HSBC NA Q4 2004 10-K-Part 1

HSBC Holdings PLC 28 February 2005 -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) (X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to________ COMMISSION FILE NUMBER 1-8198 HSBC FINANCE CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 86-1052062 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.) 2700 SANDERS ROAD PROSPECT HEIGHTS, ILLINOIS 60070 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (847) 564-5000 REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE Securities registered pursuant to Section 12(b) of the Act: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- 8.875% Adjustable Conversion-Rate Equity New York Stock Exchange Security Units 6 3/4% Notes, due May 15, 2011 New York Stock Exchange 6.875% Notes, due January 30, 2033 New York Stock Exchange 6% Notes, due November 30, 2033 New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (X) No ( ) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ( ) Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ( ) No (X) As of February 25, 2005, there were 50 shares of the registrant's common stock outstanding, all of which are owned by HSBC Investments (North America) Inc. THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I(1)(a) AND (b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM 10-K WITH THE REDUCED DISCLOSURE FORMAT. DOCUMENTS INCORPORATED BY REFERENCE None. -------------------------------------------------------------------------------- TABLE OF CONTENTS PART/ITEM NO. PAGE ------------- ---- PART I ----------------------------------------------------------------------------------- Item 1. Business Introduction.............................................. 4 General................................................... 4 Restatement............................................... 6 Operations................................................ 7 Funding................................................... 10 Regulation and Competition................................ 11 Cautionary Statement on Forward-Looking Statements........ 13 Corporate Governance...................................... 14 Item 2. Properties.................................................. 14 Item 3. Legal Proceedings........................................... 15 Item 4. Submission of Matters to a Vote of Security Holders (Omitted)................................................. 17 PART II ----------------------------------------------------------------------------------- Item 5. Market for Registrant's Common Equity and Related Stockholder Matters....................................... 17 Item 6. Selected Financial Data..................................... 19 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Restatement............................................... 22 Executive Overview........................................ 23 Basis of Reporting........................................ 28 Critical Accounting Policies.............................. 34 Receivables Review........................................ 38 Results of Operations..................................... 40 Segment Results - Managed Basis........................... 46 Credit Quality............................................ 51 Liquidity and Capital Resources........................... 63 Off Balance Sheet Arrangements and Secured Financings..... 71 Risk Management........................................... 75 Glossary of Terms......................................... 80 Credit Quality Statistics................................. 83 Analysis of Credit Loss Reserves Activity................. 85 Net Interest Margin....................................... 87 Reconciliations to GAAP Financial Measures................ 90 Item 7A. Quantitative and Qualitative Disclosures About Market Risk...................................................... 106 Item 8. Financial Statements and Supplementary Data................. 106 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................. 175 Item 9A. Controls and Procedures..................................... 175 Item 9B. Other Information........................................... 176 2 PART/ITEM NO. PAGE ------------- ---- PART III ----------------------------------------------------------------------------------- Item 10. Directors and Executive Officers of the Registrant.......... 176 Item 11. Executive Compensation (Omitted)............................ 177 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Matters (Omitted).................. 177 Item 13. Certain Relationships and Related Transactions (Omitted).... 177 Item 14. Principal Accountant Fees and Services...................... 177 PART IV ----------------------------------------------------------------------------------- Item 15. Exhibits and Financial Statement Schedules Financial Statements...................................... 178 Exhibits.................................................. 178 Signatures .................................................................. 180 3 HSBC Finance Corporation -------------------------------------------------------------------------------- PART I ITEM 1. BUSINESS. -------------------------------------------------------------------------------- INTRODUCTION -------------------------------------------------------------------------------- On March 28, 2003, Household International, Inc. ("Household") was acquired by HSBC Holdings plc ("HSBC") by way of merger with H2 Acquisition Corporation ("H2"), a wholly owned subsidiary of HSBC, in a purchase business combination. Following the merger, H2 was renamed "Household International, Inc." Subsequently, HSBC transferred its ownership interest in Household to a wholly owned subsidiary, HSBC North America Holdings Inc., who subsequently contributed Household to its wholly owned subsidiary, HSBC Investments (North America) Inc. On December 15, 2004, Household merged with its wholly owned subsidiary, Household Finance Corporation ("HFC"). Following the merger, Household changed its name to HSBC Finance Corporation. The name change was a continuation of the rebranding of the Household businesses to the HSBC brand. These actions were taken to establish a single brand in North America to create a stronger platform to advance growth across all HSBC business lines. By operation of law, following the merger, all obligations of HFC became direct obligations of HSBC Finance Corporation. GENERAL -------------------------------------------------------------------------------- HSBC Finance Corporation is the principal fund raising company for its subsidiaries. Its subsidiaries primarily provide middle-market consumers with several types of loan products in the United States, the United Kingdom, Canada, the Republic of Ireland, the Czech Republic and Hungary. HSBC Finance Corporation and its subsidiaries may also be referred to in this Form 10-K as "we," "us" or "our." We offer real estate secured loans, auto finance loans, MasterCard* and Visa* credit card loans, private label credit card loans and personal non-credit card loans. We also initiate tax refund anticipation loans in the United States and offer specialty insurance products in the United States, United Kingdom and Canada. We generate cash to fund our businesses primarily by collecting receivable balances; issuing commercial paper, medium and long term debt; borrowing from HSBC subsidiaries and customers; securitizing and selling consumer receivables; and borrowing under secured financing facilities. We use the cash generated to invest in and support receivable growth, to service our debt obligations and to pay dividends to our parent. At December 31, 2004, we had approximately 31,500 employees and over 58 million customers. 2004 DEVELOPMENTS - On September 30, 2004, we commenced rebranding the Household businesses to the HSBC brand. On that date, signs on each major facility were changed to HSBC, several business units began operating under the HSBC name and all communications converted from Household to HSBC. On December 15, after Household Finance Corporation was merged into Household International, Inc., the surviving company was renamed HSBC Finance Corporation. In 2005, the rebranding efforts will continue with name changes for our Canadian branch offices and our domestic auto finance business and credit card banking subsidiary. Our branch based consumer finance business will retain the HFC and Beneficial brands, accompanied by the endorsement signature, "Member HSBC Group." The move to a single brand in North America will promote increased awareness of HSBC, allowing all HSBC businesses in North America to align themselves to merchants and our suppliers and customers, resulting in a stronger platform for growth. Following the merger of HFC into HSBC Finance Corporation, HSBC Finance Corporation became the principal vehicle for funding the operations of its subsidiaries. With the merger, all previous obligations of HFC became direct obligations of HSBC Finance Corporation. The merger also --------------- * MasterCard is a registered trademark of MasterCard International, Incorporated and Visa is a registered trademark of Visa USA, Inc. 4 HSBC Finance Corporation -------------------------------------------------------------------------------- eliminates the need for separate financial statements by HFC that because of the substantial commonality of assets, were substantially the same as those of its parent, HSBC Finance Corporation. - On December 22, 2004, our affiliate, HSBC Bank USA, National Association ("HSBC Bank USA") received regulatory approval to purchase our domestic private label portfolio, including the retained interests associated with securitized private label credit card receivables. The sale of $12.2 billion of receivables ($15.6 billion on a managed basis) occurred on December 29, 2004 at a purchase price of $12.4 billion. We retained the related account relationships and entered into an agreement to sell additional domestic private label receivables originated under current and future private label accounts to HSBC Bank USA on a daily basis. Under a separate agreement with HSBC Bank USA, we will continue to service the portfolio for a fee. In the fourth quarter, we recorded a gain from the bulk sale of the portfolio, including retained securitization interests, of $663 million ($423 million after-tax). Included in this gain was a release of $505 million of owned credit loss reserves associated with the portfolio. In future periods, our net interest income, fee income and provision for credit losses for private label receivables will be substantially reduced, while other income will substantially increase as reduced securitization revenue associated with private label receivables will be more than offset by gains from continuing sales of private label receivables and receipt of servicing revenue on the portfolio from HSBC Bank USA. We anticipate that the net effect of these sales could result in a reduction to our 2005 net income by up to 10%. The amount of other income recorded will be dependent upon the volume of new receivables we originate during the year and will be subject to competitive factors as we sign agreements with new merchants and extend agreements with existing merchants. We and HSBC Bank USA will consider potential sales of some of our MasterCard and Visa receivables to HSBC Bank USA in the future based on the continuing evaluation of the capital and liquidity needs at each entity. - Upon receipt of regulatory approval for the sale of the domestic private label portfolio, we adopted charge-off and account management policies in accordance with the Uniform Retail Credit Classification and Account Management Policy issued by the Federal Financial Institutions Examination Council ("FFIEC Policies") for our domestic private label and MasterCard and Visa credit card portfolios. The adoption of FFIEC Policies resulted in a reduction to net income of approximately $121 million in the fourth quarter of 2004. We do not expect the adoption of FFIEC Policies for our domestic private label and MasterCard and Visa portfolios will have a significant impact on results of operations or cash flows in future periods. - In the third quarter, we announced our intention to structure all new collateralized funding transactions as secured financings. Because existing public MasterCard and Visa credit card transactions were structured as sales to revolving trusts that require replenishments of receivables to support previously issued securities, receivables will continue to be sold to the credit card trusts until the revolving periods end, the last of which is expected to occur in early 2008 based on current projections. Private label trusts that publicly issued securities will now be replenished by HSBC Bank USA as a result of the daily sale of new domestic private label credit card originated to HSBC Bank USA. We will continue to replenish, at reduced levels, certain non-public personal non-credit card and MasterCard and Visa securities issued to conduits and record the resulting replenishment gains for a period of time in order to manage liquidity. Termination of gain on sale treatment for new collateralized funding activity reduced our reported net income under U.S. GAAP in 2004 and will continue to in future periods. In 2004, our net interest-only strip receivables, excluding both the mark-to-market adjustment recorded in accumulated other comprehensive income and the private label portion purchased by HSBC Bank USA, decreased $466 million. There was no impact in 2004, however, on cash received from operations or on U.K. GAAP reported results. 5 HSBC Finance Corporation -------------------------------------------------------------------------------- - Funding synergies resulting from our acquisition by HSBC have continued to reduce our reliance on traditional sources to fund our growth. Because we are now a subsidiary of HSBC, our credit spreads relative to Treasuries have tightened compared to those we experienced during the months leading up to the announcement of our acquisition by HSBC. Primarily as a result of these tightened credit spreads, reduced liquidity requirements and lower costs due to shortening the maturity of our liabilities, principally through increased issuance of commercial paper, we recognized cash funding expense savings of approximately $350 million in 2004 and $125 million in 2003 compared to the funding costs we would have incurred using average spreads from the first half of 2002. It is anticipated that these tightened credit spreads and other funding synergies including asset transfers 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. In April 2004, Fitch Ratings revised our Rating Outlook to Positive from Stable and raised our Support Rating to "1" from "2". 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-". In December 2004, Fitch Ratings again raised our Senior Debt Rating to "AA-" from "A+" and our commercial paper rating to "F1+." Also in December 2004, Moody's Investor Service revised our rating outlook to A1 Positive from A1 Stable. RESTATEMENT -------------------------------------------------------------------------------- HSBC Finance Corporation has restated its consolidated financial statements for the previously reported quarterly periods ended March 31, 2004, June 30, 2004 and September 30, 2004; and the period March 29, 2003 through December 31, 2003. This Form 10-K and the exhibits included herewith include all adjustments relating to the restatement for all such prior periods. Amended Forms 10-Q for the periods ended March 31, 2004, June 30, 2004 and September 30, 2004 that reflect adjustments relating to the restatement will be filed with the Securities and Exchange Commission on or before March 31, 2005. During the fourth quarter of 2004, as part of HSBC Finance Corporation's preparation for the implementation of International Financial Reporting Standards ("IFRS") by HSBC from January 1, 2005, we undertook a review of our hedging activities to confirm conformity with the accounting requirements of IFRS, which differ in several respects from the hedge accounting requirements under U.S. GAAP as set out in Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS 133"). As a result of this review, management determined that there were some deficiencies in the documentation required to support hedge accounting under U.S. GAAP. These documentation deficiencies arose following our acquisition by HSBC. As a consequence of the acquisition, pre-existing hedging relationships, including hedging relationships that had previously qualified under the "shortcut" method of accounting pursuant to SFAS 133, were required to be reestablished. At that time there was some debate in the accounting profession regarding the detailed technical requirements resulting from a business combination. We consulted with our independent accountants, KPMG LLP, in reaching a determination of what was required in order to comply with SFAS 133. Following this, we took the actions we believed were necessary to maintain hedge accounting for all of our historical hedging relationships in our consolidated financial statements for the period ended December 31, 2003 and those consolidated financial statements received an unqualified audit opinion. Management, having determined during the fourth quarter of 2004 that there were certain documentation deficiencies, engaged independent expert consultants to advise on the continuing effectiveness of the identified hedging relationships and again consulted with our independent accountants, KPMG LLP. As a result of this assessment, we concluded that a substantial number of our hedges met the correlation effectiveness requirement of SFAS 133 throughout the period following our acquisition by HSBC. However, we also determined in conjunction with KPMG LLP that, although a substantial number of the impacted hedges satisfied the correlation effectiveness requirement of SFAS 133, there were technical deficiencies in the 6 HSBC Finance Corporation -------------------------------------------------------------------------------- documentation that could not be corrected retroactively or disregarded notwithstanding the proven effectiveness of the hedging relationships in place and, consequently, that the requirements of SFAS 133 were not met and that hedge accounting was not appropriate during the period these documentation deficiencies existed. We have therefore determined that we should restate all the reported periods since our acquisition by HSBC to eliminate hedge accounting on all hedging relationships outstanding at March 29, 2003 and certain fair value swaps entered into after that date. During the period from acquisition through December 31, 2004, we are reporting net income of $3.3 billion. The cumulative impact of the loss of hedge accounting during this period is to increase reported net income by $113 million. The resulting accounting does not reflect the economic reality of our hedging activity and has no impact on the timing or amount of operating cash flows or cash flows under any debt or derivative contract. It does not affect our ability to make required payments on our outstanding debt obligations. Furthermore, the restatement has no impact on our results on a U.K. GAAP basis, which are used in measuring and rewarding performance of employees. Finally, our economic risk management strategies have not required amendment. Full details of the restatement are set out in Note 3 in the accompanying consolidated financial statements. OPERATIONS -------------------------------------------------------------------------------- Our operations are divided into three reportable segments: Consumer, Credit Card Services and International. Our Consumer segment includes our consumer lending, mortgage services, retail services, direct lending and auto finance businesses. Our Credit Card Services segment includes our domestic MasterCard and Visa credit card business. Our International segment includes our foreign operations in the United Kingdom, Canada, the Republic of Ireland, the Czech Republic and Hungary. Information about businesses or functions that fall below the segment reporting quantitative threshold tests such as our insurance services, taxpayer financial services and commercial operations, as well as our treasury and corporate activities, which include fair value adjustments related to purchase accounting and related amortization, are included under the "All Other" caption within our segment disclosure. 