Household Int. Form 10-Q Q3

HSBC Holdings PLC 19 November 2003 PART 1 Part 1 - The following is a Form 10-Q for the quarter ended 30 September 2003 filed with the United States Securities and Exchange Commission by Household International, Inc., a subsidiary of HSBC Holdings plc. Copies of the complete Form 10-Q are also available on Household International, Inc.'s website at www.household.com and on the SEC website at www.sec.gov UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- FORM 10-Q (Mark One) x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2003 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 1-8198 ---------------- HOUSEHOLD INTERNATIONAL, INC. (Exact name of registrant as specified in its charter) Delaware 86-1052062 (State of Incorporation) (I.R.S. Employer Identification No.) 2700 Sanders Road, Prospect Heights, Illinois 60070 (Address of principal executive offices) (Zip Code) (847) 564-5000 Registrant's telephone number, including area code Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No At October 31, 2003, there were 50 shares of the registrant's common stock outstanding. The registrant meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this Form 10-Q with the reduced disclosure format. -------------------------------------------------------------------------------- Table of Contents HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES Table of Contents PART I. Financial Information Page Item 1. Financial Statements Condensed Consolidated Statements of Income (Unaudited) 2 Condensed Consolidated Balance Sheets 3 Condensed Consolidated Statements of Cash Flows (Unaudited) 4 Notes to Interim Condensed Consolidated Financial Statements (Unaudited) 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 4. Controls and Procedures 37 PART II. Other Information Item 1. Legal Proceedings 38 Item 6. Exhibits and Reports on Form 8-K 41 Signature 42 1 -------------------------------------------------------------------------------- Table of Contents PART I. FINANCIAL INFORMATION Item 1. Financial Statements HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Three Three months March 29 January 1 Nine months months ended through through ended ended Sept. 30, Sept. 30, March 28 Sept. 30, 2002 Sept. 30, 2002 2003 2003 2003 (Successor) (Predecessor) (Successor) (Predecessor) (Predecessor) (In millions) (Note 2) (Note 2) (Note 2) (Note 2) (Note 2) Finance and other interest $ 2,575.5 $ 2,710.9 $ 5,154.1 $ 2,470.5 $ 7,856.5 income Interest expense 556.5 999.0 1,129.9 897.4 2,918.7 Net interest margin 2,019.0 1,711.9 4,024.2 1,573.1 4,937.8 Provision for credit losses 1,001.3 973.0 2,074.1 976.1 2,746.9 on owned receivables Net interest margin after 1,017.7 738.9 1,950.1 597.0 2,190.9 provision for credit losses Securitization revenue 381.9 556.3 673.0 432.6 1,598.0 Insurance revenue 192.7 180.8 381.7 171.6 528.4 Investment income 37.0 47.6 71.5 80.0 137.8 Fee income 299.5 261.7 568.0 288.3 668.5 Other income 35.1 101.8 171.7 238.7 385.1 Total other revenues 946.2 1,148.2 1,865.9 1,211.2 3,317.8 Salaries and fringe benefits 493.3 456.6 999.2 491.3 1,354.9 Sales incentives 76.6 60.6 161.2 37.7 182.3 Occupancy and equipment 95.0 94.1 198.5 97.7 279.6 expense Other marketing expenses 128.1 135.4 268.0 138.8 409.3 Other servicing and 282.3 199.3 555.2 313.7 635.1 administrative expenses Amortization of acquired 82.4 12.7 162.7 12.3 45.1 intangibles HSBC acquisition related - - - 198.2 - costs incurred by Household Policyholders' benefits 95.0 101.2 196.4 91.0 272.6 Settlement charge and related - 525.0 - - 525.0 expenses Total costs and expenses 1,252.7 1,584.9 2,541.2 1,380.7 3,703.9 Income before income taxes 711.2 302.2 1,274.8 427.5 1,804.8 Income taxes 239.7 81.0 429.6 181.8 585.2 Net income $ 471.5 $ 221.2 $ 845.2 $ 245.7 $ 1,219.6 See notes to interim condensed consolidated financial statements. 2 -------------------------------------------------------------------------------- Table of Contents HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In millions, except share data) September December 31, 30, 2002 2003 (Unaudited) (Successor) (Predecessor) ASSETS (Note 2) (Note 2) Cash $ 268.7 $ 797.7 Investment securities 6,947.5 7,584.0 Receivables, net 91,753.1 82,050.5 Acquired intangibles, net 2,917.9 386.4 Goodwill 6,629.5 1,122.1 Properties and equipment, net 495.4 535.1 Real estate owned 543.0 427.1 Derivative financial assets 2,094.5 1,863.5 Other assets 2,869.7 3,094.2 - Total assets $ 114,519.3 $ 97,860.6 LIABILITIES AND SHAREHOLDER'S(S') EQUITY Debt: Deposits $ 1,032.0 $ 821.2 Commercial paper, bank and other borrowings 8,815.1 6,128.3 Due to affiliates 5,855.9 - Senior and senior subordinated debt (with original maturities over one year) 76,073.8 74,776.2 Company obligated mandatorily redeemable preferred securities of subsidiary 1,020.6 975.0 trusts (including $275 million due to HSBC at September 30, 2003)* Total debt 92,797.4 82,700.7 Insurance policy and claim reserves 1,310.1 1,047.6 Derivative related liabilities 329.5 1,183.9 Other liabilities 3,290.3 2,512.3 Total liabilities 97,727.3 87,444.5 Preferred stock (issued to HSBC at September 30, 2003) 1,100.0 1,193.2 Common shareholder's(s') equity: Common stock, $0.01 and $1.00 par value, 100 and 750,000,000 shares authorized, - 551.8 50 and 551,811,025 shares issued at September 30, 2003 and December 31, 2002, respectively Additional paid-in capital 14,642.4 1,911.3 Retained earnings 808.7 9,885.6 Accumulated other comprehensive income (loss) 240.9 (694.9) Less common stock in treasury, 0 and 77,197,686 shares at September 30, 2003 and - (2,430.9) December 31, 2002, respectively, at cost Total common shareholder's(s') equity 15,692.0 9,222.9 Total liabilities and shareholder's(s') equity $ 114,519.3 $ 97,860.6 - * As of September 30, 2003, the sole assets of the trusts are Junior Subordinated Deferrable Interest Notes issued by Household International, Inc. in September 2003, November 2001, January 2001 and June 2000, bearing interest at 6.375, 7.50, 8.25 and 10.00 percent, respectively, and due November 2033, November 2031, January 2031 and June 2030, respectively. As of December 31, 2002, the sole assets of the trusts also included Junior Subordinated Deferrable Interest Notes issued by Household International, Inc. in March 1998 and June 1995, bearing interest at 7.25 and 8.25 percent, respectively, and due December 2037 and June 2025, respectively. See notes to interim condensed consolidated financial statements. 3 -------------------------------------------------------------------------------- Table of Contents HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (In millions) March 29 January 1 Nine months through through ended Sept. 30, March 28, 2003 Sept. 30, 2003 2002 (Successor) (Predecessor) (Predecessor) (Note 2) (Note 2) (Note 2) CASH PROVIDED BY OPERATIONS Net income $ 845.2 $ 245.7 $ 1,219.6 Adjustments to reconcile net income to cash provided by operations: Provision for credit losses on owned receivables 2,074.1 976.1 2,746.9 Insurance policy and claim reserves (123.5) 47.2 52.6 Depreciation and amortization 232.1 53.5 170.7 Interest-only strip receivables, net change 277.4 36.4 (109.9) Other, net (143.4) 106.0 1,837.7 Cash provided by operations 3,161.9 1,464.9 5,917.6 INVESTMENTS IN OPERATIONS Investment securities: Purchased (2,770.5) (1,046.7) (3,938.4) Matured 2,106.9 584.2 1,729.7 Sold 470.3 768.4 488.6 Short-term investment securities, net change 959.5 (375.0) (4,745.7) Receivables: Originations, net (27,404.0) (8,261.6) (34,554.5) Purchases and related premiums (2,069.5) (129.0) (510.9) Initial and fill-up securitizations 18,320.1 7,300.1 26,399.9 Whole loan sales - - 2,468.4 Properties and equipment purchased (70.3) (21.6) (112.0) Properties and equipment sold 4.5 .1 15.2 Cash decrease from investments in operations (10,453.0) (1,181.1) (12,759.7) FINANCING AND CAPITAL TRANSACTIONS Short-term debt and demand deposits, net change 3,023.5 (513.5) (6,127.2) Time certificates, net change 97.9 150.3 (1,219.6) Due to affiliates, net change 5,817.5 - - Senior and senior subordinated debt issued 9,557.5 4,360.9 25,851.6 Senior and senior subordinated debt retired (11,337.2) (4,029.8) (11,604.8) Issuance of company obligated mandatorily 275.0 - - redeemable preferred securities of subsidiary trusts to HSBC Redemption of company obligated mandatorily (275.0) - - redeemable preferred securities of subsidiary trusts Policyholders' benefits paid (105.8) (35.6) (249.1) Cash received from policyholders 84.4 33.1 62.1 Shareholders' dividends (292.6) (141.4) (368.8) Purchase of treasury stock - (164.1) (279.6) Issuance of common stock - 62.2 114.5 Redemption of preferred stock - (114.4) - Issuance of preferred stock - - 726.4 Cash increase (decrease) from financing and 6,845.2 (392.3) 6,905.5 capital transactions Effect of exchange rate changes on cash 40.6 (15.2) (66.5) Decrease in cash (405.3) (123.7) (3.1) Cash at beginning of period 674.0 797.7 543.6 Cash at end of period $ 268.7 $ 674.0 $ 540.5 SUPPLEMENTAL CASH FLOW INFORMATION Interest paid $ 1,717.8 $ 897.2 $ 2,833.3 Income taxes paid 327.7 39.6 605.0 SUPPLEMENTAL NON-CASH FINANCING AND CAPITAL ACTIVITIES Push-down of purchase price by HSBC (Note 2) $ (12.0) $ 14,658.5 - Exchange of preferred stock for preferred stock - 1,100.0 - issued to HSBC See notes to interim condensed consolidated financial statements. 4 -------------------------------------------------------------------------------- Table of Contents HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements of Household International, Inc. ("Household") and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Household and its subsidiaries may also be referred to in this Form 10-Q as "we," "us" or "our." These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes included in our Annual Report on Form 10-K for the year ended December 31, 2002. 