HSBC FinanceCorp 1Q 2007 Pt.2

HSBC Holdings PLC 15 May 2007 PART 2 RECEIVABLES REVIEW -------------------------------------------------------------------------------- The following table summarizes receivables at March 31, 2007 and increases (decreases) over prior periods: INCREASES (DECREASES) FROM --------------------------------- DECEMBER 31, MARCH 31, 2006 2006 MARCH 31, --------------- --------------- 2007 $ % $ % ------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Real estate secured(1)...................... $ 96,329 $(1,432) (1.5)% $ 6,837 7.6% Auto finance................................ 12,633 129 1.0 1,447 12.9 Credit card................................. 27,293 (421) (1.5) 3,844 16.4 Private label............................... 2,500 (9) (.4) 72 3.0 Personal non-credit card(2)................. 21,201 (166) (.8) 1,195 6.0 Commercial and other........................ 158 (23) (12.7) (48) (23.3) -------- ------- ----- ------- ----- Total owned receivables..................... $160,114 $(1,922) (1.2)% $13,347 9.1% ======== ======= ===== ======= ===== -------- ()(1) Mortgage Services purchases receivables originated by other lenders referred to as correspondents. In December, the business was aligned under common executive management with our Consumer Lending business. In March 2007, we announced that Mortgage Services was ceasing correspondent channel acquisitions of receivables. Consumer Lending is a distinct business that sources, underwrites and closes 35 HSBC Finance Corporation -------------------------------------------------------------------------------- loans through a network of 1,396 branch offices located throughout the United States. The Mortgage Services and Consumer Lending businesses comprise the majority of our real estate secured portfolio as shown in the following table: INCREASES (DECREASES) FROM ------------------------------- DECEMBER 31, MARCH 31, 2006 2006 MARCH 31, -------------- -------------- 2007 $ % $ % ------------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS) Mortgage Services.................................. $44,674 $(3,294) (6.9)% $(1,784) (3.8)% Consumer Lending................................... 47,924 1,698 3.7 7,994 20.0 Foreign and all other.............................. 3,731 164 4.6 627 20.2 ------- ------- ---- ------- ---- Total real estate secured.......................... $96,329 $(1,432) (1.5)% $ 6,837 7.6% ======= ======= ==== ======= ==== -------- ()(2) Personal non-credit card receivables are comprised of the following: INCREASES (DECREASES) FROM ----------------------------- DECEMBER 31, MARCH 31, 2006 2006 MARCH 31, ------------ -------------- 2007 $ % $ % ---------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Domestic personal non-credit card.................. $13,871 $ 108 .8% $1,927 16.1% Union Plus personal non-credit card................ 213 (22) (9.4) (85) (28.5) Personal homeowner loans........................... 4,181 (66) (1.6) (60) (1.4) Foreign personal non-credit card................... 2,936 (186) (6.0) (587) (16.7) ------- ----- ---- ------ ----- Total personal non-credit card..................... $21,201 $(166) (.8)% $1,195 6.0% ======= ===== ==== ====== ===== Real estate secured receivables can be further analyzed as follows: INCREASES (DECREASES) FROM ------------------------------- DECEMBER 31, MARCH 31, 2006 2006 MARCH 31, -------------- -------------- 2007 $ % $ % ------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Real estate secured: Closed-end: First lien............................... $77,201 $ (700) (.9)% $6,591 9.3% Second lien.............................. 14,756 (334) (2.2) 561 4.0 Revolving: First lien............................... 509 (47) (8.5) (79) (13.4) Second lien.............................. 3,863 (351) (8.3) (236) (5.8) ------- ------- ---- ------ ----- Total real estate secured..................... $96,329 $(1,432) (1.5)% $6,837 7.6% ======= ======= ==== ====== ===== 36 HSBC Finance Corporation -------------------------------------------------------------------------------- The following table summarizes various real estate secured receivables information for our Mortgage Services and Consumer Lending businesses: MARCH 31, 2007 DECEMBER 31, 2006 MARCH 31, 2006 ------------------- ------------------- ------------------- MORTGAGE CONSUMER MORTGAGE CONSUMER MORTGAGE CONSUMER SERVICES LENDING SERVICES LENDING SERVICES LENDING -------------------------------------------------------------------------------------------------- (IN MILLIONS) Fixed rate....................... $20,518(1) $44,236(2) $21,733(1) $42,675(2) $19,714 $38,033 Adjustable rate.................. 24,156 3,688 26,235 3,551 26,744 1,897 ------- ------- ------- ------- ------- ------- Total............................ $44,674 $47,924 $47,968 $46,226 $46,458 $39,930 ======= ======= ======= ======= ======= ======= First lien....................... $35,630 $41,294 $38,031 $39,684 $36,444 $34,181 Second lien...................... 9,044 6,630 9,937 6,542 10,014 5,749 ------- ------- ------- ------- ------- ------- Total............................ $44,674 $47,924 $47,968 $46,226 $46,458 $39,930 ======= ======= ======= ======= ======= ======= Adjustable rate.................. $18,141 $ 3,688 $20,108 $ 3,551 $20,024 $ 1,897 Interest only.................... 6,015 - 6,127 - 6,720 - ------- ------- ------- ------- ------- ------- Total adjustable rate............ $24,156 $ 3,688 $26,235 $ 3,551 $26,744 $ 1,897 ======= ======= ======= ======= ======= ======= Total stated income.............. $11,063 $ - $11,772 $ - $11,637 $ - ======= ======= ======= ======= ======= ======= -------- ()(1) Includes fixed rate interest-only loans of $48 million at March 31, 2007 and $32 million at December 31, 2006. ()(2) Includes fixed rate interest-only loans of $54 million at March 31, 2007 and $46 million at December 31, 2006. At March 31, 2007, real estate secured loans originated and acquired subsequent to December 31, 2004 by our Mortgage Services business accounted for approximately 73 percent of total Mortgage Services receivables in a first lien and approximately 88 percent of total Mortgage Services receivables in a second lien position. At December 31, 2006, real estate secured loans originated and acquired subsequent to December 31, 2004 by our Mortgage Services business accounted for approximately 70 percent of total Mortgage Services receivables in a first lien and approximately 90 percent of total Mortgage Services receivables in a second lien position. RECEIVABLE INCREASES (DECREASES) SINCE MARCH 31, 2006 Real estate secured receivables increased significantly over the year-ago period driven by growth in our branch business. Growth in our branch-based Consumer Lending business improved due to higher sales volumes as we continue to emphasize real estate secured loans, including a near-prime mortgage product, as well as a decline in loan prepayments due to the higher interest rate environment which resulted in lower run-off rates. Also contributing to the increase was the acquisition of the $2.5 billion Champion portfolio in November 2006. Our Mortgage Services correspondent business experienced growth through June 2006 as management continued to focus on junior lien loans through portfolio acquisitions and expanded sources for purchasing newly originated loans from flow correspondents. In the second half of 2006, management revised its business plan and reduced purchases of second lien and selected higher risk products which has resulted in attrition in the Mortgage Services portfolio. As previously discussed, in March 2007, we announced our decision to discontinue correspondent channel acquisitions by our Mortgage Services business. However, our Decision One wholesale channel and our Consumer Lending retail channel will continue. These actions, combined with normal portfolio attrition will result in significant reductions in the principal balance of our Mortgage Services loan portfolio during 2007. We have also experienced strong real estate secured growth in our foreign real estate secured receivables as a result of our continuing Canadian branch operation expansions. Auto finance receivables increased over the year-ago period due to organic growth principally in the near-prime portfolio as a result of increases in newly originated loans acquired from our dealer network and growth in the consumer direct loan program. Additionally as compared to the year-ago period, we experienced continued growth from the expansion of an auto finance program in Canada. Credit card receivables reflect strong domestic organic growth in our Union Privilege and non-prime portfolios including Metris as well as continued growth in our Canadian credit card receivables. Lower securitization levels also contributed to the increase as compared to the 37 HSBC Finance Corporation -------------------------------------------------------------------------------- year-ago period. Private label receivables increased as compared to March 31, 2006 as a result of growth in our Canadian business and changes in the foreign exchange rate since March 31, 2006, partially offset by the termination of new domestic retail sales contract originations in October 2006 and lower retail sales volumes in the U.K. Personal non-credit card receivables increased as a result of increased marketing, including several large direct mail campaigns and changes in the foreign exchange rate since March 31, 2006. RECEIVABLE INCREASES (DECREASES) SINCE DECEMBER 31, 2006 Real estate secured receivables have decreased since December 31, 2006. As discussed above, actions taken at our Mortgage Services business combined with normal portfolio attrition, resulted in a decline in the overall portfolio balance at our Mortgage Services business since December 31, 2006. These decreases were partially offset by real estate secured growth in our Consumer Lending business. In addition, the decline in loan prepayments has continued during the first quarter of 2007 which has resulted in lower run-off rates for our real estate secured portfolio. Growth in our auto finance portfolio reflects organic growth and increased volume. The decrease in our credit card receivables reflects normal seasonal run-off, partially offset by growth in our non-prime portfolios including Metris. Private label receivables decreased due to the termination of new domestic retail sales contract originations in October 2006 partially offset by growth in our U.K. private label portfolio. Personal non-credit card receivables decreased primarily due to lower levels of foreign personal non- credit card receivables. RESULTS OF OPERATIONS -------------------------------------------------------------------------------- Unless noted otherwise, the following discusses amounts reported in our consolidated statement of income. NET INTEREST INCOME The following table summarizes net interest income: INCREASE (DECREASE) ------------- THREE MONTHS ENDED MARCH 31, 2007 (1) 2006 (1) AMOUNT % ------------------------------------------------------------------------------------------- Finance and other interest income......... $4,712 11.42% $4,087 11.10% $625 15.3% Interest expense.......................... 2,071 5.02 1,623 4.41 448 27.6 ------ ----- ------ ----- ---- ---- Net interest income....................... $2,641 6.40% $2,464 6.69% $177 7.2% ====== ===== ====== ===== ==== ==== -------- ()(1) % Columns: comparison to average owned interest-earning assets. The increase in net interest income during the quarter ended March 31, 2007 was due to higher average receivables and higher overall yields, partially offset by higher interest expense. Overall yields increased due to increases in our rates on fixed and variable rate products which reflected market movements and various other repricing initiatives. Yields were also favorably impacted by receivable mix with increased levels of higher yielding products such as credit cards, due in part to reduced securitization levels and higher levels of average second lien real estate secured loans. Overall yield improvements were partially offset by the impact of growth in non-performing assets. The higher interest expense, which contributed to lower net interest margin, was due to a larger balance sheet and a significantly higher cost of funds due to a rising interest rate environment. This was partially offset by the adoption of SFAS No. 159, which resulted in $76 million of realized losses on swaps which previously were accounted for as effective hedges under SFAS No. 133 and reported as interest expense now being reported in other revenues. In addition, as part of our overall liquidity management strategy, we continue to extend the maturity of our liability profile which results in higher interest expense. Our purchase accounting fair value adjustments include both amortization of fair value adjustments to our external debt obligations and receivables. Amortization of purchase accounting fair value adjustments increased net interest income by $46 million during the quarter ended March 31, 2007 and $114 million during the quarter ended March 31, 2006. Net interest margin was 6.40 percent during the three months ended March 31, 2007 compared to 6.69 percent in the year-ago period. Net interest margin decreased in the first quarter of 2007 as the improvement in the overall yield on 38 HSBC Finance Corporation -------------------------------------------------------------------------------- our receivable portfolio, as discussed above, was more than offset by the higher funding costs. The following table shows the impact of these items on net interest margin: 2007 2006 -------------------------------------------------------------------------------- Net interest margin - March 31, 2006 and 2005, respectively........ 6.69% 6.68% Impact to net interest margin resulting from: Receivable pricing............................................... .20 .32 Receivable mix................................................... .03 .08 Sale of U.K. card business in December 2005...................... - .04 Metris acquisition in December 2005.............................. - .36 Cost of funds change............................................. (.61) (.67) Investment securities mix........................................ - - Other............................................................ .09 (.12) ---- ---- Net interest margin - March 31, 2007 and 2006, respectively........ 