting Standards Board's interpretations of SFAS No. 133, the shortcut method of accounting was no longer allowed for interest rate swaps which were outstanding at the time of the merger. The discontinuation of shortcut accounting increased net income by $51.0 million in 2003. We have restructured our swap portfolio to regain use of the shortcut method of accounting and reduce the potential volatility of future earnings. We also use interest rate futures, interest rate forwards and purchased options to reduce interest rate risk. We use these instruments primarily to hedge interest rate changes on our liabilities. For example, short-term borrowings expose us to interest rate risk because the interest rate we must pay to others may change faster than the rate we receive from borrowers. Futures, forwards and options are used to fix our interest cost on these borrowings at a desired rate and are held until the interest rate on the asset changes. We then terminate, or close out, the derivative financial instrument. These terminations are necessary because the date the interest rate changes is usually not the same as the expiration date of the derivative contracts. Foreign currency exchange risk refers to the potential changes in current and future earnings or capital arising from movements in foreign exchange rates. We enter into foreign exchange rate forward contracts and currency swaps to minimize currency risk associated with changes in the value of foreign-denominated liabilities. Currency swaps convert principal and interest payments on debt issued from one currency to another. For example, we may issue Euro-denominated debt and then execute a currency swap to convert the 61 obligation to U.S. dollars. Prior to the merger, we had periodically entered into foreign exchange contracts to hedge portions of our investments in our United Kingdom and Canada subsidiaries. We estimate that a 10 percent adverse change in the British pound/U.S. dollar and Canadian dollar/U.S. dollar exchange rate would result in a decrease in common shareholder's(s') equity of $162 million at December 31, 2003 and $27 million at December 31, 2002 and would not have a material impact on net income. Counterparty Credit Risk The primary exposure on our interest rate swap portfolio is counterparty credit risk. Counterparty credit risk is the risk that the counterparty to a transaction fails to perform according to the terms of the contract. We control counterparty credit risk in derivative instruments through established credit approvals, risk control limits and ongoing monitoring procedures. Counterparty limits have been set and are closely monitored as part of the overall risk management process and contract structure. During the third quarter of 2003, we began utilizing an affiliate, HSBC Bank USA, as the primary provider of new domestic derivative products. We have never suffered a loss due to counterparty failure. Going forward, it is expected that most of our existing third party derivative contracts will be assigned to HSBC subsidiaries making them our primary counterparties in derivative transactions. Most swap agreements, both with third parties and affiliates, require that payments be made to, or received from, the counterparty when the fair value of the agreement reaches a certain level. Generally, third-party swap counterparties provide collateral in the form of cash which are recorded in our balance sheet as other assets or derivative related liabilities and totaled $.4 billion at December 31, 2003. Affiliate swap counterparties generally provide collateral in the form of securities which are not recorded on our balance sheet and totaled $.5 billion at December 31, 2003. At December 31, 2003, we had derivative contracts with a notional value of approximately $68.4 billion, including $39.7 billion outstanding with HSBC Bank USA. See Note 12 to the accompanying consolidated financial statements, "Derivative Financial Instruments, Forward Purchase Agreements and Concentrations of Credit Risk," for additional information related to interest rate risk management and Note 15, "Fair Value of Financial Instruments," for information regarding the fair value of certain financial instruments. NEW ACCOUNTING PRONOUNCEMENTS In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation Number 46, "Consolidation of Variable Interest Entities" ("Interpretation No. 46"). Interpretation No. 46 clarified the application of Accounting Research Bulletin Number 51, "Consolidated Financial Statements" to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Qualifying special purpose entities as defined by FASB Statement Number 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" are excluded from the scope of Interpretation No. 46. Interpretation No. 46 applied immediately to all variable interest entities created after January 31, 2003 and was originally effective for fiscal periods beginning after July 1, 2003 for existing variable interest entities. In October 2003, the FASB postponed the effective date of Interpretation No. 46 to December 31, 2003. In December 2003, a revised version of Interpretation 46 ("Revised Interpretation No. 46") was issued by the FASB. The revisions clarify some requirements, ease some implementation problems, add new scope exceptions, and add applicability judgments. Revised Interpretation No. 46 is required to be adopted by most public companies no later than March 31, 2004. We adopted Revised Interpretation No. 46 as of December 31, 2003. Upon adoption, we deconsolidated all of the previously established capital trust entities which issued common securities to Household and preferred securities to third parties. These trusts invested the proceeds of those offerings in junior subordinated notes of Household. As a result of the deconsolidation of those trusts, at December 31, 2003, we have reported $1.1 billion of the previously issued junior subordinated notes on our balance sheet in lieu of the preferred securities issued by the capital trusts which totaled $1.0 billion. The increase in reported liabilities of $30.2 million was offset by a corresponding investment in those trusts. The adoption of Revised Interpretation No. 46 did not have a material impact on our financial position or results of operations. 