2. Merger with HSBC On March 28, 2003, HSBC Holdings plc ("HSBC") acquired Household by way of merger with H2 Acquisition Corporation ("H2"), a wholly owned subsidiary of HSBC, acquiring 100 percent of the voting equity interest of Household in a purchase business combination. HSBC believes that the merger offers significant opportunities to extend Household's business model into countries and territories currently served by HSBC and broadens the product range available to the enlarged customer base. Subsequent to the merger, H2 was renamed "Household International, Inc." Under the terms of the merger agreement, each share of our approximately 476.0 million outstanding common shares at the time of merger was converted into the right to receive, at the holder's election, either 2.675 ordinary shares of HSBC, of nominal value $0.50 each ("HSBC Ordinary Shares"), or 0.535 American depositary shares, each representing an interest in five HSBC Ordinary Shares. Additionally, each of Household's depositary shares representing, respectively, one-fortieth of a share of 81/4% cumulative preferred stock, Series 1992-A, one-fortieth of a share of 7.50% cumulative preferred stock, Series 2001-A, one-fortieth of a share of 7.60% cumulative preferred stock, Series 2002-A and one-fortieth of a share of 7 5/8% cumulative preferred stock, Series 2002-B was converted into the right to receive $25 in cash per depositary share, plus accrued and unpaid dividends up to but not including the effective date of the merger which was an aggregate amount of approximately $1.1 billion. In consideration of HSBC transferring sufficient funds to make the payments described above with respect to Household's depositary shares, 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 at any time after March 31, 2008. Also on March 28, 2003, we called for redemption all the issued and outstanding shares of our 5.00% cumulative preferred stock, $4.50 cumulative preferred stock and $4.30 cumulative preferred stock totaling $114.4 million. Pursuant to the terms of these issues of preferred stock, we paid a redemption price of $50.00 per share of 5.00% cumulative preferred stock, $103.00 per share of $4.50 cumulative preferred stock and $100.00 per share of $4.30 cumulative preferred stock, plus, in each case, all dividends accrued and unpaid, whether or not earned or declared, to the redemption date. Additionally, on March 28, 2003, we declared a dividend of $0.8694 per share on our common stock, which was paid on May 6, 2003 to our holders of record on March 28, 2003. 5 -------------------------------------------------------------------------------- Table of Contents In conjunction with HSBC's acquisition of Household, we incurred acquisition related costs of $198.2 million. Consistent with the guidelines for accounting for business combinations, these costs were expensed in our income statement on March 28, 2003. These costs were comprised of the following: (In millions) Payments to executives under existing employment agreements $ 97.0 Investment banking, legal and other costs 101.2 Total $ 198.2 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. Information for all "predecessor" periods prior to the merger are presented using our historical basis of accounting, which impacts comparability to our "successor" periods. Results for the periods ended September 30, 2003 should not be considered indicative of the results for any future quarters or the year ending December 31, 2003. The purchase price paid by HSBC plus related purchase accounting adjustments was valued at approximately $14.6 billion and is recorded as "Additional paid-in capital" in the accompanying condensed consolidated balance sheet. The purchase price consisted of the following: (In millions) Value of HSBC ordinary shares issued $ 14,365.7 Fair value of outstanding Household stock options, net of unearned 111.9 compensation Fair value of outstanding Household restricted stock rights, net of unearned 1.9 compensation Fair value of equity portion of adjustable conversion-rate equity security 21.0 units Acquisition costs incurred by HSBC 146.0 Total purchase price $ 14,646.5 As of the acquisition date, we recorded our assets and liabilities at their estimated fair values. During the second quarter, we made adjustments to our preliminary fair value estimates as additional information, including third party valuation data, was obtained. Additional adjustments were made in the third quarter, including adjustments to accumulated other comprehensive income. As of September 30, 2003, our fair value estimates have resulted in recording approximately $6.6 billion of goodwill and $3.0 billion of acquired intangibles. Additionally, as of September 30, 2003, net fair value adjustments, before amortization, of approximately $.2 billion have been made to increase assets and approximately $2.6 billion to increase liabilities to fair value. These fair value adjustments represent current estimates and are subject to further adjustment. None of the goodwill is expected to be deductible for tax purposes. Approximately $3.0 billion of acquired intangibles were recorded as part of the allocation of the purchase price. Total acquired intangibles resulting from the merger were comprised of the following: (In millions) Purchased credit card relationships and related programs $ 1,404.0 Retail Services merchant relationships 277.0 Other loan related relationships 326.1 Trade names 715.0 Technology, customer lists and other contracts 281.0 Total acquired intangibles $ 3,003.1 6 -------------------------------------------------------------------------------- Table of Contents The trade names are not subject to amortization. The remaining acquired intangibles are being amortized over their estimated useful lives either on a straight-line basis or in proportion to the underlying revenues generated. These useful lives range from 5 years for Retail Services merchant relationships to approximately 10 years for certain loan related relationships. 3. Investment Securities Investment securities consisted of the following available-for-sale investments: September 30, 2003 December 31, 2002 (In millions) Amortized Fair Amortized Fair Cost Value Cost Value Corporate debt securities $ 2,055.1 $ 2,095.1 $ 2,032.8 $ 2,110.0 Money market funds 826.9 826.9 2,177.2 2,177.2 Time deposits 477.5 477.5 204.1 209.4 U.S. government and federal agency debt securities 2,172.4 2,174.6 1,804.4 1,820.8 Marketable equity securities 19.5 22.5 28.6 19.8 Non-government mortgage backed securities 419.0 419.2 660.5 669.0 Other 881.9 884.7 487.4 499.9 Subtotal 6,852.3 6,900.5 7,395.0 7,506.1 Accrued investment income 47.0 47.0 77.9 77.9 Total available-for-sale investments $ 6,899.3 $ 6,947.5 $ 7,472.9 $ 7,584.0 4. Receivables Receivables consisted of the following: (In millions) September December 30, 31, 2003 2002 Real estate secured $ 52,768.9 $ 45,818.5 Auto finance 3,701.1 2,023.8 MasterCard(1)/Visa(1) 9,892.1 8,946.5 Private label 12,406.6 11,339.6 Personal non-credit card 13,850.3 13,970.9 Commercial and other 408.9 463.0 Total owned receivables 93,027.9 82,562.3 Purchase accounting fair value adjustments 475.7 - Accrued finance charges 1,557.6 1,537.6 Credit loss reserve for owned receivables (3,779.2) (3,332.6) Unearned credit insurance premiums and claims reserves (674.5) (799.0) Interest-only strip receivables 967.0 1,147.8 Amounts due and deferred from receivable sales 178.6 934.4 Total owned receivables, net 91,753.1 82,050.5 Receivables serviced with limited recourse 24,108.9 24,933.5 Total managed receivables, net $ 115,862.0 $ 106,984.0 -------- (1) MasterCard is a registered trademark of MasterCard International, Incorporated and Visa is a registered trademark of VISA USA, Inc. 7 -------------------------------------------------------------------------------- Table of Contents Purchase accounting fair value adjustments represent adjustments which have been "pushed down" to record our receivables at fair value at the acquisition date. Interest-only strip receivables are reported net of our estimate of probable losses under the recourse provisions for receivables serviced with limited recourse. Our estimate of the recourse obligation totaled $1,954.0 million at September 30, 2003 and $1,759.5 million at December 31, 2002. Interest-only strip receivables also included fair value mark-to-market adjustments to accumulated other comprehensive income which increased the balance by $139.4 million at September 30, 2003 and $389.2 million at December 31, 2002. Receivables serviced with limited recourse consisted of the following: (In millions) September December 30, 31, 2003 2002 Real estate secured $ 214.0 $ 456.2 Auto finance 4,699.6 5,418.6 MasterCard/Visa 9,927.1 10,006.1 Private label 4,261.4 3,577.1 Personal non-credit card 5,006.8 5,475.5 Total $ 24,108.9 $ 24,933.5 The combination of receivables owned and receivables serviced with limited recourse, which we consider our managed portfolio, is shown below: (In millions) September December 30, 31, 2003 2002 Real estate secured $ 52,982.9 $ 46,274.7 Auto finance 8,400.7 7,442.4 MasterCard/Visa 19,819.2 18,952.6 Private label 16,668.0 14,916.7 Personal non-credit card 18,857.1 19,446.4 Commercial and other 408.9 463.0 Total $ 117,136.8 $ 107,495.8 8 -------------------------------------------------------------------------------- Table of Contents 5. Credit Loss Reserves An analysis of credit loss reserves for the three and nine months ended September 30 was as follows: Three months ended Nine months ended September 30, September 30, (In millions) 2003 2002 2003 2002 Owned receivables: Credit loss reserves at beginning of period $ 3,658.6 $ 2,983.3 $ 3,332.6 $ 2,663.1 Provision for credit losses 1,001.3 973.0 3,050.2 2,746.9 Charge-offs (976.1) (900.0) (2,907.8) (2,509.2) Recoveries 77.3 63.7 203.9 188.5 Other, net 18.1 7.3 100.3 38.0 Credit loss reserves for owned receivables at 3,779.2 3,127.3 3,779.2 3,127.3 September 30 Receivables serviced with limited recourse: Credit loss reserves at beginning of period 1,980.3 1,385.6 1,759.5 1,148.3 Provision for credit losses 419.3 498.3 1,443.6 1,365.1 Charge-offs (459.5) (357.2) (1,314.2) (1,046.2) Recoveries 24.0 22.6 67.9 71.8 Other, net (10.1) 12.2 (2.8) 22.5 Credit loss reserves for receivables serviced