HSBC Finance Corp 2007 10K-P3
HSBC Holdings PLC
03 March 2008
PART 3
U.S. economy and attrition in our real estate secured receivables portfolio
driven by our strategy to discontinue new correspondent channel acquisitions by
our Mortgage Services business which reduced the outstanding principal balance
of the Mortgage Services loan portfolio. Our credit card portfolio also reported
an increase in the two-months-and-over contractual delinquency ratio due to the
deteriorating marketplace and broader economic conditions, a shift in mix to
higher levels of non-prime receivables, and the seasoning of a growing
portfolio. The increase in two-months-and-over contractual delinquency as a
percentage of consumer receivables in our auto finance portfolio reflects
seasoning of a growing portfolio and to a lesser extent the deterioration of
marketplace and broader economic conditions as well as a seasonal trend for
higher delinquency during the second half of the year. The decrease in our
private label portfolio (which primarily consists of our foreign private label
portfolio and domestic retail sales contracts that were not sold to HSBC Bank
USA in December 2004) reflects receivable growth in our foreign portfolios. The
increase in delinquency in our personal non-credit card portfolio ratio reflects
maturation of a growing domestic portfolio, and a deterioration of 2006 and 2007
vintages in certain geographic regions in our domestic portfolio. Dollars of
delinquency increased markedly compared to the prior quarter reflecting the
increases in delinquency in our real estate secured portfolios as discussed
above due in part to lower real estate secured run-off as market conditions have
reduced refinancing and liquidation opportunities for our customers. The
increases in dollars of delinquency in other products primarily reflect higher
bankruptcy levels and portfolio seasoning as well as deteriorating economic
conditions as well as higher levels of receivables in all products except for
personal non-credit card receivables.
Compared to December 31, 2006, our total consumer delinquency ratio increased
282 basis points largely due to higher real estate secured delinquency levels
primarily at our Mortgage Services and Consumer Lending businesses. As discussed
above, with the exception of our private label portfolio, we experienced higher
delinquency levels across all products. Our credit card portfolio reported a
marked increase in the two-months-and-over contractual delinquency ratio due to
a shift in mix to higher levels of non-prime receivables, seasoning of a growing
portfolio, higher levels of personal bankruptcy filings as compared to the
exceptionally low levels experienced in 2006 following enactment of new
bankruptcy legislation in the United States in October 2005 and the
deteriorating marketplace and broader economic conditions. The increase in auto
finance portfolio ratio reflects seasoning of a growing portfolio, receivable
growth and weakening performance of certain 2006 originations. The increase in
delinquency in our personal non-credit card portfolio ratio reflects maturation
of a growing domestic portfolio, and a deterioration of 2006 and 2007 vintages
as discussed above.
See "Customer Account Management Policies and Practices" regarding the treatment
of restructured accounts and accounts subject to forbearance and other customer
account management tools. See Note 2, "Summary of Significant Accounting
Policies," for a detail of our charge-off policy by product.
NET CHARGE-OFFS OF CONSUMER RECEIVABLES
The following table summarizes net charge-off of consumer receivables as a
percent of average consumer receivables:
2007 2006
----------------------------------------------- -----------------------------------------
------
QUARTER ENDED (ANNUALIZED) QUARTER ENDED (ANNUALIZED)
FULL --------------------------------------- FULL ---------------------------------
------
YEAR DEC. 31 SEPT. 30 JUNE 30 MAR. 31 YEAR DEC. 31 SEPT. 30 JUNE 30
MAR. 31
------------------------------------------------------------------------------------------------------------------------
------
Real estate secured(1)... 2.32% 2.96% 2.47% 2.17% 1.73% 1.00% 1.28% .98% .97%
.75%
Auto finance(2).......... 4.10 5.07 4.47 3.16 3.64 3.67 4.97 3.69 2.43
3.50
Credit card.............. 7.28 8.17 7.00 6.85 7.08 5.56 6.79 5.52 5.80
4.00
Private label............ 4.73 3.71 4.74 5.30 5.30 5.80 6.68 5.65 5.29
5.62
Personal non-credit
card(2)................ 8.48 9.13 8.84 8.22 7.73 7.89 7.92 7.77 7.92
7.94
---- ---- ---- ---- ---- ---- ---- ---- ----
----
Total consumer(2)........ 4.22% 4.96% 4.37% 3.92% 3.64% 2.97% 3.45% 2.92% 2.88%
2.58%
==== ==== ==== ==== ==== ==== ==== ==== ====
====
Real estate charge-offs
and REO expense as a
percent of average real
estate secured
receivables............ 2.68% 3.79% 2.89% 2.26% 1.86% 1.19% 1.68% 1.11% 1.04%
.89%
==== ==== ==== ==== ==== ==== ==== ==== ====
====
2005
FULL
YEAR
-------------------------------------
Real estate secured(1)... .76%
Auto finance(2).......... 3.27
Credit card.............. 7.12
Private label............ 4.83
Personal non-credit
card(2)................ 7.88
----
Total consumer(2)........ 3.03%
====
Real estate charge-offs
and REO expense as a
percent of average real
estate secured
receivables............ .87%
====
--------
(1) Real estate secured net charge-off of consumer receivables as a percent of
average consumer receivables are comprised of the following:
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2007 2006
------------------------------------------------ ------------------------------------
-----------
QUARTER ENDED (ANNUALIZED) QUARTER ENDED
(ANNUALIZED)
FULL --------------------------------------- FULL ----------------------------
-----------
YEAR DEC. 31 SEPT. 30 JUNE 30 MAR. 31 YEAR DEC. 31 SEPT. 30 JUNE 30
MAR. 31
------------------------------------------------------------------------------------------------------------------------
-----------
Mortgage Services:
First lien................. 1.60% 2.29% 1.93% 1.20% 1.17% .77% .91% .75% .73%
.67%
Second lien................ 12.15 17.42 13.90 11.82 7.97 2.38 4.40 2.11 1.72
1.15
----- ----- ----- ----- ---- ---- ---- ---- ----
----
Total Mortgage Services...... 3.77 5.30 4.36 3.32 2.55 1.12 1.66 1.06 .94
.77
Consumer Lending:
First lien................. .79 1.04 .74 .56 .80 .85 .85 .84 .98
.71
Second lien................ 3.78 4.21 3.58 5.37 1.93 1.12 1.02 1.22 1.25
1.01
----- ----- ----- ----- ---- ---- ---- ---- ----
----
Total Consumer Lending....... 1.20 1.47 1.13 1.22 .96 .89 .88 .90 1.02
.75
Foreign and all other:
First lien................. 1.05 .81 .81 1.30 1.34 .54 .89 .38 .99
.24
Second lien................ 1.35 1.23 1.39 2.23 1.29 .94 1.15 .91 .81
.63
----- ----- ----- ----- ---- ---- ---- ---- ----
----
Total Foreign and all other.. 1.28 1.13 1.25 2.03 1.30 .86 1.10 .81 .85
.56
----- ----- ----- ----- ---- ---- ---- ---- ----
----
Total real estate secured.... 2.32% 2.96% 2.47% 2.17% 1.73% 1.00% 1.28% .98% .97%
.75%
===== ===== ===== ===== ==== ==== ==== ==== ====
====
2005
FULL
YEAR
-----------------------------------------
Mortgage Services:
First lien................. .68%
Second lien................ 1.11
----
Total Mortgage Services...... .75
Consumer Lending:
First lien................. .74
Second lien................ 1.21
----
Total Consumer Lending....... .80
Foreign and all other:
First lien................. 1.04
Second lien................ .37
----
Total Foreign and all other.. .47
----
Total real estate secured.... .76%
====
(2) In December 2006, our Auto Finance business changed its charge-off policy to
provide that the principal balance of auto loans in excess of the estimated
net realizable value will be charged-off 30 days (previously 90 days) after
the financed vehicle has been repossessed if it remains unsold, unless it
becomes 150 days contractually delinquent, at which time such excess will be
charged off. This resulted in a one-time acceleration of charge-offs in
December 2006, which totaled $24 million. Excluding the impact of this
change the auto finance net charge-off ratio would have been 4.19 percent in
the quarter ended December 31, 2006 and 3.46 percent for the full year 2006.
Also in the fourth quarter of 2006, our U.K. business discontinued a
forbearance program related to unsecured loans. Under the forbearance
program, eligible delinquent accounts would not be subject to charge-off if
certain minimum payment conditions were met. The cancellation of this
program resulted in a one-time acceleration of charge-off which totaled $89
million. Excluding the impact of the change in the U.K. forbearance program,
the personal non-credit card net charge-off ratio would have been 6.23
percent in the quarter ended December 31, 2006 and 7.45 percent for the full
year 2006. Excluding the impact of both changes, the total consumer charge-
off ratio would have been 3.17 percent for the quarter ended December 31,
2006 and 2.89 percent for the full year 2006.
Net charge-offs as a percentage of average consumer receivables increased 125
basis points for the full year of 2007 as compared to the full year of 2006.
With the exception of our private label portfolio, we experienced higher charge-
off across all products, in particular our real estate secured and credit card
receivable portfolios as discussed above. The increase in our Mortgages Services
business reflects the higher delinquency levels discussed above which are
migrating to charge-off and the impact of lower average receivable levels driven
by the elimination of correspondent purchases as well as the sale of $2.7
billion of receivables during 2007. The increase in our Consumer Lending
business reflects portfolio seasoning and higher losses in second lien loans
purchased in 2004 through the third quarter of 2006. The marked increase in
delinquency in our Consumer Lending real estate secured portfolio experienced in
the second half of 2007 as a result of marketplace conditions will begin to
migrate to charge-off largely in 2008. The increase in charge-offs in the credit
card portfolio is due to a higher mix of non-prime receivables in our credit
card portfolio, portfolio seasoning, increased levels of personal bankruptcy
filings as compared to the exceptionally low levels experienced in 2006
following effectiveness of a new bankruptcy law in the United States and higher
receivable balances. The increase in the auto finance portfolio is due to
seasoning of a growing portfolio and weakened performance of certain 2006
originations. The private label charge-off ratio decreased compared to the prior
year quarter primarily due to recent receivable growth, partially offset by
portfolio seasoning. The personal non-credit card charge-off ratio increased
reflecting portfolio seasoning as well as deterioration of 2006 and 2007
vintages in certain geographic regions.
We experienced an increase in overall net charge-off dollars across all products
in 2007. Higher losses at our Mortgage Services and Consumer Lending businesses
as discussed above, as well as portfolio growth and seasoning in our credit card
and auto finance portfolios were major contributing factors to this increase.
The marked increase in delinquency in our Consumer Lending real estate secured
portfolio experienced in the second half of 2007 largely as a result of
marketplace conditions will not begin to migrate to charge-off largely until
2008.
The increase in real estate charge-offs and REO expense as a percent of average
real estate secured receivables in 2007 was primarily due to higher charge-offs
in our real estate secured portfolio as discussed above, as well as
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higher REO expense due to higher levels of owned properties and higher losses on
sales due to lower home value appreciation and in some cases home value
depreciation.
Net charge-offs as a percentage of average consumer receivables decreased 6
basis points for the full year of 2006 as compared to the full year of 2005.
Decreases in personal bankruptcy net charge-offs in our credit card portfolio
following the October 2005 bankruptcy law changes in the United States was
substantially offset by higher charge-offs in our real estate secured portfolio
and in particular at our Mortgage Services business due to the deteriorating
performance of certain loans acquired in 2005 and 2006. The increase in the auto
finance ratio for the full year 2006 reflects seasoning of the portfolio and the
one-time acceleration of charge-off totaling $24 million. The decrease in the
credit card net charge-off ratio reflects the decrease in personal bankruptcy
filings discussed above, as well as the positive impact of receivable growth and
higher recoveries in our credit card portfolio as a result of increased sales
volumes of recent and older charged-off accounts. The net charge-off ratio for
our private label receivables for the full year 2006 and 2005 reflects decreased
average receivables and the deterioration of the financial circumstances of some
of our customers in the U.K. The personal non-credit card charge-off ratio was
broadly flat with the prior year as increased charge-offs in both our domestic
and U.K. businesses were offset by recent growth in our domestic business.
Charge-offs increased in our domestic business due to seasoning of a growing
portfolio. Charge-offs in our U.K. business increased due to declining
receivables and the deterioration of the financial circumstances of some of our
customers across the U.K. as well as the one-time acceleration of charge-offs
totaling $89 million from the cancellation of a forbearance program in the U.K.
as discussed above.
We experienced an increase in overall net charge-off dollars across all products
in 2006. Higher losses at our Mortgage Services business as discussed above, as
well as portfolio growth and seasoning in our credit card and auto finance
portfolios were major contributing factors to this increase.
The increase in real estate charge-offs and REO expense as a percent of average
real estate secured receivables in 2006 was primarily due to higher charge-offs
in our real estate secured portfolio as discussed above, as well as higher REO
expense due to higher levels of owned properties and higher losses on sales due
to the slowing housing market, including an actual decline in property values in
some markets.
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NONPERFORMING ASSETS
AT DECEMBER 31, 2007 2006 2005
---------------------------------------------------------------------------------------
(IN MILLIONS)
Nonaccrual receivables(1)................................. $7,562 $4,807 $3,608
Accruing consumer receivables 90 or more days delinquent.. 1,277 930 623
------ ------ ------
Total nonperforming receivables........................... 8,839 5,737 4,231
Real estate owned......................................... 1,023 670 510
------ ------ ------
Total nonperforming assets................................ $9,862 $6,407 $4,741
====== ====== ======
--------
(1) Nonaccrual receivables are comprised of the following:
AT DECEMBER 31, 2007 2006 2005
----------------------------------------------------------------------------------------
(IN MILLIONS)
Real estate secured:
Closed-end:
First lien............................................... $3,387 $1,893 $1,366
Second lien.............................................. 901 482 247
Revolving:
First lien............................................... 20 22 31
Second lien.............................................. 349 187 63
------ ------ ------
Total real estate secured.................................. 4,657 2,584 1,707
Auto finance............................................... 483 394 323
Private label.............................................. 74 76 75
Personal non-credit card................................... 2,348 1,753 1,498
Commercial and other....................................... - - 5
------ ------ ------
Total nonaccrual receivables............................... $7,562 $4,807 $3,608
====== ====== ======
With the exception of private label receivables, all products reported higher
levels of nonperforming assets in 2007 primarily due to higher overall
delinquency levels as discussed above. Real estate secured nonaccrual loans
included stated income loans at our Mortgage Services business of $1,194 million
at December 31, 2007, $571 million at December 31, 2006, and $125 million at
December 31, 2005. Consistent with industry practice, accruing consumer
receivables 90 or more days delinquent includes domestic credit card
receivables.
CREDIT LOSS RESERVES We maintain credit loss reserves to cover probable losses
of principal, interest and fees, including late, overlimit and annual fees.
Credit loss reserves are based on a range of estimates and are intended to be
adequate but not excessive. We estimate probable losses for consumer receivables
using a roll rate migration analysis that estimates the likelihood that a loan
will progress through the various stages of delinquency, or buckets, and
ultimately charge-off based upon recent historical performance experience of
other loans in our portfolio. This analysis considers delinquency status, loss
experience and severity and takes into account whether loans are in bankruptcy,
have been restructured or rewritten, or are subject to forbearance, an external
debt management plan, hardship, modification, extension or deferment. Our credit
loss reserves also take into consideration the loss severity expected based on
the underlying collateral, if any, for the loan in the event of default.