6.40% 6.69% ==== ==== The varying maturities and repricing frequencies of both our assets and liabilities expose us to interest rate risk. When the various risks inherent in both the asset and the debt do not meet our desired risk profile, we use derivative financial instruments to manage these risks to acceptable interest rate risk levels. See "Risk Management" for additional information regarding interest rate risk and derivative financial instruments. PROVISION FOR CREDIT LOSSES The following table summarizes provision for credit losses: INCREASE (DECREASE) --------------- 2007 2006 AMOUNT % -------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Three months ended March 31,......................... $1,700 $866 $834 96.3% Our provision for credit losses increased significantly during the first quarter of 2007 compared to the year-ago quarter due to higher levels of receivables due in part to lower securitization levels, higher levels of delinquency driven by growth, normal portfolio seasoning and the progression of portions of our Mortgage Services portfolio purchased in 2005 and 2006 into various stages of delinquency and charge-off, a higher mix of second lien product in Mortgage Services, increased levels of personal bankruptcy filings as compared to the exceptionally low filing levels experienced in the first quarter of 2006 as a result of the new bankruptcy law in the United States which went into effect in October 2005, and weaker early stage performance in certain Consumer Lending real estate secured loans originated since late 2005 consistent with the industry trends for fixed rate mortgages. Beginning in the second quarter of 2006, we began to experience a deterioration in the performance of mortgage loans acquired in 2005 by our Mortgage Services business, particularly in the second lien and portions of the first lien portfolio which, later in the year, began to affect the same components of loans originated in 2006 by this business, which resulted in higher delinquency, charge-offs and loss estimates in these portfolios. In the first quarter of 2007, we have seen higher levels of net charge-off in these components as the higher delinquency we began to experience in the prior year is now beginning to migrate to charge-off and continuing increased delinquency although the rate of increase in delinquency has slowed from prior quarters. Our provision for credit losses in the first quarter of 2007 also reflects higher loss estimates in second lien loans purchased in 2004 through the third quarter of 2006 by our Consumer Lending business which increased credit loss reserves $87 million during the quarter. At March 31, 2007, the outstanding principal balance of second lien loans acquired by the Consumer Lending business during this period was approximately $1.5 billion. Our provision for credit losses in the first quarter also reflects the impact from a refinement in the methodology used to calculate roll rate percentages at our United Kingdom business which increased credit loss reserves $117 million which we believe reflects a better estimate of probable losses currently inherent in the loan portfolio. Net charge-off dollars increased $560 million during the three months ended March 31, 2007 as compared to the year-ago quarter. This increase was driven by our Mortgage Services business, as loans originated and acquired in 39 HSBC Finance Corporation -------------------------------------------------------------------------------- 2005 and early 2006 are progressing to charge-off as well as higher receivable levels, portfolio seasoning in our credit card portfolio and increased levels of personal bankruptcy filings as compared to the exceptionally low filing levels experienced in the first quarter of 2006 as a result of the new bankruptcy law in the United States. The provision for credit losses may vary from quarter to quarter depending on the product mix and credit quality of loans in our portfolio. See "Credit Quality" included in this MD&A for further discussion of factors affecting the provision for credit losses. OTHER REVENUES The following table summarizes other revenues: INCREASE (DECREASE) -------------- THREE MONTHS ENDED MARCH 31, 2007 2006 AMOUNT % -------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Securitization related revenue...................... $ 21 $ 71 $(50) (70.4)% Insurance revenue................................... 230 244 (14) (5.7) Investment income................................... 26 34 (8) (23.5) Derivative income (expense)......................... (7) 57 (64) (100+) Gain (loss) on debt designated at fair value and related derivatives............................... 144 - 144 100.0 Fee income.......................................... 573 382 191 50.0 Enhancement services revenue........................ 148 123 25 20.3 Taxpayer financial services revenue................. 239 234 5 2.1 Gain on receivable sales to HSBC affiliates......... 95 85 10 11.8 Servicing and other fees from HSBC affiliates....... 133 118 15 12.7 Other income........................................ 40 73 (33) (45.2) ------ ------ ---- ----- Total other revenues................................ $1,642 $1,421 $221 15.6% ====== ====== ==== ===== SECURITIZATION RELATED REVENUE is the result of the securitization of our receivables and includes the following: INCREASE (DECREASE) ---------------- THREE MONTHS ENDED MARCH 31, 2007 2006 AMOUNT % --------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net replenishment gains(1)............................. $ 8 $15 $ (7) (46.7)% Servicing revenue and excess spread.................... 13 56 (43) (76.8) --- --- ---- ----- Total.................................................. $21 $71 $(50) (70.4)% === === ==== ===== -------- ()(1) Net replenishment gains reflect inherent recourse provisions of $5 million in the first quarter of 2007 and $14 million in the first quarter of 2006. The decline in securitization related revenue in the three months ended March 31, 2007 was due to decreases in the level of securitized receivables as a result of our decision in the third quarter of 2004 to structure all new collateralized funding transactions as secured financings. Because existing public credit card transactions were structured as sales to revolving trusts that require replenishments of receivables to support previously issued securities, receivables continue to be sold to these trusts until the revolving periods end, the last of which is currently projected to occur in the fourth quarter of 2007. While the termination of sale treatment on new collateralized funding activity and the reduction of sales under replenishment agreements reduced our reported net income, there is no impact on cash received from operations. Insurance revenue decreased in the first three months of 2007 primarily due to lower insurance sales volumes in our U.K. operations, including a planned phase out of the use of a specific broker between January and April 2007. Insurance revenue in our domestic operations was essentially flat as increases in premiums in the quarter were more than offset by the cancellation effective January 1, 2007 of a policy whereby we pay for losses which exceed a threshold specified in the policy. 40 HSBC Finance Corporation -------------------------------------------------------------------------------- Investment income, which includes income on securities available for sale in our insurance business and realized gains and losses from the sale of securities, decreased in the first three months of 2007 primarily due to lower average investment levels. Derivative income includes realized and unrealized gains and losses on derivatives which do not qualify as effective hedges under SFAS No. 133 as well as the ineffectiveness on derivatives which are qualifying hedges. Prior to the election of FVO reporting for certain fixed rate debt, we accounted for the realized gains and losses on swaps associated with this debt which qualified as effective hedges under SFAS No. 133 in interest expense and any ineffectiveness which resulted from changes in the fair value of the swaps as compared to changes in the interest rate component value of the debt was recorded as a component of derivative income. With the adoption of SFAS No. 159 beginning in January 2007, we eliminated hedge accounting on these swaps and as a result, realized and unrealized gains and losses on these derivatives are now included in Gain (loss) on debt designated at fair value and related derivatives in the consolidated statement of income which impacts the comparability of derivative income between periods. Derivative income is summarized in the table below: THREE MONTHS ENDED MARCH 31, 2007 2006 -------------------------------------------------------------------------------- (IN MILLIONS) Net realized gains (losses)........................................ $(9) $ 4 Mark-to-market on derivatives which do not qualify as effective hedges........................................................... 5 (10) Ineffectiveness.................................................... (3) 63 --- ---- Total.............................................................. $(7) $ 57 === ==== Derivative income decreased in the three months ended March 31, 2007 due to changes in the interest rate curve and to the adoption of SFAS No. 159. Rising interest rates during the fourth quarter of 2005 and the first half of 2006 caused the net outgoing payments on pay variable/received fix economic hedges to increase during the three month period ended March 31, 2007 as compared to the year-ago period. Furthermore, as discussed above, the mark-to-market on the swaps associated with debt we have now designated at fair value, as well as the mark-to-market on the interest rate component of the debt, which accounted for the majority of the ineffectiveness recorded in the first quarter of 2006, is now reported in the consolidated income statement as Gain (loss) on debt designated at fair value and related derivatives. Additionally, subsequent to March 31, 2006, we have redesignated all remaining short cut hedge relationships as hedges under the long-haul method of accounting. Redesignation of swaps as effective hedges reduces the overall volatility of reported mark-to-market income, although re-establishing such swaps as long-haul hedges creates volatility as a result of hedge ineffectiveness. Net income volatility, whether based on changes in interest rates for swaps which do not qualify for hedge accounting, the ineffectiveness recorded on our qualifying hedges under the long haul method of accounting or the impact from adopting SFAS No. 159, affects the comparability of our reported results between periods. Accordingly, derivative income for the three months ended March 31, 2007 should not be considered indicative of the results for any future periods. Gain (loss) on debt designated at fair value and related derivatives reflects fair value changes on our fixed rate debt accounted for under FVO as a result of adopting SFAS No. 159 effective January 1, 2007 as well as the fair value changes and realized gains (losses) on the related derivatives associated with debt designated at fair value. Prior to the election of FVO reporting for certain fixed rate debt, we accounted for the realized gains and losses on swaps associated with this debt which qualified as effective hedges under SFAS No. 133 in interest expense and any ineffectiveness which resulted from changes in the value of the swaps as compared to changes in the interest rate 41 HSBC Finance Corporation -------------------------------------------------------------------------------- component value of the debt was recorded in derivative income. These components are summarized in the table below: THREE MONTHS ENDED MARCH 31, 2007 2006 -------------------------------------------------------------------------------- (IN MILLIONS) Mark-to-market on debt designated at fair value: Interest rate component......................................... $(142) $- Credit risk component........................................... 244 - ----- -- Total mark-to-market on debt designated at fair value............. 102 - Mark-to-market on the related derivatives......................... 118 - Net realized gains (losses) on the related derivatives............ (76) - ----- -- Total............................................................. $ 144 $- ===== == The changes in the fair value of the debt associated with interest rates and the change in the value of the related derivatives reflects a decline in the LIBOR curve during the first quarter of 2007. The changes in credit risk were due to a general widening of financial sector, fixed income credit spreads in combination with specific spread widening attributable to our participation in the subprime mortgage market. Fee income, which includes revenues from fee-based products such as credit cards, increased in the three months ended March 31, 2007 due to higher credit card fees, particularly relating to our non-prime credit card portfolios due to higher levels of credit card receivables. Enhancement services revenue, which consists of ancillary credit card revenue from products such as Account Secure Plus (debt protection) and Identity Protection Plan, was higher in the three months ended March 31, 2007 primarily as a result of higher levels of credit card receivables and higher customer acceptance levels. Taxpayer financial services ("TFS") revenue increased during the three months ended March 31, 2007 due to increased loan volume in the 2007 tax season. Gain on receivable sales to HSBC affiliates includes the daily sales of domestic private label receivable originations (excluding retail sales contracts) and certain credit card account originations to HSBC Bank USA. The increase in the first quarter of 2007 reflects higher sales volumes of domestic private label receivable and credit card account originations as well as higher rates on our credit card account originations. Servicing and other fees from HSBC represents revenue received under service level agreements under which we service credit card and domestic private label receivables as well as real estate secured and auto finance receivables for HSBC affiliates. The increases primarily relate to higher levels of receivables being serviced on behalf of HSBC Bank USA. Other income decreased in the first quarter of 2007 primarily due to lower gains on sales of real estate secured receivables by our Decision One mortgage operations. 42 HSBC Finance Corporation -------------------------------------------------------------------------------- COSTS AND EXPENSES The following table summarizes total costs and expenses: INCREASE (DECREASE) -------------- THREE MONTHS ENDED MARCH 31, 2007 2006 AMOUNT % -------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Salaries and employee benefits...................... $ 609 $ 581 $ 28 4.8% Sales incentives.................................... 