with 1,954.0 1,561.5 1,954.0 1,561.5 limited recourse at September 30 Credit loss reserves for managed receivables at $ 5,733.2 $ 4,688.8 $ 5,733.2 $ 4,688.8 September 30 We maintain credit loss reserves to cover probable losses of principal, interest and fees, including late, overlimit and annual fees. Credit loss reserves are based on a range of estimates and are intended to be adequate but not excessive. We estimate probable losses for consumer receivables based on delinquency and restructure status and past loss experience. Credit loss reserves take into account whether loans have been restructured, rewritten or are subject to forbearance, an external debt management plan, modification, extension or deferment. Our credit loss reserves also take into consideration the loss severity expected based on the underlying collateral, if any, for the loan in the event of default. Approximately two-thirds of all restructured receivables are secured products which may have less loss severity exposure because of the underlying collateral. In addition, loss reserves on consumer receivables reflect our assessment of portfolio risk factors which may not be fully reflected in the statistical calculation which uses roll rates. Roll rates are a form of migration analysis which is a technique used to estimate the likelihood that a loan will progress through the various delinquency buckets and ultimately charge off. Risk factors considered in establishing loss reserves on consumer receivables include recent growth, product mix, bankruptcy trends, geographic concentrations, economic conditions and current levels of charge-offs and delinquencies. We also consider key ratios such as reserves to nonperforming loans and reserves as a percentage of net charge-offs in developing our loss reserve estimate. Subject to receipt of regulatory and other approvals, HSBC currently intends to hold our domestic private label credit card receivables within HSBC's U.S. banking subsidiary. HSBC anticipates regulatory accounting charge-off, loss provisioning and account management guidelines issued by the Federal Financial Institutions Examination Council, or FFIEC, will need to be applied to these receivables. Implementation of such guidelines would result in private label credit card receivables being charged off at 6 months contractually delinquent (end of the month 60 days after notification for receivables involving a bankruptcy) versus the current practice of generally being charged off the month following the month in which the account becomes 9 months contractually delinquent (end of the month 90 days after notification for receivables involving a bankruptcy). HSBC's plans for ultimate collection on these receivables would therefore be different from the current practice and would require different reserve requirements. We and HSBC are also evaluating whether select other products will also be held in the HSBC U.S. banking subsidiary, including certain real estate secured loans and certain MasterCard and 9 -------------------------------------------------------------------------------- Table of Contents Visa receivables. The process for obtaining regulatory approval requests is still ongoing. We do not anticipate that we will allocate any purchase price adjustment to owned loss reserves as the regulatory guidelines are implemented. 6. Acquired Intangibles Acquired intangibles consisted of the following: (In millions) Gross Accumulated Carrying Amortization Value September 30, 2003 Purchased credit card relationships and related programs $ 1,488.4 $ 95.1 $ 1,393.3 Retail Services merchant relationships 270.1 28.1 242.0 Other loan related relationships 326.1 22.1 304.0 Trade names 715.0 - 715.0 Technology, customer lists and other contracts 281.0 17.4 263.6 Acquired intangibles $ 3,080.6 $ 162.7 $ 2,917.9 (In millions) Gross Accumulated Carrying Amortization Value 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 Estimated amortization expense associated with our acquired intangibles for each of the following years is as follows: (In millions) Year ending December 31, 2003 $ 256.3 2004 355.5 2005 334.8 2006 327.4 2007 309.8 7. Income Taxes For the quarter, our effective tax rate was 33.7 percent in 2003 (successor) and 26.8 percent in 2002 (predecessor). Our effective tax rate was 33.7 percent for the period March 29 through September 30, 2003 (successor); 42.5 percent for the period January 1 through March 28, 2003 (predecessor); and 32.4 percent for the nine months ended September 30, 2002 (predecessor). The effective tax rate for the period ended March 28, 2003 was adversely impacted by the non-deductibility of certain HSBC acquisition related costs. Excluding HSBC acquisition related costs of $198.2 million, which resulted in a $27.3 million tax benefit, our effective tax rate was 33.3 percent for the period January 1 through March 28, 2003. The effective tax rates for the quarter and nine months ended September 30, 2002 were positively impacted by the settlement charge and related expenses. Excluding this charge of $525.0 million, which resulted in a $191.8 million tax benefit, our effective tax rate was 33.0 percent for the quarter and 33.4 percent for the nine months ended September 30, 2002. The effective tax rate differs from the statutory federal income tax rate primarily because of the effects of state and local income taxes and tax credits. 10 -------------------------------------------------------------------------------- Table of Contents 8. Comprehensive Income In 2003, comprehensive income was $495.4 million for the third quarter (successor), $1,086.1 million for the period March 29 through September 30 (successor) and $297.4 million for the period January 1 through March 28 (predecessor). In 2002, comprehensive income was $1.9 million for the third quarter (predecessor) and $1,127.4 million for the nine months ended September 30 (predecessor). The components of accumulated other comprehensive income (loss) were as follows: September December 31, 30, 2002 2003 (In millions) (Successor) (Predecessor) Unrealized gains (losses) on cash flow hedging $ 46.3 $ (736.5) instruments Unrealized gains on investments and interest-only strip 113.4 319.3 receivables Foreign currency translation and other adjustments 81.2 (277.7) - Accumulated other comprehensive income (loss) $ 240.9 $ (694.9) - The balances associated with the components of accumulated other comprehensive income (loss) on a "predecessor" basis were eliminated as a result of push-down accounting effective March 29, 2003 when the "successor" period began. 9. Stock-Based Compensation In conjunction with the HSBC merger, outstanding stock options and restricted stock rights ("RSRs") granted under our various equity plans were assumed by HSBC and converted into options to purchase or rights to receive ordinary shares of HSBC. Stock options and RSRs which were issued prior to November 2002 vested upon completion of the merger. The Household employee stock purchase plan was terminated on March 7, 2003 and upon completion of the merger, Household employees became eligible to participate in the HSBC employee stock purchase plan. The following table illustrates the effect on net income if the fair value method had been applied to all outstanding and unvested awards in each period. Three Three months March 29 January 1 Nine months months ended through through ended ended September 30, September March 28, September 30, September 2002 30, 2003 2002 30, 2003 2003 (In millions) (Successor) (Predecessor) (Successor) (Predecessor) (Predecessor) Net income, as $ 471.5 $ 221.2 $ 845.2 $ 245.7 $ 1,219.6 reported Add stock-based employee compensation expense included in reported net income, net of tax: Stock option and 1.8 1.2 3.1 6.6 1.2 employee stock purchase plans Restricted stock 2.4 9.2 4.8 11.5 26.4 rights Deduct stock-based employee compensation expense determined under the fair value method, net of tax: Stock option and (1.8) (8.2) (3.1) (52.6) (22.6) employee stock purchase plans Restricted stock (2.4) (9.2) (4.8) (11.5) (26.4) rights Pro forma net income $ 471.5 $ 214.2 $ 845.2 $ 199.7 $ 1,198.2 11 -------------------------------------------------------------------------------- Table of Contents The pro forma compensation expense included in the table above may not be representative of the actual effects on net income for future years. 10. Transactions with Affiliates Due to affiliates includes amounts owed to affiliates of HSBC (other than company obligated mandatorily redeemable preferred securities of subsidiary trusts and preferred stock) and totaled $5.9 billion at September 30, 2003. This funding was at rates comparable to those that would be made with unaffiliated parties. Interest expense on this funding totaled $23.1 million for the quarter ended September 30, 2003 (successor) and $27.7 million for the period March 29, 2003 through September 30, 2003 (successor). In consideration of HSBC affiliates 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 at any time after March 31, 2008. During the quarter we implemented a $2.5 billion revolving credit facility with HSBC and issued $275 million in company obligated mandatorily redeemable preferred securities of subsidiary trusts to HSBC. During the third quarter of 2003, we began utilizing an affiliate, HSBC Bank USA, as the primary provider of new domestic derivative products. At September 30, 2003, we had derivative contracts with a notional value of approximately $16.2 billion outstanding with this affiliate. Going forward, it is expected that most of our existing third party derivative contracts will be assigned to HSBC Bank USA, making them our primary counterparty in derivative transactions. 