Delinquency status may be affected by customer account management policies and
practices, such as the restructure of accounts, forbearance agreements, extended
payment plans, modification arrangements, external debt management programs,
loan rewrites and deferments. When customer account management policies or
changes thereto, shift loans from a "higher" delinquency bucket to a "lower"
delinquency bucket, this will be reflected in our roll rate statistics. To the
extent that restructured accounts have a greater propensity to roll to higher
delinquency buckets, this will be captured in the roll rates. Since the loss
reserve is computed based on the composite of all of these calculations, this
increase in roll rate will be applied to receivables in all respective
delinquency buckets, which will increase the overall reserve level. In addition,
loss reserves on consumer receivables are maintained to reflect our judgment of
portfolio risk factors that may not be fully reflected in the statistical roll
rate calculation or when historical trends
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are not reflective of current inherent losses in the portfolio. Risk factors
considered in establishing loss reserves on consumer receivables include recent
growth, product mix, unemployment rates, bankruptcy trends, geographic
concentrations, loan product features such as adjustable rate loans, economic
conditions, such as national and local trends in housing markets and interest
rates, portfolio seasoning, account management policies and practices, current
levels of charge-offs and delinquencies, changes in laws and regulations and
other items which can affect consumer payment patterns on outstanding
receivables, such as natural disasters and global pandemics.
While our credit loss reserves are available to absorb losses in the entire
portfolio, we specifically consider the credit quality and other risk factors
for each of our products. We recognize the different inherent loss
characteristics in each of our products as well as customer account management
policies and practices and risk management/collection practices. Charge-off
policies are also considered when establishing loss reserve requirements to
ensure the appropriate reserves exist for products with longer charge-off
periods. We also consider key ratios such as reserves to nonperforming loans and
reserves as a percentage of net charge-offs and months coverage ratios in
developing our loss reserve estimate. Loss reserve estimates are reviewed
periodically and adjustments are reported in earnings when they become known. As
these estimates are influenced by factors outside of our control, such as
consumer payment patterns and economic conditions, there is uncertainty inherent
in these estimates, making it reasonably possible that they could change.
The following table sets forth credit loss reserves for the periods indicated:
AT DECEMBER 31,
-------------------------------------------------
2007 2006 2005 2004 2003
-----------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Credit loss reserves....................... $10,905 $6,587 $4,521 $3,625 $3,793
Reserves as a percent of receivables....... 6.98%(3) 4.07%(3) 3.23% 3.39% 4.11%
Reserves as a percent of net charge-offs... 162.4(3) 145.8(3) 123.8(2) 89.9(1) 105.7
Reserves as a percent of nonperforming
loans.................................... 123.4 114.8 106.9 100.9 92.8
--------
(1) In December 2004, we adopted FFIEC charge-off policies for our domestic
private label (excluding retail sales contracts at our Consumer Lending
business) and credit card portfolios and subsequently sold this domestic
private label receivable portfolio. These events had a significant impact on
this ratio. Reserves as a percentage of net charge-offs excluding net
charge-offs associated with the sold domestic private label portfolio and
charge-off relating to the adoption of FFIEC was 109.2% at December 31,
2004.
(2) The acquisition of Metris in December 2005 positively impacted this ratio.
Reserves as a percentage of net charge-offs at December 31, 2005, excluding
Metris was 118.2 percent.
(3) This ratio was positively impacted in 2007 and 2006 by markedly higher
credit loss reserves at our Mortgage Services business and, in 2007, at our
Consumer Lending business.
Credit loss reserves at December 31, 2007 increased as compared to December 31,
2006 as we recorded loss provision in excess of net charge-offs of $4,310
million. The increase was primarily a result of the higher delinquency and loss
estimates in our domestic real estate secured receivable portfolio, our Consumer
Lending personal non-credit card portfolio and our domestic credit card
receivable portfolio as previously discussed. In addition, the higher credit
loss reserve levels reflect higher dollars of delinquency due to higher levels
of delinquent receivables driven by portfolio seasoning and increased levels of
personal bankruptcy filings as compared to the exceptionally low levels
experienced in 2006 following enactment of new bankruptcy legislation in the
United States in October 2005, partially offset by lower overall receivables.
Higher credit loss reserves at December 31, 2007 also reflect a higher mix of
non-prime receivables in our Credit Card Services business.
As previously discussed, we are experiencing higher delinquency and loss
estimates at our Mortgage Services and Consumer Lending businesses as compared
to the year-ago period. In establishing reserve levels, we considered the
severity of losses expected to be incurred above our historical experience given
the current housing market trends in the United States. During the second half
of 2007, unprecedented turmoil in the mortgage lending industry resulted in
reduced liquidity in the marketplace for subprime mortgages. In response,
lenders have markedly tightened underwriting standards and reduced the
availability of subprime mortgages. As fewer financing options currently exist
in the marketplace for subprime customers, properties are remaining on the
market for longer periods of time
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which contributes to home price depreciation. Therefore, it is now generally
believed that the slowdown in the housing market will be deeper in terms of its
impact on housing prices and the duration of this slowdown will extend through
2008. For some of our customers, the ability to refinance and access equity in
their homes is no longer an option as home price appreciation remains stagnant
in many markets and depreciates in others. As a result, the impact of these
industry trends on our portfolio has worsened, resulting in higher charge-off
and loss estimates in our Mortgage Services and Consumer Lending real estate
secured receivable portfolios. We have considered these factors in establishing
our credit loss reserve levels.
We also considered the ability of borrowers to repay their first lien adjustable
rate mortgage loans at potentially higher contractual reset rates given
fluctuations in interest rates since origination, as well as their ability to
repay any underlying second lien mortgage outstanding. Because first lien
adjustable rate mortgage loans are generally well secured, ultimate losses
associated with such loans are dependent to a large extent on the status of the
housing market and interest rate environment. Therefore, although it is probable
that incremental losses will occur as a result of rate resets on first lien
adjustable rate mortgage loans, such losses are estimable and, therefore,
included in our credit loss reserves only in situations where the payment has
either already reset or will reset in the near term. Additionally, a significant
portion of our second lien Mortgage Services mortgages are subordinate to a
first lien adjustable rate loan. For customers with second lien mortgage loans
that are subordinate to a first lien adjustable rate mortgage loan, the
probability of repayment of the second lien mortgage loan is significantly
reduced. The impact of future changes, if any, in the housing market will not
have a significant impact on the ultimate loss expected to be incurred since
these loans, based on history and other factors, are expected to perform like
unsecured loans.
Credit loss reserve levels at December 31, 2006 increased as compared to
December 31, 2005 as we recorded loss provision in excess of net charge-offs of
$2,045 million. A significant portion of the increase in credit loss reserves
resulted from higher delinquency and loss estimates at our Mortgage Services
business as previously discussed where we recorded provision in excess of net
charge-offs of $1,668 million. In addition, the higher credit loss reserve
levels were a result of higher levels of receivables due in part to lower
securitization levels and higher dollars of delinquency in our other businesses
driven by growth and portfolio seasoning including the Metris portfolio acquired
in December 2005. Reserve levels also increased due to weakening early stage
performance consistent with the industry trend in certain Consumer Lending real
estate secured loans originated since late 2005. These increases were partially
offset by significantly lower personal bankruptcy levels in the United States, a
reduction in the estimated loss exposure relating to Hurricane Katrina and the
benefit of stable unemployment in the United States.
Credit loss reserve levels at December 31, 2005 reflect the additional reserve
requirements resulting from higher levels of owned receivables including lower
securitization levels, higher delinquency levels in our portfolios driven by
growth and portfolio seasoning, the impact of Hurricane Katrina and minimum
monthly payment changes, additional reserves resulting from the Metris
acquisition and the higher levels of personal bankruptcy filings in both the
United States and the U.K. Credit loss reserves at December 31, 2005 also
reflect the sale of our U.K. credit card business in December 2005 which
decreased credit loss reserves by $104 million. In 2005, we recorded loss
provision greater than net charge-offs of $890 million.
In 2004, we recorded loss provision greater than net charge-offs of $301
million. Excluding the impact of adopting FFIEC charge-off policies for domestic
private label (excluding retail sales contracts at our Consumer Lending
business) and credit card portfolios, we recorded loss provision $421 million
greater than net charge-offs in 2004.
Reserves as a percentage of receivables at December 31, 2007 were higher than at
December 31, 2006 due to the impact of the additional reserve requirements
primarily in our Mortgage Services, Consumer Lending and Credit Card Services
businesses as discussed above. Reserves as a percentage of receivables at
December 31, 2006 were higher than at December 31, 2005 due to the impact of the
additional reserve requirements in our Mortgage Services business, partially
offset by lower levels of personal bankruptcy filing in the United States and a
reduction in the estimated loss exposure estimates relating to Hurricane
Katrina. Reserves as a percentage of receivables at December 31, 2005 and 2004
were lower than at December 31, 2003 as a result of portfolio growth, partially
offset in 2005 by the impact of additional credit loss reserves relating to the
impact of Hurricane Katrina, minimum monthly payment changes and increased
bankruptcy filings.
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Reserves as a percentage of nonperforming loans increased in 2007 as reserve
levels increased at a higher rate than the increase in nonperforming loans
driven by higher loss estimates in our Consumer Lending, Mortgage Services and
Credit Card Services portfolios due to the marketplace and broader economic
conditions. Reserves as a percentage of nonperforming loans increased in 2006
attributable to higher reserve levels primarily as a result of higher loss
estimates in our Mortgage Services business. Reserves as a percentage of
nonperforming loans increased in 2005. While nonperforming loans increased in
2005, reserve levels in 2005 increased at a more rapid pace due to receivable
growth, the additional reserve requirements related to Hurricane Katrina and
impact of increased bankruptcy filings on our secured receivable and personal
non-credit card receivable portfolios which did not migrate to charge-off until
2006.
Reserves as a percentage of net charge-offs were higher in 2007 as the increase
in reserve levels outpaced the increase in net charge-off during the year
primarily due to the significant increases in reserve levels in the second half
of 2007 resulting from the marketplace conditions and rising unemployment rates
as described above. Reserves as a percentage of net charge-offs increased in
2006 as compared to 2005 as reserve levels grew more rapidly than charge-offs
primarily due to the higher charge-offs expected in 2007 related to the
deterioration in certain mortgage loans acquired in 2005 and 2006. Reserves as a
percentage of net charge-offs increased in 2005. The 2005 ratio was
significantly impacted by the acquisition of Metris and the 2004 ratio was
significantly impacted by both the sale of our domestic private label receivable
portfolio (excluding retail sales contracts) in December 2004 as well as the
adoption of FFEIC charge-off policies for our domestic private label (excluding
retail sales contracts) and credit card portfolios. Excluding these items,
reserves as a percentage of net charge-offs increased 900 basis points. While
both our reserve levels at December 31, 2005 and net charge-offs in 2005 were
higher than 2004, our reserve levels grew for the reasons discussed above more
rapidly than our net charge-offs.
See the "Analysis of Credit Loss Reserves Activity," "Reconciliations to U.S.
GAAP Financial Measures" and Note 7, "Credit Loss Reserves," to the accompanying
consolidated financial statements for additional information regarding our loss
reserves.
CUSTOMER ACCOUNT MANAGEMENT POLICIES AND PRACTICES Our policies and practices
for the collection of consumer receivables, including our customer account
management policies and practices, permit us to modify the terms of loans,
either temporarily or permanently, and/or 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 restructuring 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.
In the third quarter of 2003, we implemented certain changes to our
restructuring policies. These changes were intended to eliminate and/or
streamline exception provisions to our existing policies and were generally
effective for receivables originated or acquired after January 1, 2003.
Receivables originated or acquired prior to January 1, 2003 generally are not
subject to the revised restructure and customer account management policies.
However, for ease of administration, in the third quarter of 2003, our Mortgage
Services business elected to adopt uniform policies for all products regardless
of the date an account was originated or acquired. Implementation of the uniform
policy by Mortgage Services had the effect of only counting restructures
occurring on or after January 1, 2003 in assessing restructure eligibility for
purposes of the limitation that no account may be restructured more than four
times in a rolling sixty-month period. Other business units may also elect to
adopt uniform policies. The changes adopted in the third quarter of 2003 have
not had a significant impact on our business model or on our results of
operations as these changes have generally been phased in as new receivables
were originated or acquired. As described more fully in the table below, we
adopted FFIEC account management policies regarding restructuring of past due
accounts for our domestic private label credit card and credit card portfolios
in December 2004. These changes have not had a significant impact on our
business model or on our results of operations.
Currently, approximately three-fourths of all restructured receivables are
secured products, which in general have less loss severity exposure because of
the underlying collateral. Credit loss reserves take into account whether loans
have been restructured, rewritten or are subject to forbearance, an external
debt management plan, modification,
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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.
Our restructuring policies and practices vary by product and are described in
the table that follows and reflect the revisions from the adoption of FFIEC
charge-off and account management policies for our domestic private label
(excluding retail sales contracts at our Consumer Lending business) and credit
card receivables in December 2004. The fact that the restructuring criteria may
be met for a particular account does not require us to restructure that account,
and the extent to which we restructure accounts that are eligible under the
criteria will vary depending upon our view of prevailing economic conditions and
other factors which may change from period to period. In addition, for some
products, accounts may be restructured without receipt of a payment in certain
special circumstances (e.g. upon reaffirmation of a debt owed to us in
connection with a Chapter 7 bankruptcy proceeding). We use account restructuring
as an account and customer management tool in an effort to increase the value of
our account relationships, and accordingly, the application of this tool is
subject to complexities, variations and changes from time to time. These
policies and practices are continually under review and assessment to assure
that they meet the goals outlined above, and accordingly, we modify or permit
exceptions to these general policies and practices from time to time. In
addition, exceptions to these policies and practices may be made in specific
situations in response to legal or regulatory agreements or orders.
In the policies summarized below, "hardship restructures" and "workout
restructures" refer to situations in which the payment and/or interest rate may
be modified on a temporary or permanent basis. In each case, the contractual
delinquency status is reset to current. "External debt management plans" refers
to situations in which consumers receive assistance in negotiating or scheduling
debt repayment through public or private agencies.