68 80 (12) (15.0) Occupancy and equipment expenses.................... 78 83 (5) (6.0) Other marketing expenses............................ 220 173 47 27.2 Other servicing and administrative expenses......... 263 253 10 4.0 Support services from HSBC affiliates............... 285 252 33 13.1 Amortization of intangibles......................... 63 80 (17) (21.3) Policyholders' benefits............................. 124 118 6 5.1 ------ ------ ---- ----- Total costs and expenses............................ $1,710 $1,620 $ 90 5.6% ====== ====== ==== ===== Salaries and employee benefits increased in the first quarter of 2007 as a result of additional staffing, primarily in our Consumer Lending, Retail Services and Canadian operations as well as in our corporate functions to support the growth which has occurred since March 2006. Salary and employee benefits for the first quarter of 2007 also includes employee severance, including benefits for employees to be terminated as part of the announcement in March 2007 to discontinue correspondent channel acquisitions by our Mortgage Services business. These increases were partially offset by lower salary expense in our Credit Card Services operations due to the completion of the integration of the Metris acquisition which occurred in December 2005. Sales incentives decreased in the first quarter of 2007 due to lower origination volumes in our Mortgage Services business due to the decision to reduce purchases including second lien and selected higher risk products in the second half of 2006 as well as lower volumes in our Consumer Lending business. As Mortgage Services terminates loan acquisitions, sales incentives will decrease in the future. Occupancy and equipment expenses decreased in the first quarter of 2007 due to lower repairs and maintenance costs as well as lower depreciation and utility expenses. These decreases were partially offset by higher rental expenses. Other marketing expenses includes payments for advertising, direct mail programs and other marketing expenditures. The increase in the first quarter of 2007 was primarily due to increased domestic credit card and co-branded credit card marketing expenses. Other servicing and administrative expenses increased during the three months ended March 31, 2007 due to higher systems costs and lower deferrals for origination costs due to lower volumes as well as a valuation adjustment of $31 million to record our investment in the U.K. Insurance Operations at the lower of cost or market as a result of designating this operation as "Held for Sale." These increases were partially offset by lower insurance operating expense in our domestic operations and an increase in our estimate of interest receivable of approximately $55 million relating to various contingent tax items with the taxing authority. Support services from HSBC affiliates includes technology and other services charged to us by HSBC Technology and Services (USA) Inc. ("HTSU"), which increased in the first quarter of 2007 primarily due to growth. Amortization of intangibles decreased in the first quarter of 2007 as an individual contractual relationship became fully amortized in the first quarter of 2006. Policyholders' benefits increased in the first quarter of 2007 for both our domestic and U.K. operations. The increase in our domestic operations was due to an increase in claims reserves for expected losses. The increase in our U.K. operations was due to higher claims in the current quarter, partially offset by lower sales volumes. 43 HSBC Finance Corporation -------------------------------------------------------------------------------- Efficiency ratio The following table summarizes our owned basis efficiency ratio: 2007 2006 -------------------------------------------------------------------------------- Three months ended March 31...................................... 38.13% 39.87% Our efficiency ratio improved compared to the prior year quarter. Excluding the $244 million change in fair value on the fixed rate debt related to credit risk resulting from the adoption of SFAS No. 159, the efficiency ratio for the three months ended March 31, 2007 deteriorated from the prior year quarter by 64 basis points. The deterioration was a result of higher provision for credit losses and higher costs and expenses to support receivable growth, partially offset by higher net interest income and higher fee income and enhancement services revenues due to higher levels of receivables. SEGMENT RESULTS - IFRS MANAGEMENT BASIS -------------------------------------------------------------------------------- We have three reportable segments: Consumer, Credit Card Services and International. Our Consumer segment consists of our Consumer Lending, Mortgage Services, Retail Services and Auto Finance businesses. Our Credit Card Services segment consists of our domestic MasterCard, Visa and Discover credit card business. Our International segment consists of our foreign operations in the United Kingdom, Canada, the Republic of Ireland and prior to November 9, 2006, our operations in Slovakia, the Czech Republic and Hungary. The All Other caption includes our Insurance and Taxpayer Financial Services and Commercial businesses, each of which falls below the quantitative threshold test under SFAS No. 131 for determining reportable segments, as well as our corporate and treasury activities. There have been no changes in the basis of our segmentation or any changes in the measurement of segment profit as compared with the presentation in our 2006 Form 10-K. Our segment results are presented on an IFRS Management Basis (a non-U.S. GAAP financial measure) as operating results are monitored and reviewed, trends are evaluated and decisions about allocating resources such as employees are made almost exclusively on an IFRS Management Basis. IFRS Management Basis results are IFRSs results which assume that the private label and real estate secured receivables transferred to HSBC Bank USA have not been sold and remain on our balance sheet. Operations are monitored and trends are evaluated on an IFRS Management Basis because the customer loan sales to HSBC Bank USA were conducted primarily to appropriately fund prime customer loans within HSBC and such customer loans continue to be managed and serviced by us without regard to ownership. However, we continue to monitor capital adequacy, establish dividend policy and report to regulatory agencies on a U.S. GAAP basis. A summary of the significant differences between U.S. GAAP and IFRSs as they impact our results are summarized in Note 11, "Business Segments." CONSUMER SEGMENT The following table summarizes the IFRS Management Basis results for our Consumer segment: INCREASE (DECREASE) --------------- THREE MONTHS ENDED MARCH 31 2007 2006 AMOUNT % --------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net income...................................... $ 238 $ 719 $ (481) (66.9)% Net interest income............................. 2,158 2,182 (24) (1.1) Other operating income.......................... 192 238 (46) (19.3) Loan impairment charges......................... 1,220 550 670 100.0+ Operating expenses.............................. 759 737 22 3.0 Intersegment revenues........................... 58 57 1 1.8 Customer loans.................................. 142,407 134,132 8,275 6.2 Assets.......................................... 142,182 135,874 6,308 4.6 Net interest margin, annualized................. 6.00% 6.62% - - Return on average assets........................ .66 2.15 - - 44 HSBC Finance Corporation -------------------------------------------------------------------------------- Our Consumer segment reported lower net income in the first quarter of 2007 due to higher loan impairment charges, lower net interest income, lower other operating income and higher operating expenses. Loan impairment charges for the Consumer segment increased significantly during the first quarter of 2007 as compared to the year-ago quarter. The increase in loan impairment charges was driven by the progression of mortgage loans acquired in 2005 and 2006 by our Mortgage Services business, particularly in the second lien and portions of the first lien portfolios, to various stages of delinquency and to charge-off. Also contributing to the increase was higher loss estimates at our Consumer Lending business due to receivable growth, portfolio seasoning as well as higher loss estimates in second lien loans purchased in 2004 through the third quarter of 2006 which increased credit loss reserves $87 million during the quarter. At March 31, 2007, the outstanding principal balance of second lien loans acquired by the Consumer Lending business during this period was approximately $1.5 billion. Loan impairment charges during the first quarter of 2006 benefited from historically low levels of bankruptcy filings following the enactment of new bankruptcy law in the United States which became effective in the fourth quarter of 2005. In the first quarter of 2007, we increased loss reserve levels as the provision for credit losses was greater than net charge- offs by $139 million. Net interest income decreased during the first quarter of 2007 as higher finance and other interest income primarily due to higher average customer loans and higher overall yields was more than offset by higher interest expense. Overall yields reflect growth in real estate secured customer loans at current market rates and a greater mix of higher yielding second lien real estate secured loans and personal non-credit card customer loans due to growth. The higher interest expense was due to a larger balance sheet and a significantly higher cost of funds due to a rising interest rate environment. The decrease in net interest margin was a result of the cost of funds increasing more rapidly than our ability to increase receivable yields. The decrease in other operating income in the three months ended March 31, 2007 was primarily due to lower gains on sales of real estate secured receivables by our Decision One mortgage operations, partially offset by higher late and overlimit fees. Operating expenses were higher in the first quarter of 2007 primarily due to lower deferred loan origination costs as mortgage origination volumes have declined. Customer loans for our Consumer segment can be further analyzed as follows: INCREASES (DECREASES) FROM ----------------------------- DECEMBER 31, MARCH 31, 2006 2006 MARCH 31, -------------- ------------ 2007 $ % $ % ------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS) Real estate secured............................ $ 94,159 $(1,212) (1.3)% $5,139 5.8% Auto finance................................... 12,557 90 .7 732 6.2 Private label, including co-branded cards...... 17,477 (979) (5.3) 1,158 7.1 Personal non-credit card....................... 18,214 (65) (.4) 1,246 7.3 -------- ------- ---- ------ --- Total customer loans........................... $142,407 $(2,166) (1.5)% $8,275 6.2% ======== ======= ==== ====== === -------- ()(1) Real estate secured receivables are comprised of the following: INCREASES (DECREASES) FROM ------------------------------- DECEMBER 31, MARCH 31, 2006 2006 MARCH 31, -------------- -------------- 2007 $ % $ % ------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Mortgage Services............................. $46,555 $(2,917) (5.9)% $(2,775) (5.6)% Consumer Lending.............................. 47,604 1,705 3.7 7,914 19.9 ------- ------- ---- ------- ---- Total real estate secured..................... $94,159 $(1,212) (1.3)% $ 5,139 5.8% ======= ======= ==== ======= ==== Customer loans decreased 2 percent at March 31, 2007 as compared to $144.6 billion at December 31, 2006. Real estate secured loans decreased at March 31, 2007 as compared to the prior quarter. The decrease in real estate 45 HSBC Finance Corporation -------------------------------------------------------------------------------- secured loans was primarily at our Mortgage Services business as we have continued to tighten underwriting standards for loans purchased from correspondents, which included the reduction of purchases of second lien and selected higher risk segments. Additionally, in March 2007, we announced our decision to discontinue all loan acquisitions by our Mortgage Services business. Although we will continue the current operating strategies for our Decision One wholesale channel, this will result in significant reductions in our Mortgage Services real estate portfolio throughout 2007 and in subsequent years. The decreases in real estate secured loans at our Mortgage Services business were partially offset by increases in the real estate secured portfolio at our Consumer Lending business as a result of sales volumes in excess of run-off. In addition, the decline in loan prepayments has continued during the first quarter of 2007 which has resulted in lower run-off rates for our real estate secured portfolio. Growth in our auto finance portfolio reflects organic growth and increased volume. The decrease in our private label portfolio is due to normal seasonal run-off, partially offset by growth in the co-branded card portfolio launched by our Retail Services operations during 2006. Compared to March 31, 2006, customer loans increased 6 percent. Real estate growth in 2006 was strong as a result of strong growth in our branch-based Consumer Lending business. In addition, our correspondent business experienced growth through June 2006 as management continued to focus on junior lien loans and expanded our sources for purchasing newly originated loans from flow correspondents. However, as previously discussed above, in the second half of 2006, management revised its business plan and began tightening underwriting standards on loans purchased from correspondents including reducing purchases of second lien and selected higher risk segments. Growth in our branch-based Consumer Lending business reflects strong sales volumes as we continue to emphasize real estate secured loans, including a near-prime mortgage product. Real estate secured customer loans also increased as a result of the acquisition of the $2.5 billion Champion portfolio in November 2006. In addition, a decline in loan prepayments in 2006 resulted in lower run-off rates for our real estate secured portfolio which also contributed to overall growth. Our Auto Finance business also reported organic growth, principally in the near-prime portfolio, from increased volume in both the dealer network and the consumer direct loan program. The private label portfolio increased from the year-ago quarter due to organic growth and the co-branded card portfolio launched by our Retail Services operations during 2006. Growth in our personal non-credit card portfolio was the result of increased marketing, including several large direct mail campaigns. ROA was .66 percent for the first quarter of 2007, compared to 2.15 percent in the year-ago period. The decrease in the ROA ratio in the first quarter of 2007 is primarily due to the increase in loan impairment charges as discussed above, as well as higher average assets. CREDIT CARD SERVICES SEGMENT The following table summarizes the IFRS Management Basis results for our Credit Card Services segment: INCREASE (DECREASE) ------------- THREE MONTHS ENDED MARCH 31 2007 2006 AMOUNT % -------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net income......................................... $ 389 $ 332 $ 57 17.2% Net interest income................................ 