HSBC Fin Corp Q1 2006 10Q - 2

HSBC Holdings PLC 15 May 2006 PART 2 NET CHARGE-OFFS OF CONSUMER RECEIVABLES - OWNED BASIS The following table summarizes net charge-offs of consumer receivables (as a percent, annualized, of average consumer receivables): MARCH 31, DECEMBER 31, MARCH 31, 2006 2005 2005 -------------------------------------------------------------------------------------------------- Real estate secured......................................... .75% .66% .87% Auto finance................................................ 3.50 3.42 3.80 MasterCard/Visa............................................. 4.00 7.99 7.17 Private label............................................... 5.62 5.60 4.18 Personal non-credit card.................................... 7.94 7.59 8.18 ---- ---- ---- Total....................................................... 2.58% 3.10% 3.15% ==== ==== ==== Real estate secured net charge-offs and REO expense as a percent of average real estate secured receivables........ .89% .78% 1.01% Net charge-offs as a percent, annualized, of average consumer receivables decreased compared to both the prior and year ago quarters primarily as a result of lower levels of personal bankruptcy filings in our MasterCard/Visa portfolio due to the new bankruptcy legislation in the U.S. which resulted in an acceleration of net charge-offs in the fourth quarter of 2005, a portion of which would have otherwise been experienced in 2006. The net charge-off ratio for our MasterCard/Visa portfolio was also positively impacted by the receivables acquired in our acquisition of Metris which were subject to the reporting requirements of SOP 03-3 as discussed above. Our real estate secured portfolio experienced an increase in net charge-offs during the first quarter reflecting seasoning of the growing portfolio. The increase in net charge-offs in the personal non-credit card portfolio is due to portfolio seasoning. Total net charge-offs for the current quarter decreased from the March 2005 quarter primarily due to a decrease in personal bankruptcy filings in our MasterCard/Visa portfolio following the October 2005 enactment of new bankruptcy legislation in the United States. Also contributing to the decrease was portfolio growth and the positive impact from the lower delinquency levels we experienced throughout 2005 as a result of a strong economy. 43 HSBC Finance Corporation -------------------------------------------------------------------------------- OWNED NONPERFORMING ASSETS MARCH 31, DECEMBER 31, MARCH 31, 2006 2005 2005 -------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Nonaccrual receivables...................................... $3,525 $3,533 $2,956 Accruing consumer receivables 90 or more days delinquent.... 740 621 499 Renegotiated commercial loans............................... 1 - 1 ------ ------ ------ Total nonperforming receivables............................. 4,266 4,154 3,456 Real estate owned........................................... 563 510 509 ------ ------ ------ Total nonperforming assets.................................. $4,829 $4,664 $3,965 ====== ====== ====== Credit loss reserves as a percent of nonperforming receivables............................................... 104.7% 108.8% 103.6% Compared to December 31, 2005, the increase in total nonperforming assets is primarily due to the seasoning of the Metris portfolio as discussed above. Consistent with industry practice, accruing consumer receivables 90 or more days delinquent includes domestic MasterCard/Visa receivables. ACCOUNT MANAGEMENT POLICIES AND PRACTICES Our policies and practices for the collection of consumer receivables, including our customer account management policies and practices, permit us to reset the contractual delinquency status of an account to current, based on indicia or criteria which, in our judgment, evidence continued payment probability. Such policies and practices vary by product and are designed to manage customer relationships, maximize collection opportunities and avoid foreclosure or repossession if reasonably possible. If the account subsequently experiences payment defaults, it will again become contractually delinquent. The tables below summarize approximate restructuring statistics in our managed basis domestic portfolio. We report our restructuring statistics on a managed basis only because the receivables that we securitize are subject to underwriting standards comparable to our owned portfolio, are generally serviced and collected without regard to ownership and result in a similar credit loss exposure for us. As previously reported, in prior periods we used certain assumptions and estimates to compile our restructure statistics. The systemic counters used to compile the information presented below exclude from the reported statistics loans that have been reported as contractually delinquent but have been reset to a current status because we have determined that the loans should not have been considered delinquent (e.g., payment application processing errors). When comparing restructuring statistics from different periods, the fact that our restructure policies and practices will change over time, that exceptions are made to those policies and practices, and that our data capture methodologies have been enhanced, should be taken into account. 44 HSBC Finance Corporation -------------------------------------------------------------------------------- TOTAL RESTRUCTURED BY RESTRUCTURE PERIOD - DOMESTIC PORTFOLIO(1) (MANAGED BASIS) MARCH 31, DECEMBER 31, MARCH 31, 2006 2005 2005 -------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Never restructured.......................................... 89.7% 89.5% 87.2% Restructured: Restructured in the last 6 months......................... 4.0 4.0 4.8 Restructured in the last 7-12 months...................... 2.4 2.4 3.2 Previously restructured beyond 12 months.................. 3.9 4.1 4.8 ------- ------- ------- Total ever restructured(2)................................ 10.3 10.5 12.8 ------- ------- ------- Total....................................................... 100.0% 100.0% 100.0% ======= ======= ======= TOTAL RESTRUCTURED BY PRODUCT - DOMESTIC PORTFOLIO(1) (MANAGED BASIS) Real estate secured......................................... $ 8,395 $ 8,334 $ 8,470 Auto finance................................................ 1,712 1,688 1,560 MasterCard/Visa............................................. 937 774 567 Private label(3)............................................ 26 26 23 Personal non-credit card.................................... 3,411 3,369 3,466 ------- ------- ------- Total....................................................... $14,481 $14,191 $14,086 ======= ======= ======= (AS A PERCENT OF MANAGED RECEIVABLES) Real estate secured......................................... 9.7% 10.4% 12.9% Auto finance................................................ 14.5 14.5 15.3 MasterCard/Visa............................................. 3.8 3.0 3.0 Private label(3)............................................ 7.3 7.3 7.0 Personal non-credit card.................................... 19.9 19.9 22.3 ------- ------- ------- Total(2).................................................... 10.3% 10.5% 12.8% ======= ======= ======= --------------- (1) Excludes foreign businesses, commercial and other. (2) Total including foreign businesses was 10.1 percent at March 31, 2006, 10.3 percent at December 31, 2005 and 11.9 percent at March 31, 2005. (3) Only reflects consumer lending retail sales contracts which have historically been classified as private label. All other domestic private label receivables were sold to HSBC Bank USA in December 2004. See "Credit Quality Statistics" for further information regarding owned basis and managed basis delinquency, charge-offs and nonperforming loans. The amount of domestic and foreign managed receivables in forbearance, modification, credit card services approved consumer credit counseling accommodations, rewrites or other customer account management techniques for which we have reset delinquency and that is not included in the restructured or delinquency statistics was approximately $.4 billion or .3 percent of managed receivables at March 31, 2006 and December 31, 2005. In addition to the above, we granted an initial 30 or 60 day payment deferral (based on product) to customers living in the Katrina FEMA designated Individual Assistance disaster areas. This deferral was extended for a period of up to 90 days or longer in certain cases based on a customer's specific circumstances, consistent with our natural disaster policies. In certain cases these arrangements have resulted in a customer's delinquency 45 HSBC Finance Corporation -------------------------------------------------------------------------------- status being reset by 30 days or more. These extended payment arrangements affected approximately $1.1 billion of managed receivables and are not reflected as restructures in the table above or included in the other customer account management techniques described in the paragraph above unless the accounts subsequently qualify for restructuring under our restructure policies and procedures as described in the 2005 Form 10-K. LIQUIDITY AND CAPITAL RESOURCES -------------------------------------------------------------------------------- We continue to focus on balancing our use of affiliate and third party funding sources to minimize funding expense while managing liquidity. During the first quarter of 2006, we supplemented unsecured debt issuances with proceeds from the continuing sale of newly originated domestic private label receivables to HSBC Bank USA, debt issued to affiliates, secured financings and higher levels of commercial paper as a result of the seasonal activity of our TFS business. Because we are a subsidiary of HSBC, our credit ratings have improved and our credit spreads relative to Treasuries have tightened compared to those we experienced during the months leading up to the announcement of our acquisition by HSBC. Primarily as a result of tightened credit spreads, we recognized cash funding expense savings of approximately $214 million during the quarter ended March 31, 2006 and approximately $120 million during the quarter ended March 31, 2005 compared to the funding costs we would have incurred using average spreads and funding mix from the first half of 2002. These tightened credit spreads in combination with the issuance of HSBC Finance Corporation debt and other funding synergies including asset transfers and debt underwriting fees paid to HSBC affiliates have enabled HSBC to realize a run rate for annual cash funding expense savings in excess of $1 billion per year. In the first quarter of 2006, the cash funding expense savings realized by HSBC totaled approximately $280 million. Debt due to affiliates and other HSBC related funding are summarized in the following table: MARCH 31, DECEMBER 31, 2006 2005 -------------------------------------------------------------------------------------- (IN BILLIONS) Debt issued to HSBC subsidiaries: Drawings on bank lines in the U.K and Europe.............. $ 4.0 $ 4.2 Term debt................................................. 11.2 11.0 Preferred securities issued by Household Capital Trust VIII to HSBC........................................... .3 .3 ----- ----- Total debt outstanding to HSBC subsidiaries............... 15.5 15.5 ----- ----- Debt outstanding to HSBC clients: Euro commercial paper..................................... 3.3 3.2 Term debt................................................. 1.3 1.3 ----- ----- Total debt outstanding to HSBC clients.................... 4.6 4.5 Cash received on bulk and subsequent sales of domestic private label credit card receivables to HSBC Bank USA, net (cumulative).......................................... 14.5 15.7 Real estate secured receivable activity with HSBC Bank USA: Cash received on sales (cumulative)....................... 3.7 3.7 Direct purchases from correspondents (cumulative)......... 4.2 4.2 Reductions in real estate secured receivables sold to HSBC Bank USA............................................... (3.7) (3.3) ----- ----- Total real estate secured receivable activity with HSBC Bank USA....................................................... 4.2 4.6 ----- ----- Cash received from sale of U.K. credit card business to HBEU (cumulative).............................................. 2.7 2.6 Capital contribution by HINO (cumulative)................... 1.2 1.2(1) ----- ----- Total HSBC related funding.................................. $42.7 $44.1 ===== ===== --------------- (1) This capital contribution was made in connection with the acquisition of Metris. 46 HSBC Finance Corporation -------------------------------------------------------------------------------- Funding from HSBC, including debt issuances to HSBC subsidiaries and clients, represented 15 percent of our total managed debt at March 31, 2006 and December 31, 2005. Cash proceeds from the December 2005 sale of our managed basis U.K. credit card receivables to HBEU of $2.6 billion were used partially to pay down drawings on bank lines from HBEU in the U.K. and partially to fund operations. At March 31, 2006, we had a commercial paper back stop credit facility of $2.5 billion from HSBC supporting domestic issuances and a revolving credit facility of $5.3 billion from HBEU to fund our operations in the U.K. There have been no draws on the domestic line. At March 31, 2006, $4.0 billion was outstanding under the U.K. lines. We had derivative contracts with a notional value of $85.6 billion, or approximately 96 percent of total derivative contracts, outstanding with HSBC affiliates at March 31, 2006. At December 31, 2005, we had derivative contracts with a notional value of $72.2 billion, or approximately 95 percent of total derivative contracts, outstanding with HSBC affiliates. SECURITIES AND OTHER SHORT-TERM INVESTMENTS Securities totaled $4.1 billion at March 31, 2006 and December 31, 2005. Securities purchased under agreements to resell totaled $91 million at March 31, 2006 and $78 million at December 31, 2005. Interest bearing deposits with banks totaled $599 million at March 31, 2006 and $384 million at December 31, 2005. COMMERCIAL PAPER, BANK AND OTHER BORROWINGS totaled $14.2 billion at March 31, 2006 and $11.4 billion at December 31, 2005. The increase at March 31, 2006 was a result of the funding of the seasonal activity of our TFS business. Included in this total was outstanding Euro commercial paper sold to customers of HSBC of $3.3 billion at March 31, 2006 and $3.2 billion at December 31, 2005. LONG TERM DEBT (with original maturities over one year) increased to $107.8 billion at March 31, 2006 from $105.2 billion at December 31, 2005. As part of our overall liquidity management strategy, we continue to extend the maturity of our liability profile. Significant third party issuances during the first quarter of 2006 included the following: - $3.0 billion of domestic medium-term notes - $.8 billion of foreign currency-denominated bonds - $.5 billion of InterNotes(SM) (retail-oriented medium-term notes) - $2.5 billion of global debt - $1.5 billion of securities backed by real estate secured and MasterCard/Visa receivables. For accounting purposes, these transactions were structured as secured financings. In the first quarter of 2006, we redeemed the junior subordinated notes issued to Household Capital Trust VI with an outstanding principal balance of $206 million. SELECTED CAPITAL RATIOS are summarized in the following table: MARCH 31, DECEMBER 31, 2006 2005 -------------------------------------------------------------------------------------- TETMA(1).................................................... 7.75% 7.56% TETMA + Owned Reserves(1)................................... 10.59 10.55 Tangible common equity to tangible managed assets(1)........ 6.44 6.07 Common and preferred equity to owned assets................. 12.45 12.43 Excluding purchase accounting adjustments: TETMA(1).................................................. 8.62 8.52 TETMA + Owned Reserves(1)................................. 11.47 11.51 Tangible common equity to tangible managed assets(1)...... 7.32 7.02 --------------- (1) TETMA, TETMA + Owned Reserves and tangible common equity to tangible managed assets represent non-GAAP financial ratios that are used by HSBC Finance Corporation management and certain rating agencies to evaluate capital adequacy and may differ from similarly named measures presented by other companies. See "Basis of Reporting" for additional discussion on the use of non-GAAP financial measures and "Reconciliations to GAAP Financial Measures" for quantitative reconciliations to the equivalent GAAP basis financial measure. 47 HSBC Finance Corporation -------------------------------------------------------------------------------- SECURITIZATIONS AND SECURED FINANCINGS Securitizations (collateralized funding transactions structured to receive sale treatment under Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a Replacement of FASB Statement No. 125," ("SFAS No. 140")) and secured financings (collateralized funding transactions which do not receive sale treatment under SFAS No. 140) of consumer receivables have been a source of funding and liquidity for us. Securitizations and secured financings have been used to limit our reliance on the unsecured debt markets. In a securitization, a designated pool of non-real estate consumer receivables is removed from the balance sheet and transferred through a limited purpose financing subsidiary to an unaffiliated trust. This unaffiliated trust is a qualifying special purpose entity ("QSPE") as defined by SFAS No. 140 and, therefore, is not consolidated. The QSPE funds its receivable purchase through the issuance of securities to investors, entitling them to receive specified cash flows during the life of the securities. The receivables transferred to the QSPE serve as collateral for the securities. At the time of sale, an interest-only strip receivable is recorded, representing the present value of the cash flows we expect to receive over the life of the securitized receivables, net of estimated credit losses and debt service. Under the terms of the securitizations, we receive annual servicing fees on the outstanding balance of the securitized receivables and the rights to future residual cash flows on the sold receivables after the investors receive their contractual return. Cash flows related to the interest-only strip receivables and