RESTRUCTURING POLICIES AND PRACTICES
FOLLOWING CHANGES IMPLEMENTED
HISTORICAL RESTRUCTURING POLICIES IN THE THIRD QUARTER 2003 AND IN DECEMBER
AND PRACTICES(1),(2),(3) 2004(1),(2),(3)
--------------------------------------------------------------------------------------
REAL ESTATE SECURED REAL ESTATE SECURED
Real Estate - Overall Real Estate - Overall(4)
- An account may be restructured if we - Accounts may be restructured prior
receive two qualifying payments to the end of the monthly cycle
within the 60 days preceding the following the receipt of two
restructure; we may restructure qualifying payments within 60 days
accounts in hardship, disaster or
strike situations with one - Accounts generally are not eligible
qualifying payment or no payments for restructure until nine months
after origination
- Accounts that have filed for Chapter
7 bankruptcy protection may be - Accounts will be limited to four
restructured upon receipt of a collection restructures in a rolling
signed reaffirmation agreement sixty-month period
- Accounts subject to a Chapter 13 - Accounts whose borrowers have filed
plan filed with a bankruptcy court for Chapter 7 bankruptcy protection
generally require one qualifying may be restructured upon receipt of
payment to be restructured a signed reaffirmation agreement
- Except for bankruptcy reaffirmation - Accounts whose borrowers are subject
and filed Chapter 13 plans, agreed to a Chapter 13 plan filed with a
automatic payment withdrawal or bankruptcy court generally may be
hardship/disaster/strike, accounts restructured upon receipt of one
are generally limited to one qualifying payment
restructure every twelve-months
- Except for bankruptcy reaffirmation
- Accounts generally are not eligible and filed Chapter 13 plans, accounts
for restructure until they are on will generally not be restructured
the books for at least six months more than once in a twelve-month
period
- Accounts whose borrowers agree to
pay by automatic withdrawal are
generally restructured upon receipt
of one qualifying payment after
initial authorization for automatic
withdrawal(5)
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RESTRUCTURING POLICIES AND PRACTICES
FOLLOWING CHANGES IMPLEMENTED
HISTORICAL RESTRUCTURING POLICIES IN THE THIRD QUARTER 2003 AND IN DECEMBER
AND PRACTICES(1),(2),(3) 2004(1),(2),(3)
--------------------------------------------------------------------------------------
Real Estate - Consumer Lending Real Estate - Mortgage Services(6),(7)
- Accounts whose borrowers agree to
pay by automatic withdrawal are - Accounts will generally not be
generally restructured upon receipt eligible for restructure until nine
of one qualifying payment after months after origination
initial authorization for automatic
withdrawal - Qualifying accounts may be
restructured if less than 30 days
delinquent.
AUTO FINANCE AUTO FINANCE
- Accounts may be extended if we - Accounts may generally be extended
receive one qualifying payment upon receipt of two qualifying
within the 60 days preceding the payments within the 60 days
extension preceding the extension
- Accounts may be extended no more - Accounts may be extended by no more
than three months at a time and by than three months at a time
no more than three months in any
twelve-month period - Accounts will be limited to four
extensions in a rolling sixty-month
- Extensions are limited to six months period, but in no case will an
over the contractual life account be extended more than a
total of six months over the life of
- Accounts that have filed for Chapter the account
7 bankruptcy protection may be
restructured upon receipt of a - Accounts will be limited to one
signed reaffirmation agreement extension every six months
- Accounts whose borrowers are subject - Accounts will not be eligible for
to a Chapter 13 plan may be extension until they are on the
restructured upon filing of the plan books for at least six months
with a bankruptcy court
- Accounts whose borrowers have filed
for Chapter 7 bankruptcy protection
may be restructured upon receipt of
a signed reaffirmation agreement
- Accounts whose borrowers are subject
to a Chapter 13 plan may be
restructured upon filing of the plan
with the bankruptcy court
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RESTRUCTURING POLICIES AND PRACTICES
FOLLOWING CHANGES IMPLEMENTED
HISTORICAL RESTRUCTURING POLICIES IN THE THIRD QUARTER 2003 AND IN DECEMBER
AND PRACTICES(1),(2),(3) 2004(1),(2),(3)
--------------------------------------------------------------------------------------
CREDIT CARD CREDIT CARD
- Typically, accounts qualify for Accounts originated between January
restructuring if we receive two or 2003 - December 2004
three qualifying payments prior to
the restructure, but accounts in - Accounts typically qualified for
approved external debt management restructuring if we received two or
programs may generally be three qualifying payments prior to
restructured upon receipt of one the restructure, but accounts in
qualifying payment approved external debt management
programs could generally be
- Generally, accounts may be restructured upon receipt of one
restructured once every six months qualifying payment
- Generally, accounts could have been
restructured once every six months
Beginning in December 2004, all
accounts regardless of origination
date
- Domestic accounts qualify for
restructuring if we receive three
consecutive minimum monthly payments
or a lump sum equivalent
- Domestic accounts qualify for
restructuring if the account has
been in existence for a minimum of
nine months and the account has not
been restructured in the prior
twelve months and not more than once
in the prior five years
- Domestic accounts entering third
party debt counseling programs are
limited to one restructure in a
five-year period in addition to the
general limits of one restructure in
a twelve-month period and two
restructures in a five-year period
PRIVATE LABEL(8) PRIVATE LABEL(8)
Private Label - Overall Private Label - Overall
- An account may generally be Prior to December 2004 for accounts
restructured if we receive one or originated after October 2002
more qualifying payments, depending
upon the merchant - For certain merchants, receipt of
two or three qualifying payments was
- Restructuring is limited to once required, except accounts in an
every six months (or longer, approved external debt management
depending upon the merchant) for program could be restructured upon
revolving accounts and once every receipt of one qualifying payment
twelve-months for closed-end
accounts
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RESTRUCTURING POLICIES AND PRACTICES
FOLLOWING CHANGES IMPLEMENTED
HISTORICAL RESTRUCTURING POLICIES IN THE THIRD QUARTER 2003 AND IN DECEMBER
AND PRACTICES(1),(2),(3) 2004(1),(2),(3)
--------------------------------------------------------------------------------------
Private Label - Consumer Lending Retail Private Label - Consumer Lending
Sales Contracts Retail Sales Contracts
- Accounts may be restructured if - Accounts may be restructured upon
we/receive one qualifying payment receipt of two qualifying payments
within the 60 days preceding the within the 60 days preceding the
restructure; may restructure restructure
accounts in a
hardship/disaster/strike situation - Accounts will be limited to one
with one qualifying payment or no restructure every six months
payments
- Accounts will be limited to four
- If an account is never more than 90 collection restructures in a rolling
days delinquent, it may generally be sixty-month period
restructured up to three times per
year - Accounts will not be eligible for
restructure until six months after
- If an account is ever more than 90 origination
days delinquent, generally it may be
restructured with one qualifying
payment no more than four times over
its life; however, generally the
account may thereafter be
restructured if two qualifying
payments are received
- Accounts subject to programs for
hardship or strike may require only
the receipt of reduced payments in
order to be restructured; disaster
may be restructured with no payments
PERSONAL NON-CREDIT CARD PERSONAL NON-CREDIT CARD
- Accounts may be restructured if we - Accounts may be restructured upon
receive one qualifying payment receipt of two qualifying payments
within the 60 days preceding the within the 60 days preceding the
restructure; may restructure restructure
accounts in a
hardship/disaster/strike situation - Accounts will be limited to one
with one qualifying payment or no restructure every six months
payments
- Accounts will be limited to four
- If an account is never more than 90 collection restructures in a rolling
days delinquent, it may generally be sixty-month period
restructured up to three times per
year - Accounts will not be eligible for
restructure until six months after
- If an account is ever more than 90 origination
days delinquent, generally it may be
restructured with one qualifying
payment no more than four times over
its life; however, generally the
account may thereafter be
restructured if two qualifying
payments are received
- Accounts subject to programs for
hardship or strike may require only
the receipt of reduced payments in
order to be restructured; disaster
may be restructured with no payments
--------
(1) We employ account restructuring and other customer account management
policies and practices as flexible customer account management tools as
criteria may vary by product line. In addition to variances in criteria
by product, criteria may also vary within a product line. Also, we
continually review our product lines and assess restructuring criteria
and they are subject to modification or exceptions from time to time.
Accordingly, the description of our account restructuring policies or
practices provided in this table should be taken only as general guidance
to the restructuring approach taken within each product line, and not as
assurance that accounts not meeting these criteria will never be
restructured, that every account meeting these criteria will in fact be
restructured or that these criteria will not change or that exceptions
will not be made in individual cases. In addition, in an effort to
determine optimal customer account management strategies, management may
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run more conservative tests on some or all accounts in a product line for
fixed periods of time in order to evaluate the impact of alternative
policies and practices.
(2) For our United Kingdom business, all portfolios have a consistent account
restructure policy. An account may be restructured if we receive two or
more qualifying payments within two calendar months, limited to one
restructure every 12 months, with a lifetime limit of three times. Prior
to October 1, 2007, an account in a hardship situation could be
restructured if a customer made three consecutive qualifying monthly
payments within the last three calendar months. Only one hardship
restructure is permitted in the life of a loan. After October 1, 2007
hardship restructures were discontinued. Pending hardship restructures
were processed through December 31, 2007.
(3) Historically, policy changes are not applied to the entire portfolio on
the date of implementation but are applied to new, or recently originated
or acquired accounts. However, the policies adopted in the third quarter
of 2003 for the Mortgage Services business and the fourth quarter of 2004
for the domestic private label (excluding retail sales contracts) and
credit card portfolios were applied more broadly. The policy changes for
the Mortgage Services business which occurred in the third quarter of
2003, unless otherwise noted, were generally applied to accounts
originated or acquired after January 1, 2003 and the historical
restructuring policies and practices are effective for all accounts
originated or acquired prior to January 1, 2003. Implementation of this
uniform policy had the effect of only counting restructures occurring on
or after January 1, 2003 in assessing restructure eligibility for the
purpose of the limitation that no account may be restructured more than
four times in a rolling 60 month period. These policy changes adopted in
the third quarter of 2003 did not have a significant impact on our
business model or results of operations as the changes are, in effect,
phased in as receivables were originated or acquired. For the adoption of
FFIEC policies which occurred in the fourth quarter of 2004, the policies
were effective immediately for all receivables in the domestic private
label credit card and the credit card portfolios. Other business units
may also elect to adopt uniform policies in future periods.
(4) In some cases, as part of the Consumer Lending Foreclosure Avoidance
Program implemented in 2003, accounts may be restructured on receipt of
one qualifying payment. In the fourth quarter of 2006, this treatment was
extended to accounts that qualified for the Mortgage Services account
modification plan, as long as it has been at least six months since such
account was originated, even if the account had been restructured in the
last twelve months. Such restructures may be in addition to the four
collection restructures in a rolling sixty-month period. Accounts receive
these restructures after proper verification of the customer's ability to
make continued payments. This generally includes the determination and
verification of the customer's financial situation. At December 31, 2007
and 2006 Consumer Lending had $981 million and $674 million,
respectively, of accounts restructured on receipt of one qualifying
payment under the Foreclosure Avoidance Program. At December 31, 2007 and
2006 Mortgage Services had $647 million and $134 million of accounts
restructured on receipt of one qualifying payment under the account
modification plan.
(5) Our Mortgage Services business implemented this policy for all accounts
effective March 1, 2004. Effective January 1, 2008 for real estate
overall, the program that allowed accounts whose borrowers agree to pay
by automatic withdrawal to be restructured upon receipt of one qualifying
payment after initial authorization for automatic withdrawal was
discontinued.
(6) Prior to January 1, 2003, accounts that had made at least six qualifying
payments during the life of the loan and that agreed to pay by automatic
withdrawal were generally restructured with one qualifying payment.
(7) Prior to August 2006, Mortgage Services accounts could not be
restructured until nine months after origination and six months after the
loan was acquired.
(8) For our Canadian business, private label accounts are limited to one
restructure every four months and if originated or acquired after January
1, 2003, two qualifying payments must be received, the account must be on
the books for at least six months, at least six months must have elapsed
since the last restructure, and there may be no more than four
restructures in a rolling 60 month period.
The tables below summarize approximate restructuring statistics in our managed
basis domestic portfolio. Managed basis assumes that securitized receivables
have not been sold and remain on our balance sheet. 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 the level of our securitized receivables
have fallen over time, managed basis and owned basis results have now largely
converged. 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.
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TOTAL RESTRUCTURED BY RESTRUCTURE PERIOD - DOMESTIC PORTFOLIO(1)
(MANAGED BASIS)
AT DECEMBER 31, 2007 2006
----------------------------------------------------------------------------------
Never restructured............................................... 83.6% 89.1%
Restructured:
Restructured in the last 6 months.............................. 7.3 4.8
Restructured in the last 7-12 months........................... 4.5 2.4
Previously restructured beyond 12 months....................... 4.6 3.7
----- -----
Total ever restructured........................................ 16.4 10.9
----- -----
Total............................................................ 100.0% 100.0%
===== =====
RESTRUCTURED BY PRODUCT - DOMESTIC PORTFOLIO(1)
(MANAGED BASIS)
AT DECEMBER 31, 2007 2006
------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Real estate secured(3)............................... $16,790 19.9% $10,344 11.0%
Auto finance......................................... 2,145 16.6 1,881 15.1
Credit card.......................................... 788 2.6 816 2.9
Private label........................................ 27 18.4 31 10.9
Personal non-credit card............................. 4,098 22.7 3,600 19.5
------- ---- ------- ----
Total(2)............................................. $23,848 16.4% $16,672 10.9%
======= ==== ======= ====
--------
(1) Excludes foreign businesses, commercial and other.
(2) Total including foreign businesses was 15.8 percent at December 31, 2007
and 10.6 percent at December 31, 2006.
(3) The Mortgage Services and Consumer Lending businesses real estate secured
restructures are as shown in the following table:
DECEMBER 31, DECEMBER 31,
2007 2006
-------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Mortgage Services....................................... $ 7,682 $ 3,963
Consumer Lending........................................ 9,108 6,381
------- -------
Total real estate secured............................... $16,790 $10,344
======= =======
The increase in restructured loans in 2007 was primarily attributable to higher
contractual delinquency due to weak loan performing portfolio growth and
seasoning, including our Mortgage Services and Consumer Lending businesses as we
continue to work with our customers who, in our judgment, evidence continued
payment probability. Additionally, beginning in the fourth quarter of 2006, we
expanded the use of account modification at our Mortgage Services business to
modify the rate and/or payment on a number of qualifying delinquent loans and
restructured certain of those accounts after receipt of one modified payment and
if certain other criteria were met. Such accounts are included in the above
restructure statistics. At December 31, 2007, we have approximately 6,900
accounts in our Mortgage Services real estate secured portfolio and
approximately 18,300 accounts in our Consumer Lending real estate secured
portfolio which have been restructured where the delinquency status was reset
and whose loan terms were also modified. The outstanding receivable balance of
these restructured and modified loans was $960 million in our Mortgage Services
real estate secured portfolio and $1.9 billion in our Consumer Lending real
estate secured portfolio at December 31, 2007. At December 31, 2007 and 2006 our
two-months-and-over contractual delinquency included $4.5 billion and $2.5
billion respectively of restructured
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accounts that subsequently experienced payment defaults. We anticipate this
number will continue to increase as restructure volumes increase as discussed
above.
Loans included in the table above which have been granted a permanent
modification, a twelve-month modification, or two or more consecutive six-month
modifications, are considered troubled debt restructurings for purposes of
determining loss reserve estimates under SFAS No. 114, "Accounting by Creditors
for Impairment of a Loan." For additional information related to our troubled
debt restructurings, see Note 6, "Receivables," to our accompanying consolidated
financial statements.
See "Credit Quality Statistics" for further information regarding owned basis
delinquency, charge-offs and nonperforming loans.
In addition to our restructuring policies and practices, we employ other
customer account management techniques that are similarly designed to manage
customer relationships, maximize collection opportunities and avoid foreclosure
or repossession if reasonably possible. These additional customer account
management techniques include, at our discretion, actions such as extended
payment arrangements, approved external debt management plans, forbearance,
modifications, loan rewrites and/or deferment pending a change in circumstances.
We typically use these customer account management techniques with individual
borrowers in transitional situations, usually involving borrower hardship
circumstances or temporary setbacks that are expected to affect the borrower's
ability to pay the contractually specified amount for some period of time. For
example, under a forbearance agreement, we may agree not to take certain
collection or credit agency reporting actions with respect to missed payments,
often in return for the borrower's agreeing to pay us an additional amount with
future required payments. In some cases, these additional customer account
management techniques may involve us agreeing to lower the contractual payment
amount and/or reduce the periodic interest rate. In most cases, the delinquency
status of an account is considered to be current if the borrower immediately
begins payment under the new account terms. We are actively using loan
modifications followed by an account restructure if the borrower makes one or
more modified payments in response to increased volumes within our delinquent
Mortgage Services portfolio. This account management practice is designed to
assist borrowers who may have purchased a home with an expectation of continued
real estate appreciation or income that has proven unfounded.
