HSBC FinCorp Restated 10Q1 Q3
HSBC Holdings PLC
31 March 2005
PART 2
Household International, Inc.
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Our interest-only strip receivables, net of the related loss reserve and
excluding the mark-to-market adjustment recorded in accumulated other
comprehensive income, decreased $122 million in the current quarter and $410
million year-to-date, compared to decreases of $79 million in the third quarter
of 2003 and $289 million for the year-to-date period as securitized receivables
decreased.
Insurance revenue increased in both periods, due primarily to increased sales in
our U.K. business.
Investment income, which includes income on securities available for sale in our
insurance business as well as realized gains and losses from the sale of
securities, was flat compared to the prior year quarter as decreases in income
due to lower yields were substantially offset by higher gains from security
sales during the quarter. The decrease in investment income for the nine month
period was due to lower yields, lower gains from security sales and the
amortization of purchase accounting adjustments.
Derivative income (expense), which includes realized and unrealized gains and
losses on derivatives which do not qualify as effective hedges under SFAS 133 as
well as the ineffectiveness on derivatives associated with our qualifying hedges
is summarized in the tables below:
THREE MONTHS ENDED SEPTEMBER 30 2004 2003
----------------------------------------------------------------------------
(IN MILLIONS)
Net realized gains (losses)................................. $19 $ (15)
Net unrealized gains (losses)............................... 53 (596)
Ineffectiveness............................................. -- (1)
--- -----
Total....................................................... $72 $(612)
=== =====
NINE MONTHS ENDED SEPTEMBER 30 2004 2003
---------------------------------------------------------------------------
(IN MILLIONS)
Net realized gains (losses)................................. $ 36 $ 55
Net unrealized gains (losses)............................... 211 119
Ineffectiveness............................................. 1 5
---- ----
Total....................................................... $248 $179
==== ====
Derivative income increased in both periods. Compared to the prior year quarter,
derivative income increased $684 million. Derivative income in the prior year
quarter was impacted by a substantial increase in the yield curve during the
first half of the quarter causing a significant decline in the value of our
receive fixed swaps. These swaps were terminated during the prior year quarter
as part of our strategy to regain the use of shortcut accounting. Derivative
income for the current quarter reflects the impact of lower long term rates on
our portfolio of receive fixed swaps and the impact of higher short term rates
on our pay fixed swap portfolio.
For the nine month periods, derivative income reflects the impact of higher
interest rates and the shift in mix to a predominately pay fixed swap portfolio.
These derivatives remain economic hedges of the underlying debt instruments.
Fee income, which includes revenues from fee-based products such as credit
cards, increased in both periods due to higher credit card fees. For the nine
month period, higher credit card fees were partially offset by higher payments
to merchant partners as a result of portfolio acquisitions in our retail
services business. See "Segment Results - Managed Basis" herein for additional
information on fee income on a managed basis.
Taxpayer financial services income, increased during the nine-month period ended
September 30, 2004 primarily due to lower funding costs as a result of our
acquisition by HSBC.
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Household International, Inc.
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Other income, increased in both periods due to higher revenues from our mortgage
operations. The increase in the three month period also reflects higher
enhancement services income and higher gains on miscellaneous asset sales.
COSTS AND EXPENSES As discussed earlier, effective January 1, 2004, our
technology services employees were transferred to HSBC Technology and Services
(USA) Inc. ("HTSU"). As a result, operating expenses relating to information
technology as well as certain item processing and statement processing
activities, which have previously been reported as salaries and employee
benefits, occupancy and equipment expenses, or other servicing and
administrative expenses are now billed to us by HTSU and reported as support
services from HSBC affiliates. Support services from HSBC affiliates also
includes banking services and other miscellaneous services provided by HSBC Bank
USA and other subsidiaries of HSBC.
The following table summarizes total costs and expenses:
INCREASE
(DECREASE)
--------------
THREE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT %
----------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Salaries and employee benefits.............................. $ 472 $ 493 $(21) (4.3)%
Sales incentives............................................ 91 77 14 18.2
Occupancy and equipment expenses............................ 77 95 (18) (18.9)
Other marketing expenses.................................... 174 128 46 35.9
Other servicing and administrative expenses................. 235 282 (47) (16.7)
Support services from HSBC affiliates....................... 183 - 183 100.0
Amortization of intangibles................................. 83 82 1 1.2
Policyholders' benefits..................................... 93 95 (2) (2.1)
------ ------ ---- -----
Total costs and expenses.................................... $1,408 $1,252 $156 12.5%
====== ====== ==== =====
INCREASE (DECREASE)
-------------------
NINE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT %
--------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Salaries and employee benefits............................. $1,414 $1,491 $ (77) (5.2)%
Sales incentives........................................... 259 199 60 30.2
Occupancy and equipment expenses........................... 237 296 (59) (19.9)
Other marketing expenses................................... 437 406 31 7.6
Other servicing and administrative expenses................ 659 869 (210) (24.2)
Support services from HSBC affiliates...................... 556 - 556 100.0
Amortization of intangibles................................ 278 174 104 59.8
Policyholders' benefits.................................... 299 287 12 4.2
HSBC acquisition related costs incurred by Household....... - 198 (198) (100.0)
------ ------ ----- ------
Total costs and expenses................................... $4,139 $3,920 $ 219 5.6%
====== ====== ===== ======
Salaries and employee benefits decreased primarily due to the transfer of our
technology personnel to HTSU. Excluding this change, salaries and employee
benefits increased $40 million for the quarter and $99 million year-to-date as a
result of additional staffing, primarily in our consumer lending, mortgage
services and international businesses to support growth and in our compliance
functions. For the nine month period, these increases were partially offset by
decreases in employee benefit expenses as a result of non-recurring expenses
incurred in the first quarter of 2003 in conjunction with the merger.
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Household International, Inc.
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Sales incentives increased in both periods reflecting higher volumes in our
branches. The year-to-date increase also reflects increases in our mortgage
services business.
Occupancy and equipment expenses decreased in both periods primarily due to the
formation of HTSU as discussed above.
Other marketing expenses increased in both periods primarily due to increased
credit card marketing, largely due to changes in marketing responsibilities
associated with the General Motors ("GM") co-branded credit card which will
result in higher marketing expense for the GM Card(R) in the future.
Other servicing and administrative expenses decreased primarily due to the
transfer of certain item processing and statement processing services to HTSU.
The decreases were partially offset by higher systems costs due to growth,
higher insurance commissions and higher legal costs from the settlement of
claims.
Support services from HSBC affiliates primarily include technology and other
services charged to us by HTSU.
Amortization of intangibles was essentially flat during the quarter. The
increase in the nine month period reflects higher amortization of intangibles
established in conjunction with our acquisition by HSBC.
Policyholders' benefits essentially remained flat in the third quarter.
Increases in policyholder benefits for the nine month period resulted from
higher sales in our U.K. business and higher amortization of fair value
adjustments relating to our insurance business, partially offset by lower
expenses in our domestic business.
HSBC acquisition related costs incurred by Household in the first quarter of
2003 include payments to executives under existing employment contracts and
investment banking, legal and other costs relating to our acquisition by HSBC.
The following table summarizes our owned basis efficiency ratio:
2004 2003
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(RESTATED) (RESTATED)
Three months ended September 30............................. 45.1% 53.5%
Nine months ended September 30:
GAAP Basis................................................ 44.0 44.0
Excluding HSBC acquisition related costs(1)............... 44.0 41.6
---------------
(1) Represents a non-GAAP financial measure. See "Basis of Reporting" for
additional discussion on the use of this non-GAAP financial measure and
"Reconciliations to GAAP Financial Measures" for quantitative
reconciliations of our operating efficiency ratio to our owned basis GAAP
efficiency ratio.
The efficiency ratio improved during the three months ended September 30, 2004
primarily as a result of significantly higher derivative income in the three
months ended September 30, 2004, partially offset by higher operating expenses,
lower securitization revenue and lower net interest income as a percentage of
average interest earning assets. Excluding the impact of the HSBC acquisition
related costs, the efficiency ratio deteriorated during the nine months ended
September 30, 2004 due to higher operating expenses, including higher intangible
amortization in the year-to-end period, lower securitization revenue and lower
net interest income as a percentage of average interest earning assets,
partially offset by higher derivative income.
SEGMENT RESULTS - MANAGED 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.
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Household International, Inc.
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Our Credit Card Services segment consists of our domestic MasterCard and Visa
credit card business. Our International segment consists of our foreign
operations in the United Kingdom, Canada, Ireland and the remainder of Europe.
Effective January 1, 2004, our direct lending business, which has previously
been reported in our "All Other" caption, was consolidated into our consumer
lending business and as a result is now included in our Consumer segment. Prior
periods have not been restated as the impact was not material. There have been
no other changes in the basis of our segmentation or any changes in the
measurement of segment profit as compared with the presentation of our 2003
financial information included in our 2004 Form 10-K.
We monitor our operations and evaluate trends on a managed basis (a non-GAAP
financial measure), which assumes that securitized receivables have not been
sold and are still on our balance sheet. We manage and evaluate our operations
on a managed basis because the receivables that we securitize are subjected to
underwriting standards comparable to our owned portfolio, are serviced by
operating personnel without regard to ownership and result in a similar credit
loss exposure for us. In addition, we fund our operations, review our operating
results, and make decisions about allocating resources such as employees and
capital on a managed basis. When reporting on a managed basis, net interest
income, provision for credit losses and fee income related to receivables
securitized are reclassified from securitization revenue in our owned statement
of income into the appropriate caption.
CONSUMER SEGMENT The following table summarizes results for our Consumer
segment:
INCREASE (DECREASE)
-------------------
THREE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT %
------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net income............................................ $ 294 $ 287 $ 7 2.4%
Net interest income................................... 1,956 1,875 81 4.3
Securitization revenue................................ (547) (42) (505) (100+)
Fee and other income.................................. 187 153 34 22.2
Intersegment revenues................................. 26 27 (1) (3.7)
Provision for credit losses........................... 506 920 (414) (45.0)
Total costs and expenses.............................. 619 606 13 2.1
Receivables........................................... 95,946 87,739 8,207 9.4
Assets................................................ 98,099 90,108 7,991 8.9
Net interest income as a percent of average
interest-earning assets, annualized................. 8.20% 8.65% - -
Return on average managed assets...................... 1.22 1.30 - -
INCREASE (DECREASE)
-------------------
NINE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT %
-----------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net income............................................. $ 855 $ 679 $ 176 25.9%
Net interest income.................................... 5,735 5,417 318 5.9
Securitization revenue................................. (1,089) 12 (1,101) (100+)
Fee and other income................................... 516 467 49 10.5
Intersegment revenues.................................. 74 82 (8) (9.8)
Provision for credit losses............................ 1,905 3,042 (1,137) (37.4)
Total costs and expenses............................... 1,892 1,765 127 7.2
Net interest income as a percent of average
interest-earning assets, annualized.................. 8.33% 8.63% - -
Return on average managed assets....................... 1.22 1.06 - -
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Household International, Inc.