servicing the receivables are collected over the life of the underlying securitized receivables. In a secured financing, a designated pool of receivables is conveyed to a wholly owned limited purpose subsidiary which in turn transfers the receivables to a trust which sells interests to investors. Repayment of the debt issued by the trust is secured by the receivables transferred. The transactions are structured as secured financings under SFAS No. 140. Therefore, the receivables and the underlying debt of the trust remain on our balance sheet. We do not recognize a gain in a secured financing transaction. Because the receivables and the debt remain on our balance sheet, revenues and expenses are reported consistently with our owned balance sheet portfolio. Using this source of funding results in similar cash flows as issuing debt through alternative funding sources. Securitizations are treated as secured financings under both IFRSs and U.K. GAAP. In order to align our accounting treatment with that of HSBC initially under U.K. GAAP and now under IFRSs, we began to structure all new collateralized funding transactions as secured financings in the third quarter of 2004. However, because existing public MasterCard and Visa credit card transactions were structured as sales to revolving trusts that require replenishments of receivables to support previously issued securities, receivables will continue to be sold to these trusts and the resulting replenishment gains recorded until the revolving periods end, the last of which is currently projected to occur in early 2008. We will continue to replenish at reduced levels, certain non-public personal non-credit card and MasterCard/ Visa securities issued to conduits and record the resulting replenishment gains for a period of time in order to manage liquidity. Since our securitized receivables have varying lives, it will take time for these receivables to pay-off and the related interest-only strip receivables to be reduced to zero. The termination of sale treatment on new collateralized funding activity reduced our reported net income under U.S. GAAP. There was no impact, however, on cash received. Because we believe the market for securities backed by receivables is a reliable, efficient and cost-effective source of funds, we will continue to use secured financings of consumer receivables as a source of our funding and liquidity. 48 HSBC Finance Corporation -------------------------------------------------------------------------------- There were no securitizations (excluding replenishments of certificateholder interests) during the first quarter of 2006 or 2005. Secured financings are summarized in the following table: THREE MONTHS ENDED MARCH 31 2006 2005 ---------------------------------------------------------------------------- (IN MILLIONS) SECURED FINANCINGS: Real estate secured......................................... $ 350 $ - MasterCard/Visa............................................. 1,120 - Auto finance................................................ - - ------ ----- Total....................................................... $1,470 $ - ====== ===== Our securitized receivables totaled $3.1 billion at March 31, 2006 compared to $4.1 billion at December 31, 2005. As of March 31, 2006, outstanding secured financings of $15.1 billion were secured by $21.4 billion of real estate secured, auto finance and MasterCard/Visa receivables. Secured financings of $15.1 billion at December 31, 2005 were secured by $21.8 billion of real estate secured, auto finance and MasterCard/Visa receivables. At March 31, 2006, securitizations structured as sales represented 2 percent and secured financings represented 11 percent of the funding associated with our managed funding portfolio. At December 31, 2005, securitizations structured as sales represented 3 percent and secured financings represented 11 percent of the funding associated with our managed funding portfolio. 2006 FUNDING STRATEGY As discussed previously, the acquisition by HSBC has improved our access to the capital markets as well as expanded our access to a worldwide pool of potential investors. Our current estimated domestic funding needs and sources for 2006 are summarized in the table that follows: ACTUAL ESTIMATED JANUARY 1 APRIL 1 THROUGH THROUGH ESTIMATED MARCH 31, DECEMBER 31, FULL YEAR 2006 2006 2006 -------------------------------------------------------------------------------------------------- (IN BILLIONS) FUNDING NEEDS: Net asset growth.......................................... $ 4 $ 9 - 19 $13 - 23 Commercial paper, term debt and securitization maturities............................................. 16 14 - 20 30 - 36 Other..................................................... - 1 - 3 1 - 3 --- -------- -------- Total funding needs....................................... $20 $24 - 42 $44 - 62 === ======== ======== FUNDING SOURCES: External funding, including commercial paper.............. $20 $23 - 37 $43 - 57 HSBC and HSBC subsidiaries................................ - 1 - 5 1 - 5 --- -------- -------- Total funding sources..................................... $20 $24 - 42 $44 - 62 === ======== ======== RISK MANAGEMENT -------------------------------------------------------------------------------- CREDIT RISK There have been no significant changes in our approach to credit risk management since December 31, 2005. At March 31, 2006, we had derivative contracts with a notional value of approximately $89.0 billion, including $85.6 billion outstanding with HSBC affiliates. Most swap agreements, both with unaffiliated and affiliated third parties, 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 is recorded in our balance sheet as other assets or derivative related liabilities and totaled $90 million at March 31, 2006 and $91 million at December 31, 2005. When the fair value of our agreements 49 HSBC Finance Corporation -------------------------------------------------------------------------------- with affiliate counterparties requires the posting of collateral by the affiliate, it is provided in the form of securities, which are not recorded on our balance sheet. Alternately, when the fair value of our agreements with affiliate counterparties requires us to post collateral, it is provided in the form of cash which is recorded on our balance sheet in other assets. At March 31, 2006, the fair value of our agreements with affiliate counterparties was above the level that requires us to post collateral. As such at March 31, 2006, we had posted cash collateral with affiliates totaling $352 million. At December 31, 2005, the fair value of our agreements with affiliate counterparties was below the level requiring the posting of collateral by the affiliate. As such, at December 31, 2005, we were not holding any swap collateral from HSBC affiliates in the form of securities. LIQUIDITY RISK There have been no significant changes in our approach to liquidity risk since December 31, 2005. MARKET RISK HSBC Group has certain limits and benchmarks that serve as guidelines in determining the appropriate levels of interest rate risk. One such limit is expressed in terms of the Present Value of a Basis Point ("PVBP"), which reflects the change in value of the balance sheet for a one basis point movement in all interest rates. Our PVBP limit as of March 31, 2006 was $2 million, which includes the risk associated with hedging instruments. Thus, for a one basis point change in interest rates, the policy dictates that the value of the balance sheet shall not increase or decrease by more than $2 million. As of March 31, 2006 and December 31, 2005, we had a PVBP position of less than $1 million reflecting the impact of a one basis point increase in interest rates. While the total PVBP position will not change as a result of the loss of hedge accounting following our acquisition by HSBC, the following table shows the components of PVBP: MARCH 31, DECEMBER 31, 2006 2005 -------------------------------------------------------------------------------------- (IN MILLIONS) Risk related to our portfolio of ineffective hedges......... $(1.9) $(1.4) Risk for all other remaining assets and liabilities......... 1.9 2.3 ----- ----- Total PVBP risk............................................. $ - $ .9 ===== ===== We also monitor the impact that an immediate hypothetical increase or decrease in interest rates of 25 basis points applied at the beginning of each quarter over a 12 month period would have on our net interest income assuming a growing balance sheet and the current interest rate risk profile. The following table summarizes such estimated impact: MARCH 31, DECEMBER 31, 2006 2005 -------------------------------------------------------------------------------------- (IN MILLIONS) Decrease in net interest income following a hypothetical 25 basis points rise in interest rates applied at the beginning of each quarter over the next 12 months............................................ $ 89 $213 Increase in net interest income following a hypothetical 25 basis points fall in interest rates applied at the beginning of each quarter over the next 12 months............................................ $197 $120 These estimates include both the net interest income impact of the derivative positions we have entered into which are considered to be effective hedges under SFAS No. 133 and the impact of economic hedges of certain underlying debt instruments which do not qualify for hedge accounting as previously discussed, as if they were effective hedges under SFAS No. 133. These estimates also assume we would not take any corrective actions in response to interest rate movements and, therefore, exceed what most likely would occur if rates were to change by the amount indicated. 50 HSBC Finance Corporation -------------------------------------------------------------------------------- As part of our overall risk management strategy to reduce earnings volatility, in 2005 a significant number of our pay fixed/receive variable interest rate swaps which had not previously qualified for hedge accounting under SFAS No. 133, have been designated as effective hedges using the long-haul method of accounting, and certain other interest rate swaps were terminated. This will significantly reduce the volatility of the mark-to-market on the previously non-qualifying derivatives which have been designated as effective hedges going forward, but will result in the recording of ineffectiveness under the long-haul method of accounting under SFAS No. 133. In order to further reduce earnings volatility that would otherwise result from changes in interest rates, we continue to evaluate the steps required to regain hedge accounting treatment under SFAS No. 133 for the remaining swaps which do not currently qualify for hedge accounting. These derivatives remain economic hedges of the underlying debt instruments. We will continue to manage our total interest rate risk on a basis consistent with the risk management process employed since the acquisition. INSURANCE RISK The principal insurance risk we face is that the cost of claims combined with acquisition and administration costs may exceed the aggregate amount of premiums received and investment income earned. We manage our insurance risks through the application of formal pricing, underwriting, and claims procedures. These procedures are also designed to ensure compliance with regulations. OPERATIONAL RISK There has been no significant change in our approach to operational risk management since December 31, 2005. 51 HSBC FINANCE CORPORATION RECONCILIATIONS TO GAAP FINANCIAL MEASURES THREE MONTHS ENDED ------------------------- MARCH 31, MARCH 31, 2006 2005 --------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) RETURN ON AVERAGE ASSETS: Net income.................................................. $ 888 $ 626 -------- -------- Average assets: Owned basis............................................... $162,688 $131,954 Serviced with limited recourse............................ 3,505 12,884 -------- -------- Managed basis............................................. $166,193 $144,838 -------- -------- Return on average owned assets.............................. 2.18% 1.90% Return on average managed assets............................ 2.14 1.73 ======== ======== RETURN ON AVERAGE COMMON SHAREHOLDER'S(S') EQUITY: Net income.................................................. $ 888 $ 626 Dividends on preferred stock................................ (9) (18) -------- -------- Net income available to common shareholders................. $ 879 $ 608 -------- -------- Average common shareholder's(s') equity..................... $ 19,379 $ 16,170 -------- -------- Return on average common shareholder's(s') equity........... 18.14% 15.04% ======== ======== NET INTEREST MARGIN: Net interest income: Owned basis............................................... $ 2,464 $ 1,888 Serviced with limited recourse............................ 103 332 -------- -------- Managed basis............................................. $ 2,567 $ 2,220 -------- -------- Average interest-earning assets: Owned basis............................................... $147,266 $112,985 Serviced with limited recourse............................ 3,505 12,884 -------- -------- Managed basis............................................. $150,771 $125,869 -------- -------- Owned basis net interest margin............................. 6.69% 6.68% Managed basis net interest margin........................... 6.81 7.06 ======== ======== MANAGED BASIS RISK ADJUSTED REVENUE: Net interest income......................................... $ 2,567 $ 2,220 Other revenues.............................................. 1,312 1,160 Excluding: Securitization related revenue............................ 54 308 Mark-to-market on derivatives which do not qualify as effective hedges and ineffectiveness associated with qualifying hedges under SFAS No. 133................... (53) (245) Net charge-offs........................................... (990) (1,118) -------- -------- Risk adjusted revenue....................................... 2,890 2,325 Average interest-earning assets............................. $150,771 $125,869 -------- -------- Managed basis risk adjusted revenue......................... 7.67% 7.39% ======== ======== 52 HSBC FINANCE CORPORATION RECONCILIATIONS TO GAAP FINANCIAL MEASURES THREE MONTHS ENDED ------------------------------------ MARCH 31, MARCH 31, DECEMBER 31, 2006 2005 2005 ------------------------------------------------------------------------------------------------- (DOLLAR AMOUNTS ARE IN MILLIONS) CONSUMER NET CHARGE-OFF RATIO: Consumer net charge-offs: Owned basis.............................................. $ 928 $ 856 $ 1,044 Serviced with limited recourse........................... 62 255 119 -------- -------- -------- Managed basis............................................ $ 990 $ 1,111 $ 1,163 -------- -------- -------- Average consumer receivables: Owned basis.............................................. $143,893 $108,928 $134,647 Serviced with limited recourse........................... 3,505 12,884 5,757 -------- -------- -------- Managed basis............................................ $147,398 $121,812 $140,404 -------- -------- -------- Owned basis consumer net charge-off ratio.................. 2.58% 3.15% 3.10% Managed basis consumer net charge-off ratio................ 2.69 3.65 3.31 ======== ======== ======== RESERVES AS A PERCENTAGE OF NET CHARGE-OFFS Loss reserves: Owned basis.............................................. $ 4,468 $ 3,581 $ 4,521 Serviced with limited recourse........................... 161 661 215 -------- -------- -------- Managed basis............................................ $ 4,629 $ 4,242 $ 4,736 -------- -------- -------- Net charge-offs: Owned basis.............................................. $ 928 $ 863 $ 1,044 Serviced with limited recourse........................... 62 255 119 -------- -------- -------- Managed basis............................................ $ 990 $ 1,118 $ 1,163 -------- -------- -------- Owned basis reserves as a percentage of net charge-offs.... 120.4% 103.7% 108.3% Managed basis reserves as a percentage of net charge-offs.............................................. 116.9 94.9 101.8 ======== ======== ======== EFFICIENCY RATIO: Total costs and expenses less policyholders' benefits...... $ 1,488 $ 1,420 $ 1,433 -------- -------- -------- Net interest income and other revenues less policyholders' benefits: Owned basis.............................................. $ 3,753 $ 3,228 $ 3,332 Serviced with limited recourse........................... 8 30 48 -------- -------- -------- Managed basis............................................ $ 3,761 $ 3,258 $ 3,380 -------- -------- -------- Owned basis efficiency ratio............................... 39.65% 43.99% 43.01% Managed basis efficiency ratio............................. 39.56 43.59 42.40 ======== ======== ======== 53 HSBC FINANCE CORPORATION RECONCILIATIONS TO GAAP FINANCIAL MEASURES MARCH 31, DECEMBER 31, MARCH 31, 2006 2005 2005 ---------------------------------------------------------------------------------------------------------- (DOLLAR AMOUNTS ARE IN MILLIONS) TWO-MONTHS-AND-OVER-CONTRACTUAL DELINQUENCY: Consumer two-months-and-over-contractual delinquency: Owned basis.............................................. $ 5,312 $ 5,366 $ 4,229 Serviced with limited recourse........................... 153 234 626 -------- -------- -------- Managed basis............................................ $ 5,465 $ 5,600 $ 4,855 -------- -------- -------- Consumer receivables: Owned basis.............................................. $146,580 $139,726 $111,911 Serviced with limited recourse........................... 3,109 4,074 11,486 -------- -------- -------- Managed basis............................................ $149,689 $143,800 $123,397 -------- -------- -------- Consumer two-months-and-over-contractual delinquency: Owned basis.............................................. 3.62% 3.84% 3.78% Managed basis............................................ 3.65 3.89 3.93 ======== ======== ======== RESERVES AS A PERCENTAGE OF RECEIVABLES: Loss reserves: Owned basis.............................................. $ 4,468 $ 4,521 $ 3,581 Serviced with limited recourse........................... 161 215 661 -------- -------- -------- Managed basis............................................ $ 4,629 $ 4,736 $ 4,242 -------- -------- -------- Receivables: Owned basis.............................................. $146,767 $139,913 $112,161 Serviced with limited recourse........................... 3,109 4,074 11,486 -------- -------- -------- Managed basis............................................ $149,876 $143,987 $123,647 -------- -------- -------- Reserves as a percentage of receivables: Owned basis.............................................. 3.04% 3.23% 3.19% Managed basis............................................ 3.09 3.29 3.43 ======== ======== ======== RESERVES AS A PERCENTAGE OF NONPERFORMING LOANS: Loss reserves: Owned basis.............................................. $ 4,468 $ 4,521 $ 3,581 Serviced with limited recourse........................... 161 215 661 -------- -------- -------- Managed basis............................................ $ 4,629 $ 4,736 $ 4,242 -------- -------- -------- Nonperforming loans: Owned basis.............................................. $ 4,266 $ 4,154 $ 3,456 Serviced with limited recourse........................... 126 197 511 -------- -------- -------- Managed basis............................................ $ 4,392 $ 4,351 $ 3,967 -------- -------- -------- Reserves as a percentage of nonperforming loans: Owned basis.............................................. 104.7% 108.8% 103.6% Managed basis............................................ 105.4 108.8 106.9 ======== ======== ======== 54 HSBC FINANCE CORPORATION RECONCILIATIONS TO GAAP FINANCIAL MEASURES MARCH 31, DECEMBER 31, 2006 2005 ---------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) TANGIBLE COMMON EQUITY: Common shareholder's equity................................. $ 19,806 $ 18,904 Exclude: Unrealized (gains) losses on cash flow hedging instruments............................................. (313) (260) Minimum pension liability................................. - - Unrealized gains on investments and interest-only strip receivables............................................. 35 3 Intangible assets......................................... (2,400) (2,480) Goodwill.................................................. (7,009) (7,003) -------- -------- Tangible common equity...................................... 10,119 9,164 HSBC acquisition purchase accounting adjustments............ 1,379 1,441 -------- -------- Tangible common equity, excluding HSBC acquisition purchase accounting adjustments.................................... $ 11,498 $ 10,605 ======== ======== TANGIBLE SHAREHOLDER'S(S') EQUITY: Tangible common equity...................................... $ 10,119 $ 9,164 Preferred stock............................................. 575 575 Mandatorily redeemable preferred securities of Household Capital Trusts............................................ 1,478 1,679 -------- -------- Tangible shareholder's(s') equity........................... 12,172 11,418 HSBC acquisition purchase accounting adjustments............ 1,376 1,438 -------- -------- Tangible shareholder's(s') equity, excluding HSBC acquisition purchase accounting adjustments............... $ 13,548 $ 12,856 ======== ======== TANGIBLE SHAREHOLDER'S(S') EQUITY PLUS OWNED LOSS RESERVES: Tangible shareholder's(s') equity........................... $ 12,172 $ 11,418 Owned loss reserves......................................... 4,468 4,521 -------- -------- Tangible shareholder's(s') equity plus owned loss reserves.................................................. 16,640 15,939 HSBC acquisition purchase accounting adjustments............ 1,376 1,438 -------- -------- Tangible shareholder's(s') equity plus owned loss reserves, excluding HSBC acquisition purchase accounting adjustments............................................... $ 18,016 $ 17,377 ======== ======== TANGIBLE MANAGED ASSETS: Owned assets................................................ $163,680 $156,669 Receivables serviced with limited recourse.................. 3,109 4,074 -------- -------- Managed assets.............................................. 166,789 160,743 Exclude: Intangible assets......................................... (2,400) (2,480) Goodwill.................................................. (7,009) (7,003) Derivative financial assets............................... (282) (234) -------- -------- Tangible managed assets..................................... 157,098 151,026 HSBC acquisition purchase accounting adjustments............ (14) (52) -------- -------- Tangible managed assets, excluding HSBC acquisition purchase accounting adjustments.................................... $157,084 $150,974 ======== ======== EQUITY RATIOS: Common and preferred equity to owned assets................. 12.45% 12.43% Tangible common equity to tangible managed assets........... 6.44 6.07 Tangible shareholder's(s') equity to tangible managed assets ("TETMA")................................................. 7.75 7.56 Tangible shareholder's(s') equity plus owned loss reserves to tangible managed assets ("TETMA + Owned Reserves")..... 10.59 10.55 Excluding HSBC acquisition purchase accounting adjustments: Tangible common equity to tangible managed assets......... 7.32 7.02 TETMA..................................................... 8.62 8.52 TETMA + Owned Reserves.................................... 11.47 11.51 ======== ======== 55 HSBC Finance Corporation -------------------------------------------------------------------------------- ITEM 4. CONTROLS AND PROCEDURES -------------------------------------------------------------------------------- We maintain a system of internal and disclosure controls and procedures designed to ensure that information required to be disclosed by HSBC Finance Corporation in the reports we file or submit under the Securities Exchange Act of 1934, as amended, (the "Exchange Act"), is recorded, processed, summarized and reported on a timely basis. Our Board of Directors, operating through its audit committee, which is composed entirely of independent outside directors, provides oversight to our financial reporting process. We conducted an evaluation, with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report so as to alert them in a timely fashion to material information required to be disclosed in reports we file under the Exchange Act. There have been no significant changes in our internal and disclosure controls or in other factors which could significantly affect internal and disclosure controls subsequent to the date that we carried out our evaluation. HSBC Finance Corporation continues the process to complete a thorough review of its internal controls as part of its preparation for compliance with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002. Section 404 requires our management to report on, and our external auditors to attest to, the effectiveness of our internal control structure and procedures for financial reporting. As a non-accelerated filer under Rule 12b-2 of the Exchange Act, our first report under Section 404 will be contained in our Form 10-K for the period ended December 31, 2007. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS -------------------------------------------------------------------------------- GENERAL We are parties to various legal proceedings resulting from ordinary business activities relating to our current and/or former operations. Certain of these actions are or purport to be class actions seeking damages in very large amounts. These actions assert 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. We believe that our defenses to these actions have merit and any adverse decision should not materially affect our consolidated financial condition. CONSUMER LITIGATION During the past several years, the press has widely reported certain industry related concerns that may impact us. Some of these involve the amount of litigation instituted against lenders and insurance companies operating in certain states and the large awards obtained from juries in those states. Like other companies in this industry, some of our subsidiaries are involved in a number of lawsuits pending against them in these states. The cases, in particular, generally allege inadequate disclosure or misrepresentation of financing terms. In some suits, other parties are also named as defendants. Unspecified compensatory and punitive damages are sought. Several of these suits purport to be class actions or have multiple plaintiffs. The judicial climate in these states is such that the outcome of all of these cases is unpredictable. Although our subsidiaries believe they have substantive legal defenses to these claims and are prepared to defend each case vigorously, a number of such cases have been settled or otherwise resolved for amounts that in the aggregate are not material to our operations. Appropriate insurance carriers have been notified as appropriate, and a number of reservations of rights letters have been received. 56 HSBC Finance Corporation -------------------------------------------------------------------------------- CREDIT CARD SERVICES LITIGATION Since June 2005, HSBC Finance Corporation, HSBC North America Holdings Inc., and HSBC Holdings plc., as well as other banks and the Visa and Master Card associations, were named as defendants in four class actions filed in Connecticut and the Eastern District of New York; Photos Etc. Corp. et al. v. Visa U.S.A., Inc., et al. (D. Conn. No. 3:05-CV-01007 (WWE)): National Association of Convenience Stores, et al. v. Visa U.S.A., Inc., et al.