The amount of domestic and foreign managed receivables in forbearance,
modification, rewrites, modifications 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 $.3 billion or .2
percent of managed receivables at December 31, 2007 and 2006.
When we use a customer account management technique, we may treat the account as
being contractually current and will not reflect it as a delinquent account in
our delinquency statistics. However, if the account subsequently experiences
payment defaults, it will again become contractually delinquent. We generally
consider loan rewrites to involve an extension of a new loan, and such new loans
are not reflected in our delinquency or restructuring statistics. Our account
management actions vary by product and are under continual review and assessment
to determine that they meet the goals outlined above.
As part of our risk mitigation efforts relating to the affected components of
the Mortgage Services portfolio, in October 2006 we established a new program
specifically designed to meet the needs of select customers with ARMs. We are
proactively writing and calling customers who have adjustable rate mortgage
loans nearing the first reset that we expect will be the most impacted by a rate
adjustment. Through a variety of means, we assess their ability to make the
adjusted payment and, as appropriate and in accordance with defined policies, we
modify the loans, allowing time for the customer to seek alternative financing
or improve their individual situation. These loan modifications primarily
involve a twelve-month temporary interest rate relief by either maintaining the
current interest rate for the entire twelve-month period or resetting the
interest rate for the twelve-month period to a rate lower than originally
required at the first reset date. At the end of the twelve-month period, the
interest rate on the loan will reset in accordance with the original loan terms
unless the borrower qualifies for and is granted a new modification. In 2007, we
have made more than 33,000 outbound contacts and modified more than 8,500 loans
with an aggregate balance of $1.4 billion. Since the inception of this program
we have made more than 41,000 outbound
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contacts and modified more than 10,300 loans with an aggregate balance of $1.6
billion. These loans are not included in the table above, as we have not reset
delinquency on these loans as they were not contractually delinquent at the time
of the modification. However, if the loan had been restructured in the past for
other reasons, it is included in the table above. We also continue to manage a
Foreclosure Avoidance Program for delinquent Consumer Lending customers designed
to provide relief to qualifying homeowners through either loan restructuring or
modification. We also support a variety of national and local efforts in
homeownership preservation and foreclosure avoidance.
GEOGRAPHIC CONCENTRATIONS The following table reflects the percentage of
domestic consumer receivables by state which individually account for 5 percent
or greater of our domestic portfolio.
PERCENT OF TOTAL
DOMESTIC
STATE RECEIVABLES
------------------------------------------------------------------------------------
California........................................................ 12%
Florida........................................................... 7
New York.......................................................... 6
Ohio.............................................................. 5
Pennsylvania...................................................... 5
Texas............................................................. 5
Because of our centralized underwriting, collections and processing functions,
we can quickly change our credit standards and intensify collection efforts in
specific locations. We believe this lowers risks resulting from such geographic
concentrations.
Our foreign consumer operations located in the United Kingdom and the Republic
of Ireland accounted for 3 percent of consumer receivables and Canada accounted
for 3 percent of consumer receivables at December 31, 2007.
LIQUIDITY AND CAPITAL RESOURCES
--------------------------------------------------------------------------------
While the funding synergies resulting from our acquisition by HSBC have allowed
us to reduce our reliance on traditional sources to fund our asset levels, our
continued success is dependent upon access to the global capital markets.
Numerous factors, internal and external, may impact our access to and the costs
associated with issuing debt in these markets. These factors may include our
debt ratings, overall capital markets volatility and the impact of overall
economic conditions on our business. We continue to focus on balancing our use
of affiliate and third-party funding sources to minimize funding expense while
maximizing liquidity. As discussed below, we supplemented unsecured debt
issuance during 2007 and 2006 with proceeds from the continuing sale of newly
originated domestic private label receivables (excluding retail sales contracts)
to HSBC Bank USA, debt issued to affiliates, the issuance of additional common
equity to HINO and, in 2007, the sale of $2.7 billion of loans from our Mortgage
Services loan portfolio.
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Debt due to affiliates and other HSBC related funding are summarized in the
following table:
DECEMBER 31, 2007 2006
----------------------------------------------------------------------------------
(IN BILLIONS)
Debt outstanding to HSBC subsidiaries:
Drawings on bank lines in the U.K. and Europe.................. $ 3.5 $ 4.3
Term debt...................................................... 11.1 10.6
Preferred securities issued by Household Capital Trust VIII to
HSBC........................................................ .3 .3
----- -----
Total debt outstanding to HSBC subsidiaries.................... 14.9 15.2
----- -----
Debt outstanding to HSBC clients:
Euro commercial paper.......................................... 2.0 3.0
Term debt...................................................... .8 1.2
----- -----
Total debt outstanding to HSBC clients......................... 2.8 4.2
Cash received on bulk and subsequent sale of domestic private
label credit card receivables to HSBC Bank USA, net
(cumulative)................................................... 19.2 17.9
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......................................................... (5.4) (4.7)
----- -----
Total real estate secured receivable activity with HSBC Bank
USA............................................................ 2.5 3.2
Cash received from sale of European Operations to HBEU
affiliate...................................................... -((2)) -(2)
Cash received from sale of U.K. credit card business to HBEU..... 2.7 2.7
Capital contribution by HINO..................................... 2.4(1) 1.4(1)
----- -----
Total HSBC related funding....................................... $44.5 $44.6
===== =====
--------
(1) Capital contributions were made in 2007 to support ongoing operations and
in 2006 in connection with our acquisition of the Champion portfolio.
(2) Less than $100 million.
At December 31, 2007 and 2006, funding from HSBC, including debt issuances to
HSBC subsidiaries and clients, represented 13 percent of our total debt and
preferred stock funding.
Cash proceeds of $2.7 billion during 2007 from the sale of loans from our
Mortgage Services loan portfolio and $206 million from the November 2007 sale of
the U.K. Insurance Operations were used to partially pay down drawings on bank
lines from HBEU for the U.K. Cash proceeds of $46 million from the November 2006
sale of the European Operations and $2.7 billion from the December 2005 sale of
our U.K. credit card receivables to HBEU were used to partially pay down
drawings on bank lines from HBEU for the U.K. Proceeds received from the bulk
sale and subsequent daily sales of domestic private label credit card
receivables to HSBC Bank USA of $19.2 billion were used to pay down short-term
domestic borrowings, including outstanding commercial paper balances. Proceeds
from each of these transactions were also used to fund ongoing operations.
At December 31, 2007 and 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 $5.7 billion from HBEU to fund our operations in the U.K. In
January 2008, the revolving credit facility from HBEU decreased to $4.5 billion.
At December 31, 2007, $3.5 billion was outstanding under the HBEU lines for the
U.K. and no balances were outstanding under the domestic lines. At December 31,
2006, $4.3 billion was outstanding under the HBEU lines for the U.K. and no
balances were outstanding under the domestic lines. We had derivative contracts
with a notional value of $91.8 billion, or approximately 97 percent of total
derivative contracts, outstanding with HSBC affiliates at
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December 31, 2007. We had derivative contracts with a notional value of $87.4
billion, or approximately 93 percent of total derivative contracts, outstanding
with HSBC affiliates at December 31, 2006.
SECURITIES AND OTHER SHORT-TERM INVESTMENTS Securities totaled $3.2 billion at
December 31, 2007 and $4.7 billion at December 31, 2006. Securities purchased
under agreements to resell totaled $1.5 billion at December 31, 2007 and $171
million at December 31, 2006. Interest bearing deposits with banks totaled $335
million at December 31, 2007 and $424 million at December 31, 2006. The decrease
in securities and interest bearing deposits with banks is due to the sale of the
U.K. Insurance Operations which had securities and interest bearing deposits
with banks of $441 million at the time of the sale as well as the use of money
market funds of $854 million at December 31, 2006 to pay down secured financings
during 2007. The increase in securities purchased under agreements to resell is
due to the decision to generate additional liquidity based on current market
conditions.
COMMERCIAL PAPER, BANK AND OTHER BORROWINGS totaled $8.4 billion at December 31,
2007 and $11.1 billion at December 31, 2006. Included in this total was
outstanding Euro commercial paper sold to customers of HSBC of $2.0 billion at
December 31, 2007 and $3.0 billion at December 31, 2006. Commercial paper
balances were lower at December 31, 2007 as a result of lower short term funding
requirements due to a reduction in the overall size of the balance sheet. Our
funding strategy requires that committed bank credit facilities will at all
times exceed 80 percent of outstanding commercial paper and that the combination
of bank credit facilities and undrawn committed conduit facilities will, at all
times, exceed 115 percent of outstanding commercial paper.
LONG TERM DEBT (with original maturities over one year) decreased to $123.3
billion at December 31, 2007 from $127.6 billion at December 31, 2006.
Significant issuances during 2007 included the following:
- $.4 billion of domestic and foreign medium-term notes
- $2.4 billion of foreign currency-denominated bonds
- $1.2 billion of InterNotes(SM) (retail-oriented medium-term notes)
- $4.0 billion of global debt
- $10.4 billion of securities backed by real estate secured, auto finance,
credit card and personal non-credit card 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. In the fourth quarter of 2006 we redeemed the junior subordinated
notes, issued to Household Capital Trust VII with an outstanding principal
balance of $206 million.
PREFERRED SHARES In June 2005, we issued 575,000 shares of Series B Preferred
Stock for $575 million. Dividends on the Series B Preferred Stock are non-
cumulative and payable quarterly at a rate of 6.36 percent commencing September
15, 2005. The Series B Preferred Stock may be redeemed at our option after June
23, 2010. In 2007 and 2006, we paid dividends each year totaling $37 million on
the Series B Preferred Stock.
COMMON EQUITY In the first quarter of 2007, HINO made a capital contribution of
$200 million and in the fourth quarter of 2007 made an additional capital
contribution of $750 million, each in exchange for one share of common stock.
These capital contributions were to support ongoing operations and to maintain
capital at levels we believe are prudent in the current market conditions. In
2006, in connection with our purchase of the Champion portfolio, HINO made a
capital contribution of $163 million. Subsequent to December 31, 2007, HINO made
a capital contribution of $1.6 billion in exchange for one share of common
stock.
SELECTED CAPITAL RATIOS In managing capital, we develop targets for tangible
shareholder's(s') equity plus owned loss reserves to tangible managed assets
("TETMA + Owned Reserves") and tangible common equity to tangible managed assets
excluding HSBC acquisition purchase accounting adjustments. These ratio targets
are based on discussions with HSBC and rating agencies, risks inherent in the
portfolio, the projected operating environment and related risks, and any
acquisition objectives. We and certain rating agencies monitor ratios excluding
the impact of the HSBC acquisition purchase accounting adjustments as we believe
that they represent non-cash transactions which do not affect our business
operations, cash flows or ability to meet our debt obligations. These ratios
also exclude the equity impact of SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities,"
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the equity impact of SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," and the impact of the adoption of SFAS No. 159, "The Fair
Value Option for Financial Assets and Liabilities," including the subsequent
changes in fair value recognized in earnings associated with debt for which we
elected the fair value option and the related derivatives. Preferred securities
issued by certain non-consolidated trusts are also considered equity in the
TETMA + Owned Reserves calculations because of their long-term subordinated
nature and our ability to defer dividends. Managed assets include owned assets
plus loans which we have sold and service with limited recourse. Our targets may
change from time to time to accommodate changes in the operating environment or
other considerations such as those listed above. In the fourth quarter of 2007,
Moody's, Standard & Poor's and Fitch changed the total outlook on our issuer
default rating from "positive" to "stable."
Selected capital ratios are summarized in the following table:
DECEMBER 31, 2007 2006
----------------------------------------------------------------------------------
TETMA + Owned Reserves(1),(2).................................... 13.98% 11.02%
Tangible common equity to tangible managed assets(1)............. 6.09 6.08
Common and preferred equity to owned assets...................... 8.56 11.21
Excluding HSBC acquisition purchase accounting adjustments:
TETMA + Owned Reserves(1),..................................... 14.18 11.67
Tangible common equity to tangible managed assets(1),(2)....... 6.27 6.72
--------
(1) TETMA + Owned Reserves and tangible common equity to tangible managed
assets excluding HSBC acquisition purchase accounting adjustments
represent non-U.S. GAAP financial ratios that are used by HSBC Finance
Corporation management and applicable 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-U.S. GAAP financial measures and "Reconciliations to U.S. GAAP
Financial Measures" for quantitative reconciliations to the equivalent
U.S. GAAP basis financial measure.
(2) On a proforma basis, if the capital contribution on February 12, 2008 of
$1.6 billion had instead been received on December 31, 2007, our TETMA +
Owned Reserves ratio would have been 99 basis points higher and our
tangible common equity to tangible managed assets ratio, excluding HSBC
acquisition purchase accounting adjustments would have been 99 basis
points higher.
HSBC FINANCE CORPORATION. HSBC Finance Corporation is an indirect wholly owned
subsidiary of HSBC Holdings plc. On March 28, 2003, HSBC acquired Household
International, Inc. by way of merger in a purchase business combination.
Effective January 1, 2004, HSBC transferred its ownership interest in Household
to a wholly owned subsidiary, HSBC North America Holdings Inc., which
subsequently contributed Household to its wholly owned subsidiary, HINO. On
December 15, 2004, Household merged with its wholly owned subsidiary, Household
Finance Corporation, with Household as the surviving entity. At the time of the
merger, Household changed its name to "HSBC Finance Corporation."
HSBC Finance Corporation is the parent company that owns the outstanding common
stock of its subsidiaries. Our main source of funds is cash received from
operations and subsidiaries in the form of dividends. In addition, we receive
cash from third parties and affiliates by issuing preferred stock and debt.
HSBC Finance Corporation received cash dividends from its subsidiaries of $169
million in 2007 and $74 million in 2006.
In conjunction with the acquisition by HSBC, we issued a series of 6.50 percent
cumulative preferred stock in the amount of $1.1 billion ("Series A Preferred
Stock") to HSBC on March 28, 2003. In September 2004, HSBC North America issued
a new series of preferred stock totaling $1.1 billion to HSBC in exchange for
our Series A Preferred Stock. In October 2004, our immediate parent, HINO,
issued a new series of preferred stock to HSBC North America in exchange for our
Series A Preferred Stock. On December 15, 2005, we issued 4 shares of common
stock to HINO in exchange for the $1.1 billion Series A Preferred Stock plus the
accrued and unpaid dividends and the Series A Preferred Stock was retired.
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In November 2005, we issued $1.0 billion of preferred securities of Household
Capital Trust IX. The interest rate on these securities is 5.911% from the date
of issuance through November 30, 2015 and is payable semiannually beginning May
30, 2006. After November 30, 2015, the rate changes to the three-month LIBOR
rate, plus 1.926% and is payable quarterly beginning on February 28, 2016. In
June 2005, we redeemed the junior subordinated notes issued to the Household
Capital Trust V with an outstanding principal balance of $309 million.
