Household 10-K DEC 03 Part 4a

HSBC Holdings PLC 01 March 2004 118 Receivables and two-month-and-over contractual delinquency for our managed and serviced with limited recourse portfolios were as follows: At December 31, ------------------------------------------------------------------------------ 2003 2002 ------------------------------------- ------------------------------------- Receivables Delinquent Receivables Delinquent Outstanding Receivables Outstanding Receivables ------------------- -------------- ------------------- -------------- (In millions) Managed receivables: First mortgage(1) $ 35.0 9.14 % $ 44.3 9.71 % Real estate secured 51,414.6 4.35 46,274.7 3.94 Auto finance 8,812.9 3.84 7,442.4 3.65 MasterCard/Visa 21,148.7 4.16 18,952.6 4.12 Private label 17,865.1 4.94 14,916.7 6.03 Personal non-credit card 18,936.0 10.69 19,446.4 9.41 --------- ----- --------- ----- Total consumer 118,212.3 5.39 107,077.1 5.24 Commercial 366.3 - 418.7 - --------- ----- --------- ----- Total managed receivables $ 118,578.6 5.37 % $ 107,495.8 5.22 % --------- ----- --------- ----- Receivables serviced with limited recourse: Real estate secured $ (193.6 ) 11.05 % $ (456.2 ) 6.82 % Auto finance (4,674.8 ) 5.01 (5,418.6 ) 3.54 MasterCard/Visa (9,966.7 ) 2.38 (10,006.1 ) 2.46 Private label (5,261.3 ) 3.79 (3,577.1 ) 4.96 Personal non-credit card (6,104.0 ) 12.12 (5,475.5 ) 10.60 --------- ----- --------- ----- Total receivables serviced with limited (26,200.4 ) 5.47 (24,933.5 ) 4.92 recourse --------- ----- --------- ----- Owned consumer receivables $ 92,011.9 5.36 % $ 82,143.6 5.34 % --------- ----- --------- ----- -------------- (1) Includes our liquidating legacy first and reverse mortgage portfolios. Average receivables and net charge-offs for our managed and serviced with limited recourse portfolios were as follows: Year Ended December 31, ---------------------------------------------------------------------- 2003 2002 --------------------------------- --------------------------------- Average Net Average Net Receivables Charge-offs Receivables Charge-offs ----------------- ------------ ----------------- ------------ (In millions) Managed receivables: First mortgage(1) $ 39.1 .77 % $ 54.0 3.70 % Real estate secured 50,123.8 1.00 47,829.8 .92 Auto finance 7,918.4 7.00 6,942.0 6.63 MasterCard/Visa 19,271.9 7.26 17,246.2 7.12 Private label 16,015.6 5.62 13,615.1 5.75 Personal non-credit card 19,040.9 9.97 18,837.1 8.32 --------- ---- --------- ---- Total consumer 112,409.7 4.67 104,524.2 4.28 Commercial 391.4 .46 429.1 (.40 ) --------- ---- --------- ---- Total managed receivables $ 112,801.1 4.66 % $ 104,953.3 4.26 % --------- ---- --------- ---- 119 Year Ended December 31, ----------------------------------------------------------------------- 2003 2002 ---------------------------------- --------------------------------- Average Net Average Net Receivables Charge-offs Receivables Charge-offs ----------------- ------------- ----------------- ------------ (In millions) Receivables serviced with limited recourse: Real estate secured $ (271.9 ) 1.69 % $ (572.1 ) 1.26 % Auto finance (4,998.7 ) 8.22 (4,412.6 ) 7.00 MasterCard/Visa (9,755.0 ) 5.38 (9,677.1 ) 5.28 Private label (4,073.4 ) 5.25 (2,840.4 ) 3.75 Personal non-credit card (5,031.6 ) 10.17 (4,869.1 ) 8.49 --------- ----- --------- ---- Total receivables serviced with (24,130.6 ) 6.91 (22,371.3 ) 6.02 limited recourse --------- ----- --------- ---- Owned consumer receivables $ 88,279.1 4.06 % $ 82,152.9 3.81 % --------- ----- --------- ---- -------------- (1) Includes our liquidating legacy first and reverse mortgage portfolios. 6. Acquired Intangibles Acquired intangibles consisted of the following: Accumulated Carrying Gross Amortization Value -------------- ---------------- --------------- (In millions) December 31, 2003 Purchased credit card relationships and related $ 1,522.6 $ 160.0 $ 1,362.6 programs Retail services merchant relationships 270.1 41.1 229.0 Other loan related relationships 326.1 33.8 292.3 Trade names 716.9 - 716.9 Technology, customer lists and other contracts 281.0 26.0 255.0 ------- ----- ------- Acquired intangibles $ 3,116.7 $ 260.9 $ 2,855.8 ------- ----- ------- December 31, 2002 Purchased credit card relationships $ 1,038.6 $ 670.8 $ 367.8 Other intangibles 26.5 7.9 18.6 ------- ----- ------- Acquired intangibles $ 1,065.1 $ 678.7 $ 386.4 ------- ----- ------- Weighted-average amortization periods for our acquired intangibles as of December 31, 2003 were as follows: (In months) Purchased credit card relationships and related programs 74 Retail services merchant relationships 60 Other loan related relationships 110 Technology, customer lists and other contracts 61 --- Acquired intangibles 73 --- Acquired intangible amortization expense totaled $245.5 million in the period March 29 through December 31, 2003, $12.3 million in the period January 1 through March 28, 2003, $57.8 million in 2002 and $99.0 million in 2001. 120 Estimated amortization expense associated with our acquired intangibles for each of the following years is as follows: Year Ending December 31, ----------------------------------------------------------- (In millions) 2004 $ 355.5 2005 334.8 2006 327.4 2007 309.8 2008 216.4 7. Goodwill Effective January 1, 2002, we adopted SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). SFAS No. 142 changed the accounting for goodwill from an amortization method to an impairment-only approach. Amortization of goodwill recorded in past business combinations ceased upon adoption of the statement on January 1, 2002. Completion of the transitional goodwill impairment test in 2002 resulted in none of our goodwill being impaired. As a result of push-down accounting, goodwill of approximately $6.6 billion was recorded upon completion of HSBC's acquisition of Household. This replaced $1.1 billion of goodwill related to previous acquisitions that was recorded prior to the merger. Goodwill established as a result of the merger has not been allocated to our reportable segments, which is consistent with management's view of our reportable segment results. Beginning January 1, 2002, goodwill is reviewed for impairment annually using discounted cash flows but impairment may be reviewed earlier if circumstances indicate that the carrying amount may not be recoverable. We consider significant and long-term changes in industry and economic conditions to be our primary indicator of potential impairment. Our goodwill was not impaired prior to our merger with HSBC on March 28, 2003. Consistent with business combination guidance, our goodwill will not be tested again for impairment until 2004 as no circumstances indicating impairment have arisen subsequent to the merger. For purposes of conducting impairment testing, our goodwill will be allocated to our operating units in 2004. The following table discloses the impact of goodwill amortization on net income for the periods indicated. March 29 January 1 through through Year Ended December 31, December 31, March 28, ---------------------------------- 2003 2003 2002 2001 ----------------- ------------- --------------- --------------- (In millions) Reported net income $ 1,419.5 $ 245.7 $ 1,557.8 $ 1,847.6 Add back: Goodwill amortization, - - - 46.4 net ------- ----- ------- ------- Adjusted net income $ 1,419.5 $ 245.7 $ 1,557.8 $ 1,894.0 ------- ----- ------- ------- 8. Properties and Equipment, Net At December 31, ----------------------------- Depreciable 2003 2002 Life ----------- -------------- ----------------- (In millions) Land $ 28.5 $ 33.6 - Buildings and improvements 266.6 576.0 10-40 years Furniture and equipment 333.1 999.0 3 - 10 ----- ------- Total 628.2 1,608.6 Accumulated depreciation and amortization 101.0 1,073.5 ----- ------- Properties and equipment, net $ 527.2 $ 535.1 ----- ------- 121 As a result of our merger with HSBC, the amortized cost of our property and equipment was adjusted to fair market value and accumulated depreciation and amortization on a "predecessor" basis was eliminated at the time of the merger. Depreciation and amortization expense totaled $101.0 million in the period March 29 through December 31, 2003, $33.1 million in the period January 1 through March 28, 2003, $138.7 million in 2002, and $139.7 million in 2001. 9. Deposits At December 31, ---------------------------------------------------------- 2003 2002 --------------------------- --------------------------- Weighted- Weighted- Average Average Amount Rate Amount Rate ----------- ------------ ----------- ------------ (All dollar amounts are stated in millions) Domestic Time certificates - - $ 22.3 4.4 % Savings accounts - - 24.3 2.1 Demand accounts - - 11.1 1.4 ----- --- ----- --- Total domestic deposits - - 57.7 2.9 ----- --- ----- --- Foreign Time certificates $ 168.4 3.6 % 704.8 4.0 Savings accounts 61.7 1.8 57.4 2.1 Demand accounts 1.4 - 1.3 - ----- --- ----- --- Total foreign deposits 231.5 3.1 763.5 3.8 ----- --- ----- --- Total deposits $ 231.5 3.1 % $ 821.2 3.7 % ----- --- ----- --- In conjunction with the fourth quarter 2002 sale of substantially all of the assets and deposits of the Thrift, we sold $4.3 billion in domestic deposits. The remaining domestic deposits were sold in the first quarter of 2003. Average deposits and related weighted-average interest rates were as follows: Year Ended December 31, ------------------------------------------------------------------------- 2003 2002 2001 --------------------- ----------------------- ----------------------- Weighted- Weighted- Weighted- Average Average Average Average Average Average Deposits Rate Deposits Rate Deposits Rate --------- --------- ----------- --------- ----------- --------- (All dollar amounts are stated in millions) Domestic Time certificates $ 1.1 4.4 % $ 5,145.8 6.9 % $ 6,468.5 6.5 % Savings and demand .1 1.9 97.8 .8 119.7 .6 accounts ----- --- ------- --- ------- --- Total domestic deposits 1.2 2.9 5,243.6 6.8 6,588.2 6.4 ----- --- ------- --- ------- --- Foreign Time certificates 952.6 3.5 417.3 3.9 1,172.8 5.7 Savings and demand 37.9 2.8 178.0 3.2 192.2 4.5 accounts ----- --- ------- --- ------- --- Total foreign deposits 990.5 3.5 595.3 3.7 1,365.0 5.5 ----- --- ------- --- ------- --- Total deposits $ 991.7 3.5 % $ 5,838.9 6.5 % $ 7,953.2 6.3 % ----- --- ------- --- ------- --- 122 Interest expense on total deposits was $27.7 million in the period March 29 through December 31, 2003, $8.3 million in the period January 1 through March 28, 2003, $380.0 million in 2002 and $498.6 million in 2001. Interest expense on domestic deposits was insignificant in 2003, $358.0 million in 2002 and $423.7 million in 2001. Maturities of time certificates in amounts of $100,000 or more at December 31, 2003, all of which were foreign, were: (In millions) 3 months or less $ 142.3 Over 3 months through 6 months 9.9 Over 6 months through 12 months 5.4 Over 12 months 10.7 ----- Total $ 168.3 ----- Contractual maturities of time certificates within each interest rate range at December 31, 2003 were as follows: 2004 2005 2006 2007 Total ---------- ------- ------ ------- ---------- (In millions) Interest Rate 4.00% $ 152.3 - - - $ 152.3 4.00% - 5.99% 5.4 $ 1.8 - $ 8.9 16.1 ----- --- -- --- ----- Total $ 157.7 $ 1.8 - $ 8.9 $ 168.4 ----- --- -- --- ----- 123 10. Commercial Paper, Bank and Other Borrowings Bank and Commercial Other Paper Borrowings Total ----------------- ----------------- ------------------ (All dollar amounts are stated in millions) 2003 Balance $ 8,256.7 $ 865.7 $ 9,122.4 Highest aggregate month-end balance 9,855.9 Average borrowings 6,357.1 1,187.2 7,544.3 Weighted-average interest rate: At year-end 1.2 % 3.6 % 1.4 % Paid during year 1.6 3.9 2.0 2002 Balance $ 4,605.3 $ 1,523.0 $ 6,128.3 Highest aggregate month-end balance 13,270.0 Average borrowings 6,830.4 1,472.6 8,303.0 Weighted-average interest rate: At year-end 1.8 % 3.9 % 2.4 % Paid during year 1.9 3.4 2.2 2001 Balance $ 9,141.2 $ 2,883.1 $ 12,024.3 Highest aggregate month-end balance 13,926.4 Average borrowings 9,221.1 2,240.1 11,461.2 Weighted-average interest rate: At year-end 2.0 % 2.6 % 2.2 % Paid during year 4.1 3.9 4.0 Commercial paper included obligations of foreign subsidiaries of $307.2 million at December 31, 2003, $497.1 million at December 31, 2002 and $374.7 million at December 31, 2001. Bank and other borrowings included obligations of foreign subsidiaries of $831.5 million at December 31, 2003, $1.5 billion at December 31, 2002 and $713.6 million at December 31, 2001. Interest expense for commercial paper, bank and other borrowings totaled $130.4 million in the period March 29 through December 31, 2003, $19.0 million in the period January 1 through March 28, 2003, $180.8 million in 2002 and $463.2 million in 2001. We maintain various bank credit agreements primarily to support commercial paper borrowings and also to provide funding in the U.K. We had committed back-up lines and other bank lines of $15.8 billion at December 31, 2003, including $7.0 billion with HSBC, and $13.9 billion at December 31, 2002. The U.K. had drawn $4.1 billion on its bank lines of credit, including $3.4 billion drawn on HSBC lines, at December 31, 2003 and $1.4 billion at December 31, 2002. Formal credit lines are reviewed annually and expire at various dates through 2007. Borrowings under these lines generally are available at a surcharge over LIBOR. None of the U.S. lines contain material adverse change clauses which could restrict availability. Because we expect our U.K. subsidiary to receive its 2004 funding directly from HSBC, we expect to eliminate its third-party back-up lines in 2004. Annual commitment fee requirements to support availability of these lines at December 31, 2003 totaled $10.0 million and included $1.6 million for the HSBC lines. 