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Our Consumer segment reported higher net income in both periods. Increases in
net interest income as well as fee and other income and decreases in provision
for credit losses were partially offset by higher operating expenses and
substantially lower securitization revenue. Net interest income increased
primarily due to higher receivable levels. Net interest income as a percent of
average interest-earning assets, however, decreased primarily due to lower
yields on real estate secured and auto finance receivables as a result of
reduced pricing and higher levels of near-prime receivables, as well as the
run-off of higher yielding real estate secured receivables, including second
lien loans largely due to refinance activity. For the three month period,
increased cost of funds due to a rising interest rate environment also
contributed to the decrease. Our auto finance business reported lower net
interest income as a percent of average interest-earning assets as we have
targeted lower yielding but higher credit quality customers. Securitization
revenue decreased in both periods as a result of a significant decline in
receivables securitized, including the impact of higher run-off due to shorter
expected lives, as a result of our decision to structure all new collateralized
funding transactions as secured financings beginning in the third quarter of
2004. Initial securitization levels were lower in the first nine months of 2004
as we used funding from HSBC, including proceeds from receivable sales, to
assist in the funding of our operations. Operating expenses increased as the
result of additional operating costs to support the increased receivable levels
including higher salaries and sales incentives.
During the nine months ended September 30, 2004, we experienced improved credit
quality. Our managed basis provision for credit losses, which includes both
provision for owned basis receivables and over-the-life provision for
receivables serviced with limited recourse, decreased in both the quarter and
year-to-date periods as a result of improving credit quality and changes in
securitization levels. Partially offsetting the decrease in managed loss
provision was an increase in estimated losses on securitized receivables at auto
finance in both periods. We have experienced higher dollars of net charge-offs
in our owned portfolio during the first nine months of 2004 as a result of
higher delinquency levels in prior quarters and higher levels of owned
receivables. However, our overall owned provision for credit losses was lower
than net charge-offs because charge-offs are a lagging indicator of credit
quality. Over-the-life provisions for credit losses for securitized receivables
recorded in any given period reflect the level and product mix of
securitizations in that period. Subsequent charge-offs of such receivables
result in a decrease in the over-the-life reserves without any corresponding
increase to managed loss provision. The combination of these factors, including
changes in securitization levels, resulted in a decrease in managed loss
reserves as net charge-offs were greater than the provision for credit losses by
$414 million for the quarter and $895 million year-to-date. For 2003, we
increased managed loss reserves by recording loss provision greater than net
charge-offs of $23 million for the quarter and $394 million year-to-date.
Managed receivables increased 4 percent compared to $92.2 billion at June 30,
2004. Growth during the quarter was driven by higher real estate secured
receivables in both our correspondent and branch-based consumer lending
businesses which was partially offset by $.7 billion of correspondent
receivables purchased directly by HSBC Bank USA (a portion of which we otherwise
would have purchased). Growth in our correspondent business was supplemented by
purchases from a single correspondent relationship which totaled $.6 billion in
the quarter. We also experienced solid growth in auto finance receivables though
our dealer network as well as in private label receivables. Personal non-credit
card receivables also experienced growth as we began to increase availability of
the product as a result of an improving economy.
Compared to September 30, 2003, managed receivables increased 9 percent.
Receivable growth was strongest in our real estate secured portfolio. Real
estate secured receivable levels reflect sales to HSBC Bank USA totaling $3.7
billion and $2.2 billion of correspondent receivables purchased directly by HSBC
Bank USA, a portion of which we otherwise would have purchased. Real estate
growth also benefited from purchases associated with a single correspondent
relationship which totaled $1.9 billion year-to-date. Our auto finance portfolio
also reported strong growth as a result of newly originated loans acquired from
our
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Household International, Inc.
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dealer network and strategic alliances established during 2003. Increases in
private label receivables were the result of portfolio acquisitions as well as
organic growth.
The decrease in return on average managed assets ("ROMA") for the quarter
reflects a higher rate of increase in average managed assets than in net income
as discussed above. For the year-to-date period, the increase in ROMA reflects
higher income as discussed above.
CREDIT CARD SERVICES SEGMENT The following table summarizes results for our
Credit Card Services segment.
INCREASE (DECREASE)
--------------------
THREE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT %
-------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net income............................................. $ 134 $ 144 $ (10) (6.9)%
Net interest income.................................... 519 490 29 5.9
Securitization revenue................................. (77) 11 (88) (100+)
Fee and other income................................... 460 392 68 17.3
Intersegment revenues.................................. 6 6 - -
Provision for credit losses............................ 364 400 (36) (9.0)
Total costs and expenses............................... 328 268 60 22.4
Receivables............................................ 18,509 18,285 224 1.2
Assets................................................. 20,620 20,826 (206) (1.0)
Net interest income as a percent of average
interest-earning assets, annualized.................. 10.24% 10.00% - -
Return on average managed assets....................... 2.60 2.85 - -
INCREASE (DECREASE)
--------------------
NINE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT %
-------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net income............................................... $ 391 $ 366 $ 25 6.8%
Net interest income...................................... 1,561 1,441 120 8.3
Securitization revenue................................... (222) 4 (226) (100+)
Fee and other income..................................... 1,271 1,116 155 13.9
Intersegment revenues.................................... 20 22 (2) (9.1)
Provision for credit losses.............................. 1,105 1,175 (70) (6.0)
Total costs and expenses................................. 890 806 84 10.4
Net interest income as a percent of average
interest-earning assets, annualized.................... 10.10% 9.87% - -
Return on average managed assets......................... 2.50 2.42 - -
Our Credit Card Services segment reported lower net income during the quarter
but higher net income year-to-date. The decrease in net income during the
quarter was due to the impact of lower securitization levels and higher
operating expenses, particularly marketing expenses, partially offset by
increases in net interest income and fee and other income and lower credit loss
provision. The trends in net interest income, fee and other income,
securitization revenue, credit loss provision and operating expenses were
consistent in both the quarter and the year-to-date periods. Net income and ROMA
for the year-to-date period, however, were higher than in the year ago period
but lower for the quarter. This is because the decreases in the level of
receivables securitized, coupled with the increased marketing expense were more
significant in the quarter than in the year-to-date period. Increases in net
interest income as well as fee and other income in both periods resulted from
higher receivable levels and product mix, with the increase
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Household International, Inc.
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in net interest income partially offset in the quarter by higher cost of funds
due to a rising interest rate environment. Provision for credit losses also
decreased in both periods as a result of improving credit quality and changes in
securitization levels. We increased managed loss reserves for the quarter by
recording loss provision greater than net charge-offs of $15 million and we
decreased managed loss reserves year-to-date by recording loss provision less
than net charge-offs of $6 million. For 2003, we increased managed loss reserves
by recording loss provision greater than net charge-offs of $43 million for the
quarter and $98 million year-to-date. Securitization revenue declined in both
periods as a result of a decline in receivables securitized, including higher
run-off due to shorter expected lives.
Managed receivables of $18.5 billion increased .8 percent compared to $18.4
billion at June 30, 2004. The increase during the quarter was due to growth in
our subprime and internally branded prime portfolios which was substantially
offset by the continued decline in certain old acquired portfolios. Although our
subprime receivables tend to have smaller balances, they generate higher
returns. Compared to September 30, 2003, managed receivables increased 1.2
percent. Receivables growth was largely attributable to organic growth in our
subprime portfolios which was partially offset by the continued decline in these
old acquired portfolios.
INTERNATIONAL SEGMENT The following table summarizes results for our
International segment:
INCREASE (DECREASE)
--------------------
THREE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT %
-------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net income............................................. $ 18 $ 42 $ (24) (57.1)%
Net interest income.................................... 185 190 (5) (2.6)
Securitization revenue................................. (87) 2 (89) (100+)
Fee and other income................................... 130 98 32 32.7
Intersegment revenues.................................. 4 3 1 33.3
Provision for credit losses............................ 19 101 (82) (81.2)
Total costs and expenses............................... 181 128 53 41.4
Receivables............................................ 11,833 10,180 1,653 16.2
Assets................................................. 12,770 11,053 1,717 15.5
Net interest income as a percent of average
interest-earning assets, annualized.................. 6.29% 7.45% - -
Return on average managed assets....................... .57 1.54 - -
INCREASE (DECREASE)
-------------------
NINE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT %
-----------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Net income................................................. $ 80 $116 $(36) (31.0)%
Net interest income........................................ 583 549 34 6.2
Securitization revenue..................................... (92) 13 (105) (100+)
Fee and other income....................................... 369 276 93 33.7
Intersegment revenues...................................... 10 9 1 11.1
Provision for credit losses................................ 207 271 (64) (23.6)
Total costs and expenses................................... 527 394 133 33.8
Net interest income as a percent of average
interest-earning assets, annualized...................... 6.76% 7.37% - -
Return on average managed assets........................... .86 1.46 - -
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Household International, Inc.
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Our International segment reported lower net income in both periods. The
decrease in net income reflects higher operating expenses and lower
securitization revenue partially offset by increased fee and other income, lower
provision for credit losses and, for the nine month period, higher net interest
income. Applying constant currency rates, which uses the average rate of
exchange for the 2003 period to translate current period net income, net income
would have been lower by $2 million in the current quarter and $7 million
year-to-date. Net interest income decreased during the quarter as increases in
net interest income due to higher receivable levels were more than offset by
higher cost of funds due to a rising interest rate environment. Net interest
income increased during the nine month period due to higher receivable levels
partially offset by higher cost of funds. Net interest income as a percent of
average interest-earning assets, annualized, decreased in both periods due to
lower pricing, run-off of higher yielding receivables, the mix of personal
non-credit card receivables and a higher cost of funds. Securitization revenue
declined as a result of lower levels of securitized receivables. Fee and other
income increased primarily due to higher insurance revenues. Provision for
credit losses decreased due to reduced securitization levels, partially offset
by a higher provision for credit losses on owned receivables due to receivable
growth. We decreased managed loss reserves by recording loss provision less than
net charge-offs of $74 million for the quarter and $52 million year-to-date. For
2003, we increased managed loss reserves by recording loss provision greater
than net charge-offs of $26 million for the quarter and $56 million
year-to-date. Total costs and expenses increased primarily due to higher salary
expenses to support receivable activity and higher policyholder benefits, which
resulted from increased insurance sales volumes.
Managed receivables increased 4 percent compared to $11.4 billion at June 30,
2004 primarily due to growth in our private label and personal non-credit card
portfolios. Compared to September 30, 2003, managed receivables increased 16
percent due to strong growth in our real estate secured and personal non-credit
card portfolios since September 30, 2003 partially offset by a decline in our
MasterCard/Visa portfolio. Applying constant currency rates, managed receivables
at September 30, 2004 would have been $.1 billion lower using June 30, 2004
exchange rates and $.9 billion lower using September 30, 2003 exchange rates.
The decrease in ROMA reflects lower net income as discussed above.