(E.D.N.Y. No. 05-CV 4520 (JG)); Jethro Holdings, Inc., et al. v. Visa U.S.A., Inc. et al.(E.D.N.Y. No. 05-CV-4521 (JG)); and American Booksellers Ass'n v. Visa U.S.A., Inc. et al. (E.D.N.Y. No. 05-CV-5391 (JG)). Numerous other complaints containing similar allegations (in which no HSBC entity is named) were filed across the country against Visa, MasterCard and other banks. These actions principally allege that the imposition of a no-surcharge rule by the associations and/or the establishment of the interchange fee charged for credit card transactions causes the merchant discount fee paid by retailers to be set at supracompetitive levels in violation of the Federal antitrust laws. In response to motions of the plaintiffs on October 19, 2005, the Judicial Panel on Multidistrict Litigation (the "MDL Panel") issued an order consolidating these suits and transferred all of the cases to the Eastern District of New York. The consolidated case is: In re Payment Card Interchange Fee and Merchant Discount Antitrust Litigation, MDL 1720, E.D.N.Y. A consolidated, amended complaint was filed by the plaintiffs on April 24, 2006. At this time, we are unable to quantify the potential impact from this action, if any. SECURITIES LITIGATION In August 2002, we restated previously reported consolidated financial statements. The restatement related to certain MasterCard and Visa co-branding and affinity credit card relationships and a third party marketing agreement, which were entered into between 1992 and 1999. All were part of our Credit Card Services segment. In consultation with our prior auditors, Arthur Andersen LLP, we treated payments made in connection with these agreements as prepaid assets and amortized them in accordance with the underlying economics of the agreements. Our current auditor, KPMG LLP, advised us that, in its view, these payments should have either been charged against earnings at the time they were made or amortized over a shorter period of time. The restatement resulted in a $155.8 million, after-tax, retroactive reduction to retained earnings at December 31, 1998. As a result of the restatement, and other corporate events, including, e.g., the 2002 settlement with 50 states and the District of Columbia relating to real estate lending practices, HSBC Finance Corporation, and its directors, certain officers and former auditors, have been involved in various legal proceedings, some of which purport to be class actions. A number of these actions allege violations of Federal securities laws, were filed between August and October 2002, and seek to recover damages in respect of allegedly false and misleading statements about our common stock. These legal actions have been consolidated into a single purported class action, Jaffe v. Household International, Inc., et al., No. 02 C 5893 (N.D. Ill., filed August 19, 2002), and a consolidated and amended complaint was filed on March 7, 2003. On December 3, 2004, the court signed the parties' stipulation to certify a class with respect to the claims brought under sec.10 and sec.20 of the Securities Exchange Act of 1934. The parties stipulated that plaintiffs will not seek to certify a class with respect to the claims brought under sec.11 and sec.15 of the Securities Act of 1933 in this action or otherwise. The amended complaint purports to assert claims under the Federal securities laws, on behalf of all persons who purchased or otherwise acquired our securities between October 23, 1997 and October 11, 2002, arising out of alleged false and misleading statements in connection with our sales and lending practices, the 2002 state settlement agreement referred to above, the restatement and the HSBC merger. The amended complaint, which also names as defendants Arthur Andersen LLP, Goldman, Sachs & Co., and Merrill Lynch, Pierce, Fenner & Smith, Inc., fails to specify the amount of damages sought. In May 2003, we, and other defendants, filed a motion to dismiss the complaint. On March 19, 2004, the Court granted in part, and denied in part the defendants' motion to dismiss the complaint. The Court dismissed all claims against Merrill Lynch, Pierce, Fenner & Smith, Inc. and Goldman Sachs & Co. The Court also dismissed certain claims alleging strict liability for alleged misrepresentation of material facts based on statute of limitations grounds. The claims that remain against some or all of the defendants essentially allege the defendants knowingly made 57 HSBC Finance Corporation -------------------------------------------------------------------------------- a false statement of a material fact in conjunction with the purchase or sale of securities, that the plaintiffs justifiably relied on such statement, the false statement(s) caused the plaintiffs' damages, and that some or all of the defendants should be liable for those alleged statements. On February 28, 2006, the Court has also dismissed all alleged sec.10 claims that arose prior to July 30, 1999, shortening the class period by 22 months. The discovery schedule currently provides that all factual discovery must be completed by May 12, 2006 and expert witness discovery must be completed by July 24, 2006. However, we expect those deadlines to be extended. Separately, one of the defendants, Arthur Andersen, entered into a settlement of the claims against Andersen. This settlement is subject to Court approval. At this time, we are unable to quantify the potential impact from this action, if any. With respect to this securities litigation, we believe that we have not, and our officers and directors have not, committed any wrongdoing and in each instance there will be no finding of improper activities that may result in a material liability to us or any of our officers or directors. On June 27, 2003, a case entitled, West Virginia Laborers Pension Trust Fund v. Caspersen, et al, was filed in the Chancery Division of the Circuit Court of Cook County, Illinois as case number 03CH10808. This purported class action named as defendants the directors of Beneficial Corporation at the time of the 1998 merger of Beneficial Corporation into a subsidiary of HSBC Finance Corporation, and claimed that those directors' due diligence of HSBC Finance Corporation at the time they considered the merger was inadequate. The Complaint claimed that as a result of some of the securities law and other violations alleged in the Jaffe case, HSBC Finance Corporation common shares lost value. Pursuant to the merger agreement with Beneficial Corporation, we assumed the defense of this litigation. In September of 2003, the defendants filed a motion to dismiss which was granted on June 15, 2004 based upon a lack of personal jurisdiction over the defendants. The plaintiffs appealed that decision. On May 11, 2005, the appellate court affirmed the trial court's ruling. The time for any further appeals expired. In addition, on June 30, 2004, a case entitled, Employer-Teamsters Local Nos. 175 & 505 Pension Trust Fund v. Caspersen, et al, was filed in the Superior Court of New Jersey, Law Division, Somerset County as Case Number L9479-04. Other than the change in plaintiff, the suit was substantially identical to the foregoing West Virginia Laborer's Pension Trust Fund case, and was brought by the same principal law firm that brought that suit. The defendants' motion to dismiss was granted on February 10, 2005. After briefing and oral argument, on February 24, 2006 the appellate court affirmed the trial court's ruling dismissing the complaint. The time for further appeals has expired. ITEM 1A. RISK FACTORS -------------------------------------------------------------------------------- Risk factors were provided in our 2005 Form 10-K; however, the following discussion provides a more detailed description of some of the important risk factors that could affect our actual results and could cause our results to vary materially from those expressed in public statements or documents. However, other factors besides those discussed below or elsewhere in other of our reports filed or furnished with the SEC, could affect our business or results. The reader should not consider any description of such factors to be a complete set of all potential risks that may face HSBC Finance Corporation. GENERAL BUSINESS, ECONOMIC, POLITICAL AND MARKET CONDITIONS. Our business and earnings are affected by general business, economic, market and political conditions in the United States and abroad. Given the concentration of our business activities in the United States, we are particularly exposed to downturns in the United States economy. For example in a poor economic environment there is greater likelihood that more of our customers or counterparties could become delinquent on their loans or other obligations to us, which, in turn, could result in higher level of charge-offs and provision for credit losses, all of which would adversely affect our earnings. General business, economic and market conditions that could affect us include short-term and long-term interest rates, inflation, recession, monetary supply, fluctuations in both debt and equity capital markets in which we fund our operations, market value of consumer