124 11. Senior and Senior Subordinated Debt (With Original Maturities Over One Year) At December 31, ------------------------------------ 2003 2002 ----------------- ---------------- (All dollar amounts are stated in millions) Senior Debt Fixed rate: 8.875% Adjustable Conversion-Rate Equity $ 519.1 $ 511.0 Security Units Secured financings: 7.00% to 7.49%; due 2004 to 2005 79.4 120.1 7.50% to 7.99%; due 2004 to 2005 16.0 24.2 8.00% to 8.99%; due 2004 to 2005 17.4 26.3 Other fixed rate senior debt: 2.15% to 3.99%; due 2004 to 2008 3,539.3 496.7 4.00% to 4.99%; due 2004 to 2023 8,152.4 1,967.1 5.00% to 5.49%; due 2004 to 2023 5,029.4 4,748.1 5.50% to 5.99%; due 2004 to 2023 6,204.9 5,704.2 6.00% to 6.49%; due 2004 to 2033 9,589.6 9,529.7 6.50% to 6.99%; due 2004 to 2033 9,186.1 9,788.6 7.00% to 7.49%; due 2004 to 2032 6,729.9 8,108.5 7.50% to 7.99%; due 2004 to 2032 7,752.6 7,956.9 8.00% to 9.25%; due 2004 to 2012 3,537.3 3,809.1 Variable interest rate: Secured financings - 1.89% to 2.62%; due 6,610.7 7,314.0 2004 to 2009 Other variable interest rate senior debt 8,503.5 14,743.8 - 1.17% to 5.00%; due 2004 to 2018 Senior Subordinated Debt - 4.56%, due 2005 170.0 170.0 Junior Subordinated Notes Issued to Capital 721.7 - Trusts Company Obligated Mandatorily Redeemable - 975.0 Preferred Securities of Capital Trusts Unamortized Discount (84.1 ) (242.1 ) Purchase Accounting Fair Value Adjustments 3,189.2 - -------- -------- Total senior and senior subordinated debt $ 79,464.4 $ 75,751.2 -------- -------- Purchase accounting fair value adjustments represent adjustments which have been "pushed down" to record our senior and senior subordinated debt at fair value at the merger date. Secured financings of $6.7 billion at December 31, 2003 are secured by $8.0 billion of real estate secured receivables. Secured financings of $7.5 billion at December 31, 2002 are secured by $8.5 billion of real estate secured receivables. At December 31, 2003, senior and senior subordinated debt included carrying value adjustments relating to derivative financial instruments which decreased the debt balance by $89.1 million and a foreign currency translation adjustment relating to our foreign denominated debt which increased the debt balance by $3.3 billion. At December 31, 2002, senior and senior subordinated debt included carrying value adjustments relating to derivative financial instruments which increased the debt balance by $2.4 billion and a foreign currency translation adjustment relating to our foreign denominated debt which increased the debt balance by $989.3 million. 125 Weighted-average interest rates were 5.1 percent at December 31, 2003 (excluding purchase accounting adjustments) and 5.0 percent at December 31, 2002. Interest expense for senior and senior subordinated debt was $1.5 billion in the period March 29 through December 31, 2003, $792.0 million in the period January 1 through March 28, 2003, $3.3 billion in 2002 and $3.2 billion in 2001. The most restrictive financial covenants contained in the terms of our debt agreements are the maintenance of a minimum shareholder's equity of $5.8 billion for Household Finance Corporation ("HFC"), a wholly owned subsidiary of Household, which is substantially lower than HFC's shareholder's equity of $13.7 billion at December 31, 2003. Debt denominated in a foreign currency is included in the applicable rate category based on the effective U.S. dollar equivalent rate as summarized in Note 12, "Derivative Financial Instruments, Forward Purchase Agreements and Concentrations of Credit Risk." In 2002, we issued $542 million of 8.875 percent Adjustable Conversion-Rate Equity Security Units. The Adjustable Conversion-Rate Equity Security Units each consist of an HFC senior unsecured note with a principal amount of $25 and a contract to purchase, for $25, between 2.6041 and 3.1249 HSBC ordinary shares, depending on the market value at the time, on February 15, 2006 or 2.6041 HSBC ordinary shares if early settlement is elected by the holder. The senior unsecured notes will mature on February 15, 2008. The net proceeds from the sale of the units were allocated between the purchase contracts and the senior unsecured notes in our balance sheet based on the fair value of each at the date of the offering. During 2003, 19.6 million stock purchase contracts were exercised. At December 31, 2003, unexercised stock purchase contracts totaled 2.1 million. The following table summarizes our junior subordinated notes issued to capital trusts ("Junior Subordinated Notes") and the related company obligated mandatorily redeemable preferred securities ("Preferred Securities"): Household Household Household Capital Household Capital Capital Household Capital Capital Trust VII Trust VI Trust V Trust IV Trust I ("HCT VII") ("HCT VI") ("HCT V") ("HCT IV")(1) ("HCT I")(1) ------------------- ------------------ -------------- ------------------- -------------- (All dollars amounts are stated in millions) Junior Subordinated Notes: Principal $206.2 $206.2 $309.3 $206.2 $77.3 balance Interest rate 7.5 % 8.25 % 10.0 % 7.25 % 8.25 % Redeemable by November January June March issuer 2006 2006 2005 2003 June 2000 Stated maturity November January June December June 2031 2031 2030 2037 2025 Preferred Securities: Rate 7.5 % 8.25 % 10.0 % 7.25 % 8.25 % Face value $200 $200 $300 $200 $75 Issue date November January June March June 2001 2001 2000 1998 1995 -------------- (1) Redeemed in 2003. As of December 31, 2003, we adopted FASB Interpretation Number 46, " Consolidation of Variable Interest Entities", as revised in December 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, we are reporting the previously issued Junior Subordinated Notes on our balance sheet rather than the Preferred Securities issued by the capital trusts. HCT I, HCT IV, HCT V, HCT VI and HCT VII (collectively, "the Trusts") were consolidated subsidiaries of Household at December 31, 2002. The Preferred Securities must be redeemed when the Junior Subordinated Notes are paid. The Junior Subordinated Notes have a stated maturity date, but are redeemable by us, in whole or in part, beginning on 126 the dates indicated above at which time the Preferred Securities are callable at par ($25 per Preferred Security) plus accrued and unpaid dividends. Dividends on the Preferred Securities are cumulative, payable quarterly in arrears, and are deferrable at our option for up to five years. We cannot pay dividends on our preferred and common stocks during such deferments. The Preferred Securities have a liquidation value of $25 per preferred security. Our obligations with respect to the Junior Subordinated Notes, when considered together with certain undertakings of Household with respect to the Trusts, constitute full and unconditional guarantees by us of the Trusts' obligations under the respective Preferred Securities. Maturities of senior and senior subordinated debt at December 31, 2003 were as follows: (In millions) 2004 $ 13,368.9 2005 12,676.5 2006 9,336.3 2007 6,610.2 2008 10,063.8 Thereafter 27,408.7 -------- Total $ 79,464.4 -------- Certain of our senior and senior subordinated debt may be redeemed prior to its stated maturity. 12. Derivative Financial Instruments, Forward Purchase Agreements and Concentrations of Credit Risk In the normal course of business and in connection with our asset/ liability management program, we enter into various transactions involving derivative financial instruments. These instruments primarily are used to manage our exposure to fluctuations in interest rates and currency exchange rates. We do not serve as a financial intermediary to make markets in any derivative financial instruments. 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 semiannually. As a result of the active involvement and guidance 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. For further information on our strategies for managing interest rate and foreign exchange rate risk, see the " Risk Management" section within our Management's Discussion and Analysis of Financial Condition and Results of Operations. Objectives for Holding Derivative Financial Instruments We generally fund our assets with liabilities that have similar interest rate features. 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 result in different funding strategies and produce different interest rate risk exposures. 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 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. 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 swaps are contractual agreements between two counterparties for the exchange of periodic interest payments generally based on a notional principal amount and agreed-upon fixed or floating rates. The majority of our interest rate swaps are used to manage our exposure to changes in interest rates by converting floating rate assets or debt to fixed rate or by converting fixed rate assets or debt to floating rate. We have also entered into currency swaps to convert both principal and interest payments on debt issued from one currency to the appropriate functional currency. 127 Forwards and futures are agreements between two parties, committing one to sell and the other to buy a specific quantity of an instrument on some future date. The parties agree to buy or sell at a specified price in the future, and their profit or loss is determined by the difference between the arranged price and the level of the spot price when the contract is settled. We have used both interest rate and foreign exchange rate forward contracts as well as interest rate futures contracts. We use foreign exchange rate forward contracts to reduce our exposure to foreign currency exchange risk. Interest rate forward and futures contracts are used to hedge resets of interest rates on our floating rate assets and liabilities. Cash requirements for forward contracts include the receipt or payment of cash upon the sale or purchase of the instrument. Purchased options grant the purchaser the right, but not the obligation, to either purchase or sell a financial instrument at a specified price within a specified period. The seller of the option has written a contract which creates an obligation to either sell or purchase the financial instrument at the agreed-upon price if, and when, the purchaser exercises the option. We use caps to limit the risk associated with an increase in rates and floors to limit the risk associated with a decrease in rates. Market and Credit Risk By utilizing derivative financial instruments, we are exposed to varying degrees of market and credit risk. Market risk is the possibility that a change in interest rates or foreign exchange rates will cause a financial instrument to decrease in value or become more costly to settle. We mitigate this risk by establishing limits for positions and other controls. Counterparty credit risk is the possibility that a loss may occur because the counterparty to a transaction fails to perform according to the terms of the contract. We control the counterparty credit (or repayment) risk in derivative instruments through established credit approvals, risk control limits and ongoing monitoring procedures. Our exposure to credit risk for futures is limited as these contracts are traded on organized exchanges. Each day, changes in futures contract values are settled in cash. In contrast, swap agreements and forward contracts have credit risk relating to the performance of the counterparty. 