RECONCILIATION OF MANAGED BASIS SEGMENT RESULTS Income statement information
included in the table for the nine months ended September 30, 2003 combines
January 1 through March 28, 2003 (the "predecessor period") and March 29 to
September 30, 2003 (the "successor period") in order to present "combined"
financial results for the nine months ended September 30, 2003. Fair value
adjustments related to purchase accounting and related amortization have been
allocated to Corporate, which is included in the "All Other" caption within our
segment disclosure. As a result, managed and owned basis consolidated totals for
the nine months ended September 30, 2003 include combined information from both
the "successor" and "predecessor" periods which impacts comparability to the
current period.
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Reconciliations of our managed basis segment results to managed basis and owned
basis consolidated totals are as follows:
MANAGED
CREDIT ADJUSTMENTS/ BASIS
CARD INTER- ALL RECONCILING CONSOLIDATED
CONSUMER SERVICES NATIONAL OTHER ITEMS TOTALS
-------------------------------------------------------------------------------------------------------
(IN MILLIONS)
THREE MONTHS ENDED
SEPTEMBER 30, 2004 (RESTATED)
Net interest income............ $1,956 $ 519 $ 185 $ (110) $ - $ 2,550
Securitization revenue......... (547) (77) (87) (31) - (742)
Fee and other income........... 187 460 130 227 (35)(2) 969
Intersegment revenues.......... 26 6 4 (1) (35)(2) -
Provision for credit losses.... 506 364 19 1 1(3) 891
Total costs and expenses....... 619 328 181 280 - 1,408
Net income..................... 294 134 18 (98) (23) 325
Receivables.................... 95,946 18,509 11,833 324 - 126,612
Assets......................... 98,099 20,620 12,770 25,030 (8,616)(4) 147,903
------ ------- ------- ------- ------- --------
THREE MONTHS ENDED
SEPTEMBER 30, 2003 (RESTATED)
Net interest income............ $1,875 $ 490 $ 190 $ 76 $ - $ 2,631
Securitization revenue......... (42) 11 2 (71) - (100)
Fee and other income........... 153 392 98 (461) (36)(2) 146
Intersegment revenues.......... 27 6 3 - (36)(2) -
Provision for credit losses.... 920 400 101 (2) 2(3) 1,421
Total costs and expenses....... 606 268 128 250 - 1,252
Net income..................... 287 144 42 (427) (24) 22
Receivables.................... 87,739 18,285 10,180 933 - 117,137
Assets......................... 90,108 20,826 11,053 25,294 (8,764)(4) 138,517
------ ------- ------- ------- ------- --------
NINE MONTHS ENDED
SEPTEMBER 30, 2004 (RESTATED)
Net interest income............ $5,735 $ 1,561 $ 583 $ (173) $ - $ 7,706
Securitization revenue......... (1,089) (222) (92) (124) - (1,527)
Fee and other income........... 516 1,271 369 969 (101)(2) 3,024
Intersegment revenues.......... 74 20 10 (3) (101)(2) -
Provision for credit losses.... 1,905 1,105 207 (1) 1(3) 3,217
Total costs and expenses....... 1,892 890 527 830 - 4,139
Net income..................... 855 391 80 (32) (66) 1,228
------ ------- ------- ------- ------- --------
NINE MONTHS ENDED
SEPTEMBER 30, 2003 (RESTATED)
Net interest income............ $5,417 $ 1,441 $ 549 $ 112 $ - $ 7,519
Securitization revenue......... 12 4 13 (147) - (118)
Fee and other income........... 467 1,116 276 843 (112)(2) 2,590
Intersegment revenues.......... 82 22 9 (1) (112)(2) -
Provision for credit losses.... 3,042 1,175 271 - 6(3) 4,494
Total costs and expenses....... 1,765 806 394 955 - 3,920
HSBC acquisition related costs
incurred by Household........ - - - 198 - 198
Net income..................... 679 366 116 (75) (75) 1,011
Operating net income(1)........ 679 366 116 92 (75) 1,178
OWNED BASIS
SECURITIZATION CONSOLIDATED
ADJUSTMENTS TOTALS
------------------------------- -----------------------------
(IN MILLIONS)
THREE MONTHS ENDED
SEPTEMBER 30, 2004 (RESTATED)
Net interest income............ $ (581)(5) $ 1,969
Securitization revenue......... 1,009(5) 267
Fee and other income........... (196)(5) 773
Intersegment revenues.......... - -
Provision for credit losses.... 232(5) 1,123
Total costs and expenses....... - 1,408
Net income..................... - 325
Receivables.................... (20,175)(6) 106,437
Assets......................... (20,175)(6) 127,728
-------- --------
THREE MONTHS ENDED
SEPTEMBER 30, 2003 (RESTATED)
Net interest income............ $ (715)(5) $ 1,916
Securitization revenue......... 487(5) 387
Fee and other income........... (192)(5) (46)
Intersegment revenues.......... - -
Provision for credit losses.... (420)(5) 1,001
Total costs and expenses....... - 1,252
Net income..................... - 22
Receivables.................... (24,109)(6) 93,028
Assets......................... (24,109)(6) 114,408
-------- --------
NINE MONTHS ENDED
SEPTEMBER 30, 2004 (RESTATED)
Net interest income............ $ (1,987)(5) $ 5,719
Securitization revenue......... 2,408(5) 881
Fee and other income........... (590)(5) 2,434
Intersegment revenues.......... - -
Provision for credit losses.... (169)(5) 3,048
Total costs and expenses....... - 4,139
Net income..................... - 1,228
-------- --------
NINE MONTHS ENDED
SEPTEMBER 30, 2003 (RESTATED)
Net interest income............ $ (2,161)(5) $ 5,358
Securitization revenue......... 1,232(5) 1,114
Fee and other income........... (515)(5) 2,075
Intersegment revenues.......... - -
Provision for credit losses.... (1,444)(5) 3,050
Total costs and expenses....... - 3,920
HSBC acquisition related costs
incurred by Household........ - 198
Net income..................... - 1,011
Operating net income(1)........ - 1,178
---------------
(1) This non-GAAP financial measure is provided for comparison of our operating
trends only and should be read in conjunction with our owned basis GAAP
financial information. Operating net income excludes $167 million
(after-tax) of HSBC acquisition related costs and other merger related items
incurred by Household in 2003. See "Basis of Reporting" for additional
discussion on the use of non-GAAP financial measures.
46
Household International, Inc.
--------------------------------------------------------------------------------
(2) Eliminates intersegment revenues.
(3) Eliminates bad debt recovery sales between operating segments.
(4) Eliminates investments in subsidiaries and intercompany borrowings.
(5) Reclassifies net interest income, fee income and provision for credit losses
relating to securitized receivables to other revenues.
(6) Represents receivables serviced with limited recourse.
CREDIT QUALITY
--------------------------------------------------------------------------------
Subject to receipt of regulatory approvals, we intend to transfer our domestic
private label credit card portfolio to HSBC Bank USA in 2004. Contingent upon
receiving regulatory approval for this asset transfer, we will adopt charge-off
and account management guidelines in accordance with the Uniform Retail Credit
Classification and Account Management Policy issued by the FFIEC for our entire
domestic private label and MasterCard and Visa portfolios. See "Executive
Overview" for further discussion.
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.
While our credit loss reserves are available to absorb losses in the entire
portfolio, we specifically consider the credit quality and other risk factors
for each of our products. We recognize the different inherent loss
characteristics in each of our products as well as customer account management
policies and practices and risk management/collection practices. Charge-off
policies are also considered when establishing loss reserve requirements to
ensure the appropriate reserves exist for products with longer charge-off
periods. We also consider key ratios such as reserves to nonperforming loans and
reserves as a percent of net charge-offs in developing our loss reserve
estimates. Loss reserve estimates are reviewed periodically and adjustments are
reported in earnings when they become known. As these estimates are influenced
by factors outside of our control, such as consumer payment patterns and
economic conditions, there is uncertainty inherent in these estimates, making it
reasonably possible that they could change. See Note 4, "Receivables," in the
accompanying consolidated financial statements for receivables by product type
and Note 5, "Credit Loss Reserves," for our credit loss reserve methodology and
an analysis of changes in the credit loss reserves.
The following table summarizes owned basis credit losses:
SEPTEMBER 30, JUNE 30, SEPTEMBER 30,
2004 2004 2003
----------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Owned credit loss reserves................................ $3,953 $3,795 $3,779
Reserves as a percent of:
Receivables............................................. 3.71% 3.82% 4.06%
Net charge-offs(1)...................................... 102.0 98.2 105.1
Nonperforming loans..................................... 104.1 103.0 92.6
---------------
(1) Quarter-to-date, annualized
During the quarter ended September 30, 2004, credit loss reserves increased as
the provision for owned credit losses was $154 million greater than net
charge-offs reflecting growth in our loan portfolio, partially offset by
improved asset quality. In the quarter ended September 30, 2003, provision for
owned credit losses was $102 million greater than net charge-offs. Reserve
levels at September 30, 2004 reflect the factors discussed above.
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Household International, Inc.
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For securitized receivables, we also record a provision for estimated probable
losses that we expect to incur under the recourse provisions. The following
table summarizes managed credit loss reserves:
SEPTEMBER 30, JUNE 30, SEPTEMBER 30,
2004 2004 2003
-------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Managed credit loss reserves.............................. $5,199 $5,699 $5,733
Reserves as a percent of:
Receivables............................................. 4.11% 4.66% 4.89%
Net charge-offs(1)...................................... 95.4 104.2 107.4
Nonperforming loans..................................... 111.1 122.8 111.7
---------------
(1) Quarter-to-date, annualized
During the quarter ended September 30, 2004, managed credit loss reserves
decreased as a result of changes in securitization levels.
See "Basis of Reporting" for additional discussion on the use of non-GAAP
financial measures and "Reconciliations to GAAP Financial Measures" for
quantitative reconciliations of the non-GAAP financial measures to the
comparable GAAP basis financial measure.
DELINQUENCY - OWNED BASIS
The following table summarizes two-months-and-over contractual delinquency (as a
percent of consumer receivables):
SEPTEMBER 30, JUNE 30, SEPTEMBER 30,
2004 2004 2003
-------------------------------------------------------------------------------------------------------------
Real estate secured....................................... 3.27% 3.39% 4.20%
Auto finance.............................................. 1.81 2.12 2.14
MasterCard/Visa........................................... 5.84 5.83 5.99
Private label............................................. 4.72 5.00 5.59
Personal non-credit card.................................. 8.83 8.92 9.96
---- ---- ----
Total..................................................... 4.43% 4.57% 5.36%
==== ==== ====
Total owned delinquency decreased 14 basis points compared to the prior quarter.
This decrease is consistent with improvements in early delinquency roll rate
trends we began to experience in the fourth quarter of 2003 as a result of
improvements in the economy and better underwriting, including both improved
modeling and improved credit quality of originations. The overall decrease in
our real estate secured portfolio reflects receivable growth and improved
collection efforts which were partially offset by the seasoning and maturation
of the portfolio. The decrease in auto finance delinquencies reflects the impact
of tightened underwriting, higher receivable levels and lower securitization
levels. Auto finance delinquency in June 2004 was also adversely impacted by
changes in collections operations. The decrease in private label delinquency
reflects receivable growth as well as improved underwriting, collections and
credit models. The decrease in personal non-credit card delinquency reflects the
positive impact of receivable growth as well as improved collection efforts.