In June 2005, we issued 575,000 shares of Series B Preferred Stock for $575
million. Dividends on the Series B Preferred Stock are non-cumulative and
payable quarterly at a rate of 6.36 percent commencing September 15, 2005. The
Series B Preferred Stock may be redeemed at our option after June 23, 2010. In
2007 and 2006, we paid dividends each year totaling $37 million on the Series B
Preferred Stock.
HSBC Finance Corporation has a number of obligations to meet with its available
cash. It must be able to service its debt and meet the capital needs of its
subsidiaries. It also must pay dividends on its preferred stock and may pay
dividends on its common stock. Dividends of $812 million were paid to HINO, our
immediate parent company, on our common stock in 2007 and $809 million were paid
in 2006. We anticipate paying future dividends to HINO, but will maintain our
capital at levels that we perceive to be consistent with our current ratings
either by limiting the dividends to or through capital contributions from our
parent.
At various times, we will make capital contributions to our subsidiaries to
comply with regulatory guidance, support receivable growth, maintain acceptable
investment grade ratings at the subsidiary level, or provide funding for long-
term facilities and technology improvements. HSBC Finance Corporation made
capital contributions to certain subsidiaries of $.5 billion in 2007 and $1.5
billion in 2006.
SUBSIDIARIES At December 31, 2007, HSBC Finance Corporation had one major
subsidiary, Household Global Funding ("Global Funding") which holds all
international operations. Prior to December 15, 2004, we had two major
subsidiaries: Household Finance Corporation ("HFC"), which managed all domestic
operations, and Global Funding. On December 15, 2004, HFC merged with and into
Household International which changed its name to HSBC Finance Corporation.
DOMESTIC OPERATIONS HSBC Finance Corporation manages all domestic operations
directly and funds these businesses primarily through the collection of
receivable balances; issuing commercial paper, medium-term debt and long-term
debt; borrowing under secured financing facilities and selling consumer
receivables. Domestically, HSBC Finance Corporation markets its commercial paper
primarily through an in-house sales force. The vast majority of our domestic
medium-term notes and long-term debt is now marketed through subsidiaries of
HSBC. Intermediate and long-term debt may also be marketed through unaffiliated
investment banks.
At December 31, 2007, advances from subsidiaries of HSBC for our domestic
operations totaled $11.1 billion. At December 31, 2006, advances from
subsidiaries of HSBC for our domestic operations totaled $10.6 billion. The
interest rates on funding from HSBC subsidiaries are market-based and comparable
to those available from unaffiliated parties.
Outstanding commercial paper related to our domestic operations totaled $7.8
billion at December 31, 2007 and $10.8 billion at December 31, 2006.
Following our acquisition by HSBC, we established a new Euro commercial paper
program, largely targeted towards HSBC clients, which expanded our European
investor base. Under the Euro commercial paper program, commercial paper
denominated in Euros, British pounds, Swiss francs and U.S. dollars is sold to
foreign investors. Outstanding Euro commercial paper sold to customers of HSBC
totaled $2.0 billion at December 31, 2007 and $3.0 billion at December 31, 2006.
The decrease in Euro commercial paper outstanding was due to a cost differential
that made domestic commercial paper a more cost efficient source of funding. We
actively manage the level of commercial paper outstanding to ensure availability
to core investors while maintaining excess capacity within our internally-
established targets as communicated with the rating agencies.
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The following table shows various debt issuances by HSBC Finance Corporation and
its domestic subsidiaries during 2007 and 2006.
2007 2006
--------------------------------------------------------------------------------
(IN BILLIONS)
Medium term notes, excluding issuances to HSBC customers and
subsidiaries of HSBC........................................... $ - $ 6.0
Medium term notes issued to subsidiaries of HSBC................. 1.1 .8
Foreign currency-denominated bonds, excluding issuances to HSBC
customers and subsidiaries of HSBC............................. 2.4 7.9
Global debt...................................................... 4.0 9.3
InterNotes(SM) (retail-oriented medium-term notes)............... 1.2 1.8
Securities backed by real estate secured, auto finance, credit
card and personal non-credit card receivables structured as
secured financings............................................. 10.4 14.9
In order to eliminate future foreign exchange risk, currency swaps were used at
the time of issuance to fix in U.S. dollars substantially all foreign-
denominated notes in 2007 and 2006.
HSBC Finance Corporation issued securities backed by dedicated receivables of
$10.4 billion in 2007 and $14.9 billion in 2006. For accounting purposes, these
transactions were structured as secured financings, therefore, the receivables
and the related debt remain on our balance sheet. At December 31, 2007, closed-
end real estate secured, auto finance, credit card and personal non-credit card
receivables totaling $30.9 billion secured $23.2 billion of outstanding debt. At
December 31, 2006, closed-end real estate secured, auto finance, credit card and
personal non-credit card receivables totaling $28.1 billion secured $21.8
billion of outstanding debt.
HSBC Finance Corporation had committed back-up lines of credit totaling $11.7
billion at December 31, 2007 for its domestic operations. Included in the
December 31, 2007 total are $2.5 billion of revolving credit facilities with
HSBC. None of these back-up lines were drawn upon in 2007. The back-up lines
expire on various dates through 2010. The most restrictive financial covenant
contained in the back-up line agreements that could restrict availability is an
obligation to maintain a minimum shareholder's(s') equity plus the outstanding
trust preferred stock of $11.0 billion. At December 31, 2007, minimum
shareholder's(s') equity balance plus outstanding trust preferred stock was
$15.4 billion which is substantially above the required minimum balance. In
2008, $2.9 billion of back-up lines from third parties are scheduled to expire.
Due to the condition of the subprime credit markets, we anticipate a portion of
these lines will not be renewed. We do not expect this reduction will have a
significant impact on the availability of short term funding.
At December 31, 2007, we had conduit credit facilities with commercial and
investment banks under which our domestic operations may issue securities backed
with up to $17.4 billion of receivables, including up to $14.2 billion of auto
finance, credit card and personal non-credit card and $3.2 billion of real
estate secured receivables. Our total conduit capacity decreased by $1.6 billion
in 2007. Conduit capacity for real estate secured receivables was decreased $.7
billion and capacity for other products was decreased $.9 billion. These
reductions are primarily the result of decisions by the providing institutions
to reduce their overall exposure to subprime receivables. The facilities are
renewable at the banks' option. At December 31, 2007, $11.2 billion of auto
finance, credit card, personal non-credit card and real estate secured
receivables were used in collateralized funding transactions structured either
as securitizations or secured financings under these funding programs. The
amount available under the facilities will vary based on the timing and volume
of public securitization transactions. We also anticipate a reduction in the
available conduit credit facilities as they mature throughout 2008 due to
continuing concerns about subprime credit quality. For the conduit credit
facilities that do renew, credit performance requirements will be more
restrictive and pricing will increase to reflect the quality of the underlying
assets. Our 2008 funding plan incorporates the anticipated reductions in these
facilities.
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GLOBAL FUNDING Global Funding includes our foreign subsidiaries in the United
Kingdom, the Republic of Ireland and Canada. Global Funding's assets were $10.8
billion at December 31, 2007 and $10.9 billion at December 31, 2006.
Consolidated shareholder's equity includes the effect of translating our foreign
subsidiaries' assets, liabilities and operating results from their local
currency into U.S. dollars.
Each foreign subsidiary conducts its operations using its local currency. While
each foreign subsidiary usually borrows funds in its local currency, both our
United Kingdom and Canadian subsidiaries have historically borrowed funds in
foreign currencies. This allowed the subsidiaries to achieve a lower cost of
funds than that available at that time in their local markets. These borrowings
were converted from foreign currencies to their local currencies using currency
swaps at the time of issuance.
UNITED KINGDOM Our United Kingdom operation is funded with HBEU debt and
previously issued long-term debt. The following table summarizes the funding of
our United Kingdom operation:
2007 2006
--------------------------------------------------------------------------------
(IN
BILLIONS)
Due to HSBC affiliates............................................. $3.5 $4.3
Long term debt..................................................... .2 .2
At December 31, 2007, $.2 billion of long term debt was guaranteed by HSBC
Finance Corporation. HSBC Finance Corporation receives a fee for providing the
guarantee. In 2007 and 2006, our United Kingdom subsidiary primarily received
its funding directly from HSBC.
As previously discussed, in November 2007, we sold our U.K. Insurance Operations
to Aviva for approximately $206 million and used the proceeds to partially pay
down amounts due to HBEU on bank lines in the U.K. Additionally, in November
2006, our U.K. operations sold its European Operations to a subsidiary of HBEU
for total consideration of $46 million and used the proceeds to partially pay
down amounts due to HBEU on bank lines in the U.K.
CANADA Our Canadian operation is funded with commercial paper, intermediate and
long-term debt. Outstanding commercial paper totaled $673 million at December
31, 2007 compared to $223 million at December 31, 2006. Given disruptions in the
Canadian debt markets in the second half of 2007, we elected to increase the
level of funding generated through commercial paper issuance. We anticipate
reducing the level of Canadian commercial paper outstanding over the first half
of 2008. Intermediate and long-term debt totaled $4.1 billion at December 31,
2007 compared to $3.4 billion at December 31, 2006. At December 31, 2007, $4.8
billion of the Canadian subsidiary's debt was guaranteed by HSBC Finance
Corporation for which it receives a fee for providing the guarantee. Committed
back-up lines of credit for Canada were approximately $102 million at December
31, 2007. All of these back-up lines are guaranteed by HSBC Finance Corporation
and none were used in 2007. In 2007, our Canadian operations declared a dividend
of $51 million to be paid to HSBC Finance Corporation in 2008.
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2008 FUNDING STRATEGY As discussed previously, the acquisition by HSBC markedly
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 2008 are summarized in the table that follows.
(IN BILLIONS)
------------------------------------------------------------------------------------
FUNDING NEEDS:
Net asset growth/(attrition)..................................... (18) - (10)
Commercial paper and term debt maturities........................ 26 - 28
Secured financings and conduit facility maturities............... 12 - 16
Other............................................................ (1) - 3
-----------
Total funding needs................................................ $19 - 37
===========
FUNDING SOURCES:
Commercial paper and term debt issuance.......................... 7 - 19
Secured financings and conduit facility renewals................. 12 - 16
HSBC and HSBC subsidiaries....................................... 0 - 2
-----------
Total funding sources.............................................. $19 - 37
===========
As previously discussed, we have experienced deterioration in the performance of
mortgage loan originations in our Mortgage Services and Consumer Lending
businesses. As a result in 2007, we decided to discontinue new correspondent
channel acquisitions and cease operations of Decision One. Additionally, we have
eliminated certain product offerings and tightened underwriting criteria in our
Consumer Lending business. These actions, combined with normal portfolio
attrition and risk mitigation efforts, will result in a continued reduction in
our aggregate portfolio in 2008. As opportunities arise, we may also consider
the possibility of selling selected portfolios, similar to the $2.7 billion
sales of real estate secured receivables completed in 2007. Constrained risk
appetite as well as any decisions to sell selected portfolios will result in
attrition in the balance sheet during 2008.
Commercial paper outstanding in 2008 is expected to be lower than 2007 balances,
except during the first three months of 2008 when commercial paper balances will
be temporarily high due to the seasonal activity of our TFS business. The
majority of outstanding commercial paper is expected to be directly placed,
domestic commercial paper. Euro commercial paper will continue to be marketed
predominately to HSBC clients.
Term debt issuances are expected to utilize several ongoing programs to achieve
the desired funding in 2008. Approximately 79 percent of term debt funding is
expected to be achieved through transactions including U.S. dollar global and
Euro transactions and large medium-term note ("MTN") offerings. Domestic retail
note programs are expected to account for approximately 11 percent of term debt
issuances. The remaining term debt issuances are expected to consist of smaller
domestic and foreign currency MTN offerings.
HSBC received regulatory approval in 2003 to provide the direct funding required
by our United Kingdom operations. Accordingly, in 2004 we eliminated all back-up
lines of credit which had previously supported our United Kingdom subsidiary.
All new funding for our United Kingdom subsidiary is now provided directly by
HSBC. Our Canadian operation will continue to fund itself independently through
traditional third-party funding sources such as commercial paper and medium
term-notes. Canadian funding needs in 2008 are expected to be in line with 2007
levels.
CAPITAL EXPENDITURES We made capital expenditures of $135 million in 2007 which
included costs related to the new office building in the Village of Mettawa,
Illinois of $89 million. Capital expenditures in 2006 were $102 million which
included costs related to the new office building in the Village of Mettawa,
Illinois of $29 million.
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COMMITMENTS We also enter into commitments to meet the financing needs of our
customers. In most cases, we have the ability to reduce or eliminate these open
lines of credit. As a result, the amounts below do not necessarily represent
future cash requirements at December 31, 2007:
(IN BILLIONS)
-----------------------------------------------------------------------------------
Private label, and credit cards..................................... 162
Other consumer lines of credit...................................... 9
----
Open lines of credit(1)............................................. $171
====
--------
(1) Includes an estimate for acceptance of credit offers mailed to potential
customers prior to December 31, 2007.
In January 2008, we extended a line of credit to H&R Block for up to $3.0
billion to fund the purchase of a participation interest in refund anticipation
loans. This available credit outstanding under this line will step down to $120
million as of March 30, 2008 and expires on June 30, 2008. Additionally, in the
event the balance outstanding under this line of credit falls below $60 million,
the line of credit may be terminated earlier.
CONTRACTUAL CASH OBLIGATIONS The following table summarizes our long-term
contractual cash obligations at December 31, 2007 by period due:
2008 2009 2010 2011 2012 THEREAFTER TOTAL
------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
PRINCIPAL BALANCE OF DEBT:
Due to affiliates.......... $ 3,543 $ 2,031 $ 1,551 $ 619 $ 1,250 $ 5,908 $ 14,902
Long term debt (including
secured financings)..... 32,844 23,821 15,773 12,808 11,443 26,759 123,448
------- ------- ------- ------- ------- ------- --------
Total debt................. 36,387 25,852 17,324 13,427 12,693 32,667 138,350
------- ------- ------- ------- ------- ------- --------
OPERATING LEASES:
Minimum rental payments.... 161 127 94 61 34 107 584
Minimum sublease income.... 37 27 15 5 2 - 86
------- ------- ------- ------- ------- ------- --------
Total operating leases..... 124 100 79 56 32 107 498
------- ------- ------- ------- ------- ------- --------
OBLIGATIONS UNDER MERCHANT
AND AFFINITY PROGRAMS...... 139 126 124 119 117 339 964
NON-QUALIFIED PENSION AND
POSTRETIREMENT BENEFIT
LIABILITIES(1)............. 31 27 36 36 40 993 1,163
------- ------- ------- ------- ------- ------- --------
TOTAL CONTRACTUAL CASH
OBLIGATIONS................ $36,681 $26,105 $17,563 $13,638 $12,882 $34,106 $140,975
======= ======= ======= ======= ======= ======= ========
--------
(1) Expected benefit payments calculated include future service component.
These cash obligations could be funded primarily through cash collections on
receivables, from the issuance of new unsecured debt or through secured
financings of receivables. Our receivables and other liquid assets generally
have shorter lives than the liabilities used to fund them.
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In January 2006, we entered into a lease for a building in the Village of
Mettawa, Illinois. The new facility will consolidate our Prospect Heights, Mount
Prospect and Deerfield offices. Construction of the building began in the spring
of 2006 and the relocation is planned for the first and second quarters of 2008.