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. Because HSBC reports results on a U.K. GAAP basis, management also separately monitors earnings excluding goodwill amortization and net income under U.K. GAAP (non-GAAP financial measures). GENERAL We generally serve non-conforming and nonprime consumers. Such customers are individuals who have limited credit histories, modest incomes, high debt-to-income ratios, high loan-to-value ratios (for real estate secured products) or have experienced credit problems caused by occasional delinquencies, prior charge-offs, bankruptcy or other credit related actions. These customers generally have higher delinquency and credit loss probabilities and are charged a higher interest rate to compensate for the additional risk of loss (where the loan is not adequately collateralized to mitigate such additional risk of loss) and the anticipated additional collection initiatives that may have to be undertaken over the life of the loan. We also originate and purchase near-prime real estate secured and auto loans. In our MasterCard and Visa, retail services and international businesses, we also serve prime consumers either through co-branding or merchant relationships. We use our centralized underwriting, collection and processing functions to adapt our credit standards and collection efforts to national or regional market conditions. Our underwriting, loan administration and collection functions are supported by highly automated systems and processing facilities. Our centralized collection system is augmented by personalized early collection efforts. 7 HSBC Finance Corporation -------------------------------------------------------------------------------- We service each customer with a view to understanding that customer's personal financial needs. We recognize that individuals may not be able to timely meet all of their financial obligations. Our goal is to assist consumers in transitioning through financially difficult times which may lead to them doing more business with our lending subsidiaries. As a result, our policies and practices are designed to be flexible to maximize the collectibility of our loans while not incurring excessive collection expenses on loans that have a high probability of being ultimately uncollectible. Proactive credit management, "hands-on" customer care and targeted product marketing are means we use to retain customers and grow our business. CONSUMER Our consumer lending business is one of the largest subprime home equity originators in the United States as ranked by Inside B&C Lending. This business has 1,344 branches located in 46 states, and approximately 2.8 million active customer accounts, $48.9 billion in managed receivables and 12,800 employees. It is marketed under both the HFC and Beneficial brand names, each of which cater to a slightly different type of customer in the middle-market population. Both brands offer secured and unsecured loan products, such as first and second lien position closed-end mortgage loans, open-end home equity loans, personal non-credit card loans, including personal homeowner loans (a secured high loan-to-value product that we underwrite and treat like an unsecured loan), and sales finance contracts. These products are marketed through our retail branch network, direct mail, telemarketing, strategic alliances and Internet sourced applications and leads. Our mortgage services business purchases non-conforming first and second lien position residential mortgage loans, including open-end home equity loans, from a network of over 200 unaffiliated third-party lenders (i.e., correspondents). This business has approximately $28.8 billion in managed receivables, 280,000 active customer accounts and 2,700 employees. Purchases are primarily "bulk" acquisitions (i.e., pools of loans) but also include "flow" acquisitions (i.e., loan by loan), and are made based on our specific underwriting guidelines. As of December 31, 2004, mortgage services serviced approximately $5 billion of receivables for other parties, including HSBC Bank USA. Under agreements with HSBC Bank USA, we source, underwrite, price and service loans purchased by HSBC Bank USA from certain correspondents. We offer forward commitments to selected correspondent lenders to strengthen our relationship with these lenders and to create a sustainable growth channel for this business. Decision One Mortgage Company, LLC ("Decision One"), a subsidiary of HSBC Finance Corporation, was purchased in 1999 to assist us in understanding the product needs of mortgage brokers and trends in the mortgage lending industry. Through more than 20 branch locations, Decision One directly originates mortgage loans sourced by mortgage brokers and sells all loans to secondary market purchasers, including to our mortgage services business. Our retail services business is one of the largest providers of third-party private label financing in the United States based on managed receivables outstanding. On December 29, 2004, our entire domestic private label portfolio of approximately $15.6 billion of managed receivables was sold to HSBC Bank USA and agreements were entered into to sell all future receivables to HSBC Bank USA on a daily basis and to service the portfolio for HSBC Bank USA for a fee. As a result, we now sell all receivables upon origination but service the entire portfolio on behalf of HSBC Bank USA. Our retail services business has over 70 active merchant relationships and we service approximately 15.5 million active customer accounts and have 2,100 employees. At December 31, 2004, the serviced private label portfolio consisted of approximately 16 percent of receivables in the furniture industry, 33 percent in the consumer electronics industry, 27 percent in the powersport vehicle (snowmobiles, personal watercraft, ATV's and motorcycles) industry and approximately 10 percent in the department store industry. Private label financing products are generated through merchant retail locations, merchant catalog and telephone sales, direct mail and Internet applications. Our auto finance business purchases, from a network of approximately 5,200 active dealer relationships, retail installment contracts of consumers who do not have access to traditional, prime-based lending sources. We also originate and refinance auto loans through direct mail solicitations, alliance partners, consumer lending customers and the Internet. At December 31, 2004, this business had approximately $10.1 billion in managed 8 HSBC Finance Corporation -------------------------------------------------------------------------------- receivables, approximately 735,000 active customer accounts and 2,000 employees. Approximately 36% of auto finance receivables are secured by new vehicles. CREDIT CARD SERVICES Our Credit Card Services business includes our MasterCard and Visa receivables in the United States, including The GM Card(R), the AFL-CIO Union Plus(R)* ("UP") credit card, Household Bank, Orchard Bank, and HSBC branded cards. This business has approximately $19.7 billion in managed receivables, 14 million active customer accounts and 4,700 employees. According to The Nilson Report, this business is the sixth largest issuer of MasterCard or Visa credit cards in the United States (based on receivables). The GM Card(R), a co-branded credit card issued as part of our alliance with General Motors Corporation ("GM"), enables customers to earn discounts on the purchase or lease of a new GM vehicle. The UP card program with the AFL-CIO provides benefits and services to members of various national and international labor unions. The Household Bank and Orchard Bank branded credit cards offer specialized credit card products to consumers underserved by traditional providers or are marketed in conjunction with merchant relationships established through our retail services business. HSBC branded cards are targeted through direct mail at the prime market. In addition, Credit Card Services services $1.0 billion of receivables held by a subsidiary of HSBC Bank USA. New receivables and accounts related to the HSBC Bank USA portfolio are originated by Household Bank (SB), N.A., and receivables are sold daily to HSBC Bank USA. Our MasterCard and Visa business is generated primarily through direct mail, telemarketing, Internet applications, application displays, promotional activity associated with our affinity and co-branding relationships, mass-media advertisement (The GM Card(R)) and merchant relationships sourced through our retail services business. We also cross-sell our credit cards to our existing consumer lending and retail services customers as well as our taxpayer financial services customers. Although our relationships with GM and the AFL-CIO enable us to access a proprietary customer base, in accordance with our agreements with these institutions, we own all receivables originated under the programs and are responsible for all credit and collection decisions as well as the funding for the programs. These programs are not dependent upon any payments, guarantees or credit support from these institutions. As a result, we are not directly dependent upon GM or the AFL-CIO for any specific earnings stream associated with these programs. We believe we have a strong working relationship with GM and the AFL-CIO and in 2004, we jointly agreed with the AFL-CIO to extend the term of this successful Affinity Card Program. These agreements do not expire in the near term. INTERNATIONAL Our United Kingdom business is a mid-market consumer lender focusing on customer service through its branch locations, and consumer electronics through its retail finance operations and telemarketing. This business offers secured and unsecured lines of credit, secured and unsecured closed-end loans, retail finance products, insurance products and credit cards (including the GM Card(R) from Vauxhall and marbles(TM), an Internet enabled credit card). We operate in England, Scotland, Wales, Northern Ireland and the Republic of Ireland. Loans held by our United Kingdom, inclusive of the Republic of Ireland, operation are originated through a branch network consisting of 216 HFC Bank and Beneficial Finance branches, merchants, direct mail, broker referrals, the Internet and outbound telemarketing. This business has approximately $10.7 billion in managed receivables, 3.5 million customer accounts and 4,000 employees. Our Canadian business offers real estate secured and unsecured lines of credit, secured and unsecured closed-end loans, insurance products, private label credit cards, retail finance products and auto loans to Canadian --------------- * The Union Plus MasterCard and Visa credit card program is an affinity arrangement with Union Privilege under which credit cards are offered to members of unions affiliated with the American Federation of Labor and Congress of Industrial Organizations (AFL-CIO). 9 HSBC Finance Corporation -------------------------------------------------------------------------------- consumers. In addition, through its trust operations, our Canadian business accepts deposits. These products are marketed through 115 branch offices in 10 provinces, through direct mail, 80 merchant relationships and the Internet. At December 31, 2004, this business had approximately $2.4 billion in managed receivables, 1.0 million customer accounts and 1,200 employees. We opened offices in the Czech Republic and Hungary in 2002 and 2001, respectively, to facilitate the expansion plans of one of our U.K. merchant alliances. These offices have approximately $104 million in managed receivables and 340 employees. ALL OTHER Our insurance services operation distributes credit life, disability and unemployment, accidental death and disability, term life, whole life, annuities, disability, long term care and a variety of other specialty insurance products to our customers. Such products currently are offered throughout the United States and Canada and are target offered to customers based upon their particular needs. Insurance is directly written by or reinsured with one or more of our subsidiaries. HSBC Taxpayer Financial Services is the leading U.S. provider of tax-related financial products to consumers through nearly 25,000 unaffiliated professional tax preparer locations and tax preparation software providers. Serving more than 8.2 million customers annually, this business leverages the annual U.S. income tax filing process to provide products that offer consumers quick and convenient access to funds in the amount of their anticipated tax refund. This business generated a loan volume of approximately $13.3 billion in 2004. To help ensure high standards of responsible lending, we provide industry-leading compliance programs for our tax preparer business partners. Key elements of our compliance efforts include mandatory online compliance and sales-practice training, expanded tax preparer due diligence processes, and on-going sales practice monitoring to help ensure that our customers are treated fairly and that they understand their financial choices. Additionally, access to free consumer financial education resources and a 48-hour satisfaction guarantee are offered to customers, which further enhances our compliance and customer service efforts. Our commercial operations are very limited in scope and are expected to continue to decline. We have less than $300 million in commercial receivables. FUNDING -------------------------------------------------------------------------------- Our continued success and prospects for growth are largely dependent upon access to the global capital markets. Numerous factors, internal and external, may impact our access to, and the costs associated with, these markets. These factors may include our debt ratings, overall economic conditions, overall capital markets volatility and the effectiveness of our management of credit risks inherent in our customer base. The merger with HSBC has improved our access to the capital markets and lowered our funding costs. In addition to providing several important sources of direct funding, our affiliation with HSBC is also expanding our access to a worldwide pool of potential investors. While these new funding synergies have reduced our reliance on traditional sources to fund our growth, we are focused on balancing our use of affiliate and third-party funding sources to minimize funding expense while maximizing liquidity. Because we are now a subsidiary of HSBC and our credit ratings have improved, our credit spreads relative to Treasuries have tightened relative to those we experienced during the months leading up to the announcement of our acquisition by HSBC. Primarily as a result of these tightened credit spreads, reduced liquidity requirements and lower costs due to shortening the maturity of our liabilities mainly through the issuance of commercial paper, we recognized cash funding expense savings of approximately $350 million in 2004 and $125 million in 2003 compared to the funding costs we would have incurred using average spreads from the first half of 2002. It is anticipated that these tightened credit spreads and other funding synergies including assets transfers will 10 HSBC Finance Corporation -------------------------------------------------------------------------------- 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. For a detailed listing of the ratings that have been assigned to HSBC Finance Corporation and our significant subsidiaries as of December 31, 2004, see Exhibit 99.1 to this Form 10-K. We fund our operations globally and domestically, using a combination of capital market and affiliate debt, preferred equity, securitizations and sales of consumer receivables and borrowings under secured financing facilities. We will continue to fund a large part of our operations in the global capital markets, primarily through the use of secured financings, commercial paper, medium-term notes and long-term debt. We will also continue to sell certain receivables to HSBC Bank USA. We will continue to use derivative financial instruments to hedge our currency and interest rate risk exposure. A description of our use of derivative financial instruments, including interest rate swaps and foreign exchange contracts, and other quantitative and qualitative information about our market risk is set forth in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" ("2004 MD&A") under the caption "Risk Management" and Note 16 of our consolidated financial statements ("2004 Financial Statements"). Additional information on our sources and availability of funding are set forth in the "Liquidity and Capital Resources" and "Off Balance Sheet Arrangements" sections of our 2004 MD&A. REGULATION AND COMPETITION -------------------------------------------------------------------------------- REGULATION CONSUMER LENDING. Our consumer finance businesses operate in a highly regulated environment. These businesses are subject to laws relating to consumer protection, discrimination in extending credit, use of credit reports, privacy matters, disclosure of credit terms and correction of billing errors. They also are subject to certain regulations and legislation that limit operations in certain jurisdictions. For example, limitations may be placed on the amount of interest or fees that a loan may bear, the amount that may be borrowed, the types of actions that may be taken to collect or foreclose upon delinquent loans or the information about a customer that may be shared. Our consumer branch lending offices are generally licensed in those jurisdictions in which they operate. Such licenses have limited terms but are renewable, and are revocable for cause. Failure to comply with these laws and regulations may limit the ability of our licensed lenders to collect or enforce loan agreements made with consumers and may cause our lending subsidiaries to be liable for damages and penalties. There also continues to be a significant amount of legislative activity, nationally, locally and