62 In May 2003, the FASB issued Statement Number 150, "Accounting for Financial Instruments with Characteristics of Liabilities, Equity, or Both" ("SFAS No. 150"). This limited scope statement establishes standards for how certain financial instruments with characteristics of both liabilities and equity are to be classified and measured. In November 2003, the FASB issued FASB Staff Position Number 150-3, which deferred indefinitely the effective date of SFAS No. 150 as it relates to certain mandatorily redeemable non-controlling interests. SFAS No. 150 was effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have a material impact on our financial position or results of operations. 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. Historically, 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 of 2003. The adoption increased real estate charge-offs by 7 basis points ($9.1 million) for the quarter ended December 31, 2003 and 1 basis point for the full year 2003, auto finance charge-offs by 12 basis points ($1.2 million) for the quarter ended December 31, 2003 and 4 basis points for the full year 2003, and total consumer charge-offs by 4 basis points ($10.3 million) for the quarter ended December 31, 2003 and 1 basis point for the full year 2003. As the adoption resulted in a reclassification between income statement lines only, it had no significant impact on our net income. The impact on prior periods was not material. In December 2003, the FASB issued Statement Number 132 (Revised), "Employer's Disclosure About Pensions and Other Postretirement Benefits" ("Statement Number 132 - Revised"). This statement revises employers' disclosure abut pension plans and other postretirement benefit plans. It does not change the measurement or recognition of those plans. The statement is effective for financial statements with fiscal years ending after December 15, 2003. Certain annual disclosures required by Statement Number 132 - Revised are effective for fiscal years ending after June 15, 2004. Interim period disclosures are effective for interim periods beginning after December 15, 2003. We adopted the required disclosure provisions of Statement 132 - Revised as of December 31, 2003. These disclosures are presented in Note 18, "Employee Benefit Plans". In December 2003, the American Institute of Certified Public Accountants (AICPA) released Statement of Position 03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer" ("SOP 03-3"). SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities acquired in a transfer if those differences are attributable to credit quality. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 15, 2004. Adoption is not expected to have a material impact on our financial position or results of operations. 63 GLOSSARY OF TERMS Acquired Intangibles - Assets (not including financial assets) that lack physical substance. Our acquired intangibles include purchased credit card relationships and related programs, merchant relationships in our retail services business, other loan related relationships, trade names, and technology, customer lists and other contracts. Affinity Credit Card - A MasterCard or Visa account jointly sponsored by the issuer of the card and an organization whose members share a common interest (e.g., the AFL-CIO Union Plus(R) credit card program). Auto Finance Loans - Closed-end loans secured by a first lien on a vehicle. Co-Branded Credit Card - A MasterCard or Visa account that is jointly sponsored by the issuer of the card and another corporation (e.g., the GM Card(R)). The account holder typically receives some form of added benefit for using the card. Consumer Net Charge-off Ratio - Net charge-offs of consumer receivables divided by average consumer receivables outstanding. Contractual Delinquency - A method of determining aging of past due accounts based on the status of payments under the loan. Delinquency status may be affected by customer account management policies and practices such as the restructure of accounts, forbearance agreements, extended payment plans, modification arrangements, external debt management plans, loan rewrites and deferments. Efficiency Ratio - Ratio of total costs and expenses less policyholders' benefits to net interest margin and other revenues less policyholders' benefits. Fee Income - Income associated with interchange on credit cards and late and other fees from the origination or acquisition of loans. Foreign Exchange Contract - A contract used to minimize our exposure to changes in foreign currency exchange rates. Futures Contract - An exchange-traded contract to buy or sell a stated amount of a financial instrument or index at a specified future date and price. Goodwill - Represents the purchase price over the fair value of identifiable assets acquired less liabilities assumed from business combinations. Interchange Fees - Fees received for processing a credit card transaction through the MasterCard or Visa network. Interest-only Strip Receivables - Represent our contractual right to receive interest and other cash flows from our securitization trusts after the investors receive their contractual return. Interest Rate Swap - Contract between two parties to exchange interest payments on a stated principal amount (notional principal) for a specified period. Typically, one party makes fixed rate payments, while the other party makes payments using a variable rate. LIBOR - London Interbank Offered Rate. A widely quoted market rate which is frequently the index used to determine the rate at which we borrow funds. Liquidity - A measure of how quickly we can convert assets to cash or raise additional cash by issuing debt. Managed Basis - A non-GAAP method of reporting whereby net interest margin, other revenues and credit losses on securitized receivables structured as sales are reported as if those receivables were still held on our balance sheet. Managed Receivables - The sum of receivables on our balance sheet and those that we service for investors as part of our asset securitization program. MasterCard and Visa Receivables - Receivables generated through customer usage of MasterCard and Visa credit cards. Net Interest Margin - Interest income from receivables and noninsurance investment securities reduced by interest expense. Nonaccrual Loans - Loans on which we no longer accrue interest because ultimate collection is unlikely. 