821 732 89 12.2 Other operating income............................. 698 478 220 46.0 Loan impairment charges............................ 420 249 171 68.7 Operating expenses................................. 483 434 49 11.3 Intersegment revenues.............................. 5 5 - - Customer loans..................................... 27,843 24,874 2,969 11.9 Assets............................................. 27,793 25,477 2,316 9.1 Net interest margin, annualized.................... 11.74% 11.40% - - Return on average assets........................... 5.54 4.99 - - 46 HSBC Finance Corporation -------------------------------------------------------------------------------- Our Credit Card Services segment reported higher net income in the first quarter of 2007. The increase in net income was primarily due to higher net interest income and higher other operating income, partially offset by higher loan impairment charges and higher operating expenses. Net interest income increased in the three months ended March 31, 2007 largely as a result of higher overall yields due in part to higher levels of non-prime customer loans, partially offset by higher interest expense. Net interest margin increased primarily due to higher overall yields due to increases in non-prime customer loans, higher pricing on variable rate products and other repricing initiatives. These increases were partially offset by a higher cost of funds. Although our non-prime customer loans tend to have smaller balances, they generate higher returns both in terms of net interest margin and fee income. Increases in other operating income resulted from portfolio growth which resulted in higher late fees, higher overlimit fees and higher enhancement services revenue from products such as Account Secure Plus (debt waiver) and Identity Protection Plan. Higher operating expenses were also incurred to support receivable growth including increases in marketing expenses. The increase in marketing expenses in the first quarter of 2007 was due to increased investment in our non-prime portfolio. Loan impairment charges were higher in the first quarter of 2007 due to higher net charge-off reflecting receivable growth and portfolio seasoning as well as an increase in bankruptcy filings as compared to the year-ago period which benefited from reduced levels of personal bankruptcy filings following the enactment of new bankruptcy law in the United States which went into effect in October 2005. We reduced loss reserves by recording loss provision less than net charge-off of $27 million in the first quarter of 2007 as overall consumer loans outstanding declined due to normal seasonal run-off. Customer loans decreased 1 percent to $27.8 billion compared to $28.2 billion at December 31, 2006. The decrease during the quarter was due primarily to normal seasonal run-off, partially offset by growth in our non-prime portfolio, including Metris. Compared to March 31, 2006, customer loans increased 12 percent. The increase reflects strong domestic organic growth in our Union Privilege as well as other non-prime portfolios, including Metris. The increase in ROA in the first quarter of 2007 is primarily due to the higher net income as discussed above, partially offset by higher average assets. INTERNATIONAL SEGMENT The following table summarizes the IFRS Management Basis results for our International segment: INCREASE (DECREASE) ---------------- THREE MONTHS ENDED MARCH 31 2007 2006 AMOUNT % --------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net (loss) income................................ $ (90) $ 22 $(112) (100.0+)% Net interest income.............................. 204 210 (6) (2.9) Other operating income........................... 47 41 6 14.6 Loan impairment charges.......................... 248 104 144 100.0+ Operating expenses............................... 128 112 16 14.3 Intersegment revenues............................ 5 7 (2) (28.6) Customer loans................................... 9,506 9,176 330 3.6 Assets........................................... 10,238 10,900 (662) (6.1) Net interest margin, annualized.................. 8.20% 8.52% - - Return on average assets......................... (3.43) .79 - - Our International segment reported lower net income in the first quarter of 2007 primarily due to higher loan impairment charges, higher operating expenses and lower net interest income, partially offset by higher other 47 HSBC Finance Corporation -------------------------------------------------------------------------------- operating income. Applying constant currency rates, which uses the average rate of exchange for the 2006 quarter to translate current period net income, the net loss in the first quarter of 2007 would have been lower by $13 million. Loan impairment charges increased in the first quarter of 2007 primarily due to a refinement in the methodology used to calculate roll rate percentages by our U. K. operations which increased credit loss reserves $117 million and which we believe reflects a better estimate of probable losses currently inherent in the loan portfolio. Despite the challenging financial circumstances faced by some of our customers in the U.K., the performance of our U.K. loan portfolios as measured by delinquency and charge-offs was steady during the first quarter of 2007. Loss reserves at our Canadian operations increased $3 million due to receivable growth. Net interest income decreased during the first quarter of 2007 primarily as a result of lower receivable levels in our U.K. subsidiary and higher interest expense. The lower receivable levels were due to decreased sales volumes in the U.K. resulting from a continuing challenging credit environment in the U.K. as well as the sale of our European Operations in November 2006. This was partially offset by higher net interest income in our Canadian operations due to growth in customer loans. Net interest margin decreased in the first quarter of 2007 primarily due to lower yields on customer loans due to a focus over the last six months on secured lending, which have lower yields, rather than unsecured lending, the impact of the sale of the European Operations in November 2006 as well as a higher cost of funds. Other operating income increased in the first quarter of 2007, due to higher credit card fee income in our Canadian operations, partially offset by lower insurance revenues in the U.K. due to lower sales volumes and a planned phase out of the use of a specific broker between January and April 2007. Operating expenses increased to support receivable growth. Customer loans for our International segment can be further analyzed as follows: INCREASES (DECREASES) FROM ---------------------------- DECEMBER 31, MARCH 31, 2006 2006 MARCH 31, ------------ ------------- 2007 $ % $ % ------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS) Real estate secured............................. $3,717 $ 165 4.6% $ 624 20.2% Auto finance.................................... 233 (13) (5.3) 69 42.1 Credit card..................................... 2,255 25 1.1 188 9.1 Private label................................... 303 (7) (2.3) 30 11.0 Personal non-credit card........................ 2,998 (184) (5.8) (581) (16.2) ------ ----- ---- ----- ----- Total customer loans............................ $9,506 $ (14) (.1)% $ 330 3.6% ====== ===== ==== ===== ===== Customer loans were $9.5 billion at March 31, 2007 and December 31, 2006. Increases in both the secured and unsecured portfolios of our Canadian operations were offset by lower personal non-credit card loans in our U.K. operations. Applying constant currency rates, customer loans at March 31, 2007 would not have been materially different using December 31, 2006 exchange rates. Compared to March 31, 2006, receivables increased 4 percent primarily as a result of foreign exchange impacts. Applying constant currency rates, customer loans at March 31, 2007 would have been approximately $670 million lower. Excluding the positive foreign exchange impacts, lower customer loans in our U.K. operations were partially offset by higher customer loans in our Canadian business. Our U.K. based private label loans decreased due to continuing lower retail sales volume following a slow down in retail consumer spending. Lower personal non-credit card loans in the U.K. reflect lower volumes as the U.K. branch network has placed a greater emphasis on secured lending. Additionally, receivable levels at March 31, 2007 reflect the sale in November 2006 of $203 million of customer loans related to our European operations. The increase in our Canadian business is due to growth in both the secured and unsecured customer loan portfolios of our Canadian operations. 48 HSBC Finance Corporation -------------------------------------------------------------------------------- ROA was (3.43) percent for the first quarter of 2007 compared to .79 percent in the year-ago period. The decrease in the ROA ratio in the first quarter of 2007 is primarily due to the increase in loan impairment charges as discussed above, partially offset by lower average assets. As part of our continuing evaluation of strategic alternatives with respect to our U.K. operations, we have entered into a non-binding agreement to sell the capital stock of our U.K. Insurance Operations to a third party for cash. The sales price will be determined, in part, based on the actual net book value of the assets sold at the time the sale is closed which is anticipated in the third quarter of 2007. The agreement also provides for the purchaser to distribute insurance products through our U.K. branch network for which we will receive commission revenue. The sale is subject to satisfactory completion of final due diligence, the execution of a definitive agreement, and any regulatory approvals that may be required. At March 31, 2007, we have classified the U.K. Insurance Operations as "Held for Sale" which included $470 million of assets and liabilities of $236 million within the International segment. After taking into consideration the goodwill allocated to the U.K. Insurance Operations of $79 million, which is included in the "All Other" caption within our segment disclosures, the carrying value of the U.K. Insurance Operations was higher than the estimated purchase price based on the March 31, 2007 net book value. The adjustment of $37 million to record our investment in these operations at the lower of cost or market has been recorded in the "All Other" caption. We continue to evaluate the scope of our other U.K. operations. CREDIT QUALITY -------------------------------------------------------------------------------- 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. 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. If customer account management policies, or changes thereto, shift loans from a "higher" delinquency bucket to a "lower" delinquency bucket, this will be reflected in our roll rate statistics. To the extent that restructured accounts have a greater propensity to roll to higher delinquency buckets, this will be captured in the roll rates. Since the loss reserve is computed based on the composite of all of these calculations, this increase in roll rate will be applied to receivables in all respective delinquency buckets, which will increase the overall reserve level. In addition, loss reserves on consumer receivables are maintained to reflect our judgment of portfolio risk factors that may not be fully reflected in the statistical roll rate calculation. Risk factors considered in establishing loss reserves on consumer receivables include recent growth, product mix, bankruptcy trends, geographic concentrations, 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, reserves as a percentage of net charge-offs and number of months charge-off coverage 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 49 HSBC Finance Corporation -------------------------------------------------------------------------------- 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 summarizes credit loss reserves: MARCH 31, DECEMBER 31, MARCH 31, 2007 2006 2006 ------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS) Owned credit loss reserves.......................... $6,798 $6,587 $4,468 Reserves as a percent of: Receivables....................................... 4.25% 4.07% 3.04% Net charge-offs(1)................................ 114.2 119.9 120.4 Nonperforming loans............................... 