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 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. Derivative financial instruments are generally expressed in terms of notional principal or contract amounts which are much larger than the amounts potentially at risk for nonpayment by counterparties. Fair Value and Cash Flow Hedges To manage our exposure to changes in interest rates, we enter into interest rate swap agreements and currency swaps which have been designated as fair value or cash flow hedges under SFAS No. 133. The critical terms of interest rate swaps are designed to match those of the hedged items, enabling the application of the shortcut method of accounting as defined by 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 HSBC merger. Prior to December 31, 2003, we restructured our interest rate swap portfolio to regain use of the shortcut method and to reduce the potential volatility of future earnings. As of December 31, 2003, 85 percent of our swap portfolio (based on notional amounts) were accounted for using the shortcut method. To the extent that the critical terms of the hedged item and the derivative are not identical, hedge ineffectiveness is reported in earnings during the current period as a component of other income. Although the critical terms of currency swaps are designed to match those of the hedged items, SFAS No. 133 does not allow shortcut 128 method accounting for this type of hedge. Therefore, there may be minimal ineffectiveness which is reported in current period earnings. Fair value hedges include interest rate swaps which convert our fixed rate debt or assets to variable rate debt or assets and currency swaps which convert debt issued from one currency into pay variable debt of the appropriate functional currency. Hedge ineffectiveness associated with fair value hedges is recorded as other income and was a gain of $82.4 million ($52.7 million after tax) in the period March 29 through December 31, 2003, a gain of $2.5 million ($1.6 million after tax) in the period January 1 through March 28, 2003, a loss of $5.3 million ($3.4 million after tax) in 2002 and a gain of $.2 million ($.1 million after tax) in 2001. The gain for the period March 29 through December 31, 2003 includes $79.8 million ($51.0 million after-tax) resulting from the discontinuation of the shortcut method of accounting for our interest rate swaps due to the merger. All of our fair value hedges were associated with debt during 2003, 2002 and 2001. We recorded fair value adjustments for open fair value hedges which increased the carrying value of our debt by $88.5 million at December 31, 2003 and $1.8 billion at December 31, 2002. Fair value adjustments for open fair value hedges on a "predecessor" basis are included in the purchase accounting fair value adjustment to debt as a result of push-down accounting effective March 29, 2003 when the "successor" period began. Cash flow hedges include interest rate swaps which convert our variable rate debt or assets to fixed rate debt or assets and currency swaps which convert debt issued from one currency into pay fixed debt of the appropriate functional currency. Gains and (losses) on derivative instruments designated as cash flow hedges (net of tax) are reported in accumulated other comprehensive income and totaled a gain of $97.4 million at December 31, 2003 and a loss of ($736.5) million at December 31, 2002. Accumulated other comprehensive income on a "predecessor" basis was eliminated as a result of push-down accounting effective March 29, 2003 when the "successor" period began. We expect $51.9 million ($32.9 million after-tax) of currently unrealized net gains will be reclassified to earnings within one year, however, these unrealized gains will be offset by increased interest expense associated with the variable cash flows of the hedged items and will result in no net economic impact to our earnings. Hedge ineffectiveness associated with cash flow hedges is recorded as other income and was immaterial in 2003, 2002 and 2001. At December 31, 2003, $3.1 billion of derivative instruments, at fair value, were recorded in derivative financial assets and $151.3 million in derivative related liabilities. At December 31, 2002, $1.9 billion of derivative instruments, at fair value, were recorded in derivative financial assets and $187.0 million in derivative related liabilities. Information related to deferred gains and losses on terminated derivatives was as follows: 2003 2002 --------------- ------------ (In millions) Deferred gains $ 137.7 $ 682.4 Deferred losses 315.3 139.1 Weighted-average amortization period: Deferred gains 6.0 4.8 years years Deferred losses 8.7 2.8 Increases (decreases) to carrying values resulting from net deferred gains and losses: Senior and senior subordinated debt $ (177.6 ) $ 560.1 Accumulated other comprehensive income - (16.8 ) Amortization of net deferred gains (losses) totaled ($7.3) million in the period March 29 through December 31, 2003, $80.3 million in the period January 1 through March 28, 2003, $155.9 million in 2002 and $43.6 million in 2001. Hedges of Net Investments in Foreign Operations From time to time, we may use forward-exchange contracts and foreign currency options to hedge our net investments in foreign operations. We use these hedges to protect against adverse movements in exchange rates. Net gains and (losses) (net of tax) related to 129 these derivatives are included in accumulated other comprehensive income and totaled $.1 million in the period March 29 through December 31, 2003, ($11.9) million in the period January 1 through March 28, 2003, $(85.9) million in 2002 and $8.9 million in 2001. Non-Qualifying Hedging Activities We may also use forward rate agreements, interest rate caps, exchange traded futures, and some interest rate swaps which are not designated as hedges under SFAS No. 133. These financial instruments are economic hedges that are not linked to specific assets and liabilities that appear on our balance sheet and do not qualify for hedge accounting. These derivatives are primarily used to minimize our exposure to changes in interest rates. Net fair value gains (losses) on derivatives which were not designated as hedges are reported as other income and totaled $(7.1) million ($4.5 million after tax) in the period March 29 through December 31, 2003, $(1.0) million ($ (.7) million after tax) in the period January 1 through March 28, 2003, $8.0 million ($5.1 million after-tax) in 2002 and $(.3) million ($(.2) million after-tax) in 2001. 130 Derivative Financial Instruments The following table summarizes derivative financial instrument activity: Exchange Traded Non-Exchange Traded -------------------------------------------- ------------------------------------------------------------------- Interest Rate Futures Foreign Exchange Rate Interest Rate Contracts Contracts Forward Contracts --------------------- Options Interest Currency --------------------- ------------- Caps and Purchased Sold Purchased Rate Swaps Swaps Purchased Sold Purchased Sold Floors Total --------- ------- --------- -------- ------- ------- ------- -------- ---- ------ ------- 2003 Notional - - $ 3,400.0 $ 44,506.4 $ 11,660.6 $376.5 $ (2,524.4 ) $ 159.1 - $ 7,221.0 $69,848.0 amount, 2002 New $ 600.0 $(600.0 ) - 7,600.7 1,219.1 20,102.1 (17,547.8) 905.9 - - 48,575.6 contracts New contracts - - 3,385.0 25,369.7 10,399.3 3,143.5 (642.4) 173.5 - 4,332.8 47,446.2 purchased from subsidiaries of HSBC Matured or - - (4,404.0) (15,137.2) (1,401.2)(3,190.3) 912.2 (506.0) - (4,926.4) (30,477.3) expired contracts Terminate - - (481.0) (11,984.4) (146.2) - - (559.0) - - (13,170.6) contracts In-substance(600.0) 600.0 - - - (19,208.6) 19,208.6 - - - (39,617.2) maturities(1) Assignment of - - - (9,043.2) (5,193.7) - - - - - (14,236.9) contracts to subsidiaries of HSBC Loss of shortcut accounting (2): Terminated - - - (26,530.1) - - - - - - (26,530.1) contracts New - - - 26,530.1 - - - - - - 26,530.1 contracts --------- --------- -------- --------- -------- --------- -------- -------- ----- -------- --------- Notional $ - $ - $ 1,900.0 $ 41,312.0 $ 16,537.9 $ 1,223.2 $ (593.8) $ 173.5 - $ 6,627.4 $ 68,367.8 amount, 2003 -------- --------- -------- --------- -------- --------- ---------- ------- ----- -------- --------- Fair value, 2003(3): Fair value - - - $ 72.7 $ 115.2 $ .4 $ (23.3) - - - $ 165.0 hedges Cash flow - - - (147.0) 2,905.5 40.9 - - - - 2,799.4 hedges Net - - - - - - - - - - - investment in foreign operations Non-hedging - - - 2.1 - - - $ (.1 ) - - 2.0 derivatives -------- --------- -------- --------- -------- -------- -------- -------- ----- ------- --------- Total - - - $ (72.2 ) $ 3,020.7 $ 41.3 $(23.3) $ (.1 ) - - $ 2,966.4 -------- ---------- ------- --------- -------- ------- --------- -------- ----- -------- -------- 2002 Notional $ 1,419.0 $(9,000.0) $2,000.0 $ 30,483.3 $ 8,694.4 $ 109.1 $(1,201.5)$ 499.6 $ - $ 3,012.6 $ 56,419.5 amount, 2001 New 23,113.0 (8,218.0) 8,800.0 30,374.6 4,415.3 23,572.2 (24,350.2) 968.9 (39.4) 6,161.6 130,013.2 contracts Matured or(7,932.0) 618.0 3,400.0) (10,385.0) (917.1) (1,609.8) 1,362.5(1,159.9) 39.4 (1,945.0)(29,368.7) expired contracts Terminated - - (4,000.0) (5,966.5) (532.0) (30.2) - (149.5) - (8.2)(10,686.4) contracts In- substance(16,600.0)16,600.0 - - - (21,664.8) 21,664.8 - - - (76,529.6) maturities(1) --------- --------- -------- --------- ------- --------- -------- -------- ----- ------ --------- Notional $ - $ - $ 3,400.0 $ 44,506.4 $ 11,660.6 $ 376.5 $ (2,524.4)$ 159.1 $ - $ 7,221.0 $ 69,848.0 amount, 2002 Fair value, 2002(3): Fair value - - - $ 1,819.2 $ 22.0 - - - - - $ 1,841.2 hedges Cash flow - - - (514.7 ) 369.3 - - - - - (145.4 ) hedges Net - - - - - $ 1.3 $ (31.2) - - - (29.9 ) investment in foreign operations Non-hedging- - - 5.1 - - - - - $ 5.5 10.6 derivatives -------- ------- -------- --------- ------ --------- -------- -------- ----- ---- --------- Total - - - $ 1,309.6 $ 391.3 $ 1.3 $ (31.2) - - $ 5.5 $ 1,676.5 ---------- ------ -------- --------- ------- --------- -------- -------- ----- ------- --------- 2001 Notional - - - $ 25,708.3 $ 7,297.9 $ 9.1 $ (245.1) $447.9 - $ 2,675.5 $36,383.8 amount, 2000 New $36,675.0 $(22,706.0)$4,750.0 22,259.0 2,481.6 9,347.4 (10,325.0) 2,074.5 - 3,481.8 114,100.3 contracts Matured or (21,850.0) 300.0 - (7,651.3) (919.5) (51.3) 172.5 (1,991.4) - (2,297.7) (35,233.7) expired contracts Terminated - - (2,750.0) (9,832.7) (165.6) - - (31.4) - (847.0) (13,626.7) contracts In- substance(13,406.0)13,406.0 - - - (9,196.1) 9,196.1 - - - (45,204.2) maturities(1) --------- --------- ----- --------- -------- -------- --------- -------- ----- -------- --------- Notional $1,419.0 $(9,000.0)$2,000.0 $30,483.3 $ 8,694.4 $ 109.1 $(1,201.5)$ 499.6 - $ 3,012.6 $56,419.5 amount, 2001. --------- ---------------- --------- -------- -------- --------- ------- ----- -------- --------- Fair value, 2001(3): Fair value - - - $ (152.9 ) $ 67.2 - - - - - $ (85.7 ) hedges Cash flow - - - (348.1 ) (1,084.6 ) $ 2.5 $ 1.7 - - - (1,428.5 ) hedges Non-hedging $.4 $ (3.4 ) $ .4 3.4 - - (3.0 ) $ (1.6 ) - $ (.2 ) (4.0 ) derivatives --------- --------- -------- --------- -------- -------- --------- -------- ----- ------- --------- Total $.4 $ (3.4 ) $.4 $ (497.6 ) $ (1,017.4) $ 2.5 $ (1.3 ) $ (1.6 ) - $ (.2 )$ (1,518.2) -------- -------- -------- --------- -------- -------- --------- ------- ----- -------- --------- (1) Represent contracts terminated as the market execution technique of closing the transaction either (a) just prior to maturity to avoid delivery of the underlying instrument or (b) at the maturity of the underlying items being hedged. (2) 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. During 2003, we restructured our interest rate swap portfolio to regain use of the shortcut method and to reduce the potential volatility of future earnings. (3) (Bracketed) unbracketed amounts represent amounts to be (paid) received by us had these positions been closed out at the respective balance sheet date. Bracketed amounts do not necessarily represent risk of loss as the fair value of the derivative financial instrument and the items being hedged must be evaluated together. See Note 15, " Fair Value of Financial Instruments," for further discussion of the relationship between the fair value of our assets and liabilities. 