at the state level, aimed at curbing lending practices deemed to be "predatory". In addition, states have sought to alter lending practices through consumer protection actions brought by state attorneys general and other state regulators. Legislative activity in this area is expected to continue targeting certain abusive practices such as loan "flipping" (making a loan to refinance another loan where there is no tangible benefit to the borrower), fee "packing" (addition of unnecessary, unwanted and unknown fees to a borrower), "equity stripping" (lending without regard to the borrower's ability to repay or making it impossible for the borrower to refinance with another lender), and outright fraud. HSBC Finance Corporation does not condone or endorse any of these practices. We continue to work with regulators and consumer groups to create appropriate safeguards to avoid these abusive practices while allowing our borrowers to continue to have access to credit for personal purposes, such as the purchase of homes, automobiles and consumer goods. As part of this effort we have adopted a set of lending best practice initiatives. Increased legislative and regulatory focus is also expected on tax refund anticipation loans. It is possible that broad legislative initiatives will be passed which will impose additional costs and rules on our businesses. Although we have the ability to react quickly to new laws and regulations, it is too early to estimate the effect, if any, these activities will have on us in a particular locality or nationally. BANKING INSTITUTIONS. Our credit card banking subsidiary, Household Bank (SB), N.A. ("Household Bank"), is a nationally-chartered 'credit card bank' which is also a member of the federal reserve system. Household 11 HSBC Finance Corporation -------------------------------------------------------------------------------- Bank is subject to regulation, supervision and examination by the Office of the Comptroller of the Currency ("OCC"). The deposits of Household Bank are insured by the FDIC, which renders it subject to relevant FDIC regulation. As a result of our acquisition by HSBC, HSBC Finance Corporation and its subsidiaries became subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve Board (the "Federal Reserve Board"). HSBC is a bank holding company under the U.S. Bank Holding Company Act of 1956 (the "BHCA") as a result of its ownership of HSBC Bank USA. On January 1, 2004, HSBC formed a new company to hold all of its North American operations, including HSBC Finance Corporation and its subsidiaries. This company, HSBC North American Holdings Inc. ("HNAH") is also a "bank holding company" under the BHCA, by virtue of its ownership and control of HSBC Bank USA. HSBC and HNAH are registered as financial holding companies ("FHC") under the Gramm-Leach-Bliley Act amendments to the BHCA, enabling them to offer a more complete line of financial products and services. The United States is a party to the 1988 Basel Capital Accord and U.S. banking regulatory authorities have adopted risk-based capital requirements for United States banks and bank holding companies that are generally consistent with the Accord. In addition, U.S. bank regulatory authorities have adopted 'leverage' capital requirements that generally require United States banks and bank holding companies to maintain a minimum amount of capital in relation to their balance sheet assets (measured on a non-risk-weighted basis). Household Bank is subject to these capital requirements. Household Bank, like other FDIC-insured banks, may be required to pay assessments to the FDIC for deposit insurance under the FDIC's Bank Insurance Fund. Under the FDIC's risk-based system for setting deposit insurance assessments, an institution's assessments vary according to the level of capital an institution holds, its deposit levels and other factors. The Federal Deposit Insurance Corporation Improvement Act of 1991 provides for extensive regulation of depository institutions such as Household Bank, including requiring federal banking regulators to take 'prompt corrective action' with respect to FDIC-insured banks that do not meet minimum capital requirements. At December 31, 2004, Household Bank was well-capitalized under applicable OCC and FDIC regulations. Our principal United Kingdom subsidiary (HFC Bank Limited, formerly known as HFC Bank plc) is subject to oversight and regulation by the U.K. Financial Services Authority ("FSA") and the Central Bank Financial Services Authority of Ireland. We have indicated our intent to the FSA to maintain the regulatory capital of this institution at specified levels. We do not anticipate that any capital contribution will be required for our United Kingdom bank in the near term. In the Republic of Ireland we are regulated by the Irish Financial Services Regulatory Authority. In May 2005, new consumer protection laws will be effective in the U.K. that may impact profitability and operations. These changes will not have a material impact on our results. We also maintain a trust company in Canada, which is subject to regulatory supervision by the Office of the Superintendent of Financial Institutions. INSURANCE. Our credit insurance business is subject to regulatory supervision under the laws of the states and provinces in which it operates. Regulations vary from state to state, and province to province, but generally cover licensing of insurance companies, premium and loss rates, dividend restrictions, types of insurance that may be sold, permissible investments, policy reserve requirements, and insurance marketing practices. Our insurance operations in the United Kingdom are subject to regulatory supervision by the FSA. COMPETITION The consumer financial services industry in which we operate is highly fragmented and intensely competitive. We generally compete with banks, thrifts, insurance companies, credit unions, mortgage lenders and brokers, finance companies, securities brokers and dealers, and other domestic and foreign financial institutions in the 12 HSBC Finance Corporation -------------------------------------------------------------------------------- United States, Canada and the United Kingdom. We compete by expanding our customer base through portfolio acquisitions or alliance and co-branding opportunities, offering a variety of consumer loan products and maintaining a strong service orientation. CAUTIONARY STATEMENT ON FORWARD-LOOKING STATEMENTS -------------------------------------------------------------------------------- Certain matters discussed throughout this Form 10-K constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make or approve certain statements in future filings with the SEC, in press releases, or oral or written presentations by representatives of HSBC Finance Corporation that are not statements of historical fact and may also constitute forward-looking statements. Words such as "believe", "expects", "estimates", "targeted", "anticipates", "goal" and similar expressions are intended to identify forward-looking statements but should not be considered as the only means through which these statements may be made. These matters or statements will relate to our future financial condition, results of operations, plans, objectives, performance or business developments and will involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from that which was expressed or implied by such forward-looking statements. Forward-looking statements are based on our current views and assumptions and speak only as of the date they are made. HSBC Finance Corporation undertakes no obligation to update any forward-looking statement to reflect subsequent circumstances or events. The important factors, many of which are out of our control, which could affect our actual results and could cause our results to vary materially from those expressed in public statements or documents are: - changes in laws and regulations, including attempts by local, state and national regulatory agencies or legislative bodies to control alleged "predatory" lending practices through broad or targeted initiatives aimed at lenders operating in consumer lending markets; - increased competition from well-capitalized companies or lenders with access to government sponsored organizations for our consumer segment which may impact the terms, rates, costs or profits historically included in the loan products we offer or purchase; - changes in accounting or credit policies, practices or standards, as they may be internally modified from time to time or changes as may be required by regulatory agencies or the Financial Accounting Standards Board; - changes to operational practices from time to time, such as determinations to sell receivables from our private label and mortgage services businesses and the potential MasterCard and Visa receivable sale, structuring more securitizations as secured financings, or changes to our customer account management policies and practices and risk management/collection practices; - changes in overall economic conditions, including the interest rate environment in which we operate, the capital markets in which we fund our operations, the market values of consumer owned real estate throughout the United States, recession, employment and currency fluctuations; - consumer perception of the availability of credit, including price competition in the market segments we target and the ramifications or ease of filing for personal bankruptcy; - the effectiveness of models or programs to predict loan delinquency or loss and initiatives to improve collections in all business areas, and changes we may make from time to time in these models, programs and initiatives; - continued consumer acceptance of our distribution systems and demand for our loan or insurance products; - changes associated with, as well as the difficulty in, integrating systems, operational functions and cultures, as applicable, of any organization or portfolio acquired by HSBC Finance Corporation; - a reduction of our debt ratings by any of the nationally recognized statistical rating organizations that rate these instruments to a level that is below our current rating; 13 HSBC Finance Corporation -------------------------------------------------------------------------------- - the costs, effects and outcomes of regulatory reviews or litigation relating to our nonprime loan receivables or the business practices or policies of any of our business units, including, but not limited to, additional compliance requirements; - increased funding costs resulting from instability in the capital markets and risk tolerance of fixed income investors; - the costs, effects and outcomes of any litigation matter that is determined adversely to HSBC Finance Corporation or its businesses; - the ability to attract and retain qualified personnel to support the underwriting, servicing, collection and sales functions of our businesses; - failure to obtain expected funding from HSBC subsidiaries and clients; and - the inability of HSBC Finance Corporation to manage any or all of the foregoing risks as well as anticipated. CORPORATE GOVERNANCE -------------------------------------------------------------------------------- HSBC Finance Corporation maintains a website at www.household.com on which we make available, as soon as reasonably practicable after filing with or furnishing to the SEC, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports. Our website also contains our Corporate Governance Standards and committee charters for the Audit, Compensation, Executive and Nominating and Governance Committees of our Board of Directors. We will provide printed copies of this information at no charge upon written request. Requests should be made to HSBC Finance Corporation, 2700 Sanders Road, Prospect Heights, Illinois 60070, Attention: Corporate Secretary. CERTIFICATIONS In addition to certifications from our Chief Executive Officer and Chief Financial Officer pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act of 2002 (attached to this report on Form 10-K as Exhibits 31 and 32), we have also filed a certification with the New York Stock Exchange (the "NYSE") from our Chief Executive Officer certifying that he is not aware of any violation by HSBC Finance Corporation of the NYSE corporate governance listing standards in effect as of February 21, 2005. ITEM 2. PROPERTIES. -------------------------------------------------------------------------------- Our operations are located throughout the United States, in 10 provinces in Canada and in the United Kingdom, with principal facilities located in Lewisville, Texas; New Castle, Delaware; Brandon, Florida; Jacksonville, Florida; Tampa, Florida; Chesapeake, Virginia; Virginia Beach, Virginia; Hanover, Maryland; Bridgewater, New Jersey; Rockaway, New Jersey; Las Vegas, Nevada; Charlotte, North Carolina; Portland, Oregon; Pomona, California; Chicago, Illinois; Elmhurst, Illinois; Franklin Park, Illinois; Mount Prospect, Illinois; Prospect Heights, Illinois; Schaumburg, Illinois; Vernon Hills, Illinois; Wood Dale, Illinois; Carmel, Indiana; Salinas, California; San Diego, California; London, Kentucky; Sioux Falls, South Dakota; Toronto, Ontario and Montreal, Quebec, Canada; and Windsor, Berkshire, United Kingdom. Substantially all branch offices, divisional offices, corporate offices, regional processing and regional servicing center spaces are operated under lease with the exception of the headquarters building for our United Kingdom operations, a credit card processing facility in Las Vegas, Nevada; a processing center in Vernon Hills, Illinois; servicing facilities in London, Kentucky, Mt. Prospect, Illinois, and Chesapeake, Virginia; offices in Birmingham, United Kingdom; and an airplane hanger in Wheeling, Illinois. We believe that such properties are in good condition and meet our current and reasonably anticipated needs. 14 HSBC Finance Corporation -------------------------------------------------------------------------------- ITEM 3. 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. Like other companies in this industry, some of our subsidiaries are involved in a number of lawsuits pending against them in these states. The cases, in particular, generally allege inadequate disclosure or misrepresentation of financing terms. In some suits, other parties are also named as defendants. Unspecified compensatory and punitive damages are sought. Several of these suits purport to be class actions or have multiple plaintiffs. The judicial climate in these states is such that the outcome of all of these cases is unpredictable. Although our subsidiaries believe they have substantive legal defenses to these claims and are prepared to defend each case vigorously, a number of such cases have been settled or otherwise resolved for amounts that in the aggregate are not material to our operations. Appropriate insurance carriers have been notified 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 HSBC Finance Corporation) violated the Illinois Interest Act by imposing points 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 ("AMTPA"). DIDMCA and AMTPA 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 filed a notice of appeal with the Illinois Supreme Court which the court accepted. Briefing in the Illinois Supreme Court is underway. Three cases and one counterclaim were filed against subsidiaries of HSBC Finance Corporation 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); MERS Inc. as nominee for HFC v. Gloss, Circuit Court of DuPage County, Illinois (filed as a foreclosure counterclaim in September, 2004); 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 the Circuit Court of Cook County, Illinois, however, plaintiffs filed a motion to return the case to the U.S. Bankruptcy Court which was granted. We are appealing this remand order. We also served an arbitration demand on plaintiff's counsel as 15 HSBC Finance Corporation -------------------------------------------------------------------------------- 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. The Gloss matter is still pending. At this time, we are unable to quantify the potential impact of the Clark decision should it be upheld and receive retroactive application. CREDIT CARD LITIGATION On November 15, 2004, the matter entitled American Express Travel Related Services Company, Inc. v. Visa U.S.A. Inc., et al. was filed in the U.S. District Court for the Southern District of New York. This case alleges that HSBC Finance Corporation, Household Bank (SB), N.A. and others violated Sections 1 and 2 of the Sherman Act by conspiring to monopolize and unreasonably restrain trade by allegedly implementing and enforcing an agreement requiring any United States bank that issues Visa or MasterCard general cards to refuse to issue such cards from competitors, such as American Express and Discover. Plaintiff seeks a declaration that defendants in this action (including Visa, MasterCard and other banks belonging to those associations), have violated the antitrust laws, and requests an injunction restraining the defendants, their directors, officers, employees, agents, successors, owners and members from "continuing or maintaining in any manner, directly or indirectly, the rules, policies, and agreements at issue," and seeks "full compensation for damages it has sustained, from each Defendant, jointly, severally," for each of plaintiff's claims, in an amount "to be trebled according to law, plus interest, attorneys' fees and costs of suit". On February 18, 2005, the Defendants filed a motion to dismiss the complaint for failure to state a cause of action. At this time, we are unable to quantify the potential impact from this action, if any. SECURITIES LITIGATION In August 2002, we restated previously reported consolidated financial statements. The restatement related to certain MasterCard and Visa co-branding and affinity credit card relationships and a third party marketing agreement, which were entered into between 1992 and 1999. All were part of our Credit Card Services segment. In consultation with our prior auditors, Arthur Andersen LLP, we treated payments made in connection with these agreements as prepaid assets and amortized them in accordance with the underlying economics of the agreements. Our current auditor, KPMG LLP, advised us that, in its view, these payments should have either been charged against earnings at the time they were made or amortized over a shorter period of time. The restatement resulted in a $155.8 million, after-tax, retroactive reduction to retained earnings at December 31, 1998. As a result of the restatement, and other corporate events, including, e.g., the 2002 settlement with 50 states and the District of Columbia relating to real estate lending practices, HSBC Finance Corporation, and its directors, certain officers and former auditors, have been involved in various legal proceedings, some of which purport to be class actions. A number of these actions allege violations of federal securities laws, were filed between August and October 2002, and seek to recover damages in respect of allegedly false and misleading statements about our common stock. These legal actions have been consolidated into a single purported class action, Jaffe v. Household International, Inc., et al., No. 02 C 5893 (N.D. Ill., filed August 19, 2002), and a consolidated and amended complaint was filed on March 7, 2003. On December 3, 2004, the court signed the parties' stipulation to certify a class with respect to the claims brought under sec.10 and sec.20 of the Securities Exchange Act of 1934. The parties stipulated that plaintiffs will not seek to certify a class with respect to the claims brought under sec.11 and sec.15 of the Securities Act of 1933 in this action or otherwise. The amended complaint purports to assert claims under the federal securities laws, on behalf of all persons who purchased or otherwise acquired our securities between October 23, 1997 and October 11, 2002, arising out of alleged false and misleading statements in connection with our sales and lending practices, the 2002 state settlement agreement referred to above, the restatement and the HSBC merger. The amended complaint, which also names as defendants Arthur Andersen LLP, Goldman, Sachs & Co., and Merrill Lynch, Pierce, Fenner & Smith, Inc., fails to specify the amount of damages sought. In May 2003, we, and other defendants, filed a motion to dismiss the complaint. On March 19, 2004, the Court granted in part, and denied in part the defendants' motion to dismiss the complaint. The Court dismissed all claims against Merrill Lynch, Pierce, Fenner & Smith, Inc. and Goldman Sachs & Co. The Court also 16 HSBC Finance Corporation -------------------------------------------------------------------------------- dismissed certain claims alleging strict liability for alleged misrepresentation of material facts based on statute of limitations grounds. The claims that remain against some or all of the defendants essentially allege the defendants knowingly made a false statement of a material fact in conjunction with the purchase or sale of securities, that the plaintiffs justifiably relied on such statement, the false statement(s) caused the plaintiffs' damages, and that some or all of the defendants should be liable for those alleged statements. 