Compared to a year ago, total delinquency decreased 93 basis points as all
products reported lower delinquency levels. The improvements are generally the
result of improvements in the economy and better underwriting.
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Household International, Inc.
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NET CHARGE-OFFS OF CONSUMER RECEIVABLES - OWNED BASIS
The following table summarizes net charge-offs of consumer receivables (as a
percent, annualized, of average consumer receivables):
SEPTEMBER 30, JUNE 30, SEPTEMBER 30,
2004 2004 2003
-------------------------------------------------------------------------------------------------------------
Real estate secured....................................... 1.19% 1.04% .91%
Auto finance.............................................. 3.66 3.05 4.62
MasterCard/Visa........................................... 8.50 9.91 8.61
Private label............................................. 4.79 5.06 5.35
Personal non-credit card.................................. 9.50 10.59 10.55
---- ----- -----
Total..................................................... 3.77% 4.02% 3.98%
==== ===== =====
Real estate secured net charge-offs and REO expense as a
percent of average real estate secured receivables...... 1.31% 1.47% 1.35%
Net charge-offs decreased 25 basis points compared to the quarter ended June 30,
2004 as the lower delinquency levels we have been experiencing due to an
improving economy are having an impact on charge-offs. Our real estate secured
portfolio experienced an increase in net charge-offs during the third quarter
reflecting lower estimates of net realizable value as a result of process
changes to better estimate property values at the time of foreclosure which has
resulted in an increase in real estate net charge-offs compared to the previous
quarter. The increase in auto finance net charge-offs reflects the impact of
higher delinquency levels in the second quarter which have progressed to
charge-off. The decrease in MasterCard/Visa reflects the impact of higher net
charge-offs in the second quarter due to seasonality. In addition to economic
conditions, the decrease in net charge-offs in personal non-credit card is a
result of improved credit quality and portfolio stabilization.
Total net charge-offs for the current quarter decreased from September 2003 net
charge-offs levels due to an improving economy and a decrease in the percentage
of the portfolio comprised of personal non-credit card receivables, which have a
higher net charge-off rate than other products in our portfolio. In addition,
auto finance, MasterCard and Visa, private label and personal non-credit card
reported lower net charge-off levels generally as a result of receivable growth,
improved collections and better underwriting, including both improved modeling
and improved credit quality of originations. The decrease in auto finance net
charge-offs also reflects the decision to target lower yielding but higher
credit quality customers as well as improved used auto prices which resulted in
lower loss severities. The increase in our real estate secured portfolio
reflects lower estimates of net realizable value at the time of foreclosure.
OWNED NONPERFORMING ASSETS
SEPTEMBER 30, JUNE 30, SEPTEMBER 30,
2004 2004 2003
----------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Nonaccrual receivables.................................... $2,891 $2,833 $3,197
Accruing consumer receivables 90 or more days
delinquent.............................................. 905 849 883
Renegotiated commercial loans............................. 1 2 2
------ ------ ------
Total nonperforming receivables........................... 3,797 3,684 4,082
Real estate owned......................................... 601 624 543
------ ------ ------
Total nonperforming assets................................ $4,398 $4,308 $4,625
====== ====== ======
Credit loss reserves as a percent of nonperforming
receivables............................................. 104.1% 103.0% 92.6%
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Household International, Inc.
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Compared to June 30, 2004, the increase in nonaccrual receivables and total
nonperforming assets is primarily attributable to an increase in our real estate
secured portfolio due to growth. Compared to September 30, 2003, the decrease in
nonaccrual receivables and total nonperforming assets is primarily due to
improved credit quality and collection efforts partially offset by growth.
Accruing consumer receivables 90 or more days delinquent includes domestic
MasterCard and Visa and private label credit card receivables, consistent with
industry practice.
ACCOUNT MANAGEMENT POLICIES AND PRACTICES
Our policies and practices for the collection of consumer receivables, including
our customer account management policies and practices, permit us to reset the
contractual delinquency status of an account to current, based on indicia or
criteria which, in our judgment, evidence continued payment probability. Such
policies and practices vary by product and are designed to manage customer
relationships, maximize collection opportunities and avoid foreclosure or
repossession if reasonably possible. If the account subsequently experiences
payment defaults, it will again become contractually delinquent.
The tables below summarize approximate restructuring statistics in our managed
basis domestic portfolio. We report our restructuring statistics on a managed
basis only because the receivables that we securitize are subject to
underwriting standards comparable to our owned portfolio, are serviced and
collected without regard to ownership and result in a similar credit loss
exposure for us. As previously reported, in prior periods we used certain
assumptions and estimates to compile our restructure statistics. We also stated
that we continue to enhance our ability to capture and segment restructure data
across all business units. In the tables that follow, the restructure statistics
presented for June 30, 2004 and September 30, 2004 have been compiled using
enhanced systemic counters and refined assumptions and estimates. As a result of
the systems enhancements, for June 30, 2004 and subsequent periods we exclude
from our reported statistics loans that had been reported as contractually
delinquent that have been reset to a current status because we have determined
that the loan should not have been considered delinquent (e.g., payment
application processing errors). Statistics reported for all periods prior to
June 30, 2004 include such loans. 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. Further, to the best of our knowledge, most of our competitors do not
disclose account restructuring, reaging, loan rewriting, forbearance,
modification, deferment or extended payment information comparable to the
information we have disclosed, and the lack of such disclosure by other lenders
may limit the ability to draw meaningful conclusions about our business based
solely on data or information regarding account restructuring statistics or
policies.
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TOTAL RESTRUCTURED BY RESTRUCTURE PERIOD - DOMESTIC PORTFOLIO(1)
(MANAGED BASIS)
SEPTEMBER 30, JUNE 30, SEPTEMBER 30,
2004 2004 2003
----------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
Never restructured........................................ 86.5% 86.1% 84.2%
Restructured:
Restructured in the last 6 months....................... 4.8 4.8 7.3
Restructured in the last 7-12 months.................... 3.6 4.0 3.5
Previously restructured beyond 12 months................ 5.1 5.1 5.0
------- ------- -------
Total ever restructured(2).............................. 13.5 13.9 15.8
------- ------- -------
Total..................................................... 100.0% 100.0% 100.0%
======= ======= =======
TOTAL RESTRUCTURED BY PRODUCT - DOMESTIC PORTFOLIO(1)
(MANAGED BASIS)
Real estate secured....................................... $ 8,895 $ 8,885 $ 9,531
Auto finance.............................................. 1,420 1,304 1,269
MasterCard/Visa........................................... 628 639 578
Private label............................................. 756 830 1,091
Personal non-credit card.................................. 3,688 3,727 4,136
------- ------- -------
Total..................................................... $15,387 $15,385 $16,605
======= ======= =======
(AS A PERCENT OF MANAGED RECEIVABLES)
Real estate secured....................................... 15.8% 16.5% 18.7%
Auto finance.............................................. 14.4 14.0 15.1
MasterCard/Visa........................................... 3.5 3.6 3.3
Private label............................................. 5.0 5.6 7.7
Personal non-credit card.................................. 24.3 25.0 26.7
------- ------- -------
Total(2).................................................. 13.5% 13.9% 15.8%
======= ======= =======
---------------
(1) Excludes foreign businesses, commercial and other.
(2) Total including foreign businesses was 12.6 percent at September 30, 2004,
13.0 percent at June 30, 2004, and 14.9 percent at September 30, 2003.
The amount of domestic and foreign managed receivables in forbearance,
modification, rewrites or other account management techniques for which we have
reset delinquency and that is not included in the restructured or delinquency
statistics was approximately $.5 billion or .4 percent of managed receivables at
September 30, 2004, $.5 billion or .4 percent of managed receivables at June 30,
2004 and $1.1 billion or .9 percent of managed receivables at September 30,
2003. For periods prior to June 30, 2004, all credit card approved consumer
credit counseling accommodations are included in the reported statistics. As a
result of our systems enhancements, we are now able to segregate which credit
card approved consumer credit counseling accommodations included resetting the
contractual delinquency status to current after January 1, 2003. Such accounts
are included in the September 30, 2004 and June 30, 2004 restructure statistics
in the table above. Credit card credit counseling accommodations that did not
include resetting contractual delinquency status are not reported in the table
above or the September 30, 2004 and June 30, 2004 statistics in this paragraph.
51
Household International, Inc.
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LIQUIDITY AND CAPITAL RESOURCES
--------------------------------------------------------------------------------
The funding synergies resulting from our merger with HSBC have allowed us to
reduce our reliance on traditional sources to fund our growth. We continue to
focus on balancing our use of affiliate and third-party funding sources to
minimize funding expense while maximizing liquidity. As discussed below, we
decreased third-party debt and initial securitization funding during the nine
months ended September 30, 2004 as we used proceeds from the sale of real estate
secured receivables to HSBC Bank USA, debt issued to affiliates and additional
secured financings to assist in the funding of our businesses.
Because we are now a subsidiary of HSBC, our credit spreads relative to
Treasuries have tightened. We recognized cash funding expense savings, primarily
as a result of these tightened credit spreads and lower costs due to shortening
the maturity of our liabilities primarily through increased issuance of
commercial paper, in excess of $235 million during the nine months ended
September 30, 2004 and less than $70 million for the prior-year period compared
to the funding costs we would have incurred using average spreads during the
first half of 2002. It is anticipated that these tightened credit spreads and
other funding synergies will eventually enable HSBC to realize annual cash
funding expense savings, including external fee savings, in excess of $1 billion
per year as our existing term debt matures over the course of the next few
years. The portion of these savings to be realized by Household will depend in
large part upon the amount and timing of the proposed domestic private label
credit card portfolio transfer to HSBC Bank USA and other initiatives between
Household and HSBC subsidiaries.
SECURITIES totaled $6.9 billion at September 30, 2004 and $11.1 billion at
December 31, 2003. Included in the September 30, 2004 balance was $2.6 billion
dedicated to our credit card bank and $3.2 billion held by our insurance
subsidiaries. Included in the December 31, 2003 balance was $2.4 billion
dedicated to our credit card bank and $3.1 billion held by our insurance
subsidiaries. Our securities balance at December 31, 2003 was unusually high as
a result of the cash received from the $2.8 billion real estate secured loan
sale to HSBC Bank USA on December 31, 2003 as well as excess liquidity.
COMMERCIAL PAPER, BANK AND OTHER BORROWINGS totaled $14.5 billion at September
30, 2004 and $9.1 billion at December 31, 2003. Included in this total was
outstanding Euro commercial paper sold to customers of HSBC of $3.7 billion at
September 30, 2004 and $2.8 billion at December 31, 2003. Commercial paper, bank
and other borrowings increased significantly during the third quarter of 2004 to
help give us greater flexibility in managing liquidity surrounding the
contemplated private label credit card sale to HSBC Bank USA.