11. New Accounting Pronouncements In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation Number 46, "Consolidation of Variable Interest Entities" (" Interpretation No. 46"). Interpretation No. 46 clarifies the application of Accounting Research Bulletin Number 51, "Consolidated Financial Statements" to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Qualifying special purpose entities as defined by FASB Statement Number 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" are excluded from the scope of Interpretation No. 46. Interpretation No. 46 applies immediately to all variable interest entities created after January 31, 2003 and is effective for fiscal periods beginning after July 1, 2003 for existing variable interest entities. In October 2003, the FASB postponed the effective date of Interpretation No. 46 to December 31, 2003. We adopted Interpretation No. 46 in the second quarter of 2003. This adoption did not have a material impact on our financial position or results of operations. In April 2003, the FASB issued Statement Number 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" ("SFAS No. 149"). This statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The guidelines are to be applied prospectively. The provisions of SFAS 149 that relate to Statement 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. This adoption did not have a material impact on our financial position or results of operations. In May 2003, the FASB issued Statement Number 150, "Accounting for Financial Instruments with Characteristics of Liabilities, Equity, or Both" ("SFAS No. 150 "). This limited scope statement prescribes 12 -------------------------------------------------------------------------------- Table of Contents changes to the classification of preferred securities of subsidiary trusts and the accounting for forward purchase contracts issued by a company in its own stock. SFAS No. 150 requires all preferred securities of subsidiary trusts to be classified as debt on the consolidated balance sheet and the related dividends as interest expense. We adopted SFAS No. 150 in the second quarter of 2003 and, therefore, have reclassified company obligated mandatorily redeemable preferred securities of subsidiary trusts as debt. Dividends on these securities have historically and will continue to be reported as interest expense in our consolidated statements of income. 12. Segment Reporting We have three reportable segments: Consumer, Credit Card Services and International. 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 and Canada. There has been no change in the basis of our segmentation or in the measurement of segment profit as compared with the presentation in our Annual Report on Form 10-K for the year ended December 31, 2002. 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 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 nine months ended September 30, 2003 combines January 1 through March 28, 2003 (the "predecessor period") and March 29 to September 30, 2003 (the "successor period") in order to present "combined" financial results for the nine months ended September 30, 2003. 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. 13 -------------------------------------------------------------------------------- Table of Contents Reportable Segments-Managed Basis (In Consumer Credit Inter- All Totals Adjustments/ Managed Securi Owned millions) Card national Other Reconciling Basis zation Basis Services Items Consoli- Adjust- Consoli- dated ments dated Totals Totals Three months ended September 30, 2003 Net interest $ 1,875.0 $ 490.3 $ 189.4 $ 174.0 $ 2,728.7 - $ 2,728.7 $ (709.7)(4) $2,019.0 margin Fee income 127.1 341.5 20.1 2.6 491.3 - 491.3 (191.8)(4) 299.5 Other (16.5) 62.1 80.3 74.5 200.4 $(35.9)(1) 164.5 482.2(4) 646.7 revenues, excluding fee income Intersegment 26.7 6.6 3.2 (.6) 35.9 (35.9)(1) - - - revenues Provision 919.6 400.2 100.6 (2.0) 1,418.4 2.2(2) 1,420.6 (419.3)(4) 1,001.3 for credit losses Net income 287.3 143.8 41.7 23.0 495.8 (24.3) 471.5 - 471.5 Operating 287.3 143.8 41.7 23.0 495.8 (24.3) 471.5 - 471.5 net income (6) Receivables 87,739.1 18,284.9 10,179.4 933.4 117,136.8 - 117,136.8(24,108.9)(5) 93,027.9 Assets 90,108.4 20,825.8 11,052.5 25,405.4 147,392.1(8,763.9) 138,628.2(24,108.9)(5) 114,519.3 (3) Three months ended September 30, 2002 Net interest $ 1,789.7 $ 454.7 $ 168.7 $ (24.9) $ 2,388.2 - $ 2,388.2 $(676.3)(4) $ 1,711.9 margin Fee income 100.3 307.8 17.3 1.2 426.6 - 426.6 (164.9)(4) 261.7 Other 279.0 47.8 69.5 194.8 591.1 $ (47.5)(1) 543.6 342.9(4) 886.5 revenues, excluding fee income Intersegment 37.5 8.1 2.4 (.5) 47.5 (47.5)(1) - - - revenues Provision 998.2 388.3 68.2 14.9 1,469.6 1.7(2) 1,471.3 (498.3)(4) 973.0 for credit losses Net income 86.2 97.7 48.7 19.8 252.4 (31.2) 221.2 - 221.2 Operating 419.4 97.7 48.7 19.8 585.6 (31.2) 554.4 - 554.4 net income (6) Receivables 81,291.1 17,028.0 8,079.6 1,172.9 107,571.6 - 107,571.6(23,407.4)(5) 84,164.2 Assets 84,302.3 20,136.6 9,378.2 20,039.4 133,856.5 (9,370.8)124,485.7(23,407.4)(5) 101,078.3 Nine months ended September 30, 2003 Net interest $ 5,417.3 $ 1,440.4 $ 549.3 $ 344.0 $ 7,751.0 - $ 7,751.0$(2,153.7)(4) $ 5,597.3 margin Fee income 342.9 962.5 59.0 5.6 1,370.0 - 1,370.0 (513.7)(4) 856.3 Other 136.6 156.8 230.2 585.8 1,109.4 $(112.4)(1) 997.0 1,223.8(4) 2,220.8 revenues, excluding fee income Intersegment 82.9 22.0 8.9 (1.4) 112.4 (112.4)(1) - - - revenues Provision 3,042.3 1,174.7 270.6 .7 4,488.3 5.5(2) 4,493.8 (1,443.6)(4) 3,050.2 for credit losses Net income 678.8 366.0 116.8 4.6 1,166.2 (75.3) 1,090.9 - 1,090.9 Operating 678.8 366.0 116.8 171.9 1,333.5 (75.3) 1,258.2 - 1,258.2 net income (6) Nine months ended September 30, 2002 Net interest $ 5,166.9 $ 1,295.5 $ 476.1 $ (16.4) $ 6,922.1 - $6,922.1 $(1,984.3)(4) $ 4,937.8 margin Fee income 273.2 834.9 40.6 5.2 1,153.9 - 1,153.9 (485.4)(4) 668.5 Other 584.8 156.1 230.6 721.4 1,692.9$(148.2)(1) 1,544.7 1,104.6(4) 2,649.3 revenues, excluding fee income Intersegment 116.1 26.2 7.2 (1.3) 148.2(148.2)(1) - - - revenues Provision 2,760.7 1,105.7 219.1 48.4 4,133.9(21.9)(2) 4,112.0 (1,365.1)(4) 2,746.9 for credit losses Net income 756.9 240.9 130.6 171.4 1,299.8 (80.2) 1,219.6 - 1,219.6 Operating 1,090.1 240.9 130.6 171.4 1,633.0 (80.2) 1,552.8 - 1,552.8 net income (6) ----- (1) Eliminates intersegment revenues. (2) Eliminates bad debt recovery sales and reclassifies loss reserves between operating segments. (3) Eliminates investments in subsidiaries and intercompany borrowings. (4) Reclassifies net interest margin, fee income and loss provisions relating to securitized receivables to other revenues. (5) Represents receivables serviced with limited recourse. (6) 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 the nine months ended September 30, 2003 and the settlement charge and related expenses of $333.2 million (after-tax) in the three and nine months ended September 30, 2002. See "Reconciliation to GAAP Financial Measures" in Management's Discussion and Analysis for additional discussion and quantitative reconciliations to GAAP basis net income. 14 -------------------------------------------------------------------------------- Table of Contents Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations FINANCIAL HIGHLIGHTS (Dollar amounts are Three Three months Combined Nine in millions) months ended nine months ended months ended Sept. 30, 2002 ended Sept. 30, Sept. 30, 2003 Sept. 2002 30, 2003 Net income $ 471.5 $ 221.2(1) $ 1,090.9 (1) $ 1,219.6 (1) Net interest margin 2,019.0 1,711.9 5,597.3 4,937.8 Provision for credit 1,001.3 973.0 3,050.2 2,746.9 losses on owned receivables Owned Basis Ratios: Return on average 1.68% .88%(1) 1.35%(1) 1.72%(1) owned assets Return on average 11.8 9.5(1) 10.4(1) 18.5(1) common shareholder's (s') equity Net interest margin 8.41 7.46 8.08 7.62 Consumer net 3.98 3.98 4.17 3.79 charge-off ratio, annualized Reserves as a 105.1 93.5 104.8 101.1 percentage of net charge-offs, annualized Efficiency ratio(2) 40.3 53.8(1) 43.3(1) 43.0(1) Managed Basis Ratios: (3) Return on average 1.39% .72%(1) 1.11%(1) 1.40%(1) managed assets Net interest margin 9.12 8.35 8.89 8.54 Consumer net 4.68 4.39 4.77 4.25 charge-off ratio, annualized Reserves as a 107.4 100.1 108.9 106.7 percentage of net charge-offs, annualized Efficiency ratio (2) 35.2 45.6(1) 37.0(1) 36.7(1) (Dollar amounts are Owned Basis Managed Basis (3) in millions) Sept. 30, December 31, Sept. December 2003 2002 30, 2003 31, 2002 Total assets $ 114,519.3 $ 97,860.6 $ 138,628.2 $ 122,794.1 Receivables 93,027.9 82,562.3 117,136.8 107,495.8 Two-month-and-over 5.36% 5.34% 5.36% 5.24% contractual delinquency ratio Reserves as a 4.06 4.04 4.89 4.74 percentage of receivables Reserves as a 92.6 94.5 111.7 112.6 percentage of nonperforming loans Common and preferred 14.66 10.64 12.11 8.48 equity to assets Tangible n/a n/a 6.79 9.08 shareholder's(s') equity to tangible managed assets(4) Tangible common n/a n/a 4.71 6.83 equity to tangible managed assets(4) -------- (1) The following non-GAAP financial information is provided for comparison of our operating trends only and should be read in conjunction with our owned basis GAAP financial information. For the nine months ended September 30, 2003, the operating results, percentages and ratios exclude $167.3 million (after-tax) of HSBC acquisition related costs and other merger related items incurred by Household. For the three and nine months ended September 30, 2002, the operating results, percentages and ratios exclude the $333.2 million (after-tax) settlement charge and related expenses. See "Reconciliation to GAAP Financial Measures" for additional discussion and quantitative reconciliations to the equivalent GAAP basis financial measure. 