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. 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 HSBC Finance Corporation, and claims that those directors' due diligence of HSBC Finance Corporation 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, HSBC Finance Corporation common shares lost value. Pursuant to the merger agreement with Beneficial Corporation, we assumed the defense of this litigation. In September of 2003, the defendants filed a motion to dismiss which was granted on June 15, 2004 based upon a lack of personal jurisdiction over the defendants. The plaintiffs 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 foregoing West Virginia Laborer's Pension Trust Fund case, and is brought by the same principal law firm which brought that suit. The defendants' motion to dismiss was granted on February 10, 2005. 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. -------------------------------------------------------------------------------- Omitted. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. -------------------------------------------------------------------------------- All 50 shares of HSBC Finance Corporation's outstanding common stock are owned by HSBC Investments (North America) Inc. Consequently, there is no public market in HSBC Finance Corporation's common stock. 17 HSBC Finance Corporation -------------------------------------------------------------------------------- (This page intentionally left blank) 18 HSBC Finance Corporation -------------------------------------------------------------------------------- ITEM 6. SELECTED FINANCIAL DATA. -------------------------------------------------------------------------------- On March 28, 2003, HSBC Holdings plc ("HSBC") acquired HSBC Finance Corporation (formerly Household International, Inc.). This resulted in a new basis of accounting reflecting the fair market value of our assets and liabilities for the "successor" periods beginning March 29, 2003. Information for all "predecessor" periods prior to the merger is presented using our historical basis of accounting, which impacts comparability to our "successor" periods. To assist in the comparability of our financial results, the "predecessor period" (January 1 to March 28, 2003) has been combined with the "successor period" (March 29 to December 31, 2003) to present "combined" results for the year ended December 31, 2003. MAR. 29 JAN. 1 YEAR ENDED YEAR ENDED THROUGH THROUGH YEAR ENDED DECEMBER 31, DEC. 31, DEC. 31, DEC. 31 MAR. 28, ----------------------------------------- 2004 2003 2003 2003 2002 2001 2000 ------------------------------------------------------------------------------------------------------------------------ (SUCCESSOR) (COMBINED)(SUCCESSOR)(PREDECESSOR)(PREDECESSOR)(PREDECESSOR) (PREDECESSOR) (RESTATED) (RESTATED)(IN MILLIONS) OWNED BASIS STATEMENT OF INCOME DATA Net interest income and other revenues-operating basis(1)............... $12,364 $11,633 $8,849 $2,784 $11,178 $9,606 $7,905 Gain on bulk sale of private label receivables(3)......... 663 - - - - - - Loss on disposition of Thrift assets and deposits............... - - - - 378 - - Provision for credit losses on owned receivables-operating basis(1)............... 4,296 3,967 2,991 976 3,732 2,913 2,117 Total costs and expenses, excluding nonrecurring expense items(1)....... 5,601 4,993 3,811 1,182 4,290 3,875 3,289 HSBC acquisition related costs incurred by HSBC Finance Corporation.... 19 - 198 - - - Settlement charge and related expenses....... - - - - 525 - - Adoption of FFIEC charge- off policies for domestic private label and MasterCard/Visa portfolios(1),(8)...... 190 - - - - - - Income taxes............. 1,000 872 690 182 695 970 868 ------- ------- ------ ------ ------- ------ ------ Net income(1)............ $ 1,940 $ 1,603 $1,357 $ 246 $ 1,558 $1,848 $1,631 ======= ======= ====== ====== ======= ====== ====== YEAR ENDED DECEMBER 31, 2004 2003 2002 2001 2000 --------------------------------------------------------------------------------------------------------------------- (SUCCESSOR) (COMBINED) (PREDECESSOR) (PREDECESSOR) (PREDECESSOR) (RESTATED) OWNED BASIS SELECTED FINANCIAL RATIOS Return on average owned assets(1).......... 1.57% 1.46% 1.62% 2.26% 2.35% Return on average common shareholder's(s') equity(1)................................ 11.0 10.7 17.3 24.1 23.2 Net interest margin........................ 7.33 7.75 7.57 7.85 7.68 Efficiency ratio(1)........................ 41.6 42.8 42.6 38.4 39.6 Consumer net charge-off ratio(1)........... 4.00 4.06 3.81 3.32 3.18 Reserves as a percent of net charge-offs(9)........................... 89.9 105.7 106.5 110.5 109.9 MANAGED BASIS SELECTED FINANCIAL RATIOS(2) Return on average managed assets(1)........ 1.33% 1.19% 1.31% 1.82% 1.85% Net interest margin........................ 7.97 8.60 8.47 8.44 8.05 Efficiency ratio(1)........................ 41.0 35.6 36.0 34.3 34.5 Consumer net charge-off ratio(1)........... 4.61 4.67 4.28 3.73 3.64 Reserves as a percent of net charge-offs(9)........................... 79.6 117.4 113.8 110.7 111.1 19 HSBC Finance Corporation -------------------------------------------------------------------------------- AT DECEMBER 31, 2004 2003 2002 2001 2000 ------------------------------------------------------------------------------------------------------------------------ (SUCCESSOR) (SUCCESSOR) (PREDECESSOR) (RESTATED) (PREDECESSOR) (PREDECESSOR) (DOLLARS ARE IN MILLIONS) OWNED BASIS BALANCE SHEET DATA Total assets....................................... $130,190 $119,052 $ 97,860 $ 88,911 $76,309 Receivables:(3) Domestic: Real estate secured............................ $ 61,946 $ 49,026 $ 44,140 $ 42,474 $33,920 Auto finance................................... 7,490 4,138 2,024 2,369 1,851 MasterCard/Visa................................ 12,371 9,577 7,628 6,967 5,847 Private label.................................. 341 9,732 9,365 9,853 8,672 Personal non-credit card....................... 12,049 9,624 11,685 11,737 9,950 Commercial and other........................... 315 399 461 505 597 -------- -------- -------- -------- ------- Total domestic................................... $ 94,512 $ 82,496 $ 75,303 $ 73,905 $60,837 -------- -------- -------- -------- ------- Foreign: Real estate secured............................ $ 2,874 $ 2,195 $ 1,679 $ 1,383 $ 1,260 Auto finance................................... 54 - - - - MasterCard/Visa................................ 2,264 1,605 1,319 1,174 2,207 Private label.................................. 3,070 2,872 1,974 1,811 1,675 Personal non-credit card....................... 4,079 3,208 2,285 1,600 1,378 Commercial and other........................... 2 2 2 2 2 -------- -------- -------- -------- ------- Total foreign.................................... $ 12,343 $ 9,882 $ 7,259 $ 5,970 $ 6,522 -------- -------- -------- -------- ------- Total owned receivables: Real estate secured............................ $ 64,820 $ 51,221 $ 45,819 $ 43,857 $35,180 Auto finance................................... 7,544 4,138 2,024 2,369 1,851 MasterCard/Visa................................ 14,635 11,182 8,947 8,141 8,054 Private label.................................. 3,411 12,604 11,339 11,664 10,347 Personal non-credit card....................... 16,128 12,832 13,970 13,337 11,328 Commercial and other........................... 317 401 463 507 599 -------- -------- -------- -------- ------- Total owned receivables.......................... $106,855 $ 92,378 $ 82,562 $ 79,875 $67,359 ======== ======== ======== ======== ======= Deposits........................................... $ 47 $ 232 $ 821 $ 6,562 $ 8,677 Commercial paper, bank and other borrowings........ 9,013 9,122 6,128 12,024 10,788 Due to affiliates(4)............................... 13,789 7,589 - - - Long term debt..................................... 85,378 79,632 75,751 57,799 45,728 Preferred stock(5)................................. 1,100 1,100 1,193 456 164 Common shareholder's(s') equity(6)................. 15,841 16,391 9,222 7,843 7,667 -------- -------- -------- -------- ------- OWNED BASIS SELECTED FINANCIAL RATIOS Common and preferred equity to owned assets........ 13.01% 14.69% 10.64% 9.33% 10.26% Consumer two-month-and-over contractual delinquency...................................... 4.07 5.36 5.34 4.43 4.19 Reserves as a percent of receivables............... 3.39 4.11 4.04 3.33 3.14 Reserves as a percent of nonperforming loans....... 103.0 93.7 94.5 92.7 91.1 -------- -------- -------- -------- ------- MANAGED BASIS BALANCE SHEET DATA AND SELECTED FINANCIAL RATIOS(2) Total assets....................................... $144,415 $145,253 $122,794 $109,859 $96,558 Managed receivables:(3) Real estate secured.............................. $ 64,901 $ 51,415 $ 46,275 $ 44,719 $36,638 Auto finance..................................... 10,223 8,813 7,442 6,395 4,563 MasterCard/Visa.................................. 22,218 21,149 18,953 17,395 17,584 Private label.................................... 3,411 17,865 14,917 13,814 11,997 Personal non-credit card......................... 20,010 18,936 19,446 17,993 16,227 Commercial and other............................. 317 401 463 507 599 -------- -------- -------- -------- ------- Total managed receivables.......................... $121,080 $118,579 $107,496 $100,823 $87,608 ======== ======== ======== ======== ======= Tangible shareholder's(s') equity to tangible managed assets ("TETMA")(7)...................... 6.68% 7.03% 9.08% 7.57% 7.13% Tangible shareholder's(s') equity plus owned loss reserves to tangible managed assets ("TETMA + Owned Reserves")(7).............................. 9.45 9.89 11.87 10.03 9.36 Tangible common equity to tangible managed assets(7)........................................ 4.67 5.04 6.83 6.24 6.25 Excluding purchase accounting adjustments: TETMA............................................ 8.34 8.90 8.90 7.57 7.13 TETMA + Owned Reserves........................... 11.12 11.77 11.87 10.03 9.36 Tangible common equity to tangible managed assets......................................... 6.35 6.94 6.83 6.24 6.25 Risk adjusted revenue.............................. 7.30 7.18 7.18 7.64 7.40 Consumer two-month-and-over contractual delinquency...................................... 4.24 5.39 5.24 4.46 4.20 Reserves as a percent of receivables............... 3.73 5.20 4.74 3.78 3.65 Reserves as a percent of nonperforming loans....... 108.4 118.0 112.6 105.0 107.0 -------- -------- -------- -------- ------- 20 HSBC Finance Corporation -------------------------------------------------------------------------------- (1) The following table, which contains non-GAAP financial information is provided for comparison of our operating trends only and should be read in conjunction with our owned basis GAAP financial information. For 2004, the operating trends, percentages and ratios presented below exclude the $121 million decrease in net income relating to the adoption of Federal Financial Institutions Examination Council ("FFIEC") charge-off policies for our domestic private label and MasterCard/Visa receivables and the $423 million (after-tax) gain on the bulk sale of domestic private label receivables to an affiliate, HSBC Bank USA, National Association ("HSBC Bank USA"). For 2003, the operating results, percentages and ratios exclude $167 million (after-tax) of HSBC acquisition related costs and other merger related items and for 2002, exclude the $333 million (after-tax) settlement charge and related expenses and the $240 million (after-tax) loss on disposition of Thrift assets and deposits. See "Basis of Reporting" and "Reconciliations to GAAP Financial Measures" in Management's Discussion and Analysis for additional discussion and quantitative reconciliations to the equivalent GAAP basis financial measure. YEAR ENDED DECEMBER 31, 2004 2003 2002 2001 2000 --------------------------------------------------------------------------------------------------------------------- (SUCCESSOR) (COMBINED) PREDECESSOR) (PREDECESSOR) (PREDECESSOR) (RESTATED) (DOLLARS ARE IN MILLIONS) Operating net income............................ $1,638 $1,770 $2,131 $1,848 $1,631 ====== ====== ====== ====== ====== Return on average owned assets.................. 1.32% 1.61% 2.21% 2.26% 2.35% Return on average common shareholder's(s') equity........................................ 9.2 11.9 23.9 24.1 23.2 Owned basis consumer net charge-off ratio....... 3.84 4.06 3.81 3.32 3.18 Managed basis consumer net charge-off ratio..... 4.44 4.67 4.28 3.73 3.64 Owned basis efficiency ratio.................... 43.4 41.0 36.3 38.4 39.6 Return on average managed assets................ 1.12 1.32 1.80 1.82 1.85 Managed basis efficiency ratio.................. 42.9 34.1 30.8 34.3 34.5 (2) We monitor our operations and evaluate trends on both an owned basis as shown in our financial statements and on a managed basis. Managed basis reporting (a non-GAAP financial measure) assumes that securitized receivables have not been sold and are still on our balance sheet. Managed basis information is intended to supplement, and should not be considered a substitute for, owned basis reporting and should be read in conjunction with reported owned basis results. See "Basis of Reporting" and "Reconciliations to GAAP Financial Measures" for additional discussion and quantitative reconciliations to the equivalent GAAP basis financial measure. (3) In 2004, we sold $.9 billion of higher quality non-conforming real estate secured receivables and sold our domestic private label receivable portfolio of $12.2 billion ($15.6 billion on a managed basis) to HSBC Bank USA. In 2003, we sold $2.8 billion of higher quality non-conforming real estate secured receivables to HSBC Bank USA and acquired owned basis private label portfolios totaling $1.2 billion ($1.6 billion on a managed basis) and MasterCard and Visa portfolios totaling $.9 billion. In 2002, we sold $6.3 billion of real estate secured whole loans from our consumer lending and mortgage services businesses and purchased a $.5 billion private label portfolio. In 2001, we sold approximately $1 billion of MasterCard and Visa receivables as a result of discontinuing our participation in the Goldfish credit card program and purchased a $.7 billion private label portfolio. In 2000, we acquired real estate secured portfolios totaling $3.7 billion. (4) As of December 31, 2004, we had received $35.7 billion in HSBC related funding. As of December 31, 2003, we had received $14.7 billion in HSBC related funding. See Liquidity and Capital Resources for the components of this funding. (5) In conjunction with the acquisition by HSBC, our 7.625%, 7.60%, 7.50% and 8.25% preferred stock was converted into the right to receive cash which totaled approximately $1.1 billion. In consideration of HSBC transferring sufficient funds to make these payments, we issued Series A preferred stock to HSBC on March 28, 2003. Also on March 28, 2003, we called for redemption our $4.30, $4.50 and 5.00% preferred stock. In September 2004, HSBC North America Holdings Inc. ("HNAH") issued a new series of preferred stock to HSBC in exchange for our Series A preferred stock. In October 2004, HSBC Investments (North America) Inc. ("HINO") issued a new series of preferred stock to HNAH in exchange for our Series A preferred stock. (6) Common shareholder's equity at December 31, 2004 and 2003 reflects push-down accounting adjustments resulting from the HSBC merger. (7) TETMA, TETMA + Owned Reserves and tangible common equity to tangible managed assets are non-GAAP financial ratios that are used by HSBC Finance Corporation management or certain rating agencies as a measure 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. (8) In December 2004, we adopted charge-off and account management policies in accordance with the Uniform Retail Credit Classification and Account Management Policy issued by the FFIEC for our domestic private label and MasterCard and Visa portfolios. The adoption of the FFIEC charge-off policies resulted in a reduction to net income of $121 million. See "Credit Quality" in Management's Discussion and Analysis and Note 5, "Sale of Domestic Private Label Receivable Portfolio and Adoption of FFIEC Policies," in the accompanying consolidated financial statements for further discussion of these policy changes. (9) The adoption of FFIEC charge-off policies for our domestic private label and MasterCard and Visa portfolios and subsequent sale of the domestic private label portfolio in December 2004 have negatively impacted these ratios. Reserves as a percentage of net charge-offs excluding domestic private label charge-offs in 2004 and the impact of adopting FFIEC charge-off policies for these portfolios was 109.2 percent on an owned basis and 96.0 percent on a managed basis. 