131 We operate in three functional currencies, the U.S. dollar, the British pound and the Canadian dollar. The U.S. dollar is the functional currency for exchange-traded interest rate futures contracts and options. Non-exchange traded instruments are restated in U.S. dollars by country as follows: Foreign Exchange Interest Rate Contracts Interest Rate Other Risk Rate Currency ---------------------------- Forward Contracts Management Swaps Swaps Purchased Sold Purchased Instruments ------------- ------------- ------------ ------------- ----------------- -------------- (In millions) 2003 United States $ 39,653.5 $ 14,994.7 $ 1,223.2 $ (592.9 ) - $ 6,595.2 Canada 404.8 - - (.9 ) $ 173.5 - United Kingdom 1,253.7 1,543.2 - - - 32.2 -------- -------- ------- -------- ----- ------- $ 41,312.0 $ 16,537.9 $ 1,223.2 $ (593.8 ) $ 173.5 $ 6,627.4 -------- -------- ------- -------- ----- ------- 2002 United States $ 42,682.3 $ 10,210.3 $ 351.0 $ (2,524.4 ) - $ 7,194.2 Canada 270.4 - - - $ 159.1 - United Kingdom 1,553.7 1,450.3 25.5 - - 26.8 -------- -------- ------- -------- ----- ------- $ 44,506.4 $ 11,660.6 $ 376.5 $ (2,524.4 ) $ 159.1 $ 7,221.0 -------- -------- ------- -------- ----- ------- 2001 United States $ 28,405.2 $ 7,259.8 $ 109.1 $ (1,199.5 ) - $ 2,989.9 Canada 287.5 - - (2.0 ) $ 499.6 - United Kingdom 1,790.6 1,434.6 - - - 22.7 -------- -------- ------- -------- ----- ------- $ 30,483.3 $ 8,694.4 $ 109.1 $ (1,201.5 ) $ 499.6 $ 3,012.6 -------- -------- ------- -------- ----- ------- The table below reflects the items hedged using derivative financial instruments which qualify for hedge accounting at December 31, 2003. The critical terms of the derivative financial instruments have been designed to match those of the related asset or liability. Foreign Interest Rate Currency Exchange Swaps Swaps Rate Contracts ------------------- ---------------- ------------------- (In millions) Investment securities $ 6.4 - - Commercial paper, bank and other borrowings 607.2 - $ 1,245.3 Senior and senior subordinated debt 40,698.4 $ 16,537.9 - Advances to foreign subsidiaries - - 571.7 -------- -------- ------- Total items hedged using derivative $ 41,312.0 $ 16,537.9 $ 1,817.0 financial instruments -------- -------- ------- 132 The following table summarizes the maturities and related weighted-average receive/pay rates of interest rate swaps outstanding at December 31, 2003: 2004 2005 2006 2007 2008 2009 Thereafter Total ----------- ----------- ----------- ---------- --------- --------- ---------- ------------ (All dollar amounts are stated in millions) Pay a fixed rate/ receive a floating rate: Notional value $ 5,463.6 $ 4,981.6 $ 2,764.7 $ 1,857.4 $ 453.0 - $ 326.7 $ 15,847.0 Weighted-average 1.66 % 1.73 % 1.24 % 1.13 % 1.26 % - 4.70 % 1.60 % receive rate Weighted-average 3.04 2.90 3.38 2.81 3.94 - 5.46 3.10 pay rate Pay a floating rate/receive a fixed rate: Notional value $ 350.6 $ 133.0 $ 57.8 $ 2,588.4 $ 5,010.0 $ 1,458.4 $ 15,866.8 $ 25,465.0 Weighted-average 1.19 % 1.59 % 3.74 % 3.00 % 3.48 % 3.81 % 4.82 % 4.25 % receive rate Weighted-average 1.14 3.55 2.75 1.33 1.25 1.16 1.25 1.27 pay rate ------- ------- ------- ------- ------- ------- -------- -------- Total notional $ 5,814.2 $ 5,114.6 $ 2,822.5 $ 4,445.8 $ 5,463.0 $ 1,458.4 $ 16,193.5 $ 41,312.0 value ------- ------- ------- ------- ------- ------- -------- -------- Total weighted-average rates on swaps: Receive rate 1.63 % 1.73 % 1.30 % 2.22 % 3.30 % 3.81 % 4.82 % 3.23 % Pay rate 2.92 2.91 3.37 1.95 1.47 1.16 1.34 1.97 The floating rates that we pay or receive are based on spot rates from independent market sources for the index contained in each interest rate swap contract, which generally are based on either 1-, 3- or 6-month LIBOR. These current floating rates are different than the floating rates in effect when the contracts were initiated. Changes in spot rates impact the variable rate information disclosed above. However, these changes in spot rates also impact the interest rate on the underlying assets or liabilities. We use derivative financial instruments to hedge the interest rate inherent in balance sheet assets and liabilities, which manages the volatility of net interest margin resulting from changes in interest rates on the underlying hedged items. Had we not utilized these instruments, owned net interest margin would have decreased by 70 basis points in 2003, decreased by 31 basis points in 2002 and increased by 13 basis points in 2001. Forward Purchase Agreements At December 31, 2002, we had agreements to purchase, on a forward basis, approximately 4.9 million shares of our common stock at a weighted-average forward price of $53.05 per share. As a result of settlements under these forward contracts, we 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, we 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. Concentrations of Credit Risk A concentration of credit risk is defined as a significant credit exposure with an individual or group engaged in similar activities or affected similarly by economic conditions. 133 Because we primarily lend to consumers, we do not have receivables from any industry group that equal or exceed 10 percent of total owned or managed receivables at December 31, 2003 and 2002. We lend nationwide and our receivables are distributed as follows at December 31, 2003: Percent of Total Percent of Total Owned Domestic Managed Domestic State/Region Receivables Receivables ----------------------------------------------------------- ------------------- ------------------- California 14 % 14 % Midwest (IL, IN, IA, KS, MI, MN, MO, NE, ND, OH, SD, WI) 22 23 Southeast (AL, FL, GA, KY, MS, NC, SC, TN) 20 19 Middle Atlantic (DE, DC, MD, NJ, PA, VA, WV) 15 15 Southwest (AZ, AR, LA, NM, OK, TX) 10 11 Northeast (CT, ME, MA, NH, NY, RI, VT) 10 10 West (AK, CO, HI, ID, MT, NV, OR, UT, WA, WY) 9 8 13. Preferred Stock At December 31, ---------------------------------- 2003 2002 ---------------- --------------- (All dollar amounts are stated in millions) Series A 6.5% Cumulative Preferred Stock $ 1,100.0 - 7.625% preferred stock - $ 350.0 7.60% preferred stock - 387.4 7.50% preferred stock - 291.4 $4.30 preferred stock - 83.6 $4.50 preferred stock - 10.4 5.00% preferred stock - 20.4 8.25% preferred stock - 50.0 ------- ------- Total preferred stock $ 1,100.0 $ 1,193.2 ------- ------- As of December 31, 2003, there were 1,100 shares of the Series A Cumulative Preferred Stock ("Series A preferred stock") outstanding, all of which were held by HSBC. Dividends are cumulative and payable annually at a rate of 6.5 percent. The Series A preferred stock may be redeemed at our option after March 31, 2008. The redemption and liquidation value is $1 million per share plus accrued and unpaid dividends. HSBC is entitled to payment before any capital distribution is made to the common shareholder. HSBC is entitled to vote with the holder of our common stock on matters including the dissolution, liquidation or sale of our assets or business. In conjunction with the HSBC merger, our 7.625%, 7.60%, 7.50% and 8.25% preferred stock was converted into the right to receive cash which totaled approximately $1.1 billion. In consideration of HSBC transferring sufficient funds to make these payments, we issued the Series A preferred stock to HSBC on March 28, 2003. Also on March 28, 2003, we called for redemption our $4.30, $4.50 and 5.00% preferred stock. 14. Transactions with Affiliates Due to affiliates includes amounts owed to subsidiaries of HSBC (other than preferred stock) and totaled $7.6 billion at December 31, 2003. Affiliate funding was at interest rates (both the underlying benchmark rate and credit spreads) comparable to third party rates for debt with similar maturities. The maturities of affiliate funding in 2003, however, were generally shorter than those we would have issued to third parties. In early 2004 we received regulatory approval to extend the maturities of future debt issuances to a HSBC subsidiary, 134 which will replace shorter-term affiliate funding issued in 2003. Interest expense on this funding totaled $72.6 million for the period March 29 through December 31, 2003. In consideration of HSBC transferring sufficient funds to make the payments described in Note 2 with respect to certain Household preferred stock, we issued a new series of 6.50% cumulative preferred stock in the amount of $1.1 billion to HSBC on March 28, 2003. The preferred stock is redeemable by Household after March 31, 2008. During 2003, we implemented a $2.5 billion domestic revolving credit facility with HSBC and $4.5 billion in lines of credit with HSBC in the U.K. As of December 31, 2003, $3.4 billion has been drawn on the U.K. lines and nothing has been drawn on the domestic line. During 2003, Household Capital Trust VIII issued $275 million in mandatorily redeemable preferred securities to HSBC. The terms of this issuance were as follows: (All dollars amounts are stated in millions) Junior Subordinated Notes: Principal balance $283.5 Redeemable by issuer September 26, 2008 Stated maturity November 15, 2033 Preferred Securities: Rate 6.375 % Face value $275 Issue date September 2003 During the third quarter of 2003, we began utilizing an affiliate, HSBC Bank USA, as the primary provider of new domestic derivative products. At December 31, 2003, we had derivative contracts with a notional value of approximately $39.7 billion outstanding with this affiliate. 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. On December 31, 2003, we sold $2.8 billion of real estate secured receivables from our mortgage services business to HSBC Bank USA. We recorded a pre-tax gain of $16.0 million on the sale. Under a separate servicing agreement, we have agreed to service all real estate secured receivables sold to HSBC Bank USA including all future business they purchase from correspondents. During the period March 29 through December 31, 2003, we paid $26.8 million for various fees and services, primarily related to funding, to subsidiaries of HSBC. Included in this total were loan commitment fees, debt issuance costs, and fees for banking services. Fees paid to HSBC subsidiaries are consistent with amounts which would be paid to third parties. In many cases, these fees were based on third-party market quotes. During the fourth quarter of 2003, we reached an agreement with HSBC Bank USA whereby risk associated with HSBC Bank USA's credit life and disability insurance policies was transferred to us. Also during the fourth quarter of 2003, our credit card services business entered into a credit card servicing and processing agreement and our auto finance business entered into a loan origination and servicing agreement with subsidiaries of HSBC. Fees received pursuant to such agreements were not significant. 