The future lease payments for this building are currently estimated as follows:
(IN MILLIONS)
-----------------------------------------------------------------------------------
2008................................................................ $ 5
2009................................................................ 11
2010................................................................ 11
2011................................................................ 11
Thereafter.......................................................... 115
----
$153
====
Our purchase obligations for goods and services at December 31, 2007 were not
significant.
OFF BALANCE SHEET ARRANGEMENTS AND SECURED FINANCINGS
--------------------------------------------------------------------------------
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 and can be more cost-effective sources of alternative
funds.
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.
Certain securitization trusts, such as credit cards, are established at fixed
levels and, due to the revolving nature of the underlying receivables, require
the sale of new receivables into the trust to replace runoff so that the
principal dollar amount of the investors' interest remains unchanged. We refer
to such activity as replenishments. Once the revolving period ends, the
amortization period begins and the trust distributes principal payments, in
addition to interest, to the investors.
When loans are securitized in transactions structured as sales, we receive cash
proceeds from investors, net of transaction costs and expenses. These proceeds
are generally used to re-pay other debt and corporate obligations and to fund
new loans. The investors' shares of finance charges and fees received from the
securitized loans are collected each month and are primarily used to pay
investors for interest and credit losses and to pay us for servicing fees. We
retain any excess cash flow remaining after such payments are made to investors.
Generally, for each securitization and secured financing we utilize credit
enhancement to obtain investment grade ratings on the securities issued by the
trust. To ensure that adequate funds are available to pay investors their
contractual return, we may retain various forms of interests in assets securing
a funding transaction, whether structured as a securitization or a secured
financing, such as over-collateralization, subordinated series, residual
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interests in the receivables (in the case of securitizations) or we may fund
cash accounts. Over-collateralization is created by transferring receivables to
the trust issuing the securities that exceed the balance of the securities to be
issued. Subordinated interests provide additional assurance of payment to
investors holding senior securities. Residual interests are also referred to as
interest-only strip receivables and represent rights to future cash flows from
receivables in a securitization trust after investors receive their contractual
return. Cash accounts can be funded by an initial deposit at the time the
transaction is established and/or from interest payments on the receivables that
exceed the investor's contractual return.
Our retained securitization interests are included in receivables on our
consolidated balance sheets. These retained interests were comprised of the
following at December 31, 2007 and 2006:
AT DECEMBER
31,
-------------
2007 2006
---------------------------------------------------------------------------------
(IN MILLIONS)
Overcollateralization............................................. $16 $ 52
Interest-only strip receivables................................... - 6
Cash spread accounts.............................................. 2 40
Other subordinated interests...................................... - 870
--- ----
Total retained securitization interests........................... $18 $968
=== ====
In a secured financing, a designated pool of receivables are conveyed to a
wholly owned limited purpose subsidiary which in turn transfers the receivables
to a trust which sells interests to investors. Repayment of the debt issued by
the trust is secured by the receivables transferred. The transactions are
structured as secured financings under SFAS No. 140. Therefore, the receivables
and the underlying debt of the trust remain on our balance sheet. We do not
recognize a gain in a secured financing transaction. Because the receivables and
the debt remain on our balance sheet, revenues and expenses are reported
consistently with our owned balance sheet portfolio. Using this source of
funding results in similar cash flows as issuing debt through alternative
funding sources.
Securitizations are treated as secured financings under both IFRS and U.K. GAAP.
In order to align our accounting treatment with that of HSBC initially under
U.K. GAAP and now under IFRS, we began to structure all new collateralized
funding transactions as secured financings in the third quarter of 2004.
However, because existing public credit card transactions were structured as
sales to revolving trusts that require replenishments of receivables to support
previously issued securities, receivables continued to be sold to these trusts
and the resulting replenishment gains recorded until the revolving periods
ended, the last of which occurred in September of 2007. 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 from operations.
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Replenishment securitizations and secured financings were as follows:
YEAR ENDED DECEMBER 31,
--------------------------
2007 2006 2005
------------------------------------------------------------------------------------
(IN MILLIONS)
REPLENISHMENT SECURITIZATIONS:
Credit card............................................. $ 1,540 $ 2,469 $8,620
Personal non-credit card................................ 5 71 211
------- ------- ------
Total................................................... $ 1,545 $ 2,540 $8,831
======= ======= ======
SECURED FINANCINGS:
Real estate secured..................................... $ 3,283 $ 4,767 $4,516
Auto finance............................................ 1,596 2,843 3,418
Credit card............................................. 4,168 4,745 1,785
Personal non-credit card................................ 1,310 2,500 -
------- ------- ------
Total................................................... $10,357 $14,855 $9,719
======= ======= ======
Additionally, as part of the Metris acquisition in 2005, we assumed $4.6 billion
of securities backed by credit card receivables which we restructured so that
they are now accounted for as secured financings.
Outstanding securitized receivables consisted of the following:
AT DECEMBER
31,
-----------
2007 2006
-------------------------------------------------------------------------------
(IN
MILLIONS)
Auto finance...................................................... $ - $271
Credit card....................................................... 124 500
Personal non-credit card.......................................... - 178
---- ----
Total............................................................. $124 $949
==== ====
Our remaining securitized receivable credit card trust began its amortization
period in October 2007 and was fully amortized in January 2008.
The securities issued in connection with collateralized funding transactions may
pay off sooner than originally scheduled if certain events occur. For certain
auto and personal non-credit card transactions, early payoff of securities may
occur if established delinquency or loss levels are exceeded or if certain other
events occur. For all other transactions, early payoff of the securities begins
if the annualized portfolio yield drops below a base rate or if certain other
events occur. Presently we do not anticipate that any early payoff will take
place. If early payoff occurred, our funding requirements would increase. These
additional requirements could be met through issuance of various types of debt
or borrowings under existing back-up lines of credit. We believe we would
continue to have adequate sources of funds if an early payoff event occurred.
At December 31, 2007, securitizations structured as sales represented less than
1 percent and secured financings represented 16 percent of the funding
associated with our managed funding portfolio. At December 31, 2006,
securitizations structured as sales represented 1 percent and secured financings
represented 14 percent of the funding associated with our managed funding
portfolio.
We will continue to use secured financings of consumer receivables as a source
of our funding and liquidity. However, if the market for securities backed by
receivables were to change, we may be unable to enter into new secured
financings or to do so at favorable pricing levels. Factors affecting our
ability to structure collateralized funding transactions as secured financings
or to do so at cost-effective rates include the overall credit quality of our
securitized loans, the stability of the securitization markets, the
securitization market's view of our desirability as an
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investment, and the legal, regulatory, accounting and tax environments governing
collateralized funding transactions.
At December 31, 2007, we had domestic facilities with commercial and investment
banks under which we may use up to $17.4 billion of our receivables in
collateralized funding transactions structured either as securitizations or
secured financings. The facilities are renewable at the banks' option. The
amount available under the facilities will vary based on the timing and volume
of collateralized funding transactions. As discussed above, we anticipate some
of these facilities which expire in 2008 will not be renewed. Our 2008 funding
plan incorporates the anticipated reductions in these facilities.
For additional information related to our securitization activities, including
the amount of revenues and cash flows resulting from these arrangements, see
Note 8, "Asset Securitizations," to our accompanying consolidated financial
statements.
RISK MANAGEMENT
--------------------------------------------------------------------------------
Some degree of risk is inherent in virtually all of our activities. Accordingly,
we have comprehensive risk management policies and practices in place to address
potential financial risks, which include credit, liquidity, market (which
includes interest rate and foreign currency exchange risks), reputational and
operational risk (which includes compliance and technology risks). Our risk
management policies are designed to identify and analyze these risks, to set
appropriate limits and controls, and to monitor the risks and limits continually
by means of reliable and up-to-date administrative and information systems. We
continually modify and enhance our risk management policies and systems to
reflect changes in markets and products and to better overall risk management
processes. Training, individual responsibility and accountability, together with
a disciplined, conservative and constructive culture of control, lie at the
heart of our management of risk.
Our risk management policies are primarily carried out in accordance with
practice and limits set by the HSBC Group Management Board which consists of
senior executives throughout the HSBC organization. In addition, due to the
increasingly complex business environment and the evolution of improved risk
management tools and standards, HSBC Finance Corporation has significantly
upgraded, and continues to upgrade, its risk management function. New practices
and techniques have been implemented to enhance data analysis, modeling, stress
testing, management information systems, risk self-assessment, and independent
oversight. Senior managers independently ensure risks are appropriately
identified, measured, reported and managed.
Risk management oversight begins with the HSBC Finance Corporation Board of
Directors and its various committees, principally the Audit Committee.
Management oversight is provided by corporate and business unit risk management
committees with the participation of the Chief Operating Officer or his staff.
An HSBC Finance Corporation Risk Management Committee, chaired by the Chief
Operating Officer, focuses on credit and operational risk management strategies.
In addition, the HSBC Finance Corporation Asset Liability Committee ("ALCO")
meets regularly to review risks and approve appropriate risk management
strategies within the limits established by the HSBC Group Management Board.
CREDIT RISK MANAGEMENT Credit risk is the risk that financial loss arises from
the failure of a customer or counterparty to meet its obligations under a
contract. Our credit risk arises primarily from lending and treasury activities.
Day-to-day management of credit risk is administered by Chief Credit Officers in
each business line who have solid reporting lines to both the business line
Chief Executive Officer and the Chief Retail Credit Officer. Independent
oversight is provided by the corporate Chief Retail Credit Officer who reports
to our Chief Operating Officer and indirectly to the Group Managing Director,
Head of Credit Risk for HSBC globally. The Chief Retail Credit Officer may
override business unit credit policy decisions. An appeal process exists through
the Chief Operating Officer and Chief Executive Officer of the business to the
Group Managing Director, Head of Credit Risk. We have established detailed
policies to address the credit risk that arises from our lending activities. Our
credit and portfolio management procedures focus on sound underwriting,
effective collections and customer account management efforts for each loan. Our
lending guidelines, which delineate the credit risk we are willing to take and
the related terms, are specific
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not only for each product, but also take into consideration various other
factors including borrower characteristics. We also have specific policies to
ensure the establishment of appropriate credit loss reserves on a timely basis
to cover probable losses of principal, interest and fees. See "Credit Quality"
for a detailed description of our policies regarding the establishment of credit
loss reserves, our delinquency and charge-off policies and practices and our
customer account management policies and practices. Also see Note 2, "Summary of
Significant Accounting Policies," to our consolidated financial statements for
further discussion of our policies surrounding credit loss reserves. While we
develop our own policies and procedures for all of our lending activities, they
are consistent with HSBC standards and are regularly reviewed and updated both
on an HSBC Finance Corporation and HSBC level.
Counterparty credit risk is our primary exposure on our interest rate swap
portfolio. Counterparty credit risk is the risk that the counterparty to a
transaction fails to perform according to the terms of the contract. We control
counterparty credit risk in derivative instruments through established credit
approvals, risk control limits, collateral, and ongoing monitoring procedures.
Counterparty limits have been set and are closely monitored as part of the
overall risk management process and control structure. We utilize an affiliate,
HSBC Bank USA, as the primary provider of domestic derivative products. We have
never suffered a loss due to counterparty failure.
Currently the majority of our existing derivative contracts are with HSBC
subsidiaries, making them our primary counterparty in derivative transactions.
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. At December 31,
2007, we provided third party swap counterparties with $51 million collateral.
At December 31, 2006, third party counterparties had provided $158 million in
collateral to us. Beginning with the second quarter of 2006, when the fair value
of our agreements with affiliate counterparties require the posting of
collateral, it is provided in the form of cash and recorded on the balance
sheet, consistent with third party arrangements. At December 31, 2007, the fair
value of our agreements with affiliate counterparties required the affiliate to
provide cash collateral of $3.8 billion which is offset against the fair value
amount recognized for derivative instruments that have been offset under the
same master netting arrangement in accordance with FASB Staff Position No. FIN
39-1, "Amendment of FASB Interpretation No. 39," ("FSP 39-1") and recorded in
our balance sheet as a component of derivative related assets. At December 31,
2006, the fair value of our agreements with affiliate counterparties required
the affiliate to provide cash collateral of $1.0 billion which was offset
against the fair value amount recognized for derivative instruments that have
been offset under the same master netting arrangement in accordance with FSP 39-
1 and recorded in our balance sheet as a component of derivative related assets.
See Note 14, "Derivative Financial Instruments," to the accompanying
consolidated financial statements for additional information related to interest
rate risk management and Note 23, "Fair Value Measurements," for information
regarding the fair value of our financial instruments.
LIQUIDITY RISK The management of liquidity risk is addressed in HSBC Finance
Corporation's funding management policies and practices. HSBC Finance
Corporation funds itself principally through unsecured term funding in the
markets, through secured financings and through borrowings from HSBC and HSBC
clients. Generally, the lives of our assets are shorter than the lives of the
liabilities used to fund them. This initially reduces liquidity risk by ensuring
that funds are received prior to liabilities becoming due.
Our ability to ensure continuous access to the capital markets and maintain a
diversified funding base is important in meeting our funding needs. To manage
this liquidity risk, we offer a broad line of debt products designed to meet the
needs of both institutional and retail investors. We maintain investor diversity
by placing debt directly with customers, through selected dealer programs and by
targeted issuance of large liquid transactions on a global basis. Through
collateralized funding transactions, we are able to access an alternative
investor base and further diversify our funding sources. We also maintain a
comprehensive, direct marketing program to ensure our investors receive
consistent and timely information regarding our financial performance.
The measurement and management of liquidity risk is a primary focus. Three
standard analyses are utilized to accomplish this goal. First, a rolling 60 day
funding plan is updated daily to quantify near-term needs and develop
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the appropriate strategies to fund those needs. As part of this process, debt
maturity profiles (daily, monthly, annually) are generated to assist in planning
and limiting any potential rollover risk (which is the risk that we will be
unable to pay our debt or borrow additional funds as it becomes due). Second,
comprehensive plans identifying monthly funding requirements for the next twelve
months are updated at least weekly and monthly funding plans for the next two
years are maintained. These plans focus on funding projected asset growth and
debt maturities and drive both the timing and size of debt issuances. These
plans are shared on a regular basis with HSBC. And third, a Maximum Cumulative
Outflow (MCO) analysis is updated regularly to measure liquidity risk.
Cumulative comprehensive cash inflows are subtracted from outflows to generate a
net exposure that is tracked both monthly over the next 12 month period and
annually for 5 years. Net outflow limits are reviewed by HSBC Finance
Corporation's ALCO and HSBC.
We recognize the importance of being prepared for constrained funding
environments. While the potential scenarios driving this analysis have changed
due to our affiliation with HSBC, contingency funding plans are still maintained
as part of the liquidity management process. Alternative funding strategies are
updated regularly for a rolling 12 months and assume limited access to unsecured
funding and continued access to the collateralized funding markets. These
alternative strategies are designed to enable us to achieve monthly funding
goals through controlled growth, sales of receivables and access to committed
sources of contingent liquidity including bank lines and undrawn securitization
conduits. Although our overall liquidity situation has improved significantly
since our acquisition by HSBC, the strategies and analyses utilized in the past
to successfully manage liquidity remain in place today. The combination of this
process with the funding provided by HSBC subsidiaries and clients should ensure
our access to diverse markets and investor bases thereby allowing us to meet our
funding requirements.
See "Liquidity and Capital Resources" for further discussion of our liquidity
position.
MARKET RISK The objective of our market risk management process is to manage and
control market risk exposures in order to optimize return on risk while
maintaining a market profile as a provider of financial products and services.