116.1 114.8 103.3 -------- ()(1) Quarter-to-date, annualized. Credit loss reserve levels at March 31, 2007 increased as compared to December 31, 2006 as we recorded loss provision in excess of net charge-offs of $212 million during the three months ended March 31, 2007. This increase was largely due to higher reserve requirements in our Consumer Lending and United Kingdom businesses. At our Consumer Lending business, we recorded loss provision in excess of net charge-offs of $115 million primarily due to higher loss estimates in second lien loans purchased from 2004 through the third quarter of 2006. At March 31, 2007, the outstanding principal balance of second lien loans acquired by the Consumer Lending business during this period was approximately $1.5 billion. Our United Kingdom business recorded loss provision in excess of net charge-off of $106 million which was largely attributable to a refinement in the methodology used to calculate roll rate percentages which we believe reflects a better estimate of probable loss currently inherent in the loan portfolio. We recorded loss provision in excess of net charge-offs at our Mortgage Services business of $55 million primarily due to continued higher delinquency levels as previously discussed although the rate of increase has slowed from prior quarters. These increases were partially offset by the impact of normal seasonal run-off in our credit card portfolio as well as seasonal improvements in our collection activities in the first quarter as customers across our businesses use their tax refunds to reduce their outstanding balances. Credit loss reserves at March 31, 2007 increased significantly as compared to March 31, 2006 primarily as a result of the higher delinquency and loss estimates at our Mortgage Services business. In addition, the higher credit loss reserve levels are the result of higher levels of receivables due in part to lower securitization levels, higher dollars of delinquency in our other businesses driven by growth and portfolio seasoning, weakening early stage performance consistent with the industry trend in certain Consumer Lending real estate secured loans originated since late 2005 and increased levels of personal bankruptcy filings as compared to the exceptionally low levels experienced in the first quarter of 2006 following enactment of new bankruptcy legislation in the United States. As previously discussed, we are experiencing higher delinquency and loss estimates at our Mortgage Services business as compared to the year-ago period. Credit loss reserve levels of $2.1 billion at our Mortgage Services business at March 31, 2007, which are consistent with our credit loss reserve levels at December 31, 2006, reflect our best estimate of losses in the portfolio. In establishing these reserve levels we considered the severity of losses expected to be incurred, particularly in our second lien portfolio, above our historical experience given the current housing market trends in the United States. We also considered the ability of borrowers to repay their first lien adjustable rate mortgage loans at higher contractual reset rates given increases in interest rates by the Federal Reserve Bank from June 2004 through June 2006, 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. A significant portion of the Mortgage Services second lien 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 50 HSBC Finance Corporation -------------------------------------------------------------------------------- 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 behave like unsecured loans. As a result, expected losses for these second lien loans held in our Mortgage Services portfolio are included in our credit loss reserve levels at March 31, 2007. Reserves as a percentage of receivables at March 31, 2007 were higher than at March 31, 2006 and December 31, 2006 due to the impact of additional reserve requirements as discussed above and, compared to December 31, 2006, lower receivable levels. Reserves as a percentage of net charge-offs decreased as compared to March 31, 2006 as the higher net charge-offs in our Credit Card Services and Mortgage Services business in the first quarter of 2007 more than offset the increase in reserves, primarily at our Mortgage Services business. The increase in charge-offs in our Credit Card Services business is due to increased levels of personal bankruptcy filings as compared to the exceptionally low levels experienced in the first quarter of 2006 following enactment of the new bankruptcy law in the United States. Compared to December 31, 2006, reserves as a percentage of net charge-offs decreased slightly as charge-offs increased more rapidly than reserve levels during the quarter. Reserves as a percentage of nonperforming loans increased as compared to both March 31, 2006 and December 31, 2006 as reserve levels grew more rapidly than nonperforming loans primarily due to the higher reserve requirements in our Consumer Lending and United Kingdom businesses as previously discussed. DELINQUENCY The following table summarizes two-months-and-over contractual delinquency (as a percent of consumer receivables): MARCH 31, DECEMBER 31, MARCH 31, 2007 2006 2006 ------------------------------------------------------------------------------------------ Real estate secured(1).............................. 3.73% 3.54% 2.46% Auto finance........................................ 2.32 3.18 2.17 Credit card......................................... 4.53 4.57 4.35 Private label....................................... 5.27 5.31 5.50 Personal non-credit card............................ 10.21 10.17 8.86 ----- ----- ---- Total consumer...................................... 4.64% 4.59% 3.66% ===== ===== ==== -------- ()(1) Real estate secured two-months-and-over contractual delinquency (as a percent of consumer receivables) are comprised of the following: MARCH 31, DECEMBER 31, MARCH 31, 2007 2006 2006 ------------------------------------------------------------------------------------------- Mortgage Services: First lien......................................... 4.98% 4.50% 2.94% Second lien........................................ 6.69 5.74 1.83 ---- ---- ---- Total Mortgage Services.............................. 5.33 4.75 2.70 Consumer Lending: First lien......................................... 2.01 2.07 1.87 Second lien........................................ 3.32 3.06 2.68 ---- ---- ---- Total Consumer Lending............................... 2.20 2.21 1.99 Foreign and all other: First lien......................................... 1.65 1.58 1.77 Second lien........................................ 5.07 5.38 5.57 ---- ---- ---- Total Foreign and all other.......................... 4.35 4.59 4.88 ---- ---- ---- Total real estate secured............................ 3.73% 3.54% 2.46% ==== ==== ==== Total delinquency increased 5 basis points, compared to the prior quarter. The increase was due to higher real estate secured delinquency levels primarily at our Mortgage Services business as previously discussed, partially offset by lower delinquency levels at our Auto Finance business. Two-months-and-over contractual delinquency as a 51 HSBC Finance Corporation -------------------------------------------------------------------------------- percentage of consumer receivables was broadly flat in the quarter across all our other products which included seasonal improvements in our collection activities in the first quarter as customers use their tax refunds to reduce their outstanding balances. The decrease in our auto finance portfolio ratio reflects seasonal improvements in collection activities as well as the impact of the change in the charge-off policy in the fourth quarter of 2006 as accounts are now charging off sooner. The increase in delinquency in our personal non- credit card portfolio ratio reflects maturation of a growing domestic portfolio as well as slight deterioration of certain customer groups in our domestic portfolio. Dollars of delinquency decreased slightly compared to the prior quarter as increases in delinquency in our real estate secured portfolios were more than offset by decreases in other products, particularly in our auto finance portfolio, as discussed above. Compared to the year-ago period, total delinquency increased 98 basis points largely due to higher real estate secured delinquency levels primarily at our Mortgage Services business as previously discussed. With the exception of our private label portfolio, all products reported higher delinquency levels due to higher receivable levels. Additionally, the increase in the Consumer Lending real estate delinquency ratio reflects the addition of the Champion portfolio. While the Champion portfolio carries higher delinquency, its low loan-to-value ratios are expected to result in lower charge-offs compared to the existing portfolio. The increase in our auto finance and credit card delinquency ratios is due to the seasoning of a growing portfolio. The increase in the credit card delinquency levels is also due to higher bankruptcy levels. 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 as well as deterioration of certain customer groups in our domestic portfolio. NET CHARGE-OFFS OF CONSUMER RECEIVABLES The following table summarizes net charge-offs of consumer receivables (as a percent, annualized, of average consumer receivables): MARCH 31, DECEMBER 31, MARCH 31, 2007 2006 2006 ------------------------------------------------------------------------------------------ Real estate secured(1).............................. 1.74% 1.28% .75% Auto finance(2)..................................... 3.64 4.97 3.50 Credit card......................................... 7.08 6.79 4.00 Private label(2).................................... 5.87 6.68 5.62 Personal non-credit card(2)......................... 7.96 7.92 7.94 ---- ---- ---- Total(2)............................................ 3.69% 3.46% 2.58% ==== ==== ==== Real estate secured net charge-offs and REO expense as a percent of average real estate secured receivables....................................... 1.86% 1.68% .89% -------- ()(1) Real estate secured net charge-off of consumer receivables as a percent, annualized, of average consumer receivables are comprised of the following: 52 HSBC Finance Corporation -------------------------------------------------------------------------------- MARCH 31, DECEMBER 31, MARCH 31, 2007 2006 2006 ------------------------------------------------------------------------------------------- Mortgage Services: First lien......................................... 1.17% .91% .67% Second lien........................................ 7.97 4.40 1.15 ---- ---- ---- Total Mortgage Services.............................. 2.55 1.66 .77 Consumer Lending: First lien......................................... .80 .85 .71 Second lien........................................ 1.93 1.02 1.01 ---- ---- ---- Total Consumer Lending............................... .96 .88 .75 Foreign and all other: First lien......................................... 1.34 .89 .24 Second lien........................................ 1.29 1.15 .63 ---- ---- ---- Total Foreign and all other.......................... 1.30 1.10 .56 ---- ---- ---- Total real estate secured............................ 1.74% 1.28% .75% ==== ==== ==== -------- ()(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. 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 private label net charge-off ratio would have been 5.85 percent and the personal non-credit card net charge-off ratio would have been 6.32 percent in the quarter ended December 31, 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. Net charge-offs as a percent, annualized, of average consumer receivables increased 23 basis points compared to the prior quarter primarily due to higher charge-offs in our real estate secured portfolios, in particular at our Mortgage Services business due to the progression to charge-off of certain loans acquired in 2005 and 2006. We anticipate the increase in the net charge-off ratio for our real estate secured portfolio will continue throughout 2007 as the loans purchased by Mortgage Services in 2005 and 2006 continue to progress to various stages of delinquency and ultimately charge-off. The increase in the Consumer Lending real estate secured net charge-off ratio was primarily due to portfolio seasoning. The charge-off ratio for our Auto Finance business decreased due to the seasonal improvements in collection activities in the first quarter as well as the impact of the one-time acceleration of charge-offs in December 2006 related to the change in the charge-off policy described above. The increase in our credit card ratio is due to the seasoning of a growing portfolio, partially offset by seasonal improvements in collection activities. Excluding the impact of the discontinuance of a forbearance program in our U.K. business in the prior quarter, the private label charge-off ratio was essentially flat compared to the prior quarter. Excluding the impact of the discontinuance of a forbearance program in our U.K. business in the prior quarter, the personal non-credit card charge-off ratio increased reflecting portfolio seasoning as well as a slight deterioration of certain customer groups in our domestic portfolio. As compared to the prior year quarter, net charge-offs as a percent, annualized, of average consumer receivables increased 111 basis points primarily due to higher charge-offs in our real estate secured portfolios, as discussed above, as well as higher charge-offs in our credit card portfolio. The increase in charge- offs in the credit card portfolio is due to increased levels of personal bankruptcy filings as compared to the exceptionally low levels experienced in the first quarter of 2006 following enactment of the new bankruptcy law in the United States. The increase in the auto finance portfolio is due to seasoning of a growing portfolio. 53 HSBC Finance Corporation -------------------------------------------------------------------------------- NONPERFORMING ASSETS MARCH 31, DECEMBER 31, MARCH 31, 2007 2006 2006 ------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS) Nonaccrual receivables(1),(2)....................... $4,945 $4,807 $3,582 Accruing consumer receivables 90 or more days delinquent........................................ 909 929 742 Renegotiated commercial loans....................... 1 1 1 ------ ------ ------ Total nonperforming receivables..................... 5,855 5,737 4,325 Real estate owned................................... 863 794 563 ------ ------ ------ Total nonperforming assets.......................... $6,718 $6,531 $4,888 ====== ====== ====== Credit loss reserves as a percent of nonperforming receivables....................................... 116.1% 114.8% 103.3% -------- ()(1) Nonaccrual receivables are comprised of the following: MARCH 31, DECEMBER 31, MARCH 31, 2007 2006 2006 ------------------------------------------------------------------------------------------- (IN MILLIONS) Real estate secured: Closed-end: First lien......................................... $2,032 $1,893 $1,352 Second lien........................................ 521 482 320 Revolving: First lien......................................... 17 22 29 Second lien........................................ 225 187 72 ------ ------ ------ Total real estate secured............................ 2,795 2,584 1,773 Auto finance......................................... 291 394 241 Credit card.......................................... - - - Private label........................................ 