Search the web
Welcome, Guest
[Sign Out, My Account]
EDGAR_Online

Quotes & Info
Enter Symbol(s):
e.g. YHOO, ^DJI
Symbol Lookup | Financial Search
HFC-PB > SEC Filings for HFC-PB > Form 10-K on 6-Mar-2006All Recent SEC Filings

Show all filings for HSBC FINANCE CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-K for HSBC FINANCE CORP


6-Mar-2006

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

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".
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, including retail sales contracts, and personal non-credit card loans in the United States, the United Kingdom, Canada, the Republic of Ireland, Slovakia, 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.
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 have historically monitored our operations and evaluated 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 $1.8 billion in 2005, $1.9 billion in 2004 and $1.6 billion in 2003. In measuring our results, management's primary focus is on 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 $1.8 billion in 2005 compared to $1.6 billion in 2004 and $1.8 billion in 2003. Operating net income increased in 2005 primarily due to higher other revenues and higher net interest income, partially offset by a higher provision for credit losses as well as higher costs and expenses. Other revenues on an operating basis increased primarily due to higher fee and other income as well as higher gains on affiliate receivable sales and higher affiliate servicing fees, partially offset by lower derivative income and lower securitization related revenue. The higher gains on affiliate receivable sales and higher affiliate servicing revenue were largely driven by the gains on daily sales of domestic private label receivable originations and fees earned for servicing the domestic private label receivable portfolio sold to HSBC Bank USA, National Association ("HSBC Bank USA") in December 2004. Fee income was higher as a result of higher credit card fees due to higher volume in our MasterCard/ Visa portfolios. Other income was higher

* MasterCard is a registered trademark of MasterCard International, Incorporated and Visa is a registered trademark of Visa USA, Inc.


Table of Contents

HSBC Finance Corporation

primarily due to higher ancillary credit card revenue and higher gains on asset sales, including the partial sale of a real estate investment. The increases were partially offset by lower securitization related revenue due to reduced securitization activity and lower derivative income. The decrease in derivative income was primarily due to an upward shift in the forward yield curve which decreased the value of our pay variable interest rate swaps which do not qualify for hedge accounting under SFAS No. 133 and to the reduction in the portfolio of receive variable interest rate swaps which do not qualify for hedge accounting. The increase in net interest income was due to growth in average receivables and an improvement in the overall yield on the portfolio, partly offset by a higher cost of funds. As discussed in more detail below, the higher provision for credit losses reflects receivable growth, increased credit loss exposure from Hurricane Katrina and higher charge-off due to significantly higher bankruptcy filings as a result of new bankruptcy legislation in the United States, partially offset by otherwise improved credit quality. Costs and expenses increased to support receivables growth as well as due to increases in marketing expenses, partially offset by lower other servicing and administrative expenses. Amortization of purchase accounting fair value adjustments increased net income by $102 million in 2005, which included $1 million relating to Metris, compared to $152 million in 2004.
Operating net income declined in 2004 compared to 2003 primarily due to higher costs and expenses and higher provision for credit losses due to receivables growth, partially offset by higher net interest income and higher other revenues. Costs and 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 related 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 $152 million in 2004 compared to $91 million in 2003.
Our owned net interest margin was 6.73 percent in 2005 compared to 7.33 percent in 2004 and 7.75 percent in 2003. The decrease in 2005 was due to higher funding costs, partially offset by improvements in the overall yield on the portfolio. The higher yields in 2005 are due to increases in our rates on variable rate products which were in line with market movements and various other repricing initiatives. In addition, there was a net increase in yields due to a change in receivables mix in the owned balance sheet. Increased levels of higher yielding MasterCard/ Visa and personal non-credit card receivables were held on the balance sheet due to lower securitization activity, but the effect of this on yields was partially offset by growth in lower yielding real estate secured and auto finance receivables as well as higher levels of near-prime receivables and a significant decline in the level of private label receivables as discussed above. The decrease in net interest margin in 2004 was due to lower overall yields on our receivables, partially offset by lower funding costs. The lower yields in 2004 reflect a change in mix with higher levels of near-prime receivables, competitive pressure on pricing and the run-off of higher yielding real estate secured receivables, including second lien loans, largely due to refinancing activity.
In August 2005, Hurricane Katrina ("Katrina") caused destruction and loss to individuals, businesses and public infrastructure. As of December 31, 2005, we had $1.3 billion, or 1.0 percent ($1.3 billion or 1.0 percent on a managed basis) of consumer receivables outstanding with customers living in the Katrina Federal Emergency Management Agency ("FEMA") designated Individual Assistance disaster areas(1) with approximately $835 million of these receivables secured by real estate. Assessment of the impact of Katrina on the collectibility of these receivables has been complicated by the number of customers that were displaced from their primary residence. Estimates of loss take into account a number of factors, such as:
how the current and long-term financial impact of the disaster on our customers will affect future loan payments;