15 -------------------------------------------------------------------------------- Table of Contents Three Three months Combined Nine months ended nine months ended months ended Sept. 30, ended Sept. 2002 Sept. 30, Sept. 30, 2003 30, 2003 2002 Operating net income (in millions) $ 471.5 $ 554.4 $ 1,258.2 $ 1,552.8 Return on average owned assets 1.68% 2.22% 1.56% 2.19% Return on average common 11.8 24.7 12.1 23.7 shareholder's(s') equity Owned basis efficiency ratio(2) 40.3 34.7 41.0 36.4 Return on average managed assets 1.39 1.81 1.27 1.78 Managed basis efficiency ratio(2) 35.2 29.4 35.0 31.1 -------- (2) Ratio of total costs and expenses less policyholders' benefits to net interest margin and other revenues less policyholders' benefits. (3) We monitor our operations and evaluate trends on both an owned basis as shown in our financial statements and on a managed basis. Managed basis reporting adjustments assume that securitized receivables have not been sold and are still on our balance sheet. Managed basis information is intended to supplement, and should not be considered a substitute for, owned basis reporting and should be read in conjunction with reported owned basis results. See "Reconciliation to GAAP Financial Measures" for additional discussion and quantitative reconciliations to the equivalent GAAP basis financial measure. (4) Tangible shareholder's(s') equity to tangible managed assets ("TETMA") and tangible common equity to tangible managed assets are non-GAAP financial ratios that are used by certain rating agencies as a measure to evaluate capital adequacy and may differ from similarly named measures presented by other companies. Common and preferred equity to total owned assets is the most directly comparable GAAP financial measure. Excluding the impact of " push-down" accounting on our assets and common shareholder's equity, TETMA would have been 8.80 percent and tangible common equity to tangible managed assets would have been 6.76 percent at September 30, 2003. See " Reconciliation to GAAP Financial Measures" for additional discussion and a quantitative reconciliation to the equivalent GAAP basis financial measure. 16 -------------------------------------------------------------------------------- Table of Contents Basis of Reporting Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the condensed consolidated financial statements, notes and tables included elsewhere in this report and in the Household International, Inc. Annual Report on Form 10-K for the year ended December 31, 2002 (the "2002 Form 10-K"). Management's discussion and analysis may contain certain statements that may be forward-looking in nature within the meaning of the Private Securities Litigation Reform Act of 1995. Our results may differ materially from those noted in the forward-looking statements. Forward-looking statements are typically identified by words or phrases such as "believe", "expect", "anticipate", "intend", "probable", "may", "will", "should ", "would" and "could". Forward-looking statements involve risks and uncertainties and are based on current views and assumptions. For a list of important factors that may affect our actual results, see our 2002 Form 10-K. In addition, as a subsidiary of HSBC Holdings plc ("HSBC"), we may be affected by decisions made by HSBC or the perception investors, regulators or rating agencies have of HSBC. Such decisions and perceptions may also affect our forward-looking statements. Reconciliation to GAAP Financial Measures Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). In addition to the GAAP financial results reported in our consolidated financial statements, Management's Discussion and Analysis includes reference to the following information which is presented on a non-GAAP basis: Operating Results, Percentages and Ratios Certain percentages and ratios have been presented on an operating basis and have been calculated using "operating net income", a non-GAAP financial measure. "Operating net income" is net income excluding certain nonrecurring expenses. These nonrecurring expenses are also excluded in calculating our "normalized" efficiency ratios. We believe that excluding nonrecurring items helps readers of our financial statements to better understand the results and trends of our underlying business. A reconciliation of net income to operating net income follows: Three months ended Nine months ended (In millions) September September September September 30, 30, 30, 30, 2003 2002 2003 2002 Net income $ 471.5 $ 221.2 $ 1,090.9 $ 1,219.6 HSBC acquisition related costs and other merger - - 167.3 - related items incurred by Household, after-tax Settlement charge and related expenses, - 333.2 - 333.2 after-tax Operating net income $ 471.5 $ 554.4 $ 1,258.2 $ 1,552.8 Net income during both the quarter and nine months ended September 30, 2003 were positively impacted by purchase accounting adjustments and by the discontinuation of the shortcut method of accounting for our interest rate swaps under SFAS No. 133 due to the merger. Amortization of purchase accounting adjustments increased net income by $32.1 million for the quarter and $75.4 million for the nine months ended September 30, 2003. The loss of the shortcut method of accounting for our interest rate swaps also increased net income by $3.7 million for the quarter and $51.0 million for the nine months ended September 30, 2003. During the third quarter, we completed the restructure of substantially all of our interest rate swap portfolio to regain use of the shortcut method of accounting and to reduce the potential volatility of future earnings. Managed Basis Reporting We monitor our operations and evaluate trends on a managed basis (a non-GAAP financial measure), which assumes that securitized receivables have not been sold and are still on our balance sheet. We manage and evaluate our operations on a managed basis because the receivables that we 17 -------------------------------------------------------------------------------- Table of Contents securitize are subjected to underwriting standards comparable to our owned portfolio, are serviced by operating personnel without regard to ownership and result in a similar credit loss exposure for us. In addition, we fund our operations, review our operating results, and make decisions about allocating resources such as employees and capital on a managed basis. When reporting on a managed basis, net interest margin, provision for credit losses and fee income related to receivables securitized and sold are reclassified from securitization revenue in our owned statements of income into the appropriate caption. Additionally, charge-off and delinquency associated with these receivables are included in our managed basis credit quality statistics. Debt analysts, rating agencies and others also evaluate our operations on a managed basis for the reasons discussed above and have historically requested managed basis information from us. We believe that managed basis information, which enables investors and other interested parties to better understand the performance and quality of our entire managed loan portfolio, is important to understanding the quality of originations and the related credit risk inherent in our owned portfolio. See Note 12 to the accompanying condensed consolidated financial statements, "Segment Reporting," for a reconciliation of managed basis net interest margin, fee income and provision for credit losses to the comparable owned basis amounts. See Note 4 to the accompanying condensed consolidated financial statements, "Receivables," for a reconciliation of our owned loan portfolio by product to our managed loan portfolio. Reconciliations between owned basis GAAP reported amounts and non-GAAP operating basis managed basis amounts are as follows: Three months ended Nine months ended (Dollar amounts are in millions) September September 30, September September 30, 2002 30, 30, 2003 2003 2002 Return on Average Assets: Net income $ 471.5 $ 221.2 $ 1,090.9 $ 1,219.6 Operating net income 471.5 554.4 1,258.2 1,552.8 Average assets: Owned $ 112,095.2 $ 100,064.4 $ 107,632.3 $ 94,496.2 Serviced with limited recourse 23,719.3 22,598.0 23,984.7 21,750.2 Managed $ 135,814.5 $ 122,662.4 $ 131,617.0 $ 116,246.4 Return on average owned assets 1.68 % .88 % 1.35 % 1.72% Return on average owned assets, 1.68 2.22 1.56 2.19 operating basis Return on average managed assets 1.39 .72 1.11 1.40 Return on average managed 1.39 1.81 1.27 1.78 assets, operating basis Return on Average Common Shareholder's(s') Equity: Net income $ 471.5 $ 221.2 $ 1,090.9 $ 1,219.6 Dividends on preferred stock (17.8) (16.6) (58.5) (40.6) Net income available to common 453.7 204.6 1,032.4 1,179.0 shareholders HSBC acquisition related costs, - - 167.3 - after-tax Settlement charge and related - 333.2 - 333.2 expenses, after-tax Operating net income available $ 453.7 $ 537.8 $ 1,199.7 $ 1,512.2 to common shareholders Average common shareholder's(s') $ 15,433.9 $ 8,657.4 $ 13,265.7 $ 8,482.7 equity Return on average common 11.8 % 9.5 % 10.4 % 18.5 % shareholder's(s') equity Return on average common 11.8 24.7 12.1 23.7 shareholder's(s') equity, operating basis 18 -------------------------------------------------------------------------------- Table of Contents Three months ended September 30, 2003 Three months ended September 30, 2002 (Dollar amounts Owned Serviced Managed Owned Serviced Managed are in millions) with with Limited Limited Recourse Recourse Net interest margin: Net interest $ 2,019.0 $ 709.7 $ 2,728.7 $ 1,711.9 $ 676.3 $ 2,388.2 margin Average 95,998.9 23,719.3 119,718.2 91,850.8 22,598.0 114,448.8 interest-earning assets Net interest 8.41 % 11.97 % 9.12 % 7.46 % 11.97 % 8.35% margin, annualized Consumer net charge-offs: Consumer net $ 896.5 $ 435.5 $ 1,332.0 $ 836.7 $ 334.6 $ 1,171.3 charge-offs Average consumer 90,172.0 23,719.3 113,891.3 84,031.6 22,598.0 106,629.6 receivables Consumer net 3.98 % 7.34 % 4.68 % 3.98 % 5.92 % 4.39 % charge-off ratio, annualized Reserves as a percentage of net charge-offs: Reserves $ 3,779.2 $ 1,954.0 $ 5,733.2 $ 3,127.3 $ 1,561.5 $ 4,688.8 Net charge-offs 898.8 435.5 1,334.3 836.3 334.6 1,170.9 Reserves as a 105.1 % 112.2 % 107.4 % 93.5 % 116.7 % 100.1% percentage of net charge-offs, annualized Efficiency ratio: Total costs and $ 1,157.7 - $ 1,157.7 $ 1,483.7 - $ 1,483.7 expenses less policyholders' benefits Settlement - - - 525.0 - 525.0 charge and related expenses Total costs and 1,157.7 - 1,157.7 958.7 - 958.7 expenses less policyholders' benefits, operating basis Net interest 2,870.2 $ 419.3 3,289.5 2,758.9 $ 498.3 3,257.2 margin and other revenues less policyholders' benefits Efficiency ratio 40.3% 35.2% 53.8% 45.6% Efficiency 40.3% 35.2% 34.7% 29.4% ratio, normalized Nine months ended September 30, 2003 Nine months ended September 30, 2002 (Dollar amounts