77 76 77 Personal non-credit card............................. 1,782 1,753 1,490 Commercial and other................................. - - 1 ------ ------ ------ Total nonaccrual receivables......................... $4,945 $4,807 $3,582 ====== ====== ====== -------- ()(2) As previously discussed, in December 2006, our Auto Finance business changed its charge-off policy and in connection with this policy change also changed the methodology for reporting two-months-and-over contractual delinquency. These changes resulted in an increase in nonaccrual receivables at December 31, 2006. Prior period amounts have been restated to conform to the current year presentation. Compared to December 31, 2006, the increase in total nonperforming assets is due to higher levels of real estate secured nonaccrual receivables at our Mortgage Services business due to the progression of certain loans acquired in 2005 and 2006 to various stages of delinquency as previously discussed. Real estate secured nonaccrual loans included stated income loans at our Mortgage Services business of $682 million at March 31, 2007, $571 million at December 31, 2006, and $194 million at March 31, 2006. Consistent with industry practice, accruing consumer receivables 90 or more days delinquent includes domestic credit card receivables. ACCOUNT MANAGEMENT POLICIES AND PRACTICES Our policies and practices for the collection of consumer receivables, including our customer account management policies and practices, permit us to reset the contractual delinquency status of an account to current, based on indicia or criteria which, in our judgment, evidence continued payment probability. Such policies and practices vary by product and are designed to manage customer relationships, maximize collection opportunities and avoid foreclosure or repossession if reasonably possible. If the account subsequently experiences payment defaults, it will again become contractually delinquent. 54 HSBC Finance Corporation -------------------------------------------------------------------------------- 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. 55 HSBC Finance Corporation -------------------------------------------------------------------------------- TOTAL RESTRUCTURED BY RESTRUCTURE PERIOD - DOMESTIC PORTFOLIO(1) (MANAGED BASIS) MARCH 31, DECEMBER 31, MARCH 31, 2007 2006 2006 ------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS) Never restructured.................................. 87.9% 89.1% 89.7% Restructured: Restructured in the last 6 months................. 5.6 4.8 4.0 Restructured in the last 7-12 months.............. 2.8 2.4 2.4 Previously restructured beyond 12 months.......... 3.7 3.7 3.9 ------- ------- ------- Total ever restructured(2)........................ 12.1 10.9 10.3 ------- ------- ------- Total............................................... 100.0% 100.0% 100.0% ======= ======= ======= TOTAL RESTRUCTURED BY PRODUCT - DOMESTIC PORTFOLIO(1) (MANAGED BASIS) Real estate secured................................. $11,779 $10,344 $ 8,395 Auto finance........................................ 1,919 1,881 1,712 Credit card......................................... 802 816 937 Private label(3).................................... 30 31 26 Personal non-credit card............................ 3,722 3,600 3,411 ------- ------- ------- Total............................................... $18,252 $16,672 $14,481 ======= ======= ======= (AS A PERCENT OF MANAGED RECEIVABLES) Real estate secured................................. 12.7% 11.0% 9.7% Auto finance........................................ 15.3 15.1 14.5 Credit card......................................... 2.9 2.9 3.8 Private label(3).................................... 11.5 10.9 7.3 Personal non-credit card............................ 20.3 19.5 19.9 ------- ------- ------- Total(2)............................................ 12.1% 10.9% 10.3% ======= ======= ======= -------- ()(1) Excludes foreign businesses, commercial and other. ()(2) Total including foreign businesses was 11.7 percent at March 31, 2007, 10.6 percent at December 31, 2006 and 10.1 percent at March 31, 2006. ()(3) Only reflects consumer lending retail sales contracts which have historically been classified as private label. All other domestic private label receivables were sold to HSBC Bank USA in December 2004. The increase in restructured loans was primarily attributable to higher levels of real estate secured restructures due to portfolio growth and seasoning, including higher restructure levels at our Mortgage Services business 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 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 beginning in the fourth quarter of 2006. See "Credit Quality Statistics" for further information regarding owned basis and managed basis delinquency, charge-offs and nonperforming loans. The amount of domestic and foreign managed receivables in forbearance, modification (excluding Mortgage Services for March 31, 2007 and December 31, 2006), credit card services approved consumer credit counseling accommodations, rewrites or other customer account management techniques for which we have reset delinquency and that is not included in the restructured or delinquency statistics was approximately $.3 billion or .2 percent of managed receivables at March 31, 2007 and December 31, 2006, and $.4 billion or .3 percent of managed receivables at March 31, 2006. 56 HSBC Finance Corporation -------------------------------------------------------------------------------- LIQUIDITY AND CAPITAL RESOURCES -------------------------------------------------------------------------------- We continue to focus on balancing our use of affiliate and third party funding sources to minimize funding expense while managing liquidity. During the first quarter of 2007, we supplemented unsecured debt issuances with proceeds from the continuing sale of newly originated domestic private label receivables to HSBC Bank USA, debt issued to affiliates and increased levels of secured financings. Debt due to affiliates and other HSBC related funding are summarized in the following table: MARCH 31, DECEMBER 31, 2007 2006 -------------------------------------------------------------------------------------- (IN BILLIONS) Debt issued to HSBC subsidiaries: Drawings on bank lines in the U.K. and Europe............. $ 4.2 $ 4.3 Term debt................................................. 10.6 10.6 Preferred securities issued by Household Capital Trust VIII to HSBC........................................... .3 .3 ----- ----- Total debt outstanding to HSBC subsidiaries............... 15.1 15.2 ----- ----- Debt outstanding to HSBC clients: Euro commercial paper..................................... 2.9 3.0 Term debt................................................. 1.1 1.2 ----- ----- Total debt outstanding to HSBC clients.................... 4.0 4.2 Cash received on bulk and subsequent sales of domestic private label credit card receivables to HSBC Bank USA, net (cumulative).......................................... 17.2 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............................................... (4.9) (4.7) ----- ----- Total real estate secured receivable activity with HSBC Bank USA....................................................... 3.0 3.2 ----- ----- Cash received from sale of European Operations to HBEU affiliate................................................. -(1) -(1) Cash received from sale of U.K. credit card business to HBEU...................................................... 2.7 2.7 Capital contribution by HSBC Investments (North America) Inc. ("HINO") (cumulative)................................ 1.6 1.4 ----- ----- Total HSBC related funding.................................. $43.6 $44.6 ===== ===== -------- ()(1) Less than $100 million. Funding from HSBC, including debt issuances to HSBC subsidiaries and clients, represented 13 percent of our total debt and preferred stock funding at March 31, 2007 and December 31, 2006. Cash proceeds of $46 million from the November 2006 sale of the European Operations and the December 2005 sale of our U.K. credit card receivables to HBEU of $2.7 billion in cash were used to partially pay down drawings on bank lines from HBEU for the U.K. and fund operations. Proceeds received from the bulk sale and subsequent daily sales of domestic private label credit card receivables to HSBC Bank USA of $17.9 billion were used to pay down short-term domestic borrowings, including outstanding commercial paper balances, and to fund operations. At March 31, 2007, 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. At March 31, 2007, $4.2 billion was outstanding under the HBEU lines for the U.K. and no balances were outstanding under the domestic lines. At March 31, 2007, we had derivative contracts with a notional value of $83.0 billion, or approximately 87 percent of total derivative contracts, outstanding with HSBC affiliates. At December 31, 2006, we 57 HSBC Finance Corporation -------------------------------------------------------------------------------- had derivative contracts with a notional value of $82.8 billion, or approximately 88 percent of total derivative contracts, outstanding with HSBC affiliates. SECURITIES AND OTHER SHORT-TERM INVESTMENTS Securities totaled $4.1 billion at March 31, 2007 and $4.7 billion at December 31, 2006. Securities purchased under agreements to resell totaled $59 million at March 31, 2007 and $171 million at December 31, 2006. Interest bearing deposits with banks totaled $87 million at March 31, 2007 and $424 million at December 31, 2006. The decreases in securities and interest bearing deposits with banks is largely due to the reclassification of the assets of the U.K. Insurance Operations which at March 31, 2007 are classified as "Held for Sale." COMMERCIAL PAPER, BANK AND OTHER BORROWINGS totaled $10.9 billion at March 31, 2007 and $11.1 billion at December 31, 2006. Our funding strategy requires that bank credit facilities will at all times exceed 85% of outstanding commercial paper and that the combination of bank credit facilities and undrawn committed conduit facilities will, at all times, exceed 115% of outstanding commercial paper. Included in this total was outstanding Euro commercial paper sold to customers of HSBC of $2.9 billion at March 31, 2007 and $3.0 billion at December 31, 2006. LONG TERM DEBT (with original maturities over one year) decreased to $125.5 billion at March 31, 2007 from $127.6 billion at December 31, 2006. Significant issuances during the first quarter of 2007 included the following: - $.2 billion of InterNotes(SM) (retail-oriented medium-term notes) - $1.0 billion of global debt - $3.1 billion of securities backed by 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. COMMON EQUITY In the first quarter of 2007, HINO made a capital contribution of $200 million to support ongoing operations. In 2006, in connection with our purchase of the Champion portfolio, HINO made a capital contribution of $163 million. SELECTED CAPITAL RATIOS In managing capital, we develop targets for tangible shareholder's(s') equity to tangible managed assets ("TETMA"), tangible shareholder's(s') equity plus owned loss reserves to tangible managed assets ("TETMA + Owned Reserves") and tangible common equity to tangible managed assets. These ratio targets are based on discussions with HSBC and rating agencies, risks inherent in the portfolio, the projected operating environment and related risks, and any acquisition objectives. These ratios exclude the equity impact of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," 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 credit risk on debt for which we elected the fair value option. Preferred securities issued by certain non-consolidated trusts are also considered equity in the TETMA and 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. We and certain rating agencies also monitor our equity ratios excluding the impact of the HSBC acquisition purchase accounting adjustments. We do so because we believe that the HSBC acquisition purchase accounting adjustments represent non-cash transactions which do not affect our business operations, cash flows or ability to meet our debt obligations. Our targets may change from time to time to accommodate changes in the operating environment or other considerations such as those listed above. 58 HSBC Finance Corporation -------------------------------------------------------------------------------- SELECTED CAPITAL RATIOS are summarized in the following table: MARCH 31, DECEMBER 31, 2007 2006 -------------------------------------------------------------------------------------- TETMA(1).................................................... 7.49% 7.16% TETMA + Owned Reserves(1)................................... 11.55 11.02 Tangible common equity to tangible managed assets(1)........ 6.39 6.08 Common and preferred equity to owned assets................. 11.09 11.13 Excluding purchase accounting adjustments: TETMA(1).................................................. 8.07% 7.80% TETMA + Owned Reserves(1)................................. 12.13 11.66 Tangible common equity to tangible managed assets(1)...... 6.96 6.72 -------- ()(1) TETMA, TETMA + Owned Reserves and tangible common equity to tangible managed assets represent non-U.S.GAAP financial ratios that are used by HSBC Finance Corporation management and certain rating agencies to evaluate capital adequacy and may differ from similarly named measures presented by other companies. See "Basis of Reporting" for additional discussion on the use of non-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. 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 often are more cost-effective than 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 will continue to be sold to these trusts and the resulting replenishment gains recorded until the revolving periods end, the last of which is currently projected to occur in the fourth quarter 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. Because we believe the market for securities backed by receivables is a reliable, efficient and cost-effective source of funds, we will continue to use secured financings of consumer receivables as a source of our funding and liquidity. There were no securitizations (excluding replenishments of certificateholder interests) during the first quarter of 2007 or 2006. Secured financings are summarized in the following table: THREE MONTHS ENDED MARCH 31 2007 2006 --------------------------------------------------------------------------------- (IN MILLIONS) SECURED FINANCINGS: Real estate secured............................................. $ - $ 350 Credit card..................................................... 1,890 1,120 Auto finance.................................................... 