15. Fair Value of Financial Instruments In accordance with the guidelines for accounting for business combinations, the purchase price paid by HSBC plus related purchase accounting adjustments have been "pushed-down" and recorded in our financial statements for the period subsequent to March 28, 2003. This has resulted in a new basis of accounting reflecting the fair market value of our assets and liabilities for the "successor" period beginning March 29, 2003. We have estimated the fair value of our financial instruments in accordance with SFAS No. 107, 135 "Disclosures About Fair Value of Financial Instruments" ("SFAS No. 107"). Fair value estimates, methods and assumptions set forth below for our financial instruments are made solely to comply with the requirements of SFAS No. 107 and should be read in conjunction with the financial statements and notes in this Annual Report. A significant portion of our financial instruments do not have a quoted market price. For these items, fair values were estimated by discounting estimated future cash flows at estimated current market discount rates. Assumptions used to estimate future cash flows are consistent with management's assessments regarding ultimate collectibility of assets and related interest and with estimates of product lives and repricing characteristics used in our asset/ liability management process. All assumptions are based on historical experience adjusted for future expectations. Assumptions used to determine fair values for financial instruments for which no active market exists are inherently judgmental and changes in these assumptions could significantly affect fair value calculations. As required under generally accepted accounting principles, a number of other assets recorded on the balance sheets (such as acquired credit card relationships, the value of consumer lending relationships for originated receivables and the franchise values of our business units) are not considered financial instruments and, accordingly, are not valued for purposes of this disclosure. We believe there is substantial value associated with these assets based on current market conditions and historical experience. Accordingly, the estimated fair value of financial instruments, as disclosed, does not fully represent our entire value, nor the changes in our entire value. The following is a summary of the carrying value and estimated fair value of our financial instruments: At December 31, --------------------------------------------------------------------------------------------------------- 2003 2002 --------------------------------------------------- --------------------------------------------------- Carrying Estimated Carrying Estimated Value Fair Value Difference Value Fair Value Difference --------------- --------------- --------------- --------------- --------------- --------------- (In millions) Assets: Cash $ 463.4 $ 463.4 - $ 797.7 $ 797.7 - Investment 11,073.1 11,073.1 - 7,584.0 7,584.0 - securities Receivables 91,027.3 91,596.9 $ 569.6 82,050.5 84,461.8 $ 2,411.3 Derivative 3,117.7 3,117.7 - 1,863.5 1,863.5 - financial assets --------- --------- -------- --------- --------- -------- Total assets 105,681.5 106,251.1 569.6 92,295.7 94,707.0 2,411.3 --------- --------- -------- --------- --------- -------- Liabilities: Deposits (231.5 ) (232.4 ) (.9 ) (821.2 ) (825.2 ) (4.0 ) Commercial paper, (9,122.4 ) (9,122.4 ) - (6,128.3 ) (6,128.3 ) - bank and other borrowings Due to affiliates (7,589.3 ) (7,603.0 ) (13.7 ) - - - Senior and senior(79,464.4 ) (80,514.2 ) (1,049.8 ) (75,751.2 ) (77,495.7 ) (1,744.5 ) subordinated debt Insurance policy (1,258.0 ) (1,254.7 ) 3.3 (1,047.6 ) (1,369.0 ) (321.4 ) and claim reserves Derivative (151.3 ) (151.3 ) - (187.0 ) (187.0 ) - financial liabilities --------- --------- -------- --------- --------- -------- Total liabilities (97,816.9 ) (98,878.0 ) (1,061.1 ) (83,935.3 ) (86,005.2 ) (2,069.9 ) --------- --------- -------- --------- --------- -------- Total $ 7,864.6 $ 7,373.1 $ (491.5 ) $ 8,360.4 $ 8,701.8 $ 341.4 --------- --------- -------- --------- --------- -------- Cash: Carrying value approximates fair value due to cash's liquid nature. 136 Investment securities: Investment securities are classified as available-for-sale and are carried at fair value on the balance sheets. Fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Receivables: The fair value of adjustable rate receivables generally approximates carrying value because interest rates on these receivables adjust with changing market interest rates. The fair value of fixed rate consumer receivables was estimated by discounting future expected cash flows at interest rates which approximate the rates that would achieve a similar return on assets with comparable risk characteristics. Receivables also includes our interest-only strip receivables. The interest-only strip receivables are carried at fair value on our balance sheets. Fair value is based on an estimate of the present value of future cash flows associated with securitizations of certain real estate secured, auto finance, MasterCard and Visa, private label and personal non-credit card receivables. Deposits: The fair value of our savings and demand accounts equaled the carrying amount as stipulated in SFAS No. 107. The fair value of fixed rate time certificates was estimated by discounting future expected cash flows at interest rates that we offer on such products at the respective valuation dates. Commercial paper, bank and other borrowings: The fair value of these instruments approximates existing carrying value because interest rates on these instruments adjust with changes in market interest rates due to their short-term maturity or repricing characteristics. Due to affiliates: The estimated fair value of our fixed rate debt instruments was determined using either quoted market prices or by discounting future expected cash flows at interest rates offered for similar types of debt instruments. Carrying value is typically used to estimate the fair value of floating rate debt. Senior and senior subordinated debt: The estimated fair value of our fixed rate debt instruments was determined using either quoted market prices or by discounting future expected cash flows at interest rates offered for similar types of debt instruments. Carrying value is typically used to estimate the fair value of floating rate debt. Insurance policy and claim reserves: The fair value of insurance reserves for periodic payment annuities was estimated by discounting future expected cash flows at estimated market interest rates at December 31, 2003 and 2002. The fair value of other insurance reserves is not required to be determined in accordance with SFAS No. 107. Derivative financial assets and liabilities: All derivative financial assets and liabilities, which exclude amounts received from or paid to swap counterparties, are carried at fair value on the balance sheet. Where practical, quoted market prices were used to determine fair value of these instruments. For non-exchange traded contracts, fair value was determined using accepted and established valuation methods (including input from independent third parties) which consider the terms of the contracts and market expectations on the valuation date for forward interest rates (for interest rate contracts) or forward foreign currency exchange rates (for foreign exchange contracts). We enter into foreign exchange contracts to hedge our exposure to currency risk on foreign denominated debt. We also enter into interest rate contracts to hedge our exposure to interest rate risk on assets and liabilities, including debt. As a result, decreases/increases in the fair value of derivative financial instruments which have been designated as effective hedges are offset by a corresponding increase/decrease in the fair value of the individual asset or liability being hedged. See Note 12, "Derivative Financial Instruments, Forward Purchase Agreements and Concentrations of Credit Risk," for additional discussion of the nature of these items. 16. Leases We lease certain offices, buildings and equipment for periods which generally do not exceed 25 years. The leases have various renewal options. The office space leases generally require us to pay certain operating expenses. Net rental expense under operating leases was $111.6 million in the period March 29 through December 31, 2003, $36.3 million in the period January 1 through March 28, 2003, $135.1 million in 2002 and $124.9 million in 2001. 137 We have a lease obligation on a former office complex which has been subleased through 2010, the end of the lease period. The sublessee has assumed our future rental obligations on this lease. Future net minimum lease commitments under noncancelable operating lease arrangements were: Minimum Minimum Rental Sublease Year Ending December 31, Payments Income Net ------------------------------------------------- ----------- ----------- ---------- (In millions) 2004 $ 170.2 $ 24.4 $ 145.8 2005 134.1 23.6 110.5 2006 122.0 23.2 98.8 2007 90.5 23.1 67.4 2008 75.2 23.0 52.2 Thereafter 229.1 39.6 189.5 ----- ----- ----- Net minimum lease commitments $ 821.1 $ 156.9 $ 664.2 ----- ----- ----- 17. Incentive Compensation and Stock Option Plans Stock Option Plans The HSBC Holdings Group Share Option Plan (the "Group Share Option Plan"), which replaced the former Household stock option plans, is a long-term incentive compensation plan available to certain Household employees. Grants are usually made each year. Options granted to Household employees in 2003 will vest 75 percent in year 3 with the remaining 25 percent vesting in year 4 and expire 10 years from the date of grant. Options are granted at market value. Total options to purchase HSBC ordinary shares granted to Household employees under the Group Share Option Plan in 2003 were 4,069,800. The fair value of options granted was $4.74 per option. Compensation expense related to these options is recognized over the vesting period and totaled $.8 million for the period March 29 through December 31, 2003. Beginning in 2004, options granted under the Group Share Option Plan will be exercisable between the third and tenth anniversaries of the date of grant subject to vesting conditions. The fair value of each option granted under the Group Share Option Plan was estimated as of the date of grant using the Black-Scholes option pricing model. The fair value estimates used the following weighted-average assumptions: Risk-free interest rate 5.27 % Expected life 5 years Expected volatility 30.00 % Prior to the merger with HSBC, certain Household employees were eligible to participate in Household's stock option plan. Employee stock options generally vested equally over four years and expired 10 years from the date of grant. Upon completion of the merger with HSBC, all options granted prior to November 2002 vested and became outstanding options to purchase HSBC ordinary shares. Options granted under the former Household plans subsequent to October 2002 were converted into options to purchase ordinary shares of HSBC, but did not vest under the change in control. Compensation expense related to the former Household plan totaled $4.6 million in the period March 29 through December 31, 2003, $3.8 million in the period January 1 through March 28, 2003 and $1.5 million in 2002. No compensation expense was recognized in 2001. Prior to 2003, non-employee directors annually received options to purchase shares of Household's common stock at the stock's fair market value on the day the option was granted. Director options had a term of ten years and one day, fully vested six months from the date granted, and once vested were exercisable at any time during the option term. In November 2002, non-employee directors chose not to receive their annual option to purchase 10,000 shares of Household's common stock in light of the transaction with HSBC. Instead, each director received a cash payment of $120,000 which was the fair market value of the options he or she would have otherwise received. 138 Information with respect to stock options granted under the former Household plan is as follows: 2003 2002 2001 ------------------------------ ------------------------------ ------------------------------ Weighted- Weighted- Weighted- Average Average Average Price per Price per Price per Shares Share Shares Share Shares Share ---------------- ----------- ---------------- ----------- ---------------- ----------- Outstanding at 19,850,371 $ 36.80 17,750,284 $ 37.19 16,687,142 $ 31.09 beginning of year Granted - - 2,933,600 29.59 3,080,400 57.16 Exercised (439,087 ) 11.04 (730,977 ) 15.36 (2,015,723 ) 17.26 Expired or canceled (231,557 ) 53.28 (102,536 ) 49.88 (1,535 ) 28.22 ---------- ----- ---------- ----- ---------- ----- Outstanding at March 19,179,727 37.20 - - - - 28, 2003 Conversion to HSBC 51,305,796 13.90 - - - - ordinary shares Exercised (4,749,726 ) 5.00 - - - - Expired or canceled (1,361,727 ) 16.49 - - - - ---------- ----- ---------- ----- ---------- ----- Outstanding at end of 45,194,343 $ 14.76 19,850,371 $ 36.80 17,750,284 $ 37.19 year ---------- ----- ---------- ----- ---------- ----- Exercisable at end of 39,743,144 $ 15.32 13,184,371 $ 33.80 11,502,384 $ 29.44 year ---------- ----- ---------- ----- ---------- ----- Weighted-average fair $ - $ 11.57 $ 18.25 value of options granted ----- ----- ----- The following table summarizes information about stock options outstanding under the former Household plan, all of which are in HSBC ordinary shares, at December 31, 2003. Options Outstanding Options Exercisable ---------------------------------------------------------- ------------------------------------- Range of Number Weighted-Average Weighted-Average Number Weighted-Average Exercise Prices Outstanding Remaining Life Exercise Price Outstanding Exercise Price -------------------- ----------------- ----------------- ------------------ ---------------- ------------------ $ 4.01 255,106 .68 years $ 4.17 255,106 $ 4.17 - $ 5.00 $ 5.01 4,943,279 1.98 6.92 4,943,279 6.92 - $10.00 $10.01 