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Household International, Inc.
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DUE TO AFFILIATES and other HSBC related funding are summarized in the following
table:
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------------------------------------------------------------------------------------
(IN BILLIONS)
Debt issued to HSBC subsidiaries:
Domestic short-term borrowings......................... $ - $ 2.6
Drawings on bank lines in the U.K. .................... 6.3 3.4
Term debt.............................................. 5.4 1.3
Preferred securities issued by Household Capital Trust
VIII.................................................. .3 .3
----- -----
Total debt issued to HSBC subsidiaries................. 12.0 7.6
----- -----
Debt issued to HSBC clients:
Euro commercial paper.................................. 3.7 2.8
Term debt.............................................. .7 .4
----- -----
Total debt issued to HSBC clients...................... 4.4 3.2
Preferred stock issued to HNAH (issued to HSBC at December
31, 2003)................................................. 1.1 1.1
Real estate secured receivable activity with HSBC Bank USA:
Cash received on sales (cumulative).................... 3.7 2.8
Direct purchases from correspondents (cumulative)...... 2.2 -
Run-off of real estate secured receivable activity with
HSBC Bank USA......................................... (1.0) -
----- -----
Total real estate secured receivable activity with HSBC Bank
USA....................................................... 4.9 2.8
----- -----
Total HSBC related funding.................................. $22.4 $14.7
===== =====
Proceeds from the December 2003 sale of $2.8 billion of real estate secured
loans to HSBC Bank USA, which at year-end 2003 had been temporarily held as
securities available for sale, were used to pay-down domestic short-term
borrowings in the first quarter of 2004. Proceeds from the March 2004 real
estate secured receivable sale were used to pay-down commercial paper balances
which had been used as temporary funding in the first quarter of 2004 and to
fund various debt maturities.
As of September 30, 2004, we had revolving credit facilities with HSBC of $2.5
billion domestically and $7.5 billion in the U.K. There have been no draws on
the domestic line. We also had derivative contracts with a notional value of
$59.2 billion, or approximately 87 percent of total derivative contracts,
outstanding with HSBC affiliates. In July 2004, a $4.0 billion credit facility
was provided by an HSBC affiliate in Geneva to allow temporary increases in
commercial paper issuance to help give greater flexibility in managing liquidity
surrounding the contemplated private label credit card sale to HSBC Bank USA.
LONG TERM DEBT (with original maturities over one year) decreased to $78.8
billion at September 30, 2004 from $79.6 billion at December 31, 2003.
Significant issuances during the nine months ended September 30, 2004 included
the following:
- $4.2 billion of domestic and foreign medium-term notes
- $1.8 billion of foreign currency-denominated bonds (including $243
million which was issued to customers of HSBC)
- $1.2 billion of InterNotes(SM) (retail-oriented medium-term notes)
- $1.3 billion of global debt
- $4.0 billion of securities backed by home equity and auto finance loans.
For accounting purposes, these transactions were structured as secured
financings.
53
Household International, Inc.
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SELECTED CAPITAL RATIOS are summarized in the following table:
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------------------------------------------------------------------------------------
(RESTATED) (RESTATED)
TETMA(1).................................................... 7.18% 7.03%
TETMA + Owned Reserves(1)................................... 10.10 9.89
Tangible common equity to tangible managed assets(1)........ 5.22 5.04
Common and preferred equity to owned assets................. 13.96 14.69
Excluding purchase accounting adjustments:
TETMA(1)............................................... 8.88 8.94
TETMA + Owned Reserves(1).............................. 11.81 11.81
Tangible common equity to tangible managed assets(1)... 6.96 6.98
---------------
(1) TETMA, TETMA + Owned Reserves and tangible common equity to tangible managed
assets represent non-GAAP financial ratios that are used by Household
management and certain rating agencies to evaluate capital adequacy and may
differ from similarly named measures presented by other companies. See
"Basis of Reporting" for additional discussion on the use of non-GAAP
financial measures and "Reconciliations to GAAP Financial Measures" for
quantitative reconciliations to the equivalent GAAP basis financial measure.
In April 2004, Fitch Ratings revised our Rating Outlook to Positive from Stable
and raised our Support Rating to "1" from "2". In addition, in July 2004 Fitch
Ratings raised our Senior Debt Rating to "A+" from "A" and raised our Senior
Subordinated Debt Rating and our Preferred Stock Rating to "A" from "A-". We are
committed to maintaining at least a mid-single "A" rating and as part of that
effort will continue to review appropriate capital levels with our rating
agencies.
On September 8, 2004, we declared a $850 million common stock dividend to our
immediate parent, HSBC Investments (North America) Inc. ("HINO"), which was paid
on September 30, 2004. In October 2004, we paid an accrued dividend of $108
million on our preferred stock to HNAH.
SECURITIZATIONS AND SECURED FINANCINGS Securitizations (which are 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 (which do not receive sale treatment under
SFAS No. 140) of consumer receivables are used to limit our reliance on the
unsecured debt markets and often are more cost-effective than alternative
funding sources.
In a securitization, a designated pool of non-real estate consumer receivables
is removed from the balance sheet and transferred to an unaffiliated trust. This
unaffiliated trust is a qualifying special purpose entity ("QSPE") as defined by
SFAS No. 140 and, therefore, is not consolidated. The QSPE funds its receivable
purchase through the issuance of securities to investors, entitling them to
receive specified cash flows during the life of the securities. The receivables
transferred to the QSPE serve as collateral for the securities. At the time of
sale, an interest-only strip receivable is recorded, representing the present
value of the cash flows we expect to receive over the life of the securitized
receivables, net of estimated credit losses. Under the terms of the
securitizations, we receive annual servicing fees on the outstanding balance of
the securitized receivables and the rights to future residual cash flows on the
sold receivables after the investors receive their contractual return. Cash
flows related to the interest-only strip receivables and servicing the
receivables are collected over the life of the underlying securitized
receivables.
In a secured financing, a designated pool of receivables are conveyed to a
wholly owned limited purpose subsidiary which in turn transfers the receivables
to a trust which sells interests to investors. Repayment of the debt issued by
the trust is secured by the receivables transferred. The transactions are
structured as secured financings under SFAS No. 140. Therefore, the receivables
and the underlying debt of the trust remain on our balance sheet. We do not
recognize a gain in a secured financing transaction. Because the
54
Household International, Inc.
--------------------------------------------------------------------------------
receivables and the debt remain on our balance sheet, revenues and expenses are
reported consistently with our owned balance sheet portfolio. Using this source
of funding results in similar cash flows as issuing debt through alternative
funding sources.
Under U.K. GAAP as reported by HSBC, securitizations are treated as secured
financings. In order to align our accounting treatment with that of HSBC under
U.K. GAAP, we began to structure all new collateralized funding transactions as
secured financings in the third quarter of 2004. However, because existing
public private label and MasterCard and Visa credit card transactions were
structured as sales to revolving trusts that require replenishments of
receivables to support previously issued securities, receivables of each of
these asset types will continue to be sold to these trusts and the resulting
replenishment gains recorded until the revolving periods end, the last of which
is expected to occur in 2007. In addition, we will continue to replenish at
reduced levels, certain non-public personal non-credit card and MasterCard/Visa
securities issued to conduits and record the resulting replenishment gains for a
period of time in order to manage liquidity. Since our securitized receivables
have varying lives, it will take several years for these receivables to pay-off
and the related interest-only strip receivables to be reduced to zero. The
termination of sale treatment on new collateralized funding activity reduces our
reported net income under U.S. GAAP. There is no impact, however, on cash
received from operations or on U.K. GAAP reported results. 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.
As previously discussed, securitization levels were much lower in 2004 as a
result of the use of alternate funding sources, including funding from HSBC
subsidiaries and our decision to structure all new collateralized funding
transactions as secured financings beginning in the third quarter of 2004.
Receivables securitized (excluding replenishments of certificateholder
interests) are summarized in the following table:
THREE MONTHS ENDED SEPTEMBER 30 2004 2003
---------------------------------------------------------------------------
(IN MILLIONS)
Auto finance................................................ $ - $ -
MasterCard/Visa............................................. - 350
Private label............................................... - -
Personal non-credit card.................................... - 885
---- ------
Total....................................................... $ - $1,235
==== ======
NINE MONTHS ENDED SEPTEMBER 30 2004 2003
---------------------------------------------------------------------------
(IN MILLIONS)
Auto finance................................................ $ - $1,007
MasterCard/Visa............................................. 550 670
Private label............................................... 190 250
Personal non-credit card.................................... - 1,700
---- ------
Total....................................................... $740 $3,627
==== ======
Our securitized receivables totaled $20.2 billion at September 30, 2004,
compared to $26.2 billion at December 31, 2003. As of September 30, 2004,
closed-end real estate secured and auto finance receivables totaling $9.3
billion secured $7.3 billion of outstanding debt related to securitization
transactions which were structured as secured financings. At December 31, 2003,
closed-end real estate secured receivables totaling $8.0 billion secured $6.7
billion of outstanding debt related to secured financing transactions.
Securitizations structured as sales represented 16 percent of the funding
associated with our managed portfolio at September 30, 2004 and 21 percent at
December 31, 2003. Secured financings represented
55
Household International, Inc.
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6 percent of the funding associated with our managed portfolio at September 30,
2004 and 5 percent at December 31, 2003.
2004 FUNDING STRATEGY Our current estimated domestic funding needs and sources
for 2004 are summarized in the table that follows. Because we cannot predict
with any degree of certainty the timing as to when or if approval will be
received for our proposed transfer of our domestic private label credit card
receivables to HSBC Bank USA, such transfer is not contemplated in the following
2004 funding plan. If the proposed transfer does occur, our external funding
needs will decrease.
ACTUAL ESTIMATED
JANUARY 1 OCTOBER 1
THROUGH THROUGH ESTIMATED
SEPTEMBER 30, DECEMBER 31, FULL YEAR
2004 2004 2004
---------------------------------------------------------------------------------------------------
(IN BILLIONS)
FUNDING NEEDS:
Net asset growth....................................... $ 7 $ 5 - 6 $12 - 13
Commercial paper, term debt and securitization
maturities.......................................... 23 4 - 5 27 - 28
Other.................................................. 1 0 - 1 1 - 2
--- ------- --------
Total funding needs, including growth.................. $31 $9 - 12 $40 - 43
=== ======= ========
FUNDING SOURCES:
External funding, including HSBC clients............... $27 $ 7 - 9 $34 - 36
HSBC and HSBC subsidiaries............................. 4 2 - 3 6 - 7
--- ------- --------
Total funding sources.................................. $31 $9 - 12 $40 - 43
=== ======= ========
RISK MANAGEMENT
--------------------------------------------------------------------------------
LIQUIDITY RISK There have been no significant changes in our approach to
liquidity risk since December 31, 2003.
INTEREST RATE AND CURRENCY RISK HSBC has certain limits and benchmarks that
serve as guidelines in determining 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 September 30, 2004 was $3
million, which includes 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 $3 million. As of
September 30, 2004, we had a PVBP position of less than $.1 million reflecting
the impact of a one basis point increase in interest rates. Our total PVBP
position was $.7 million at December 31, 2003 which does not change as a result
of the loss of hedge accounting.