Market risk is the risk that movements in market risk factors, including
interest rates and foreign currency exchange rates, will reduce our income or
the value of our portfolios.
Future net interest income is affected by movements in interest rates. Although
our main operations are in the U.S., we also have operations in Canada and the
U.K. which prepare their financial statements in their local currency.
Accordingly, our financial statements are affected by movements in exchange
rates between the functional currencies of these subsidiaries and the U.S.
dollar. We maintain an overall risk management strategy that uses a variety of
interest rate and currency derivative financial instruments to mitigate our
exposure to fluctuations caused by changes in interest rates and currency
exchange rates. We manage our exposure to interest rate risk primarily through
the use of interest rate swaps, but also use forwards, futures, options, and
other risk management instruments. We manage our exposure to foreign currency
exchange risk primarily through the use of currency swaps, options and forwards.
We do not use leveraged derivative financial instruments for interest rate risk
management. Since our acquisition by HSBC, we have not entered into foreign
exchange contracts to hedge our investment in foreign subsidiaries.
Interest rate risk is defined as the impact of changes in market interest rates
on our earnings. We use simulation models to measure the impact of anticipated
changes in interest rates on net interest income and execute appropriate risk
management actions. The key assumptions used in these models include expected
loan payoff rates, loan volumes and pricing, cash flows from derivative
financial instruments and changes in market conditions. While these assumptions
are based on our best estimates of future conditions, we can not precisely
predict our earnings due to the uncertainty inherent in the macro economic
environment. At December 31, 2007, our net interest margin at risk was in
compliance with the guidelines defined in our existing policy.
Customer demand for our receivable products shifts between fixed rate and
floating rate products, based on market conditions and preferences. These shifts
in loan products produce different interest rate risk exposures. We use
derivative financial instruments, principally interest rate swaps, to manage
these exposures. Interest rate futures, interest rate forwards and purchased
options are also used on a limited basis to manage interest rate risk.
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We 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 for 2007 a
declining balance sheet and the current interest rate risk profile. The
following table summarizes such estimated impact:
AT DECEMBER
31,
-----------
2007 2006
-------------------------------------------------------------------------------
(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................................. $153 $180
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................................. 132 54
In the December 2006 calculation, looking forward through 2007, a significant
portion of the ARM portfolio was eligible for repricing. At that time it was
anticipated that the ARM portfolio would prepay and therefore create less
benefit to net interest income in a falling interest rate environment. In the
December 2007 calculation, looking forward through 2008, a greater volume of
ARMs are expected to remain on the books due to fewer refinancing options
available to subprime customers. As a result, the total benefit to net interest
income has increased in the declining rate scenario. However, we anticipate
higher levels of delinquency and loan impairment charges as these remain on the
books longer.
These estimates include the impact of debt and the corresponding derivative
instruments accounted for using the fair value option under SFAS No. 159. 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. A principal consideration
supporting this analysis is the projected prepayment of loan balances for a
given economic scenario. Individual loan underwriting standards in combination
with housing valuations and macroeconomic factors related to available mortgage
credit are the key assumptions driving these prepayment projections. While we
have utilized a number of sources to refine these projections, we cannot
currently project prepayment rates with a high degree of certainty in all
economic environments given recent, significant changes in both subprime
mortgage underwriting standards and property valuations across the country.
HSBC also has certain limits and benchmarks that serve as guidelines in
determining the appropriate levels of interest rate risk. One such limit is
expressed in terms of the Present Value of a Basis Point ("PVBP"), which
reflects the change in value of the balance sheet for a one basis point movement
in all interest rates. Our PVBP limit as of December 31, 2007 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
December 31, 2007, we had a PVBP position of $(1.7) million reflecting the
impact of a one basis point increase in interest rates. This increase was
primarily due to an anticipated extension in the average lives of mortgages held
in both the Consumer Lending and Mortgage Services portfolios.
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:
2007 2006
---------------------------------------------------------------------------------
(IN MILLIONS)
Risk related to our portfolio of balance sheet items marked-to-
market.......................................................... $ (.2) $(1.8)
Risk for all other remaining assets and liabilities............... (1.5) 2.9
----- -----
Total PVBP risk................................................... $(1.7) $ 1.1
===== =====
Foreign currency exchange risk refers to the potential changes in current and
future earnings or capital arising from movements in foreign exchange rates. We
enter into foreign exchange rate forward contracts and currency swaps to
minimize currency risk associated with changes in the value of foreign-
denominated liabilities. Currency swaps convert principal and interest payments
on debt issued from one currency to another. For example, we may issue Euro-
denominated debt and then execute a currency swap to convert the obligation to
U.S. dollars. We estimate that
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a 10 percent adverse change in the British pound/U.S. dollar and Canadian
dollar/U.S. dollar exchange rates would result in a decrease in common
shareholder's equity of $160 million at December 31, 2007 and $159 million at
December 31, 2006 and would not have a material impact on net income.
We have issued debt in a variety of currencies and simultaneously executed
currency swaps to hedge the future interest and principal payments. As a result
of the loss of hedge accounting on currency swaps outstanding at the time of our
acquisition, the recognition of the change in the currency risk on these swaps
is recorded differently than the corresponding risk on the underlying foreign
denominated debt. Currency risk on the swap is now recognized immediately in the
net present value of all future swap payments. On the corresponding debt,
currency risk is recognized on the principal outstanding which is converted at
the period end spot translation rate and on the interest accrual which is
converted at the average spot rate for the reporting period.
OPERATIONAL RISK Operational risk is the risk of loss arising through fraud,
unauthorized activities, error, omission, inefficiency, systems failure or from
external events. It is inherent in every business organization and covers a wide
spectrum of issues.
HSBC Finance Corporation has established an independent Operational Risk
Management function, headed by a Corporate Operational Risk Coordinator
reporting directly to the Chief Operating Officer and indirectly to the Head of
Operational Risk for HSBC. The Operational Risk Coordinator provides independent
functional oversight by managing the following activities:
- maintaining a network of business line Operational Risk Coordinators;
- developing scoring and risk assessment tools and databases;
- providing training and developing awareness; and
- independently reviewing and reporting the assessments of operational
risks.
An Operational Risk Management Committee is responsible for oversight of the
operational risks being taken, the analytic tools used to monitor those risks,
and reporting. Business unit line management is responsible for managing and
controlling all risks and for communicating and implementing all control
standards. This is supported by an independent program of periodic reviews
undertaken by Internal Audit. We also monitor external operations risk events
which take place to ensure that we remain in line with best practice and take
account of lessons learned from publicized operational failures within the
financial services industry. We also maintain and test emergency policies and
procedures to support operations and our personnel in the event of disasters.
COMPLIANCE RISK Compliance risk is the risk arising from failure to comply with
relevant laws, regulations, and regulatory requirements governing the conduct of
specific businesses. It is a composite risk that can result in regulatory
sanctions, financial penalties, litigation exposure and loss of reputation.
Compliance risk is inherent throughout the HSBC Finance Corporation
organization.
Consistent with HSBC's commitment to ensure adherence with applicable regulatory
requirements for all of its world-wide affiliates, HSBC Finance Corporation has
implemented a multi-faceted Compliance Risk Management Program. This program
addresses the following priorities, among other issues:
- anti-money laundering (AML) regulations;
- fair lending and consumer protection laws;
- dealings with affiliates;
- permissible activities; and
- conflicts of interest.
The independent Corporate Compliance function is headed by a Chief Compliance
Officer who reports to the Chief Operating Officer, the Chief Compliance Officer
of HSBC North America and the Head of Compliance for HSBC. The Corporate
Compliance function is supported by various compliance teams assigned to
individual business units. The Corporate Compliance function is responsible for
the following activities:
- advising management on compliance matters;
- providing independent assessment and monitoring; and
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- reporting compliance issues to HSBC Finance Corporation senior management
and Board of Directors, as well as to HSBC Compliance.
The overall Corporate Compliance program elements include identification,
assessment, monitoring, control and mitigation of the risk and timely resolution
of the results of risk events. These functions are generally performed by
business line management, with oversight provided by Corporate Compliance.
Controls for mitigating compliance risk are incorporated into business operating
policies and procedures. Processes are in place to ensure controls are
appropriately updated to reflect changes in regulatory requirements as well as
changes in business practices, including new or revised products, services and
marketing programs. A wide range of compliance training is provided to relevant
staff, including mandated programs for such areas as anti-money laundering, fair
lending and privacy. A separate Corporate Compliance Control Unit, along with
Internal Audit, tests the effectiveness of the overall Compliance Risk
Management Program through continuous monitoring and periodic target audits.
REPUTATIONAL RISK The safeguarding of our reputation is of paramount importance
to our continued prosperity and is the responsibility of every member of our
staff. Reputational risk can arise from social, ethical or environmental issues,
or as a consequence of operations risk events. Our good reputation depends upon
the way in which we conduct our business, but can also be affected by the way in
which customers, to whom we provide financial services, conduct themselves.
Reputational risk is considered and assessed by the HSBC Group Management Board,
our Board of Directors and senior management during the establishment of
standards for all major aspects of business and the formulation of policy. These
policies, which are an integral part of the internal control systems, are
communicated through manuals and statements of policy, internal communication
and training. The policies set out operational procedures in all areas of
reputational risk, including money laundering deterrence, environmental impact,
anti-corruption measures and employee relations.
We have established a strong internal control structure to minimize the risk of
operational and financial failure and to ensure that a full appraisal of
reputational risk is made before strategic decisions are taken. The HSBC
internal audit function monitors compliance with our policies and standards.
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GLOSSARY OF TERMS
Affinity Credit Card - A MasterCard or Visa account jointly sponsored by the
issuer of the card and an organization whose members share a common interest
(e.g., the AFL-CIO Union Plus(R) credit card program).
Auto Finance Loans - Closed-end loans secured by a first lien on a vehicle.
Basis point - A unit that is commonly used to calculate changes in interest
rates. The relationship between percentage changes and basis points can be
summarized as a 1 percent change equals a 100 basis point change or .01 percent
equals 1 basis point.
Co-Branded Credit Card - A MasterCard, Visa or American Express account that is
jointly sponsored by the issuer of the card and another corporation (e.g., the
GM Card(R)). The account holder typically receives some form of added benefit
for using the card.
Consumer Net Charge-off Ratio - Net charge-offs of consumer receivables divided
by average consumer receivables outstanding.
Contractual Delinquency - A method of determining aging of past due accounts
based on the status of payments under the loan. Delinquency status may be
affected by customer account management policies and practices such as the
restructure of accounts, forbearance agreements, extended payment plans,
modification arrangements, external debt management plans, loan rewrites and
deferments.
Efficiency Ratio - Ratio of total costs and expenses less policyholders'
benefits to net interest income and other revenues less policyholders' benefits.
Enhancement Services Income - Ancillary credit card revenue from products such
as Account Secure (debt protection) and Identity Protection Plan.
Fee Income - Income associated with interchange on credit cards and late and
other fees from the origination, acquisition or servicing of loans.
Foreign Exchange Contract - A contract used to minimize our exposure to changes
in foreign currency exchange rates.
Futures Contract - An exchange-traded contract to buy or sell a stated amount of
a financial instrument or index at a specified future date and price.
HBEU - HSBC Bank plc, a U.K. based subsidiary of HSBC Holdings plc.
HINO - HSBC Investments (North America) Inc., which is the immediate parent of
HSBC Finance Corporation.
HSBC North America - HSBC North America Holdings Inc. and the immediate parent
of HINO.
HSBC - HSBC Holdings plc.
HSBC Bank USA - HSBC Bank USA, National Association
HTSU - HSBC Technology & Services (USA) Inc., which provides information
technology services to all subsidiaries of HSBC North America and other
subsidiaries of HSBC.
Goodwill - Represents the purchase price over the fair value of identifiable
assets acquired less liabilities assumed from business combinations.
IFRS Management Basis - A non-U.S. GAAP measure of reporting results in
accordance with IFRSs and assumes the private label and real estate secured
receivables transferred to HSBC Bank USA have not been sold and remain on our
balance sheet. IFRS Management Basis also assumes that all purchase accounting
fair value adjustments relating to our acquisition by HSBC have been "pushed
down" to HSBC Finance Corporation.
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Intangible Assets - Assets (not including financial assets) that lack physical
substance. Our acquired intangibles include purchased credit card relationships
and related programs, merchant relationships in our retail services business,
other loan related relationships, trade names, technology, customer lists and
other contracts.
Interchange Fees - Fees received for processing a credit card transaction
through the MasterCard, Visa, American Express or Discover network.
Interest-only Strip Receivables - Represent our contractual right to receive
interest and other cash flows from our securitization trusts after the investors
receive their contractual return.
Interest Rate Swap - Contract between two parties to exchange interest payments
on a stated principal amount (notional principal) for a specified period.
Typically, one party makes fixed rate payments, while the other party makes
payments using a variable rate.
LIBOR - London Interbank Offered Rate. A widely quoted market rate which is
frequently the index used to determine the rate at which we borrow funds.
Liquidity - A measure of how quickly we can convert assets to cash or raise
additional cash by issuing debt.
Managed Receivables - The sum of receivables on our balance sheet and those that
we service for investors as part of our asset securitization program.
MasterCard, Visa, American Express and Discover Receivables - Receivables
generated through customer usage of MasterCard, Visa, American Express and
Discover credit cards.
Near-prime receivables - A portion of our non-prime receivable portfolio which
is comprised of customers with somewhat stronger credit scores than our other
customers that are priced at rates generally below the rates offered on our non-
prime products.
Net Interest Income - Interest income from receivables and noninsurance
investment securities reduced by interest expense.
Net Interest Margin - Net interest income as a percentage of average interest-
earning assets.
Nonaccrual Loans - Loans on which we no longer accrue interest because ultimate
collection is unlikely.
Non-prime receivables - Receivables which have been priced above the standard
interest rates charged to prime customers due to a higher than average risk for
default as a result of the customer's credit history and the value of
collateral, if applicable.
Options - A contract giving the owner the right, but not the obligation, to buy
or sell a specified item at a fixed price for a specified period.
Owned Receivables - Receivables held on our balance sheet.
Personal Homeowner Loan ("PHL") - A high loan-to-value real estate loan that has
been underwritten and priced as an unsecured loan. These loans are reported as
personal non-credit card receivables.
Personal Non-Credit Card Receivables - Unsecured lines of credit or closed-end
loans made to individuals.
Portfolio Seasoning - Relates to the aging of origination vintages. Loss
patterns emerge slowly over time as new accounts are booked.
Private Label Credit Card - A line of credit made available to customers of
retail merchants evidenced by a credit card bearing the merchant's name.
Real Estate Secured Loan - Closed-end loans and revolving lines of credit
secured by first or subordinate liens on residential real estate.
Receivables Serviced with Limited Recourse - Receivables we have securitized in
transactions structured as sales and for which we have some level of potential
loss if defaults occur.
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Return on Average Common Shareholder's Equity - Net income less dividends on
preferred stock divided by average common shareholder's equity.
Return on Average Assets - Net income divided by average owned assets.
Secured Financing - The process where interests in a dedicated pool of financial
assets are sold to investors. Generally, the receivables are transferred through
a limited purpose financing subsidiary to a trust that issues interests that are
sold to investors. These transactions do not receive sale treatment under SFAS
No. 140. The receivables and related debt remain on our balance sheet.