(1) Customers in the Individual Assistance Counties, as defined by FEMA on the list last updated and published on September 9, 2005.


Table of Contents

HSBC Finance Corporation

the condition and value of any collateral supporting the amounts outstanding; and
the availability of insurance to cover losses on the underlying collateral.

In an effort to assist our customers affected by the disaster, we initiated various programs including extended payment arrangements and interest and fee waivers for up to 90 days or more for certain products depending on customer circumstances. These interest and fee waivers totaled $14 million during 2005. We recorded an incremental provision for credit losses for Katrina of $185 million in 2005, which represents our best estimate of Katrina's impact on our loan portfolio. Because our estimate is influenced by factors outside of our control, there is uncertainty inherent in the estimate, making it reasonably possible that it could change. As additional information becomes available relating to the financial condition of our affected customers, the physical condition of the collateral for loans which are secured by real estate and the resultant impact on customer payment patterns, we will continue to review our estimate of credit loss exposure relating to Katrina and any adjustments will be reported in earnings when they become known. During the fourth quarter of 2005, $11 million of loan accounts outstanding to affected customers was charged-off in accordance with our charge-off policies.
During 2005, we experienced higher bankruptcy filings, in particular during the period leading up to the October 17, 2005 effective date of new bankruptcy legislation in the United States. We had been maintaining credit loss reserves in anticipation of the impact this new legislation would have on net charge-offs. However, the magnitude of the spike in bankruptcies experienced immediately before the new legislation became effective was larger than anticipated which resulted in an additional $100 million credit loss provision being recorded during the third quarter of 2005. Our fourth quarter results include an estimated $125 million in incremental charge-offs of principal, interest and fees and $113 million in provision expense attributable to bankruptcy reform. The incremental charge-offs in the fourth quarter of 2005 are primarily related to our MasterCard/ Visa portfolio where bankrupt accounts charge-off sooner than in our secured and personal non-credit card portfolios in accordance with our charge-off policies for these products. This provision expense included in our fourth quarter results relating to bankruptcies in our secured and personal non-credit card portfolios will not begin to migrate to charge-off until 2006 in accordance with their respective charge-off policies. As expected, the number of bankruptcy filings subsequent to the enactment of this new legislation have decreased dramatically. We believe that a portion of the increase in net charge-offs resulting from the higher bankruptcy filings is an acceleration of net charge-offs that would otherwise have been experienced in future periods.
Owned receivables increased to $139.9 billion at December 31, 2005, a 30.9 percent increase from December 31, 2004. With the exception of our private label portfolio, 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 $1.5 billion and $2.8 billion during 2005 and 2004, a portion of which we otherwise would have purchased. Purchases of real estate secured receivables from our correspondents by HSBC Bank USA were discontinued effective September 1, 2005. Additionally, as discussed in more detail below, our owned receivable balances increased in 2005 by $5.3 billion as a result of our acquisition of Metris Companies, Inc. and decreased by $2.5 billion as a result of the sale of our U.K. credit card business. Lower securitization levels also contributed to the increase in owned receivables in 2005.
We previously reported that as part of ongoing integration efforts with HSBC we have been working with HSBC to determine if management efficiencies could be achieved by transferring all or a portion of our U.K. and other European operations to HSBC Bank plc ("HBEU"), a U.K. based subsidiary of HSBC, and/or one or more unrelated third parties. In December 2005, we sold our U.K. credit card business, including $2.5 billion of receivables ($3.1 billion on a managed basis), the associated cardholder relationships and the related retained interests in securitized credit card receivables to HBEU for an aggregate purchase price of $3.0 billion. The purchase price, which was determined based on a comparative analysis of sales of other credit card portfolios, was paid in a combination of cash and $261 million of preferred stock issued by a subsidiary of HBEU with a rate of one-year Sterling LIBOR, plus 1.30 percent. In addition to the assets referred to above,