Owned Serviced Managed Owned Serviced Managed are in millions) with with Limited Limited Recourse Recourse Net interest margin: Net interest $ 5,597.3 $ 2,153.7 $ 7,751.0 $ 4,937.8 $ 1,984.3 $ 6,922.1 margin Average 92,319.8 23,984.7 116,304.5 86,347.2 21,750.2 108,097.4 interest-earning assets Net interest 8.08% 11.97% 8.89% 7.62% 12.16% 8.54 % margin, annualized Consumer net charge-offs: Consumer net $ 2,701.5 $ 1,246.3 $ 3,947.8 $ 2,322.4 $ 974.4 $ 3,296.8 charge-offs Average consumer 86,269.4 23,984.7 110,254.1 81,652.6 21,750.2 103,402.8 receivables Consumer net 4.17% 6.93% 4.77% 3.79% 5.97% 4.25% charge-off ratio, annualized Reserves as a percentage of net charge-offs: Reserves $ 3,779.2 $ 1,954.0 $ 5,733.2 $ 3,127.3 $ 1,561.5 $ 4,688.8 Net charge-offs 2,703.9 1,246.3 3,950.2 2,320.7 974.4 3,295.1 Reserves as a 104.8% 117.6% 108.9% 101.1 % 120.2% 106.7% percentage of net charge-offs, annualized Efficiency ratio: Total costs and $ 3,634.5 - $ 3,634.5 $ 3,431.3 - $ 3,431.3 expenses less policyholders' benefits HSBC acquisition 198.2 - 198.2 - - - related costs Settlement - - - 525.0 - 525.0 charge and related expenses Total costs and 3,436.3 - 3,436.3 2,906.3 - 2,906.3 expenses less policyholders' benefits, operating basis Net interest 8,387.0 $ 1,443.6 9,830.6 7,983.0 $ 1,365.1 9,348.1 margin and other revenues less policyholders' benefits Efficiency ratio 43.3 % 37.0% 43.0% 36.7% Efficiency 41.0% 35.0% 36.4% 31.1% ratio, normalized 19 -------------------------------------------------------------------------------- Table of Contents September 30, 2003 December 31, 2002 (Dollar amounts Owned Serviced Managed Owned Serviced Managed are in millions) with with Limited Limited Recourse Recourse Total assets $ 114,519.3 $ 24,108.9 $ 138,628.2 $ 97,860.6 $ 24,933.5 $ 122,794.1 Total receivables 93,027.9 24,108.9 117,136.8 82,562.3 24,933.5 107,495.8 Two-month-and-over contractual delinquency: Two-month-and-over $ 4,965.5 $ 1,289.0 $ 6,254.5 $ 4,384.3 $ 1,227.1 $ 5,611.4 contractual delinquency Consumer 92,655.9 24,108.9 116,764.8 82,143.6 24,933.5 107,077.1 receivables Two-month-and-over 5.36% 5.35% 5.36% 5.34% 4.92% 5.24% contractual delinquency ratio Reserves as a percentage of receivables: Reserves $ 3,779.2 $ 1,954.0 $ 5,733.2 $ 3,332.6 $ 1,759.5 $ 5,092.1 Receivables 93,027.9 24,108.9 117,136.8 82,562.3 24,933.5 107,495.8 Reserves as a 4.06% 8.10% 4.89% 4.04% 7.06% 4.74% percentage of receivables Reserves as a percentage of nonperforming loans: Reserves $ 3,779.2 $ 1,954.0 $ 5,733.2 $ 3,332.6 $ 1,759.5 $ 5,092.1 Nonperforming 4,081.7 1,051.4 5,133.1 3,527.9 994.1 4,522.0 loans Reserves as a 92.6% 111.7% 94.5% 112.6% percentage of nonperforming loans June 30, 2003 September 30, 2002 (Dollar amounts Owned Serviced Managed Owned Serviced Managed are in millions) with with Limited Limited Recourse Recourse Reserves as a percentage of receivables: Reserves $ 3,658.6 $ 1,980.3 $ 5,638.9 $ 3,127.3 $ 1,561.5 $ 4,688.8 Receivables 88,307.0 24,268.2 112,575.2 84,164.2 23,407.4 107,571.6 Reserves as a 4.14 % 8.16% 5.01% 3.72% 6.67% 4.36% percentage of receivables Reserves as a percentage of nonperforming loans: Reserves $ 3,658.6 $ 1,980.3 $ 5,638.9 $ 3,127.3 $ 1,561.5 $ 4,688.8 Nonperforming 3,866.5 978.3 4,844.8 3,310.0 837.5 4,147.5 loans Reserves as a 94.6 % 116.4% 94.5% 113.1% percentage of nonperforming loans Three Months ended June 30, 2003 (Dollar amounts Owned Serviced Managed are in millions) with Limited Recourse Reserves as a percentage of net charge-offs: Reserves $ 3,658.6 $ 1,980.3 $ 5,638.9 Net charge-offs 931.2 412.3 1,343.5 Reserves as a 98.2 % 120.1% 104.9% percentage of net charge-offs, annualized 20 -------------------------------------------------------------------------------- Table of Contents Equity Ratios Tangible shareholder's(s') equity to tangible managed assets (" TETMA") and tangible common equity to tangible managed assets are non-GAAP financial measures that are used by certain rating agencies as a measure to evaluate capital adequacy. These ratios may differ from similarly named measures presented by other companies. The most directly comparable GAAP financial measure is common and preferred equity to owned assets. We also monitor our equity ratios excluding the impact of purchase accounting adjustments. We do so because we believe that the purchase accounting adjustments represent non-cash transactions which do not affect our business operations, cash flows or ability to meet our debt obligations. Equity ratios are calculated as follows: (Dollar amounts are in millions) September June 30, December 30, 31, 2003 2003 2002 Tangible common equity: Common shareholder's(s') equity $ 15,692.0 $ 15,119.2 $ 9,222.9 Exclude: Unrealized (gains) losses on cash flow hedging instruments (46.3) 85.1 736.5 Minimum pension liability - - 30.5 Unrealized gains on investments and interest-only strip (113.4) (126.5) (319.3) receivables Acquired intangibles (2,917.9) (3,000.3) (386.4) Goodwill (6,629.5) (6,542.1) (1,122.1) Tangible common equity 5,984.9 5,535.4 8,162.1 Purchase accounting adjustments 2,563.5 2,580.1 - Tangible common equity, excluding purchase accounting $ 8,548.4 $ 8,115.5 $ 8,162.1 adjustments Tangible shareholder's(s') equity: Tangible common equity $ 5,984.9 $ 5,535.4 $ 8,162.1 Preferred stock 1,100.0 1,100.0 1,193.2 Company obligated mandatorily redeemable preferred 1,020.6 1,021.5 975.0 securities of subsidiary trusts Adjustable Conversion-Rate Equity Security Units 511.0 511.0 511.0 Tangible shareholder's(s') equity 8,616.5 8,167.9 10,841.3 Purchase accounting adjustments 2,517.9 2,533.6 - Tangible shareholder's(s') equity, excluding purchase $ 11,134.4 $ 10,701.5 $ 10,841.3 accounting adjustments Tangible managed assets: Owned assets $ 114,519.3 $ 111,579.4 $ 97,860.6 Receivables serviced with limited recourse 24,108.9 24,268.2 24,933.5 Managed assets 138,628.2 135,847.6 122,794.1 Exclude: Acquired intangibles (2,917.9) (3,000.3) (386.4) Goodwill (6,629.5) (6,542.1) (1,122.1) Derivative financial assets (2,094.5) (3,601.3) (1,863.5) Tangible managed assets 126,986.3 122,703.9 119,422.1 Purchase accounting adjustments (471.3) 38.3 - Tangible managed assets, excluding purchase accounting $ 126,515.0 $ 122,742.2 $ 119,422.1 adjustments Equity ratios: Common and preferred equity to owned assets 14.66 % 14.54 % 10.64 % Common and preferred equity to managed assets 12.11 11.94 8.48 Tangible common equity to tangible managed assets 4.71 4.51 6.83 Excluding purchase accounting adjustments 6.76 6.61 6.83 Tangible shareholder's(s') equity to tangible managed 6.79 6.66 9.08 assets Excluding purchase accounting adjustments 8.80 8.72 9.08 21 -------------------------------------------------------------------------------- Table of Contents Our company obligated mandatorily redeemable preferred securities of subsidiary trusts are considered equity in the TETMA calculation because of their long-term subordinated nature and our ability to defer dividends. Our Adjustable Conversion-Rate Equity Security Units, which exclude purchase accounting adjustments, are also considered equity in the TETMA calculation because they include obligations to purchase HSBC ordinary shares in 2006. Merger with HSBC On March 28, 2003, HSBC acquired Household by way of merger with H2 Acquisition Corporation ("H2"), a wholly owned subsidiary of HSBC, in a purchase business combination (see Note 2 to the accompanying condensed consolidated financial statements). Subsequent to the merger, H2 was renamed "Household International, Inc." 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 periods subsequent to March 28, 2003, resulting in a new basis of accounting for the "successor" period beginning March 29, 2003. As of the acquisition date, we recorded our assets and liabilities at their estimated fair values. During the second quarter, we made adjustments to our preliminary fair value estimates as additional information, including third party valuation data, was obtained. Additional adjustments were made in the third quarter, including adjustments to accumulated other comprehensive income. Information for all "predecessor" periods prior to the merger is presented on the historical basis of accounting which impacts its comparability to our "successor" periods. To assist in the comparability of our financial results and to make it easier to discuss and understand our results of operations, the following discussion combines the "predecessor period" (January 1 to March 28, 2003) with the " successor period" (March 29 to September 30, 2003) to present "combined" results for the nine months ended September 30, 2003. At the time of the merger, we identified several items as near term priorities. Since the merger, we have established numerous integration teams and have made the following progress: â€¢ Funding benefits - As of September 30, 2003, we have received $9.2 billion in HSBC related funding. This total includes $5.9 billion in advances from affiliates of HSBC, $1.9 billion in funding from HSBC's customers and $1.1 billion in preferred stock and $275 million in company obligated mandatorily redeemable preferred securities of subsidiary trusts issued to HSBC. We also implemented a $2.5 billion revolving credit facility with HSBC (none of which has been drawn upon). We currently anticipate that we will continue to use HSBC's available funding to partially fund our operations. This will reduce our reliance on the debt markets. Since the merger, we have experienced lower funding costs because we are now a subsidiary of HSBC. We anticipate that the tighter spreads we have experienced and will continue to experience as a result of our merger with HSBC along with other funding synergies will eventually lead to cash funding expense savings of approximately $1.0 billion per year. However, it will take us some time to realize the full amount of these cash savings as our existing term debt will mature over the course of the next several years. â€¢ Technology integration - To date, we have made significant progress in integrating Household and HSBC technology teams and systems, including identifying HSBC data centers for consolidation. We have also renegotiated our telecommunications contracts. â€¢ Exporting and using our consumer credit business models and "best practices" into HSBC's operations - Our credit risk management department is providing on-going assistance to HSBC affiliates. Additionally, our credit card services business is providing collections and other card management practices assistance. 