64 Options - A contract giving the owner the right, but not the obligation, to buy or sell a specified item at a fixed price for a specified period. Owned Receivables - Receivables held on our balance sheet. Personal Homeowner Loan ("PHL") - A high loan-to-value real estate loan that has been underwritten and priced as an unsecured loan. These loans are reported as personal non-credit card receivables. Personal Non-Credit Card Receivables - Unsecured lines of credit or closed-end loans made to individuals. Portfolio Seasoning - Relates to the aging of origination vintages. Loss patterns emerge slowly over time as new accounts are booked. Private Label Credit Card - A line of credit made available to customers of retail merchants evidenced by a credit card bearing the merchant's name. Product Vintage Analysis - Refers to loss curves on specific product origination pools by date of origination. Real Estate Secured Loan - Closed-end loans and revolving lines of credit secured by first or second liens on residential real estate. Receivables Serviced with Limited Recourse - Receivables we have securitized in transactions structured as sales and for which we have some level of potential loss if defaults occur. Refund Anticipation Loan ("RAL") Program - A cooperative program with H&R Block Tax Services, Inc. and certain of its franchises, along with other independent tax preparers, to provide loans to customers entitled to tax refunds and who electronically file their returns with the Internal Revenue Service. Return on Average Common Shareholder's(s') Equity - Net income less dividends on preferred stock divided by average common shareholder's(s') equity. Return on Average Managed Assets - Net income divided by average managed assets. Return on Average Owned Assets - Net income divided by average owned assets. Secured Financing - The process where interests in a dedicated pool of financial assets, typically real estate secured receivables, are sold to investors. Generally, the receivables are transferred to a trust that issues interests that are sold to investors. These transactions do not receive sale treatment under SFAS No. 140. The receivables and related debt remain on our balance sheet. Securitization - The process where interests in a dedicated pool of financial assets, typically credit card, auto or personal non-credit card receivables, are sold to investors. Generally, the receivables are sold to a trust that issues interests that are sold to investors. These transactions are structured to receive sale treatment under SFAS No. 140. The receivables are then removed from our balance sheet. Securitization Revenue - Includes income associated with current and prior period securitizations structured as sales of receivables with limited recourse. Such income includes gains on sales, net of our estimate of probable credit losses under the recourse provisions, servicing income and excess spread relating to those receivables. Tangible Common Equity - Common shareholder's(s') equity (excluding unrealized gains and losses on investments and cash flow hedging instruments and any minimum pension liability) less acquired intangibles and goodwill. Tangible Shareholder's(s') Equity - Tangible common equity, preferred stock, company obligated mandatorily redeemable preferred securities of subsidiary trusts (including amounts due to affiliates) and senior debt which contains mandatorily redeemable obligations to purchase HSBC common stock in 2006 (the Adjustable Conversion-Rate Equity Security Units), excluding purchase accounting adjustments. Tangible Managed Assets - Total managed assets less acquired intangibles, goodwill and derivative financial assets. Whole Loan Sales - Sales of loans to third parties without recourse. Typically, these sales are made pursuant to our liquidity or capital management plans. 65 HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES CREDIT QUALITY STATISTICS - OWNED BASIS At December 31, unless otherwise indicated. ------------------------------------------------------------------- 2003 2002 2001 2000 1999 ----------- ----------- ----------- ----------- ----------- (All dollar amounts are stated in millions) Owned Two-Month-and-Over Contractual Delinquency Ratios Real estate secured 4.33 % 3.91 % 2.63 % 2.58 % 3.10 % Auto finance 2.51 3.96 2.92 2.46 2.02 MasterCard/Visa 5.76 5.97 5.67 4.90 3.59 Private label 5.42 6.36 5.99 5.60 6.09 Personal non-credit card 10.01 8.95 8.44 7.62 8.75 ------- ------- ------- ------- ------- Total consumer 5.36 % 5.34 % 4.43 % 4.19 % 4.75 % ------- ------- ------- ------- ------- Ratio of Owned Net Charge-offs to Average Owned Receivables for the Year Real estate secured .99 % .91 % .52 % .42 % .51 % Auto finance 4.91 6.00 4.00 3.29 3.42 MasterCard/Visa 9.18 9.46 8.17 6.55 7.95 Private label 5.75 6.28 5.59 5.34 5.60 Personal non-credit card 9.89 8.26 6.81 7.02 6.50 ------- ------- ------- ------- ------- Total consumer 4.06 3.81 3.32 3.18 3.67 Commercial .46 (.40 ) 2.10 2.69 .95 ------- ------- ------- ------- ------- Total 4.05 % 3.79 % 3.31 % 3.18 % 3.63 % ------- ------- ------- ------- ------- Real estate charge-offs and REO 1.42 % 1.29 % .84 % .70 % .74 % expense as a percent of average real estate secured receivables ------- ------- ------- ------- ------- Nonaccrual Owned Receivables Domestic: Real estate secured $ 1,777.4 $ 1,367.1 $ 906.8 $ 685.6 $ 532.5 Auto finance 104.0 80.1 69.2 45.5 24.9 Private label 42.7 38.0 38.6 47.6 58.1 Personal non-credit card 897.7 902.4 782.4 610.0 537.8 Foreign 315.6 263.6 215.3 226.0 236.7 ------- ------- ------- ------- ------- Total consumer 3,137.4 2,651.2 2,012.3 1,614.7 1,390.0 Commercial and other 6.2 14.7 15.2 42.0 46.6 ------- ------- ------- ------- ------- Total $ 3,143.6 $ 2,665.9 $ 2,027.5 $ 1,656.7 $ 1,436.6 ------- ------- ------- ------- ------- Accruing Consumer Owned Receivables 90 or More Days Delinquent Domestic: MasterCard/Visa $ 443.0 $ 342.4 $ 352.4 $ 272.0 $ 140.2 Private label 429.3 491.3 462.2 355.1 386.7 Foreign 32.2 27.0 29.5 22.3 23.5 ------- ------- ------- ------- ------- Total $ 904.5 $ 860.7 $ 844.1 $ 649.4 $ 550.4 ------- ------- ------- ------- ------- Real Estate Owned Domestic $ 626.6 $ 424.1 $ 394.7 $ 333.5 $ 268.1 Foreign 4.6 3.0 4.2 3.6 3.4 ------- ------- ------- ------- ------- Total $ 631.2 $ 427.1 $ 398.9 $ 337.1 $ 271.5 ------- ------- ------- ------- ------- Renegotiated Commercial Loans $ 1.6 $ 1.3 $ 2.1 $ 12.3 $ 12.3 ------- ------- ------- ------- ------- 66 HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES CREDIT QUALITY STATISTICS - MANAGED BASIS(1) At December 31, unless otherwise indicated. ------------------------------------------------------------------- 2003 2002 2001 2000 1999 ----------- ----------- ----------- ----------- ----------- (All dollar amounts are stated in millions) Managed Two-Month-and-Over Contractual Delinquency Ratios Real estate secured 4.35 % 3.94 % 2.68 % 2.63 % 3.27 % Auto finance 3.84 3.65 3.16 2.55 2.43 MasterCard/Visa 4.16 4.12 4.10 3.49 2.78 Private label 4.94 6.03 5.48 5.48 5.97 Personal non-credit card 10.69 9.41 8.87 7.97 8.81 ------- ------- ------- ------- ------- Total consumer 5.39 % 5.24 % 4.46 % 4.20 % 4.66 % ------- ------- ------- ------- ------- Ratio of Managed Net Charge-offs to Average Managed Receivables for the Year Real estate secured 1.00 % .92 % .53 % .45 % .58 % Auto finance 7.00 6.63 5.31 4.80 4.96 MasterCard/Visa 7.26 7.12 6.63 5.58 6.66 Private label 5.62 5.75 5.18 5.35 5.65 Personal non-credit card 9.97 8.32 6.79 6.97 6.52 ------- ------- ------- ------- ------- Total consumer 4.67 4.28 3.73 3.64 4.13 Commercial .46 (.40 ) 2.10 2.69 .95 ------- ------- ------- ------- ------- Total 4.66 % 4.26 % 3.72 % 3.63 % 4.09 % ------- ------- ------- ------- ------- Real estate charge-offs and REO 1.42 % 1.29 % .83 % .71 % .78 % expense as a percent of average real estate secured receivables ------- ------- ------- ------- ------- Nonaccrual Managed Receivables Domestic: Real estate secured $ 1,790.7 $ 1,391.2 $ 940.8 $ 734.1 $ 626.9 Auto finance 338.4 271.9 201.8 116.2 73.9 Private label 42.7 38.0 38.6 47.6 58.1 Personal non-credit card 1,464.1 1,320.5 1,106.3 902.0 828.8 Foreign 367.1 310.9 263.5 270.4 278.3 ------- ------- ------- ------- ------- Total consumer 4,003.0 3,332.5 2,551.0 2,070.3 1,866.0 Commercial and other 6.2 14.7 15.2 42.0 46.6 ------- ------- ------- ------- ------- Total $ 4,009.2 $ 3,347.2 $ 2,566.2 $ 2,112.3 $ 1,912.6 ------- ------- ------- ------- ------- Accruing Consumer Managed Receivables 90 or More Days Delinquent Domestic: MasterCard/Visa $ 601.0 $ 513.1 $ 527.4 $ 420.3 $ 286.4 Private label 581.9 633.4 503.2 417.2 430.0 Foreign 32.2 27.0 29.5 22.3 23.5 ------- ------- ------- ------- ------- Total $ 1,215.1 $ 1,173.5 $ 1,060.1 $ 859.8 $ 739.9 ------- ------- ------- ------- ------- -------------- (1) These non-GAAP financial measures are provided for comparison of our operating trends and should be read in conjunction with our owned basis GAAP financial information. Refer to "Reconciliations to GAAP Financial Measures" for a discussion of non-GAAP financial information and for quantitative reconciliations to the equivalent GAAP basis financial measure. 67 HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY - OWNED RECEIVABLES 2003 2002 2001 2000 1999 ------------- ------------- ------------- ------------- -------------- (All dollar amounts are stated in millions) Total Owned Credit Loss Reserves at $ 3,332.6 $ 2,663.1 $ 2,111.9 $ 1,757.0 $ 1,734.2 January 1 -------- -------- -------- -------- -------- Provision for Credit Losses 3,966.9 3,732.0 2,912.9 2,116.9 1,716.4 -------- -------- -------- -------- -------- Charge-offs Domestic: Real estate secured (496.0 ) (429.7 ) (194.0 ) (123.2 ) (103.8 ) Auto finance (148.0 ) (158.4 ) (94.3 ) (61.3 ) (39.4 ) MasterCard/Visa (935.8 ) (736.2 ) (645.4 ) (432.1 ) (477.8 ) Private label (684.1 ) (649.9 ) (590.9 ) (536.9 ) (547.7 ) Personal non-credit card (1,354.7 ) (1,193.2 ) (893.2 ) (723.5 ) (534.6 ) Foreign (256.9 ) (223.1 ) (237.0 ) (232.7 ) (233.9 ) -------- -------- -------- -------- -------- Total consumer (3,875.5 ) (3,390.5 ) (2,654.8 ) (2,109.7 ) (1,937.2 ) Commercial and other (2.8 ) (2.1 ) (12.2 ) (17.1 ) (10.1 ) -------- -------- -------- -------- -------- Total owned receivables charged off (3,878.3 ) (3,392.6 ) (2,667.0 ) (2,126.8 ) (1,947.3 ) -------- -------- -------- -------- -------- Recoveries Domestic: Real estate secured 9.9 6.9 4.4 4.7 7.5 Auto finance 4.6 6.8 1.5 1.5 1.2 MasterCard/Visa 87.4 59.1 52.0 24.9 34.7 Private label 72.2 48.3 60.6 54.0 74.3 Personal non-credit card 81.8 91.5 75.6 62.4 45.3 Foreign 34.2 49.1 62.5 57.5 46.6 -------- -------- -------- -------- -------- Total consumer 290.1 261.7 256.6 205.0 209.6 Commercial and other .7 1.8 .4 .4 .3 -------- -------- -------- -------- -------- Total recoveries on owned receivables 290.8 263.5 257.0 205.4 209.9 Other, net 81.2 66.6 48.3 159.4 43.8 -------- -------- -------- -------- -------- Owned Credit Loss Reserves Domestic: Real estate secured 669.9 550.9 284.4 172.9 149.2 Auto finance 171.9 126.4 77.3 51.0 39.1 MasterCard/Visa 805.8 648.9 593.4 540.8 304.4 Private label 519.1 526.4 499.4 425.2 487.2 Personal non-credit card 1,347.5 1,274.8 1,031.9 734.2 568.9 Foreign 247.4 172.3 137.1 141.6 143.1 -------- -------- -------- -------- -------- Total consumer 3,761.6 3,299.7 2,623.5 2,065.7 1,691.9 Commercial and other 31.5 32.9 39.6 46.2 65.1 -------- -------- -------- -------- -------- Total Owned Credit Loss Reserves at $ 3,793.1 $ 3,332.6 $ 2,663.1 $ 2,111.9 $ 1,757.0 December 31 -------- -------- -------- -------- -------- Ratio of Owned Credit Loss Reserves to: Net charge-offs 105.7 % 106.5 % 110.5 % 109.9 % 101.1 % Receivables: Consumer 4.09 4.02 3.31 3.10 3.30 Commercial 6.80 6.64 7.12 7.43 7.70 -------- -------- -------- -------- -------- Total 4.11 % 4.04 % 3.33 % 3.14 % 3.36 % -------- -------- -------- -------- -------- Nonperforming loans: Consumer 93.2 % 94.0 % 91.9 % 91.2 % 87.2 % Commercial 469.8 229.7 278.7 85.4 116.8 -------- -------- -------- -------- -------- Total 93.7 % 94.5 % 92.7 % 91.1 % 87.9 % -------- -------- -------- -------- -------- 68 HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY - MANAGED RECEIVABLES(1) 2003 2002 2001 2000 1999 ------------- ------------- ------------- ------------- -------------- (All dollar amounts are stated in millions) Total Managed Credit Loss Reserves at $ 5,092.1 $ 3,811.4 $ 3,194.2 $ 2,666.6 $ 2,548.1 January 1 -------- -------- -------- -------- -------- Provision for Credit Losses 6,241.8 5,655.0 4,018.4 3,252.4 2,781.8 -------- -------- -------- -------- -------- Charge-Offs Domestic: Real estate secured (500.6 ) (436.9 ) (202.4 ) (139.9 ) (134.1 ) Auto finance (566.7 ) (477.7 ) (286.7 ) (188.4 ) (120.4 ) MasterCard/Visa (1,462.1 ) (1,274.3 ) (1,147.9 ) (880.7 ) (1,020.8 ) Private label (917.6 ) (764.0 ) (640.2 ) (605.6 ) (598.3 ) Personal non-credit card (1,861.7 ) (1,600.1 ) (1,196.2 ) (1,030.6 ) (821.6 ) Foreign (330.0 ) (280.0 ) (282.2 ) (275.8 ) (281.4 ) -------- -------- -------- -------- -------- Total consumer (5,638.7 ) (4,833.0 ) (3,755.6 ) (3,121.0 ) (2,976.6 ) Commercial and other (2.8 ) (2.1 ) (12.2 ) (17.1 ) (10.1 ) -------- -------- -------- -------- -------- Total managed receivables charged off (5,641.5 ) (4,835.1 ) (3,767.8 ) (3,138.1 ) (2,986.7 ) -------- -------- -------- -------- -------- Recoveries Domestic: Real estate secured 9.9 6.9 4.4 4.7 7.5 Auto finance 12.2 17.1 4.0 4.0 2.8 MasterCard/Visa 127.2 96.5 81.1 49.7 68.4 Private label 91.7 55.9 62.3 57.0 77.0 Personal non-credit card 105.6 121.7 100.9 79.2 61.2 Foreign 40.0 59.1 71.9 69.0 54.1 -------- -------- -------- -------- -------- Total consumer 386.6 357.2 324.6 263.6 271.0 Commercial and other .7 1.8 .4 .4 .3 -------- -------- -------- -------- -------- Total recoveries on managed receivables 387.3 359.0 325.0 264.0 271.3 Other, net 86.9 101.8 41.6 149.3 52.1 -------- -------- -------- -------- -------- Managed Credit Loss Reserves Domestic: Real estate secured 671.3 561.3 303.8 195.9 172.8 Auto finance 845.6 758.5 448.8 323.8 242.4 MasterCard/Visa 1,113.9 957.0 975.6 849.0 612.6 Private label 886.2 791.4 603.0 599.4 603.7 Personal non-credit card 2,243.6 1,697.4 1,217.4 957.5 761.6 Foreign 374.5 293.6 223.2 222.4 208.4 -------- -------- -------- -------- -------- Total consumer 6,135.1 5,059.2 3,771.8 3,148.0 2,601.5 Commercial and other 31.5 32.9 39.6 46.2 65.1 -------- -------- -------- -------- -------- Total Managed Credit Loss Reserves at $ 6,166.6 $ 5,092.1 $ 3,811.4 $ 3,194.2 $ 2,666.6 December 31 -------- -------- -------- -------- -------- Ratio of Managed Credit Loss Reserves to: Net charge-offs 117.4 % 113.8 % 110.7 % 111.1 % 98.2 % Receivables: Consumer 5.19 4.73 3.77 3.62 3.68 Commercial 6.80 6.64 7.12 7.43 7.70 -------- -------- -------- -------- -------- Total 5.20 % 4.74 % 3.78 % 3.65 % 3.72 % -------- -------- -------- -------- -------- Nonperforming loans: Consumer 117.6 % 112.3 % 104.5 % 107.4 % 98.8 % Commercial 469.8 229.7 278.7 85.4 116.8 -------- -------- -------- -------- -------- Total 118.0 % 112.6 % 105.0 % 107.0 % 100.1 % -------- -------- -------- -------- -------- -------------- (1) These non-GAAP financial measures are provided for comparison of our operating trends and should be read in conjunction with our owned basis GAAP financial information. Refer to "Reconciliations to GAAP Financial Measures" for a discussion of non-GAAP financial information and for quantitative reconciliations to the equivalent GAAP basis financial measure. 69 HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES NET INTEREST MARGIN - 2003 COMPARED TO 2002 (OWNED BASIS) Finance and Interest Income/ Increase/(Decrease) Due to: Average Outstanding(1) Average Rate Interest Expense ----------------------- ------------ ------------------------ -------------------------------------- Volume Rate 2003 2002 2003 2002 2003 2002 Variance Variance(2) Variance(2) ---------- ----------- ---- ----- ----------- ----------- ---------- --------- ---------- (All dollar amounts are stated in millions) Receivables: Real estate $ 49,851.9 $ 47,257.7 9.7 % 10.7 % $ 4,851.9 $ 5,051.2 $ (199.3 ) $ 267.9 $ (467.2 ) secured Auto finance 2,919.7 2,529.4 13.5 14.7 393.5 372.6 20.9 54.3 (33.4 ) MasterCard/ 9,516.9 7,569.1 14.8 14.8 1,406.4 1,119.3 287.1 287.8 (.7 ) Visa Private label 11,942.2 10,774.7 11.6 12.2 1,380.6 1,314.3 66.3 137.4 (71.1 ) Personal 14,009.3 13,968.0 16.6 18.1 2,321.9 2,526.4 (204.5 ) 7.4 (211.9 ) non-credit card Commercial and 430.5 483.1 2.2 2.1 9.6 10.2 (.6 ) (1.2 ) .6 other Purchase 396.8 - - - (200.4 ) - (200.4 ) (200.4 ) - accounting adjustments ---------- ----------- ---- ----- ----------- ----------- ---------- --------- ---------- Total 89,067.3 82,582.0 11.4 12.6 10,163.5 10,394.0 (230.5 ) 781.4 (1,011.9 ) receivables Noninsurance 5,279.8 5,302.0 1.9 2.5 98.9 131.6 (32.7 ) (.5 ) (32.2 ) investments ---------- ----------- ---- ----- ----------- ----------- ---------- --------- ---------- Total $ 94,347.1 $ 87,884.0 10.9 % 12.0 % $ 10,262.4 $ 10,525.6 $ (263.2 ) $ 733.1 $ (996.3 ) interest- earning assets (excluding insurance investments) Insurance 3,159.6 3,191.4 investments Other assets 12,632.4 5,228.2 ---------- ----------- Total Assets $ 110,139.1 $ 96,303.6 ----------- ----------- Debt: Deposits $ 991.7 $ 5,838.9 3.6 % 6.5 % $ 36.0 $ 380.0 $ (344.0 ) $ (224.4 ) $ (119.6 ) Commercial 6,357.1 6,830.4 1.6 1.9 103.5 130.1 (26.6 ) (8.6 ) (18.0 ) paper Bank and other 1,187.2 1,472.6 3.9 3.4 45.9 50.7 (4.8 ) (10.6 ) 5.8 borrowings Due to 3,029.1 - 2.4 - 72.6 - 72.6 72.6 - affiliates Senior and 77,650.5 69,405.6 3.0 4.8 2,363.2 3,310.5 (947.3 ) 358.1 (1,305.4 ) senior subordinated debt (with original maturities over one year) ---------- ----------- ---- ----- ----------- ----------- ---------- --------- ---------- Total debt $ 89,215.6 $ 83,547.5 2.9 % 4.6 % $ 2,621.2 $ 3,871.3 $ (1,250.1 ) $ 247.6 $ (1,497.7 ) Other 5,842.2 3,251.1 liabilities ---------- ----------- Total 86,798.6 86,798.6 liabilities Preferred 1,119.4 864.5 securities Common 13,961.9 8,640.5 shareholder's (s') equity ---------- ----------- Total $ 110,139.1 $ 96,303.6 Liabilities and Shareholder's (s') Equity ---------- ----------- Net Interest 8.1 % 7.6 % $ 7,641.2 $ 6,654.3 $ 986.9 $ 485.5 $ 501.4 Margin - Owned Basis(3) (5) ---- ----- ----------- ----------- ---------- --------- ---------- Interest Spread 8.0 % 7.4 % - Owned Basis(4) ---- ----- -------------- (1) Nonaccrual loans are included in average outstanding balances. (2) Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total interest variance. For total receivables, total interest-earning assets and total debt, the rate and volume variances are calculated based on the relative weighting of the individual components comprising these totals. These totals do not represent an arithmetic sum of the individual components. (3) Represents net interest margin as a percent of average interest-earning assets. (4) Represents the difference between the yield earned on interest-earning assets and the cost of the debt used to fund the assets. (5) The net interest margin analysis includes the following for foreign businesses: 2003 2002 2001 ------------ ------------ ------------ Average interest-earning assets $ 8,778.7 $ 6,616.2 $ 6,988.7 Average interest-bearing liabilities 7,957.4 6,075.5 5,973.3 Net interest margin 659.5 483.3 431.2 Net interest margin percentage 7.5 % 7.3 % 6.2 % 70 HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES NET INTEREST MARGIN - 2002 COMPARED TO 2001 (OWNED BASIS) Average Outstanding(1) Average Rate --------------------------------- ------------------- 2002 2001 2002 2001 --------------- --------------- -------- -------- (All dollar amounts are stated in millions) Receivables: Real estate $ 47,257.7 $ 38,850.4 10.7 % 11.6 % secured Auto finance 2,529.4 2,319.1 14.7 15.3 MasterCard/ 7,569.1 8,138.3 14.8 13.8 Visa Private label 10,774.7 10,516.4 12.2 13.4 Personal non- 13,968.0 12,486.0 18.1 20.0 credit card Commercial 483.1 554.9 2.1 2.3 and other -------- -------- ---- ---- Total 82,582.0 72,865.1 12.6 13.6 receivables Noninsurance 5,302.0 894.1 2.5 6.1 investments -------- -------- ---- ---- Total interest- $ 87,884.0 $ 73,759.2 12.0 % 13.5 % earning assets (excluding insurance investments) Insurance 3,191.4 3,006.2 investments Other assets 5,228.2 5,278.7 -------- -------- Total Assets $ 96,303.6 $ 82,044.1 -------- -------- Debt: Deposits $ 5,838.9 $ 7,953.2 6.5 % 6.3 % Commercial 6,830.4 9,221.1 1.9 4.1 paper Bank and 1,472.6 2,240.1 3.4 3.9 other borrowings Senior and 69,405.6 50,905.7 4.8 6.3 senior subordinated debt (with original maturities over one year) -------- -------- ---- ---- Total debt $ 83,547.5 $ 70,320.1 4.6 % 5.9 % Other 3,251.1 3,885.5 liabilities -------- -------- Total 86,798.6 74,205.6 liabilities Preferred 864.5 249.4 securities Common 8,640.5 7,589.1 shareholders' equity -------- -------- Total $ 96,303.6 $ 82,044.1 Liabilities and Shareholders' Equity -------- -------- Net Interest 7.6 % 7.8 % Margin - Owned Basis(3)(5) ---- ---- Interest Spread 7.4 % 7.6 % - Owned Basis(4) ---- ---- (Additional columns below) (Continued from above table, first column(s) repeated) Finance and Interest Income/ Interest Increase/(Decrease) Due to: Expense ------------------------------------------------- ----------------------------- Volume Rate 2002 2001 Variance Variance(2) Variance(2) -------------- ------------ ------------ --------------- ---------------- (All dollar amounts are stated in millions) Receivables: Real estate $ 5,051.2 $ 4,516.1 $ 535.1 $ 920.0 $ (384.9 ) secured Auto finance 372.6 354.0 18.6 31.3 (12.7 ) MasterCard/ 1,119.3 1,121.3 (2.0 ) (81.2 ) 79.2 Visa Private label 1,314.3 1,405.3 (91.0 ) 33.9 (124.9 ) Personal non- 2,526.4 2,496.9 29.5 280.7 (251.2 ) credit card Commercial 10.2 13.0 (2.8 ) (1.6 ) (1.2 ) and other -------- ------- ------ ------- -------- Total 10,394.0 9,906.6 487.4 1,258.1 (770.7 ) receivables Noninsurance 131.6 54.7 76.9 126.6 (49.7 ) investments -------- ------- ------ ------- -------- Total interest- $ 10,525.6 $ 9,961.3 $ 564.3 $ 1,771.9 $ (1,207.6 ) earning assets (excluding insurance investments) Insurance investments Other assets Total Assets Debt: Deposits $ 380.0 $ 498.6 $ (118.6 ) $ (137.0 ) $ 18.4 Commercial 130.1 376.3 (246.2 ) (80.5 ) (165.7 ) paper Bank and 50.7 86.9 (36.2 ) (27.3 ) (8.9 ) other borrowings Senior and 3,310.5 3,212.0 98.5 996.9 (898.4 ) senior subordinated debt (with original maturities over one year) -------- ------- ------ ------- -------- Total debt $ 3,871.3 $ 4,173.8 $ (302.5 ) $ 705.6 $ (1,008.1 ) Other liabilities Total liabilities Preferred securities Common shareholders' equity Total Liabilities and Shareholders' Equity Net Interest $ 6,654.3 $ 5,787.5 $ 866.8 $ 1,066.3 $ (199.5 ) Margin - Owned Basis(3)(5) -------- ------- ------ ------- -------- Interest Spread - Owned Basis(4) 71 HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES NET INTEREST MARGIN - 2003 COMPARED TO 2002 AND 2001 (MANAGED BASIS) Net Interest Margin on a Managed Basis As receivables are securitized rather than held in our portfolio, net interest margin is reclassified to securitization revenue. We retain a substantial portion of the profit inherent in the receivables while increasing liquidity. The comparability of net interest margin between periods may be impacted by the level and type of receivables securitized. Net interest margin on a managed basis includes finance income earned on our owned receivables as well on our securitized receivables. This finance income is offset by interest expense on the debt recorded on our balance sheet as well as the contractual rate of return on the instruments issued to investors when the receivables were securitized. Finance and Interest Average Outstanding(1) Average Rate Income/Interest Expense ------------------------------------- ------------------------ ----------------------------------------- 2003 2002 2001 2003 2002 2001 2003 2002 2001 ----------- ----------- ----------- ----- ------- ------ ------------ ---------- ---------- (All dollar amounts are stated in millions) Receivables: Real $ 50,123.8 $ 47,829.8 $ 40,049.6 9.7 % 10.7 % 11.6 % $ 4,874.6 $ 5,113.8 $ 4,650.2 estate secured Auto 7,918.4 6,942.0 5,323.5 14.9 16.7 17.5 1,179.8 1,155.9 929.5 finance MasterCard 19,271.9 17,246.2 17,282.9 12.9 13.4 14.0 2,484.7 2,304.2 2,411.3 /Visa Private 16,015.6 13,615.1 12,260.6 11.5 12.2 13.5 1,844.8 1,663.0 1,655.8 label Personal 19,040.9 18,837.1 17,013.8 17.8 18.6 19.9 3,390.0 3,504.7 3,379.7 non- credit card Commercial 430.5 483.1 554.9 2.2 2.1 2.3 9.6 10.2 13.0 and other Purchase 396.8 - - - - - (200.4 ) - - accounting adjustment ----------- ----------- ----------- ----- ------- ------ ------------ ---------- ---------- Total 113,197.9 104,953.3 92,485.3 12.0 13.1 14.1 13,583.1 13,751.8 13,039.5 receivables Noninsurance 5,279.8 5,302.0 894.1 1.9 2.5 6.1 98.9 131.6 54.7 investments ----------- ----------- ----------- ----- ------- ------ ------------ ---------- ---------- Total $ 118,477.7 $ 110,255.3 $ 93,379.4 11.5 % 12.6 % 14.0 % $ 13,682.0 $ 13,883.4 $ 13,094.2 interest- earning assets (excluding insurance investments) ----------- ----------- ----------- ----- ------- ------ ------------ ---------- ---------- Total debt $ 113,346.2 $ 105,918.8 $ 89,940.3 2.8 % 4.3 % 5.8 % $ 3,187.2 $ 4,546.2 $ 5,212.9 ----------- ----------- ----------- ----- ------- ------ ------------ ---------- ---------- Net Interest Margin - Managed 8.9 % 8.5 % 8.4 % $ 10,494.8 $ 9,337.2 $ 7,881.3 Basis(3) ----- ------- ------ ------------ ---------- ---------- Interest 8.7 % 8.3 % 8.2 % Spread - Managed Basis(4) ----- ------- ------ Increase/(Decrease) Due to: ----------------------------------------------------------------------------------------- 2003 Compared to 2002 2002 Compared to 2001 ------------------------------------------ -------------------------------------------- Volume Rate Volume Rate Variance Variance(2) Variance(2) Variance Variance(2) Variance(2) ----------- ---------- ----------- ----------- ------------- ------------ Receivables: Real $ (239.2 ) $ 237.6 $ (476.8 ) $ 463.6 $ 852.5 $ (388.9 ) estate secured Auto 23.9 152.8 (128.9 ) 226.4 271.2 (44.8 ) finance MasterCard 180.5 263.3 (82.8 ) (107.1 ) (5.1 ) (102.0 ) /Visa Private 181.8 280.6 (98.8 ) 7.2 173.6 (166.4 ) label Personal (114.7 ) 37.6 (152.3 ) 125.0 347.8 (222.8 ) non- credit card Commercial (.6 ) (1.2 ) .6 (2.8 ) (1.6 ) (1.2 ) and other Purchase (200.4 ) (200.4 ) - - - - accounting adjustment ----------- ---------- ----------- ----------- ------------- ------------ Total (168.7 ) 1,036.4 (1,205.1 ) 712.3 1,676.4 (964.1 ) receivables Noninsurance (32.7 ) (.5 ) (32.2 ) 76.9 126.6 (49.7 ) investments ----------- ---------- ----------- ----------- ------------- ------------ Total $ (201.4 ) $ 1,024.7 $ (1,226.1 ) $ 789.2 $ 2,191.3 $ (1,402.1 ) interest- earning assets (excluding insurance investments) ----------- ---------- ----------- ----------- ------------- ------------ Total debt $ (1,359.0 ) $ 304.4 $ (1,663.4 ) $ (666.7 ) $ 827.3 $ (1,494.0 ) ----------- ---------- ----------- ----------- ------------- ------------ Net Interest Margin - Managed $ 1,157.6 $ 720.3 $ 437.3 $ 1,1455.9 $ 1,364.1 $ 91.8 Basis(3) ----------- ---------- ----------- ----------- ------------- ------------ ----------- (1) Nonaccrual loans are included in average outstanding balances. (2) Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total interest variance. For total receivables, total interest-earning assets and total debt, the rate and volume variances are calculated based on the relative weighting of the individual components comprising these totals. These totals do not represent an arithmetic sum of the individual components. (3) Represents net interest margin as a percent of average interest-earning assets. (4) Represents the difference between the yield earned on interest-earning assets and cost of the debt used to fund the assets. 72 HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES RECONCILIATIONS TO GAAP FINANCIAL MEASURES Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). In addition to the GAAP financial results reported in our consolidated financial statements, MD&A includes reference to the following information which is presented on a non-GAAP basis: Operating Results, Percentages and Ratios Certain percentages and ratios have been presented on an operating basis and have been calculated using "operating net income", a non-GAAP financial measure. "Operating net income" is net income excluding certain nonrecurring items. These nonrecurring items are also excluded in calculating our operating basis efficiency ratios. We believe that excluding nonrecurring items helps readers of our financial statements to understand better the results and trends of our underlying business. Managed Basis Reporting We monitor our operations and evaluate trends on a managed basis (a non-GAAP financial measure), which assumes that securitized receivables have not been sold and are still on our balance sheet. We manage and evaluate our operations on a managed basis because the receivables that we securitize are subjected to underwriting standards comparable to our owned portfolio, are serviced by operating personnel without regard to ownership and result in a similar credit loss exposure for us. In addition, we fund our operations, review our operating results, and make decisions about allocating resources such as employees and capital on a managed basis. When reporting on a managed basis, net interest margin, provision for credit losses and fee income related to receivables securitized are reclassified from securitization revenue in our owned statements of income into the appropriate caption. Additionally, charge-off and delinquency associated with these receivables are included in our managed basis credit quality statistics. Debt analysts, rating agencies and others also evaluate our operations on a managed basis for the reasons discussed above and have historically requested managed basis information from us. We believe that managed basis information enables