Table of Contents

HSBC Finance Corporation

the sale also included the account origination platform, including the marketing and credit employees associated with this function, as well as the lease associated with the credit card call center and the related leaseholds and call center employees to provide customer continuity after the transfer, as well as to allow HBEU direct ownership and control of origination and customer service. We have retained the collection operations related to the credit card operations and have entered into a service level agreement for a period of not less than two years to provide collection services and other support services, including components of the compliance, financial reporting and human resource functions, for the sold credit card operations to HBEU for a fee. Additionally, the management teams of HBEU and our remaining U.K. operations will be jointly involved in decision making involving card marketing to ensure that growth objectives are met for both businesses. Because the sale of this business is between affiliates under common control, the premium received in excess of the book value of the assets transferred of $182 million, including the goodwill assigned to this business, has been recorded as an increase to additional paid in capital and has not been included in earnings. In future periods, the net interest income, fee income and provision for credit losses related to the U.K. credit card business will be reduced, while other income will be increased by the receipt of servicing and support services revenue from HBEU. We do not anticipate that the net effect of this sale will result in a material reduction of our consolidated net income. We continue to evaluate strategic alternatives with respect to our other U.K. and European operations.
Additionally, in a separate transaction in December 2005, we transferred our information technology services employees in the U.K. to a subsidiary of HBEU. Subsequent to the transfer, operating expenses relating to information technology, which have previously been reported as salaries and fringe benefits or other servicing and administrative expenses, are now billed to us by HBEU and reported as support services from HSBC affiliates. During the first quarter of 2006, we anticipate that the information technology equipment in the U.K. will be sold to HBEU for a purchase price equal to the book value of these assets. Our return on average common shareholder's(s') equity ("ROE") was 9.97 percent in 2005 compared to 10.99 percent in 2004, and 10.89 percent in 2003. Our return on average owned assets ("ROA") was 1.27 percent in 2005 compared to 1.57 percent in 2004 and 1.46 percent in 2003. On an operating basis, ROE was 9.97 percent in 2005 compared to 9.21 percent in 2004 and 12.08 percent in 2003, and ROA was 1.27 percent in 2005 compared to 1.32 percent in 2004 and 1.61 percent in 2003. The increase in our operating basis ROE in 2005 reflects higher net income, as discussed above, while average common shareholder's equity remained flat. Operating basis ROA decreased during 2005 and 2004 as average owned assets increase at a faster pace than operating net income primarily due to lower net interest margin, lower securitization revenue and, in 2005, lower derivative income.
Our owned basis efficiency ratio was 43.52 percent in 2005 compared to 41.64 percent in 2004 and 42.77 percent in 2003. Our owned basis efficiency ratio on an operating basis was 43.52 percent in 2005 compared to 43.42 percent in 2004 and 41.01 percent in 2003. These ratios have been significantly impacted by the results of the domestic private label portfolio which was sold in December 2004. Excluding the results of this domestic private label portfolio from both periods, our 2005 efficiency ratio improved 259 basis points as compared to 2004. This improvement is primarily a result of higher net interest income and other revenues due to higher levels of owned receivables as discussed above, partially offset by the increase in total costs and expenses to support receivable growth. In 2004, the deterioration in the efficiency ratio on an operating basis reflects higher operating expenses including higher intangible amortization, lower securitization related revenue and lower overall yields on our receivables, partially offset by higher derivative income. On December 1, 2005, we acquired Metris Companies Inc. ("Metris") for $1.6 billion in cash. In order to support this acquisition, we received a $1.2 billion capital contribution from our parent, HSBC Investments (North America) Inc. ("HINO"). This acquisition will expand our presence in the near-prime credit card market and will strengthen our capabilities to serve the full spectrum of credit card customers This acquisition resulted in an increase in our MasterCard/ Visa credit card receivable portfolio of $5.3 billion. See Note 3, "Acquisitions," to our accompanying consolidated financial statements for additional information on the acquisition of Metris.