1,069 - Personal non-credit card........................................ 110 - ------ ------ Total........................................................... $3,069 $1,470 ====== ====== Our securitized receivables totaled $795 million at March 31, 2007 compared to $949 million at December 31, 2006. As of March 31, 2007, outstanding secured financings of $23.4 billion were secured by $30.1 billion of real estate secured, auto finance, credit card and personal non-credit card receivables. Secured financings of 59 HSBC Finance Corporation -------------------------------------------------------------------------------- $21.8 billion at December 31, 2006 were secured by $28.1 billion of real estate secured, auto finance, credit card and personal non-credit card receivables. At March 31, 2007, securitizations structured as sales represented 1 percent and secured financings represented 15 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. 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. MARCH 31, DECEMBER 31, 2007 2006 -------------------------------------------------------------------------------------- (IN BILLIONS) Private label, and credit cards............................. $190 $186 Other consumer lines of credit.............................. 7 7 ---- ---- Open lines of credit(1)..................................... $197 $193 ==== ==== -------- ()(1) Includes an estimate for acceptance of credit offers mailed to potential customers prior to March 31, 2007 and December 31, 2006, respectively. At March 31, 2007, our Mortgage Services business had commitments with numerous correspondents to purchase up to $188 million of real estate secured receivables at fair market value, subject to availability based on current underwriting guidelines specified by our Mortgage Services business and at prices indexed to general market rates. These commitments have terms of up to one year, the last of which expires in June, 2007. Also at March 31, 2007, our Mortgage Services business had outstanding forward sales commitments relating to real estate secured loans totaling $352 million and unused commitments to extend credit relating to real estate secured loans to customers (as long as certain conditions are met), totaling $740 million. At March 31, 2007, we also had a commitment to lend up to $120 million to H&R Block to fund its acquisition of a participation interest in refund anticipation loans for the 2007 tax season. At March 31, 2007, H&R Block had $72 million outstanding under this commitment which is due no later than June 30, 2007. 2007 FUNDING STRATEGY Our current estimated domestic funding needs and sources for 2007 are summarized in the table that follows: ACTUAL ESTIMATED JANUARY 1 APRIL 1 THROUGH THROUGH ESTIMATED MARCH 31, DECEMBER 31, FULL YEAR 2007 2007 2007 ------------------------------------------------------------------------------------------ (IN BILLIONS) FUNDING NEEDS: Net asset growth.................................. $(3) $(7) - 3 $(10) -0 Commercial paper, term debt and securitization maturities..................................... 19 11 - 17 30 - 36 Other............................................. (1) 2 - 4 1 - 3 --- -------- -------- Total funding needs............................... $15 $ 6 - 24 $ 21 -39 === ======== ======== FUNDING SOURCES: External funding, including commercial paper...... $15 $ 5 - 21 $20 - 36 HSBC and HSBC subsidiaries........................ - 1 - 3 1 - 3 --- -------- -------- Total funding sources............................. $15 $ 6 - 24 $21 - 39 === ======== ======== As previously discussed, we have experienced deterioration in the performance of mortgage loan originations in our Mortgage Services business and in March 2007 announced our decision to discontinue loan acquisitions by that 60 HSBC Finance Corporation -------------------------------------------------------------------------------- business. These actions, combined with normal portfolio attrition and risk mitigation efforts we began in the second half of 2006, will result in negative growth in our aggregate portfolio in 2007. As opportunities arise, we may also choose to sell selected portfolios. Future decisions to constrain growth in additional portfolios as well as decisions to sell selected portfolios would also result in negative year over year growth in the balance sheet. RISK MANAGEMENT -------------------------------------------------------------------------------- CREDIT RISK There have been no significant changes in our approach to credit risk management since December 31, 2006. At March 31, 2007, we had derivative contracts with a notional value of approximately $95.3 billion, including $83.0 billion outstanding with HSBC affiliates. Most swap agreements, both with unaffiliated and affiliated third parties, require that payments be made to, or received from, the counterparty when the fair value of the agreement reaches a certain level. Generally, third- party swap counterparties provide collateral in the form of cash which is recorded in our balance sheet as other assets or derivative related liabilities and totaled $131 million at March 31, 2007 and $158 million at December 31, 2006 for third-party counterparties. Beginning in the second quarter of 2006, when the fair value of our agreements with affiliate counterparties require the posting of collateral by the affiliate, it is provided in the form of cash and recorded on the balance sheet, consistent with third party arrangements. At March 31, 2007, the fair value of our agreements with affiliate counter parties required the affiliate to provide cash collateral of $1.2 billion, which is recorded in our balance sheet as a component of derivative related liabilities. At December 31, 2006, the fair value of our agreements with affiliate counter parties required the affiliate to provide cash collateral of $1.0 billion, which is recorded in our balance sheet as a component of derivative related liabilities. LIQUIDITY RISK There have been no significant changes in our approach to liquidity risk since December 31, 2006. MARKET RISK HSBC has certain limits and benchmarks that serve as guidelines in determining the appropriate levels of interest rate risk. One such limit is expressed in terms of the Present Value of a Basis Point ("PVBP"), which reflects the change in value of the balance sheet for a one basis point movement in all interest rates. Our PVBP limit as of March 31, 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 March 31, 2007, we had a PVBP position of less than $1 million reflecting the impact of a one basis point increase in interest rates. As of December 31, 2006, we had a PVBP position of $1.1 million. The total PVBP position will not change as a result of the early adoption of SFAS No. 159, however instruments previously accounted for on an accrual basis will now be accounted for under the fair value option election. As a result, the PVBP risk for March 31, 2007, summarized in the table below, reflects a realignment of instruments from December 31, 2007, between accrual and mark-to- market. Total PVBP risk is lower as a result of normal risk management actions. The following table shows the components of PVBP: MARCH 31, DECEMBER 31, 2007 2006 -------------------------------------------------------------------------------------- (IN MILLIONS) Risk related to our portfolio of balance sheet items marked- to-market................................................. $ .5 $(1.8) Risk for all other remaining assets and liabilities......... (.5) 2.9 ---- ----- Total PVBP risk............................................. $ - $ 1.1 ==== ===== We also monitor the impact that an immediate hypothetical increase or decrease in interest rates of 25 basis points applied at the beginning of each quarter over a 12 month period would have on our net interest income assuming a 61 HSBC Finance Corporation -------------------------------------------------------------------------------- growing balance sheet and the current interest rate risk profile. The following table summarizes such estimated impact: MARCH 31, 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......... $217 $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......... $ 88 $ 54 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. OPERATIONAL RISK There has been no significant change in our approach to operational risk management since December 31, 2006. COMPLIANCE RISK There has been no significant change in our approach to compliance risk management since December 31, 2006. REPUTATIONAL RISK There has been no significant change in our approach to reputational risk management since December 31, 2006. 62 HSBC FINANCE CORPORATION RECONCILIATIONS TO U.S. GAAP FINANCIAL MEASURES MARCH 31, DECEMBER 31, 2007 2006 -------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) TANGIBLE COMMON EQUITY: Common shareholder's equity................................. $ 19,108 $ 19,515 Exclude: Fair value option adjustment.............................. 462 - Unrealized (gains) losses on cash flow hedging instruments............................................ 188 61 Minimum pension liability................................. 1 1 Unrealized gains on investments and interest-only strip receivables............................................ 16 23 Intangible assets......................................... (2,165) (2,218) Goodwill.................................................. (6,905) (7,010) -------- -------- Tangible common equity...................................... 10,705 10,372 HSBC acquisition purchase accounting adjustments............ 960 1,105 -------- -------- Tangible common equity, excluding HSBC acquisition purchase accounting adjustments.................................... $ 11,665 $ 11,477 ======== ======== TANGIBLE SHAREHOLDER'S(S') EQUITY: Tangible common equity...................................... $ 10,705 $ 10,372 Preferred stock............................................. 575 575 Mandatorily redeemable preferred securities of Household Capital Trusts............................................ 1,275 1,275 -------- -------- Tangible shareholder's(s') equity........................... 12,555 12,222 HSBC acquisition purchase accounting adjustments............ 960 1,105 -------- -------- Tangible shareholder's(s') equity, excluding HSBC acquisition purchase accounting adjustments............... $ 13,515 $ 13,327 ======== ======== TANGIBLE SHAREHOLDER'S(S') EQUITY PLUS OWNED LOSS RESERVES: Tangible shareholder's(s') equity........................... $ 12,555 $ 12,222 Owned loss reserves......................................... 6,798 6,587 -------- -------- Tangible shareholder's(s') equity plus owned loss reserves.. 19,353 18,809 HSBC acquisition purchase accounting adjustments............ 960 1,105 -------- -------- Tangible shareholder's(s') equity plus owned loss reserves, excluding HSBC acquisition purchase accounting adjustments............................................... $ 20,313 $ 19,914 ======== ======== TANGIBLE MANAGED ASSETS: Owned assets................................................ $177,488 $180,435 Receivables serviced with limited recourse.................. 795 949 -------- -------- Managed assets.............................................. 178,283 181,384 Exclude: Intangible assets......................................... (2,165) (2,218) Goodwill.................................................. (6,905) (7,010) Derivative financial assets............................... (1,676) (1,461) -------- -------- Tangible managed assets..................................... 167,537 170,695 HSBC acquisition purchase accounting adjustments............ (23) 64 -------- -------- Tangible managed assets, excluding HSBC acquisition purchase accounting adjustments.................................... $167,514 $170,759 ======== ======== EQUITY RATIOS: Common and preferred equity to owned assets................. 11.09% 11.13% Tangible common equity to tangible managed assets........... 6.39 6.08 Tangible shareholder's(s') equity to tangible managed assets ("TETMA")................................................. 7.49 7.16 Tangible shareholder's(s') equity plus owned loss reserves to tangible managed assets ("TETMA + Owned Reserves")..... 11.55 11.02 Excluding HSBC acquisition purchase accounting adjustments: Tangible common equity to tangible managed assets......... 6.96 6.72 TETMA..................................................... 8.07 7.80 TETMA + Owned Reserves.................................... 12.13 11.66 ======== ======== 63 HSBC Finance Corporation -------------------------------------------------------------------------------- ITEM 4. CONTROLS AND PROCEDURES -------------------------------------------------------------------------------- We maintain a system of internal and disclosure controls and procedures designed to ensure that information required to be disclosed by HSBC Finance Corporation in the reports we file or submit under the Securities Exchange Act of 1934, as amended, (the "Exchange Act"), is recorded, processed, summarized and reported on a timely basis. Our Board of Directors, operating through its audit committee, which is composed entirely of independent outside directors, provides oversight to our financial reporting process. We conducted an evaluation, with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report so as to alert them in a timely fashion to material information required to be disclosed in reports we file under the Exchange Act. There have been no significant changes in our internal and disclosure controls or in other factors which could significantly affect internal and disclosure controls subsequent to the date that we carried out our evaluation. HSBC Finance Corporation continues the process to complete a thorough review of its internal controls as part of its preparation for compliance with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002. Section 404 requires our management to report on, and our external auditors to attest to, the effectiveness of our internal control structure and procedures for financial reporting. As a non-accelerated filer under Rule 12b-2 of the Exchange Act, our first report under Section 404 will be contained in our Form 10-K for the period ended December 31, 2007. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS -------------------------------------------------------------------------------- GENERAL We are parties to various legal proceedings resulting from ordinary business activities relating to our current and/or former operations. Certain of these actions are or purport to be class actions seeking damages in very large amounts. These actions assert violations of laws and/or unfair treatment of consumers. Due to the uncertainties in litigation and other factors, we cannot be certain that we will ultimately prevail in each instance. We believe that our defenses to these actions have merit and any adverse decision should not materially affect our consolidated financial condition. CONSUMER LITIGATION During the past several years, the press has widely reported certain industry related concerns that may impact us. Some of these involve the amount of litigation instituted against lenders and insurance companies operating in certain states and the large awards obtained from juries in those states. Like other companies in this industry, some of our subsidiaries are involved in lawsuits pending against them in these states. The cases, in particular, generally allege inadequate disclosure or misrepresentation of financing terms. In some suits, other parties are also named as defendants. Unspecified compensatory and punitive damages are sought. Several of these suits purport to be class actions or have multiple plaintiffs. The judicial climate in these states is such that the outcome of all of these cases is unpredictable. Although our subsidiaries believe they have substantive legal defenses to these claims and are prepared to defend each case vigorously, a number of such cases have been settled or otherwise resolved for amounts that in the aggregate are not material to our operations. Insurance carriers have been notified as appropriate, and from time to time reservations of rights letters have been received. CREDIT CARD SERVICES LITIGATION Since June 2005, HSBC Finance Corporation, HSBC North America, and HSBC, as well as other banks and the Visa and Master Card associations, were named as defendants in four class actions filed in Connecticut and the Eastern District of New York; Photos Etc. Corp. et al. v. Visa U.S.A., Inc., et al. (D. Conn. No. 3:05-CV-01007 64 HSBC Finance Corporation -------------------------------------------------------------------------------- (WWE)): National Association of Convenience Stores, et al. v. Visa U.S.A., Inc., et al. (E.D.N.Y. No. 05-CV 4520 (JG)); Jethro Holdings, Inc., et al. v. Visa U.S.A., Inc. et al. (E.D.N.Y. No. 05-CV-4521 (JG)); and American Booksellers Ass'n v. Visa U.S.A., Inc. et al. (E.D.N.Y. No. 05-CV-5391 (JG)). Numerous other complaints containing similar allegations (in which no HSBC entity is named) were filed across the country against Visa, MasterCard and other banks. These actions principally allege that the imposition of a no-surcharge rule by the associations and/or the establishment of the interchange fee charged for credit card transactions causes the merchant discount fee paid by retailers to be set at supracompetitive levels in violation of the Federal antitrust laws. In response to motions of the plaintiffs on October 19, 2005, the Judicial Panel on Multidistrict Litigation (the "MDL Panel") issued an order consolidating these suits and transferred all of the cases to the Eastern District of New York. The consolidated case is: In re Payment Card Interchange Fee and Merchant Discount Antitrust Litigation, MDL 1720, E.D.N.Y. A consolidated, amended complaint was filed by the plaintiffs on April 24, 2006. Discovery has begun. At this time, we are unable to quantify the potential impact from this action, if any. SECURITIES LITIGATION In August 2002, we restated previously reported consolidated financial statements. The restatement related to certain MasterCard and Visa co-branding and affinity credit card relationships and a third party marketing agreement, which were entered into between 1992 and 1999. All were part of our Credit Card Services segment. In consultation with our prior auditors, Arthur Andersen LLP, we treated payments made in connection with these agreements as prepaid assets and amortized them in accordance with the underlying economics of the agreements. Our current auditor, KPMG LLP, advised us that, in its view, these payments should have either been charged against earnings at the time they were made or amortized over a shorter period of time. The restatement resulted in a $155.8 million, after-tax, retroactive reduction to retained earnings at December 31, 1998. As a result of the restatement, and other corporate events, including, e.g., the 2002 settlement with 50 states and the District of Columbia relating to real estate lending practices, HSBC Finance Corporation, and its directors, certain officers and former auditors, have been involved in various legal proceedings, some of which purport to be class actions. A number of these actions allege violations of Federal securities laws, were filed between August and October 2002, and seek to recover damages in respect of allegedly false and misleading statements about our common stock. These legal actions have been consolidated into a single purported class action, Jaffe v. Household International, Inc., et al., No. 02 C 5893 (N.D. Ill., filed August 19, 2002), and a consolidated and amended complaint was filed on March 7, 2003. On December 3, 2004, the court signed the parties' stipulation to certify a class with respect to the claims brought under sec.10 and sec.20 of the Securities Exchange Act of 1934. The parties stipulated that plaintiffs will not seek to certify a class with respect to the claims brought under sec.11 and sec.15 of the Securities Act of 1933 in this action or otherwise. The amended complaint purports to assert claims under the Federal securities laws, on behalf of all persons who purchased or otherwise acquired our securities between October 23, 1997 and October 11, 2002, arising out of alleged false and misleading statements in connection with our collection, sales and lending practices, the 2002 state settlement agreement referred to above, the restatement and the HSBC merger. The amended complaint, which also names as defendants Arthur Andersen LLP, Goldman, Sachs & Co., and Merrill Lynch, Pierce, Fenner & Smith, Inc., fails to specify the amount of damages sought. In May 2003, we, and other defendants, filed a motion to dismiss the complaint. On March 19, 2004, the Court granted in part, and denied in part the defendants' motion to dismiss the complaint. The Court dismissed all claims against Merrill Lynch, Pierce, Fenner & Smith, Inc. and Goldman Sachs & Co. The Court also dismissed certain claims alleging strict liability for alleged misrepresentation of material facts based on statute of limitations grounds. The claims that remain against some or all of the defendants essentially allege the defendants knowingly made a false statement of a material fact in conjunction with the purchase or sale of securities, that the plaintiffs justifiably relied on such statement, the false statement(s) caused the plaintiffs' damages, and that some or all of the defendants should be liable for those alleged statements. On February 28, 2006, the Court also dismissed all alleged sec.10 claims that arose prior to July 30, 1999, shortening the class period by 22 months. The bulk of fact discovery concluded on January 31, 2007. Expert discovery is expected to conclude on September 14, 2007. Separately, one of the defendants, Arthur Andersen LLP, entered into a 65 HSBC Finance Corporation -------------------------------------------------------------------------------- settlement of the claims against Arthur Andersen. This settlement received Court approval in April 2006. At this time we are unable to quantify the potential impact from this action, if any. With respect to this securities litigation, we believe that we have not, and our officers and directors have not, committed any wrongdoing and in each instance there will be no finding of improper activities that may result in a material liability to us or any of our officers or directors. ITEM 6. EXHIBITS -------------------------------------------------------------------------------- Exhibits included in this Report: 12 Statement of Computation of Ratio of Earnings to Fixed Charges and to Combined Fixed Charges and Preferred Stock Dividends 31 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.1 Debt and Preferred Stock Securities Ratings 66 HSBC Finance Corporation -------------------------------------------------------------------------------- SIGNATURE -------------------------------------------------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HSBC FINANCE CORPORATION (Registrant) /s/ Beverley A. Sibblies ---------------------------------------- Beverley A. Sibblies Senior Vice President and Chief Financial Officer Date: May 14, 2007 67 HSBC Finance Corporation -------------------------------------------------------------------------------- EXHIBIT INDEX -------------------------------------------------------------------------------- 12 Statement of Computation of Ratio of Earnings to Fixed Charges and to Combined Fixed Charges and Preferred Stock Dividends 31 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.1 Debt and Preferred Stock Securities Ratings 68 HSBC Finance Corporation -------------------------------------------------------------------------------- EXHIBIT 12 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS THREE MONTHS ENDED MARCH 31, 2007 2006 --------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net income...................................................... $ 541 $ 888 Income tax expense.............................................. 332 511 ------ ------ Income before income tax expense................................ 873 1,399 ------ ------ Fixed charges: Interest expense.............................................. 2,071 1,623 Interest portion of rentals(1)................................ 18 16 ------ ------ Total fixed charges............................................. 2,089 1,639 ------ ------ Total earnings as defined....................................... $2,962 $3,038 ====== ====== Ratio of earnings to fixed charges.............................. 1.42 1.85 Preferred stock dividends(2).................................... 15 14 Ratio of earnings to combined fixed charges and preferred stock dividends..................................................... 1.41 1.84 -------- (1) Represents one-third of rentals, which approximates the portion representing interest. (2) Preferred stock dividends are grossed up to their pretax equivalents. HSBC Finance Corporation -------------------------------------------------------------------------------- EXHIBIT 31 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION OF CHIEF EXECUTIVE OFFICER I, Brendan P. McDonagh, Chief Executive Officer of HSBC Finance Corporation, certify that: 1. I have reviewed this report on Form 10-Q of HSBC Finance Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 14, 2007 /s/ BRENDAN P. MCDONAGH ---------------------------------------- Brendan P. McDonagh Chief Executive Officer HSBC Finance Corporation -------------------------------------------------------------------------------- CERTIFICATION OF CHIEF FINANCIAL OFFICER I, Beverley A. Sibblies, Senior Vice President and Chief Financial Officer of HSBC Finance Corporation, certify that: 1. I have reviewed this report on Form 10-Q of HSBC Finance Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 14, 2007 /s/ BEVERLEY A. SIBBLIES ---------------------------------------- Beverley A. Sibblies Senior Executive Vice President and Chief Financial Officer HSBC Finance Corporation -------------------------------------------------------------------------------- EXHIBIT 32 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The certification set forth below is being submitted in connection with the HSBC Finance Corporation (the "Company") Quarterly Report on Form 10-Q for the period ending March 31, 2007 as filed with the Securities and Exchange Commission on the date hereof (the "Report") for the purpose of complying with Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the "Exchange Act") and Section 1350 of Chapter 63 of Title 18 of the United States Code. I, Brendan P. McDonagh, Chief Executive Officer of the Company, certify that: 1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of HSBC Finance Corporation. May 14, 2007 /s/ BRENDAN P. MCDONAGH ---------------------------------------- Brendan P. McDonagh Chief Executive Officer HSBC Finance Corporation -------------------------------------------------------------------------------- CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The certification set forth below is being submitted in connection with the HSBC Finance Corporation (the "Company") Quarterly Report on Form 10-Q for the period ending March 31, 2007 as filed with the Securities and Exchange Commission on the date hereof (the "Report") for the purpose of complying with Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the "Exchange Act") and Section 1350 of Chapter 63 of Title 18 of the United States Code. I, Beverley A. Sibblies, Senior Vice President and Chief Financial Officer of the Company, certify that: 1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of HSBC Finance Corporation. May 14, 2007 /s/ BEVERLEY A. SIBBLIES ---------------------------------------- Beverley A. Sibblies Senior Vice President and Chief Financial Officer This certification accompanies each Report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by HSBC Finance Corporation for purposes of Section 18 of the Securities Exchange Act of 1934, as amended. Signed originals of these written statements required by Section 906 of the Sarbanes-Oxley Act of 2002 have been provided to HSBC Finance Corporation and will be retained by HSBC Finance Corporation and furnished to the Securities and Exchange Commission or its staff upon request. HSBC Finance Corporation -------------------------------------------------------------------------------- EXHIBIT 99.1 DEBT AND PREFERRED STOCK SECURITIES RATINGS STANDARD & MOODY'S POOR'S INVESTORS CORPORATION SERVICE FITCH, INC. DBRS, INC. ------------------------------------------------------------------------------------------------- AS OF MARCH 31, 2007 HSBC Finance Corporation Senior debt.............................. AA- Aa3 AA- AA (low) Senior subordinated debt................. A+ A2 A+ * Commercial paper......................... A-1+ P-1 F-1+ R-1 (middle) Series B preferred stock................. A-2 A2 A+ * HFC Bank Limited Senior debt.............................. AA- Aa3 AA- * Commercial paper......................... A-1+ P-1 F-1+ * HSBC Financial Corporation Limited Senior notes and term loans.............. * * * AA (low) Commercial paper......................... * * * R-1 (middle) -------- ()* Not rated by this agency. This information is provided by RNS The company news service from the London Stock Exchange

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