We also monitor the impact that an immediate hypothetical 100 basis points
parallel increase or decrease in interest rates would have on our net interest
income. The following table summarizes such estimated impact:
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------------------------------------------------------------------------------------
(IN MILLIONS)
Decrease in net interest income following an immediate
hypothetical 100 basis points parallel rise in interest
rates..................................................... $316 $406
Increase in net interest income following an immediate
hypothetical 100 basis points parallel fall in interest
rates..................................................... $337 $385
56
Household International, Inc.
--------------------------------------------------------------------------------
These estimates include both the net interest income impact of the derivative
positions we have entered into which are considered to be effective hedges under
SFAS 133 and the impact of economic hedges of certain underlying debt
instruments which do not qualify for hedge accounting as previously discussed,
as if they were effective hedges under SFAS 133. These estimates also assume we
would not take any corrective actions in response to interest rate movements
and, therefore, exceed what most likely would occur if rates were to change by
the amount indicated.
This approach best reflects the economic risks inherent in our balance sheet.
Despite the loss of hedge accounting for certain underlying debt instruments as
discussed above, the interest rate derivative positions hedging specific debt
issues remain effective economic transactions. At inception, each hedge was
structured to match the critical terms of the underlying debt. The validity of
these financial structures and the effectiveness of corresponding economic
hedges has been subsequently confirmed by an independent third party. From March
29, 2003 through September 30, 2004, the daily change in price of a substantial
number of these derivative instruments which do not qualify for hedge accounting
under SFAS 133 correlated highly with the change in price of the underlying
debt. In this analysis, there is no intent to manage or otherwise alter existing
derivative contracts meaning that at maturity of the derivative and the
underlying debt instrument, no net value remains, unlike a portfolio with a
focus on trading. Thus the treatment of all hedges as if they were effective
under SFAS 133 remains the most effective way of depicting the impact of
interest rate changes. Nevertheless, we have calculated a sensitivity to a 100
basis point immediate rise and fall in interest rates at December 31, 2004 which
considers the loss of hedge accounting. See our 2004 Form 10-K for the results
of this sensitivity analysis.
COUNTERPARTY CREDIT RISK At September 30, 2004, we had derivative contracts with
a notional value of approximately $68.2 billion, including $59.2 billion
outstanding with HSBC affiliates. Most swap agreements, both with third parties
and affiliates, 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 $.3 billion at September 30, 2004. Affiliate
swap counterparties generally provide collateral in the form of securities which
are not recorded on our balance sheet and totaled $1.5 billion at September 30,
2004.
There have been no significant changes in our approach to managing counterparty
credit risk since December 31, 2003.
57
HOUSEHOLD INTERNATIONAL, INC.
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------------- -----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
----------------------------------------------------------------------------------------------------------------------
(RESTATED) (RESTATED) (RESTATED) (RESTATED)
(DOLLARS ARE IN MILLIONS)
RETURN ON AVERAGE ASSETS:
Net income............................................. $ 325 $ 22 $ 1,228 $ 1,011
HSBC acquisition related costs and other merger related
items incurred by Household, after-tax............... - - - 167
-------- -------- -------- --------
Operating net income................................... $ 325 $ 22 $ 1,228 $ 1,178
======== ======== ======== ========
Average assets:
Owned basis.......................................... $124,512 $112,059 $120,456 $107,619
Serviced with limited recourse....................... 21,542 23,719 23,462 23,985
-------- -------- -------- --------
Managed basis........................................ $146,054 $135,778 $143,918 $131,604
======== ======== ======== ========
Return on average owned assets......................... 1.04% .08% 1.36% 1.25%
Return on average owned assets, operating basis........ 1.04 .08 1.36 1.46
Return on average managed assets....................... .89 .06 1.14 1.02
Return on average managed assets, operating basis...... .89 .06 1.14 1.19
RETURN ON AVERAGE COMMON SHAREHOLDER'S EQUITY:
Net income............................................. $ 325 $ 22 $ 1,228 $ 1,011
Dividends on preferred stock........................... (18) (18) (54) (58)
-------- -------- -------- --------
Net income available to common shareholders............ 307 4 1,174 953
HSBC acquisition related costs and other merger related
items incurred by Household.......................... - - - 167
-------- -------- -------- --------
Operating net income available to common
shareholders......................................... $ 307 $ 4 $ 1,174 $ 1,120
======== ======== ======== ========
Average common shareholder's equity.................... $ 17,367 $ 15,544 $ 17,057 $ 13,396
Return on average common shareholder's equity.......... 7.1% .1% 9.2% 9.5%
Return on average common shareholder's equity,
operating basis...................................... 7.1 .1 9.2 11.1
NET INTEREST INCOME:
Net interest income:
Owned basis.......................................... $ 1,969 $ 1,916 $ 5,719 $ 5,358
Serviced with limited recourse....................... 581 715 1,987 2,161
-------- -------- -------- --------
Managed basis........................................ $ 2,550 $ 2,631 $ 7,706 $ 7,519
======== ======== ======== ========
Average interest-earning assets:
Owned basis.......................................... $107,955 $ 95,999 $102,957 $ 92,320
Serviced with limited recourse....................... 21,542 23,719 23,462 23,985
-------- -------- -------- --------
Managed basis........................................ $129,497 $119,718 $126,419 $116,305
======== ======== ======== ========
Owned basis net interest margin........................ 7.29% 7.98% 7.41% 7.74%
Managed basis net interest margin...................... 7.88 8.79 8.13 8.62
MANAGED BASIS RISK ADJUSTED REVENUE:
Net interest income.................................... $ 2,550 $ 2,631 $ 7,706 $ 7,519
Other revenues, excluding securitization revenue....... 969 146 3,024 2,590
Less: Net charge-offs.................................. (1,363) (1,334) (4,172) (3,950)
-------- -------- -------- --------
Risk adjusted revenue.................................. $ 2,156 $ 1,443 $ 6,558 $ 6,159
======== ======== ======== ========
Average interest-earning assets........................ $129,497 $119,718 $126,419 $116,305
Managed basis risk adjusted revenue.................... 6.66% 4.82% 6.92% 7.06%
58
HOUSEHOLD INTERNATIONAL, INC.
RECONCILIATIONS TO GAAP FINANCIAL MEASURES (CONTINUED)
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------------------- -----------------------------
SEPTEMBER 30, JUNE 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2004 2004 2003 2004 2003
----------------------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
CONSUMER NET CHARGE-OFF RATIO:
Consumer net charge-offs:
Owned basis............................... $ 969 $ 966 $ 897 $ 2,905 $ 2,702
Serviced with limited recourse............ 394 401 435 1,267 1,246
-------- -------- -------- -------- --------
Managed basis............................. $ 1,363 $ 1,367 $ 1,332 $ 4,172 $ 3,948
======== ======== ======== ======== ========
Average consumer receivables:
Owned basis............................... $102,821 $ 96,189 $ 90,172 $ 97,328 $ 86,269
Serviced with limited recourse............ 21,542 23,568 23,719 23,462 23,985
-------- -------- -------- -------- --------
Managed basis............................. $124,363 $119,757 $113,891 $120,790 $110,254
======== ======== ======== ======== ========
Owned basis consumer net charge-off ratio... 3.77% 4.02% 3.98% 3.98% 4.17%
Managed basis consumer net charge-off
ratio..................................... 4.38 4.57 4.68 4.61 4.77
RESERVES AS A PERCENT OF NET CHARGE-OFFS
Loss reserves:
Owned basis............................... $ 3,953 $ 3,795 $ 3,779 $ 3,953 $ 3,779
Serviced with limited recourse............ 1,246 1,904 1,954 1,246 1,954
-------- -------- -------- -------- --------
Managed basis............................. $ 5,199 $ 5,699 $ 5,733 $ 5,199 $ 5,733
======== ======== ======== ======== ========
Net charge-offs:
Owned basis............................... $ 969 $ 966 $ 899 $ 2,905 $ 2,704
Serviced with limited recourse............ 394 401 435 1,267 1,246
-------- -------- -------- -------- --------
Managed basis............................. $ 1,363 $ 1,367 $ 1,334 $ 4,172 $ 3,950
======== ======== ======== ======== ========
Owned basis reserves as a percent of net
charge-offs............................... 102.0% 98.2% 105.1% 102.1% 104.8%
Managed basis reserves as a percent of net
charge-offs............................... 95.4 104.2 107.4 93.5 108.9
EFFICIENCY RATIO (RESTATED):
Total costs and expenses less policyholders'
benefits.................................. $ 1,315 $ 1,228 $ 1,157 $ 3,840 $ 3,633
HSBC acquisition related costs incurred by
Household................................. - - - - 198
-------- -------- -------- -------- --------
Total costs and expenses less policyholders'
benefits, excluding nonrecurring items.... $ 1,315 $ 1,228 $ 1,157 $ 3,840 $ 3,435
======== ======== ======== ======== ========
Net interest income and other revenues less
policyholders' benefits:
Owned basis............................... $ 2,916 $ 2,889 $ 2,162 $ 8,735 $ 8,260
Serviced with limited recourse............ (232) 148 420 169 1,444
-------- -------- -------- -------- --------
Managed basis............................. $ 2,684 $ 3,037 $ 2,582 $ 8,904 $ 9,704
======== ======== ======== ======== ========
Owned basis efficiency ratio................ 45.1% 42.5% 53.5% 44.0% 44.0%
Owned basis efficiency ratio, operating
basis..................................... 45.1 42.5 53.5 44.0 41.6
Managed basis efficiency ratio.............. 49.0 40.4 44.8 43.1 37.4
Managed basis efficiency ratio, operating
basis..................................... 49.0 40.4 44.8 43.1 35.4
59
HOUSEHOLD INTERNATIONAL, INC.