21 HSBC Finance Corporation -------------------------------------------------------------------------------- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. -------------------------------------------------------------------------------- RESTATEMENT -------------------------------------------------------------------------------- HSBC Finance Corporation has restated its consolidated financial statements for the previously reported quarterly periods ended March 31, 2004, June 30, 2004 and September 30, 2004; and the period March 29, 2003 through December 31, 2003. This Form 10-K and the exhibits included herewith include all adjustments relating to the restatement for all such prior periods. Amended Forms 10-Q for the periods ended March 31, 2004, June 30, 2004 and September 30, 2004 that reflect adjustments relating to the restatement will be filed with the Securities and Exchange Commission on or before March 31, 2005. During the fourth quarter of 2004, as part of our preparation for the implementation of International Financial Reporting Standards ("IFRS") by HSBC from January 1, 2005, we undertook a review of our hedging activities to confirm conformity with the accounting requirements of IFRS, which differ in several respects from the hedge accounting requirements under U.S. GAAP as set out in Statement of Financial Accounting Standards No. 133, "Accounting for Derivatives and Hedging Activities ("SFAS 133"). As a result of this review, management determined that there were some deficiencies in the documentation required to support hedge accounting under U.S. GAAP. These documentation deficiencies arose following our acquisition by HSBC. As a consequence of the acquisition, pre-existing hedging relationships, including hedging relationships that had previously qualified under the "shortcut" method of accounting pursuant to SFAS 133, were required to be reestablished. At that time there was some debate in the accounting profession regarding the detailed technical requirements resulting from a business combination. We consulted with our independent accountants, KPMG LLP, in reaching a determination of what was required in order to comply with SFAS 133. Following this, we took the actions we believed were necessary to maintain hedge accounting for all of our historical hedging relationships in our consolidated financial statements for the period ended December 31, 2003 and those consolidated financial statements received an unqualified audit opinion. Management, having determined during the fourth quarter of 2004 that there were certain documentation deficiencies, engaged independent expert consultants to advise on the continuing effectiveness of the identified hedging relationships and again consulted with our independent accountants, KPMG LLP. As a result of this assessment, we concluded that a substantial number of our hedges met the correlation effectiveness requirement of SFAS 133 throughout the period following our acquisition by HSBC. However, we also determined in conjunction with KPMG LLP that, although a substantial number of the impacted hedges satisfied the correlation effectiveness requirement of SFAS 133, there were technical deficiencies in the documentation that could not be corrected retroactively or disregarded notwithstanding the proven effectiveness of the hedging relationships in place and, consequently, that the requirements of SFAS 133 were not met and that hedge accounting was not appropriate during the period these documentation deficiencies existed. We have therefore determined that we should restate all the reported periods since our acquisition by HSBC to eliminate hedge accounting on all hedging relationships outstanding at March 29, 2003 and certain fair value swaps entered into after that date. This was accomplished primarily by reclassifying the mark to market of the changes in fair market value of the affected derivative financial instruments previously classified in either debt or other comprehensive income into current period earnings. The period to period changes in the fair value of these derivative financial instruments have been recognized as either an increase or decrease in our current period earnings through derivative income. As part of the restatement process, we have reclassified all previous hedging results reflected in interest expense associated with the affected derivative financial instruments to derivative income. 22 HSBC Finance Corporation -------------------------------------------------------------------------------- The cumulative restatement is as follows for the periods presented below: RESTATEMENTS TO REPORTED INCOME ---------------------------------------------- % CHANGE PRE-TAX TAX EFFECT AFTER TAX TO REPORTED ------- ---------- --------- ----------- (DOLLARS IN MILLIONS) March 29, 2003 through December 31, 2003............. $(97) $ 35 $(62) (4.4)% Quarter ended March 31, 2004......................... (17) 6 (11) 2.3% Quarter ended June 30, 2004.......................... 59 (21) 38 9.6% Quarter ended September 30, 2004..................... 5 (2) 3 .9% During the period from acquisition through September 30, 2004, we reported net income of $2.6 billion. The cumulative impact of the restatement during this period is to reduce reported net income by $32 million. The loss of hedge accounting also increased net income by $145 million for the quarter ended December 31, 2004. During the period from acquisition through December 31, 2004, we are reporting net income of $3.3 billion. The cumulative impact of the loss of hedge accounting during this period is to increase reported net income by $113 million. The resulting accounting does not reflect the economic reality of our hedging activity and has no impact on the timing or amount of operating cash flows or cash flows under any debt or derivative contract. It does not affect our ability to make required payments on our outstanding debt obligations. Furthermore, the restatement has no impact on our results on a U.K. GAAP basis, which are used in measuring and rewarding performance of employees. Finally, our economic risk management strategies have not required amendment. EXECUTIVE OVERVIEW -------------------------------------------------------------------------------- ORGANIZATION AND BASIS OF REPORTING HSBC Finance Corporation (formerly Household International, Inc.) and subsidiaries is an indirect wholly owned subsidiary of HSBC North America Holdings Inc. ("HNAH") which is a wholly owned subsidiary of HSBC Holdings plc ("HSBC"). HSBC Finance Corporation may also be referred to in Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") as "we", "us", or "our". On September 30, 2004, Household International, Inc. ("Household") commenced the rebranding of the majority of its U.S. and Canadian businesses to the HSBC brand. Businesses previously operating under the Household name are now called HSBC. Our branch-based consumer lending business has retained the HFC and Beneficial brands, accompanied by the HSBC Group's endorsement signature, "Member HSBC Group." The single brand allows HSBC in North America to better align its businesses, providing a stronger platform to service customers and advance growth. The HSBC brand also positions us to expand the products and services offered to our customers. As part of this initiative, we merged with our subsidiary, Household Finance Corporation, and changed our name to HSBC Finance Corporation in December 2004. HSBC Finance Corporation provides middle-market consumers with real estate secured loans, auto finance loans, MasterCard* and Visa* credit card loans, private label credit card loans and personal non-credit card loans in the United States, the United Kingdom, Canada, the Republic of Ireland, the Czech Republic and Hungary. We also initiate tax refund anticipation loans in the United States and offer credit and specialty insurance products in the United States, the United Kingdom and Canada. We generate cash to fund our businesses primarily by collecting receivable balances; issuing commercial paper, medium and long term debt; borrowing from HSBC subsidiaries and customers; securitizing and selling consumer receivables and borrowing under secured financing facilities. We use the cash generated to invest in and support receivable growth, to service our debt obligations and to pay dividends to our parent. * MasterCard is a registered trademark of MasterCard International, Incorporated and Visa is a registered trademark of Visa USA, Inc. 23 HSBC Finance Corporation -------------------------------------------------------------------------------- The acquisition by HSBC on March 28, 2003 resulted in a new basis of accounting reflecting the fair market value of our assets and liabilities for the "successor" periods beginning March 29, 2003. Information for all "predecessor" periods prior to the merger is presented using our historical basis of accounting, which impacts comparability to our "successor" periods beginning March 29, 2003. During 2003, the "predecessor" period contributed $246 million of net income and the "successor" period contributed $1.4 billion of net income. To assist in the comparability of our financial results and to make it easier to discuss and understand our results of operations, Management's Discussion and Analysis combines the "predecessor period" (January 1 to March 28, 2003) with the "successor period" (March 29 to December 31, 2003) to present "combined" results for the year ended December 31, 2003. In addition to owned basis reporting, we also 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. See "Basis of Reporting" for further discussion of the reasons we use this non-GAAP financial measure. PERFORMANCE, DEVELOPMENTS AND TRENDS Our net income was $1.9 billion in 2004, $1.6 billion in 2003 and $1.6 billion in 2002. In measuring our results, management's primary focus is on managed receivable growth and operating net income (a non-GAAP financial measure which excludes certain nonrecurring items). See "Basis of Reporting" for further discussion of operating net income. Operating net income was $1.6 billion in 2004 compared to $1.8 billion in 2003 and $2.1 billion in 2002. Operating net income declined in 2004 primarily due to higher operating expenses and higher provision for credit losses due to receivables growth, partially offset by higher net interest income and higher other revenues. Operating expenses increased due to receivables growth, increases in marketing expenses and higher amortization of intangibles which were established in connection with our acquisition by HSBC. Other revenues increased due to higher derivative income and higher fee and other income, partially offset by lower securitization revenue due to reduced securitization activity. The increase in net interest income was due to higher average receivable balances partially offset by lower yields on our receivables, particularly in real estate secured, auto finance and personal non-credit card receivables, and by higher interest expense. Interest expense was higher in 2004 resulting from a larger balance sheet, partially offset by a lower cost of funds. Amortization of purchase accounting fair value adjustments increased net income by $128 million in 2004 compared to $92 million in 2003. Operating net income declined in 2003 compared to 2002 due to higher operating expenses to support receivable growth; increased legal and compliance costs; higher amortization of intangibles; lower initial securitization activity as a result of the use of alternative funding sources and higher provision for credit losses as a result of higher charge-offs partially offset by higher net interest margin and fee income due to receivable growth, higher derivative income and lower funding costs. Owned receivables increased to $106.9 billion at December 31, 2004, a 16 percent increase from December 31, 2003. Excluding the impact of the sale of our domestic private label portfolio, owned receivables grew 29 percent in 2004 as we experienced growth in all our receivable products with real estate secured receivables being the primary contributor of the growth. Real estate secured receivable levels reflect sales to HSBC Bank USA in 2004 and 2003 and purchases of correspondent receivables directly by HSBC Bank USA of $2.8 billion during 2004, a portion of which we otherwise would have purchased. Lower securitization levels also contributed to the increase in owned receivables in 2004. Our return on average common shareholder's(s') equity ("ROE") was 11.0 percent in 2004, compared to 10.7 percent in 2003 and 17.3 percent in 2002. The decrease in ROE in both 2004 and 2003 reflects higher average equity levels as a result of push-down accounting resulting from our acquisition by HSBC. Our return on average owned assets ("ROA") was 1.57 percent in 2004 compared to 1.46 percent in 2003 and 1.62 percent in 2002. On an operating basis, ROE was 9.2 percent in 2004 compared to 11.9 percent in 2003 and 23.9 percent in 2002, and ROA was 1.32 percent in 2004 compared to 1.60 percent in 2003 and 24 HSBC Finance Corporation -------------------------------------------------------------------------------- 2.21 percent in 2002. The decline in ROA on an operating basis in 2004 reflects lower net interest margin and lower securitization revenue. In 2003, the decline reflects higher operating expenses, higher provisions for credit losses and lower securitization revenue. Our owned net interest margin was 7.33 percent in 2004, compared to 7.75 percent in 2003 and 7.57 percent in 2002. The decrease in 2004 was due to lower yields on our receivables, particularly real estate secured, auto finance and personal non-credit card partially offset by lower funding costs. The increase in 2003 was attributable to lower cost of funds including amortization of purchase accounting fair value adjustments, partially offset by lower yields on our receivables, particularly real estate secured receivables. The lower yields in 2004 and 2003 reflect a change in mix with higher levels of near-prime receivables, competitive pressure on pricing and, in 2004, the run-off of higher yielding real estate secured receivables, including second lien loans, largely due to refinancing activity. Our owned basis efficiency ratio was 41.6 percent in 2004, compared to 42.8 percent in 2003 and 42.6 percent in 2002. Our owned basis efficiency ratio on an operating basis was 43.4 percent in 2004, compared to 41.0 percent in 2003 and 36.3 percent in 2002. In 2004, the increase in the efficiency ratio on an operating basis reflects higher operating expenses including higher intangible amortization, lower securitization revenue and lower overall yields on our receivables, partially offset by higher derivative income. In 2003, higher operating expenses, including higher intangible amortization, and planned higher legal and compliance costs were partially offset by higher net interest margin and higher derivative income. On December 29, 2004, we sold our domestic private label receivable portfolio, including the retained interests associated with securitized private label receivables, to HSBC Bank USA for an aggregate purchase price of $12.4 billion. The domestic private label receivable portfolio sold consisted of receivables with a balance of $12.2 billion ($15.6 billion on a managed basis). We also released credit loss reserves of $505 million associated with this portfolio. The purchase price was determined based upon an independent valuation opinion. We retained the customer relationships and by agreement will sell additional domestic private label receivable originations generated under current and future private label accounts to HSBC Bank USA on a daily basis at fair market value. We will also service the receivables for HSBC Bank USA for a fee under a service agreement that was reviewed by the staff of the Federal Reserve Board. We recorded a pre-tax gain from the sale of the domestic private label receivable portfolio, including retained securitization interests, of $663 million, which is reported as gain on bulk sale of private label receivables in our consolidated statement of income. In future periods, our net interest income, fee income and provision for credit losses for private label receivables will be substantially reduced, while other income will substantially increase as reduced securitization revenue associated with private label receivables will be more than offset by gains from continuing sales of private label receivables and receipt of servicing revenue on the portfolio from HSBC Bank USA. We anticipate that the net effect of these sales could result in a reduction to our 2005 net income by up to 10%. The amount of other income recorded will be dependent upon the volume of new receivables we originate during the year and will be subject to competitive factors as we sign agreements with new merchants and extend agreements with existing merchants. We and HSBC Bank USA will consider potential sales of some of our MasterCard and Visa receivables to HSBC Bank USA in the future based on the continuing evaluation of the capital and liquidity needs at each entity. Upon receipt of regulatory approval for the sale of the domestic private label receivable portfolio, we adopted charge-off and account management policies in accordance with the Uniform Retail Credit Classification and Account Management Policy issued by the Federal Financial Institutions Examination Council for our domestic private label and MasterCard and Visa portfolios ("FFIEC Policies"). The adoption of the FFIEC charge-off policies resulted in a decrease to our net income of $121 million in the fourth quarter of 2004. We do not expect the adoption of FFIEC Policies for these portfolios to have a significant impact on our business model or on our results of operations or cash flows in future periods. See "Credit Quality" in Management's Discussion and Analysis and Note 5, "Sale of Domestic Private Label Receivables and Adoption of FFIEC Policies," to the accompanying consolidated financial statements for further discussion. 25 HSBC Finance Corporation -------------------------------------------------------------------------------- Because HSBC reports results on a U.K. GAAP basis, management also separately monitors earnings excluding goodwill amortization and net income under U.K. GAAP (non-GAAP financial measures). The following table summarizes U.K. GAAP results: YEAR ENDED MARCH 29 THROUGH DECEMBER 31, 2004 DECEMBER 31, 2003 --------------------------------------------------------------------------------------------------- (IN MILLIONS) Earnings excluding goodwill amortization - U.K. GAAP basis..................................................... $3,105 $1,768 Net income - U.K. GAAP basis................................ 