22 -------------------------------------------------------------------------------- Table of Contents â€¢ Expanding business opportunities including broader consumer product offerings and leveraging our existing business to business model with HSBC's capabilities - Efforts have been focused on our mortgage services, insurance services and retail services businesses. Also, in conjunction with HSBC Bank USA we have initiated a customer referral program. â€¢ Global processing opportunities - We have identified areas for better utilization of our existing processing centers as well as the use of new centers in more cost effective countries. Operations Summary Our net income was $471.5 million in the third quarter of 2003 and $221.2 million in the third quarter of 2002. Net income was $1.1 billion for the first nine months of 2003 and $1.2 billion for the first nine months of 2002. Operating net income (a non-GAAP financial measure which excludes $167.3 million, after-tax, of HSBC acquisition related costs and other merger related items incurred by Household in March 2003 and the settlement charge and related expenses of $333.2 million, after-tax, incurred in September 2002) was $471.5 million in the third quarter of 2003 and $554.4 million in the third quarter of 2002. Operating net income for the first nine months of 2003 was $1.3 billion, compared to $1.6 billion in the year-ago period. Compared to the prior year periods, operating net income for the quarter and nine months ended September 30, 2003, declined due to higher credit loss provision due to higher charge-offs and lower securitization activity as a result of the use of alternative funding sources. Higher operating expenses to support receivables growth as well as increased legal and compliance costs and amortization of intangibles also contributed to the decline over prior year periods. Partially offsetting these decreases were higher net interest margin and fee income. Net income during both the quarter and nine months ended September 30, 2003 were positively impacted by purchase accounting adjustments and by the discontinuation of the shortcut method of accounting for our interest rate swaps under SFAS No. 133 due to the merger. Amortization of purchase accounting adjustments increased net income by $32.1 million for the quarter and $75.4 million for the nine months ended September 30, 2003. The loss of the shortcut method of accounting for our interest rate swaps also increased net income by $3.7 million for the quarter and $51.0 million for the nine months ended September 30, 2003. During the third quarter, we completed the restructure of substantially all of our interest rate swap portfolio to regain use of the shortcut method of accounting and reduce the potential volatility of future earnings. We are committed to taking a leadership role in the consumer finance industry by establishing a benchmark for quality. As a result, we are significantly increasing our investment in compliance, monitoring and training to approximately $150 million during 2003 which is more than double the amount invested in 2002. Segment Results-Managed Basis Consumer Segment Our Consumer segment reported net income of $287.3 million for the third quarter of 2003 compared to $86.2 million in the year-ago quarter. Year-to-date, net income was $678.8 million compared to $756.9 million for the first nine months of 2002. Net income in both prior year periods was impacted by the $525.0 million settlement agreement with state attorneys general and regulatory agencies. Operating net income (a non-GAAP measurement of net income excluding the settlement charge and related expenses of $333.2 million, after-tax) was $419.4 million for the third quarter of 2002 and $1.1 billion for the first nine months of 2002. Increases in net interest margin and fee income were more than offset by higher operating expenses and lower other revenues as a result of a decline in securitization activity. Year-to-date results also reflect higher credit loss provision. Net interest margin increased $85.3 million to $1.9 billion for the quarter and $250.4 million to $5.4 billion year-to-date and fee income increased $26.8 million to $127.1 million for the quarter and $69.7 million to 23 -------------------------------------------------------------------------------- Table of Contents $342.9 million year-to-date as a result of higher receivable levels. Other revenues decreased $295.5 million for the quarter and $448.2 million year-to-date as a result of a decline in receivables securitized. Securitization levels were much higher in 2002 as a result of our liquidity management plans. Operating expenses, excluding the third quarter 2002 settlement charge, increased $111.0 million to $605.8 million for the quarter and $250.8 million to $1.8 billion year-to-date as the result of additional operating costs to support the increased receivable levels and higher legal and compliance costs. Our managed basis credit loss provision decreased $78.6 million for the quarter primarily due to decreases in loss provision on securitized receivables including the impact of lower securitized levels, but increased $281.6 million year-to-date. We increased our managed loss reserves by recording loss provision greater than charge-offs of $22.9 million in the quarter and $394.2 million year-to-date. Managed receivables grew to $87.7 billion at September 30, 2003, compared to $84.0 billion at June 30, 2003 and $81.3 billion at September 30, 2002. Compared to June 30, 2003, growth was driven by higher real estate secured receivables primarily in our correspondent business. Our branch-based Consumer Lending business reported strong originations during the quarter, however, this growth was partially offset by higher run-off. Compared to September 30, 2002, growth was strongest in our real estate secured and private label portfolios. Strong year-over-year real estate secured growth in our correspondent business was partially offset by $3.8 billion of whole loan sales in the fourth quarter of 2002. Year-over-year growth in our branch-based Consumer Lending business was impacted by weak sales momentum through the first part of 2003 following our intentional fourth quarter 2002 slowdown and higher run-off. Growth in our private label portfolio was the result of portfolio acquisitions and organic growth. Return on average managed assets ("ROMA") was 1.30 and 1.06 percent in the third quarter and first nine months of 2003 compared to .41 and 1.26 percent in the year-ago periods. Excluding the settlement charge and related expenses, ROMA was 1.99 percent in the third quarter of 2002 and 1.79 percent in the first nine months of 2002. The decline in the ratios reflect lower securitization revenue and higher operating expenses. The year-to-date ratio also reflects higher credit loss provision. Credit Card Services Segment Our Credit Card Services segment reported improved results over the prior-year periods. Net income increased to $143.8 million for the third quarter compared to $97.7 million for the year-ago quarter. Year-to-date, net income increased to $366.0 million compared to $240.9 million for the first nine months of 2002. The increase was due primarily to higher net interest margin and fee income. Net interest margin increased $35.6 million to $490.3 million for the quarter and $144.9 million to $1.4 billion year-to-date as a result of higher receivable levels and margin spreads. Net interest margin as a percent of average receivables increased in the quarter as a result of lower funding costs and pricing floors which capped rate reductions on certain variable rate credit card products. Fee income increased $33.7 million to $341.5 million for the quarter and $127.6 million to $1.0 billion year-to-date. Partially offsetting the revenue growth was higher credit loss provision which increased $11.9 million during the quarter and $69.0 million year-to-date as a result of the higher receivable levels and the continued weak economy. Managed receivables were $18.3 billion at September 30, 2003, compared to $17.4 billion at June 30, 2003 and $17.0 billion at September 30, 2002. Growth over both prior periods reflects a $.5 billion portfolio acquisition during the quarter as well as organic growth in our subprime direct mail and our partner programs, which include both our GM and Union Plus portfolios. ROMA was 2.85 and 2.42 percent in the third quarter and first nine months of 2003 compared to 2.00 and 1.76 percent in the year-ago periods. The increase in the ratios reflects higher net interest margin and fee income. International Segment Our International segment reported net income of $41.7 million for the third quarter compared to $48.7 million for the year-ago quarter. Year-to-date, net income was $116.8 million compared to $130.6 million for the first nine months of 2002. Net interest margin increased $20.7 million to $189.4 million for the quarter and $73.2 million to $549.3 million year-to-date due to higher receivable levels. Although receivable levels have increased over the year-ago period, net interest margin as a percentage of 24 -------------------------------------------------------------------------------- Table of Contents average receivables declined due to mix and pricing. Credit loss provision rose $32.4 million to $100.6 million for the quarter and $51.5 million to $270.6 million year-to-date primarily as a result of increased levels of receivables. Total costs and expenses increased $13.9 million during the quarter and $60.3 million year-to-date primarily as a result of higher salary expenses to support receivables growth and higher policyholder benefits, which resulted