Table of Contents

HSBC Finance Corporation

Credit Quality
Our owned basis two-months-and-over contractual delinquency ratio decreased to 3.84 percent at December 31, 2005 from 4.07 percent at December 31, 2004. The decrease is consistent with the improvements in the delinquency trends we experienced beginning in 2004 as a result of portfolio growth including higher levels of real estate secured receivables, improvements in the economy, better underwriting standards and improved credit quality of originations. These decreases were partially offset by higher bankruptcy delinquency in our secured and personal non-credit card receivable portfolios resulting from the spike in bankruptcy filings in the United States discussed above, which will not begin to migrate to charge-off until 2006. In addition, our delinquency ratio was positively impacted by the charge-off in the fourth quarter of 2005 of a significant number of accounts in our domestic MasterCard/ Visa portfolio as a result of the spike in bankruptcy filings in the United States discussed above. Dollars of delinquency at December 31, 2005 increased compared to December 31, 2004 due to higher levels of owned receivables in 2005 resulting from a decline in securitized levels and receivable growth as well as the higher delinquency levels from higher bankruptcy filings in our real estate secured, auto finance and personal non-credit card receivable portfolios discussed above. Net charge-offs as a percentage of average consumer receivables for 2005 decreased 97 basis points from 2004 (or 81 basis points excluding the impact of the adoption of FFIEC charge-off policies in December 2004 for our domestic private label (excluding retail sales contracts at our consumer lending business) and MasterCard/ Visa portfolios) primarily as a result of portfolio growth, the positive impact from the lower delinquency levels we experienced throughout 2005 as a result of a strong economy as well as improved credit quality of originations. This was partially offset by an increase in charge-offs in the fourth quarter of 2005 for our MasterCard/ Visa receivable portfolio resulting from the spike in bankruptcy filings prior to the effective date of new bankruptcy legislation in the United States. While our real estate secured, auto finance and personal non-credit card receivables also experienced a spike in bankruptcy filings prior to the effective date of the new legislation, these accounts have not yet migrated to charge-off in accordance with our charge-off policies for these receivable products. Also contributing to the decrease in 2005 was a shift in mix to higher levels of higher credit quality receivables, particularly real estate secured and auto finance receivables, partially as a result of the sale of our domestic private label receivable portfolio in December 2004 as discuss above.
During 2005, our credit loss reserves increased as a result of higher levels of owned receivables, including lower securitization levels which results in an increase in our interest in the receivables of certain securitization trusts, additional reserves resulting from the Metris acquisition, higher dollars of delinquency driven by growth, increases in bankruptcy filings in both our domestic and foreign operations and higher credit loss exposure resulting from Katrina and changes in the required minimum monthly payment for credit card accounts. These increases were partially offset by the impact of improved credit quality, and a shift in mix to higher levels of secured receivables and the release of credit loss reserves of $104 million from the sale of our U.K. credit card business in December 2005.
Funding and Capital
During 2005, we supplemented unsecured debt issuances with proceeds from the continuing sale of newly originated domestic private label receivables to HSBC Bank USA following the bulk sale of this portfolio in December 2004, debt issued to affiliates, increased levels of secured financings and higher levels of commercial paper compared to December 31, 2004. 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 tightened credit spreads, we recognized cash funding expense savings in excess of approximately $600 million during 2005, $350 million in 2004 and $125 million in 2003 compared to the funding costs we would have incurred using average spreads and funding mix from the first half of 2002. It is anticipated that these tightened credit spreads in combination with the issuance of HSBC Finance Corporation debt and other funding synergies including asset transfers and external fee savings will enable HSBC to realize annual cash