Securitization - The process where interests in a dedicated pool of financial
assets, typically credit card, auto or personal non-credit card receivables, are
sold to investors. Generally, the receivables are sold to a trust that issues
interests that are sold to investors. These transactions are structured to
receive sale treatment under SFAS No. 140. The receivables are then removed from
our balance sheet.
Securitization Related Revenue - Includes income associated with current and
prior period securitizations structured as sales of receivables with limited
recourse. Such income includes gains on sales, net of our estimate of probable
credit losses under the recourse provisions, servicing income and excess spread
relating to those receivables.
Stated Income (low documentation) - Loans underwritten based upon the loan
applicant's representation of annual income, which is not verified by receipt of
supporting documentation.
Tangible Common Equity - Common shareholder's equity (excluding unrealized gains
and losses on investments and cash flow hedging instruments, any minimum pension
liability and the impact of adoption of SFAS No. 159, including subsequent
changes in fair value recognized in earnings associated with credit risk) less
acquired intangibles and goodwill.
Tangible Shareholder's(s') Equity - Tangible common equity, preferred stock, and
company obligated mandatorily redeemable preferred securities of subsidiary
trusts (including amounts due to affiliates) adjusted for HSBC acquisition
purchase accounting adjustments.
Tangible Managed Assets - Total managed assets less acquired intangibles,
goodwill and derivative financial assets.
Taxpayer Financial Services ("TFS") Revenue - Our taxpayer financial services
business provides consumer tax refund lending in the United States. This income
primarily consists of fees received from the consumer for a short term loan
which will be repaid from their Federal income tax return refund.
Whole Loan Sales - Sales of loans to third parties without recourse. Typically,
these sales are made pursuant to our liquidity or capital management plans.
111
HSBC FINANCE CORPORATION AND SUBSIDIARIES
CREDIT QUALITY STATISTICS
2007 2006 2005 2004 2003
-----------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
TWO-MONTH-AND-OVER CONTRACTUAL DELINQUENCY RATIOS
Real estate secured(1)............................. 7.08% 3.54% 2.72% 2.96% 4.33%
Auto finance....................................... 3.67 3.18 3.04 3.03 3.39
Credit card(2)..................................... 5.77 4.57 3.66 4.88 5.76
Private label...................................... 4.26 5.31 5.43 4.13 5.42
Personal non-credit card........................... 14.13 10.17 9.40 8.69 10.01
------ ------ ------ ------ ------
Total consumer(2).................................. 7.41% 4.59% 3.89% 4.13% 5.40%
====== ====== ====== ====== ======
RATIO OF NET CHARGE-OFFS TO AVERAGE RECEIVABLES FOR
THE YEAR
Real estate secured(3)............................. 2.32% 1.00% .76% 1.10% .99%
Auto finance(6).................................... 4.10 3.67 3.27 3.43 4.91
Credit card(4)..................................... 7.28 5.56 7.12 8.85 9.18
Private label(4)................................... 4.73 5.80 4.83 6.17 5.75
Personal non-credit card(6)........................ 8.48 7.89 7.88 9.75 9.89
------ ------ ------ ------ ------
Total consumer(4)(6)............................... 4.22 2.97 3.03 4.00 4.06
Commercial......................................... - .43 2.60 - .46
------ ------ ------ ------ ------
Total.............................................. 4.21% 2.97% 3.03% 3.98% 4.05%
====== ====== ====== ====== ======
REAL ESTATE CHARGE-OFFS AND REO EXPENSE AS A
PERCENT OF AVERAGE REAL ESTATE SECURED
RECEIVABLES...................................... 2.68% 1.19% .87% 1.38% 1.42%
------ ------ ------ ------ ------
NONACCRUAL RECEIVABLES
Domestic:
Real estate secured(5)........................... $4,526 $2,461 $1,601 $1,489 $1,777
Auto finance..................................... 480 389 320 227 140
Private label.................................... 25 31 31 24 43
Personal non-credit card......................... 2,092 1,444 1,190 908 898
Foreign............................................ 439 482 463 432 316
------ ------ ------ ------ ------
Total consumer..................................... 7,562 4,807 3,605 3,080 3,174
Commercial and other............................... - - 3 4 6
------ ------ ------ ------ ------
Total.............................................. $7,562 $4,807 $3,608 $3,084 $3,180
====== ====== ====== ====== ======
ACCRUING CONSUMER RECEIVABLES 90 OR MORE DAYS
DELINQUENT
Domestic:
Credit card...................................... $1,240 $ 894 $ 585 $ 469 $ 429
Private label.................................... - - - - 443
Foreign............................................ 37 35 38 38 32
------ ------ ------ ------ ------
Total.............................................. $1,277 $ 929 $ 623 $ 507 $ 904
====== ====== ====== ====== ======
REAL ESTATE OWNED
Domestic........................................... $1,008 $ 785 $ 506 $ 583 $ 627
Foreign............................................ 15 9 4 4 4
------ ------ ------ ------ ------
Total.............................................. $1,023 $ 794 $ 510 $ 587 $ 631
====== ====== ====== ====== ======
RENEGOTIATED COMMERCIAL LOANS...................... $ - $ 1 $ - $ 2 $ 2
====== ====== ====== ====== ======
--------
((1) Real estate secured two-months-and-over contractual delinquency (as a
percent of consumer receivables) are comprised of the following:
2007 2006 2005 2004 2003
--------------------------------------------------------------------------------------------
Mortgage Services:
First lien............................................... 10.91% 4.50% 3.21% 3.26% 5.49%
Second lien.............................................. 15.43 5.74 1.94 2.47 4.90
----- ---- ---- ---- ----
Total Mortgage Services.................................. 11.80 4.75 2.98 3.16 5.40
Consumer Lending:
First lien............................................... 3.72 2.07 2.14 2.69 3.40
Second lien.............................................. 6.93 3.06 3.03 3.02 5.07
----- ---- ---- ---- ----
Total Consumer Lending................................... 4.15 2.21 2.26 2.73 3.59
Foreign and all other:
First lien............................................... 2.62 1.58 2.11 1.95 3.14
Second lien.............................................. 4.59 5.38 5.71 3.94 4.03
----- ---- ---- ---- ----
Total Foreign and all other.............................. 4.12 4.59 5.09 3.66 3.91
----- ---- ---- ---- ----
Total real estate secured................................ 7.08% 3.54% 2.72% 2.96% 4.33%
===== ==== ==== ==== ====
112
HSBC FINANCE CORPORATION AND SUBSIDIARIES
CREDIT QUALITY STATISTICS (CONTINUED)
(2) In December 2005, we completed the acquisition of Metris which included
receivables of $5.3 billion. This event had a significant impact on this
ratio. Excluding the receivables from the Metris acquisition from this
calculation, our consumer delinquency ratio for our credit card portfolio
was 4.01% and total consumer delinquency was 3.89%.
(3) Real estate secured net charge-off of consumer receivables as a percent of
average consumer receivables are comprised of the following:
2007 2006 2005 2004 2003
--------------------------------------------------------------------------------------------
Mortgage Services:
First lien............................................... 1.60% .77% .68% .81% .54%
Second lien.............................................. 12.15 2.38 1.11 2.64 2.89
----- ---- ---- ---- ----
Total Mortgage Services.................................. 3.77 1.12 .75 1.05 .94
Consumer Lending:
First lien............................................... .79 .85 .74 1.03 .89
Second lien.............................................. 3.78 1.12 1.21 2.77 2.44
----- ---- ---- ---- ----
Total Consumer Lending................................... 1.20 .89 .80 1.21 1.07
Foreign and all other:
First lien............................................... 1.05 .54 1.04 .89 1.19
Second lien.............................................. 1.35 .94 .37 .24 .38
----- ---- ---- ---- ----
Total Foreign and all other.............................. 1.28 .86 .47 .33 .50
----- ---- ---- ---- ----
Total real estate secured................................ 2.32% 1.00% .76% 1.10% .99%
===== ==== ==== ==== ====
(4) The adoption of FFIEC charge-off policies for our domestic private label
(excluding retail sales contracts at our consumer lending business) and
credit card portfolios in December 2004 increased private label net charge-
offs by $155 million (119 basis points) and credit card net charge-offs by
$3 million (2 basis points) and total consumer net charge-offs by $158
million (16 basis points) for the year ended December 31, 2004.
(5) Domestic real estate nonaccrual receivables are comprised of the following:
2007 2006 2005 2004 2003
------------------------------------------------------------------------------------------------
Real estate secured:
Closed-end:
First lien........................................ $3,367 $1,884 $1,359 $1,287 $1,437
Second lien....................................... 790 369 148 105 121
Revolving:
First lien........................................ 20 22 31 40 92
Second lien....................................... 349 186 63 57 127
------ ------ ------ ------ ------
Total real estate secured......................... $4,526 $2,461 $1,601 $1,489 $1,777
====== ====== ====== ====== ======
(6) In December 2006, our Auto Finance business changed its charge-off policy to
provide that the principal balance of auto loans in excess of the estimated
net realizable value will be charged-off 30 days (previously 90 days) after
the financed vehicle has been repossessed if it remains unsold, unless it
becomes 150 days contractually delinquent, at which time such excess will be
charged off. This resulted in a one-time acceleration of charge-offs in
December 2006, which totaled $24 million. Excluding the impact of this
change the auto finance net charge-off ratio would have been 4.19 percent in
the quarter ended December 31, 2006 and 3.46 percent for the full year 2006.
Also in the fourth quarter of 2006, our U.K. business discontinued a
forbearance program related to unsecured loans. Under the forbearance
program, eligible delinquent accounts would not be subject to charge-off if
certain minimum payment conditions were met. The cancellation of this
program resulted in a one-time acceleration of charge-off which totaled $89
million. Excluding the impact of the change in the U.K. forbearance program,
the personal non-credit card net charge-off ratio would have been 6.23
percent in the quarter ended December 31, 2006 and 7.45 percent for the full
year 2006. Excluding the impact of both changes, the total consumer charge-
off ratio would have been 3.17 percent for the quarter ended December 31,
2006 and 2.89 percent for the full year 2006.
113
HSBC FINANCE CORPORATION AND SUBSIDIARIES
ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY
2007 2006 2005 2004 2003
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
TOTAL CREDIT LOSS RESERVES AT JANUARY 1.......... $ 6,587 $ 4,521 $ 3,625 $ 3,793 $ 3,333
------- ------- ------- ------- -------
PROVISION FOR CREDIT LOSSES...................... 11,026 6,564 4,543 4,334 3,967
------- ------- ------- ------- -------
CHARGE-OFFS Domestic:
Real estate secured(1)......................... (2,199) (931) (569) (629) (496)
Auto finance................................... (595) (468) (311) (204) (148)
Credit card(2)................................. (2,463) (1,665) (1,339) (1,082) (936)
Private label(2)............................... (45) (43) (33) (788) (684)
Personal non-credit card....................... (1,729) (1,455) (1,333) (1,350) (1,354)
Foreign.......................................... (575) (600) (509) (355) (257)
------- ------- ------- ------- -------
Total consumer................................... (7,606) (5,162) (4,094) (4,408) (3,875)
Commercial and other............................. - (2) (6) (1) (3)
------- ------- ------- ------- -------
Total receivables charged off.................... (7,606) (5,164) (4,100) (4,409) (3,878)
------- ------- ------- ------- -------
RECOVERIES
Domestic:
Real estate secured(3)......................... 72 33 27 18 10
Auto finance................................... 80 50 18 6 5
Credit card.................................... 383 274 157 103 87
Private label.................................. 9 13 6 79 72
Personal non-credit card....................... 211 216 171 120 82
Foreign.......................................... 135 59 68 50 34
------- ------- ------- ------- -------
Total consumer................................... 890 645 447 376 290
Commercial and other............................. - - - - 1
------- ------- ------- ------- -------
Total recoveries on receivables.................. 890 645 447 376 291
OTHER, NET....................................... 8 21 6 (469) 80
------- ------- ------- ------- -------
CREDIT LOSS RESERVES
Domestic:
Real estate secured............................ 5,119 2,365 718 645 670
Auto finance................................... 254 241 222 181 172
Credit card.................................... 2,635 1,864 1,576 1,205 806
Private label.................................. 26 38 36 28 519
Personal non-credit card....................... 2,378 1,732 1,652 1,237 1,348
Foreign.......................................... 492 346 312 316 247
------- ------- ------- ------- -------
Total consumer................................... 10,904 6,586 4,516 3,612 3,762
Commercial and other............................. 1 1 5 13 31
------- ------- ------- ------- -------
TOTAL CREDIT LOSS RESERVES AT DECEMBER 31........ $10,905 $ 6,587 $ 4,521 $ 3,625 $ 3,793
======= ======= ======= ======= =======
RATIO OF CREDIT LOSS RESERVES TO:
Net charge-offs(6)............................... 162.4% 145.8% 123.8%(4) 89.9%(5) 105.7%
Receivables:
Consumer(6).................................... 6.99 4.07 3.23 3.39 4.09
Commercial..................................... .76 .60 2.67 8.90 6.80
------- ------- ------- ------- -------
Total(6)....................................... 6.98% 4.07% 3.23% 3.39% 4.11%
======= ======= ======= ======= =======
Nonperforming loans:
Consumer....................................... 123.4% 114.8% 106.8% 100.7% 92.2%
Commercial..................................... - 100.0 166.7 260.0 620.0
------- ------- ------- ------- -------
Total.......................................... 123.4% 114.8% 106.9% 100.9% 92.8%
======= ======= ======= ======= =======
--------
(1) Domestic real estate secured charge-offs can be further analyzed as follows:
2007 2006 2005 2004 2003
-----------------------------------------------------------------------------------------------
Closed end:
First lien.......................................... $ (879) $(582) $(421) $(418) $(279)
Second lien......................................... (928) (256) (105) (151) (152)
Revolving:
First lien.......................................... (20) (17) (22) (34) (35)
Second lien......................................... (372) (76) (21) (26) (30)
------- ----- ----- ----- -----
Total................................................. $(2,199) $(931) $(569) $(629) $(496)
======= ===== ===== ===== =====
(2) Includes $3 million of credit card and $155 million of private label charge-
off relating to the adoption of FFIEC charge-off policies in December 2004.
114
HSBC FINANCE CORPORATION AND SUBSIDIARIES
ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY (CONTINUED)
(3) Domestic real estate recoveries can be further analyzed as follows:
2007 2006 2005 2004 2003
--------------------------------------------------------------------------------------------
Closed end:
First lien.............................................. $45 $11 $11 $ 5 $ 3
Second lien............................................. 20 15 10 8 5
Revolving:
First lien.............................................. 2 2 2 2 -
Second lien............................................. 5 5 4 3 2
--- --- --- --- ---
Total..................................................... $72 $33 $27 $18 $10
=== === === === ===
(4) The acquisition of Metris in December 2005 has positively impacted this
ratio. Reserves as a percentage of net charge-offs excluding Metris was
118.2 percent.
(5) In December 2004 we adopted FFIEC charge-off policies for our domestic
private label (excluding retail sales contracts at our consumer lending
business) and credit card portfolios and subsequently sold this domestic
private label receivable portfolio. These events had a significant impact on
this ratio. Reserves as a percentage of net charge-offs excluding net
charge-offs associated with the sold domestic private label portfolio and
charge-off relating to the adoption of FFIEC was 109.2% at December 31,
2004.
(6) This ratio was positively impacted in 2007 and 2006 by markedly higher
credit loss reserves at our Mortgage Services business and, in 2007, at our
Consumer Lending business.
115
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