10,166,015 7.22 10.87 4,714,816 11.11 - $12.50 $12.51 9,564,976 4.46 14.11 9,564,976 14.11 - $15.00 $15.01 6,234,187 5.65 16.95 6,234,187 16.95 - $17.50 $17.51 6,459,458 6.85 18.41 6,459,458 18.41 - $20.00 $20.01 7,571,322 7.87 21.37 7,571,322 21.37 - $25.00 The fair value of options granted under the former Household plans was estimated as of the date of grant using the Black-Scholes option pricing model. The fair value estimates used the following weighted-average assumptions: 2002 2001 ----------- ----------- Risk-free interest rate 3.17 % 3.62 % Expected dividend yield 3.43 1.44 Expected life 5 5 years years Expected volatility 55.4 % 34.3 % The Black-Scholes model uses different assumptions that can significantly effect the fair value of the options. As a result, the derived fair value estimates cannot be substantiated by comparison to independent markets. Restricted Share Plans Subsequent to the merger, key employees are also provided awards in the form of restricted shares ("RSRs") under HSBC's Restricted Share Plan. Awards to Household employees in 2003 139 generally vest over a 3 or 5 year period and do not require the achievement of performance targets. In 2003, 5,893,889 RSRs were awarded under HSBC's Restricted Share Plan. Compensation expense related to these RSRs are recognized over the vesting period and totaled $9.2 million for the period March 29, 2003 through December 31, 2003. Beginning in 2004, awards granted under HSBC's Restricted Share Plan will vest over five years and may require the achievement of certain performance targets. Prior to the merger, Household's executive compensation plans also provided for issuance of RSRs which entitled an employee to receive a stated number of shares of Household common stock if the employee satisfied the conditions set by the Compensation Committee for the award. Upon completion of the merger with HSBC, all RSRs granted under the former Household plan prior to November 2002 vested and became outstanding shares of HSBC. RSRs granted under the former Household plan subsequent to October 2002 were converted into rights to receive HSBC ordinary shares. Upon vesting, the employee can elect to receive either HSBC ordinary shares or American depository shares. Information with respect to RSRs awarded under the pre-merger Household plan is as follows: 2003 2002 2001 ----------------- ----------------- ---------------- RSRs awarded 134,552 1,711,661 794,700 Weighted-average fair market value per $ 27.11 $ 34.19 $ 57.74 share RSRs outstanding at December 31. 2,512,242 4,740,827 4,266,178 Compensation cost: (in millions) Pre-tax $ 23.2 $ 56.8 $ 45.4 After-tax 14.8 36.1 29.7 Compensation cost with respect to the RSR's awarded under the pre-merger Household plan for the period March 29 to December 31, 2003 was $5.1 million. Employee Stock Purchase Plans The HSBC Sharesave Contribution Plan (the " HSBC Sharesave Plan"), which replaced the former Household employee stock purchase plan, allows eligible employees to enter into savings contracts to save up to approximately $400 per month, with the option to use the savings to acquire shares. There are currently two types of plans offered which allow the participant to select saving contracts of either a 3 or 5 year length. The options are exercisable within six months following the third or fifth year, respectively, of the commencement of the related savings contract, at a 20 percent discount for options granted in 2003. In 2003, 2,810,598 HSBC ordinary share options with a fair value of $9.0 million were granted under the 3 year vesting period and 903,171 HSBC ordinary share options with a fair value of $3.0 million were granted under the 5 year vesting period. Compensation expense related to grants under the HSBC Sharesave Plan totaled $1.8 million for the period March 29 through December 31, 2003. The fair value of each option granted under the HSBC Sharesave Plan was estimated as of the date of grant using the Black-Scholes option pricing model. The fair value estimates used the following weighted-average assumptions: Risk-free interest rate 4.07 % Expected life 3 or 5 years Expected volatility 30.00 % Prior to the merger, Household also maintained an Employee Stock Purchase Plan (the "ESPP"). The ESPP provided a means for employees to purchase shares of Household's common stock at 85 percent of the lesser of its market price at the beginning or end of a one-year subscription period. The ESPP was terminated on March 7, 2003 and 775,480 shares of Household common stock were purchased on that date. Compensation expense related to the ESPP totaled $6.6 million in the period January 1 to March 28, 2003 and $3.7 million in 2002. No ESPP expense was recognized in 2001. 140 18. Employee Benefit Plans Defined Benefit Pension Plans Household sponsors several defined benefit pension plans covering substantially all of its U.S. and non-U.S. employees. During 2003, we changed the benefit plan measurement date for our domestic plan from September 30 to December 31 to conform with the date used by HSBC. We use a December 31 measurement date for the majority of our plans. Pension expense (income) for defined benefit plans included the following components: Year Ended March 29 through December 31, December 31, January 1 through -------------------------- 2003 March 28, 2003 2002 2001 ------------------- -------------------- ---------- ------------ (In millions) Service cost - benefits earned $ 36.1 $ 10.6 $ 32.5 $ 26.9 during the period Interest cost on projected 35.4 5.4 23.9 37.4 benefit obligation Expected return on assets (48.7 ) (16.2 ) (67.0 ) (101.6 ) Amortization of prior service .6 .4 .4 (.9 ) cost Recognized losses - 14.0 22.0 - ----- ----- ----- ------ Pension expense (income) $ 23.4 $ 14.2 $ 11.8 $ (38.2 ) ----- ----- ----- ------ The assumptions used in determining pension expense (income) of the domestic defined benefit plans are as follows: 2003 2002 2001 --------- -------- --------- Discount rate(1) 6.50 % 7.5 % 8.25 % Salary increase assumption 4.0 4.0 4.0 Expected long-term rate of return on plan assets 8.0 8.0 10.0 -------------- (1) The discount rate used to determine pension expense for the period January 1 through March 28, 2003 was 6.75%. We retain an unaffiliated third party to provide investment consulting services. Given the plan's current allocation of equity and fixed income securities and using investment return assumptions which are based on long term historical data and supplied by the consultant, the long term expected return for plan assets is reasonable. The funded status of our defined benefit pension plan was as follows: At December 31, --------------------------- 2003 2002 ------------ ----------- (In millions) Funded status $ 53.2 $ 9.9 Unrecognized net actuarial (gain) loss (148.0 ) 531.0 Unamortized prior service cost 6.3 7.3 ------ ----- (Accrued pension liability)/Prepaid pension cost $ (88.5 ) $ 548.2 ------ ----- The prepaid pension cost was eliminated in 2003 as a result of the application of push-down accounting effective March 29, 2003. There were no intangible assets related to these plans in the amounts recognized on our balance sheet at December 31, 2003 and 2002. 141 A reconciliation of beginning and ending balances of the fair value of plan assets associated with our defined benefit pension plans is as follows: Year Ended December 31, ------------------------------ 2003 2002 -------------- ------------ (In millions) Fair value of plan assets at beginning of year $ 837.7 $ 859.8 Actual return on plan assets 278.3 (100.9 ) Foreign currency exchange rate changes 16.0 4.2 Employer contributions .2 116.1 Benefits paid (60.2 ) (41.5 ) ------- ------ Fair value of plan assets at end of year $ 1,072.0 $ 837.7 ------- ------ For our domestic plan, the fair value of plan assets was $969.5 million at December 31, 2003 and $755.9 million at December 31, 2002. We do not currently anticipate making employer contributions to our domestic defined benefit plan in 2004. We made contributions totaling $116.1 million during 2002 to improve the funded status of our defined benefit pension plans given the declines in return on plan assets experienced during the year. The actual allocation of our domestic pension plan assets at December 31, 2003 and 2002 as well as our target allocation for 2004 are as follows: Percentage of Plan Assets Target at December 31, Allocation ----------------------- 2004 2003 2002 -------------- ---------- --------- Equity securities 78 % 77 % 72 % Debt securities 21 21 22 Other 1 2 6 --- --- --- Total 100 % 100 % 100 % --- --- --- At December 31, 2003, equity securities included our investment in 177,624 HSBC American depository shares with a fair value of $14.0 million. At December 31, 2002, equity securities included an investment in 1,112,546 shares of Household's common stock with a fair market value of $30.9 million. The primary objective of our defined benefit pension plans is to provide eligible employees with regular pension benefits. Since our domestic plans are governed by the Employee Retirement Income Security Act of 1974 ("ERISA"), ERISA regulations serve as guidance for the management of plan assets. Consistent with prudent standards of preservation of capital and maintenance of liquidity, the goals of our plans are to earn the highest possible rate of return consistent with our tolerance for risk as determined by our investment committee in its role as a fiduciary. In carrying out these objectives, short-term fluctuations in the value of plan assets are considered secondary to long-term investment results. We use a third party to provide investment consulting services such as recommendations on the type of funds to be invested in and monitoring the performance of fund managers. In order to achieve the return objectives of our plans, our plans are diversified to ensure that adverse results from one security or security class will not have an unduly detrimental effect on the entire investment portfolio. Assets are diversified by type, characteristic and number of investments as well as by investment style of management organization. Equity securities are invested in large, mid and small capitalization domestic stocks as well as international stocks. 142 A reconciliation of beginning and ending balances of the projected benefit obligation of the defined benefit pension plans is as follows: Year Ended December 31, ----------------------------- 2003 2002 -------------- ----------- (In millions) Projected benefit obligation at beginning of year $ 827.8 $ 677.8 Service cost 46.7 32.5 Interest cost 40.8 23.9 Actuarial gains 142.0 125.7 Foreign currency exchange rate changes 15.5 5.3 Plan amendments 6.3 4.1 Benefits paid (60.2 ) (41.5 ) ------- ----- Projected benefit obligation at end of year $ 1,018.9 $ 827.8 ------- ----- The accumulated benefit obligation for all defined benefit pension plans was $922 million at December 31, 2003 and $748 million at December 31, 2002. Estimated future benefit payments for our domestic plan are as follows: (In millions) 2004 $ 50.8 2005 55.1 2006 53.5 2007 57.9 2008 63.9 2009-2013 373.2 The assumptions used in determining the projected benefit obligation of the domestic defined benefit plans at December 31 are as follows: 2003 2002 2001 ---------- ---------- --------- Discount rate 6.25% 6.75% 7.5% Salary increase assumption 3.75 4.0 4.0 We also sponsor a non-qualified supplemental retirement plan. This plan, which is currently unfunded, provides eligible employees defined pension benefits outside the qualified retirement plan. Benefits are based on average earnings, years of service and age at retirement. The projected benefit obligation was $80.2 million at December 31, 2003 and $57.8 million at December 31, 2002. Pension expense related to the supplemental retirement plan was $8.7 million in the period March 29 through December 31, 2003, $2.5 million in the period January 1 through March 28, 2003, $17.1 million in 2002 and $10.0 million in 2001. Defined Contribution Plans We sponsor various 401(k) savings plans and profit sharing plans for employees meeting certain eligibility requirements. Under these plans, each participant's contribution is matched by the company up to a maximum of 6 percent of the participant's compensation. Prior to the merger with HSBC, company contributions were in the form of Household International common stock. Subsequent to the merger, company contributions are in the form of cash. Total expense for these plans was $49.5 million in the period March 29 through December 31, 2003, $21.3 million in the period January 1 through March 28, 2003, $69.2 million in 2002 and $56.7 million in 2001. Postretirement Plans Other Than Pensions We have several plans which provide medical, dental and life insurance benefits to retirees and eligible dependents. These plans cover substantially all employees who meet certain age and vested service requirements. We have instituted dollar limits on our payments under the plans to control the cost of future medical benefits. 