Table of Contents

HSBC Finance Corporation

funding expense savings in excess of $1 billion per year which is anticipated to be achieved in 2006. In 2005, the cash funding expense savings realized by HSBC totaled approximately $865 million.
Securitization of consumer receivables has been a source of funding and liquidity for us. In order to align our accounting treatment with that of HSBC initially under U.K. GAAP and now under International Financial Reporting Standards ("IFRS"), starting in the third quarter of 2004 we began to structure all new collateralized funding transactions as secured financings. 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 currently projected to occur in 2008. Private label trusts that publicly issued securities are now 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 securities issued to conduits and record the resulting replenishment gains for a period of time in order to manage liquidity. Since our securitized receivables have varying lives, it will take time for these receivables to pay-off and the related interest-only strip receivables to be reduced to zero. The termination of sale treatment on new collateralized funding activity reduced our reported net income under U.S. GAAP. There is no impact, however, on cash received from operations. In 2005, our net interest-only strip receivables, excluding the mark-to-market adjustment recorded in accumulated other comprehensive income and the U.K. credit card portion purchased by HBEU, decreased $253 million. 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.
Tangible shareholder's(s') equity to tangible managed assets ("TETMA") was 7.56 percent at December 31, 2005, and 6.27 percent at December 31, 2004. TETMA
+ Owned Reserves was 10.55 percent at December 31, 2005 and 9.04 percent at December 31, 2004. Tangible common equity to tangible managed assets was 6.07 percent at December 31, 2005 and 4.67 percent at December 31, 2004. Beginning in the third quarter of 2005, and with the agreement of applicable rating agencies, we have refined our definition of TETMA and TETMA + Owned Reserves to exclude the Adjustable Conversion-Rate Equity Security Units for all periods subsequent to our acquisition by HSBC as this more accurately reflects the impact of these items on our equity. All periods subsequent to our acquisition by HSBC have been revised to reflect the current period presentation. Our capital levels at December 31, 2005 reflect a capital contribution of $1.2 billion from HINO. Capital levels also reflect common stock dividends of $980 million and $2.6 billion paid to our parent in 2005 and 2004, respectively. Tangible common equity at December 31, 2005 reflects the exchange of our Series A Preferred Stock of $1.1 billion plus accrued and unpaid interest for common equity in December 2005. These ratios represent non-GAAP financial ratios that are used by HSBC Finance Corporation management and certain rating . . .

  Add HFC-PB to Portfolio     Set Alert         Email to a Friend  
Get SEC Filings for Another Symbol: Symbol Lookup
Quotes & Info for HFC-PB - All Recent SEC Filings
Sign Up for a Free Trial to the NEW EDGAR Online Pro
Detailed SEC, Financial, Ownership and Offering Data on over 12,000 U.S. Public Companies.
Actionable and easy-to-use with searching, alerting, downloading and more.
Request a Trial Sign Up Now


Copyright © 2014 Yahoo! Inc. All rights reserved. Privacy Policy - Terms of Service
SEC Filing data and information provided by EDGAR Online, Inc. (1-800-416-6651). All information provided "as is" for informational purposes only, not intended for trading purposes or advice. Neither Yahoo! nor any of independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. By accessing the Yahoo! site, you agree not to redistribute the information found therein.