2,584 1,387 CREDIT QUALITY Our owned basis two-months-and-over contractual delinquency ratio in 2004 decreased from 5.36 percent to 4.07 percent compared to 2003. The decrease is consistent with the improvements in early delinquency trends we began to experience in the fourth quarter of 2003 as a result of improvements in the economy, better underwriting standards and improved credit quality of originations. Dollars of delinquency in 2004 decreased compared to 2003 due to the adoption of FFIEC charge-off policies for our domestic private label and MasterCard and Visa portfolios and the subsequent bulk sale of the domestic private label receivable portfolio in December 2004, partially offset by higher levels of receivables in 2004. Excluding these factors, dollars of delinquency would have increased only modestly despite significant growth in our owned portfolios as improvements in credit quality were more than offset by growth as securitized levels declined and our interest in the receivables of certain securitization trusts increased. Net charge-offs as a percentage of average consumer receivables for 2004 decreased 6 basis points over 2003 despite being negatively impacted by a charge-off of $158 million related to the adoption of FFIEC Policies in the fourth quarter of 2004 as discussed above. Excluding the charge-off associated with the adoption of FFIEC Policies, net charge-offs as a percentage of average consumer receivables would have decreased 22 basis points in 2004. The lower delinquency levels we have been experiencing as a result of an improving economy as well as the impact of improved collection activities and higher levels of average receivables are having a positive impact on net charge-offs. During 2004, our credit loss reserves decreased as a result of the bulk sale of our domestic private label receivables to HSBC Bank USA. Excluding this sale, owned credit loss reserves would have increased in 2004 reflecting growth in our loan portfolio, including lower securitization levels which result in our interest in the receivables of certain securitization trusts to increase, partially offset by improved credit quality. FUNDING AND CAPITAL During 2004, we were less reliant on third party debt and securitization funding as we used proceeds from the sales of real estate secured and private label receivables to HSBC Bank USA and debt issued to affiliates to assist in the funding of our businesses. Because we are now a subsidiary of HSBC, our credit ratings have improved and our credit spreads relative to Treasuries have tightened compared to those we experienced during the months leading up to the announcement of our acquisition by HSBC. Primarily as a result of these tightened credit spreads, reduced liquidity requirements and lower costs due to shortening the maturity of our liabilities, principally through increased issuance of commercial paper, we recognized cash funding expense savings in excess of approximately $350 million in 2004 and $125 million in 2003 compared to the funding costs we would have incurred using average spreads from the first half of 2002. It is anticipated that these tightened credit spreads and other funding synergies including asset transfers 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. Securitization of consumer receivables has been a source of funding and liquidity for us. Under U.K. GAAP as currently reported by HSBC, our securitizations are treated as secured financings. In order to align our accounting treatment with that of HSBC under U.K. GAAP (and beginning in 2005 International Financial 26 HSBC Finance Corporation -------------------------------------------------------------------------------- Reporting Standards), we began to structure all new collateralized funding transactions as secured financings in the third quarter of 2004. However, because existing public MasterCard and Visa credit card transactions were structured as sales to revolving trusts that require replenishments of receivables to support previously issued securities, receivables will continue to be sold to these trusts until the revolving periods end, the last of which is expected to occur in early 2008 based on current projections. Private label trusts that publicly issued securities will now be replenished by HSBC Bank USA as a result of the daily sale of new domestic private label credit card originations to HSBC Bank USA. We will continue to replenish at reduced levels, certain non-public personal non-credit card and MasterCard and 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 reduced our reported net income under U.S. GAAP. In 2004, our net interest-only strip receivables, excluding both the mark-to-market adjustment recorded in accumulated other comprehensive income and the private label portion purchased by HSBC Bank USA, decreased $466 million. There was no impact, however, on cash received from operations or on U.K. GAAP reported results. Tangible shareholder's(s') equity to tangible managed assets ("TETMA") was 6.68 percent at December 31, 2004 and 7.03 percent at December 31, 2003. TETMA + Owned Reserves was 9.45 percent at December 31, 2004 and 9.89 percent at December 31, 2003. Tangible common equity to tangible managed assets was 4.67 percent at December 31, 2004 and 5.04 percent at December 31, 2003. Capital levels at December 31, 2004 reflect common stock dividends of $2.6 billion paid to our parent in 2004. These ratios represent non-GAAP financial ratios that are used by HSBC Finance Corporation management or certain rating agencies to evaluate capital adequacy and may be different from similarly named measures presented by other companies. See "Reconciliations to GAAP Financial Measures" for additional discussion and quantitative reconciliation to the equivalent GAAP basis financial measure. FUTURE PROSPECTS Our continued success and prospects for growth are dependent upon access to the global capital markets. Numerous factors, both internal and external, may impact our access to, and the costs associated with, these markets. These factors may include our debt ratings, overall economic conditions, overall capital markets volatility and the effectiveness of our management of credit risks inherent in our customer base. Our acquisition by HSBC has improved our access to the capital markets. It also has given us the ability to use HSBC's liquidity to partially fund our operations and reduce our overall reliance on the debt markets. Our affiliation with HSBC has also expanded our access to a worldwide pool of potential investors. Our results are also impacted by general economic conditions, primarily unemployment, underemployment and interest rates, which are largely out of our control. Because we generally lend to customers who have limited credit histories, modest incomes and high debt-to-income ratios or who have experienced prior credit problems, our customers are generally more susceptible to economic slowdowns than other consumers. As unemployment and underemployment increase, as they have in recent years, a higher percentage of our customers default on their loans and our charge-offs increase. Changes in interest rates generally affect both the rates that we charge to our customers and the rates that we must pay on our borrowings. In 2004, the interest rates that we paid on our debt increased. We have also experienced reduced pricing to our customers from a larger portion of our portfolio consisting of near prime receivables, and a higher mix of real estate secured receivables. Refinancing activity has also resulted in a higher rate of run-off of higher yielding real estate secured receivables, including second lien loans. Our ability to adjust our pricing on many of our products reduces our exposure to an increase in interest rates. The primary risks and opportunities to achieving our business goals in 2005, which are largely dependent upon economic conditions, could result in changes to loan volume, charge-off and net interest income. 27 HSBC Finance Corporation -------------------------------------------------------------------------------- BASIS OF REPORTING -------------------------------------------------------------------------------- Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP"). Unless noted, the discussion of our financial condition and results of operations included in MD&A are presented on an owned basis of reporting. HSBC Finance Corporation's acquisition by HSBC on March 28, 2003 resulted in a new basis of accounting reflecting the fair value of our assets and liabilities for the "successor" periods beginning March 29, 2003. Information for all "predecessor" periods prior to the merger are presented using our historical basis of accounting, which impacts comparability with the "successor" period beginning March 29, 2003. To assist in the comparability of our financial results and to make it easier to discuss and understand our results of operations, MD&A combines the "predecessor" period (January 1 through March 28, 2003) with the "successor" period (March 29 through December 31, 2003) to present "combined" results for the year ended December 31, 2003. In addition to the GAAP financial results reported in our consolidated financial statements, MD&A includes reference to the following information which is presented on a non-GAAP basis: OPERATING RESULTS, PERCENTAGES AND RATIOS Certain percentages and ratios have been presented on an operating basis and have been calculated using "operating net income," a non-GAAP financial measure. "Operating net income" is net income excluding certain nonrecurring items shown in the following table: 2004 2003 2002 -------------------------------------------------------------------------------------- (IN MILLIONS) Net income.................................................. $1,940 $1,603 $1,558 Gain on bulk sale of private label receivables, after tax... (423) - - Adoption of FFIEC charge-off policies for domestic private label and MasterCard and Visa portfolios, after tax....... 121 - - HSBC acquisition related costs and other merger related items, after tax.......................................... - 167 - Settlement charge and related expenses, after tax........... - - 333 Loss on disposition of Thrift assets and deposits, after tax....................................................... - - 240 ------ ------ ------ Operating net income........................................ $1,638 $1,770 $2,131 ====== ====== ====== We believe that excluding these nonrecurring items helps readers of our financial statements to better understand the results and trends of our underlying business. While we continue to make daily sales of new private label receivable originations to HSBC Bank USA, we consider the initial gain on bulk sale of the receivable portfolio including the retained interests associated with securitized private label receivables as nonrecurring because our results of operations for 2004 also include the net interest income, fee income, credit losses and securitization revenue generated by the portfolio and the related retained securitization interests through the date of sale on December 29, 2004. On an ongoing basis, net interest income, fee income, provision for credit losses and securitization revenue from this portfolio will be substantially reduced while other income will substantially increase as reduced securitization revenue associated with private label receivables will be more than offset by gains from continuing sales of private label receivables and servicing revenue on the portfolio received from HSBC Bank USA. MANAGED BASIS REPORTING We monitor our operations and evaluate trends on a managed basis (a non-GAAP financial measure), which assumes that securitized receivables have not been sold and are still on our balance sheet. We manage and evaluate our operations on a managed basis because the receivables that we 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. 28 HSBC Finance Corporation -------------------------------------------------------------------------------- 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. Additionally, charge-off and delinquency associated with these receivables are included in our managed basis credit quality statistics. Debt analysts, rating agencies and others also evaluate our operations on a managed basis for the reasons discussed above and have historically requested managed basis information from us. We believe that managed basis information enables investors and other interested parties to better understand the performance and quality of our entire loan portfolio and is important to understanding the quality of originations and the related credit risk inherent in our owned and securitized portfolios. As the level of our securitized receivables falls over time, managed basis and owned basis results will eventually converge, and we will only report owned basis results. EQUITY RATIOS Tangible shareholder's equity to tangible managed assets ("TETMA"), tangible shareholder's equity plus owned loss reserves to tangible managed assets ("TETMA + Owned Reserves") and tangible common equity to tangible managed assets are non-GAAP financial measures that are used by HSBC Finance Corporation management and certain rating agencies to evaluate capital adequacy. These ratios may differ from similarly named measures presented by other companies. The most directly comparable GAAP financial measure is common and preferred equity to owned assets. We and certain rating agencies also monitor our equity ratios excluding the impact of purchase accounting adjustments. We do so because we believe that the purchase accounting adjustments represent non-cash transactions which do not affect our business operations, cash flows or ability to meet our debt obligations. Preferred securities issued by certain non-consolidated trusts are considered equity in the TETMA and TETMA + Owned Reserves calculations because of their long-term subordinated nature and the ability to defer dividends. Our Adjustable Conversion-Rate Equity Security Units, adjusted for purchase accounting adjustments, are also considered equity in these calculations because they include investor obligations to purchase HSBC ordinary shares in 2006. U.K. GAAP Because HSBC reports results on a U.K. GAAP basis, our management also separately monitors net income and earnings excluding goodwill amortization under U.K. GAAP (non-GAAP financial measures). The following table reconciles our net income on a U.S. GAAP basis to earnings excluding goodwill amortization and net income on a U.K. GAAP basis: YEAR ENDED MARCH 29 THROUGH DECEMBER 31, 2004 DECEMBER 31, 2003 --------------------------------------------------------------------------------------------------- (RESTATED) (IN MILLIONS) Net income - U.S. GAAP basis................................ $1,940 $1,357 Adjustments, net of tax: Deferred origination expenses.......................... (111) (157) Derivative financial instruments....................... (175) 21 Securitizations........................................ 710 (430) Intangibles............................................ 210 147 Purchase accounting adjustments........................ 400 923 Other.................................................. 131 (93) ------ ------ Earnings excluding goodwill amortization - U.K. GAAP basis..................................................... 3,105 1,768 Goodwill amortization....................................... 521 381 ------ ------ Net income - U.K. GAAP basis................................ 2,584 1,387 ====== ====== 29 HSBC Finance Corporation -------------------------------------------------------------------------------- Differences between U.S. and U.K. GAAP are as follows: LOAN ORIGINATION U.K. GAAP - Fee and commission income is accounted for in the period when receivable, except when it is charged to cover the costs of a continuing service to, or risk borne for, the customer, or is interest in nature. In these cases, it is recognized on an appropriate basis over the relevant period. - Loan origination costs are generally expensed as incurred. As permitted by U.K. GAAP, HSBC applies a restricted definition of the incremental, directly attributable origination expenses that are deferred and subsequently amortized over the life of the loans. U.S. GAAP - Certain loan fee income and direct loan origination costs are amortized to the profit and loss account, on a straight-line basis, over the life of the loan as an adjustment to interest income (Statement of Financial Accounting Standard ("SFAS") 91, "Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases".) Prepayment and delinquency estimates are regularly monitored and fee and cost amortization rates adjusted accordingly. - Credit card annual fees are netted with direct lending costs, deferred, and amortized on a straight-line basis over one year. DERIVATIVES U.K. GAAP - Non-trading derivatives are those which are held for hedging purposes as part of our risk management strategy against cash flows, assets, liabilities, or positions measured on an accruals basis. Non-trading transactions include qualifying hedges and positions that synthetically alter the characteristics of specified financial instruments. - Non-trading derivatives are accounted for on an equivalent basis to the underlying assets, liabilities or net positions. Any profit or loss arising is recognized on the same basis as that arising from the related assets, liabilities or positions. - To qualify as a hedge, a derivative must effectively reduce the price, foreign exchange or interest rate risk of the asset, liability or anticipated transaction to which it is linked and be designated as a hedge at inception of the derivative contract. Accordingly, changes in the market value of the derivative must be highly correlated with changes in the market value of the underlying hedged item at inception of the hedge and over the life of the hedge contract. If these criteria are met, the derivative is accounted for on the same basis as the underlying hedged item. Derivatives used for hedging purposes include swaps, forwards and futures. - Interest rate swaps are also used to alter synthetically the interest rate characteristics of financial instruments. In order to qualify for synthetic alteration, a derivative instrument must be linked to specific individual, or pools of similar, assets or liabilities by the notional principal and interest rate risk of the associated instruments, and must achieve a result that is consistent with defined risk management objectives. If these criteria are met, accrual based accounting is applied, i.e. income or expense is recognized and accrued to the next settlement date in accordance with the contractual terms of the agreement. - Any gain or loss arising on the termination of a qualifying derivative is deferred and amortized to earnings over the original life of the terminated contract. Where the underlying asset, liability or position is sold or terminated, the qualifying derivative is immediately marked-to-market through the profit and loss account. - Derivatives that do not qualify as hedges or synthetic alterations at inception are marked-to-market through the profit and loss account, with gains and losses included within "other income". 