RECONCILIATIONS TO GAAP FINANCIAL MEASURES (CONTINUED)
SEPTEMBER 30, JUNE 30, SEPTEMBER 30,
2004 2004 2003
------------------------------------------------------------------------------------------------------
(DOLLARS ARE IN MILLIONS)
TWO-MONTHS-AND-OVER-CONTRACTUAL DELINQUENCY:
Consumer two-months-and-over-contractual delinquency:
Owned basis............................................... $ 4,702 $ 4,534 $ 4,966
Serviced with limited recourse............................ 1,092 1,194 1,289
-------- -------- --------
Managed basis............................................. $ 5,794 $ 5,728 $ 6,255
======== ======== ========
Consumer receivables:
Owned basis............................................... $106,130 $ 99,115 $ 92,656
Serviced with limited recourse............................ 20,175 22,836 24,109
-------- -------- --------
Managed basis............................................. $126,305 $121,951 $116,765
======== ======== ========
Consumer two-months-and-over-contractual delinquency:
Owned basis............................................... 4.43% 4.57% 5.36%
Managed basis............................................. 4.59 4.70 5.36
RESERVES AS A PERCENT OF RECEIVABLES:
Loss reserves:
Owned basis............................................... $ 3,953 $ 3,795 $ 3,779
Serviced with limited recourse............................ 1,246 1,904 1,954
-------- -------- --------
Managed basis............................................. $ 5,199 $ 5,699 $ 5,733
======== ======== ========
Receivables:
Owned basis............................................... $106,437 $ 99,432 $ 93,028
Serviced with limited recourse............................ 20,175 22,836 24,109
-------- -------- --------
Managed basis............................................. $126,612 $122,268 $117,137
======== ======== ========
Reserves as a percent of receivables:
Owned basis............................................... 3.71% 3.82% 4.06%
Managed basis............................................. 4.11 4.66 4.89
RESERVES AS A PERCENT OF NONPERFORMING LOANS:
Loss reserves:
Owned basis............................................... $ 3,953 $ 3,795 $ 3,779
Serviced with limited recourse............................ 1,246 1,904 1,954
-------- -------- --------
Managed basis............................................. $ 5,199 $ 5,699 $ 5,733
======== ======== ========
Nonperforming loans:
Owned basis............................................... $ 3,797 $ 3,684 $ 4,082
Serviced with limited recourse............................ 881 958 1,052
-------- -------- --------
Managed basis............................................. $ 4,678 $ 4,642 $ 5,134
======== ======== ========
Reserves as a percent of nonperforming loans:
Owned basis............................................... 104.1% 103.0% 92.6%
Managed basis............................................. 111.1 122.8 111.7
60
HOUSEHOLD INTERNATIONAL, INC.
RECONCILIATIONS TO GAAP FINANCIAL MEASURES (CONTINUED)
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------------------------------------------------------------------------------------
(RESTATED) (RESTATED)
(DOLLARS ARE IN MILLIONS)
EQUITY RATIOS
TANGIBLE COMMON EQUITY:
Common shareholder's equity................................. $ 16,727 $ 16,391
Exclude:
Unrealized gains (losses) on:
Derivatives classified as cash flow hedges.............. (35) 10
Securities available for sale and interest-only strip
receivables............................................ (129) (167)
Intangible assets, net.................................... (2,684) (2,856)
Goodwill.................................................. (6,811) (6,697)
-------- --------
Tangible common equity...................................... 7,068 6,681
Purchase accounting adjustments............................. 2,335 2,548
-------- --------
Tangible common equity, excluding purchase accounting
adjustments............................................... $ 9,403 $ 9,229
======== ========
TANGIBLE SHAREHOLDER'S EQUITY:
Tangible common equity...................................... $ 7,068 $ 6,681
Preferred stock............................................. 1,100 1,100
Mandatorily redeemable preferred securities of Household
Capital Trusts............................................ 1,026 1,031
Adjustable Conversion-Rate Equity Security Units............ 527 519
-------- --------
Tangible shareholder's equity............................... 9,721 9,331
Purchase accounting adjustments............................. 2,284 2,492
-------- --------
Tangible shareholder's equity, excluding purchase accounting
adjustments............................................... $ 12,005 $ 11,823
======== ========
TANGIBLE SHAREHOLDER'S EQUITY PLUS OWNED LOSS RESERVES:
Tangible shareholder's equity............................... $ 9,721 $ 9,331
Owned loss reserves......................................... 3,953 3,793
-------- --------
Tangible shareholder's equity plus owned loss reserves...... 13,674 13,124
Purchase accounting adjustments............................. 2,284 2,492
-------- --------
Tangible shareholder's equity plus owned loss reserves,
excluding purchase accounting adjustments................. $ 15,958 $ 15,616
======== ========
TANGIBLE MANAGED ASSETS:
Owned assets................................................ $127,728 $119,052
Receivables serviced with limited recourse.................. 20,175 26,201
-------- --------
Managed assets.............................................. 147,903 145,253
Exclude:
Intangible assets, net.................................... (2,684) (2,856)
Goodwill.................................................. (6,811) (6,697)
Derivative financial assets............................... (3,001) (3,016)
-------- --------
Tangible managed assets..................................... 135,407 132,684
Purchase accounting adjustments............................. (278) (431)
-------- --------
Tangible managed assets, excluding purchase accounting
adjustments............................................... $135,129 $132,253
======== ========
EQUITY RATIOS:
Common and preferred equity to owned assets................. 13.96% 14.69%
Tangible common equity to tangible managed assets........... 5.22 5.04
Tangible shareholder's equity to tangible managed assets
("TETMA")................................................. 7.18 7.03
Tangible shareholder's equity plus owned loss reserves to
tangible managed assets ("TETMA + Owned Reserves")........ 10.10 9.89
Excluding purchase accounting adjustments:
Tangible common equity to tangible managed assets......... 6.96 6.98
TETMA..................................................... 8.88 8.94
TETMA + Owned Reserves.................................... 11.81 11.81
61
ITEM 4. CONTROLS AND PROCEDURES
--------------------------------------------------------------------------------
DISCLOSURE CONTROLS As of the end of the period covered by this report, with the
participation of our Chief Executive Officer and Chief Financial Officer, we
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange
Act of 1934). Based upon that evaluation, our Chief Executive Officer and our
Chief Financial Officer concluded that as of the end of such period, our
disclosure controls and procedures were effective in timely alerting them to
material information relating to Household International, Inc. required to be
included in our periodic reports with the Securities and Exchange Commission.
As a result of a subsequent evaluation of the effectiveness of our disclosure
controls and procedures as of the end of the period covered by our Annual Report
on Form 10-K for the year ended December 31, 2004, with the participation of our
Chief Executive Officer and Chief Financial Officer, we identified a material
weakness in our internal controls over financial reporting relating to the
process of establishing and maintaining effective hedges under the "shortcut"
method of accounting pursuant to Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities." As a
result, and as set forth in Note 2 to the Consolidated Financial Statements and
the "Restatement" section included in Item 2, Management's Discussion and
Analysis of Financial Condition and Results of Operations, we have restated our
unaudited consolidated financial statements for the periods covered by this
report. We have also undertaken remedial action to address and correct the
weakness in our internal controls over this process.
INTERNAL CONTROLS There have not been any changes in our internal control over
financial reporting (as that term is defined in Rules 13a-15(f) and 15d-15(f)
under the Securities Exchange Act of 1934) during the fiscal quarter to which
this report relates that have materially affected, or are reasonably likely to
materially affect, our internal controls over financial reporting.
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 LENDING 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 finance and insurance
companies operating in certain states and the large awards obtained from juries
in those states (Alabama and Mississippi are illustrative). Like other companies
in this industry, some of our subsidiaries are involved in a number of lawsuits
pending against them in these states. The Alabama and Mississippi cases, in
particular, generally allege inadequate disclosure or misrepresentation of
financing terms. In some suits, other parties are also named as defendants.
Unspecified compensatory and punitive damages are sought. Several of these suits
purport to be class actions or have multiple plaintiffs. The judicial climate in
these states is such that the outcome of all of these cases is unpredictable.
Although our subsidiaries believe they have substantive legal defenses to these
claims and are prepared to defend each case vigorously, a number of such cases
have been settled or otherwise resolved for amounts that in the aggregate are
not material to our operations. Appropriate insurance carriers have been
notified of each claim, and a number of reservations of rights letters have been
received. Certain of the financing of merchandise claims have been partially
covered by insurance.
In a case decided on March 31, 2004 and published on May 13, the Appellate Court
of Illinois, First District (Cook County), ruled in U.S. Bank National
Association v. Clark, et al., that certain lenders (which did not include any
subsidiaries of Household) violated the Illinois Interest Act by imposing points
62
and finance charge fees in excess of 3% of the principal amount on loans with an
interest rate in excess of 8%. The Appellate Court held for the first time that
when the Illinois legislature made amendments to the late fee provisions of the
Interest Act in 1992, Illinois opted out of the Federal Depository Institutions
Deregulation and Monetary Control Act of 1980 ("DIDMCA") and, in "certain
instances," the Federal Alternative Mortgage Transaction Parity Act of 1982
("AMPTA"). DIDMCA and AMPTA each contain provisions that preempt certain state
laws unless state legislatures took affirmative action to "opt-out" of the
federal preemptions within specified time frames. The Court found that as a
result of 1992 legislative action, the State's 3% restriction on points and
finance charge fees are now enforceable in Illinois. The Appellate Court's
ruling reversed the trial court's decision, which had relied on previous
opinions of the Illinois Attorney General, the Illinois Office of Banks and Real
Estate, and other courts. Should the decision stand and be applied retroactively
throughout Illinois, lenders would be required to make refunds to customers who
had a closed-end real estate secured first mortgage loan of double the interest
paid or contracted for, whichever is greater. The plaintiffs in the Clark case
have filed a notice of appeal with the Illinois Supreme Court. Three cases have
been filed against subsidiaries of Household based upon the Clark decision:
Wilkes v. Household Finance Corporation III, et al., Circuit Court of Cook
County, Illinois, Chancery Division, filed on June 18, 2004 (purported class
action); Aslam v. Accredited Home Lenders, Inc., et al., Circuit Court of Cook
County, Illinois, Chancery Division, filed on June 11, 2004 (purported class
action); and Morris, et al. v. Household Mortgage Services, Inc., U.S. District
Court for the Northern District of Illinois, filed on June 22, 2004. On our
motion, the Wilkes case was removed to Bankruptcy Court, however, plaintiffs
have filed a motion to return the case to the U.S. District Court. We also
served an arbitration demand on plaintiff's counsel as permitted under the loan
documents and filed a motion to stay or dismiss the case pending arbitration.
The Aslam case was settled for an immaterial amount and was dismissed on October
28, 2004. The portion of the Morris case alleging violations of the Illinois
Interest Act was settled for an immaterial amount. At this time, we are unable
to quantify the potential impact of the Clark decision should it receive
retroactive application.
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, Household,
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. To date, none
of the class claims has been certified. 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. The amended
complaint purports to assert claims under the federal securities laws, on behalf
of all persons who purchased or otherwise acquired Household securities between
October 23, 1997 and October 11, 2002, arising out of alleged false and
misleading statements in connection with Household's 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
63
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. The Court has ordered
that all factual discovery must be completed by January 13, 2006 and expert
witness discovery must be completed by July 24, 2006.