investors and other interested parties to better understand the performance and quality of our entire managed loan portfolio and is important to understanding the quality of originations and the related credit risk inherent in our owned portfolio. Equity Ratios Tangible shareholder's(s') equity to tangible managed assets ("TETMA"), tangible shareholder's(s') equity plus owned loss reserves to tangible managed assets ("TETMA + Owned Reserves") and tangible common equity to tangible managed assets are non-GAAP financial measures that are used by Household management or certain rating agencies to evaluate capital adequacy. These ratios may differ from similarly named measures presented by other companies. The most directly comparable GAAP financial measure is common and preferred equity to owned assets. We also monitor our equity ratios excluding the impact of purchase accounting adjustments. We do so because we believe that the purchase accounting adjustments represent non-cash transactions which do not affect our business operations, cash flows or ability to meet our debt obligations. Preferred securities issued by certain non-consolidated trusts are considered equity in the TETMA and TETMA + Owned Reserves calculations because of their long-term subordinated nature and the ability to defer dividends. Our Adjustable Conversion-Rate Equity Security Units, which exclude purchase accounting adjustments, are also considered equity in these calculations because they include investor obligations to purchase HSBC ordinary shares in 2006. Quantitative Reconciliations of Non-GAAP Financial Measures to GAAP Financial Measures For a reconciliation of managed basis net interest margin, fee income and provision for credit losses to the comparable owned basis amounts, see Note 22, "Segment Reporting," to the accompanying consolidated financial statements. For a reconciliation of our owned loan portfolio by product to our managed loan portfolio, see Note 4, "Receivables," to the accompanying consolidated financial statements. Reconciliations of our owned basis and managed basis credit quality, loss reserves, net interest margin, selected financial ratios, including operating ratios, and our equity ratios follow. 73 HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES RECONCILIATIONS TO GAAP FINANCIAL MEASURES CREDIT QUALITY STATISTICS - 2003 Two-Months-and-Over Year-to-Date Charge-offs, Contractual Delinquency Net of Recoveries -------------------------------------------------------- ------------------------------------------- Two-Months-and- Two-Months-and- Over Contractual Receivables Over Contractual Net Average Net Delinquency Outstanding Delinquency Charge-offs Receivables Charge-offs ------------------ -------------- ------------------ ------------ -------------- ----------- (All dollar amounts are stated in millions) Owned: First mortgage $ 3.2 $ 35.0 9.14 % $ .3 $ 39.1 .77 % (1) Real estate 2,216.9 51,221.0 4.33 496.0 49,851.9 .99 secured Auto finance 104.0 4,138.1 2.51 143.4 2,919.7 4.91 MasterCard/Visa 643.7 11,182.0 5.76 873.6 9,516.9 9.18 Private label 683.7 12,603.8 5.42 686.8 11,942.2 5.75 Personal 1,284.6 12,832.0 10.01 1,385.6 14,009.3 9.89 non-credit card --------- --------- --------- ------- --------- ----- Total consumer 4,936.1 92,011.9 5.36 3,585.7 88,279.1 4.06 Commercial - 366.3 - 1.8 391.4 .46 --------- --------- --------- ------- --------- ----- Total $ 4,936.1 $ 92,378.2 5.34 % $ 3,587.5 $ 88,670.5 4.05 % --------- --------- --------- ------- --------- ----- Serviced with Limited Recourse: Real estate $ 21.4 $ 193.6 11.05 % $ 4.6 $ 271.9 1.69 % secured Auto finance 234.4 4,674.8 5.01 411.1 4,998.7 8.22 MasterCard/Visa 236.8 9,966.7 2.38 525.1 9,755.0 5.38 Private label 199.3 5,261.3 3.79 214.0 4,073.4 5.25 Personal 740.0 6,104.0 12.12 511.9 5,031.6 10.17 non-credit card --------- --------- --------- ------- --------- ----- Total $ 1,431.9 $ 26,200.4 5.47 % $ 1,666.7 $ 24,130.6 6.91 % --------- --------- --------- ------- --------- ----- Managed: First mortgage $ 3.2 $ 35.0 9.14 % $ .3 $ 39.1 .77 % (1) Real estate 2,238.3 51,414.6 4.35 500.6 50,123.8 1.00 secured Auto finance 338.4 8,812.9 3.84 554.5 7,918.4 7.00 MasterCard/Visa 880.5 21,148.7 4.16 1,398.7 19,271.9 7.26 Private label 883.0 17,865.1 4.94 900.8 16,015.6 5.62 Personal 2,024.6 18,936.0 10.69 1,897.5 19,040.9 9.97 non-credit card --------- --------- --------- ------- --------- ----- Total consumer 6,368.0 118,212.3 5.39 5,252.4 112,409.7 4.67 Commercial - 366.3 - 1.8 391.4 .46 --------- --------- --------- ------- --------- ----- Total $ 6,368.0 $ 118,578.6 5.37 % $ 5,254.2 $ 112,801.1 4.66 % --------- --------- --------- ------- --------- ----- -------------- (1) Includes our liquidating legacy first and reverse mortgage portfolios. 74 Serviced with Owned Limited Recourse Managed ---------------- ------------------------ ---------------- (All dollar amounts are stated in millions) Nonaccrual Receivables Domestic: Real estate secured $ 1,777.4 $ 13.3 $ 1,790.7 Auto finance 104.0 234.4 338.4 Private label 42.7 - 42.7 Personal non-credit card 897.7 566.4 1,464.1 Foreign 315.6 51.5 367.1 -------- --------- -------- Total consumer 3,137.4 865.6 4,003.0 Commercial and other 6.2 - 6.2 -------- --------- -------- Total $ 3,143.6 $ 865.6 $ 4,009.2 -------- --------- -------- Accruing Consumer Receivables 90 or More Days Delinquent Domestic: MasterCard/Visa $ 443.0 $ 158.0 $ 601.0 Private label 429.3 152.6 581.9 Foreign 32.2 - 32.2 -------- --------- -------- Total $ 904.5 $ 310.6 $ 1,215.1 -------- --------- -------- Real Estate Charge-offs and REO Expense as a Percent of Average Real Estate Secured Receivables Real estate charge-offs and REO expense $ 708.6 $ 4.6 $ 713.2 Average real estate secured receivables 49,851.9 271.9 50,123.8 -------- --------- -------- Real estate charge-offs and REO expense as a percent 1.42 % 1.69 % 1.42 % of average real estate secured receivables -------- --------- -------- This information is provided by RNS The company news service from the London Stock Exchange MORE TO FOLLOW FR BLGDXUUGGGSB

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