30 HSBC Finance Corporation -------------------------------------------------------------------------------- U.S. GAAP - All derivatives must be recognized as either assets or liabilities in the balance sheet and be measured at fair value (SFAS 133, "Accounting for Derivative Instruments and Hedging Activities"). - The accounting for changes in the fair value of a derivative (i.e., gains and losses) depends on the intended use of the derivative and the resulting designation as described below: - For a derivative designated as hedging exposure to changes in the fair value of a recognized asset or liability or a firm commitment, the gain or loss is recognized in earnings in the period of change together with the associated loss or gain on the hedged item attributable to the risk being hedged. Any resulting net gain or loss represents the ineffective portion of the hedge. - For a derivative designated as hedging exposure to variable cash flows of a recognized asset or liability, or of a forecast transaction, the derivative's gain or loss associated with the effective portion of the hedge is initially reported as a component of other comprehensive income and subsequently reclassified into earnings when the forecast transaction affects earnings. The ineffective portion is reported in earnings immediately. - For net investment hedges in which derivatives hedge the foreign currency exposure of a net investment in a foreign operation, the change in fair value of the derivative associated with the effective portion of the hedge is included as a component of other comprehensive income ("OCI"), together with the associated loss or gain on the hedged item. The ineffective portion is reported in earnings immediately. - In order to apply hedge accounting it is necessary to comply with documentation requirements and to demonstrate the effectiveness of the hedge on a retrospective and prospective basis. - For a derivative not designated as a hedging instrument, the gain or loss is recognized in earnings in the period of change in fair value. SECURITIZATIONS U.K. GAAP - Financial Reporting Standard ("FRS") 5, "Reporting the Substance of Transactions," requires that the accounting for securitized receivables is governed by whether the originator has access to the benefits of the securitized assets and exposure to the risks inherent in those benefits and whether the originator has a liability to repay the proceeds of the note issue: - The securitized assets should be derecognized in their entirety and a gain or loss on sale recorded where the originator retains no significant benefits and no significant risks relating to those securitized assets. - The securitized assets and the related finance should be consolidated under a linked presentation where the originator retains significant benefits and significant risks relating to those securitized assets but where the downside exposure is limited to a fixed monetary amount and certain other conditions are met. - The securitized assets and the related finance should be consolidated on a gross basis where the originator retains significant benefits and significant risks relating to those securitized assets and does not meet the conditions required for linked presentation. U.S. GAAP - SFAS 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," requires that receivables that are sold to a special purpose entity and securitized can only be derecognized and a gain or loss on sale recognized if the originator has surrendered control over those securitized assets. - Control has been surrendered over transferred assets if and only if all of the following conditions are met: - The transferred assets have been put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership. 31 HSBC Finance Corporation -------------------------------------------------------------------------------- - Each holder of interests in the transferee (i.e., holder of issued notes) has the right to pledge or exchange their beneficial interests, and no condition constrains this right and provides more than a trivial benefit to the transferor. - The transferor does not maintain effective control over the assets through either an agreement that obligates the transferor to repurchase or to redeem them before their maturity or through the ability to unilaterally cause the holder to return specific assets, other than through a clean-up call. - If these conditions are not met the securitized assets should continue to be consolidated. - Where we retain an interest in the securitized assets, such as a servicing right or the right to residual cash flows from the special purpose entity, we recognize this interest at fair value on sale of the assets. - There are no provisions for linked presentation of securitized assets and the related finance. INTANGIBLE ASSETS U.K. GAAP - An intangible asset is recognized separately from goodwill where it is identifiable and controlled. It is identifiable only if it can be disposed of or settled separately without disposing of the whole business. Control requires legal rights or custody over the item. - An intangible asset purchased as part of a business combination is capitalized at fair value based on its replacement cost, which is normally its estimated market value. U.S. GAAP - An intangible asset is recognized separately from goodwill when it arises from contractual or other legal rights or if it is separable, i.e. it is capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented, or exchanged in combination with a related contract, asset or liability. The effect of this is that certain intangible assets such as trademarks and customer relationships are recognized under U.S. GAAP, although such assets will not be recognized under U.K. GAAP. - Intangible assets are initially recognized at fair value. An intangible asset with a finite useful life is amortized on a straight-line basis over the period for which it contributes to the future cash flows of the entity. An intangible asset with an indefinite useful life is not amortized but is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. PURCHASE ACCOUNTING ADJUSTMENTS - The reconciling "purchase accounting adjustments" predominantly reflect: - the measurement of equity consideration at the date the terms of acquisition are agreed and announced under U.S. GAAP; under U.K. GAAP equity consideration is measured at the date of acquisition; - recognition of deferred tax on all fair value adjustments under U.S. GAAP, and corresponding amortization post-acquisition; - non-recognition of residual interests in securitization vehicles existing at acquisition under U.K. GAAP. Instead, the assets and liabilities of the securitization vehicles are recognized on the U.K. GAAP balance sheet, and credit provisions are established against the loans and advances. This GAAP adjustment existing at acquisition unwinds over the life of the securitization vehicles; and - certain costs which under U.K. GAAP, relate to either post-acquisition management decisions or certain decisions made prior to the acquisition are required to be expensed to the post-acquisition profit and loss account and cannot be capitalized as goodwill, or included within the fair value of the liabilities of the acquired entity. OTHER - Includes adjustments related to suspension of interest accruals on nonperforming loans, capitalized software costs and other items. - Capitalized software costs - U.K. GAAP - HSBC generally expenses costs of software developed for internal use. If it can be shown that conditions for capitalization are met under FRS 10, "Goodwill and intangible assets," or FRS 15, "Tangible fixed assets", the software is capitalized and amortized over its useful life. 32 HSBC Finance Corporation -------------------------------------------------------------------------------- Website design and content development costs are capitalized only to the extent that they lead to the creation of an enduring asset delivering benefits at least as great as the amount capitalized. - U.S. GAAP - The American Institute of Certified Public Accountants' ("AICPA") Statement of Position 98-1, "Accounting for the costs of computer software developed or obtained for internal use," requires that all costs incurred in the preliminary project and post implementation stages of internal software development be expensed. Costs incurred in the application development stage must be capitalized and amortized over their estimated useful life. Website design costs are capitalized and website content development costs are expensed as they are incurred. GOODWILL U.K. GAAP - Goodwill arising on acquisitions of subsidiary undertakings, associates or joint ventures prior to 1998 was charged against reserves in the year of acquisition. - For acquisitions made on or after January 1, 1998, goodwill is included in the balance sheet and amortized over its estimated useful life on a straight-line basis. U.K. GAAP allows goodwill previously eliminated against reserves to be reinstated, but does not require it. In common with many other U.K. companies, HSBC elected not to reinstate such goodwill on the grounds that it would not materially assist the understanding of readers of its accounts who were already familiar with U.K. GAAP. - Goodwill included in the balance sheet is tested for impairment when necessary by comparing the recoverable amount of an entity with the carrying value of its net assets, including attributable goodwill. The recoverable amount of an entity is the higher of its value in use, generally the present value of the expected future cash flows from the entity, and its net realizable value. - At the date of disposal of subsidiaries, associates or joint ventures, any unamortized goodwill or goodwill charged directly against reserves is included in our share of the undertakings' total net assets in the calculation of the gain or loss on disposal. - Where quoted securities are issued as part of the purchase consideration in an acquisition, the fair value of those securities for the purpose of determining the cost of acquisition is the market price at the date of completion. U.S. GAAP - Goodwill acquired up to June 30, 2001 was capitalized and amortized over its useful life but not more than 25 years. The amortization of previously acquired goodwill ceased from December 31, 2001. - SFAS 142, "Goodwill and Other Intangible Assets" requires that goodwill should not be amortized but should be tested for impairment annually at the reporting unit level by applying a fair-value-based test. - The goodwill of a reporting unit should be tested for impairment between annual tests in response to events or changes in circumstance which could result in an impairment. - Where quoted securities are issued as part of the purchase consideration in an acquisition, the fair value of those securities for the purpose of determining the cost of acquisition is the average market price of the securities for a reasonable period before and after the date that the terms of the acquisition are agreed and announced. The European Union ("EU") has determined that all European listed companies will be required to prepare their consolidated financial statements using International Financial Reporting Standards ("IFRS GAAP") by 2005. As a result, HSBC will be required to report their financial results under IFRS GAAP rather than U.K. GAAP beginning January 1, 2005. Therefore, beginning in the first quarter of 2005, we will replace our reconciliation of U.S. GAAP net income to both U.K. GAAP earnings excluding goodwill amortization and U.K. GAAP net income with a reconciliation of our U.S. GAAP net income to IFRS GAAP net income. QUANTITATIVE RECONCILIATIONS OF NON-GAAP FINANCIAL MEASURES TO GAAP FINANCIAL MEASURES For a reconciliation of managed basis net interest income, fee income and provision for credit losses to the comparable owned basis amounts, see "Segment Results - Managed Basis" in this MD&A. For a reconciliation of our 33 HSBC Finance Corporation -------------------------------------------------------------------------------- owned loan portfolio by product to our managed loan portfolio, see Note 7, "Receivables," to the accompanying consolidated financial statements. For additional quantitative reconciliations of non-GAAP financial measures presented herein to the equivalent GAAP basis financial measures, see "Reconciliations to GAAP Financial Measures." CRITICAL ACCOUNTING POLICIES -------------------------------------------------------------------------------- Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. We believe our policies are appropriate and fairly present the financial position of HSBC Finance Corporation. The significant accounting policies used in the preparation of our financial statements are more fully described in Note 2 to the accompanying consolidated financial statements. Certain critical accounting policies, which affect the reported amounts of assets, liabilities, revenues and expenses, are complex and involve significant judgment by our management, including the use of estimates and assumptions. We recognize the different inherent loss characteristics in each of our loan products as well as the impact of operational policies such as customer account management policies and practices and risk management/collection practices. As a result, changes in estimates, assumptions or operational policies could significantly affect our financial position or our results of operations. We base and establish our accounting estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions, customer account management policies and practices, risk management/collection practices, or conditions as discussed below. We believe that of the significant accounting policies used in the preparation of our consolidated financial statements, the items discussed below involve critical accounting estimates and a high degree of judgment and complexity. Our management has discussed the development and selection of these critical accounting policies with the audit committee of our Board of Directors, including the underlying estimates and assumptions, and the audit committee has reviewed our disclosure relating to these accounting policies and practices in this MD&A. CREDIT LOSS RESERVES Because we lend money to others, we are exposed to the risk that borrowers may not repay amounts owed to us when they become contractually due. Consequently, we maintain credit loss reserves at a level that we consider adequate, but not excessive, to cover our estimate of probable losses of principal, interest and fees, including late, overlimit and annual fees, in the existing owned portfolio. Loss reserve estimates are reviewed periodically, and adjustments are reflected through the provision for credit losses in the period when they become known. We believe the accounting estimate relating to the reserve for credit losses is a "critical accounting estimate" for the following reasons: - The provision for credit losses totaled $4.3 billion in 2004, $4.0 billion in 2003 and $3.7 billion in 2002 and changes in the provision can materially affect net income. As a percentage of average owned receivables, the provision was 4.28 percent in 2004 compared to 4.45 percent in 2003 and 4.52 percent in 2002. - Estimates related to the reserve for credit losses require us to consider future delinquency and charge-off trends which are uncertain and require a high degree of judgment. - The reserve for credit losses is influenced by factors outside of our control such as customer payment patterns, economic conditions, bankruptcy trends and laws. Because our loss reserve estimate involves judgment and is influenced by factors outside of our control, it is reasonably possible such estimates could change. Our estimate of probable net credit losses is inherently uncertain because it is highly sensitive to changes in economic conditions which influence growth, portfolio seasoning, bankruptcy trends, delinquency rates and the flow of loans through the various stages of delinquency, or buckets, the realizable value of any collateral and actual loss exposure. Changes in such 34 HSBC Finance Corporation -------------------------------------------------------------------------------- estimates could significantly impact our credit loss reserves and our provision for credit losses. For example, a 10% change in our projection of probable net credit losses on owned receivables could have resulted in a change of approximately $400 million in our credit loss reserve for owned receivables at December 31, 2004. The reserve for credit losses is a critical accounting estimate for all three of our reportable segments. Credit loss reserves are based on a range of estimates and are intended to be adequate but not excessive. We estimate probable losses for owned consumer receivables using a roll rate migration analysis that estimates the likelihood that a loan will progress through the various stages of delinquency, or buckets, and ultimately charge off. This analysis considers delinquency status, loss experience and severity and takes into account whether loans are in bankruptcy, have been restructured or rewritten, or are subject to forbearance, an external debt management plan, hardship, modification, extension or deferment. In addition, our loss reserves on consumer receivables are maintained to reflect our judgment of portfolio risk factors that may not be fully reflected in the statistical roll rate calculation. Risk factors considered in establishing loss reserves on consumer receivables include recent growth, product mix, bankruptcy trends, geographic concentrations, economic conditions, portfolio seasoning, account management policies and practices and current levels of charge-offs and delinquencies. While our credit loss reserves are available to absorb losses in the entire portfolio, we specifically consider the credit quality and other risk factors for each of our products. We recognize the different inherent loss characteristics in each of our products as well as customer account management policies and practices and risk management/collection practices. Charge-off policies are also considered when establishing loss reserve requirements to ensure the appropriate reserves exist for products with longer charge-off periods. We also consider key ratios such as reserves to nonperforming loans and reserves as a percentage of net charge-offs in developing our loss reserve estimate. We periodically re-evaluate our estimate of probable losses for consumer receivables. Changes in our estimate are recognized in our statement of income as provision for credit losses in the period that the estimate is changed. Our credit loss reserves for owned receivables decreased $168 million to $3.6 billion at December 31, 2004 as a direct result of the release of $505 million in December 2004 of credit loss reserves associated with the bulk sale of our domestic private label receivables to HSBC Bank USA. Excluding the bulk sale, credit loss reserves would have increased at December 31, 2004 reflecting growth in our loan portfolio, including lower securitization levels, partially offset by improved asset quality. Our reserves as a percentage of receivables were 3.40 percent at December 31, 2004, 4.11 percent at December 31, 2003 and 4.04 percent at December 31, 2002. Reserves as a percentage of receivables at December 31, 2004 were lower than at December 31, 2003 as a result of improved credit quality and higher levels of real estate secured receivables. Compared to December 31, 2002, our reserves as a percentage of receivables at December 31, 2003 increased as a result of the sale of $2.8 billion of higher quality real estate secured loans to HSBC Bank USA in December 2003. Had this sale not occurred, reserves as a percentage of receivables at December 31, 2003 would have been lower than 2002 as a result of improving credit quality in the latter half of 2003 as delinquency rates stabilized and charge-off levels improved. For more information about our charge-off and customer account management policies and practices, see "Credit Quality - Delinquency and Charge-offs" and "Credit Quality - Customer Account