143 The net postretirement benefit cost included the following: March 29 January 1 Year Ended through through December 31, December 31, March 28, -------------------- 2003 2003 2002 2001 --------------- ------------ -------- -------- (In millions) Service cost-benefits earned during the period $ 2.9 $ .9 $ 3.7 $ 3.2 Interest cost on accumulated postretirement 9.8 1.4 6.5 11.1 benefit obligation Amortization of transition obligation - 1.6 6.6 6.6 Amortization of prior service cost - (.3 ) (1.4 ) (1.7 ) Recognized actuarial gain - - (1.1 ) (3.1 ) ---- --- ---- ---- Net periodic postretirement benefit cost $ 12.7 $ 3.6 $ 14.3 $ 16.1 ---- --- ---- ---- The assumptions used in determining the net periodic postretirement benefit cost for our domestic postretirement benefit plans are as follows: 2003 2002 2001 ---------- --------- ---------- Discount rate(1) 6.50% 7.5% 8.25% Salary increase assumption 4.0 4.0 4.0 -------------- (1) The discount rate used to determine periodic postretirement benefit cost for the period January 1 through March 28, 2003 was 6.75%. A reconciliation of the beginning and ending balances of the accumulated postretirement benefit obligation is as follows: Year Ended December 31, -------------------------- 2003 2002 ----------- ----------- (In millions) Accumulated benefit obligation at beginning of year $ 243.6 $ 196.8 Service cost 3.8 3.7 Interest cost 11.2 6.4 Foreign currency exchange rate changes 1.5 .1 Actuarial losses 8.2 47.6 Benefits paid (16.5 ) (11.0 ) ----- ----- Accumulated benefit obligation at end of year $ 251.8 $ 243.6 ----- ----- Our postretirement benefit plans are funded on a pay-as-you-go basis. We currently estimate that we will pay benefits of approximately $17 million relating to our postretirement benefit plans in 2004. The components of the accrued postretirement benefit obligation are as follows: At December 31, -------------------------- 2003 2002 ----------- ----------- Funded status $ 251.8 $ 243.6 Unamortized prior service cost - 16.8 Unrecognized net actuarial (loss) gain 3.6 (17.4 ) Unamortized transition obligation - (70.2 ) ----- ----- Accrued postretirement benefit obligation $ 255.4 $ 172.8 ----- ----- 144 Estimated future benefit payments for our domestic plans are as follows: (In millions) 2004 $ 16.9 2005 18.3 2006 19.4 2007 20.2 2008 20.7 2009-2013 105.4 The assumptions used in determining the benefit obligation of our domestic postretirement benefit plans at December 31 are as follows: 2003 2002 2001 --------- --------- -------- Discount rate 6.25 % 6.75 % 7.5 % Salary increase assumption 3.75 4.0 4.0 A 12.8 percent annual rate of increase in the gross cost of covered health care benefits was assumed for 2004. This rate of increase is assumed to decline gradually to 5.6 percent in 2013. Assumed health care cost trend rates have an effect on the amounts reported for health care plans. A one-percentage point change in assumed health care cost trend rates would increase (decrease) service and interest costs and the postretirement benefit obligation as follows: One Percent One Percent Increase Decrease ---------------- ---------------- (In millions) Effect on total of service and interest cost components $ .5 $ (.4 ) Effect on postretirement benefit obligation 11.0 (9.6 ) In December 2003, President Bush signed into law a new Medicare bill that provides prescription drug coverage to Medicare-eligible retirees. In its present form, our retiree medical plans provide prescription drugs to certain Medicare-eligible retirees. The results contained in these financial statements do not anticipate any changes to our retiree medical plans in light of the expected Medicare legislation. We are currently studying the impact of the new legislation and the resulting impact, if any, on our financial statements. Specific authoritative guidance on the accounting for the federal subsidy is pending and that guidance, when issued, may require us to change previously reported information. 145 19. Income Taxes Total income taxes were: March 29 January 1 Year Ended through through December 31, December 31, March 28, -------------------------- 2003 2003 2002 2001 -------------- -------------- ---------- ------------ (In millions) Provision for income taxes related to $ 725.4 $ 181.8 $ 695.0 $ 970.8 operations Income taxes related to adjustments included in common shareholder's(s') equity: Unrealized gains (losses) on 104.7 (13.5 ) 52.6 110.6 investments and interest-only strip receivables, net Unrealized gains (losses) on cash flow 52.4 57.6 (22.8 ) (391.6 ) hedging instruments Minimum pension liability - - (16.0 ) - Foreign currency translation - (6.9 ) (49.5 ) 2.3 adjustments Exercise of stock based compensation (14.5 ) (2.5 ) (11.4 ) (35.5 ) ----- ----- ----- ------ Total $ 868.0 $ 216.5 $ 647.9 $ 656.6 ----- ----- ----- ------ Provisions for income taxes related to operations were: March 29 January 1 Year Ended through through December 31, December 31, March 28, -------------------------- 2003 2003 2002 2001 --------------- ------------- ------------ ---------- (In millions) Current United States $ 688.0 $ 73.5 $ 731.1 $ 907.1 Foreign 85.0 18.7 83.5 69.8 ----- ----- ------ ----- Total current 773.0 92.2 814.6 976.9 ----- ----- ------ ----- Deferred United States (51.9 ) 91.8 (125.9 ) (3.9 ) Foreign 4.3 (2.2 ) 6.3 (2.2 ) ----- ----- ------ ----- Total deferred (47.6 ) 89.6 (119.6 ) (6.1 ) ----- ----- ------ ----- Total income taxes $ 725.4 $ 181.8 $ 695.0 $ 970.8 ----- ----- ------ ----- The significant components of deferred income tax provisions attributable to income from operations were: March 29 January 1 Year Ended through through December 31, December 31, March 28, --------------------------- 2003 2003 2002 2001 --------------- -------------- ------------ ----------- (In millions) Deferred income tax provision (excluding $ (47.6 ) $ 89.6 $ (136.3 ) $ (11.1 ) the effects of other components) Adjustment of valuation allowance - - 12.6 (11.8 ) Change in operating loss carryforwards - - 4.1 16.8 ----- ---- ------ ----- Deferred income tax provision $ (47.6 ) $ 89.6 $ (119.6 ) $ (6.1 ) ----- ---- ------ ----- 146 Income before income taxes were: March 29 January 1 Year Ended through through December 31, December 31, March 28, ------------------------------ 2003 2003 2002 2001 ---------------- ------------ ------------- ------------- (In millions) United States $ 1,898.4 $ 378.7 $ 1,931.9 $ 2,540.5 Foreign 246.5 48.8 320.9 277.9 ------- ----- ------- ------- Total income before income taxes $ 2,144.9 $ 427.5 $ 2,252.8 $ 2,818.4 ------- ----- ------- ------- Effective tax rates are analyzed as follows: March 29 January 1 Year Ended through through December 31, December 31, March -------------------- 2003 28, 2003 2002 2001 --------------- ------------- -------- -------- (In millions) Statutory federal income tax rate 35.0 % 35.0 % 35.0 % 35.0 % Increase (decrease) in rate resulting from: State and local taxes, net of federal 1.4 1.9 1.4 2.8 benefit Tax credits (2.9 ) (5.1 ) (3.8 ) (2.7 ) Noncurrent tax requirements (1.4 ) (3.0 ) (2.2 ) (.2 ) Nondeductible acquisition costs - 11.0 - - Other 1.7 2.7 .5 (.5 ) ---- ---- ---- ---- Effective tax rate 33.8 % 42.5 % 30.9 % 34.4 % ---- ---- ---- ---- Provision for U.S. income taxes had not been made on net undistributed earnings of foreign subsidiaries of $552.9 million at December 31, 2003 and $553.6 million at December 31, 2002. Determination of the amount of unrecognized deferred tax liability related to investments in foreign subsidiaries is not practicable. In addition, provision for U.S. income taxes had not been made at December 31, 2003 on $80.1 million of undistributed earnings of life insurance subsidiaries accumulated as policyholders' surplus under tax laws in effect prior to 1984. If this amount were distributed, the additional income tax payable would be approximately $28 million. Household Bank, f.s.b., our U.S. savings and loan subsidiary which was disposed of in the fourth quarter of 2002, previously had credit loss reserves for tax purposes that arose in years beginning before December 31, 1987 in the amount of $55.3 million. A deferred tax liability was not established previously since we did not expect the amount to become taxable in the future. However, the sale of substantially all of its assets and deposits in 2002 caused this amount to become taxable resulting in a $20.2 million tax liability. 147 Temporary differences which gave rise to a significant portion of deferred tax assets and liabilities were as follows: At December 31, ------------------------------- 2003 2002 -------------- ------------- (In millions) Deferred Tax Assets Credit loss reserves $ 1,995.6 $ 1,613.0 Debt 559.4 - Pension plan assets 49.4 - Settlement charge and related expenses 14.1 186.6 Market value adjustments 19.4 250.8 Other 602.9 520.4 ------- ------- Total deferred tax assets 3,240.8 2,570.8 Valuation allowance - (13.1 ) ------- ------- Total deferred tax assets net of valuation 3,240.8 2,557.7 allowance ------- ------- Deferred Tax Liabilities Receivables sold $ 1,100.8 $ 994.4 Intangibles 866.7 - Fee income 470.5 425.7 Receivables 337.2 - Leveraged lease transactions, net 191.8 372.6 Deferred loan origination costs 63.0 143.1 Pension plan assets - 180.9 Other 187.5 185.0 ------- ------- Total deferred tax liabilities $ 3,217.5 $ 2,301.7 ------- ------- Net deferred tax asset $ 23.3 $ 256.0 ------- ------- The deferred tax asset valuation allowance at December 31, 2002 related entirely to foreign tax credit carryforwards. At December 31, 2003 we had no foreign tax credit carryforwards. 20. Commitments and Contingent Liabilities Both we and certain of our subsidiaries are parties to various legal proceedings resulting from ordinary business activities relating to our current and/or former operations which affect all three of our reportable segments. Certain of these activities are or purport to be class actions seeking damages in significant amounts. These actions include assertions concerning violations of laws and/or unfair treatment of consumers. Due to the uncertainties in litigation and other factors, we cannot be certain that we will ultimately prevail in each instance. Also, as the ultimate resolution of these proceedings is influenced by factors that are outside of our control, it is reasonably possible our estimated liability under these proceedings may change. However, based upon our current knowledge, our defenses to these actions have merit and any adverse decision should not materially affect our consolidated financial condition, results of operations or cash flows. 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. These commitments have terms of up to one year and can be renewed upon mutual agreement. See Note 16 for discussion of lease commitments. 148 21. Attorney General Settlement On October 11, 2002, we reached a preliminary 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 with respect to secured real estate lending from Household Finance Corporation and Beneficial Corporation and their subsidiaries conducting retail branch consumer lending operations. This preliminary agreement, and related subsequent consent decrees and similar documentation entered into with each of the 50 states and the District of Columbia, are referred to collectively as the "Multi-State Settlement Agreement", which became effective on December 16, 2002. Pursuant to the Multi-State Settlement Agreement, we funded a $484 million settlement fund that was divided among the states (and the District of Columbia), with each state receiving a proportionate share of the funds based upon the volume of the retail branch originated real estate secured loans we made in that state during the period of January 1, 1999 to September 30, 2002. No fines, penalties or punitive damages were assessed by the states pursuant to the Multi-State Settlement Agreement. In August 2003, notices of a claims procedure were distributed to holders of approximately 591,000 accounts identified as having potential claims. As of February 1, 2004, approximately 80% of customers had accepted funds in settlement and had executed a release of all civil claims against us relating to the specified consumer lending practices. The bulk of the checks were mailed in December 2003. Each state has agreed that the settlement resolves all current civil investigations and proceedings by the attorneys general and state lending regulators relating to the lending practices at issue. We recorded a pre-tax charge of $525.0 million ($333.2 million after-tax) during the third quarter of 2002 related to the Multi-State Settlement Agreement. The charge reflects the costs of this settlement agreement and related matters and has been reflected in the statement of income in total costs and expenses. 