Other actions arising out of the restatement, which purport to assert claims
under ERISA on behalf of participants in Household's Tax Reduction Investment
Plan, were consolidated into a single purported class action, In re Household
International, Inc. ERISA Litigation, Master File No. 02 C 7921 (N.D. Ill). A
consolidated and amended complaint was filed against Household, William Aldinger
and individuals on the Administrative Investment Committee of the plan. The
consolidated complaint purports to assert claims under ERISA that are similar to
the claims in the Jaffe case. Essentially, the plaintiffs allege that the
defendants breached their fiduciary duties to the plan by investing in Household
stock and failing to disclose information to Plan participants. A motion to
dismiss the complaint was filed in June 2003. On March 30, 2004, the Court
granted in part, and denied in part, the defendants' motion to dismiss the
complaint. The Court dismissed all claims alleging that some or all of the
defendants breached their co-fiduciary obligations; misrepresented the prudence
of investing in Household stock; failed to disclose nonpublic information
regarding alleged accounting and lending improprieties; and failed to provide
other defendants with non-public information. The claims that remained
essentially alleged that some or all of the defendants failed to prudently
manage plan assets by continuing to invest in, or provide matching contributions
of, Household stock. On October 8, 2004, the parties entered into a settlement
agreement and documents have been filed with the Court seeking preliminary
approval of the settlement. Preliminary approval was granted on October 13,
2004. Notice of the proposed terms were published and mailed to applicable Plan
participants in October and the Court will hold a fairness hearing on November
22, 2004. If approved by the Court and not appealed, the settlement will become
final at that time. The settlement provides for a payment of $46.5 million which
will be paid into Plan accounts after deduction of plaintiffs' legal fees and
costs. The entire settlement will be funded by insurance proceeds.
On June 27, 2003, a case entitled, West Virginia Laborers Pension Trust Fund v.
Caspersen, et al., was filed in the Chancery Division of the Circuit Court of
Cook County, Illinois as case number 03CH10808. This purported class action
names as defendants the directors of Beneficial Corporation at the time of the
1998 merger of Beneficial Corporation into a subsidiary of Household, and claims
that those directors' due diligence of the Company at the time they considered
the merger was inadequate. The Complaint claims that as a result of some of the
securities law and other violations alleged in the Jaffe case, the Company's
common shares lost value. Pursuant to the merger agreement with Beneficial
Corporation, we assumed the defense of this litigation. In September of 2003,
the defendants filed a motion to dismiss which was granted on June 15, 2004
based upon a lack of personal jurisdiction over the defendants. The plaintiffs
have appealed this decision. In addition, on June 30, 2004, a case entitled,
Employer-Teamsters Local Nos. 175 & 505 Pension Trust Fund v. Caspersen, et al.,
was filed in the Superior Court of New Jersey, Law Division, Somerset County as
Case Number L9479-04. Other than the change in plaintiff, the suit is
substantially identical to the above West Virginia Laborer's Pension Trust Fund
case, and is brought by the same principal law firm which brought that suit. The
defendants have filed a motion to dismiss this case.
With respect to these securities litigation matters, 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 5. OTHER INFORMATION
--------------------------------------------------------------------------------
As approved by the Audit Committee of the Board of Directors, we have engaged
KPMG to perform certain non-audit services during the year. Those services
include language translation services relating to debt offerings of
subsidiaries, preparation of SAS70 reports relating to services performed for
contractual
64
counterparties, reporting on an annual report for the pension plan for our UK
operations, and certain tax services including account analysis, advice
regarding certain transactions and preparation of returns for securitization
trusts.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------------------------------------------------------
(a) Exhibits
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.
99.2 Report of KPMG LLP, independent registered public accounting
firm.
99.3 Letter of independent registered public accounting firm,
KPMG LLP, regarding unaudited interim financial information.
(b) Reports on Form 8-K
During the quarter ended September 30, 2004, the Registrant filed a Current
Report on Form 8-K on August 2, 2004 with respect to the financial supplement
pertaining to the financial results of Household International, Inc. for the
quarter ended June 30, 2004.
65
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
(formerly known as Household
International, Inc.)
(Registrant)
/s/ Simon C. Penney
--------------------------------------
Simon C. Penney
Senior Executive Vice President and
Chief Financial Officer
Date: March 31, 2005
66
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.
99.2 Report of KPMG LLP, independent registered public accounting
firm.
99.3 Letter of independent registered public accounting firm,
KPMG LLP, regarding unaudited interim financial information.
EXHIBIT 12
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND
TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
NINE MONTHS MARCH 29 JANUARY 1
ENDED THROUGH THROUGH
SEPTEMBER 30, SEPTEMBER 30, MARCH 28,
2004 2003 2003
------------------------------------------------------------------------------------------------------
(SUCCESSOR) (PREDECESSOR)
(SUCCESSOR) (RESTATED)
(RESTATED) (IN MILLIONS)
Net income............................................. $1,228 $ 765 $ 246
Income tax expense..................................... 619 384 182
------ ------ ------
Income before income tax expense....................... 1,847 1,149 428
------ ------ ------
Fixed charges:
Interest expense(1).................................. 2,225 1,362 898
Interest portion of rentals(2)....................... 39 26 18
------ ------ ------
Total fixed charges.................................... 2,264 1,388 916
------ ------ ------
Total earnings as defined.............................. $4,111 $2,537 $1,344
====== ====== ======
Ratio of earnings to fixed charges..................... 1.82 1.83 1.47(4)
Preferred stock dividends(3)........................... 81 59 32
Ratio of earnings to combined fixed charges and
preferred stock dividends............................ 1.75 1.75 1.42(4)
---------------
(1) For financial statement purposes for the periods January 1 through March 28,
2003 and March 29 through September 30, 2003, these amounts are reduced for
income earned on temporary investment of excess funds, generally resulting
from over-subscriptions of commercial paper issuances.
(2) Represents one-third of rentals, which approximates the portion representing
interest.
(3) Preferred stock dividends are grossed up to their pretax equivalents.
(4) The ratios for the period January 1 through March 28, 2003 have been
negatively impacted by $167 million (after-tax) of HSBC acquisition related
costs and other merger related items incurred by Household. Excluding these
charges, our ratio of earnings to fixed charges would have been 1.69 and our
ratio of earnings to combined fixed charges and preferred stock dividends
would have been 1.63. These non-GAAP financial ratios are provided for
comparison of our operating trends only.
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, William F. Aldinger, Chairman and Chief Executive Officer of HSBC Finance
Corporation (formerly known as Household International, Inc.), certify that:
1. I have reviewed this amended report on Form 10-Q/A 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 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
function):
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.
/s/ William F. Aldinger
--------------------------------------
William F. Aldinger
Chairman and Chief Executive Officer
Date: March 31, 2005
2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Simon C. Penney, Senior Executive Vice President and Chief Financial Officer
of HSBC Finance Corporation (formerly known as Household International, Inc.),
certify that:
1. I have reviewed this amended report on Form 10-Q/A 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 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
function):
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.
/s/ Simon C. Penney
--------------------------------------
Simon C. Penney
Senior Executive Vice President and
Chief Financial Officer
Date: March 31, 2005
3
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
In connection with the amended Quarterly Report of HSBC Finance Corporation,
formerly known as Household International, Inc. (the "Company"), on Form 10-Q/A
for the period ending September 30, 2004 as filed with the Securities and
Exchange Commission on the date hereof (the "Report"), I, William F. Aldinger,
Chairman and Chief Executive Officer of HSBC Finance Corporation, certify,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
/s/ William F. Aldinger
--------------------------------------
William F. Aldinger
Chairman and Chief Executive Officer
March 31, 2005
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the amended Quarterly Report of HSBC Finance Corporation,
formerly known as Household International, Inc. (the "Company"), on Form 10-Q/A
for the period ending September 30, 2004 as filed with the Securities and
Exchange Commission on the date hereof (the "Report"), I, Simon C. Penney,
Senior Executive Vice President and Chief Financial Officer of HSBC Finance
Corporation, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
/s/ Simon C. Penney
--------------------------------------
Simon C. Penney
Senior Executive Vice President and
Chief Financial Officer
March 31, 2005
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 the Company 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.
EXHIBIT 99.1
DEBT AND PREFERRED STOCK SECURITIES RATINGS
STANDARD & MOODY'S
POOR'S INVESTORS
AT SEPTEMBER 30, 2004 CORPORATION SERVICE FITCH, INC.
---------------------------------------------------------------------------------------------------
Household International, Inc.
Senior debt............................................... A A2 A+
Preferred stock........................................... BBB+ Baa1 A
Household Finance Corporation
Senior debt............................................... A A1 A+
Senior subordinated debt.................................. A- A2 A
Commercial paper.......................................... A-1 P-1 F-1
HFC Bank Limited
Senior debt............................................... A A1 A+
Commercial paper.......................................... A-1 P-1 F-1
Household Bank (SB), N.A
Senior debt............................................... A A1 A+
EXHIBIT 99.2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholder
HSBC Finance Corporation
We have reviewed the consolidated balance sheet of HSBC Finance Corporation
(formerly Household International, Inc.) (the Company), an indirect wholly-owned
subsidiary of HSBC Holdings plc, and subsidiaries as of September 30, 2004
(successor basis), the related consolidated statements of income for the three
and nine months ended September 30, 2004 (successor basis), the three months
ended September 30, 2003 (successor basis), and the periods January 1, 2003
through March 28, 2003 (predecessor basis) and March 29, 2003 through September
30, 2003 (successor basis), and the consolidated statements of changes in
shareholder's(s') equity and cash flows for the nine months ended September 30,
2004 (successor basis), and the periods January 1, 2003 through March 28, 2003
(predecessor basis) and March 29, 2003 through September 30, 2003 (successor
basis). These consolidated financial statements are the responsibility of the
Company's management.
We conducted our reviews in accordance with the standards established by the
Public Company Accounting Oversight Board (United States). A review of interim
financial information consists principally of applying analytical procedures and
making inquiries of persons responsible for financial and accounting matters. It
is substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board (United States), the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the consolidated financial statements referred to above for them to
be in conformity with U.S. generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, HSBC Finance
Corporation was acquired by HSBC Holdings plc on March 28, 2003 in a purchase
business combination recorded under the "push-down" method of accounting. As a
result of the acquisition, the consolidated financial information for the period
after the acquisition is presented on a different cost basis than that for the
period before the acquisition and, therefore, is not comparable.
As discussed in Note 2 to the consolidated financial statements, HSBC Finance
Corporation has restated its consolidated financial statements as of September
30, 2004 (successor basis) and for the three and nine months ended September 30,
2004 (successor basis), the three months ended September 30, 2003 (successor
basis), and the period March 29, 2003 through September 30, 2003 (successor
basis).
/s/ KPMG LLP
Chicago, Illinois
November 15, 2004 (except as to Note 2, which is as of March 31, 2005)
EXHIBIT 99.3
HSBC Finance Corporation
Prospect Heights, Illinois
Re: Quarterly Report Pursuant to Section 13 of the Securities Exchange Act of
1934 for the quarterly period ended September 30, 2004 as filed on Form
10-Q/A on March 31, 2005
With respect to the subject quarterly report pursuant to Section 13 of the
Securities Exchange Act of 1934 for the quarterly period ended September 30,
2004 as filed on Form 10-Q/A on March 31, 2005, we acknowledge our awareness of
the use therein of our report dated November 15, 2004 (except as to Note 2,
which is as of March 31, 2005) related to our reviews of interim financial
information.
Pursuant to Rule 436 under the Securities Act of 1933 (the Act), such report is
not considered part of a registration statement prepared or certified by an
accountant, or a report prepared or certified by an accountant within the
meaning of Sections 7 and 11 of the Act.
/s/ KPMG LLP
Chicago, Illinois
March 31, 2005
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