from increased insurance sales volumes. Managed receivables totaled $10.2 billion at both September 30, 2003 and June 30, 2003 and $8.1 billion at September 30, 2002. Compared to the prior quarter, growth in our real estate secured portfolio was offset by reductions in our U.K. MasterCard and Visa portfolio. Growth over the prior year quarter was strongest in our private label portfolio as the result of a $.4 billion portfolio acquisition in the second quarter of 2003. Our real estate secured and MasterCard and Visa portfolio in the U.K. also reported strong growth over the prior year quarter. Receivables also reflect favorable translation adjustments of $.7 billion compared to the prior year quarter. ROMA was 1.54 and 1.46 percent in the third quarter and first nine months of 2003 compared to 2.12 and 2.02 percent in the year-ago periods. The decreases reflect lower net interest margin as a percent of average receivables and higher provision for credit losses and costs and expenses. Receivable Review (All dollar amounts are stated in September Increase Increase (decrease) millions) 30, (decrease) from 2003 from September 30, June 30, 2003 2002 $ % $ % Real estate secured $ 52,768.9 $ 3,012.7 6% $ 4,233.5 9% Auto finance 3,701.1 1,124.8 44 1,385.0 60 MasterCard(1)/Visa(1) 9,892.1 523.5 6 2,249.4 29 Private label 12,406.6 346.5 3 1,812.3 17 Personal non-credit card(2) 13,850.3 (264.9) (2) (751.8) (5) Commercial and other 408.9 (21.7) (5) (64.7) (14) Total owned receivables $ 93,027.9 $ 4,720.9 5% $ 8,863.7 11% ---------- (1) MasterCard is a registered trademark of MasterCard International, Incorporated and Visa is a registered trademark of VISA USA, Inc. (2) Personal non-credit card receivables are comprised of the following: (In millions) September June 30, September 30, 2003 30, 2003 2002 Domestic personal unsecured $ 6,458.5 $ 6,673.5 $ 6,909.2 Union Plus personal unsecured 755.4 862.0 1,195.7 Personal homeowner loans 3,735.0 3,851.5 4,339.2 Foreign unsecured 2,901.4 2,728.2 2,158.0 Total personal non-credit card $ 13,850.3 $ 14,115.2 $ 14,602.1 Owned receivables of $93.0 billion at September 30, 2003 increased $8.9 billion from a year ago. Driven by growth in our correspondent business, real estate secured receivables increased $4.2 billion over the year-ago period, despite whole loan sales of $3.8 billion in the fourth quarter of 2002. Receivable levels in our branch- based Consumer Lending business are beginning to improve, with stronger sales volume over the past several months compared to earlier in the year following our intentional fourth quarter 2002 slowdown. Auto finance receivables increased $1.4 billion year-over-year to $3.7 billion at September 30, 2003 due to newly originated loans acquired from our dealer network and strategic alliances established during the year and lower 25 -------------------------------------------------------------------------------- Table of Contents securitization levels. MasterCard and Visa receivables increased $2.2 billion to $9.9 billion at September 30, 2003. MasterCard and Visa growth includes a $.5 billion portfolio acquisition during the quarter as well as organic growth which was strongest in our domestic subprime direct mail and U.K. marblesTM portfolios. Our partner programs, which include both our GM and Union Plus portfolios, also reported growth. Private label receivables increased $1.8 billion to $12.4 billion. This growth reflects owned portfolio acquisitions of $1.2 billion during the second quarter of 2003 and $.5 billion during the fourth quarter of 2002 as well as organic growth through existing merchants which were partially offset by securitization activity. Personal non-credit card receivable growth generated by our branches was more than offset by securitization activity. Compared to June 30, 2003, growth in our real estate secured portfolio was primarily due to growth in our correspondent business. MasterCard and Visa growth was largely due to a $.5 billion portfolio acquisition. Our auto finance portfolio was impacted by lower levels of securitizations. Liquidity and Capital Resources The merger with HSBC has improved our access to the capital markets and lowered our funding costs compared with those that we would have incurred had the merger not occurred. We currently anticipate that we will continue to use HSBC's available funding to partially fund our operations. This will reduce our reliance on the debt markets. We anticipate that the tighter spreads we have experienced and will continue to experience as a result of our merger with HSBC along with other funding synergies will eventually lead to cash funding expense savings of approximately $1.0 billion per year. However, it will take us some time to realize the full amount of these cash savings as our existing term debt will mature over the course of the next several years. Significant liquidity and capital transactions during the first nine months of 2003, included the following: â€¢ At September 30, 2003, advances from affiliates of HSBC totaled $5.9 billion, a $2.6 billion increase from June 30, 2003. This total included $3.9 billion in domestic and $2.0 billion in U.K. funding. The interest rates on this funding are comparable to those available to us from unaffiliated parties. â€¢ We increased our outstanding commercial paper balance by $3.4 billion to $8.0 billion at September 30, 2003. The increase is attributable to the upgrade of our debt ratings following the HSBC merger which expanded our universe of potential buyers and to a new Euro commercial paper program. At September 30, 2003, outstanding Euro commercial paper totaled $2.2 billion, including $1.9 billion which was sold to customers of HSBC. This program has expanded our European investor base. â€¢ Investment securities totaled $6.9 billion at September 30, 2003 and $7.6 billion at December 31, 2002. Included in the September 30, 2003 balance was $2.4 billion dedicated to our credit card bank and $3.2 billion held by our insurance subsidiaries. Included in the December 31, 2002 balance was $2.2 billion dedicated to our credit card bank and $3.1 billion held by our insurance subsidiaries. â€¢ We reduced our committed back-up lines of credit with third parties by $2.4 billion. In the third quarter, we also established a $2.5 billion revolving credit facility with HSBC. There have been no draws against our back-up lines of credit. â€¢ We reduced our conduit capacity for real estate secured receivables by $4.5 billion and for MasterCard and Visa receivables by $850 million as a result of additional liquidity capacity now available from HSBC and its affiliates. We increased our conduit capacity for personal non-credit card receivables by $800 million. â€¢ We issued $3.7 billion of domestic medium-term notes, $4.2 billion in foreign currency-denominated bonds (including $.9 billion issued to affiliates of HSBC) and $3.3 billion of global debt. We also issued $1.2 billion of InterNotes(SM) (retail-oriented medium-term notes). â€¢ In July 2003 we called Household Capital Trusts I and IV. These company obligated mandatorily redeemable preferred securities of subsidiary trusts totaled $275 million, were redeemed in August 2003 and were replaced by preferred securities of Household Capital Trust VIII which were issued to HSBC. 26 -------------------------------------------------------------------------------- Table of Contents â€¢ The composition of receivables securitized (excluding replenishments of certificateholder interests) was as follows: (In millions) Three months ended Nine months ended September 30, September 30, 2003 2002 2003 2002 Auto finance - $ 986.0 $ 1,007.1 $ 2,336.0 MasterCard/Visa $ 350.0 160.0 670.0 1,373.4 Private label - 390.0 250.0 890.0 Personal non-credit card 885.0 1,000.0 1,700.0 2,352.7 Total $ 1,235.0 $ 2,536.0 $ 3,627.1 $ 6,952.1 Securitization levels during 2003 reflect the use of additional sources of liquidity provided by HSBC and its affiliates. Securitization levels in the first nine months of 2002 reflect the impact of our liquidity management plans. â€¢ We issued securities backed by dedicated home equity loans of $1.9 billion during the current quarter. For accounting purposes, these transactions were structured as secured financings. Therefore, the receivables and the related debt remain on our balance sheet. â€¢ During the first quarter of 2003, we redeemed outstanding shares of our $4.30, $4.50 and 5.00 percent cumulative preferred stock pursuant to their respective terms. Additionally, the outstanding shares of our 7.625, 7.60, 7.50 and 8.25 percent preferred stock were converted into the right to receive cash from HSBC in an amount equal to their liquidation value, plus accrued and unpaid dividends which was an aggregate amount of $1.1 billion. In consideration of HSBC transferring sufficient funds to make the payments described above with respect to our 7.625, 7.60, 7.50, and 8.25 percent preferred stock, we issued a new series of 6.50 percent cumulative preferred stock in the amount of $1.1 billion to HSBC on March 28, 2003. â€¢ Selected capital ratios were as follows: Sept. June Dec. 30, 30, 31, 2003 2003 2002 TETMA(1) 6.79% 6.66% 9.08% Tangible common equity to tangible managed assets(1) 4.71 4.51 6.83 Common and preferred equity to owned assets 14.66 14.54 10.64 Excluding purchase accounting adjustments: TETMA(1) 8.80 8.72 9.08 Tangible common equity to tangible managed assets(1) 6.76 6.61 6.83 -------- (1) TETMA and tangible common equity to tangible managed assets represent non-GAAP financial ratios that are used by certain rating agencies to evaluate capital adequacy and may differ from similarly named measures presented by other companies. See "Reconciliation to GAAP Financial Measures" for additional discussion and quantitative reconciliations to the equivalent GAAP basis financial measure. 27 -------------------------------------------------------------------------------- This information is provided by RNS The company news service from the London Stock Exchange MORE TO FOLLOW QRTILFFVLDLALIV

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