Management Policies and Practices." RECEIVABLES SOLD AND SERVICED WITH LIMITED RECOURSE AND SECURITIZATION REVENUE We have historically used a variety of sources to fund our operations. These sources include the use of collateralized funding transactions which are either structured as securitizations, which receive sale treatment, or as secured financings, which do not receive sale treatment. For securitizations which qualify as sales, the receivables are removed from the balance sheet and a gain on sale and interest-only strip receivable are recognized. Determination of both the gain on sale and the interest-only strip receivable include estimates of future cash flows to be received over the 35 HSBC Finance Corporation -------------------------------------------------------------------------------- lives of the sold receivables. We believe the accounting estimates relating to gains on sale and the value of the interest-only strip receivable are "critical accounting estimates" for the following reasons: - Changes in the estimates of future cash flows used to determine gains on sale and the value of interest-only strip receivables may materially affect net income. - The value of our interest-only strip receivable totaled $323 million at December 31, 2004 and $1,036 million at December 31, 2003. This value may be influenced by factors outside of our control such as customer payment patterns and economic conditions which impact charge-off and delinquency. - Estimates relating to the gain on sale and the value of our interest-only strip receivable require us to forecast cash flows which are uncertain and require a high degree of judgment. The lives of the receivables that we securitize and that qualify as sales, are relatively short. Recording gains on sales for receivables with shorter lives reduces the period of time for which cash flows must be forecasted and, therefore, reduces the potential volatility of these projections. Because our securitization accounting involves judgment and is influenced by factors outside of our control, it is reasonably possible such forecasts and estimates could change. Changes in such estimates or in the level or mix of receivables securitized could significantly impact the gains on sale we record and the value of our interest-only strip receivables. Determination of both the gain on sale and the interest-only strip receivable are critical accounting estimates for all three of our reportable segments. We have not structured any real estate secured receivable securitization transactions to receive sale treatment since 1997. As a result, the real estate secured receivables, which generally have longer lives than our other receivables, and related debt remain on our balance sheet. In the third quarter of 2004, we decided to structure all new collateralized funding transactions as secured financings. However, because existing public MasterCard/Visa transactions were structured as sales to revolving trusts that require replenishments of receivables to support previously issued securities, receivables will continue to be sold to these trusts until the revolving periods end, the last of which is expected to occur in early 2008 based on current projections. Private label trusts that publicly issued securities will now be replenished by HSBC Bank USA as a result of the daily sale of new domestic private label credit card originations to HSBC Bank USA. We will continue to replenish, at reduced levels, certain non-public personal non-credit card and MasterCard and Visa securities issued to conduits and record the resulting replenishment gains for a period of time in order to manage liquidity. See "Off Balance Sheet Arrangements and Secured Financings" for further discussion of our decision to fund all new collateralized funding transactions as secured financings. A gain on sale is recognized for the difference between the carrying value of the receivables securitized and the adjusted sales proceeds. The adjusted sales proceeds include cash received and the present value estimate of future cash flows to be received over the lives of the sold receivables. Future cash flows are based on estimates of prepayments, the impact of interest rate movements on yields of receivables and securities issued, delinquency of receivables sold, servicing fees and estimated probable losses under the recourse provisions based on historical experience and estimates of expected future performance. Gains on sale net of recourse provisions, servicing income and excess spreads relating to securitized receivables are reported as securitization revenue in our consolidated statements of income. Securitizations structured as sales transactions also involve the recording of an interest-only receivable which represents our contractual right to receive interest and other cash flows from the securitization trust. Our interest-only strip receivables are reported at fair value using discounted cash flow estimates as a separate component of receivables, net of our estimate of probable losses under the recourse provisions. Cash flow estimates include estimates of prepayments, the impact of interest rate movements on yields of receivables and securities issued, delinquency of receivables sold, servicing fees and estimated probable losses under the recourse provisions. Unrealized gains and losses are recorded as adjustments to common shareholder's(s') equity in accumulated other comprehensive income, net of income taxes. Our interest-only strip receivables are reviewed for impairment quarterly or earlier if events indicate that the carrying value may not be recovered. Any decline in the value of our interest-only strip receivable which is deemed to be other than temporary is charged against current earnings. 36 HSBC Finance Corporation -------------------------------------------------------------------------------- Assumptions used in estimating gains on sales of receivables are evaluated with each securitization transaction. Assumptions used in valuing interest-only strip receivables are re-evaluated each quarter based on experience and expectations of future performances. During 2004 and 2003, we experienced lower interest rates on both the receivables sold and securities issued. In 2004, we generally experienced lower delinquency and charge-offs on the underlying receivables sold but in 2003 we generally experienced higher delinquency and charge-off on the underlying receivables sold. We also had lower initial securitization of receivables in 2004 and in 2003 as a result of the use of alternative funding sources including HSBC subsidiaries and clients and in 2004, as a result of the decision to structure all new collateralized funding transactions as secured financings as discussed above. These factors impact both the gains recorded and the values of our interest-only strip receivables. Securitization gains will vary each year based on the level and rate of receivables securitized in that particular year. The sensitivity of our interest-only strip receivable to various adverse changes in assumptions and the amount of gain recorded and initial receivables securitized in each period is disclosed in Note 9, "Asset Securitizations," to the accompanying consolidated financial statements. Due to our decision to structure all new collateralized funding as secured financings, securitization transactions should continue to decrease in 2005 while secured financings in 2005 should increase over the 2004 levels. GOODWILL AND INTANGIBLE ASSETS Goodwill and intangible assets with infinite lives are not subject to amortization. Intangible assets with finite lives are amortized over their estimated useful lives. Goodwill and intangible assets are reviewed annually on July 1 for impairment using discounted cash flows, but impairment may be reviewed earlier if circumstances indicate that the carrying amount may not be recoverable. We consider significant and long-term changes in industry and economic conditions to be our primary indicator of potential impairment. We believe the impairment testing of our goodwill and intangibles is a critical accounting estimate due to the level of goodwill ($6.9 billion) and intangible assets ($2.7 billion) recorded at December 31, 2004 and the significant judgment required in the use of discounted cash flow models to determine fair value. Discounted cash flow models include such variables as revenue growth rates, expense trends, interest rates and terminal values. Based on an evaluation of key data and market factors, management's judgment is required to select the specific variables to be incorporated into the models. Additionally, the estimated fair value can be significantly impacted by the cost of capital used to discount future cash flows. The cost of capital percentage is generally derived from an appropriate capital asset pricing model, which itself depends on a number of financial and economic variables which are established on the basis of management's judgment. When management's judgment is that the anticipated cash flows have decreased and/or the cost of capital has increased, the effect will be a lower estimate of fair value. If the fair value is determined to be lower than the carrying value, an impairment charge will be recorded and net income will be negatively impacted. Impairment testing of goodwill requires that the fair value of each reporting unit be compared to its carrying amount. A reporting unit is defined as any distinct, separately identifiable component of an operating segment for which complete, discrete financial information is available that management regularly reviews. For purposes of the annual goodwill impairment test, we assigned our goodwill to our reporting units. At July 1, 2004, the estimated fair value of each reporting unit exceeded its carrying value, resulting in none of our goodwill being impaired. Impairment testing of intangible assets requires that the fair value of the asset be compared to its carrying amount. At July 1, 2004, the estimated fair value of each intangible asset exceeded its carrying value and, as such, none of our intangible assets were impaired. CONTINGENT LIABILITIES Both we and certain of our subsidiaries are parties to various legal proceedings resulting from ordinary business activities relating to our current and/or former operations which affect all three of our reportable segments. Certain of these activities are or purport to be class actions seeking damages in significant amounts. These actions include assertions concerning violations of laws and/or unfair treatment of consumers. 37 HSBC Finance Corporation -------------------------------------------------------------------------------- Due to the uncertainties in litigation and other factors, we cannot be certain that we will ultimately prevail in each instance. Also, as the ultimate resolution of these proceedings is influenced by factors that are outside of our control, it is reasonably possible our estimated liability under these proceedings may change. However, based upon our current knowledge, our defenses to these actions have merit and any adverse decision should not materially affect our consolidated financial condition, results of operations or cash flows. RECEIVABLES REVIEW -------------------------------------------------------------------------------- The following table summarizes owned receivables at December 31, 2004 and increases (decreases) over prior periods: INCREASES (DECREASES) FROM ------------------------------ DECEMBER 31, DECEMBER 31, 2003 2002 DECEMBER 31, ------------- ------------- 2004 $ % $ % ----------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Real estate secured............................. $ 64,820 $13,599 27% $19,001 41% Auto finance.................................... 7,544 3,406 82 5,520 273 MasterCard/Visa................................. 14,635 3,453 31 5,688 64 Private label................................... 3,411 (9,193) (73) (7,928) (70) Personal non-credit card........................ 16,128 3,296 26 2,158 15 Commercial and other............................ 317 (84) (21) (146) (32) -------- ------- --- ------- --- Total owned receivables......................... $106,855 $14,477 16% $24,293 29% ======== ======= === ======= === REAL ESTATE SECURED RECEIVABLES Driven by growth in our correspondent and branch businesses, real estate secured receivables increased over the year-ago period. Real estate secured receivable levels reflect sales to HSBC Bank USA of $.9 billion on March 31, 2004 and $2.8 billion on December 31, 2003, as well as HSBC Bank USA's purchase of receivables directly from correspondents totaling $2.8 billion in 2004, a portion of which we otherwise would have purchased. Growth in real estate secured receivables was also supplemented by purchases from a single correspondent relationship which totaled $2.6 billion in 2004. Real estate secured receivable levels in our branch-based consumer lending business improved because of higher sales volumes than the prior year as we continue to emphasize real estate secured loans, including a near-prime mortgage product we first introduced in 2003. Also contributing to the increase was $900 million of acquisitions from a portfolio acquisition program. The increases in the real estate secured receivable levels have been partially offset by run-off of higher yielding real estate secured receivables, including second lien loans, largely due to refinance activity. AUTO FINANCE RECEIVABLES Auto finance receivables increased over the year-ago period due to newly originated loans acquired from our dealer network, strategic alliances established during 2003, increased originations from direct mail solicitations, the Internet and lower securitization levels. This growth was partially offset by the continued liquidation of previously acquired portfolios. MASTERCARD AND VISA RECEIVABLES MasterCard and Visa receivables reflect organic growth especially in our subprime and Household Bank prime portfolios as well as strong growth in the U.K. Lower securitization levels also contributed to the increase at December 31, 2004. PRIVATE LABEL RECEIVABLES The significant decrease in private label receivables reflects the sale of $12.2 billion of domestic private label receivables to HSBC Bank USA in December 2004. Prior to the sale of the domestic private label portfolio, private label receivables were higher than the prior year balance by approximately $3.0 billion due to lower securitization levels, a $.5 billion portfolio acquisition and organic growth through existing merchants. 38 HSBC Finance Corporation -------------------------------------------------------------------------------- PERSONAL NON-CREDIT CARD RECEIVABLES Personal non-credit card receivables are comprised of the following: DECEMBER 31, 2004 2003 2002 ----------------------------------------------------------------------------------------- (IN MILLIONS) Domestic personal non-credit card........................... $ 7,881 $ 5,608 $ 6,447 Union Plus personal non-credit card......................... 474 714 1,095 Personal homeowner loans.................................... 3,693 3,302 4,144 Foreign personal non-credit card............................ 4,080 3,208 2,285 ------- ------- ------- Total personal non-credit card.............................. $16,128 $12,832 $13,971 ======= ======= ======= Personal non-credit card receivables increased during 2004 as a result of lower securitization levels and increased marketing. In the second half of 2004, we began to increase the availability of this product as a result of the improving U.S. economy. In 2003, we intentionally decreased the size of this portfolio through tightened underwriting and decreased marketing in our branches. Domestic and foreign personal non-credit card loans (cash loans with no security) are made to customers who may not qualify for either a real estate secured or personal homeowner loan ("PHL"). The average personal non-credit card loan is approximately $6,500 and 60 percent of the personal non-credit card portfolio is closed-end with terms ranging from 12 to 60 months. The Union Plus personal non-credit card loans are part of our affinity relationship with the AFL-CIO and are underwritten similar to other personal non-credit card loans. PHL's typically have terms of 120 to 240 months and are subordinate lien, home equity loans with high (100 percent or more) combined loan-to-value ratios which we underwrite, price and manage like unsecured loans. The average PHL is approximately $19,000. Because recovery upon foreclosure is unlikely after satisfying senior liens and paying the expenses of foreclosure, we do not consider the collateral as a source for repayment in our underwriting. Historically, these loans have performed better from a credit loss perspective than traditional unsecured loans as consumers are more likely to pay secured loans than unsecured loans in times of financial distress. DISTRIBUTION AND SALES We reach our customers through many different distribution channels and our growth strategies vary across product lines. The consumer lending business originates real estate and personal non-credit card products through its retail branch network, direct mail, telemarketing, strategic alliances and Internet applications. The mortgage services business originates real estate secured receivables through brokers and purchases real estate secured receivables primarily through correspondents. Private label receivables are generated through merchant promotions, application displays, Internet applications, direct mail and telemarketing. Auto finance receivables are generated primarily through dealer relationships from which installment contracts are purchased. Additional auto finance receivables are generated through direct lending which includes alliance partner referrals, Internet applications and direct mail. MasterCard and Visa receivables are generated primarily through direct mail, telemarketing, Internet applications, application displays, promotional activity associated with our co-branding and affinity relationships, mass media advertisements and merchant relationships sourced through our retail services business. We also supplement internally-generated receivable growth with portfolio acquisitions. Our acquisition by HSBC has allowed us to enlarge our customer base through cross-selling products to HSBC customers as well as generating new business with various major corporations. The rebranding of the majority of our U.S. and Canadian businesses to the HSBC brand in September 2004 has positively impacted these efforts. A Consumer Finance team has been established to help extend the U.S. business model to emerging markets across the HSBC Group. Based on certain criteria, we offer personal non-credit card customers who meet our current underwriting standards the opportunity to convert their loans into real estate secured loans. This enables our customers to have access to additional credit at lower interest rates. This also reduces our potential loss exposure and improves our portfolio performance as previously unsecured loans become secured. 39 This information is provided by RNS The company news service from the London Stock Exchange

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