owned real estate throughout the United States, consumer perception as to the availability of credit and the ease of filing of bankruptcy. Certain changes to these conditions could diminish demand for our products and services, or increase the cost to provide such products or services. Political conditions also can impact our earnings. Acts or threats of war or 58 HSBC Finance Corporation -------------------------------------------------------------------------------- terrorism, as well as actions taken by the United States or other governments in response to such acts or threats, could affect business and economic conditions in the United States. FEDERAL AND STATE REGULATION. We operate in a highly regulated environment. Changes in federal, state and local laws and regulations affecting banking, consumer credit, bankruptcy, privacy, consumer protection or other matters could materially impact our performance. Specifically, attempts by local, state and national regulatory agencies to control alleged "predatory" or discriminatory lending practices through broad or targeted legislative or regulatory initiatives aimed at lenders operation in consumer lending markets, including non-traditional mortgage products or tax refund anticipation loans, could affect us in a substantial and unpredictable ways, including limiting the types of consumer loan products we can offer. In addition, there may be amendments to, and new interpretations of risk-based capital guidelines and reporting instructions, including changes in response to Basel II Capital Accords. We cannot determine whether such legislative or regulatory initiatives will be instituted or predict the impact of such initiatives would have on our results. CHANGES IN ACCOUNTING STANDARDS. Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time the Financial Accounting Standards Board ("FASB"), the SEC and our bank regulators, including the Office of Comptroller of the Currency and the Board of Governors of the Federal Reserve System, change the financial accounting and reporting standards that govern the preparation of external financial statements. These changes are beyond our control, can be hard to predict and could materially impact how we report our financial results and condition. We could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements in material amounts. COMPETITION. We operate in a highly competitive environment and we expect competitive conditions to continue to intensify as continued merger activity in the financial services industry produces larger, better-capitalized and more geographically-diverse companies, including lenders with access to government sponsored organizations for our consumer segment, that are capable of offering a wider array of consumer financial products and services at competitive prices. In addition, the traditional segregation of the financial services industry into prime and non-prime segments has eroded and in the future is expected to continue to do so, further increasing competition for our core customer base. Such competition may impact the terms, rates, costs and/or profits historically included in the loan products we offer or purchase. There can be no assurance that the significant and increasing competition in the financial services industry will not materially adversely affect our future results of operations. MANAGEMENT PROJECTIONS. Pursuant to U.S. GAAP, our management is required to use certain estimates in preparing our financial statements, including accounting estimates to determine loan loss reserves, reserves related to future litigation, and the fair market value of certain assets and liabilities, among other items. In particular, loan loss reserve estimates are judgmental and are influenced by factors outside our control. As result, estimates could change as economic conditions change. If our management's determined values for such items turn out to be substantially inaccurate, we may experience unexpected losses which could be material. LAWSUITS AND REGULATORY INVESTIGATIONS AND PROCEEDINGS. HSBC Finance Corporation or one of our subsidiaries is named as a defendant in various legal actions, including class actions and other litigation or disputes with third parties, as well as investigations or proceedings brought by regulatory agencies. These or other future actions brought against us may result in judgments, settlements, fines, penalties or other results, including additional compliance requirements, adverse to us which could materially adversely affect our business, financial condition or results of operation, or cause us serious reputational harm. OPERATIONAL RISKS. Our businesses are dependent on our ability to process a large number of increasingly complex transactions. If any of our financial, accounting, or other data processing systems fail or have other significant shortcomings, we could be materially adversely affected. We are similarly dependent on our employees. We could be materially adversely affected if an employee causes a significant operational break-down or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently 59 HSBC Finance Corporation -------------------------------------------------------------------------------- manipulates our operations or systems. Third parties with which we do business could also be sources of operational risk to us, including relating to break-downs or failures of such parties' own systems or employees. Any of these occurrences could result in diminished ability by us to operate one or more of our businesses, potential liability to clients, reputational damage and regulatory intervention, all of which could materially adversely affect us. We may also be subject to disruptions of our operating systems arising from events that are wholly or partially beyond our control, which may include, for example, computer viruses or electrical or telecommunications outages or natural disasters, such as Hurricane Katrina, or events arising from local or regional politics, including terrorist acts. Such disruptions may give rise to losses in service to customers, inability to collect our receivables in affected areas and other loss or liability to us. In a company as large and complex as ours, lapses or deficiencies in internal control over financial reporting are likely to occur from time to time, and there is no assurance that significant deficiencies or material weaknesses in internal controls may not occur in the future. In addition there is the risk that our controls and procedures as well as business continuity and data security systems prove to be inadequate. Any such failure could affect our operations and could materially adversely affect our results of operations by requiring us to expend significant resources to correct the defect, as well as by exposing us to litigation or losses not covered by insurance. Changes to operational practices from time to time, such as determinations to sell receivables from our domestic private label portfolio, structuring all new collateralized funding transactions as secured financings, or changes to our customer account management and risk management/collection policies and practices could materially impact our performance and results. For instance, it is unclear what impact, if any, the raising of the minimum payment on our credit card accounts which was effective in January 2006 will have. LIQUIDITY. Our liquidity is critical to our ability to operate our businesses, grow and be profitable. A compromise to our liquidity could therefore have a negative effect on us. Potential conditions that could negatively affect our liquidity include diminished access to capital markets, unforeseen cash or capital requirements, an inability to sell assets and an inability to obtain expected funding from HSBC subsidiaries and clients. Our credit ratings are an important part of maintaining our liquidity, as a reduction in our credit ratings would also negatively affect our liquidity. A credit ratings downgrade, depending on its severity, could potentially increase borrowing costs, limit access to capital markets, require cash payments or collateral posting, and permit termination of certain contracts material to us. ACQUISITION INTEGRATION. We have in the past and may in the future seek to grow our business by acquiring other businesses or loan portfolios, such as our acquisition of Metris Companies, Inc. ("Metris") in 2005. There can be no assurance that our acquisitions will have the anticipated positive results, including results relating to: the total cost of integration; the time required to complete the integration; the amount of longer-term cost savings; or the overall performance of the combined entity. Integration of an acquired business can be complex and costly, sometimes including combining relevant accounting and data processing systems and management controls, as well as managing relevant relationships with clients, suppliers and other business partners, as well as with employees. There is no assurance that our most recent acquisitions or that any businesses or portfolios acquired in the future will be successfully integrated and will result in all of the positive benefits anticipated. If we are not able to integrate successfully our past and any future acquisitions, there is the risk our results of operations could be materially and adversely affected. RISK MANAGEMENT. We seek to monitor and control our risk exposure through a variety of separate but complementary financial, credit, operational, compliance and legal reporting systems, including models and programs that predict loan delinquency and loss. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, those techniques and the judgments that accompany their 60 HSBC Finance Corporation -------------------------------------------------------------------------------- application cannot anticipate every economic and financial outcome or the specifics and timing of such outcomes. Accordingly, our ability to successfully identify and manage risks facing us is an important factor that can significantly impact our results. EMPLOYEE RETENTION. Our employees are our most important resource and, in many areas of the financial services industry, competition for qualified personnel is intense. If we were unable to continue to retain and attract qualified employees to support the various functions of our business, including the credit risk analysis, underwriting, servicing, collection and sales, our performance, including our competitive position, could be materially adversely affected. REPUTATIONAL RISK. Our ability to attract and retain customers and transact with our counterparties could be adversely affected to the extent our reputation is damaged. Our failure to address, or to appear to fail to address, various issues that could give rise to reputational risk could cause harm to us and our business prospects. These issues include, but are not limited to, appropriately addressing potential conflicts of interest, legal and regulatory requirements, ethical issues, money-laundering, privacy, record-keeping, sales and trading practices, and the proper identification of the legal, reputational, credit, liquidity and market risks inherent in our products. The failure to address appropriately these issues could make our customers unwilling to do business with us, which could adversely affect our results. 61 HSBC Finance Corporation -------------------------------------------------------------------------------- ITEM 6. EXHIBITS -------------------------------------------------------------------------------- Exhibits included in this Report: 12 Statement of Computation of Ratio of Earnings to Fixed Charges and to Combined Fixed Charges and Preferred Stock Dividends 31 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.1 Debt and Preferred Stock Securities Ratings 62 HSBC Finance Corporation -------------------------------------------------------------------------------- SIGNATURE -------------------------------------------------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HSBC FINANCE CORPORATION (Registrant) /s/ Beverley A. Sibblies -------------------------------------- Beverley A. Sibblies Senior Vice President and Chief Financial Officer Date: May 12, 2006 63 HSBC Finance Corporation -------------------------------------------------------------------------------- EXHIBIT INDEX -------------------------------------------------------------------------------- 12 Statement of Computation of Ratio of Earnings to Fixed Charges and to Combined Fixed Charges and Preferred Stock Dividends 31 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.1 Debt and Preferred Stock Securities Ratings 64 HSBC Finance Corporation -------------------------------------------------------------------------------- EXHIBIT 12 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS THREE MONTHS ENDED MARCH 31, ------------------- 2006 2005 --------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net income.................................................. $ 888 $ 626 Income tax expense.......................................... 511 341 ------ ------ Income before income tax expense............................ 1,399 967 ------ ------ Fixed charges: Interest expense.......................................... 1,623 1,062 Interest portion of rentals(1)............................ 16 15 ------ ------ Total fixed charges......................................... 1,639 1,077 ------ ------ Total earnings as defined................................... $3,038 $2,044 ====== ====== Ratio of earnings to fixed charges.......................... 1.85 1.90 Preferred stock dividends(2)................................ 14 28 Ratio of earnings to combined fixed charges and preferred stock dividends........................................... 1.84 1.85 --------------- (1) Represents one-third of rentals, which approximates the portion representing interest. (2) Preferred stock dividends are grossed up to their pretax equivalents. HSBC Finance Corporation -------------------------------------------------------------------------------- EXHIBIT 31 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION OF CHIEF EXECUTIVE OFFICER I, Siddharth N. Mehta, Chairman and Chief Executive Officer of HSBC Finance Corporation, certify that: 1. I have reviewed this report on Form 10-Q of HSBC Finance Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 12, 2006 /s/ SIDDHARTH N. MEHTA -------------------------------------- Siddharth N. Mehta Chairman and Chief Executive Officer HSBC Finance Corporation -------------------------------------------------------------------------------- CERTIFICATION OF CHIEF FINANCIAL OFFICER I, Beverley A. Sibblies, Senior Vice President and Chief Financial Officer of HSBC Finance Corporation, certify that: 1. I have reviewed this report on Form 10-Q of HSBC Finance Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 12, 2006 /s/ BEVERLEY A. SIBBLIES -------------------------------------- Beverley A. Sibblies Senior Executive Vice President and Chief Financial Officer HSBC Finance Corporation -------------------------------------------------------------------------------- EXHIBIT 32 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The certification set forth below is being submitted in connection with the HSBC Finance Corporation (the "Company") Quarterly Report on Form 10-Q for the period ending March 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report") for the purpose of complying with Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the "Exchange Act") and Section 1350 of Chapter 63 of Title 18 of the United States Code. I, Siddharth N. Mehta, Chairman and Chief Executive Officer of the Company, certify that: 1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of HSBC Finance Corporation. May 12, 2006 /s/ SIDDHARTH N. MEHTA ---------------------------------------------- Siddharth N. Mehta Chairman and Chief Executive Officer HSBC Finance Corporation -------------------------------------------------------------------------------- CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The certification set forth below is being submitted in connection with the HSBC Finance Corporation (the "Company") Quarterly Report on Form 10-Q for the period ending March 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report") for the purpose of complying with Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the "Exchange Act") and Section 1350 of Chapter 63 of Title 18 of the United States Code. I, Beverley A. Sibblies, Senior Vice President and Chief Financial Officer of the Company, certify that: 1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of HSBC Finance Corporation. May 12, 2006 /s/ BEVERLEY A. SIBBLIES ---------------------------------------------- Beverley A. Sibblies Senior Vice President and Chief Financial Officer This certification accompanies each Report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by HSBC Finance Corporation for purposes of Section 18 of the Securities Exchange Act of 1934, as amended. Signed originals of these written statements required by Section 906 of the Sarbanes-Oxley Act of 2002 have been provided to HSBC Finance Corporation and will be retained by HSBC Finance Corporation and furnished to the Securities and Exchange Commission or its staff upon request. HSBC Finance Corporation -------------------------------------------------------------------------------- EXHIBIT 99.1 DEBT AND PREFERRED STOCK SECURITIES RATINGS STANDARD & MOODY'S POOR'S INVESTORS DOMINION BOARD CORPORATION SERVICE FITCH, INC. RATING SERVICE ------------------------------------------------------------------------------------------------------- AS OF MARCH 31, 2006 HSBC Finance Corporation Senior debt.................................. A Aa3 AA- AA (low) Senior subordinated debt..................... A- A2 A+ * Commercial paper............................. A-1 P-1 F-1+ R-1 (middle) Series B preferred stock..................... BBB+ A3 A+ * HFC Bank Limited Senior debt.................................. A Aa3 AA- * Commercial paper............................. A-1 P-1 F-1+ * HSBC Bank Nevada, National Association Senior debt.................................. A A1 AA- * HSBC Financial Corporation Limited Senior notes and term loans.................. * * * AA (low) Commercial paper............................. * * * R-1 (middle) --------------- * Not rated by this agency. This information is provided by RNS The company news service from the London Stock Exchange

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