22. Segment Reporting We have three reportable segments: Consumer, Credit Card Services, and International. Our segments are managed separately and are characterized by different middle-market consumer lending products, origination processes, and locations. Our Consumer segment consists of our consumer lending, mortgage services, retail services, and auto finance businesses. Our Credit Card Services segment consists of our domestic MasterCard and Visa credit card business. Our International segment consists of our foreign operations in the United Kingdom, Canada and Europe. The Consumer segment provides real estate secured, automobile secured and personal non-credit card loans. Loans are offered with both revolving and closed-end terms and with fixed or variable interest rates. Loans are originated through branch locations, correspondents, mortgage brokers, direct mail, telemarketing, independent merchants or automobile dealers. The Credit Card Services segment offers MasterCard and Visa credit card loans throughout the United States primarily via strategic affinity and co-branding relationships, direct mail, and our branch network to subprime customers. The International segment offers secured and unsecured lines of credit and secured and unsecured closed-end loans primarily in the United Kingdom, Canada, the Republic of Ireland, the Czech Republic and Hungary. In addition, the United Kingdom operation offers MasterCard and Visa credit card loans and credit insurance in connection with all loan products. We also cross sell our credit cards to existing real estate secured, private label and tax services customers. All segments offer products and service customers through the Internet. The All Other caption includes our insurance and tax services, direct lending and commercial businesses, as well as our corporate and treasury activities, each of which falls below the quantitative threshold tests under SFAS No. 131 for determining reportable segments. The accounting policies of the reportable segments are described in the summary of significant accounting policies. For segment reporting purposes, intersegment transactions have not been eliminated. We generally account for transactions between segments as if they were with third parties. We evaluate performance and allocate resources based on income from operations after income taxes and returns on equity and managed assets. We allocate resources and provide information to management for decision making on a managed basis. Therefore, an adjustment is required to reconcile the managed financial information to our reported financial 149 information in our consolidated financial statements. This adjustment reclassifies net interest margin, fee income and loss provision into securitization revenue. Income statement information included in the table for the year ended December 31, 2003 combines January 1 through March 28 2003 (the "predecessor period") and March 29 to December 31, 2003 (the "successor period") in order to present "combined" financial results for the year. Fair value adjustments related to purchase accounting and related amortization have been allocated to Corporate, which is included in the "All Other" caption within our segment disclosure. As a result, managed and owned basis consolidated totals for the year ended December 31, 2003 include combined information from both the " successor" and "predecessor" periods which impacts comparability to prior periods. 150 REPORTABLE SEGMENTS - MANAGED BASIS Managed Credit Adjustments/ Basis Owned Basis Card All Reconciling Consolidated Securitization Consolidated Consumer Services International Other Totals Items Totals Adjustments Totals ---------- --------- ----------- ------- ------ -------- ----------- -------------- --------- (In millions) For the Year Ended December 31, 2003 Net interest $7,333.0 $1,954.3 $ 752.9 $ 454.6 $ 10,494.8 - $ 10,494.8 $ (2,853.6)(6) $ 7,641.2 margin Fee income 470.7 1,327.6 79.6 7.5 1,885.4 1,885.4 (715.1)(6) 1,170.3 Other 530.8 204.3 317.2 719.6 1,771.9 (147.2)(2) 1,624.7 1,293.8 (6) 2,918.5 revenues, excluding fee income Intersegment 107.5 29.8 12.3 (2.4) 147.2 (147.2)(2) - - - revenues Provision 4,274.7 1,598.0 358.8 3.5 6,235.0 6.8 (3) 6,241.8 (2,274.9)(6) 3,966.9 for credit losses Depreciation 13.6 52.4 29.8 295.2 391.0 - 391.0 (391.0) - and amortization HSBC - - - 198.2 198.2 - 198.2 - 198.2 acquisition related costs incurred by Household Income tax 630.8 286.7 89.7 (44.3) 962.9 (55.7)(4) 907.2 - 907.2 expense (benefit) Net income 1,061.1 500.0 170.1 32.3 1,763.5 (98.3) 1,665.2 - 1,665.2 Operating 1,061.1 500.0 170.1 199.6 1,930.8 (98.3) 1,832.5 - 1,832.5 net income (1) Receivables 87,103.9 19,551.6 11,002.9 920.2 118,578.6 - 118,578.6 (26,200.4)(8) 92,378.2 Assets 89,791.0 22,505.0 11,922.7 29,855.6 154,074.3 (8,720.0)(5)145,354.3 (26,200.4)(8) 119,153.9 Expenditures 30.4 3.0 18.2 82.9 134.5 - 134.5 - 134.5 for long-lived assets(7) -------- -------- -------- -------- --------- -------- --------- --------- --------- For the Year Ended December 31, 2002 Net interest $ 6,975.6 $ 1,768.0 $ 641.5 $ (47.9) $ 9,337.2 - $ 9,337.2 $ (2,682.9)(6) $ 6,654.3 margin Fee income 380.6 1,172.1 59.0 6.1 1,617.8 - 1,617.8 (669.4)(6) 948.4 Other 860.3 209.4 358.4 905.6 2,333.7 (187.2)(2) 2,146.5 1,429.3 (6) 3,575.8 revenues, excluding fee income and loss on disposition of Thrift assets and deposits Loss on 378.2 - - - 378.2 - 378.2 - 378.2 disposition of Thrift assets and deposits Intersegment 145.3 34.1 9.7 (1.9 ) 187.2 (187.2)(2) - - - revenues Provision 3,902.6 1,428.1 280.1 63.9 5,674.7 (19.7)(3) 5,655.0 (1,923.0)(6) 3,732.0 for credit losses Depreciation 17.6 60.4 24.0 131.3 233.3 - 233.3 - 233.3 and amortization Settlement 525.0 - - - 525.0 - 525.0 - 525.0 charge and related expenses Income tax 519.8 249.1 89.7 (102.4 ) 756.2 (61.2)(4) 695.0 - 695.0 expense (benefit) Net income 837.8 414.0 231.5 180.8 1,664.1 (106.3 ) 1,557.8 - 1,557.8 Operating 1,411.0 414.0 231.5 180.8 2,237.3 (106.3 ) 2,131.0 - 2,131.0 net income (1) Receivables 79,447.8 18,071.0 8,769.0 1,208.0 107,495.8 - 107,495.8 (24,933.5)(8) 82,562.3 Assets 82,685.2 21,078.7 10,011.1 17,836.8 131,611.8 (8,817.7)(5)122,794.1 (24,933.5)(8) 97,860.6 Expenditures 30.0 1.3 29.4 112.6 173.3 - 173.3 - 173.3 for long-lived assets(7) -------- -------- -------- -------- --------- -------- --------- --------- --------- For the Year Ended December 31, 2001 Net interest $5,829.0 $ 1,496.8 $ 592.5 $ (37.0) $ 7,881.3 - $ 7,881.3 $ (2,093.8)(6) $ 5,787.5 margin Fee income 368.5 1,106.7 60.5 6.7 1,542.4 - 1,542.4 (638.9)(6) 903.5 Other 357.5 99.4 244.0 821.7 1,522.6 $ (234.3)(2) 1,288.3 1,627.2 (6) 2,915.5 revenues, excluding fee income Intersegment 190.4 38.2 8.4 (2.7 ) 234.3 (234.3)(2) - - - revenues Provision 2,550.3 1,167.3 226.9 72.2 4,016.7 1.7(3 ) 4,018.4 (1,105.5)(6) 2,912.9 for credit losses Depreciation 64.5 117.2 23.7 109.3 314.7 - 314.7 - 314.7 and amortization Income tax 840.5 188.3 65.2 (36.8 ) 1,057.2 (86.4)(4) 970.8 - 970.8 expense (benefit) Net income 1,327.7 291.7 204.1 173.7 1,997.2 (149.6 ) 1,847.6 - 1,847.6 Receivables 75,640.8 17,178.5 7,157.5 845.9 100,822.7 - 100,822.7 (20,948.0)(8) 79,874.7 Assets 78,698.8 18,370.2 8,375.2 14,116.7 119,560.9 (9,702.0)(5) 109,858.9 (20,948.0)(8) 88,910.9 Expenditures 17.0 4.5 27.8 125.9 175.2 - 175.2 - 175.2 for long-lived assets(7) -------- -------- -------- -------- -------- -------- --------- --------- --------- (1) This non-GAAP financial measure is provided for comparison of our operating trends only and should be read in conjunction with our owned basis GAAP financial information. Operating net income excludes $167.3 million (after-tax) of HSBC acquisition related costs and other merger related items incurred by Household in 2003 and the settlement charge and related expenses of $333.2 million (after-tax) in 2002. See "Reconciliations to GAAP Financial Measures" in Management's Discussion and Analysis for additional discussion and quantitative reconciliations to GAAP basis net income. (2) Eliminates intersegment revenues. (3) Eliminates bad debt recovery sales between operating segments. (4) Tax benefit associated with items comprising adjustments/reconciling items. (5) Eliminates investments in subsidiaries and intercompany borrowings. (6) Reclassifies net interest margin, fee income and loss provisions relating to securitized receivables to other revenues. (7) Includes goodwill associated with purchase business combinations other than the HSBC merger as well as capital expenditures. (8) Represents receivables serviced with limited recourse. 151 Managed Receivables The following summarizes our managed receivables, which includes both our owned receivables and receivables serviced with limited recourse. At December 31, ----------------------------------------------------------- 2003 2002 2001 ----------------- ----------------- ----------------- (In millions) Real estate secured $ 51,414.6 $ 46,274.7 $ 44,718.6 Auto finance 8,812.9 7,442.4 6,395.5 MasterCard/Visa 21,148.7 18,952.6 17,395.2 Private label 17,865.1 14,916.7 13,813.9 Personal non-credit card 18,936.0 19,446.4 17,992.6 Commercial and other 401.3 463.0 506.9 --------- --------- --------- Total $ 118,578.6 $ 107,495.8 $ 100,822.7 --------- --------- --------- Geographic Data The tables below summarize our owned basis assets, revenues and income before income taxes by material country. Purchase accounting adjustments are reported within the appropriate country. At December 31, -------------------------------------------------------------------------------------- Identifiable Assets Long-Lived Assets(1) ------------------------------------------- ---------------------------------------- 2003 2002 2001 2003 2002 2001 ------------- ------------ ------------ ------------ ----------- ----------- (In millions) United States $ 107,443.8 $ 89,309.9 $ 81,715.9 $ 9,132.0 $ 1,948.5 $ 1,995.8 United Kingdom 9,401.2 6,845.2 5,709.6 809.2 88.3 93.1 Canada 2,182.5 1,588.4 1,379.4 137.2 4.5 5.2 Europe 126.4 117.1 106.0 1.6 2.3 - --------- -------- -------- -------- ------- ------- Total $ 119,153.9 $ 97,860.6 $ 88,910.9 $ 10,080.0 $ 2,043.6 $ 2,094.1 --------- -------- -------- -------- ------- ------- -------------- (1) Includes properties and equipment, goodwill and acquired intangibles. Year Ended December 31, ------------------------------------------------------------------------------------ Revenues Income Before Income Taxes ------------------------------------------ --------------------------------------- 2003 2002 2001 2003 2002 2001 ------------ ------------ ------------ ----------- ----------- ----------- (In millions) United States $ 12,935.6 $ 13,397.3 $ 12,526.0 $ 2,331.5 $ 1,931.9 $ 2,540.5 United Kingdom 1,091.4 1,006.1 1,014.4 147.0 247.2 206.4 Canada 283.8 236.4 220.2 68.4 54.7 48.4 Europe 40.4 31.8 19.7 25.5 19.0 23.1 -------- -------- -------- ------- ------- ------- Total $ 14,351.2 $ 14,671.6 $ 13,780.3 $ 2,572.4 $ 2,252.8 $ 2,818.4 -------- -------- -------- ------- ------- ------- This information is provided by RNS The company news service from the London Stock Exchange MORE TO FOLLOW FR BLGDXLDGGGSB

Companies

HSBC Holdings (HSBA)

Thursday, 25th July 2024

COMPANIES COVERED:

ULVR CNA AAF

Unilever surges as margin growth impresses, but Airtel Africa slumps as currency headwinds take a toll and Centrica also struggles as interims show big decline in profits at British Gas.

Full Archive

UK 100

Latest directors dealings

12 hours ago B&M European Value Retail S.A. (DI)
12 hours ago Compass Group
12 hours ago Creightons
13 hours ago Manolete Partners
13 hours ago National Grid

All directors dealings today